Flotek Industries, Inc. (FTK) Q4 2011 Earnings Report, Transcript and Summary

Good morning, and welcome to the Flotek Industries Inc. Year-End 2011 Earnings Conference Call. [Operator Instructions] This conference is being recorded. At this time, I would like to turn the conference over to Mr. Glenn Neslony, Vice President and Treasurer for Flotek Industries. Mr. Neslony, 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 annual report for the United States Securities and Exchange Commission were filed and distributed last evening and are available on the Flotek website. Before I turn the call over to Flotek's Chairman, CEO and President, John Chisholm, I wish to remind everyone participating in this call or listening to the replay or reading a transcript of this call of the following: Some of the comments made during this teleconference may consist forward-looking statements -- 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, 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 United States Securities and Exchange Commission. Now I'd like to introduce Mr. John Chisholm, Flotek's Chairman of the Board, CEO and President.

Glenn, thank you. I would also like to welcome each of you to Flotek's 2011 annual review conference call. With me today are Johnna Kokenge, Flotek's Chief Accounting Officer; Jempy Neyman, Flotek's Executive Vice President of Finance; Steve Reeves, our Executive Vice President of Operations; Kevin Fisher, our Executive Vice President of Global Business Development; and Glenn Neslony, Vice President and Treasurer. Last evening, we filed our annual report with the U.S. 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. 2011 was a year of achievement from Flotek. As we noted in our press release and annual report last night and as we will discuss over the next several minutes, the achievements of the Flotek team make all of us very proud. For me, however, as I reflect on the accomplishments of this remarkable group of men and women that comprise the Flotek family, I'm most proud of their dedication to returning Flotek to a position of leadership among oilfield technology companies, their care for their customers, their communities and, most importantly, each other in doing so, and their tenacity and resolve to come to play each day looking for ways to make Flotek a better company and create value for our shareholders. At the beginning of this past year, we said we could synthesize our mission in 2011 in 3 simple words: Lead, support and accelerate. While there are plenty of challenges and opportunities ahead for Flotek, in 2011, it is fair to say we lived our mission and, in large part, accomplished what we set out to do. We lead on many fronts. Our leadership team rose to the challenge to find ways to grow our company, providing shareholders industry-leading results. In fact, Flotek was 1 of only 2 New York Stock Exchange listed companies to be among the top 10 in total return of New York Stock Exchange companies for 2 consecutive years. That performance and value appreciation [ph] is the result of Flotek's industry-leading revenue and profit growth, which is the result of the commitment of the entire Flotek team to lead our industry in innovative solutions to industry challenges, customer responsiveness and new market penetration. We did support. We supported our customers with new and innovative solutions to beat some specific challenges as well through new customer service initiatives that improved responsiveness to and quality for our clients. We supported our communities through involvement with veterans programs, the Red Cross, Toys for Tots and numerous other philanthropic endeavors. Most importantly, we supported each other. The Flotek leadership team, I believe, has set a tone that fosters collaboration, a sense of personal responsibility and trust that allows each member of the Flotek team to take ownership of their work, provides an environment where innovation and initiative are encouraged and where support is available when things don't work quite as planned. While we aren't perfect, the best way to strive for perfection is to provide the tools to each of our team members to excel at what they do. We will continue to do so in 2012 and as long as I serve as the Chief Executive Officer of Flotek. Finally, we did accelerate. As noted in last evening's press release, the acceleration of our chemistry R&D effort resulted in the introduction of new products that have grown from a concept to a top producer in less than 18 months. We accelerated the development of wireless communication of Teledrift reading so corporate engineers will be able to review measurement results whether on a well site, at the corporate headquarters or on another project halfway around world. And we accelerated value, whether it was improving our balance sheet through a series of strategic moves to reduce debt and regain the confidence of traditional lenders or gaining the confidence of a new group of institutional equity investors. Flotek was focused on accelerating its return to financial normalcy. While we won't always be in the New York Stock Exchange Top 10, we won't stop striving to be there year in and year out. In short, 2011 was a year of significant accomplishment for Flotek. That is even more remarkable when I think back to the days of late 2009 and early 2010, when Flotek was teetering on the brink of financial calamity, with just $600,000 of cash and a balance sheet tangled more tightly than a Gordian knot. Today our balance sheet is as strong as it's ever been. Flotek's culture is one that is focused on external opportunities rather than internal commotion, and the opportunities for growth, both here and abroad, are greater than ever before. That said, it has been said and proven many times that those who ignore history are bound to repeat it. As Flotek's Chief Executive, I pledge Flotek will never intentionally find itself in the financial position experienced in 2009. Not only is our discipline such that unacceptably high levels of leverage are no longer in Flotek's DNA, but no member of this team is willing to relive the pain and challenges of 2009, nor are we willing to subject our stakeholders to such uncertainty and displeasure. As long as I'm your President, we will remember the lessons learned over the past 2 years and work tirelessly to ensure they are continuously used to improve your company. As we close the books on 2011, I want to sincerely thank the entire Flotek team. In August of 2009 and into 2010, it would have been very easy to simply give up. However, the level of pride and determination amongst every member of this organization is precisely what led me to believe we had the opportunity to transform a company on the precipice of irrelevance to a world-class oilfield technology company. To all of my colleagues, thank you, congratulations, and I look forward to continuing the journey with you. And indeed, the journey is just beginning. While we've made great progress in the past 2 years, we are not yet satisfied with where we are. While we must continue to pursue opportunities to grow, we must also continue our focus to assure that growth creates long-term opportunities to increase profit. As we continue to improve our balance sheet, we must do so with a keen focus on ways to add shareholder value. And our focus on positioning Flotek as a leader in advanced oilfield technologies must come with the understanding that leadership will require new ways of thinking about the balance between productivity and the environment and our customers and our communities. These are not new concepts to Flotek. We've consistently been leaders in environmental stewardship, applying for our first environmental patents before concerns over environmental impacts of drilling were in the news. However, every day, we must recommit ourselves to these principles as they are the foundation upon which Flotek's success is based. As I've said on each call since I took the helm, now over 2 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 now to Johnna Kokenge, Flotek's Chief Accounting Officer, to review 2011 highlights and provide some additional color on certain financial issues. Johnna?

