FLOTEK INDUSTRIES INC/CN/ 10-K

Item 1. Business. General Flotek creates unique solutions to reduce the environmental impact of energy on air, water, land and people. A technology-driven, specialty green chemistry and data company, Flotek helps customers across industrial and commercial markets improve their environmental performance. The Company serves specialty chemistry needs for both domestic and international energy markets. The Company’s Chemistry Technologies (“CT”) segment designs, develops, manufactures, packages and distributes green, specialty chemicals that help their customers meet their environmental, social and governance (“ESG”) and operational goals, aiming to enhance the profitability of hydrocarbon producers. The Company’s Data Analytics (“DA”) segment aims to enable users to maximize the value of their hydrocarbon associated processes by providing analytics associated with their hydrocarbon streams in seconds rather than minutes or days. The real-time access to information prevents waste, reduces reprocessing and allows users to pursue automation of their hydrocarbon streams to increase their profitability. The Company was initially incorporated under the laws of the Province of British Columbia in 1985. In October 2001, the Company changed its corporate domicile to the State of Delaware. In December 2007, the Company’s common stock began trading on the New York Stock Exchange (“NYSE”) under the stock ticker symbol “FTK.” Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are posted to the Company’s website, www.flotekind.com , as soon as practicable subsequent to electronically filing or furnishing to the SEC. Information contained in the Company’s website is not to be considered as part of any regulatory filing. 3 As used herein, “Flotek,” the “Company,” “we,” “our” and “us” refers to Flotek Industries, Inc. and/or the Company’s wholly-owned subsidiaries. The use of these terms is not intended to connote any particular corporate status or relationship. Recent Developments On February 2, 2022, the Company entered into a long-term supply agreement with ProFrac Services, LLC (the “Initial ProFrac Agreement”) upon issuance of $10 million in aggregate principal amount of the convertible notes (the “Contract Consideration Convertible Notes Payable”) to ProFrac Holdings LLC. Under the Initial ProFrac Agreement, ProFrac Services, LLC was obligated to order chemicals from the Company at least equal to the greater of (a) the chemicals required for 33% of ProFrac Services, LLC’s hydraulic fracturing fleets and (b) a baseline measured by the first ten hydraulic fracturing fleets deployed by ProFrac Services, LLC during the term of the Initial ProFrac Agreement. If the minimum volumes are not achieved in any given year, ProFrac Services LLC shall pay to the Company, as liquidated damages an amount equal to twenty-five percent (25%) of the difference between (i) the aggregate purchase price of the quantity of products comprising the minimum purchase obligation and (ii) the actual purchased volume during such calendar year. The Initial ProFrac Agreement has a term of 3 years from April 1, 2022. On May 17, 2022, the Company entered into an amendment to the Initial ProFrac Agreement (the “Amended ProFrac Agreement” and collectively the “ProFrac Agreement”) upon issuance of $50 million in aggregate principal amount of Contract Consideration Convertible Notes Payable. The Initial ProFrac Agreement was amended to (a) increase ProFrac Services LLC’s minimum purchase obligation for each year to the greater of 70% of ProFrac Services LLC’s requirements and a baseline measured by ProFrac Services LLC’s first 30 hydraulic fracturing fleets, and (b) increase the term to 10 years. On February 1, 2023, the Company entered into an amendment to the ProFrac Agreement (the “Amended ProFrac Agreement No. 2”) dated February 2, 2022. The Amended ProFrac Agreement No. 2 has an effective date of January 1, 2023. The ProFrac Agreement was amended to (1) provide a ramp-up period from January 1, 2023 to May 31, 2023 for ProFrac Services, LLC to increase the number of active hydraulic fracturing fleets to 30 fleets, (2) waive any liquidated damages payment relating to any potential order shortfall prior to January 1, 2023, (3) add additional fees to certain products, and (4) provide margin increases based on revenue percentages from non-ProFrac customers. The Company believes the net present value of the economic benefit attributable to the Amended ProFrac Agreement No. 2 will exceed the value of the liquidated damages payments that would have been received for the period from April 1, 2022 through December 31, 2022. On February 2, 2023, the Convertible Notes Payable and certain Contract Consideration Convertible Notes Payable previously issued on February 2, 2022 were converted upon maturity into 10,355,840 shares of common stock and 25,366,561 Pre-Funded Warrants to purchase common stock for a nominal exercise price of $0.0001 per share exercisable subject to the limitations on exercise described therein. All of the holders elected to receive shares of common stock upon conversion except for Profrac Holdings LLC, which elected to receive the Pre-Funded Warrants. On January 19, 2023, the Company announced the departure of John W. Gibson, Jr. from his role as Chief Executive Officer and President of the Company, effective January 19, 2023. Mr. Gibson also stepped down from his role as Chairman of the Board of Directors (the “Board”) of the Company. Mr. Gibson’s departure was treated as a termination without cause. Mr. Gibson’s departure as Chairman of the Board, Chief Executive Officer and President of the Company was not due to any disagreement with the Company or any matter relating to the Company’s operations, policies or practices. The Board has an active search process underway to select a permanent Chief Executive Officer of the Company. During the transition period, Harsha V. Agadi, who has served as a member of the Board since July 2020, will serve as the Company’s interim Chief Executive Officer. Description of Operations and Segments The Company’s operations have two business segments, CT and DA, which are both supported by the Company’s Research & Innovation (“R&I”) advanced laboratory capabilities. Financial information about the Company’s operating segments and geographic concentration is provided in Note 19, “Business Segment, Geographic and Major Customer and Supplier Information” in Part II, Item 8 – “Financial Statements and Supplementary Data” of this Annual Report. 