Greetings, and welcome to the Flotek Industries First Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce Danielle Allen, Senior Vice President, Global Communications and Technology Commercialization for Flotek. Thank you. Madam, you may begin.

Thank you, and good morning, everyone. We appreciate your participation. And with me on today's call are John Chisholm, Chairman, President and Chief Executive Officer; and Elizabeth Wilkinson, our Chief Financial Officer. Our earnings press release was distributed yesterday, which is available on our website. In addition, today's call is being webcast, and replay will be available on our website, along with our updated investor deck. Before we begin formal remarks, I would like to remind participants that during this call, some of the comments may constitute forward-looking statements within the meaning of Section 27A of 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, plans, believes, estimates and similar expressions or variations of such words are intended to identify forward-looking statements but are not an exclusive means of identifying such forward-looking statements. These matters involve risks and uncertainties that could cause our actual results to differ from such forward-looking statements. Risks are discussed in our SEC filings, including our Form 10-K. Also, please refer to our reconciliations provided in our earnings press release as management may discuss non-GAAP metrics on this call. Finally, after our prepared remarks, we will answer any questions you may have. So with that, I will turn it over to John.

Thanks, Danielle. We appreciate everyone joining us for today's call. The entire industry clearly has enjoyed seeing crude prices meaningfully increase from the start of the year. However, during the first quarter, the oilfield services sector continued to operate in an environment of heightened volatility for U.S. onshore drilling and completions activity, and we expect a similar backdrop for the second quarter. As such, we were pleased to have first quarter total revenue hold steady with the fourth quarter. During the first quarter, we continued to benefit from our transformation to a full-service provider of reservoir-centric fluid systems directly to our clients at the wellsite. This holistic and direct-to-wellsite approach, which is our Prescriptive Chemistry Management or PCM platform, allows us to work directly with our clients to achieve the full value of our chemistry offerings. We continue to gain traction in the market for our full-service PCM technologies while also seeing increased pull-through of our proprietary value-add chemistries. To drive further market penetration, we are working closely with clients to monitor the long-term economic benefits provided by our differentiated fluid systems. Several studies completed over the past year in multiple basins have clearly shown the benefits of our customized chemistry offerings. The list of these benefits includes higher incremental and sustainable production levels and improved gas-to-oil ratio, increased capital efficiency, lower operational costs through reduced horsepower requirements, prevention of fluid incompatibility and mitigation of frac hits to avoid reservoir pressure and production loss in parent and child wells. In any pricing environment, but especially in the current and expected backdrop, a $50 to $60 per WTI barrel, the combination of these benefits has a material positive impact on both short- and long-term return on capital for E&P operators in their drilling and completion programs. Compared to most other industries,…

Thanks, John. The financial tables in our press release present the operations of our CICT segment as a discontinued operation for all periods. As such, I will focus my discussion today on quarterly results for our continuing operations, which include our energy business as well as our supporting research and innovation and corporate functions. As John discussed, given the continued volatile environment for U.S. onshore drilling and completions activity, we were pleased to have a first quarter revenue that was essentially flat with the fourth quarter of 2018. Operating expense increased $2.6 million from the fourth quarter primarily due to higher material costs and a number of either nonrecurring or noncash items. These items included a $1.3 million bonus accrual reversal taken in the fourth quarter of 2018, $8.4 million write-off in the first quarter of a software license no longer needed and a $0.3 million net increase in allowance for doubtful accounts primarily due to the writing down of a specific customer receivable. However, lower logistics costs partially offset the overall increase in operating expense in the first quarter. Please note that the nonrecurring bonus accrual reversal, software license write-off and adjustment to allowance for doubtful accounts are not called out as adjustments to EBITDA in the table provided in our release. Corporate G&A rose to $7.3 million from $6.8 million for the fourth quarter. The increase reflected approximately $0.6 million related to shareholder-related activities in Q1 2019, partially offset by $0.1 million in lower severance costs quarter-over-quarter. I would note that shareholder-related activities and severance costs are called out as adjustments to EBITDA. Research and innovation costs were flat quarter-over-quarter at $2.3 million. Moving down the income statement. We recorded a loss on disposal of assets of $1.1 million during the first quarter, which was primarily associated with…

Thanks a lot, Elizabeth. Heightened investor scrutiny of E&P capital spending, cash flow generation and return on capital has escalated demand from operators for improved well economics and price transparency. This has placed more pressure on oilfield service providers to truly differentiate product and service offerings as operators decouple in connection with the completion process. Similar to diesel and frac sand, operators are expanding and accelerating their efforts to source chemistries directly. As we've discussed in the past, operators are facing diminishing returns as mechanical variables have reached and, in some cases, exceeded both our economic and technical limits in completion designs. Chemistry customized for the reservoir is critical to driving enhanced performance and capital efficiency. In recognition of this environment, we have invested significantly to expand our unique portfolio of proprietary products and further enhance our in-house technical understanding accumulated over more than a decade of fluid system designs and applications. As we stated in the past, we believe this will clearly set Flotek apart from its competitors and place us in a solid position for long-term success. To more fully leverage our differentiated market position, last week, we announced that Mark Lewis joined Flotek as our Senior Vice President of Global Sales and Business Development. In this role, he will lead the company's domestic and international sales and business development strategies as well as oversee the delivery of our products and services to clients. With more than 35 years of experience, Mark came to us from Baker Hughes, where he led business units, strategic accounts and teams in the Americas, Middle East, Africa, Asia Pacific and Europe. Mark has extensive experience developing strategies to provide technology-driven products to both upstream and downstream oil and gas operators of all sizes. We look forward to Mark leveraging his unique skill…

[Operator Instructions]. Our first question comes from Georg Venturatos of Johnson Rice.