John, thank you. As John mentioned, Flotek filed its Form 10-K annual report for the period ended December 31, 2011, with the U.S. Securities and Exchange Commission yesterday afternoon. In that report, Flotek reported revenue for the year ended December 31, 2011, at $258.8 million, an increase of $111.8 million or 76% compared to $147 million for the same period in 2010. While revenue increased in all 3 of the company's operating segments, growth was driven primarily by the Chemicals and Logistics and Drilling Products segments. In those segments, revenue growth was a result of improved pricing, increased drilling activity, and improved marketing efforts that resulted in increased market share. For the year ended December 31, 2011, the company posted net income attributable to common shareholders of $26.5 million or $0.56 per diluted share. That compares to a net loss attributable to common shareholders of $50 million or $1.94 per diluted common share for the 12 months ended December 31, 2010. Included in 2011 net income is a gain of approximately $9.6 million related to the change in the fair value of the warrant liability associated with the warrants issued and the August 2009 preferred stock offering. In 2010, the company recognized the loss of approximately $21.5 million related to the warrant liability. Excluding the noncash income associated with the change in the fair value of the warrant liability, 2011 net income was approximately $17 million or $0.36 per diluted common share. In the company's fiscal fourth quarter, the 3 months ended December 31, 2011, Flotek posted revenue of $74.9 million, an increase of $27.4 million or 57.7%. This is compared to $47.5 million in the same period of 2010. Revenue in Chemical and Logistics and Drilling Products business segments improved. Our Artificial Lift revenues remained comparable during the fourth quarter when compared to the year-ago period. Excluding the effect of the change in the fair value of the warrant liability, the company posted net income for the fiscal fourth quarter of 2011 of $10 million or $0.20 per diluted common share. As of December 31, 2011, the company's cash balance was $46.7 million compared to $19.9 million as of December 31, 2010. The company's cash balance improved as a result of an improved operating environment, a more diligent approach to expense management, and as a result of exercise of the warrants issued in conjunction with the August 2009 preferred stock offering. During 2011, Flotek took several steps to improve its balance sheet. First, the company repaid the remaining $33.6 million on its $40 million senior credit facility. Second, the company arranged for a traditional $35 million revolving credit facility through PNC Bank to meet future working capital and expansion needs. To date, the facility remains undrawn. Third, through an equity exchange with an existing noteholder, Flotek reduced the convertible notes outstanding by $4.5 million. In addition, at the conclusion of 2011, the company announced it would repurchase the $36 million of outstanding senior secured convertible notes. The transaction was completed in January 2012. Including the senior note repurchases in January, the company reduced its debt by approximately 50% to $70.5 million, excluding capital leases. As of February 28, 2012, after taking into account the $37.8 million of cash required to repurchase the senior convertible notes, the payment of 2011 incentive compensation and the payment of interest due on the remaining convertible 2010 notes, Flotek's cash balance was approximately $10 million. Cash continues to grow in March with the company's cash balance as of March 6 at approximately $13.8 million. While we are pleased with our 2011 financial results, we will strive to provide even more robust results in 2012. In addition to growing business, Flotek's finance and accounting groups continued to look for ways to improve efficiencies and streamline information to better support our frontline team members who are the core extent of sales and revenue growth. One way we will accomplish that in 2012 is through the continued implementation of a new enterprise-wide accounting and reporting system. While we have experienced the standard growing pain and challenges and are slightly delayed in the final implementation, our initial work with the system suggests it will provide a new level of information and detail that should empower all levels of the organization to make more informed and profitable decisions in realtime. We anticipate the final steps of the conversion to be complete by the end of the first quarter. Like John, while pleased with our progress in 2011, I am more excited about the future opportunities and possibilities that lie ahead for Flotek. I would now like to turn the call over to Steve Reeves to discuss our business operations. Steve?

