Flotek Industries, Inc. (FTK) Q1 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the Flotek Industries Inc. First Quarter 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded. At this time, I would now 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 with the U.S. Securities and Exchange Commission were filed and distributed last evening and are also available on the Flotek website. Before I turn the call over to Flotek's Chairman, President and Chief Executive Officer, John Chisholm, I wish to remind everyone participating in this call, listening to the replay or reading a transcript of this call of the following: Some of the comments made during this teleconference may constitute forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, reflecting Flotek's views about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements but are not the exclusive means of identifying forward-looking statements on this call. These matters involve 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 U.S. Securities and Exchange Commission. Now I'd like to introduce Mr. John Chisholm, Flotek's Chairman of the Board, President and Chief Executive Officer.

Glenn, thank you. I would also like to welcome each of you to Flotek's First Quarter 2013 Conference Call. With me today are Rich Walton, Flotek's Chief Financial Officer; Steve Reeves, our Executive Vice President of Operations; Kevin Fisher, our Executive Vice President of Global Business Development; Chris Edmonds, our Senior Director of Corporate Finance and Strategy; and Glenn Neslony, Flotek's Vice President and Treasurer. I'm also delighted to introduce Josh Snively, President of Florida Chemical in his first call as a member of the Flotek leadership team. More on Josh in just a moment. Last evening, we filed our quarterly 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. However, before doing so, I'm pleased to tell you that this morning, Flotek announced an agreement to acquire Florida Chemical Company, the world's largest processor of citrus oils and a pioneer in solvent chemical synthesis and flavor and fragrance applications from citrus oils from facilities in Florida and Texas. Since its founding in 1942, the privately held company has been an innovator in creating high performance bio-based products for a variety of industries, including applications in the oil and gas business. Under the terms of the agreement, Flotek will pay $49.5 million in cash and 3,284,180 shares of Flotek common stock for the outstanding shares of Florida Chemical. In conjunction with the acquisition, Flotek has entered into an amended and restated credit agreement with PNC Bank. Under the terms of the facility, PNC has agreed to increase the company's total availability to $125 million, comprised of a $15 million term loan and a $75 million revolving credit facility. Flotek intends to fund the cash portion of the acquisition through the proceeds from both the term loan and revolving credit facility. In my nearly 4 years at the helm of Flotek, there has never been one singular event that I believe to be more important, indeed more transformational to the future of Flotek than our announcement of the acquisition of Florida Chemical this morning. Not only is the transaction accretive for Flotek's shareholders from an earnings perspective, it immediately creates the global leader in advanced industrial and consumer renewable and sustainable chemistry. Not only has Florida Chemical been a key supplier and partner to Flotek for over 15 years, they've been a leading innovator of renewable and sustainable chemistry for the oilfield, industrial and consumer staple industries. Flotek intends to leverage the vast expertise of Florida Chemical's world-class research facilities and chemists with its own research expertise to create a leading global research team in renewable and sustainable chemistries for the oilfield as well as other industrial and consumer applications. Moreover, this strategic acquisition enables Flotek to secure supply of key raw materials, as well as direct control over raw material costs and inventory. Over the course of the next several weeks, we pledge to provide more information regarding our exciting growth objectives with Florida Chemical beyond the financial and operational information we provided this morning and what is available in the Florida Chemical websites. However, it is now my pleasure to introduce you to Josh Snively, President of Florida Chemical Company and the new member of the Flotek leadership team. Josh spent his formative years learning the citrus business from his father in Central Florida, where he owned a fully integrated citrus operation. He completed his undergraduate education at Florida Southern College with a degree in Finance and Citrus Management. Josh joined Florida Chemical in 1995 and was instrumental in transforming the company from its origin as a family-run business to a multi-national, citrus-based specialty chemical company, with manufacturing facilities in Metropolitan Orlando and Houston. He is responsible for Florida Chemical's commodity supply chain strategy, a task for which he is uniquely qualified given his background growing up in a prominent Florida citrus family. Combined with his formal training and financial expertise, Mr. Snively has become known globally as an expert in citrus commodity markets. Prior to his position as President, he was Vice President and General Manager, as well as Vice President of Procurement and Business Development with the company. Before joining Florida Chemical, Josh was Vice President of commercial agricultural finance at SunTrust Bank. While impressive, more important is the fact that Josh has become a trusted colleague, has been responsible for forging a 15-year partnership between Florida Chemical and Flotek and has become a good friend. Josh, I'm delighted to welcome you to the Flotek team, and I and all of the Flotek team look forward to making a difference with you and our new colleagues at Florida Chemical.

