FLOTEK INDUSTRIES INC/CN/ 10-K

Item 8. Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors Flotek Industries, Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Flotek Industries, Inc. and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, cash flows, and stockholders’ equity for each of the years in the two-year period ended December 31, 2022, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. Going Concern The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring operating losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Change in Accounting Principle As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for convertible instruments as of January 1, 2022 due to the adoption of ASU No. 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or 34 disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Recoverability of contract assets As described in Note 2 to the Company’s consolidated financial statements, the Company’s contract assets represent consideration issued in the form of convertible notes and other incremental costs related to obtaining a contract with ProFrac Services, LLC, a related party customer. The contract assets are tested for recoverability on a recurring basis and the Company will recognize an impairment loss to the extent that the carrying amount of the contract assets exceeds the amount of revenue the Company expects to receive in the future for the transfer of goods under the long-term supply agreement and the amendment to that agreement (collectively, the ProFrac Agreement) less the direct costs that relate to providing those goods in the future. As described in Note 4, the Company had recorded contract assets, net of $79.7 million as of December 31, 2022. We identified the evaluation of the recoverability of contract assets as a critical audit matter. There was subjective auditor judgement in evaluating the key assumptions used in the Company’s contract asset recoverability assessment, specifically the forecasted product revenue and related forecasted costs to provide products over the term of the ProFrac Agreement. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design of certain internal controls related to the Company’s contract assets recoverability assessment, including controls over the development of forecasted revenue and costs over the term of the ProFrac Agreement. To assess the Company’s ability to forecast revenue and costs, we compared revenue and cost forecasts for the current year to actual results. We performed sensitivity analyses over the Company’s contract asset recoverability assessment by evaluating the effect of changes in the forecasted revenue and costs over the term of the ProFrac Agreement. We assessed the reasonableness of forecasted revenue and costs by considering whether such amounts were consistent with evidence obtained in other areas of the audit. /s/ KPMG LLP We have served as the Company’s auditor since 2021. Houston, Texas March 22, 2023 FLOTEK INDUSTRIES, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data) December 31, 2022 2021 ASSETS Current assets: Cash and cash equivalents $ 12,290 $ 11,534 Restricted cash 100 1,790 Accounts receivable, net of allowance for doubtful accounts of $ 623 and $ 659 at December 31, 2022 and December 31, 2021, respectively 19,136 11,997 Accounts receivable, related party 22,683 1,300 Inventories, net 15,720 9,454 Other current assets 4,045 3,762 Current contract assets 7,113 — Assets held for sale — 2,762 Total current assets 81,087 42,599 Long-term contract assets 72,576 — Property and equipment, net 4,826 5,296 Operating lease right-of-use assets 5,900 2,041 Deferred tax assets, net 404 279 Other long-term assets 17 29 TOTAL ASSETS $ 164,810 $ 50,244 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 33,375 $ 7,616 Accrued liabilities 8,984 8,996 Income taxes payable 97 4 Interest payable 130 82 Current portion of operating lease liabilities 3,328 602 Current portion of finance lease liabilities 36 41 Current portion of long-term debt 2,052 1,436 Convertible notes payable 19,799 — Contract consideration convertible notes payable 83,570 — Total current liabilities 151,371 18,777 Deferred revenue, long-term 44 91 Long-term operating lease liabilities 8,044 7,779 Long-term finance lease liabilities 19 53 Long-term debt 2,736 3,352 TOTAL LIABILITIES 162,214 30,052 Stockholders’ equity: Preferred stock, $ 0.0001 par value, 100,000 shares authorized; no shares issued and outstanding — — Common stock, $ 0.0001 par value, 240,000,000 shares authorized; 83,915,918 shares issued and 77,788,391 shares outstanding at December 31, 2022; 79,483,837 shares issued and 73,461,203 shares outstanding at December 31, 2021 8 8 Additional paid-in capital 388,177 363,417 Accumulated other comprehensive income 181 81 Accumulated deficit ( 351,519 ) ( 309,214 ) Treasury stock, at cost; 6,127,527 and 6,022,634 shares at December 31, 2022 and December 31, 2021, respectively ( 34,251 ) ( 34,100 ) Total stockholders’ equity 2,596 20,192 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 164,810 $ 50,244 FLOTEK INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Years ended December 31, 2022 2021 Revenue: Revenue from external customers $ 54,344 $ 39,627 Revenue from related party 81,748 3,641 Total revenues 136,092 43,268 Cost of sales 142,792 40,012 Gross profit (loss) ( 6,700 ) 3,256 Operating costs and expenses: Selling, general, and administrative 27,124 20,166 Depreciation 734 1,011 Research and development 4,438 5,537 Gain on disposal of property and equipment ( 2,916 ) ( 94 ) Gain on lease termination ( 584 ) — Gain on fair value of contract consideration convertible notes payable ( 75 ) — Impairment of goodwill — 8,092 Total operating costs and expenses 28,721 34,712 Loss from operations ( 35,421 ) ( 31,456 ) Other income (expense): Paycheck protection plan loan forgiveness — 881 Interest expense ( 7,051 ) ( 78 ) Other income, net 145 87 Total other income (expense) ( 6,906 ) 890 Loss before income taxes ( 42,327 ) ( 30,566 ) Income tax benefit 22 40 Net loss $ ( 42,305 ) $ ( 30,526 ) Loss per common share: Basic $ ( 0.57 ) $ ( 0.42 ) Diluted $ ( 0.57 ) $ ( 0.42 ) Weighted average common shares: Weighted average common shares used in computing basic loss per common share 74,425 73,361 Weighted average common shares used in computing diluted loss per common share 74,425 73,361 The accompanying Notes are an integral part of these Consolidated Financial Statements. 37 FLOTEK INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands) Years ended December 31, 2022 2021 Net loss $ ( 42,305 ) $ ( 30,526 ) Other comprehensive income: Foreign currency translation adjustment 100 100 Comprehensive Loss $ ( 42,205 ) $ ( 30,426 ) The accompanying Notes are an integral part of these Consolidated Financial Statements. 38 FLOTEK INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Years ended December 31, 2022 2021 Cash flows from operating activities: Net loss $ ( 42,305 ) $ ( 30,526 ) Adjustments to reconcile net loss to net cash used in operating activities: Change in fair value of contingent consideration ( 25 ) ( 808 ) Change in fair value of contract consideration convertible notes payable ( 75 ) — Amortization of convertible note issuance cost 1,002 — Paid-in-kind interest expense 5,956 — Amortization of contract assets 3,371 — Depreciation 734 1,011 Provision for doubtful accounts, net of recoveries 203 ( 127 ) Inventory purchase commitment settlement — ( 7,633 ) Provision for excess and obsolete inventory 1,734 623 Impairment of goodwill — 8,092 Gain on sale of property and equipment ( 2,916 ) ( 94 ) Gain on lease termination ( 584 ) — Non-cash lease expense 226 279 Stock compensation expense 3,325 3,757 Deferred income tax benefit ( 125 ) ( 56 ) Paycheck protection plan loan forgiveness — ( 881 ) Changes in current assets and liabilities: Accounts receivable ( 7,342 ) ( 106 ) Accounts receivable, related party ( 21,383 ) ( 1,300 ) Inventories ( 7,917 ) 1,760 Income taxes receivable 14 381 Other assets ( 285 ) ( 609 ) Contract assets ( 3,600 ) — Accounts payable 25,760 1,829 Accrued liabilities ( 34 ) ( 860 ) Operating lease liabilities ( 507 ) ( 603 ) Income taxes payable 93 ( 17 ) Interest payable 48 48 Net cash used in operating activities ( 44,632 ) ( 25,840 ) Cash flows from investing activities: Capital expenditures ( 421 ) ( 39 ) Proceeds from sale of assets 5,752 151 Net cash provided by investing activities 5,331 112 Cash flows from financing activities: Proceeds from issuance of convertible notes 21,150 — Payment of issuance costs of convertible notes ( 1,084 ) — Proceeds from issuance of warrants 19,500 — Payment of issuance costs of stock warrants ( 1,170 ) — Payments to tax authorities for shares withheld from employees ( 224 ) ( 390 ) Proceeds from issuance of stock 133 80 Payments for finance leases ( 38 ) ( 62 ) Net cash provided by (used in) financing activities 38,267 ( 372 ) Effect of changes in exchange rates on cash and cash equivalents 100 100 Net change in cash, cash equivalents and restricted cash ( 934 ) ( 26,000 ) Cash and cash equivalents at the beginning of period 11,534 38,660 Restricted cash at the beginning of period 1,790 664 Cash and cash equivalents and restricted cash at beginning of period 13,324 39,324 Cash and cash equivalents at end of period 12,290 11,534 Restricted cash at the end of period 100 1,790 Cash, cash equivalents and restricted cash at end of period $ 12,390 $ 13,324 The accompanying Notes are an integral part of these Consolidated Financial Statements. 