Flotek Industries Inc (FTK) 2012 Q4 法說會逐字稿

Welcome to the Flotek Industries Incorporated year-end 2012 earnings conference call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of the Company's prepared remarks. An operator will provide instructions on how to ask questions at that time.

(Operator Instructions)

This conference is being recorded. At this time, I would like to turn the conference over to Mr Glenn Neslony, Vice President and Treasurer of Flotek Industries. Please, go ahead, sir.

Thank you. Good morning. Today's call is being webcast. A replay will be available on Flotek's website. Our earnings and operational update press release as well as annual report with the United States Securities and Exchange Commission will be filed and distributed -- were filed and distributed last evening and are also available on the Flotek website.

Before I turn the call over to Flotek's Chairman, President and Chief Executive Officer, John Chisholm, I wish to remind everyone participating in this call, listening to the replay, or reading a transcript of this call of the following -- some of the comments made during this teleconference may constitute forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 and Section 21-E of the Securities Exchange Act of 1934, reflecting Flotek's views about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements but are not the exclusive means of identifying forward-looking statements on this call. These matters involve risk and uncertainties that could impact operations and the financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek's filings with the United States Securities and Exchange Commission.

Now, I'd like to introduce Mr John Chisholm, Flotek's Chairman of the Board, President and Chief Executive Officer.

Glenn, thank you. I would also like to welcome each of you to Flotek's 2012 annual review conference call. With me today are -- Rich Walton, Flotek's Chief Financial Officer; Steve Reeves, our Executive Vice President of Operations; Kevin Fisher, our Executive Vice President on Global Business Development; Chris Edmonds, our Senior Director of Finance; and Glenn Neslony, Flotek's Vice President and Treasurer. Last evening, we filed our annual report with the US Securities and Exchange Commission. While we won't take your valuable time to regurgitate those filings, we will provide a summary of the results, attempt to add some color regarding current operations, as well as a sense of our future and then be happy to answer your questions.

2012 was a year of significant achievement and evolution for Flotek, both from an operational as well as a financial perspective. Very simply, Flotek posted record revenues and margins while at the same time completing the transformation of your Company from a debt-laden, challenged enterprise, to an oilfield technology leader with one of the strongest balance sheets in the industry and a focus on cutting edge technologies that improve the efficacy of hydrocarbon production while remaining a leading advocate of environmental stewardship in oil and gas exploration and production.

At the beginning of 2012, we said that Flotek's goal was to make a difference for our clients, our communities, our employees, the environment and first and foremost, you, our shareholders. By nearly every account, we have done just that. Our customer leverage Flotek's expertise in completion Chemistry, production systems and drilling technologies to create more efficient drilling, completion and production systems; thereby, increasing the number of viable exploration horizons as well as improving returns to their stakeholders. Our communities benefit from Flotek's robust business growth. Our team members' involvement in programs that better the communities in which we live and work and Flotek's direct support of programs in and around the communities we serve that focus on education, human services and ways to improve the quality of life. Our employees benefit through more robust business opportunities which create opportunities for personal and professional growth as well as Flotek's stock ownership program that casts a very wide net.

We are committed to making a difference in the environment. From the day in 2003 when Flotek filed for its first patent of a biodegradable completion Chemistry to today, where we are generating efficacious alternatives to traditional, less friendly Chemicals for use across the life cycle of a well, we understand that it isn't good enough just to be green. Our products have to be both green and great, meaning our products not only protect the environment, they improve outcomes for our customers and clients. Finally we've made a difference for our shareholders. Through strength in our operations and the deleveraging and repositioning of our balance sheet, Flotek has provided industry-leading returns to our shareholders, both in 2012 and over longer periods. In 2012, Flotek's shares increased approximately 22% compared to 13% for the New York Stock Exchange composite index and 2% for the Philadelphia Oilfield Service index or OSX.

To show just how far the Flotek journey has come, for the three-year period ending December 31, 2012, Flotek's shares improved 810% compared to 18% for the New York Stock Exchange and 13% for the OSX. Those results are a testament to the hard work and dedication of the entire Flotek team. That said and as I've noted before, those who ignore history are bound to repeat it. As Flotek's Chief Executive, I pledge Flotek will never intentionally find itself in the financial position experienced in 2009. Not only is our discipline such, that unacceptably high levels of leverage are no longer in Flotek's DNA, but no member of this team is willing to re-live the pain and challenges of 2009, nor are we willing to subject our stakeholders to such uncertainty and displeasure. As long as I'm your President, we will remember the lessons learned over the past two years and work tirelessly to assure they are continuously used to improve your Company.

Moreover, we are not willing to rest comfortably in the past. But rather, your Company will strive to reach for a future where our industry-leading innovation can create value for all our stakeholders. Indeed, the journey is just beginning. While we've made great progress in the past three years, we are not yet satisfied with where we are. While we must continue to pursue opportunities to grow, we must also continue our focus to assure that growth creates long-term opportunities to increase profit. Our focus on positioning Flotek as a leader in advanced oilfield technologies must come with an understanding that leadership will require new ways of thinking about the balance between productivity and the environment and our customers and our communities. That future is embodied in ideas and people that can continue to make a difference for all Flotek stakeholders.

