Flotek Industries Inc (FTK) 2015 Q4 法說會逐字稿

Good morning, and welcome to the Flotek Industries, Inc. fourth-quarter and year-end 2015 earnings conference call.

(Operator Instructions)

This conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Edmonds, Senior Director of Corporate Finance and Strategy for Flotek Industries. Mr. Edmonds, please go ahead.

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 annual report filed on Form 10-K 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 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 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange 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 exclusive means of identifying forward-looking statements on this call.

These matters involve risks and uncertainties that could impact operations in 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. John?

Chris, thank you. I would also like to welcome each of you to Flotek's fourth-quarter and full-year 2015 conference call. We are glad you are here. With me today are Rob Schmitz, 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; and Richard Walton, Flotek's Chief Financial Officer Emeritus.

Last evening, we filed our annual report with the US Securities and Exchange Commission. While we won't take your valuable time to regurgitate all 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.

As we noted last night, Flotek reported revenue for the year ended December 31, 2015, of $334.4 million, a decrease of $114.8 million, or 25.6%, compared to the year ended December 31, 2014. As we noted last evening, the current oilfield environment, as we experienced last year and continue to face as we begin 2016, is the most difficult, unforgiving market I have seen in my entire career. The accelerated decline in overall activity from drilling to completions, and even production enhancement, has created overwhelming challenges for many industry participants.

While Flotek was not immune to the sharp market deterioration, continued opportunities in our patented hallmark CnF completion chemistry business did provide us with some shelter from the otherwise tsunami-like declines in overall activity. That said, as we look into our very clouded crystal ball, we consider the possibility of additional challenges and uncertainty in the coming months and are working diligently to prepare our Firm for the potential rocky road ahead.

The tenets of our preparation include an acute focus on efficiency and liquidity, while at the same time making certain we preserve our options to pursue value-creating opportunities as they present themselves. We are very fortunate that our balance sheet remains amongst the strongest in the industry and we intend to protect our liquidity as we remember all too well the daunting challenges of 2009, which we have vowed not to repeat.

Liquidity remains a core canon of our financial leadership, and we will do our very best to protect, preserve, and propagate liquidity to ensure a plethora of capital options remain available to the Company. As we noted last night, we are intensely focused on efficiency, looking for ways to improve workflow, reduce overhead, and work smarter to achieve the same results with fewer resources. For example, this month, the Company made several adjustments to the Drilling Technologies business that we believe should reduce expenses by another $2 million annually.

In addition, we are considering a wide range of options that we believe are aimed at improving value for all of our business units. While such strategic opportunities take time and are more difficult to navigate in a challenging market, we believe they are real opportunities to showcase the value of our businesses to our stakeholders and others. Of course, there is no assurance that any of the potential options will, in fact, occur.

Finally, we will continue to focus on innovation. We're in the process of completing our new global research and innovation facility, which we believe provides us a platform for a more efficient research process today and the infrastructure to be the global leader in advanced oilfield chemistry research tomorrow and well into the future. In combination with our academic and commercial research partners, we are excited about our opportunities to be one of the go-to oilfield chemistry companies to provide solutions to drilling, completion, and production challenges both here and abroad.

While I know there are numerous challenges, both known and unknown, ahead for Flotek and the industry in the coming months, I sleep well at night knowing Flotek has built one of the best teams in our industry, from our corporate leadership and support team in Houston, to our technicians and customer service folks from Dickinson to Denver. While it would be easy to quit in this environment, our people don't understand what that means. Instead, our team has worked hard to become more efficient, ask the tough questions that help improve our workflow, and, quite simply, are on a mission to prove that companies can be successful, even in the most challenging of times.

That said, we are acutely aware of how our world has changed and know that the challenges in front of us are substantial. As such, we are focused on ensuring the appropriate balance between caution and opportunity, making certain that our business is appropriately sized to a more constrained and volatile opportunity set, yet not lacking the resources to seize what we believe will be an abundance of business opportunities as we navigate through the current cyclical tumult.

