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Flotek Industries Inc (NYSE:FTK)

Q4 2008 Earnings Call

March 16, 2009 10:00 am ET

Executives

Jerry Dumas - Chairman, Chief Executive Officer and President

Steve Reeves - Executive Vice President, Chief Operating Officer

Jempy Neyman - Senior Vice President and Chief Financial Officer

Andrew Jowett - Chief Accounting Officer

Brian Shannon - Investor Relations

Analysts

Mark Brown - Pritchard Capital Partners

Sara Hunt - Alpine

Jacob Segar - Alameda Investments

Tom Sullivan - Private Investor

Operator

Good morning, and welcome to the Flotek fourth quarter and year end 2008 results conference call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. An operator will give instructions on how to ask your questions at that time (Operator Instructions). This conference is being recorded.

At this time, I would like to turn the conference over to Brian Shannon. Mr. Shannon, you may begin, sir.

Brian Shannon

Good morning and welcome to the Flotek year end 2008 conference call. Today’s call is being webcast and a replay will be available on Flotek’s website for seven days. The press release announcing the year end results will also be available on the Flotek website.

Before turning the call over to Chairman, CEO and President Jerry Dumas, I’d like to remind everyone that some of today’s comments may include forward-looking statements reflecting Flotek’s views about future events and that potential impact on performance. These matters involve risks and uncertainties that could impact operations and the financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in Flotek’s filings with the SEC.

Now I’ll turn to call over to Jerry Dumas.

Jerry Dumas

Thank you, Brian and welcome to all of you. We appreciate you joining our call this morning. Joining me today are members of the management Steve Reeves, our Executive Vice President and Chief Operating Officer; Jempy Neyman, our Senior VP and Chief Financial Officer; Andrew Jowett our Chief Accounting Officer.

In today’s call Steve will provide segment results and comments on our operations and Jempy will discuss our financial performance in our liquidity position. We will welcome questions after we complete our prepared remarks and we’d like to say to all of you that we’re looking forward to a very interesting period of time of questions, we welcome those questions.

In the year 2008, we increased our total revenue for the fifth year in a row growing 43% to a total of $226 million. This revenue increase occurred across all three segments of our business. In our drilling product segment, we are pleased with growth assisted by acquisition of Teledrift.

With the addition of this technology, we have achieved a significant increase in operating profit and in addition this gives a technological content to our downhole tool group, which is one of our goals as to continue to build the technological capability. Our proprietary chemicals continue to see greater growth and acceptance from our customers an increased activity could lead to gains in Artificial Lift.

Every year in the fourth quarter, we review goodwill and other intangible assets. Given the general economic climate and have an experience to decline in stock price inline with the market, management determent an impairment of $67.7 million was appropriate to right down goodwill to its fair value. Our net loss for the year was $31.9 million for our current year.

Excluding the effects of the impairment, adjusted income for the full year 2008 was $16.4 million or $0.85 per fully diluted share. Jempy Neyman our CFO who will provide further details in our presentation. He will expand greatly on our credit facility changes, which reflects the corporation and the support of our banking relationship with Wells Fargo, Prudential and Comerica.

I personally continue to monitor closely our SG&A cost and have identified $3 million in one-time cost that have impacted 2008. These costs related to increases in IT expenses, consulting and professional fees to improve assistance for reporting, severance costs and fees associated with Teledrift acquisition.

Although we typically provide earnings guidance for the upcoming year with the current uncertainty surrounding the duration and severity of this downturn, it would be difficult for us to provide earnings guidance within a great level of competence. Therefore we will not be issuing guidance for 2009. My confidence in this company and employees that work side-by-side with management is very strong.

At this point, I would like to have our Chief Operating Officer, Steve Reeves to give the segment performance. He will point out changes and events that affected our fourth quarter beyond the usual occurrences. Steve.

Steve Reeves

Thank you, Jerry. In our Chemical and Logistics sections, year-end revenue increased 26.8% to $109.4 million for 2008. Sales of biodegradable ‘green’, micro-emulsion chemicals grew 37.2% to $77.4 million for the year, as a result of increased fracturing activities and wider acceptance of our micro-emulsion products for both independent and the major pumping companies.

The operating income was $37.4 million in 2008, a 16% increase over 2007. However, due to rising costs of raw materials such as petroleum-based feedstock, operating income as a percentage of revenue declined 34.2% for the year. The increasing cost was partially offset by a price increase to our customers using these products.

