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Edited Transcript of FTK earnings conference call or presentation 21-Feb-18 3:30pm GMT

Q4 2017 Flotek Industries Inc Earnings Call

HOUSTON Mar 21, 2018 (Thomson StreetEvents) -- Edited Transcript of Flotek Industries Inc earnings conference call or presentation Wednesday, February 21, 2018 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* H. Richard Walton

Flotek Industries, Inc. - CFO and EVP

* John William Chisholm

Flotek Industries, Inc. - Chairman of the Board, CEO and President

* Joshua A. Snively

Flotek Industries, Inc. - Head of Operations

* Matthew Brian Marietta

Flotek Industries, Inc. - SVP of Corporate Development & IR

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Conference Call Participants

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* Georg Philip Venturatos

Johnson Rice & Company, L.L.C., Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Flotek Industries Inc. Fourth Quarter 2017 Earnings Conference Call. (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.

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Matthew Brian Marietta, Flotek Industries, Inc. - SVP of Corporate Development & IR [2]

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Thank you, and good morning, on behalf of the Flotek team. Joining me this morning are John Chisholm, Flotek's Chairman, President and CEO; Rich Walton, our Chief Financial Officer; and Josh Snively, Executive Vice President and our Head of Operations; as well as other members of our leadership team. Our earnings press release was distributed yesterday afternoon 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 participants that during this call, some of the comments made 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 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 exclusive means of identifying those forward-looking statements. These matters involve risks and uncertainties that could 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.

Also, please refer to our reconciliations provided in our earnings press release and filed in an 8-K this morning as management may discuss non-GAAP metrics.

With that, I'll turn the call over to John Chisholm.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [3]

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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 with some introductory remarks followed by Rich, who will review our financial highlights, followed by Josh, who'll provide an operational overview. Finally, I'll end with closing remarks and outlook before taking your questions.

Before we begin, I would like to thank our hard-working employees at Flotek for their efforts in the transformation of Flotek that occurred in 2017.

The accomplishments they have made in a short amount of time is inspiring. I'm honored to lead the organization as we head into our first full year as a pure-play custom chemistry technology company.

To outline the accomplishments in 2017, first, our leadership team was transformed during the year and now reflects our go-forward vision for the company. We thank prior leadership for their service, but I believe the team we have put together is built to last and furthermore, thrive for our shareholders.

Second, and while it may seem like a long time ago to some, it was only back in May that we successfully divested our Drilling Technologies and Production Technologies segments. These segments were cornerstones of the Flotek legacy, and while difficult to move away from the businesses, it was the right decision for our shareholders.

Third, we paid off our term loan and reduced the balance on a credit facility. The financial stability of Flotek has never been as strong as it is today.

Fourth, we put into place an aggressive SG&A reduction initiative, which has allowed us to manage the organization to positive operating income and improved profitability in the fourth quarter despite sequentially lower revenues. While the bulk of the heavy lifting has been done, we will continue to make progress on this front.

Finally, and through all these initiatives, we've been steadfast in our dedication to research and innovation, which has contributed to our growth and opportunities through the new product development and data analytics initiatives.

At our core, Flotek is an organization centered around innovation, and we are much more agile today than ever before due to our asset-light business model.

To first comment on our energy end markets with the 2017 recovery behind us, the industry remains in a state of flux. The historic declines we saw in '15 and '16 are once in a lifetime or a career. Regardless of the volatility and fluctuating capital demands, Flotek remains well positioned and financially sound to weather any environment going forward.

After the sizable U.S. land activity ramp, there is somewhat of a hangover effect that has carried into 2018. Many of our peers, clients and business partners have commented on a variety of issues we have also experienced, which includes deep freezes, lack of labor, infrastructure and takeaway challenges and logistic bottlenecks, to name the most pressing. While we see the promise of momentum, this recovery is not linear nor smooth and remains in a state of change. In 2018, growth is likely to be more tepid than last year but also more inclusive of international geographies and with broader opportunities.

The industry has achieved incredible milestones over the past 4 years. The industry has pushed cost down, drillers can drill faster than ever, service company equipment now lasts longer, operators have tested the limits of well spacing and frac stages and have applied more intensive fracs using more proppant.

Having achieved these remarkable feats, there is no question chemistry is the new frontier to push our limits even further. And there is much more to achieve through customization of treatment to the reservoir. Given the vast diversification of geology and reservoir types, the demand for prescriptive chemistry is critical for greater completion, optimization and performance and is poised to gain a greater portion of the industry's attention going forward.