I remind you that we have long memories and remember vividly the frenzied, frantic nature of Flotek finances when we began this journey in 2009. At that time, I had made it clear that our responsibility as corporate stewards was to ensure our level of care would virtually eliminate such fiscal crises in the future.

As I've said on each call since I took the helm now six 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. Today, once again, we are refocused on our vision to restore growth to the Company and continue to be enthused that, through the efforts of our people, the future will once again present opportunities to create value for our stakeholders.

As I conclude these remarks, I ask you to remember -- as I remind myself nearly everyday -- what Flotek is all about. Flotek is, at its core, an oilfield technology company with a focus on innovative chemistries and other products and services that make a difference in the productivity of a well at every point in its lifecycle, from the spudding of a well to the last barrels of production.

And our objective is to make a positive difference for our clients so we can, in turn, create positive opportunities for our employees, the communities in which they live and -- most importantly -- you, our shareholders. While we may not always get everything right, we will strive -- even in the most difficult of environments -- to do the right thing for all our stakeholders. As we continue to face challenging times, we need to remind ourselves of our vision, our mission, and our values. Flotek is indeed all about making a difference.

With that, I'd like to turn the call over to Rob Schmitz to review our fourth-quarter and full-year financial highlights and provide some additional color on certain financial issues. Rob.

Thank you, John. As John mentioned, Flotek filed its Form 10-K for the period ended December 31, 2015, with the US Securities and Exchange Commission, yesterday afternoon. Flotek reported that revenue for the quarter ended December 31, 2015, was $77 million, a decrease of 38.1% compared to the same period of 2014. Revenue decreased 12.4% compared to third-quarter 2015.

For the full year of 2015, the Company reported revenue of $334.4 million, a decrease of 25.6% compared to the full year of 2014. The decrease in revenue was primarily due to the drop in oilfield market activity as reflected by the 47.8% decrease in average North American active rig count from 2014 to 2015.

Flotek reported a loss from operations for the three months ended December 31, 2015, of $2.1 million, a decrease of $25.6 million, compared to $23.6 million in the same period of 2014. Income from operations decreased $4.8 million compared to the third quarter of 2015.

Flotek reported a loss from operations of $19.2 million for the year ended December 31, 2015. Excluding the impairment charges taken in the second quarter of 2015, we reported income from operations of $1.2 million for the year ended December 31, 2015. We reported a net loss per share for the third quarter of 2015 of $0.03 per share, compared to $0.29 per share for the fourth quarter of 2014.

For the year ended December 31, 2015, the Company reported a net loss of $13.5 million, or $0.25 per share fully diluted, compared to net income of $53.6 million, or $0.97 per share fully diluted, for the year ended December 31, 2014. Excluding nonrecurring non-cash charges taken in the second quarter, Flotek reported a net loss from continuing operations of $31,000, or flat for a common share, for the 12 months ended December 31, 2015.

Earnings before interest, taxes, depreciation and amortization -- or EBITDA -- for the three months ended December 31, 2015, was $2.3 million, a decrease of $25.7 million, compared to $28.1 million for the three months ended December 31, 2014. Adjusted earnings before interest, taxes and depreciation -- or adjusted EBITDA, a non-GAAP measure of financial performance -- for the year ended December 31, 2015, was $19 million, compared to $98.3 million for the year ended December 31, 2014.

The Company recorded an income tax benefit of $7.7 million, yielding an effective tax rate of 36.2% for the year ended December 1, 2015, compared to an income tax provision of $25.3 million, yielding an effective tax rate of 32% in 2014. Accounts receivable, net of allowance for doubtful accounts at December 31, 2015, was $49.2 million, compared to $78.6 million for the period ending December 31, 2014. The Company's allowance for doubtful accounts was 2.4% of accounts receivable at December 1, 2015 (sic - see press release, "December 31, 2015").

While we recognize that our operating environment has changed meaningfully -- even since the end of the year -- we continue to believe Flotek is well positioned, as nearly any energy company, not only to weather the cyclical pressures and market volatility, but to take advantage of opportunities created as a result of a cycle change. As John said, we intend to be very vigilant in protecting our liquidity, rationalizing costs and making certain we are maintaining a high level of financial flexibility as the industry searches for the next cyclical inflection point.

