Q1 2023 Flotek Industries Inc Earnings Call
Participants
Harsha V. Agadi; Interim CEO & Director; Flotek Industries, Inc.
J. Bond Clement; CFO & Principal Accounting Officer; Flotek Industries, Inc.
Ryan Gillis Ezell; President; Flotek Industries, Inc.
Unidentified Company Representative
Donald Peter Crist; Research Analyst; Johnson Rice & Company, L.L.C., Research Division
Eric Benjamin Swergold
Presentation
Operator
Greetings everyone, and welcome to Flotek Industries First Quarter 2023 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to turn the call over to [Wes Harris], Investor Relations Representative for Flotek. Thank you. You may begin.
Unidentified Company Representative
Thank you, Jamie and good morning, everyone. We appreciate your participation. Joining me today and participating on the call are Harsha V. Agadi, Interim Chief Executive Officer; Ryan Ezell, President; 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 answer any questions you have. We have released our earnings announcement for the first quarter of 2023, which is available on our website. 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 cause actual results to differ materially from our current expectations. 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 management may discuss non-GAAP metrics on this call.
I will now turn it over to Mr. Agadi.
Harsha V. Agadi
Thank you, Wes and good morning, everyone. We appreciate everyone's interest in joining us today to discuss our first quarter 2023 operational and financial results.
I believe the first quarter of 2023 marks a significant turning point for Flotek. With the unwavering support of our talented and dedicated employees, our new management team has made significant strides in executing our comprehensive plan to continue to capitalize on the many opportunities to drive Flotek to profitability ASAP. This includes rightsizing the company's costs, improving our pricing, enhancing our product mix and diversifying our customer base to drive Flotek to sustainable profitability.
While we still have more work to do to attain profitability, I am extremely proud of what the Flotek team has accomplished in just a few months. While Ryan and Bond will discuss our operational and financial details in their prepared remarks, I first wanted to provide highlights of why I'm confident we're headed in the right direction.
The improvement in first quarter gross margin and adjusted EBITDA materially exceeded our internal expectations for the time period. This included achieving a $3.2 million sequential improvement in adjusted gross profit from the fourth quarter on a nearly identical revenue base. It is clear representation of how our efforts to drive operational efficiencies is taking hold as we further execute on opportunities to leverage our economies of scale in purchasing raw materials, improving efficiency in freight costs and finally, deploying labor just in time to match volumes. We also saw a material improvement in our adjusted EBITDA results as evidenced by growth of 24% from fourth quarter on sequentially flat revenue.
Similarly to our operational cost reduction efforts through thoughtful and deliberate actions during the period, we achieved important efficiencies from targeted cost reductions and improved process efficiencies in SG&A-related activities. In short, I view the first quarter as an inflection point for gross profit, with support from additional revenue opportunities and more targeted cost reduction initiatives in place, we remain absolutely focused on generating positive adjusted EBITDA during 2023.
As we continue to gain cost efficiencies, our efforts now have pivoted to revenue accretion focused on both fronts. First, industry-leading chemistry technologies and second, data analytics. Both carry an undeniable value proposition as it enhanced customer profitability. This in turn will generate a healthy return on investment for our investment -- investor base.
Based on our much improved results in the first quarter and confidence in our plan and its continued successful execution, we are initiating guidance for the first time in 5 years including full year 2023 guidance for total revenue of $210 million to $230 million and an adjusted gross profit margin of 8% to 10%. The midpoint of our revised guidance represents revenue growth of 62% from 2022. Using the midpoint of the revenue and the gross profit guidance, we would generate an annual gross profit for 2023 of $20 million, which would be nearly a $22 million improvement from last year. This is quite an accomplishment.
As always, we appreciate the continued support of our shareholders and look forward to keeping all stakeholders apprised of our continued progress.
With that, I will turn it over to Ryan to discuss our operational results. Ryan?
Ryan Gillis Ezell
Thank you, Harsha, and good morning, everyone. The first quarter of 2023 demonstrates that our strategy, competitive position as service quality delivery for customers are continuing to gain momentum throughout all dimensions of our business.
Flotek is establishing itself as a collaborative partner of choice for sustainable, optimized chemistry and data solutions that are differentiated. This differentiation not only relates to being technologically advanced, but also being operationally efficient at reducing costs and environmental impact while improving the overall performance of our customers' assets.
