Flotek Industries, Inc. (FTK) Q2 2017 Earnings Report, Transcript and Summary

Good morning and welcome to Flotek Industries Inc., Second Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you'd ask questions at the end of the Company's prepared remarks and operator will provide instructions on how to ask your questions at that time. [Operator Instructions] This conference is being recorded. At this time, I would like to turn the conference over to Matt Marietta, Flotek's Senior Vice President of Corporate Development and Investor Relations. Mr. Marietta, you may begin.

Thank you and good morning on behalf of the Flotek team. Joining me this morning are John Chisholm, Flotek's Chairman, President and Chief Executive Officer; Rich Walton, our Chief Financial Officer; Josh Snively, Executive Vice President and Florida Chemical President; and Robert Bodnar, Executive Vice President of Performance and Transformation, as well as other members of our leadership team. Our earnings press release was distributed yesterday and is available on the Flotek website. In addition, today's call is being webcast, and a replay will be available on our website. Before we begin, our formal remarks, I would like to remind everyone participating in this call, listening to the replay or reading a transcript 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, comments or expectations 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 an exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek's filings, including our Form 10-K, with the U.S. Securities and Exchange Commission. With that, it is my pleasure to turn the call over to John for opening remarks, followed by a financial review from Rich and insights into key initiatives of our organization by Robert and Josh followed by an outlook from John. We will open for Q&A after their remarks. With that, John?

