Flotek Industries Q3 2024 Earnings Call Transcript

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November 5, 2024

There are 7 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Flotek Industries Third Quarter 2024 Earnings Conference Call. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on Tuesday, November 5, 2024. I would now like to turn the conference over to Mike Critelli, Director of Finance and Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, and good morning, everyone. We appreciate your participation in Flotek's Q3 2024 earnings conference call. Joining me on the call today are Ryan Izel, Chief Executive Officer and Von Clement, Chief Financial Officer. First, we will provide prepared remarks concerning our business operations and financial results for the Q3 of 2024 as well as our updated guidance for the full year 2024. Following that, we will open up the call for any questions you have.

Speaker 1

Flotek's Q3 2024 financial and operating results press release was issued yesterday afternoon. We also posted an updated Q3 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, 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.

Speaker 1

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 reconciliation 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 Izzo.

Speaker 2

Thank you, Mike, and good morning. We appreciate everyone's interest in Flotek and for joining us today as we discuss our Q3 of 2024 operational and financial results. I'm pleased with our overall strategy execution during this quarter, but we remain laser focused on elevating our performance to increase market share and profitability growth in both of our complementary business segments as we challenged the organization to close out our strongest year since 2017. These final months of the year are going to be arduous work. We are confident in our team's ability to execute in the face of market headwinds and continue to trend to delivering strong results and result in value creation for Flotek shareholders.

Speaker 2

With that in mind, I'd like to turn to Slide 5 and touch on our key highlights for the quarter that Baum will discuss in detail in just a moment. With the backdrop of weaker North American oilfield services activity, we were able to grow total revenue 5% compared to the Q3 of 2023 8% sequentially over the Q2 of 2024, highlighting our strong execution and the continued progress we have made in capturing market share. This is quite an accomplishment when considering the fact that the active frac fleet counts have declined over 14% from the peak of the Q1 of 2024. Our data analytics segment revenues grew 30% in the 3rd quarter as shown on Slide 7, with data as a service revenue growth of 40% sequentially. Following the EPA's approval of our JP-three analyzer in mid July of 2024, we recognized our first revenues for flare monitoring in August September, which comprised 25% of total quarterly segment revenues.

Speaker 2

Revenue from our Chemistry Technologies segment increased 7% in the 3rd quarter. Our persistent revenue growth in this segment, despite a declining frac fleet market, is clear evidence that we are gaining market share through our differentiated chemistry technology solutions. We delivered significant year over year improvements in virtually all profitability metrics, resulting in net income of $2,500,000 and adjusted EBITDA of $4,800,000 representing a year over year increase of 97% 43%, respectively. This marks Flotek's 5th consecutive quarter of net income and 8th consecutive quarter of improvement in adjusted EBITDA. As a result, we are increasing our adjusted EBITDA guidance for the 2nd time this year.

Speaker 2

On a trailing 12 month basis, as is shown in Slide 8, Flotek has delivered almost $25,000,000 of improvement in adjusted EBITDA. Finally, we reduced borrowings outstanding under the asset based loan by 81 percent or $6,100,000 when compared to year end of 2023. And most importantly, all of these achievements were accomplished with 0 recordable and lost time incidents. I'd like to take a moment to thank all of our employees for their hard work and commitment to safety and service quality in achieving these outstanding results. And I continue to be excited about the future of Flotek and believe we are well positioned to capture further market share.

Speaker 2

We continue to be an industry leader, driving innovation and delivering differentiated chemistry and data solutions that are tailored to our customers' needs. We strive to create solutions for the future challenges that will impact our industry before they are needed by leveraging chemistry as the common value creation platform. Flotek will remain at the forefront of innovation and multidisciplinary advancements as we bring new technologies to the market. Through the convergence of data and chemistry solutions, Lotec is creating AI driven reservoir modeling to address the impacts of water imbibition, dry pressuriential microfluidic behavior in nanopore environments and improve the ultimate recovery of hydrocarbons from each asset. Through the utilization of real time data measurements, we are unlocking the potential to apply predictive analytics to holistically manage our customers' assets and maximize their return on invested capital.

Speaker 2

We expect the continued expansion of our data as a service model with the launch of our next generation near infrared, Raman and aqueous environment measurement systems, unlocking significant upstream and downstream market opportunities if we expect the business to see continued growth going forward. As part of our commitment to being at the forefront of innovation, we announced in July the EPA approval of our JP3 system with respect to recently enacted flare regulations. A picture of our new flare monitoring cart that is currently on location can be seen on Slide 10. This state of the art optical instrument is designed for the precise measurement of net heating values in flare gases and is the first to be approved as an alternative method under the new regulations. According to the EPA, there are over 55,000 existing players in the United States and are expected to be subject to monitoring regulations by 2028.

