Flotek Industries, Inc. (FTK) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the Flotek Industries Inc. Second Quarter 2013 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 quarterly report with the United States Securities and Exchange Commission were filed and distributed last evening and are also available on the Flotek website. Before we begin our formal remarks, I wish to remind everyone participating in this call, listening to the replay or reading a transcript of this call of the following. Some of the comments made during this conference may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and other applicable statutes reflecting Flotek's views about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements but are not the exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact the 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, President and Chief Executive Officer.

Glenn, thank you. I'd also like to welcome each of you to Flotek's Second 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. In addition, Josh Snively, President of Florida Chemical and also a Flotek Executive Vice President, joins us from a secret vacation spot. Josh had this vacation on account of prior to our acquisition of Florida Chemical and given the demands we've placed on him in the last quarter, it is well deserved. Nonetheless, he joins us today, and we will do our best to coordinate Josh's participation in the discussion following our prepared remarks. 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 that it has entered into a contract to provide certain chemistry technologies to AlMansoori Production Services Company of Abu Dhabi in the United Arab Emirates. The contract, the initial phase of which provides revenue potential of approximately $4 million, calls for Flotek to assist AlMansoori in the development and execution of a program to enhance production in maturing wells and sustain long-term production using Flotek's chemistries. There are a number of maturing producing assets in Abu Dhabi, including the Bab field, the largest onshore field in Abu Dhabi covering approximately 1,200 square kilometers. Flotek will work with AlMansoori and its clients to enhance recovery opportunities through the use of the Flotek's chemistries in acidizing and other application, including the use of Flotek's CnF chemistries designed specifically for enhanced oil recovery. This new relationship is noteworthy on a number of fronts. First, the credibility of Flotek's technical staff, notably our Chief Technology Officer, Glenn Penny, and his decades-long professional relationships with key decision makers in the region, led to this opportunity. As I've noted before, building and maintaining intellectual talent is a key component of our future success. Second, this key contract award is continued validation that our internal strategy -- excuse me, international strategy is working. Combined with our emerging partnership in Oman, the acceleration of our work in Saudi Arabia and other international projects in various stages of development, Flotek's expertise in key technologies is steadily finding opportunities around the globe. While we have consistently noted that international growth is somewhat less predictable and certainly nonlinear, the lack of boundaries to Flotek's future growth continues to become more clear. Finally, this groundbreaking opportunity is a chance for Flotek to showcase our expanding Enhanced Oil Recovery, or EOR, capabilities on the global stage. We've talked consistently about the market opportunities in EOR and have deployed meaningful resources to develop key EOR competencies. Our ability to deploy our best practices around the globe will only increase awareness of Flotek's capabilities and lead to additional opportunities in the months to come, which will only be enhanced by our recently announced Letter of Intent to acquire Eclipse IOR Services, a leading polymer-focused EOR technology company. We are excited about our new relationship with AlMansoori not only for the actual contract but also for future opportunities inside of Abu Dhabi as well in other parts of the region, where EOR will become a much more important part of the production landscape in the years to come. On the topic of EOR, as just noted, we recently announced our intent to Eclipse IOR Services, also known as EOGA. Eclipse offers Enhanced Oil Recovery technologies and services that including water control polymers for producing wells, sweep improvement technology for waterfloods and CO2 floods, mobility control polymer flooding, injectivity improvement for waterfloods, permanent clay stabilization and alkaline-surfactant processes for waterfloods, as well as a wide range of consulting services to its clients in North America and internationally. The addition of Eclipse to the Flotek EOR team is an important milestone in the development of our Enhanced Oil Recovery strategy and business platform. Jay Portwood and his team have developed a far-reaching reputation for being the leading innovators in the application of polymer technology for EOR. And in the process have built a client base of the leading EOR companies around the globe. The combination of Eclipse's existing technology and service breadth with Flotek's chemistry and consulting and initiatives should create immediate opportunities to become a significant player in global EOR markets. Under the terms of the LOI, Flotek will provide total consideration of approximately $6.5 million in cash and Flotek common stock for Eclipse, subject to completion of due diligence and certain working capital adjustments. Our due diligence is well underway, and we hope to close this transaction prior to the Labor Day holiday. I'm more enthused about the future of Flotek today than ever before. When I took the helm of Flotek 4 years ago this coming Sunday, August 11, I believed in the potential of the company. Like many of you and many of the Flotek team members, the potential was dwarfed by the overabundance of the immediate daunting challenges. As I said 3 months ago, Flotek is 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. This key