Thank you, Matt, and thank you all for joining today's call hosted from our Global Research and Innovation Center Headquarters here in Houston. I'll begin by giving a summary of our quarterly results, followed by an overview of our Business segments. Additionally, I will highlight ongoing initiatives which we believe are creating substantial operating leverage to accelerate maximize our delivery of cash flow in future periods. Rich Walton, will then review our financial highlights for the quarter and provide additional financial details followed by Robert Bodnar who will discuss an operational overview. Josh Snively, will provide an update of citrus end markets and ongoing initiatives at Florida Chemical. Our integrated operating subsidiary was on our consumer and Industrial Chemistry Technology segment. Finally, I'll end with closing remarks and an outlook with guidance before taking your questions. Overall, Flotek's second quarter results were mixed versus broader expectations primarily due to timing of operations of a handful of clients and weaker than expected results in Canada which is our largest international geography. However, we did experience uptake for our prescriptive chemistry management platform which is showing signs of accelerating market adoption. We continue to manage a challenging citrus market in Consumer and Industrial Chemistry Technology segment which outperformed on revenues but margins turned into lighter than we expected due to product mix and timing of a large order. Our commitment to reducing general and administrative expense can be measured in the quarter as we are transitioning to a leaner and growth focused pure play Chemistry Technology Company. Additionally, as you will hear later in the call we have a better handle on our ability to provide reliable guidance and introduce a detail outlook for the first time in our Company's recent history. For continuing operations which encompasses our Energy Chemistry Technology or ECT and Consumer and Industrial Chemistry Technology or CICT segments. Flotek's consolidated second quarter revenue was up 7% sequentially, and up 33% year-over-year in line with our expectations. To provide an update in our Energy Chemistry Technology segment, domestic revenues experienced growth of 17% led by an expansion of our PCM or Prescriptive Chemistry Management solutions and an ongoing growth in demand for our core CnF technology product offering. This was preceded by growth of ECT of 14% in the first quarter of 2017 and speaks to our ability to deliver consistent compound in growth in this segment. Our clients are showing signs of receptivity to a period of increasing pricing as we experienced domestic complex nano-Fluid or CnF revenue outpace volume growth in the quarter, while gross margins expanded by 135 basis points. This is truly an incredible accomplishment as you consider the raw material inflation of citrus products, which we believe will begin to moderate and Josh will have more comments later in the call. The second quarter marks a record quarter of CnF sales by volume and our momentum which may vary a short-term fluctuations due to FRAC schedule shifts is showing no signs of slowing as the opportunities continue to grow. Since the peak of the energy commodity cycle in mid-2014, our CnF volumes have expanded 143% to the second quarter today. The long-term trends we are experiencing with CnF compares favorably to industry macro trends like completion activity which is down 50% over the same period and exemplifies our success over time. Domestic CnF volumes expanded by 7% sequentially and it's important to point out that pad completions in FRAC schedule movement of key clients in U.S. land impacted our CnF volume by as much as 3% to 4% of growth, and M&A activity carried through minor decrements in the 1% to 2% range. Due to mix with ECT gross margins declined as conventional chemistry sales meaningfully snapped back above our expectations relative to the transitory challenges for CnF. As you can recognize in our conventional chemistry or non-CnF components of ECT, operators of all sizes are moving towards the trend of decoupling their energy chemistry selection and purchases. This is a trend which is in the early innings and pioneered by our Flotek Store business model over two years ago in anticipation of this shift. Now that this trend is becoming more mainstream. We are confident that our commitment to research through the downturn and our expansion efforts have positioned our company perfectly to benefit from the ongoing evolution in completion designs. Our clients in the industry are moving from conventional one-size fits all approaches to embracing now custom completions chemistry like our industry leading CnF technology and our Prescriptive Chemistry Management or PCM platform, and yes the Flotek Store. In addition, our initiatives with IBM utilizing the RC squared capabilities and our joint breadth of exposure around the globe with companies of all sizes has Flotek at the forefront of the emerging desire for big data analytics. We are excited to have opportunities in the coming months to showcase these expanding capabilities. Internationally, we saw our business face seasonal break-up challenges in Canada, which declined meaningfully more than we expected. International activity will continue to fluctuate on a sequential basis due to the nature of large shipping orders and inventory management, which is how our clients operate abroad. We will make an effort to better predict these orders and offer more timely updates as they become meaningful to our performance. Despite this movement, we expect long-term growth to continue to occur. Additionally, the growing success of our suite of chemistry offerings and CnF around the world is undeniably being communicated back to us by our clients. These successes range from Argentina to the Middle East and recently include China in a variety of other geographies. It is important that we remain committed to selective international expansion as we believe opportunity for high margin growth will evolve with completion techniques around the globe. We are taking a close look at certain geo regions, which may not have the same opportunities in others and rationalizing costs in those areas should also help our broader G&A reduction initiatives. From the onset of the recovery, which began last year, we've been consistent in our narrative of the likelihood of a pump through brakes recovery, a message other companies are beginning to adopt. Flotek is uniquely positioned and that we do not have any major CapEx, hiring or equipment spending needs as we penetrate new clients. We believe our leadership position as a custom chemistry technology company will become more apparent to our shareholders and the broader investment community as our growth in ability to drive strong incremental margins even in a flat macro environment becomes apparent. Our asset-light business model provides maximum flexibility and limited risk and further G&A reductions are intended to make this more impactful to our shareholders. As Robert will discuss in more detail, we've expanded our CnF manufacturing from 750,000 gallons per month from just over two years ago to more than double that amount today. We believe that as we look out two years, we will once again double our capacity to manufacture CnF. To be clear with a somewhat agnostic view of commodity pricing, we believe that our CnF output capacity has the potential to quadruple from volume levels in late 2014 to mid to late 2019, while maintaining the same level of manufacturing utilization percentage to meet the secular growth in demand. This countercyclical market penetration is a remarkable accomplishment when put into the context of the broader industry backdrop and speaks to the market penetration success we are in the early innings of experiencing. Moving to our Consumer and Industrial Chemistry Technologies segments or CICT, citrus oil pricing inflation remains a challenge and impacts our whole organization. Josh and his team continue to perform at a high level at Florida Chemical and we are - when we see exciting opportunities materialize by the day. The value of the seamless integration of Florida Chemical as a cornerstone division within Flotek has proven itself completely. We are extremely pleased with the ability of our entire organization to manage a difficult end market in energy, while our input raw material costs have inflated by more than two times since the acquisition back in 2013, and led to greater than expected inventory dollar builds in the quarter as purchase season occurred this year at a level of pricing that we believe should signal a peak. As Josh will later discuss, we believe the citrus markets will begin to soften in coming months, allowing our Energy Chemistry Technologies segment to improve its costs position on this critical raw material and benefit our entire supply chain. During the quarter, we receive proceeds from the sale of the drilling and production technologies business segment, we repaid all term debt from our capital structure in our only current borrowings are backed by current assets on our credit facility. This puts us effectively in a debt neutral position as we will continue to utilize our borrowing to fund working capital demands in our growth. While the recent working capital demands were greater than our initial internal projections, largely due to citrus market inflation, we will maintain maximum financial flexibility going forward and continued to develop our relationship with our lender. Additionally, I'm pleased with the companywide efforts to reduce G&A and find areas of operational efficiency improvement. Our focus has remained on investing in our future through the downturn and building the necessary platform across our two key segments. Our ability to drive growth expands product lines and change a business model through the energy downturn has required these investments. We've remain focused on creating fixed cost leverage and instituting a variety of enhanced cost controls through our organization restructuring and operational efficiency improvements. These efforts are moving fast and to some it may seem like not fast enough, but we can say that they are making an impact in our business and we will not sacrifice critical relationships with our clients or jeopardize our growth in this process. As our scale grows and our cash flows begin to cover internal growth, we will continue to assess opportunities to deploy cash as well as maximize our financial flexibility. While our filing of the S-3 is simply good housekeeping on our part, it is important to remind our investors that we have a $54.4 million of remaining authorization on our share repurchase program and we will continue to assess the M&A marketplace. Given our position of strength today we can be selective and how we allocate capital and in many cases investing in our own company may be the best return. Finally, our commitment to data is opening doors to projects with operators that have unique an expansive scope. We believe the industry needs a better approach to analyzing the large numbers of variables and streamlining endless amounts of data. This is where cognitive is key. Our relationship with IBM continues to grow and our joint efforts have the potential to be significant for industry stakeholders of all sizes, ranging from small operators in the Permian to Supermajor Energy companies with global footprints. We will provide more updates in this effort as developments materialize. Now I'd like to turn it over to our CFO, Rich Walton to provide a review of our key financial information and provide an update. Rich.