Speaker 2

And this approval positions Flotek for growth in this new upstream space. We have already received numerous orders with 11 units already being delivered, which is up from 3 we mentioned on our call in August. The majority of flare application revenues to date have been through rental and service contracts, which imply a recurring revenue stream. Furthermore, our upstream custody transfer use cases continue to expand in the field trials with a total of 3 active units in the 3rd quarter and additional 8 committed units added thus far in the 4th quarter. We're on track to receive full certification for field utilization by year end.

Speaker 2

Our ability to monitor hydrocarbon composition and quality in real time with measurements taken every 5 seconds will create an emerging market for Flotek to enter into 2025 and beyond. This revolutionary application creates an elevated level of transparency and enterprise risk minimization for producing wells that's never been achieved in the oil and gas industry to date. As we look forward, we see the demand for oil and gas is expected to expand for the next decade with further requirements needed through 2,045. For the first time in nearly 2 decades, the demand for electricity in U. S.

Speaker 2

Is expected to decline 15% by 2,030, with natural gas expected to provide the bulk of the incremental demand. We expect the overall expansion of the global economy to continue to create substantial demand for all forms of energy, which will increase service intensity within the sector. As we look at the remainder of 2024, our efforts remain focused on revenue growth, market share expansion, cost efficiency gains and creating value for our shareholders as we are well positioned to capitalize on opportunities both domestically and internationally. We are confident that our expanding suite of positions us to deliver unique and superior solutions to a variety of our industry's most challenging problems, while maximizing our customers' value chain. Now I'll turn the call over to Bahn to provide key financial highlights.

Speaker 3

Thanks, Ryan. Thank you everyone for joining us this morning. Yesterday afternoon, we reported strong results for the Q3. On the income statement side, we posted sequential increases in revenue, net income and adjusted EBITDA, even though industry fundamentals were weaker. On the balance sheet side, we increased working capital and paid down debt.

Speaker 3

Our ABL balance at September 30 was down 75% from the end of the second quarter as we utilized the 12% improvement in DSOs during the quarter and $5,000,000 in cash flow from operations to pay down the line. Quickly touching on a few specific results, I'll be referring to the slides in the presentation posted to our website yesterday afternoon. Slide 5 summarizes certain of our 3rd quarter achievements. Revenues, net income, adjusted EBITDA were all up compared to the Q3 of last year. Net income nearly doubled, adjusted EBITDA jumped over 40% versus the year ago quarter.

Speaker 3

Regarding revenue for the quarter, we reported total revenues of $49,700,000 which was a sequential increase of 8%. This increase was highlighted by strong growth in revenue from our data analytics segment as well as a 19% increase in related party chemistry revenue. While external customer chemistry revenues were down sequentially, they're still up 3% through the 1st 9 months versus last year. It's worth noting that we had 3 large customers experienced operational delays in September, which caused certain external chemistry sales to be pushed to the Q4. We fully expect external chemistry revenues to bounce back strong in the Q4.

Speaker 3

3rd quarter gross profit was flat as compared to the 2nd quarter. On a percentage basis, gross profit margin was down around 150 basis points sequentially stemming from lower external chemistry revenues, which impact our revenue our product mix as well as lower revenue attributable to the order shortfall penalty under our long term supply agreement, which is the result of the sequential growth in our related party business. Partially offsetting these items was our data analytics segment, which provided a meaningful contribution to gross profit during the Q3. As shown on Slide 7, gross profit from data analytics totaled $1,200,000 during the Q3 of this year, an 88% increase compared to the Q2. Data analytics gross margin came in at 44% during the quarter, a 47% improvement sequentially as we grew recurring revenue during the quarter.

Speaker 3

These strong margins are why we are so excited about the outlook for continued revenue growth in this segment that Ryan touched upon earlier. Moving down the income statement, we had an outstanding quarter as it relates to reducing overhead. 3rd quarter SG and A costs declined to $5,700,000 a 12% improvement compared to the Q3 of last year and a 9% sequential improvement. SG and A costs through the 1st 9 months are now down 15% from last year, resulting in over $3,000,000 in savings or roughly half of the year to date net income. This is an area we will continue to apply maximum focus on improvement.

