adminFlotek Industries, Inc. (NYSE:FTK) Q3 2023 Earnings Conference Call November 8, 2023 10:00 AM ET
Company Participants
Larry Busnardo – Investor Relations
Ryan Ezell – Chief Executive Officer
Bond Clement – Chief Financial Officer
Conference Call Participants
Cory Johnson – Epistrophy Capital
Gerry Sweeney – ROTH Capital Partners
Operator
Good morning, and welcome, Flotek International Third Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded.
I’d like to turn the conference over to Mr. Larry Busnardo, Investor Relations Representative. Please go ahead.
Larry Busnardo
Thank you, and good morning. We appreciate your participation in Flotek’s third quarter earnings conference call. Joining me on the call today are Ryan Ezell, Chief Executive Officer; and Bond Clement, Chief Financial Officer.
On today’s call, we will first provide prepared remarks concerning our business and results for the quarter. Following that, we will open up the call for any questions you have.
We issued our earnings announcement for the third quarter of 2023 yesterday afternoon, which is available on the Investor Relations section of Flotek’s website. We also filed an 8-K with an updated corporate presentation that we will be referencing on today’s call. This will also be posted to our website this morning.
In addition, today’s call is being webcast, and a replay will be available on our website shortly following the conclusion of this call. Please note that the 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. These risks and uncertainties can actually — can cause actual results to differ materially from our current expectations and projections. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. Also, please refer to the reconciliations provided in our earnings press release as non-GAAP financial metrics may be discussed on this call.
With that, I will turn the call over to Ryan Ezell. Ryan?
Ryan Ezell
Thank you, Larry, and good morning. We appreciate everyone’s interest in Flotek and for joining us today as we discuss our third quarter 2023 operational and financial results. I’m extremely pleased with our third quarter results as we continue to demonstrate significant progress in executing our corporate strategy while improving our core business fundamentals, as is highlighted by the first quarter of positive adjusted EBITDA in 5 years.
Our results built upon the strong financial and operational momentum we established this year and reflect a meaningful year-over-year improvement in all of our profitability metrics. Flotek’s complementary and unique business segments carry an undeniable value proposition that maximize our customers’ asset performance. We will continue to leverage our differentiated technologies in both chemistry and data analytics solution platforms to positively impact our customers’ value chain while systematically gaining market share and margin expansion to generate an impactful return on investment for our shareholders.
With that in mind, I’d like to turn to Slide 8 and touch on our third quarter highlights that Bond will discuss in detail in just a moment. During the third quarter, we reported positive adjusted EBITDA and the ninth consecutive quarter of EBITDA improvement. We achieved positive adjusted gross margin for the third consecutive quarter with an associated margin of 22%. In addition, adjusted gross profit through the first 9 months is up nearly $20 million from the same period of 2022.
Transactional chemistry revenues have grown each quarter in 2023 due to our rapidly expanding customer base, and the continued adoption of our Prescriptive Chemistry Management business model, which exhibited 128% sequential growth and applications of our proprietary complex nano-fluids and over 250% growth annually. Our multidisciplinary approach to reservoir-centric technologies has been proven to provide enhanced well productivity while utilizing our chemistry applications on site when all else is being equal.
Our Data Analytics subscription-based revenue was up 81% for the first 9 months 2023 versus the prior year. The segment has seen a 2x increase in the number of subscription-based services, which supports our segment strategy to evolve at a data-as-a-service business model. These subscription-based services have had a 98% annualized retention rate.
Revenues not attributable to ProFrac totaled 38% during the third quarter. This is a 58% increase from the first quarter of this year, with further improvements expected in the fourth quarter. We strengthened our liquidity through the addition of a $10 million ABL that was upsized to $13.8 million in October. We successfully completed our corporate office move, providing annualized $1 million per year of savings. We expanded our global footprint with a new international entity in Abu Dhabi to facilitate market share growth and margin expansion as we strengthen our in-country value-add components while lowering our operational cost base by approximately 30% which would equate to greater than $1 million in annual savings.
Finally, we announced the promotion of three internal team members and one external hire to executive leadership roles. I’d like to congratulate Nathan Snoke, on his promotion to Senior Vice President of Global Business Lines; Shane Wise, on his promotion to Senior Vice President of Operations; Andrea Berry, on her promotion to Vice President of People Operations in addition of Tom Redlinger as Vice President of our high-margin Data Analytics segment. These moves complete the transition of the company’s executive leadership team as we have emerged as an employer of choice amongst chemistry and data services landscape.
