Flotek transforms technology experience

OGFJ: Many upstream companies are reorganizing and some have been forced to file for bankruptcy. A recent mid-year forecast is for only about 14,500 wells to be drilled in the United States in 2016 - the lowest total since 1933. Oil prices are up and down, but mostly are lingering between $40 and $50 per barrel. Can some companies survive and even thrive with prices in this range? What price level do we need to get to in order to say the market is back?

CHISHOLM: I don't think there is any doubt you can survive, but to thrive, companies needed to have the foresight to have an unlevered balance sheet and the internal cost structure to reflect the level of activity we have now. And I think you had to be a bit fortunate, especially as an E&P company. You need to have the acreage in the right places. If you were smart enough and lucky enough to do this, you can thrive.

To answer your question about oil prices, I think it needs to be $50 or above and that price level needs to be sustained for at least two quarters. That's been the difficulty in 2016. Although it has touched $50, it wasn't sustained. The price needs to be a consistent $50, and I would define consistent as at least a couple of quarters.

OGFJ: Do you think we are headed in the right direction now?

CHISHOLM: I think the production decline should push us in that direction, but this downturn has defied logic and reasonable expectations. It's been deeper and lasted longer than anyone expected, including those experts who make a living forecasting all this. Overall, I do think we're headed toward an increase in oil prices in the near future due to a rise in demand and decline in production.

OGFJ: Some basins are better performers than others. As everyone knows, the Permian is hot right now. About 70% of the recent M&A / A&D deals have been in either the Delaware Basin or the Midland Basin within the Permian. The SCOOP and STACK plays in Oklahoma also seem to be doing better than average. What makes these plays better than some of the others?

CHISHOLM: Folks in the land part of the industry would say that the cost of leasing in the Permian really hasn't dropped off since 2014. If you want to acquire acreage in the prime part of the Permian, you're going to pay the same as you would have paid three years ago. There's been no drop-off in land prices. The main reason is there are so many horizons in the Permian. It's not just going for one zone, and you either get it or you don't. There are multiple chances to try to make an economic well. That's also the case to some extent in the SCOOP and the STACK. But Permian operators have really worked on their cost structures, which has helped make the wells more economic to drill and complete. Currently, roughly 40% of all drilling rigs in the US are drilling in the Permian basin. There's a reason for that - the rock there is more prolific than anywhere else in the country.

OGFJ: Flotek is a global supplier of drilling and production products and services. The company has four main divisions, or product groupings. How did Flotek come to focus on these particular areas, and did you grow the company organically or through acquisitions?

CHISHOLM: Well, we've grown both ways. Since I joined the company in 2009, most of the acquisitions have been what we call "technical, tuck-in acquisitions." They were in the several million-dollar range with the exception of Florida Chemical in 2013, which was a $100 million acquisition that really changed the direction of Flotek and the way it is perceived in the industry. That acquisition really has helped shape the company into what it is today.

Before I became president of the company, Flotek had recognized that there are at least three main parts in the life of a well. The drilling part - you need to have the tools and equipment you can rent to drill the well. The completion part of it - which is mostly where the chemistry applies. And, the production side or artificial lift. So that kind of aligns with the three main oil and gas industry service lines that Flotek provides to the industry.

The fourth part came with the acquisition of Florida Chemical, where some of the citrus oil components are used in commercial and industrial chemistry for other applications outside the energy industry, anywhere from degreaser to perfume to the flavor in orange juice, And it's all because that citrus oil is needed and it's all part of the refinery process for us to get what we need on the oil and gas side. So those are the four main products and segments, some by acquisition and some by organic growth.

OGFJ: Is this a particularly good time for a lot of the products and services you offer? Since cost cutting and increasing efficiencies are crucial during a downturn, wouldn't that heighten demand for Flotek's products due to the greater efficiencies you provide?

CHISHOLM: Well, I'm not sure an industry downturn is ever a good time for a company. It's definitely an adventure out there. But you're right about one thing. When you have technically differentiating services, I think that gives you good standing in the market whether you're in a period of high activity or low activity because you can differentiate yourself from a product that is purchased just based on price. We strive very hard to make that happen.

OGFJ: Is Flotek facing the same kind of intense pressure from your customers to keep prices down that all oilfield services companies are dealing with?

CHISHOLM: In the chemistry side of things, we've been able to hold the line on our pricing. We've kept our gross margins up because we have multiple patented technologies and the benefits to the customer can be validated. As I mentioned previously, this is what differentiates us from the other companies. When you decrease your prices as much as others have had to, it will take time for those companies to get back to higher prices. Prices go down fast, but they recover much slower.

OGFJ: When an E&P company says it costs $10 million to drill a well in the Bakken in 2014, and today they have reduced that figure to $6 million, does most of that increased "efficiency" come from the lower prices they've negotiated with their service providers?

CHISHOLM: I believe so. There is no question the rigs have become more effective with technology, but I believe the majority of that cost savings has come at the expense of the service companies.

OGFJ: Flotek recently closed on the acquisition of International Polymerics Inc. (IPI), one of the largest domestic suppliers of natural polymers, including guar, to the oil and gas industry. What is the net benefit of this acquisition to Flotek and to your customers?