4 Chemistry Technologies The Company’s CT segment provides sustainable, optimized chemistry solutions that maximize our customer’s value by elevating their ESG performance, lowering operational costs, and delivering improved return on invested capital. The Company’s proprietary green chemistries, specialty chemistries, logistics, and technology services enable its customers to pursue improved efficiencies and performance throughout the life cycle of its desired chemical applications program. The Company designs, develops, manufactures, packages, distributes and markets optimized chemistry solutions that accelerate existing sustainability practices to reduce the environmental impact of energy on the air, water, land and people. Customers of the CT segment include those of energy related markets, such as our related party ProFrac Services, LLC, with whom we have a long-term supply agreement, as well as consumer and industrial applications. Major integrated oil and gas companies, oilfield services companies, independent oil and gas companies, national and state-owned oil companies, geothermal energy companies, solar energy companies and advanced alternative energy companies benefit from our best-in-class technology, field operations, and continuous improvement exercises that go beyond existing sustainability practices Data Analytics The DA segment delivers real-time information and insights to our customers to enable optimization of operations and reduction of emissions and their carbon intensity. Real-time composition and physical properties are delivered simultaneously on their refined fuels, natural gas liquids (NGLs), natural gas, crude oil, and condensates using the industry’s only field-deployable, in-line optical near-infra-red spectrometer that generates no emissions. The instrument's response is processed with advanced chemometrics modeling, artificial intelligence, and machine learning algorithms to deliver these valuable insights every 15 seconds. Our customers in North America include the supermajors, some of the largest midstream companies and large gas processing plants as well as ProFrac Services, LLC, to whom twenty JP3 units are expected to be deployed in 2023. We have developed a line of Verax™ analyzers for deployment internationally in hazardous locations and harsh weather conditions. Research & Innovation R&I supports the acceleration of ESG solutions for both business segments through green chemistry formulation and Environmental Protection Agency (“EPA”) regulatory guidance, technical support, basin and reservoir studies, data analytics and new technology projects. The purpose of R&I is to supply the Company’s business segments with enhanced products and services that generate current and future revenues, while advising Company management on opportunities concerning technology, environmental and industry trends. The R&I facilities support advances in chemistry performance, detection, optimization and manufacturing. For the years ended December 31, 2022 and 2021, the Company incurred $ 4.4 million and $ 5.5 million, respectively, of research and development expense. The Company expects that its 2023 research and development investment will continue to support new product development, especially in support of enhanced ESG standards, increased adoption of green chemistry and conventional customization initiatives for its clients. Seasonality Overall, operations generally are not significantly affected by seasonality; however, weather conditions can cause delays in clients’ activity levels. Certain working capital components build and recede throughout the year in conjunction with established purchasing and selling cycles that can impact operating results and financial position. The sale of the Company’s products and performance of the Company’s services can be susceptible to both weather and naturally occurring phenomena, including, but not limited to, the following: • the severity and duration of winter temperatures in North America, which impacts natural gas storage levels, drilling activity, commodity prices and operations at the Company’s facilities; • material deviations from normal seasonality for an extended period can impact access to operations, reduced performance at manufacturing facilities, inability to deploy required personnel, supply chain interruptions, facility damage and customer activity levels; • the timing and impact of hurricanes upon coastal and offshore operations; and • the COVID-19 pandemic or other pandemics or similar phenomena, which may impact seasonal purchasing and selling cycles. 