Not only does the new team bring vastly more technical and operational experience, but when compared to the overhead cost of the previous teams, it will save the company approximately $0.5 million per year. These impressive results reflect the positive and impactful changes we have achieved within a short period of time.
Most importantly, all of these milestones were achieved with zero recordable and lost time incidents in the field of operations. I’d like to thank all of our employees for their commitment to safety and service quality in achieving these outstanding results. I expect us to continue to build upon this momentum throughout the remainder of the year.
Now looking at the quarter in a bit more granularity. Revenue was slightly down sequentially. This decrease is directly attributable to the overall market slowdown in upstream onshore activity that has been experienced this year. And I’d also like to add an additional color here. The U.S. land rig count is down 19% and total frac fleets are down 12% from the third quarter of 2022. And despite this decline in overall drilling and completion activity, the impact of Flotek has been much less given the execution of our strategy around our differentiated and complementary chemistry and data technologies.
To that end, we have continued to grow our transactional chemistry business revenues every quarter this year, and they were up another 5% in the third quarter, which has clearly mitigated the impact of the broader market slowdown. Furthermore, the chemistry purchase requirements contained in the long-term supply agreement with ProFrac, were designed to mitigate the volatility of the market and provide some insulation to Flotek operations for maintaining economies of scale and stability.
On a more macro level, the demand for oil and gas is expected to expand for the next decade with further requirements needed through 2045. Long-term investments in both short- and long-cycle barrels will be necessary to maintain production and add the required incremental supply.
Consistent with this outlook, we expect continued demand for oilfield service in 2024 and beyond. We believe that the demand for our advanced chemistry and data solutions will continue to increase and will provide new opportunities in other market verticals, such as industrial, geothermal, agricultural, solar and hydrogen.
Now I’ll turn the call over to Bond to provide key financial highlights.
Bond Clement
Thanks, Ryan. It’s great to be with you all this morning. I want to start by echoing what Ryan said in that we’re all extremely pleased by our third quarter results. Our corporate strategy is paying dividends and delivering impressive results as we achieved several important milestones during the quarter.
As shown on Slide 8 of this morning’s deck, we reported a solid quarter of results across the board highlighted by strong growth in all the year-over-year profitability metrics. We reached a significant milestone by reporting positive adjusted EBITDA for the first time since the third quarter of 2018, which also represented the ninth consecutive quarter of improvement. This is an important achievement that reflects the progress we’ve made maximizing Flotek’s revenue stream from our diversified business segments and our continued initiatives to drive cost improvements across the business. Lastly, we strengthened our liquidity with the entry into an ABL in August, which we were able to upsize in October.
Looking at the income statement, Slide 9 shows the growth in total revenues over the last few years, including our latest guidance range for 2023. Third quarter revenues were 4% higher compared to the year ago quarter, but were down 6% compared to the second quarter of this year. As Ryan mentioned, the sequential decrease is attributable to the overall market pullback in upstream drilling and completion activity.
On a positive note, Flotek’s transactional chemistry revenues were up almost 80% from the first quarter of this year. In addition, using the midpoint of our latest revenue guidance, we would achieve annual revenue growth of 41% this year versus 2022, which certainly will be a tremendous achievement given the onshore market dynamics.
As it relates to revenue, I’d like to briefly discuss Flotek’s supply agreement with ProFrac. The agreement contains minimum requirements for annual chemistry purchases by ProFrac. If purchases do not meet the contractual requirements, we are entitled to additional payments at the conclusion of the measurement period, which currently runs from June 1, 2023 through December 31, 2023. Based on recent activities, we do not expect that the chemistry purchase requirements will be met during the measurement period. And accordingly, our third quarter and 9-month 2023 revenues include expected shortfall payments, which positively impacts our profitability.
For more specifics regarding the supply agreement and the modifications and amendments that have been made to date, I encourage you to review the 8-Ks we filed on February 6 of this year and May 18, March 10 and February 4 of last year.