Johnna, thank you. In general, North American drilling activity continues to provide a constructive backdrop for Flotek's portfolio of oilfield technologies. While natural gas prices remain challenged, strength in liquids prices continue to provide new opportunities for growth. Our continued focus on developing a more balanced portfolio of oilfield technologies positively impact both liquids, while natural gas projects continues to yield positive results. Nearly 3 quarters of our revenue is now associated with liquids-related initiatives compared to nearly the opposite just 2 years ago. Indeed, Flotek's research and market initiatives have created a company that is truly hydrocarbon agnostic. Our products are equally effective from working in concert with natural gas, natural gas liquids or oil exploration, development and production. As discussed previously, while pricing improvement typically lags in the early stages of recovery, 2011 did provide opportunities to push price consistent with our ability to add value to our customers. While we are carefully watching evolving dynamics in the oilfield, we remain optimistic about our ability to maintain and expand margins in 2012. Chemical's 2011 revenues totaled $140.8 million, an increase of $74.7 million or 113% compared to $66.1 million in 2010, due to increased oil-directed and liquid-rich natural gas drilling activity, driven by increased global crude oil prices and stabilized liquid-rich natural gas prices. Strategic adaptation of proprietary natural-gas-effective Complex Nano-Fluid microemulsions to oil-effective Complex Nano-Fluid microemulsifiers, in conjunction with new and increased existing customer demand, domestic and international market penetration and industry growth, particularly within the Bakken and Niobrara shale plays, contributed to the period-over-period increase in revenue. Chemical's 2011 gross margin increased $26.9 million or 91.5%, yet declined 4.4% as a percentage of revenue as compared to 2010. The period-over-period increased gross margin is primarily attributable to increased pricing instituted in June of 2011, combined with increased domestic and international market product penetration. The year-over-year decline in the gross margin as a percentage of revenue is attributable to increased raw material costs due to supply shortages in 2011, customer demand shifts to lower margin products, increased transportation expense and increased international storage facility fees. The company's decision to expand the breadth of the suite of chemical offerings, combined with newly developed products in 2011 tailored to customer specifications, resulted in lower margins due to increased raw material costs and competitive pricing constraints. However, we believe this initiative will lead to long-term customer relationships, sales gains and, ultimately, stronger margins. One hallmark of our present and future success in our chemical segment is our commitment to research and development. Our team of scientists has worked diligently to be responsive to client requests for new products and new applications of existing products resulting in innovations that have instantly become top industry performers, including cross-linkers, friction reducers, shale inhibitors and new Complex Nano-Fluid formulation that address specific shale dynamics. The impact of the R&D and innovation efforts is best illustrated by the fact that 6 of the top 10 chemical revenue producers were not on Flotek's product list in the first half of 2010. The company has also worked to diversify its customer base with a focus on both integrated service companies as well as exploration and production companies, the principal end-user beneficiaries of many of our chemistries. New marketing strategies and an improved technical sales force has brought meaningful success in these initiatives. In addition, Flotek's international initiatives are showing signs of meaningful success. In addition to early success in Poland, Turkey and other unconventional plays, the company's chemicals are gaining acceptance in Russia, the Middle East, Central and South America. Flotek expects its first commercial shipment to depart for Russia in the coming weeks. Finally, Flotek positioned itself for future growth by investing in expansion of its Marlow, Oklahoma, production facilities in 2011, without any disruption of existing activity or production. In addition to creating a larger and more efficient production facility, the company also acquired acreage for future growth. In addition to traditional applications of our suite of Complex Nano-Fluids, our direct marketing efforts have identified other potential product applications, which could result in meaningful future opportunities for Flotek. As discussed in the past, the interest in the application of C&S in Enhanced Oil Recovery is growing. The volume of surfactants used in Enhanced Oil Recovery dwarfs most of other applications, making it a proprietary market for Flotek. While still in the early stages of development, our Complex Nano-Fluids appear right for effective use in EOR. Drilling revenue for the year ended December 31, 2011, totaled $102.5 million, an increase of $36.7 million or 55.8% compared to $65.8 million for the year ended December 31, 2010. The favorable variance resulted from domestic and international market share growth with both new and existing customers, changing customer product mix demands, increased rig count, increased lost-in-hole revenue, favorable crude oil commodity prices, new product development, specialized customer demand for existing product adaptation, continued cross-segment sales marketing efforts, sales force revitalization and competitive pricing relief. Drilling's 2011 gross margin increased $24 million or 129.6% relative to 2010, driven by increased product, rental and service prices, product mix shift to higher-margin products and continued cost containment. Efforts to market higher-margin motors within targeted market growth areas also contributed to the period-over-period increase. Gross margins as a percentage of revenue increased 13.7%, from 28.9% to 42.6% in 2011 versus 2010, respectively. 