Flotek Industries, Inc.

Greetings and welcome to Flowtech Industries second quarter 2021 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Nick Bigney, Senior Vice President, General Counsel, and Chief Compliance Officer for Flowtech. Thank you. You may begin.

Thank you, and good morning, everyone. Joining me today and participating on the call are John Gibson, Chairman, CEO, and President, Michael Borton, Chief Financial Officer, Teng-Bang Coyd, President of Global Business, and Ryan Ezell, President of Chemistry Technologies. On today's call, we will first provide prepared remarks around our business and the results for the quarter. Following that, we will answer any questions you may have. Yesterday, we released our earnings announcement for the second quarter of 2021, which is available on our website. Today's call is being webcast, and a replay will also be available on our website. 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 results to differ materially from our current expectations, and 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 in our earnings press release as we may discuss non-GAAP metrics on this call. And with that, I will now turn it over to John.

Well, thank you, Nick, and good morning to everyone. First, let me address our second quarter performance, which was meaningfully impacted by market consolidation in the Permian Basin. As we discussed at our annual general meeting in early June, two of our most significant customers changed ownership in the quarter on accelerated timelines, resulting in a disruption in committed inventory and anticipated revenue. Having observed many consolidation events such as these in my career, It's very common for pauses in services or changes in vendors to occur as companies integrate. We are in talks with both customers about becoming their green chemistry supplier, and with one, we should be back to work shortly. Blowtech has historically had a high customer concentration in our energy chemistry business, and diversifying our customer mix has been a personal mission since I joined the company last year. Unfortunately, with the downturn, it's been challenging to reduce our customer concentration, but we have been making steady progress against our diversification goals as the industry has begun to recover. Because the industry is recovering, we have chosen to accelerate our sales strategy to diversify our customer base. We have diversified our revenue by increasing the number of both E&P operators and oilfield services companies we sell to today versus a year ago and expect the revenue to grow with our new customers during the coming year. To boost revenue growth, we've also reduced non-revenue generating costs in order to add sales and marketing resources. We have focused our expertise and passion on the delivery of green chemistry and data solutions to reduce the environmental impact of energy production on air, water, land, and people. We have catalyzed our shift to ESG, and we've engaged with the industry to demonstrate the strategic benefits of our sustainable chemistry and data solutions in support of our customers' ESGs and operational goals. Building upon our decade-plus track record of supplying our bio-based, high-performance chemistries, today we are actively partnering with energy customers to maximize the convergence of asset performance, environmental protection, economic value, and safety of the community. Fundamentally, we intend to assist our customers in their efforts to sustain the social license to operate in every geography. We are invigorated by the response we're receiving as we increase awareness of the benefits of our green chemistry and real-time data solutions. In support of those efforts, we are actively engaging with one of the most influential accounting standards agencies to impact the industry's ESG chemistry reporting standards. I'm excited about the potential outcomes associated with this engagement because I am a firm believer in what gets measured gets improved. In that vein, as we have expanded our C-suite engagements, we are beginning to see some competitive bids include ESG components as they evaluate chemistry partners. The emergence of ESG components in tenders works in our favor. Finally, we partnered with an important customer to conduct an analysis of their chemistry usage to support their ESG reporting and performance. We envision this scorecard to be the prototype for future engagement with the industry. And while these are all very encouraging steps, we still have to work to do more broadly to drive awareness and action to replace toxic chemicals such as those formulated with xylene with safer, renewable, and sustainable alternatives. Ryan will provide more in-depth commentary on that when he speaks. To eliminate delay in the implementation of critical ESG solutions, there must be stronger connectivity throughout our customers' organizations to move from ESG intent to purchasing behavior at the well site. This transition has begun but needs to become an imperative. We are ready to support this change with our customers. Now let's move on and touch a few of the quarterly highlights. While there's no question the loss of revenue associated with the change in ownership the two customers just discussed was a setback for our energy chemistry business, it is important to note that if we were to exclude those events, Our sales and adjusted EBITDA were both above our expectations, further validating that our focus on green chemistry is gaining momentum. During the quarter, we marked the one-year anniversary of the acquisition of JP3, and I am pleased that our second quarter was the best-performing period for JP3 since the acquisition. We continue to make progress around our international market entry, and I am thrilled that we have received our first international purchase order, and you're going to hear a lot more about that from Tang Bang Khoid momentarily. We have taken multiple actions to strengthen our balance sheet. First, we recently announced that we've completed a long-term lease agreement for our Waller, Texas facility with Resolute Oil, which will generate other income while offsetting our cost. Resolute's a global leader in high-quality white mineral oil, and we are excited to explore opportunities to leverage our respective green chemistries to adjacent markets we serve. We are also in negotiation on a lease for our Monahans facility, which will make it income generating as well. Additionally, in the quarter, we secured full forgiveness for the JP3 Paycheck Protection Program, or PPP loan, and we have filed for forgiveness of Flotex PPP loan and hope to have an update for you next quarter. And finally, we're pleased that we've signed a term sheet for an asset-based line of credit, and we'll keep you informed as the details of this agreement are finalized. In terms of cost initiatives, as referenced earlier in my comments, we have realigned our structure to ensure we are built to seize the ESG opportunities ahead of us. With the keen awareness, now is the time to grow our market share, given our unique position and offerings. As a result, we eliminated roles that were not directly generating revenue and are reinvesting to expand our sales team. The net annualized cost savings is more than $1 million, including the reinvestment. We're also pleased with our inclusion in the Russell Micro Cap Index in June, which represents an opportunity to improve our visibility within the investor community and to help us expand our shareholder base. Now, before I pass this call over to Tang Bang and Ryan, let me just give you some commentary on some new key partners that have joined us. First, I'd like to formally welcome Lisa Mayer to our Board of Directors and Audit Committee. She really gives us strength in governance. She has over 25 years of financial accounting experience and is the current CFO of Internet Holding, a digital infrastructure provider. Lisa is a strong addition, and I know that she will immediately have positive contributions to make to our board and our company. I'm also happy to welcome KPMG as our new audit partner. We just began our relationship in July, and the team and I are very impressed with their professionalism, I look forward to a collaborative partnership. And I'm amazed that KPMG and our team, in just five weeks, managed to get the queue out on time. So congratulations to both of you. We are pleased to have expanded our coverage to include noble capital markets, and we welcome research analyst Michael Heim to our call. And we look forward to hearing his questions this morning, along with Daniel Burke, our esteemed analyst for quite some time from Johnson Rice. Now I'd like to turn the call over to Tang Bang for further discussion on our data analytics segment. Tang Bang?