Investment in infrastructure for international initiatives and declining market conditions experienced in the fourth quarter also impacted our performance in Chemical and Logistics. In response to declining market conditions and forecast for 2009, we’ve taken measures to size the segment to the marketplace and we’ll continue to do those. One of our production chemical facilities will be relocated to our Marlow Oklahoma facility.

The chemical segment required minimal capital expenditures. However, in keeping with our technology-driven strategy, we remain active in our R&D efforts and we will maintain these costs at current levels as a percentage of revenue. We’re experiencing pricing pressures of course from customers and we’ll therefore focus efficiently on margin protection through managing our raw materials and all our fixed costs.

Our drilling products revenue was $98.3 million for 2008, an increase of 73% on most over 2007. The Teledrift acquisition contributed more than 50% of this growth. Organic growth related to tool rentals, services and inspection, and the expansion of mud motor fleet provided the balance of segment’s increase.

While our initiative to develop Flotek shock subs and drilling jars replacing our sub-rentals had a minimal positive effect in 2008, we anticipate the benefits to these initiatives to be realized in 2009.

Loss from operations was $43.8 million in 2008. Adjusting for the effective impairment of $59.1 million related in this segment, adjusted income from operations was $15.3 million for the year ended December 31, 2008 approximately 170% higher than 2007.

Income from operations as a percentage of revenue increased to 15.6% for the year. The increase in operating profit was primarily driven by the acquisition of Teledrift and our expansion into higher margin tools, motors and services. We also made many strategic investments in new North America sales facilities and we opened two new repair facilities during the year.

The Drilling Products segments required higher levels of capital expenditures than our other segments. Capital expenditures in the year 2008 were approximately $20.1 million for the drilling segment. Due to current market conditions that began to develop late last year, we plan to reduce capital spend in this area by more than 50% in 2008.

Our plan is designed to meet our maintenance capital requirements and provide opportunities to grow our business in the area of higher margin drilling jars and seal bearing motors as part of our strategic drilling products suite.

We are taking actions also to size the Drilling Products segment to the current marketplace through strategic actions that are focused on personnel and our fixed costs. Our decisions, while in reaction to the current trend are being made to provide us with the greatest flexibility to capitalize on the anticipated return to more normal market conditions sometime in the near future.

Pricing remains very competitive and we will aggressively defend our market share with competitive prices and market protection by combining technology with commodity products. Drilling Products will continue the initiative of replacing sub-rented drilling jars and shock subs with higher margin proprietary tools.

Additionally we’ll continue to draw our presence in the international markets through CAVO mud motors and the Teledrift line of MWD products including the new TelePulse MWD for horizontal drilling that we will introduce in 2009.

Artificial Lift sales were $18.4 million for the year 2008. This was an increase of 23.8% over last year, primarily due to the very active coal bed methane drilling in Wyoming. A price increase implemented in August and an increase in rod pump sales. However, some of this was offset by an increase in our raw material costs.

Loss from operations was $6.7 million for Artificial Lift for year 2008, primarily as a result of the previously discussed impairment charge. An impairment of $8.6 million was recorded related to the Artificial Lift segment. Excluding the effect of the impairment, adjusted income from operations was $1.8 million or approximately 33.5% higher than adjusted income from operations of $1.4 million in 2007.

Income from operations as a percentage of revenue increased slightly to 10% for the year 2008. We also made strategic investments in this segment by adding two new rough rod pump repair facilities and increased our field sales presence.

Consistent with our strategy within our other two segments, we plan to reduce our operating cost structure to align with the current changing market conditions while maintaining flexibility to capitalize on our return. In the first quarter 2009, we’ve instituted reduction in workforce in response to a decrease in our customers drilling activity in coal bed methane and related pricing pressures.

Our strategy is to focus on competitive processing and exceptional service by offering our proprietary downhole gas separator technology and Petrovalve rod pump systems especially in the international markets.

Now, I’ll turn the call over to Jempy for the financials.

Jempy Neyman

Thanks, Steve. Our cash flow from operations net cash of $24.9 million for the year, our cash flow from investments was a negative $117.2 million, of which $98 million was for the acquisition of Teledrift and $23.7 million was for capital expenditures. Cash flow from our financing activities contributed net cash of $91.2 million, of which $155 million were the gross proceeds from the issuance of our convertible bond and $27.6 million was net amount repaid under our revolving credit facilities during the year.

Our EBITDA for 2008 was $49.7 million. The company evaluated its goodwill and other intangible asset values in the fourth quarter of 2008 and we concluded that an impairment of $67.7 million should be recorded in 2008. Even though this analysis coincided with our annual goodwill impairment review, management felt that given current market conditions the general malaise of the world economy and the fact that our book value was greater than our market cap, a trigger event had occurred.

