Good morning, and welcome to the Flotek Industries, Inc. Fourth Quarter and Year-End 2015 Earnings Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of the company’s prepared remarks. An operator will provide instructions on how to ask questions at that time. [Operator Instructions]. This conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Edmonds, Senior Director of Corporate Finance and Strategy for Flotek Industries. Mr. Edmonds, please go ahead.

Thank you and good morning. Today’s call is being webcast and a replay will be available on Flotek’s Web site. Our earnings and operational update press release, as well as our annual report filed on Form 10-K with the U.S. Securities and Exchange Commission were filed and distributed last evening and are also available on the Flotek Web site. 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 teleconference may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and other applicable statutes reflecting Flotek’s views 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 exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and the financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek’s filings with the U.S. Securities and Exchange Commission. Now, I would like to introduce Mr. John Chisholm, Flotek’s Chairman of the Board, President and Chief Executive Officer. John?

Chris, thank you. I would also like to welcome each of you to Flotek’s fourth quarter and full year 2015 conference call. We are glad you are here. With me today are Rob Schmitz, Flotek’s Chief Financial Officer; Steve Reeves, our Executive Vice President of Operations; Josh Snively, President of our Florida Chemical subsidiary as well as our Executive Vice President of Research and Innovation; and Richard Walton, Flotek’s Chief Financial Officer, Emeritus. Last evening, we filed our annual report with the U.S. Securities and Exchange Commission. While we won’t take your valuable time to regurgitate all 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 a couple of opening comments. As we noted last night, Flotek reported revenue for the year ended December 31, 2015 of $334.4 million, a decrease of 114.8 million or 25.6% compared to the year ended December 31, 2014. As we noted last evening, the current oilfield environment as we experienced last year and continue to face as we begin 2016 is the most difficult unforgiving market I have seen in my entire career. The accelerated decline in overall activity from drilling to completions and even production enhancement has created overwhelming challenges for many industry participants. While Flotek was not immune to the sharp market deterioration, continued opportunities in our patented hallmark CnF completion chemistry business did provide us with some shelter from the otherwise tsunami-like declines in overall activity. That said, as we look into our very clouded crystal ball, we consider the possibility of additional challenges and uncertainty in the coming months, and are working diligently to prepare our firm for the potential rocky…

Thank you, John. As John mentioned, Flotek filed its Form 10-K for the period ended December 31, 2015 with the U.S. Securities and Exchange Commission yesterday afternoon. Flotek reported that revenue for the quarter ended December 31, 2015 was 77 million, a decrease of 38.1% compared to the same period of 2014. Revenue decreased 12.4% compared to third quarter 2015. For the full year 2015, the company reported revenue of 334.4 million, a decrease of 25.6% compared to the full year 2014. The decrease in revenue was primarily due to the drop in oilfield market activity as reflected by the 47.8% decrease in average North American active rig count from 2014 to 2015. Flotek reported a loss from operations for the three months ended December 31, 2015 of 2.1 million, a decrease of 25.6% compared to 23.6 million in the same period of 2014. Income from operations decreased 4.8 million compared to the third quarter of 2015. Flotek reported a loss from operations of 19.2 million for the year ended December 31, 2015. Excluding the impairment charges taken in the second quarter of 2015, we reported income from operations of 1.2 million for the year ended December 31, 2015. We reported a net loss per share for the fourth quarter of 2015 of $0.03 per share compared to $0.29 per share for the fourth quarter of 2014. For the year ended December 31, 2015, the company reported a net loss of 13.5 million or $0.25 per share fully diluted compared to net income of 53.6 million or $0.97 per share fully diluted for the year ended December 31, 2014. Excluding non-recurring, non-cash charges taken in the second quarter, Flotek reported a net loss from continuing operations of $31,000 or a flat per common share for the 12 months ended December…

