Flotek Industries Inc (FTK) 2014 Q3 法說會逐字稿

Good morning and welcome to the Flotek industries Inc. third quarter 2014 earnings conference call.

(Operator Instructions)

This conference is being recorded.

At this time I would like to turn the conference over to Mr. Rob Schmitz, Vice President and Corporate Controller for Flotek Industries. Mr. Schmitz you may begin.

Thank you and good morning.

Today's call is being webcast and a replay will be available on Flotek's website. Our earnings and operational update press release as well as our quarterly report with the US Securities and Exchange Commission, were filed and distributed last evening and are also available on the Flotek website.

Before we begin our formal remarks, I wish to remind everyone participating on this call listening to a 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 27A of the Securities Act of 1933 and section 21E of the Securities Act of 1934 and other applicable statutes 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 risks 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 US Securities and Exchange Commission.

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

Rob, thank you. And I'd also like to welcome each of you to Flotek's third quarter 2014 conference call. We are glad you are here.

With me today are Rich Walton, Flotek's Chief Financial Officer; Steve Reeves, our Executive Vice President of Operations; Josh Snively, President of our Florida Chemical subsidiary as well as our Executive Vice President of Research and Innovation; Chris Edmonds, Senior Director of Corporate Finance and Strategy; and Rob Schmitz, Flotek's Vice President and Corporate Controller.

Last evening, we filed our quarterly 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.

However, before doing so, a couple of opening comments. Yesterday, we were once again reminded about just how fragile the world in which we live can be.

In a senseless and callous act a person or people brought commerce and government to a standstill in Ottawa, Ontario. Not only is a company with commercial interests with our northern ally but also as Americans, a label all of us living in North America identify with, our thoughts and prayers are with the people of Ottawa as well as across Ontario and all of Canada.

We understand the unsettling challenges that result from such senseless violence and are reminded of the vigilance that is required in today's uncertain world. We are proud to be a growing part of the Canadian energy industry and to employ a number of Canadians. We want you to know you have our support, empathy and remain in the thoughts of the entire Flotek team.

As we noted last night, Flotek posted revenue of $116.8 million for the quarter ending September 30, 2014 which is record quarterly revenue for Flotek and a direct result of the effort and determination of our team. This represents the fourth consecutive quarter with revenue exceeding $100 million. A trend we expect to accelerate in the coming quarters.

To provide even greater perspective of the progress we have made on our journey, revenues for the entire 2009 calendar year were just over $112 million. While revenue growth is important, profitable growth is even more impactful to the value of your investment and we've made profitable growth a consistent goal since 2009.

During the last 90 day period quarterly revenue increased nearly 19% compared to the same period a year ago, yet operating income rose over 38%. Nearly double the pace of revenue growth. That is a strong indication that we are gaining operating leverage from our expanding oil field technology platform.

While technologies like our patent pending FracMax software application are important to our growth in both revenue and profitability, Flotek would not be where we are today without a team of dedicated women and men who are the best in the business and who collectively are acutely focused on two things, creating better wells and bigger returns for our clients and as a result, generating greater profits for our shareholders. Along the way, they have found ways to not only work harder, but smarter.

2011 to today on an annualized basis, revenue per employee increased from $735,000 to $864,000, an increase of nearly 18%. Moreover, operating income per employee for the same period rose from $139,000 to $152,000, an increase of nearly 10%. Both measures are at or near the top of our industry. All members of the Flotek team should be proud of. We'll work diligently to continue that growth as we believe the best opportunities are yet to come.

While I'm pleased with our efforts to date, I'm not satisfied and as I have said before, Flotek is not willing to rest comfortably in the past but rather the company will strive to reach for a future where our industry leading innovation can create more value each and every day to our stakeholders.

As I've said on each call since I took the helm now five 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 believed as a group they could 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 our third quarter financial highlights and to provide some additional color on certain financial issues. Rich?

John, thank you.

As John mentioned, Flotek filed its quarterly report on form 10-Q for the quarter ended September 30, 2014 with the US Securities and Exchange Commission, yesterday afternoon. Flotek reported that revenue for the quarter ended September 30, 2014 was $116.8 million compared to $98.4 million for the quarter ended September 30, 2013. Consolidated revenue for the three months ended September 30, 2014 increased $18.4 million or 18.7% relative to the comparable period of 2013.

