Q2 2023 Flotek Industries Inc Earnings Call
Participants
J. Bond Clement; CFO & Principal Accounting Officer; Flotek Industries, Inc.
Ryan Gillis Ezell; CEO & Director; Flotek Industries, Inc.
Donald Peter Crist; Research Analyst; Johnson Rice & Company, L.L.C., Research Division
Richard Dearnley
Larry Busnardo
Presentation
Operator
Greetings, and welcome to the Flotek Industries Second Quarter 2023 Earnings Conference Call. (Operator Instructions) As a result, this conference is being recorded. It is now my pleasure to turn the call over to Larry Busnardo, Investor Relations Representative for Flotek. Thank you. You may begin.
Larry Busnardo
Thank you, Dave, and good morning. We appreciate your participation in Flotek's Second Quarter 2023 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 second quarter of 2023 yesterday afternoon, which is available on the Investor Relations section of Flotek's website. We've also posted an updated and enhanced corporate presentation that we will be referencing on today's call. We encourage you to take the time to review it.
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. In addition, please refer to the reconciliations provided in our earnings release as management may discuss non-GAAP financial metrics on this call.
With that, I will turn the call over to Ryan Ezell, Chief Executive Officer. Ryan?
Ryan Gillis Ezell
Thank you, Larry, and good morning. We appreciate everyone's interest in Flotek and for joining us today as we discuss our second quarter 2023 operational and financial results. As most of you know, this is my first earnings call as CEO of Flotek, and I'm honored to be in this role as such a transformational time in the organization. I'd like to take a moment to thank Harsha Agadi for his tenure as interim CEO and congratulate him on his return to Flotek's Board of Directors as Chairman.
Now turning to the quarter. Our second quarter performance demonstrates the meaningful progress we've made in improving Flotek's business fundamentals as we execute our corporate strategy. This, in turn, has resulted in a significant increase in the profitability of Flotek's complementary and unique business segments. Furthermore, I expect the organization to continue its trajectory of improving results for the remainder of the year.
And let's make no mistake. Our efforts are laser-focused on revenue growth, market share expansion and cost efficiency gains via our differentiated technologies in both chemistry and Data Analytics solution platforms. Both carry an undeniable value proposition that maximize our customers' value chain while generating a meaningful return on investment for our shareholders.
With that in mind, I'd like to turn to Slide 7 and touch on our second quarter highlights. I'm pleased with the overall results as we delivered a 72% increase in total revenues in the second quarter of 2022. We also had strong growth in gross profit, which more than doubled from the first quarter of 2023. We reported positive adjusted gross profit for the second consecutive quarter and showed an improvement in adjusted EBITDA for the eighth consecutive quarter and are now forecasting positive adjusted EBITDA before year-end.
Our transactional chemistry business revenues increased 68% from the first quarter of 2023. This is due to our rapidly expanding customer base and continued adoption of our Prescriptive Chemistry Management business model, which has exhibited 171% growth in applications of our proprietary Complex nano-Fluids compared to the second quarter of 2022. Also, our Data Analytics revenues have continued to gain momentum as the first half of 2023 revenues have approximately equaled what we had in all of 2022.
These improved results reflect the positive and impactful changes we have achieved during a very short period of time. Most importantly, all of these milestones were achieved with 0 recordable and lost time incidences 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.
Now as highlighted on Slide 12, Flotek continues to differentiate itself as the collaborative partner of choice in the industry for sustainable, optimized chemistry and data solutions for E&P operators and oilfield service providers. What truly distinguishes Flotek from its peers is our global presence in over 15 countries, including all major U.S. shale basins and our extensive expertise providing sustainable, chemical and data solutions on over 20,000 completed wells worldwide.
A recent example of this differentiation is the approval of Flotek's slick water system by Aramco. Our fluid solution is now 1 of only 2 approved hydraulic fracturing systems currently being utilized in Saudi Arabia. This competitive advantage not only relates to being technologically advanced, but also being operationally efficient in reducing cost and environmental impact while improving the overall performance of our customers' assets.