opportunity in the Middle East and our acquisition of EOGA are very important examples 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 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 believe 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 second 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 quarter ended June 30, 2013, with the U.S. Securities and Exchange Commission yesterday afternoon. In that report, Flotek reported that revenue for the 3 months ended June 30, 2013, was $93.6 million compared to $78.3 million for the 3 months ended June 30, 2012. Revenue in the second quarter increased $15.3 million when compared to the same period in the previous year. During the quarter, Flotek acquired Florida Chemical Company. As a result of the acquisition, Florida Chemical's financial results for the months of May and June are included in the company's consolidated financial statements and provided $14.5 million of incremental revenue during the second quarter. Excluding Florida Chemical revenue, Flotek would have reported revenues of $79.1 million, the second highest revenue quarter in Flotek's history. For the 3 months ended June 30, 2013, the company reported net income of $8.4 million, or $0.16 per share on a fully diluted basis, compared to a net income of $13.2 million, or $0.25 per share on a fully diluted basis, for the same period in 2012. For comparison purposes, results for the second quarter 2012 include noncash income of $6.5 million related to the increase in the fair value of our warrant liability resulting from securities issued in a preferred stock offering in 2009. Due to a change in terms of the remaining warrants, the company no longer accounts for these securities as derivative instruments with fluctuating value. In addition, during the second quarter of 2012, the company recorded a $1 million expense related to the extinguishment of debt. Excluding these 2 items, net income in the quarter ended June 30, 2012, would have been $7.6 million. Earnings before interest, taxes, depreciation and amortization, or EBITDA, for the 3 months ended June 30, 2013, was $17.6 million compared to $23.6 million for the 3 months ended June 30, 2012. EBITDA for the quarter ended June 30, 2012, included the impact of both the change in the fair value of the warrant liability and extinguishment of debt, as previously described. Excluding those items, EBITDA for the second quarter of 2012 would have been $18.1 million. Stock compensation expense for the 3 months ended June 30, 2013, totaled $3.6 million compared to $3.7 million for the prior year period. For the second quarter of 2013, noncash stock compensation represented approximately 17% of total selling, general and administrative expense. As a result of new market development, extrinsic growth opportunities and continued development of intellectual capital, the company's sales and administrative costs rose during the period. Selling, general and administrative expenses for the 3 months ended June 30, 2013, were $21.1 million compared to $15.8 million for the same period in 2012. Included in those 2013 expenses were approximately $1.5 million in costs related to the acquisition of Florida Chemical and approximately $0.5 million in expenses related to the development of new international markets, including our joint venture in Oman and new opportunities in Saudi Arabia and the United Arab Emirates. In addition, the acquisition of Florida Chemical and the consolidation of their financial results added an incremental $1.7 million in selling, general and administrative expense for the 2 months, that's May and June, for which their financial results were included in our consolidated numbers. The company recorded an income tax provision of $4.7 million for the 3 months ended June 30, 2013, an effective tax rate of 35.9% compared to an income tax provision of $5.4 million for the 3 months ended June 30, 2012, which reflected an effective tax rate of 29.2%. Accounts receivable at June 30, 2013, were $58.3 million compared to $42.3 million at June 30, 2012. The company's allowance for doubtful accounts was at 1.3% at June 30, 2013. Finally, as a result of the acquisition of Florida Chemical, Flotek has modified its business reporting segments to better reflect the acquisition and changes to Flotek's ongoing business growth. We are now reporting key operating and financial results in the following 4 segments: Chemical Technologies, which designs, develops, manufactures, packages and markets specialty chemicals, some of which hold patent protection, used in the oil and gas well cementing, stimulation, acidizing, drilling and production. This segment will include Florida Chemical's energy-related chemistry operations. The new segment, Non-Energy Chemical Technologies, designs, develops and manufactures products that are sold to companies in the flavor and fragrance industry and specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies and companies providing household and industrial cleaning products. The third segment, Drilling Technologies, rents, sells, inspects, manufactures and markets downhole drilling equipment used in energy, mining, water w ell and industrial drilling activities. The fourth segment, Artificial Lift Technologies, assembles and markets artificial lift equipment, including the Petrovalve product line of rod pump components, electric submersible pumps, gas operators, valves and other technologies. We have provided information on these segments in our currently -- in our current quarterly report as well as in the pro forma combined financial information filed in a Form 8-K in late July. Moreover, we are very pleased with the progress in integrating Florida Chemical into the Flotek team. Josh, Tom Hodge, who is Florida Chemical's Chief Financial Officer, and their staff have been incredibly helpful, and we are delighted to have them as members of our team. We are pleased with our second quarter financial performance in 2013, and we will continue to strive to provide maximum transparency and accountability to you, our shareholders. I would now like to turn the call back to John Chisholm. John?