5 Product Demand and Marketing Demand for the Company’s energy-focused product s and services in both the CT and DA segments is driven by energy supply and demand, as well as operator desire to deploy improved ESG solutions. Demand for the Company’s energy chemistry products and services is dependent on levels of conventional and unconventional oil and natural gas well drilling and completion activity, both domestically and internationally. The Company markets its products to end user customers using both direct and indirect sales channels. These sales channels are accessed using a mix of in-house sales professionals as well as certain contractual agency agreements. The Company also actively participates in industry trade shows, both live and virtual, publishes articles in industry publications, and participates in podcasts and creates other online content to educate the market on its product and service offerings. While the Company’s primary marketing efforts remain focused in North America, resources and efforts are also deployed on emerging international markets, especially in the Middle East. Product revenues include significant sales to related parties as described in Note 18, “Related Party Transactions” in Part II, Item 8 - “Financial Statements and Supplementary Data” of this Annual Report. Facilities and Offices See Part 1, Item 2 - “Properties”, for information regarding our manufacturing, warehouse and research facilities and sales offices. Intellectual Property The Company endeavors to protect its intellectual property, both within and outside of the U.S. The Company considers patent protection for all products and methods deemed to have commercial significance and that may qualify for patent protection. The decision to pursue patent protection is dependent upon several factors, including whether patent protection can be obtained, cost effectiveness, and alignment with operational and commercial interests. The Company believes its patent and trademark portfolio, combined with confidentiality agreements, EPA registrations and licensing, trade secrets, proprietary designs, and manufacturing and operational expertise, are sufficient to protect its intellectual property and provide continued strategic advantage. As of December 31, 2022, the Company had 136 granted patents, including 111 patents in our CT segment and 24 patents in our DA segment. In addition, the Company also had 13 pending patent applications filed in the U.S. and abroad, including 9 for the CT segment and 4 for the DA segment. The patents of the CT segment cover various chemical compositions and methods of use. The patents of the DA segment cover various systems and methods of use for online determination of chemical composition and data analysis. In addition, the Company had 50 registered trademarks in the U.S. and abroad, covering a variety of its goods and services. Competition Our ability to compete is dependent upon the Company’s ability to differentiate its products and services by providing superior quality and service, and maintaining a competitive cost structure with sufficient and reliable access to raw material supplies. Activity levels in the oilfield goods and services industry are impacted by current and expected oil and natural gas prices, oil and natural gas drilling activity, production levels, customer drilling and completion-designated capital spending, and customer commitment to improved ESG performance. The unpredictability of the energy industry and commodity price fluctuations create both increased risk and opportunity for the products and services of both the Company and its competitors. The DA segment faces competition from other providers of equipment and services for real-time information in the upstream, midstream, refining and distribution market. Raw Materials Materials and components used in the Company’s servicing and manufacturing operations, as well as those purchased for sale, are generally avail able on the open market from multiple sources. When able, the Company uses multiple suppliers, both domestically and internationally, to purchase raw materials on the open market. The prices paid for raw materials vary based on availability, weather, other commodity price fluctuations, contractual obligations, tariffs, duties on imported materials, foreign currency exchange rates, business cycle position and global demand. Higher prices for chemistries and certain raw materials could adversely impact future sales, contract fulfillment and product margins. The Company is diligent in its efforts to identify alternate suppliers in its contingency planning utilizing competitive bidding practices to proactively reduce costs and potential supply shortages. During 2022, the Company worked to broaden the technical specifications of some products to help ensure that required molecules could be sourced from more than one supplier. 6 The DA segment currently sources spectrometers from a single supplier. Due to long lead times, supply chain disruption could adversely impact the results of the segment in 2023 and the years beyond. Government Regulations The Company is subject to federal, state, and local laws and regulations, including laws related to the environment, occupational safety, health, transportation and trade within the U.S. and other countries in which the Company does business. These laws and regulations strictly govern the manufacture, storage, transportation, sale, use and disposal of chemistry products. The Company strives to ensure full compliance with all regulatory requirements. The Company continually evaluates the environmental impact of its operations and attempts to identify potential liabilities and costs of any environmental remediation, litigation or associated claims. Several products of the CT segment are considered hazardous materials. In the event of a leak or spill in association with Company operations, the Company could be exposed to risk of material cost, net of insurance proceeds, if any, to remediate any contamination. To the Company’s knowledge, no environmental claims are currently being litigated or investigated. Sustainability Flotek’s vision is to create solutions to reduce the environmental impact of energy on air, water, land and people. Our mission is to be the collaborative ESG partner of choice for sustainable chemistry technology and digital analytics solutions. We believe that green chemistry and digital transformation reduce the total cost of ownership and environmental risk of our customers and can transform business by reducing carbon footprints, energy consumption, emissions and overall environmental impact. We have green, sustainable chemistry at our core, and we focus on providing responsible specialty chemistry solutions that are environmentally friendly and cost-competitive. Our products offered by our CT segment displace harmful chemicals such as benzene, toluene, ethylbenzene