Rob, thank you very much. Before we take questions, I’d like to add a few concluding thoughts. As I noted earlier, as challenging as the current market environment may be, Flotek’s challenges would have been even more significant without our patented hallmark CnF suite of completion chemistries. In a market that showed steep declines year-over-year and even from the third to fourth quarter, CnF volumes continue to increase. Sales volumes of the company’s CnF suite of completion chemistries increased 18% in 2015 when compared to 2014 levels; fourth quarter volumes increased 5%, sequentially. Year-over-year revenues were down approximately 8% while fourth quarter revenues grew approximately 1%. As noted last evening, the decline in revenues relative to volumes is primarily the result of product substitution, the introduction of a less expensive yet equally or more effective formulation of CnF and volume-based price incentives rather than simple ad hoc price reductions. Moreover, interest in CnF chemistries continue to grow as we concluded 2015. During the fourth quarter, the company completed 17 validations for operators across diverse basins and plays including the Permian, Anadarko basins; Eagle Ford, Utica and Bakken shales; and the STACK and Mississippi Lime plays. While validations may be slightly extended as a result of current market fundamentals, Flotek continues to see meaningful opportunities as new clients search for ways to maximize economic benefits in a challenging commodity price environment. In a new application opportunity for Flotek chemistry, Flotek completed its first offshore FracPack treatment using CnF chemistries in the Gulf of Mexico. And the company continues to find success in CnF assisted well remediations, a trend we believe could continue in an environment with more moderate commodity prices. Finally, while CnF activity was relatively resilient in the quarter, the non-CnF portion of the energy chemistry segment was challenged. The…

Thank you. [Operator Instructions]. Our first question is from the line of Matt Marietta with Stephens Inc. Please go ahead.

Hi, guys. Good morning. Thanks for taking the questions.

Sure.

Wanted to start first kind of on the competitive landscape here. We all hear anecdotes, a fear of a threat of imminent competition. Sometimes these are smaller companies [indiscernible] companies, stuff like that with no history of really customized chemistries trying to copy all success. There’s few public competitors out there on the energy chemical side and those that are competitors are sometimes ironically these larger public frac companies, they’re also some of your largest customers. So, I’m trying to understand a few things here. One, first, are you aware of any competitors out there still trying to clone your CnF technology? Second, what can you do to maintain the high barriers there? And finally, if these competitive products are finding their way into the wells of any of your existing customers, maybe help us understand the competitive landscape and elaborate on that, if you can?

Sure. A great series of questions, Matt, and I’m sure other folks are thinking the same thing. Overarching, we focus on our continuing commitment to research and innovation, which we can control. It’s very easy for someone to say that they have something that is like CnF but doesn’t infringe on our patents. But I want to remind everyone that CnF is not just one product. It has 38 custom formulations. It has gold band certification in the North Sea, which is the best environmental rating. It has recently passed a no sheen test in the Gulf of Mexico, which let to, as I mentioned earlier, our first work in frac packing in the Gulf of Mexico at a loading significantly higher of per gallon compared to normal onshore loading. And we’re not aware of losing any opportunities to what we’ve described as a competitive CnF with our existing client base. Is someone using something that’s represented or similar to companies we’re not aware of, could be. But in terms of the client base of Flotek, we’re not aware of losing any opportunities to quote a competitive CnF.

Okay. Thanks for that. And moving over to the validations, I think you guys said that there were 17 concluded in the quarter. How many of these validations are with large potential customers? You guys specifically highlighted a group of large companies in progress at some point in the past. And how many are with small and midsized companies? Maybe help us understand the contribution potential or demand potential of these customers that concluded their validations in the quarter.

Yes, so that’s a good question and we’ll say that more than half of those validations are what we would consider to be larger companies. And the reason why we feel that’s important is just to the size of the company. It’s our estimate that the larger companies have the same power to drive through this cycle as opposed to perhaps some companies that just may have a one or two rig running program. From just a standpoint of I think good business practice, we’re not going to specifically call out who those folks are. We’ve mentioned them in the past. I think the fact that the volumes of CnF speak for themselves in terms of the increase in the fourth quarter, I think we’ll leave it at that. But more and more of these validations are what you would consider larger companies.

