Flotek Industries Inc (FTK) 2017 Q2 法說會逐字稿

Good morning, and welcome to Flotek Industries Inc. Second Quarter 2017 Earnings Conference Call. (Operator Instructions) This conference is being recorded. At this time, I would like to turn the conference over to Matt Marietta, Flotek's Senior Vice President of Corporate Development and Investor Relations.

Mr. Marietta, you may begin.

Thank you, and good morning on behalf of the Flotek team. Joining me this morning are John Chisholm, Flotek's Chairman, President and Chief Executive Officer; Rich Walton, our Chief Financial Officer; Josh Snively, Executive Vice President and Florida Chemical President; and Robert Bodnar, Executive Vice President of Performance and Transformation as well as other members of our leadership team.

Our earnings press release was distributed yesterday and is available on the Flotek website. In addition, today's call is being webcast, and a replay will be available on our website.

Before we begin our formal remarks, I would like to remind everyone participating in this call, listening to the replay or reading a transcript 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, comments or expectations 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 an exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and financial results, and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek's filings, including our Form 10-K, with the U.S. Securities and Exchange Commission.

With that, it's my pleasure to turn the call over to John for opening remarks, followed by a financial review from Rich, and insights into key initiatives of our organization by Robert and Josh, followed by an outlook from John. We will open for Q&A after the remarks.

With that, John?

Thank you, Matt, and thank you all for joining today's call hosted from our Global Research and Innovation Center headquarters here in Houston. I'll begin by giving a summary of our quarterly results, followed by an overview of our business segments. Additionally, I will highlight ongoing initiatives, which we believe are creating substantial operating leverage to accelerate and maximize our delivery of cash flow in future periods. Rich Walton will then review our financial highlights for the quarter and provide additional financial details followed by Robert Bodnar, who will discuss an operational overview. Josh Snively will provide an update of citrus end markets and ongoing initiatives at Florida Chemical, our integrated operating subsidiary within our Consumer and Industrial Chemistry Technologies segment. Finally, I will end with closing remarks and an outlook with guidance before taking your questions.

Overall, Flotek's second quarter results were mixed versus broader expectations primarily due to timing of operations of a handful of clients and a weaker-than-expected results in Canada, which is our largest international geography. However, we did experience uptick for our Prescriptive Chemistry Management platform, which is showing signs of accelerating market adoption. We continue to manage a challenging citrus market and Consumer and Industrial Chemistry Technologies segment, which outperformed on revenues, but margins turned in lighter than we expected due to product mix and timing of a large order. Our commitment to reducing general and administrative expense can be measured in the quarter as we're transitioning to a leaner and growth-focused, pure-play chemistry technology company.

Additionally, as you will hear later in the call, we have a better handle on our ability to provide reliable guidance, and we'll introduce a detailed outlook for the first time in our company's recent history. For continuing operations, which encompasses our Energy Chemistry Technology, or ECT; and Consumer and Industrial Chemistry Technology, or CICT segments, Flotek's consolidated second quarter revenue was up 7% sequentially and up 33% year-over-year in line with our expectations.

To provide an update in our Energy Chemistry Technologies segment, domestic revenues experienced growth of 17% led by an expansion of our PCM or Prescriptive Chemistry Management solutions, and an ongoing growth in demand for our core CnF technology product offering. This was preceded by growth of ECT of 14% in the first quarter of 2017, and speaks to our ability to deliver consistent compounding growth in this segment.

Our clients are showing signs of receptivity to a period of increasing pricing as we experienced domestic Complex nano-Fluid or CnF revenue outpace volume growth in the quarter, while gross margins expanded by 135 basis points. This is truly an incredible accomplishment as you consider the raw material inflation of citrus products, which we believe will begin to moderate and Josh will have more comments later in the call.

The second quarter marks a record quarter of CnF sales by volume and our momentum, which may vary a short-term fluctuations due to FRAC schedule shifts is showing no signs of slowing as the opportunities continue to grow. Since the peak of the energy commodity cycle in mid-2014, our CnF volumes have expanded 143% to the second quarter today. The long-term trends we're experiencing with CnF compares favorably to industry macro trends like completion activity, which is down 50% over the same period and exemplifies our success over time.