John, thank you. On behalf of my colleagues at Florida Chemical and the Schulz family, whose father, Bert Schulz, founded our company over 70 years ago, we are delighted to become a part of the Flotek family. As many of you know, the partnership between Flotek and Florida Chemical has spanned over 15 years, beginning in 1998 with collaboration on formulation and by supplying product samples to a group of oilfield chemists. In 2000, we shipped a 5-gallon pail of d-limonene to Flotek's CESI subsidiary. In 2012, Florida Chemical supplied Flotek with 16 unique chemical products, with revenue over $20 million. Moreover, the world-class chemist from both our firms have consistently collaborated on some of both companies' most innovative chemistries. In our view, this combination is not only an extension of our existing partnership, but a way to ensure that we maximize the benefits and value of each company's strengths and expertise for our stakeholders. Our core shareholders, including myself, believe so strongly in the future potential of this combination that we agreed to take over 50% of the total consideration in Flotek shares. My vision for the combined companies is simple: To create a world-class organization providing leadership and environmental innovations of value added chemistries for applications in the energy, industrial and consumer staple industries. In doing so, we will create renewable and sustainable chemistries that assist our clients in becoming exceptional environmental stewards, provide compelling returns for our stakeholders and create a work environment that challenges and stimulates our people. In short, and as John would say, the combined companies will make a difference in the lives of those we touch. We believe we have just touched the surface of the growth potential of citrus-based chemistry applications for the oil and gas business. While 2012 presented challenges due to the citrus commodity price loan, the first 3 months of 2013 showed the recovery and growth potential of our business. Combined with Flotek and the ability to create even more higher-margin, value-added proprietary chemistries to our product mix, we are excited about 2013 and beyond as members of the Flotek team. Finally, we believe in Flotek and its leadership team. In 2009, during a great deal of tumult at Flotek, John took the time to reach out to me and explain the perfect storm in which Flotek was caught. He asked me for patience and pledged to me that he and the Flotek team had a plan to not only recover, but to reemerge as an energy technology leader. He promised to be honest and sincere in his communication and to remember how important Florida Chemical had been to Flotek's chemistry growth. It was that reassurance and rekindling of trust that created a bond that, at that time, I believe, could someday lead to the combination of our companies. Our shareholders and team members are excited about the opportunity and, more importantly, about the prospects of the future. We are very pleased to be members of the Flotek family. I look forward to meeting many of you in the weeks and months ahead, pledge to you I will work hard to earn your trust as a steward of your capital. John, again, thank you for your kind words and welcome. The entire Florida Chemical team looks forward to working closely with you as we build an exciting future with Flotek.

Josh, thank you, and again, welcome. Like you, we are excited about the future of Flotek, even more so with the addition of Florida Chemical. As I said on the year-end conference call, we are not willing to rest comfortably in the past, but rather your company will strive to reach for a future where our industry-leading innovation can create value for all of our stakeholders. The acquisition of Florida Chemical is a very important example of the type of unique thinking that has changed the culture and opportunities for Flotek. As I've said on each call since I took the helm now almost 4 years ago, it continues to be my privilege to serve as the President of your company. I remain immensely proud and humbled by the commitment and support of the members of the Flotek team that believed, as a group, they can make a difference in the future of Flotek and believed in our vision to restore stability and growth to the company and continue to be enthused that through the efforts of our people, the future is filled with opportunities to create value for our stakeholders. With that, I'd like to turn the call over to Rich Walton to review our first quarter financial highlights and provide some additional color on certain financial issues. Rich?

John, thank you. As John mentioned, Flotek filed its Form 10-Q for the period ended March 31, 2013 with the U.S. Securities and Exchange Commission yesterday afternoon. In that report, Flotek reported that revenue for the 3 months ended March 31, 2013 was $78.2 million, compared to $79.2 million for the 3 months ended March 31, 2012. Year-over-year revenue was relatively flat even as total North American drilling activity decreased by over 11% during the past 12 months. For the quarter ended March 31, 2013, the company posted net income of $7.8 million or $0.15 per share on a fully diluted basis. That compares to net income of $3.6 million or $0.07 per share for the 3 months ended March 31, 2012. Included in net income for the 3 months ended March 31, 2013 is $900,000 in nonrecurring expenses relating to executive severance. Net of tax, this had an impact of $0.01 per share on a fully diluted basis in the first quarter. In addition, the company recorded stock-based compensation expense during the quarter of $2.2 million. That compares to stock-based compensation expense in the first quarter of 2012 of $2.2 million, the same amount. Net of tax, this had an impact of $0.03 per share on a fully diluted basis in the first quarter of each period. Consolidated gross margins for the 3 months ended March 31, 2013 were 41.7%, compared to 42.2% in the same period of 2012. That was a decrease in gross margin of 1/2 of 1%. Consolidated gross margin for the 3 months ended March 31, 2013, decreased $800,000 or 2.5%, compared to the 3 months ended March 31, 2012. The decline in consolidated gross margin was the result of a modest pricing pressures and a shifting product mix within the chemical segment offset by an increase from favorable pricing and margins on International sales within the company's Artificial Lift segment. The company's Drilling gross margin for the first quarter of 2013 remain consistent to the comparable period of 2012. Flotek's strong operational performance continues to provide support for improvement in the company's balance sheet. Flotek used cash for tax payments of $3.5 million during the quarter and for capital expenditures of $4.4 million. Yet as of March 31, 2013, the company's outstanding balance on its revolving credit facility was only $800,000. In addition, the company continues to reduce its senior term loan. As of March 31, 2013, the outstanding balance on this loan was $24.4 million. Outstanding receivables as of March 31, 2013 were $46.2 million, compared to $47.7 million as of March 31, 2012. That's a decrease of $1.5 million. The company's allowance for doubtful accounts was at 1.2% at March 31, 2013. The company continues to generate $1 million of cash weekly. During the second quarter, the company anticipates making tax payments of $4.2 million. While we are pleased with our first quarter financial performance, we will strive to perform even more robust results during the balance of the year. We look forward to the addition of the Florida Chemical team to our family and are off to a good start in our integration of Florida Chemical's financial systems into Flotek's structure. In addition to growing the business, Flotek's finance and accounting groups continue to look for ways to improve efficiencies and streamline information to better support our frontline team members, who are the cornerstone of sales and revenue growth. We also continue to work diligently to improve our reporting and control systems to ensure maximum transparency and accountability to you, our shareholders. I would now like to turn the call over to Steve Reeves to discuss our business operations. Steve?