Let's get right to our Q1 2023 highlights. As Harsh said earlier, we achieved positive gross profit, representing an almost 200% increase sequentially from Q4 and growth of nearly 500% from the year ago quarter. In a moment, I'll provide more details of what is driving our sustainable improved performance. We increased revenue by more than 270% from the first quarter of 2022, primarily as a result of Flotek's strategic 10-year supply agreement with ProFrac and an increasingly diverse base of non-ProFrac customers. We realized 135% revenue growth year-over-year and 23% revenue growth sequentially in the company's data analytics segment.
First quarter 2023 revenue totaled $2.5 million, representing 45% of our total data analytics revenue for all of 2022. We expect revenue in the first half of this year will exceed annual revenue for 2022. We expanded the average number of ProFrac fleet service from 17 in the fourth quarter of 2022 to 19 in the first quarter of 2023, while achieving a high watermark of 23 fleets in March. We achieved stellar growth to 12% market share of active U.S. frac fleets by the end of the first quarter of 2023 versus approximately 2% market share a year ago.
Flotek remains well-positioned to capture additional market share as a result of its anticipated expanded scope of work with ProFrac and a strong sales pipeline of the company's unique product and service offerings. While ProFrac provides a steady, repeatable base of revenue, we have never felt better about our significantly expanding diverse base of non-ProFrac customers.
Most importantly, the growth milestones I just discussed were achieved with 0 recordable and lost time incidents in the field of operations. Now on our last call, we outlined several continuous improvement initiatives, which are key parts of our comprehensive plan to reduce costs and improve margins.
Utilizing a multidisciplinary approach to sustainable margin enhancement. I'm proud to report that we are ahead of our plan as we saw the following key impacts. We garnered a 400 basis point improvement in our material cost of goods sold as a percentage of revenue, resulting in $3 million of savings. This was driven by a combination of technology sales, sourcing strategy, enhanced manufacturing processes and improved contractual economies of scale.
We also lowered freight cost sequentially by more than 16% as we completed the termination of our dedicated trucking fleet, consolidated the delivery of non-book materials and launched the digitization program for our optimized last-mile dispatch. We saw a reduction in total company overtime by over 25% sequentially on a similar activity level. We also executed the sublease of our existing corporate and R&D facility to right-size our office space to a more fit-for-purpose business execution.
And finally, we received the first prototype of the new JP3 flow cell sensor for our proprietary Verax analyzer for field testing and validation. This represents a monumental step change in our manufacturing and operational cost for data analytics segment going forward as we make the transition to a more subscription-based service model. The evolution of our enhanced technologies will further accelerate our growth in the proven golden applications within the midstream as well as our exciting entry into field gas monitoring for power generation in the upstream.
But more importantly, it will open new market verticals for data analytics revenue growth, such as natural gas infrastructure transmission monitoring. The quality of natural gas is measured by its energy content and the proprietary Verax analyzer can do this in real-time versus the traditional sampling practices.
Furthermore, it enhances the buyer and seller agreement on transaction methodology when considering the chain of custody, which could revolutionize how the industry looks at this part of production. And in total, these actions, in combination with our SG&A cost reduction initiatives are expected to deliver at least $18 million in annualized savings.
And despite normal seasonal disruptions in December that extended into the start of Q1 2023, we are confident in our view that the underlying market fundamentals remain strong as the supply of hydrocarbons continues to be tight due to underinvestment in infrastructure and new sources of oil and gas production.
Additionally, E&Ps and major oilfield service companies have remained focused on capital discipline. Industry's demand for services, focus on returns and capital discipline plays well to our strategy of being the collaborative partner of choice to customers as our engineered solutions maximize total well production while reducing emissions and the overall carbon footprint of the asset.
Our producer customers report achieving better well performance with Flotek's chemistry and data analytics on site when all else is being equal. I continue to be optimistic about the future and I'm excited about our mission to provide differentiated technologies that maximize value to our massively expanding customer base.
Simply speaking, we are focused on protecting water quality, minimizing formation damage and improving the estimated ultimate recovery of every completion while maintaining our commitment to corporate responsibility, market share growth and cost discipline.
Now I'll turn the call over to Bond to provide key financial highlights.
J. Bond Clement
Thanks, Ryan. Good morning, everyone. Like Ryan and Harsha, we're thrilled with the results for the first quarter. It's exciting to reach the inflection point of sustainable positive gross margins. During the quarter, we improved our gross margin by nearly $4 million in the previous quarter, a testament to the hard work going on behind the scenes from our team.
Looking at the income statement. During the quarter, we reported net income of $21.3 million. Quarterly net income benefited from a large noncash gain associated with the fair value change of our convertible notes as well as a $4.5 million gain associated with our PPP loan forgiveness.