Thanks. And then one more out of me here and I’ll jump back in the queue. Now that this kind of snake-oil narrative is behind us by the sales volumes and MHA, other third party analysis of the efficacy of CnF. I really want to dig into cash flows of the company but when I look at the segments, you have this Energy Chemical Tech business. It’s actually exited 2015 at a higher rate than it entered 2015 for the year. I don’t cover any companies that have done that; the exit rate at about 50 million of EBITDA in Energy Chemical Tech. But when you look at the Drilling Tech in G&A that significantly offsets those successes. You guys snuck the strategic options in the press release. You mentioned it a couple of times already. Can you elaborate on what you can do there really to let your shareholders benefit from getting fair valuation on the CnF and on the Energy Chemical Tech segment, maybe some color there would be helpful?

Sure. We’ll let Rob answer the cash flow question but I think to be fair as to preserving all of our options, we try to address it as best we could in the press release and our prepared remarks. We recognize this is a very difficult environment for the downhaul tools. We’ve reduced the headcount there by over 30% from when this year started and we are continuing to look at ways to further reduce the expenses. The fact that we were able to outperform what the drilling rig count was in the fourth quarter I think speaks to the quality of our people. But we’re keenly aware that we want to make sure that the performance on the chemistry side of things is not unduly affected by that segment and believe me it’s got the focus. But Rob will give you a little bit more clarity on the cash flow.

Yes, I think from levers and cash flow standpoint of it, I’d add to what John said. We announced and reported in our 10-K that we expect to just spend between 20 million, 25 million in CapEx this year; 7 million of that is to complete our R&I lab. The vast majority of the rest of that is really revenue opportunity dependent. Certainly all the stuff in the tools business, the production technology business goes to generating rental tools that are going to be revenue producing. So if we don’t have transparency to those opportunities then we won’t spend that money. Similarly, in our Energy Chemicals business we’ve got some money in our budget that we’re not going to spend unless it’s an opportunity to align with another strategic player who needs some logistics help from us. So, there’s a lot of room for flexibility in our cash flow process related to our CapEx. And I’d just reinforce what John said that we’re looking at all of our segments, even some areas within our Energy Chemicals business that we think we have opportunities to potentially make some adjustments. So, you’ll be seeing more of those things as we go forward.

Does that help you, Matt?

That did. Thank you for the color there. Obviously, it’s difficult to talk about things in the works but thanks for commenting on that.

Sure.

Our next question is from the line of Georg Venturatos with Johnson Rice. Please go ahead

Hi. Good morning, guys.

Good morning, Georg.

I just wanted to speak a little bit more and maybe you can address just the conversations you’re having with customers post the FracMax issues. Obviously, we saw nice numbers relative to the rig count in the fourth quarter but just any commentary you can give us in terms of commercial impact, which appears to be minimal but wanted to kind of confirm how those conversations were going?

Great question. Again, I think it’s another one on lot of folks’ minds. Anytime you have a transformational product like CnF whether it’s in the business world or in the consumer world, you move through the cycle of early adopters and more into mainstream. And as you move more into mainstream, what happens is the clients that are using it are more freely talking about the benefit of the technology. And that’s what happening. I think you’re seeing folks at our conferences that are talking more about CnF if not publicly at least in breakout sessions that everybody on this call is familiar with. And so it’s moving into more of a communication from operator-to-operator, service company-to-operator and so that’s really part of the process. We’ve kind of anticipated that would happen that would be beneficial for us while we’re reshaping FracMax. And if there’s one thing I’ve learned in business, the most important factor is for your clients to trust you and ours do. And that’s why more and more of them are willing to share the benefit of what they’re seeing when they use CnF.

Okay, I appreciate that, John. And you mentioned the 17 validation programs you completed in the quarter. Can you give us any update in terms of framing that for reference in terms of what you’re working on today? And I know you gave us some numbers in previous quarters in terms of how that pipeline might look.

