Flotek Industries Inc (FTK) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Flotek Industries Inc. Third Quarter 2017 Earnings Conference Call. (Operator Instructions) This conference is being recorded.

At this time, I would like to turn the conference over to Matt Marietta, Flotek's Senior Vice President of Corporate Development and Investor Relations. Mr. Marietta, you may begin.

Thank you, and good morning on behalf of the Flotek team. Joining me this morning are John Chisholm, Flotek's Chairman, President and Chief Executive Officer; Rich Walton, our Chief Financial Officer; and Josh Snively, Executive Vice President and our Head of Operations; as well as other members of our leadership team and board.

Our earnings press release was distributed this morning and is available on the Flotek website. In addition, today's call is being webcast and a replay will be available on our website.

Before we begin our formal remarks, I would like to remind everyone participating in this call, listening to the replay or reading a transcript of the following, some of the comments made during this teleconference may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and other applicable statutes reflecting Flotek's views, comments or expectations about future events and their potential impact on performance.

Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations are intended to identify forward-looking statements, but they are not an exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek's filings, including our Form 10-K with the U.S. Securities and Exchange Commission.

With that, it is my pleasure to turn the call over to John for opening remarks, followed by a financial review from Rich and insights into our operations given by Josh, followed by our outlook. We will open for Q&A after the remarks. And with that, John?

Thank you, Matt, and thank you all for joining today's call hosted from our Global Research and Innovation Center headquarters in Houston. I'll begin by giving a summary of our quarterly results, followed by an overview of our business segments and ongoing strategic initiatives aimed at maximizing our ability to generate free cash flow in future periods regardless of the commodity price scenario.

Rich will then review our financial highlights for the quarter and provide additional financial details, followed by Josh, whose role at Flotek was recently expanded to oversee operations for our entire organization. We are pleased Josh has accepted this critical role, and we are confident in his vast experience in chemistry manufacturing, efficiency improvements, as we believe this change will further integrate our organization.

Josh will provide an operational overview on our Energy Chemistry Technologies segment and an update around our citrus end markets and ongoing initiatives at Florida Chemical, our integrated operating subsidiary within our Consumer and Industrial Chemistry Technologies segment. Finally, I'll end with closing remarks and outlook before taking your questions.

Overall, Flotek's third quarter results were below expectations primarily due to challenges we faced related to Hurricane Harvey, but also impacted by client slowdowns in the Rockies region in our ECT segment.

Our CICT segment performed relatively in line with our expectations, while we were able to execute higher-than-expected sales after Hurricane Irma created disruptions in the global citrus marketplace.

The third quarter was disappointing. However, our ability to extract cash from our business highlights the shift we have made from a diversified oilfield equipment provider, which requires higher CapEx, into an asset-light pure-play specialty chemistry technology company.

For continuing operations, which encompasses our Energy Chemistry Technologies or ECT and Consumer and Industrial Chemistry Technology or CICT segments, Flotek's consolidated third quarter revenue was down 6.7% sequentially and up 23.5% year-over-year. Adjusted EBITDA for the company was $3.3 million and we generated free cash flow, net of CapEx, of $6.8 million in the third quarter.

To provide you an update in our Energy Chemistry Technologies segment, total revenues declined 7.1% to $61.2 million compared to the second quarter, and the segment generated adjusted EBITDA of $11.7 million.

Domestic revenues declined 11.5% sequentially in the third quarter. And outside of approximately $5 million, which can be attributed to hurricane-related issues, significant decreases in our Rockies region negatively impacted our results.

Our clients in this region have stepped back completion intensity and, in some cases, moved away from optimized completions as takeaway capacity constraints have limited well flow performance. This is the primary driver for domestic completion nano-Fluids or CnF revenues, declining 16.3% and volumes declining by 18.4% sequentially, outside of the hurricane-related impacts that we have previously disclosed.

This region should benefit from higher commodity prices and increased takeaway capacity in future periods, and we believe these issues are transitory as operators continue to focus on driving better economics through technology over the long run.

