Flotek Industries, Inc. (FTK) Q1 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Flotek Industries Incorporated First Quarter 2016 Earnings Conference Call. [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, you may begin.

Cathy, 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 U.S. 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 the 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 view about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and the financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek’s filings with the U.S. Securities and Exchange Commission. Now, I would like to introduce Mr. John Chisholm, Flotek’s Chairman of the Board, President and Chief Executive Officer. John, good morning.

Hey, Chris, thank you. I would also like to welcome each of you to Flotek’s first quarter 2016 conference call. We are glad you are here. Along with Chris, 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 Rich Walton, Flotek’s Chief Financial Officer, Emeritus. 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, tend 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 period ended March 31, 2016 of $72.3 million, a decrease of $10.1 million or 12.2% compared to the same period in 2015. As noted in our release yesterday, current oilfield environment, as we experienced last year and continued to face in the first quarter is the most difficult unforgiving market I have seen in my nearly 40-year career. The accelerated decline in overall activity from drilling to completions and even production enhancement has created overwhelming challenges for many industry participants. Consider that from December 31 of last year to April 1 of this year, the active rig count as measured by Baker Hughes dropped from 781 to 499. That is a decline of 282 rigs or approximately 36%. In just 90 days, over one-third of all drilling activity evaporated, following one of the weakest years in recent memory. To put it another way that is a decline of over three working rigs per day. No oilfield service company, much less an energy technology company like Flotek can completely escape such a swoon in activity. That said, while we were not and are not immune to the sharp market deterioration continued opportunities and our hallmark speed of completion chemistries did provide us with some shelter from the otherwise tsunami-like declines in overall activity. However, unlike on our year-end call when we had hypothesized that our world was likely to face even greater challenges in the months ahead, today we are, while still very cautious, somewhat more sanguine about the energy market in the months ahead. While we believe there is still market rationalization and consolidation likely in the second quarter, we do see very early signs of regeneration in the oil and gas markets. Simply, the deconstruction of the industry and company fundamentals both financial and operational will not be fixed overnight. However, we are beginning to see more commercial and strategic opportunities than we have seen in the past six months, generally an early indication of a cyclical inflection point, although we remain somewhat guarded in our optimism until additional data confirm our preliminary assessment. Regardless of our assessment and indeed hope that the energy markets are slowly healing, we remain acutely focused on efficiency and liquidity while working to preserve our options to pursue value-creating opportunities as they present themselves. We are fortunate that even after the impairment announced last night, our balance sheet remains strong and we believe our current liquidity position provides the necessary flexibility in the current environment. As I said on our year end call, liquidity remains a core canon of our financial leadership and we will do our best to protect, preserve and propagate liquidity to ensure a diverse range of capital options remain available to the company. In addition, we continue to consider a wide range of options that we believe are aimed at improving value for all of our business units. While such strategic opportunities take time and are more difficult to navigate in a challenging market, we believe there are real opportunities to showcase the value of our businesses to our stakeholders and others. While there is no assurance that any of the potential options will be successful, we made progress during the quarter and are acutely focused on executing our strategy to focus on our core competencies while seeking alternatives for other ventures that maybe more valuable to others than they are to Flotek. Assessing existing and future businesses’ potential and sizing the business appropriately is an important step in that process. Finally, as I have noted before, Flotek’s focus on innovation will remain a hallmark of our strategic mission. As noted last night, we can see the finish line in the race to complete our new global research and innovation facility. The state-of-the-art facility will, we believe, provide Flotek with a world-class platform for advanced research and the infrastructure to be the global leader in advanced oilfield chemistry research tomorrow and well into the future. In combination with our academic and commercial research partners, we are excited about our opportunities to be one of the elite oilfield chemistry firms that has the capacity to provide solutions to a complete spectrum of challenges across the lifecycle of the well both here and abroad. Even as we begin to see a glimmer of light at the end of the proverbial tunnel, I know a plethora of challenges both known and unknown remain for Flotek and the industry in the coming months. However, as I have said just 90 days ago, I do sleep well at night knowing Flotek has built one of the best teams on our industry, from our corporate leadership and support team in Houston to our technicians and client services folks from Williston to Waller and Denver to Dalton. Make no mistake, we are acutely aware of how our world has changed and know that the challenges in front of us are substantial. As such, we are focused on ensuring the appropriate balance between caution and opportunity making certain that our business is appropriately sized to a more constrained and volatile opportunity set, yet not lacking the resources to seize what we believe will be an abundance of business opportunities as we navigate through the current cyclical climate. As I said last night, our goal in this environment is to balance short-term liquidities with long-term opportunity. If we are able to do so, the potential for Flotek as we accelerate from the nadir of this cycle is significant. As I have said on each call since I took the helm now six 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. Today, once again, we are refocused on our vision to restore growth to the company, continue to be enthused that through the efforts of our people, the future will once again present opportunities to create value for our stakeholders. As I conclude these remarks, I ask you to remember as I remind myself nearly everyday what Flotek is all about. Flotek is at its core an oilfield technology company with a focus on the innovative chemistries and other products and services that make a difference in the productivity of a well at every point in its lifecycle, from the spudding level well to the last barrels of production. And our objective is to make a positive difference for our clients, so we can in turn create positive opportunities for our employees, the communities in which they live, and most importantly you, our shareholders. While we may not always get everything right, we will strive even in the most difficult of environments to do the right thing for all of our stakeholders. With that, I would like to turn the call over to Rob Schmitz to review our first quarter financial highlights and provide some additional color on certain financial issues. Rob?

