Matthew Marietta - EVP, Finance & Corporate Development John Chisholm - Chairman, President & CEO Joshua Snively - EVP, Operations.

Georg Venturatos - Johnson Rice & Company Michael Urban - Seaport Global Securities David Sachs - Hocky Management Company.

Good morning, and welcome to the Flotek Industries Incorporated Second Quarter 2018 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 Executive Vice President of Finance and Corporate Development. 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 CEO; Rich Walton, our Chief Accounting 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 our 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 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 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. Please refer to our reconciliations provided in our earnings press release as management may discuss non-GAAP metrics.

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

Thank you, Matt, and thank you all for joining today's call. I'll begin with some introductory remarks, followed by Matt, who will provide a financial overview and outlook. And then Josh will provide an update on operations. Finally, I'll end with closing thoughts before taking your questions.

I'd first like to thank all the Flotek employees for their effort and our stakeholders during a dynamic time at our company and within the industry. Unquestionably, it was a challenging quarter for us. One that improved as the quarter progressed, with positive momentum that has continued into the third quarter.

Overall, industry activity remains steady in the second quarter as commodities and spending activity remain at improving overall levels. The quarterly U.S. rig count and EIA completions both increased sequentially, the weather and sand-related issues early on the year have abated.

As we highlighted last quarter, we began the year with an accelerated ad abrupt shift in one of our key channels market. We also lost our largest client due to cost pressures. But have since partnered with another large client and deepened our work together.

Although we've experienced extremely difficult disruptions, it has affirmed our long-term business strategy as the industry transitions their sourcing behavior for consumables, starting with diesel, moving to profit and now extending to chemistry to drive cost efficiencies and align objectives surrounding improve well performance.

Far from an isolated impact, the energy industry at large has reported significant reverberations as a result of this transitioning behavior.

As a result of this disruption and drive towards chemistry, we've seen an increase in demand for our Prescriptive Chemistry Management or PCM platform, where we provide full-service value-added fluid systems customized for the unique complexities of our clients' reservoirs.

Based on commercials successes with our existing client base gives the opportunities to expand our partnerships in the new basins with a broader product offering, including use of CnF technology.

We're doing our part in effort to continue reducing the cost of our clients spend per well, while at the same time increasing their performance as Josh will explain on in a minute.

I am pleased to announce that during the second quarter, we received the single largest ever Complex nano-Fluid order related to a large unconventional gas project in the Middle East.

This is the proof of multiple years of research, testing and validation by the technology divisions of our business partners, and we are excited to provide our technology to help maximize the recovery of hydrocarbons from this large-scale program.

In line with our aggressive cost reduction strategy, we removed another $2 million of annualized cash SG&A and continue to find more areas for further savings. This is designed to benefit our shareholders as Flotek's revenue cycle is showing a positive inflection into the third quarter.

Additionally, we've planned initiatives to expand gross margins as we move forward throughout the year.

Our Florida Chemical operation, which is our Consumer and Industrial Chemistry Technologies or CICT segment continues to operate at a high level as temporarily product mix pressured margins in the second quarter as we sold a greater component of lower margin terpene.

We've identified opportunities for targeted capital investment and expansion to meaningfully increase the penetration of CICT into high-margin growth opportunities. In summary, we began 2018 with a very challenging and dynamic start, but our current and committed activity is robust, which we expect to benefit our third quarter.

Finally, as we committed we would, we enhanced our Board of Directors with the addition of our newest board members, David Nierenberg and Kate Richard.

Together with our leadership team, we are focused on expanding our client base, strengthening our direct channel to market, lowering or fixed cost and improving operational efficiencies to increase revenue and focus on delivering consistent EBITDA expansion, cash flow, and ultimately, bottom line profitability.

I'll now turn it over to Matt Marietta to provide an update on our key financials..

Thank you, John. For the second quarter, Flotek reported revenue of $59.1 million compared with $85.2 million in the prior year period, a decrease of 30.6%. On a sequential basis, quarterly revenue was down $1.4 million or 2.4%.

Energy Chemistry quarterly revenue increased 40% compared to the prior-year period, and declined 3.7% on a sequential basis to $39.5 million.

Of note, domestic revenue remained relatively flat from the prior quarter, while international revenue declined just about 22% due to the breakup in Canada, which has remained our largest international region in this segment and we expect conditions to begin to recover there.

