Good morning and welcome to the Flotek Industries, Inc. Third Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of the Company’s prepared remarks. [Operator Instructions] This conference is being recorded. At this time, I would like now like to turn the conference over to Mr. Rich Walton, Flotek’s Chief Financial Officer, Emeritus. Mr. Walton, you may begin.

Thank you, and good morning. Today’s call is being webcast and a replay will be available on Flotek’s website. Our earnings and operational update press release as well as our quarterly report with the U.S. Securities and Exchange Commission were filed and distributed last night and are also available on Flotek’s website. Before we begin our formal remarks, I wish to remind everyone participating in this call listening to the replay or reading a transcript of this call of the following. Some of the comments made during this teleconference may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and other applicable statutes reflecting Flotek’s views about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and the financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek’s filings with the U.S. Securities and Exchange Commission. Now, I would like to introduce Mr. John Chisholm, Flotek’s Chairman of the Board, President and Chief Executive Officer.

Rich, thank you. I would also like to welcome each of you to Flotek’s third quarter 2016 conference call. We are glad you are here. Our call originates this morning from our new global research and innovation headquarters in Huston, a facility we believe is game-changer for Flotek and which we will discuss more in a moment. With me today are Rob Schmitz, Flotek’s Chief Financial Officer; Steve Reeves, our Executive Vice President of Operations; Josh Snively, President of our Florida Chemical subsidiary, as well as our Executive Vice President of Research and Innovation; and who you just heard from Rich Walton, Flotek’s Chief Financial Officer, Emeritus. Last evening, we filed our quarterly report with the U.S. Securities and Exchange Commission. While we won’t take your valuable time to regurgitate to take those filings, we will provide a summary of the results, attempt to add some color regarding current operations, as well as a sense of our future, and then be happy to answer your questions. As we noted last night, Flotek reported revenue for the period ended September 30, 2016 of $73.7 million, a 1.9% increase compared to the second quarter of 2016. The current oilfield environment remains one of the most difficult markets I’ve seen in my carrier. While we may well be at or near the bottom of this cycle, the volatility in underlying commodity prices and other economic and geopolitical uncertainties continue to rattle the confidence of our clients and colleagues as they prepare to make new investment decisions. We feel fortunate that our focus on high-end value added technology, especially in our energy chemistry segment has provided some insulation from the storm. In fact, we are proud of the fact that while many of our peers continue to experience sequential challenges, Flotek specialty chemistry performance…

Thank you, John. As John mentioned, we filed our Form 10-Q for the period ended September 30, 2016 with the U.S. Securities and Exchange Commission, yesterday afternoon. Revenue for the current quarter was $73.7 million, a decrease of 16.2% compared to the same period of 2015, but an increase of 1.9% compared to the second quarter of 2016. We reported a loss from operations of $4.3 million for the quarter. For the quarter ended September 30, 2016 we reported a net loss of $2.7 million or $0.05 per share fully diluted compared to a net income of $2 million or $0.04 per share for the quarter ended September 30, 2015. Gross margins for the Company increased sequentially to 34.4% from 33.1% in the second quarter of 2016, as margins in the drilling, production, and consumer and industrial segments all showed increases. Margins in our energy chemistry segment were essentially flat sequentially. Company-wide SG&A returned to normal levels after our second quarter downward adjustment to our incentive compensation accrual. Year-over-year Company-wide SG&A is up only 3.3% as growth in our energy chemistry business has been offset by significant reductions in the drilling segment, as we have adjusted to the new market reality for that business. Adjusted earnings before interest, taxes, depreciation and amortization or adjusted EBITDA for the three months ended September 30, 2016 was a negative $0.8 million compared to a positive $7.3 million for the three months ended September 30, 2015. As John mentioned earlier and we discussed in last evening’s release, we have altered our credit facility with PNC Bank, now the Company is sole lender. The new agreement extends the maturity of the facility to May 2020 from the previous maturity of May 2018 and provides a total of $65 million in debt capacity, consisting initially of…