Another important aspect of Flotek's competitive advantage is our producer customers reporting enhanced well productivity while utilizing our chemistry applications. Slide 16 depicts a comparative production analysis of wells utilizing Flotek's Prescriptive Chemistry Management for wells in the Permian Basin versus wells from non-Flotek wells. As shown in the graph, wells that employed our Prescriptive Chemistry Management exhibited a 26% average uplift in performance or a cumulative increase of 75,000 barrels of oil equivalent after 24 months compared to wells that did not have Flotek chemistry. This highlights how powerful Flotek's chemistry solutions are in delivering improved asset performance. While this only represents a sample of results from the Permian Basin, we have also seen similar results in all other shale basins.
Turning to Slide 17. We continue to leverage our expertise into emerging and existing market verticals. This positions Flotek to capitalize on our proprietary patents, technology advancements and collaborative partnerships that have proven commercial applications in other industry subsectors, providing significant future growth opportunities while diversifying our revenue stack. We believe that the demand for our sustainable chemistry solutions will continue to increase and will provide opportunities in other international and domestic market verticals, such as industrial, geothermal, agricultural, solar and hydrogen.
Turning now to Slide 18. As discussed last quarter, our Data Analytics segment received the first prototype of the next-generation spectrometer for field testing and validation, which is shown on the slide. The proprietary Verax analyzer can monitor the quality of hydrocarbons in real time versus traditional sampling practices. When operational, this next-generation Verax unit will represent a massive step change in our manufacturing capabilities and operational costs for the Data Analytics segment as we make the important transition to a more subscription-based service model.
As outlined on Slide 19, extensive industry applications exist throughout the upstream, midstream and downstream segments. We believe the next-generation model will have the scalability to further penetrate what we believe will be [an immense] upstream market opportunity. I would now like to turn the call over to Bond to discuss the detailed financial highlights.
J. Bond Clement
Thanks, Ryan. It's great to be with you all this morning. I want to start by saying that everyone here at Flotek is extremely excited about the results we announced yesterday. I think yesterday's release checks a lot of the boxes regarding items that we've been working hard to achieve and that shareholders have been wanting to see.
Moving back to Slide 7 for a bit. We reported a huge growth in gross profit. We generated strong revenue contribution from our transactional chemistry business. We provided visibility on reaching positive adjusted EBITDA before year-end, and we updated you on significant progress towards securing an ABL.
Our success in execution during the first half of the year gives us confidence in achieving our full year guidance, which calls for total revenues of between $210 million and $230 million, which equates to more than 60% growth in annual revenue versus last year and achieving an 8% to 10% adjusted gross profit margin. Hitting the midpoint of these 2 metrics would represent a nearly $22 million annual improvement in adjusted gross margin versus the results we achieved last year. Obviously, quite a turnaround and an accomplishment that we're proud of.
Moving to the income statement. Sequentially, revenues were up 5% in spite of a well-documented pullback in upstream land activity during the quarter. As Ryan discussed, our transactional chemistry revenues jumped by more than $6 million during the quarter and ended up making up over 30% of total revenue, which is up from only 19% in the first quarter. This is a significant accomplishment as it provides a revenue source diversity in terms of reducing our customer concentration.
Turning to Slide 10. Our second quarter gross profit was up 108% from the first quarter, and our adjusted gross profit, which excludes certain noncash costs achieved a 92% jump in the first quarter. Gross profit margin and adjusted gross profit margin during the quarter increased to 8% and 10%, respectively. With back-to-back quarters of positive gross profit, our cumulative gross profit through the first 2 quarters of 2023 is running nearly $10 million higher than the cumulative gross profit for the preceding 2 final quarters of last year.
Contributing to positive margins during the quarter were $1.2 million of revenue related to the ProFrac contract modification that we announced earlier this year, along with a 13% sequential reduction in our freight costs. This marks the second consecutive quarter of double-digit reduction in freight costs. In terms of dollars, second quarter freight costs were about $0.5 million less than first quarter 2023 and about $1.3 million less than the fourth quarter of 2022. And that's in spite of revenues being 5% higher for the second quarter.
Moving to Slide 11. Second quarter adjusted EBITDA improved another 48% sequentially. As noted in yesterday's release, we are now forecasting reporting positive adjusted EBITDA before the end of this year. I, and I'm sure many of you are very excited about the prospect of no longer having to discuss the relative improvement in negative numbers.