39 FLOTEK INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Years Ended December 31, 2022 and 2021 (In thousands of U.S. dollars and shares) Common Stock Treasury Stock Additional Paid-in Capital Accumulated Other Comprehensive Income Accumulated Deficit Total Stockholders’ Equity Shares Issued Par Value Shares Cost Balance, December 31, 2021 79,484 $ 8 6,022 $ ( 34,100 ) $ 363,417 $ 81 $ ( 309,214 ) $ 20,192 Net loss — — — — — — ( 42,305 ) ( 42,305 ) Foreign currency translation adjustment — — — — — 100 — 100 Stock issued under employee stock purchase plan — — ( 40 ) — 140 — — 140 Restricted stock granted 1,533 — — — — — — — Restricted stock forfeited ( 3 ) — 30 — — — — — Restricted stock units vested 144 — — — ( 31 ) — — ( 31 ) Stock compensation expense — — — — 3,325 — — 3,325 Shares withheld to cover taxes ( 35 ) — 115 ( 151 ) ( 42 ) — — ( 193 ) Issuance of stock warrants, net of transaction fee — — — — 9,930 — — 9,930 Equity contribution — — — — 8,400 — — 8,400 Conversion of notes to common stock 2,793 — — — 3,038 — — 3,038 Balance, December 31, 2022 83,916 $ 8 6,127 $ ( 34,251 ) $ 388,177 $ 181 $ ( 351,519 ) $ 2,596 Common Stock Treasury Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Stockholders’ Equity Shares Issued Par Value Shares Cost Balance, December 31, 2020 78,669 $ 8 5,581 $ ( 33,851 ) $ 359,721 $ ( 19 ) $ ( 278,688 ) $ 47,171 Net loss — — — — — — ( 30,526 ) ( 30,526 ) Foreign currency translation adjustment — — — — — 100 — 100 Stock issued under employee stock purchase plan — — ( 136 ) — 80 — — 80 Restricted stock granted 1,702 — — — — — — — Restricted stock forfeited ( 284 ) — 422 — — — — — Restricted units vested 86 — — — — — — — Stock compensation expense — — — — 3,757 — — 3,757 Shares withheld to cover taxes ( 76 ) — 155 ( 273 ) ( 150 ) ( 423 ) Other (1) ( 613 ) — — 24 9 — — 33 Balance, December 31, 2021 79,484 $ 8 6,022 $ ( 34,100 ) $ 363,417 $ 81 $ ( 309,214 ) $ 20,192 (1) See Note 14, “Stockholders’ Equity” for further discussion. The accompanying Notes are an integral part of these Consolidated Financial Statements. 40 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 — Organization and Nature of Operations General Flotek Industries, Inc. (“Flotek” or the “Company”) 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’s Chemistry Technologies (“CT”) segment develops, manufactures, packages, distributes, delivers, and markets green specialty chemicals that aim 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 maximize their profitability. The Company’s two operating segments, CT and DA, are both supported by its Research & Innovation advanced laboratory capabilities. For further discussion of our operations and segments, see Note 19, “Business Segment, Geographic and Major Customer Information.” Going Concern These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) assuming the Company will continue as a going concern. The going concern assumption contemplates the realization of assets and satisfaction of liabilities in the normal course of business. However, substantial doubt about the Company’s ability to continue as a going concern exists. The Company currently funds its operations from cash on hand and other current assets. The Company has a history of losses and negative cash flows from operations and expects to utilize a significant amount of cash within one year after the date of filing the consolidated financial statements. The availability of capital is dependent on the Company’s operating cash flow currently expected to be principally derived from the ProFrac Agreement (see Note 18, “Related Party Transactions”). It is not certain that the Company’s cash and other current assets and our forecasted operating cash flows currently expected to be generated from the ongoing execution of the ProFrac Agreement will provide the Company with sufficient financial resources to fund operations and meet our capital requirements and anticipated obligations as they become due in the next twelve months. The Company may require additional liquidity to continue its operations over the next twelve months to sufficiently alleviate or mitigate the conditions and events noted above, which results in substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued. The Company is evaluating strategies to obtain additional funding for future operations. These strategies may include, but are not limited to, obtaining equity financing, issuing debt or entering into other financing arrangements, obtaining higher prices for its products and services, increasing the percentage of its sales from higher margin products, monetizing non-core assets, and reducing expenses. However, the Company may be unable to access further equity or debt financing when needed. As such, there can be no assurance that the Company will be able to obtain additional liquidity when needed or under acceptable terms, if at all. The consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if the Company were unable to continue as a going concern. Note 2 — Summary of Significant Accounting Policies Basis of Presentation The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. The consolidated financial statements include the accounts of Flotek Industries, Inc. and subsidiaries it controls. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company does not have investments in any unconsolidated subsidiaries. 41 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cash Equivalents Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase. Restricted Cash The Company’s restricted cash is $ 0.1 million and $ 1.8 million as of December 31, 2022 and December 31, 2021, respectively. The Company’s restricted cash as of December 31, 2022 consists of cash that the Company is contractually obligated to maintain in accordance with the terms of its credit card program with a financial institution. The restricted cash balance as of December 31, 2021 included cash maintained in accordance with the credit card program and cash held in escrow of $ 1.75 million for amounts due under the terms of the legal settlement discussed in Note 13, “Commitments and Contingencies”. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable and Accounts receivable, related party, arise from product sales and services and are stated at estimated net realizable value. This value incorporates an allowance for doubtful accounts to reflect any loss anticipated on accounts receivable balances. The Company regularly evaluates its accounts receivable to estimate amounts that will not be collected and records the appropriate allowance for doubtful accounts as a charge to operating expenses. The allowance for doubtful accounts is based on a combination of the age of the receivables, individual customer circumstances, credit conditions, and historical write-offs and collections. The Company writes off specific accounts receivable when they are determined to be uncollectible. The recovery of accounts receivable previously written off is recorded as a reduction to the allowance for doubtful accounts charged to operating expense. The majority of the Company’s customers are engaged in the energy industry. The cyclical nature of the energy industry may affect customers’ operating performance and cash flows, which directly impact the Company’s ability to collect on outstanding obligations. Additionally, certain customers are located in international areas that are inherently subject to risks of economic, political, and civil instability, which can impact the collectability of receivables. Changes in the allowance for doubtful accounts are as follows (in thousands): Years ended December 31, 2022 2021 Balance, beginning of year $ 659 $ 1,316 Charges to provision for doubtful accounts, net of recoveries 203 ( 127 ) Write-offs ( 239 ) ( 530 ) Balance, end of year $ 623 $ 659 As of December 31, 2022 and 2021 the Company has not recorded an allowance for doubtful accounts for the related party accounts receivable, including ProFrac Services, LLC. Contract Assets The Company’s contract assets represent consideration issued in the form of convertible notes (Contract Consideration Convertible Notes Payable as discussed in Note 10, “Debt and Convertible Notes Payable”) and other incremental costs related to obtaining the ProFrac Agreement. The contract assets are amortized over the term of the ProFrac Agreement ( 10 years) based on forecasted revenues as goods are transferred to ProFrac Services, LLC and the amortization is presented as a reduction of the transaction price included in related party revenue in the consolidated statements of operations. The contract assets are tested for recoverability on a recurring basis and the Company will recognize an impairment loss to the extent that the carrying amount of the contract assets exceeds the amount of consideration the Company expects to receive in the future for the transfer of goods under the ProFrac Agreement less the direct costs that relate to providing those goods in the future. Based on our tests of recoverability, we did not identify an impairment of the contract assets during the year ended December 31, 2022. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost determined using the weighted-average cost method, or net realizable value. Finished goods inventories include raw materials, direct labor and production overhead. The Company periodically reviews inventories on hand and current market conditions to determine if the cost of raw 42 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS materials and finished goods inventories exceed current market prices and impairs the cost basis of the inventory accordingly. Obsolete inventory or inventory in excess of management’s estimated usage requirement is written down to its net realizable value if those amounts are determined to be less than cost. Write-downs or write-offs of inventory are charged to cost of sales. Property and equipment Property and equipment are stated at cost. The cost of ordinary maintenance and repair is charged to operating expense, while replacement of critical components and major improvements are capitalized. Depreciation or amortization of property and equipment, including operating lease right-of-use assets (“ROU”), is calculated using the straight-line method over the shorter of the lease term or the asset’s estimated useful life as follows: Buildings and leasehold improvements 2 - 30 years Machinery and equipment 7 - 10 years Furniture and fixtures 3 years Land improvements 20 years Transportation equipment 2 - 5 years Computer equipment and software 3 - 7 years Property and equipment, including ROU assets, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. If events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable, the Company first compares the carrying amount of an asset or asset group to the sum of the undiscounted future cash flows expected to result from the use and eventual disposal of the asset. If the carrying amount of an asset or asset group exceeds the sum of the undiscounted future cash flows expected to result from the use and eventual disposal of the asset, the Company will determine the fair value of the asset or asset group. The amount of impairment loss recognized is the excess of the asset or asset group’s carrying amount over its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary. There were no impairments of property and equipment and ROU assets during the years ended December 31, 2022 and 2021. Assets to be disposed of are reported as assets held for sale at the lower of the carrying amount or the asset’s fair value less cost to s ell and depreciation is ceased. Upon sale or other disposition of an asset, the Company recognizes a gain or loss on disposal measured as the difference between the net carrying amount of the asset and the net proceeds received. Leases The Company leases certain facilities, land, vehicles, and equipment. The Company determines if an arrangement is classified as a lease at inception of the arrangement. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the related lease. Finance leases are under the current and non-current liabilities and the underlying assets are included in property and equipment on the consolidated balance sheet. As most of the Company’s leases do not provide an implicit rate of return, on a quarterly basis, the Company’s incremental borrowing rate is used, together with the lease term information available at commencement date of the lease, in determining the present value of lease payments . Operating lease liabilities include related options to extend or terminate lease terms that are reasonably certain of being exercised. Leases with an initial term of 12 months or less (“short term leases”) are not recorded on the balance sheet; and the lease expense on short-term leases is recognized on a straight-line basis over the lease term. Convertible Notes Payable and Liability Classified Contract Consideration Convertible Notes Payable The Company accounts for the Convertible Notes Payable at amortized cost pursuant to Financial Accounting Standards Board (“FASB”) ASC Topic 470, Debt. The Company accounts for the Contract Consideration Convertible Notes Payable issued as consideration related to a related party contract (see Note 10, “Debt and Convertible Notes Payable”), as liability classified convertible instruments in accordance with FASB ASC 718, “Stock Compensation” (“ASC 718”). Under ASC 718, liability classified convertible instruments are 43 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS measured at fair value at the grant date and at each reporting date (see Note 11, “Fair Value Measurements”) with the change in fair value included in the consolidated statements of operations. Fair Value Measurements The Company categorizes financial assets and liabilities using a three-tier fair value hierarchy, based on the nature of the inputs used to determine fair value. Inputs refer broadly to assumptions that market participants would use to value an asset or liability and may be observable or unobservable. When determining the fair value of assets and liabilities, the Company uses the most reliable measurement available. See Note 11, “Fair Value Measurements.” Revenue Recognition The Company only has revenue from customers. The Company recognizes revenue when it satisfies performance obligations under the terms of the contract with a customer, and control of the promised goods are transferred to the customer or services are performed, in an amount that reflects the consideration the Company expects to be entitled in exchange for those goods or services. The Company recognizes revenue based on a five-step model when all of the following criteria have been met: (i) a contract with a customer exists, (ii) performance obligations have been identified, (iii) the price to the customer has been determined, (iv) the price to the customer has been allocated to the performance obligations, and (v) performance obligations are satisfied. Products and services are sold with fixed or determinable prices. Certain sales include right of return provisions, which are considered when recognizing revenue and deferred accordingly, and discounts offered to customers for prompt payment. The Company does not act as an agent in any of its revenue arrangements. In recognizing revenue for products and services, the Company determines the transaction price of contracts with customers, which may consist of fixed and variable consideration. Determining the transaction price may require judgment by management, which includes identifying performance obligations, estimating variable consideration to include in the transaction price, and determining whether promised goods or services can be distinguished in the context of the contract. The majority of the CT segment revenue is chemical products that are sold at a point in time based on when control transfers to the customer determined by agreed upon delivery terms. Contracts with customers for the sale of products generally state the terms of the sale, including the quantity and price of each product purchased. Additionally, the CT segment offers various services associated to products sold which includes field services, installation, maintenance, and other functions. These services are recognized upon completion of commissioning and installation due to the short-term nature of the performance obligation when the Company has a right to invoice the customer. The DA segment recognizes revenue for sales of equipment at the time of sale based on when control transfers to the customer based on agreed upon delivery terms. Additionally, the Company offers various services associated to products sold which includes field services, installation, maintenance, and other functions. Services are recognized upon completion of commissioning and installation due to the short-term nature of the performance obligation. There may be additional performance obligations related to providing ongoing or reoccurring maintenance. Revenue for these types of arrangements is recognized ratably over time throughout the contract period. Additionally, the Company may provide subscription-type arrangements with customers in which monthly reoccurring revenue is recognized ratably over time in accordance with agreed upon terms and conditions. Customers may be invoiced for such maintenance and subscription-type arrangements and revenue not yet recognizable is reported under accrued liabilities and deferred revenue on the consolidated balance sheets. Subscription-type arrangements were not a material revenue stream in the years ended December 31, 2022 and 2021. Payment terms for both the CT and DA segments are customarily 30 - 60 days for domestic and 90 - 120 days f or international from invoice receipt. Under revenue contracts for both products and services, customers are invoiced once the performance obligations have been satisfied, at which point payment is unconditional. Contract assets associated with incomplete performance obligations are not material. The Company applies several practical expedients including: • Sales commissions are expensed as selling, general and administrative expenses when incurred because the amortization period is generally one year or less. • The Company’s payment terms are short-term in nature with settlements of one year or less. As a result, the Company does not adjust the promised amount of consideration for the effects of a significant financing component. 44 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS • In most service contracts, the Company has the right to consideration from a customer in an amount that corresponds directly with the value to the customer of the Company’s performance obligations completed to date and as such the Company recognizes revenue in the amount to which it has a right to invoice. • The Company excludes from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer. Such taxes are included in accrued liabilities on our consolidated balance sheet until remitted to the governmental agency. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of sales in our consolidated statement of operations. Foreign Currency Translation The Company’s functional currency is primarily the U.S. dollar. The Company operates principally in the United States and substantially all assets and liabilities of the Company are denominated in U.S. dollars. Financial statements of foreign subsidiaries that are not U.S. dollar functional currency are prepared using the currency of the primary economic environment of the foreign subsidiaries as the functional currency. Assets and liabilities of those foreign subsidiaries are translated into U.S. dollars at exchange rates in effect as of the end of identified reporting periods. Revenue and expense transactions are translated using the average monthly exchange rate for the reporting period. Resultant translation adjustments are recognized as other comprehensive income (loss) within stockholders’ equity. Comprehensive Loss Comprehensive loss encompasses all changes in stockholders’ equity, except those arising from investments and distributions to stockholders. The Company’s comprehensive loss includes consolidated net loss and foreign currency translation adjustments. Research and Development Costs Expenditures for research activities relating to product development and improvement are charged to expense as incurred. Income Taxes Deferred tax assets and liabilities are recognized for temporary differences between financial statement carrying amounts and the tax bases of assets and liabilities and are measured using the tax rates expected to be in effect when the differences reverse. Deferred tax assets are also recognized for operating loss and tax credit carry forwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The establishment of a valuation allowance requires significant judgment and is impacted by various estimates. Both positive and negative evidence, as well as the objectivity and verifiability of that evidence, is considered in determining the appropriateness of recording a valuation allowance on deferred tax assets. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company’s policy is to record interest and penalties related to uncertain tax positions as income tax expense. Stock-Based Compensation Stock-based compensation expense, related to stock options, restricted stock awards and restricted stock units, is recognized based on their grant-date fair values. The Company recognizes compensation expense, net of estimated forfeitures, on a straight-line basis over the requisite service period of the award. Estimated forfeitures are based on historical experience. Stock Warrants 45 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company evaluated the Prefunded Warrants issued in June 2022 (see Note 14, “Stockholders’ Equity) in accordance with ASC 815-40, “Contracts in Entity’s Own Equity” and determined that the warrants meet the criteria to be classified within stockholders’ equity and recorded the proceeds received for the Prefunded Warrants within additional paid in capital in the consolidated balance sheets. Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and reported amounts of revenue and expenses. Actual results could differ from these estimates. Significant items subject to estimates and assumptions include the useful lives of property and equipment; long lived asset impairment assessments; stock-based compensation expense; valuation allowances for accounts receivable, inventories, and deferred tax assets; recoverability and timing of the realization of contract assets; and fair value of liability classified Contract Consideration Convertible Notes Payable and equity classified stock warrants. Recent Accounting Pronouncements Changes to U.S. GAAP are established by the FASB. We evaluate the applicability and impact of all authoritative guidance issued by the FASB. Guidance not listed below was assessed and determined to be either not applicable, clarifications of items listed below, immaterial or already adopted by the Company. New Accounting Standards Issued and Adopted as of January 1, 2022 The FASB issued ASU No. 2020-06, “ Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. ” This standard changes the accounting for convertible instruments by reducing the number of accounting models, amends the requirements for a conversion option to be classified in equity and amends diluted earnings per share calculations for certain convertible debt instruments. The pronouncement is effective for smaller reporting companies for fiscal years beginning after December 15, 2023, with earl y adoption allowed for fiscal years beginning after December 15, 2020. The Company adopted this standard as of January 1, 2022, and the adoption did not have a material impact on the Company’s consolidated financial statements and related disclosures. The FASB issued ASU No. 2021-10, “Government Assistance (Topic 832), Disclosures by Business Entities about Government Assistance.” This standard provides guidance on disclosures for transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy. The pronouncement is effective for fiscal years beginning after December 15, 2021.The Company adopted this standard as of January 1, 2022 and the adoption did not have a material impact on the Company’s consolidated financial statements and related disclosures. New Accounting Standards Issued But Not Adopted as of December 31, 2022 The FASB issued ASU No. 2016-13, “ Measurement of Credit Losses on Financial Instruments .” This standard replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects estimates of expected credit losses over their contractual life that are recorded at inception based on historical information, current conditions, and reasonable and supportable forecasts. The pronouncement is effective for smaller reporting companies for fiscal years beginning after December 15, 2022. The Company regularly evaluates its accounts receivable to estimate amounts that will not be collected and records the appropriate allowance for doubtful accounts as a charge to operating expenses therefore the Company does not expect the adoption of this standard to have a material impact on the consolidated financial statements and related disclosures. Note 3 — Revenue from Contracts with Customers Disaggregation of Revenue The Company differentiates revenue based on whether the source of revenue is attributable to product sales or service revenue. 46 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Total revenue disaggregated by revenue source is as follows (in thousands): Years ended December 31, 2022 2021 Revenue: Products (1) $ 132,521 $ 40,265 Services 3,571 3,003 $ 136,092 $ 43,268 (1) Product revenues include sales to related parties as described in Note 18, “Related Party Transactions.” Disaggregation of Cost of Sales The Company differentiates cost of sales based on whether the cost is attributable to tangible goods sold, cost of services sold or other costs which cannot be directly attributable to either tangible goods or services. Total cost of sales disaggregated is as follows (in thousands): Years ended December 31, 2022 2021 Cost of sales: Tangible goods sold $ 126,914 $ 24,083 Services 285 532 Other $ 15,593 $ 15,397 $ 142,792 $ 40,012 Other cost of sales represent costs directly associated with the generation of revenue but which cannot be attributed directly to tangible goods sold or services. Examples of other costs of sales are certain personnel costs and equipment rental and insurance costs. Cost of sales for the year ended December 31, 2021 included a one time credit of $ 7.6 million (shown in Other and below in cost of sales for external customers), related to the release of accrued costs subsequent to the ADM settlement (see Note 13, “Commitments and Contingencies”). Cost of sales split between external and related party sales is as follows (in thousands): Years ended December 31, 2022 2021 Cost of sales: Cost of sales for external customers $ 56,844 $ 36,646 Cost of sales for related parties 85,948 3,366 $ 142,792 $ 40,012 Note 4 - Contract Assets Contract assets are as follows (in thousands): December 31, 2022 2021 Contract assets $ 83,060 $ — Less accumulated amortization ( 3,371 ) — Contract assets, net 79,689 — Less current contract assets ( 7,113 ) — Contract assets, long term $ 72,576 $ — 47 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In connection with entering into the ProFrac Agreement on February 2, 2022 and May 17, 2022 as discussed in Note 10, “Debt and Convertible Notes Payable” and Note 18, “Related Party Transactions”, the Company recognized contract assets of $ 10.0 million and $ 69.5 million, respectively, and associated fees of $ 3.6 million. As of December 31, 2022, $ 72.6 million of the contract assets are classified as long term based upon our estimate of the forecasted revenues from the ProFrac Agreement which will not be realized within the next twelve months of the ProFrac Agreement. During the year ended December 31, 2022 the Company recognized $ 3.4 million of contract assets amortization which is recorded as a reduction of the transaction price included in the related party revenue in the consolidated statement of operations. The below table reflects our estimated amortization per year (in thousands) based on the Company’s current forecasted revenues from the ProFrac Agreement. Years ending December 31, Amortization 2023 $ 7,113 2024 8,456 2025 8,845 2026 8,845 2027 8,845 Thereafter through May 2032 37,585 Total contract assets $ 79,689 Note 5 — Inventories Inventories are as follows (in thousands): December 31, 2022 2021 Raw materials $ 5,800 $ 5,610 Finished goods 18,130 13,985 Inventories 23,930 19,595 Less reserve for excess and obsolete inventory ( 8,210 ) ( 10,141 ) Inventories, net $ 15,720 $ 9,454 Changes in the reserve for excess and obsolete inventory are as follows (in thousands): Years ended December 31, 2022 2021 Balance, beginning of year $ 10,141 $ 11,058 Charged to provisions 1,734 623 Deductions for sales and disposals ( 3,665 ) ( 1,540 ) Balance, end of the year $ 8,210 $ 10,141 The provisions recorded in the year ended December 31, 2022 w ere $ 1.6 million for the CT segment an d $ 0.1 million for the DA segment. The CT segment provision includes $ 1.0 million for the exit of the hand sanitizers business line. The provisions recorded in the year ended December 31, 2021 wer e $ 0.6 million for the CT segment and nil for the DA segment. 48 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 — Property and Equipment Property and equipment are as follows (in thousands): December 31, 2022 2021 Land $ 886 $ 886 Land improvements 520 520 Buildings and leasehold improvements 5,356 5,473 Machinery and equipment 6,758 6,843 Furniture and fixtures 532 620 Transportation equipment 784 878 Computer equipment and software 1,425 1,176 Property and equipment 16,261 16,396 Less accumulated depreciation ( 11,435 ) ( 11,100 ) Property and equipment, net $ 4,826 $ 5,296 Depreciation expense totaled $ 0.7 million and $ 1.0 million for the years ended December 31, 2022 and 2021, respectively. During 2022, the Company sold its two facilities that were classified as held for sale as of December 31, 2021 for proceeds of $ 5.8 million resulting in a net gain of $ 2.9 million. Note 7 — Leases Rental income recognized from leasing manufacturing facilities was $ 375 thousand and $ 197 thousand for the years ended December 31, 2022 and December 31, 2021, respectively, and is included in other income in the consolidated statement of operations. As discussed in Note 6, “Property and Equipment” these facilities were sold in 2022 and the lease agreements between the tenants and the Company terminated. The components of lease expense and supplemental cash flow information are as follows (in thousands): Years ended December 31, 2022 2021 Operating lease expense $ 2,393 $ 797 Finance lease expense: Amortization of assets 15 15 Interest on lease liabilities 12 12 Total finance lease expense 27 27 Short-term lease expense 341 267 Total lease expense $ 2,761 $ 1,091 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 2,934 $ 1,107 Operating cash flows from finance leases 39 62 Financing cash flows from finance leases 6 8 49 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Maturities of lease liabilities as of December 31, 2022 are as follows (in thousands): Years ending December 31, Operating Leases Finance Leases 2023 $ 4,159 $ 39 2024 2,676 20 2025 1,391 — 2026 1,418 — 2027 1,339 — Thereafter 3,444 — Total lease payments $ 14,427 $ 59 Less: Interest ( 3,055 ) ( 4 ) Present value of lease liabilities $ 11,372 $ 55 Supplemental balance sheet information related to leases is as follows (in thousands): December 31, 2022 December 31, 2021 Operating Leases Operating lease right-of-use assets $ 5,900 $ 2,041 Current portion of operating lease liabilities $ 3,328 $ 602 Long-term operating lease liabilities 8,044 7,779 Total operating lease liabilities $ 11,372 $ 8,381 Finance Leases Property and equipment $ 147 $ 147 Accumulated depreciation ( 55 ) ( 33 ) Property and equipment, net $ 92 $ 114 Current portion of finance lease liabilities $ 36 $ 41 Long-term finance lease liabilities 19 53 Total finance lease liabilities $ 55 $ 94 Weighted Average Remaining Lease Term Operating leases 5.3 years 9.1 years Finance leases 1.6 years 2.9 years Weighted Average Discount Rate Operating leases 9.3 % 8.9 % Finance leases 8.9 % 8.9 % Note 8 - Goodwill Based upon the results of our annual quantitative impairment test for the year ended December 31, 2021, the Company concluded that the carrying value of the DA reporting unit exceeded its estimated fair value as of the testing date, which resulted in goodwill impairment charges of $ 8.1 million and reduced the goodwill balance to $ 0 as of December 31, 2021. The goodwill impairment was calculated as the amount that the carrying value of the DA reporting unit, including any goodwill, exceeded its fair value. 