Flotek Industries, Inc. (FTK) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the Flotek Industries, Inc. Third 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. Rob Schmitz, Vice President and Corporate Controller for Flotek Industries. Mr. Schmitz, 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 press release, as well as our quarterly report with the Securities and Exchange Commission were filed and distributed last evening and are available on Flotek's website. Before we begin our formal remarks, I wish to remind everyone participating in the 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 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 meaning 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 Securities and Exchange Commission. Now I would like to introduce Mr. John Chisholm, Flotek's Chairman of the Board, President and Chief Executive Officer.

Rob, thank you. I would also like to welcome each of you to Flotek's third quarter 2013 conference call. While we aren't Twitter, and we doubt our call will give rise to many tweets, we are delighted you're here with us today. 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; Josh Snively, our Executive Vice President of Research and President of our Florida Chemical subsidiary; and Rob Schmitz, Flotek's Vice President and Corporate Controller. A special welcome to Rob who many of you have met as he formally participates in his first earnings call. Rob joined us several months ago, we are delighted to have him as part of the Flotek team. He most recently served as the Chief Accounting Officer of Champion Technologies, a well-known oilfield chemical company that was recently acquired. He brings a wealth of experience and rounds out our financial team nicely. 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 it has completed negotiations with its perspective Middle Eastern partner, Tasneea Oil and Gas Technologies, an affiliate of Gulf Energy, and has signed a binding shareholder agreements to establish companies to provide chemistry technology and research and development services in the Middle East and across the continent of Africa. The company is a chemical manufacturing company and a research and development firm will be based in the Sultanate of Oman and provide a wide range of chemical technology services to Middle Eastern nations that are members of the Gulf Coordinating Council or GCC, as well as many African nation states. When we initially announced this transaction in May, we were excited about the prospective opportunities in the region and believe that a central location in Oman with a partner like Gulf Energy will provide the best opportunity to establish a business in this important hydrocarbon-producing region. After working with our friends at Gulf Energy on these agreements and gaining a better understanding of the potential market, we are more excited than ever about the opportunities that we have in front of us. Not only do we believe that demand for technology to tap unconventional resources will grow in the Middle East and North and West Africa in the coming years, we believe Flotek's expertise in chemistry technology for conventional plays and Enhanced Oil Recovery projects is also a remarkable fit in the region. We already are experiencing inquiries in even early orders for Flotek chemistries in the very nascent stages of our relationship. While we are excited about the prospects for this long-term relationship, it is also important to understand that there is plenty of work ahead in the coming months to construct and develop the infrastructure to run a new business halfway around the world. In the coming weeks, we will finalize the formal corporate structure with the appropriate Omani ministries, establish formal plans for construction of necessary infrastructure and begin to identify the best leadership available for our venture. At the same time, our international sales and marketing team, led by Gary Flock, is already in the field promoting our new venture and working to secure prospective clients. Combined with the commercial opportunities to be presented by our Omani partners, we believe this effort established deliberately and executed properly, will make a significant difference for Flotek and our shareholders for years to come. While this is a significant event in the evolution of Flotek, is it not the only important initiative underway for your company, and we will share many of those in the next several minutes as we share our most recent results and our future with you. I am more enthused about the future of Flotek today than ever before. However, 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. As I've said on each call since I took the helm now over 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 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 third 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 September 30, 2013 with the U.S. Securities and Exchange Commission yesterday afternoon. In that report, Flotek reported that revenue for the 3 months ended September 30, 2013, was $98.4 million compared to $78.6 million for the 3 months ended September 30, 2012. Revenue in the third quarter increased $19.8 million when compared to the same period in the previous year. The increase in revenue was primarily due to the acquisition of Florida Chemical Company, which contributed incremental revenue of $18.6 million during the third quarter. For the 3 months ended September 30, 2013, the company reported net income of $9 million or $0.16 per share on a fully diluted basis compared to a net income of $9.8 million or $0.19 per share on a fully diluted basis for the same period in 2012. Earnings before interest, taxes, depreciation and amortization, or EBITDA for the 3 months ended September 30, 2013 was $19.2 million compared to $17.5 million for the 3 months ended September 30, 2012. Stock compensation expense for the 3 months ended September 30, 2013 totaled $2.9 million compared to $3.7 million for the same prior year period. For the third quarter of 2013, noncash stock compensation represented approximately 15% of total selling, general and administrative expense. SG&A for the quarter ended September 30, 2013 increased by $2.4 million or 13.8% compared to the same period of 2012. Excluding the incremental SG&A cost of the Florida Chemical business acquired, SG&A costs increased $200,000 or 1.2% compared to the same period of 2012. SG&A cost as a percentage of revenue declined from 21.8% to 19.9% in the 3 months ended September 30, 2013 compared to the same period of 2012 as revenues grew significantly faster than SG&A costs. The company recorded an income tax provision of $5.6 million for the quarter ended September 30, 2013, reflecting an effective tax rate of 38.6% compared to an income tax provision of $2.9 million for the quarter ended September 30, 2012, which reflected an effective tax rate of 23.1%. Accounts receivable at September 30, 2013 was $62.2 million compared to $44 million at September 30, 2012. The company's allowance for doubtful accounts was 1.2% at September 30, 2013. As a result of the acquisition of Florida Chemical, Flotek modified its business reporting segments to better reflect the acquisition and changes to Flotek's ongoing business growth. We announced those segments last quarter. In an attempt to more accurately describe our business, we modified the segments and now report in the following 4 business segments: Energy Chemical Technologies; Consumer and Industrial Chemical Technologies, which was previously referred to as Non-energy Chemical Technologies; Drilling Technologies; and Artificial Lift Technologies. Finally, as noted in the press release yesterday afternoon, the company is experiencing the benefits of a fully functional accounting and reporting system, the JD Edwards Enterprise Resource Planning system. The enhancements initiated in 2012 provide for better reporting, accounting and planning resources, which creates significant, enterprise-wide efficiencies. I would now like to turn the call over to Steve Reeves to discuss recent operating results and trends. Steve?