Thank you, John. As John mentioned we have completed the sale of substantially all of the assets of our Drilling Technologies and Production Technologies segments. Closing of these transactions occurred in late May. Cash consideration was $19.9 million with a customary $1.9 million escrow hold back to be realized over the next 18 months. The assets, liabilities and results of Drilling Technologies and Production Technologies segments continued to be reported as discontinued operations. The financial statements in this Form 10-Q and going forward should more accurately represent the results of our core businesses, Energy Chemistry Technologies and Consumer and Industrial Technologies as continuing operations. For the second quarter we reported total revenue of $85.2 million compared with $64.1 million in the prior year period, an increase of $21.1 million or 32.9%. On a sequential basis quarterly revenue was up 6.5%. Our topline growth was driven by strength in Energy Chemistry. Sequential growth in Energy Chemistry revenue was 8.4% due to increasing domestic well completion activity by customers. International sales for Energy Chemistry historically down in the second quarter due to the spring break up in Canada were impacted by an extended breakup period in Canada this year. Revenue in Canada was down $1.4 million in the second quarter compared to the same period of 2016 and down 68% sequentially. Consumer and Industrial Chemistry revenue for the second quarter was flat sequentially and down 6.7% compared to the same period of 2016. However, international sales in the second quarter increased $2 million compared to the same period of 2016. The segment operating margin was 14.1% in the Energy Chemistry segment and 6.3% in the Consumer and Industrial Chemistry segment. Corporate general and administrative expense was $11.2 million, an increase of $1.6 million from the second quarter of 2016 and a reduction of $1.1 million from the first quarter of 2017. Our corporate G&A as a percentage of revenues decreased to 13.1% from 14.9% in the second quarter of 2016 and 15.3% in the first quarter of 2017 as we make progress in our cost reduction initiatives. During the first six months of 2017, the Company incurred non-recurring charges of $1.6 million dollars related to executive retirement and $0.4 million related to the shareholder lawsuit and SEC inquiry. Segment selling and administrative expense was $9.4 million, an increase of $1.3 million from the second quarter of 2016 and a reduction of $0.9 million from the first quarter of 2017. Segment selling and administrative expense as a percentage of revenue decreased to 11% from 12.6% in the second quarter of 2016 and 12.9% in the first quarter of 2017. Non-cash compensation was $3.6 million in the second quarter. For the quarter research and development expense was $4.1 million compared to $2 million for the same period in 2016. In addition to the opening of the Research and Innovation Center in the third quarter of 2016, this increase is attributable to new project development and demand which Robert will discuss later. For the second quarter Flotek reported a net loss from continuing operations of $1.1 million representing a loss of $0.02 per share on a fully diluted basis. This compares to a net loss from continuing operations of $0.1 million for the second quarter of the prior year. For the six months of 2017 Flotek reported a net loss from continuing operations of $1.9 million representing a loss of $0.03 per share on a fully diluted basis. This compares to a net loss from continuing operations of $0.1 million for the first six months of the prior year. Flotek recorded and income tax benefit of the $0.4 million yielding an effective tax rate of 28.3% for the three months ended June 30, 2017 compared to an income tax benefit of $0.4 million and the prior year. As I note, discontinued operations did negatively impact cash flows by $2.8 million during the second quarter. This burden will reduce as divestures closed during May. At June 30, 2017, the Company had accounts receivable of $60.1 million compared to $47.2 million at December 31, 2016. At June 30, 2017 days revenue and accounts receivable was approximately 64.5 days, a decrease of seven days since March 31, 2017. For the quarter ended June 30, 2017 the provision for doubtful accounts was $0.3 million. And at June 30, the allowance for doubtful accounts remains minimal at less than $1 million or $1.6 percent of the receivable balance. At June 30, 2017 inventories totaled $78.4 million compared to $58.3 million at December 31, 2016, an increase of 35%. Three quarters of this increase occurred in the Consumer and Industrial Chemistry segment which historically has an inventory build during the first half of the year. The impact was more pronounced this year because of citrus raw material cost inflation. Our inventory turnover at June 30, 2017 is approximately three times per year. During the second quarter we repaid our term loan in full with proceeds from the sales of assets of our Drilling and Production Technologies segments. At June 30, 2017 borrowing under our revolving credit facility was $42.7 million and there was an indrawn availability of $22.2 million. During the first six months capital expenditures were $4.5 million compared to $8.2 million in the same period of the prior year. Expected capital expenditures for 2017 have been further reduced to a range of $9 to $12 million. As a reminder our financial statements report the continuing operations of our Energy Chemistry Technology and Consumer and Industrial Chemistry Technology segments. The Form 10Q provides a description and analysis of our discontinued operations that's Drilling Technologies and Production Technologies in the footnotes. We continue to be focused on monitoring capital expenditures lowering SG&A costs protecting our liquidity and growing our core businesses in Energy Chemistry Technology and Consumer and Industrial Chemistry Technology. As I note, yesterday the Company filed a Form S-3 with the Securities and Exchange Commission. Upon effectiveness this filing will permit the Company to sell new securities to the public with a maximum initial offering price of up to $350 million. The securities that maybe offered include common and preferred stock, senior and subordinated debt, warrants, and units of securities. We currently have no intention to issue stock at current price levels. And now I'll turn the call over to Robert to provide an operational performance update of the Company. Robert?