50 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 — Accrued Liabilities Current accrued liabilities are as follows (in thousands): December 31, 2022 2021 Severance costs (see Note 13, “Commitments and Contingencies”) $ 2,617 $ 2,581 Loss on purchase commitments (Note 13, “Commitments and Contingencies”) — 1,750 Payroll and benefits 684 1,054 Legal costs 447 1,013 Contingent liability for earn-out provision 583 608 Deferred revenue, current 655 528 Taxes other than income taxes 1,884 241 Other 2,114 1,221 Total current accrued liabilities $ 8,984 $ 8,996 Note 10 — Debt and Convertible Notes Payable Long Term Debt Paycheck Protection Program Loans In April 2020, the Company received a $ 4.8 million loan (the “Flotek PPP loan”) under the Paycheck Protection Program (“PPP”), which was created through the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and is administered by the U.S. Small Business Administration (“SBA”). In October 2021, the Flotek PPP loan maturity date was extended from April 15, 2022 to April 15, 2025. On January 5, 2023 the Company received notice from the SBA that $ 4.4 million of the $ 4.8 million principal amount and accrued interest to this date of $ 0.1 million, was forgiven. The remaining principal amount of $ 0.4 million and accrued interest, will be repaid over the remaining term of the loan through April 15, 2025 beginning on March 15, 2023. The forgiveness of the Flotek PPP loan will be accounted for as an extinguishment of the debt and will result in the Company recording a $ 4.5 million gain in the first quarter of 2023 comprising the principal amount forgiven of $ 4.4 million and accrued interest of $ 0.1 million. In connection with the acquisition of JP3 in May 2020, the Company assumed a PPP loan of $ 0.9 million obtained by JP3 (the “JP3 PPP loan”) in April 2020 prior to its acquisition by Flotek. In June 2021, the Company received notice from the SBA that the JP3 PPP loan and accrued interest were fully forgiven. Accordingly, during the year ended December 31, 2021, the Company recorded $ 0.9 million for the amount of principal and accrued interest forgiven associated with the JP3 PPP loan in other income on the consolidated statements of operations. Long-term debt, including current portion, is as follows (in thousands): December 31, 2022 2021 Flotek PPP loan $ 4,788 $ 4,788 Less current maturities ( 2,052 ) ( 1,436 ) Total long-term debt, net of current portion $ 2,736 $ 3,352 51 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Convertible Notes Payable On February 2, 2022, Flotek entered into a Private Investment in Public Equity transaction (the “PIPE transaction”) with a consortium of investors to secure growth capital for the Company. Pursuant to the PIPE Transaction, Flotek issued $ 21.2 million in aggregate initial principal amount of Convertible Notes Payable for net cash proceeds of approximately $ 20.1 million. The investors are ProFrac Holdings, LLC, Burlington Ventures Ltd., entities associated with North Sound Management, certain funds associated with one of Flotek's directors including the D3 Family Fund and the D3 Bulldog Fund, and Firestorm Capital LLC. The Convertible Notes Payable accrue paid-in-kind interest at a rate of 10 % per annum, have a maturity of one year, and are converted into common stock of Flotek or pre-funded warrants to purchase common stock of Flotek, (a) at the holder's option at any time prior to maturity, at a price of $ 1.088125 per share, (b) at Flotek's option, if the volume-weighted average trading price of Flotek's common stock equals or exceeds $ 2.50 for 20 trading days during a 30 consecutive trading day period, or (c) at maturity, at a price of $ 0.8705 . The issuance cost of $ 1.1 million is amortized on a straight line basis over the term of the Convertible Notes Payable and the amortization is included in interest expense in the consolidated statements of operations. On March 21, 2022, $ 3.0 million of the Convertible Notes Payable, plus accrued paid-in-kind interest thereon, were converted at the holder’s option into approximately 2.8 million shares of common stock resulting in a 3.0 million credit to additional paid-in-capital in stockholders’ equity. As of December 31, 2022, the remaining Convertible Notes Payable are recorded at carrying value of $ 19.8 million, including accrued paid-in-kind interest of $ 1.8 million, and net of unamortized issuance costs of $ 0.1 million. The estimated fair value of the Convertible Notes Payable at December 31, 2022 was $ 25.8 million. Interest expense for the year ended December 31, 2022 includes $ 1.8 million of accrued paid-in-kind interest and $ 1.0 million of issuance cost amortization related to these Convertible Notes Payable. Interest expense relating to the Convertible Notes Payable held by ProFrac Holdings, LLC (related party) is $ 1.0 million for the year ended December 31, 2022. Initial ProFrac Agreement Contract Consideration Convertible Notes Payable On February 2, 2022, the Company entered into a long-term supply agreement with ProFrac Services, LLC (the “Initial ProFrac Agreement”), a subsidiary of ProFrac Holdings LLC, in exchange for $ 10 million in aggregate principal amount of Contract Consideration Convertible Notes Payable (“Initial ProFrac Agreement Contract Consideration Convertible Notes Payable”), under the same terms as the Convertible Notes Payable issued in the PIPE Transaction described above, including the paid-in-kind interest at a rate of 10% per annum and conversion features. The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable are accounted for as liability classified convertible instruments and were initially recorded at fair value of $ 10.0 million on the issuance date with a corresponding contract asset. The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable were remeasured to fair value of $ 14.2 million as of December 31, 2022 which includes paid-in-kind interest of $ 1.0 million. The fair value adjustment increased the carrying amount of the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable by $ 3.3 million during the year ended December 31, 2022 and is recognized in gain on fair value of contract consideration convertible notes payable, net on our consolidated statements of operations. See Note 11, “Fair Value Measurements”. Amended ProFrac Agreement Contract Consideration Convertible Notes Payable 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 (“Amended ProFrac Agreement Contract Consideration Convertible Notes Payable”) to ProFrac Holdings LLC. The Amended ProFrac Agreement Contract Consideration Convertible Notes Payable accrue paid-in-kind interest at a rate of 10 % per annum and may be converted at any time prior to the maturity date, which is one year from the date of issuance under the same conversion terms as the Convertible Notes Payable issued in the PIPE Transaction described above. 52 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Amended ProFrac Agreement Contract Consideration Convertible Notes Payable are accounted for as liability classified convertible instruments and were initially recorded at fair value of $ 69.5 million on the issuance date with a corresponding contract asset. The Amended ProFrac Agreement Contract Consideration Convertible Notes Payable were remeasured to fair value of $ 69.4 million as of December 31, 2022 which includes paid-in-kind interest of $ 3.2 million The fair value adjustment resulted in a $ 3.3 million decrease during the year ended December 31, 2022 and is recognized in gain on fair value of contract consideration convertible notes payable, net on our consolidated statement of operations. See Note 11, “Fair Value Measurements”. Note 11 — Fair Value Measurements Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company categorizes financial assets and liabilities into the three levels of the fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value and bases categorization within the hierarchy on the lowest level of input that is available and significant to the fair value measurement. • Level 1 — Quoted prices in active markets for identical assets or liabilities; • Level 2 — Observable inputs other than Level 1, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and • Level 3 — Significant unobservable inputs that are supported by little or no market activity or that are based on the reporting entity’s assumptions about the inputs. Fair Value of Other Financial Instruments The carrying amounts of certain financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accrued liabilities and accounts payable approximate fair value due to the short-term nature of these accounts. Liabilities Measured at Fair Value on a Recurring Basis The following table presents the Company’s liabilities that are measured at fair value on a recurring basis and the level within the fair value hierarchy (in thousands): December 31, December 31, Level 1 Level 2 Level 3 2022 Level 1 Level 2 Level 3 2021 Contingent earnout consideration $ — $ — $ 583 $ 583 $ — $ — $ 608 $ 608 Initial ProFrac Agreement contract consideration convertible notes — — 14,220 14,220 — — — — Amended ProFrac Agreement contract consideration convertible notes — — 69,350 69,350 — — — — Total $ — $ — $ 84,153 $ 84,153 $ — $ — $ 608 $ 608 Contingent Earnout Consideration Key Inputs The estimated fair value of the remaining stock performance earn-out provision, with respect to the JP3 transaction, is included in accrued liabilities as of December 31, 2022 and 2021. The estimated fair value of the earn-out provision at the end of each period was valued using a Monte Carlo model analyzing 20,000 simulations performed using Geometric Brownian Motion with inputs such as risk-neutral expected growth and volatility. 