Just this morning, we announced that Flotek had signed a Letter of Intent with Gulf Energy of Oman to construct a specialty oilfield chemical production and distribution facility as well as a research and development center in Oman, that we believe will quickly become one of the region's technological leaders in environmentally responsible, high performance drilling, completion and production chemistries. From Oman we will serve the Middle East and North Africa, amongst the most prolific oil and gas producing regions in the world.

This relationship is a result of the vision and persistence of the Flotek team, our ongoing relationship with Basin Supply and our continued belief that incremental progress ultimately can lead to positive outcomes in international markets. We have consistently said that international business development is time-consuming, less certain and can provide lumpy results. But when results come, they are worth the wait. While we still have a lot of work to do before the full benefits of the Oman efforts are realized, we are starting to deliver specialty Chemicals into Oman as a result of this fledgling relationship. More importantly, we are excited about the future in Oman and throughout the Middle East and North Africa.

On the people front, I'm pleased to announce that earlier this week, the Flotek Board of Directors elected Rich Walton to the position of Executive Vice President and Chief Financial Officer, a position he has held on an interim basis since earlier this year. As noted at the time of his appointment, Rich has been a valued member of the Flotek team for over three years, has been in public accounting for over three decades and has the demeanor, skill-set and ethic that will serve Flotek and its shareholders well. I'm delighted Rich has accepted this challenge. I'm confident he's the right person at the right time to lead Flotek's continued efforts to continuously improve its financial reporting and transparency. Along with the entire Flotek family, it's a privilege for me to welcome Rich to the financial team.

As I have said on each call since I took the helm now over three years ago, it continues to be my privilege to serve as President of your Company. I remain immensely proud and humbled by the commitment and support of members of the Flotek team that believe as a group, they can make a difference in the future of Flotek and believed in our vision to restore stability and growth to the Company and continue to be enthused that through the efforts of our people, the future is filled with opportunities to create value for our stakeholders. With that I'd like to turn the call over to Rich Walton to review 2012 financial highlights and provide some additional color on certain financial issues. Again, Rich, congratulations.

John, thank you. As John mentioned, Flotek filed its Form 10-K annual report for the year ended December 31, 2012 with the US Securities and Exchange Commission yesterday afternoon. In that report, Flotek reported revenue for the year ended December 31, 2012 of $312.8 million, an increase of $54 million or 21% compared to the $258.8 million for the same period in 2011. Growth was driven primarily by the Chemicals and Logistics and the Drilling Products segments. In those segments, revenue growth was a result of improved pricing and improved marketing efforts which resulted in increased market share.

For the year ended December 31, 2012, the Company posted net income attributable to common shareholders of $49.8 million or $0.97 per share on a fully diluted basis. That compares to net income attributable to common shareholders of $26.5 million or $0.56 per share for the 12-months ended December 31, 2011. Included in 2012 net income is a gain of approximately $2.6 million related to the change in the fair value of the warrant liability associated with warrants issued in August of 2009 in our preferred stock offering.

Included in 2011 net income was a gain of approximately $9.6 million related to this similar change in the fair value of the warrant liability in 2011. Also included in 2012 net income is a loss of approximately $7.3 million related to the early extinguishment of debt, which resulted from the early retirement of the Company's convertible notes which were issued in 2008. Included in 2011 net income was a loss of approximately $3.2 million related to the early extinguishment of debt.

At December 31, 2012, the Company also determined that it was able to record a benefit of $16.5 million against income tax expense, as a result of decreasing its valuation allowance on its deferred tax assets. This valuation allowance was required to be established back in 2009. In 2011, the Company did not decrease its valuation allowance on deferred tax assets. Excluding these nonrecurring items, net income for the 12-months ended December 31, 2012 was $37.9 million or $0.71 per share on a fully diluted basis. That compares to $20.2 million or $0.42 a share on a fully diluted basis for the year ended December 31, 2011.

A reconciliation of this non-GAAP measure of financial performance to GAAP net income can be found at the conclusion of the press release that we released last night. In addition, a reconciliation of 2012 and 2011 EBITDA also on a non-GAAP measure of financial performance is also included in that same press release.

For the period ended December 31, 2012, Flotek's non-cash compensation expense was approximately $13.4 million or $0.25 per common share on a fully diluted basis. For a year earlier period, the year ended December 31, 2011, non-stock compensation expense was approximately $7.4 million or $0.16 per share. Gross margins for the 12-months ended December 31, 2012 were 42.1% compared to 40.9% for the year ended December 31, 2011. Excluding an inventory mark-to-market adjustment which was taken on December 31, 2012, gross margins for the 12-months ended December 31, 2012 were 42.5%. For the three-months ended December 31, 2012, Flotek posted revenue of $76.7 million, an increase of $1.8 million or 2% compared to the $74.9 million reported in the same period of 2011. Quarterly results in 2012 were improved in both the Chemical and the Drilling Products segments. However, much slower activity over the Thanksgiving holiday week and in the last week of December had a meaningful impact on growth dynamics in the quarter.

On a GAAP basis, Flotek posted earnings per share on a fully diluted basis for the three-months ended December 31, 2012 of $0.44 compared to $0.02 for that same three-month quarter ended December 31, 2011. Consolidated gross margins for the three-months ended December 31, 2012 were 40.8% compared to 42.3% in the same period in 2011. Excluding an inventory mark-to-market adjustment taken on December 31, 2012, gross margins for the three-months ended December 31, 2012 were 45.0%. As of December 31, 2012, the Company's cash balance was $2.7 million compared to $46.7 million as of December 31, 2011. During the quarter, the Company used approximately $25 million of its cash balance to repurchase approximately 50 million of its outstanding convertible notes.