This increase in revenue was primarily due to increased sales of stimulation chemical additives in our Energy Chemical Technologies segment, increased actuated tool and Teledrift tool rentals in our Drilling Technology segment and increased international valve and valve equipment sales in our Production Technologies segment.

For the quarter ended September 30, 2014, the company reported net income of $14.3 million or $0.26 per share on a fully diluted basis, compared to net income of $9 million or $0.16 per share on a fully diluted basis for the quarter ended September 30, 2013. Net income benefited by approximately $900,000 or just under $0.02 per share on a fully diluted basis related to the tax treatment of certain deferred tax liabilities and other benefits related to the 2013's acquisition of Florida Chemical.

Earnings before interest, taxes, depreciation and amortization or EBITDA for the quarter ended September 30, 2014, was $25.2 million compared to $19.2 million for the quarter ended September 30, 2013. Selling, general and administrative expenses as a percentage of revenue declined to 18.4% for the three months ended September 30, 2014, compared to 19.9% for the same period of 2013 as revenue grew faster than SG&A costs.

The company recorded an income tax provision of $6.1 million reflecting an effective tax rate of 29.8% for the three months ended September 30, 2014, compared to an income tax provision of $5.6 million, reflecting an effective tax rate of 38.6% for the comparable period in 2014 (sic -- see press release "2013"). We expect the effective tax rate to return to more traditional levels in the coming quarter.

During the three months ended September 30, 2014, the company identified and recorded a final adjustment related to the acquisition of Florida Chemical. Current deferred tax assets were increased by $1.2 million with a corresponding decrease to goodwill within the Consumer and Industrial Chemical Technologies reporting unit.

Flotek's resilient operating performance continues to support a strong balance sheet and financial position. During the quarter ended September 30, 2014, Flotek's total outstanding debt decreased by $15.4 million or 27%. Since December 31, 2013, Flotek has reduced outstanding debt by $20.6 million or 33.1%.

Flotek's borrowings on its revolver have been negligible since mid-October. To put our debt repayment in perspective, Flotek carried $88.8 million in debt following the acquisition of Florida Chemical in May of 2013. As of September 30, 2014, Flotek's debt stood at just $41.6 million, a reduction of over $47 million or 53% in just 15 months.

Flotek's cash generation remains the key to such rapid debt reduction. Cash from operations in the third quarter was $21.5 million.

For the first nine months of 2014, Flotek generated cash from operations of approximately $39.9 million or about $1 million per week. That compares to just $39.5 million of cash from operations for the entire year of 2013.

Inventories were $81.4 million at September 30, 2014, an increase of 29% from $63.1 million as of December 31, 2013. The increase is largely attributable to an increase in citrus product inventory at Florida Chemical in anticipation of increased sales as well as opportunistic buying based on our proprietary citrus pricing model. The overall increase in inventories supports the increase in sales that we are experiencing.

Accounts Receivable at September 30, 2014, were $69.3 million compared to $65 million as of December 31, 2013. The company's allowance for doubtful accounts was 0.9% at September 30, 2014.

Now I would like to turn the call over to Steve Reeves who will discuss second quarter operating highlights.

Rich, thank you.

As noted earlier, consolidated revenue for the three months ended September 30, 2014, was $116.8 million compared to $98.4 million for the three months ended September 30, 2013. Third quarter enterprise wide gross margins equal 39.5%, an increase from 38.1% in the same period of 2013. A result of improved margins in both our Production Technologies and Drilling Technology segments including significant margin expansion in international sales.

Energy Chemical Technologies revenue in the third quarter was $68.2 million, an increase of $16.5 million or 32% compared to last year. Gross margin as a percentage of revenue decreased to 41.7% for the three months ended September 30, 2014 from 42.3% in the same period of 2013. Primarily due to a new incentive pricing structure, increased logistics costs and inventory adjustments during 2014 partially offset by improved margins for xylene replacement products, expanded markets for CnF and productivity improvements in the manufacturing process.

We made strides in the third quarter and validations that we believe will lead to meaningful gains in market share over the coming months. As we have noted in recent presentations, while we remain committed to premium price integrity for CnF chemistry, we are working on a number of win-win pricing schemes for operators to entice more rapid and widespread adoption of CnF chemistries. We believe that pricing and volume balance is a proven approach to accelerating market share expansion.