Thank you, John, and good morning, everyone. In the data analytics segment, we are pleased to see continued financial performance improvements in revenue and gross margin. Revenue was up slightly in the quarter, improving sequentially over the past three quarters and the best quarter since the acquisition of JP3. Sales were driven by the addition of a number of new customers particularly in Canada and existing customers here in the U.S., continuing to make additional purchases. These new orders and repeat customer purchases are testament to our game-changing digital transformation technology that provide real-time data and analytics to our customers. The second quarter marks two major milestones for data analytics. First, we have completed the specifications and manufacturing of our Varex Analyzer prototype for international markets and we are in the final process of undergoing extensive certifications and hope to obtain the certificates for international deployment soon. Secondly, we have received our first international purchase order. This sale will support a major international oil company representing two exciting firsts for JP3. This system will be installed in an offshore platform in Southeast Asia expanding both our geographical footprint and application use cases, i.e., in an offshore environment. Although our focus continues to be on onshore, upstream, midstream, and downstream applications, the lockup of a competitive bid in support of offshore operations validates the value of our real-time data solutions across the energy sector and represents an exciting new frontier with vast market opportunities. At JP3, we continue to focus on executing our strategy, especially in technology development where we have a very robust technology development roadmap that includes many new capabilities that will become available in the near future. With that, I will send a call to Ryan Ezell to discuss our chemistry technology segment. Ryan?