2011 drilling revenue increased 55.8% compared to 2010, with only a 20.5% increase in associated cost of revenue due to continued cost containment efforts and focus on operational efficiency. In the Drilling Products segment, Teledrift and Cavo drilling motors continue to lead the way. The company's Teledrift segment continues to dominate the vertical measurement-while-drilling business. Two of Flotek's MWD offerings, ProDrift and ProShot, posted exceptional growth on an absolute basis as well as on a revenue-per-job basis. ProDrift revenue per job increased 28.2% in 2011 when compared to 2010, and the average ProShot ticket increased 22.6% from 2010 levels. Overall, Teledrift continues to dominate the MWD market in the Permian Basin and continues to post significant growth in several other domestic basins. Teledrift is also growing internationally with recent interest and deliveries into South America as well as the former Soviet Union. Looking toward the future, Flotek has developed a number of enhancements to its Teledrift line of products, including wireless reading technologies that will allow the review of Teledrift positioning results nearly anywhere a wireless signal is available. The company's Cavo drilling motors business is also continuing to grow on the back of solid performance improvement, making Flotek motors the first choice among many operators in demanding shale applications like the Bakken and Niobrara. Better performance led to better pricing in 2011, and the company expects to sustain pricing gains in 2012. While Drilling Products segment revenue growth was company-wide during 2011, the Southern region posted extraordinary results with revenue growth up 49% when compared to 2010, and an increase in revenue per rig of over 22% compared to 2010 levels. Artificial Lift revenue increased $0.4 million to $15.5 million in 2011 from $15.1 million in 2010, primarily due to $3.1 million of incremental year-over-year international revenue, tempered with softened unit installation activity due to lower than expected 2011 natural gas prices as compared to 2010. The company anticipates international product sales activity will continue to be significant for the first 6 months of 2012. Artificial Lift's gross margin increased $1.4 million, or 28.9%, to $6.1 million in 2011 from $4.7 million in 2010 due to greater than average margins realized on international product sales, which were partially offset by increased replacement inventory costs and the inability to pass incremental price increases on to certain customers due to industry pricing constraints. While the company's Artificial Lift segment posted modest year-over-year growth, depressed natural gas prices created a difficult operating environment for our Powder River Basin-focused coal bed methane production system. Nonetheless, a focus on exceptional service and aggressive marketing helped the business perform above 2010 levels. In addition, as a result of Flotek's relationships and superior service, the company has been asked to install lift systems into a group of oil-producing wells in both Uinta and San Juan basins. As a result, the company is beginning to market its artificial lift system into liquid-rich plays with early signs of success. In addition, Flotek has been asked to bid on international lift projects that may provide additional diversification of the Artificial Lift segment in 2012 and beyond. Combined with the company's Petrovalve sales into Venezuela in late 2011 and continuing into 2012, Flotek continues to be proactive in seeking opportunities to expand the Artificial Lift business with only modest initial capital investment. While Flotek's business remained weighted in North American drilling markets, we continue to make significant improvement in key international arenas and believe that international opportunities will be a key of Flotek's growth in the coming year. While small in the scope of Flotek's overall profile, revenues attributable to international activity in 2011 were approximately $36.5 million, an increase of $16.8 million or 85% compared to $19.7 million in revenue generated from international activity in 2010. While results will remain somewhat lumpy as we establish new international beachheads, we believe dynamic growth is possible in the coming quarters. We're excited about the opportunities in front of us in 2012. While we will remain vigilant in our careful watch of commodity prices and drilling activity, we believe we are well positioned to gain market share, while at the same time improve margin through select pricing power and better operating efficiency. In addition, we will continue to focus on smart international growth that should provide additional opportunities for revenue and profit growth. On a personal note, congratulations are in order for John Chisholm who, earlier this week, added Chief Executive Officer to his role at Flotek. The Board of Directors approved the promotion which, and I speak for your entire leadership team, is well deserved. John, we are proud to work alongside you, and look forward to your leadership as we reach even further in 2012. With that, I'd like to turn the call back to John Chisholm.