Rich, thank you. With overall oilfield activity provided a mixed environment in which to work during the quarter, more focused sales and marketing efforts combined with success in new marketing programs help maintain general sales levels. Our continued focus on developing a more balanced portfolio of oilfield technologies to positively impact both liquids as well as natural gas projects continues to yield positive results. Nearly 3 quarters of our revenue is associated with liquids-related initiatives compared to nearly the opposite just 2 years ago. Indeed, Flotek's research and marketing 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 noted in the company's year end conference call, while January and early February activity was sluggish, activity for Flotek products and services accelerated into the end of the quarter. Revenue in the first quarter of 2013 was $78.2 million, only the fourth time in the company's history that quarterly revenue has exceeded $78 million. Chemicals revenue for the 3 months ended March 31, 2013 totaled $44.7 million, compared to $47.6 million in the year ago period. Chemical gross margins for the quarter were 42.8%, down slightly from the 43.9% in the first quarter of 2012, the result of both seasonal and demand pressures on pricing. Margins benefited from a decline in certain CnF raw material inputs. The year-over-year decline in chemical sales is almost entirely explained by weakness in Canada. Volatile weather patterns, including an early initial end to the winter drilling season combined with the loss of approximately $2 million in natural gas-related chemical sales in Canada, impacted quarterly revenues. Our International markets made significant contributions to overall chemical sales, including significant sales in the Mexico, the Netherlands and Turkey. In addition, new emerging markets for Flotek such as Guatemala and the United Arab Emirates suggest the company's International marketing strategy continues to make solid progress. In addition, as announced in March, the company signed a letter of intent with Gulf Energy, a leading Omani oilfield technology company to jointly develop oilfield chemistry in production facilities in the Sultanate of Oman to serve the rapidly growing hydrocarbon market in the Middle East and North Africa. Flotek and Gulf Energy are in the final stages of completing the definitive joint venture agreements and expect to begin formal development plans in the second quarter. On the domestic front, Flotek continues to see benefits from its users' marketing initiatives. From individual consultation to professional conference appearances, interest in Flotek's chemistry applications and customized research capabilities reached new levels in the first quarter. Flotek continues to create more efficiencies in its production facilities with the improvement at the company's Marlow, Oklahoma facility, allowing the company to increase bulk shipments by 70% in the first quarter when compared to the same period a year ago, helping further lower operating costs. The company has completed [ph] approximately 80% of its Marlow facility upgrades in the second year of the 2-year capital improvement project. In research and product development, Flotek completed the groundwork for the initial commercial test of the next generation of the company's CnF chemistry product, which is now underway. In addition to continued acceleration and client research requests, the company's research chemists submitted 4 new patent applications and introduced 9 next-generation products for field evaluation. Flotek also continues to make progress in the application of its advanced chemistries in Enhanced Oil Recovery projects, now working on commercial projects with several of the major EOR-focused production companies in North America. As we've noted in the past, we expect steady commercial revenue growth from these projects in the second half of 2013. The company continues to diversify its customer base with a focus on selling the integrated service companies, as well as marketing to exploration and production companies, the principal end-user beneficiaries of many of our chemistries. New marketing strategies and an improved technical sales force have brought meaningful success in these initiatives. Drilling revenue for the 3 months ended March 31, 2013 totaled $28.9 million, compared to $29 million for the 3 months ended March 31, 2012. Revenue for the Drilling segment remained essentially flat year-over-year in spite of an 11% decline in the U.S. active rig count, weaker oil prices and pricing pressure from competitors. Gross margins for the quarter were 39.2%, compared to 39.7% in the quarter ended March 31, 2012. Even with an overall lower rig count, Flotek continues to see an increase in the total spending per rig for the company's products, a sign of relative strength amongst its peers. The company's Teledrift products continue to dominate the vertical measurement Oil Drilling business and continue to post strong results. Not only does Teledrift continue to gain market share in key basins, clients continue to elect to use Flotek's new Pro series of measurement tools, which once established should lead to even better margins for the Teledrift division. Internationally, Teledrift continues to win accolades and gain traction with key clients. Revenue from Saudi Aramco hit record levels in the first quarter, with Aramco recently indicating demand for Teledrift tools will continue to grow. Work in Argentina and Kazakhstan also continues to grow. Flotek expects Teledrift to continue to post International growth throughout the balance of the year. Flotek continues to invest in new technologies in the Drilling Products divisions as well. The company is in the final stages of commercial tests of a new technology that accelerates the drilling of a horizontal well and expects to begin commercial production and [indiscernible] of this product this quarter with meaningful revenue expected to begin in the second half of the year. Also worth noting is Flotek's Galleon manufacturing group, which primarily produces drilling tools for base and precious metals mining. The company's Galleon mining group -- tools group continues to operate with near record backlog and received new orders from Honduras and Columbia. Artificial Lift revenue for 2012 was $4.7 million, an increase of $2.1 million from the first quarter of 2012. The increase in first quarter revenue was primarily due to increased sales -- International sales of $1.6 million and $0.5 million of increased sales related to expansion efforts in North Dakota. Gross margin as a percentage of revenue was 46.4% for the first quarter of 2013, up significantly from 40.9% [ph] in the first 3 months of 2012. The increase in gross margin and gross margin percentage was due to favorable pricing and margins on International sales made in the first quarter of 2013. Whilst Flotek's business remains weighted to North American drilling markets, we continue to make significant progress in key International arenas and believe that International opportunities will be a key component of Flotek's growth in the coming years. While small in the scope of Flotek's overall profile, revenues attributable to International activity in the first quarter of 2013 were approximately $12.2 million, an increase of $1 million or 8.9%, compared to $11.2 million in revenue generated from International activity in the first quarter of 2012. While results will remain somewhat lumpy as we establish new International beachheads, we believe dynamic growth is ahead in the coming quarters. We are excited about the opportunities in front of us in 2013. While we will remain vigilant in our careful watch of commodity prices and drilling activities, we believe we are well positioned to continue to gain market share in the months ahead. Of course, we will remain vigilant in protecting margins through select pricing power and better operating efficiency. In addition, we will continue to focus on smart International growth that should provide additional opportunities for revenue and profit growth. With that, I'd like to turn the call back to John Chisholm.