In addition, the Company entered into a new credit facility with PNC Bank. The facility provides the Company with a $50 million revolving line of credit as well as a $25 million term loan which has been drawn to help facilitate the note repurchase. The $50 million revolver remains undrawn and available. Subsequent to the year-end -- and actually on February 15 of 2013, the Company repurchased the remaining 5.2 million of its outstanding convertible notes. The notes were repurchased with cash on hand and without additional borrowing. As a result, the Company no longer has any outstanding convertible notes. Exclusive of capital leases, the Company's only debt obligation is the term loan with PNC Bank which has a current balance of $24.4 million.

While we are pleased with our 2012 financial performance, we will strive to provide even more robust results in 2013. In addition to growing the business, Flotek's finance and accounting groups continue to look for ways to improve efficiencies and streamline information to better support our front line team members who are the cornerstone of sales and revenue growth.

Finally, I'm delighted that John and the leadership team and Board of Directors have shown confidence in me to lead the financial efforts of Flotek into the future. As someone who has spent his entire career in public accounting, I can sincerely say that I'm excited to become the CFO of a public Company, especially one with the potential and leadership of Flotek. I pledge to you that I will work diligently to ensure our financial statements are accurate and transparent and will work tirelessly to add value to the stewards of financial reporting for Flotek and its shareholders. I would now like to turn the call over to Steve Reeves to discuss our business operations. Steve?

Rich, thank you. Let me also offer my congratulations on your appointment as our Chief Financial Officer. I've had the opportunity to work with Rich for the past several years and have the highest regard for his work, his professionalism and have little doubt that his new permanent role will serve Flotek and its shareholders well.

In general, North American Drilling activity continues to provide a constructive albeit less robust backdrop for Flotek's portfolio of oilfield technologies. While natural gas prices remain challenged, strong liquids prices continue to provide opportunities for growth. Our continued focus on developing a more balanced portfolio of oilfield technologies that positively impact both liquids as well as natural gas projects continues to yield positive results. Nearly three-quarters of our revenue is associated with liquids related initiatives compared to nearly the opposite just two years ago. Indeed, Flotek's research and marketing initiatives have created a Company that is truly hydrocarbon agnostic. Our products are equally as effective when working in concert with natural gas, natural gas liquids or oil exploration, development and production.

Chemical's 2012 revenue totaled $184 million, an increase of $43.2 million or 30.6% compared to $140.8 million in 2011. The primary increase in revenue was driven by an increase in sales of our patented complex nano-fluids which increased 63.7% for the year. In the Chemical segment, while pricing remained steady in 2012, margins improved as a result of better raw material pricing and a significant increase in the efficiency in the Company's Marlow, Oklahoma Chemical production facility. In fact, capital projects at Marlow helped increase production throughput by over 50% while reducing the overall labor need by nearly 20%. Moreover, Flotek's Chemical production facility continues to have a stellar safety record with no OSHA recordable incidents in 2012.

Gross margins for the 12-months ended December 31, 2012 in the Chemical segment were 44.3% compared to 39.8% for the same period in 2011. The Company continues to be acutely focused on margin improvement through pricing, cost containment and efficiency. Excluding the impact of a mark-to-market inventory adjustment in the fourth quarter, Chemical gross margins for the three-months ended December 31, 2012 were 42.4% compared to 39.4% in the same period in 2011. Flotek's patented complex nano-fluid suite of chemistries continue to gain market share in unconventional oil and natural gas completions. From the Denver-Julesburg and Williston Basins in the Rocky Mountains to the Permian Basin and South Texas, CnF additives continue to provide exploration and production companies with outstanding completion results compared to wells where CnF fluids are not used. Activity continues to increase in the Niobrara formation as well as the Bakken and Eagle Ford Shales as well as other emerging unconventional plays. Of note, Flotek clients have begun to use CnF additives in the Utica Shale with promising results.

A hallmark of our present and future success in our Chemical segment is our commitment to research and development. Our team of scientists has worked diligently to be responsive to client requests for new products and new applications of existing products, resulting in innovations that have instantly become top industry performers including cross-linkers, friction reducers, scale inhibitors and new CnF formulations that address specific shale dynamics. As a symbol of the Company's commitment to research, Flotek expanded the size of its Chemical research facility located in the Woodlands, Texas by more than 30% in 2012. As a result of research efforts, Flotek introduced CnF 2.0 fracturing additive in 2012, an advanced concentrated CnF product that is currently being tested. The Company believes the CnF 2.0 product has characteristics that could significantly reduce the overall environmental footprint of unconventional completions while at the same time improving production efficacy of oil and natural gas wells. The Company has been very pleased with the initial reception to the innovations and expects strategic marketing and distribution to grow in the first half of 2013.

The Company continues to diversify its customer base with a focus on selling to integrated service companies as well as marketing to exploration and production companies, the principal end user beneficiaries of many of our chemistries. New marketing strategies and an improved technical sales force have brought meaningful success in these initiatives. In addition, Flotek's international initiatives continue to show results. We continue to work with a number of partners as well as through our own international sales professionals and are making meaningful commercial progress in Latin America, Europe, the Middle East and North Africa. We expect to discuss additional opportunities in those regions throughout the year.