Domestic CnF volumes expanded by 7% sequentially, and it's important to point out that pad completions and FRAC schedule movement of key clients in U.S. land impacted our CnF volumes by as much as 3% to 4% of growth, and M&A activity carried through minor decrements in the 1% to 2% range. Due to mix with ECT, gross margins declined as conventional chemistry sales meaningfully snapped back above our expectations relative to the transitory challenges for CnF.

As you can recognize in our conventional chemistry or non-CnF components of ECT, operators of all sizes are moving towards the trend of decoupling their energy chemistry selection and purchases. This is a trend, which is in the early innings and pioneered by our Flotek store business model over 2 years ago in anticipation of this shift. Now that this trend is becoming more mainstream, we are confident that our commitment to research through the downturn and our expansion efforts have positioned our company perfectly to benefit from the ongoing evolution in completion designs. Our clients in the industry are moving from conventional, one-size-fits-all approaches to embracing now custom completions chemistry. Like our industry-leading CnF technology and our Prescriptive Chemistry Management or PCM platform, and yes, the Flotek Store.

In addition, our initiatives with IBM utilizing the RC2 capabilities and our joint breadth of exposure around the globe with companies of all sizes has Flotek at the forefront of the emerging desire for big data analytics. We're excited to have opportunities in the coming months to showcase these expanding capabilities.

Internationally, we saw our business face seasonal break-up challenges in Canada, which declined meaningfully more than we expected. International activity will continue to fluctuate on a sequential basis due to the nature of large shipping orders and inventory management, which is how our clients operate abroad. We will make an effort to better predict these orders and offer more timely updates as they become meaningful to our performance. Despite this movement, we expect long-term growth to continue to occur. Additionally, the growing success of our suite of chemistry offerings and CnF around the world is undeniably being communicated back to us by our clients. These successes range from Argentina to the Middle East, and recently includes China and a variety of other geographies. It is important that we remain committed to selective international expansion as we believe opportunity for high margin growth will evolve with completion techniques around the globe.

We are taking a close look at certain geo-regions, which may not have the same opportunities than others, and rationalizing cost in those areas should also help our broader G&A reduction initiatives.

From the onset of the recovery, which began last year, we've been consistent in our narrative of the likelihood of a comp-to-breaks recovery, a message other companies are beginning to adopt. Flotek is uniquely positioned in that we do not have any major CapEx, hiring or equipment spending needs as we penetrate new clients. We believe our leadership position as a custom chemistry technology company will become more apparent to our shareholders and the broader investment community as our growth and ability to drive strong incremental margins even in a flat-macro environment becomes apparent.

Our asset light business model provides maximum flexibility and limited risk, and further G&A reductions are intended to make this more impactful to our shareholders.

As Robert will discuss in more detail, we've expanded our CnF manufacturing from 750,000 gallons per month from just over 2 years ago to more than double that amount today. We believe that as we look out 2 years, we will once again double our capacity to manufacture CnF. To be clear, with a somewhat agnostic view of commodity pricing, we believe that our CnF output capacity has the potential to quadruple from volume levels in late 2014 to mid-to-late 2019, while maintaining the same level of manufacturing utilization percentage to meet the secular growth in demand. This countercyclical market penetration is a remarkable accomplishment when put into the context of the broader industry backdrop and speaks to the market penetration success we are in the early innings of experiencing.

Moving to our Consumer and Industrial Chemistry Technologies segments or CICT. Citrus oil price inflation remains a challenge and impacts our whole organization. Josh and his team continued to perform at a high level at Florida Chemical and we are -- [suddenly] see exciting opportunities materialize by the day. The value of the seamless integration of Florida Chemical as a cornerstone division within Flotek has proven itself completely. We're extremely pleased with the ability of our entire organization to manage a difficult end market in energy, while our input raw material cost have inflated by more than 2x since the acquisition back in 2013. And led to greater-than-expected inventory dollar bills in the quarter, as purchase season occurred this year, had a level of pricing that we believe should signal a peak.

As Josh will later discuss, we believe the citrus markets will begin to soften in coming months allowing our Energy Chemistry Technologies segment to improve its cost position on this critical raw material and benefit our entire supply chain. During the quarter, we received proceeds from the sale of the Drilling and Production Technologies business segment. We repaid all term debt from our capital structure, and our only current borrowings are backed by current assets on our credit facility. This puts us effectively in a debt-neutral position as we will continue to utilize our borrowing to fund working capital demands in our growth.