Speaker 3

Moving to Slide 8, adjusted EBITDA for the quarter increased to $4,800,000 Keep in mind, we grew adjusted EBITDA 9% sequentially despite revenue from the order shortfall penalty under our supply agreement declining by 19% or $1,600,000 from the Q2. Touching on the balance sheet at September 30, we had $1,400,000 drawn under the ABL. Our September 30 debt to trailing 12 month adjusted EBITDA was less than 0.1 times. With respect to our updated 2024 guidance, for the 2nd time this year, we're raising our guidance based on the strong operational performance we delivered to date and our outlook for the Q4. We now expect adjusted EBITDA to be in the range of $16,500,000 to $18,500,000 which is an increase of 35% at the midpoint compared to our initial 2024 guidance range of $10,000,000 to $16,000,000 Put another way, the floor of our current guidance range now exceeds the ceiling of the original guidance range.

Speaker 3

Based on current projections, we expect our 2024 adjusted gross profit margin to be between 20% 22%, which compares very favorably to our 2023 adjusted gross profit margin of 15%. In closing, we posted solid 3rd quarter numbers that build upon several consecutive quarters of financial and operational momentum. We're excited about our results in the 1st 3 quarters and we anticipate closing 2024 out in strong fashion. If we're able to hit the midpoint of our updated guidance, we would achieve a $16,000,000 improvement in adjusted EBITDA versus 2023 and a $26,000,000 improvement versus 2022. With that, I'll turn the call back over to Ryan for closing comments.

Speaker 2

Thanks, Bong. We're excited about the remainder of 2024 as we have tremendous growth potential in both our chemistry and data analytics segments despite the ongoing market headwinds. We believe that Flotek continues to represent a compelling investment opportunity. The expanding opportunities within our Data Analytics segment provides a strong catalyst for future revenue and profitability growth. Our Q3 results delivered profitability and we continue to be positioned for sustained growth as a collaborative partner of choice for chemistry and data solutions.

Speaker 2

I'm proud of the progress we've made and I'm confident in our ability to continue to execute going forward. We appreciate the continued support of all of 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're now ready to take questions.

Operator

Thank you. Your first question comes from Jeff Grampp with Alliance Global Partners. Your line is now open.

Speaker 4

Good morning, guys. Congrats on the quarter.

Speaker 2

Hey, Jeff. How are you doing, buddy?

Speaker 4

Good, good. Thanks. Wanted to start on the flare market, some nice updates there. First, I'm curious if you guys can touch on kind of the preferred sales model that you're seeing from upstream customers, kind of lease versus buy? And then also kind of curious on the customer concentration there.

Speaker 4

Are you guys seeing maybe a few customers really kind of going all in on this? Or is it a few a broader set of customers that are maybe kind of dipping their toe in the water with some potential for increased adoption later? If you could touch on both those points, that'd be great. Thanks.

Speaker 2

Yes. I think when we look at the commercial model, obviously the preferential for us is more on the rental service agreement type. And that's where as we mentioned in the notes earlier that we push the majority. There are a few customers who are looking at, what we would consider to be full time flare monitoring where they don't just come and monitor for the 2 week period as set out by the EPA regulations. In doing so, they're looking at a potential capital purchase for those in the long term where we have a long term agreement in place for the monitoring software, etcetera, with it.

Speaker 2

But I would say currently, we are pushing in the preferential area of a full rental service model, whether we're doing it multiple wells at each time or single testing wells going forward. In the types of customer concentration, I think that initially we had, I would say, 5 to 10 customers who were really pushing forward. Those are customers that really are focused on sustainability side and overall environmental performance and we've made great progress. But I'll tell you, the diversification of the customer base is quickly expanding. I suspect if you look at what's going on today with the current political environment, a few people slowed down in terms of just wanting to see what happened.

Speaker 2

I don't think it's going to negate the fact that the testing is going to be ongoing. We've had recent conversations with the EPA and their expectations is that these regulatory and regulations will continue moving forward as is. So we're probably we're expecting a little bit more of an acceleration at the end of this week from where we are, but we've had great customer diversity so far.

Speaker 4

Great. Appreciate those details, Ryan. For my follow-up on the cost side, you guys have continued to have really nice performance there, particularly with SG and A. I'm wondering, does there come a point where it makes sense to start to grow that line, given the EBITDA margins are growing and should continue to grow, it seems like, and the growth opportunities you have with things like JP3, like how do you guys think about continuing the impressive results you've had on the cost side versus kind of reinvesting in the growth of the company?