Thank you. I would now like to turn the call back over to John Chisholm for some closing remarks. John?

Rob, thank you very much. Before we take questions, I would like to add a few concluding thoughts. As I noted earlier, as challenging as the current market environment may be, Flotek's challenges would have been even more significant without our patented hallmark CnF suite of completion chemistries. In a market that showed steep declines year over year, and even from the third to fourth quarter, CnF volumes continued to increase.

Sales volumes of the Company's CnF suite of completion chemistries increased 18% in 2015, when compared to 2014 levels. Fourth-quarter volumes increased 5% sequentially. Year-over-year revenues were down approximately 8%, while fourth-quarter revenues grew approximately 1%.

As noted last evening, the decline in revenues relative to volumes is primarily the result of product substitution, the introduction of a less expensive yet equally or more effective formulation of CnF, and volume-based price incentives rather than simple ad hoc price reductions. Moreover, interest in CnF chemistries continued to grow as we concluded 2015.

During the fourth quarter, the Company completed 17 validations for operators across diverse basins and plays, including the Permian and Anadarko Basins, Eagle Ford, Utica and Bakken Shales, and the STACK and Mississippi Lime plays. While validations may be slightly extended as a result of current market fundamentals, Flotek continues to see meaningful opportunities as new clients search for ways to maximize economic benefits in a challenging commodity price environment.

In a new application opportunity for Flotek chemistry, Flotek completed its first offshore frac pack treatment using CnF chemistries in the Gulf of Mexico. And the Company continues to find success in CnF-assisted well remediations, a trend we believe could continue in an environment with more moderate commodity prices.

Finally, while CnF activity was relatively resilient in the quarter, the non-CnF portion of the Energy Chemistry segment was challenged. The majority of the decline in other chemistries was the result of a precipitous decline in orders from one major client who significantly curtailed its work in the quarter. We've seen a modest uptick in orders from that client in early January, although we and they don't expect a full recovery in the near term. That said, we believe the non-CnF business was close to a trough run rate in the fourth quarter.

As we noted last evening, the Drilling Technologies business is dependent on rig activity and, as a result, continued to weaken in the fourth quarter, although outperformed activity levels in that same period. We believe that trend could continue as smaller capital challenge competitors exit the marketplace, a common phenomenon in the trough of the cycle. While we don't expect any improvement in pricing or margins in the near term, we have seen pockets of revenue growth such as North Louisiana, where revenues increased by over 50% sequentially in the fourth quarter.

We're also seeing nice opportunities for Teledrift in international markets, especially Argentina and other select South America and Middle Eastern markets. As noted earlier, in an attempt to determine the optimal structure for Flotek, the Company is considering a number of strategic options to improve the value of our Drilling Technologies business.

Our Production Technologies business continues to build relationships with key vendors and customers, and should benefit from those efforts in 2016. With an emerging supply chain agreement for key lift technology, combined with our purchase of International Artificial Lift, now a year ago, we are actually excited about new prospects in this coming year.

On a brighter note -- which means it must not be oilfield related -- we are pleased with the results from our Consumer and Industrial Chemical Technologies segment. While we discussed operating metrics last evening, the growth in sales was driven by stronger pricing and resulted in higher operating income. What is more important is that, under the direction of Josh Snively, Florida Chemical has provided Flotek with a stable, opportunistically priced source for our growing need of citrus terpenes. Very simply, without Josh's ability to strategically source and manage our terpene inventory, it is likely Flotek's CnF product line would be a fraction of its current size and significantly less profitable than it is today -- if profitable at all. We're all incredibly thankful to have Josh and his team as part of the Flotek family.

Finally, a couple of concluding thoughts. First, yesterday, we released the first of three studies being conducted by Denver-based MHA Petroleum Consultants, LLC, through our Special Technical Committee, which was established to review the efficacy of CnF and the Company's data analytics software. The first study looked at CnF performance in the DJ Basin in Weld County, Colorado. The complete study is available on Flotek's website. We are pleased that the study found what our clients already know -- CnF completion chemistries work. The remaining studies will complete similar analysis in the Permian Basin and the South Texas Basin, which includes the Eagle Ford Shale.