In addition to traditional applications of our suite of complex nano-fluids, our direct marketing efforts have identified other potential product applications which are creating meaningful opportunities for Flotek. As discussed in the past, interest in the application of CnF in Enhanced Oil Recovery is growing. The volume of surfactants used in Enhanced Oil Recovery dwarfs most other applications, making it a primary market for Flotek. We continue to make progress in EOR markets through direct sales as well as partnerships with key players in the EOR industry. EOR will remain a core focus of new Chemistry applications in 2013.

Drilling revenue for the year ended December 31, 2012 totaled $116.7 million, an increase of $14.3 million or 13.9% compared to $102.5 million for the year ended December 31, 2011. The increase in revenue is attributable to increased domestic and international market share from existing and new customers, favorable shifts in customer demand to higher margin products and increased customer demand as a result of sustained oil-focused drilling activity, a result of strong crude oil prices. In the Drilling Products segment, a declining rig count in the second half of the year combined with a normal seasonal slowdown in activity were offset by increased market share, increased depth of work for existing customers and a continued acceleration in revenue from the Company's Teledrift measurement-while-drilling products in it's Cavo's motor division. Even with an overall lower rig count, Flotek continues to see an increase in the total spending per rig for the Company's products, a sign of relative strength amongst its peers.

The Company's Teledrift products continue to dominate the vertical measurement-while-drilling business. Two of Flotek's MWD offerings, ProDrift and ProShot continue to show solid growth, increasing market reach as well as profitability based on upgrades from the basic Teledrift products. In fact, over 50% of Teledrift customers upgraded to ProDrift and ProShot in 2012. Overall, Teledrift continues to dominate the MWD market in the Permian Basin and continues to post significant growth in several other domestic [Basins]. Teledrift also continued to post strong growth in international markets, especially in Argentina, Kazakhstan and Saudi Arabia. In 2012, Flotek introduced a number of enhancements to its Teledrift line of products, including wireless telemetry technologies that allow the review of Teledrift positioning results nearly anywhere a wireless signal is available.

Also worth noting is, Flotek's Galleon manufacturing group which primarily produces drilling tools for base and precious metals mining. The group had a record year and continues to see growth in backlog for its core mining tools.

Artificial Lift revenue for 2012 was $12.1 million, a decrease of $3.4 million from 2011. Customer activity and demand decreased as a result of the decline in natural gas prices during 2012. Artificial Lift's gross margin for 2012 was $4.5 million, a decrease of $1.6 million from 2011. Gross margin as a percentage of revenue was 36.9% for 2012, down from 39.4% in 2011. The decline in gross margin and gross margin percentage was attributable to lower sales of pumps and pump products and downward pricing pressure from products used in gas directed drilling activities.

Notwithstanding, the decline in the Artificial Lift segment, we made significant progress in evolving our Lift business from a gas centric operation to one focused on both gas and liquids. We continue to grow our Lift operations in oily operations in the Rockies and southwestern United States. Specifically, we opened a new facility in the Williston Basin which will provide Lift services to companies operating in North Dakota's prolific Bakken Shale. We believe this new operation will have a meaningful impact on 2013 Artificial Lift activity. In addition, our patented Petrovalve mechanical production is gaining traction in key North American markets and remains a popular offering in South American markets focused on heavier oil production.

While Flotek's business remains weighted to North American drilling markets, we continue to make significant progress in key international arenas and believe that international opportunities will be a key component of Flotek's growth in the coming years. While small in scope of Flotek's overall profile, revenues attributable to international activity in 2012 were approximately $39.9 million, an increase of $3.4 million or 9.3% compared to $36.5 million in revenue generated from international activity in 2011. While results will remain somewhat lumpy as we establish new international beachheads, we believe dynamic growth is ahead in the coming quarters.

As we noted this morning, international activity continues to accelerate with increased opportunities in the Middle East and North Africa through our joint venture with Gulf Energy to build a Chemical production Company as well as a research and development facility to serve the Middle East and North Africa. We are excited about the opportunities in front of us in 2013. While we will remain vigilant in our careful watch of commodity prices and drilling activity, we believe we are well positioned to continue to gain market share in the months ahead. Of course, we will remain vigilant at protecting margins through select pricing power and better operating efficiency. In addition, we will continue to focus on smart, international growth that should provide additional opportunities for revenue and profit growth. With that, I'd like to turn the call back to John Chisholm.

Steve, thank you very much. Before we take questions, I'd like to address two specific initiatives that for Flotek will continue to grow in 2013. First, while we discussed international opportunities earlier, I would like to provide a bit of additional color that will help you understand our long-term excitement regarding Flotek's evolution into an international oilfield technology Company. The opportunity in Oman is the result of a significant amount of time and effort on the part of a number of members of the Flotek team, our partners such as Basin Supply and others who have been singularly focused on creating profitable international prospects for Flotek. We believe the development of the Chemical research and production business in Oman is precisely what will propel our international efforts forward in key regions of the world, Middle East and North Africa.

Clearly, this is the first step in a process. The end result won't happen overnight. However, the final product will be a durable contributor to Flotek's revenue and earnings growth for years to come. Moreover, while we have said consistently over the past several quarters that timing of these opportunities is less certain than with domestic business development, Oman is just the beginning of a number of international opportunities in front of us in the months to come. We look forward to sharing progress with you throughout 2013 and beyond.