We noted earlier this month that logistics costs did factor in to slightly lower margins for Energy Chemistries in the quarter. Variables that impacted margins included long distance transportation costs with Canadian shipments continue to increase and generally higher transportation costs out of our Moore, Oklahoma chemistry facility. We have aggressively addressed such cost issues for new transportation contracts and arrangements that should help mitigate future cost freeze.

A Consumer and Industrial Chemical Technology segment or CICT was formed in the second quarter of 2013 with the acquisition of Florida Chemical. Segment revenues in the third quarter were $13.7 million approximately $1.5 million lower than year ago levels.

CICT gross margins for the quarter were approximately 24.1%, an increase from 23.5% in the year ago period and 22.9% in the second quarter of this year. Largely a result of product mix, specifically a reduction in outside turpine cells allowing higher margin, flavor and fragrance products to provide a greater contribution to segment results.

Drilling Technologies revenue for the quarter totaled $29.9 million, an increase of $2.4 million or 8.5% relative to the same period in 2013. Primarily due to an increase in actuated tool rentals, Teledrift tool rentals and increases in float equipment product sales. Drilling Technologies gross margin for the quarter was 39.9%, an increase from 39.3% compared to the same period 2013.

In Drilling Technologies the company's Teledrift measurement well drilling technology continues to be the market leader in North America while continuing to expand in international markets in the Middle East and South America. So far in 2014, Teledrift has worked for 99 new clients in North America indicating the continued market growth of our vertical NWD offering.

Also during the quarter, Flotek introduced Telepulse, a horizontal guidance NWD technology. Commercial validations are underway and commercialization is expected in early 2015.

The company continues to market the Stemulator, an axial vibration tool used both domestically and internationally. With fine tuning and tool enhancements largely complete, the Stemulator is ready for full-scale commercial launch.

The company is currently ramping up manufacturing, the speed of which is somewhat moderated by backlog and carbide coding processors. While commercial growth should be seen in the fourth quarter, more rapid growth is expected in the new year.

Revenue for the Production Technology segment for the quarter was $4.9 million, an increase of $1.1 million compared to the same period in 2013 due to increased sales of international valves, valve equipment and domestic hydraulic lifting units. Production Technologies gross margin percentage increased to 48.8% for the three months ended September 30, 2014 from 32.3% for the same period in 2013. These increases are largely due to increased international sales.

Under the leadership of David McMahon, our Production Technologies business continues to refocus its efforts on niche added value technologies that will create a competitive advantage for Flotek in the coming months. The company is in the advanced stages and we're exploring options to accelerate its growth in unique technologies and services that will add value to Flotek clients and stakeholders.

While we remain vigilant in our watch of commodity price fluctuation and what sets volatility could mean for activity in our commercial operations, we remain optimistic about the overall trends that should continue to benefit our business. A focus on technology that helps our customers make better wells and provide better returns for the shareholders. We are excited about the prospects ahead for the fourth quarter.

With that, I'd like to turn the call back to John Chisholm. John?

Steve, thank you very much.

Before we take questions I'd like to add a handful of concluding thoughts. The introduction of FracMax the company's patent pending application for comparing the performance of wells using Flotek's advanced net generation CnF completion chemistries versus those that use conventional surfactants or nothing at all continues to be uniquely successful in fueling interest in Flotek's innovative chemistries. As a direct result of FracMax, Flotek added over a dozen meaningful commercial chemistry validation projects with over a dozen prospective clients across multiple domestic basins.

In addition, we are actively working many more projects creating the most robust prospect book in the history of the company. As indicated just three months ago, FracMax is one of the most compelling sales and value validation tools I have experienced in my three decades in this industry and we believe operators will find it hard to ignore their own data which conclusively validates the economic advantage of using CnF chemistries in completions.

Let me be clear about one other item that seems to be lost to some follow our enterprise. FracMax is not a tool required to prove up the science of CnF. Candidly, the thousands of wells that contain CnF do that quite nicely on their own as does the research and analysis provided by the likes of independent analyst such as Dr. Jim Crafton and the work of Texas A&M University in their nanotechnology effort.