Steve, thank you very much. Before we take questions, I'd like to address 2 specific initiatives that for Flotek will continue to grow in 2012. First, while we discussed international opportunities earlier, I'd like to provide a bit of additional color that will help you understand our long-term excitement regarding Flotek's evolution into an international oilfield technology company. In previous calls, we've discussed the continued development of our relationship with Basin Supply and several other opportunities for Flotek to capture additional international business. Our work with Basin continues, and we are pleased with our steady progress. As a result of the Basin relationship, we expect shipment of our first commercial order of specialty chemicals to Russia in the coming weeks. In addition, Basin has opened the doors to key relationships in the Middle East, South America and the former Soviet Union that we expect to contribute to Flotek's success in 2012. We continue to look for ways to combine Basin's marketing prowess with our operational skill set in other venues to continue the solid start to this dynamic relationship. In addition to our relationship with Basin, we continue to develop more expansive relationships with other international partners, including large integrated service companies. We've scheduled a number of global joint marketing seminars with those partners to introduce Flotek products and services to new markets. We are excited about these opportunities and believe they will, over time, lead to new profit opportunities for Flotek. In short, there is not a hydrocarbon-producing region in the world that Flotek now does not touch. A major change from just 2 years ago. While the development of consistent commercial opportunities will take time, our progress in the past year is both significant and encouraging. Finally, we continue to make marked progress in our Enhanced Oil Recovery initiatives. As we've noted before, the demand for surfactants and other specialty chemicals in EOR projects is greater than any other hydrocarbon application. And early study suggests Flotek's Complex Nano-Fluids provide the same value-added benefits in EOR projects as in primary recovery. While we continue to be very deliberate in our approach to this new market, we are currently involved in a number of projects to further demonstrate the efficacy of our technology and economic benefits of our suite of specialty chemistries in enhanced recovery projects. To that end, Flotek is currently involved in 8 distinct EOR projects, from scientific investigations to commercial floods, with companies ranging from private independent operators to international majors. While not a major contribution to commercial revenues to date, we are very encouraged by the early results and expect notable commercial revenue generation in 2012. Finally, a few comments about early first quarter performance. As noted in the past, Flotek's first quarter is traditionally more moderate than the balance of the year, a result of seasonal weather and environmental regulations that can dampen activity in various regions of the United States. In addition, customer-budgeting vagaries tend to slow spending in the early weeks of a new year. However, Flotek was strong out of the gate in both January and February, a combination of continued market growth, the company's improved marketing culture and unseasonably cooperative weather. As a result, Flotek's revenues in the first 2 months should exceed $48 million, an increase of nearly 50% from the first 2 months of 2011. Absent significant weather disruptions, we should expect March to grow sequentially from January and February. We are very pleased with the start to 2012 and believe even with spring breakup approaching, we should continue to post solid year-over-year comparisons in the coming months as our marketing strategy, combined with best-in-class products, attracts the attention of more prospective clients. That said, we won't rest until every possible customer can say they use Flotek in their well. In 2011, we challenged ourselves with 3 words: Lead, support and accelerate. In 2012, we will challenge the Flotek team with 3 new words: Make a difference. First, we want to make a difference for our customers through innovation, creating solutions and a can-do attitude that wins new clients, creates enduring relationships and provides win-win solutions to challenges. In short, our goal is to turn our casual customers into durable clients who rely on Flotek not only for cutting-edge products, but for long-term counsel on exploration and development design and execution. Second, we want to make a difference to the environment. Our suite of biodegradable products not only enhance production performance, they do so with solid environmental stewardship. We continue to look for ways to make our chemistries more environmentally friendly. In addition, we look for ways to make our environmental footprint smaller by working smarter, deploying technology in environmentally-conscious ways, and creating more efficient product and service delivery systems. Third, we want to make a difference in our communities. Whether it is corporate contributions to the American Red Cross, Toys for Tots, or veteran redeployment programs, we believe being good corporate citizens is good business. That's not to mention the countless hours of volunteer time and local contributions made by our team members in their hometowns. Fourth, we want to make a difference for each other. We will work harder to create a more family-like environment at Flotek, striving to celebrate our successes, providing the pickup when things don't go quite as planned and being there for each other when the unexpected turns into the unexplainable. Finally, we want to make a difference for you, our stakeholders. Many of you have stood by our side during some very dark days. On behalf of the entire Flotek team, thank you. And please note, you are the reason we are here, to develop an elite oilfield technology enterprise that you can be proud of and that can make a difference for you and your clients' well being. As I said in the press release last evening, I marvel at the distance Flotek has traveled in such a short period of time, and I concluded the following: If we were able to accomplish so much starting with so little, imagine what we can accomplish with the resources at Flotek's disposal today. That indeed is the challenge for 2012: To harness the resources we have developed to create more opportunities for growth, more opportunities for value creation, and more opportunities for future self-improvement in 2012 and beyond. With our team in place, I'm more excited than ever about the future of Flotek. Again, thank you for your interest in Flotek. We're pleased with our 2011 results, excited about the future and energized by the opportunities in front of us. And operator, with that, we'll now open the call to questions.