While our relationship with Basin Supply may not have moved as quickly as either Basin or Flotek had hoped, we would not be in Oman without their help. We believe that 2013 will provide several other opportunities for Flotek to collaborate with Basin in additional international projects. In addition to our relationship with Basin, we continue to develop more expansive relationships with other international partners including large, integrated service companies. We've scheduled a number of global marketing seminars with these partners to introduce Flotek products and services to new markets. We're excited about these opportunities and believe they will, over time, lead to new profit opportunities for Flotek.

In short, there is not a hydrocarbon producing region in the world that Flotek now does not touch, a major change from just two years ago. While the development of consistent commercial opportunities will take time, our progress in the past year is both significant and encouraging. We continue to make marked progress in our Enhanced Oil Recovery initiatives. As we've noted before, the demand for surfactants and other specialty Chemicals in EOR projects is greater than any other hydrocarbon application. Early studies suggest, Flotek's complex nano-fluids provide the same value-added benefits in EOR projects as in primary recovery. While we continue to be very deliberate in our approach to this new market, we are currently involved in several projects to further demonstrate the efficacy of our technology and economic benefits of our suite of specialty Chemicals in Enhanced Oil Recovery projects, included are projects for two of the largest players in the EOR market.

In 2013, we are focused at pushing our EOR initiatives forward both through intrinsic growth and quite possibly through extrinsic opportunities that add to the breadth and depth of our EOR service offerings. Consistent with our belief in research and development in our primary completion business, we believe that investment in the best leading edge science and technology for enhanced recovery will only make Flotek a more ubiquitous player in this incredibly dynamic and growing market.

Finally, a few comments about early first quarter performance. As noted in the past, Flotek's first quarter is traditionally more moderate than the balance of the year, a result of seasonal weather and environmental regulations that can dampen activity in various regions of the United States. In addition, customer budgeting vagaries tend to slow spending in the early weeks of the new year. 2013 has been very predictable, with a relatively slow start in early January and deliberate acceleration into February. However, business trends accelerated meaningfully in late February and continue to show significant strength into March. Moreover, we believe that a plethora of new opportunities are on the near-term horizon which should generate new business for Flotek and add value for our shareholders.

While we remain a bit cautious on the macroeconomic backdrop and continue to watch in disbelief as the dysfunction in our political system continues, we are pleased with the start to 2013, even noting challenging comparisons from an unusually strong first quarter in 2012. That said, notwithstanding the slow start, we should post constructive year-over-year comparisons in the coming months, as our marketing strategy combined with Best-in-Class products attract the attention of more prospective clients. We simply won't rest until every possible customer can say they use Flotek in their wells. Over the past three years, we have endeavored to provide a clear road map regarding our objectives and game plan.

In 2010, we asked you for patience while we worked diligently to re-engineer our Company with a bruised psyche, a broken balance sheet and a battered operating structure. In 2011, we dedicated ourselves to returning the Company to an industry-leading technology position, supporting our clients and communities through innovation and accelerating profitable growth and return to shareholders. In 2012, we pledged to make a difference by assuring our chemistries were both green and improving our leading edge down hole products, providing expanded opportunities for employees and creating industry-leading value for our shareholders. In 2013, we now must focus on wisely investing capital to create optimal returns for our shareholders, through a wise balance of intrinsic growth and external opportunities.

While we will be deliberate, we will not be afraid to consider extrinsic growth opportunities. However, we know from Flotek's history that every acquisition will be closely scrutinized. Any transaction will are have to be compelling from both a strategic and value perspective. Moreover, we understand that any transaction will have to be precisely integrated to assure your Company does not undergo the growing pains experienced in the past decade. As Flotek has evolved, our challenge now is to create value with the capital we generate through our dynamically profitable operations. While a new challenge for Flotek, we understand the importance of the mission and pledge to use every resource available to us to remain the leader in value creation among oilfield technology Companies.

As I said in the press release last evening, I marvel at the distance Flotek has traveled in such a short period of time. I've concluded the following. If we were able to accomplish so much starting with so little, imagine what we can accomplish with the resources Flotek has at its disposal today. That indeed is the challenge for 2013. To harness the resources we have developed to create more opportunities for growth, more opportunities for value creation and more opportunities for further self-improvement in 2013 and beyond. With our team in place, I'm more excited than ever about the future of Flotek.

Again, thank you for your interest in Flotek. We are pleased and proud with our 2012 results, excited about the future and energized about the opportunities in front of us. Operator, we will now open the call to questions.

(Operator Instructions)

Michael Marino, Stephens Incorporated.

John, just wanted to kind of dig in a little bit on your commentary around Q1 or how it's progressing. You mentioned, January was a slow start and kind of moving higher from there. Should we think about Q1 as maybe the mirror image of Q4? Or do you think Q4 is kind of maybe indicative of some sort of bottoming here as your customers now get back to work and hopefully you get a little bit of an industry tailwind?

Yes. Given those two choices, we'd say that we would look at Q4 as a bottoming out and that our expectation midway through March's Q1, will be above the Q4 number.

Okay. Maybe specifically, what's driving that? Is there a particular customer? Is it some of the pioneer work that's maybe ramping up? Or is it one thing you can point to that gives you kind of the confidence that maybe this acceleration within the quarter kind of continues?