We’ve retained the services of an outside valuation consultant and an appraiser to assist in the valuation exercise to determine if any assets, both goodwill and intangibles were impaired and to help us determine the fair market value of assets and liabilities necessary to compute the applied goodwill under the current market conditions.

The result of this analysis was the aforementioned non-cash charge of $67.7 million and that is reflected on the December 31, 2008 financials for the company. The impact of this charge was that as of December 31, 2008, we didn’t meet the minimum net worth covenant contained in our credit agreement dated March 31, 2008.

On February 25, 2009, with the assistance of our lending group, we entered into the First Amendment and Temporary Waiver Agreement, which amended the terms of the credit agreement and this amendment among other things increased the interest rate margins applicable to the advances under the credit agreement to our prevailing market rates. It decreased the aggregate revolving commitment under the credit agreement to $15 million from $25 million.

That was a mutually decided upon reduction. We felt that under the current, covenant structure that we would not reach those availabilities anyway and so that was reduced to a more probable level and we were able to save commitment fees on $10 million, and it also provided a temporary waiver of any breach by Flotek of the minimum network covenant through May 15, 2009.

The amendment also permits the company to exchange shares of its common stock for up to $40 million of convertible senior notes, which otherwise was prohibited under the credit agreement. At the time we did the temporary waiver, it was contemplated that the first amendment and waiver would be followed in short order with the second amendment, to address the potential noncompliance within the next year of the leverage ratio and the fixed charge coverage ratio covenants. That was determined by looking at projections for 2009, that we provided the bank.

Due to all these factors, we executed the second amendment to the credit agreement, which closed on March 13, and the second amendment among other things permanently reduces the aggregate commitment amount for our revolving credit to $15 million. It establishes a new interest rate metrics again at current market, as well as commitment fee levels.

It limits our permitted maximum capital expenditures to $8 million in ‘09 and $11 million in 2010, and it establishes new covenants related to the minimum net worth, the leverage ratio and fixed charge coverage ratio.

The CapEx, limits that were set were based on amounts that we felt were necessary for maintenance CapEx and the capital required to maintain the revenue projections that we had developed. Amortization schedules for the repayment of our debt were unchanged and the required payments of $2 million quarterly, through maturity of the credit facility, on March 31, 2011.

So with that, I’ll turn things back over to Jerry.

Jerry Dumas

At this point we would like to turn the call back to our participants for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Brown - Pritchard Capital Partners.

Mark Brown - Pritchard Capital Partners

Under what condition would you go through with exchanging shares of common for the convertible debt?

Jempy Neyman

Well Mark as you well surmise, we have looked at numerous strategies that would involve the conversion of debt or strategies actually that would entail repurchase of those shares. The amendment that we reached with the bank was with no particular strategy in mind, it was simply to give us the flexibility, if that opportunity presented itself and we thought at that time that it would make sense to do that.

I think the, sort of the seductive part of either repurchasing the bonds or converting the bonds is that long term if you could bring them back at the significant discounts, which they’re currently trading that might be attractive.

However, there is a liquidity issue if we were to use cash or try to arrange some sort of borrowing to buy those back and then there is a dilution issue if we do a conversion. So, I guess the long-winded answer is that we simply have looked at all those strategies and we just want to be positioned incase an opportunity presented itself that made sense.

Steve Reeves

So, let me further comment on that, Mark. I’m sure that when that part of the announcement was made, there were a lot of people who assumed that we were presuming to do that immediately and thereby dilute to shareholders. That is the furtherest thing from the truth at that point.

We view the entire situation relative to our stock and relative to the marketplace that we are faced with as being one of liquidity. Clearly, that’s been our priority and because of the cooperation of our bank and through their work of Jempy, we have addressed that issue and we feel relatively comfortable.

So, with regard to looking at converting the bonds to equity in any fashion, we feel like our priority is to deal with the debt that we have with our bank and if in the future, improvement occurs in certain areas then we clearly would continue to look at every avenue of improving the liquidity of our company.

But obviously the priority was to work with our bank, the priority of our bank was to work with us and that has been accomplished and we’re very comfortable now as we go forward into this very challenging year, which is clearly our objective to come out of 2009 in good health.

Mark Brown - Pritchard Capital Partners

Have you changed the ratios for the three covenants that you talked about Leverage, Fixed Charge Coverage and Minimum Net Worth or maybe you could just comment on a little more detail in terms of, if those have changed from the March ‘08 agreement?

