Earnings Call Transcript - FTK Q4 2021

Operator, Operator

Greetings, and welcome to Flotek Industries’ Fourth Quarter and Full Year 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow management’s prepared remarks. As a reminder, this conference is being recorded. It is now my pleasure to introduce Nick Bigney, Senior Vice President, General Counsel and Chief Compliance Officer for Flotek. Thank you. You may begin.

Nick Bigney, Senior Vice President, General Counsel and Chief Compliance Officer

Thank you, and good morning, everyone. We appreciate your participation with us today. Joining me and participating on the call are John Gibson, Chairman, Chief Executive Officer and President; Michael Borton, Chief Financial Officer; Ryan Ezell, Chief Operating Officer; and James Silas, Interim President of Data Analytics and Senior Vice President of Research and Innovation. On today’s call, we will first provide prepared remarks concerning our business and results for the quarter. Following that, we will answer your questions. We have now released our earnings announcement for our 2021 fourth quarter and full year results, which is available on our website. Additionally, we have uploaded an Investor Presentation to our website. Today’s call is being webcast and a replay will also be available on our website. Please note that any comments we make on today’s call regarding projections or our expectations for future events are forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings releases and the risk factors discussed in our filings with the SEC. Also, please refer to our reconciliations provided in the earnings release, as we may discuss non-GAAP metrics on this call. And with that, I will now turn it over to John.