Steve, thank you very much. Before we take questions, I'd like to address 3 specific initiatives that Flotek will continue to grow in 2013. 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. We remain incredibly excited about the opportunity in Oman. We continue to believe the development of a chemical research and production business in Oman is precisely what will propel our International efforts forward in key regions of the world, the Middle East and North Africa. We're in the final stages of a very deliberate process of completing the formatted documentation and organizational structure of our Oman venture. We believe we'll be well underway with the development of our facility. By the end of summer, we continue to believe we can be selling chemistry in the key markets from an Omani beachhead by the end of the year or early 2014. While Oman is represented by our commitment of developing International markets, it is just one of several new markets we have entered in the past year, many of which were mentioned in last night's press conference and early in this call. In short, there's 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. As we mentioned last quarter, we continue to make market 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 studies suggest Flotek's complex nano fluids provide the same value-added benefits in EOR projects as in primary recovery. While we continue to be very deliberative in our approach to this new market, we remain involved in several projects to further demonstrate the efficacy of our technology and economic benefits of our suite of specialty chemistries in enhanced recovery projects. Included are projects for some of the largest players in the EOR market. In 2013, we are very focused at pushing our EOR initiatives forward both through intrinsic growth and quite possibly through extrinsic opportunities that add to the breadth and depth of our EOR service offerings. Consistent with our belief in research and development in our primary completion business, we believe that investment in the best leading-edge science and technology for enhanced recovery will only make Flotek a more ubiquitous player in this incredibly dynamic and growing market. Finally, with the acquisition of Florida Chemical, we will renew and intensify our commitment to environmental stewardship. For example, through Florida Chemical's FC-PRO operating unit, we gain access to a key environmentally responsible substitute for xylene, a long-time chemical used in the cleanup of hydrocarbon wells. While xylene is effective, it is also toxic. Through research and innovation, Florida Chemical and Flotek have developed efficacious substitutes for xylene that provide similar results while at the same time eviscerate the environmental impact of harmful toxins. This is just one example of how our combined companies can and will provide the environmental stewardship of the oil and gas industry. Very simply, we are focused on producing oilfield chemistries that are both green and great. As you can tell, we are very excited about this opportunity and look to seize the moment, to capture the imagination of our clients to create value for you, our shareholders. At the end of the last call, I indicated that in 2013 we now must focus on wisely investing capital to create optimal returns for our shareholders through a wise balance and external opportunities. We believe the Florida Chemical transaction will do just that. Again, thank you for your interest in Flotek. We are pleased with our first quarter results, especially excited about our new future and energized by the opportunities in front of all of us. Most important, we appreciate the trust and confidence you've placed in us and take the responsibilities of being the stewards of your capital very seriously. Operator, we will now open the call to questions.