Thank you, John. As John mentioned, Flotek filed its Form 10-Q for the period ended March 31, 2016, with the U.S. Securities and Exchange Commission yesterday afternoon. We reported that revenue for the quarter ended March 31, 2016, was $72.3 million, a decrease of 12.2% compared to the same period of 2015. Revenue decreased 6.1% compared to the fourth quarter of 2015. Flotek reported a loss from operations of $46 million for the quarter ended March 31, 2016. Excluding the impairment charges taken during the quarter, we reported a loss from operations of $5.6 million for the quarter. For the first quarter of 2016, we reported a net loss of $30.2 million or $0.55 per share compared to a net loss of $1.5 million or $0.03 per share for the quarter ended March 31, 2015. Excluding non-recurring, non-cash charges taken in the quarter, we reported a net loss from continuing operations of $4.6 million or a loss of $0.08 per common share for the three months ended March 31, 2016. Earnings before interest, taxes, depreciation and amortization, excluding the impairment or adjusted EBITDA, for the three months ended March 31, 2016, was a negative $1.4 million, a decrease of $4.5 million compared to $3.1 million for the first quarter of 2015. We recorded an income tax benefit of $16.4 million for the three months ended March 31, 2016, compared to an income tax benefit of $0.4 million for the comparable period of 2015. Accounts receivable, net of the allowance for doubtful accounts at March 31, 2016, was $45.6 million compared to $49.2 million at December 31, 2015. The company’s allowance for doubtful accounts was 1.9% of accounts receivable at March 31, 2016. As noted in our filings last evening, during the quarter we reassessed our drilling and production technologies segments. As a result of a careful review of the current business environment, our long-term view of the businesses and resulting changes in our approach to the businesses, we recorded a $40.4 million non-cash impairment charge on long lived assets and inventory. This accounting treatment is consistent with our ongoing strategic review of the businesses, which continues today. In addition, Flotek and its lending group, led by PNC Bank, entered into an amendment to the company’s existing credit facility to provide additional financial flexibility as the company navigates through the current cyclical trough. Under the amendment, the financial covenants to maintain a fixed charge coverage ratio and a ratio of funded debt to adjusted EBITDA were suspended until June 30, 2017. These covenants will be reinstated due required compliance with these ratios for the 12 months ended June 30, 2017 and continuing as of the last day of each fiscal quarter in the future. The amendment establishes a requirement to maintain certain minimum adjusted EBITDA levels for the periods ending September 30, 2016, December 31, 2016 and March 31, 2017. For purposes of this requirement, adjusted EBITDA includes the add-back of non-cash stock compensation expense. In addition, until June 30, 2017, the company is required to maintain under its revolving credit facility a minimum average un-drawn availability of $10 million, including a continuing un-drawn availability of $5 million. The amendment reduces the annual limit on capital expenditures during 2016 to approximately $25 million. The annual capital expenditure limit returns to approximately $32 million beginning in fiscal year 2017. Excluding the impairments, the covenants would not have come into play during this quarter. However, the amendment provides us with additional financial flexibility as we navigate through the cyclical trough without jeopardizing our liquidity needs in the coming quarters. There is a little question that the market deteriorated rapidly in the first quarter, which has impacted Flotek as well as nearly every other oilfield company in North America, if not around the globe. There is no doubt that our operating environment has changed meaningfully in the first three months of 2016, which will require even more focus on cost and efficiency. We have taken meaningful cost reductions as part of our resizing of the drilling segment, as well as additional actions elsewhere in the organization and we will be taking further actions in the coming months. As John said, we intend to be very vigilant in protecting our liquidity, rationalizing cost and making certain that we are maintaining a high level of financial flexibility even as the industry searches for the next cyclical inflection point. Even in a challenging market, we believe our actions both recent and pending will provide adequate room under our current credit obligations. Thank you. I would like now to turn the call back over to John for some closing remarks. John?