Our Consumer and Industrial Chemistry segment quarterly revenue increased 1.2% compared to the prior year period, and increased 0.5% on a sequential basis. We experienced consolidated gross margin compression, primarily due to lower plant utilization, PCM start-up costs and product mix within our ECT segment.

Higher spot terpene sales during the quarter and timing of key Flavor and Fragrance opportunities impacted our CICT segment gross profit. Corporate, general and administrative expense for the second quarter was $8.7 million, a decrease of $2.5 million or 22.3% compared to the prior year period, and increased marginally by 2% sequentially.

Our corporate G&A during the second quarter of 2018 was 14.7% as a percent of revenue. Noncash compensation was $2.4 million in the second quarter. Segment selling and administrative expenses for the second quarter was $6.9 million, a decrease of $2.5 million or 26.8% compared to the prior year period and decreased 3.5% sequentially.

Segment selling and administrative expense during the second quarter of 2018 was 11.6% of revenue. Total cash SG&A reductions declined to further $500,000 sequentially, while we are executing on the cost buckets we updated last quarter, namely executive compensation, employee expense accounts, professional fees and contract labor.

As John alluded to, we are in the finishing stages of an ERP upgrade and numerous process overhauls, which we believe will begin to also drive higher gross margins and further SG&A cost management opportunities and efficiency gains across organization.

Relative to our initial benchmark we have discussed, we have not lowered our annual cash SG&A run rate by $25 million as we continue to focus on corporate-wide efficiencies and cost discipline. For the quarter, research and innovation expense was $3.1 million, down from $4.1 million in the same period a year ago.

For the second quarter of 2018, we reported a loss from operations of $9.3 million, excluding the impairment of goodwill and ECT. For the second quarter, Flotek reported a net loss of $75 million or a loss of $1.30 per share on a fully diluted basis. We incurred several onetime items during the second quarter.

Our goodwill impairment testing resulted in a writeoff of our ECT goodwill of $37.2 million. In addition, we added a valuation allowance against our deferred tax assets of $22.8 million, which impacted our effective tax rate in the quarter.

We also plan to divest of a non-core facility, which is now classified as held-for-sale and wound down other projects that resulted in approximately $4.2 million of additional onetime expenses during the quarter. At June 30, 2018, the company had accounts receivables of $43.2 million compared to $46 million at year-end 2017.

At June 30, days' revenue and accounts receivable was approximately 67 days, a level which remains above our target, and we expect to drive this down in coming months and quarters through enhancing our collection of billing processes, an effort that is already underway.

At quarter end, the allowance for doubtful accounts is $0.8 million or 1.9% of the receivable balance. Moving to inventory. At June 30, 2018, inventories totaled $90.8 million compared to $75.8 million at year end 2017. Inventories remained elevated due to slower internal consumption of citrus terpene in the first half of 2018.

Additionally, we were in the process of fulfilling a large order for CnF during the second quarter, of which is currently turning into sales. Historically, our inventory balances declined in the second half of the year, in line with seasonal citrus purchases from South America that are scheduled during the harvest season to start the year.

We expect this seasonal factor to also impact 2018 and we view inventory as a source of working capital benefit moving forward. At June 30, 2018, borrowing under our revolving credit facility was $49.1 million.

Debt increased by $9.4 million during the second quarter to fund working capital and negative net operating cash flow of $7.3 million in the quarter. At June 30, 2018, there was an undrawn availability of just under $17 million under our revolving credit facility.

We believe we have sufficient liquidity and are currently taking proactive measures to increase our borrowing base capitalization through the inclusion of certain insured receivables. We're also able to defer the covenant testing to 2019.

We are grateful for our working relationship with our lender, and continue to take proactive measures to enhance our liquidity position. Moving to capital expenditures. During the second quarter of 2018, CapEx was $1.4 million. We continue to have a very flexible program that we will scale to our cash flows and liquidity position.

Last quarter, it was difficult to offer top line guidance given the dynamic shift ongoing within the ECT segment. For the third quarter, we anticipate that the ECT top line may expand 18% to 23% sequentially with margins that show stabilization to slight expansion in both gross profit and EBITDA.

In our CICT segment, we expect sequential top line growth in the mid-single digits with EBITDA margins in the mid- to-low teens. We do not foresee an increase to our current SG&A levels going forward, and continue to identify further room for savings even as our business shows our expected recovery.

Please refer to our 10-Q filing for a comprehensive disclosures and a full discussion of our second quarter results, which we will expect to file later today. I'll now turn the call to Josh, who will provide an update on our operations..