While the recent working capital demands were greater than our initial internal projections, largely due to citrus market inflation, we will maintain maximum financial flexibility going forward, and continue to develop our relationship with our lender. Additionally, I'm pleased with the company-wide efforts to reduce G&A and find areas of operational efficiency improvement.

Our focus has remained on investing in our future through the downturn, and building the necessary platform across our 2 key segments. Our ability to drive growth, expand product lines and change a business model through the energy downturn has required these investments. We remain focused on creating fixed cost leverage, and instituting a variety of enhanced cost controls through our organization restructuring and operational efficiency improvements. These efforts are moving fast and to some, it may seem like not fast enough, but we can say that they are making an impact in our business, and we will not sacrifice critical relationships with our clients or jeopardize our growth in this process.

As our scale grows and our cash flows begin to cover internal growth, we will continue to assess opportunities to deploy cash as well as maximize our financial flexibility. While our filing of the S-3 is simply good housekeeping on our part, it is important to remind our investors, that we have a $54.4 million of remaining authorization on our share repurchase program and we will continue to assess the M&A marketplace. Given our position of strength today, we can be selective in how we allocate capital, and in many cases investing in our own company may be the best return.

Finally, our commitment to data is opening doors to projects with operators that have unique and expansive scope. We believe the industry needs a better approach to analyzing the large numbers of variables and seemingly endless amounts of data. This is where Cognitive is key. Our relationship with IBM continues to grow, and our joint efforts have the potential to be significant for industry stakeholders of all sizes ranging from small operators in the Permian to super-major energy companies with global footprints. We will provide more updates in this effort as developments materialize.

Now I'd like to turn it over to our CFO, Rich Walton, to provide a review of our key financial information and provide an update, Rich?

Thank you, John. As John mentioned, we have completed the sale of substantially all of the assets of our Drilling Technologies and Production Technologies segments. Closing of these transactions occurred in late May.

Cash consideration was $19.9 million with a customary $1.9 million escrow holdback to be realized over the next 18 months. The assets, liabilities and results of Drilling Technologies and Production Technologies segments continue to be reported as discontinued operations. The financial statements in this Form 10-Q, and going forward, should more accurately represent the results of our core businesses, Energy Chemistry Technologies and Consumer Industrial Technologies, as continuing operations.

For the second quarter, we reported total revenue of $85.2 million compared with $64.1 million in the prior year period, an increase of $21.1 million or 32.9%. On a sequential basis, quarterly revenue was up 6.5%. Our topline growth was driven by strength in Energy Chemistry. Sequential growth in Energy Chemistry revenue was 8.4% due to increasing domestic well completion activity by customers. International sales for Energy Chemistry, historically down in the second quarter due to the spring breakup in Canada, were impacted by an extended breakup period in Canada this year. Revenue in Canada was down $1.4 million in the second quarter compared to the same period of 2016 and down 68% sequentially.

Consumer and Industrial Chemistry revenue for the second quarter was flat sequentially and down 6.7% compared to the same period of 2016. However, International sales in the second quarter increased $2 million compared to the same period of 2016. The segment operating margin was 14.1% in the Energy Chemistry segment, and 6.3% in the Consumer and Industrial Chemistry segment.

Corporate, general and administrative expense was $11.2 million, an increase of $1.6 million from the second quarter of 2016, and a reduction of $1.1 million from the first quarter of 2017. Our corporate G&A as a percentage of revenue decreased to 13.1% from 14.9% in the second quarter of 2016, and 15.3% in the first quarter of 2017, as we make progress in our cost-reduction initiatives.

During the first 6 months of 2017, the company incurred nonrecurring charges of $1.6 million related to executive retirement, and $0.4 million related to the shareholder lawsuit and SEC inquiry.

Segment, selling and administrative expense was $9.4 million, an increase of $1.3 million from the second quarter of 2016, and a reduction of $0.9 million from the first quarter of 2017. Segment, selling and administrative expense as a percentage of revenue decreased to 11% from 12.6% in the second quarter of 2016, and 12.9% in the first quarter of 2017.

Noncash compensation was $3.6 million in the second quarter. For the quarter, research and development expense was $4.1 million compared to $2 million for the same period in 2016. In addition to the opening of the research and innovation center in the third quarter of 2016, this increase is attributable to new project, development and demand, which Robert will discuss later.