Well, there's a couple of things. First, a little bit of clarity on the fourth quarter. We made at that time, early in November, a conscious decision to maintain our Best-in-Class margins and our pricing when there was a situation quite frankly with several of these private equity funded hydraulic stimulation companies that were beginning to stretch their payables. Oftentimes, when you stretch your payables then you become a question, are you going to get your money? Our receivable number's Best-in-Class, 51 days turn. Our bad debt allowance is Best-in-Class 2%. We wanted to be mindful of that and protect that. That was an impact in terms of fourth quarter revenue. In terms of the first quarter, we can accurately say that there are more people using our complex nano-fluid from a client basis than any time ever in Flotek. There's not one specific event that I would say that has the first quarter where it is, but it's a broad-based exposure that, as we've said all along, will take time through this education process. Like I said, we can state that there are more E&P clients using complex nano-fluid than at any time before.

Okay. Thanks. That kind of leads into a follow-up question on the margin front. I guess the Chemical margins dipped in Q4, which you allude the to some of the issues there. How should we think about margins going forward? Is there room from kind of -- I guess Q3 was kind of the high watermark on the gross margin line in Chemicals. Is that something we can see you get back to in the near-term?

Yes. I want to talk about one thing in the margins in the fourth quarter regarding Chemical. We took a $1.2 million inventory write-down on guar. That was an event that had to be looked at as a commodity in terms of market to market pricing of guar. Earlier in that -- in the late summer, we had several clients that expressed a frustration in the availability (inaudible- technical difficulty). The way the inventory has worked out, it was the right thing to do in terms from an accounting treatment to make that adjustment. So we're very comfortable with where the margins are, excluding that event for the overall Chemical segment.

Okay. The guar is not something that you guys look at as an ongoing business line, it was more just an opportunity that presented itself?

That's correct.

Okay. It's all behind us now?

That's correct.

Rudy Hokanson, Barrington Research.

Two questions. One, how are you positioning CnF 2.0 versus your earlier version? How is that being marketed? Second, on the Gulf Energy joint venture now, I was just wondering how soon do you expect that to ramp-up? On what scale?

Sure. I'll answer the second question first and turn the first one over to Kevin Fisher. We can't speak to the approval process in Oman with the Omani government. But I think kind of a stake in the ground that all of us should try to remember is, we would expect that the facility based on what we've been giving in the guidance so far is, by the end of this year, we'll be pushing Chemicals out the door. We expect a gradual ramp-up of sales through that relationship, through the remainder of the year. But it will be towards the end of the year before we really fully realize the benefit of having a facility over there. So somewhere towards the end of the fourth quarter is when we'll be able to give you some further clarity in terms of the status of that facility. But in terms of the first question, Kevin Fisher will be glad to answer it for you.

Hi, there. So regarding the CnF 2.0, we have spent -- we've discussed this before, the last six months of 2012 doing exhaustive studies in the laboratories, comparing CnF 2.0 against our other CnF products and then comparing it Basin by Basin, formation by formation, to find out which formations will benefit from the most uplift. If you recall some of our earlier comments around CnF 2.0, the primary goal in the research and development of that product was to make a product that would be as good or better than existing CnF products and be able to pump that at half the concentration. So you use half as much, get the same benefit in terms of productive uplift or maybe a little bit better in some reservoirs. So now, we've finished the lab testing and the pilot looks at reservoir by reservoir where we think that product has the most uplift. It's going into the field. In fact, during the fourth quarter, the first shipments of the CnF 2.0 were sent to a customer in the field out there. Does that answer your question?

Yes. I was just wondering, as you -- is there any issue in terms of how you are pricing the product relative to earlier CnF products? What you expect that might, basically, influence market receptivity?

The margins on the CnF 2.0, we expect -- well, they will be as good or better than on the previous products. The CnF 2.0, as I mentioned, will be pumped at half the volume as previous products. So, it'll be more expensive on a per gallon basis. The client still can use less of it. I think at the end of the day, the cost of application in the field with the 2.0 will be about the same, maybe only slightly less than the existing CnF products.

Greg Garner, Singular Research.

Can you give us some more color, John, on the EOR field test? How many tests? Maybe how many Basins? How many companies? Your perception of how long they're going to last? Or maybe progress on the prior tests?

Sure. I really don't want to sound like a broken record on that question as to -- as it's been asked in previous calls in terms of our frustration, no different than yours, of the difficulty of having more publicity of who exactly we are working with. As I mentioned just maybe 10 or 15 minutes ago, we are now having field applications for two of the largest EOR companies in this industry. That's a very small class. There's only about four that you would consider as the four largest. So we've got applications going with two of that four. So you can probably fill in the blanks there. We have mentioned consistently that this would be a process that we would demonstrate the value on the smaller companies and migrate up to the larger ones. We've done that.

We are currently involved in four different Basins, I believe, with these companies. We will continue to expand it that way. We're involved in a couple of different industry -- if you will, in the summertime, we will be presenting information and SPE-type papers that are able to talk more about the EOR. But we're as frustrated as anyone else that the nature of this is, the clients just prefer not to have a level of publicity as to what they're doing with this EOR. But we're -- there's nothing that has changed our view as to where we're headed with our complex nano-fluid chemistries in the EOR applications.