Our conventional chemistry revenues, our non-CnF component of ECT, grew 2.5% sequentially. Demand remains strong for our friction reducer product lines and patented pressure reducing fluid, or PrF, as well for our full fluid systems in our Prescriptive Chemistry Management or PCM platform.

The emerging trend of decoupling, which began with the downturn in commodities, has reached less than 10% of completions. And while no blueprint has been established, it is clear that indications are that this trend is very favorable to operators' economics.

It is our view that this trend will grow over time. It will also be influenced by equipment capacity, product pricing and technology. Flotek was a first mover in this trend in chemistry and full fluid system design represented by PCM, and we believe operators will continue to shift to use our leadership as the standard in this ongoing shift.

Internationally, ECT revenues expanded 85.3% from the second quarter or by $2.5 million, primarily driven by higher CnF sales. Canada rebounded from a larger-than-normal seasonal slowdown. And sales were higher sequentially in all regions except Latin America, which was negligible in size as a percentage of international revenue.

Canada remains our most significant geo-market, but outside of Canada's typical seasonality, we expect that international activity will continue to fluctuate on a sequential basis due to the nature of large shipping orders and inventory management, which creates lumpiness as we continue to penetrate new markets.

We believe the opportunity for high-margin growth will evolve, with completion techniques around the globe. However, we are also taking a close look at certain geo reasons, which may not have the same opportunities as others, and rationalizing costs in those areas which should also help our broader G&A reduction initiatives.

We remain as committed as ever to research and innovation, which continues to expand our market opportunities and deepen our client relationships. Our pipeline of client-specific projects at our R&I facility increased by 12.2% quarter-over-quarter; in October, continued the positive trend into the fourth quarter. In addition, our initiatives with IBM, utilizing the Reservoir Cognitive Consultant capabilities, positions Flotek to capitalize on this demand once we've commercialized our offering.

We see operators working towards aligning CapEx and cash flow, which should bring a more stable U.S. shale market and will likely smooth out the large fluctuations we've experienced in the past few years. We believe it is unsustainable for the industry to expand and contract at the pace it has since the commodities cycle turn down. We welcome an era of a narrower spread between cash flows and capital spending of our clients and see the importance of technology differentiating oil and gas producers globally.

Flotek is uniquely positioned in that we do not have any major CapEx, hiring or equipment spending needs as we penetrate new clients and geo regions. Our leadership position in the specialty chemistry and completion chemistry marketplace, coupled with further G&A reductions, are intended to increase our profitability in a more flat spending outlook environment.

Moving to our Consumer and Industrial Chemistry Technologies segment or CICT. Less than 90 days ago, we had anticipated citrus pricing to moderate due to significant increases in forecasted global crops. For example, the Brazil crop alone is expected to grow greater than 50% versus last season's levels. However, Hurricane Irma has impacted the near- to intermediate-term pricing dynamic as Florida suffered substantial losses in its current crop.

Revenues in CICT for the quarter were $18.3 million, a decrease of $1 million in the second quarter. Adjusted EBITDA of $1.9 million was slightly lower for the second quarter due to product mix and declining prices prior to Hurricane Irma.

We are continuing to penetrate new clients and market channels, and believe our margin profile in this segment has potential to improve in coming quarters. We believe we are ideally positioned in the citrus value chain and we'll continue to serve the needs of a growing list of clients.

Moving to the balance sheet. Subsequent to quarter-end, we reduced the balance on our revolver by another 25% or $10.2 million to $30.4 million, after reducing the balance from $48.4 million at year-end 2016 to $42.7 million at the end of the second quarter, or by 11.8%.

We are effectively in a debt-neutral situation as our only current borrowings are backed by current assets, and we will continue to utilize our borrowing to fund working capital demands in our growth. I would like to highlight that we generated $7 million of free cash flow during the quarter after capital expenditures.

Additionally, while it's taken some time to reflect on our financials, I'm pleased with company-wide efforts to reduce G&A and find areas of operational and efficiency improvement. Our efforts are far from over, however, and we believe we can further reduce SG&A levels in the coming quarters.