Rich, thank you. As noted earlier, consolidated revenue for the 3 months ended September 30, 2013 was $98.4 million compared to $78.6 million for the 3 months ended September 30 of 2012. Revenue in the third quarter increased $19.8 million when compared to the same period in the previous year. Revenues in the Energy Chemical Technologies segment for the 3 months ended September 30, 2013 were $51.7 million compared to revenues of $44.2 million for the 3 months ended September 30, 2012. Excluding the incremental revenue provided from the Florida Chemical acquisition, Energy Chemical Technologies segment revenues increased $4.2 million or 9.4% for the quarter ended September 30, 2013 compared to the same period of 2012. Increased sales of stimulation chemical additives accounted for the majority of the revenue increase. Energy Chemical Technologies segment gross margins were 42.3% for the 3 months ended September 30, 2013, a decline from the 47% posted the same period in 2012. The decline in gross margin percentage for the 3 months ended September 30, 2013 was primarily attributable to product portfolio mix resulting from proportionately higher sales of non-proprietary products, partially offset by the supply chain benefits of the Florida Chemical acquisition. The company continues to process of integrating the Florida Chemical assets and intellectual capital with the Flotek team, which has and should continue to provide new research opportunities and operating efficiencies. In addition, Flotek's Marlow, Oklahoma, facility debuted its new 20,000 square foot warehouse and truck scales in the first quarter, furthering the company's bulk delivery and efficiency efforts. Consumer and Industrial Chemical Technologies, CICT revenue for the quarter ended September 30, 2013 totaled $15.3 million. Revenue for the third quarter and year-to-date periods ended September 30, 2013 is incremental to the company for both the periods as the segment is a new segment acquired during the second quarter of 2013. CICT 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 from citrus isolates produced for the flavor and fragrance industry. Revenue results are subject to market seasonality and availability of raw materials. CICT gross margin for the third quarter ended September 30, 2013 was $3.6 million or 23.5% of revenues. The primary drivers of the margin for CICT 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 seasonality of flavor compounds can also impact margin results. Drilling Technologies revenue for the 3 months ended September 30, 2013, totaled $27.6 million. Revenue for the quarter and year-to-date period ended September 30, 2013, decreased $2.9 million or 9.4% for the same period in 2012. Revenue declines can be primarily attributed to the decline in actuated [indiscernible] Rentals, continued market penetration, especially with advanced technologies, such as Teledrift, the company's drilling motors provided for a relatively strong results, especially in an environment that saw an 8.8% 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 regions resulted from more competitive customer pricing due to better material outsourcing, new customer contacts and higher sales to existing customers. Drilling Technologies gross margin increased to 39.3%, up from 37% compared to the same period in 2012. The rental exchange from lower margin actuated [indiscernible] rental to higher-margin Teledrift and other drilling tools helped to increase the overall gross margin percentages. During the quarter, Flotek relocated it's mid-continent operations to a new advanced technology headquarters in Oklahoma City, which should provide for further efficiencies in operations, including the ability to service our downhole motors closer to market. The new facility also allows us to consolidate Teledrift and other drilling technologies providing more efficient sales and marketing efforts. The company's Measurement While Drilling, MWD service continues to grow in both domestic and international markets with the Permian Basin continuing to provide robust opportunities. In addition, international markets in the Middle East and South America continue to fuel non-North American growth. Not only is Teledrift continuing to provide growth opportunities, our Stemulator product line is beginning its commercial roll out. While Stemulator rentals in the third quarter were less than $100,000, October rentals were nearly $300,000 with acceleration expected to continue for the balance of the year. Revenue for the Artificial Lift Technology segment for the quarter ended September 30, 2013 was $3.9 million compared to $4 million for the period ended September 30, 2012. Declining international valve sales following a 2012 contract were offset by increased pump equipment sales domestically. For the 9 months ended September 30, 2013 revenue increased by $2.9 million or 31.6% relative to the same period in 2012 as sales of pumps and pump equipment have increased due to rebounds in the gas workover drilling market, additional installs in 2013, and diversification into more oil-related equipment sales in the Bakken region, including the marketing of new pumping units as alternatives to traditional pumpjack systems. The company has continued to focus on the development of infrastructure to support its growing portfolio of oilfield technology. That said, the company has managed to continue to develop infrastructure more efficiently than expected, spending approximately $10 million of its $19 million capital budget through the end of the third quarter, less than the $15 million spent in the same period a year ago. To date, projects include completion of production, storage and transportation enhancement to the company's primary chemistry production facility in 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 operation in North Dakota's Williston Basin, expansion of Florida Chemical's storage capacity in Waller, Texas; the development of expanded laboratory 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 Commercial and Industrial Chemical Technologies facilities in Florida and in Enhanced Oil Recovery infrastructure. While we will 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 introduce Kevin Fisher to discuss recent chemistry initiatives. Kev?

