Flotek Industries - Q1 2024

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the Flotek Industries First Quarter 2024 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, May 8, 2024. I would now like to turn the conference over to Michael Critelli, Director of Finance. Please go ahead.

Michael Critelli (Director of Finance)

Thank you, and good morning, everyone. We appreciate your participation in Flotek's first quarter 2024 earnings conference call. Joining me on the call today are Ryan Ezell, Chief Executive Officer, and Bond Clement, Chief Financial Officer. First, we will provide prepared remarks concerning our business operations and financial results for the first quarter of 2024, as well as guidance for the full year 2024. Following that, we will open up the call for any questions you have. Flotek's first quarter 2024 financial and operating results press release was issued yesterday afternoon. We also posted an updated Q1 earnings presentation that we will be referencing on today's call. These can all be found on the investor relations section of our website. In addition to.

In addition, today's call is being webcast, and a replay will be available on our website following the conclusion of this call. Please note that the comments made on today's call regarding projections or 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 risk factors discussed in our filings with the SEC. Please refer to the reconciliations provided in the earnings press release and corporate presentation, as management will be discussing non-GAAP metrics on this call. With that, I will turn the call over to our CEO, Ryan Ezell.

Ryan Ezell (CEO)

Thank you, Mike, and good morning. We appreciate everyone's interest in Flotek and for joining us today as we discuss our first quarter of 2024 operational and financial results. I'm pleased with the first quarter of 2024 performance and even more energized about what's to come this year. Without a doubt, 2023 was a transformative year for the organization, but 2024 will be the beginning of a revitalized Flotek that demonstrates consistent profitability and expansion in shareholder value as we accelerate into a new era of differentiated chemistry and data analytics solutions.

There is no company better positioned to provide strategic solutions to a variety of our industry's most challenging problems, whether it's operators solving for complex completion challenges such as increased water production and reduced BOE, pumping companies looking to advance their differentiation through maximizing utilization, or oil and gas operators racing to meet the new EPA flare regulations with their unique real-time measurement technologies. There's never been a more exciting time to be at Flotek. With that in mind, I'd like to turn to slide 7 and touch on our key highlights for the quarter that Vaughn will discuss in detail in just a moment.

We delivered significant year-over-year improvements in gross profit, adjusted gross profit, and adjusted EBITDA, leading to the third consecutive quarter of net income and eleventh consecutive quarter of improved adjusted EBITDA as a percentage of revenue.

Notably, Q1 2024 Adjusted EBITDA surpassed the total for the entire year of 2023. We realized gross profit margin and adjusted gross profit margin of 22% and 25%, respectively. Our Q1 2024 external chemistry sales were the highest achieved in the first quarter since we began this turnaround over three years ago and was up 27% year-over-year. And although down sequentially, this pattern is consistent with the first quarter in each of the last three years, as well as average fleet counts in Q1 were down sequentially. Our data analytics segment saw 18% quarter-over-quarter revenue growth, thanks in part to our continued progress in data as a service revenues.

In addition to this progress, we continue to push forward with the field testing of our new CalX spectrometer, which is still on track for a mid-year 2024 release. Most importantly, all of these achievements were accomplished with zero recordable and lost time incidences in the field of operations, extending Flotek's current streak to over 843 days without a recordable incident. I'd like to take the time to thank every single employee for their commitment to safety and service quality in achieving these outstanding results. I expect us to continue to build upon this momentum throughout 2024. Now, looking at the quarter in a bit more granularity, revenue was slightly down sequentially. This decrease is mostly attributable to lower external chemistry sales versus Q4 2023.

We have observed this consistent seasonality since the organization began its strategic turnaround over three years ago. At a detailed glance on slide 9, Q1 2024 external chemistry revenues were up 27% versus Q1 2023. This was the largest Q1 revenue reported for our external chemistry sales during the last three years, with the lowest average Frac fleet counts in North America Land during the same period. This indicates we are gaining market share through each annual cycle of fleet count stabilization by the execution of our corporate strategy, utilizing chemistry as the common value creation platform.... We are seeing continued adoption of our Prescriptive Chemistry Management business model that leverages our customized engineering approach, combined with our proprietary Complex nano-Fluids technologies, to deliver wells that outperform adjacent competitor wells.