As stated last quarter, while to some it may seem like changes have not come fast enough, we can say that we are making an impact in our business and we will not sacrifice critical relationships or jeopardize our growth opportunities in this process.

In the third quarter, we repurchased 630,000 shares of stock for $3.7 million and we have $50.7 million of remaining board authorization on our share repurchase program. Additionally, we will continue to assess the M&A marketplace.

I'll turn it over now to our CFO, Rich Walton, to provide a review of our key financial information and provide an update. Rich?

Thank you, John. As we have previously discussed, the assets, liabilities and results of the Drilling Technologies and Production Technologies segments continue to be presented as discontinued operations.

During the third quarter, the company completed the sale of substantially all of the remaining assets of the company's Drilling Technologies segment for $1 million in cash consideration and a note receivable of $1 million due in 1 year.

The company expects to have sold or liquidated all assets and settled liabilities related to these 2 segments by year-end. A customary escrow holdback of $1.9 million should be realized over the next 13 months. The financial statements in the Form 10-Q and going forward should more accurately represent the results of our core businesses, Energy Chemistry Technologies and Consumer and Industrial Technologies (sic) [Consumer and Industrial Chemistry Technologies] as continuing operations.

For the third quarter, we reported total revenue of $79.5 million compared with $64.3 million in the prior year period, an increase of $15.2 million or 23.5%. On a sequential basis, quarterly revenue was down $5.7 million or 6.7%.

Energy Chemistry quarterly revenue was $61.2 million, an increase of $16.1 million or 35.8% over the prior year period. A sequential quarterly decline in revenue of $4.7 million or 7.1% was experienced in the Energy Chemistry. International sales for this segment increased $2.5 million during the third quarter of 2017 compared to the second quarter of 2017.

Consumer and Industrial Chemistry revenue for the third quarter was down $1.1 million or 5.2% sequentially, and down $1.1 million compared to the same period of 2016.

Our third quarter consolidated operating margin was a negative 3.9%. The segment operating margin was 11.2% in the Energy Chemistry Segment and 5.4% in the Consumer and Industrial Chemistry segment.

Corporate general and administrative expense was $10.3 million, flat from the third quarter of 2016 and a reduction of $0.9 million from the second quarter of 2017. Our corporate G&A during the third quarter as a percentage of revenue decreased to 13% from 16% in the third quarter of 2016 and 13.1% in the second quarter of 2017 as we progressed our cost-reduction initiatives.

During the first 9 months of 2017, the company incurred nonrecurring charges of $1 million related to executive retirement and $0.4 million related to the shareholder lawsuit and SEC inquiry. Early in the fourth quarter, the company took significant measures to reduce contract labor and consulting expenses.

Segment selling and administrative expense was $9.3 million, a decrease of $0.5 million from the third quarter of 2016 and a reduction of $0.1 million from the second quarter of 2017. Segment selling and administrative expense as a percentage of revenue decreased to 11.7% from 15.2% in the third quarter of 2016. Noncash compensation was $3 million in the third quarter.

For the quarter, research and development expense was $2.7 million compared to $2.3 million in the same period of 2016. This increase of $0.4 million is attributable to meeting customer demands and for new product development and new chemistries which are expected to expand the company's intellectual property portfolio.

For the third quarter, Flotek reported a net loss from continuing operations of $3.4 million, representing a loss of $0.06 per share on a fully diluted basis. This compares to a net loss from continuing operations of $1.9 million for the third quarter of the prior year.

For the first 9 months of 2017, Flotek reported a net loss from continuing operations of $5.3 million, representing a loss of $0.09 per share on a fully diluted basis. This compares to a net loss from continuing operations of $2 million for the first 9 months of the prior year.

Flotek reported a minor tax expense for the 3 months ended September 30, 2017, compared to an income tax benefit of $0.9 million in the prior year. A reduction of an expected tax benefit of $0.6 million related to stock-based awards that, beginning in 2017, must now be charged against income.

At September 30, 2017, the company had accounts receivable of $56 million, compared to $47.2 million at December 31, 2016. At September 30, 2017, days revenue and accounts receivable was approximately 64.5 days compared to 62.5 days at December 31, 2016.