Yes, it certainly seems like a great opportunity. I'm just wondering, what your view might be on a potential revenue ramp? Is that pushing out now towards 2014 for this? Or do you have any sense that there would be a contribution in 2013?

No, we've consistently said that, we expect by the middle of this year to have an EOR contribution on a monthly run rate similar to the Chemical contribution over the past year, internationally. So, again, you can kind of connect the dots there. But we expect somewhere just under $1 million a month in the latter part of the summer to be coming from EOR opportunities. We haven't changed from that view. That's still our view as of today.

Okay. All right. Thanks. Appreciate that. On the CnF 2.0, perhaps it's my misunderstanding here, but is this -- in the use, in the completion, is this essentially expanding the market for your CnF technology? Because I thought the majority of the CnF was really used more in the fracking side.

Yes. This is Kevin again. So the CnF 2.0 is the same market space as the original CnF's. We've talked about this before, that in the gas plays, the primary purpose of the CnF in the dry gas drilling boom was to remove the water that was pumped while in the frac jobs, in order for the gas to be able to flow back into the well bore and through the fracture and up the hole. Oily reservoirs are more difficult. The molecules of oil are larger. They're more viscous. It's harder to get that through the [port] space and in the formation and into the (inaudible) and harder to move it through the fracture. Just because of the size of the molecules and that increased viscosity. So we find that with the CnF's -- we now have about a dozen different CnF products. We find with the CnF's that some work better in one reservoir, but not as well in another reservoir. It's a fine-tuning process to determine which CnF is the best for a given reservoir. So we may run a different CnF in the Bakken than we do in the Woodford. A different one in the Woodford than in the Eagle Ford in South Texas. The CnF 2.0 product is a better product for a wide variety of these reservoirs, but still of use in the fracturing process there. The CnF product is (inaudible) surfactants and solvents, emulsifiers and things that are very useful in the oil.

I'm sorry, you seemed to fade out there a little bit after you mentioned that 2.0 is better for a wide variety of Basins. I didn't catch what you had to say after that, I'm sorry. Could you repeat that please?

Yes. That's correct. The CnF 2.0 has application in a wider variety of Basins. So there will probably be fewer CnF 2.0 products than there are of the original CnF products. Again, as I mentioned earlier, the primary benefit of the CnF 2.0 is that it can be run at half the volume or half the concentration in a frac job with the expectation to get as good or better performance from that well.

Okay. But I'm still a little bit unclear, perhaps it's my own mental block. I'm sorry if that's the case. Is it used more in completion? Or still we're just focused on fracking here?

It's focused on fracturing.

Yes. Okay. Okay. Just one final item on the CapEx, you mentioned in the 10-K how it looks like CapEx for Chemicals is about doubling. Is this associated with the CnF 2.0? Or is there something else going on? The forecast for CapEx for 2013 is what I'm referencing.

Right. We have built in -- part of that CapEx will to be build this plant in Oman. So we have put in several million dollars in the CapEx there. Then to continue the rest of the construction buildout up at Marlow, Oklahoma. So that's where the extra CapEx come in, in Chemical.

Brian Uhlmer, Global Hunter Securities.

I had a couple of quick follow-ups. First off, your press release says that your 42 point something percent margin in Chemicals excludes the inventory. Is that a typo? Because it sounds like it does not -- that includes it, right? So your true margins in Chemicals would have been about 45%? Is that accurate?

Yes, that was a typo in the press release. The actual reported margin that's for the fourth quarter in Chemicals was 42.4%. That was the actual. If you back out the $1.2 million inventory adjustment that occurred on December 31, that would -- if you exclude that write-down, the margin would have been 45%.

Okay. Solid. The other $200,000 of inventory reserves was from another segment and that affected Drilling Products? Is that correct? You had a $1.4 million total write-down.

I believe that total write-down was $1.2 million.

On the inventory. Okay. We'll catch up offline on that other -- on reconciling that $1.4 million on the cash flow statement. My next question is really on the G&A. On the quarter, you're $19.4 million, about 25% of your sales. I realize sales were down in the quarter. Can we talk about where that's going to shake out on an absolute basis moving forward? I guess notably, what type of revenues that G&A can support -- if we're growing the business, are we going to keep adding G&A as a percent of sales -- on an absolute basis, so as a percent of sales, it remains flat? Or will it go down?

Brian, this is John. Our expectation is, it's going to be flat or go down as a percentage of sales. We tried to illustrate, that in that SG&A is that non-cash number on the stock and on the equity program. If you'll allow me to take just a little bit of your time, then I'll be glad to answer a follow-up question for you. I wanted to provide just a little bit of color on that, because I think it provides an inside look into the culture of Flotek. In that, we have distributed this stock program to over 25% of the Flotek people. That 25% gets over 40% of the equity. To that point -- we pushed this equity all the way down to dispatchers, administrative people in the districts that are in charge with invoicing and reconciling from an accounting standpoint, getting things to the right place at the right time.

That has created an alignment of our folks with the shareholders like nothing I've ever seen before. Those people understand that equity -- there will come a time that can pay for a kid's college or a new house. That's why we wanted to illustrate that as to what it is from a non-cash standpoint on the earnings per share. That we think we've done something that's really kind of special. That, in part, leads to the performance of Flotek. We watch that SG&A very carefully. As you know probably as good as anyone on this call, when you're in kind of a growth mode as Flotek is, sometimes you've got to build up that SG&A in anticipation of the growth. But to more directly answer your question, we believe the SG&A will be flat or slightly down as a percentage of revenue for 2013.