Moving to SG&A. As a reminder, for everyone, the first quarter of 2023 did benefit from a $1.1 million credit for noncash stock comp that was associated with headcount reductions that we implemented in the first quarter. Excluding stock comp, SG&A during the second quarter increased by about $0.5 million and included legal fees related to the settlement of a portion of our legacy litigation, and it also included the final costs associated with our CEO transition. We have now settled 2 of the 3 components in our legacy litigation, so we're encouraged that this can be wrapped up before the end of the year. Accordingly, we expect G&A costs to trend back down during the third quarter.
Quickly touching on the severance expense credit during the quarter. We had previously accrued certain severance costs associated with the legacy litigation just discussed. In connection with that settlement of this portion of the litigation, we were able to reverse that accrual during the second quarter.
Moving to the bottom line. We reported a slight net loss this quarter versus $21 million of net income during the first quarter. Net income for the first quarter did benefit from a $26 million 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. The final tranche of the convertible notes converted in May to 63.5 million shares, so we'll no longer have the earnings volatility associated with the fair value measurement of the notes going forward.
Touching on the balance sheet. In connection with the conversion of that final tranche of convertible notes to equity, our June 30 balance sheet is now almost completely delevered with only about $300,000 of total debt reflected.
Moving to Slide 21 real quickly. I am very pleased to report considerable progress has been made towards securing an ABL facility. The fact that a loan like this was simply unavailable to Flotek a year ago, highlights the substantial financial improvements made by the company over the last few quarters. The ABL is expected to be secured by certain of our receivables, inventory as well as our Marlow, Oklahoma blending facility. We recently received credit approval from the prospective lender, and we are reviewing the loan documents currently and completing some final administrative items prior to closing. We are very excited about the expectation of announcing the results of this process well before the end of the month.
Quickly touching on the NYSE sub-$1 listing issue. We're obviously going to monitor how the stock trades over the next few weeks. As we've mentioned before, our strong preference would be to cure the deficiency organically by leveraging the potential benefits from the very positive financial results we reported yesterday. Additional updates on our progress regarding an ABL as well as our participation at the EnerCom conference next week. Our compliance deadline is October 12, so we have some time before we have to decide. As a reminder, and as we mentioned last quarter, we already have shareholder approval to enact up to a 1-for-6 reverse split if necessary.
Touching upon our special shareholder meeting scheduled for September 5, we have filed the definitive proxy statement and shareholders should be receiving voting materials. We have engaged a proxy solicitor to conduct an outreach campaign to ensure that we get maximum participation from shareholders. Our Board unanimously recommends a vote for both proposals. As a reminder, everyone, shareholder approval of the June 2022 prefunded warrants held by ProFrac provides Flotek the opportunity to receive $4.5 million in cash proceeds upon the conversion of those warrants to shares. Obviously, that's something that would benefit all shareholders.
There's a lot to be proud of in terms of what we've accomplished at the midway point of the year. Through June, we've reported a nearly $10 million improvement in adjusted gross margin and nearly $7 million improvement in adjusted EBITDA as compared to the first 6 months of last year. We expect to see gross margins continue to rise over the coming quarters, and we will keep attacking SG&A at every opportunity.
As it relates to SG&A cuts, we recently executed a new lease for our corporate headquarters. We expect to complete the move over the next 2 weeks. With a significantly reduced footprint, our new office lease will provide annual savings of over $500,000 versus the current office location we are exiting.
That concludes my remarks. I'll now turn the call back over to Ryan for closing comments.
Ryan Gillis Ezell
Thanks, Bond. Now turning to Slide 22. In summary, Flotek is a compelling investment opportunity to date as the turnaround momentum we've gained in rightsizing our business and improving our profitability is not currently reflected in our share price. And I'm confident in our ability to execute our corporate strategy going forward.
Flotek's new leadership team has deep industry experience to lead Flotek forward and execute on our next phase of growth. We have complementary business segments, and we'll continue to drive revenue expansion and a sustained improvement in profitability as we anticipate delivering greater than 60% growth in annual revenues and greater than $20 million in annual gross margin improvement.
We maintain a $2 billion backlog of future revenue over the next decade as supported by our long-term ProFrac partnership. In addition, we expect ongoing domestic and international growth in our high-margin transactional chemistry and data analytics businesses as we continue to gain market share in both areas.