Steve, thank you. Flotek continues to make very good progress and extending its market reach with both key energy service companies, as well as exploration and production end users. We remain encouraged by the opportunities in front of us as we conclude 2013 and plan for the new year. During the third quarter, Flotek accelerated commercialization of the company's next-generation CnF chemistry, commonly referred to as CnF 2.0. The next-generation product was pumped for 3 unique clients in the Eagle Ford Shale, the Permian Basin and the D-J Basin. The company currently has additional commercial validation pilots underway for 2 clients in the Eagle Ford. Adoption of CnF as a key chemistry and fracture stimulation projects continues to increase across multiple plays, including the Eagle Ford, Utica, Bakken and Woodford Shales and in projects in the D-J and Permian Basins, as well as a unique project in Indiana. The wider acceptance of our completion chemistries is validation of our end user marketing efforts, as well as the growing belief in the efficacy of our advanced chemistry technology. We believe our momentum with key pressure pumping companies and integrated service companies continues to improve. We are working with more service companies today than at any time in the past and believe that number should continue to grow, both domestically and internationally as the positive impact of our chemistry on both production rates and reserves additions becomes more widely understood. The company also continues to gain traction in the marketing and commercialization of terpene-based solvents to replace xylene, a known environmental contaminant, in the drilling, completion and production of oil and natural gas. We're working closely with a number of key customers on Vtech's replacement programs and expect to have additional comments on our year-end call. Flotek's Enhanced Oil Recovery efforts continue to grow as well. During the quarter, the company began work on several Texas and Louisiana remediation projects that should significantly increase the profile of Flotek's EOR capabilities. We continue to believe that EOR will become a more important part of Flotek's commercial portfolio in 2014 and continue to look for opportunities similar to the pending Eclipse transaction that will contribute to Flotek's comprehensive expertise and Enhanced Oil Recovery projects. Finally, like John and others have indicated, we're very excited about international market opportunities. This week's announcements regarding the development of unconventional resource opportunities around the globe strengthen our resolve that opportunities abound beyond our borders. Our Oman ventures, recent successes in Saudi Arabia, our project in the United Arab Emirates and others all should contribute to future revenues and profits. Moreover, we are hopeful that proposed changes in Mexico to provide opportunities for Flotek and increase its presence in our Southern neighbor. We will be delivered in assessing and acting on the international opportunities and will need patience that we develop the right approach. However, Flotek's transformation into a global oilfield technology provider should add meaningful value for you, our shareholders. Thank you for your time and interest in Flotek. I will now turn the call back to John. John?