John, I wanted to kind of kick off on more of a higher-level question, and maybe it bleeds into some of the changes in leadership roles that are coming about on the sales side. But I just wanted to get your overarching thoughts on the landscape, particularly in the Permian, with scale being a focus and majors and large independents and consolidation and obviously, potentially longer term, fewer players really driving production. How are you all trying to get in front of that, one? And how has your kind of sales strategy changed to go after what may be kind of a changing landscape on that side over the next few years?

Thanks for the question. And so that falls into Mark. This was a process that took a couple of months, not a couple of weeks, for that position. The fact he has the experience of dealing from the top to bottom with large operators on a global basis from supply chain to the C-level was the driving reason why we wanted Mark and why, actually, he felt with our technology, he wanted Flotek. And we have targeted 8 or 9 what we call multi-basin players that we believe are going to be here for the long term, and that's a focus as to how we're approaching our sales effort. We are seeing with inside these operators that more and more if -- not just the influencing but outright selection of technology is occurring with reservoir engineers, geologists and geophysicists in areas that they previously weren't involved with, those disciplines were typically involved with selecting where to drill and then they kind of moved on. Now they're being engaged in the process of trying to get more oil out of the rock, and we feel that, that suits ideally with where we position Flotek, where the research and innovation, the custom chemistry has a certain level of technical appeal to those folks. So with that as a backdrop, we've evolved our sales organization to -- and its constant. It's not like we're done. But we've evolved that to people that are more in tune with that, whether their degree is in chemistry, degree is in reservoir engineering. I think a lot of people know we've got a geology reservoir team at research, but also, we're pushing that more out into the frontline selling because of the way the industry, we believe, is evolving. The completion petroleum engineers are now really empowered with execution for efficiency, which is very important. That's one big part of the equation. And now more and more of these other fellows, girls, ladies are engaged on what we would call the effectiveness of that completion. So it's been a major change in the way we are approaching these clients, and hopefully, that gives you the backdrop.

No, that's helpful, John. Other item I wanted to discuss, I guess Elizabeth mentioned cash neutrality in the second quarter. Last quarter, you all were able to provide at least some longer, intermediate-term targets on G&A and the R&I line. Just wanted to see if we could get an update of kind of whether those are still intact and where you stand in that process over the next few quarters.

Yes, absolutely. As mentioned, actually, earlier in the call, we are absolutely continuing to expect to get our G&A down to about $5 million a quarter and our R&I expenses down to about $2 million a quarter. And you should see some improvement even in the second quarter for that but really get there by the end of the year.

Okay. I just wanted to confirm that. And then last one, and then maybe I'll re-queue. But it sounds like, based on some of the marketing efforts in the next couple of quarters, you should see that margin inflection in the back half as some of that starts to counteract. But can you maybe talk to the potential magnitude there, expectations and maybe what that -- kind of the drag has been as a result of some of the items you called out on the margin side?

Yes. We'll give you kind of a soft circle number of a couple of hundred basis points has been the drag. And I think one thing we want to -- I just want to kind of also reestablish with what Elizabeth said because you even called it out in your morning note. What we had put out there 5 months ago is expected capital. Now it's been meaningfully changed from an expected $20 million or so now to $4 million, which is part of great work by the Strategic Capital Committee. But I think the other thing that we see that we want to put out there is that everybody's pretty familiar with this oversupply of fracturing equipment, but I think something that's not being talked about that much is now it takes fewer frac fleets to keep up with drilling rigs. And that's keeping a certain level of pricing volatility in the whole sector of completions, which cascades to everything associated with that event, whether it's sand or whether it's chemistry. So what's really happened is two years ago, it would take two frac fleets to keep up with four rigs. Now it's kind of like one. And so that's still sorting itself out, Georg, which is why we can't give you a harder number on the improvement on the margins. But there's certainly a drag to the number that I said, and we expect that to improve as we work through the year.

Our next question comes from Mike Urban of Seaport Global.

Sorry for the background noise. I'm running around Boston today. So a question on some of the efforts that you're undertaking around logistics and distribution. I think -- if I'm thinking about it correctly, PCM is a little bit more of a distributed model. Are some of those efforts that are underway, does that get you to a point where you have kind of sustainable profitability and cash flow at your current volume and scale? Or do you need to see growth to get there, whether that's organic or some of the inorganic things you might be looking at?