We also continue to benefit from our cost control initiatives that enhance profitability and underpin a transition to positive adjusted EBITDA by year-end. And finally, we maintain a strong balance sheet with very little debt that has to be augmented with the additional liquidity from the proposed ABL facility we are working to put in place in the near term.
We realized that there is more work to be done, but we are all positioned to capitalize on the significant opportunity set 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'll share our excitement regarding the future of Flotek.
Operator, we are now ready to take questions.
Question and Answer Session
Operator
(Operator Instructions) The first question comes from Don Crist with Johnson Rice.
Donald Peter Crist
Ryan, I wanted to start on Slide 16. Obviously, I haven't seen this data before. But the 26% uplift in well performance. Number one, how widespread or how many wells is that covering? And number two, is this really kind of getting some traction for your transactional business out there in the Permian?
Ryan Gillis Ezell
Yes. Don, when you look at this data, we were very meticulous about how we went at doing this analysis, and we looked at over 1,800 wells in the Permian Basin. More importantly, we set strict guidelines on when we looked at it, lateral length, completion design, proppant intensity and fluid system choice, which we got from the publicly available data. And you're 100% correct that we are starting to see significant traction in our transactional business, driven by the value proposition around our customized chemistry technologies.
And what's unique about this is we went down this pursuit. It's kind of been a long-term pursuit for us. In that, we started these EUR type interactions with our customers almost 18 months ago, and you're really starting to see them come to fruition as you can see what's coming out of this data.
Donald Peter Crist
It's very exciting data. And one other question on the cost side. You called out freight and logistics cost coming down. I know you've been working on that for quite a while. Where are we in that progress? And do you see additional cost savings going forward?
Ryan Gillis Ezell
Yes. So if we look at freight, when you look at, say, where we ended the year in Q4 of '22 versus this current quarter, our freight costs were down about $1.3 million when we had an increase of almost $500,000 in revenue. And more importantly, we saw -- just from Q1 to Q2, we saw a $500,000 drop in freight costs with increasing revenue. So you can start to imagine that we are gaining significant efficiencies in terms of how we look at our long-term short hauls and also what we look [at infield] delivery.
Donald Peter Crist
Okay. And Bond, just one for you. Now that the convertible notes are all converted, can we get a clean share count? I mean, obviously, there's the warrant center still out there, but what's the clean share count today?
J. Bond Clement
Yes. Assuming both of the items in the special meeting passed, there's 2 tranches of prefunded warrants that need to be approved by shareholders. The final share count is going to be somewhere around 190 million shares.
Donald Peter Crist
All right. I appreciate the color, guys. Good quarter. I'll turn it back.
Operator
Our next question comes from Richard Dearnley with Longport Partners.
Richard Dearnley
Doing the math on your comments about transactional business being 30% of revenue, that would be about $15.2 million versus $9.1 million in the first quarter. Am I getting that correctly?
J. Bond Clement
That's correct. It was up about $6 million Q1 to Q2.
Richard Dearnley
Right. So then your ProFrac business would be down about 11% quarter-to-quarter?
J. Bond Clement
Yes. It's off about 10% from the first quarter. That's correct as well.
Richard Dearnley
And what were the dynamics there?
Ryan Gillis Ezell
So there's a couple of things to look at. And so a lot of this has been spoken about in the public market is that what we've seen is a little bit of disruption in activity where the E&P operators who are transacting the business for pressure pumping activities and completions, we've started to see what I would call white space in between activities. Traditionally speaking, we would see 1 to 2 days, maybe 3 days transitioning pad to pad, et cetera. But we're seeing a lot of customers buying in the spot market, and we're seeing bigger delays between pads, sometimes 5 to 7 days.
So although your average fleet count is staying relatively the same quarter-on-quarter, the amount of activity or pumping days went down a little bit. And so with some of that, we would look at our total fleet count. We moved chemistry on a similar number of fleets. But when you average out the volume, it was down a little bit, particularly in what we saw in May, but we've seen that come back strong in July and coming into August.
Richard Dearnley
Right, I see. And on Slide 16, back to the productivity question. How much of that improvement is -- this is a soft guess kind of answer, but how much of that is due to analytics? How much is due to nano-Fluids? And how much is due to the rest of everything?