As previously disclosed, the Company and several officers have been named in a series of security class actions. These types of suits are commonplace when there is a large decline in a company's stock price. All of the lawsuits have been consolidated into one, and the court is in the process of appointing lead plaintiffs for the class. After lead plaintiffs are appointed and the consolidation complaint is filed, we plan to file a motion to dismiss. While we cannot predict the outcome of the case, these types of lawsuits are subject to strict requirements and are frequently dismissed.

The Company's officers and directors have also been named in several derivative suits based on similar allegations in the class actions. A derivative suit seeks to hold individual officers and directors liable for allegedly breaching their fiduciary duties to the company. It is common for these type of cases to be filed after a class action. Derivative cases are also subject to strict requirements and are frequently dismissed.

Also as previously disclosed, the US Securities and Exchange Commission is conducting an inquiry and has asked the Company for information concerning FracMax and CnF. The SEC frequently conducts these types of inquiries when there is a significant stock price decline and when securities class actions are filed. While we cannot predict the outcome of the SEC inquiry regarding Flotek, we are cooperating fully with the SEC.

Before we take your questions, I want to say a special thank you to Rob Schmitz, Rich Walton, and our accounting and finance teams for continuing to accelerate our reporting timeline. Just as we want to be a leader in oilfield technology, we also want to continue to be a leader in corporate governance, stewardship, and transparency. That said, we understand the challenges in front of us as we face an extraordinary level of uncertainty in our industry in the coming months.

We will leave rig-count guesstimates and oil price predictions to the pundits, instead remaining acutely focused on what we can control: our cost structure and resulting financial position; our level of service, which we will strive to take to an even higher level; our marketing efforts that focus on how Flotek products and services can make better wells and, as a result, provide better returns for our clients; crafting creative business structures that create mutually rewarding results for both Flotek and our clients; and remaining true to our goal of maximizing value for our shareholders throughout the economic cycle.

Simply, we will strive to be at the top of our market and focused on both relative and absolute performance. We can do very little about oilfield activity, oil prices, or rig counts, but we are confident we have the best products and provide the best service with the best people. As we focus on our business, I'm confident we can remain at the top of our game and, at least on a relative basis, strive to outperform the benchmarks our stakeholders watch closely.

Regardless of the challenges ahead, what I pledge to you today -- as I did on my first call, now six years ago -- is that my team and I will come to work each and every day knowing that you have placed your confidence and trust in us as stewards of your capital. We will always take that responsibility very seriously and work hard each day to earn that trust. Let me be clear -- the success of Flotek is the 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 is 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 am glad to be here, and we look forward to sharing our journey -- both challenges and successes -- with you in the coming months.

And with that, operator, we will now open the call to questions.

Thank you.

(Operator Instructions)

Matt Marietta, Stephens Inc.

Good morning. Thanks for taking the questions.

Wanted to start first on the competitive landscape here. We all hear anecdotes, fear of a threat of imminent competition. Sometimes these are smaller companies, [quar] companies, stuff like that with no history of really customized chemistries trying to copy all success. There's few public competitors out there on the energy chemical side. And those that are competitors are sometimes ironically these larger public frac companies. They're also some of your largest customers.

So I'm trying to understand a few things here. One, first, are you aware of any competitors out there still trying to clone your CnF technology? Second, what can you do to maintain the high barriers there? And finally, if these competitive products are finding their way into the wells of any of your existing customers, maybe help us understand the competitive landscape and elaborate on that, if you can.

Sure. Great series of questions, Matt. And I'm sure other folks are thinking the same thing.

Overarching, we focus on our continuing commitment to research and innovation, which we can control. It is very easy for someone to say that they have something that is like CnF but doesn't infringe on our patents. But I want to remind everyone that CnF is not just one product.

It has 38 custom formulations. It has gold band certification in the North Sea, which is the best environmental rating. It has recently passed a no sheen test in the Gulf of Mexico, which led to, as I mentioned earlier, our first work in frac packing in the Gulf of Mexico at a loading significantly higher of per-gallon compared to normal onshore loading.