CHISHOLM: What I think is really amazing about Flotek is that we have transformed ourselves during this horrific downturn. With our acquisition of Florida Chemical in 2013, we put a stake in the ground that Flotek would be recognized as a customized chemistry company that provides the best solutions to help these reservoirs. That enabled us to move away from our dependency on the downhole tool segment, which was largely dependent on rig count. So we did this even before the rig count started to fall. That has allowed us to weather the downturn better than we would have otherwise.

Since you last visited with us, we have made three or four acquisitions- all driven toward the chemistry side of Flotek, whether it was analytical work or specialty products that we felt we could distribute with our industry footprint. Flotek is a completely different company now than we were in 2012. We have greater financial stability and also a bigger global reach than we had at that time. We are now completely focused on doing all we can to enable and protect the reservoirs of our clients.

OGFJ: How did International Polymerics figure into this equation?

CHISHOLM: Even though the company had a very good reputation, we made that acquisition from a strategic view rather than strictly what the company was currently doing. We looked at what, Flotek's business could become through the synergies of adding the IPI business. Almost without exception, all unconventional wells are hydraulically fractured with two types of fluid systems. One is called "slickwater," and one uses polymer or guar. With the resources provided by International Polymerics, we can now provide the entire fluid system for the reservoir in addition to our suite of Complex nano-Fluid® technology. We've been looking at this opportunity for more than a year, and this was a logical evolution for Flotek. The time was right to be able to create a connected value - to be able to offer a complete, prescriptive solution to our clients.

Our plan is to not simply to put a Flotek label on the same type of polymer that International Polymerics had been making. Now that we have control of that asset, our mission is to turn something that has been a commodity into a special custom chemistry.

OGFJ: Is the oil and gas industry using mainly slickwater today?

CHISHOLM: There are three types of wells currently - slickwater, guar, and hybrid (a combination of the two). I would estimate that about 60% of wells today use slickwater, or friction-reducers. With 40% using polymer/guar in some fashion. So it's very important for us to be in both markets in order to offer a complete prescriptive solution to our customers.

OGFJ: Flotek gets high marks for innovation and the quality of its research and development. What did you do to develop this level of competence in your R&D team?

CHISHOLM: We've been able to instill a culture that encourages imaginability, and we've never wavered from our commitment to research, up to and including the construction of the one-of-a-kind Global Research and Innovation Center that is now open. We've encouraged our people to look at these challenges in a non-traditional way. Our chemistry research folks are kind of a United Nations team, in that they come from all types of different industries, whether it's consumer products, whether it's flavorings, or whether it's the more traditional oil and gas operating and service companies that people are familiar with. I think that blending of different disciplines enables us to look at problems from a wider perspective than it would be if everyone came from the same industry. That's a real strength of ours. We have created an environment that encourages people to think differently.

OGFJ: You mentioned your Global Research and Innovation Center. Would you tell our readers why Flotek decided to invest in a high-tech technology center that rivals anything I've seen outside Silicon Valley or maybe a futuristic Walt Disney production? What benefits do you expect to accrue from the facility?

CHISHOLM: We are extremely excited to share our Global Research and Innovation Center with our clients, our partners and the community. It's truly unique. Every detail - from the concept to the design to the theater seating overlooking the research area - was created with intention to inspire innovation and push the bounds of what's possible. With this new Center, we have we have created a space for collaboration, learning and research in a setting that provides an experience like never before.

We believe it provides an important backdrop for how we build relationships with our clients. I've noticed for years that trust has been eroding between business partners within the energy industry and it has simply become too impersonal. There is an over-emphasis on costs, and not enough focus on the benefit to the customer. We are committed to returning trust to technology and restoring the focus on the customer. This Center brings to life that vision and creates both an environment and an experience where the individual is central to how we do business. Ultimately, this is a space where ideas and partnerships come to flourish based upon the strong belief that together we can make a difference.

OGFJ: In July, MHA Petroleum Consultants, a Denver-based petroleum reservoir consulting company, released a study about the efficacy of Flotek's suite of nanofluid completion chemicals in several shale plays. What can you tell us about the results of that study?

CHISHOLM: This was actually two studies - one was in the DJ Basin and the other was in the Permian and Eagle Ford plays in Texas. We asked MHA, which is a respected firm with a global reach, to independently analyze the efficacy of Flotek's Complex nano-Fluid®. What came out of the studies is pretty much what we have told folks for years: if used properly, the technology should increase the probability of obtaining better well performance, particularly in oil-prone areas. I would encourage everyone to visit our website for more details about the MHA results.

We've had other studies with other organizations in the industry as well, so the results are not surprising. But, historically, it's been very difficult in this industry to point to one additive or one technology that provides "X" amount of uplift in the performance of a reservoir. It just so happens that with the data points available for CnF®you can start to make these types of comparisons. That's why there has been the interest in those independent studies. They match up very well with what we have heard from our clients and what we, internally, believed the performance was. We're pleased and not surprised that it came out the way it did. That, essentially, is a summary of the MHA study.

