Flotek Industries Inc. (NYSE:FTK) Q4 2019 Earnings Conference Call March 6, 2020 10:00 AM ET
Danielle Allen - Senior Vice President, Global Communications
John Gibson - Chairman, Chief Executive Officer and President
Ryan Ezell - Senior Vice President, Operations
Nick Bigney - Senior Vice President, General Counsel and Corporate Secretary
Elizabeth Wilkinson - Chief Financial Officer
Mark Lewis - Senior Vice President, Global Business Development
Conference Call Participants
Daniel Burke - Johnson Rice
Jim Kennedy - Marathon Capital
Greetings and welcome to Flotek Industries’ Fourth Quarter and Full Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow management’s prepared remarks. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Danielle Allen, Senior Vice President, Global Communications for Flotek. Thank you. You may begin.
Thank you and good morning everyone. We appreciate your participation. Joining me today are John Gibson, Chairman, Chief Executive Officer and President; Ryan Ezell, Senior Vice President of Operations; Nick Bigney, Senior Vice President, General Counsel and Corporate Secretary; and Elizabeth Wilkinson, our Chief Financial Officer.
On today’s call, we will first share prepared remarks concerning our business and results for the quarter and full year. Following that, we will answer any questions you may have. Yesterday, we released our earnings announcement for the fourth quarter and full year 2019, which is available on our website. Today’s call is being webcast and a replay will also be available on our website along with our updated corporate presentation.
Please note that any 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 events to differ materially from our current expectations. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. Also, please refer to our reconciliations provided on our earnings press release as management may discuss non-GAAP metrics on this call.
So, with that, I will turn it over to John.
Thanks, Danielle. We appreciate everyone joining us for today’s call. And before I begin my comments, given the importance of the topic, I am going to turn it back to Danielle to update everyone on the process we have in place at Flotek related to the coronavirus. Danielle?
Thank you. And as John said we do recognize the importance of planning for potential scenarios and anticipated impacts related to coronavirus. And that’s why we have developed a task force comprised of leaders across the company and also supported by input from key suppliers and customers. Following guidance from the CDC, the WHO local health organizations, and OSHA, the task force has developed action plans to address related risks and we continue to monitor this very dynamic situation. Back to you, John.
Thanks, Danielle. As she pointed out, we are leading an important effort to put people first in Flotek and that includes our customers and our suppliers. When we take ESG seriously and health of employees and suppliers are very important to us, that’s great to be here, I am very grateful for the warm welcome I have received from our customers and shareholders, supplier partners, employees and the board. I am humbled and thankful to all of our stakeholders for taking the time to share with me their perspectives on the strengths and opportunities at Flotek.
Since this is my first call, I want to let you know what you can expect to hear from me and the team on our quarterly calls. On this first call, I want to you to get to know me a little bit better, my background and the roadmap I see going forward. In the future, you will likely hear less from me and more from the leadership team of the company and we are going to start introducing them to you today. What you will not hear from me is promises around what I hope to achieve in the future. To be clear, I am relentlessly focused on execution and I intend to focus on what we have accomplished as a team thus far rather than promising things that we have not done yet.
Now, as I have talked with our shareholders, one of the most common questions I hear is why did you come to Flotek? I wanted to share my perspective with those whom I haven’t had a chance to get to know yet. First, I will share a little bit about my background. For more than 25 years, my career has been focused on identifying and commercializing unique and disruptive technologies in the oil and gas sector. I came to Flotek from Tudor, Pickering, Holt, where I led and continued to act as a senior advisor to the energy technology team which focuses on emerging oil and gas technologies. So a great team there at TPH. Prior to TPH, I was the President and CEO of Tervita, which is a major Canadian based environmental and oilfield services company. Prior of that, President and CEO of Paradigm Geophysical, Landmark Graphics as well as President in Haliburton’s Energy Service Group. First 12 years of my career included various roles in Gulf Chevron in exploration, production research. So, I have been on the producing side, I have been on the technology side, the oilfield service side, the environmental side. I have seen our industry full circle and I am excited about being in the chemistry, the specialty chemistry.