Rather, FracMax helps us demonstrate the proven science of CnF and leads to validations that the chemistry works in specific applications. These projects are not tests or science projects, they are applications of a proven chemistry in what each operator considers a unique circumstance. FracMax and our effective sales team have not only gained traction in basins in which Flotek has a strong presence but more importantly, our growth is taking hold in basins across North America.

In short, we believe CnF is a ubiquitous chemistry with application in nearly every unconventional basin in North America and most likely around the globe. The DNA of some basins may be more complex, the scientists working side-by-side with our clients will shepherd a solution for even the toughest challenges.

The Bakken is a case in point. After significant analytical effort, we believe we've developed a CnF formulation that should make a meaningful difference in the Bakken. Through this process not only do we believe we cracked the code in the Bakken, we've landed a project to work with a large Bakken operator to develop a recompletion validation using Flotek chemistry. We believe this project will not only provide validation of CnF's positive impact on Bakken production, it could open a new market for Flotek that over time could be as large as the primary completion market.

The accolades to our scientific approach also provide evidence of the success of our program. In the first nine months of the year, our chemists have been asked to analyze over 150 well related material samples, a significant increase over the 100 samples analyzed during all of 2013.

More often than not, this analytical work leads to commercial work from validations to ongoing commercial projects. Moreover, this year's work has involved samples from all major domestic basins and from all over the world.

Finally, while we talked a lot about established basins like the DJ in South Texas we've made significant strides in the past six months in the Permian which we believe will be among the fastest-growing basins in the coming months. Moreover, recently we were involved in one of the best completions to date in the Utica and a handful of outperforming wells in British Columbia's Montney shale formation.

In short, our proven patented CnF completion chemistries travel well. We look forward to sharing the global travel adventures with you in the coming months.

Finally, CnF is not just for primary and initial completion but through our acquisitions of EOGA and Site Lark in the past year, we continue to position ourselves for growth in the enhanced oil recovery business. And in fact, we recently signed a key CnF EOR related project in conjunction with EOGA. We expect this project to begin in the coming weeks with early indications of results expected in the new year.

Our international work also deserves mention especially given the sizable growth in international revenue in the quarter. In the Middle East we continue to move forward. Albeit deliberately to ensure our development efforts are both prudent and successful with our Omani joint venture. During the quarter we funded our joint venture entities and continue to move forward towards facility operations by mid-next year.

Even though our bricks and mortar development has been more measured than expected the impact of our presence has been positive including commercial opportunities in Oman, Kuwait, the UAE and Saudi Arabia. We are pleased with our progress in Saudi under the leadership of Amir Magoo and believe opportunities from chemistry to drilling and production technologies will continue to grow into the new year.

As noted in our release yesterday, we continue to work through chemistry validations in Mexico and believe there will be meaningful revenue opportunities beginning in 2015. There are also interesting production technology applications in Mexico that we are hopeful will develop as we conclude the year.

Canada, while not terribly exotic might star in Flotek's portfolio. As noted earlier, it is one of our fastest growing markets and we expect that to continue for the balance of the year 2015.

As we conclude, a quick word on commodity prices. While we won't resolve the market debate over the short-term direction of commodity prices in this forum, I will leave you with this thought about the long-term direction of commodity prices and how I believe Flotek benefits from a longer-term view commodity prices.

Regardless of where oil trades in the next week, or month, for that matter even this quarter one thing is certain, oil is a finite resource and each incremental build that is discovered today is as costly if not more so to produce than the barrel before it. The easy oil already discovered and produced more costly unconventional and enhance recovery projects leading the sources of future supply, the marginal cost of recovery will continue to inch higher. Hence, the long-term pricing trend can only be higher.

For Flotek and its suite of chemistries, drilling and production technologies, the opportunity is in the fact that more complex exploration, completion and production projects require more advanced cutting edge technologies that can help explorers and operators make better wells and better returns for their shareholders. We believe we are one of those select companies that can help our clients make better wells and as a result provide industry-leading returns to our shareholders.

In the short run, we're excited about what we've seen in October and while carefully watching short-term price volatility and the potential impact on activity, we believe the momentum from October will carry into the balance of the quarter combined with the opportunities provided by FracMax and the Flotek team we believe the remaining months of 2014 to provide another solid quarter for Flotek shareholders.