Speaker 3

Hey, Jeff, it's Bahn. Thanks for the question. Yes, we're looking at potentially adding some people relative to this demand that we're seeing on the Flare marketing side. So these would be JP3 folks that would most likely show up in the cost of goods sold part of the balance income statement versus SG and A, but nothing as of yet. Right now, we're just kind of monitoring the demand to see how we can do with existing employee group, but likely headcount might tweak up a little bit next year.

Speaker 3

But again, given the growth in the revenue side that we're expecting on a percentage of revenue basis, we would expect SG and A continue to trend down.

Speaker 2

And I think in the middle of additional color from mine on that, Jeff, we started to look at it from an SG and A side, it's more than likely not a significant expansion. It would be more on the direct cost side for field delivery as we evolve in that service model. And there's no doubt that we're looking at probably a good bit of CapEx going into the Data as a Service business to stay in front of the demand curve that we're going to see coming in 2025.

Speaker 4

Understood. Those are great details. I'll let someone else hop in. Thanks

Operator

guys. Thanks. Your next question comes from Gerry Sweeney with Roth Capital. Your line is now open.

Speaker 5

Good morning, Bond and Ryan. Thanks for taking my call.

Speaker 2

Good morning, Gerry. Hey, Gerry.

Speaker 5

I wanted to stay on the data side. I'm just interested in the pipeline, how you see the sales cycle? How long will it take to maybe get deals across the finish line? I think you gave Brian, you gave a little bit of details on that, especially around the election, but just curious in general. And then just as the quad O regulation sort of take hold, how that would impact the sales cycle as well, especially as we move they become a little bit more entrenched next year and the year after?

Speaker 2

It's some great things to add some color around, Jerry, to be honest with you, because when we look at our data as a service business on the data analytics side, we really look at the opportunities in the pipeline. We kind of bifurcate those into what we have with our traditional core business around reed vapor pressure monitoring, trans mix, crude monitoring, etcetera. And the CAGR from the market in those areas, those typically have a longer sales cycle. We're looking anywhere from 9 to 12 months and they follow CapEx plans as part of OpEx expense usually. As we've started to create, I would basically use emerging markets in monitoring flare gas, our chain of custody that I mentioned, which is an exciting new area, these markets and the size of them are continuing to expand and they offer intriguing opportunities for the growth of the company because the sales cycles obviously in a government regulated area are much faster as people are going to have to start to meet the requirements.

Speaker 2

And so we're seeing these go from 9 to 12 months down to weeks at a time on the pursuit, sometimes less than a month. And so that's adding a great opportunity for a market that we're still starting to understand the actual size of it, which if you just start doing some rough math on 55,000 active wells and if we look on the chain of custody side, probably over 100,000 wells to monitor, you can start to see the potential there. But back to the pipeline, I think on our core business, we've seen about a 15% or 20% growth in opportunities for 2025. It's expanding double digit percentages every month on the upstream pieces when you look at the size of what's coming on with Flare and chain and custody side. And as we look forward going into 2025 and 2026, we're kind of doing a low, medium and high range on the potentials of the size of these markets, how we look at ensuring that we reinvest the proper CapEx to make sure that we capture all the growth potential there.

Speaker 3

Hey, Jerry, it's Bon. Just a quick follow-up. Just to think about the velocity of the sales on the flare monitoring. We got the EPA regulations in, call it, mid July. We got the approval.

Speaker 3

August, we did about $100,000 of revenue. September, we did about $600,000 So it's really starting to gain some traction.

Speaker 5

On that front, and that's what I want to get to next was, I think you said you had and there was a lot of information given out there, so I apologize if I have this wrong. 3 units, I think, in the quarter and you're looking to go to 11 units. And just on

Speaker 2

the No. We Okay. No, sorry. I'm sorry. Finish the question and then I'll finish up.

Speaker 5

No, no. I was just one I wanted to make sure that is for the flare gas monitoring the 3 units to 11 units. And the numbers Bond just gave sort of implies that the flare gas is starting to take off and is having a meaningful impact in 4th quarter should see a meaningful impact as more and more units come in onboard. Now I know there's probably some nuances to rental versus capital sale, but maybe we can discuss that.

Speaker 2

Yes. So just to clarify on the numbers. So the 3 we mentioned were on our call our earnings call we had in August for Q2. They were in location. That number grew from 3 to 11.

Speaker 2

And that will actually be 12 by Friday of this week, active in flare monitoring. And we expect continued growth in that area throughout the quarter. We also discussed our chain of custody applications, a completely different piece. Where we're looking at hydrocarbon composition of flowing. That one was we had 3 field trials running.