Jerry Dumas

Yes, they have. Let me start with the Minimum Net Worth. Essentially, what will happen on the Minimum Net Worth to accommodate the goodwill impairment write-down, in the old agreement the base booked Net Worth was the ’07 Net Worth, and what we’ve agreed to with the banks is that we reset that to the 12/31/08 Net Worth and so the starting point would be 90% of that and then the calculation for each subsequent quarter remains the same as it is in the current agreement.

The Fixed Charge Coverage Ratio remains the same with the exception of one quarter and that is fourth quarter ‘09, which is a quarter where we anticipate things could be fairly tight and that’s been reduced from the 1.25 coverage. The Leverage Ratios are discrete for each quarter and I think if the agreement is being filed with the K and so you’ll be able to see what those are specifically as we go out through 2010.

Jempy Neyman

One thing Mark, that there might be an oversight as looking at the fact that we attended to the issue of liquidity and Steve will get into more detail about how we’ve sized our company to this marketplace that we’re dealing with. Another question from you, as we have other --

Mark Brown - Pritchard Capital Partners

No, I’m good. I’ll go back in queue.

Operator

Your next question comes from Sara Hunt - Alpine.

Sara Hunt - Alpine

Can you talk a little bit about, where that the debt stands now? You’re paying $2 million a quarter. Is there something else that goes on? I seem to remember the possibility of a further payment in April. Can you just talk a little bit about, where that stands since you didn’t file a balance sheet?

Jerry Dumas

Yes, good question Sara. The K will be filed today, so you will be able to see that this afternoon. Yes there is a mandatory prepayment that will be required and it is calculated looking at our, essentially our free cash flow as of 12/31/08 and that number’s going to be roughly $3.6 million required prepayment and we’ll make that April 15.

Jempy Neyman

Sara, we’re currently at $34 million and at the end of March we’ll drop that down to $32 million, and then on April 15 we will knock that down to $28.4 or something to that level. That was the areas that we’re paying considerable attention to and our cash flow as projected and as performed and so forth is allowing us to handle that.

Sara Hunt - Alpine

Okay and then to switch gears now and I’ll let somebody else ask a question. I know you don’t want to talk about what 2009 looks like, but can you talk at all about current conditions and what you’re seeing now, versus what you saw at the end of last year?

Because a lot of rigs have gone down between now and then, I think all of us who are still involved are interested in how that’s affecting you, and how you see that playing itself out. Because clearly with natural gas prices where they are, I would expect to see a fairly low rig count for a while and I’ve remember talking about some of the areas where it was most beneficial for you. Could you just talk a little about business conditions?

Steve Reeves

Sure, I’ll take that up, Sara. This is Steve Reeves, thanks for the question. It’s a tough world, but so world I’ve lived in five or six times before. So, we’re going to come out of this thing all right making the right decisions. We have some places that we’ll hold up during the downturn. We’re well aware that rig counts off 45% and still going downward. We are making, when we talk about sizing to the marketplace to keep cash flows up, we’ve had a major round of reduction in force already which will come up to about a $5 million savings for the year.

We’re trying to stay on top of the things, we are consolidated some facilities and taking them out, and at the same time we’re moving into some facilities. We just opened up in the northeast, in our Pittsburgh facility last week and are having very good success for early on. So what we’ve done, we set triggers this year on rig count and national gas prices because that is such a big driver in our business; and as those triggers are met we have action items that we step up and look at to try to stay right in line with what is going on.

We’re well aware of each one that’s coming along. Where we have built our business in the Haynesville, we’re trying to focus where we see things in the northeast, in the Marcellus. The other side that we’re on, we’re pushing hard on our international activities to help pick some of this up. We expect to see some improvement in our Teledrift facility.

Sara Hunt - Alpine

How much of Teledrift is overseas versus domestic?

Steve Reeves

Teledrift overseas is about 30% totally. We do about 70 of Teledrift domestically. We expect that to pick up, be at either through some of our stuff like Libya, our contracts in Saudi and some other focus we have. We also believe that our MWD will sell well, will translate well into international sales for Teledrift. So, we are mitigating some of these things with international activities and like I say, making the adjustments to trigger as it falls [inaudible].

In addition to that, Sara, I mentioned earlier in my comments that we have identified in IT, in our areas of consultants that we used in our internal auditing, as required by [SAWS] and our SAWS deal that we’ve identified approximately and some reduction personnel which costs us some severance pay. We’ve identified about $3 million that are nonrecurring costs which we anticipate being able to take advantage of in ‘09.