As we look back into 2019 (sic) [2013], we acquired Florida Chemical in order to protect our supply chain. We recognize one of the biggest threats to Flotek was the inability to source and manage key raw materials that went into our patented Complex nano-Fluid technologies. Since that time, the synergies have been tremendous for both organizations. We would not have been able to navigate the energy downturn, while citrus prices more than doubled, if not for the strategic merger and acquisition.

Now Florida Chemical, our Consumer and Industrial, or CICT, segment continues to navigate the challenges in the citrus industry at an exceptional level. As such, we are allocating capital appropriately as we spent roughly 40% of our 2017 CapEx toward projects in CICT, and CICT will earn a similar portion of our 2018 planned expenditures. We are far on our journey of fully integrating the businesses and sharing best practices due to the transformation we put in place in mid- to late 2017.

Against this backdrop, Flotek remains focused on controlling what we can control, and we will protect our accomplishments by maintaining a strong balance sheet and allocating capital where we believe the highest return opportunities exist for our shareholders.

I'll now turn it over to our CFO, Rich Walton, to provide a review of our key financial information. Rich?

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H. Richard Walton, Flotek Industries, Inc. - CFO and EVP [4]

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Thank you, John. I will address key financial information as of and for the fourth quarter and the year ended December 31, 2017.

Flotek expects to file its Form 10-K for 2017 with the U.S. Securities and Exchange Commission before the end of the first week of March.

We have continued to strengthen our balance sheet during the fourth quarter. In addition, we returned to generating operating income during the fourth quarter as we successfully addressed and reduced our corporate, general and administrative costs and segment selling and administrative costs.

For the fourth quarter, we reported total revenue of $72.5 million compared with $70.6 million in the prior year period, an increase of $1.9 million or 2.7%. On a sequential basis, quarterly revenue was down $6.9 million or 8.7%.

For the full year 2017, revenue was $317.1 million compared with $262.8 million in 2016, an increase of 20.6%. Energy chemistry quarterly revenue increased compared to the prior year period but declined 9.6% on a sequential basis to $55.3 million. Our Consumer and Industrial Chemistry segment quarterly revenue increased 11.3% compared to the prior year period, but declined 5.9% on a sequential basis to $17.2 million, primarily resulting from the seasonal impact of sales to the beverage industry.

For the fourth quarter, we had income from operations of $2.1 million. This follows 3 quarters of losses from operations. For the full year 2017, the consolidated loss from operations totaled $2.9 million. For the fourth quarter, the consolidated operating margin was a positive 2.9%. For the full year 2017, the consolidated operating margin was a negative 0.9%.

The segment operating margins were 13.8% in the Energy Chemistry segment and 10.1% in the Consumer and Industrial Chemistry segment. Corporate general and administrative expense for the fourth quarter was $7.7 million, a decrease of $2.6 million from the third quarter of 2017. Early in the fourth quarter, the company took significant measures to reduce contract labor and consulting expenses, and the benefits of these measures are now being seen.

Our corporate G&A during 2017, as a percentage of revenue, decreased to 13.1% from 16.6% in 2016 as we progress our cost-reduction initiatives.

During 2017, the company incurred nonrecurring charges of $2 million related to executive retirement and severance and $0.4 million related to the shareholder lawsuit and SEC inquiry.

Noncash compensation was $1.5 million in the fourth quarter. Segment selling and administrative expense for the fourth quarter was $8.3 million, a decrease of $1 million from the third quarter of 2017. Segment selling and administrative expense during 2017, as a percentage of revenue, decreased to 11.7% from 13.9% in 2016.

For the quarter, research and innovation expense was $3.7 million compared to $3 million for the same period of 2016. This increase of $0.7 million is attributable to meeting client demands and to cost for new product development and new chemistries, which are expected to expand the company's intellectual property portfolio.

For the fourth quarter, Flotek reported a net loss from continuing operations of $7.8 million, representing a loss of $0.14 per share on a fully diluted basis. The fourth quarter of 2017 includes income tax charges of $7.3 million relating to the new Tax Cuts and Jobs Act signed into law in December 2017 and an income tax charge of $1.1 million resulting from a reduction in the tax benefit related to stock-based compensation.

This compares to net income from continuing operations of $3.9 million for the fourth quarter of 2016, representing income of $0.07 per share on a fully diluted basis.

For the full year 2017, Flotek reported a net loss from continuing operations of $13.1 million, representing a loss of $0.23 per share on a fully diluted basis. This compares to net income from continuing operations of $1.9 million for 2016, representing income of $0.03 per share on a fully diluted basis.