Finally, a special thank you to Rich Walton, Rob Schmitz and our entire accounting and finance teams for continuing to accelerate our reporting timeline. Just as we want to be a leader in oil field technology we also want to be a leader in corporate governance and stewardship. While we won't always be perfect, we will strive to hold ourselves to the highest standards in the industry whether it relates to business opportunities or opportunities to improve accountability and transparency to our shareholders.

What I pledge to you today as I did on my very first call, now five years ago, is that my team and I will come to work each and every day, knowing that you've placed your confidence and trust in us as stewards of your capital. We will take that responsibility very seriously and work hard each day to earn that trust.

Let me be clear. The success of Flotek is a result of the hard work and untiring efforts of a group of people who believe they can shape the future. As a leadership team it's incumbent on us to communicate our vision, challenge the spirit and ensure our team has the tools to exceed even their wildest expectations.

Thank you for your interest in Flotek. I'm glad to be here, and we look forward to sharing our journey with you in the coming months.

Operator, we will now open the call to questions.

(Operator Instructions)

Matt Marietta, Stephens.

I wanted to focus on some of the commentary from the release specifically as it relates to CnF sales activity in West Texas. When we go back and compare the language that you used to describe sales traction in the Permian basin, what used to be clearly a number of validations and opportunities and so on, now it looks like the language has shifted to state that you are seeing a significant increase in the use in wells. Can you maybe provide some more specifics and why the confidence in the region is growing and maybe some color on what's really going on out there?

I'll address that question in half a second but also I want to provide additional clarity of the Permian basin because as you know, we're not just a chemistry company. We just moved into a new facility for Teledrift which will also hold Telepulse.

We're also going to acquire another facility there for expanding activity with Spidle Turbeco, Downhole Tools. So the Permian basin on all facets of the Flotek enterprise is growing and we have an increased level of optimism for it.

Now specifically regarding complex nanos, we have more CESI resources in the Permian basin than any other geographic area in the country. Interestingly enough, now we actually have clients referring other clients of their benefit of using CnF which I'd have to say is the first time I have experienced that in any basin around. Where the benefit that was directed specifically to one operator they've now shared with others.

The Permian basin has moved on from just validating to consistent revenue and I think the encouraging thing for us is that revenue is being generated from folks who have never experienced the benefit of CnF. Again, we have more resources there. We're facilitating both storage capability there and not only handling current levels but also expected activity levels in the near future.

Thanks, that sounds very encouraging. To follow up, you announced the Houston facility expansion earlier this month. Can you elaborate on what the rationale was? What we can expect as a result from this expansion in the longer term? Maybe discuss some of the specific capabilities the facility will have?

Great question. The facility will be five minutes from our central command of the headquarters of Flotek. We think that in itself will create greater continuity for our clients and our folks. We're essentially doubling the square footage footprint of what we had in the Woodlands and that's evidenced by my comments earlier of an over 50% increase in these client studies where they provide rock properties or rock cuttings, ores, fluid samples for us to customize specific CnF chemistry for a particular area.

That's kind of the overview, but with a little bit more context. I think you've heard us say, the real value of the Florida Chemical Flotek integration is for the near to midterm future where we now have the innovative research of this citrus capability to create more environmentally friendly chemistry solutions combined with the more traditional activities that Flotek's research has been involved with.

So now we have everybody, or they will be by next September, all under one footprint, one roof line. But I think, as importantly, we are going to create a client experience that we believe will be second to none in terms of the interactive ability that if a client were to go to that facility they could interact with the scientists that are working on their specific request.

Finally, one more out of me if you don't mind. More of a modeling accounting question and I apologize in advance for that.

But can you help us reconcile and I know you've probably explained this in the past but the difference in SG&A from the adback provided in the EBITDA reconciliation versus the number in the income statement? Is there something in a different area on the income statement that I'm missing?

Great question and my guess is you probably had the courage to ask a question that others are thinking about. Rob or Rich, do you want to handle that specific question?

This is Rich Walton.

Depreciation and amortization is reflected two places on our income statement. It is in SG&A which you see and part of it is also included in cost of sales. That would be the depreciation on direct equipment that's used in the manufacturing process and it turns out that about half of the depreciation and amortization is in cost to sales.