And we are not aware of losing any opportunities to what we've described as a competitive CnF with our existing client base. Is someone using something that is represented as similar to companies we are not aware of? It could be. But in terms of the client base of Flotek, we are not aware of losing any opportunities to, quote, a competitive CnF.

Thanks for that.

And moving over to the validations, I think you said that there were 17 concluded in the quarter. How many of these validations are with large potential customers? You specifically highlighted a group of large companies and progress at some point in the past.

And how many are with small and midsize companies? Maybe help us understand the contribution potential or demand potential of these customers that concluded their validations in the quarter.

Yes. That's a good question.

And we will say we want -- more than half of those validations are what we would consider to be larger companies. And the reason why we feel that's important is just the size to the size of the Company, it is our estimate that the larger companies have the staying power to drive through this cycle, as opposed to perhaps some companies that just may have a one- or two-rig running program.

From just a standpoint of good business practice, we're not going to specifically call out who those folks are. We've mentioned them in the past. I think the fact that the volumes of CnF speak for themselves in terms of the increase in the fourth quarter. I think we will leave it at that. But more and more of these validations are with what you would consider larger companies.

Thanks.

One more out of me here, and I will jump back in the queue.

Now that this snake oil narrative is behind us by the sales volumes and MHA, other third-party analysis of the efficacy of CnF, I really wanted to dig into cash flows at the Company. When I look at the segments, you have this energy chemical tech business. It actually exited 2015 at a higher rate than it entered 2015 for the year. I don't cover any companies that have done that. The exit rate at about $50 million of EBITDA in energy chemical tech.

But when you look at the drilling tech in G&A, that significantly offsets those successes. You snuck the strategic options in the press release. You mentioned it a couple times already. Can you elaborate on what you can do there really to let your shareholders benefit from getting fair valuation on the CnF and on the energy chemical tech segment? Maybe some color there would be helpful.

Sure. We will let Rob answer the cash flow question.

But I think to be fair as to preserving all of our options, we tried to address it as best we could in the press release and our prepared remarks. We recognize this is a very difficult environment for the down-hole tools. We have reduced the headcount there by over 30% from when this year started. And we are continuing to look at ways to further reduce the expenses.

The fact that we were able to outperform what the drilling rig count was in the fourth quarter, I think, speaks to the quality of our people. But we are keenly aware that we want to make sure that the performance on the chemistry side of things is not unduly affected by that segment. And believe me, it has got the focus.

Rob will give you a little bit more clarity on the cash flow.

Yes, I think from a levers and cash flow standpoint, I'd add to what John said.

We announced and reported in our 10-K that we expected to spend between $20 million and $25 million in CapEx this year. $7 million of that is to complete our R&I lab. The vast majority of the rest of that is really revenue opportunity dependent. Certainly all the stuff in the tools business and the production technology business goes to generating rental tools that are going to be revenue producing. So if we don't have transparency to those opportunities, then we won't spend that money.

Similarly, in our energy chemicals business, we've got some money in our budget that we are not going to spend unless it is an opportunity to align with another strategic player who needs some logistics help from us. So there is a lot of room for flexibility in our cash flow process related to our CapEx.

And I would just reinforce what John said. We are looking at all of our segments, even some areas within our energy chemicals business. We think we have opportunities to potentially make some adjustments. So you will be seeing more of those things as we go forward.

Does that help you, Matt?

That did. Thank you for the color there. Obviously, it is difficult to talk about things in the works. But thanks for commenting on that.

Sure.

Georg Venturatos, Johnson Rice.

I just wanted to speak a little bit more and maybe you could address the conversations you're having with customers post the FracMax issues. Obviously, we saw nice numbers relative to the rig count in the fourth quarter. But just any commentary you can give us in terms of commercial impact, which appears to be minimal, but wanted to confirm how those conversations were going.

Great question. Again, I think it's another one on a lot of folks' minds.

Any time you have a transformational product, like CnF, whether it's in the business world or in the consumer world, you move through the cycle of early adopters and more into mainstream. As you move more into mainstream, what happens is the clients that are using it are more freely talking about the benefit of the technology. And that is what is happening.