For the quarter ended September 30, 2017, the provision for doubtful accounts was $0.2 million. At September 30, the allowance for doubtful accounts is $1.1 million or less than 2% of the receivable balance.

At September 30, 2017, inventories totaled $70.7 million compared to $58.3 million at December 31, 2016, an increase of 21%. This increase primarily resulted from higher costs for citrus oil. This inventory historically builds during the first half of the year and is now being used.

The impact was more pronounced this year because of citrus oil cost inflation. While the volume of citrus oil held constant and was the same at December -- at September 30, 2017, and September 30, 2016, the average unit price was up significantly.

During the third quarter, inventory decreased $7.7 million. Our inventory turnover at September 30, 2017, is approximately 3.2x per year. At September 30, 2017, borrowing under our revolving credit facility was $40.6 million and there was undrawn availability of $34.3 million.

Our credit agreement was amended on September 29, 2017. It increased the maximum revolving advance amount by $10 million to $75 million and extended the maturity for 2 years until May 2022. Limits on capital expenditures were increased for 2018 and thereafter, and the amount of permitted repurchases of our common or preferred stock was increased by $10 million.

During the first 9 months, capital expenditures were $6.2 million compared to $10.6 million in the same period of the prior year. Expected capital expenditures for 2017 have been further reduced to a range of $9 million to $11 million, and we expect to be toward the lower end of that range.

During the quarter, the third quarter, the company repurchased 630,000 shares of its common stock for $3.7 million or an average price of $5.85 per share. As of September 30, 2017, the company may make additional share repurchases of up to $10.7 million.

During the third quarter, the company filed a universal shelf registration statement on Form S3 with the Securities and Exchange Commission. The universal shelf was declared effective by the SEC on October 11, 2017. This filing permits the company to sell new securities to the public with a maximum initial offering price of up to $350 million.

As a reminder, our financial statements report the continuing operations of our Energy Chemistry Technologies and Consumer and Industrial Chemistry Technologies segments. The Form 10-Q provides a description and analysis of our discontinued operations, Drilling Technologies and Production Technologies, in the footnotes.

We continue to be focused on monitoring capital expenditures, lowering SG&A costs, protecting our liquidity and growing our core businesses.

And now, I'll turn the call over to Josh to provide an operational performance update of the company.

Thank you, Rich. I'm honored to take on the role of operations for the entire organization and believe, through greater efficiencies, we will maximize our ability to generate cash flow for our shareholders.

Beginning with our CICT segment, we have positioned our inventory to withstand citrus market disruptions that the global citrus industry is experiencing since Hurricane Irma. As we announced last quarter, progress continues to occur in the expansion at Florida Chemical, and the new distillation tower being installed this month enhances our capabilities into new citrus varietal opportunities and will relieve any potential bottlenecks with our citrus isolate production.

We've established new channels to market with our Japan sales office, which contributed to our first Asia end market sale in October. We believe we have a runway of opportunities in our CICT segment and we have laid the groundwork to capitalize on our strong position in the global citrus markets.

To provide an overview of the impact from Hurricane Irma on the global citrus industry, we believe crop damage in Florida will lead to tighter supplies. This has already caused prices for citrus oils to increase and is unlikely to alleviate until at least the end of the second quarter of 2018.

This has changed our outlook from last quarter, but it is important to keep in mind that the current Brazilian crop is expected to decline 50% or greater to last season. To put this into context, the growth in Brazil more than offsets the volume of the entire Florida citrus crop. It is for this reason we believe the Irma-associated impacts as temporary, and we have adjusted for this market dynamic.

In taking on leadership of the cross-segment operational activities, we can leverage our manufacturing and G&A efficiencies of the entire Flotek organization. Under my leadership, we will drive out operational inefficiencies and further integrate our 2 segments. This requires a full review in our cost controls, execution, logistics and ability to stay ahead of changes in our clients' demands.

And part of our transition, we have delayered reporting structures in our business that reduces G&A at the corporate and field level, while creating greater visibility throughout our organization. Many of these changes have occurred, but the full impact of these changes are unlikely to be fully realized until early 2018.