As a reminder, the final tranche of the convertible notes will be converted on May 17. So the second quarter is likely the last one subject to these volatile earnings swings caused by fair value remeasurement. Our adjusted gross margin, which excludes noncash costs, primarily the amortization of our contract assets, totaled $2.6 million during the quarter and represented approximately 5% of revenues.
As Harsha noted earlier, we are now guiding toward full year adjusted gross margins of 8% to 10%, so we expect to see meaningful improvement as we move throughout the year. Contributing to positive margins during the quarter were $1.5 million of high-margin revenue related to the previously announced ProFrac contract modification that went into effect January 1, along with the sequential reduction in freight and materials costs that Ryan outlined earlier. The reduction in our cost of materials speaks to our success in leveraging the ProFrac business to negotiate better product pricing. It's important to note that we're able to show meaningful improvement in margins during the quarter despite flat revenue.
Having margin improvement in the absence of sequential revenue growth demonstrates the progress that the team is making to the cost side of the operation. Fourth quarter adjusted EBITDA improved another 24% sequentially as we continue to march toward turning that metric positive this year. This marked the seventh consecutive quarter of improvement.
SG&A during the quarter was slightly higher than last quarter because of nonrecurring professional fees, partially offset by an approximately $1.1 million credit to stock compensation expense related to head count reductions. First quarter professional fees included approximately $1.2 million of legal costs associated with the lawsuit that we have been working through since 2021.
Finally, as it relates to the first quarter SG&A versus the fourth quarter, keep in mind that the fourth quarter of 2022 did include the benefit of a $1.5 million bonus accrual reversal. During our year-end conference call, we outlined SG&A cost-cutting initiatives that included head count reductions aimed at saving roughly $5 million in annualized compensation costs. These cuts have been completed, and accordingly, we have recorded separation and severance costs of $2.2 million during the first quarter of 2023. In order to improve the comparability of SG&A between periods, we have broken out separation and severance costs on a separate line on the income statement.
Quickly moving to the balance sheet. Cash balances at March 31 stayed flat with year-end at around $12 million. As it relates to our ABL process, we have received nonbinding term sheets from 4 potential lenders. We're evaluating each of the proposals to assess the various terms and conditions.
In general, they offer potential credit between $10 million and $15 million, supported by various combinations of receivables and inventory. Our close relationship with our largest customer is being assessed by potential ABL providers as it makes up roughly 2/3 of our current receivables balance. We are working through this issue and will provide updates as this process progresses.
We plan to file our 10-Q later this week. Our remediation of previously disclosed internal control weaknesses continues. I would note that we have taken significant steps in enhancing processes that we believe will be effective in strengthening our internal controls and ultimately resolving these issues in short order.
As it relates to compliance with the NYSE's minimum stock price requirement, we're contemplating options targeted toward organically regaining compliance over the next few months as we do have until October 12 to cure this issue.
As previously disclosed, we already have shareholder approval for up to a 1-for-6 reverse split if necessary. As I close out, we are pleased to have achieved a positive gross margin in Q1, but we are not satisfied with that alone. We will continue to push toward positive adjusted EBITDA. And as evidenced by our guidance, we would expect to see positive gross margins continue to rise with each reported quarter.
With that, I'll turn it back to Harsha for his closing comments.
Harsha V. Agadi
Thank you, Bond. I hope you can see from our significantly improved financial results and the comments we have provided on today's call, why we are so positive in our outlook for the company. Also the management team providing guidance is a clear indicator of growing confidence in the predictability of our business.
Again, to reiterate, we are providing guidance for the first time in 5 years. As I said in my opening comments, we have made substantial progress during the first quarter by declaring a positive gross profit quarter and a materially improved adjusted EBITDA margin.
Having said that, we still have work ahead of us in our efforts to build a long-term sustainable business that can weather and mitigate the inherent volatilities of the oil and gas industry. With the backdrop of our long-term ProFrac business relationship that we truly appreciate and firmly in our hand, I remain encouraged by our growing business diversification beyond what we have with our direct relationship with ProFrac. This is reflected in our robust sales pipeline of more than $350 million. That is in place as well as a growing demand for our subscription-based data analytics offering.
Combined with our successful efforts to ensure we drive long-term profitability in our business operations, I believe Flotek continues to position itself for a very successful future. I thank our customers, employees and shareholders for having faith in Flotek and its management team.
With that, we will open up the call for questions. Operator?
Question and Answer Session
Operator
(Operator Instructions) Our first question today comes from Don Crist from Johnson Rice.