Rich, thank you. As I mentioned earlier, Josh Snively, our citrus guru and President of Florida Chemical, is on a well-deserved respite this week. However, he volunteered for duty today to update us on Florida Chemical and, if we're lucky, maybe even a -- share a South Florida fishing success story with us because I've seen the pictures and he has got a lot of them. Josh, thanks for making the effort to be on the call this morning.

John, thank you. I'm pleased to be with you this morning from sunny South Florida. While I won't take much of your time this morning, I do want to highlight a couple of items that I think will be of interest to you. First, we couldn't be more pleased to be part of the Flotek team. The transition to a team environment between the research teams of Florida Chemical and Flotek was nearly seamless. And the energy that both teams bring to the table is contagious. I simply could not be more excited that John tasked me to create a holistic research team that works across the chemistry value chain, from the citrus molecule focus of Florida Chemical to the practical application chemistry of Flotek. As a result of our united teams, we have begun to accelerate our research and development efforts, especially in the areas where we can improve the environmental steward of oil and gas producers with bio-based alternatives to traditional products that have less desirable environmental impacts. While we remain in the early stages of market analysis and development, we have already received meaningful orders for xylene and replacement [ph] products from key operators across multiple basins. We are excited to talk about these products in the coming months. In addition to our oilfield applications, Florida Chemical's core flavor and fragrance business continues to experience opportunities for growth. Customer retention as a result of the merger has been terrific, and we have several opportunities to expand existing relationships in a number of meaningful ways. Once we have a full quarter under our belts, we will have an opportunity to discuss the numbers in greater detail. Our focus in the third quarter will be to continue to grow our core business, accelerate the integration of our research teams and remain a leader in innovation and bio-based chemistry solutions that stand in support of environmental stewardship in the oil and natural gas industries. With that, I would like to turn the call over to Steve Reeves, our Executive Vice President of Operations, to discuss our second quarter operating results. Steve?

