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Flotek Industries Inc (NYSE:FTK)

Q4 2007 Earnings Call

March 17, 2008 11:30 am ET

Executives

Jerry Dumas - Chairman and CEO

Lisa Meier - VP and CFO

Analysts

Joe Hill - Copia Capital

Thomas Escott - Pritchard Capital

Terese Fabian - Sidoti

Megan Bissell - Fig Partners

William Conroy - FMH Capital

Operator

Good morning and welcome to the Flotek Industries Incorporated conference call. (Operator Instructions)

At this time, I would like to turn the conference call over to Mr. Jerry Dumas. Mr. Dumas, you may begin.

Jerry Dumas

Good morning, everybody. Thank you for joining us today. I want to remind everyone that this call may contain forward-looking statements about future financial results. Any actual results may differ materially as a result of factors that are outlined in our filings with the SEC.

Flotek delivered a strong performance in '07 and we had earned net income of $16.7 million or $0.88 per fully diluted during 2007 compared to $11.4 million or $0.61 per fully diluted share in '06. Our net income increased 47% and fully diluted earnings per share increased 45% in '07 versus '06. All amounts reflect a 2-for-1 split we completed in July of '07.

Our focus has been clearly on expanding sales and rentals, our proprietary technology-driven products. Because of this company-wide, we increased our gross profit margins from 41% in 2006 to 43% in 2007. Operating income margin remain constant at 19% in 2007 and 2006.

We generated total revenues of $158 million compared to $101 million in 2006 despite adverse weather and lower gas prices due to the lack of pipeline outlets in the Rocky Mountains. Our organic sales growth makes approximately 64% of our year-over-year growth. The acquisition of Triumph Drilling Tools, Sooner Energy Services and CAVO Drilling Motors made up the bounce.

The Chemicals and Logistics segment increased revenue 71% year-over-year of the result of 117% growth in our biodegradable, environmentally benign green chemical sales.

In the latter part of 2007, we completed our state-of-the-art research and development lab north of Houston in the Woodlands. This lab is directed by Dr. Kaufman who has had over 15 years of research, patent development and publication experience.

The company also signed a five-year agreement to build and operate a liquid chemical distribution facility for a major service company. And this construction of our liquids and chemical facility was completed during the fourth quarter of 2007 and is expected to double our throughput service revenue in '08.

The new liquid chemical distribution facility and our existing cement handling and blending facility will provide a broad range of blending and logistical services to our customer for cementing and stimulation products used offshore, in the Gulf of Mexico and along the entire Gulf Coast.

In September of '07, the company acquired Sooner Energy Services to establish a platform for expansion into production chemicals. Sooner develops, produces and distributes specialty chemical products and services for the drilling and production of natural gas. The Sooner acquisition contributed approximately $2 million in revenue in '07. Our plan for this firm is to move our bio-safe products from CESI to that organization.

Our drilling products revenues grew 55% year-over-year despite significantly drilling price competition. The acquisition of Triumph Drilling Tools and CAVO Drilling Motors contributed approximately $18 million in incremental revenue in 2007.

The focus in this segment is continued integration of business acquired, product line expansion and moving from sub-renting products to owning them to increase the profitability on those rentals. The acquisition of Teledrift in February of '08 will promote these core objectives.

Our artificial sales grew 11.7% year-over-year. Low gas prices and pipeline capacity constraints significantly reduced our coal bed methane production activity in the Powder River Basin in '07 versus '06. The opening of various pipelines in this region should promote higher activity levels in 2008.

Our corporate costs were $9.7 million in '07 versus $5.8 million in '06. The primary increase in this relates to the expansion of our accounting and the support personnel for our growing company, our IT initiatives, our IT equipment and IT personnel, as well as compensation expense for equity granted to officers, directors and employees.

At this time, I will turn the call back over to the operator for any questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Joe Hill from Copia Capital. Please go ahead with your question or comment.

Joe Hill - Copia Capital

Good morning, Jerry.

Jerry Dumas

Good morning, Joe.

Joe Hill - Copia Capital

How are sales of the micro-emulsion tracking for the first quarter?

Jerry Dumas

Well, with exception of some heavy slow turns, we feel like we're tracking reasonably well.

Joe Hill - Copia Capital

Okay. And what is your outlook for pricing in the mud motors business for this year?