[Operator Instructions] Our first question comes from the line of Michael Marino with Stephens.

Question on Q4 CnF sales. I was wondering if you could give a little bit more color on kind of what portion of overall chemicals they represent.

Yes. The CnF typically represents 50% to 60% of the overall chemical sales. That appears to be growing slightly, but right now I'd say that's about a pretty good number to work on.

Okay. And then if I could, you-all commented in the prepared remarks that you expect segment margins -- the, I guess, the potential for expansion there in 2012. Which segments specifically, or is it something broad-based or one more than the other? Or maybe some color there, how you see margins kind of developing in 2012?

Yes. We feel that through some good cost containment measures with some of our raw material suppliers, both on the drilling side and the chemical side, I think we've consistently said on presentations that I've made that we are looking for a 100 to 200 basis point uplift in both those segments. Not that sure of that in the Artificial Lift side yet because of the depressed gas prices. But both of the main workhorse segments, we accept -- expect a margin uplift.

Okay. That's helpful. And just if I could follow up on that. Pricing for CnF kind of on a go-forward basis. Is that something you'll continue to push, or where do we stand there?

Right. We continue to push the upside of the pricing. We've got some new products that we're starting to advertise now that will be coming commercial in the second quarter that we think will also create a pricing opportunity for us. So we'd say stay tuned for that.

Our next question comes from the line of Brian Uhlmer with Global Hunter.

As you guys well know, I'm not an obsequient person, but I have to say a phenomenal job this year or last year in growing the company. Moving forward, you're obviously not reveling in it. You've got a lot of growth planned. I was curious, as we look forward, as a cash-generating machine that you're becoming, are we looking to dramatically expand R&D? Are there small chemical companies that could be acquired? Now we have a good question, a good problem is. What's going to happen with all this cash, what are we going to do here?

Right. Good question. One that we're asked more frequently, obviously. We've got the $70 million debt situation on the bond that's the put call coming in 2013. That's certainly, as we've talked about, an issue that we think is well within the typical debt amount for a company our size. But cash could be used, part of that answer. We have expanded the research facility by 50%. And we'll talk a little bit about that more in the months ahead. And yes, there are strategic niche technical/chemical companies that people are reaching out to us now more frequently than they did in years past. And our commitment to the people listening in on this call is, any acquisition that we would make with that has to have a direct fit into what we're trying to do with Flotek, in particular from a chemical standpoint.

Okay, fair enough. Quick follow-up on the ERP system. A lot of companies line out those charges as non-op and try and get us to adjust estimates forward, which you do not. So I'm curious as, once the consultants leave and you guys finish going live, what type of adjustment are we going to make to G&A? Is it going to have a material effect just on going live as well as creating efficiencies for margins in your financial systems?

Yes, the expenses for that are capitalized. I wouldn't expect a material effect on G&A. We've never mentioned that the accounting effort will decrease by 40% of manpower or anything like that because, obviously, with the growth of the company, that's difficult. A lot of credit to Johnna on that on the foresight. With the growth that the company's had, had we not made this move now, we would have had to add more manpower in accounting to handle just, as you can imagine, the sheer volume of paperwork at a 50% year-over-year growth. So don't expect a big drop-off in SG&A, but we're very encouraged about the efficiency that will be gained by the new system.

Okay. And then one final one, if I may. The Teledrift product going into the FSU, was that part of the Basin arrangement? And can you go into a little more detail of kind of what differentiated that product or what facilitated that sell? And how it's going to benefit customers over there and how you can see that growing over there? And that's it for me.

Yes, Steve will talk that it's not specifically connected with Basin. Actually it's connected in through Weatherford. But go ahead, Steve.

Right, we have picked up, it's an MSA that we will be working through Kazakhstan with Weatherford on a 2- to 4-year situation for them, starting some wells. Hopefully, the delivery will start in April. We're trying to get the equipment in there right now. And that was not a Basin, but that was worked through our Teledrift people themselves.

Our next question comes from the line of Josh Silverstein with Enerecap Partners.

A couple questions within the chemical segment. I guess, first just sticking with Russia. You had mentioned that the first shipments are going over there. I was curious if this is ongoing, sustainable revenue? Is it something that's kind of short term? I know you were doing some testing over there. So is this now kind of 1-year or 2-year contract? Can you just elaborate a little bit more on that?

We're not prepared to elaborate on the extent of the contract yet. We are comfortable to say the first commercial products will be shipped. In particular, with the logistics of Russia, everyone should expect that once we create the initial products over there, we anticipate it to grow slowly. But quite frankly, if I was a client over there, I wouldn't commit an entire year's contract to Flotek till I could make sure we could deliver. And so that's what's happening with a couple of different clients over there. And we're very confident that, through Basin and ourselves, logistically we'll handle the supply chain with some top-notch products. But we are -- we hope to be able to tell you more details on the type of contract here as the months play out.