For the second quarter, Flotek reported a net loss from continuing operations of $1.1 million, representing a loss of $0.02 per share on a fully diluted basis. This compares to a net loss from continuing operations of $0.1 million for the second quarter of the prior year. For the 6 months of 2017, Flotek reported a net loss from continuing operations of $1.9 million, representing a loss of $0.03 per share on a fully diluted basis. This compares to a net loss from continuing operations of $0.1 million for the first 6 months of the prior year.

Flotek recorded an income tax benefit of $0.4 million, yielding an effective tax rate of 28.3% for the 3 months ended June 30, 2017, compared to an income tax benefit of $0.4 million in the prior year. As a note, discontinued operations did negatively impact cash flows by $2.8 million during the second quarter. This burden will reduce as the divestitures close during May.

At June 30, 2017, the company had accounts receivable of $60.1 million compared to $47.2 million at December 31, 2016. At June 30, 2017, days revenue and accounts receivable was approximately 64.5 days, a decrease of 7 days since March 31, 2017.

For the quarter ended June 30, 2017, the provision for doubtful accounts was $0.3 million. And at June 30, the allowance for doubtful accounts remains minimal at less than $1 million or 1.6% of the receivable balance.

At June 30, 2017, inventories totaled $78.4 million compared to $58.3 million at December 31, 2016, an increase of 35%. 3/4 of this increase occurred in the Consumer and Industrial Chemistry segment, which historically has an inventory build during the first half of the year. The impact was more pronounced this year because of citrus raw material cost inflation. Our inventory turnover at June 30, 2017, is approximately 3x per year.

During the second quarter, we repaid our term loan in full with proceeds from the sales of assets of our Drilling and Production Technologies segments. At June 30, 2017, borrowing under our revolving credit facility was $42.7 million, and there was an undrawn availability of $22.2 million.

During the first 6 months, capital expenditures were $4.5 million compared to $8.2 million in the same period of the prior year. Expected capital expenditures for 2017 have been further reduced to a range of $9 million to $12 million.

As a reminder, our financial statements report the continuing operations of our Energy Chemistry Technology and Consumer and Industrial Chemistry Technologies segments. The Form 10-Q provides a description and analysis of our discontinued operations, that's Drilling Technologies and Production Technologies, in the footnotes.

We continue to be focused on monitoring capital expenditures, lowering SG&A costs, protecting our liquidity and growing our core businesses in Energy Chemistry Technology and Consumer and Industrial Chemistry Technology.

As a note, yesterday, the company filed a Form S-3 with the Securities and Exchange Commission. Upon effectiveness, this filing will permit the company to sell new securities to the public with a maximum initial offering price of up to $350 million. The securities that may be offered include common and preferred stock, senior and subordinated debt, warrants and units of securities. We currently have no intention to issue stock at current price levels.

And now I'll turn the call over to Robert to provide an operational performance update of the company. Robert?

Thank you, Rich. We've made a number of operational enhancements that are creating greater alignment with our clients within the ECT segment. For example, just over 2 years ago, our CnF manufacturing capacity, our core processing facility in Marlow, Oklahoma, was just around 750,000 gallons per month. At quarter-end, our capacity was above 1.5 million gallons of CnF per month, and we are in progress to expand to above 2 million gallons per month as we enter 2018. We continue to target 70% to 80% plant utilization, which is a level that maximizes our financial performance and allows cushion for rapid growth.

A recent project to expand our inventory and processing capabilities in the Permian has been yielding substantial success. We've increased our throughput in Monahans, which is located in the heart of the Delaware Basin, by 10x since the first quarter. Our clients are responding very favorably to our ability to adjust to their schedules and provide cushion for CnF and our total fluid chemistry designs. We now have the ability to execute water analysis, pre-FRAC testing, sample collection and quality control for our clients in the basin. These new capabilities should increase our penetration rates and even further enhance our reliability to our clients.

We've also just executed an expansion in the Marcellus Utica region located in Canonsburg, Pennsylvania. This new facility is under a multiyear lease, and should allow our business to expand more quickly into the North East areas of the country. From this location, we can offer bulk storage, technical support and local sales office presence to maximize our response time and accelerate basin penetration. In addition, we have ongoing projects designed to enhance our operating leverage. We are optimizing liquid production flows in our manufacturing facilities, which includes large water storage facilities in Marlow. While these projects sound like blocking and tackling and require little capital, the reality is they may contribute as much as $0.50 a gallon of gross margin to a variety of our product sales, or what could amount to 200 to 400 basis points over time, which should mostly flow to the bottom line.