We have a number of systems implementations and optimizations that are underway that will further allow us to eliminate cost at a variety of levels. To provide more clarity, in our ECT segment, as John noted, we experienced a step back in our Rockies region. We see this issue occurring in the region as a -- as fairly transitory.

PCM activity has increased in the third quarter, which has broadened our customer base and expanded our direct sales opportunities. However, with this growth, we have experienced some growing pains and cost inefficiencies related to deliveries and building out scale in this offering. As we manage through the ramp up of our PCM activities, it should be noted that our gross margin profile has and may continue to fluctuate as scale is achieved.

With that, I'll turn it back to John to offer concluding remarks.

Thanks, Josh, and before we take questions, I would like to offer an outlook and add some concluding thoughts.

While we acknowledge disappointments in the quarter, we continue to progress the company towards an asset-light pure-play specialty chemistry business model that is positioned to generate free cash flow regardless of the commodity price.

To that note, as of month-end in October, we have a $27.4 million net debt position and current liquidity of $47.5 million, which includes undrawn balances on the company's revolving line of credit. This is as strong as a financial position Flotek has been in since I began leading the organization in 2009.

In ECT, visibility in the fourth quarter is challenged given the anticipated holiday slowdown, commodity swings and client desire to align CapEx with cash flows. However, recent success with new clients opens the door for further penetration of our CnF product portfolio as evidenced by more wells being identified by operators in their public remarks which have utilized our technology. To that extent, we are excited to see well names and programs in the public domain, but we will continue to refrain from speaking about their success.

In our CICT segment, where we have greater client visibility, we anticipate a normal seasonal slowdown. However, we expect the top line to be in the $15 million to $18 million range with flat margins.

On the cost front, we will continue to drive G&A lower. We have undergone an extensive cost reduction program. To outline our strategy, we've reduced our total continuing operations headcount by around 10% from this time last year to current. In addition, we project executive salary and benefits have declined by 15%, and expenses by employee on expense accounts are down more than 30% from a year ago.

We've also eliminated consulting and contract labor positions, which reduces the spending in this category by 40%. In all, our long-term target is to operate at a 20% or below G&A level relative to revenues, which we are targeting in early 2018.

For the fourth quarter, we believe we will recognize an additional $1 million of cash savings for a total of cash SG&A level of $15 million to $16 million for the quarter, which will be mostly recognized at the corporate G&A line. We expect further savings into 2018, which we look forward to update on its ongoing initiatives, will take time to reflect through the financial reporting.

As we move forward, our business is more efficient, our costs are structurally lower and we see opportunities arising to continue our long-term outperformance of growth relative to benchmarks.

Finally, I would like to thank our shareholders, employees, clients and stakeholders for their support of Flotek. And to all veterans, we thank you for your service and honor you on this upcoming Veterans Day weekend. With that operator, we'll now open the call to questions.

(Operator Instructions) Our first question comes from the line of George Venturatos with Johnson Rice.

John, I just wanted to start on the ECT segment. In relation to your top 1 or 2 customers, and certainly we saw in the Q some continued follow-through there. But can you maybe just provide us what you can in terms of discussions there with your key customers, as that's been a point of emphasis in recent quarters with investors? And then, secondly, within the ECT segment, just kind of wanted to get an updated market share status as it relates to -- obviously, you guys called out the Rockies, but Permian and Eagle Ford, and just get a sense if your penetration targets have changed at all given at least the trend we've seen in the last quarter or so.