Got you. And then you had mentioned in the press release and in your comments that the R&D department put out 6 -- the top 10 producing -- revenue producers this year for the chemical group. Is that a trend for you guys? Do you expect to kind of come out with 5 or 6 new products that will be within the top 10 revenue producers each year, or is that just a bit of a one-year increase?

Well, I think the short answer to that, it's hard to say. The more detailed answer is, as you and others have probably gathered with our theme here, we're making a very conscious effort to listen to the clients as to what they need and whether we can provide it; if we don't have, can we develop it. And so it's hard to tell whether that will repeat itself in 2012, but the process of being more tuned-in to our clients than just merely being a blending, packaging, shipping, chemical company is what we're in the middle of. But we've expanded the capacity at research to be even more responsive to the inquiries from our customers.

Got you. And then lastly for me, you had mentioned in the Drilling Products segment that the strong growth there was from the Southern region. Was that all from the Eagle Ford or were there other basins in there? And then I'm curious if you guys have started deploying any equipment up to Ohio for the Utica.

To answer the last part, first, yes, we are in the Utica. Our sales are improving up there. We've repositioned some sales folks into the Utica and are experiencing some success in there and some growth. For the Eagle Ford, that was an awful important part to this, but we had 2 other parts that really grew well for us. Oklahoma grew with the Granite Wash, and the Mississippian limestone. So we got quite a bit out of there. And the Permian is just, as we all know, booming and we're participating very well in the Permian. We're very strong there. So overall, our entire trend, we fell off some in the Haynesville, of course, but we are making it up rapidly in the Eagle Ford.

[Operator Instructions] Our now our next question comes from the line of Greg Garner with Singular Research.

I just want to ask about the surfactants as a new product area. Can you tell me a little bit more. Is this in development, is it early-stage development? Are you already starting to implement some test products on it? Or -- and also, how is it better than what's out there already? How would you compete it? Is it on a cost basis or biodegradability? Just want to give us some -- could you give us some flavor for how that is?

Yes. I think the appropriate thing to say at this point in time is we are enhancing the current Complex Nano-Fluid formulation and capability with a new second generation of that product. And it would be just inappropriate at this point in time for us to give you any more information than that. And we hope you're happy with that answer. It's just ahead of when we're prepared to do that.

Okay. That's understandable. And any sense for what the market opportunity is for here?

Well, we -- let's just put it this way. We think that the original CnF product has demonstrated for sure economic value, and we think this product should have a bigger market penetration than the existing CnF product that's out there.

Our next question comes from the line of Sarah Hunt with Alpine.

A quick question. I missed the beginning of the call, so if you covered this, forgive me. A quick question on how much of the chemicals right now are the biodegradable sort? Are they all from that original set of formulations, which I believe had a natural ingredient source, or is there more of a blend now? And can you just kind of talk about what that looks like?

Sure. The main biodegradable product suite, as it is right now, is what we refer to as the Complex Nano-Fluid, that is one of the main base products is d-limonene, which is out of orange peels. And that represents about 50%, sometimes, depending on the month, 60% of the overall chemical sales. At one time, 2007, '08, it represented about 95%. And it's not that, that business is going down, it's because we've broadened out the breadth of the different chemical products we intend to offer to various clients. The rest of those don't have the same biodegradable features as that particular suite of products.

Okay. And then given the sort of interest right now in what's going on from the EPA standpoint of trying to regulate what's going to be called diesel and what's not going to be called diesel for frac-ing purposes, does that -- is that part of why you're working on the secondary formulation of the CnF? Does that -- am I thinking about that in the right way?

Well, I think -- I guess the answer is you could be. Here's the way we would go about that, because we want to leave everybody with a takeaway. Long before you read about the EPA and various state agencies wanting to understand what's going on in these wells, we had developed the initial, we called it a time microemulsion, because the technology really wasn't able to verify it actually had nano size particles, and patented well before all this started. So you can assume, based on that basic belief in our research and our company, that we're working on things before people have gathered some type of public momentum to say, "This is what we think needs to happen." We're very aware of the environmental scoring of different products. We like where our products are in that scoring. The new enhanced second-generation Complex Nano-Fluid actually will improve on the slightly, not exponentially but it'll improve on that slightly.

Our next question comes from the line of Richard Dearnley with Longport Partners.

Could you talk about specific statistical evidence in the results from CnF and how they demonstrate that they make a difference in a specific basin, on a "This group of wells used it and this group didn't and here were the results"?