Flotek will remain at the forefront of innovation and multidisciplinary advancements as we bring new technologies to the market, including AI-driven reservoir modeling, to address the impacts of water imbibition, drive preferential microfluidic behavior in nanopore environments, and improve the ultimate recovery of hydrocarbons from each asset. We expect a substantial increase in our external customer chemistry sales during the second quarter and anticipate total annual external chemistry growth for 2024. To that note, April external chemistry sales have already achieved over 70% of what we did in all of Q1 of 2024. We realized 19% sequential growth in our ProFrac-related revenue. 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 operational stability.

Our partnership continues to evolve into a truly transformational offering for E&P operators in regards to efficiency and overall reservoir performance. Our data analytics segment revenues increased 18% from the fourth quarter of 2023. Our continued success in converting to a data-as-a-service model, combined with the launch of the next generation JP3 measurement system, continues to unlock significant upstream market opportunities as the company expects the data analytics business to grow by 50% in 2024. 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 barrel cycles will be necessary to maintain production and add the required incremental supply. Despite near-term volatility in commodity pricing, the fundamentals for energy-related services remain strong.

For the first time in nearly two decades, the demand for electricity in the U.S. will climb over 15% by 2030, with natural gas providing over 40% of the current demand. The overall expansion of the global economy will continue to create substantial demand for all forms of energy, which will increase service intensity within our sector. As we look at the remainder of 2024, our efforts remain laser-focused on revenue growth, market share expansion, cost efficiency gains, and returns on shareholder value, as we are well positioned to capitalize on opportunities both domestically and internationally. We are confident that our expanding suite of services positions us to provide unique and superior solutions to maximize our customers' value chains. Now I'll turn the call over to Bond to provide key financial highlights.

Bond Clement (CFO)

Thanks, Ryan. Good morning, everyone. Our first quarter 2024 results reflect solid performance despite relatively soft oil and service demand related to natural gas-directed completions. While revenue was impacted by seasonality and lower frac fleet activity, we grew margins and continued the trend of improving financial results, highlighted by another strong quarter of Adjusted EBITDA. Let me run through a handful of key financial items for the first quarter of 2024. I'll be referring to slides in the presentation that we posted to our website yesterday. Slide 7 highlights our first quarter accomplishments and the strong financial improvement we delivered. Headlining our results were year-over-year growth and net income of $11 million when adjusting for non-cash gains in the first quarter of 2023.

Gross profit increased by $6.9 million, adjusted gross profit was higher by $7.4 million, and adjusted EBITDA improved by $7.9 million. Regarding revenue for the quarter, we reported total revenues of $40 million, which was down versus the first quarter of last year. This decline was attributable to lower related party activity associated with ProFrac. That was partially offset by a 27% increase in revenue from external chemistry customers. As Ryan mentioned earlier and showed on slide 9, we've experienced a decline in first quarter external chemistry revenues in each of the past three years. Based on current projections and a strong start in April, we expect a significant jump in external customer chemistry revenues during the second quarter.

As a reminder, external chemistry revenue increased by 68% during the second quarter of last year as compared to the low point in the first quarter of 2023. With respect to data analytics, we generated strong growth from this segment as revenues associated with JP3 increased 18% sequentially. We expect growth in data analytics revenue to be weighted toward the second half of 2024, which is in line with our expectations for the timing of the commercial deployment of our new analyzer. Moving to slide 10, fourth quarter gross profit increased for the fifth consecutive quarter. First quarter gross profit grew by $7 million, or nearly 400% compared to gross profit of just $1.9 million in the comparable period of 2023.

It's important to note that the minimum chemistry purchase requirements in our supply agreement were in effect during the first quarter of 2024, but not the first quarter of 2023, as the measurement of the minimum purchase requirements began on June 1 of last year. The additional revenue from our supply agreement requirements, combined with our continued focus on cost improvements, allowed us to generate strong margins during the quarter.

Touching on a few specific examples of how we are continuing to improve margins during the first quarter, we reduced freight costs as a percentage of revenue by roughly 50% versus the same quarter of last year as a result of numerous initiatives executed over the past year, including eliminating dedicated trucking and utilizing strategically placed staging yards to allow us to improve the efficiency in last mile deliveries. Over the past year, we have also made great improvements in how we purchase materials. We've consolidated vendors to leverage our spend to negotiate better pricing and rebates. We've also focused our efforts on buying direct in order to eliminate costly layers of middleman margins to reduce the highest spend on our P&L.