I think you are seeing folks that are at conferences that are talking more about CnF. If not publicly, at least in breakout sessions that everybody on this call is familiar with. And so it is moving into more of a communication from operator to operator, service company to operator. And so that's really part of the process. We kind anticipated that would happen, that would be beneficial for us while we are reshaping FracMax.

And if there is one thing I've learned in business, the most important factor is for your clients to trust you; and ours do. And that is why more and more of them are willing to share the benefit of what they are seeing when they use CnF.

Okay. I appreciate that, John.

And you mentioned the 17 validation programs you completed in the quarter. Can you give us any update in terms of framing that for reference in terms of what you are working on today? I know you gave us some numbers in previous quarters in terms of how that pipeline might look.

Yes. I hope everyone on this call understands that in particular in this environment, in terms of forward-looking type comments with the legal situation that we are in, we have to be a little bit more careful and reserved as to how we address that. But we are pleased with the ongoing validations.

And as I've mentioned in the past, the sustain rate of validations into ongoing client usage remains very high. And I think we probably should leave it at that and, hopefully, everybody can understand that.

Understood.

On the non-CnF side, you did a good job of addressing that, certainly, in the pre-announcement and also talked about it in your prepared remarks. But how should we think about that going forward? I know you said you felt like it had troughed.

Should that be more in line with the rig count on a go-forward basis? Is that how we should think about that business? Or do you think there is still some pretty significant lumpiness, depending on what frac tech may do going forward?

I want to remind everyone that at the end of our third quarter call, we put that out there because we have got a very good projected level of activity with that particular client. And we told folks ahead of time that based on their input into us for supply chain management and all that, we pretty well telegraphed what the fourth quarter would be, especially after Thanksgiving. And, sure enough, that is what it was.

But that particular client -- you named them -- their activity seems to be picking up. And we participate then when that activity does pick up. Does that give you enough clarity?

That helps.

Okay.

We can speak further about that later, but that helps.

Okay.

The last one for me and then I'll get back in.

But I thought it was interesting, your comment on the offshore side. Just wanted to get a few more details on that in terms of potential scope and where this could go. Because I know we've talked about potential for CnF. And it had always been boxed into the onshore space. And I just wanted to see what you thought could come of what you did this past quarter.

Sure. That particular client is moving on now to a second frac pack that is using us. The loading factor is significantly higher than what's traditional onshore. We will keep that proprietary for obvious reasons. But we had to pass what people on this call are probably familiar with, the no-sheen test when you dispose of return fluids over the side. And we think that's just one more environmental barrier for other people that our technology was able to pass.

But a word of caution for everybody. The volume on these jobs is much, much smaller than horizontal frac jobs. So I think more than anything, it further illustrates the efficacy of the CnF technology. Folks can try to remember two or three years ago, people were trying to say, well, it's just limited to one type of rock and one basin.

At the same time, we didn't talk about it in our prepared remarks. But we're also were involved with a major asset job in the Middle East, where the well was making 6,000 barrels a day. The projection was 9,000. They used CnF, and it actually doubled to 12,000 for a national oil company there in the UAE.

So again, folks typically think of -- and we probably need to do a better at this -- they typically think of CnF as one product. It is not. There's over 38 formulations.

They typically think of it as one application in fracturing. It's not. It can be used in frac pack, as I mentioned. It is used in acid jobs, starting to grow in the Middle East.

But a word of caution is, most folks know these frac pack jobs are much, much smaller than even a vertical frac job on land, much less a horizontal job.

Right. Thanks for the details, John. Appreciate it.

Sure.

(Operator Instructions)

Darren Gacicia, KLR Group.

Thanks for taking my question. I wanted to follow up on a couple points.

Just to get some clarity because I don't think it's really (inaudible). Is there anyway you can frame what percentage of energy chemicals is CnF versus other, just so we can try to triangulate? Because I think I have a sense of what it may be on a historical run rate. I do not know if it's changed this quarter and how much we should think of it from a modeling perspective going forward.