Josh, thank you. As noted earlier, consolidated revenue for the 3 months ended June 30, 2013, was $93.6 million compared to $78.3 million for the 3 months ended June 30, 2012. Revenue in the second quarter increased $15.3 million when compared to the same period in the previous year. Also, as Rich noted, in conjunction with the filing of pro forma financial statements, the company announced it has adjusted its business segment reporting to reflect the acquisition of Florida Chemical and more precisely describe the company's existing business. In addition to Flotek's 3 traditional segments, a new segment, Non-energy Chemical Technologies, has been added to capture Florida Chemical's non-energy specialty chemistry business. Revenues in the Chemical technology segment for the 3 months ended June 30, 2013, were $47.7 million compared to revenues of $46 million for the 3 months ended in the June 30, 2012. Excluding the incremental revenue provided from the merger, Chemical Technologies' segment revenues were relatively flat year-over-year. Chemical Technologies segment's gross margin were 43.1% for the 3 months ended June 30, 2013, a decline from 44% posted in the same period in 2012. The modest change in margins, albeit from record levels, was primarily the result of product mix, including moderately lower priced margin contributions from production-related products acquired in the Florida Chemical acquisition. A slower-than-anticipated recovery in Canada, combined with moderation of overall oilfield activity in North America, largely explains subdued year-over-year growth in Chemical Technologies' revenue in the second quarter. However, the marketing efforts related to the company's core CnF chemistries has resulted in a number of important new customer validations in the first 6 months of the year, which should result in increased market penetration in the second half of the year. Moreover, the stability of margins, including modest sequential improvement, is evidence of the impact of improved marketing penetration and continued improvement in input pricing. The Florida Chemical acquisition should provide additional cost benefits in coming quarters. Flotek continues to focus on the commercialization of the next generation of CnF chemistries. The company is involved in a full-scale commercial validation of CnF 2.0 and expects to make key decisions regarding marketing strategy in the third quarter. Early results are encouraging, and the company believes the product should have commercial impact in the second half of 2013. In addition, and as a direct result of the acquisition of Florida Chemical, Flotek is a nascent [ph] stages of an aggressive marketing plan to replace the use of xylene and related petrochemical solvents in oil and gas productions. Through the development of citrus-based, non-toxic chemistries, the company believes it has replacement products that provide effective alternatives to xylene. With little marketing, Flotek reported revenues of approximately $0.5 million in sales of the alternative product in July. Non-energy Chemical Technologies, or NECT, revenue for the quarter ended June 30, 2013, totaled $12.7 million. This segment, the result of the acquisition of Florida Chemical, debuts this quarter with all revenue incremental to the company with no comparable data available. NECT revenue is primarily driven by demand for d-limonene, a citrus terpene derived from the processing of raw citrus oils, and other bio-based chemistries offered by the company globally to a multitude of industries, as well as some citrus isolates produced for the flavor and fragrance industry. Revenue results are subject to market seasonality and availability of raw materials. NECT gross margin for the second quarter and year-to-date period ended June 30, 2013, was $3.7 million or 29.1% of revenues. The primary drivers of the margin for the NECT segment are demand for the company's bio-based chemistries and the high-value flavor and fragrance isolates. The general direction of the citrus oil markets and the seasonality of flavor compounds can also impact margin results. Contribution from the Non-energy Chemical Technologies segments are for May and June of 2013, the period for which Florida Chemical results were consolidated with Flotek upon closing of the acquisition. Drilling Technologies' revenue for the 3 months ended June 30, 2013, totaled $29.8 million, relatively unchanged when compared with the year-ago period. Continued market penetration, especially with advanced technologies such as Teledrift and the company's drilling motors, provided for relatively strong results, especially in an environment that saw an 11% decline in the U.S. active rig count and increased pricing pressures from competitors. Improved sales of centralizers, float equipment and motor parts and equipment in the Northeast Bakken and Eagle Ford region resulted from more competitive customer pricing due to better material outsourcing, new customer contracts and higher sales to existing customers. Drilling Technologies' gross margin increased to 41.8%, up from 40.3% compared to the same period in 2012. The increase was primarily due to increased rental pricing, minimums on current motor rentals and on a non-motor-related rentals and increased service charges with higher margins. Flotek continues to tweak the commercial offering of its new downhole agitation product, the Stemulator. In addition to improving drilling performance in horizontal wells, the Stemulator will add the ability to monitor and record downhole performance. Various sizes of the Stemulator are in production and should provide commercial revenues for the company in the second half of 2013. Revenue for the Artificial Lift Technology segment for the quarter ended June 30, 2013, was $3.4 million compared to $2.5 million for the period ended June 30, 2012. Penetration of new oil markets as well as a modest rebound in the gas workover market provided additional revenue opportunities, as have our international sales. Margins in the quarter declined to 25.2% from 33.3% in the year-ago quarter, the result of a decline in valve sales in the South American markets which hold higher-than-average margins. While largely in the shadow of the company's chemistry and downhole technology offerings, the company's Artificial Lift segment should see meaningful growth in the second half of the year through increased installations of its traditional products in oilier basins as well as the introduction of new products, including new lift systems and other components. While small in the scope of Flotek's overall profile, revenues attributable to international activity in the second quarter of 2013 were approximately $10.1 million, an increase of $1.7 million, or 20.3%, compared to $8.4 million in revenue generated from international activity in the second 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. Flotek's oilfield technology innovations are supported by an infrastructure portfolio that is quickly becoming the benchmark for the industry. The company's $19 million capital budgets includes completion of production, storage and transportation enhancements through the company's primary chemistry production facility of Marlow, Oklahoma; the construction and development of a state-of-the-art technology facility for Teledrift, Cavo Motors and Flotek's other drilling technologies in Moore, Oklahoma; the construction of a new facility to house the company's expanding operations in North Dakota's Williston Basin; expansion of Florida Chemical's storage capacity in Waller, Texas; the development of expanded lab facilities in the Woodlands to support the combination of Flotek and Florida Chemical's advanced chemistry research; production of new Stemulator tools; and capital for expansions to meet growth in Non-energy Chemical Technology facilities in Florida and in Enhanced Oil Recovery infrastructure. When I was asked at our recent Florida investor meetings what excited me most, the answer was simple. If you consider all of the efforts to refocus our business, the strategic moves Flotek has made to ensure a solid financial base and the investments we have made, including those I have just described in the last 24 months, I am most enthused about what the next 6 to 12 months hold for Flotek. Very simply, we work hard to create opportunities. Now we simply must execute. If we are able to execute on most of the opportunities currently in front of us, then Flotek and you, as shareholders, should be pleased with the results. While we remain vigilant in our careful watch of commodity prices and drilling activity, we believe we are well positioned to continue to gain market share across segments and across geographies in the months ahead. With that, I'd like to turn the call back to John Chisholm.