Thank you, Rich. We have made a number of operational enhancements that are creating greater alignment with our clients within the ECT segment. For example, just over two years ago, our CnF manufacturing capacity or core processing facility in Marlow, Oklahoma was just around 750,000 gallons per month. At quarter end, our capacity was above 1.5 million gallons of CnF per month and we are in progress to expand to about 2 million gallons per month as we enter 2018. We continue to target 70% to 80% plant utilization, which is a level that maximizes our financial performance and allows cushion for rapid growth. A recent project to expand our inventory and processing capabilities in the Permian has been yielding substantial success. We've increased our throughput Monahan's, which is located in the heart of the Delaware Basin by 10 times since the first quarter. Our clients are responding very favorably to our ability to adjust to their schedules and provide cushion for CnF and our total fluid chemistry designs. We now have the ability to execute water analysis, pre-frac testing, sample collection and quality control for our clients in the basin. These new capabilities should increase our penetration rates and even further enhance our reliability to our clients. We have also just executed an expansion in the Marcellus, Utica region located in Canonsburg, Pennsylvania. This new facility is under a multi-year lease and should allow our business to expand more quickly into the northeast areas of the country. From this location, we can offer bulk storage, technical support, and local sales office presence to maximize our response time and accelerate basin penetration. In addition, we have ongoing projects designed to enhance our operating leverage. We are optimizing liquid production flows in our manufacturing facilities, which includes large water storage facilities in Marlow. While these projects sound like blocking and tackling and require a little capital, the reality is they may contribute as much as $0.50 a gallon of gross margin to a variety of our products sales or what could amount to 200 basis points to 400 basis points over time, which is mostly flow to the bottom line. And I want to point out that many of these projects require minimal CapEx and are already included in our CapEx guidance. I'll now give you an update on our Global Research and Innovative Center, which is allowed us to accelerate the pace of our prescriptive analytical chemistry business approach. We continue to experience increasing inbound demand for our lab capabilities and ability to prescribe the most impactful and precise fluid systems to maximize the returns and performance of our clients reservoirs. This demand is highlighted by our current backlog of projects at R&I, which is now at more than 90 projects. This is up 14% from the 1Q end, and up 50% exiting 2016. To provide more color, our client delivered projects grew 47% in the second quarter from the prior quarter. This may not be a perfect predictor of future growth, but as we have evolved our business model, demand for our research is growing and gaining momentum. We believe these are very favorable trends to be seeing within our business as our clients depend more on our integrated capabilities. To provide a brief update on Reservoir Cognitive Consultant or RC2, which is a proprietary platform that incorporates IBM's Watson Technology, we continue to joint develop new capabilities never before seen in the old field. We are making very considerable progress in the development and functionality currently we are working to probably import checking code analytics and look to begin public demos during the third quarter. And turning to our health, safety, environmental efforts, we have maintained an excellent best-in-class safety record. We believe this is critical as our business model expands to better serve our customers and to ensure on site deliverability and quality control to frac fluids in our clients' completion initiatives. And with that, I'll turn it to Josh to provide an operational and high level update of the CICT segment.