Rob, thanks a lot. Before we take your questions, I would like to add a few concluding thoughts. As challenging as the current environment may be for Flotek and the rest of the industry, it would be even more so without the benefit of our patented hallmark CnF suite completion chemistries. Even in a market marked by accelerated record activity declines, CnF held its own and then some. Compared to the first quarter of 2015, sales volumes of CnF in the first three months of 2016 more than doubled, with revenues increasing by nearly 91%. On a sequential basis, CnF sales volumes declined by just 7.3%, while revenues declined by just 6.5% compared to rig count, which fell by 282 rigs or 36.1% from December 31, 2015 to April 1, 2016. Moreover, we continued to see new interest in our CnF completion fluids. We executed validations with 20 companies, from small private operators to large independents and across the country, from the Rockies to the Appalachians, during the first quarter. While securing validations requires a bit more effort in the current environment, there is no shortage of prospects who are willing to invest in technology that provides a significant uplift in production and cash flow in the current operating environment. In addition, as noted last night, the positive impact of CnF for existing clients is providing nice peer marketing opportunities that result in referrals of potential new clients from existing clients. There is nothing more flattering or effective than a satisfied client sharing the Flotek experience with peers and colleagues. We are deeply appreciative of that type of support. Not only our existing clients providing key referral opportunities, they are also beginning to use higher loading levels of CnF, which adds to overall volumes. As noted yesterday, a major client is beginning to validate the benefits of higher loading levels. In addition, a number of validations are prescribing loading to 2 3 gallons and even 3 gallons per 1,000 gallons of completion fluid, looking for the optimal cocktail to boost production. In contrast to the strong performance of CnF, it’s fair to characterize our non-CnF chemistry business as less robust, largely due to the overall decline in completion activity during the quarter. We continue to work diligently to keep our existing client base, as well as develop new opportunities, which we believe are possible with our expanded chemistry offerings in the coming months. One such breakthrough technology is our recently introduced multi-patented pressure reduction chemistry we believe will change the way completions are executed. Building on years of experience in developing customized completion fluids, Flotek’s new patented PrF fluid technology has undergone validations and is currently being marketed commercially. As the next generation of pressure and friction reduction technology, Flotek has created a more efficacious chemistry that should reduce overall well cost, while improving performance and reducing damage to production structure caused by legacy friction reducing fluids. The commercialization of this new chemistry, which will contain at least 25% less polyacrylamide and require up to, in many cases, 50% less volume than traditional friction reducers is underway with over a dozen opportunities across multiple operating basins. In short, while our enthusiasm is measured as a result of current fundamentals, we strongly believe we will continue our chemistry success as we focus on the one fundamental question. What chemistry technologies can Flotek design, create and innovate that give the reservoir a better opportunity to produce hydrocarbons? Not only does PrF allow us to expand our chemistry offerings, it should combined with CnF and other chemistries allow us to further leverage our direct distribution efforts as we work toward offering a total fluid solution for our clients. And with our Research and Innovation team, we will strive to create a total solution that is customized for our clients with precision to address the specific basin and field completion challenges. Flotek’s international business continues to grow now under the leadership of Nicolas Lopez who spent nearly two decades in various leadership positions at the largest global integrated service company. During the quarter, Flotek completed its first three wells with CnF completion chemistry with Argentina’s largest energy company. In addition, the company’s CnF completion chemistries are being used ubiquitously in acid recipes for new wells by a major operator in Abu Dhabi. The initial results resulted in additional work with ADNOC. In fact, the OTC just this week, I met with the Director of Strategy and Coordination at ADNOC, Ali Khalifa Al Shamsi. His response to my inquiry about the impact of CnF on their acid work was John chemistry matters. We appreciate Ali’s confidence. Away from the energy sector, Flotek’s consumer and industrial chemistry technology segment posted solid results, with year-over-year sales growing over 42% and sequential sales up 41%, in large part a result of improved pricing and market share. In anticipation of one of the smallest orange crops in modern history, combined with increased demand for the company’s flavor and fragrance chemistries, Flotek’s Florida Chemical subsidiary built inventory during this quarter. In addition, Florida Chemical has recently joined a consortium of citrus stakeholders from a scientific, academic and commercial arenas that is working together to develop solutions to citrus greening. Florida Chemical, combined with the Flotek chemistry team, is actively involved in developing chemistries that combat greening and will work with the Citrus Research Development Foundation on a wide range of solutions to address this industry challenge. Before we take your thoughts, a couple of concluding – excuse me, before we take your questions, a couple of concluding thoughts. As I indicated earlier, the last 15 months have been challenging on a number of levels, the greatest of which is knowing that regardless of how hard we labor there is nothing the Flotek team can do to change the deceleration of the cycle and the daily decline in oilfield activity that continually shrinks our opportunity set. Yet each and everyday, the men and women of the Flotek team have come to play looking for opportunities even when it seems about as probable as finding the proverbial needle in a haystack. And more often than not, they come back with that needle. In short, this is a team that has no quit that strives to be better each day and believes that they can make a difference, no matter the size of the challenge or the length of the odds. We will continue to focus on delivering the Flotek message and sharing the benefits of the Flotek experience with anyone around our business that will listen. We understand the challenges as we face an extraordinary level of uncertainty in our industry. That said, we remain acutely focused on what we can control – our cost structure and resulting financial position, our level of service, which we will strive to take to an even higher level, our marketing efforts, the focus on how Flotek products and services can make better wells and as a result provide better returns for our clients, crafting creative business structures that create mutually rewarding results for both Flotek and our clients, remaining true to our goal of maximizing value for our shareholders throughout the economic cycle. Regardless of the challenges ahead, what I pledge to you today, as I did on my first call now 6 years ago, is that my team and I will come to work each and every day knowing that you have placed your confidence and trust in us as stewards of your capital. We will take that responsibility very seriously and work hard each day to continue to earn that trust. Let me be clear. The success of Flotek is the result of the hard work and untiring efforts of the group of people who believe they can shape the future. As a leadership team, its incumbent on us to communicate our vision, challenge the spirit and ensure our team has the tools to exceed even their wildest expectations. Thank you for your interest in Flotek. I am glad to be here and we look forward to sharing our journey, both challenges and successes with you in the coming months. Now, operator, we will open up the call to take questions.