Yes. We have to be – and I hope everyone on this call understands that in particular in this environment in terms of forward-looking type comments with the legal situation that we’re in, we have to be a little bit more careful and reserved as to how we address that. But we’re pleased with the ongoing validations. And as I’ve mentioned in the past, the sustained rate of validations into ongoing client usage remains very high. And I think we probably should leave it at that and hopefully – but everybody can understand that.

Understood, understood. On the non-CnF side, you guys did a good job of addressing that certainly in the preannouncement and also talked about it in your prepared remarks. But how should we think about that going forward? I know you said you felt like it had troughed. Should that be more in line with the rig count on a go-forward basis? Is that how we should think about that business or do you think there’s still some pretty significant lumpiness depending on what frac tech they do going forward?

Well, and I want to remind everyone that in our – end of our third quarter call we put that out there because we’ve got a very good projected level of activity with that particular client and we told folks ahead of time that based on their input into us for supply chain management and all that, we pretty well telegraphed what the fourth quarter would be especially after Thanksgiving and sure enough, that’s what it was. But that particular client, you name them, their activity seems to be picking up and we participate then when that activity does pick up. Does that give you enough clarity or --?

Yes, that’s helpful, John.

Okay.

We can speak further about that later, but that’s helpful.

Okay.

Last one from me and then I’ll get back in, but I thought it was interesting your comment on the offshore side. Just wanted to get a few more details on that in terms of potential scope and where this could go, because I know we’ve talked about a potential for CnF and it has always kind of been boxed into the onshore space and just kind of wanted to see what your thought could come of, of what you did this past quarter?

Sure. So that particular client is moving on now to a second FracPack that is using us. The loading factor is significantly higher than what’s traditional onshore. We’ll keep that proprietary for obvious reasons. But we had to pass what people on this call are probably familiar with the no sheen test when you dispose of return fluids over the side, and we think that’s just one more environmental barrier for other people that our technology was able to pass. But a word of caution for everybody. The volume on these jobs are much, much smaller than horizontal frac jobs. So I think more than anything it further illustrates the efficacy of the CnF technology that folks can try to remember two or three years ago people were trying to say, well, it’s just limited to one type of rock and one basin. At the same time, we didn’t talk about it in our prepared remarks but we also were involved with a major acid job in the Middle East where the well was making 6,000 barrels a day, the projection was 9,000. They used CnF and it actually doubled to 12,000 for a national oil company there in the UAE. So again, folks typically think of – and we need to probably do a better of this – they typically think of CnF as one product, it’s not. There’s over 38 formulations. They typically think of it as one application in fracturing, it’s not. It can be used in FracPack, as I mentioned. It’s used in acid jobs starting to grow in the Middle East. But a word of caution is most folks know these FracPack jobs are just much, much smaller than even a vertical frac job on land much less a horizontal job.

Right. Thanks for the details, John. I appreciate it.

Sure.

[Operator Instructions]. Our next question is from the line of Darren Gacicia with KLR Group. Please go ahead.

Hi. Thanks for taking my questions.

Sure.

I wanted to follow up on a couple of points. Just to get some clarity because I don’t think it’s really broken. Is there any way you can frame what percentage of Energy Chemicals is CnF versus other, just so we can try to triangulate? Because I think I have a sense of what it may be on an historical run rate, I don’t know if it’s changed this quarter, and how we should kind of think of this on the modeling perspective going forward?

Right. Because of the drop-off of the non-completion or non-CnF business, it actually is now at the highest end that I think it’s ever been with Flotek at 70%. But Rob can you give a little additional color on that.

Yes, it’s a little over 70% for the quarter. I would just caution you in terms of modeling going forward that it’s going to be influenced by what we talked about earlier, which is how the market for the rest of our chemistry comes back in the next year. So it’s run historically kind of the 50 – 45% to 60% range. But it’s at the high point and I would guess that’s probably a ceiling or close to a ceiling anyway.