Thank you, Matt. After a disappointing start of the year, monthly activity levels stabilized from Q1 exit rate as we progressed throughout the second quarter.

Our business continues to evolve from a traditional chemistry manufacturing operation to providing all fluid systems to the industry, which has resulted in a negative impact to our gross margins as we scale.

Many of our PCM prescriptions have changed the reservoir-centric fluid design to alter proppant carrying capacity and thereby reducing our clients cost, while improving the performance of their reservoir.

And one recent and evolving case, our PCM program has reduced our client's chemistry spend by 50%, while maximizing their profit delivery and resulting in better performing wells.

This is opening the door to enhancing the reservoir treatment to include CnF and other propriety offerings, which can mitigate damage to well offset and increase the primary production of new completions. Building on these successes, we have been able to continue to add PCM personnel and equipment to meet demand.

Our field crews required few field chemists and a mobile chemistry facility to provide real-time fluid system diagnostics. To further support these efforts, we added additional tanks, increased our committed truck drivers and optimized our blending capabilities in our Waller facility as well as expanded our operations in Marlow and Monahans.

These initiatives, combined with scaling up of our PCM platform that saw deterioration in gross margins. But looking ahead, are designed to expand our gross margins as our utilization rates improve.

Additionally, through our research and innovation efforts, we have enhanced our offerings expanding applications of our CnF technology to address the full life cycle of the well, beyond completions to include secondary and tertiary recovery, IOR or improved oil recovery to enhance water flooding, acidizing and remediation.

While we are in the early stages of market development for new applications for our flagship technology, we are excited about the initial update as well as commercial successes.

Recently, we partnered with a large operator and client at the Unconventional Resources Technology Conference to discuss how our CnF technology was used to mitigate frac hits and remediate underperforming wells.

While CICT sales increased slightly year-over-year and sequentially, the segment performed a little lighter than we expected, largely due to normal fluctuations of our clients order behaviors and market forces combined with greater terpene sales that we anticipated and timing of higher margin orders.

The new distillation column is fully operational and through the expansion of our manufacturing flexibility we can execute on our product line diversification strategies.

While the Chemicals world-class process and capabilities and ability to deliver consistent volume of Flavor and Fragrance molecules has allowed our clients consistent and reliable products and available for market.

While citrus greening and the projective smaller crop in Brazil continues to keep markets elevated relative to past, there is now a sense of stability in the orange oil markets.

Looking forward, we see opportunities to continue our expansion into other citrus varietals and processing techniques, specifically for grapefruit flavors as well as lemon and other cultivar options for clients. Clearly, the second quarter was a disappointment. However, the operational improvements continue to move forward.

With the turn we are experiencing an ECT and future opportunities for CICT, we should be able to capture more gross margin through operating scale and plant efficiency in coming quarters. Flotek is positioned to execute at a higher level and our competition across both segments as our R&I capability and personnel remain unmatched.

Our focused commitment to formulating, manufacturing and delivering premium chemistry technology and precise applications remains paramount. We have made progress operationally, but have more to go to further execute on our plan. With that, I'll turn it back to John to offer concluding remarks..

Thanks, Josh. And before we take questions, I would like to add some concluding thoughts. The second quarter was clearly disappointing. But as the quarter progressed, we ultimately received the largest order for CnF in the company's history.

We are experiencing a notable market shift towards our PCM platform, and clients are vocally expanding their desire to source and identify differentiated chemistry technology and the restructuring of our cost framework makes the second quarter as the next inflection point in our outlook for the company.

While 1 month or 1 quarter does not establish a trend, our July performance and inflection and planned activity and interest substantiates our optimism and confidence in our strategy. This leads us to be able to guide up our third quarter despite overall market conditions in the U.S.

Further, multiple leading industry analysts have shared a growing set of data, which suggests many completion designs have reached the limits of mechanical methods, such as proppant loading, stage cluster spacing, lateral length and asset delineation. This is leading the industry for it's chemistry and reservoir optimization.

With more recycled water being used and the desire for technology increasing, Flotek is positioned to be the industry's leading source of chemistry-centric technological improvements in both recovery factors and cost. We're observing emerging perspectives that bigger wells with more sand and greater spending are not necessarily more economic wells.