Well, obviously, we're eager to see both. But yes, indeed, we definitely expect to make significant headway in our logistics costs. And actually, that involves tightening of policies and procedures related to sales and service delivery arrangements. It relates to engaging logistics experts to address some specific issues we're working on and generally just working, looking at a lot of different efficiencies across our business.

And do you have a sense for -- do you need more scale? Or do those things get you to a point, with the level of demand and volume, where you can be consistently profitable and cash positive?

Yes. So I mean consistent with our last conference call, our target in our cost-cutting endeavors and the things that we're doing this year is to get us to a point where we get to a positive adjusted EBITDA towards the latter part of the year. I mean that's what we're after, even in this weaker $50, $60 oil environment.

Okay. Got you. And then I fully recognize that the capital committee has a lot of ground to cover, just a lot of things to look at. It's really just a critical element of the value proposition here. But is this -- in terms of kind of figuring out what we're -- the plans are going forward, is that a this quarter event? Does that take the rest of the year? I mean just rough time frame in terms of what we should think about in terms of you expecting some conclusions there.

Sure. And would David chime in there? It's one of the reasons, actually, not this foresight, in August when I asked him to come on the Board, but he is ideally suited, which is why we wanted him to be co-chair of this. But David, if you want to take that question, it'd be great.

Thank you, John, and thank you, Mike, for your question. As you heard from Elizabeth's comments, at this moment, of course, the company is doing a nice job of conserving cash while we go through our deliberations. We hope to be able to deliver some, perhaps, most of our recommendations to the Board when the Board meets at the end of July, which at least creates the potential that we could provide some elimination to our stakeholders about this when we have our second quarter earnings call in early August. Hope to do that is different from a guarantee, however. That date could slip, but that's what we're trying to do. I would like to also mention why this project takes time. First, we decided to do this work ourselves rather than to spend millions of dollars on outside consultants. And the reason that we did that was so that our team at Flotek would own the strategy that they would be responsible for executing. Otherwise, there's always a risk that a consultant's report can become a very expensive doorstop gathering dust, and we did not want that to happen. Second, as you heard from John and Elizabeth, the process we're going through is deliberative and inclusive, hearing from virtually all types of stakeholders on a regular basis. And finally, as you've also heard, the process we're going through is a data-driven process and analytical process trying to look out about 3 years to build the value of the company. And in connection with that, it's very important that the data that we use be good data. Flotek completed an information system conversion last year, and the committee understandably wanted confidence that the data we get from that new system about product line profitability, including freight, returns and SG&A allocations,…

[Operator Instructions]. Our next question comes from Walter Morris of Baraboo Growth.

Congratulations on holding revenues flat sequentially in a tough oilfield environment. My question is for Elizabeth. Could you reiterate the 3 items you talked about earlier, the software write-off, reversal of bonus and another item? Reiterate the dollars involved in each area and the net amount and why you didn't consider those as nonrecurring or why they were not included in your calculation of adjusted EBITDA.

Okay. So you're talking about -- so the write-off...

The $1.3 million software write-off, reversal of bonus.

Yes. Okay. So the $1.3 million bonus accrual reversal occurred in the fourth quarter, and I guess what I'm saying is that when we accrue bonus or reverse bonus accrual, we don't do -- we don't take that as a call-out to adjusted EBITDA. Like we don't adjust EBITDA to remove the impact of that because we consider that a continuing piece of our business. And although it fluctuates quarter to quarter in that case, it doesn't really make sense to us to be treating that as not truly a nonrecurring thing. The other thing is something like the software write-off, which was a license. That's booked as part of our regular operating expense for ECT, and it happened to be a circumstance where we transitioned to a -- our ERP -- an integrated system that's linked into our JDE ERP system. And therefore, it didn't need to continue with another software product that we were using. And so we wrote off the license even though we couldn't get out of paying -- making an annual payment that was required that had already been committed much previously. So that's another case where it's just part of doing ongoing operations, and we just don't make the habit of pulling something like that out of our operating results. And then what was the other one? Then allowance for doubtful accounts. Same sort of thing. I mean you have fluctuations in whatever allowance you might be taking, and it's a noncash adjustment, but at the same time, it's really part of general ongoing business, business as usual. So we don't call that out either. We try to really make the things that we do that we call out of that significant and truly more what we would be thinking of in terms of nonrecurring, unusual items that don't reflect the ongoing nature of the business.

And the software license write-off was how much, did you say?

That was $400,000.

And the allowance for doubtful accounts?

Roughly $300,000 adjustment, net.

This concludes our question-and-answer session. I would like to turn the conference back over to John Chisholm for any closing remarks.

Thank you, Nichole. Just want to say thanks again for everyone joining us today. In the new normal of anticipated and ongoing commodity and completion activity volatility, we've made significant progress in transforming our business to better leverage our industry-leading chemistry technologies and direct-to-client service offerings. Underpinning our efforts is a strong financial position, and we will remain aggressive in our efforts to build a profitable, true cycle business that drives long-term benefits for all our stakeholders. We appreciate everyone's interest today in Flotek and the support of our shareholders and ask you all have a great day, looking ahead to a great weekend. Thanks again.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.