Thank you, Robert. Our CICT segment performed mix during the quarter as timing of orders, mix and material inflation did impact margins while revenue exceeded our initial expectations. We have made inroads with a variety of new client relationships and believe our growth opportunities remain abundant. Additionally, our corporate inventory positioned increased during the quarter driven by a seasonal crop cycles and historically high prices. I would like to provide an update of the citrus markets as we have not said enough in the past and the future we believe there will be ample more to discuss the past two years have been some of the most volatile we have ever experienced, the greening disease challenges have resulted in raw material inflation of greater than 200%. We have properly staggered contracts and utilized our scale as a top 10% citrus oil purchaser globally to manage these challenges and take market share. Recently the USDA Brazil crop report was released and indicates the orange crop for processing will expand 53% after four years of declines. We will purchase diligently as we believe cost should soften over the next few months. We managed our inventory to accommodate lower citrus prices as our quantity on hand is seasonally lower than normal but our inventory value is as high as it has been and long time. While as premature to guess what the deflation slope maybe we are confident the direction should be beneficial to our entire supply chain. As John alluded to earlier where expanding and Florida as well internationally. Currently we are in the final phases of adding another distillation column in Florida increasing our total number of commercial units to eight. The new unit will not only add to our ability to produce orange molecules it will also allow flexibility for expansion into other citrus cultivars. We've also going to project which will enhance our capabilities at Florida chemical do encourage more client interaction and expand our ability to utilize more of the citrus molecules, across a broader value chain and the flavor and fragrance industries. Also we are utilizing our research capabilities to expand the application of CnF into other industries outside of oil and gas which is an initiative still in early phases but could open unique opportunities for a Company. Today we are pleased to announce that we have opened Flotek branch in Japan. We have sought out top local talent to run our business development initiatives there and believe that will support our growth in the Asian markets. This is a key geography for our long term success and we are excited about the prospects. Our growth within CSCT investments will be measured, but will also be precise. We see a very large multi-year runway for profitable growth which should exceed broader economic metrics and establish a stable stream of cash flow for Flotek which over time can help smooth out consolidated performance turn energy cycle fluctuations. With that, I'll turn it back to John to offer concluding remarks.