Within SG&A there is a significant portion of that which relates to amortization of our intangible assets. That runs about $1.2 million a quarter. The specific amounts of that amortization are disclosed in the footnotes to our financial statements in the goodwill and other intangible assets footnote. In summary, they are included two places in SG&A and also in cost of sales.

I appreciate the clarification there and congratulations on the good quarter. Things sound very encouraging. Look forward to next quarter.

Thank you, Matt.

Georg Venturatos, Johnson Rice.

I wanted to touch on the margin side in Energy Chemicals. Obviously, great to hear about continued momentum in CnF but we did see a pullback there in a few items you highlighted.

The new incentive pricing structure obviously it sounds like something that likely continues. On the other side, it sounds like the logistic issues are largely mitigated at this point and inventory adjustments should be largely one time. At least it appears. Maybe just walk us through a little more detail on how we should expect the progression into Q4 from what we saw this quarter and maybe what we should expect to continue at least on some of those items?

Great series of comments and question there. At the end of this question here I'll let Rob talk about the inventory adjustment which actually involved third-party handlers that sit between us and the pumping service companies that I think speaks very well to our robust accounting effort to make sure the numbers are actually the numbers.

We are being requested by several of the larger pumping companies to provide more chemistry then just CnF. And I think sometimes everybody gets their mind focused around CnF because it really does add value and creates the opportunity of more oil to come out of this rock.

But as a lot of folks know that are on this call, there's other chemicals that essentially stop things from happening whether it's corrosion, scale, bacteria creating and friction reduction and those are all chemistries that we have the capability of delivering. We are not going to turn down those opportunities when it's a specific request from us or from other pumping companies to provide some of that work. And they come in, as we've said on previous calls like this, they don't carry the same type of gross margin, operating margin as the patented CnF suite of chemistries.

But again, I think it speaks to the broadening reach of our research effort. It speaks to the broadening reach of our sales effort that we do not want to be, A, regarded as a one type chemistry company. Nor are we.

That margin number I think from planning from a fourth quarter standpoint, Georg, should be consistent with where we are here. There might be a little bit uplift because that inventory adjustment was a one time event, we believe in the third quarter.

And I'll let Rob talk a little bit more about that inventory deal just so you've got clarity on that and then if you want to follow-up for sure come on back.

Thanks, John.

As John mentioned, we've began to use a lot more third-party storage and blending facilities and we just discovered that some of those parties weren't providing a complete set of information to us about the chemicals that they had been using in the packaging and blending process. So we've adjusted our processes to follow-up more promptly with them in the future and you're correct it won't be a recurring item.

One other thing and then Georg we'll let you follow up if you want to. The logistics situation, I talked about this a little bit earlier in the quarter in terms of us creating take or pay contracts with some of the logistic folks that move these chemicals around.

I think that'll mitigate the logistics issue going forward and it's a credit to our supply chain team that's been able to negotiate that. We don't see any further compression in the margin from Energy Chemicals and I think you can model it going forward something consistent with the third quarter maybe a little bit uplift. But go ahead.

I appreciate that clarity, John.

I guess my next one is with regards to FracMax. Obviously, it seems like it's really generating a lot of traction for CnF. Just wanted to know where we stand in terms of dedicated personnel on that marketing side?

And then secondly, you provided some nice commentary in terms of obviously early weeks of October sounds like demand hasn't been impacted by the volatility. Just wanted to get maybe a few thoughts on what operators are saying to you now in terms of the conversations you've had over the last few weeks with regard to the volatility. Does it come up or is it something that's been largely overlooked at least to this point?

Couple of great questions.

We have a dedicated team of four folks, I believe, on the FracMax analytics that are providing us the data that from our perspective is the most exact system of record that specificity of completion additives and corresponding production in this industry in North America. We now have 66,000 plus wells that have FrakFocus data on them over the last three years with corresponding production across every basin in the country. And again, I think one of our side objectives is to have that become the de facto standard of accurate information with respect to additives and are you able to illustrate value.

With respect to your question on the clients, I'm sure that's on a lot of folks' mind. Intuitively, I think folks would think that when you get a compression at a commodity pricing that should inherently become more difficult for something that's perceived as a value add.

Our message is always very consistent. Whether it's $105 a barrel or $85. And that is, if you can validate the value you should strongly consider using that technology, whatever it is.