Thank you. [Operator Instructions] And our first question comes from the line of Matt Marietta from Stephens. Please proceed with your question.

Thanks a lot and good morning guys. Thanks for taking the questions.

Of course.

Congrats on the impressive chemistry performance this quarter in both segments, certainly better than I think any reasonable expectations, given the macro conditions you are navigating here in the first quarter and certainly going into the second quarter. But I want to revisit something for context before I asked my question. About a year ago, there was some fear, a narrative out there that your largest customer today was essentially ordering a bunch of CnF due to a contract that expired. I think the theory was that they were going to stop using CnF after that contract. Sitting here today obviously the opposite has proven itself to be true and now that, that customer, the largest and arguably most well-respected Permian operator appears to be increasing their CnF per well and even testing concentrations that are, I guess, 2x the prior loading of the company. So, can you just maybe elaborate a little bit more on how this advocate of the CnF technology is resulting in incremental wins from offsetting operators? And it seems like this is a shift in the industry. Usually, operators are pretty quiet about what they are doing, not willing to help their offsetting operators or competitors. But John, you kind of hinted at this a little bit, I was hoping to get more elaboration on what’s happening here and how this dynamic is shifting and what opportunities this provides?

Sure, thanks for the question, Matt and thanks for refreshing our memory. I think everybody or I would hope everybody on this call understands that in this environment if you are using a technology that some people have viewed as a like to have versus a have to have, the microscope look on every dollar that’s spent is even heightened. And the fact that, that largest operator in Midland has continued to use CnF on best practices for every well and is increasing its usage speaks to the point of the benefit they can isolate for CnF being involved in the optimization of their completion program as they continue to refine and optimize it. With respect to the peer-to-peer communication, I think there really is a change in the industry that a lot of, as you say, keep your cards close to your vest by many of these operators has changed. I think everybody kind of understands they are in this together. A lot of the leases have been secured in the Permian. Some people are even swapping leases with each other to be able to affect different operators having more lateral length to be able to drill with. And I think it’s a level of cooperation that I have certainly not seen in many years and so people are being a little bit more free with how they are going about their completions and drilling programs, which I think is overall very good for the industry. And we are – we like to point out that folks have a little different experience when they involve Flotek and it is great that those operators are sharing that to the other people that are, in many cases just across the fence line from them. But we certainly as you recognize, see a dynamic changing in the industry from what most of us have been used to for the last couple of decades. Does that help?