Rob, thank you. Before we take your questions, I’d like to add a few concluding thoughts. In last evening’s release, Flotek announced a new cooperative agreement with Anton Oilfield Services Group of China. While still in its early stages, our relationship is worth noting for a number of reasons. Anton, headquartered in Beijing is a leading integrated oilfield service company in China. Listed on the Hong Kong Exchange, the company is rich in oilfield intellectual property with nearly 400 industry patents and patent applications. Anton’s commitment to research is evidenced by its scientific research commitment in China, as well as its technology R&D center in Houston. In China, Anton works in all major onshore oil and gas fields in China with regional bases covering the Tarim, Erdos, and Sichuan Basins, as well as Beijing. Internationally, Anton is focused on Central Asia and the Middle East as well as the Americas. The strength of the Anton name and its global brand is further exemplified by the fact that the world’s largest integrated oilfield service company is a meaningful equity investor in Anton. Under the terms of the agreement, Flotek will provide Anton with exclusive rights to use certain Flotek chemistry in China and other key Anton markets in exchange for certain purchase commitments. In addition, I am honored that Anton has asked me to join the board of directors, an appointment the Flotek Board has approved. We are pleased that a company within Anton’s reach has selected Flotek as a strategic partner, especially in one of the key global hydrocarbon growth markets outside of North America. The Chinese market presents challenges for foreign companies, and the right partner is the primary key to success. Our discussions quickly led me to understand that the cultures of Anton and Flotek fit well together,…

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

I wanted to -- first question out of me here on the G&A line; that’s really the biggest variance in my model versus what you reported, probably others as well. Can you maybe help us understand what’s behind the step-up from the second quarter to the third quarter and maybe how to think about that on a run rate going forward and maybe to 2017 to get our models in line? Perhaps we just kind of failed to model the R&I center or additional sales force, or maybe the dynamic there would be great?

This is Rob. Yes, I’ll help you out there. I think kind of mid 20s is a good path forward on that line. The variance from the second quarter is we made a significant catch-up adjustment to our incentive accrual in that quarter. You are going to see us continue to invest in the sales force in our energy chemistry business, but throughout the rest of the businesses, I think you’ll see those very stable. And obviously, if we do something strategic in the other businesses, then that will certainly help in that area.

Thanks for the color and congrats on the retirement announcement, Rob, and all the color behind the reasons helps remove any speculation out there that any may have. But, as Rich steps in, is this a permanent move? If not, is there a timeline that we should think about, shareholders should think about in the transition planning process, just to set expectations?

I think the plan is still under development there. So, we’re just beginning our planning process, and that’s why we established a longer lead time on this.

And switching gears, can we talk a little bit about the customer mix? Pretty well known that your largest customer stepped down in activity from the second to the third quarter, and I appreciate the color there. Definitely, a cause of concern by many into the report. But it looks like with CnF volumes managing to remain flat, John, you hit on this a little bit, but can you elaborate more on the offsetting pickup in CnF demand? Was this through pumping companies; was this direct sales? And maybe the composition, is this new customers, current customer base increasing? And then, just kind of walk through knows dynamics, to give us a sense on who is picking up as -- obviously pioneer the completed well count step down?

The majority of the uplift in the non-pioneer business was operators, essentially through our Flotek’s store. As you know sometimes, we’ll actually sell through service company, but really it was all business that was picked up from our sales force out there working directly with operators. In terms of the change from the second quarter, the vast majority -- it may not have been new customers all time with Flotek but they were new in a third quarter versus second quarter. So, as a result of our guys out there really hustling, pursuing a lot of different opportunities and then getting people to convert. And these are people who -- they may not be there quarter after quarter but they are not validation cases, they’re business that we expect over time to continue to have with these guys.

That’s encouraging. So, it’s a wider footprint in the customer base, just to kind of be specific?

Right, absolutely.

Yes, I think it speaks to the effort that sometimes it takes a quarter and sometimes two to see the realization of the effort. But, there has been a narrative that the A and B clients overweight the perception of the complete market penetration of the CnF. I think the third quarter hopefully at least started to change that thinking as to -- as you noted, keeping the volume up with the decrease of that client at the same of reduction and the completion overall activity. We are very enthused with that internal market penetration for sure.

Great. And the final one out of me. You’ve executed a couple of higher profile joint ventures internationally this year, one in Argentina, one in the Far East that you discussed today. Can you maybe elaborate on why you guys are forming these sort of arrangements, why the structure is beneficial to shareholders and the Company? And are there minimum volume agreements, are there any deliverables on your side, and maybe help us understand why this sort structure? And that’s all out of me. Thank you.