And I want to point out that many of these projects require a minimal CapEx and are already included in our CapEx guidance.

I'll now give you an update on our Global Research and Innovation Center, which has allowed us to accelerate the pace of our prescriptive analytical chemistry business approach. We continue to experience increasing inbound demand for our lab capabilities, and ability to prescribe the most impactful and precise fluid systems to maximize the returns and performance of our clients' reservoirs. This demand is highlighted by our current backlog of projects at R&I, which is now at more than 90 projects, which is up 14% from the 1Q end and up 50% exiting 2016.

To provide more color, our client-delivered projects grew 47% in the second quarter from the prior quarter. This may not be a perfect predictor of future growth, but as we have evolved our business model, demand for our research is growing and gaining momentum. We believe these are very favorable trends to be seen within our business as our clients depend more on our integrated capabilities.

To provide a brief update on Reservoir Cognitive Consultants, or RC2, which is a proprietary platform that incorporates IBM's Watson technology. We continue to jointly develop new capabilities never before seen in the oil field. We're making very considerable progress in the development and functionality; currently where we're working to properly import check and code analytics, and look to begin public demos during the third quarter.

And turning to our health, safety and environmental efforts, we have maintained an excellent best-in-class safety record. We believe this is critical as our business model expands to better serve our customers and to ensure on-site deliverability and quality control of the FRAC fluids in our clients completion initiatives.

And with that, I'll turn it to Josh to provide an operational and high-level update of the CITC (sic) [CICT] segment.

Thank you, Robert. Our CICT segment performed mixed during the quarter as timing of orders, mix and material inflation did impact margins while revenue exceeded our initial expectations. We have made inroads with a variety of new client relationships and believe our growth opportunities remain abundant.

Additionally, our corporate inventory position increased during the quarter driven by seasonal crop cycles and historically high prices. I would like to provide an update of the citrus markets so as we have not said enough in the past and the future, we believe there will be ample more to discuss. The past 2 years have been some of the most volatile we have ever experienced. The greening disease challenges have resulted in raw material inflation of greater than 200%. We've properly staggered contracts and utilized our scale as a top 10% citrus oil purchaser globally to manage these challenges and take market share.

Recently, the USDA Brazil crop report was released and indicates that orange crop for processing will expand 53% after 4 years of declines. We will purchase diligently as we believe costs should soften over the next few months. We've managed our inventory to accommodate lower citrus prices as our core -- as our quantity on hand is seasonally lower than normal, but our inventory value is as high as it has been in a long time. While it's premature to guess what the cost deflation slope may be, we are confident the direction should be beneficial to our entire supply chain. As John alluded to earlier, we're expanding at Florida as well internationally. Currently, we are in the final phases of adding another distillation column in Florida, increasing our total number of commercial units to 8. The new unit will not only add to our ability to produce orange molecules, it will also allow flexibility for expansion in to other citrus cultivars.

We've also begun a project which will enhance our capabilities at Florida Chemical to encourage more client interaction, and expand our ability to utilize more of the citrus molecules across a broader value chain in the flavor and fragrance industries. Also, we are utilizing our research capabilities to expand the application of CnF into other industries outside of oil and gas, which is an initiative still in early phases, but could open unique opportunities for our company.

Today, we're pleased to announce that we've opened a Flotek branch in Japan. We have sought out top local talent to run our business development initiatives there, and believe that it will support our growth into Asian markets. This is a key geography for our long-term success and we're excited about the prospects. Our growth within CICT investments will be measured but will also be precise. We see a very large multiyear runway for profitable growth, which should exceed broader economic metrics and establish a stable stream of cash flow for Flotek, which overtime can help smooth out consolidated performance during energy cycle fluctuations.

With that, I will turn it back to John to offer concluding remarks.

Thanks, Josh, and before we take questions, I'd like to offer an outlook and add some concluding thoughts. While there were some successes and yes, some disappointments in the quarter, the second quarter marks the most important transition for our company today. As we are now a technology-focused, pure-play specialty chemistry company, we've successfully exited our Drilling and Production Technologies segments, we paid our term debt and the industry is shifting right into where we are positioned.