[Operator Instructions] And our first question is coming from the line of Michael Marino with Stephens Inc.

Question on -- John, you mentioned the pricing dynamics and some, I guess -- I can't remember the exact terminology in the press release, but there were some comments around pricing softness. Could you elaborate on that? And also, maybe talk about kind of the margin trend in the chemical business and how you see that going forward?

Sure. I think as we mentioned in the last call, just like any company, we're involved with the atmospherics of the cost-cutting mantra of the oil and gas operators. So we have made a conscious effort to keep the margins at a level that we think are industry leading. And from quarter-to-quarter, they'll go up and down. We feel very confident about the process we've put in place to improve our supply chain with -- as you've heard us talk about, to be able to buy in bulk, store in bulk, ship in bulk. Obviously, that's one of the key components of the acquisition of Florida Chemical. It allows a vertical integration of a complete connection of that supply chain. The better we can do to forecast out the usage of our chemicals, the better Josh and his group will be able to purchase the raw material at the right time with the right amount at the right price. And we would -- we don't expect any type of margin compression through the rest of the year. In fact, as the year goes along, we would expect to see some to be determined margin uplift because of the vertical integration and the connection between our 2 organizations.

Okay. And, I guess, could you -- maybe to take it one step further, just talk a little bit more about near-term trends. Kevin mentioned some acceleration, or maybe it was Steve, kind of exiting the quarter. I don't know if you're prepared to give kind of an April update or -- but if you could just maybe talk about kind of the trends in the business on a monthly basis. And then more specifically, where maybe you see the most growth over the balance of the year on a basin level for your -- and I'm talking more on the chemical side here.

Sure. Although, obviously, financially, we look at these months, we'd urge everyone to focus on certainly more of a quarterly aspect than -- and through the balance of the year. We've told everyone repeatedly that yourself and Global Hunter that put out the expectation of what you expect for 2013. We haven't run away from our numbers on a month-to-month or quarterly basis. It might be slightly different from yours, but at the end of the year, we feel comfortable where we will end up. This is one of these unique times where I believe that the numbers themselves tell the whole story. We clearly believe our leadership group understands that we're in a what we have you done for me lately industry. We get all that, but there are numerous initiatives underway that, obviously, we can't talk about that we believe will have commercial, financial impact for us as the year continues. So we're comfortable with where we are through the first 4 months or 1/3 of the year. We, like you, feel that there'll be an uplift in activity in the second half of the year. Some of the headwinds we've all felt had -- involving us will start to mitigate, but we're -- we like where we are heading in through the last 8 months of the year. From a basin-to-basin perspective, Kevin can chime in on that. I don't know if there's any one particular basin that we expect more than other, but Kevin go ahead.

Well, as we've said in previous calls, really, it's the oiliest basins, the ones that are most liquid rich because of the big bulk [indiscernible] in getting those viscous larger molecules of liquid out of the reservoir. The -- from a chemistry perspective, that's where the nano fluids have the biggest bang for the bucks. So basins like the Bakken, the Eagle Ford, the D-J is a really strong area and getting stronger for us at the moment. The Mid-Con, Weatherford and Mississippian and even in the gassy basins like the Marcellus, we continue to provide products. But really, I think you would think more of the oily basins from the middle of the country in Canada, down to the Gulf of Mexico is where we can anticipate the largest amount of our domestic growth.

Okay. And then if I could, one more on the Florida Chemical acquisition side. Are there any additional capital requirements there? I know they have the facility in Texas. I mean, is that -- and you guys were talking about maybe a Marlow light, I think what you were calling it, a couple months back. I mean, does this satisfy that requirement? Or are there additional capital requirements that need to be put in, in Texas to kind of get what you need there?

Yes, sure. We'll let Josh take part of that. First off, strategically, that -- we now have 3 unique blending areas: Marlow; Waller, Texas; Winter Haven, Florida that should give assurance to all of our clients we have a redundancy capability for any type of business interruption that very few specialty chemical companies have in this industry. And that's one key part of this whole acquisition. But Josh can talk about some of the Capital that's on plan in terms of -- in general numbers or activity for Florida Chemical.