Speaker 2

We will add an additional 8 units here in Q4 and pushing that number up. So it's quite an exciting story. I would say 3 quarters ago, we talked about monitoring field gas, flare monitoring, chain of custody. And now those use cases are in effect and growing. So a lot of potential there in those areas.

Speaker 5

A little bit of a nuance question. You had flare monitoring and chain of custody. Are they on track or going faster than you maybe anticipated 6 months?

Speaker 2

I would say that I would call the chain I mean the flare monitoring is relatively on track considering how everybody would feel with the geopolitical issues around November 5, right? I look for those things to as we had mentioned to you earlier that we expect them to kick back in even a higher gear on the back half of the year on deliveries and on flare. And I would say that the chain of custody piece is probably a little ahead of what we're thinking because there's a lot of pieces around that in terms of what people do with it, the transparency of that data and how it costs in terms of whether they're looking at the price or paying for the composition of that crude, etcetera, compared to a composite sample. So that's the reason why we're also talking about the certification of the measurement in terms of how the market looks at it. But it's obviously it's ahead of schedule right now.

Speaker 5

Yes. I obviously with the election and everything and I think some of the changes to the regs, I felt like, Polaris Gas Monitoring is doing really well with some nuances in the market and different things going on. It feels like it's actually stronger than I anticipated.

Speaker 2

Yes. And again, we're excited about it because of the great success in the field. We're able to hook up monitoring. We've done up to 3 wells in one day with some of the testing. So it's run really well so far.

Speaker 5

Great. I'll jump back in line. Thanks, guys.

Operator

Jeff. Your next question comes from Josh Jain with Daniel Energy Partners. Your line is now open.

Speaker 6

Thanks. Good morning. First question I had is just on the chemistry side, up 7% quarter over quarter in the face of continued weak frac count and rig count. Just you gave some thoughts about electricity demand out to 2,030, and I'm not going to ask you for forecast up that far. But maybe you could just talk about where we are in the U.

Speaker 6

S. Land cycle today, what you're hearing from your customers over the next couple of quarters? And if you think that you can or reasons you may be able to outperform as you have been over the last sort of 9 to 12 months on the chemistry side?

Speaker 2

Yes. I think it's still a little bit of a crystal ball for us, right? I would say we're in a spot where we are in Q4. I would think the Q4 is going to be relatively I would say for the market itself is going to be relatively soft. I think that we've had some really good sticky transactional business with our customer base And I expect to see an acceleration in our international chemistry markets.

Speaker 2

And so I think we will have a strong quarter in the chemistry side. When I look at 2025, our customers are telling us over the coming quarters, particularly as you get towards the mid year that we're going to see a strength in the operational intensity, a little bit of an increase there. But I still think that all comes down to the quality of our commodity pricing in terms of natural gas and how the geopolitical environment holds that price of oil on the demand side. But I think that I'm hoping and what we're reading the tea leaves is that the Q4 is going to be the slower spot. You start to see a little bit an increase when we roll into 2025 is how we're looking at it right now.

Speaker 2

And I think the diversification of supplementing some of the North American activity, what we're doing in international markets in Latin America and the Middle East is going to give us a little bit extra window in our wings in terms of being able to outperform.

Speaker 6

Okay, thanks. That's helpful. And then maybe just one on the income statement or sorry, on the cash flow statement for bond. Working capital has built a little bit over the last, call it, 9 months. Thoughts on converting some of the AR to cash just as we move forward over the next couple of quarters and reasons we may be able to convert more cash than you've been generating so far?

Speaker 6

Thanks.

Speaker 3

Yes. Just remember, Josh, a big component of that build in working capital is related to the order shortfall penalty. That order shortfall penalty settles on an annual basis. So that receivable just grows throughout the year to the extent ProFrac doesn't purchase the requisite amount of chemistry. So that's one that we don't have a lot of control over.

Speaker 3

So but if you back out the OSP from the change in working capital, AR was actually down during the Q2. So we're doing a pretty good job. I think as I mentioned DSOs were improved by 12% during the quarter when you exclude that order shortfall penalty, which is kind of on a different pay terms than the rest of our standard business.

Speaker 6

Okay. Thank you for clarifying that. I'll turn it back.

Operator

There are no further questions at this time. I will now turn the call over to Ryan Ezell, CEO for closing remarks.

Speaker 2

Thanks everyone for joining the call. Again, we continue to be excited about the future of Flotek. The evolution of our business is how we bring together the synergies of our unique and innovative chemistry technologies group with our emerging markets and data analytics and look forward to our call here in Q4. Thank you for your time today.

Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating in Assai. Please disconnect your lines.

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