As Jefferies noted in their recent U.S. Shale Deep Dive Report, and I quote, "True science is needed to increase recoveries from here. " Referencing the Permian Basin. And RS Energy has published similar findings in their analysis. As we look ahead, we remain resolutely committed to our mission and offer these [indiscernible] thoughts.

For a decade, the energy industry has conducted its business as they transactionally been between two companies as vendors rather than partners. But we think different. We believe that traditional industry model focuses too much on cost and not enough on benefit.

Our vision is to return trust to technology and restore the focus on our energy clients assets. After all, we are aligned in our objectives and we treat our clients assets as if they were our own. Unwaveringly, our mission is to create value to enable and protect our clients reservoir.

In closing, I would like to humbly thank our shareholders, employees, clients and stakeholders for their continued support and patience. With that, operator, we will now open the call to questions..

[Operator Instructions]. Our first question coming from George Venturatos from Johnson Rice..

I wanted to touch off on the ECT side. Just wanted to see if we can get a little bit more clarification or detail on just kind of the breakdown.

I know you mentioned PCM was up sequentially, north of 30%, but kind of off what baseline? And how that breakdown is today? And then, I guess, secondarily on this one, just strategically on the margin side, which has been more disappointing.

I guess, looking forward, I know you talked about the cost of the PCM expansion, but what kind of time line are we looking at to kind of see that utilization ramping start to see margins potentially improve more dramatically?.

Sure. I'll turn it over to Josh. He will give you some internal metrics that we follow that I think will be in large part help answer your question there for you, George..

George, on the PCM growth as far as clarifying the baseline, PCM came into existence really in Q4 of last year. It was a need and response to the market demands on us as a company. And CnF, 33-plus-percent increase in that segment or product line offering is meaningful for us. It's not a small number.

We're not going to get into the specific dollar amounts, but it is meaningful with that kind of growth.

And when you ask about the margin side, yes, we are adding cost, direct cost ahead of being able to build for these services, because we have to hire field crews, and we have to build-out trailers and hoses and ancillary equipment to support that activity.

So you have to front load some of the direct cost prior to the sales recognition, and that is squeezing the margin as we build. We're starting to get critical mass. We have over 20 people in the field today. At the beginning of the year, we had 9 people in the field.

And these people sit these jobs 24/7 until the job's completed, making sure that the right chemistry and the right dosage gets pumped correctly on each stage of the job. So it is a significant skill set. We want to make sure we train these people.

That's normally about 60-day training program before the training wheels come off and we release them in the field. So as we continue to build moving forward, we do see those margins getting better, just because of the scale of the number of people we have..

Yes, I think just kind of one follow-up on there, George. Over 60% of these completions now have a value-added chemistry from us, which is like a CnF-type product. So that will help elevate the margins as this continues to grow..

Okay. Makes sense. Your largest order in history, wanted to talk about that.

Good to see, and obviously, big boost to your 3Q visibility, but just wanted to get a sense of generally the magnitude there and what's that baked into the sequential growth as a result of that single order? And it sounds like domestic baseline business, excluding that order, we'd still be up modestly as the way I kind of heard it on the call.

But just wanted to get 2 clarifying points there.

And then, I would imagine you're hopeful that this type of relationship can continue down the line, but what kind of visibility do you have for additional orders?.

Yes, so I am sure that's a question a lots of folks are thinking about. The project is designed to be multi-year, so it's just not like a onetime order. As we mentioned in our prepared remarks, this was the result of multi-year research work, validation work with our partners there.

And I think in previous earnings calls, folks have always asked me, from an international standpoint, where do we think the next -- the meaningful area would be? And I always led off with the Middle East. Obviously, we couldn't say back then what we now know. But we had a feeling over this several year period that this opportunity would be out there.

I think it does a couple of things. Number one, from time to time, there's a narrative that Complex nano-Fluid only works in certain counties, like Reagan or Upton County. Hopefully, as this project moves forward, that will dispense with that narrative, which would be meaningful for the technology and the industry.

The second thing is, in June, we celebrated actually the 10-year anniversary of the patenting of Complex nano-Fluids. It's kind of a sink up full circle that in the month of the 10-year anniversary, we got the largest order in the history of the company for Complex nano-Fluids.

And we do think there's going to be a ripple effect in that part of the world as other people become aware of the project as it moves forward. So although it has -- was mentioned, revenue generating in July and building through Q3, assuming that the project performs the way the client expects it to, this is designed to be a multi-year program..