Yes, it does. And switching gears some here, I want to dig into the covenants a little bit, the credit facility amendment, can you remind us, first of all, since the downturn, is this the second or third time you have amended it, maybe some context there. And then Rob, this question is really I guess, maybe for you then, what add-backs are possible in the bank’s calculation to adjusted EBITDA and what was the bank calculated adjusted EBITDA in 1Q, to maybe help us kind of calibrate versus the reported adjusted EBITDA number and how the bank views it, that could be pretty helpful for us?

Sure. So the adjusted EBITDA calculation for purposes of the bank covenants is EBITDA plus stock comp expense. In the first quarter, stock comp expense was $2.4 million. It was a little lower than normal because of how we settled the year end stock comp expense for our executives. Going forward, that number usually runs about $3.4 million per quarter.

And is there – is that the only add-back is the stock comp expense?

Yes, that’s the only add-back, the stock comp expense.

Okay, great. That’s helpful in us figuring that out. And then the language on the trailing – I guess it starts in September, can you maybe help us understand, is that for a trailing two quarters or three quarters, I think the…?

That’s two quarters, so at September 30, we will combine the second and third quarter adjusted EBITDA to achieve the $8.4 million that’s required by the covenant.

Okay. And tying kind of those questions into what you guys have talked about as strategic options in non-performing segments, what else can you guys do in the form of really refocusing here on the chemistry side where the performance is resilient, if not improving from here, can you maybe talk about what other self help initiatives there are to give yourself plenty of room here on that specific covenant that I addressed here and maybe elaborate on how that process is proceeding, if you can?

Right. So if we bridge from the first quarter to what we would end up with in the third quarter for the trailing two quarters, we feel like the cost reductions that we have already taken and what we have near-term, clear line of sight to is going to be adequate to get us over that covenant level. Now, the business obviously, as you are inferring can continue to deteriorate and that will probably be manifested mostly in our drilling segment. But we feel confident that the opportunities that John was referring to internationally, as well as the new product line and other things that we have clear and close line of sight to, will be more than enough to offset any additional downturn we might see in the drilling business. We don’t have to have all of those things come in for us to achieve what we anticipate the additional downturn might be in the drilling segment. So we are comfortable that going forward, we will have the coverage that we need in the next couple quarters.

And is there any assumptions in I guess the ECT business, is there a degree of confidence there that – is there something that the customers are doing or can you help us clarify what gives you that confidence on maybe the ECT side in terms of incremental demand for CnF or even the non-CnF products that you offer in that segment?

Yes. Matt, this is John and for everyone on the call, I think like all of our brethren before us that have had their earnings call, they are talking about how difficult it is to see through the second quarter and we want to remind everybody that the second quarter is traditionally a very difficult, unpredictable quarter even in good times, due to the Canadian breakup. For heaven’s sakes, I think there is 37 rigs running up there now. The weather that normally happens through the Central part of the United States and the Rockies, but from what we can see, we don’t see any type of material degradation in the chemistry activity. In fact and maybe we will have a chance to talk a little bit more during the rest of the call, but this PrF technology that we have worked on should really – it’s a market penetration story. Once again, we are very confident of the market’s receptivity to it because now we have got a whole series of years that people have trusted our way of customizing chemistry, as opposed to where we were 4.5 years ago. But as comfortable if someone can feel in this environment, we feel okay looking through the second quarter heading into the summer.

Got it, okay. And I will hop back into the queue and ask additional questions if there are any. Thank you.

Sure. Thanks.

[Operator Instructions] And our next question comes from the line of Mark Brown with Seaport Global. Please proceed with your question.

Hi guys. I wanted to ask about the comments around building your CICT inventories in anticipation of a potential smaller crop this year and what – maybe you could just help me understand a little bit in terms of how much inventory do you have, how many months worth of product and is there any further risk of shortage impacting your input costs for that business?

Yes. So I will take just the first part of that and then Josh can give you the full color. But we don’t let anyone to leave this call feeling that we are concerned about a shortage of the citrus as it pertains in particular to the energy chemistry effort. And it is really through the proper positioning of the purchasing, the short-term and long-term contracts we have, that give us that great assurance that really was a terrific result of the acquisition of Florida Chemical. But the guys who purchases more citrus oil in the Western Hemisphere than anyone, fortunately is with us, Josh and he will give you a little more color on that.