and xylenes (BTEX) in energy production, and our logistics and delivery methodology results in lower product usage and lower carbon emissions due to delivery. The analyzers produced by our DA segment are a closed-loop system, meaning that samples of potentially harmful gasses and fluids do not need to be routinely taken and flared, as is the case with gas chromatographs. This results in lower emissions. In addition, our analyzers’ ability to determine the mixing of two batches of product (“transmix”) in real-time results in less time, energy and resources spent processing the transmix. Human Capital Employee Overview As of December 31, 2022, the Company had approximately 146 employees, exclusive of existing worldwide agency relationships. None of the Company’s employees are covered by a collective bargaining agreement and labor relations are generally good. Employees & Health, Safety & Environment The Company is committed to acting with care to protect the health and safety of people, resources and the environment. Each employee is responsible for working towards the health, safety and environment (“HSE”) goals, as they are not isolated to certain individuals or roles. We aim to hold each other accountable to a high standard. Thus, every employee is empowered and expected to stop any activity, big or small, that could jeopardize people, the environment or assets. Our safety, health and environmental goals are designed to sustain our drive to zero incidents. As a result, safety is woven into the fabric of the Company, from our robust training programs, to our safety moments that begin team meetings, to our Hazardous Observation Card program. Our training program is fundamental to operating safely and protecting people and the environment. The Company maintains a robust health, safety and environmental training program that includes both classroom and online curriculum. We assign specific trainings to employees based on their role and function within the Company. Additionally, the Company’s field and plant personnel complete more than 24 hours of training annually. We continuously monitor all operational activities and update training programs as needed to ensure the curriculum remains relevant and effective for minimizing risk and protecting our employees and the environment. 7 We have a strong commitment to safety in all aspects of our operations through training, safety culture, and tracking of key safety metrics. In 2022, the Company recorded a Total Recordable Incident Rate (TRIR) of 0.397. The TRIR is a key safety performance metric which calculates the number of recordable incidents per full-time workers during a one-year period. Compensation: Wages & Benefits The Company’s compensation programs are designed to provide employee wages that are competitive and consistent with employee positions, skill levels, experience, knowledge and geographic location. We align our programs to attract, retain and motivate employees to achieve high-impact results that create value for all of our stakeholders. In addition to competitive base wages, all employees are eligible for a discretionary bonus, which is based upon individual performance and triggered by company performance, subject to the Company’s liquidity position. Benefits are a key component of our compensation program. We engage an outside benefits consulting firm to independently evaluate the effectiveness and competitiveness of our employee benefits program, as well as to tailor our program to the unique needs of the Company’s employee base. All full-time employees are eligible for comprehensive health insurance, including medical insurance, prescription drug benefits, dental insurance and vision insurance. Additionally, the Company offers flexible spending and health savings accounts, life and disability/accident coverage, telemedicine, critical illness insurance and paid leave. Eligible employees may elect to participate in the Company’s employee stock purchase plan and retirement plans, including its 401(k) plan in the U.S. and its Registered Retirement Savings Plan in Canada. The Company currently matches 401(k) contributions at 100 % of up to 2 % of an employee’s compensation. The Company also offers access to online and personalized financial planning services as a component of its retirement plan benefit. The Company continues to prioritize mental health and wellness for employees, maintaining an ongoing dialogue with employees and providing resources through its employee assistance program, which is available to all employees and their families. Outlook Our business is subject to numerous variables which impact our outlook and expectations given the shifting conditions of the industry. We have based our outlook on the market conditions we perceive today. Changes often occur. Energy Going into 2023 we believe that we are in the early years of a tight supply cycle for oil and gas triggered by a long period of underinvestment in energy development, infrastructure and new sources of oil and gas production. While the demand for oil and gas could fluctuate depending on the macroeconomic condition, we believe that this tight supply cycle could last and could provide support to high oil prices for multiple years. We expect that the strongest potential growth throughout 2023 will likely come from independent, rather than large major exploration and production companies. Independent exploration and production companies operate the majority of U.S. land rigs and react quickly to changing commodity prices. In the current commodity price environment, we expect these companies to increase activity and the larger companies to have modest spending increases in the year ahead. Digital Analytics The use of data and digital analytics is a growing trend in all industries where technology is leveraged to analyze large datasets of operational information to improve performance, as well as for predictive maintenance, advanced safety measures and reduced environmental impact of operations. We