Kevin, thank you very much. Before we take questions, I'd like to add a couple of concluding thoughts. The opportunities in front of Flotek, many of which you've heard about today and make it very exciting to come to work each and everyday. At the end of our last call, I indicated that in the balance of 2013, we now must 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 should do just that. In addition, we must be acutely focused on execution. Our leadership is more focused than ever on turning opportunities into action and prospects into enduring relationships. While we won't convert every prospect, we believe our compelling technologies, combined with the best people in the industry have us positioned to lead our industry in new customer growth. We believe the efforts of our entire team began to yield significant results in the third quarter, somewhat muted by the impact of Colorado and continued into the early returns in the fourth quarter. Also, implicit in successful execution is creating a more efficient work environment. The successful implementation of the new ERP systems, as Rich discussed earlier, is a big step in the right direction. As a result, we've not only been able to improve data delivery to allow management to make more timely and informed decisions, we're able to do so with a more focused staff and less recurring costs. We will continue to look for ways to make your company more efficient, allowing more of each dollar of revenue growth to create greater profitability along the way. As noted in yesterday's release, our October revenues were in excess of $35.5 million, set a new benchmark for Flotek, and were driven largely by strong growth in chemistry, especially CnF sales. As noted earlier this week, Colorado is also rebounded after a sluggish October start, and we expect that to continue. While the fourth quarter can be a bit tricky to predict due to holidays and weather, we like the new business that contributed to a strong October is now up to us to work tirelessly to convert new customers to dedicated clients and grow those relationships. You have my word. I will be at the front of the lines to deliver remarkable technologies, exceptional service and an overall client experience that will exceed the expectations of each of our new relationships. Even before October, the revenue growth, when you look back 4 years, is truly remarkable. From a base of just over $10 million in quarterly chemistry revenue in the third quarter of 2009, the Flotek team has made great strides and created profitable opportunities for all of our stakeholders. We look forward to working hard to achieve industry-leading growth in the months and years ahead. I'd like to add a comment regarding politics and recent elections. Earlier this week, the citizenry of a handful of Colorado municipalities voted to restrict fracture stimulation in their cities and towns. While respectful of their right to act and understand with the privilege of democracy, sometimes come outcomes with which we don't agree. We're troubled by a movement that is rooted in emotion, without regard for fact and absent any apparent understanding of the impact of their actions on the future of their communities and fellow Coloradians. Let me be clear, we support responsible development of our country's oil and gas assets and are here to lead the charge on environmentally-friendly development. It is important to note that Flotek filed its first patent related to its biodegradable completion chemistry in 2003, well before environmentalism was a concern among the industry or activists. Today, we are a leader in sustainable chemistry, including our quest to remove xylene and other BTEX compounds from oilfield chemistries. We both walk and talk the environmental line. That said, the position espoused by environmentalist that no frac is a safe frac is simply devoid of reason. There are thousands of fracture stimulation jobs in the U.S. and elsewhere that are not linked to any ill effects on people or the places in which they occur. Moreover, we are certain, if you ask those who are universally opposed to frac-ing if they ever heard of Flotek, they would come up with a blank stare. The real fact is that most of those opposed to frac-ing are opposed because someone told them they should be. And not a single member of the opposition can credibly espouse the position that all frac-ing is bad without at least considering the environmentally-friendly chemistries provided by Flotek. Moreover any credible advocate would at least acknowledge the widespread economic benefits of energy developments and should want to at least consider ways to preserve such benefits. While the battle in Colorado is just beginning, it'll be a difficult one for our industry. That said, we will do our part in trying to advocate for sensible environmental oversight of oil and gas development, while continuing our quest to expand our suite of environmentally-friendly chemistries used across the industry and join our clients and industry members in a program to educate the citizenry about the benefits of development, while pursuing a rational dialogue about responsible ways to balance development and the environment. And finally, as Monday is Veteran's Day, we say in especially heartfelt thanks to all members of our Flotek family and their families who have served this great nation. From board members to those in the field, we salute you. Thank you for your service and sacrifice and are especially grateful for your commitment to our country and its people. And again, thank you for your interest in Flotek. While we're pleased with our third quarter results, we are even more enthused about our future and energized by the opportunities in front of us. Most importantly, we appreciate the trust and confidence you have placed in us and take the responsibilities of being stewards of your capital very seriously. Operator, we'll now open the call to questions.