Right. Because of the drop off of the non-CnF business, it actually is now at the highest end that I think it's ever been with Flotek at 70%. But Rob can give you a little additional color on that.

Yes, it's a little over 70% for the quarter. I would just caution you, in terms of modeling going forward, that it's going to be influenced by what we talked about earlier, which is how the market for the rest of our chemistry comes back in the next year. So it has run historically in the 45% to 60% range.

But it is probably at the high point. And I would guess that's probably a ceiling or close to a ceiling anyway.

Okay. The second question, if I could. People have approached trying to understand the validations and the process a few different ways during the call. Can you maybe walk us through what is involved with the timeline of a validation process?

I noticed in the release you talked about timeline, that extending those. So I'm trying to get a sense of what it means to extend. Does that mean we need further validations than maybe what we've already had? Is there any impact from some concerns about FracMax that may be extending some of those validations as well?

Sure. Great question. It's really two ways to answer that question.

Just by the overall activity which, as everyone on this call knows, we are in an environment of extreme conditions. From companies that have filed Chapter 11 to the depressed rate count to the price of commodities, I think people just inherently move a little bit slower. So a four-well validation that might have taken a month six months ago may now take six weeks or two months to complete. So that's one part of what we talked about, the potential slowing of the validations.

But again, as I think most folks know on this call, when your validations are moving into the larger sized companies -- not that we haven't been working with them before -- but they typically take a longer period of time because they are more bureaucratic in looking at the performance of anything new that they may try. Whether it is an increased sand concentration, whether it is a different perforation cluster. Whereas your smaller independents may look at a two-week, three-week or a month uplift in production and say, we've seen enough. We now want to move on.

These more bureaucratic larger companies typically will take a longer period of time to evaluate any type of change they make in their effort to get more oil out of the reservoir.

So that is a two-part answer to your question and hopefully that gives you some clarity.

Does that suggest of the 17, more than one-half or maybe three-quarters are larger customers within that mix? I know you have given some color on that on the call. I'm just trying to get a little bit better sense of what the mix is of the 17 between large and small.

Yes, I think I mentioned on an earlier question that a meaningful portion of those 17 are what people would classify as larger companies, as opposed to someone that might have a one- or two-rig drilling program.

Thank you. I appreciate the help.

Thank you for your interest.

Mark Brown, Seaport Global.

Hello, Mark?

Mr. Brown, your line is now open. Please go ahead.

Come in, Mark Brown.

Okay. We will go to the next question. We now have a follow-up question from the linen of Matt Marietta.

Hello, I will fill the void there. One more out of me.

You added in the press release another shift of scientists in the labs up in Woodlands. Is this driven by current or future potential customers? I want to understand if this is the leading indicator of future CnF demand. Or are you just simply growing the support functions into current demand? Maybe help us understand why that is in the press release.

Sure. And I will let Josh take that balance of that question for you, Matt. But it is safe to say that we have more projects for more clients that they have sent us -- whether it's their drill cuttings, their cores, their oil samples, their water samples -- to further refine and customize CnF than at any time in the history of Flotek.

But Josh can give you some more color on that.

Good morning, Matt.

To John 's point, just to put it in perspective in what we are seeing within research and the interest in the CnF and the variety of CnF solutions that we can provide to the marketplace, this fourth quarter we completed 110 client studies. If you look at that same fourth-quarter period in 2014, it was 35 projects that we completed. So the interest and the workload is what drove the second shift.

As far as the client base, it's a pretty good mix. But we are seeing a lot of the A&P companies come in wanting to understand, wanting to validate through our chemist, through our understanding, which is the best chemistry that will be compatible with their water, oil, mineralogy, as well as the fluid systems that it'll be going into.

That's quite an increase. Thanks for the color there. I really do appreciate it. Thank you.

Before we go to the next call, I just want to add on one thing to try to put that into perspective.

We are working for a particular client in the DJ Basin that I met with that on two different wells, with a 12-mile distance between the two wells, the API gravity of the oil was a difference between 58 and 34. That requires custom chemistry. To put the same CnF in both those wells would be absolutely not technically advanced, nor giving the operator the best chance to maximize the performance of his well.