Good morning, Mark. When you look at our inventory position, we have to think not only about internal moves, but our external needs of our customers. And we lay that against what we see coming not only out of Florida, but out of Brazil and Mexico and other places around the globe to ensure that we have availability for those needs. That’s one of our primary functions to the marketplace. And in anticipation of Florida’s crop being lessened, we went ahead and purchased more materials, accelerated some deliveries from offshore suppliers to make sure that we would be in an adequate position during Q1 to supply the market needs. That certainly has proven to be a good strategy. I don’t see any shortages or any concerns about availability going forward. We are well positioned. And when you look at our forward sales on the other side of the equation, we have also had more demand from the customer base externally that helps to justify that increase.

Does that help you, Mark?

Yes, it helps a lot. I appreciate it John and Josh. And then, I just wanted to shift to your international prospects, which there is some great color in this press release and in your comments around some of the work you are doing down in Argentina and in Abu Dhabi and other countries and I just wanted to understand where you see the opportunities internationally going forward and perhaps how much of your revenues or your EBITDA, whatever is the best metric came from outside North America this quarter and what sort of growth prospects you see going forward?

Okay. I think the folks – and great question. Again, really kind of to refresh people’s memory, I think if you check back over the last couple of earnings calls, I have tried to be pretty consistent that we see Latin America through South America with Argentina not only with chemistry, but also with our down-hole technology, which is really increasing more distribution not only with Teledrift, but now stimulator is down there, motors are there and there is 100 some odd rigs running in Argentina, three times the amount of Canada, for heaven’s sakes, or four times. So, we think that again word of caution as everyone, I think on this call knows international projects take a little bit longer, but Argentina has righted itself with the new government that’s more favorable to doing business there, good for us, good for the other service companies that work down there. But the Middle East, as we have consistently said, we have more than a handful of unique research projects underway with the largest oil company in the world, Saudi Aramco between their research group here and their group over there in Dhahran. And our business is continuing to increase there as they are trying to figure out with us how to be the most effective in their unconventional completion efforts. So, I’d say those two areas certainly have our focus and stay tuned. And then in the weeks and months ahead, we will be able, I think, give you some additional information as to why we are positive there. Does that help? And in terms of the revenue side of things, Rob will give you a little bit of clarity on the international portion of our overall business.

About 15% of our total revenues, being outside of North America.

Perfect, perfect. Thank you very much. I will turn it back.

Okay. Thank you, Mark.

And our next question comes from Sean Milligan with Coker Palmer. Please proceed with your question.

Hey, guys. Good morning.

Hey, Sean.

I guess if we focus on CnF for a little while, you mentioned 20 validation projects. Is there anyway you can provide some type of indication on kind of what sort of 1Q volumes were validation related and what percentage were repeatable volumes?

Yes, I don’t know that we really give that level of specificity as much as anything for just protecting some of our market penetration strategy. We will tell you this that there is a high level of movement, always has been, north of 80% easily when someone does a validation to become a repeatable client and there is the repetitiveness retention rate of a repeatable client also is well above 80%. And I think what folks really need to try to keep in perspective is that a lot of the validations that have been done in the fourth quarter and in the first quarter were done with companies that had expectations to have more rigs running now than they do. So, some may have 6 – had 6 rigs and are now at 2, some at 4, now at 1, but they keep running CnF. And then the opportunity has shrunk somewhat with those that have completed validations, but we have even, surprisingly enough, had commentary from some of those clients that when they pick rigs back up that they are targeting in June and July, they will start right back with CnF which is really pretty unusual from my experience. So, I hope that answers your question. I am not trying to be evasive, but trying to protect some market intel for ourselves just because I think it’s the prudent thing to do. Does that help for you?

That helps. And then on the gallons per 1,000, if we think about major customers trying 2 gallons per 1,000, how does that compare to what you think you are selling into the market right now on an average basis? Are you at 1 gallon per 1,000 average or 1.5, how do we think about how that could be in terms of a step change?