For the first time in our company's recent history, we will offer some high-level guidance to help set expectations in both the near and longer term. Our team has worked hard to be able to help communicate our outlook in financial terms and be more precise in this communication to our shareholders, an area we will continue to enhance. We have also improved our internal forecasting capabilities and focused on our client and market intelligence, which we believe will be powerful for our business going forward.

We expect ECT revenues to expand in the low to mid-double digits on a sequential percentage growth basis, and believe that we can deliver segment EBITDA margins 100 to 200 basis points above the second quarter due to pricing benefits, product mix and fixed-cost leverage. We believe CICT revenues will decline in the mid-teen percentage range sequentially due to seasonal factors, and EBITDA margins to improve slightly into the low double digits due to higher margin sales.

Our corporate G&A unallocated to our segments is expected to continue to moderate. CapEx should continue its current run rate and remain minimal. We will direct focus to our EBITDA margins going forward as we believe it is more relevant to our shareholders and for competitive reasons.

We exited the second quarter with a considerable amount of momentum. June CnF revenues were at an all-time record high, and total ECT sales in June matched our company record back in late 2014 for a single month.

The beginning of July started modestly, but in our last couple of weeks, we began seeing acceleration in bookings and commitments. The last week of July marks yet another record week for ECT weekly sales for the year. And we now have generated more ECT revenues year-to-date than early November of last year.

In addition, our orders yet to be shipped are consistently running at high levels indicating this momentum should continue well through the third quarter. A large part of our increased confidence in the outlook is our direct sales increasingly being referred to as disaggregation in the market through the Flotek Store. In total, ECT revenues through the Flotek Store are up 59% from the second quarter of last year. As we get closer to the end-users of our technologies, our visibility is growing with greater communication between ourselves and the beneficiaries of our technology.

The industry is quickly shifting, and if investors carefully listen to other market participants, they will recognize a growing chorus of companies who are describing what we are seeing. Companies like EOG, Devon, Pioneer have disclosed their desire to decouple proppant, fluids and chemistry. And companies -- and pumping companies of all sizes recognize this trend of disaggregation. This allows operators to lower spending and maintain activity while leveraging our relationships.

Core Laboratories, also recently discussed, touts demand for analysis on chemicals is growing for longer laterals, a nice endorsement of our product suite and our market positioning. Operators are more open to discuss chemistry and their desire to find the best solutions is leading them to Flotek. These are trends we see on a daily basis and we are positioned to meet the expanding demand of our clients.

Also, within our Global Research and Innovation Center, we've seen further demand for our research project capabilities. Our client-dedicated projects entered are at an all-time high at more than 160 in the quarter. Our ongoing projects at second quarter end stands at a record and indicates plenty of work to be done. We believe these projects indicate future sales opportunities within ECT as well as CICT. The total number of delivered projects in the second quarter set another company record, a trend we expect to see for some time.

I would also like to take a moment to welcome Sally Cheadle into our organization as Vice President and Controller. Sally has had an exceptional carrier with over 25 years of experience at Baker Hughes. She brings with her valuable contacts, industry experience and the skills required to further enhance our accounting and finance efforts.

It is a very exciting time to lead Flotek. Our company is evolving faster and my outlook has never been more positive. Our CICT division provides growing cash flow stability to our shareholders, while our ECT market penetration is continuing. We are positioned ideally as a high-returns, technology-focused custom chemistry organization.

Our growth driven by CnF in the past few years has been an extraordinary accomplishment, occurring through the energy cycle downturn unlike any I have experienced in my 40-plus-year career. When you consider the citrus market inflation we managed through within CICT, it is clear that Flotek's best days are in the not-too-distant future.

From Florida to Monahans, and across all of our employees, our organization is more determined and more energized than ever for the exciting period in our evolution that we are now entering.

Finally, I would like to thank our shareholders, employees, clients and stakeholders for their support to allow Flotek to be in the remarkable position we are in today.

With that, operator, we'll now open the call to questions.

(Operator Instructions) And our first question comes from the line of Georg Venturatos with Johnson Rice.