Okay. I appreciate that, John. And last one from me. You guys mentioned a loss of your largest customer, which kind of been an ongoing discussion here. Going forward, and I'd assume, and you can correct me if I'm wrong, that's not embedded within any forecast to see them coming back.

But just wanted to maybe revisit, certainly, this has occurred before in the past, I think back in 2015, I believe.

So any thoughts or at least comments on whether you still remain engaged with that customer moving forward? And what kind of expectations you have baked in, which I assume are nothing, at least in the near-term forecast?.

Yes. As everybody has come to understand, we don't specifically talk about our clients. But there is no basis for revenue with respect to that client for the remainder of the year. But we are engaged with them on a technical level, and I'll let Josh speak a little bit more to that.

On an ongoing basis with different products and services that they're interested in, and we're on good terms with them. But Josh will certainly add to that..

Yes, George, as we mentioned on the Q1 call that we had introduced some new products to match the needs of the market largely driven by lower cost points with certain benefit characteristics. So we talked about our FRO lines for proppant carrying and viscosity building. We talked about our lower-cost flowback aids.

Those are specifically designed to meet the needs of the market is asking for. And so we are certainly engaged in not only the customer that you're asking about, but other customers across the basin as well. So we constantly knock on doors. We have very good relations with most operators.

They're very interested in our chemistry options, and we are at a point now where we can expand those offerings and give them more of what they're asking for to help them meet their price points..

Our next question coming from the line of Mike Urban with Seaport Global..

So you guys have done a good job kind of explaining the shifts in the market, especially in the U.S. I understood the trend towards unbundling and the change in channels to market. I was just wondering if, to the extent you can, just take a step back and think about and maybe help us think about what the U.S.

market ultimately looks like? Whether that is relative to where you might have been in prior cycles? Is that lower because of the change in completion designs? Is it ultimately higher for the reasons that you said in terms of just the mechanical recovery methods reaching their limits? I don't know if you have any way of quantifying that on an aggregate basis, or per well, or just helping us kind of frame how this plays out over the next few years?.

Yes, sure. I'll take a stab at that. As we mentioned, there's been several reports, we called out Jefferies, RS Energy that have really looked at what's the production uplift in relationship to the increased amount of sand.

And certainly, our own internal data says, in different geographic pods that have geological uniqueness, more sand can lead to improving the performance of those wells. But as a broad brush more sand everywhere, now more people are talking about that. For the last year, the increase of the sand affected the AFEs.

That increase in AFEs with a lot of cost pressure on these operators concluded them to be even more hesitant on value-added chemistry. From what we can see that's changing for what we mentioned in our opening comments, that there's more and more of an interest of what you put into that rock has a bearing of what comes out.

So we believe, and I think this is substantiated independently with some of these analyst reports that are coming out now, that science is going to play an ever important role in improving the initial and ongoing production of these wells.

When you talked about the de-bundling, again, as we try to line out, but maybe this is not something everybody is familiar with, but it certainly started with diesel, where now many of the E&P operators provide the diesel themselves to fuel these trucks on these 4, 5, 6, 7-day, 24-hour pumping operations, that wasn't the case 2 years ago.

You've heard many of the service companies in their earnings call talk about now bordering 50% of the proppant is sole sourced by the operators. That was not the case 2 years ago. And clearly, it's heading to chemistry. And we're prepared for that. We believes it gives us a much closer contact to the operator.

We still provide chemistry through the traditional service company channel. We consider a lot of those folks are friends. They work with us to customizing certain fluid-carrying chemistries.

But we can see a trend that more and more of the operators as their desire to become more and more efficient in their cost structure have looked at sole sourcing these consumables. I think this is a trend that's going to continue for the next several years. We think we're probably in the early stages of this.

Does that help?.

It does kind of qualitatively. And maybe there just isn't an answer for this right now, but there's a lot of countervailing trends here. And I am just trying to get a sense for, and I think a lot of people are -- that I talked to today, just in terms of how do we think about this and model this going forward.

So as these kind of mega-trends, if you will, settle out, as you -- it sounds like you got some good traction with PCM.

Is there a kind of a way to think about it in the terms of the dollar per well, and aggravating that across what's the number of wells that are getting drilled? Or just anything kind of quantitatively to help us think about what the addressable market is ultimately, because there are just kind of too many trend pointing in too many different directions right now to give us any confidence in our ability to model all this right now..

I think, and yes, we certainly appreciate the frustration in your question. I think one thing to step back to is, last quarter, we were uncomfortable of really providing much clarity through the second quarter, and we said that.