The agreement in Argentina and with China may appear to be similar but they are different. The agreement in Argentina is with Y-TEC, the technology arm of YPF, to work with them to develop collaboratively through our experience with Shale, their experience, what has the opportunities to be the best fluid system for them to realize the best opportunity to maximize their unconventional shale resource. There is not a commitment from YPF of purchasing the chemistry but they are certainly a very tight in connection between YPF and Y-TEC as to what we’re doing with that technology arm. And I think as everybody has read in recent time, whether it’s the CEO of BP, the CEO of Exxon, GE Oil and Gas have all talked about increasing the capital into Argentina as recognized as the largest potential unconventional resource outside the North America. And the relationship we have with the technology arm of YPF, we think should position Flotek uniquely as that develops. Regarding China, we felt for some time, there is really two frontiers that you’d have to look at for Flotek to feel comfortable about the opportunity to penetrate, and those are China and Russia, the former Soviet Union. And the China opportunity presented itself over the last several months with the leading independent energy services company there that is looking at a term that you’re familiar with, Matt, that some of the service companies here have talked about, which is trying to become more asset light. And they’ve looked at how this chemistry that doesn’t require as much assets, improve their continued penetration into China and other international areas. And we felt that Flotek going it alone in China had the opportunity to be a recipe for disaster that many people are listening in on this call, when you hear about China, they immediately go to one thought process, which is the potential reengineering of your technology. And so, we, after several quarters of looking at this -- as we mentioned in our prepared remarks, the DNA of Anton and Flotek is very similar. And the fact that they wanted me to sit on their Board, I think speaks to the confidence I have that we are going to keep the technology confined to a specific service provider in China as a way to develop the market there. So, hopefully, that gives some more background for not only you but the folks on the call. And there is a commitment of CnF usage by them that is we felt important to have the exclusivity conversation in China. But hopefully that will better answer any questions that folks may have and also yourself.

Thanks a lot for all that color, really appreciate it. I’ll hop back in queue.

Our next question comes from the line of George Venturatos with Johnson Rice. Please proceed with your question.

John, maybe circling back to CnF, I want to discuss little bit further detail of the third quarter numbers. I take a look at just kind of back into what we would assume Pioneer contributed on the CnF side, which expect primarily majority of that spend was on CnF, certainly implies a pretty strong CnF revenue growth ex Pioneer in the quarter, north of the rig count gains. I know you talked about some of those were some customers that may be coming on and off. But would you anticipate that that progression should be sustainable for that non-Pioneer portion of your business, absent some holiday season impacts upcoming? And then, second one on that is, it’s just -- I know you touched on this in terms of the incremental customers, but could you maybe give a little bit more detail on kind of the basin mix, the new customers in the quarter as well?

Great series of questions there, George. The CnF uplift was essentially slightly over 20% of companies that were new. And again, as Rob did a good job of explaining, they may be new from the third quarter to the second quarter but I think if folks look back into our previous earning calls, we talked about how numerous of the people that had done validations at the end of 2015 and 2016 had said that although their rig count activity would not stay up, when it did come back, they would reengage with the technology of CnF. That is certainly part of the uplift in the third quarter. And as long as their activity stays up, we expect that uplift to continue. So, we are very encouraged about that and the fact that what they told us over six months ago they would do, in fact they have done. And I think it speaks to the resiliency of the technology. So, I think we are -- outside of the holidays, we continue to expect to outperform what I think has become a new metric in the industry, which is the completion metric, as identified by the EIA. And through this earning season, different companies have tried to speak to this completion number as opposed to the drilling rig number, whether it’s folks that brought rigs back and they had numerous wells on a pad that they would not start completing until they drilled all their wells. And I think the drilling activity in large part gave some folks some unrealistic expectation of the timing of an increase in completion activity but I think that will now start to come. So, as we continue forward, we’re going to try to focus people’s attention on what the reported completions are, but we continue to expect to outperform that number as we have consistently said, as it remains a market penetration story for Flotek. With respect to your question, I think everybody on the call would expect this. The overall U.S. industry is dominated inside the Permian Basin. I think over 50% of the drillings rigs now in the United States are in 150-mile radius of Midland. So, I think the number we’re comfortable with telling you is that over 50% of the chemistry revenue for us occurs in that area in North America. You would expect that. And you would also expect that the majority of the increase in those clients in the third quarter occurred in the Permian Basin.