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

John, you mentioned in the remarks that, I guess, that there was some impact in October from the Niobrara. I was curious if you could quantify that as and get that -- do you think October included any kind of catch-up given the break in activity there?

Yes. There is a -- we're not exactly going to quantify it just from a competitive standpoint. But there was a rebound towards the -- after about the first 10 days in October of activity in the D-J Basin, but again, as you know, as well as anyone, there is a finite amount of fracturing equipment in that area, and it's not like you can catch-up all at one time. The growth we experienced in October was not just limited to some type of improvement in the activity in the D-J Basin.

Okay. Yes and that was kind of my follow-up there was, you mentioned new basins, I mean, is that -- is it new basins that's going to drive in October, maybe is it new customers? Or more of the same? Or all of the above?

I wouldn't say it's so much new basins. We feel like most of North America, we certainly have a presence in -- from a chemistry standpoint, Michael, but there are new clients in the quarter -- or certainly in October that will continue into the fourth quarter in those basins that we haven't experienced before now.

And what kind of visibility do you have with those guys? I mean, are these programs do you think that are kind of kicked into gear? Or is this just guys trying it and...

Yes, as we stated in the past, a lot of times, how these programs start is with a 5 or 7 well pilot validation. I think, frankly, those validations are becoming a little bit easier because there is more and more data that we are able to share with these folks that are starting out using our complex nano-fluids. So obviously, we hope these validations lead to an ongoing relationships. As I mentioned earlier, they don't all happen that way. But there's more that are happening that way than ever before.

Okay, that's good to hear. And just shifting gears, maybe this is more for Josh, but trying to figure out how maybe I should model the non-energy chemicals business? It seems kind of choppy and seasonally -- are there certain quarters that are always going to be better than others? Or is it just too hard to predict? Maybe some color as it relates to the volatility in that business?

Right, Michael, that's a great question. There certainly is volatility associated with the natural raw materials that come from the citrus crops. Steve alluded that earlier, that you do see some demand swings. Obviously, we did swing down a little bit in the third quarter, in our margins. That really can be attributed to the uncertainty associated with the crop fundamentals. The U.S. government did not release its USDA crop estimate to date. So that is information that the market is lacking, which certainly creates a little bit of softness in the market from a demand standpoint, which does lead to a little bit softer margin as we experienced in the third quarter.

So it is. It can be difficult to predict. Certainly, the fall this time of year with the crop estimates coming out, creates a period where it can be a little bit lumpy. As customers wait to hear the data to make their informed decisions, so they can position themselves appropriately on the raw materials from us.

So will Q4 see a pickup or is that going to be a Q1 event?

I think we'll see a little more clarity, certainly, by Q4. I expect the pickup not to happen though until Q1.

Okay. So it's safe to say that, that's not an October number, the non-energy kind of ramp?

Right, correct.

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

Wanted to ask a follow-up on EOR. It seems like your not able to hit your target this year and right, how is that shaping up and what are kind [indiscernible] that are slowing it down in your [indiscernible]?

Yes, your question kind of broke up there, Brian, but I think we kind of infer that you're saying we're not exactly pleased where we are with EOR, was that the question?

[indiscernible] .

Yes, for some reason, we've got a bad connection there with you. But just kind of an overview with EOR, for the benefit of the other folks listening in. Our basis for EOR was to get to where we felt by this time of the year when I was talking about it a year ago, our expectation would be to have as much EOR activity on a monthly basis as we were generating internationally, which we felt would be in the neighborhood of $1 million or actually generating appreciably more than that internationally, just because of the growth that we've experienced internationally. But the EOR effort, I think, the folks that are dialed into that the amount of publication, the amount of interest in EOR is very apparent in terms of trying to understand that market and that segment of the market, and it's just taken us, quite frankly, a little bit longer than we thought it would to be embedded the way we wanted to be. I think early on, I've said, we've got one chance to make a first impression, we still believe that, in terms of the clients that we're engaging with, that they are seeing improvement with. We're still committed to EOR, that's why we're in conversations with Eclipse regarding that acquisition that also brings polymer technology into our EOR portfolio. And again, it's -- candidly, it's taken us a little bit longer than what we thought, but that doesn't deter us from where we think we'll get to.

Our next question comes from the line of Rudy Hokanson from Barrington Research.