Jerry Dumas

At this point, we haven't run into a great deal of pricing pressure in the motors. The pricing pressure has been primarily on what I would call the dumb iron or the [main two] products. Interestingly enough, the pricing pressure is coming from some of our larger competitors. At this point, Flotek Downhole Tools is arguably one of the largest among the two others. And we've resisted pricing reductions, but there seems to be some pricing pressure out there. Let me restate, Joe, definitely some pricing pressure out there, but not in the motors.

Joe Hill - Copia Capital

But not in the motors, so can you give more specific as to what product categories or what tools are seeing the pressure?

Jerry Dumas

Sure. What I call the dumb iron, the stabilizers, the roller reamers, things of that sort. And you know that's where you have a lot of small mom-and-pop operations that can get into that business, which is exactly the reason that we've moved to a far greater percentage of our downhole tools to be technologically advanced, such as our acquisition of Teledrift and CAVO.

Joe Hill - Copia Capital

Okay. And last question, you mentioned that pipeline capacity expansions may help artificial lift this year. Can you give us some detail, are you talking about rigs, are you talking about something else in terms of seeing a pickup in that business?

Jerry Dumas

Well, right now, we're seeing a significant increase in planned drilling in the CBM business by our customers. And we feel like that we will see a much stronger market for our product in the Powder River Basin. In addition to that, we're clearly looking at the opportunity to move geographically through our organic growth and our artificial lift is our plan for this year primarily.

Joe Hill - Copia Capital

Geographically what are your opportunities in the list?

Jerry Dumas

Well, in the Oklahoma, Eastern Oklahoma area, and Southern Kansas, certainly in the San Juan Basin and forming to New Mexico in the Four Corners. Those are two very quick areas that we are looking at. In fact, we are looking at Oklahoma as we speak.

Joe Hill - Copia Capital

Okay, is that Petrovalve or the Gas Breaker?

Jerry Dumas

Both.

Joe Hill - Copia Capital

Okay. Thank you, sir.

Jerry Dumas

And also that the coal bed methane product of that.

Joe Hill - Copia Capital

Okay. Thank you very much.

Jerry Dumas

Okay, Joe. Thank you.

Operator

Our next question comes from Thomas Escott from Pritchard Capital.

Jerry Dumas

Hi, Tom.

Thomas Escott - Pritchard Capital

Good morning. A couple of things. One, can you comment on new product introductions or let's say the success of new product introductions in the chemicals side of the business, and then, in addition to that, the success or progress in introducing the chemicals into different foreign applications?

Jerry Dumas

Before I answer your question, did you get your roof blown off out there in Atlanta?

Thomas Escott - Pritchard Capital

It was quite a blow, but we did okay. Thank you.

Jerry Dumas

Okay. Let me have your question again with regard to introducing our chemical products into the international field. We're very enthused about the potential for that, and I can only say to you that we have begun our activity and our initiative internationally and we have complete cooperation among our organization in the addition of that initiative. So I feel that we will see some progress in the latter half. It's going to take first half of the year to get our actions in place, but we're definitely doing that.

Now, what was the other part of your question?

Thomas Escott - Pritchard Capital

Well, on chemicals, you spent a lot of effort on introducing some new chemicals or developing some new chemical applications in the US. How was that success doing?

Jerry Dumas

Well, we basically have introduced the micro-emulsion sometime ago, and it continues to be a very successful application in unconventional gas play, whether it be in a shale sections or whether it be in the tight sands. At this point, other than the other products that we've had and the increase in formulations that we've had with our micro-emulsion, we have introduced no other new products at this point, although we are clearly geared up to that. And hopefully, we will be able to introduce a whole new product line in this year.

With regard to our micro-emulsion, we have now determined that while it has been a tremendous success in using it for unconventional sands, we've now found out that it is now an acceptable and profitable decision on the part of the operator to use it in acidizing. So, we would anticipate that that would give us a broader acceptance to the product in North America, but particularly in a international market where acidizing is far greater than fracing.

Thomas Escott - Pritchard Capital

Okay. On the tool business, obviously, there has been a lot of price pressure and margin compression in the downhole tool segment. With the addition of Teledrift, is that going to be enough to hold profit margins stable to better in '08 or are margins there continuing to deteriorate kind of gradually through the year?