Moving to the balance sheet metrics. At December 31, 2017, the company had accounts receivable of $46 million compared to $47.2 million at December 31, 2016. At December 31, 2017, days revenue and accounts receivable was approximately 58.5 days compared to 62.5 days at December 31, 2016. At December 31, the allowance for doubtful accounts is $0.7 million or 1.6% of the receivable balance.

At December 31, 2017, inventories totaled $75.8 million compared to $58.3 million at December 31, 2016, an increase of 30%. This increase primarily resulted from higher cost for citrus oil and an increase in the volume of citrus oil held. Our inventory historically builds during the first half of the year and is dependent upon the timing of citrus oil deliveries.

At December 31, 2017, borrowing under our revolving credit facility was $28 million and there was undrawn availability of $43.9 million. Debt was reduced by $20.4 million during 2017.

As previously mentioned, our credit agreement was amended in September 2017. It increased the maximum revolving advance amount by $10 million to $75 million and extended the maturity 2 years until May 2022.

During 2017, capital expenditures were $9 million compared to $14 million in 2016. Expected capital expenditures for 2018 are estimated to range between $12 million and $16 million.

During the fourth quarter, the company repurchased 225,000 shares of its common stock for $1 million or an average price of $4.57 per share. As of December 31, 2017, the company may make additional share repurchases of up to $9.7 million.

The Form 10-K, which will be filed shortly, will provide full disclosures of our 2017 results and a full discussion in management's discussion and analysis. We continue to be focused on growing our core businesses, lowering SG&A costs, monitoring capital expenditures and protecting our liquidity.

And now I'll turn the call over to Josh to provide an operational performance update for the company. Josh?

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Joshua A. Snively, Flotek Industries, Inc. - Head of Operations [5]

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Thank you, Rich. First, in our ECT segment, the business model is evolving, shifting from purely FOB manufacturing to downhole delivery, which means delivering inventory and the chemistry experience to the client, whether that client is an operator or service company. The industry is hungry for proven technology and reliable service, which Flotek can and will continue to deliver.

This shift creates an increasing need for partnerships with our operator clients as well as alignment with our service company clients. Working together, we can deliver the highest-value chemistries to the operators while reducing redundant logistics and distribution costs all with the ultimate goal of improving reservoir and well performance.

Interest in our Prescriptive Chemistry Management, or PCM, platform remains very high and is likely to become more of a growth engine for Flotek. While this trend is not a quarter-to-quarter story, momentum will continue to build throughout 2018 and into future years.

We are in the process of building out our facilities to fill our clients' needs, covering logistics requirements and identifying the right partnerships.

Our footprint needs to be enhanced, and we are spending capital dollars to ensure we are optimized for delivery on that need. We are looking into opportunities to decentralize certain aspects of our manufacturing activities to lower our cost. Additionally, we are pursuing inventory strategies that will allow us to improve our delivery capabilities and respond faster to our clients.

We will use these benefits to help accelerate the energy market penetration for our chemistry offerings during 2018. Overall, energy companies remain cost-conscious but understand the need for value-added technology. We believe there will continue to be optimization efforts by our clients, and while sometimes cost can overshadow performance or returns, we believe this is a temporary position. We remain confident in our technology and ability to develop and apply our chemistry faster and better than our competitors.

Our Complex nano-Fluids, Prescriptive Chemistry Management and Pressure reducing Fluid platforms provide recognizable product portfolios that have the reputation for the industry-leading technology and performance in the field, and we will continue to expand our footprint accordingly.

Likewise, we will continue to partner with service companies to develop and deliver differentiating technologies that bring value to our clients' assets.

Moving to our CICT segment, demand for natural citrus flavors remains high. Operationally, we remain focused on breaking into higher-margin flavor opportunities and leveraging our world-class manufacturing facilities and personnel in Winter Haven, Florida. Applications of our chemistry knowledge was expanded in 2017 and we have begun to invest more into this segment of our organization. This includes our expansion into Japan with the opening of our first East Asian sales office for this side of our organization as well as bringing online our new distillation unit in Winter Haven, which is enabling us to enhance and expand our citrus oil processing efficiency and capacity.

CICT is well positioned on inventory, and our supply chain department has done a fantastic job staying in front of the challenges the citrus industry has faced for a number of years, which hit a significant pinch point after Hurricane Irma made landfall in Florida's citrus-growing region.

Looking out, we see the need to continue our expansion into other citrus varietals specifically for grapefruit flavors as well as lemon and other cultivar options for our clients. We are being pulled to do more, and we will respond to meet the demands and market opportunities we have.