And folks have heard us talk about this customized chemistry now for three years. But I just wanted to put that into perspective of a real-world example in the DJ Basin, where it required two different CnF formulations just within 12 miles of each other.

(Operator Instructions)

Mark Brown, Seaport Global.

Can you hear me okay?

Loud and clear. Glad you're back.

Okay. Thank you.

Question on the very strong gross margins in energy chem in terms of your sequential performance. I was just wondering whether you are able to hold pricing on CnF, or have you have to give a little bit to the operators? And also, just what you meant in the press release regarding product substitution and volume-based pricing incentives. If you have any more that you could elaborate, I would appreciate it.

Sure. We will try to take those one at a time.

The product base substitution, we have talked about maybe for about three calls now, that through the effort of the R&I group, we were able to create a new CnF that has a lower cost structure to us. That we were able to pass on a lower pricing number, whether it's to a Halliburton or someone directly, but still maintain a very meaningful gross margin for us. And we felt that in this business environment, it was just the thing to do.

And again, to try to further penetrate the market. So when we talk about product substitution, it's product that we came out with early in the first quarter. It has continued to gain acceptance with the results and performance.

With respect to -- we have, to my knowledge, I think two separate volume arrangements that when a certain client will exceed a volume of CnF pumped on a calendar basis, they get a modest price reduction whenever that happens. And that happened in the fourth quarter. That is now reset to the main pricing as of January 1, 2016.

As we've said on the third-quarter call, we have had no price decrease with the core CnF technology throughout the year. And so in part, the reason why the margin was at the number that it is, is when you have 70% of your chemistry sales coming through CnF, I think most folks on this call know, those carry a higher margin than the more traditional chemicals that we provide. That's number one.

But number two, as we mentioned in the prepared remarks, it's through the many, many years' relationship that we have of sourcing citrus terpene on a global basis. Where we refine north of 40% of the citrus terpene in the Western Hemisphere, we have a meaningful raw cost input advantage of one of the main costs of our CnF.

We were certainly aware of back in 2013 of that opportunity when we purchased Florida Chemical. It certainly has come to very important benefit in this environment. And that is one of the other reasons why that gross margin number is where it is.

Does that provide context for you?

Yes, very helpful.

And just an unrelated follow-up question on the timing of the reviews that MHA and perhaps other third parties are taking part in. You laid out the three basins where you are going to review the efficacy of CnF. But what about the overall data analysis, the software review, that the Technical Committee is undertaking? Should we expect that after the three basin studies, or is that a different timeline?

I think this is real important for everyone to understand who is listening in on the call with respect to the engagement with MHA. Because it has been a period of time before we were able to create any level of clarity. MHA was hired by the Technical Committee, with absolutely no guidance from Flotek, after they looked at a series of companies that they felt could provide that service.

The only guidance that we gave to the Technical Committee was we wanted a meaningful number of wells to be looked at in every geographic area. We wanted, where it was applicable, thousands not hundreds and, if necessary, hundreds not tens. We have absolutely no input as to the timing of their ability to return these reports because if we did, it would not be an independent study.

So as much as I would love to be able to tell you and the rest of the people listening that there is a scheduled timeline of expected deliverability, as most times you have when you engage with consultants, there is absolutely no timeline directed, guided, implied by Flotek. The only guidance is do it thorough, do it right and take your time. And we just ask for everyone to have patience in that because it is the proper way to do it.

With respect to the analysis of the statistical FracMax, that is ongoing. And maybe a little bit of clarity on that for folks. We are moving it from more of just a statistical app to more of a true software app and creating a more robust software foundation underneath it. And we will be able to give some more information on that in the weeks and months ahead.

But that analysis is ongoing again, by the outside committee. And hopefully that gives you the proper clarity you need, Mark.

I appreciate the clarity. Thank you very much.

There are no further questions at this time.

Okay. Thanks for the questions. As usual, they are all great. And I'm sure they captured the thoughts of a lot of folks listening in.

And thank you, everyone, for your support of Flotek. We appreciate your interest, are pleased you joined us this early and would like everyone to have a great Thursday and rest of the week. 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.