Jerry Dumas

I think from a strategic point of view or from a strategy and then a tactical activity execution of that strategy, we've made a decision that, as opposed to what we did in '07, we are going to meet the competition with our dumb iron business. On the other hand, the Teledrift product line and the CAVO motor line, which have not been hammered, have not had that kind of pressure, will certainly contribute to the profitability of our downhole tool business. And without question, we're going to continue to seek pricing pressure on the dumb iron section of our downhole tool.

The other thing we're working on as rapidly as we can is to bring as many new tools into our inventories, specifically jars and motors and [sharp subs], which will eliminate the [sub-reining] and approximately double our margins when we own a product ourselves.

Thomas Escott - Pritchard Capital

Okay. And then lastly, and then I'll let you go, in the press release I didn't see a comment specifically about the 2008 guidance. You just gave guidance a month ago. There was no mention of it in this release. Can we conclude from that then that the guidance is basically unchanged from that that you'd issued here in recent weeks?

Jerry Dumas

We haven't changed it.

Thomas Escott - Pritchard Capital

Yeah. Okay. Well, thank you.

Operator

Our next question comes from Terese Fabian from Sidoti. Please go ahead with your question or comment.

Terese Fabian - Sidoti

Hi.

Jerry Dumas

Good morning, Terese.

Terese Fabian - Sidoti

Good morning, Jerry. I have a couple of questions. One is I know the Teledrift has some international exposure. Do you have an idea of what your sort of international part of revenues will be or what is it now?

Lisa Meier

Terese, this is Lisa Meier. The Teledrift revenue sources are about a third international and two thirds domestic. However, the majority of the international contracts are dollar denominated. So, there is not as much foreign currency exposure. The primary exposure will be to the Canadian dollar.

Terese Fabian - Sidoti

Okay. Thank you. That's helpful. And because of rounding and all, you didn't give a fourth quarter EPS number or diluted share count. Is that $0.18 or $0.19 for the fourth quarter that you get?

Lisa Meier

It is, I believe, $0.19 off the top of my head, but let me double-check.

Jerry Dumas

It is $0.19. Lisa is checking, but I'm quite sure it was $0.19, Terese.

Terese Fabian - Sidoti

Yeah, I know it's really close. But while Lisa is checking, let me ask you about the share lending arrangement you have with Bear Stearns. Will Bear's difficulties affect the trading of your shares? Do you have any idea of what's happening at that end?

Jerry Dumas

Well, we made a comment in significant events or subsequent events rather and are filing, and basically say that we had headcounts who will look at that. So, that's really all we'll have to say. We don't see any immediate impact at all on our stock, unless somebody views that situation which would occur at the end of that contract, which a long way down the road. Okay. That would be what I'd call ultra cautious.

Terese Fabian - Sidoti

Okay. And are there any implications in transferring the bio-safe chemicals to the Sooner portion of the work? Is that just an organizational or are you going to be doing more developments with Sooner?

Jerry Dumas

Currently the CESI organization, which is our chemical segment, have had the ability and the time to develop quite a few bio-safe products as well as other products that are used in production chemicals, and because we did not have a platform to sell that in the North American market and only had a few rifle-shot approaches at it internationally. That's just simply a matter of selling them or transferring them over to the Sooner organization.

Terese Fabian - Sidoti

And is that the micro-emulsion or is that the whole package?

Jerry Dumas

Everything we have that would be in production chemicals which clearly would include any micro-emulsion product as well.

Terese Fabian - Sidoti

Got you. Okay. So just a production end of that.

Jerry Dumas

Yeah. That's correct.

Terese Fabian - Sidoti

Okay. Thank you.

Jerry Dumas

Thank you, Terese.

Operator

Our next question comes from Megan Bissell from Fig Partners.

Megan Bissell - Fig Partners

Good morning, Jerry. Hi, Lisa.

Lisa Meier

Good morning.

Megan Bissell - Fig Partners

Just wanted to check with you on a couple of items, Jerry. On the chemicals side you guys have talked about being able to implement some price increases there. That sounds to me like that's on the backburner now, is that right?

Jerry Dumas

No. That's not on the backburner. We're always going to be aggressively seeking to do value pricing and we are, in fact, doing that.