Steve, thank you very much. Before we take questions, I would like to add a couple of concluding thoughts. 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 chemistry research and production business in Oman is precisely what will propel our international efforts forward in key hydrocarbon-producing regions of the world, the Middle East and North Africa. We're in the final stages of a very deliberate process of completing the formative documentation and organizational structure of our Oman venture. The company is finalizing the legal joint venture entity, finalizing the definitive agreement between the parties and completing the legal transfer of real property into the joint venture entity. It is expected that the legal entity will be completed no later than the end of the third quarter, providing for the planning and development of commercial facilities to begin, as originally anticipated, in the fourth quarter of this year. We've been very clear that we will not rush into an agreement without a thorough understanding of the structure and with certainty that it will stand to maximize value and minimize risk, especially when it is halfway around the world. The time and diligence we spent to ensure those tenets [ph] are preserved will result in a better partnership, especially for Flotek. While Oman is representative of our commitment to developing international markets, it's just one of several new markets we've entered in the past year, many of which were mentioned in last night's press release, our announcement this morning and earlier 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. At our recent Investor Conference in Orlando, we announced an important new research initiative in conjunction with the Texas A&M Department of Petroleum Engineering that we believe will provide additional validation of the efficacy of Flotek's patented CnF technologies. Under the direction of Dr. Yucel Akkutulu, Associate Professor of Petroleum Engineering of the Texas A&M, the research team will investigate the impact of nanotechnology on oil and natural gas production in emerging unconventional resource plays. Specifically, the research will focus its investigation on the oil recovery potential of Complex Nanofluids and selected surfactants under subsurface pressure and temperature conditions of liquid-rich shales. While we know Flotek's Complex Nanofluid chemistries have been successful in enhancing production in a tight resource formations, we believe a more complete understanding of the interaction between our chemistries and geologic formations, as well as a more precise comprehension of the physical properties and the impact of our nanofluids in the completion process will significantly enhance the efficacy of the unconventional hydrocarbon completion process. This research continues our relationship with Texas A&M where we are also conducting research into acidizing application in Enhanced Oil Recovery. While we believe the research will be another important step in the validation of the effectiveness of Flotek's CnF chemistries, we also believe it will add meaningful insight and understanding to the academic literature on advanced completion technologies. Not only do we believe this research will be invaluable to the industry, we believe it could be so significant as to create considerable demand for yet another Aggies autograph. Finally, while both Josh and Steve have addressed our focus on replacing the use of toxic solvents in the oilfield, a final comment is in order. The potential impact of the combination of the Flotek and Florida Chemical is no better represented than our successful quest to create alternatives to BTEX solvents used in oil and natural gas production. We are in the very early innings of defining this vast market and best understanding on how to capture market share. However, given our safe and effective alternative, we are confident that this product will transform the way producers view oilfield solvents and should become a major product in Flotek's portfolio of advanced oilfield chemistries. Moreover, much of the demand from xylene comes from existing wells. Creating a "direct to the end user" marketing strategy. While we're excited about this new opportunity as we are certain it will make a difference to our shareholders, we are just as excited because it'll make a difference to our customers, our communities and as importantly, to the environment. Rarely do opportunities to create value align so perfectly amongst all of our stakeholders. And be it in this case, Flotek is poised to make a big difference. At the end of our last call, I indicated that in 2013, we must now focus on wisely investing capital to create optimal returns for our shareholders through a wise balance of intrinsic growth and external opportunities. We believe our recent investments, our pending investments and opportunities on our immediate horizon do just that. Again, thank you for your interest in Flotek. While we're pleased with our second quarter results, we're even more enthused about our future and energized by the opportunities in front of us. Most importantly, 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'll now open the call to questions.

[Operator Instructions] Your first question comes from the line of Brian Uhlmer from Global Hunter.

I had a couple of quick ones, actually, not difficult this morning as we covered so much last week. On the announced contract this morning in Abu Dhabi, what is the timing of that $4 million revenue potential? Is this a long-term agreement? Or just a short one, 1 or 2 project-type agreement and how does the revenues play out on that?

Good question. It's designed for 12 months with a renewable year extension, and we expect that revenue to start within about 30 days. So you can roll it out at plus or minus right around $400,000 a month.

Okay. Quick one on the Florida Chem and the acquisition. Should we assume that the results from Florida Chem were pro rata for the time that we missed during the quarter that there's no step-up or anything like that in the quarter? So moving forward, rolling our forecast forward, we could use that same pro rata number on a daily basis to forecast 3Q, 4Q, et cetera?

I think that's fair.

