Flotek stages amazing comeback

All photos courtesy of Flotek Industries

EDITOR'S NOTE: On the brink of collapse in 2009, Flotek has engineered an amazing comeback. The company was able to raise new equity and rework its senior debt. Since 2010, Flotek has reduced its debt by $99M, or 64%, mainly through cash flow. Today, the company has a modest $55M in debt, nearly $20M in cash on hand, and a $35M undrawn credit facility. Chairman and CEO John Chisholm talked to OGFJ about his company and its incredible turnaround.

OIL & GAS FINANCIAL JOURNAL: John, you have said that the shale revolution has been enabled by technology. Can you elaborate on this a little?

JOHN CHISHOLM: The shale revolution's success has been precipitated by two technical advances: directional/horizontal drilling and multi-stage stimulation of horizontal wellbores. Without both of these advances, obtaining commercial production from nano-darcy reservoirs would have never been possible. Flotek offers high value/high impact services that augment both of these technical advances, from our Complex Nanofluids® which improve hydraulic fracturing effectiveness to our directional MWD Teledrift services.

OGFJ: What is Flotek's role in drilling and completing wells? That is, what services do you offer your customers?

JC: Flotek plays an important role in the entire lifecycle of a well. In the drilling process, our Downhole Tools division provides a variety of equipment used in the drill string including drilling jars, shock subs, drilling stabilizers, roller reamers, and mud motors. Flotek also provides real-time MWD directional surveys through our Teledrift subsidiary. In addition, Flotek furnishes a number of drilling chemicals and products that enhance the drillbit penetration rate. Once drilled, Flotek assists clients in their primary completions with cementing float shoes and our casing centralizers, including bowsprings, turbulator centralizers, and phenolic centralizers to ensure an easier entry for the casing and better cement integrity. Flotek also provides cement additives to ensure that the cement quality is adequate for zonal isolation. Once the primary completion is accomplished, then Flotek is heavily involved in providing stimulation chemicals such as our Complex nano-fluid (CnF®) which enhance the production rate and reserves obtained through hydraulic fracturing operations. After the well is drilled, completed, and stimulated, Flotek's pump services division provides electrical submersible pumps (ESPs) and our patented Petrovalve for our client's artificial lift needs. And further along in the life of the reservoir, Flotek's chemical group provides various chemistries for conformance control and other IOR applications.

OGFJ: Where do you operate, and how much of your business is outside the US currently? Do you expect this to change much in the near term?

JC: Flotek operates all over the world including the US, Canada, Latin America, Europe, the FSU, and the Middle East. The majority of our fracturing chemicals business is in countries where hydraulic fracturing is widely used. From a Teledrift project in Kazakhstan to Petrovalve sales in Venezuela to chemical sales in the Middle East and Europe, Flotek is well positioned in key oilfield markets around the globe. Today about 85% of our business is in the US and Canada due to the heavy concentration of hydraulic fracturing equipment in North America and the fracture pumping company's dependence on the type of chemicals that Flotek develops.

OGFJ: How would you describe the impact shale development has had on your business?

JC: Shale development has been a game changer for all of the pumping service companies and their suppliers. Flotek in particular is well suited for shale development due to the effectiveness of our Complex nano-Fluids on the nano-darcy rock found in many shale plays. The original CnF was designed to more effectively remove the fracturing load water which created permeability issues that hamper gas flow. About three years ago, we began development of CnF which is tailored for oily reservoirs that both improve load recovery AND assist in the demulsification of crudes, allowing them to flow easier from the small pore throats seen in shales. Shale development also depends heavily upon directional drilling from pads and horizontal drilling, both of which find Flotek's downhole tool services particularly useful at improving penetration rates, more accurately hitting the desired target interval and obtaining a better completion.

OGFJ: Can you give us a little background as to how Flotek started and how the company has expanded? Did you grow organically, through acquisition, or a combination of the two?

JC: The company was founded in Canada with the original Petrovalve as the primary product. Along the way, we grew through acquisitions including centralizers, downhole tools, Teledrift, and chemicals. Since 2009, our growth has been entirely organic as we've grown all three product lines substantially (Chemicals and Logistics, Downhole Tools, Artificial Lift) and also drove growth in new geographies for these same product lines. Flotek's revenue in 2010 was up about 31% from 2009 and up again in 2011 by 76% over 2010.

OGFJ: In 2009, Flotek experienced some serious financial challenges. What happened and how has the company repositioned itself as a result of those challenges?