So, why I decided to come to Flotek? Well, I felt my skills throughout my career sort of match Flotek situation. I have established a proven track record of solving complex challenges and building successful and sizable businesses and many times, the ground-up or is a turnaround and in each instance, this requires the development of a shared vision, supporting strategies and then solid execution. In addition, I am financially motivated to see Flotek succeed. Prior to joining, I worked closely with the board to establish a pay structure heavily equity weighted. As a result, I am aligned with shareholders on wanting to see material stock price appreciation as we move forward. I’d also note that my pay is structured where I do not earn above any bonus in 2020 unless we achieve at least breakeven adjusted EBITDA on a full year basis. Bottom line, that would mean a nearly $35 million improvement year-over-year in adjusted EBITDA reasonably easy to see what my motivation is in 2020.
My first priority when joining Flotek was to identify additional opportunities for cost reduction. Working closely together, we have embarked on a journey to reduce all cost to accelerate our ability to regain profitability in 2020. A prime example is the recent amendment of our terpene supply agreement with Florida Chemical Company highlighted in our recent 8-K. I will now have Ryan discuss the key provisions of the amended agreement, but the bottom line is that we will materially improve our cost and cash flow through the terms of the new and amended contract. Ryan?
Thanks, John and good morning to everyone. We are pleased with the modifications to the current terpene supply agreement. The amended contract represents a significant improvement in Flotek strategic relationship with Florida Chemical Company and our ability to mange our inventory and ancillary cost.
Let me recap the key provisions of the original agreement and the according consequences. Our original agreement required the purchase of approximately twice the value of terpene required to support our current business. This resulted in excess inventory and storage cost. The agreement also had an effective price that was greatly exceeded the market price. We worked with FCC to align the agreement with our current business. In order to achieve alignment, we agreed on a reduction in the quantity of terpene we required to purchase from FCC by approximately 3/4 for 2020 and by approximately half in each of 2021, 2022 and 2023 and we also agreed to an all-in fixed price per pound for terpene in 2020, that is 45% below the price of the original agreement. To make the amended terms and conditions effective, Flotek made a one-time payment of $15.8 million to FCC. Including the payment, this effectively reduces our commitment to less than 50% of the original contract based on current market pricing.
In addition, the agreed price of volume reduction for the purchase of terpene in the amended contract for 2020 alone should substantially offset the one-time payment of $15.8 million cash made to FCC. I want to also note that in years 2021, 2022 and 2023, the negotiated volume reduction of approximately 50% in each year should reduce our cash commitments proportionately. Bottom line, we are now positioned to be more competitive in the market with regards to our procurement and customized chemical solutions portfolios and this opens up opportunities to pursue new channels to market.
Since joining Flotek at the end of August, we have been relentless in our pursuits to identify opportunities to reduce operational cost and create positive synergies. Value stream mapping and continuous improvement efforts have resulted in millions of dollars in annualized cost savings in the areas of strategic sourcing, logistics, field operations and facilities management. The amended terpene agreement represents another step forward and our commitment to get to positive profitability.
With that, I will turn it back over to John.
Thank you, Ryan. Modifying the terms of the terpene agreement clearly places us in a better position for improved financial results in 2020. We are not done yet. We have identified several opportunities aimed at rationalizing our office space without impacting our market presence. We intend to move out of our current headquarters and two satellite offices in the next quarter. This should result a decrease in expense of millions of dollars over the remaining life of the leases. And in taking about that move, I have explained to our staff that we are going to do it quickly that includes if we have to use concrete blocks in the few doors from lows in order to achieve the move in the most expeditious way. In addition, we also believe we can improve our risk mitigation as well as reducing our legal cost. And to discuss the opportunities we see on the legal side, I am going to hand it off to our new General Counsel and great new add to our team, Nick. Nick?