Thank you, Corey. Today, I will discuss our chemistry technology segment performance, first highlighting our energy chemistry technologies and then moving on to professional chemistries. As John mentioned earlier, energy chemistry technologies was impacted by the unplanned acceleration of M&A activity affecting two domestic customers in the quarter. And excluding the loss of this revenue, we were on target to exceed quarterly growth projections and deliver strong results. And to provide a bit more color around the impact of the revenue loss associated with the market consolidation, the business would have been up by 22% if we were to include the expected revenue recognition from these two customers. And despite these consolidation setbacks, we are confident that the execution of our strategy to be the collaborative partner of choice for sustainable chemistry is gaining traction. And we are keenly focused on building our market share to include domestic and international EMP operators, as well as service companies, thus diversifying our revenue stack and minimizing future risk from customer concentration. In the second quarter, we also reassessed our organizational structure to accelerate these efforts. As a result, we made a number of structural changes and reallocated resources to expand our sales and marketing efforts. And accordingly, we plan to double our sales force to focus on broader adoption of our green chemistry solutions across the energy lifecycle while generating more than $1 million in annualized salary savings. Our expanded sales force will help us build upon important fundamental progress that we saw in the second quarter, which includes first, and as discussed last quarter, our green chemistries are being utilized in an important field trial in the Permian Basin. And based upon the initial success We are excited that the pilot has been expanded not only in scope to include new technology applications in the Permian, but also into new unconventional basins in North America. Secondly, during the quarter, we secured multiple new remediation treatment applications utilizing our complex nanofluid technologies. The bio-based, high-performance chemistry built upon non-toxic plant-based solvents is enabling FlowTex customers to cost-effectively replace the use of benzene, toluene, ethylbenzene, and xylene, also referred to BTEX, and other harmful solvents, thus reducing the environmental risk of their remediation and production programs. And additionally, we're also pleased to announce we are partnering with a very important customer to provide an ESG scorecard assessment of their full well cycle chemistry utilization to identify opportunities to support their ESG reporting goals and operational efficiencies. Furthermore, we have made notable progress in rebuilding our indirect channels to market with our service company revenue side. We saw our indirect customer base increase by 58% and domestic indirect channel revenue grow by 68% sequentially. We also expanded our operational safety record in the field to exceed more than 2,000 days without an OSHA recordable or lost time incident. And finally, We entered into a multi-year agreement with Resolute Oil, a leader in high-quality white mineral oil that services consumer and industrial customers. Resolute Oil will utilize our chemical blending facility in Waller, Texas, to manufacture USP and NF-grade white mineral oil that will be distributed globally. And our facility is customized for production of green chemistries, and our consumers are taking notice of how they can leverage our capabilities and facilities to drive growth in adjacent green markets. Now turning to professional chemistry business, during the second quarter, we saw overall volume improvement sequentially driven by strength in janitorial, disinfectants, and cleaning products. And we are pleased to see that we are building momentum for these categories, contributing to our improved quarterly performance with revenue up more than 30% sequentially. In the quarter, we made positive progress to build important foundational relationships that will amplify upon our internal sales team, led by JanSan veteran Matt Sullivan, These milestones include the securing of contracts with national and leading large-scale distributors and redistributors. Now, I'll turn over the call to Mike to discuss our financial results.