Thanks, Josh, and before we take questions. I'd like to offer an outlook and add some concluding thoughts. While there were some successes and yes some disappointments in the quarter. The second quarter marks the most important transition for our Company to date. As we are now a technology focused, pure play specialty chemistry company. We've successfully exit it our Drilling and Production Technologies segments repaid our term debt and the industry is shifting right into where we are positioned. For the first time in our Company's recent history we offer some high level guidance to help set expectations in both the near and longer-term. Our team has worked hard to be able to help communicate our outlook in financial terms and be more precise in this communication to our shareholders and area we will continue to enhance. We have also improve our internal forecasting capabilities and focused on our client and market intelligence which we believe will be powerful for our business going forward. We expect ECT revenues to expand in the low-to-mid double-digits on a sequential percentage growth basis and believe that we can deliver segment margins 100 to 200 basis points above the second quarter due to pricing benefits, product mix and fixed cost leverage. We believe see CICT revenues will decline in the mid teen percentage range sequentially due to seasonal factors and EBITDA margins to improve slightly into the low double-digits due to higher margin sales. Our corporate G&A and allocated to our segments is expected to continue to moderate. CapEx should continue its current run rate and remain minimal. We will direct focus to our EBITDA margins going forward as we believe it is more relevant to our shareholders and for competitive reasons. We exited the second quarter with a considerable amount of momentum. June CnF revenues were at an all-time record high and total ECT sales in June matched our company record back in late 2014 for a single month. The beginning of July started modestly and in our last couple of weeks, we began seeing acceleration in bookings and commitments. The last week of July marks yet another record week for ECT weekly sales for the year and we now have generated more ECT revenues year-to-date than early November of last year. In addition, our orders yet to be shipped are consistently running at high levels indicating this momentum should continue well through the third quarter. A large part of our increased confidence in the outlook is our direct sales increasingly being referred to as desegregation in the market through the Flotek Store. In total, ECT revenues through the Flotek Store are up 59% from the second quarter of last year. As we get closer to the end users of our technologies, our visibility is growing with greater communication between ourselves and the beneficiaries of our technology. The industry is quickly shifting and if investors carefully listen to other market participants they will recognize a growing chorus of companies or describing what we are seeing. Companies like EOG, Devon, Pioneer have disclosed their desire to decouple proppant, fluids and chemistry. And pumping companies of all sizes recognize this trend of desegregation. This allows operators to lower spending and maintain activity, while leveraging our relationships. Core laboratories also recently discussed how its demand for analysis on chemicals is growing for longer laterals and nice endorsement of our products suite and our market positioning. Operators are more open to discuss chemistry and their desire to find the best solutions is leading them to Flotek. These are trends we see on a daily basis and we are positioned to meet the expanding demand of our clients. Also within our Global Research and Innovation Center, we've seen further demand for our research project capabilities. Our client dedicated projects entered are at an all-time high and more than 160 in the quarter. Our ongoing projects at second quarter end stands at a record and indicates plenty of work to be done. We believe these projects indicates future sales opportunities within E.C.T as well as CICT. The total number of deliberate projects in the second quarter set another company record of trend we expect to see for some time. I would also like to take a moment to welcome Sally Cheadle into our organization as Vice President and Controller. Sally has had an exceptional career with over 25 years of experience at Baker Hughes. She brings with her the valuable contacts, industry experience and the skills required to further enhance our accounting and finance efforts. It is a very exciting time to leave Flotek. Our company is evolving faster and my outlook has never been more positive. Our CICT division provides growing class flow stability to our shareholders, while our ECT market penetration is continuing. We are positioned ideally as a high returns technology focused custom chemistry organization. Our growth driven by CnF in the past few years has been an extraordinary accomplishment, occurring through the energy cycle downturn unlike any I have experienced in my 40 plus year career. When you consider the citrus market inflation we manage through within CICT, it is clear that Flotek's best days are in the not too distant future. From Florida to Monahans and across all of our employees, our organization is more determined and more energized than ever for the exciting period in our evolution that we are now entering. Finally, I would like to thank our shareholders, employees, clients and stakeholders for their support to allow Flotek to be in the remarkable position we are in today. With that operator, we will now open the call to questions.

Thank you. [Operator Instructions] And our first question comes from the line of Georg Venturatos with Johnson Rice. Please proceed with your question.

Good morning guys.

Hi there, Georg.