OGFJ: How do you measure quantitatively the performance achieved when customers use your products?

CHISHOLM: Well, fortunately, our clients do a lot of that work for us. As you know and as the readers of OGFJ know, when the price of a commodity is depressed, like it has been, people become hyper-focused on costs. The fact that our chemistry business has been so resilient absolutely tells us that our clients have quantitatively determined that there is a benefit to purchasing and owning the CnF® technology in their reservoirs. This is much more impactful than anything we can show them. What we're trying to do is create a business environment where the decisions are more evidence-based as opposed to experience-based. I think the industry is moving in that direction - towards data and hard evidence rather than conjecture. I believe Flotek is playing a meaningful role to encourage that business mindset.

OGFJ: Flotek sells its products directly to end-users in addition to large oilfield services firms. Can you explain how this came about and why you do both?

CHISHOLM: Great question. The business model in our industry for decades has been that companies like Flotek would sell their products to a distributive service company that would rebrand it, rename it, reprice it, and you would have very little control over that. After looking at various other industries and companies that have transformational technologies, it became clear to us that the best way to succeed is to have a direct pathway to the ultimate user of your technology. Actually, the company that we decided to model this after is Apple®. When Apple® created The Apple Store®, Steve Jobs realized that they couldn't count on other retail stores to know how to sell their computers because their sales people didn't understand how to sell the benefits of the Mac®. That's why he decided in 2001 to create The Apple Store® so they could use sales personnel who understood their products. We agreed that model was the right way to showcase and sell our products, so we created the virtual Flotek StoreTM services in 2015. That enabled E&P companies to purchase our chemistry directly if they preferred, or they could go to an oilfield service provider and buy it. It's worked out even better than we expected, especially for our clients, because it's created much better transparency as to who is providing the technology and what the price should be for that technology. I think when people look back, that may be a defining moment for Flotek and also for the industry.

OGFJ: When you made the decision last year to sell directly to end-users, did you and your staff visit personally with E&P companies to discuss your products? How did that go?

CHISHOLM: We had actually been visiting with E&P companies for two years prior to making the decision to allow them to purchase directly from Flotek. We had been selling the value to the end-user, but had been invoicing the service company that was the middle man in the transaction. So end-users were already familiar with our sales people and familiar with Flotek. When the day came in 2015 to create a direct pathway, we had already cultivated the customers. It was not as dramatic a change as you might expect. In my view, the virtual Flotek StoreTM was absolutely essential to Flotek maintaining its level of activity through today.

OGFJ: Can you tell our readers a little about your leadership team and how they have contributed to the company's success?

CHISHOLM: Sure. Our leadership team demographically is closer to 60 years old than to 40, and normally that might mean that they would be resistant to change. But not in this case. This group embraces change, which is crucial in this industry. Some of them come from oilfield service firms and others from chemical companies, and even software data companies, and we get the benefit of their experience and the many challenges they have faced, including industry downturns. Their experience is an asset for us, and it has been a stabilizing effect on the organization. That is their real strength.

OGFJ: Flotek is a global company, and I know you travel outside the US quite a bit. How much of your business is outside North America?

CHISHOLM: In the past two years, the international side of our business has grown from 15% to 25%. We expect that to continue to grow. We think that the Middle East is a key area of growth for us and that there are opportunities for growth in South America as well. In August, we announced a five-year collaborative agreement with Y-Tec, the technical research arm of YPF, the national oil company of Argentina, that speaks to their confidence that they trust that Flotek can provide the optimum chemistry solution for their unconventional shale wells in Argentina.

OGFJ: Is Flotek in most of the US basins? Also, second part of question, are Flotek's products designed to work equally well for dry gas, gas liquids, condensate, and crude oil?

CHISHOLM: That's the unique thing about our chemistry technology. It's designed to be basin and formation agnostic. That allows us to operate whether it's in Saudi Arabia or Poland or the Wolfcamp in West Texas. We're continually tweaking the basic formula of the products so that they are customized for a particular basin or formation. That is the real strength of our products. It is not a one-size-fits-all product mentality. It is customized chemistry to meet the customer's requirements. We are in all major US basins - I don't know one that we're not in.

OGFJ: The final question is financial. In looking at Flotek's 2Q results, your revenue is down just 17% over the same period in 2015. That's really not bad compared to many companies in the industry during this downturn. What are your thoughts on this?

CHISHOLM: We would all like to see positive revenue growth, but that's not easy to come by during a severe industry downturn. As you know, industry activity overall is down about 65% to 70%, so a 17% decline over last year is actually pretty darn good. Frankly, our results would have been substantially less had we not opened up the virtual Flotek StoreTM. That enabled us to connect directly to the E&P companies at a better economic value for them and us. Going forward, I see amazing potential for Flotek using this business model. We provide our users/clients a seamless, precision design, synchronized experience, which we believe will be difficult for others to replicate in scale. Our mission is the same - to provide technology that adds benefit to the reservoir - whether the price of crude is $35 or $100 per barrel.

OGFJ: Thanks for your time today, John.