John Gibson, Chairman, CEO and President

Thank you, Nick, and good morning. I just want to thank you for joining our discussion on the 2021 fourth quarter and full year results. 2021 has been another challenging year for many businesses and individuals; supply chain instability became a household term, and worries about inflation have had an impact on the market. As we hold this call, the conflict between Ukraine and Russia continues. Although 2021 was a difficult year here at Flotek, we used the opportunity to strengthen our company both financially and operationally. We’ve also focused intently on our strategic objectives. Those objectives called us to emphasize flawless execution, profitable growth, and strengthening our financial position. In this call, I will highlight the strategic priorities through the lens of what we accomplished in 2021, all of which may not be evident by strictly reviewing the financials. These accomplishments are what put us on the path to transformative deals like the recently announced ProFrac agreement. We believe that the Flotek of 2022 and beyond will be vastly different than the version coming out of 2021. Instead of focusing on the past, let me share with you the Flotek of the future. Our strategic priorities are built around a core commitment to environmental leadership. In the last few years, the term ESG has gained tremendous traction. Like many topics in popular discourse, trending items often have their moment and then fade away. At Flotek, we believe that improved environmental stewardship is inseparable from long-term sustainable growth in the energy industry. Along with maintaining a social license to operate, companies already deal with increasing pressure around the availability of water, minimizing waste, and maximizing efficiency of operations amidst tighter cost structures. Our products and services, including specialty green chemistry solutions, Verax analyzers, and data analytics help our customers minimize their environmental impact and make timely, efficient operating decisions. For this reason, environmental leadership is a key element of our business strategy today and will be in the future. To achieve our mission to be the collaborative environmental partner of choice for sustainable chemistry technology and digital analytics solutions, we will continue our focus on flawless execution of our vision. Morris Chang said, "without strategy, execution is aimless; without execution, strategy is useless." Our vision created opportunities we now possess. Our execution will establish us as a leader in this field. Flotek will continue to prioritize safety and service quality throughout our organization. I’m extremely proud of the Flotek team for achieving our goal of zero total recordable incidents and zero non-productive time for our customers in 2021, and we will build on this focus in 2022. I will tell you it’s the first time in my career that I have achieved zero TRIR and no non-productive time. It’s an amazing accomplishment. Congratulations to the operations team and all our employees. Our consistent attention to and performance on safety considerations communicates that Flotek is a company that actively manages risk both for ourselves and our partners. Into 2022 and beyond, Flotek will continue to build upon the progress we made in 2021 and reestablish our relationships with indirect channels to market through energy service companies, a critically important segment of the market. In fact, half of our new energy chemistry customers were service companies in 2021. Certainly, our most exciting win on the sustainable revenue goal is our new contract with ProFrac, valued at over $2 billion in revenues over the next decade, which will commence on April 1. If you missed our in-depth discussion regarding our contract with ProFrac, I encourage you to listen to our recorded investor call from March 10. As we build upon this success, we will continue to solidify our partnerships, winning daily, and remaining committed to building trust through reliability and quality of our products and services, impeccable logistics, transparency, and mutual value creation. As we enter 2022, we arrive at a significantly more efficient, streamlined organization, achieved by realigning our entire organization to our vision. We have rebuilt our business development structure and tools to accelerate our revenue growth, and more seamlessly forecast with our supply chain. We have implemented new supply chain management strategies to ensure we have multiple sourcing options, including invasive sourcing, which has lowered our operational and logistics costs. These changes mean we deliver more effectively to our customers while significantly improving our margins. The Flotek of 2022 and beyond is a lean, operationally efficient organization. Looking to the future, we will maintain financial discipline by adhering to cost-saving initiatives that began in 2019. We are effectively managing our SG&A and our costs, which have improved from 2020 by 11% and 23%, respectively. We also entered 2022 with greater transparency in how we report our margins, which you will see reflected in our 10-K when it’s released. As the saying goes, "what gets measured gets managed." Mike Borton will discuss in more detail some changes you will see moving forward. Finally, our future success as an organization comes down to having the right leaders, teams, and structure to drive profitable growth well into the future. We’ve made changes to our cost structure, the way we approach our markets, and we’ve also implemented leadership changes that will help us better respond to uncertainty and support operational excellence at a top-line revenue growth of over 4x for the next three years alone. This underlies the creation of a Chief Operating Officer role. We named Ryan Ezell our COO in early March. I have no doubt that Ryan and the Flotek team will move forward with success. In December, we also named Dr. James Silas as the Interim Head of Data Analytics. James also retains his previous role as Senior Vice President of Research and Innovation. For anyone who has not had the great benefit of knowing James Silas, let me share a bit about him. James joined Flotek eight years ago following 15 years of academic research, investigating the physics and chemistry of surfactants and polymers, personal care products, bioengineering, and the oil industry. Since joining Flotek, James has been critical to our strategy of environmental leadership and developing ESG green scorecards as well as our intellectual property strategy. One significant reason Flotek’s green chemistry stands apart from our competitors is James's leadership. Partners' technical expertise in sales is highly engaged with our customers and possesses an exceptional commercial mind. For these reasons, I appointed him as Interim Head of Data Analytics, as he has already added exceptional value in this role, and I expect him to add more as the year progresses. With that, I’d like to turn the call over to James Silas to give you his perspective on the data analytics sector.

James Silas, Interim President of Data Analytics and Senior Vice President of Research and Innovation

Thank you for the kind words, John, and good morning, everyone. As a segment, we did not achieve our goals in the fourth quarter. I have had the opportunity to work closely with a team since December, and I’m impressed with our customer engagements and the market opportunities that lie ahead of us. Let me mention a couple of points about the Data Analytics segment. First, our core JP3 technology. Our new line of Verax analyzers represents an optimized blend between speed of measurement, versatility of applications, and robust operating conditions. We deliver data every minute that drives operational efficiencies. These critical compositional and physical property measurements enable our customers to manage their product and inventory more effectively by optimizing their blending and separation processes in real-time. Given the enterprise-wide impacts of our solutions, our sales and marketing efforts must align with our customers’ leadership. While our current sales efforts have built powerful use cases, we are expanding our focus beyond siloed, single-level applications to enterprise-wide solutions and partnerships. We will continue to elevate our engagements with C-Suite customers, especially to communicate the value proposition our technology enables in meaningful improvements in ESG performance. Access to critical real-time information supports decisions that reduce carbon footprints, energy consumption, and emissions while automating large-scale processes and minimizing waste and inefficient reprocessing. The versatility of optical analyzers and edge-embedded chemometric modeling means we have a platform capable of delivering next-generation reductions in greenhouse gas emissions. In 2021, we initiated several international pilot programs, currently in various stages of execution. These pilots are on schedule, and we feel confident that they will prove the value proposition established in our North American markets and afford us a defined growth trajectory. In summary, the technology to drive the next generation of ESG performance globally is available here and now. With that, I will turn the call to Ryan to discuss our chemistry technology side.