53 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2022 2021 Risk-free interest rate 4.34 % 1.02 % Expected volatility 100.0 % 90.0 % Term until liquidation (years) 2.38 3.38 Stock price $ 1.12 $ 1.13 Discount rate 9.95 % 6.71 % Initial ProFrac Agreement Contract Consideration Notes Payable Key Inputs The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable were measured at fair value at issuance and on a recurring basis. The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable had an initial fair value of $ 10.0 million on February 2, 2022. The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable were classified as Level 2 at the initial measurement upon issuance due to the use of a quoted price for a similar liability at that date (the PIPE transaction), and subsequently classified as Level 3 due to the use of unobservable inputs. The estimated value of the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable as of December 31, 2022 was valued using a Monte Carlo simulation. The key inputs into the Monte Carlo simulation used to estimate the fair value of the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable maturing February 2, 2023, as of December 31, 2022 were as follows: December 31, 2022 Risk-free interest rate 4.12 % Expected volatility 100.0 % Term until liquidation (years) 0.09 Stock price $ 1.12 Discount rate 4.12 % Amended ProFrac Agreement Contract Consideration Convertible Notes Payable Key Inputs On May 17, 2022, the Company measured the Amended ProFrac Agreement Contract Consideration Convertible Notes Payable classified as Level 3 using a Monte Carlo simulation at an estimated fair value of $ 69.5 million. The Company reduced the discount rate assumed due to the reduced likelihood of occurrence of any of the default events in the shorter term remaining on the notes. The estimated value of the Amended ProFrac Agreement Contract Consideration Convertible Notes Payable as at December 31, 2022 was valued using a Monte Carlo simulation. The key inputs into the Monte Carlo simulation used to estimate the fair value of the Amended ProFrac Agreement Contract Consideration Convertible Notes Payable, on the issuance date of May 17, 2022, and as of December 31, 2022 were as follows: May 17, 2022 December 31, 2022 Risk-free interest rate 2.16 % 4.59 % Expected volatility 90.0 % 100.0 % Term until liquidation (years) 1.00 0.38 Stock price $ 1.29 $ 1.12 Discount rate 8.40 % 4.59 % 54 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets Measured at Fair Value on a Nonrecurring Basis The Company’s non-financial assets, including property and equipment and operating lease ROU assets, are measured at fair value on a non-recurring basis and are subject to adjustment to their fair value in certain circumstances. Impairment of goodwill of $ 8.1 million was recorded during the year ended December 31, 2021. See Note 8, “Goodwill”. Level 3 Rollforward for Assets and Liabilities Measured at Fair Value on a Recurring Basis The following table presents the changes in balances of liabilities for the years ended December 31, 2022 and 2021 classified as Level 3 balances (in thousands): Years ended December 31, 2022 2021 Balance - beginning of period $ 608 $ 1,416 Transfer of Initial ProFrac Agreement contract consideration convertible notes payable from Level 2 10,000 — Issuance of Amended ProFrac Agreement contract consideration convertible notes payable 69,460 — Increase in principle of Initial ProFrac Agreement contract consideration convertible notes payable for paid-in-kind interest 954 — Increase in principle of Amended ProFrac Agreement contract consideration convertible notes payable for paid-in-kind interest 3,231 — Change in fair value of contingent earnout consideration ( 25 ) ( 808 ) Change in fair value of Initial ProFrac Agreement contract consideration convertible notes payable 3,266 — Change in fair value of Amended ProFrac Agreement contract consideration convertible notes payable ( 3,341 ) — Balance - end of period $ 84,153 $ 608 Note 12 — Income Taxes Components of the income tax benefit are as follows (in thousands): Years ended December 31, 2022 2021 Current: Federal $ 101 $ — State 2 16 Foreign — — Total current expense 103 16 Deferred: Federal — — State ( 125 ) ( 56 ) Foreign — — Total deferred benefit ( 125 ) ( 56 ) Income tax benefit $ ( 22 ) $ ( 40 ) The components of loss before income taxes are as follows (in thousands): Years ended December 31, 2022 2021 United States $ ( 42,242 ) $ ( 30,037 ) Foreign ( 85 ) ( 529 ) Loss before income taxes $ ( 42,327 ) $ ( 30,566 ) 55 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The income tax benefit differed from the amounts computed by applying the U.S. federal income tax rate of 21% respectively, to loss before income tax for the reasons set forth below: Years ended December 31, 2022 2021 U.S. federal statutory tax rate 21.0 % 21.0 % State income taxes, net of federal benefit 0.2 0.1 Non-U.S. income taxed at different rates ( 0.1 ) 0.5 Increase in tax benefit related to stock-based awards ( 0.4 ) 0.1 Increase in valuation allowance ( 21.8 ) ( 24.9 ) Permanent differences related to CARES Act — 2.6 Other 1.2 0.7 Effective income tax rate 0.1 % 0.1 % Deferred income taxes reflect the tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the value reported for income tax purposes, at the enacted tax rates expected to be in effect when the differences reverse. The movement in the temporary differences for the year ended December 31, 2022 does not affect the estimated annual effective tax rate as it is offset by a corresponding change in the valuation allowance. The component of deferred tax assets and liabilities are as follows (in thousands): December 31, 2022 2021 Deferred tax assets: Net operating loss carryforwards $ 41,453 $ 33,166 Intangible assets 4,066 2,916 Tax credit carryforwards 4,011 4,001 Goodwill 4,920 5,284 Property and equipment 3,644 3,229 Lease liability 2,634 1,750 Inventory valuation reserves 2,033 2,675 Allowance for doubtful accounts 1,180 1,184 Accrued liabilities 320 569 Accrued compensation 491 401 Equity compensation 536 399 Interest limitation 1,616 13 Other 230 291 Total gross deferred tax assets 67,134 55,878 Valuation allowance ( 64,960 ) ( 54,875 ) Total deferred tax assets, net 2,174 1,003 Deferred tax liabilities: ROU asset ( 1,377 ) ( 453 ) Prepaid insurance and other ( 393 ) ( 271 ) Total gross deferred tax liabilities ( 1,770 ) ( 724 ) Net deferred tax assets $ 404 $ 279 As of December 31, 2022, the Company had U.S. net operating loss carryforwards of $ 176 million, including $ 46.4 million expiring in various amounts from 2029 through 2037 which can offset 100 % of taxable income and $ 129.6 million that has an indefinite carryforward period which can offset 80 % of taxable income per year. The ability to utilize net operating losses and other tax attributes could be subject to a significant limitation if the Company were to undergo a change in control as defined for purposes of Section 382 of the Internal Revenue Code of 1986, as amended. The Company performed a study in which it determined that no ownership change has occurred as of December 31, 2022. However, the Company anticipates that a change in control will occur in the near term when certain convertible notes are converted during the year ended 2023. Although the 56 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS change in control will significantly limit the ability of the Company to utilize the pre-change net operating losses and credits, the Company does not expect a significant impact to their financial statements given the valuation allowance that is recorded to estimate the realizability of the deferred tax assets. The Company’s cumulative recent losses (before permanent items) of $ 215.5 million in the recent thirty-six months are negative evidence that it will not likely generate sufficient future income to utilize its deferred tax assets. Therefore, the Company believes that it is not more likely than not that it will realize its deferred tax assets in all taxing jurisdictions with the exception of a portion of Louisiana and Texas. Therefore, the Company recorded a valuation allowance for the years ended December 31, 2022 and December 31, 2021 to reflect the estimated amount of deferred tax asset realizability. The Company intends to reinvest the unremitted earnings of its non-U.S. subsidiaries. As of December 31, 2022 and 2021, the Company had approximately $ 7.4 million and $ 8.5 million, respectively, in unremitted earnings from its foreign jurisdictions. As a result of the 2017 Tax Act these earnings have been previously taxed in the U.S. although they have not been repatriated. However, certain withholding taxes may need to be paid upon repatriation depending on the US treaty with the applicable country. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. The Company has performed an analysis of its tax positions for the year ended December 31, 2022, concluding all tax positions taken were highly certain. Note 13 — Commitments and Contingencies Litigation The Company is subject to routine litigation and other claims that arise in the normal course of business. Except as disclosed below, management is not aware of any pending or threatened lawsuits or proceedings that are expected to have a material effect on the Company’s financial position, results of operations or liquidity. Former CEO (J Chisholm) Matter During the year ended December 31, 2021, Flotek commenced an internal investigation into the activities of John Chisholm (a previous CEO of Flotek) due to irregularities in expenses and transactions during the years from 2014 to 2018. The investigation revealed evidence of related party transactions/self-dealing, inappropriate personal expenses, and general corporate waste. Flotek’s Board engaged a third party to review the findings of the investigation. After the third-party review, Flotek concluded that its current and historical financial statements can be relied upon, that proper action had been taken, and that no members of current management were implicated in any way. Beginning in December 2021, Flotek sent demand letters to, and subsequently filed arbitration and other legal proceedings against, John Chisholm, Casey Doherty/Doherty & Doherty LLP (Flotek’s former outside general counsel) and Moss Adams LLP (Flotek’s former independent public audit firm) to recover damages. John Chisholm subsequently filed a counterclaim against Flotek in the arbitration proceeding for his remaining severance (currently accrued by the Company, but payment for which was suspended). Although Flotek believes its claims are supported by the available evidence, the timing and amount of any outcome cannot reasonably be predicted. Terpene Supply Agreement On October 29, 2021, the Company reached agreement (“the ADM Settlement) with Archer-Daniels-Midland Company (“ADM”), Florida Chemical Company (“FCC”) and other parties to pay $ 1.75 million and resolve all claims between the parties in relation to lawsuit claiming damages relating to the terpene supply agreement between Flotek Chemistry, LCC (“Flotek Chemistry”), a wholly owned subsidiary of the Company and FCC. The one-time payment of $ 1.75 million from Flotek to ADM was paid on January 3, 2022 and was included as restricted cash on the consolidated balance sheet as of December 31, 2021. A credit of $ 7.6 million was recorded in cost of sales in the consolidated statements operations for the year ended December 31, 2021 relating to the release of excess costs accrued for this matter. Other Commitments and Contingencies The Company is subject to concentrations of credit risk within trade accounts receivable, and related party accounts receivable, as the Company does not generally require collateral as support for trade receivables. In addition, the majority of the Company’s cash is invested in three major U.S. financial institutions and balances often exceed insurable amounts. 57 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14 — Stockholders’ Equity On March 21, 2022, Convertible Notes Payable pursuant to the PIPE Transaction discussed in Note 10, “Debt and Convertible Notes Payable”, which had been purchased by certain funds associated with one of the Company’s directors including the D3 Family Fund and the D3 Bulldog Fund, which aggregated $ 3.0 million plus $ 39 thousand of accrued interest, were converted into 2,793,030 shares of the Company’s common stock. On June 21, 2022, ProFrac Holdings II, LLC paid $ 19.5 million for PreFunded Warrants of the Company. The PreFunded Warrants were recorded in equity at their fair value of $ 11.1 million, estimated using a Black-Scholes Option Pricing model, le ss $ 1.2 million of transaction costs paid. The remaining cash received of $ 8.4 million was recognized as an equity contribution. Th e Prefunded Warrants permit ProFrac Holdings II, LLC to purchase 13,104,839 shares of common stock of the Company at an exercise price equal to $ 0.0001 per share, representing a 20 % premium to the 30-day volume average price of the Company’s common stock at the close of business on the day prior to the date of the issuance of the Prefunded Warrants. The Prefunded Warrants, net of transaction fees of $ 1.1 million, and the equity contribution of $ 8.4 million from ProFrac Holdings, II, LLC are included in additional paid-in capital as of December 31, 2022. The key inputs into the Black-Scholes Option Pricing Model used to estimate the fair value of the Pre-Funded Warrants as of the issuance on June 21, 2022 were as follows: Risk-free interest rate 3.21 % Expected volatility 90.0 % Term until liquidation (years) 2.00 Stock price $ 1.11 Strike price (exercise fee) $ 4.5 million ProFrac Holdings II, LLC and its affiliates may not receive any voting or consent rights in respect of the Prefunded Warrants or the underlying shares unless and until (i) the Company has obtained approval from a majority of its shareholders excluding ProFrac Holdings II, LLC and its affiliates and (ii) ProFrac Holdings II, LLC has paid an additional $ 4.5 million to the Company. The additional $ 4.5 million will be accounted for as an equity contribution if received. During the first quarter of 2021, the Company identified 613,000 shares that were improperly included in the December 31, 2020 issued share count, and the Company adjusted the issued share count presented on the statement of stockholders’ equity. This adjustment was not material to the December 31, 2020 consolidated financial statements or basic and diluted earnings per share. Treasury Stock The Company accounts for treasury stock using the cost method and includes treasury stock as a component of stockholders’ equity. During the years ended December 31, 2022 and 2021, the Company withheld 114,797 shares and 155,317 shares, respectively, of the Company’s common stock at market value as payment of income tax withholding owed by employees upon the vesting of restricted shares and the exercise of stock options. Shares issued as restricted stock awards to employees under the 2018 long-term incentive plan that were forfeited were 39,547 and 135,092 during the years ended December 31, 2022 and 2021, respectively, are accounted for as treasury stock. During the years ended December 31, 2022 and 2021, forfeited stock awards returned to treasury stock were 30,055 shares and 421,389 shares, respectively. Note 15 — Stock-Based Compensation and Other Benefit Plans Stock-Based Incentive Plans Stockholders approved long-term incentive plans in 2020, 2019 and 2018 (the “2020 Plan”, the “2019 Plan,” and the “2018 Plan,”, respectively) under which the Company may grant equity awards to officers, key employees, non-employee directors and service providers in the form of stock options, restricted stock, restricted stock units, and certain other incentive awards. The maximum number of shares that may be issued under the 2020 Plan, 2019 Plan and 2018 Plan are 3 million, 1.0 million, and 8.5 million, respectively. At December 31, 2022 and 2021, the Company had a total o f 2.8 million and 4.2 million shares remaining, respectively, to be granted under the 2020 Plan, 2019 Plan and 2018 Plan. 58 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock Options All stock options are granted with an exercise price equal to the market value of the Company’s common stock on the date of grant. During the year ended December 31, 2022 no market-based stock options were granted compared to 1.4 million during the year ended December 31, 2021. The market-based options are restricted until criteria defined in the agreements are met. Proceeds received from stock option exercises are credited to common stock and additional paid-in capital, as appropriate. The Company uses historical data to estimate pre-vesting option forfeitures. Estimates are adjusted when actual forfeitures differ from the estimate. Stock-based compensation expense is recorded for all equity awards expected to vest. During the years ended December 31, 2022 and 2021, 0.5 million and 0.2 million stock options vested, respectively. During the year ended December 31, 2022, no stock options were forfeited compared to 0.8 million for the year ended December 31, 2021. The total fair value of the stock options that vested was $ 0.3 million and $ 0.2 million for the years ended December 31, 2022 and 2021, respectively. Stock option activity for the years ended December 31, 2022 and 2021, are as follows: Shares Weighted-Average Exercise Price Weighted-Average Fair Value Outstanding as of December 31, 2020 3,660,000 Granted 1,448,959 $ 1.07 $ 0.88 Forfeited ( 777,084 ) 1.02 0.52 Expired ( 50,000 ) 0.52 0.52 Outstanding as of December 31, 2021 4,281,875 Expired ( 120,000 ) $ 0.72 $ 0.10 Outstanding as of December 31, 2022 4,161,875 Vested or expected to vest at December 31, 2022 3,889,147 . The below table shows the aggregate intrinsic value and weighted average remaining contractual term of share options outstanding, currently exercisable and vested or expected to vest. Share Options Outstanding Share Options Currently Exercisable Share Options Vested or Expected to Vest Number 4,161,875 840,000 3,889,147 Weighted-average exercise price $ 1.19 $ 1.28 $ 1.19 Aggregate intrinsic value ($000’s) 121 24 114 Weighted-average remaining contractual term in years 3.41 2.15 3.43 The following table sets forth significant assumptions used in the Monte Carlo model for market-based options to determine the fair value of the option s at the date of grant for the year ended December 31, 2021. There were no options granted during the year ended December 31, 2022. Year Ended December 31, 2021 Risk-free interest rate 1.61 % Expected volatility of common stock 90.00 % Expected life of options in years 10 Dividend yield — % 59 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2022 and 2021, the unrecognized compensation cost related to stock options was $ 2.1 million and $ 3.3 million, respectively. Upon the departure of the Company’s Chief Executive Officer and President effective January 19, 2023, 3,000,000 of the outstanding stock options were forfeited (see Note 20, “Subsequent Events”). The unrecognized compensation expense related to these forfeited options was $ 1.8 million. Restricted Stock The Company grants employees and directors either time-vesting or market-based restricted shares in accordance with terms specified in the Restricted Stock Agreements. During the years ended December 31, 2022 and 2021, all of the restricted stock granted were time-vesting restricted shares. Grantees of restricted shares retain voting rights for the granted shares. • Time-vesting restricted shares vest after