Sarah Hunt - Alpine

On the $3 million that’s non-recurring in 2008, that's above and beyond the $5 million that you're talking about from personnel cuts and everything else that you already triggered for 2009 into cost savings, is that correct or two different pieces there?

Steve Reeves

That is correct. We also have made another adjustment incorporate coming around. We will be looking at probably another $700,000 that we identified. So, we are looking at these, Sarah. We realize that the market is what the market is, but we will be reducing costs across our entire group.

Right now, as a matter of fact, one of the things that goes on. Last year our cost of goods got a little out of control because we couldn’t do anything about our petroleum feedstock products. We have driven those down significantly already this year, where it won’t make up for all of the loss of it. It will help us protect our margins. So, we are as aware of costs as we are of the lack of revenue that we can generate with lower rig count.

Jerry Dumas

I want to clarify Steve's comment that we have identified another $700 or $750. We not only have identified it, we actually acted on it. So, that reduction began effective April 1, so that's another reduction and that's a net reduction that will occur in the last nine months of the year. We are sizing the company to what a 1,000 rig estimate will do for us.

Sarah Hunt - Alpine

Okay. So, you are thinking about a world with a longer term 1,000 rig counts at least for now, because that’s sort of what things look like?

Jerry Dumas

Well, I'm looking at a downturn that will take you to 1,000 rigs. Frankly, there is all kinds of conversation about how long this thing is going to last. So, I can give you a scenario where it will not last a long time. I can give you a scenario where it will. I don't know.

Sarah Hunt - Alpine

Yes. I think that's sort of the way of the world right now. So, that part I can appreciate.

Jerry Dumas

Well, that’s the world we are living with right today. So, we are actually looking right now for the possibility of what we might do if the rig count stays at 1,000 for two years and frankly I just can’t see that, but then I can't see that far.

Sarah Hunt - Alpine

Well, I mean there is a lot of controversy or at least questioning about the prolificness of somebody’s plays, that means we don’t have to go back to a higher rig count, but I think that’s we’re going to play itself out, we’ll just got to have to wait and see what happens there, but I appreciate it and after I get a chance to look at the K, I’m sure I'll come check back with you with a couple questions, but that you for now.

Operator

Your next question comes from [Jacob Segar] - Alameda Investments.

Jacob Segar - Alameda Investments

Jerry, I know you talked last time about your personal plans on repurchasing shares?

Jerry Dumas

And our going to, as soon as the Flotek Secretary tells me that the closeout period is open for me, I will do so, because I believe in this company. I think that the price of the stock is a very attractive price for me to pay. If other people agree to that and Mr. Reeves purchased stock in the company, I think he bought 100,000 shares and I intend to spend approximately $100,000 on stock on my first move as soon as soon as I'm allowed to do so.

Jacob Segar - Alameda Investments

That was about in the April timeframe, is that correct?

Jerry Dumas

Our Corporate Secretary is standing here right now.

Rosalie Melia

It will be in the middle of May. That was depends on when our earnings release for the first quarter. We’re in blackout until that time.

Operator

Your next question comes from Tom Sullivan - Private Investor.

Tom Sullivan - Private Investor

Given the performance of the company this year, can you all comment a little bit about the recent grants given to you and the Board of roughly half a million shares?

Jerry Dumas

Well, what we’ve done is the Board of Directors and Compensation Committee decided to forego any cost associated with our compensation that would have normally occurred in a company and put the board and the board and the Comp Committee made a decision to give us opportunity to share the performance hopefully in a positive way with all of the other shareholders.

If you will take a look at my salary, it has remained static for the last two years and as a result, my compensation is going to come from improvement in the shares as it is the appreciation for the shareholders.

We also have a group of individuals that we use these as an incentive to continue to perform. These are people that we have great confidence in and that will assist us in getting through these very difficult and trying times. We basically have given them the incentive of participating in the appreciation of the stock because there will not be any salary adjustments at all this year for those people.

Interestingly enough, Tom in this downturn quality people are being solicited by competition. As a matter of fact we’ve been able to successfully bring a board, I know of two very, very strong people that we brought a board that were would not necessarily have been available to us, and we are taking this opportunity to upgrade and strengthen our organization in two or three different areas.

So, as I said interestingly enough some of your best people are becoming available to other companies and we can’t afford to lose people in that regard. I think Steve has made that very clear in his organization.

Operator

Thank you. There are no further questions at this time.

Jerry Dumas

Well, thank you very much everyone.

Operator

Thank you for participating in today’s conference call. The call has now concluded. You may release your lines.

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