Ryan Ezell, Chief Operating Officer

Thank you, James. Today, I’ll discuss our chemistry technology segment performance, which includes our energy chemistry technologies, as well as our professional chemistries for industrial and consumer chemistry solutions. At the completion of the fourth quarter, I’m pleased to report that our energy chemistry technology strategy to be the collaborative partner of choice for delivering sustainable, optimized chemistry solutions is being fully executed and gaining momentum. Flotek's differentiated solutions focus on maximizing our customers' value by elevating their ESG performance, lowering operational costs, and delivering improved return on invested capital. We are continuing to see growth with both domestic and international E&P operators, as well as service companies, delivering on our continued commitment to diversify our revenue stack and minimize risk of customer concentration. In the fourth quarter, we observed implementation of our accelerated structural changes, already paying dividends as our costs continue to decrease while our revenue growth outpaced the growth of the domestic hydraulic fracturing fleet market. Additionally, we completed a year with stellar performance in safety, service quality, and customer satisfaction. As a result, I’m pleased to report the following highlights for the fourth quarter. First, revenue for the energy chemistry technologies improved 32% quarter-on-quarter, significantly outpacing the market and indicating continued market share growth. This marks a 26% improvement from Q4 in the prior year. Secondly, revenue generated from domestic accounts grew 34%, while international accounts grew 24% quarter-on-quarter, demonstrating the continued emphasis on improving revenue diversification. Revenue from our Material and Translogistics facility in Raceland, Louisiana, with the world’s top oilfield services providers expanded by more than 53% quarter-on-quarter as it became a key facility for delivering services to minimize the impact of Hurricane Ida, and we continue to make notable progress in rebuilding our indirect channels to market with service companies. We have solidified a partnership with ProFrac to deliver downhole chemistries to its hydraulic fracturing fleets in North America. Should the contract extension be approved by shareholders, we anticipate combined organic-related 2023 revenues to be well in excess of $200 million. Furthermore, the segment has continued its growth into adjacent energy markets with revenue generation in geothermal drilling, cementing operations, and solar panel coatings. In the spirit of minimizing risks, we continue to negotiate with key suppliers to secure future purchase prices and material allocation volumes with our top product lines for 2022 as we focus on accelerated growth and margin expansion. Finally, we’re pleased to announce that Flotek completed the year with zero total recordables and zero hours of non-productive time in the field and manufacturing operations, thus further exemplifying our commitment to execute for our customers and deliver on our value proposition. Going forward, we’re excited about the future and the continued opportunities for our Chemistry Technology segment as we continue to empower our customers with our enhanced chemistry solutions. Now I’ll turn the call over to Mike to discuss our financial results.