A couple of questions. One, could you elaborate a little bit more on CnF 2.0? Because I know in previous conversations, we've talked about the fact that you essentially customize your CnF product as required for individual customers and where they are considering to use it. But CnF 2.0 is something that you've talked a little bit about in the past, and then it seems to come up every now and then. And now it's more than announcement. So I was wondering if you could, maybe elaborate on that? And then I'd like to just have some update on your Drilling Technology, the SSI, the lift system. And also in the Artificial Lift, the Stemulator, what you're finding in terms of customer responses?

Sure. Kevin will -- thanks Rudy, we'll answer those in the sequence of which they were asked. Kevin, will take the first one for you with CnF 2.0.

Rudy. As you may remember from the conference out in California -- or in Florida, the CnF 2.0 took about 2 years to develop. The primary objective with CnF 2.0 was something that our clients could pump at half the concentration. So pump half as much and get at least as good a result. And we anticipate 2.0 will become a family of products that fulfill that need. But until the third quarter, we have pumped, I think, just a couple of jobs and begin gathering some production data. In the third quarter it jumped up dramatically, we had multiple wells in 3 different basins for different operators and since then, we've had a few more wells down in the Eagle Ford that have gone in the ground. So by the end of this year, we expect to begin seeing the early returns of production enhancement from the CnF 2.0 in those basins. Right now, it's just a single product. As I said, we will begin developing CnF 2.0 for other basins but it appears to be performing, at least as well as we anticipated, and after 90 days of production, we'll have a much better idea of where the 2.0 comes in. But we're really pleased in how it kicked off in a bigger way in the third quarter. I'll turn it over to Steve for the SSI and Stemulator discussion.

Hello Rudy, from the SSI perspective, the last couple of days I've stood up in Wyoming, as we've been looking at our sales, we put out 5 units in the third quarter and what is transpiring with that is, the customers up in the northern part are doing a kind of a run and see during the winter months, it's new technology to them, its new product for us putting out. They're wanting to make sure that the bitter winter in North Dakota months don't have a service affect on these units, which since they were originated in Canada, were not too worried about that, we feel like we'll be fine. So I expect more uplift in the first and second quarter of next year, as we get more months of operating time and can go in and talk to the people, talk to the customers and clients about our performance in the nasty weather of the North. As far as the Stemulators go, we're very excited about that. We, finally, after several technology movements, adjustments to it. We got through in the third quarter and we ran in the month October 3x the revenue, as you saw in there, that we did for the entire quarter of startup. So and we're still seeing the steam on that a lot. It's just getting introduction with a brand new product into the field. But we are as excited about it as we have talked all along. We see no reason to have a hiccup with it on a go forward. And we do expect to see in the following years, substantial revenues contributed by the Stemulator in all areas across the United States.

Our next question comes from the line of Roman Kuznetsov with Gates Capital.

It's actually Jeff. I have a couple of questions. But the $3 million of sales that you lost in Colorado during the quarter, I guess it was CnF, primarily. So what would the flow-through gross margin, typically, be on that $3 million of incremental sales of that highest margin product?

Yes. We don't really publicly put that out there, Jeff. I think, everybody pretty well understands CnF is our prime gross margin product. But safer to say, it had a measurable impact on the financial performance at the end of the quarter, that's for sure.

The other question I have was the -- how should we be looking at the growth rate, the next 2 or 3 years on the core chemical side?

Well, we put the statistic in there. From where it was in 2009 for now -- till now for a reason and that was to illustrate for folks that may not have kept track of just how far we've come and what, I think, many people would describe is, at least, if not a complete headwind, at least a partial headwind market. So with respect to CnF, we've consistently said that by this time, at the end of 2015, we expect to have 3x as much activity with CnF as we do today. We see nothing that changes our view of that opinion. The core rest of the chemicals, we expect to continue to grow at a rate slightly above wells drilled. I think, everybody understands now that the rig count is kind of an outdated measure of activity. It's now much more of what people refer to as service intensity and there appears to be an indication that these fracture completions are growing in volume, which will drive more the friction reducer and chemicals of that nature. So but again, we see nothing to make us waiver from our view that within 2 years, the end of will be at the pace of 3x the activity of CnF that we are today.

And then my last question is, how would you handicap the integration of Florida Chemical so far and how soon, might you be ready to take on something else on the acquisition side?

That's a great question. We would give ourselves somewhere around B to a B+. But we set also kind of pretty high standards for ourselves. The integration of JD Edwards is moving quite nicely. All the financial numbers are blended through the central system will be fully integrated with JD Edwards by the end of the year with Florida Chemical. I think, that for the folks that have been with us as long as you have, I think 2 years ago, we made a statement that it would have been absolutely irresponsible for us to consider an acquisition of Florida Chemical size without an ERP system like JD Edwards. So the fact that we can have that completely ingrained within 8 months or so, we're pretty proud of, and to directly answer your question, we would be prepared in 2014, to embrace if the circumstances are right and the value is right. Another meaningful acquisition if that were in the best interest for Flotek.