Sure. Michael, the capital needs, we're really looking at expanding our footprint to service our customers better. The Winter Haven and Waller facilities -- Winter Haven certainly is -- or the Orlando area is built out for bulk storage that we need. So limited capital needs will be there. We have the ability to expand our tank farm in Waller as we see the demand for the products go up, which is what we expect to happen over the next 12 to 24 months. So there will be some tankage additions. And then as we look at our product development efforts through the combination of our 2 R&D groups and those development processes, we're looking at new technology together. This merger will allow us to accelerate the R&D efforts and product development that could lead to more CapEx for manufacturing, but all in all, I think we're in pretty good shape. There will be some expansions, but predominantly, internal structure. We are considering an expansion into Canada. That is going to be vetted out. But right now, I think the primary expansion will be in Waller, finish out that tank farm.

Okay. Any dollar amount on that? I mean...

It wouldn't be overly excessive. You're looking -- $1 million to $2 million to finish up the tank farm.

And your next question comes from the line of Brian Uhlmer with Global Hunter Securities.

I wanted to -- can I get into the Florida Chemical a little bit more with you, Josh? I'm just trying to figure out the earnings power or EBITDA generation power after the 3 years. I'm trying to figure out what exactly occurred when you went from $65 million to around $150 million and then back to $100 million and now you're on kind of $90 million to $100 million run rate. Were there some onetime events in there that led to that huge jump in 2011? Or do you think you've got the potential to do that $145 million type revenue run rate? And then on the EBITDA margins, you went from a 15% to a 10%. And then Q1 looked like around 15%. What should we look at as a standardized EBITDA margin for that business?

Yes, great questions, Brian. Obviously, with citrus oils, we are tied to a natural product which does create some commodity swings in our business. We position ourselves to minimize any impact in declining markets, as well as position ourselves to maximize opportunities in increasing markets. So those numbers, if you look at it, especially between 2011 and 2012, those 2 really smooth out. Commodity-based products will fluctuate a little bit from year-to-year. But really, the future in smoothing those numbers out is going to be the conversion of our commodity trading activities into the product development and how margin value-added products that we will develop together with Flotek and Florida Chemicals' research and development teams. We've done that successfully in the past. We've worked very closely with this group. We get really excited about the ability to work collaboratively hand-in-hand with the curtains pulled back to fully accelerate the product development to move toward the higher-margin performance products versus some of the commodity and cyclical trading activity that you've seen historically.

Okay, very helpful. What -- and can we get a potential -- what type of revenue was Flotek's? Or what kind of intercompany eliminations should we look at now, number one. And the second question is more -- as you discuss human capital, are the majority of your R&D and sciences guys in the Waller area or in the Houston area or out in the Winter Haven area? And what's the plan of attack, and this for both of you, Josh, and Kevin and John to kind of make sure you maintain that human capital and integrate all those folks together into a collaborative process?

Again, the intercompany eliminations or transactions, you're looking at about 20%. On the human capital side, the real beauty about what we've done coming together is our 2 R&D teams have worked together very well for 15 years. We know each other. We expect that integration to go very, very well. We will be adding to our R&D staff because we believe that we are going to see better and bigger opportunities because of public awareness, environmental regulations, there is going to be a continued to be a large push for our products, so we will be adding to our technical staff to take advantage of those opportunities. We want to have the answers when the market is knocking on our door.

Is that primarily in the Florida location?

We will -- Florida will certainly add some. Most of that addition will be in the Waller, Woodlands facilities. We will develop a group within our -- within the combined companies that focuses specifically on the bio-based activities that will be collaborative with what the work is in the Woodlands already. So we will be adding more in the Woodlands and the Houston areas specifically.

Yes. Brian, this is John for just a second. I think going forward, and I think this is something we want folks to really focus on is, there is going to be what we'd called an environmental innovative research effort. A lot of that's going to be headed up with the expertise from the folks from Florida Chemical or as we've got a commercial research effort with the existing Woodlands facility, but where we can share equipment, obviously, we want to do that, so they're going to be connected very closely. But they're going to be separately focused but collaboratively joined to create what we certainly believe a custom chemical capability that there's no other chemical company whereof that will have that commitment going forward. But most of it will be at the Woodlands area.

Okay. Well, from my perspective, yes, the University of Florida spits out some brilliant chemical engineers as you're aware. But...

Well, you will be glad to know that Josh is a diehard, go-Gator supporter. So we're all dialed in there with you, Brian.

Amen, Brian.

That plan enhances my view on this acquisition. Well, I'll turn it over.

[Technical Problem] [Operator Instructions] And our next question is coming from Rudy Hokanson with Barrington Research.