Thanks, John and good morning, everybody. I am glad to be here as part of the team. While I only joined the company recently, I am excited about the opportunities we have to improve our legal approach here at Flotek. We are focused on our corporate governance, our compliance programs and mitigating the legal risk that we have and in particular, we are working to enhance all of our board interactions, our international trade compliance, our export controls, HR-related policies and similar matters of the company. We believe that putting effort into these areas will reduce our ongoing legal exposure, especially in our international operations. We are also striving to bring down our outside legal spend. Historically, the legal costs of Flotek have been high and we have an opportunity for substantial reduction. For example, we intend to utilize smaller reporting company rules for our SEC filings which simplifies the process. And in addition, we are bringing more work in-house and only using outside advisors when necessary and cost effective. While we are still working on identifying all opportunities, our goal is to bring our legal expenditures down to a level that is at or below what is expected for a company of our size. I look forward to working with the rest of the team to make a positive impact going forward. John?
Thanks Nick. It’s really a pleasure to have Nick on board. And looking at the current environment for Flotek’s products and services, it’s clear we must grow our market share by demonstrating how and why our chemistry exceeds competitors and creating tangible returns for our customers in a very, very cost conscious environment. I have also focused much of my attention on evaluating our sales effort how we can more effectively engage with current and prospective clients. While there is a consensus, there will be no further softening that there will be – excuse me, I wish it was no further. That’s a misstatement. While there is consensus that we are going to see a lot additional softening in the U.S. onshore oil and gas market 2020, we believe an increase in the adoption of specialty chemicals could more than offset the decrease in drilling and completions activity. Very few of the wells that are being completed actually used specialty chemicals if we were to see a tremendous material reduction and volume in drilling, it should not impact our ability to go out and make a difference in those wells that are being completed.
Our key sales focus is growing market strategy by improving returns for our current customers, rebuilding relationships with past customers, and identifying new customers that can benefit from our chemistry solutions. Additionally, we are catalyzing focus on total cost of recovery per barrel of oil equivalent rather than just the initial purchase cost as well as strengthening the publicly available evidence for the efficacy of using advanced C&F products to materially impact oil and gas recovery and profitability for operators. Since joining the company in early January, I spent time with Mark Lewis, our Senior Vice President of Global Business Development and Sales and member of his teams evaluating our market strategy and related efforts as well as making several sales calls with Mark.
Our direct sales channel focus on customers where we believe we have a high probability of creating improvement and their returns through technology is something that we want to continue to execute. We are targeting our efforts on those customers focused on achieving the highest return on capital rather than the lowest initial purchase cost per activity. We intend to maintain and extend our knowledge and evidence of chemistry’s positive impact on well production, completion designs and spacing models. Therefore this year, we are going to focus on analytics both internally and externally to include partnering with specific clients in many cases anonymously that are willing to share the required data to validate publicly the increased long-term profitability of wells when using Flotek’s proprietary chemistry, very common today for companies to make their data available anonymously so that we can take advantage of big data analytics in order to understand the totality of trends and improved results. We are also looking forward to utilizing third-party digital fluid flow modeling experts to provide production forecast for wells with and without treatment for use and discussions with customers about our products. In addition, we will continue to fund R&D to sustain differentiation in our products and services and we believe that, that differentiation is going to determine the winners and losers in this market.
Finally, instead of a formal strategic capital committee in the company, the formal strategic capital committee, the company will continue to evaluate alternatives with the Board of Directors for deploying the cash we have on hand. Our current evaluations for further capital deployment includes seeking growth opportunities that reduce our dependence on rig count, provide new product lines that create a greater amount of backlog and/or annually recurring revenue, maintain differentiation of our offering from competitors, enhance our capability to provide digital transformation of chemistry, drawing on my background at Landmark, at Paradigm, and TPH and strengthen our market share for our current product launch. Bottom line, we believe that our cash position, our public equity, our North American presence, the fact we have no debt continuous focus on cost reduction, our commitment to ESG make us very attractive. The absence of an IPO market has given us a portfolio of numerous opportunities seeking liquidity. We are vetting those opportunities to select those providing the greatest long-term shareholder value.