Okay. And was the NECT, something we don't spend a lot of time on, was that in line with kind of where -- if we look out at that versus Florida Chem on a year-over-year or a sequential basis in terms of margins and revenues, is that in line, up, down and how are we supposed to forecast that moving forward?

Yes, I think, it's actually may have been slightly up over what we expected. So somewhere around the 27% margin, I think, is fair going forward, Brian, for the NECT side of things. One thing we didn't spend a whole lot of time with is, but I think you had looked at the pro formas, the -- a lot of the Florida Chemical energy revenue is production-related, which typically doesn't carry as high a margin as our specialty chemical and that was blended into our normal energy business. And again, once we get into the third quarter, we'll even give more transparency on that on our next earnings call.

Okay. As we blend that in -- and obviously, it's not the largest piece of the pie, but does that mean that margins should tick downward in Q3? Or will that be made up through kind of integration efforts and higher sales volumes?

Yes, we're not expecting any margin ticking down.

Continuing on, our next question comes from the line of Michael Marino from Stephens.

John, you outlined a lot and a lot of things to be excited about. And you noted in the press release, I guess, some commentary about significant growth for the back half and into '14. But I was curious, if you could dial it in, maybe on -- is there one specific thing that you guys are -- or that you are most excited about as you look into the back half of the year, a product that maybe moves the needle, that we'll see show up in the results in the back half of the year? Or is it a combination of a lot of things, I guess? If you could just maybe -- if there's one thing you could hone in on or not?

Yes. We're, I think overall -- and as you see the company evolve, Michael, this used to be just a 1-product chemical event and we've broadened that, and the downhole tools is the same way. But several different announcements throughout the earnings season of wells in the D-J Basin, wells in the Uinta basin that were talked about in the upper quartile of performance, those wells carried our CnF chemistries in them, which excites us. So we're really looking forward to the further validation and growth in the second half of that. But also, Steve will add a little bit of color in the Stemulator of some recent data running with that, that is also a reason for our enthusiasm.

As we talked, when we were down to Florida, we had pulled them back in, put all the new mods in them and were running these final beta tests on them. The first 6.5-inch run that we just finished up in the Uinta, we did 5,500 feet drilling out there, and 44 hours going through the curve in the horizontal section, which give us an ROP rate of 133 feet per hour, that's just outstanding results. We have 2 more into the hole that were beta testing right now. We'll have those results by the end of the week. And the Bakken, we have 4 in the hole, 1 just finished, 9 days drilling, no damage, everything went rate of penetration of over 100 feet per hour, and these are with all the new mods. We have 10 6.5 ready to go, 10 4.5 ready to go -- 4.75, I'm sorry, and we have about 35 ready to build up after that. So it looks like our final testing of the phase is almost completed and as we talk, we expect to be commercial here by the end of this quarter, at the very least.

Okay. And do you expect those 20 tools to go to work pretty quickly, all 20?

Pretty rapidly. When I said that we had 7 tools in the hole right now, that's without turning any salesmen loose. That is just all-in [ph] work because we just want to get some slow test, analyze the results, do all the analysis and make sure that we're ready to go out.

Okay. And a question on, John, on the margins in the chemical business. I guess with going forward, a little bit different product mix with the xylene replacement, hopefully, taking a bigger part of the percentage there and then the international business. How does that affect margins on kind of a go-forward -- if I were to look out 12 months or 18 months from now?

Yes, so that's going to be a work in progress and we don't want to get too down into the weeds, but we'll just give you kind of a bit of an insight there. The xylene replacement product based on d-limonene will not require as a high a purity as the d-limonene requires for our Complex Nanofluids. So our expectation is, and Josh may be on the call, maybe I'll feed him in here, is that in that net segment where we have lower end margins of the d-limonene, we're going to move that usage of d-limonene into the energy side where we can get a higher margin for that. And so that is a work in progress that we're in the middle of right now. But that's one of the reasons why we have such a level of cautious enthusiasm of this whole xylene replacement as we can take d-limonene from a lesser margin business line and move it in to a higher business margin line because it doesn't require the same purity. But if Josh is on the phone, still, he may want to weigh in. Go ahead.

Yes, thank you, John. Michael, as we look at the xylene replacement opportunity, that, for us, was big it part of the strategy in coming together with Flotek for accelerating that growth opportunity that we see in the marketplace. Timing obviously, is the key. As you heard in the comments, we've already recently had some success with that product as we move forward and the data rolls out and the word continues to spread and the sales force gets more active on promoting that product, we do believe we'll see that continue to ramp up as we move forward.