That is helpful, John. I appreciate that. And kind of building off that second question, care to give us an update just in terms of a stab at anticipated market share currently in the Permian? And then, just building off some of the comments you said in terms of IPI and their positioning in the Basin, how that might be helpful going forward in terms of building that position?

So, those are two great questions. And I think I’d ask for your indulgence and also the folks on the call, we will try to give you greater color on that by the -- at our year-end call sometime in January as to allow us to have the whole year come together. Clearly, we’ve talked about that we believe we’re on 15% of the completions in the seven, most active basins, and that’s what EIA tracks is the seven most active basins. We believe that the CnF technology is on 15% of those completions. And we’ll certainly give better clarity, as I mentioned at the start of 2017 as to what it looks like in the Permian Basin, keeping in mind that some of that is a competitive number for us. But, we’ll try to give as much clarity as we can for that. Regarding IPI, we mentioned when we made the acquisition that -- if this acquisition was actually made in 2014, you could talk to the total value might be worth what Monahans is worth. The strategic positioning of that facility and the fact we’ve already -- the team has already I think within 45 to 50 days created a what we call a micro blending capability there, will be meaningful for us as we try to continue to contain and where we can, reduce the internal cost structure of the logistics of serving the Permian Basin. And again, I think we’ll be able to give you more clarity on that in January as we will have nearly a quarter and a half of what we believe will be a cost reduction event. And I just don’t want to say how many basis points now but I think it stands to reason to have a micro blending facility in the heart of where the majority of your activity is, is a very meaningful asset as we continue to focus on our internal cost. Does that help you?

Perfect. That’s helpful. And last one for me. Just in terms of the progression, CnF throughout 3Q, if you could just comment on that? And then whatever details you feel comfortable providing in terms of where we have run, at least quarter-to-date relative to kind of exit rate 3Q, ahead of what could be a choppy holiday season would be helpful?

To the extent that we really don’t get into kind of monthly outlook, October is very nice from an activity standpoint. I think I haven’t listened to all the earnings calls, but I think some that have occurred and some that may still occur, folks are saying that the fracturing activity -- many people are saying that they’re booked up through the end of the year in the Permian that we are talking about, that’s certainly encouraging for us. And so, I think the fourth quarter should be just fine unless there is some type of unique weather event. It should be just fine I think for us and other folks. Is it going to be a dramatic uplift from the third quarter? No. But I think it should be just fine.

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

I wanted to congratulate you on the construction of the global research and innovation center. That’s a great accomplishment. I was wondering if you can talk a little bit about what you see as the goals of that facility, whether it’s branding the Company or educating your customers, or you mentioned you’ve taken a few university to tour the facility, and is this a potential recruiting tool for you? Maybe you can just comment a little bit about that.

I don’t want anyone to think I am a smart alec, but my answer would be, yes. I think you hit all the high points. We’ve -- if folks have listened to the way we’ve positioned this commitment, it was a commitment not only to helping brand Flotek but also a commitment to the industry that we would have the ability for interaction with university studies, we would have space available for entrepreneurs that are starting businesses that may need the access to a chemistry research area like we have here that otherwise they wouldn’t be able to afford. And it really was a commitment to the industry as much as it was just to our own internal requirements. That said, the facility was designed to be very interactive. And from time-to-time, folks like yourself and others on the call, certainly are invited and we’ll get you here so you can fully appreciate it. But it was designed to be an interactive experience much more than just coming into see a research lab. I think that’s the starting point. I think when you go through that experience, you leave with an understanding of just what it takes to create this transformational technology that the group of the research folks here at Flotek are able to do. And I think it positions that technology in a different way when you leave the facility than if you had maybe gone to just a typical lab. We are very committed to the community. We are right in the middle of the independent school district of Cy-Fair. We’ve got initiatives with that school district of awarding teacher recognition in science and math, not only your field trips planned for the facility but also there is a scholarship program for kids in that disciplined, starting n their middle school up and through high school that will lead them into college. We think that’s important. So, again, I think you normally do not do that when you open just a lab. But when you open up a facility that’s trying to create an experience, you are I think -- it’s a commitment that you have to look a little bit outside of just your own benefit. And that’s what we’re trying to do here. But thank you for noticing that. It took a lot of people to pull it together, and it really is special.