Sure. So our retention rate quarter-over-quarter is as high as it's ever been throughout the year. In fact, we increased the number of unique clients by a little bit over 10% third quarter over second quarter. The -- as I've said consistently on these calls, the -- this is -- when you have transformational technology and you're not going to have as much as folks would like to have a predictable, steady growth, it just doesn't happen that way. I think that kind of bears out with other transformational technologies over the last decade or so in this industry. So from time to time, there'll be a leveling off, and in some cases, it may even decrease as the market continues to work its way through and we continue to penetrate. Another statistic is that our amount of revenue directly to clients in the quarter was 66%. Two years ago at this time, it was essentially 10%. And so that trend, we believe, is very encouraging as it gives us the direct contact with the clients that expose them directly to our technical capability. We've -- and again, folks that have followed the story of the way we reported, we've made a decision in terms of not talking specifically about clients, although I think folks have seen over the last 4 -- maybe in the last 4 or 5 weeks, certain clients have talked about their frustration of not having the amount of frac [fluids] available that they wanted to have, certain clients have talked about an overall 20% lack of efficiency in the completion process, and certainly that was in effect for us. But we've just taken the approach that we're not going to specifically talk about well performance unless that client does it themselves. Regarding the top 2, we don't see any benefit in expanding on communication there because we have certain confidentiality agreements with those folks, and we honor that and we hope everybody respects that with the question that you provided there. And I hope that kind of extra granularity in terms of the retention, the increase in clients, the increase in business that's flowing directly through to the client gives you greater context.

No, that makes sense, John. I appreciate at least the data points on what you can provide us here on the call. On the margin side, just wanted to hit on this as well. And obviously, we saw EBITDA margins in the ECT segment were lower than we were looking for, right, and certainly kind of a tough quarter, down 500 basis points. Can you maybe break out -- and you did a little bit. But the factors -- obviously, mix shift likely there, citrus pricing. But just kind of want to get a sense of what we can see in terms of a potential recovery in the margins from where we are and looking at those particular aspects that can improve. And I know that Josh mentioned kind of mid-2018 to kind of see that, really, reversal in citrus pricing with the Brazil crop coming on.

Right. So I think the kind of gem to take out of that question is that the CnF margins are essentially flat. We've held up those margins. We've made a real focus on that. We've made a real focus on maintaining the pricing model on that. The PCM margins are in a state of flux. Josh talked about that a little bit. And I'll give you kind of a business approach in answering that in that when -- in the fall of 2016, when we really started this and the industry really started to gain momentum on decoupling and disaggregation, self-sourcing, whatever different people want to call it, it's been my view over history that you're given really kind of one chance to make a first impression. Because when you take on the responsibility delivering the chemistry package directly to location, those operators are expecting a seamless performance to what they've been used to. I think there's a tendency to overstaff that to ensure that it gets done right. And it's taken us some time to really understand the optimal amount of folks that are needed to be able to provide that service. And that's part of the rationalization of the people that we've undergone in the last quarter that we talked about, and we're still working through. Like when now products are returned to us because they're not all completely pumped, that's a different situation than when we were selling directly to the service companies. And if they didn't use it, they'd save it and use it perhaps on the next well. So the return freight, the return logistics and all that, it's still a work in progress, which from time to time has an effect on the margins. But it's something we've got our hands around. And again, with Josh's position there, the connective of the logistics and the supply chain between CICT and ECT, we're pretty confident that those margins will improve. Does that help?

Yes. Last one for me and then I'll re-queue. But on the SG&A front, look this has been long discussed topic, and certainly pleased to see you guys put that in the release today. And I know you have been putting a lot of efforts in that. Just wanted to confirm -- but just in terms of timing, it sounds like you saw the called out sequential reduction here in the fourth quarter. But as we look to the full efforts that you've done, you think it's going to be largely fully realized in the early part of 2018? Is that the right way to think about it?

Yes. I'd say first quarter, you'll see another kind of step change, maybe a tail in the second quarter. But I think -- yes, we believe your assumption is correct there, George. And we're already, as we've talked about with the free cash flow and all that, seeing early benefits of that initiative. And I think we wanted to call out to the folks that are listening or are going to read the transcript, it goes all the way to really looking at inside the expense accounts in terms of can we be as efficient as possible. So this has been a top to the bottom effort of really looking at how can we make Flotek as efficient as we can to be able to deliver the returns we want.

(Operator Instructions) And gentlemen, we are showing no further questions on the audio lines at this time.

Okay.

Ladies and gentlemen...

Thank you, operator.

This concludes the conference call for today. You're welcome. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you kindly disconnect your lines. Have a good day, everyone.