Looking at Slide 10. Third quarter gross profit increased to $9 million compared to a gross loss of $2 million for the comparable period of 2022. Adjusted gross profit, which excludes certain noncash costs, totaled $10 million compared to gross profit of only $250,000 for the comparable quarter. Gross profit margin and a gross — adjusted gross profit margin during the quarter increased to 19% and 22%, respectively. The improvement in third quarter gross profit was driven by the shortfall payments expected under the ProFrac supply agreement, an increase in our transactional chemistry revenue and continued cost reductions to material and freight.
Adjusted gross profit through the first 9 months of 2023 is up $19 million versus the comparable period of 2022. Based on the midpoints of our updated guidance, we now anticipate an approximately $27 million improvement in full year 2023 adjusted gross profit compared to last year.
Moving to Slide 11. Third quarter adjusted EBITDA was a positive $3.3 million. As shown on the chart, this is the ninth consecutive quarter of improvement in this metric. Touching on SG&A, third quarter totaled $6.5 million compared to $9.3 million for the third quarter of last year, a 30% year-over-year decline and improvement was primarily the result of lower employee compensation expense as well as reduced legal and professional fees. In October, we settled the final matter of previously disclosed litigation that began in 2021. The cost of this litigation has been nearly $2 million this year, so the resolution of this matter should be extremely beneficial as we begin to turn our focus to 2024 G&A costs.
Going to the bottom line, we reported net income of $1.3 million in the third quarter compared to a net loss of $19 million in the comparable quarter of 2022. Net loss for the third quarter of last year did include a $4 million non-cash loss associated with the fair value change of our convertible notes.
Touching on the balance sheet, in August, we announced the completion of an asset-based loan, which provided initial credit availability of $10 million. We were able to increase that to $13.8 million in October through the pledging of certain real estate assets. Approximately $5.4 million of borrowings are currently outstanding under the facility, which is subject to an 11% interest rate, and we currently have about $6.4 million of borrowings available under the ABL in addition to the roughly $3 million of cash currently on hand for total liquidity approaching $10 million.
As it relates to our outlook on 4Q, we have updated our full year guidance as follows. As a result of the slowdown that Ryan touched upon earlier in onshore activity, total revenues are now expected to total $185 million to $200 million compared to a previous estimate of $210 million to $230 million. But really more importantly, adjusted gross profit margin has been increased to a range of 12% to 14%, which is up from the previous range of 8% to 10%. So if you take the midpoint of the new guidance, it would imply a 30% improvement in gross profit versus the previous guidance.
That concludes my remarks. I’ll now turn the call back over to Ryan for closing comments.
Ryan Ezell
Thanks, Bond. In summary, Flotek delivered impressive third quarter as we saw virtually every financial metric improve year-over-year and a reporting of positive adjusted EBITDA for the first time in 5 years. We have demonstrated a track record of delivering continuing improvement in our profitability that is not being reflected in our share price. The exploration and production as well as oil field service markets have fundamentally changed. The current market is more consolidated, with focus on returns and free cash flow generation. Customers design value to technology and efficiency and the service industry is rewarded for returns and profitability enhancement.
Flotek is well positioned within this space as a collaborative partner of choice for our customers that are seeing the importance of maximized production and rate of return for their assets moved to the forefront of their operations. This plays right to the strength of our differentiated chemistry and data technologies that target improved recovery and maximize the value of our customers’ hydrocarbons. This value proposition is what differentiates Flotek from its peers.
We believe that there is more work to be done, but we are well positioned to capitalize on the significant opportunity we have before us as we build value for our shareholders. We appreciate the continued support of all our stakeholders, and we hope that you share our excitement regarding the future of Flotek and we look forward to reporting further progress.
Operator, we’re now ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions] First question will be from Cory Johnson, Epistrophy.
Cory Johnson
My question is about the fleet. I have a question on the fleet and what’s happened with deployments? How have you changed the fleet deployment themselves, both in terms of numbers and the way you deploy them to add to gross margin?
Bond Clement
Hi, Cory, you got a lot of feedback behind you. We’re really not able to hear your question. Would you mind repeating that?
Cory Johnson
Yes, I’ll start one more time. Question about the fleet, how you’ve changed the deployment to add to gross margin?
Ryan Ezell
Yes. So if I understand correctly, you’re asking around where the fleets are being deployed and how this has impacted our gross margins. A couple of comments around that. And so when we look at the fleet deployment, one is, is that we’ve actually seen, obviously, the total count itself was down. But really where we’re seeing the big impact is in those gas-rich basins such as the Haynesville and we’ve seen some of these fleets transition to other areas in South Texas or West Texas, et cetera.