Yes, that’s a great question. I am sure other folks are thinking about it. And right now, it’s at about, on an average, about 1.2 gallons. We have several folks that are injecting the CnF at 1.5 gallons. And as we have mentioned one particular validation at 2 gallons per 1,000 and I think what again we need to try to put into perspective is that for years and years and decades, the rule of thumb, no matter what the attitude was, you pump 1 gallon per 1,000, I don’t care what you are pumping. And what we are trying to illustrate here is that, that’s not necessarily the best and most optimum use of your investment. And then when it’s appropriate to pump more than that, you should. And if it’s appropriate to pump something less than that, you should do that as well. So, moving the industry off of this traditional 1 gallon per 1,000 mindset has really been – has been quite an accomplishment. And I think it resonates with custom chemistry. But long answer to your question a little bit, but about 1.2 – average 1.2 gallons per 1,000 is the average right now, but it’s moving up.

Okay, thank you. And lastly and then I will jump back in, but you addressed the minimum EBITDA covenants at kind of length. If we look at the minimum availability covenant on the revolver, can you just talk about how CapEx this year might be weighted either first half – how the kind of CapEx run-rate might change first half as you finish building out facilities in the second half? And then second, there was a – within consumer, it looked like a big pull on working capital, so how that might unwind as the year progresses?

This is Rob. I will take that. The CapEx, certainly our biggest spend in CapEx right now is the completion of our global Research and Innovation lab. That should be finished just around the end of the second quarter or early in the third quarter, so most of that spend is going to be finished by that point in time. The remainder of our CapEx, we have a fair amount of flexibility around whether we pull the trigger on it or not. So, I think in the last half of the year we certainly have more flexibility in whether we spend it or we don’t. The build in inventory was really – impacted the working capital draw in the first quarter and that will tend to unwind in the fourth – in the third and fourth quarters of this year.

Okay. Thanks, guys.

Sure. Thanks, Sean.

And the next question comes from the line of Darren Gacicia with KLR Group. Please proceed with your question.

Hey, good morning.

Hi, Darren.

I wanted to follow-up on the last line of questions per asking about kind of sort of CnF per ton or per 1,000. Obviously, it’s increasing. When you think about kind of your volumes, if I am not on the press release hoping you were up, you were down about 6.5%, obviously beating – significantly ahead of what was happening with activity? Well, I guess what my question is, is how much of that was increased kind of CnF per well or chemistry per well versus further market penetration?

Yes, that really is – that’s a great question. It’s kind of a tough one to answer because these wells have such variability in their volume based on their lateral length, but we would say that somewhere around 25% to 30% of that is continued increased penetration. The rest of it is ramping up more usage either at a more gallons per 1,000 or on some of our clients are going to longer laterals, where they have a higher volume, but it’s about a 25% to 30% of that number is with new folks that haven’t been exposed to CnF prior to the first quarter. Does that help you?

That is helpful. And I think it’s important that you are growing share. I think when I think back to your Investor Day, the longer term goals that have roughly 30% market penetration, is that still sort of where your goals are and is that still where you are at?

Yes, I think what we have consistently said and we haven’t really modified this even though for heaven’s sake since that Investor Day the world has kind of changed in terms of activity, but we felt that exiting 2017 in the fourth quarter, we should be at 3x the revenue run rate of what we were in the third quarter of 2015. We don’t see anything that makes us feel different about that right now. And I think one thing just from a personal opinion, I think folks are going to have to recalibrate this whole rig count deal because they get fixated on this number and we all know that 400 rigs can drill more wells than what 400 rigs could do 3 years ago. So I think there is going to have to be some kind of understanding that even though we get down in the mouth and all that about the depressing rig count, the efficiency of these rigs, the technology we have introduced and others, like the Stemulator, that you drill these wells faster, you are able to have a higher level of drilling. So, I think because of that is why we still believe that when we exit ‘17 we should have that type of activity. Does that help you?

It does. And if I could squeeze in kind of one broader, maybe 10,000 foot question, when you think about the Halliburton Baker yield and how that’s not going to come to fruition, does that change your competitive landscape at all relative maybe what you would have thought it would have been with the deal going through?

Yes, another great question. There was kind of a storyline that had circulated and it involved us. It may have involved other companies that deal with both of them that if they got together, there would be some type of technology that might make it difficult for us. And the way we have always responded to that is Halliburton has been a very key client for us to distribute our technology to their clients. Baker Hughes has consistently been at the top five or six clients for us to distribute to some of their clients, obviously. And for that reason we didn’t see much of a change as to what would happen. So we believe that the fact that they are now going to be independent won’t – shouldn’t affect us. I think there are some opportunities in particular, since you brought it up with Baker Hughes for us to work with some chemistry with them. But we will see how that plays out. They have got a big mission on their hand, sort things out as they move forward. But we don’t see any change. There hasn’t been any change. The only change has been the reduced activity from both of them as an industry, not regarding us specifically.