And then the impact of the international business on margins?

I think those margins are going -- I think the way it's worked out so far, until we get more of a beachhead in the Middle East, the transportation costs, freight may affect those slightly. But we're only talking about 100 or 200 basis points on the international revenue, which, when you blend it in to the overall chemistry margin, won't be that noticeable. And I think again, within another quarter, we'll even have a better understanding of that. One thing we didn't talk a whole lot about, but I think you've picked up with the other earnings call through the season is that Canada is now rebounding. We -- as others consider Canada international and that activity is improving for us through the balance of the year, and that area carries a good margin for us.

[Operator Instructions] Our next question comes from the line of Rudy Hokanson from Barrington Research.

Could you maybe talk more about your marketing efforts right now, as well as the expected costs built in? I know that you've been working hard on it in the first half and you see promise of it coming to fruition in the second half. But going forward, especially now that you have this new portfolio sort of in place, what do you see in terms of the marketing effort itself, also the costs and where it might impact anything on the P&L?

Sure. So -- and we tried to really give real transparency in that SG&A category, both in the press release and the call, and try to point out that there were several what we would call nonrecurring events in the quarter regarding SG&A and the whole issue and events surrounding the noncash on the stock. But more directly to your question, we have stated consistently since I became involved here that whenever we could upgrade the intellectual sales ability of the company, we would do that. And invariably, that occurs before you see the benefit of the revenue created from that strategy. The contract that we announced signing today was a result of numerous trips to the Middle East to enable that to happen. And those were embedded in expenses in the second quarter that we will now see the benefit in the third quarter throughout next year. But, so our view is that from a pure dollar standpoint, because of those nonrecurring efforts, SG&A dollars will go down as a percentage of revenue, it will go down because our expectation clearly is revenue will increase. But Kevin can talk, maybe, a little bit more specifically as to our philosophy of trying to hire as talented people as we can, when we can.

Yes, Rudy, this is Kevin. As you remember just a few weeks ago in our press release, we announced a new sales hire that we have just made, a very senior salesman that had come from a ceramic profit business, not announced in that same release were 2 other pretty high-end type sales folks that we've hired during the quarter out there and we continue to look really for people, and not for slots to replace or to fit a body into. And as we find incremental sales talent that boosts our overall capabilities, we'll bring those in as well. We've also, in our -- we've talked about this in previous quarters as well, we continue to shift assets in our downhole tool business and the sales business, because the market has changed, the activity with downhole tools has changed from the tight gas basins to the oily basins and we continue to shift resources into the more liquids-rich basins. And then add resources there as well. We certainly, if you pay attention so the trade journals and the trade shows and the upstream business there, we're more visible now than ever, more technical pieces being written and published, more advertisements, more presence at trade shows and things like that. I think our marketing has ramped up dramatically in the last year. And as I've said, we'll continue to add where it makes sense because of the technical talent available to add sales folks and engineering type expertise where it makes sense.

Okay. And then one other question and this -- I realize it's very simple and yet you've been probably answering it in so many words, one way or the other. But in terms of the product shift in the second quarter, both in chemicals as well as in Artificial Lift that you highlight, could you maybe, just maybe say in a few simple sentences exactly what that shift meant in terms of product shift. I understand in markets, what was going on between South America and Canada. But as far as product shift went and if that's something you see continuing? Or should we be going back to the type of mix that you had prior to the second quarter? Just sort of in a simple concept.

Sure. Artificial Lift first. The product shift there was, in particular, the Petrovalve revenue that, as we've chronicled in the past, is a lumpy, if you will, unpredictable revenue opportunity that's primarily in the international arena and it happened in the first quarter, didn't happen in the second. And that was the main product shift there, pretty straightforward explanation for you. Regarding the chemicals, again, we didn't want to give a whole lot of color on that. But to the extent that we can, it's not any more complicated than when you add fundamentally a production chemical product line coming from Florida Chemical into the chemistry of what we call, Flotek Classic, the specialty chemicals friction reduction and the Complex Nanofluids and our complex cross-linkers, that is a product shift. And we did that on the fly. We're going to look at that through the third quarter and see what type of pricing opportunity there is for us with many of the same customers. And so that's a work in progress. But that, I think, in the simplest terms explains that for you.

And we now have a question from the line of Richard Dearnley from Longport Partners.

Two questions on international. With the Oman completing soon, do you expect that the Abu Dhabi agreement will take about the same time to finalize and will other country agreements take a long time?