With that, I am going to turn it over to Elizabeth to discuss our financial results, but it’s a good thing I have turned it over. I am going to turn it over to Elizabeth. She is going to walk us through financial results. Elizabeth?
Thanks, John. Similar to the past few quarters, the financial tables in our press release present the operations of our CICT segment as a discontinued operation for all periods. As such, I will focus my discussion today on quarterly results for our continuing operations, which includes our energy business as well as our supporting research and innovation and corporate functions.
Looking at our financial results, revenue for the fourth quarter was $19.5 million compared to $21.9 million for the third quarter. ECT operating expenses were $42.6 million for the fourth quarter versus $23.7 million in the third quarter. Included in the fourth quarter was the $15.8 million loss on purchase commitments associated with the company’s 2019 terpene supply agreement and the recording of an additional $4.4 million reserve related specifically to our terpene inventory balance as of December 31, 2019. As the result of the work done in 2019 to improve supply chain and operational efficiencies together with our negotiation of the amendment to our terpene contract, we will be able to dynamically manage our inventory to lower levels going forward.
Corporate G&A increased to $9 million in the fourth quarter versus $5.7 million in the third quarter due to the severance of $3.7 million recorded in Q4 primarily related to the exit of our former CEO. Research and innovation costs decreased to $2.2 million from $2.3 million in the preceding quarter. At this point, going forward, we anticipate corporate G&A costs will average below $5 million per quarter and R&I costs to average approximately $2 million per quarter. We reported a loss from continuing operations at $37.1 million or a $0.64 loss per diluted share for the fourth quarter compared to a loss of $11.2 million or $0.19 loss per diluted share for the third quarter.
As I mentioned earlier significantly impacting the fourth quarter was the loss on the purchase commitments associated with the terpene supply agreement, the additional reserve taken against our year end terpene inventory balance and total severance of $3.8 million. Our adjusted EBITDA for the fourth quarter was a loss of $8.9 million compared to a loss of $8.1 million for the third quarter. The change in adjusted EBITDA is primarily a reflection of lower margin as a result of lower revenue. Please refer to our table in the release for more details on adjusted EBITDA.
Turning to the balance sheet, as of December 31, we had cash and equivalents of $100.6 million, no debt outstanding and $9.9 million in escrowed funds still included on our balance sheet reflecting the estimates of our claim to the remaining balance of the indemnity escrow related to the sale of Florida Chemical to Archer-Daniels-Midland, or ADM. The $15.8 million loss on purchase commitments in Q4 and the $4.4 million reserve taken against the terpene balances as of 12/31 reflect our prospective that looking forward into the remaining term of our 2019 terpene supply agreement neither the price nor volume of the agreement aligned with our current plans to sell terpene in diverse formulations and in raw forms through potential new channels to market. Accordingly, we were able to record a loss on the contract commitment as it stood as of December 31, 2019 and reserve against a specific portion of our terpene product on hand at that date.
As discussed by Ryan, last month, we paid $15.8 million to FCC to amend the terpene supply agreement. Also in February 2020, the independent third-party mutually engaged by ADM and Flotek to resolve our transaction post-closing working capital dispute awarded $4.1 million, the disputed amount all in favor of ADM. As a recorded subsequent event, this amount net of tax is reflected as a loss in Q4 2019 discontinued operations. Echoing John and Ryan’s comments, in addition to setting ourselves up to materially reduce our inventory moving forward, over the past couple of months, we have identified additional opportunities to further improve our cost profile. These initiatives complement the approximately $30 million of annualized cost reductions across the business, which we implemented in 2019. We look forward to discussing our current efforts in more detail when we report first quarter results in a couple of months.