And the unique thing with Flotek is we can validate the value. Whether it's our CnF chemistries through FracMax or our downhole sensors that are embedded in a couple of our more technical drilling tools.

You could actually make a case, and I know you're very familiar with this, many of these ENP companies that have a separation between cash flow and what the capital required is to continue their programs, that the opportunity to improve production or improve barrels of oil per lateral foot is actually more impactful for them at $85 a barrel then $105. I think the important message that we want to leave for everyone is that our messaging is very consistent.

A year ago, we weren't saying well now because price of oil is high you can afford to use this. No, it was because we can validate the value and it's the same message today.

Specifically regarding the clients, I would echo the sentiments that you've heard in the earlier earning calls this season with Slumber J and Baker Hughes and Haliburton, that they've not seen any type of slow down in activity and we haven't experienced it as well. From what we can tell looking through the remainder of the year, in terms as how some of these projects are lining up, we don't expect to see that as well.

(Operator Instructions)

Mark Brown, Global Hunter Securities.

I wanted to ask about comparing the second quarter to the third quarter Q, it looked like your US revenues weren't growing as quickly as the international revenues in other countries. And I just wanted to know if there's a specific reason for that or if there's any commentary you can provide around that?

That's a fine question. There is one specific event regarding a major operator in the DJ basin that we -- I think I talked about this actually in the second quarter, that due to a CnF product we didn't believe was providing the type of recovery that was sustainable for them, we took that product off the market and have been reformulating it and have met with them. They've been engaged with us.

No different than the operator we mentioned in the Bakken. And are prepared to reengage towards the end of the fourth quarter with their CnF additive program.

In fact, offsetting that operators activity and still increasing domestic activity I think speaks well to the diversity that we're able to accomplish with more people using CnF in the third quarter than ever before.

I understood.

Wanted to ask about your micro solutions drilling fluid product which I saw in the press release that Saudi Aramco is going to commence work with that in the fourth quarter. Just curious how we should think about that product being tested and rolled out and are there any other countries that you think would be good candidates for using that product or any of the basins here in the US?

Great question.

And the status is, it's our expectation after -- as I mentioned, Amerr Mahgoub who heads up our effort there in the Middle East, was actually over here this week with us. We expect that those first wells for Saudi Aramco to initiate within 2 to 3 weeks with the micro solutions.

Some people are probably wondering why in the world do we select Saudi Aramco. We selected and they actually helped select us because, quite frankly, they are the good housekeeping seal of approval in the Middle East. And just by their interest up to this point there has been other interest from Kuwait, there has been other interest from the UAE about this additive that's designed to extend, if you will, the utilization of a water-based drilling fluid as opposed to an oil-based drilling fluid.

We need to make sure that there's real clarity on this. We are not in the drilling fluid business. No different than we are not in the frac fluid business.

We are in the specialty additive business of making those fluids behave better. It's certainly our expectation that in the end of the year call in January that we will be able to report back as to the benefit that Saudi Aramco saw with this initiative.

I think I mentioned earlier, in maybe the second quarter call, this validation of the technology we expect to work on the first of three wells but it may require some tweaking for another series of wells. But we're going into this with an expectation because their technical people have been over to our research facility, we've been over there. The initial opportunity has a high probability of success.

I think probably everyone that's connected with the activity inside Saudi Aramco can make their own conclusions that if we are able to improve the performance of the water-based fluid drilling systems with Saudi Aramco, it has a meaningful uplift opportunity for Flotek. With respect to North America, closer to home, that's another reason why we're expanding the research facility. We're going to have drilling fluid engineers inside the research facility. Specifically, engaged with this micro solutions effort, and we will also have drilling fluid business development people geographically located in North America starting in 2015.

Again, I just want to make one thing clear, this is not an effort to get into the drilling fluid business. We'd be crazy to do that. This is an effort to do what we do best which is to hopefully add value to existing fluid systems.

One more question for me, if I may on Production Technologies? Just was curious, that you're exploring options to accelerate the growth with new technologies and services.

I imagine there's probably not a whole lot you can say at this point but I just thought I'd ask if there are? If you can give us any hints in terms of whether there's a specific product area or type of customer that you are focused on with this production technology strategy?

Great question.

The honest and legal answer that we can give you is stay tuned over the next really just several weeks. It's not even going to be months. But again, our approach on this whole production technology effort is understanding the capability of what we can deliver with the size of Flotek.