This quarter, we feel greater clarity, which is what Matt had talked about on the uplift of the activity third quarter over the second quarter, because it is starting to become a little bit more clear.

But it's very difficult to predict the number of clients that will move in that direction and when they will move, because it's never been done before. So I think, that's -- it's not the hesitancy on our part, it's just the way the industry moves, that is very difficult to pick a date certain or a client certain as to when they will move.

But clearly, there's more communication with the clients. It's a progression that you've seen with the proppant. All of our indications are, this is the next wave of people wanting to become more efficient. And at the same time, the ones that are started on this, we believe they are becoming more effective as well.

There's a closer coupling with our research group, with their technical folks, and that's enabling a shorter cycle to try to get to the right fluid sooner instead of experimenting as often case happens with the way these wells are completed. And hopefully, that helps for you..

No, it does. And I appreciate the difficulty in kind of navigating all the stuff on the fly. I guess, last question would be, maybe it's another one which is difficult to answer, is that your gut feeling that's a, 3, 5 years out. So kind of beyond a reasonable window where we're kind of trying to model this stuff quarter-to-quarter.

So kind of 2, 3, 5 years out, whatever the case may be, is your sense that kind of the addressable market for what you're doing is bigger, smaller or roughly the same as it might have been in say in your prior cycle in 2014?.

Now that's a great question. And we believe it's going to be meaningfully bigger. And for the other folks that are listening on this call, one of the challenges to answer your question is, there is a wide disparity in the cost of chemistry on these completions. It in part is dependent on the type of fluid that you're pumping.

It depends on the lateral length and certain things like that. But just to give an idea, it can the range from, at the low end of $150,000 per well to the high end over a $1 million a well. And there is a wide disparity.

There is not a number that we could tell you, multiply that times the EIA completion number and you're going to get to the number, because it's just so spread out, based on the type and the customization with the chemistry that the folks want to use.

We would say that the overall market, again, this is a hard number to get to, but one we'll kind of put out there, is that less than 20% of the operators have decoupled into chemistry.

And our business model, and Josh spoke to this, is that -- when he spoke about the 50% reduction in chemistry, there was not a difference so much between sourcing to us versus the traditional way.

It was us actually changing the chemistry to a less expensive product to carry the proppant that translated to more a cost-efficient program for that client. So we're not here trying to sell more and more chemicals, we're trying to prescribe the right cost-effective chemistry for them..

Okay..

Is that [indiscernible]. We hope that [indiscernible]. Those were great questions, and thank you for bringing that on the call today..

Mike, this is Matt. Maybe to expand on this, just to touch. As PCM has grown, we've seen a decline in the revenue per client for ECT. As we signed up clients that are maybe initially at the lower end of that spend range, but we've begun to see a bottoming and an improvement actually in the second quarter of our quarterly revenue for domestic client.

So the internal metrics of spend per client has begun to come up for us, underlying the numbers that you don't see in our reported numbers. So maybe that can also help that.

For our revenue stream, we've seen an uptick in the second quarter of our average quarterly revenue per domestic client, which indicates that clients are moving up the value proposition as Josh pointed out, that now 60% of our PCM crews are selling value-added chemistry.

So initially, some of these PCM clients start at the lower end of that range and then build into some of the value-added products, increasing our revenue opportunity with those clients over time. And I hope that's a little bit a more color that can help you in trying to identify the addressable market..

Yes, you're absolutely right. I appreciate the color. And I recognize this was a difficult thing that have been done..

[Operator Instructions]. Our next question coming from the line of David Sachs with Hocky Capital..

So I had a series of questions that will come across, maybe just jointed, but we're trying to build a little bit of a mosaic here.

So first, if you could share with us what uniquely was about Kate Richard's background that made her a valuable addition to the board?.

Sure. Let me step back for just a second and share with everybody. It was part of a process. The board at last year, we brought in an independent consultant to really look at the strengths, and maybe weaknesses and where the board was versus where the company had evolved to.

And as a result of that, 3 of our directors concluded that we needed to have a refreshing of the board. The overall board came to that. And so we had some certain qualities that we want to look for. And I'll talk about David Nierenberg first, then we'll get to Kate.

We wanted to have a real emphasis on independence and governance, and I think if you have a chance to go to the website, for both of them, but David, you'll see, his background is in governance, independence and he also had the history of being a Flotek shareholder for a couple of years. So he knew the company very well.