And when you look at that change the gross margins for us are impacted in terms of product mix and destination to delivery and how can we change the customers, in other words the white space or changes of pad locations. And what we’ve seen is that we’ve seen a slight impact to overall revenue. But in reality, the products that we’re moving is quite more efficient for us. And our freight costs have gone down as a percentage of revenue, and our material cost as a percentage of revenue are where we work pre the ProFrac contract, which means we’ve seen significant improvement in our overall material cost base. I hope this kind of adds a little bit of color around that question followed that.
Operator
[Operator Instructions] Next question from Gerry Sweeney from ROTH Capital.
Gerry Sweeney
Good morning, Ryan and Bond. I did actually have a similar question on gross margins. I think that Cory just asked. I just want to dig in and understand not just what was driving gross margins, but maybe some of the — what’s going to drive it in the future is that some of the prescription — prescriptive management, but I think you also described a location of where your work is. So I’m not sure if we can add to that. Obviously, I’m a little bit new to the story, but I was just curious if maybe just dig in a touch further.
Ryan Ezell
Yes. So just to build on the commentary to Cory. So when you look at overall operational contribution to gross margin improvement, a lot of that has been driven by our improvement of our logistical networks and automization that we’ve done there as we continue to see freight as a percentage of material costs go down every quarter this year.
The second component that contribute to that is the types of materials that we’re moving in the general operations, our material cost as a percentage of revenue are where we were prior to us ramping up our ProFrac contract. So as we have been predicting on our path to profitability there, we’re starting to see those margins return to the strength that we would want to see.
The other big component that we’re extremely excited about probably has had the most impact for us is that our prescriptive chemistry based sales are continuing to increase every quarter. And we refer to those as the transactional business models and what’s more important there is the proprietary technologies that we see with our complex nano-fluids. Those have grown 151% on quarter and are up over almost 250% year-on-year. And in Q3, they represented almost 40% of the sales in the transactional business component, which if you go back to our best years of profitability back in 2014 and ’15, it was at those percentages of revenue. So we’re continuing to see that evolve, and that’s really helping push our gross margin business.
And when you look at it in terms of why that revenues continue to grow, those are 12- to 18-month sales that we’ve been in place in long-term pursuits on. And as you see, E&P operators look to wanting better performance out of every well drilled. This has become more and more and more important. And that’s why I think we’re in a really good position to continue to improve our gross margin base.
Bond Clement
Hi, Gerry, it’s Bond. I’ll just add a little bit. Just to give you a framework of the dollars Ryan’s talking about. So our transactional, which we define as non-ProFrac chemistry business in Q3 did just over $16 million of revenue. During the first quarter of this year, that was $9.2 million of revenue.
Gerry Sweeney
Got it. That’s helpful. And again, little bit newer. But Ryan, I think you were just talking about a 12- to 18-month sales cycle. Can you — if you’re comfortable with this, maybe just describing what your current sort of backlog or pipeline or how many entities you’re talking with today and maybe even conversion rates or something along those lines if you could or would.
Ryan Ezell
Yes. That’s a great question. I think in terms of the details, provides quite a bit of color, not only the diversification of our revenue stack, but also the strength of pursuits, they are in play right now. If I was to refer back to say, in 2021, our revenue stack was represented by 2 customers that had over 90% of our revenue. If you were to go now on the transaction of our chemistry base, we don’t have a single customer that represents more than 8%. And so we’ve seen a significant diversification, in terms of who we’re getting revenue from and that change over there. And I would say that almost 50% of our revenue that came in Q3 was attributable to new customers, which is fantastic.
And then if I look at our pipeline, that starts through Q4 and roll through the end of next year, we’ve got almost $400 million worth of opportunities identified in our domestic and international business. And so we’re really excited about what some of those opportunities are. And again, as I look at it, if I see, these technologies that we have moved into the forefront for these E&P operators as well as helping and growing our relationship with the pressure pumping companies, we’re in a really good position there.
Operator
[Operator Instructions] This concludes our question-and-answer session. Now I’d like to turn the conference back over to Mr. Larry Busnardo for closing remarks.
Larry Busnardo
Thank you again for joining us today on our call. We know it’s a busy morning with other calls within the industry, so please feel free to reach out to Bond if you have any additional questions. Thanks again, and have a good day.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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