We are focused on efficiencies across our company as we further integrate our ECT and CICT segments. And doing so, we have integrated our supply chain, shared best practices in manufacturing and are finding synergies in our logistics activities and improving systems and internal reporting capabilities. These efforts should reflect in smaller, smarter -- in a smarter organization and allow our operations to make decisions faster and with more information.

We will manage our business -- we are managing our business at the EBITDA level, which is apparent in our results. Our fourth quarter adjusted EBITDA margins expanded to 10.7%, up from 4.1% in the third quarter, a testament to the execution of our team.

The role that research and innovation plays in our sales cycle and channels continues to expand. Our global research and innovation center is where it all starts for Flotek. And we have accelerated our time to respond to clients' request in both segments. We have new product introductions coming to market now and are expecting more throughout 2018. Due to our R&I capabilities, we can quickly identify and respond to a wide range of opportunities, enhancing oil and gas production around the world, to delivering flavor and fragrance technologies to our clients. The feedback loop we have created in ECT and CICT is very strong and has allowed us to see more chemistry applications than ever before. This, in turn, allows us to develop better, more cost-effective solutions faster than our competition while also enhancing our intellectual property. We are listening to our clients, and we will deliver at a cadence that our competition cannot keep pace with.

In all, we have made progress operationally, but have more to go to further execute on our plan.

With that, I will turn it back to John to offer concluding remarks.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [6]

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Thanks, Josh, and really well done. Before we take questions, I'd like to offer an outlook and add some concluding thoughts.

We put in substantial effort to rapidly transform Flotek during 2017, and entering 2018, we continue to push to make a difference. In the second half of 2017, we managed our performance to enhance profitability and executed on our strategy to reduce SG&A. In doing so, we exceeded expectations of what we could accomplish in such a short amount of time. We continue to assess our product and business portfolio and have exited certain offerings we determined to be unacceptable to our goal of maximizing our returns.

Moving forward, our focus is on 3 key buckets: cost discipline; managing the expansion of our PCM platform; and new product development. On this last point, Flotek remains committed to custom chemistry solutions that meet the performance and the price point of our clients in both of our segments. Furthermore, in energy markets, even as the decoupling trend expands throughout the industry, service companies remain critical partners of ours in delivering maximum value-add to the reservoir and the operator. Our unwavering commitment to research and innovation sets us apart from just chemical providers as we chose to invest more during the energy downturn to create the complete chemistry experience, as Josh referenced earlier. Evidence to this success, in 2017, approximately 40% of our ECT revenue came from formulations that we created in 2015 or later.

This accomplishment is why we believe our R&I investment will be a key milestone in the journey ahead for our company.

We recently expanded an initiative to improve our case study in marketing publications. It is important for the industry to better understand our chemistry and the technologies we offer. Service companies and operators of all sizes can depend on our chemistry expertise and many have begun discussing ways to obtain our technology offerings earlier and engage in technical relationships to keep them on the cutting edge of science. In addition, we are able to improve the economics of our chemistry through our unique pricing opportunities that we are now able to offer.

Moving to our outlook. There are a number of things which are always out of our control, like logistical bottlenecks for other consumables, labor shortcomings, equipment issues and overall and widespread inflationary pressures. However, we will continue to manage what we can control and communicate transparently to our shareholders. We want to reiterate our trajectory and path has not been nor will it be linear. Clients continue to manage cost inflation by testing the market, forcing greater competition and we'll always seek to optimize and pressure suppliers. Given these dynamics, we believe what sets Flotek apart is our commitment to research and innovation and data analytics and the empirical field data that proves our ability to maximize the economics of our clients' reservoirs.

2018 will mark the first year in our company's history that we will focus 100% of our attention on custom chemistry technology, as it is the first year without the Drilling and Production Technology segments for this company. Despite the challenges we have faced, the momentum running with both of our segments feels strong. Our strategy is focused on improving returns, maximizing our shareholder value and adding value to our clients of all types and all sizes. We will invest our shareholders' capital wisely.

We intend to update our shareholders with better visibility into the first quarter soon, as weather issues in January, which have been well publicized this earnings season, have now receded and activity ramps through the remainder of this quarter.

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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we do have a question on the phone line that is from the line of Georg Venturatos with Johnson Rice.

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [2]

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John, thanks for some of those final comments on what you're seeing near term. Just wanted to touch on that quickly first. Just in terms of expectations for 1Q in terms of flattish activity, certainly heard that from pressure-pumping peers, weather, labor logistics, but it sounds like February did see a bounce from what we saw at least early in the year, in January. Maybe just a few more comments on that? And then, what is implied for a kind of through the rest of the quarter within your flattish expectation, say, for March?