Hey, John. Last part I appreciate the guidance here. I think that's helpful guide goes for everybody in the near-term and I know it's something you often working on. As we think about that I guess first off on the revenue side and certainly nice to see a low to mid-teens double-digit type sequential increase. Can you give us a little better sense of how comfortable we should feel about that relative to existing bookings and also in relation to kind of the select opportunities you talked about in the release. Is that further upside potential? I guess I'm just getting trying to get a little better sense of what's kind of big into that number from a backlog perspective?

Sure. As we try to detail out with other commentary from other players in the industry, there is more and more decoupling occurring with the overall chemistry beyond CnF. So that growth is including - CnF increasing along with conventional chemistry as the decoupling continues to accelerate.

Okay. I'd say really our confidence level is 80% plus in the guidance, unless there's some type of down draft with the oil commodity price. We've got the best line of sight visibility that we've ever had due to the amount of people that are purchasing directly through Flotek.

Perfect, that's sort of I was just getting that in terms of backlog visibility and work for the near-term. You mentioned it here and I think it's important to and from an industry perspective, we've heard it. But certainly a positive trend in non-CnF side, I mean during the quarter 27% sequential growth in that business, some of it bounce back from 1Q. But can you maybe talk a little more about the broadening PCM opportunity set, and like you said [indiscernible] talked about some of the usages of friction reducers for extending that average lateral length across the industry? And how that kind of plays broader to the story and ability for your chemistry business to grow and even a flattish rig count environment that opportunity set expanding?

So great question, what we're able to do because the industry is wanting to do it is have a larger chemistry footprint on location beyond selling a CnF service, so some of these conventional PCM programs do not include CnF. We think that's okay, because over time we believe those clients will grow to embed CnF in the total solutions, some start with CnF. And so we believe it broadens the opportunity of expanding CnF and clearly the industry has a momentum that we think will not go back to appreciating what the economics look like with the decoupling of the chemistry. And so the fact that this should sit in directly with our cost structure and the same amount of sales people can sell this offering as they were just selling CnF within reason the same amount of blenders are able to blend the chemistry. It will create the leverage that we've talked about here in this call to the EBITDA line, which is what we want folks like yourself and others to focus on.

Got it. And last one and then already queue here, but I thought it was - is nice to get some of the updates from Josh on the citrus pricing, the inflation we've seen. In recognizing that we're entering is period here in the second half .Can you talk to is and maybe Josh can answer it, but more directly in terms of how that timing and that lag effect may impact the bottom line and when that inflection point is from results standpoint as you work through that existing inventory maybe as you get into 2018 I was trying to get a better sense of when we should see that turn in numbers if we see the market play out like something?

Sure. And all right Georg take and just a second. One thing and I try to point out your question gives us the opportunity our unit volume citrus oil really is at a low level crediting to Josh is 30-plus years of the way you purchased citrus oil. The reason inventory dollar number up is because of the increased in the pricing that the contracts that had to be executed. But he'll talk about for you now as we get closer in heading into the fourth quarter how we think there is definitely because of his relationships not only to Brazil and others how that will start to even out.

Hey, Georg, you certainly saw some of the impact of the shift in the market in Q2 you know we lost several 100 basis points on the Turpin categories. So the psychology of the market changed when the bigger numbers started becoming reality out of Brazil and they started processing. Some of it has already occurred to John's point we - volume wise were to a four-year low on the volume of inventory that we actually have. So I think we're pretty well-positioned we will fight a declining market in Q3 and in Q4 that certainly contributes to the lower topline guidance that we provided. But we feel Q3, Q4 we will work through this final it will compress our margins a little bit. So little bit different story than what we told after Q1. At Q1 we didn't know the crop was going to be so big out of Brazil, but we're positioned well our inventory is volume wise it'll low you saw some of the impact this quarter that will be offset by some of the positive opportunities we see in Asia and other parts of the world with a new product development.

And maybe to help on the model you should begin to see those inventory turns move quicker with the dollar value going down per unit of raw material. And so I think you know from a working capital perspective those metrics should improve with that deflation through the model if you want to talk about that more offline let me know.

And just to be clear Georg, we're not anticipating a crash of citrus oil prices. We're expecting prices to moderate to hopefully more normal levels and that will be beneficial to the total Flotek Company.

Great. That's helpful guys. Thanks a lot.

[Operator Instructions] Our next question comes from the line of Sean Milligan with Coker & Palmer. Please proceed with your question.