Understood. Thanks for your help. I appreciate it.

Sure.

And our next question comes from the line of Matt Marietta with Stephens. Please proceed with your question.

Hi guys. Thanks for letting me back in here and have another chance. But in line – I have got a couple more questions, but in line with that last series of questioning on the failure of this merger to be completed, as recently as yesterday, Baker Hughes discussed its production chemistries as being a relative bright spot in its asset portfolio and I think Halliburton, they went as far to identify chemistry being a hole in their portfolio and suggested it is looking to fill that hole through strategic acquisitions. I guess can you maybe talk a little bit about the overall competitive landscape in energy chemicals, maybe not as much focused on the CnF side, but just in general, are you seeing more or less competition in energy chemicals, are companies falling out or scaling back on the energy side yet and maybe tie that into my next question, which will be really around PrF and the application there and why the decision to create a new product in this environment?

Sure. And I hope everybody indulges me for kind of an expanded answer to those questions because they were good ones. Let me take the last one first, regarding PrF. So again, we want everyone to leave the call with a clear understanding. First, as we mentioned, it’s multi-patented and we have spent over 2 years to develop the technology, which essentially is on dealing a 40-year approach to pressure in this industry. And without getting too technical on the weeds, folks pump friction reduction chemistry to reduce the hydraulic horsepower on a frac job, A, to reduce cost and B, to be able to have the tubulars withstand high rate and higher pressure as they pump these fluids. And it’s been essentially the same technology for 40 years. And as often the case, the engineers will solve a problem instead of trying to find the best solution and there is a big difference. So we have challenged our own people to reduce the amount of really what’s damaging chemistry, it’s called polyacrylamide and kind of the layman’s term for that is Saran wrap. So when you pump that down to reduce the friction, you are actually putting a damaging chemical into the reservoir. And we have challenged our folks to be able to reduce that per gallon and to reduce the overall volume that’s needed and I think that’s what really sets Flotek apart is not many companies start out with the mission to sell less of what you are empowered to do, but it’s not about selling more. It is about selling what’s right. So it really also was designed in conjunction to be enhanced when you have CnF with it. The chemistry activity between the two additives creates a better performing fluid in terms of helping the reservoir than not together. And it’s not in any way that we see a diminishment of CnF activity. It’s an effort for us again, to take our customized chemistry approach to something that like I say has not changed for over 40 years. On your other question, Matt, yes I think just like any other segments in this industry, the smaller, less capitalized, overleveraged regional chemical companies have – some of them have disappeared. And I think we don’t really see much competition in our segment that we have carved out for ourselves and that’s not to say that we are not always aware of what people are trying to do. But what’s interesting I think and we would like to take a little bit of credit for this, both of those big service companies, I think if everybody looked back 4 years or 5 years ago in the earnings call, they didn’t spend a lot of time talking about chemistry. And what’s happened is that chemistry now has no longer the forgotten part of how do you improve the performance of these wells. And the more people talk about that, the more that you are going to have the best opportunity to have good chemistry. And hopefully, that answers your question. If I can expand just one more thought on that, I think everybody gets caught up in the numbers when you report your earnings and you have a tendency often to miss out that you are really in the middle of a movement. And for example, 5 years ago, I don’t think people expected the amount of household products could be delivered at your doorstep that Amazon does. 3 years ago, we didn’t know the word Uber, much less now that’s the way you get cars instead of taxis. And the amount of people that no longer go to malls, but shop on the internet on their phone. Well, as it pertains to us, 5 years ago folks didn’t know what CnF was. 3 years ago, I think custom chemistry was not a familiar term. 1 year ago, we opened the virtual Flotek store and now it’s the introduction of PrF. And so, it’s the movement that is changing the industry that’s focusing on something that really is important as these folks try to reduce their cost per barrel, but at the same time improve their production. And hopefully that wasn’t too winding of the story, but I think it puts into perspective why we are doing, what we are doing, why we are spending the money on research to have that differentiation.

Thank you. I think that was a great answer.

I will turn the call back over to you.

Okay. Thank you for everyone’s interest on our call this morning. Thank you for the questions. I am sure they spoke for a lot of people that were listening in. And as always, we appreciate your interest and are pleased you joined us. We hope everybody has a great Wednesday.

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. Have a great day.