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [3]

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Sure. No, you're right, Georg. We've seen February rebound from the January hangover with the freeze and everything else we talked about. And we see meaningful momentum based on the booking of activity for sure through March and into the second quarter.

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [4]

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Okay. Got it. We'll look for an update, like you said, when you've got that available. On the customer side, John, I think it's just a point that investors are focusing on, but what we've heard from Pioneer most recently talking about continued focus on completion costs, chemistry-related, can you give us any insight in terms of conversations there? We understand that all of your customers test other products and you welcome that, given the uplift that you expect they'll see CnF related to others. But just wanted to see if you could provide any thoughts or color around that given where we are today.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [5]

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Thanks for the question, Georg. Of course, we honor the confidentiality agreements we have with our clients, and so we have a policy against speaking specifically about individual clients. And I think, as everybody knows, we've evolved way past just a client or a product over the last several years. That said, we expect diversification of our client mix in 2018, that's something we're pretty pleased about. We're extremely proud of our client retention rate. As we said during the call, competition is high, pressure will always be on for clients to manage their cost inflation by testing the market, actually as you mentioned, which will force greater competition and will always seek to optimize and pressure their suppliers, that's the way the industry, as you know, works.

So we respect operators' choice to explore options in the marketplace, again, as you talked about. We certainly know we're not the only product, but we can say confidently that when field performance is analyzed, our technology consistently shows meaningful uplift with economic benefits, as evidenced by our recently released study of more than 400 wells in the Wolfcamp B, in the Midland Basin. And I think, as everybody knows on this call, some operators' decisions at times, become cost-focused versus performance, that's always been the case. And we want to always be valued on the performance we help create, and we feel really good about that.

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Operator [6]

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(Operator Instructions) And I'm showing no further questions at this time. (Operator Instructions) And we do have a follow-up question from the line of Georg Venturatos with Johnson Rice.

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [7]

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I guess, I got cut off there.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [8]

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Georg, we were worried about you there.

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [9]

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Well, you'll have to bear with me for a couple more here.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [10]

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Okay.

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [11]

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John, I was curious -- when I look at -- everybody's focused on ECT, but if you look at growth opportunities and you all mentioned an interesting comment about 30%, 40% of CapEx here in the next 12 months dedicated to CICT, guidance called for kind of flattish top line year-over-year. Do you see those as opportunities for kind of '19 and beyond with where you're putting that capital? And maybe just a little more on where that capital is going and what opportunities you're seeing in that side of the business? And then on top of that, '18 looks like a potential turning point for international markets. I know that's been a big drag on you all for the last few years, as others within ECT. So maybe just talk about potential tailwind on the international side as well.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [12]

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Sure. I'll talk first just briefly on your question about CICT. So 2018 is going to be what we would call a positioning and also a high-performance year for CICT, which seldom you get to do that at the same time, but the capital you mentioned is positioned for the future, and Josh will speak directly to that, then we'll come back to the international for a second.

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Joshua A. Snively, Flotek Industries, Inc. - Head of Operations [13]

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Georg, on the CICT side, you're looking at the back half of '18, really in Q4, where we expect to see some of that impact being realized and then certainly in 2019 forward. If you look at our numbers, we certainly added to expenses in '17 to help build out some of this capacity in addition to the CapEx we invested, and really, you're looking at back half of '18 Q4 and forward for that impact.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [14]

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Does that answer your question, Georg?

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Georg Philip Venturatos, Johnson Rice & Company, L.L.C., Research Division - Associate Analyst [15]

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No, I appreciate that, Josh.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [16]

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So regarding on your second part of the 2-parter there, Georg. Regarding international, it's still the -- the 2 or 3 main areas globally that have our most interest outside of Canada and that's always important to us, that area is really going through a tough time activity-wise in '18, I think some of the other earlier earnings calls probably spoke to that. But if you look outside of North America, it's Argentina, it's the Middle East and understanding how to penetrate what, arguably, is the third-largest fracturing market in the world, which is China, which at the same time, is one of the lowest cost structures in the world. But those are the 3 areas that we really look at. We're pleased again with the performance where we've run our technology in those areas, and we think '18 will continue to build on that. And yes, so I think that's where we are there.

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Operator [17]

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And I'm showing no further questions at this time.

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John William Chisholm, Flotek Industries, Inc. - Chairman of the Board, CEO and President [18]

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Okay. Thank you, operator, and thanks for everyone's interest. As we mentioned, we'll be transparent as the quarter moves on and look forward to chatting with you again, further on in the year. Thanks for everyone's interest. Bye for now.

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Operator [19]

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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.