JC: Flotek was on the brink of collapse in 2009 as a result of the global recession, a pronounced slowdown in oilfield activity, and a seriously over-levered balance sheet. We had $600,000 in cash, were in default of our credit facility, and were concerned about making the next week's payroll.

From left: Steve Reeves, Flotek EVP - operations; Johnna Kokenge, Flotek VP, chief accounting officer, compliance officer; Kevin Fisher, Flotek EVP - global business development.

However, through the effort of Chris Edmonds, now our senior director of finance, we were able to raise enough new equity to keep the company going. We then focused on reworking our senior debt to provide additional working capital and more flexible repayment terms to provide operating room in 2010.

The journey continued as operations improved – largely the result of an improved culture – and we found ways to continuously reduce leverage, both from operational cash flow and a small equity raise.

Since 2010, we have reduced our debt by $99 million, or 64%, mostly through internally generated cash flow. Today, we have a modest $55 million of debt, nearly $20 million of cash and a $35 million undrawn credit facility. Our intent is to use leverage conservatively and in ways that enhance the overall value of the enterprise, focusing first and foremost on being an unlevered, growth-focused oilfield technology play. With our best-in-class chemical and measurement-while-drilling technology, we believe we can achieve meaningful growth targets without the undue use of leverage.

OGFJ: Can you elaborate a little more about how you were able to come back from the brink of financial disaster?

JC: Sure. As I noted earlier, the company had become far too levered due mainly to acquisitions made just prior to the downturn. At the same time, we saw revenues and operating income eviscerate rapidly in 2009 as the economic swoon accelerated. Due to some incredible work by every member of the Flotek team, we weathered the storm by making difficult choices in reducing the size of the organization and doing "more with less." We were able to boost sales productivity even as we worked to fix the balance sheet.

While the financial challenges were significant when I became president in 2009, the more important challenges were cultural: specifically to refocus the Flotek team and keep our team motivated, being ever-ready for the upturn we knew would come. Since those dark days when we were literally a phone call away from insolvency, we've dramatically improved our revenue and profitability and have paid down significant debt to help Flotek become one of the best- positioned oilfield service companies in North America. We've been a top 10 NYSE performer for the past two years and have seen our company's reputation grow alongside our financial performance.

OGFJ: Flotek is known for its innovative technology. Can you elaborate a little as to how you work with operators to optimize production in multiple basins, especially given that the geology differs considerably from play to play, from well to well, and sometimes even in the same well bore?

JC: I'll give you two examples of how Flotek's R&D Team has worked with our clients to develop solutions that are meaningful to our customers' bottom line. First, our Teledrift division was approached by customers asking how they could get faster bottomhole location surveys from our unmanned Teledrift services. Very quickly, we developed a real-time satellite telemetry system that took these unmanned data and pushed them to our real-time drilling operations center. There, drilling survey specialists QC and confirm the accuracy of the data, then update the drilling plot to reflect the most recent data so that our clients know where their bottomhole location is at any given moment.

Another example is in our chemical division where clients familiar with the efficiency of using CnF to extract oil and gas when placed during fracturing operations asked if they could somehow use CnF in IOR flooding applications. Our team went to work with reservoir models, laboratory experiments, and engineering studies to determine how to modify our CnF portfolio to create new nano-fluids tailored for waterfloods, CO2 floods, and polymer floods, which, depending on the application, can either improve conformance control by plugging off high permeability channel "thieves" or improve the sweep efficiency by recovering more oil for the same or less flood volumes.

CESI lab technician running experiment to determine CNF effectiveness

OGFJ: Can you provide an example of a breakthrough or cutting-edge technology that Flotek has developed that has made a real difference in the economics of drilling and production?

JC: Our Complex nano-Fluid has been utilized in nearly every shale basin to improve the productivity of unconventional resources. Generally, the payback time seen from the use of CnF is less than 30 days. Production rates have improved from 5% to over 200% when compared to neighboring wells in the same plays without CnF. So the initial recovery rates are substantially improved, leading to a very quick pay-back for our clients, who then enjoy a sustained production uplift over the entire life of the well.

OGFJ: The world's petroleum resources are in increasingly more difficult geologic settings, deeper in the earth, and in the oceans, and require addressing more challenging environmental situations. What is the most difficult challenge that Flotek has faced, and how did you overcome it?