Thank you, Ryan. Building on the earlier comments, I will expand on the quarterly financial performance. During the quarter, consolidated revenue was $9.2 million, up more than 3% from the $8.9 million in the second quarter of 2020, but below the $11.8 million of revenue for the first quarter of 2021. By segment in the second quarter, chemistry technology segment saw a 3% decline in revenue year-over-year to $7.7 million and a 25% decline sequentially from Q1 2021. The decline from Q1 2021 was primarily driven by the loss of sales from the two domestic energy customers discussed earlier on the call. As we further analyze our chemistry technology segment, the energy chemistry saw a decline in revenue sequentially with the loss of the two Clients, year-over-year revenue and energy calamities, excluding raw terpene inventory sales, increased 87 percent, despite the loss of sales from those previously discussed clients. Professional chemistry saw an improvement sequentially driven by strengthened degreasers and disinfectants, but sales were down significantly year-over-year, given the peak COVID pricing and demand levels a year ago. Turning to data analytics. As a reminder, we acquired JP3 in May of 2020, and thus, we do not have a full quarterly year-over-year comparison for the segment. Sequential revenue was slightly better for the quarter. Consolidated operating expenses were $12.1 million in the second quarter of 2021, a 12% decline sequentially, but increased 4% from last year's level of $11.6 million in the second quarter. The operating expense increase over the last year was impacted by having only a half-quarter of JP3 expenses in Q2 2020 versus a full quarter of expenses in Q2 2021. Corporate G&A decreased 34 percent from the first quarter of 2021, primarily due to the receipt of a $1.9 million employee retention credit, which includes both the Q1 and Q2 credit. and also a reduction in contractor spend, which were partially offset by an accrual for severance expenses associated with the personnel changes discussed by John and Ryan earlier today. We reported a net loss of $6.5 million or $0.09 loss per diluted share in the second quarter of 2021, a significant improvement over the net loss of $9.6 million or $0.14 loss per diluted share last year. Our adjusted EBITDA for the second quarter was a loss of $6.7 million, slightly higher than last year's loss of $6.5 million, and flat with last year's loss of $6.7 million. Now, let's move on to the balance sheet, where our focus remains on preserving liquidity. At the end of the second quarter, we had cash in equivalents of $28.8 million, approximately 40 cents per diluted share, versus $33.9 million in the first quarter. Our cash position was impacted by the operating losses and prior severance agreements, which were partially offset by the employee retention credits and improved working capital changes. We are pleased to report during the second quarter, JP3 received full forgiveness of its $881,000 Paycheck Protection Program PPP loan from the SBA, which was recorded as other income during the quarter. FloodTech also filed in June for forgiveness of a significant portion of the remaining $4.8 million in PPP loans remaining on the balance sheet. Additionally, we recently signed a term sheet for an asset baseline, which we will use for funding future working capital growth as the business expands. Lastly, as John and Ryan discussed, we completed a long-term lease agreement for a Waller facility, and we are in negotiations to rent our Monaghan facility. Our balance sheet at the end of Q2 still included the accrued liability of $9.4 million associated with the company's previous supply agreement with ADM, recorded last year in the fourth quarter. The $9.4 million represents the expected losses from the sales of excess terpene beyond our product usage for our clients. We will continue to monitor this accrual quarterly. The balance sheet also includes a receivable for $1.1 million for the remainder of the employee retention credit cash benefit. Our tax net operating loss of $115 million, roughly a dollar's diluted share, continues to grow quarterly. Now I'll turn the call back to John.

Well, thank you, Mike. Thank you, Mike. I'll turn my mic back on. Before we take any questions, I thought I'd make a few summarizing comments. First, no doubt you'd like to hear how the third quarter is tracking now that July is behind us. While we will not provide any guidance for the quarter, I would like to share that our July revenue number is higher than any individual month in Q2 2021. This is certainly a positive indicator that we're on a solid path. We made significant progress to deliver against our stated commitments, demonstrating we're steadily converting aspiration to action because it all comes down to our ability to execute on our strategy. For many months, we've been working to take steps to further solidify our liquidity and and we delivered on several fronts this quarter, and there is more to come. I'm very proud of the leasing situation that we have that converts liabilities into income. Since our acquisition of JP3, Tank Bang and the team have been working diligently to internationalize our VRAC system, and this quarter we secured our first purchase order as well as completed our international prototype. We have made steady progress toward diversifying our customer base in our energy chemistry business and I'm optimistic about the future under Ryan's leadership. Finally, I'd encourage you to take a look at our new investor presentation on our website. It encapsulates Flowtech today and our unique value proposition to advance ESG solutions for our customers. We will be attending the Intercom Oil and Gas Conference next week, and I'll be presenting on Tuesday afternoon, and we'd welcome you to tune in to that as well. Now, with that, operator, we'd like to open up the floor for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. We will now pause for a moment to assemble our roster. Our first question today will come from Daniel Burke with Johnson Rice.

Hey, guys. Hey, John. Good morning.

Good morning, Daniel.

Let me actually start with one on JP3. You know, COVID was pretty disruptive last year, encouraging to hear the progress on some of the international efforts there. Could you step back and maybe talk about the efforts as well to rebuild JP3's sort of midstream, downstream domestic business and where you are with Phillips 66?