Hey guys.

Hi Sean

Can you walk me through the guidance on the ECT side for topline, so I guess to start, if we just look that - I'm trying to understand how much international headwinds cost you in revenue in the second quarter?

Yes. Sean that number is around $3 million and primarily driven by Canada, Canada's revenue declined was about - it was more than 65% sequentially. And so there's two factors going on there, obviously, the seasonality of the breakup, but there's been a consolidation of two large frac companies in Canada that we're working through. So it would be - we don't want to say we're going to get right back to the first quarter levels, but over the next few quarters, we do expect to get back to that first quarter level.

Okay. Let's just say you gained half of that back in the second quarter, is that primarily CnF or is that non-CnF?

It's primarily CnF Sean.

Okay. And then I guess what I'm trying to get to back into is heading into the third quarter, do you see the domestic CnF trends better than 6% on a volume basis?

We do.

Okay. Is that double-digit quarter-over-quarter or is it going to be kind of equally weighted versus the non-CnF side?

It should be in the double digits and here is the one qualifier that I think other people have talked to in their earnings calls. We had two or three CnF clients that were scheduled to go in June, but when tracks get delayed because of operational issues or whatever they don't just pick those up the next week. They have to get back in the queue and in several cases these clients are going to be done in the middle to end of August, which we have no control over. But from what we can see it should be a double-digit on the CnF from what we can see.

Okay. And then just to confirm the 100 to 200 basis points incremental margin, is that on the gross line or the EBITDA line.

That's on the EBITDA line and we called out the increase in the gross margin on CnF really as much as anything - let folks know that the pricing is intact and the pricing has continued to be accepted, but from a pricing resiliency and from any type of competitive standpoint, we want really our shareholders and folks like yourself to focus on the EBITDA line margin and its growth as the conventional chemistry will continue to grow and just give folks kind of a fair way here. CnF well can range between say $200,000 to $350,000 range. A full chemistry PCM well can range from $700,000 to $1 million. And so as more and more of that happen as we kind of telegraphed a couple of quarters ago, there will be gross margin compression, but the leverage will come with the EBITDA. And that's as we talked about the EBITDA lifted by 100 basis points this quarter, we believe it will uplift another 100 to 200 basis points in the third quarter and that's the line we want to have folks focus on. And what's really happening is these operators and I think even a couple of them have talked about in their press releases are able to reduce their AFEs due to this decoupling and that actually affords a window of looking at CnF as its high valued economics maybe differently than they would have a year ago. So there's a double advantage of the way this industry is moving from what we can see.

Okay, thanks John.

Sure.

On G&A side, if you back out the retirement comp, you say or you cut G&A a little bit in second quarter. Can you kind of qualify for us the impact that you might see in third quarter on a G&A basis for many time kind of cuts you're making at the corporate level?

Yes, so I think for everyone out there, I'll give you a couple of benchmarks from first quarter to second quarter. If you look at cash, on the corporate side of G&A, it went from $9.9 million to $8.3 million, a reduction of 15%. If you look at the total enterprise went from $19.6 million to $17 million. And we believe there will be a continued tapering of that. As we look at just exactly as this business model takes effect with PCM more decoupling. So as I've told folks in the past, we are focused on this. And continue to be and I think this quarter speaks to that. And I think offline or that maybe able to time in terms of a modeling standpoint, how to look at that going forward, if that's something you would like to have. But again I think it's important to note, the reduction that we did occur from the second to first quarter.

Yes, Sean, so we took a couple million out sequentially in the quarter if you consolidate what's in corporate and what's in the segment. I don't know that we'll get another couple million out sequentially in the third quarter, then in another million out in the third quarter is certainly possible, and furthermore into the fourth quarter. But we will give updates on those metrics as we move forward to you.

All right, thanks. I'll re-queue.

Thank you, Sean. There are no further questions at this time. I'll turn the call back to you.

Okay. Thank you for those that listened in and those that you'll be reading the transcript will be out on the road at intercom in the middle of August, up in Denver that conference and again we'll continue to do our best to provide the best clarity we can as to the repositioning of Flotek that we've undergone during this period, and thanks again for everyone's interest. We'll talk to you next quarter if not before.

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.