And as far as other capital requirements, how much capital will Oman, your share of the Oman construction require as a capital contribution? And what would your -- you anticipate your range for CapEx for 2014?

Yes, so we consistently said about $6 million is our part of the Oman endeavor and to be fully candid with you, we're in the planning stages right now for the 2014 plan. Inherent in that plan is what we expect capital to be at the outset going in. We don't expect it to be any more than what we envision for this year. As you heard us say earlier, actually, our actual capital is less through the third quarter than what we anticipated it to be, but we don't expect 2014 to be at the rate any higher than what we expected for this year.

Our next question is a follow-up question from the line of Rudy Hokanson from Barrington Research.

I was just wondering, and I know that you don't get that specific about this John, but my impression with when customers approach you about using CnF, maybe this is something Kevin would like to comment on, that you do have a lab and do research on cores and you look at what their formation is about and what you need to tweak with your particular cocktail or the ingredients for the CnF to be used there. I was just wondering, is there a way to talk about backlog of customers waiting to find out what you can construct for them? Or the number of customers, maybe in queue waiting for interest rather than -- it sometimes -- and the reason why I'm asking this is that, I gathered that there might be more pent-up demand than the revenue numbers show and it has to do with matter of making sure that you have the right thing to go out and work with them, not just sell something off the shelf. If you can maybe comment on that or talk about what you're doing to make sure that you address everybody's needs?

Sure. I'll answer that for just a second, I'll turn it over to Kevin. I think one thing that we have certainly discovered through the commitment to research is the value of customized chemistry, and it may or may not be written when the history books are written. But we really believe that we took a leadership role of illustrating that the shale is not the shale is not the shale. And it is all different. And now Kevin can talk to, maybe, with a little bit more specificity of your question about pent-up demand and backlog at our Woodlands research facility.

John. Yes, Rudy, you're a perceptive guy, this lab test that we do for clients continues to build. Our win rate is pretty high. When we have a customer committed to provide his core, their oil samples, their frac fluid samples so that we can run the tests in our lab, we have a pretty high win rate from there. The backlog through the beginning of this year or the resident's time in our lab of all those samples in order to get it sort of a final answer of what, which product is best for a customer to use with about 3 weeks and that number has been increasing. We've added people, we've added equipment, but we're gaining ever more of those samples in. The things we look at in the lab are things like the rock itself, how does it absorbed and spend up our surfactants, the oil, what is the properties of the oil and what do we need to do in terms of thinning and demulsification and scrubbing that oil. [indiscernible] has a lot to do with performance. So we have a number of tests that have to be performed and typically, with the backlog it had been 3 weeks is probably more like 4 weeks in the lab now that we've added, as I've said, resources to address that. But it's a very important part of customizing that chemistry but as John says, the shale is not the shale, it's not all alike.

So while you you've been adding capacity, the backlog continues to go up?

That's correct. And we measure that backlog, both in terms of number of samples that are in the lab to be tested. And just that residence time of what it require -- how much time it requires to get a test that comes in today before we have the answer to the customer.

Okay. Can I just ask after you go through and have that answer to the customer, what's the normal time until the sale is realized? I mean, all the way from getting the okay from the customer to making up whatever kind of batch you need to make up and then dispensing it or shipping it and recognizing it as revenue. What sort of the lead time how long does it take when somebody comes in and says "I've heard about this, I really want to do it." How long do you have to say, "well, will be -- the fastest we can get it to you is x or something?" Do you have a ballpark on that?

It's really, Rudy, kind of depends on the customer what his activity, his or her activity levels are with the pad drilling that goes on today, where there are drilling multiple wells from the same pad, the amount of frac-ing that goes on 24/7 is quite a bit higher than when they were out there drilling the [indiscernible] because they can things so much faster, and so the time from the conclusion of a test can be anywhere from a week or so. If they've got an ongoing pad that's being fracked everyday out there, it can go fairly quickly. But some of these clients, and the ones who are maybe not quite as active and the ones who are maybe a little more perceptive that come in with some lead time, their project may not start for a couple months. So it can range from a week away to 2 to 3 months away, depending on when the client's project actually kicks off.