Michael Borton, Chief Financial Officer

Thank you, Ryan. As John mentioned earlier, the 10-K now reflects gross margin in the consolidated statement of operations for the first time since 2017. Segment-level sales and marketing costs and corporate G&A are now combined and reported as selling, general and administration on the statement of operations. Cost of goods sold as reported now represents product costs, transportation, and certain other costs required to produce and deliver goods and services. The company made these changes in reporting in an effort to provide greater transparency after considerable review of industry peers and in consultation with our external auditors. Let’s go through the income statement in more detail. During the fourth quarter, consolidated revenue was $12.2 million, up 20% from the $10.2 million in the third quarter, and slightly up from $12.1 million of revenue during the same period last year. Total revenue for the year was down 19% from 2020, but was only impacted by the M&A activity affecting two significant customers and the non-recurring sales of excess terpene. Even with a lower revenue for the year, our losses improved from last year both in the fourth quarter and total year as we managed our business more efficiently across the organization. By segment, chemistry technology, including the impact of excess terpene sales, saw a 23% increase in sequential revenue, or $11.6 million for the fourth quarter. This also represents a 7% increase from the same period in 2020. The Data and Analytics segment witnessed a 27% decrease in sales sequentially from Q3, driven by several product purchases being pushed out into 2022. In the fourth quarter, we made an $8.1 million impairment of goodwill, roughly $0.11 loss per diluted share relates to the Data and Analytics segment. Ultimately, we believe this asset has considerable long-term value. The impairment decision is a non-cash transaction that reflects a slower ramp of cash flows as we continue to move certain customers to a gated-as-a-service model. We ended the year with consolidated gross margin of $3.3 million, a substantial improvement from the loss of $28.7 million in 2020. The primary reasons for differences in gross margin dollars between the periods were driven by the accrual of the ADM reserve in Q4 2020 of $9.4 million and the subsequent reversal of reserve in Q3 2021, which assumed a payment of $1.75 million. Fourth quarter SG&A was $5.8 million, up $1.7 million from Q3 2021. This increase is driven by the elimination of the federal employee retention credit program, data and analytics severance, and the reversal of 2021 planning rules in Q3. We continue to renegotiate annual contracts to drive more improvement in our response run rates. For the year, we reported a loss of $30.5 million or $0.42 loss per diluted share for 2021, a sharp improvement over the loss of $136.5 million, or $2 loss per diluted share last year. The 2020 loss per diluted share included a few significant adjustments: $1.28 in impairment, $0.26 in ADM terpene reserves, and $0.14 in product rationalization, all one-off impacts. Our adjusted EBITDA for the fourth quarter was a loss of $5.7 million, which is an improvement over the third quarter’s loss of $6.3 million and last year’s fourth quarter loss of $6.8 million. In the latter part of 2021, the company also leased out two idle facilities, which improved our EBITDA run rate by roughly $250,000 per quarter. Let’s move on to the balance sheet performance as we focus on preserving our liquidity. At the end of the fourth quarter, we had cash equivalents of $11.6 million versus $20.5 million in the third quarter. Several factors impacted our cash position: operating losses, higher revenue impacting working capital for receivables and inventory, and ADM settlement-related expenditures. The company has $4.8 million of loans outstanding pursuant to the Paycheck Protection Program related to the CARES Act. It can be applied for forgiveness; we expect feedback in the near term. As we look forward to 2022, our goal is to continue leveraging back office cost efficiencies, growing our top line, including organic and ProFrac-related revenue, ensuring the necessary working capital next year for strategies. In February 2022, Flotek closed a $21.2 million pipe as previously announced; we continue to work with Piper Sandler on various additional cash generation avenues including, but not limited to debt and monetization of non-core assets to fund ProFrac-related working capital needs. Both our water and Monaghan facilities should be sold in the next several months, potentially yielding proceeds in excess of $6 million. Before I pass this call back to John, I want to express my gratitude to the accounting and internal teams, and many other employees at Flotek, who have supported the successful remediation of our 2020 material weaknesses. It was hard work, but another example of building a strong governance and monitoring program that will help this company continue to deliver on our commitments. At this point, I will pass the call back to John for his final remarks.