believe Verax ™ analyzers have gained a foothold in North American markets for critical applications where compositional information is needed in real-time. The technology delivers insight on valuable operational data like vapor pressure, boiling point, flash point, octane level, API gravity, viscosity, BTU and more, simultaneously. We continue to work with our customers to identify further facilities and applications where our technology has the highest value. To drive recurring revenue, we continue to build on the modular nature of our sensor and analysis packages with new data processing techniques that enhance the value of our installations. AIDA (Automated Interface Detection Algorithm) provides real-time detection of interfaces in a liquids pipeline without the need for additional sampling or chemometric modeling. The application can identify products such as refined fuels, crude and NGLs with its advanced machine learning algorithms and detect interfaces real-time versus traditional lab analysis. We believe this allows customers to cut batches quickly and accurately, reduce transmix and minimize off-spec product that requires downgrades. We are also gaining traction leveraging the Verax™ in applications where operators and service companies are using field gas as a substitute for 8 diesel in dual fuel engines as the market moves to Tier 4 equipment and eFleets. Analyzing this in real-time allows companies to maximize the substitution rate while lowering emissions, reducing fuel consumption/costs, and protecting the equipment from damage. ESG ESG-focused solutions continue to be an emphasis for the Company as the energy, industrial and consumer markets are seeking to accelerate their focus on sustainability and minimized impact on the environment. We anticipate the Company’s products and services could offer a significant benefit to businesses seeking to improve their ESG performance, including improving safety, reliability and efficiency of their operations. The Company offers sustainable chemistry solutions, tailoring product selection to enable operational efficiencies, improve water management and reduce greenhouse gas emissions for its customers in the exploration and production sector of the oil and gas industry. Further, the Company’s patented line of Complex nano-Fluid® (also known as CnF®) products are formulated with highly effective, plant-based solvents offering safer, renewable and sustainable alternatives to toxic BTEX-based (benzene, toluene, ethylbenzene and xylene) chemicals. Additionally, we believe the Company’s real-time sensor technology helps to enable process and operational efficiencies, minimize waste and processing and reduce emissions. We believe the industry focus on maintaining a “social license to operate” provides the platform to accelerate the sale of our products and services that we believe can help the customer achieve a greener goal. We believe the performance driven ESG focus of the Company assists in reducing environmental liabilities and improving returns for our customers. Supply Chain The principal supply issues facing our industry for the next twelve months will include: • Fluctuating freight costs for shipping to our customers; • Availability of raw materials; • Delays due to port congestion; • Labor shortages; and • Demand forecasting. All bidding will require the risk of shipping costs and delays to be factored into proposals. Trucking availability and pricing will impact North American opportunities while sea-freight costs will impact sales of North American manufactured goods being delivered internationally for the foreseeable future. The import of raw materials from China will also incur price increases. Accelerating tensions between China and the U.S. could also result in supply disruption. COVID-19 The impacts of COVID-19 pandemic continue to affect the U.S. and global economy. We believe our protocols and processes established to maintain business continuity with COVID-19 have proven robust enough to diminish concern about business disruption unless new variants emerge. The pandemic has already affected and may continue to affect the U.S. economy, including capital expenditures of our customers. In addition, depending upon the length and severity of the pandemic, which cannot be predicted, we may experience disruptions to business operations in the future if new COVID-19 variants emerge. Available Information and Website The Company’s website is www.flotekind.com . Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available (see the “Investor Relations” section of the Company’s website), as soon as reasonably practicable, subsequent to electronically filing or otherwise providing reports to the SEC. Corporate governance materials, including but not limited to our corporate governance guidelines, board committee charters, bylaws, certain policies, and code of business conduct and ethics are also available on the website. A copy of corporate governance materials is also available upon written request to the Company. The SEC maintains the www.sec.gov website, which contains reports, proxy and information statements, and other registrant information filed electronically with the SEC. The Company filed, or furnished, as applicable, all principal executive officer and financial officer certifications as required under Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 with this Annual Report. Information with respect to the 9 Company’s executive officers and directors is incorporated herein by reference to information to be included in the definitive proxy statement for the Company’s 2023 Annual Meeting of Stockholders. The Company has disclosed and will continue to disclose any changes or amendments to the Company’s code of business conduct and ethics as well as waivers to the code of ethics applicable to executive management by posting such changes or waivers on the Company’s website in the “Corporate Governance” section under “Investor Relations”or in filings with the SEC.