Okay, John, last part, appreciate the guidance here, I think that's helpful guide post for everybody in the near term. And I know it's something you all have been working on. As we think about that, I guess, first off on the revenue side, certainly nice to see a low to mid-teens double-digit-type sequential increase. Can you give us a little better sense of how comfortable we should feel about that relative to existing bookings? And also in relation to kind of the select opportunities you talked about in the release, I mean, is that further upside potential? I guess I am just getting -- trying to get a little better sense of what's kind of baked into that number from a backlog perspective.

Sure. There's -- as we try to detail out with other commentary from other players in the industry, there's more and more decoupling occurring with the overall chemistry beyond CnF. So that growth is including CnF increasing along with conventional chemistry as the decoupling continues to accelerate. Okay, I have to say really our confidence level is 80-plus percent in the guidance, unless there's some type of down drift -- downdraft with the oil commodity price, we've got the best line of sight visibility that we've ever had due to the amount of people that are purchasing directly through Flotek.

Perfect. Yes that's really what I was just getting at in terms of backlog visibility and work for the near term. You mentioned it here and I think it's important too, and from an industry perspective, we've heard it. But certainly a positive trend on the non-CnF side, I mean, during the quarter, 27% sequential growth in that business. Some of it bounced back from 1Q. But could you maybe talk a little bit more about the broadening PCM opportunity set? And like you said, Core talked about some of the usages of friction reducers for extending that average, a lateral length across the industry, and how that kind of plays broader to the story and the ability for your chemistry business to grow in even a flattish rig count environment as that opportunity set is expanding?

Now, so great question. What we're able to do because the industry is wanting to do it is have a larger chemistry footprint on location beyond selling a CnF service. So some of these conventional PCM programs do not include CnF. We think that's okay, because over time we believe those clients will grow to embed CnF in the total solution, some start with CnF in them, and so we believe it broadens the opportunity of expanding CnF, and clearly the industry has a momentum that we think will not go back to appreciating what the economics look like with the decoupling of the chemistry. And so the fact that this should fit in directly with our cost structure, and the same amount of salespeople can sell this offering as they were just selling CnF, this -- within reason, the same amount of blenders are able to blend the chemistry, it will create the leverage that we've talked about here in this call to the EBITDA line, which is what we want folks like yourself and others to focus on.

Got it. And last one and then I'll re-queue here, but thought it was nice to get some of the updates from Josh on the citrus pricing, the inflation we've seen. In recognizing that we're entering this period here in the second half. Can you talk to us, and maybe Josh can answer it, but more directly in terms of how that timing and that lag effect may impact the bottom line and when that inflection point is from a result standpoint as you work through that existing inventory, maybe as you get into 2018, I was just trying to get a better sense of when we should see that turn in numbers if we see the market play out like today?

Sure, and I will let Josh take that in just a second. One thing I try to point out and your question gives us the opportunity, our unit volume of citrus oil really is at a low level crediting to Josh's 30-plus years of the way he purchases citrus oil. The reason the inventory dollar number up is because of the increase in the pricing the contracts that had to be executed. But he will talk about for you now as we get closer in heading into the fourth quarter, how we think there is definitely because of his relationships, not only into Brazil and others, how that will start to even out.

Yes, hello, Georg. You certainly saw some of the impact of the shift in the market in Q2. We lost several hundred basis points on the terpene categories. So the psychology of the market changed when the bigger number started to become reality out of Brazil and they started processing. Some of it has already occurred. To John's point, we -- volume wise, we're at a 4-year low on the volume of inventory that we actually have. So I think we're pretty well positioned. We will fight a declining market in Q3 and in Q4; that certainly contributes to the lower topline guidance that we provided. But we feel Q3, Q4, we will work through this fine, it'll compress our margins a little bit, it's a little bit different story than what we told after Q1. The Q1, we didn't know the crop was going to be so big out of Brazil. But we're positioned well, our inventory is volume wise at a low. You saw some of the impact this quarter. That will be offset by some of the positive opportunities we see in Asia and other parts of the world with new product development.

And maybe to help on the model, you should begin to see those inventory turns move quicker with the dollar value going down per unit of raw material. And so I think from a working-capital perspective, those metrics should improve with that deflation through the model. If you want to talk about that more offline, let me know.

And we're, just to be clear, Georg, we are not anticipating a crash of citrus oil prices. We're expecting prices to moderate to hopefully more normal levels. And that will be beneficial to the total Flotek company.