Sure. Couple of things. We can direct you to our website and you can see a 3-minute video that shows how CnF improves the producing of oil through a sand column as compared through a reservoir that doesn't have the CnF. There's several white papers and SPE papers that have been published that specifically talk through wells that have CnF and don't have it. And the most recent paper that was presented in the fracture symposium conference 3 weeks ago in the Woodlands also talks about the effect of CnF actually improving your expenditures that you spend on different types of proppant. Whether you're using a ceramic or whether you're using a white Ottawa sand, as to what the impact is of CnF on that. So we feel very confident that we can represent -- once we know the reservoir that we're dealing with and we've had a chance to look at and model produced fluids and drill cuttings in the regard, we feel very confident we can represent that there will be an uplift in the performance of that well that far exceeds the cost of using CnF.

In the 3-minute video, which basin were you referring to at the end when you talked about the 80 barrels a day going to 200, I believe it was?

Actually that was in the oily section of the Barnett Shale.

And is that 150% or 200% increase in productivity the normal sort of number in a basin?

Yes, it ranges between 40% and sometimes 300%. And I would just tell you, again, that stay tuned. We are looking forward in 30 or 60 more days to be able to give you even more detail on that specific application of CnF.

[Operator Instructions] And our next question is a follow-up question from the line of Michael Marino with Stephens.

John, you guys gave some detail on EOR and that you're working 8 small projects. Could you maybe help us understand, are these things that could move the needle in 2012 or is this kind of longer term and these projects maybe take a little bit longer before you get results that would allow you to go to the next step and maybe move the financial needle?

Yes, good question. And I'm sure it's a question that a lot of folks are thinking about. I think here's the way to look at this. As we talked about in the prepared remarks, there are more surfactants used in EOR than any other hydrocarbon application of surfactants. So you can assume that if we are successful in having a long-term commercial usage of those surfactants on any one of these projects, it will have a meaningful impact on the amount of surfactants we use on a year -- or we ship on a yearly basis out of the chemical division. Now that being said, I can't speak to the length of the pilot testing time that some of these companies want to pursue before they make the decision to go all-in on using our product. And I'm not trying to in any way be vague on your question. I'm just saying that we're so early in this part of the journey with EOR, we don't have an experience factor to be able to give you a more direct answer. But all we can tell you, again, no different than the video that's on the website, we know that there will be improvement when you use CO2, when you use surfactants in EOR. But, I think, the amount of capital that these companies use on these projects is so large, they become even more conservative and cautious before they make a change. So we're encouraged. We're where we want to be. And if any one of these comes to the level of usage that they should, it will have an effect on the financials of Flotek, there's no doubt about it.

But it's reasonable to think that these things take a while, and these decisions will -- I mean, this is something they're going to want to see months of data on before they make any big decision?

Right. And that's a good catch there, Michael. I think -- and just to give you an analogy, and again at this fracture symposium, there was a paper presenting that, on these Bakken wells, when you get the first 60 days of production, you pretty know how your well is going to do. On these EOR projects, as you say, they want to observe because sometimes the breakthrough, if folks are familiar with EOR where oil goes from an injecting area to a producing area, it takes months. It doesn't take 60 days. It may take 200 days. So it's just a more of an elongated process, elongated sell on our part. But if in any way we were discouraged, we'd go in a different direction. But there's nothing that's led us to be discouraged at this point in time.

And our last question comes from the line of Dan Kapolfil [ph] with Invecta [ph].

When you look at the different segments of the business, what's the best way to kind of think about the growth in 2012 as it relates to, say, whatever the rig count growth will be in North America?

Well, we've consistently said that we're not going to provide guidance, but along with that, what we have said is we expect the 2 main workhorse segments, downhole drilling tools and chemical, to exceed any activity uplift of the drilling rig count. I think that's verified in the last year. The overall rig count year-over-year, '11 to '10, was up 21%. And you are familiar with the numbers of the increase in chemical and downhole tool revenue. We believe that it's still a very -- we call it target-rich environment out there for us, both chemical-wise and things we're doing on the downhole tool-wise. And so, as we've consistently said over the last 2 years, the good thing about where Flotek is right now, we don't need a 30% increase in activity to be okay because we're still in the process of making more of the industry of what we have. So there's -- based on where we are right now, there's nothing to make us in any way discouraged of 2012. We feel good where we are. Artificial Lift, that's going to depend on our ability to move in a couple of different areas. Again, we talked about it. It's a low-capital expansion. Coal bed methane gas is at the end of everybody's spectrum of where they want to spend money today. That's what the wheelhouse has been for the Artificial Lift group of Flotek. But fortunately, as we talked in the prepared comments, we've got some other technology that we can move to a couple other basins and we're looking at that right now.

And there appear to be no further questions at this time. I'll turn the call back to you. Please continue with your presentation or closing remarks.

Okay. Thank you very much, operator, and thanks for questions and the interest. Again, I thank all of you for your support at Flotek. We look forward to speaking to you again in May, seeing many of you at the IPAA New York investor Conference in New York or at our Annual Meeting in May as well. And thanks, again, for your interest.

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.