Quickly on SG&A, our first quarter SG&A declined to $6.1 million, which was about a 6% improvement compared to the same quarter of last year and sequentially. This decline was a result of lower personnel costs and professional fees. Moving to slide 11, adjusted EBITDA was positive for the third consecutive quarter, an increase of $7.9 million compared to the first quarter of last year. This is the 11th consecutive quarter of improvement in adjusted EBITDA, a streak that goes back to the second quarter of 2021. Going to the bottom line, reported net income of $1.6 million in the first quarter, compared to a net loss of $9.3 million during the first quarter of 2023, when adjusting for $31 million in non-cash gains.

Touching on the balance sheet, at March 31, we had $3.1 million drawn under our ABL, which was $4.4 million lower, or a 58% reduction than we had at year-end. As a result, our debt to trailing 12-month adjusted EBITDA moved down to 0.3 times as of March 31. Quickly commenting on our 2024 guidance. While we did not give specific revenue guidance for 2024 due to uncertainty around the timing of improved natural gas pricing and the corresponding impact on completion activity, we expect that first quarter revenues will mark the lowest quarter of the year, and we believe that annual 2024 revenues will generally approximate last year.

As a result of the positive impact of the numerous cost reductions implemented in a full year measurement period during 2024 related to the minimum chemistry purchase requirements, we anticipate a substantial increase in margins compared to 2023. Based on current projections, we expect our 2024 adjusted gross profit margin to range between 18% to 22%, which compares very favorably to our 2023 adjusted gross profit margin of 15%. With higher margins expected, we anticipate 2024 adjusted EBITDA to range between $10 to 16 million, which again, is a significant increase over 2023 adjusted EBITDA of just $1.5 million. In closing, Flotek continues to drive strong, repeatable performance focused on resilient profitability. Based on the current slope of the curve for natural gas pricing, we anticipate higher completion activity as we move into the back half of the year.

However, in the event that activity levels remain flat throughout the year, our first quarter results demonstrate our resiliency as we achieve strong margins and bottom line growth in a quarter of relatively light activity. With that, I'll turn the call back over to Ryan to close it out.

Ryan Ezell (CEO)

Thanks, Bond. Turning to slide 19, we are extremely excited about 2024 as we have tremendous growth potential in both our chemistry and data analytics segments, and we believe that Flotek represents a compelling investment opportunity to date. Our first quarter results delivered profitability, and we continue to be positioned for sustained growth as the collaborative partner of choice for sustainable chemistry and data solutions. I'm proud of the progress that we have made, and I'm confident in our ability to execute going forward. 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 are now ready to take questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press star followed by one on your touch tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please leave the handset before pressing any keys. One moment please, for your first question. Your first question comes from the line of Jeff Grampp from Alliance Global Partners. Your line is now open. Please ask your question.

Jeff Grampp (Managing Director and Senior Research Analyst)

Good morning, guys.

Ryan Ezell (CEO)

Good morning.

Jeff Grampp (Managing Director and Senior Research Analyst)

First, a question on Ryan, a question on JP3, specifically as it relates to the EPA regulatory approval you guys are working towards. Any kind of update on the timeline there or guesstimate as best you can provide today? And then, wondering what you guys are thinking or expecting in terms of the adoption curve or pace that you might expect from that, if and when you do get that approval.

Ryan Ezell (CEO)

So right now, we're happy with our progress and continued interaction with the EPA. Tom and the team are doing a phenomenal job there. Right now we're expecting the adoption of the EPA to come in line with regulations about the time that our production comes online, about mid-year. So I think we're making solid progress on both those fronts. And what's been really exciting is we're continuing to see massive adoption of our data as a service as a percentage of revenue. If you look back at Q1 of 2023, data as a service was about 23% of our revenue. In Q1 of 2024, it was almost 50%.

So, significant opportunities there, and I think as, as our, you know, the CalX model, which is our, our new 3rd-gen measurement unit, comes online into production, full steam by the mid, middle of the year, I think where we are with the regulatory body with EPA will be right in line with that, and it should give us a boost in the, in the back half of the year.

Jeff Grampp (Managing Director and Senior Research Analyst)

Great. Sounds good. I appreciate that. And, for my follow-up, more of a capital allocation question. Given the modest debt you guys have and the capital light model, and obviously the transition to becoming a more meaningful kind of EBITDA cash generative company, how do you guys kinda think about, you know, kinda reinvesting that potentially in the business or looking at M&A or any other kinda options on the table you guys may be considering?

Ryan Ezell (CEO)

... So a couple of things that we're doing is, for the first time since I've been here, we have invested into some trucking capitalization components. We'll be bringing in quite a few of some long-haul trucking for our chemistry to deliver in basin, which would be some capital allocation. This will provide a significant amount of savings in our logistics costs. We're also continuing to spend some CapEx in JP3 at the advancement of building units to support the growth in the back half of the year, particularly on the data-as-a-service model. And, you know, we're continuing to evaluate potential opportunities around M&A.