So through a selection process and interviewing process, we wanted him to fill that requirement. Regarding Kate, for her age, she has really accomplished a lot, not only individually, but she -- her family background is in oil and gas and the energy industry in Oklahoma.

And we wanted frankly, a more youthful perspective on the energy side of our business that the directors could give guidance to. And her technical team at Warwick a 1.5 year ago had met with our research guys here at research. They have a very substantial position of joint ownership of -- in operators in Oklahoma.

And through that relationship that evolved over a year, our other directors became convinced myself, they are certainly, that she could open up a different way for us to look at clients.

A lot of her clients come from a private equity foundation that she has a background on that as to why people are interested in the performance of their wells from a private equity standpoint.

And so we felt that she could bring a different perspective as to how to penetrate certain types of clients and be able to retain them in a way that would benefit Flotek. I hope that helps for you..

Okay. Certainly. Hopefully, a step in the right direction.

If you could share with us your vision today for Flotek? And then perhaps opine on your perspective 5 years ago, when you acquired Florida Chemical and the strategic importance of that business at that point in time? And then maybe if we were to bring that thought process to today and the strategic importance of Florida Chemical as you see it for the future and your current vision for Flotek for tomorrow?.

Sure. Florida Chemical has always been, we believe, a underappreciated asset inside Flotek, undervalued. And when we acquired and created the business combination in 2013, it was much more even at that time -- it was much more than a vertical supply chain rationale.

We knew that, that was certainly important for secure sourcing of terpene for d-limonene. We felt at that time through getting, you know Josh, there were other avenues that as time wore on, we would be able to exploit by being the largest refiner of citrus oil, certainly, in the Western Hemisphere. And that view hasn't changed.

We continually look at other ways to further put a bright light on the value of the CICT segment with Florida Chemical and business relationships, whether it's in a partnering way or any type of way that would continue to grow that business model, I'd again, say it's true of anything.

We're always looking at trying to have the best return for the shareholders with anything that's inside Flotek, and that's especially true, I think right now with CICT that there is an increasing interest of the way we can expand the refining of citrus oil into other markets that have not been present to us up to this point in time.

And Josh can certainly chime in as well if you'd care to, Josh..

On the CICT side, if you look at market trends in that segment on the beverage markets, the consumer demand is really pushing for natural. They want to know what's in their food products, citrus oils or ubiquitous to beverage flavors around the world. So there is a very, very good runway there for that business.

We've talked about varietal expansions at CICT. Really we're strong in orange. We have a very good position in grapefruit. We do some stuff in tangerines. But lemon and lime are a big portion of that market, we're being asked to do more there. That was a part of the expansion.

But if you think forward, how does that fit, is really complete utilization and optimization of the value chain of these raw materials that are available to us globally.

And you match that with our manufacturing and technical expertise in Florida to create value-added products for these beverage markets and flavor companies, we think that has a pretty attractive future to it..

Okay. And in terms of the going-forward vision for this business. I understand that we've been pushing or trying to push up the value chain and getting to this, hopefully, new turn with a much higher selling price and margins. But initially, it would have seemed like this was an acquisition to secure suppl of fluids for your Energy business.

And I'm looking now at a company 5 years after the acquisition, where the financial health of the businesses has eroded. On the core side, the profitability has been eradicated best on CICT, and some of that is out of your control with changes in orange prices.

But it's been an extraordinarily frustrating ride, and I'm only on the ride for the last couple of months, let alone what people have been experiencing for the past 5 years.

And my question would be, if you have 2 opportunity sets and limited capital, and how do you address or would allocate how that capital is being used? I am just struggling to sort of see how we can supply the growth potential for both of these businesses without compromising them.

And you paid around $100 million for Florida Chemical to bout with the equity value of Flotek is trading at as we're speaking on this call today.

And that business, at least in the public market, has a valuation with a fairly similarly sized competitor of multiples of what your current stock price is just for a citrus distillation business, forgetting about your multi-$100 million Energy business.

So the market is telling us, one, they don't trust and believe in the management in company's allocation of capital and its ability to deliver on its promises within the overall portfolio, highlighted by the disparity interest of small portion of your business and another public company doing essentially the same thing at a similar size in revenues.

So how do we manage the ability to invest in both sides of the business with our current capital structure? And does it make sense to be in both businesses, whereas perhaps we could monetize 1 to more aggressively invest and the opportunity set in the other?.