I'm happy to do that. I'll turn it over to Tang Bang. I'll first say, though, really exciting to have a sale in the Far East and offshore. So you combine those two things, first offshore sale, and even that was impacted by COVID as the country made it – It made it difficult for us to actually deploy the equipment yet as a result of COVID being on the platform potentially offshore. So, it continues to be a problem and it's a country by country problem. With that, we'll take back.

Yeah. So, John, to your point, the international market is still affected by COVID restrictions. And at first we thought it was getting better, but obviously with the recent strain, prevented us from sending people to install a system in Middle East and also in Far East. So what we're working through is getting those people there. So we had a few Saudis over at our facilities. They can come over here. It's difficult for us to go over there. So now we've got them trained up and hopefully we'll get that going on the international front. So despite the COVID restrictions and all the issues, we managed to get the sale international and also progressing very well on the pilot. There were a few other areas, other countries, that we expected some firm orders, and with some of it, I think we can see some of this coming to fruition probably in the next couple of quarters. Domestically, Daniel, to your question, we're seeing the midstream companies' budgets starting to open up, so we're seeing progress in that area, and especially towards year-end, we'll see more budgets opening up and seeing progress in that area. On the partnership with Phillips 66, we are continuing to make progress. There are a number of customers, rather, or potential customers that we've been working closely with Phillips 66. In fact, last week, last Friday, we had our joint collaboration partnership meeting again with them and making progress despite the COVID situation.

Got another question, Daniel?

Yeah, sure, John. I appreciate the comment on July, and that's encouraging. But still, I guess, any reason that July could prove to be non-representative of what the quarter on the whole might look like? I just want to make sure we don't over-extrapolate.

No, I don't want to over-extrapolate either. I don't. Didn't enjoy having to come out at the AGM last time and say that we'd lost a customer. So not anticipating anything. I mean, we're actually in much better shape. As Ryan discussed, we've really diversified customers already as a result, so I'm not concerned about that. My two biggest concerns would be COVID again, and government reaction to that would be number one, and customer reaction to it. And then the second one is sort of, we'll call it operational fatigue happening in fourth quarter. And so when do they stop? Do they stop on Thanksgiving or do they stop on Christmas in terms of spending for the year? And so as I look out for the second half, it's more of, you know, where are the budgets going to go? And does COVID rear its ugly head again? Otherwise, we're really seeing some solid gains here. in the green chemistry side that I can get Ryan to comment on maybe in a little bit. And it's, I'm optimistic, but I'm, I'm not going to give guidance.

Understood. Understood. That's helpful. Okay. Yeah. And maybe, maybe just a final one for me. Can you wrap, can you wrap up, John, comments on green chemistry in the energy markets. You talked about a number of discussions and sort of fruitful initial, I don't want to even call them initial, but efforts that you're seeing out there in the field of marketing. Can you give us a sense of just how broad those discussions are? Does that make sense rather than sort of individual discussions?

No, that'll be fine. I think if I could, I'll get Ryan to comment on sort of how remediation jobs are increasing and what else he sees on the green adoption side. Brian.

Yeah, sure, John. It's quite, we're really excited about what we're seeing. We're seeing, if I look at an overall kind of macro scale of it, we're starting to see the conversations that we were having at the C-suite level around green chemistry now transcending across into the multiple basin operations and also in some of the impacts we're seeing internationally. When we look at the type of business, you know, the core, what is a differentiator for Flowtech is around the over 170 patents we have around green chemistry utilization, these natural bio-based solvents and things that can replace BTEX. And what we've really done is we've continued to grow in our simulation market and with our customer base of we're selling to the oil field service companies and the direct NUCMP operator. improvements up taking that but what i'm really excited about is now we're starting to diversify into these various verticals a little further down the line on the remediation treatment and we've seen substantial application improvement of the green based chemistry on the remediation side where traditionally xylene has been used or other btex related solvents or other i would consider be non-gross related solvents and we're consuming it see that grow and we're really excited about the future on where that's going around the vertical side. And we're also seeing that also translate to operations on the well construction side. And when I talk about well construction, I talk about drilling fluids and cementing products where we've seen substantial improvement with the oil field service companies in there. And that's led to some of the things that we're looking at on diversifying our customer base because we're using similar treatments to do mud flushes and displacement treatments for improved cement bond logs, et cetera. So a lot of applications on the green side that are continuing to evolve. And the most notable thing, though, is, you know, when you're out in the basins now, these conversations are making their way into the field operation discussions. And so that's a transitional trend that we're seeing that may not have been seen in the past. It was typically just a C-suite sustainability messaging. So that's a really positive step.