Ryan Gillis Ezell
So that's a great question and something that we have kind of combined in our overall approach. You heard me mention that we have 20,000 wells under the belt of applications of our chemistry. So in combination with what our Data Analytics group does with the chemistry, we've done a lot of, I would say, machine learning on applications of our proprietary chemistries in the various basins and target zones. And we've brought that into discussions with our customers, how we choose our chemistry.
And what's even more important is we look at our overall engineering process that we call Prescriptive Chemistry Management where we look at the X-ray diffraction of the cuttings and core samples, we look at the produced water and its composition, we look at the compositional analysis of the potential crude and hydrocarbons that are coming out of the reservoir. And we also look at other potential opportunities around the biocide selections, et cetera.
And we give them a holistic customized approach, which is choosing the right friction reducer, clay control, corrosion components as well as when we can have an application of a surfactant enhanced possibility, which you look at as a [flowback aid] or a Complex nano-Fluids. Because what we see is sometimes, traditionally, when [it's just] look at pure Complex nano-Fluids, it's a little bit higher, but we look at a holistic approach of the chemistry management side. And that's where we get the 26% number. And I will say it varies well to well, depending on the formation type and completion design.
Richard Dearnley
So you're saying that it's not possible to break out the nano-Fluids and the analytics and so on? It's just a [big package].
Ryan Gillis Ezell
I think it is in terms of we can look at it just where we have specific to just Complex nano-Fluid is being applied. We have those analytics. But we like to prefer to look at our holistic engineering approach for the full design of the slick water system that we're utilizing. But we do have that data. And in some of -- I think some of the more detailed presentations that we'll be doing at some of the upcoming investor conferences, we'll talk specifically around impacts of Complex nano-Fluids versus the full engineering and scope design.
Operator
(Operator Instructions) At this time, there are no more questions. The next question comes from Don Crist with Johnson Rice.
Donald Peter Crist
Ryan, I just want to ask about JP3. Obviously, you had some field tests going on with the new design. Where are we in that? And are you seeing some interest in more widespread adoption of JP3?
Ryan Gillis Ezell
Yes. Don, that's another good question is that, as I mentioned, we have the new generation model in the field testing. We've got 2 units. The testing has grown -- gone phenomenal. And we're expecting scale up of that business coming to the latter part of Q4 and going into 2024 for having the new units on the production side coming out and that's opened up.
We recently went over with our Board kind of the strategic applications of this new technology into the field. And we see significant opportunities in the upstream segment by looking at the quality and energy count and BTUs and natural gas. We look at flare gas operations and we also look at power generation overall, whether you're powering rigs, frac fleets, electrical turbines, et cetera. So we're really excited about JP3.
And when you look at what JP3 and chemistry do together, we see not only applications in domestically North America land, but we see significant applications for these internationally for both units and then particularly even offshore for our chemistry. So it's really exciting about what synergies being created between data and chemistry alone because data is the monitoring of the actual chemistry at the well site.
Donald Peter Crist
Right. That's very exciting going forward. Bond, if I can ask just one more with you as well. Obviously, there were some moving parts in G&A this quarter. Are you still pretty confident that you can get it close to that $5 million a quarter run rate or below by year-end?
J. Bond Clement
Yes. We're working hard. That's the goal internally. We just -- we had a few items that we mentioned here, some higher legal costs. We're trying to get this litigation wrapped up. We were able to knock out 2 of the 3 components. We have one piece left. We've got the CEO transition cost behind us. So yes, I mean, Don, that's the goal internally, and that's what we're working towards.
Donald Peter Crist
I'm looking forward to seeing positive EBITDA going forward. I appreciate it guys. Good color.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Larry Busnardo for any closing remarks.
Larry Busnardo
Thank you again for joining us today. I would like to remind you that Flotek's CEO, Ryan Ezell, will be presenting next Tuesday, August 15 at EnerCom Denver, the Energy Investment Conference in Denver at 8:50 a.m. Mountain time. He will be joined by CFO, Bond Clement, in hosting meetings with investors throughout the day. A copy of the presentation that will be posted to the website -- a copy of the presentation will be posted to the website prior to the start of the presentation. Dr. Ezell will also be participating in a service industry panel discussion at the same conference on August 16 at 9:50 a.m. Both events will be webcast, and we look forward to seeing many of you next week. Thank you again for joining us today. Please feel free to contact the company if you have any additional questions. Have a good day.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