John Gibson, Chairman, CEO and President

Thank you, Mike. Today, Flotek stands as an operationally efficient organization positioned for profitable long-term growth, backed by a team who can execute on our mission of delivering solutions that reduce the environmental impact of energy on air, water, land, and people. I believe there’s plenty of room to be optimistic this year. We’ve seen some prominent names, particularly among energy producers, posting considerable gains already through 2021. While there’s typically a time lag between producer events and the impact on service companies, we believe that much of the momentum among operators will yield gains for us as well. Looking forward to 2022, we believe we can hold the budget flat and that we’re going to see our margins improve. As I mentioned earlier, we recently hosted an investor call and better explained the elements of our ProFrac impact, which gives us $225-plus million in contracted revenue over the next three years, presenting tremendous upside over the next decade. Combined with the organic growth, we anticipate our first month of business profitability in 2022, with uninterrupted profitability thereafter. When I joined the Flotek team in January 2020, I came in with a philosophy of looking forward. I feel confident today that the ProFrac deal has the potential to secure our future and allow us to maintain this forward-looking outlook. Of course, this is contingent on approval at our upcoming Special Shareholder Meeting, so I’d like to take this opportunity to strongly encourage you to vote in favor of the proposals in our proxy at this time. In closing, I want to thank everyone at Flotek. It’s been an endurance contest and we’ve emerged from it in a great and successful position to move forward. I particularly want to thank our customers and shareholders for their continued support. Together, let’s move forward. With that, operator, I’ll turn it back to you for questions.

Operator, Operator

We will now begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. Our first question is from Jeff Robertson of Water Tower Research. Please go ahead.

Jeff Robertson, Analyst

Thank you. Good morning. Ryan, can you talk a little bit about capacity utilization on the energy chemistry business in 2022 and 2023 with the ProFrac contract and then also about penetration with other service company customers for utilization of the amount of capacity they are not taking up?

John Gibson, Chairman, CEO and President

Yeah, absolutely. It’s a great question. When we look at some of the uniqueness around the ProFrac contract, it is a non-exclusive agreement. So it allows us to continue growth in our other areas of the market. When we look at our current manufacturing operations, we are actually running probably less than half at around 15% overall utilization to deliver our field services and chemical blending operations. That was only running an atypical day shift. With the growth from the ProFrac component, we will probably still be sitting at around 52% of our operational capacity even without any capital expenditures. So we definitely have the opportunity to grow without having to spend a lot of money on that support. If we look back two years, as far back as 2017, we actually moved 300 million pounds of chemicals that year. This falls in line with how we will expand with ProFrac, all organic growth. So we have plenty of room to grow before requiring any significant capital expansion. The unique part of our service delivery model now is that we leverage in-basin support; we don’t have to bring all the chemicals through our main manufacturing facilities, as some are basically repackaged materials that we buy. This allows us to source those in basin and deliver directly to the rig side, via rail spurs, for the chemical companies we are working with. So we have a great opportunity to not only fulfill the non-exclusivity components of our agreement and appropriately contract our growth, but also have the capacity to handle this growth in the long-term without needing any significant capital expansion.

Jeff Robertson, Analyst

Ryan, to be clear, the 52% capacity is what will be used for the ProFrac contract, including the supply amendment and what Flotek’s baseline business has been in 2021?

John Gibson, Chairman, CEO and President

That’s correct. That's correct.

Jeff Robertson, Analyst

Okay. Does the ProFrac agreement in the basins that they are operating in enhance potentially Flotek margins with other customers in that basin by giving you more scale?

John Gibson, Chairman, CEO and President

Absolutely. We feel that the more volume we move helps us leverage our operations for margin enhancements. One significant advantage for suppliers is if we can get an accurate forecast of volume from them. In partnering with ProFrac and some of our core organic business, we are receiving much better lead time to forecast material usage, which gives us better leverage with our suppliers to assist in reducing our overall costs and leverage that for margin improvement.

Michael Borton, Chief Financial Officer

Thank you for your question, Jeff. A majority of the working capital for the initial supply agreement is covered by the pipe financing we raised in February. However, we are projecting future needs based on how quickly we ramp up the ProFrac activities and as we monetize non-core assets in the organization.

John Gibson, Chairman, CEO and President

Yes, that is a longer-term issue than short-term.

Operator, Operator

Before we move on to the next questions in the queue, we’ve received an inbound question via e-mail for John from Eric Swergold, Firestorm Capital. Eric asks what the sensitivity of the ProFrac contract is concerning oil prices?