Another question I had, separate topic is CICT, the focus has typically been on your energy chem segment, but CICT has seen steady growth and is actually a pretty significant pores of your operating profit. And that from your commentary, it seems like that might even grow. And you mentioned in the press release some unique growth opportunities, particularly in the field of research and innovation. And I was just wondering if there is anything specific you can talk about at this time?

Yes. Ultimately where we want CICT to get to, ultimately being in a couple, three years from now is the balancing of any type of near-term slowdown in the energy activity that that activity would offset to be kind of a counterbalance to these shorter slowdowns that occur from time to time in the energy sector. So, we’ve recognized ever since we acquired Florida Chemical, they are great people, it’s great technology, it has dominating footprint in the Western Hemisphere regarding citrus oil. And I’ll let Josh Snively give some more color on that. As you know, he heads up that effort along with our research and innovation. And he will give you and the other folks some more color as to what’s happening there.

Good morning, Mark. When it comes to CICT and our growth opportunities, if you look at the total available citrus oil, specifically orange, it is declining, which means we’ve got to get more out of what we have to continue to contribute value-added compounds, signature compounds to these beverage companies around the world. So, we’re really turning our attention to get more out of what we have and putting these molecules and unique combinations that they provide more uplift and more benefit and more impact to the consumers of these very large brand beverages that depend on citrus oils. Given our footprint and our size on the citrus oils, we are uniquely positioned to take advantages of those opportunities for the next several years. And that’s where our primary focus is going to be.

And now, our final question comes from the line of Sean Milligan with Coker Palmer. Please proceed with your question.

On the G&A side, how much of you guys have been spending on a kind of quarterly basis in terms of the SEC inquiry? That’d be my first question. And then, I’ll just ask the second question now. A couple of guys have sent me news articles about the pricing of frozen orange juice concentrates. Maybe Josh can address how that might impact your business [indiscernible].

So, Rob will answer the first question for you and then will also give you some color on terms of the insurance portion of these expenses. But, Rob will give that to you.

We spend a total of about $2 million responding to the SEC inquiry and the defense of the shareholder lawsuit to date. And from an insurance standpoint, we think our total out of pocket exposure ultimately limited to something under $1 million.

Does that help, Sean, or you anything else you want on that?

No. That’s great.

And that obviously is winding down.

Yes. And then in the first part of the year, how much were you spending on MHA studies? That would be the other part of that.

That’s fairly small amount.

Okay.

Yes. So, small being it’s under a $0.25 million.

And then on the frozen orange juice pricing, I mean if you can just walk through? I think I know the answer, but how that might impact your business? Obviously, your citrus oil is an input, but just kind of give us some feedback on that that would be helpful.

Yes, glad to do it, Sean. This is Josh. When we look at our raw material stream, and this is one of the key benefits of Florida Chemical or the CICT group brings to Flotek is we see that supply and demand ratio better than anyone else in the marketplace. And knowing that greening was going to be a problem in future years, we continually maintained our inventory positions, we staggered our purchasing programs beyond spot multiyear type agreements to make sure that we had availability. And given the value that we can extract out of the citrus oils because of our manufacturing capability, it gives us an advantage on that raw material stream. Fact is. there is going to be less oil for the next several years. That is going to force prices up. So, where our volumes may go down, the pricing will go up for external sales and CICT. But the internal cost to Flotek should remain relatively stable, the way we’ve positioned ourselves.

Perfect. Thank you.

Thanks for the question.

As there are no further questions at this time I’ll turn the call back to you. Please continue with your closing remarks.

Thank you. Before we sign off, I do want to say that it’s typically this time of year that I indicate I will see some of you in New York in one of our favorite conferences. However, due to a scheduling conflict, it will take me and some of the Flotek team to Abu Dhabi for the ADIPEC conference with a number of our key international clients. We unfortunately won’t be in New York next week. That said, we look forward to visiting with you soon, certainly before the New Year. Again, thank all of you for your support of Flotek. We appreciate your interest and are I pleased you joined us today on the call. Have a great Thursday and try to take time to enjoy the upcoming holidays. Thank you very much.

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