I was wondering if you could maybe elaborate on your next generation of products that you have alluded to. I was wondering if maybe -- and this sort of fits in with what you're doing with Florida Chemical, I guess, or how you see the development rolling out. I was wondering if you could give us a status on CnF 2.0. And are the comments about the next stage -- are those related still to CnF 2.0? Or is there a CnF 3.0? And could you maybe give us a big picture view of how fast you plan to be rolling out new products as you do the R&D and now you have the capabilities of Florida Chemical together? I mean, that's a really big picture, but I was looking for the -- both a more immediate answer and also the longer term strategic view.

Sure. A lot of ground to cover in that question, Rudy, and I'll take the first part of it. And then we'll turn it over to Kevin, and Josh may want to chime in. First off, we really believe we've got one of the best research-to-market timelines and commercial revenue-generating efforts of new products. And it's something we're very, very proud of currently. We think we can even improve on that further as Josh mentioned, when you've got the curtains completely pulled back, guys are interacting together with the research efforts of the experience of Florida Chemical and Flotek. It's really going to be a dynamic special situation. Again, I think the important thing to get through to the folks listening on this call, this isn't about one competitor buying another competitor and people looking over their shoulder, who's going to stay, who's going to let go. This isn't that play at all. This is about a joining of companies that have worked together. In fact, for heaven's sakes, there's a couple of people who have worked in Florida Chemical that used to work for Flotek. And it's all about how we take 2 really entrepreneurial philosophy-driven companies and combine those together to be able to bring world-class environmentally guided products into an industry that is going to go that way. That's the big picture. In terms of 2.0 and all that, I'll turn that over to Kevin. Again, as we've mentioned, we're very mindful about this in terms of the opportunity of certain geographic or company-specific borderline exclusives or preferred opportunities, but Kevin can give you an idea of where we are there.

Hi, Rudy. So you specifically asked about the CnF 2.0. We now have jobs in the ground with the CnF 2.0 product and we're gathering production data awaiting that to do comparisons so that 2.0 with existing CnF products, as well as against the more conventional surfactants use in the oil patch. In the earlier part of the discussion and the comments, we did -- we mentioned that our chemical research group has filed in the year-to-date period for new patents. That illustrates the new product development that is ongoing. We have also launched 9 new CnF chemicals that boosts us to over 20 different CnFs that are commercially available on the market today. And most of these new ones, as we mentioned, are developed more towards the oily reservoirs. Let me give you just a little bit of technical background about oil. There's a fellow that works for Apache, George King, who's a global technology consultant at Apache and he specifically focuses on stimulation and completion. He was named SPE, the Society of Petroleum Engineers, distinguished lecturer circuit. It's a handful of well-known and renowned industry experts. He's on sort of a global tour. And he gave a couple of very interesting facts in his distinguished lecture talk. Primarily around the difficulty in producing these large oil molecules that are viscous from a formation whose pore space are the size of a methane molecule. So 30x to 100x larger molecules that are more viscous, getting that out of the ground in these low permeable formations is very, very difficult. But the cracks that are in that shale matrix both induced by the hydraulic fracture procedure and naturally occurring with natural fractures range from like 0.001 inches down to 0.0001 inches. So these are really small cracks. By sort of comparison, the thickness of a newspaper sheet is in that range, about 0.0025 inches. So imagine trying to flow oil down these micro cracks to get into the hydraulic fracture that you've propped open. And what George says, and this is what our research is almost totally dedicated towards, is you have to reduce the interfacial and surface tension of these fluids to make them flow from the matrix and through the fracture. You need to have something that scrubs the oil or cleans the oil from that rock. And as we mentioned earlier, this d-limonene citrus oil is an incredibly efficient solvent for cleaning oil from surfaces out there. You need to change the wettability of the rock which -- in order for it to repel rather than attract the oil and hold it, and CnFs do that very well, and reduce viscosity. And we have various components in the nano fluids to do that. So our research is really tailored more towards addressing those needs to produce that oil from the rock, and we find that basin-by-basin and sometimes even with any given basin, the chemistry needs to change to be the most optimal. And that's where we spend a lot of time. But again, 9 new products on the market since the beginning of this year, 4 new patents filed. The number of new products continues to accelerate.

Does that help you on that, Rudy?

Yes. So basically, don't get too caught up with what the labels of each of the products is? But that there is a broader array of products depending on what your particular shale play is and what the configuration is you're going to have something that can basically approach the need to scrub the oil, as you say, to get out of a particular shale you were in. Is that the way to look at it?

That's correct. The CnF 2.0 just -- we were out of good names for marketing as much as anything. But all of these 20-some odd products now, some of those work better in one formation than in another or one type of crude than the others. So we are continually testing our own products to find out which is best. And if they're not performing as well as we would like, we're developing new products for a different reservoir. So almost every one of those oil basins that I named earlier are -- have 1 or 2 products that sort of stand out from the crowd, and we're continuing to both improve those and also to develop them for other basins.