John Gibson, Chairman, CEO and President

I'll answer a bit and then throw it over to Ryan. The great part about this contract is that it provides continuity regardless of oil prices. The contract ensures a minimum of 30 crews, even if they must come down by nearly 33% to reach that threshold. I don’t anticipate any price scenario for commodities that would affect that number of crews, so we effectively maintain a backlog for a company providing a decade of secure revenue in the current price environment. We’re pretty excited about that, and it’s layout as robust revenue to support our planning.

Ryan Ezell, Chief Operating Officer

No, I agree with John. What we’re witnessing in the near-term, particularly in a decade-long contract, showcases a lot of protection in how ProFrac operates. We observe that upper-tier service companies are beginning to have longer-term contracts, so their projects don’t fluctuate in a transactional manner. This gives us increased stability in the near-term regardless of oil price fluctuations.

John Gibson, Chairman, CEO and President

Another thing that excites me is the upcoming call in six to seven weeks to present our Q1 results. We’ve now gone through April, which will mark our first month of ramping up on the ProFrac contract. I look forward to sharing the details of that progress in the Q1 call.

Operator, Operator

The next question is from Mike Heim of Noble Capital Markets. Please go ahead.

Michael Heim, Analyst

Thanks for taking my question. I’m looking to get a better understanding of the nature of sales associated with data analytics. I heard Mike make some comments about projects being pushed out into 2022. I understand that it can be a lumpy business, but we were also writing down the goodwill. Can you share more about the nature of sales, timing issues, and the impact of specific projects or customers in terms of timing?

John Gibson, Chairman, CEO and President

Sure. James is here with me as well. The impairment issue was mainly due to discount rate sensitivities. We evaluated the situation and decided to address it now to avoid revisiting this in future quarters. Currently, we’re focused on our chemistry business that’s poised for significant growth. The data analytics sales cycles can be lengthy, but we’re excited about upcoming use cases and new customer engagements. With that, I’ll pass it to James for additional insights.

James Silas, Interim President of Data Analytics and Senior Vice President of Research and Innovation

Thank you, Mike. As I mentioned earlier, we are aiming to transition from single-use or single-project engagements to advocating for broader technology adoption from the customer side. This involves discussions with stakeholders at various levels and collaborating with other service providers to offer comprehensive solutions.

Operator, Operator

The next question is a follow-up from Jeff Robertson of Water Tower Research. Please go ahead.

Jeff Robertson, Analyst

James, a follow-up on data analytics. I believe you mentioned an international pilot project and a move towards enterprise-type solutions for customers. Can you discuss the hurdles you face in these initiatives and what it would mean for you to sell units across a company’s platform as opposed to one-off sales?

John Gibson, Chairman, CEO and President

Certainly. We are on track with the international pilot programs; however, when dealing with national oil companies, schedules can shift anywhere from 18 to 24 months between initial proposals. We see the value in these programs and are excited to show that value as we move ahead. We look forward to sharing this progress as we develop.

Jeff Robertson, Analyst

Is part of the goal to secure corporate adoption of the JP3 systems rather than just a single manager and a single plant, effectively enabling the corporate to deploy it across a wider asset base?

John Gibson, Chairman, CEO and President

Yes, that’s correct. We aspire to be seen as a platform rather than just a device. We are collaborating with companies in process engineering to integrate our sensors into their systems. We want to raise our offering from just selling sensors to providing a business decision support platform. This transition is exciting, and we look forward to discussing it further in the coming quarters. That’s all the time we have for questions today. Thank you all for joining us. Please revisit the call regarding our ProFrac contract and get out there and vote in favor of this proxy. We are enthusiastic about collaborating with them and look forward to seeing impacts in Q3 and Q4 as we ramp up business operations. Together, we can establish a reliable revenue stream to help produce positive results. Thank you, everyone.

Operator, Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.