And with that, we will now open it up for questions. I would note that joining us for the Q&A session are Mark Lewis and James Silas, Senior Vice President of Research and Innovation. Operator?
Thank you. [Operator Instructions] The first question today comes from Daniel Burke with Johnson Rice. Please go ahead.
Hi good morning everyone.
Good morning, Daniel.
John, thinking about the top line, I appreciate the sort of upside adoption scenario for this year, but you also talked maybe about just customer concentration risk, does that pose any challenges to you guys as you look at your customer base in 2019 versus their proposed activity levels in 2020? And then if I could elicit it just because we are pretty deeply into Q1 ‘20 at this point, any thoughts on trends in top line in the very near-term here in Q1?
Okay. So, it’s such a thoughtful question, Daniel, give me just a second here. The first thing is since joining if we sort of think of it as numerator and denominator I have spent the majority of the first 60 days on the denominator trying to get out what we think maybe an estimated $15 million of additional cost in 2020 and that’s been our focus. On the numerator, I have spent some time on the revenue side with Mark and Q1, we are actually working away I don’t want to give any guidance on that, but the customer concentration question is we do have some, few large customers that have been very loyal and we are excited to be working with and we are expanding out beyond that. So Mark and I both are looking at getting a broader spectrum of customers. As I’ve said before, not very many wells, I mean, I suspect a single-digit percentage of completions actually use specialty chemicals. So our challenge is making sure that the whole of the specialty chemical business for completions increases and then we want to get that market share. So I am pretty confident about the numerator, but we are going to expand beyond just taking advantage of our chemicals. We have some infrastructure as well that we think is going to be very valuable to us in the year ahead. And so we are looking at there is nothing that we have that we won’t try to create shareholder value with revenue. And so I know that the question will come around when do we see breakeven. And I can tell you, I don’t want to give guidance on it, but assume I don’t get a bonus until I get there and I have every intention of getting a bonus for 2020. So at what date, I will get there on a full year basis is TBD. Revenue side, we have some – a lot of logistical problems that were solved in ‘19. Thanks to Ryan and the team there. And I think the sales team is really beginning to get focused and congeal around what the customer value proposition is. And so we are pretty excited about that. But give me till the end of Q1 and come back at the end of Q1 and I will concentrate the whole of the call on revenue side of the equation that’s better call.
I think that makes sense. And just follow-up for one more clarity John, I think you said you are focused on an additional $15 million of cost savings in 2020, it seems self-evident, but want to make sure that’s the case that would be incremental to the savings you will achieve under the new terpene price arrangement. Is that right?
That included that – yes, I think it’s sort of the three buckets where I think we have got really good cost savings I can quantify is the terpene agreement. The reduction in external legal cost is a result of bringing on Nick and the office moves. Okay, those are three and that does not mean we are done there. It just means that those three are the most material that we have identified in the first quarter.
Okay. You will capture that ‘15 in 2020 that’s not like an exit run-rate, that’s helpful. That’s okay. And then like maybe one other one, when addressing the cash balance, you all spoke to growth focused in terms of how to deploy that cash, can you maybe – it certainly makes sense that there would be some interesting or attractive deal opportunities out there, but what size deal makes sense for the company, what’s the right range of deal size do you think for you all to contemplate?
Well, another really good question. I think it’s pretty easy for us to see that using a combination of cash and equity that we believe we could do deals given the really low multiples that could bring in revenues that range anywhere from say $15 million for higher multiple sector to as much as $200 million in the lower multiple sector. So, we are sort of vetting deals that range from at the low end $15 to the high end to a couple of 100 that we think are things that we would be able to do.
Okay. Alright, guys. I will leave it there for now. Thank you for the time.
[Operator Instructions] The next question comes from Jim Kennedy with Marathon Capital. Please go ahead.
Hi, John. Welcome board.