I do believe that, you know, when you look at the fragmentation in the chemistry markets and opportunities there, comparatively to the front end on the EP side, there's potential opportunities to look at some consolidation mechanisms there. Or when we look at advancements in bringing in some new technologies on the, JP3 and data analytics side of the business. So we are, we are continuing to evaluate opportunities there. The biggest thing on use of proceeds there is it needs to be extremely accretive to the organization, with most things that we, we put capital into.

Jeff Grampp (Managing Director and Senior Research Analyst)

Absolutely. Great. Sounds good, guys. Thanks for the time.

Ryan Ezell (CEO)

Yep.

Bond Clement (CFO)

All right, Jeff.

Operator (participant)

Your next question comes from the line of Don Crist from Johnson Rice. Your line is now open. Please ask your question.

Don Crist (Analyst)

Morning, guys. How are you?

Ryan Ezell (CEO)

Morning, Don.

Don Crist (Analyst)

I wanted to ask about the pilot project. Obviously, it's been going for a while now, and it appears that that customer is pretty pleased with the process so far. But have you had any other kind of field trips with other operators going out, seeing the sensor and kind of seeing the progress that's being made there? And is there anything to extrapolate between other potential sales there versus just the company doing the pilot with?

Ryan Ezell (CEO)

Yeah. So we've had quite a bit of expansion in that, Don, and I can't necessarily drop the exact names of the customer bases, but what I will tell you is we've seen expansion in monitoring field gas. We've seen an increase in the number of customers looking at monitoring flares in real time. We've also seen an exponential increase in the field trials and process validations we have around on chain of custody measurements in multiple field and geographic locations. So we're really excited. We've got in the double-digit number of units deployed in these different areas, particularly running the CalX spectrometer through its phases and making sure that... And typically, we've got it in line with a former Verax unit to make sure everything's lined out and run effectively.

We're really excited about this, and the opportunities continue to come to us, and we're hard at pursuit of these.

Don Crist (Analyst)

Okay. And as you look to ramp up, I mean, obviously, the opportunity set is significant in front of you, assuming everything goes to plan. But as you look forward, any significant CapEx requirements or anything to build out the larger amount of sensors that you would need, or is that kinda in place already?

Ryan Ezell (CEO)

So we in alignment right now, where we're forecasting the growth just in, say, 2024, that 50% range, we've dedicated capital to front load a little over $2 million, to advance the build on the units. Now, that $2 million goes further in building the CalX units because they have a much lower cost base than the original Verex unit. So it's a solid improvement there. And then we're going through the processes now with the adoptions that we're expecting with the EPA around how much additional capital we'll bring forward in the early parts of, 2025, looking at the growth there.

Don Crist (Analyst)

Okay. But it's not significant at this point, though?

Ryan Ezell (CEO)

No, it—I would say that because we can... Like I say, when you have a substantial drop in the cost of units versus, you know, let's put $2.5 million, we can bring quite a few, quite a few units on between now and the end of the year.

Bond Clement (CFO)

Yeah. Don, you'll remember that was the important thing about moving to this next generation of analyzer because the costs are roughly 50% to 60% less than the previous generation.

Don Crist (Analyst)

Right. Exactly. And I know in the past you've sold these units, but you're, you know, trying to shift over to more of a subscription model. Have you had any, you know, positive or negative influence or, you know, feedback from customers on either way? I mean, are people still wanting to buy these, or are they more happy with a subscription model with you making sure everything's running properly going forward?

Ryan Ezell (CEO)

That, that's a great question. I think when we look at it, it depends on if you're an upstream, midstream, or a downstream application. What I would consider to be more the golden applications in the midstream part, a lot of the customers that, that we continue to expand business with prefer, the capital purchase just because of how the unit is utilized. What we're seeing is a predominance in the upstream business to be 90%+, in terms of a either, one, a data-as-a-service model or a hybrid-type service, with a large subscription-based model with the minimal capital investment upfront for the installation. So, I think it kind of depends on the application. But, you know, pretty much the application is heavy on subscription-based and upstream. There's still a little preference to the capital purchase in the midstream part.

Bond Clement (CFO)

Yeah, Don, Ryan gave some stats on the percentage of revenue from DaaS versus capital sales, 1Q versus 1Q. Including those percentages, when you look at just pure DaaS revenue, quarter-over-quarter, it's up 30%, first quarter of 2024 versus first quarter of 2023. So people are migrating to the DaaS model, certainly.