Okay. The second question, if I could, people have approached I think trying to understand the validations and the process a few different ways during the call. Can you maybe walk us through like what’s involved with kind of the timeline of a validation process? I noticed in the release you talked about timelines extending those, so I’m trying to get a sense of what it means to extend? Does that mean we kind of need further validation as to maybe what we’ve already had? And is there any impact from some concerns about FracMax that may be extending some of those validations as well?

Sure. That’s really – and great question. It’s really two ways to answer that question. Just by the overall activity, which as everyone on this call knows, one in environment of extreme conditions from companies that have filed Chapter 11 to the depressed rig count to the price of commodities, I think people just inherently move a little bit slower. So a four-well validation that might have taken a month six months ago may now take six weeks or two months to complete. So that’s one part of what we’ve talked about, the potential slowing of the validation. But again as I think most folks know on this call when your validations are moving into the larger sized companies, not that we haven’t been working with them before, but they typically take a longer period of time because they’re more bureaucratic in looking at the performance of anything new that they may try, whether it’s an increased sand concentration, whether it’s a different proliferation cluster whereas your smaller independents may look at a two-week, three-week or a month uplift in production and say, we’ve seen enough, we now want to move on. These more bureaucratic larger companies typically will take a longer period of time to evaluate any type of change they make in their effort to get more oil out of the reservoir. So that’s kind of a two-part answer to your question and hopefully that gives you some clarity.

Does that suggest that like of 17, more than half or maybe three-quarters are sort of larger customers within that mix or --? I know you’ve given some color on that in the call, just trying to get a little bit better sense of what the mix is at the 17 between large and small?

Yes, so I think I mentioned on an earlier question that a meaningful portion of those 17 are what people would classify as larger companies as opposed to someone that might have a one or two rig drilling program.

Got you. Thank you. I appreciate the help.

Thank you for your interest.

Our next question is from the line of Mark Brown with Seaport Global. Please go ahead.

Hello, Mark.

Mr. Brown, your line is now open. Please go ahead.

Come in, Mark Brown.

Okay. So we’ll go to the next question. We now have a follow-up question from the line of Matt Marietta. Please go ahead.

Hi, guys. I’ll feel the void there. One more out of me.

Sure.

You guys added the press release another shift of scientists in the labs up in Woodlands. Is this driven by current or future potential customers? I want to understand if this is a leading indicator of future CnF demand or are you just simply growing the support functions into current demand? Maybe help us understand why that’s in the press release.

Sure, and I’ll let Josh take the balance of that question for you, Matt. But it’s safe to say that we have more projects for more clients that they’ve sent us their – whether it’s their drill cuttings, their cores, their oil samples, their water samples to further refine and customize CnF than in any time in the history of Flotek. But Josh can give you some more color on that.

Good morning, Matt. To John’s point and just to put it in perspective and what we’re seeing within research and the interest in the CnF and the variety of CnF solutions that we can both provide to the marketplace, this fourth quarter we completed 110 client studies. If you look at that same fourth quarter period in 2014, it was 35 projects that we completed. So the interest and the workload is what drove the second shift. As far as the client base, it’s a pretty good mix. But we’re seeing a lot of the E&P companies come in wanting to understand, wanting to validate through our chemists, through our understanding which is the best chemistry that will be compatible with their water, oil, mineralogy as well as the fluid systems they’ll be going into.

That’s quite an increase. Thanks for the color there, really do appreciate it. Thank you, guys.

Before we maybe have the next caller, I just want to add on one thing to try to put that into perspective. We’re working for a particular client in the D-J Basin that I met with that on two different wells between – with a 12-mile distance between the two wells, the API gravity of the oil was a difference between 58 and 34. That requires custom chemistry to put the same CnF in both those wells with the absolutely not technically advanced nor giving the operator the best chance to maximize the performance of his well. And folks have heard us talk about this customized chemistry now for three years but I just wanted to put that into perspective of a real world example in the D-J Basin where it required two different CnF formulations just within 12 miles of each other.