Well, the short answer to that is, we like everyone to feel confident, in particular, with the additions to our Board of Directors that we rigorously look at everything that you just talked about. And you're right, it is, has been frustrating for us that the value, we believe, of that segment has never been appreciated by the outside world.

And we're looking at ways to better illustrate what that value is..

The best way to do that would be to deliver industry average or peer average profitability. Your segment EBITDA is barely positive versus competitors that are significantly higher with fully burdened cost structures.

So I think, you're dramatically under-earning tree as an example, were you to close the gap, I would think there would be a significant recognition in the public markets as the business value..

Well, we are more certainly very familiar with tree. We're in a process, as I mentioned, of understanding what the capital requirements will be, could be, to be able to propel that segment closer to what you described, and to counterbalance that with the capital needs inside the energy side.

And that's an ongoing review, and there's different ways we can accomplish that, that probably everyone on this call is familiar with.

And from a disclosure standpoint right now, I think the most accurate thing to say is, we are focused on understanding what those capital needs are required to be able to give a appropriate return to the shareholders who believe in Flotek..

It would seem that you have made the investment in the third tower. That seem like the last significant capital investment for FCC. Is that correct? Or you're talking about marketing resources, or talking about formulation and R&D expenditure.

I'm not sure what you're angling towards?.

Well, the last meaningful capital expenditure that closed in I think the early part of this year, was for the third distillation tower, which enabled us, as part of what we've lined out here, to be more exposed to the lemon and lime, flavor and citrus side the flavor industry, and not just on the orange citrus side.

You're correct, that's the last meaningful capital expenditure we've had. Are we expanding internally, the technical team? Yes, in Florida. That's not a capital event, of course.

And we're in the process right now of looking out into next year as to what that capital would entail, and what are the mechanisms for us to be able to fund that internally or to look at business arrangements from people in that industry that are aware of the resources that we have..

And no one is going to dispute that, that's a unique asset. And hopefully, in the very short order, you can an demonstrate an improvement or a significant improvement in the underlying business performance that you can highlight that it's not only a unique asset, but a uniquely profitable one as well.

And just lastly from a business standpoint on the ECT side. The previous conference call, for the first quarter, you talked about disruption in the service channel. You addressed that a bit in one of the previous questioners responses.

But can we talk about whether there is now growth in that channel? Whether that channel should continue to dissipate over the next year or 2 based on your comments about decoupling? And how do you see that playing out? And is that kind of past the point where it can hurt us, since we're growing with independent relationships as opposed to going for distribution?.

Well, internally, we feel that we've weathered the biggest part of the storm of that channel through the first 6 months of this year. But again, we're in uncharted waters of a business model that has changed, that was a model for 40 years.

But to your point, and I mentioned this earlier to the earlier caller, we honestly believe more and more E&P operators will continue to do what they can to source consumables directly, if A, they feel they have the activity set that makes sense, and they have the internal capability to do that.

But that is what we're seeing today as mentioned by the uplift Josh talked about the second quarter over first quarter, our continuing of hiring people to support that full chemistry experience all the way to the well site..

Congratulations on the win in the Middle East. Hopefully, there's a halo that can shine brightly and attract some additional attention to Flotek and the unique chemistry propositions that you offer to the customers. And congratulations as well on the improvement in your credit line and push out until next year for the first testing of that.

Hopefully, the trends you described in today's call, the sequential revenue improvement and cost management will allow us to meet that covenant test next year. But shareholders, on assets floated with their feet at this point and suggest to you that the status quo isn't going to be acceptable going forward.

So hopefully, there's further vigilance and discipline being taken on costs and a renewed effort to drive profitability in CICT and ECT. Good luck with the process..

Well, thank you for your questions. Thank you for your comments. We can assure you, we're fully engaged to accomplish what you talked about..

Mr. Chisholm, there are no further questions at this time. I will turn the call back to you. Please continue with your presentation or closing remarks..

Sure. Thank you, operator, thanks for the folks that listened in. Thanks for our questions. In the near future, we look to seeing perhaps some of you in person. We'll be at EnterCom in Denver. I think third week in August, we'll be with Seaport Global Conference. The last week in August, we'll be at Johnson Rice.

I think the last in September in New Orleans, and we can continue to further update folks from a transparency standpoint as we move through the reorientation of the business model and further address questions and comments that folks either ask here or share with us in person.

But thanks, again, for everyone's attention and interest, and we'll see you out there on the road..

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