Is that on average for the year? That's -- the fourth quarter run rate was obviously a little bit high with revenues coming in. Are you saying that as a percent for the whole year? Kind of [run rate] 21% to 22%.

Yes. If you -- Right. If you look at it over an annual basis in terms of the way you like to model things, that's correct. It will be flat or slightly down on an annual basis.

Now, let's --

Rich wants to add -- hold on one second, Brian, then we'll let you have a follow-up. Rich wants to add one thing.

Yes, Brian, I understand your question. The $1.4 million amount that is a provision for inventory adjustments that's shown in the statement of cash flows compared to the $1.2 million mark-to-market write-down that we just discussed. The $1.4 million contains an additional $200,000 that was a provision for our reserve for excess and obsolete inventory. That is something that we do review each quarter. The specifics of that are presented in the inventory footnote in the Form 10-K. That would be in Note 5.

Okay. Perfect. Thanks. Now, John, on the stock based comp, you know very well that I'm fully on-board with pushing down -- pushing this down. Looks like it's primarily auctions and restricted stocks, not ESOPs, right? So, should we look at -- as our share count rising -- potentially 2% of your share count per year being allocated out to your employees? Is that the best way to look at -- can you talk a little more about whether it's options to those employees or restricted stock? If so, what's the vesting period? When are we going to actually have to see that cash outflow by Flotek for that stock -- to buy in that stock?

Yes. No, that's fine. All great questions. The stock is all restricted stock. There are no options. The vesting program that's in place is now three years. The last year was a bit of a unique one in terms of, we had some cliff vesting from previous equity plans and some other plans. But going forward, it will all be on a three year vesting program. Part of that, for folks listening in and say, well heck, some people are a five year, whatever. Quite frankly, the age demographics of Flotek is such that some of the folks sitting around this table are close or over 60 than closer to 50. But we've tried to be respectful of that. So it's a three year vesting program. It should be the percentage that you mentioned or slightly less.

Okay. Great answers. Great answers. Finally, no one spent a lot of time on this. You guys know how I like Steve Reeves to talk at least once. Can we talk about the Drilling Products performance and even on kind of a revenue miss why the margins were up so smartly? If that is something that we should expect ongoing? Or we should actually expect it to improve as the Permian activity ramps up and the Mississippian holds flat at a minimum?

We are going -- thanks very much for calling me in, Brian. (laughter) As you look at the margins in there, there's a lot of pressure out there right now with the less rig count, as you follow that very closely. Until we start seeing an improvement on that, we're going to be very hard-pressed to do anything with margins. The margins are probably -- we're not -- anything in the high 30%s on the Drilling Products margins is pretty acceptable. We're pretty comfortable with where we are. We're fighting to hold that right now. So I would look -- until we see some rig count improvement, we're not going to see any possibility of increased margins, Brian.

Okay. But you think you can hold them, which -- they're the best in the biz, so I'm not putting them down definitely.

Right.

Thank you.

That's it. If we hold that, we're doing very well. We're pretty satisfied with what we're doing right now.

Good deal.

Chris Orski, Bow Street Capital.

Just two quick questions on revenue. The first, what was total CnF revenue in Q4? Then, if you could actually share January and February Q1 to date total revenue numbers that would be extremely helpful.

Yes, Chris. John here. We would actually like you to ask two other questions. Only because, we don't give out CnF revenue by quarter like that. We've made a practice from a guidance standpoint not to give out the specific revenue of months while we're in the middle of a quarter. I'd just ask you to be comfortable with the answer we answered early on with Mike Marino. That we believe the first quarter will be an uplift over the fourth quarter of 2012.

Got it. Can you just provide any directional guide -- or indication on CnF revenue sequentially, Q4 versus Q3?

Yes, I think -- it was certainly as good as or up over the third quarter. I think we put a statistic in there as to what CnF was year over year. But Kevin, do you want to add anything to that question?

Yes. Chris, this is Kevin. The Chemical group revenue, Q3 to Q4, was up $2 million. It's fair to say most of that was CnF. The other thing I'd like to and sort of related to your first question. Again, as John said, we don't break out the individual product segments within those various groups of ours. But when you look year over year in Q4 versus Q4 of 2011, the Chemical revenue was up $5 million quarter over quarter from 2011 Q4 to 2012 Q4. Down Hole Tool revenues fell a little bit in Q4 versus the earlier year Q4. But when you look at the change in rig count -- about 200 count drop in rigs from year-to-year in that fourth quarter. That Down Hole Tool revenue per rig running out there was actually up 9%. So both of the units performed very well in Q4.

(Operator Instructions)

Mr Chisholm, there are no further questions at this time.

Okay. Thank you, operator. Folks, thanks to all of you for your support and questions of Flotek. We look forward to speaking to you again in April; seeing many of you at the IPAA New York investor conference; or we have our annual meeting here in May. You will obviously be aware of that as we get closer to that to the exact time and date. Then our first quarter call will be sometime there towards the first end of the week of May. Again, thank you for your interest in Flotek. We'll talk to you all again soon.

Ladies and gentlemen, that does conclude the conference call for today. Have a great day, everyone.