Donald Peter Crist
Congratulations on the first positive operating margin quarter and 5 years, it's been a long-term comment. Good job. I wanted to start with the ProFrac fleets being supplied. It seems like the ramp-up has been a little bit slower than I would have imagined given the contract requirements. But is that a function of a little bit of whitespace showing up in their schedules, which impacts overall utilization? And how does that progress as we move into the back half of the year?
Harsha V. Agadi
Don, this is Harsha, very impressed with your question. I'm going to have Ryan respond first. Ryan, please go ahead.
Ryan Gillis Ezell
It's a great question. I think we look at -- we also referred to in this contract in terms of fleets. And in actuality, we just use the fleet to drive the volumes of the contract. So as I mentioned, we got to a high watermark of 23 in March, and we're continuing to evolve our way into what we feel like will reach the contractual required volumes. I do believe, though, that in Q1 we did see some seasonal disruption and you're seeing the impacts of natural gas and a couple of fleets moving around.
And there's been some -- a little bit of whitespace, I think, in the scheduling this caused that number to go up and down a bit. So the averages are coming in the low 20s right now. But we do see strength of that recurring in late May and rolling into June as the schedule starts to stabilize and a lot of the activities will be on longer-term applications as we see towards the June time frame and the back half of the year.
Harsha V. Agadi
Thank you, Ryan. I think, Don, one more thing, a lot of credit to Ryan and his team. They have laid out and identified a possible schedule between now and the end of the year, by the week, by the day. And when there is whitespace, they have become very diligent in going after non-ProFrac business to offset any of the whitespace. So there is a method to the madness. And Ryan and team are really on it to reduce the amount of whitespace.
Donald Peter Crist
Yes. I appreciate that color. And the fact that you're able to give guidance now really shows that you have a better handle on activity going forward. My next question is for Bond. On the G&A side, if I strip out the lower expense in the first quarter, it looks like G&A was down roughly $0.5 million quarter-over-quarter. How do you see that progressing given that you're moving offices and kind of rightsizing the business even more than you've done in the first quarter as we progress through the year? Do you think you can get it below that $5 million level?
J. Bond Clement
Yes, definitely, especially on a recurring basis. But also keep in mind, Don, in the first quarter, we did have a pretty big stock comp credit from the head count reductions. There were a lot of shares that we had previously been expensing that we effectively took a big credit for. So there is a lot of noise in the first quarter. But certainly, as we move forward outside of what we call our add-back professional fees, we think we can hit those kind of numbers.
Donald Peter Crist
Okay. I'll ask one more on the JP3 side. Ryan, obviously, the new prototype has come in. I don't know where you are in the testing in that. But what do you think the time line is before it's kind of active in the field and possibly working for some of those transmission companies?
Ryan Gillis Ezell
So as of today, the unit itself is in a field and hooked up in a pipeline now. We've been recording measurements on a accuracy and how we look at the calibrations and how it ties into our data library of over 40,000 hydrocarbon samples and we're very pleased with where we are in the testing and validation components right now. And this is kind of represents a monumental stage gate process at the completion of this testing, which we're expecting probably towards the end of next week, we'll look at moving items into production and we should start receiving units in the latter half of the year.
Donald Peter Crist
Trying times. I appreciate all the color, and good quarter, guys.
Harsha V. Agadi
Thank you, Don.
Operator
Our next question comes from Eric Swergold from Firestorm Capital.
Eric Benjamin Swergold
Nice to see a renewed sense of urgency on the cost side. Given that some of these costs were taken out roughly halfway through the quarter, what's the full impact for Q2 of these cost reductions?
J. Bond Clement
Are you talking above the gross margin line or below, Eric?
Eric Benjamin Swergold
This is at headquarters, just corporate.
J. Bond Clement
Got you. Yes. I mean like I told Don, there was a lot of noise involved in the first quarter with the high legal costs, the stock comp reduction. We had the fourth quarter of last year had a bonus accrual reversal. We will have, as we previously talked about, a retention bonus that starts to be accrued during 2023, 2Q through 4Q, which is effectively the bonus that we reversed out last year.
And yes, the move from office space, we haven't fully settled on where our new office will be. We've got 2 candidates that we're looking at. There's a bit of a cost difference between the 2 options. But in total, I think the move is going to save us somewhere around $0.5 million a year, and we obviously haven't seen those costs come through. So I think you will see SG&A continue to trend down throughout the year with head count reductions now complete and all the other things that we talked about.
Harsha V. Agadi
Yes. Eric, if I may add another word or 2. Once you have a handle on where your gross margins are coming out, we as a team have quickly realized SG&A has to be lower than the gross margins for us to have an adjusted EBITDA. And so therefore, the word rightsizing is very important and that is we will do everything possible to make sure our SG&A does not exceed gross margins because mathematically, that's how you make money. And as each quarter goes, you're going to see an improvement.