But I think it's fair, Ryan, to say – in Q1, Q2, we did seven remediation jobs eliminating xylene, and we're anticipating as many as 40 in Q4. And the potential there continues to grow as we have the conversation. And these are not as big a job as stimulation jobs, so I don't want to overstate here, but I'd rather have higher margin, smaller revenue opportunities in terms of per well than I would less margin, big opportunity. So I think we got a really big opportunity here in the remediation space.

Got it. Okay. All right, guys, I'll leave it there. Thank you for the comments this morning. Appreciate it.

Our next question comes from Mike Heim with Noble Financial.

Thanks for taking my question. Looking for a little bit more color on the loss of two customers in your comments that you might be able to get some of the a green business back on one of them so specifically why do you feel that's the case how soon could it come about would we be talking about similar numbers similar sales to what you're doing before maybe even larger and what's the status of the second customer so

It's a good question. I'm not going to be too cagey here, but the two customers, they were sort of customer A, customer B, if you take a look in with regard to our business. One of the losses, which was really important to us, went to a customer that does not use Flowtech at this time. And they already have relationships and they have methodologies. And we are definitely talking to them at the C-suite level. And we're engaged with them throughout the organization. But I'd say our ability to come back there is more limited than the second customer. But we continue to engage with them all the time. And I do look forward to doing business with them again in the future. The other customer we think will be back by Q4. And so we've engaged with the new owner. And it's a property that we know well. And in both cases, the performance of these properties were better than offset operators. And I would say we contributed to that. Obviously, we're not 100% of the reason that's the case. But our chemistry really contributed to their performance. their enhanced production and the premiums they receive for these companies. And so now I'm hoping that we'll be able to get out and tell that story and help other companies improve their production to where they receive premiums as well as they go forward. So one's gone, the other one back in Q4, and the one that's gone for a while, we are steady working on.

Okay, and then let me ask a question about the cost reductions that you had this year. And I know you've talked about the sales force, a million dollars, but you did a really good job lowering the cost in the other areas. I'm just trying to get a sense, are these permanent reductions or are these delays and expenditures that maybe you did in reaction to the drop in revenues?

Ryan, why don't you talk about the reductions you made in order to hire more sales staff?

Yeah, so we looked at quite a few things across the board. These have transcended from cost of goods realignment, service delivery realignment on where we're sourcing chemicals in basin, which is that impacted on blending costs and logistical costs and operational support needs. And more importantly, we did in alignment with our value proposition, the strategy that we are, we looked at every role across the board in the organization to say, you know, are we creating value or not? And we needed to, you know, realign the structure for full 100% directional approach around growing our revenue and reinvesting in the growth of the sales force focused on our green chemistry applications. And that's what we've been able to do. The majority of our operational structural changes, we look to be able to maintain with significant growth. And, you know, I would say potentially all revenue focused on would be potential improvement on how many additional Salesforce that we add for coverage because we are looking at basis specific customer representation, et cetera, for that going forward. So I look for a lot of our structural changes to be maintained.

These weren't just holding payments, et cetera. Okay. Then in talking about the Salesforce restructuring before you've talked about it being maybe a three to six month time of process, Is that still kind of a good number to use and where do you see yourself in terms of how far along we are?

Did that question come through?

It seems we may be having some technical difficulties with our speaker lines, so please give us a moment here while we figure that out. And again, ladies and gentlemen, my apologies. It does seem like we are having some difficulties with our speaker lines, so just please hold for a moment while we get them reconnected.

Thank you for your patience. It looks like we will be able to