Don Crist (Analyst)

... That's, that's good to hear. It's much more sustainable, and it gets a higher multiple. I appreciate the color, guys. I'll, I'll turn it back.

Ryan Ezell (CEO)

All right, thanks.

Operator (participant)

Your next question comes from the line of Eric Swergold from Firestorm Capital. Your line is now open. Please ask your question.

Eric Swergold (Managing Member and Chief Investment Officer)

Good morning, and congratulations on your hard-fought progress. There's-

Ryan Ezell (CEO)

Appreciate it, Eric.

Eric Swergold (Managing Member and Chief Investment Officer)

There's been a number of industry pieces talking about the use of AI in the E&P space. Can you speak to how your data analytics and chemistry segments fit into this new AI framework for E&Ps? Thanks.

Ryan Ezell (CEO)

Yeah, you know, this is actually a real, I would say, exciting frontier for us, Eric, is that initially, most of the AI-oriented activities that we're doing were around our chemometric modeling and things that we're doing on the JP3 side, leveraging that large database of crude samples that we've had over the last 5-7 years. And so there's a lot of advancements that we're making to accelerate the accuracy of the models, accelerate the group fits, particularly when you look at, I would say, these chain of custody and readback pressure measurements and stuff that we're doing there. And AI continues to be a large part of that.

What's been really exciting is we took a step back and said, "Hey, if you've been an innovative chemistry company with, you know, 200 patents in the advanced reservoir technologies component," when you look at some of these influences at the nanopore level and what goes on with subsurface interactions and things, we've completed over 20,000 wells, and we have production data and chemistry modeling for these things. So we've gone in and now using AI to actually take these data sets, crunch them, create cubes of different datas with that, and advancing at how we look at the performance of our chemistry to make small formulation changes and actually advance where we're gonna be in the future and what I consider to be improved oil recovery for the total life of the asset.

So I think it's playing an essential part for us to accelerate our technology and the thinking that we do on both the chemistry and the data side. And what it's starting to do is really create an amount of synergy and a unique platform, I think, to Flotek, that we're gonna be talking quite a bit about in some of the upcoming events we have at the Louisiana Energy Conference and what we're gonna talk about EnerCom in Denver later in August. We're gonna be presenting some of this work.

Eric Swergold (Managing Member and Chief Investment Officer)

Sounds good. Thanks very much, guys. Keep it up.

Operator (participant)

Your next question comes from the line of BJ Cook, an individual investor. Your line is now open. Please ask your question.

Speaker 7

Hey, guys. Thanks for taking my call. BJ Cook with Singular Research. You guys talked about external chemistry this year. I expect it to increase here, but I know it's determined on volume quite a bit. I'm just curious if you guys anticipate or are adding new external operators to your platform?

Ryan Ezell (CEO)

Yeah, 100%. I mean, the biggest part we look at on external chemistry is we've seen since the tenure of being here, our seasonality shift a little bit from what used to be Q3 to Q4. Now, with a little bit, I consider it to be the capital discipline, the way to look at frac plans and the ability to turn the spigot on and off here in the U.S. We've seen some of that seasonality shift into Q1, and that's traditionally been probably our least active quarter on the external chemistry sales component of that. But comparatively speaking, over the tenure that we've done this turnaround, you've seen average frac fleets in those quarters go down, and our revenues continue to go up substantially.

As you look at, say, for Q2 to Q4 through the rest of this year, we've got a substantial, a really healthy and robust pipeline and continued activity with a strong group of what we call, you know, our stickier customer base and quite a few new opportunities on the backside here. As the adoption of our prescriptive chemistry management and our understanding of reservoir technologies are coming into prominence, as you're starting to see a lot of these operators move into infill, well design, and down spacing on how they do their completions.

Speaker 7

Great. Thanks. I appreciate that

Ryan Ezell (CEO)

Yep.

Operator (participant)

We don't have further questions at this time. Presenters, please continue.

Michael Critelli (Director of Finance)

Thank you again for joining us today. Flotek CEO, Ryan Ezell, will be participating on a service industry panel at the Louisiana Energy Conference on May 29, 2024, at 4:00 PM. He will be joined by CFO Bond Clement in hosting meetings with investors, and a copy of the presentation will be used in the discussions with the investors will be available on the corporate website prior to the event. We look forward to meeting with you. Thanks again for joining us today. Please feel free to contact us if you have any additional questions. Have a great day.