And just a question in regard to the pad drilling, as we are seeing more and more companies announce results of being able to go down through various benches and again, knowing that even though they might be standing on top of the same location, there could be several different formations that they're going through. Have you had to address somebody coming to you and saying, "We really want to use it but by the way, we have got 2 or 3 locations at the same time that we want to be doing?"

Yes. The bigger plays, the South Texas Eagle Ford play has Buda and Austin Chalk, overlying that Woodbine in some cases, the Bakken has Three Forks in [indiscernible] and other benches up above the Bakken. The Permian of course, is famous for 1,000 feet of stack pays out there, so when we talked about running the samples and running the test in the lab we're running it for one of those pays. If they've got multiple pays and they're actually exploiting multiple pays and there is more testing to be done because each pay even though it's in the same -- from the same pad or from the same county, can be different. One thing I will say though, is that the pad drilling -- my belief is -- offers better opportunities for clients to really benchmark the performance of the CnF because now we're drilling 5, 6, 10 wells off the same pad that are all pretty close together versus wells that are kind of remote as they delineate the field. Now, we've got a great test case where they can pump CnF in 3 wells and not pump CnF in 3 wells and directly compare those results from wells that very close by. It's very useful for the operators and for us to be able to benchmark the performance of the CnF, and we're very happy with the pad drilling concept.

And our last question comes from the line of Keith Maher with Singular Research.

Question about -- all right -- just you were talking about the CnF and seeing some market penetration beginning to accelerate, and I know you've touched on this a little bit just a little bit more color there as to why you think that's happening at this point in time?

Well, the process takes time. We've tried to really try to put this in a framework that it's not a step functional change in terms of activity, that it will take time to realize that and it's a culmination of there is now more publicity. There was an American Business Congress meeting in Houston on the Eagle Ford completions, a particular operator by the name of Plains that's now been sold to Freeport McMoran, that operational CEO manager reviewed different technologies in that, that they had tried to improve their EUR and the one they could see real benefit from was CnF, 2 others didn't make the grade. That was a very important event for us in terms of having independent validation from an operator in that community, particularly, with respect to the Eagle Ford, and there's just more and more acceptance that's developing in the marketplace. Its not atypical of this than other technologies, not only in this industry and others in terms of the growth that you expect and that's the way it's playing out.

Okay, great, that was helpful. Question on the terpene-based xylene replacement, I don't think you have revenues from that yet, but just curious as to when you may and just are you looking maybe if you could talk about some of the markets beyond oil and gas where that might have some applications?

Right. Actually, we do have revenues for the xylene replacement initiative, we talked about early on in the quarter some revenues, and Josh, can talk to you certainly in general terms of some activities with cleaning, steam cleaning of solvents and all that, that we're trying to replace xylene with completely unrelated to going into the oil and gas flow. But Josh, will give you a background on that.

Yes, the terpene chemistries and on the xylene replacement. Everyday, we continue to get more and more calls. We had a great meeting yesterday with a group that has the potential to expand to a couple of million pounds of new volume next year. So we continue to get more calls from whether it's the E&P companies or service companies that are looking at alternatives. They're not completely, I mean, they're not required to move. So it is a little bit of a slower play. But whether it's cleaning out dump trucks up in Canada that have all kinds of asphalt teams that make them less inefficient, whether it's going down into the well bore or whether it's cleaning wellheads or other equipment, there is numerous opportunities for us to replace the BTEX compounds, not only in oil and gas but also in other related industries as we look at -- look across that were into the CICT group as well.

That was helpful. A question on SG&A, obviously it ticked up recently as a result of a Florida Chemical acquisition, but it looks like its come back down this quarter. I was just hoping you give some guidance going forward as to what level we should expect SG&A to be at?

Yes, from a pure dollar standpoint, we don't see anything materially that will affect the dollar number. We've done most of the heavy lifting to get us into a position of to where it is now. So as a percentage of revenue, that SG&A number will continue to trend down. We look at it a couple of different ways. We slice it, not only in the SG&A of the company, but what we would call the corporate SG&A, specifically dialed in just to the corporate and that number, over the last 3 quarters has trended down as well. So we feel very good about where we are with the SG&A and the ERP initiative actually has had a positive effect on that in terms of the efficiency of the accounting and finance effort at Flotek.

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

Thank you very much, and thank you, everyone, for your support of Flotek. It's right before the holiday season. We hope everybody has great holidays. And we look forward to speaking to everyone again early in the New Year and thank you, again for your interest in Flotek.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.