Yes, great question. Sorry if we didn't provide better clarity. The Abu Dhabi agreement with AlMansoori is completed, signed, sealed, delivered, and we expect the first chemicals to be shipped there within the month, certainly within this quarter. The Omani agreement is just in absolute order of magnitude, more complicated in terms of long-term leasing of land in Oman, the structure of the shareholder rights agreement where there are different issues, as many as the folks on the line know, in terms of how do you treat capital calls, can both partners meet the calls when you need to have increased capital, those type of issues are what we're nailing down in that agreement. But as far as an order of complexity, different.

And do you expect that the agreements in the Middle East will largely be on a country-by-country basis? Does every country need a leader on the ground there or joint venture partner or local?

Well, I think, that in itself is a work in progress. I think, what we've committed to do is to look at each one of these country opportunities individually and do what's in the best interest of the Flotek's shareholders. And if we think joint venture is the way to do it, great. If we think it's through an agent relationship like we have with the Teledrift inside Saudi Arabia, great. And each one is judged on their own merits with the use of our capital as to what we think has the best return for our shareholders.

And we now have a question from the line of Greg Garner from Singular Research.

I wanted to ask you about the Eclipse acquisition, what you're thinking was behind there? It appears that you're gaining marketing presence and also some technology. And so I want to understand, is it -- was one better than another? Did you really want to purchase it for the marketing enhancement? Or was there a technology component that was more compelling?

I think the way to answer that is, several of what you proposed there factored into the decision. Here's the way some of these acquisitions come about. These different technologies, many times you're seeing the same people in the same clients. And the clients, many times, push you in a direction to become interested in a technology we didn't have and we didn't have polymer expertise, not only from a technical design standpoint but also from a field injection standpoint. So I think you could infer from that, that several of our current and soon-to-be EOR clients expressed to us that they felt that this company embedded inside a public company that had the capital and infrastructure wherewithal could benefit Flotek. And so we investigated that and came to that conclusion that in several instances, we think we can have the chance to sell more CnF in conjunction with polymer and we think there's an opportunity in certain applications to sell polymer in conjunction with the leading punch [ph] of CnF if that made sense to you.

Okay. And so is it fair to assume then that, that would be -- just looking it from an EOR standpoint, so apparently there are some other CnF advantages there. But just from an EOR standpoint, would that in any way accelerate the revenue stream, to Flotek with the acquisition?

That answer is categorically yes.

But I guess by accelerate, I mean, in the short term of this year, because before we've been mentioning about -- it's been mentioned about how the -- you knew the revenues would start some ramping up their in EOR approximately third quarter. Is this more an enhancement for 2014 or is it something that would occur more soon?

Well, EOGA is generating revenue today. And so we intend to build on that. And like I say, we think there's an opportunity. We feel pretty confident of it that in some of the polymer projects that they have looking at them. Now there's an opportunity to look at CnF a little bit differently than maybe by itself and vice versa. So yes, we bought that with the expectation that the revenue would not only be immediate but also have the opportunity to increase.

Okay. All right. And just one item on the xylene. Is there any sense for what size of that market? It seems like it could be quite large. Is there any way to quantify the xylene market in the oil and gas industry?

Well, that is kind of a difficult, but I think there's 2 ways to kind of put this in perspective. We believe that over half of the xylene market is used on existing wells. And that is very key to us and we therefore believe key to our shareholders to be able to spread out revenue opportunity not dependent on what is the horizontal or gas or oil current drilling rig activity, that's number one. Number two, there's just -- within a couple of operators in the Permian Basin, they use in excess of 20 railcars a month, a railcar is 30,000 gallons. So that's 600,000 gallons of xylene used every month, just for 2 oil and gas operators in the Permian Basin to give you a, at least, a snapshot in that area of just 2 clients, potential clients in a particular geographic area. So we'll do our best by the earnings call in the next quarter to give an order of magnitude of the size of the market. But we think it certainly is significant and that's why we're targeting into that. And again, a special emphasis, it's not dependent on new well activity.

And Mr. Chisholm, I'll now turn the conference back to you for your concluding remarks. Thank you, sir.

Thank you, operator. Again, I'd like to thank everyone for their support of Flotek. We'll actually be in Denver next week at the EnerCom conference. I think in early October, we'll be in San Francisco at the IPAA OGIS conference. We might be able to see some of you at those locations. And we look forward to speaking to you again later this summer. Hope everybody has a great rest of the summer. Thanks for joining us.

Thank you, sir. Ladies and gentlemen, that does conclude the conference call for today. We thank you, all, for your participation and ask that you please disconnect. Thank you, once again. Have a fantastic day.