[Operator Instructions]. Our next question is from the line of Mark Brown with Seaport Global. Please go ahead.

Hi, John. Can you hear me okay?

Loud and clear.

Okay. Thank you. A question on very strong gross margins in Energy Chem. and I just – in terms of your sequential performance, I was just wondering whether you’re able to hold pricing on CnF or have you had to give a little bit to the operators? And also just what you meant in the press release regarding product substitution and volume-based pricing incentives, if you have anymore that you can elaborate I appreciate it?

Sure. We’ll kind of try to take those one at a time. The product base substitution we’ve talked about really for about three calls now that through the effort of the R&I group, we were able to create a new CnF that has a lower cost structure to us that we’re able to pass on a lower pricing number whether it’s to Halliburton or someone directly but still maintain a very meaningful gross margin for us. And we felt that in this business environment, it was just the thing to do and again to try to further penetrate the market. So, when we talk about product substitution, it’s a product that we came out with early in the first quarter. It’s continued to gain acceptance with the results and performance. With respect to – we have to my knowledge I think two separate volume arrangements that when a certain client will exceed a volume of CnF pumped on a calendar basis, they get a modest price reduction whenever that happens. And that happened in the fourth quarter that’s now reset to the main pricing as of January 1. As we’ve said on the third quarter call, we had not price decrease with the core CnF technology throughout the year. And so in part the reason why the margin was at the number that it is, is when you have 70% of your chemistry sales coming through CnF, I think most folks on this call know, those carry a higher margin than the more traditional chemicals that we provide. That’s number one. But number two as we mentioned in the prepared remarks, it’s through the many, many years relationship that we have of sourcing citrus terpene on a global basis where we refine in north of 40% of the citrus terpene in the Western Hemisphere. We have a meaningful long cost input advantage of one of the main cost of our CnF that we were certainly aware of back in 2013 of that opportunity when we purchased Florida Chemical. It certainly has come to very important benefit in this environment and that’s one of the other reasons why that gross margin number is where it is. Does that provide context for you?

Yes, so very helpful. And just an unrelated follow up. A question on the timing of the reviews that MHA and perhaps other third parties are taking part in, you’ve kind of laid out the three basins where you’re going to review the efficacy of CnF, but what about the overall data analysis, the software review that the Technical Committee is undertaking. Should we expect that after the three basin studies or is that a different timeline?

So I think this is real important for everyone to understand who’s listening in on the call with respect to the engagement with MHA, because it’s been a period of time before we were able to create any level of clarity. MHA was hired by the Technical Committee with absolutely no guidance from Flotek after they looked at a series of companies that they felt could provide that service. The only guidance that we gave to the Technical Committee was we wanted a meaningful number of wells to be looked at in every geographic area. We wanted where it was applicable thousands not hundreds and if necessary hundreds not tens. We have absolutely no input as to the timing of their ability to return these reports. Because if we did, it would not be an independent study. So as much as I love to be able to tell you and the rest of the people listening that there is a scheduled timeline of expected deliverability as most times you have when you engage with consultants, there is absolutely no timeline directed, guided, implied by Flotek. The only guidance is do it thorough, do it right and take your time. And we just asked for everyone to have patience in that because it’s the proper way to do it. With respect to the analysis of the statistical FracMax, that’s ongoing. And maybe a little bit of clarity on that for folks. We are moving it from more of a – just a statistical app to more of a true software app and creating a more robust software foundation underneath it. And we’ll be able to give some more information on that in the weeks and months ahead. But that analysis is ongoing again by the outside committee and hopefully that gives you the proper clarity you need, Mark.

I appreciate the clarity. Thank you very much.

There are no further questions at this time.

Okay. Thanks for the questions. As usual, they’re all great and I’m sure they captured the thoughts of a lot of folks listening in. And thank you everyone for your support of Flotek. We appreciate your interest, are pleased you joined us this early and like everyone to have a great Thursday and rest of the week. Thank you very much.

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