Hi, Elizabeth. Hey, John, this maybe a question for Mark, but I am just wondering in the short time you have spent there, could you speak a little bit to kind of the sales force/go-to-market strategy, how you see that evolving over the course of this year in terms of the focus possibly the number of people, how it maybe a little different than it has been in the past, can you speak to that sort of go-to-market strategy?
Let me give you a brief overview then I will turn it over to Mark. One thing that transpired was the company sort of moved from being mostly indirect to mostly direct in 2019. As we go forward, we are going to sell product higher where we sell product, which means that we are going to have a direct channel approach, because we think that’s important for a segment of customers. We are going to reintroduce in the direct sales channel approach. We think that is a great way to reach a large portion of the market and particularly internationally and in some regards and we are working through that. And we are also contemplating we’ll call it quite labeling our products, letting other people sell our advanced products under their name. So, if there is any way to sell products, you can assume that all of that is fair game for us today because we are interested in amplifying our sales and we think all of those different methodologies can result in improved sales and I had a chance to make a few calls with Mark. So, Mark, you want to talk about the direct? I mean, what is your – when you are meeting with customers, what’s the real value proposition that you explain to people today?
I think the real value proposition is improving the rate of return. A lot of our customers are clearly living within cash flow, limited on CapEx spends, very disciplined in terms of the CapEx that they invest. So, we are very much focused on the outcomes of the customer. And a lot of our key technologies, particularly, the CnF technology, that really shows incremental production in a number of cases in the market. So we think the value proposition is really, really strong. And our sales force is aligned to those outcomes of the client. We have retooled and rebuilt the entire sales team pretty much over the last 6 to 9 months. So, we have a full complement of sales stuff around the key basins where that we are concentrated in the Northeast and Midland, Denver, Dallas, Huston and Oklahoma, these folks are very professional. They are professional sales people there, chemists, chemical engineers, petroleum engineers, business graduates, all graduates on the focus on the outcome of the clients. So, we are very confident and our sales staff on their ability to delivery the right outcome for the customer.
One of things we did too, Jim, is a lot of emphasis has been placed upon sales channel transition and new sales channel and give them a chance. And going forward, we are just not going to make any excuses using anything. So whatever happens we are accountable for the results of the company. So, I am not going to talk about the sales channel and whether it’s new or transitioning. We have an accountability to grow the revenue of the company and we are going to focus on getting that done. And I think the time is all you have known from making sure that results are what we are focused on, not on excuses for why we missed.
Great. Thank you. One further question relative to the terpene agreement or adjusted agreement, if you do have increased demand and you do let’s say white label of product and you end up with hopefully a good problem to have where the demand is much, much higher, a year from now than it is today. How does that tie back into the agreement in terms of your reduced commitment and pricing, how should we look at that in case demand does increase dramatically?
So, the simplest answer is all I did was cap our take-or-pay and then anything we need above that, we can buy at market and we can buy it from whomever we find the best price. And so what we did is just reduce an obligation that’s there to a level that matches what we believe the forecast for our – demand of our product is this year. We hope that we are back buying more from Florida Chemical. Later in the year, we have developed a great relationship. I am very thankful to them for working with us to get this change, so that it underpins a success for our company, but we can buy as much as we need.
Great. Okay, thank you very much.
It looks like we are out of questions, operator.
It does there. So this will finish our question-and-answer session. I would now like to turn it over to John Gibson for any closing remarks.
Thank you so much. I just want to say thanks to everybody for joining us today. I am looking here at all the people on the call and lot of them are employees and we have got an all-hands meeting here in a just a little bit and I am excited to hear that our employees are listening in and want to know where the company is going and we are going to talk to them in person in just a moment. I am really happy to be here and I look forward to working closely with the management and the employees as we focus on building a successful long-term business at Flotek and getting to that breakeven point as soon as we can. We appreciate the support of all our shareholders and we are going to update everyone on our continued efforts at the end of Q1 and I hope we have some really good things to talk about them too. Thanks so much and appreciate it.
This conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.