Okay. Is there any more that any of you want to answer on that question? Or can I ask another one?

Go ahead.

Okay. What are you seeing in terms of activity on vertical drilling right now? And where are you seeing the strengths that you're able to sort of hold up in this market?

Sure. We'll let Steve take that one for you.

Obviously, the true vertical drilling that we're seeing is holding its own pretty well is in the Midland area because of the tough formations that you have with small springers that you ran through to get in all of the formations out there. Most everything else we're seeing, especially down in the Eagle Ford is turning over to pad drilling, which is, if you look at it, I don't have the exact numbers in front of me, but each quarter, we lose more and more vertical rigs, and these turn out to go into the overall pad drilling as you say. So we're seeing 4 to 5 horizontal -- or directional wells going off of the pad in South Texas, the Mid-Continent, but the vertical is losing ground each quarter.

Okay. And then if I can shift over to the Artificial Lift. That's still primarily natural gas, right? Or are you finding some applications, and this is where my knowledge is lacking, some application towards the liquids activity that's going on? I guess, my question is, why is Artificial Lift -- why do you see the pick-up? Were you expecting that? Is there something going on?

Yes. We were expecting it. We did know that we were booking an International sale that helped us have our pad in the Petrovalves. We knew that would be coming. If you remember from our previous calls, we have expanded into the Bakken with a new facility. We have a contract that's there. As we're all aware, that is mainly oil. The products that we have, the Petrovalve, the ESPs, we're getting into more oilfield installations of those. So for a long time, all we had was our Powder River natural gas -- methane gas facilities that we operated. We have continually expanded those. And while this is slow growth, we would not have expanded into the Bakken if we didn't feel we had an excellent chance of succeeding. And it's coming to fruition. So we're moving into the liquids rich and the oil in our Artificial Lift and expect to do that continuously throughout this year.

Okay. And one last question. On -- you're doing a great deal of marketing efforts right now and -- both domestically and internationally. I was just wondering, as we look at the run rate on SG&A going forward, is there any guidance you can give in terms of at what level that's likely to be or if it's going to be strictly a percent of sales or if you're going to be investing more that we might see?

That's a fair question. You can imagine we look at SG&A pretty much about as closely as you do, Rudy, and others. A couple of things in that, that folks need to know as to why maybe a little bit higher than what we would like, but how it'll be corrected. Everyone is very familiar with us talking about the new ERP system. There's a certain amount of time that you can capitalize the events for that. We've now gone into the phase where those costs properly need to be expensed. Some companies try to talk about Phase 1 or Phase 2. We've taken a very conservative approach under the guidance of Rich that when it comes to time to expense that that's what's we do. That will start to tail off a little bit. As we talked about, there was the one-off nonrecurring event for the separation agreement with a former officer of the company. That's obviously nonrecurring. And the whole SG&A deal, admittedly, is a bit of a challenge. You try to hit it just right when you're in a growth mode. And by hitting it just right, it means that you are going to incur some costs with research folks, maybe some additional couple of sales folks. You try to hit that 90 to 120 days ahead when the revenue is going to come. That may move 30 days one way or another, but rest assured we're very focused on SG&A on a regular basis.

And our next question comes from Richard Dearnley with Longport Partners.

Could you talk about what the new product that you're going to introduce that accelerates horizontal drilling actually does?

Sure. Steve will give you a little bit more clarity on that. And again, there's something to be said to keep some of the specifics close to our vest, if you will, but he will give you a little more color on that.

A tool that we've developed in the last couple of years and are just doing Beta testing on right now, what we do is we put this tool in the tool string in the horizontal well and it performs, it gives a vibration. And it over comes the inertia of sitting still and moving the path. So most of -- we would say that a good majority of horizontal wells have this in. It helps in keeping from getting stuck, it keeps all the mud flow is going full time, it keeps the pipe in an excited state and keeps it moving at all times. So we have run several tests on this. We're very happy with our tests. We're looking at the last results. We have it in a couple of sizes. And we will go out with a full marketing effort with it probably within the next quarter or so, but we expect this to be an entirely new piece of business for us in the horizontal well market.

Mr. Chisholm, there are no further questions at this time. I'll now turn the call back to you.

Thank you. Again, we appreciate the support of Flotek. Those of you that are shareholders and are in Houston next Friday, come on to our annual meeting here at corporate headquarters. We'd like to see you. If not, I'm sure we'll see a lot of you on the road, and it goes without saying that those of you that are on this journey this with us since the fall of 2009 through this call today, we appreciate that confidence. Those of you that are new to the journey, we appreciate it as well, and we'll see you on the next quarter call. And again, we appreciate the support and confidence in us. Thank you very much.

And 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.