JC: Our most difficult challenges involve convincing clients to spend more money on a well in order to produce substantially more revenue. Well costs are closely monitored by clients and even their investors in the market, and it is not always well understood which products or services give the most return on investment. Flotek performs engineering studies incorporating production data on wells with our CnF product to compare "apples to apples" with neighboring wells that did not have the benefit of applying our superior CnF fluid during the fracturing operations. CnF is the clear winner in numerous studies we've performed and presented to our clients.

OGFJ: Talk a little about your CESI subsidiary. How did Flotek happen to acquire CESI and how do they complement your existing service and technology?

JC: CESI was a niche specialty chemical manufacturer with a great patented product that no one had ever heard of. When Flotek acquired CESI, we put our industry contacts and relationships together with the outstanding technical talent at CESI and from that combination have built Flotek's fastest growing and most profitable business line. And CESI didn't stop there. In addition to the CnF family of products, we've since developed some world-class friction reducers and other green chemicals that are making our clients' wells produce better and with less environmental impact.

OGFJ: What do you see as the key drivers for your business?

JC: The key driver for future success is to continually attract top talent. A service company is all about people and recruiting. Hiring and retaining good oilfield talent is an everyday challenge. These top performing people will design and develop Flotek's technologies of the future. Flotek is probably less dependent upon rig count as a business driver than most companies because our relatively small market share allows us to continue to grow our business through incremental market penetration even in the face of small downward adjustments to rig count. We believe the global hydraulic fracturing market is in its infancy. Today, nearly 90% of the commercial hydraulic horsepower is in North America. While creating a robust market close to home, we also know that the rest of the globe is "running on empty" when it comes to easy hydrocarbon production – the high permeability reservoirs – and is beginning to look seriously at horizontal drilling and hydraulic fracturing as the solution to attacking the "second tier" reservoirs in other parts of the world. That creates huge market opportunities for Flotek.

Chris Edmonds, founder, managing partner of Enerecap Partners.

OGFJ: What do you see as some of the obstacles you might have to overcome – for example, regulatory compliance, tax issues, and so forth?

JC: Business uncertainty is a fact of life in the oil patch. No one can predict tomorrow whether it's the November elections or future regulations and issues imposed on our industry. Today, however, we believe our business is positioned properly for the current regulatory scheme. While items like the upcoming EPA Fracturing Report could certainly influence how we do business regarding disclosure of chemical composition and other intellectual property, we believe those challenges can be managed.

Flotek has some of the greenest chemicals being used today in the drilling, completion, and production of hydrocarbons. How nice is it that we can make a product (CnF) out of oranges, coconuts, alcohol, and water and have that product dramatically improve the performance of a well? It is a nice, environmentally friendly cocktail for success.

OGFJ: How can you assure investors and stakeholders that Flotek has the vision and the ability to deliver value to them and satisfactory return on their investment?

JC: Each quarter in our comments to our stakeholders, we pledge to post transparent results, operate in a highly ethical manner, and work tirelessly to earn the trust of our clients and shareholders. This is our mantra. We will treat our capital as if it were our own and make certain that every decision we make is based on what we believe to be in the best interest of our stakeholders.

When I arrived as president in 2009, Flotek had eviscerated any goodwill and trust it had with its stakeholders. Today, through the dedication and hard work of the Flotek team, we have regained some of that. We believe we have positioned the company to continue to build on that success but, at the same time, we will never forget where we have been. Every day we will strive to be the best at what we do and do so with the highest degree of integrity. If we do that, we will be well on our way to creating value in a company in which every stakeholder can be proud.

OGFJ: Finally, John, what is the significance of your cover photo with the oranges? I know you were a college quarterback, but I didn't think you ever played in the Orange Bowl.

JC: I played football at a small Colorado school, Fort Lewis College, and, you're right, I never did play in the Orange Bowl. However, one of Flotek's key patented, environmentally friendly products is made from the oils extracted from orange peels. The oranges represent a fresh approach to thinking about our company and our industry. We're about to move into new corporate headquarters, which will help position our company to facilitate future growth. It's incredibly symbolic – and powerful to the Flotek team – that something as small as an orange – combined with a lot of added-value research and technology – can serve as the base to transform a company from the brink of the abyss to an oilfield technology concern that is helping reshape the future of hydrocarbon completion and production methods. Small but mighty, that's the story of the orange and, we hope, the way our stakeholders will think of Flotek in the years to come.