We are selecting what we believe are unique niches in that segment of this industry that the experience of the group that David McMahon has brought in and continues to bring into Flotek are uniquely suited for us to exploit. Either through a perhaps new technology or through better service.

I'd say great question. Just hang loose for, like I say, just a few weeks and we'll be able to provide more clarity there.

George Austin,

John, perhaps you could elaborate on this valuable metric of revenue and operating income per employee which you continue to highlight? And it is indeed very favorable. You say top of the industry, I think it's twice, Slumber J, Haliburton and Baker which are about $400,000 per head. And you are in Microsoft and Google territory at $800,000 and $1 million respectively and obviously, they have value added products for consumers and corporations.

So as you elaborate, I think my focus is going to be on headcount looking forward and this new incentive system and impact on pretax margins. By that I mean, if you are geared up headcount wise now as these validation projects come to fruition, perhaps even another dozen, that the incremental revenue, assuming you're geared up staff wise, flows substantially to the bottom line at least to pretax margins.

Maybe you could elaborate on that? Are you staffed up well and can you see a substantial impact on margins? And tie that in with what this win-win that Steve referred to, incentive system means.

Whether its production incentives or whatever. So headcount incentives impact on pretax margins?

George, that was a great question. Let me answer it in different parts there for you.

The efficiency and the effectiveness of the revenue per employee is something we are very proud of and I appreciate you taking the time to compare us to other people in the industry and then other industries. It's something that we watch very closely and I think it combines with three other main tenants of what makes Flotek different.

Our debt structure we think is second to none in this industry and the cash throw off as it relates to earnings per share and all that is very high. And we like to think that positions us very well for any type of irregularities in this whole commodity pricing environment with outstanding revenue for employee, outstanding operating income per employee, the debt structure and the cash flow throw off.

A little bit more specifically to your question in terms of incremental. We have been able to meaningfully reduce the cost of the cost per barrel or per gallon of chemistry that's produced in Marlow due to the efficiency of the expansion effort there.

When you pull out just the Marlow blending facility, in terms of its impact on operating margin, it's greater than what you see in the overall Energy Chemistry segment because of the added infrastructure we put into place in Business Development and Research building for the future. But the impact of producing chemicals in Marlow is at an all-time record low and that's what will, as you correctly pointed out, as we layer on additional revenue that will have even a more significant impact for us.

In terms of the win-win you brought up from Steve's perspective, we're on the verge of having a production measured performance engagement with one or two clients. And it's not that we hesitate from that because, for heaven sakes, we've got this database of those 66,000 wells that I referenced, over 15% of those have complex nano fluid in them. We've got a very good feel as to what one should expect from a production uplift in a particular geographic area as a result of that FracMax database.

The reason we haven't initiated sooner, as you can imagine, it's a more complicated and elongated sale and it's one that quite frankly the operators are not as eager as one might think to pursue. And there's also the added complexity of making sure that the pumping service company, the Haliburton's or whatever, are engaged in that whole process. But that's the conversations that we're starting to have. That's the conversations we're eager to have and I'd say stay tuned. It's not something that creates, that we have to have it to continue to penetrate this market, but it's certainly something that we're now in the first process of pursuing.

One other thing, if I could also follow up, directs to the win-win. Probably a lot of the folks that are listening into this call had a chance to listen to earlier calls by Baker Hughes where their CEO, Martin Craighead, talked about upstream chemicals as a way to improve the cash flow of their clients. They also probably had a chance to listen to Jeff Miller, the COO of Haliburton, who for several quarters has not talked about customized chemistry and the impact they see that has on their clients.

We really embrace that. So it's not just Flotek that is talking about the benefit of customized chemistry especially in the oil pricing environment that we are today. And they themselves are also looking at different economic models as it pertains to the ultimate end-user that benefit from this chemical focus. And hopefully, that helps you.

I'll turn the call back to you.

Beatrice, thank you. And we'd like to thank everyone that took the time to get up a little bit earlier today. We wanted to do that because we had some requests from several of our stakeholders that there were other calls going on today that they wanted to at least have a chance to listen into.

And again, we appreciate everyone's interest in Flotek. We are pleased that you've joined us and we would like everyone to have a great Thursday. We'll talk to you all soon, again. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.