Megan Bissell - Fig Partners

At what areas have you guys been successful in pushing pricing up?

Jerry Dumas

Well, we've been able to raise the prices on our chemical group at this point. There is no price increasing at our downhole tools. We're just fighting.

Megan Bissell - Fig Partners

No, I'm just actually just chemicals.

Jerry Dumas

No. In the chemical business, we've effected successfully a price increase, that's correct. And that went into effect at various times in March.

Megan Bissell - Fig Partners

Okay.

Jerry Dumas

We had no effect on that. There will be very little effect in the first quarter, but it will accrue to us in the second, third and fourth quarters.

Megan Bissell - Fig Partners

Okay. On the drilling product side, the fourth quarter results were well short of even my revised expectations. Can you just remind me of what the accounting treatment is? As you bought the remaining 50% of CAVO in November, so you have a half quarter of their results in equity and earnings and a half in consolidated with the legacy business, is that right?

Lisa Meier

There is one month that's in equity earnings and two months that are fully consolidated.

Megan Bissell - Fig Partners

Okay. So we'll see a step-up in the first quarter from another month of CAVO in the results plus the Teledrift?

Lisa Meier

Correct.

Megan Bissell - Fig Partners

Okay. And then, just a couple of housekeeping things, interest expense in the first quarter, and then the run rate after that, what are you guys expecting?

Lisa Meier

Interest expense up through February 14 should be consistent with what you've seen in the past because it will be under our old facility.

Megan Bissell - Fig Partners

Right.

Lisa Meier

And obviously, go-forward from February 14 later in the convertible debt, which is 5.25 on the $115 million, and then a slight pricing increase with LIBOR plus 3.75.

Megan Bissell - Fig Partners

Right. Okay. And I think that's all. Thanks so much, guys.

Lisa Meier

Thank you.

Jerry Dumas

Thank you, Megan.

Operator

Our next question comes from William Conroy with FMH Capital.

Jerry Dumas

Hi, Bill. How are you?

William Conroy - FMH Capital

Good morning, Jerry. I'm well. How are you?

Jerry Dumas

Good.

William Conroy - FMH Capital

Couple of questions. When I dissected the earnings, it looked like the effect of income tax rate from the fourth quarter ticked up, what should we be thinking about for '08?

Lisa Meier

I think for '08 looked for approximately 37%, 38%. That's going to be relatively dynamic as we integrate Teledrift, which has more foreign operations and resulting foreign tax credit, but ballparking I would say that's the best rate to use right now.

William Conroy - FMH Capital

Got it. And Jerry, kind of a specific question to follow on to an earlier one on the share lending agreement, can you tell us the name of the entity that borrowed the shares at Bear Stearns?

Lisa Meier

It's disclosed in our prospective at Bear Stearns. That's a federary of Bear Stearns.

Jerry Dumas

BSIL is the name of it.

William Conroy - FMH Capital

And last thing, you had mentioned earlier and I think it was in the pre-announcement that we had seen the operating expenses pickup. You had mentioned back then, SOX compliance, the tool tracking system, et cetera, how should we be thinking about those expenses going forward? Should we see the dollar amounts come down or should we see the revenue base grow and the percent of revenue come down, but dollar held flat?

Jerry Dumas

I think that you'll see the fact that dollars will go up because we're a much larger company. And as a result, we're working very diligently to get a much more comfortable hand-alone numbers, particularly as we move internationally, and we have to look at the consequences of international tax credits and all of the other aspects. It will benefit us over ends at the tax rate.

We pass Sarbanes-Oxley, and let me tell you that was a chore. And I think this year Sarbanes-Oxley will be a little bit easier to do, because we understand a little bit better what we're doing. We made a lot of progress from '06. We will now have to do the same thing for CAVO and Sooner, because we did do trials this year. So, only CAVO and Sooner at this point and both of those should be reasonably easy relatively speaking.

William Conroy - FMH Capital

Great. Thank you very much.

Jerry Dumas

All right, Bill. Thank you.

Operator

(Operator Instructions) And sir, at this time, I'm showing no additional questions. Would you like to make any final comments?

Jerry Dumas

No. But thank you for taking care of the call, and everyone who had called in, thank you. And we'll sign off.

Operator

And at this time, you may disconnect your lines.

Jerry Dumas

Thank you.

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