The only thing that might stand out, but you won't see that in the adjusted EBITDA is if there is a onetime cost here or there, but we're going to outline that. But we are reasonably confident that the surprises are slowly disappearing. Predictability is starting to increase revenue line as well as the cost line.
Eric Benjamin Swergold
Okay. And then my next question is for Ryan. What's it going to take to historic margin structure of 4, 5, 6 years ago?
Ryan Gillis Ezell
Yes. Eric, that's a unique question because it's a little bit complex. And if you allow me, I'll break that apart a bit. When we look at the product margins, I feel like as we're starting to transition to a lot of our value-add sales, we talked about our advanced technologies. We're starting to see on a like-for-like basis, the product margins themselves on our complex nanofluid, et cetera, and that increasing volume already approaching where we were a few years ago.
The difference is, is that we also have a full service chemistry suite going to location, whereas in the past, that wasn't necessarily the case in terms of we look at delivering [FRs] to location, engineering services on site, et cetera. And so those carry a little bit different margin profile than what we saw in the past.
But what I can tell you is on a product to product margins, we are now in the latter half of the year starting to approach where we were on just selling complex nanofluids a few years ago. And that's the goal that we're trying to get to. And we're confident in that there as we continue to lean up how we are in logistics. But it's kind of hard. It's a little bit of an apple and orange comparison at the service delivery looks completely different than what it did 5 years ago.
Harsha V. Agadi
Yes. Another -- Eric, is when you look at our businesses, you got the ProFrac business, you got the non-ProFrac business, and then you've got data analytics, which is now shifting into a subscription-based model. The combined mix of gross margins is going to be eventually stronger than where we began. Is that a fair statement, Ryan? And when I say where we began, I'm talking going back a couple of years.
Ryan Gillis Ezell
That's correct.
Eric Benjamin Swergold
Okay. And then 2 more questions, if I might. First question is on the reverse split. Most of the shareholders I've spoken to are in favor of a reverse split simply because having a higher share price decreases fears of spiraling. Is the hesitancy about that that you think you can get your share price cured organically?
Harsha V. Agadi
Well, here's how I would respond, Eric. We have had an internal assessment for the Board by certain investment bankers. We are evaluating it and we will take action accordingly. It is pretty clear to me from the beginning of my investment time that if you have a stock price greater than $5, you're better placed. No question, no doubt.
So having said that, we're going to watch this organic movement, but we are not closing the door on the reverse split. We're examining it very, very carefully. What we have created now is optionality; one, our performance is going to drive the stock price; two, reverse split; three, liquidity. As liquidity on our balance sheet continues to increase, I think we're going to be moving on several fronts here. So I think we're open to it. We're not against the idea.
Eric Benjamin Swergold
Okay. And then my last question is with respect to insider ownership. I know there's been some frustration on behalf of management and from shareholders that there was basically no window last quarter between when you reported and when the next quarter ended. Can you speak to the coming window for increasing insider ownership?
Harsha V. Agadi
Yes, Eric. Normally speaking, when you finish your second quarter within a couple of days, the inside windows should open. But Bond is right in the middle of the ABL negotiation, which is a major event. We're also very close to announcing our permanent CEO for Flotek. So we have 2 major announcements that the Board is deliberating. So we may delay that just a tad bit, but the intention is to get to open window really, really quick because it will give us sufficient time.
And yes, I am frustrated that I cannot buy my own stock as per the SEC rules until open window opens. But we have these major decisions at a tipping point. And obviously, we could not delay our earnings call. Ideally, we could have had all that neat and nice, but things don't happen that way. So having said that, just be patient, we're almost there.
Thank you, Eric, for your continued support.
Operator
And ladies and gentlemen, with that, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to management for any closing remarks.
Harsha V. Agadi
Thank you very much. I think in closing, let me say the following. I have definitely had the pleasure of working with the Flotek team very closely first as a Board member, but now as Interim CEO. We have some major decisions that will come out all very favorable to the company.
One thing (technical difficulty) that is very much in sync is we had Flotek believe in daily continuous improvement. Every day has to be better than the previous day going forward and that is the mantra we are going after on a repeated basis. And again, thanks, everybody, starting with the non-ProFrac customers. Thank you, ProFrac, for supporting us through all of this. Thanks to all the employees as well as the shareholders. Best wishes. Thank you.
Operator
Ladies and gentlemen, with that, we'll be concluding today's conference call and presentation. We thank you for joining. You may now disconnect your lines.