(Operator Instructions) Our next question comes from the line of Sean Milligan with Coker & Palmer.

Can you walk me through the guidance on the ECT side for topline? So I guess to start, if we just looked at -- I'm trying to understand how much international headwinds cost you in revenue in the second quarter?

Yes, Sean, that number is around $3 million and primarily driven by Canada. Canada's revenue decline, it was about 60 -- it was more than 65% sequentially, and so there's 2 factors going on there. Obviously, the seasonality of the breakup, but we -- there's been a consolidation of 2 large FRAC companies in Canada that we're working through. So it would be -- we don't want to say we're going to get right back to the first quarter levels, but over the next 2 quarters, we do expect to get back to that first quarter level.

Okay, so let’s just say you gain half of that back in the second quarter. Is that primarily CnF? Or is that non-CnF?

It's primarily CnF, Sean.

Okay. And then I guess what I'm trying to back into is heading into the third quarter, do you see the domestic CnF trends better than 6% on a volume basis?

We do.

We do.

Okay, is it -- is that double digit quarter-over-quarter? Or is it going to be kind of equally weighted first to non-CnF side?

It should be in the double digits, and here's the one qualifier that I think other people have talked to in their earnings calls. We had 2 or 3 CnF clients that were scheduled to go in June, but when FRACs get delayed because of operational issues or whatever, they don't just pick those up the next week, they have to get back in the queue and in several cases, these clients are going to be done in the middle to end of August, which we have no control over. But from what we can see, it should be a double digit on the CnF from what we can see.

Okay, and then just to confirm the 100 to 200 basis points incremental margin, is that on the gross line or the EBITDA line?

That's on the EBITDA line. And we called out the increase in the gross margin on CnF really as much as anything to let folks know that the pricing is intact and the pricing is continued to be accepted. But from a pricing-resiliency and from any type of competitive standpoint, we want really our shareholders and folks like yourself to focus on the EBITDA line margin and its growth as the conventional chemistry will continue to grow and just give folks kind of a fairway here. CnF wells can range from between, say, $200,000 to $350,000 range. A full chemistry PCM well can range from $700,000 to $1 million. And so as more and more of that happens, as we kind of telegraphed a couple of quarters ago, there will be gross margin compression, but the leverage will come with the EBITDA, and that's as we talked about the EBITDA lifted by 100 basis points this quarter, we believe it will uplift another 100 to 200 in the third quarter and that's the line we want to have folks focus on. And what's really happening is these operators, and I think even a couple of them have talked about it in their press releases, are able to reduce their AFEs due to this decoupling, and that actually affords a window of looking at CnF as its high-valued economics maybe differently than they would have a year ago. So there is a double advantage of the way this industry is moving from what we can see.

And then, okay, John. And on the G&A side, if you back out the retirement comp, you saved or you cut G&A a little bit in the second quarter. Can you kind of qualify for us the impact that you might see in the third quarter on the G&A basis from any type -- kind of cuts you're making at the corporate level?

Yes, so I think for everyone out there, I'll give you a couple of benchmarks from first quarter to second quarter. If you look at cash, on the corporate side of G&A, it went from $9.9 million to $8.3 million, a reduction of 15%. If you look at the total enterprise, it went from $19.6 million to $17 million, and we believe there will be a continued tapering of that as we look at just exactly as this business model takes effect with PCM, more decoupling. So as I've told folks in the past, we are focused on this and continued to be and I think this quarter speaks to that. And I think offline or Matt may be able to chime in terms from a modeling standpoint, how to look at that going forward, if that's something you'd like to have. But again, I think it's important to note the reduction that we did occur from the second to first quarter.

Yes, Sean, so we took a couple of million out sequentially in the quarter if you consolidate what's at corporate and what's in the segments. I don't know that we will get another couple of million out sequentially in the third quarter, but another million out in the third quarter is certainly possible and furthermore into the fourth quarter. But we'll give updates on those metrics as we move forward to you.

And there are no further questions at this time. I'll turn the call back to you.

Okay. Thank you for those that listened in and those that you'll be reading the transcript. We'll be out on the road at EnerCom in middle of August up in Denver at that conference. And again, we'll continue to do our best to provide the best clarity we can as to the repositioning of Flotek that we've undergone during this period. And thanks again for everyone's interest. We'll talk to you next quarter, if not before.

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.