a stipulated period has elapsed after the date of grant, generally three years . Certain time-vested shares have also been issued with a portion of the shares granted vesting immediately. • Market-based restricted shares are issued with criteria defined over a designated period and vest only when, and if, the outlined criteria are met. Restricted stock share activity for the years ended December 31, 2022 and 2021, are as follows: Restricted Stock Shares Shares Weighted- Average Fair Value at Date of Grant Non-vested at December 31, 2020 2,795,100 $ 1.00 Granted 1,702,289 1.73 Vested ( 1,453,854 ) 1.24 Forfeited ( 1,275,172 ) 1.36 Non-vested at December 31, 2021 1,768,363 1.61 Granted 1,532,926 1.32 Vested ( 967,684 ) 1.77 Forfeited ( 33,926 ) 1.69 Non-vested at December 31, 2022 2,299,679 $ 1.37 The total fair value of restricted stock that vested during the years ended December 31, 2022 and 2021 was $ 1.3 million and $ 2.5 million, respectively. At December 31, 2022 and 2021, unrecognized compensation expense related to non-vested restricted stock was $ 2.0 million and $ 1.9 million, respectively. The unrecognized compensation expense is expected to be recognized over a weighted-average period of 1.7 years. Restricted Stock Units No RSU’s were granted during the years ended December 31, 2022 and 2021. Restricted stock units activity for the years ended December 31, 2022 and 2021, are as follows: Restricted Stock Units Units Weighted- Average Fair Value at Date of Grant RSUs at December 31, 2020 1,141,144 $ 2.30 Vested ( 186,901 ) — Forfeited ( 184,173 ) 2.61 RSUs at December 31, 2021 770,070 1.91 Vested ( 500,868 ) 1.90 Forfeited $ ( 41,202 ) 1.92 RSUs at December 31, 2022 228,000 $ 1.93 60 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2022 and 2021, unrecognized compensation expense related to restricted stock units was $ 0.4 million and $ 1.0 million. Upon the departure of the Company’s Chief Executive Officer and President effective January 19, 2023, all the unvested restricted stock units outstanding as of December 31, 2022 were forfeited (see Note 20, “Subsequent Events”). Employee Stoc k Purchase Plan The Company’s Employee Stock Purchase Plan (“ESPP”) was approved by stockholders in 2012. The Company registered 500,000 shares of its common stock, currently held as treasury shares, for issuance under the ESPP. The purpose of the ESPP is to provide employees with an opportunity to purchase shares of the Company’s common stock through accumulated payroll deductions. The ESPP allows participants to purchase common stock at a purchase price equal to 85 % of the fair market value of the common stock on the last business day of a three-month offering period which coincides with calendar quarters. Payroll deductions may not exceed 10 % of an employee’s compensation and participants may not purchase more than 1,000 shares in any one offering period. In addition, for each calendar year, an employee may not be granted purchase rights valued over $ 25,000 , as determined at the time such purchase right is granted. The fair v alue of the discount associated with shares purchased under the plan is recognized as stock-based compensation expense and wa s $ 10.2 thousand and $ 23.6 thousand for the years ended December 31, 2022 and 2021, respectively. The total fair value of the shares purchased under the plan during each of the years ended December 31, 2022 and 2021 was $ 0.1 million and $ 0.2 million , respectively . The employee payment associated with participation in the plan occurs through payroll deductions. Stock-Based Compensation Expense Non-cash stock-based compensation expense related to stock options, restricted stock, restricted stock unit grants and stock purchased under the Company’s ESPP was $ 3.3 million and $ 3.8 million during the years ended December 31, 2022 and 2021, respectively. 401(k) Retirement Plan The Company maintains a 401(k) retirement plan for the benefit of eligible employees in the U.S. All employees are eligible to participate in the plan upon employment. The Company currently matches contributions at 100 % of up to 2 % of an employee’s compensation . During the years ended December 31, 2022 and 2021, compensation expense included $ 0.3 million and $ 0.2 million, respectively, related to the Company’s 401(k) match. Note 16 — Loss Per Share Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted loss per common share is calculated by dividing the adjusted net loss by the weighted average number of common shares outstanding combined with dilutive common share equivalents outstanding, if the effect is dilutive. Potentially dilutive common share equivalents consist of incremental shares of common stock issuable upon conversion of convertible notes payable, exercise of stock warrants and vesting and settlement of stock awards. The dilutive effect of non-vested stock issued under share‑based compensation plans, shares issuable under the Employee Stock Purchase Plan (ESPP), employee stock options outstanding, and the prefunded stock warrants are computed using the treasury stock method. The dilutive effect of the Convertible Notes is computed using the if converted method in accordance with ASU 2020-06, which was adopted by the Company on January 1, 2022 (see Note 2, “Summary of Significant Accounting Policies”). The calculation of the basic and diluted loss per share for the years ended December 31, 2022 and 2021 is as follows (in thousands): 61 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year ended December 31, 2022 2021 Numerator: Net loss for basic earnings per share $ ( 42,305 ) $ ( 30,526 ) Anti-dilutive adjustment to net income available to shareholders excluded from numerator for diluted earnings computation Paid-in-Kind interest expense on convertible notes payable and contract consideration convertible notes payable, net of tax 5,956 — Valuation gain on convertible notes carried at fair value, net of tax ( 75 ) — Total numerator adjustment excluded from diluted earnings computation $ 5,881 $ — Denominator: Basic and diluted weighted average shares outstanding 74,425 73,361 Anti-dilutive incremental shares excluded from denominator for diluted earnings computation Average number of diluted shares for convertible notes payable and contract consideration convertible notes payable 54,649 — Average number of diluted shares for stock warrants 4,814 — Average number of diluted shares for stock options and restricted stock 598 906 Basic and diluted loss per share $ ( 0.57 ) $ ( 0.42 ) For the year ended December 31, 2022 paid-in-kind interest expense, net of tax, on Convertible Notes Payable and the change in fair value related to the Contract Consideration Convertible Notes Payable, net of tax, were not included in the dilution calculation since including them would have an anti-dilutive effect on the loss per share due to the net loss incurred during the periods. For the year ended December 31, 2022 weighted average shares for convertible notes payable, weighted average shares for stock warrants and weighted average shares for employee stock awards were not included in the dilution calculation since including them would have an anti-dilutive effect on the loss per share due to the net loss incurred during the period. For the year ended December 31, 2021, potentially dilutive securities were excluded from the calculation of diluted loss per share, since including them would have an anti-dilutive effect on loss per share due to the net loss incurred during the year. Note 17 — Supplemental Cash Flow Information Supplemental cash flow information is as follows (in thousands): Years ended December 31, 2022 2021 Supplemental cash payment information: Interest paid $ 45 $ 26 Income taxes received — ( 351 ) Supplemental non-cash financing and investing activities: Issuance of convertible notes payable as consideration for ProFrac Agreement $ 79,460 $ — Conversion of convertible notes payable to common stock 3,038 $ — . 62 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18 — Related Party Transaction On February 2, 2022, the Company entered into 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 (see Note 10, “Debt and Convertible Notes Payable”). Under the Initial ProFrac Agreement, ProFrac Services, LLC is 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. 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 (see Note 10, “Debt and 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. During the years ended December 31, 2022 and 2021, the Company’s revenues from ProFrac Services LLC were $ 80.4 million and zero , respectively. For the year ended December 31, 2022, these revenues were net of amortization of contract assets of $ 3.4 million . Cost of sales attributable to these revenues were $ 84.5 million and nil , respectively, for the years ended December 31, 2022 and 2021. As of December 31, 2022 and 2021 our accounts receivable from ProFrac Services, LLC was $ 22.7 million and zero , respectively which is recorded in accounts receivable, related party on the consolidated balance sheet. Also during 2022, we entered into the following related party transactions with ProFrac Holdings, LLC and ProFrac Holdings II, LLC: • PIPE Transaction (see Note 10, “Debt and Convertible Notes Payable”) • PreFunded Warrants (see Note 14, “Stockholders’ Equity) On March 21, 2022, the Convertible Notes Payable which had been purchased by certain funds associated with one of the Company’s directors including the D3 Family Fund and the D3 Bulldog Fund, which aggregated $ 3.0 million plus $ 39 thousand of accrued interest and amortization of issuance costs of $ 90 thousand, were converted into 2,793,030 shares of the Company’s common stock. Mr. Ted D. Brown was a Director of the Company beginning in November of 2013 and is the President and CEO of Confluence Resources LP (“Confluence”), a private oil and gas exploration and production company. As of April 15, 2022 Mr. Brown stepped down from being a Director of the Company and Confluence is no longer be considered a related party as of April 15, 2022. The Company’s revenues and related cost of sales for product sales to Confluence were $ 1.4 million and $ 1.4 million, respectively, through April 15, 2022. The accounts receivable balance from Confluence as at December 31, 2021 was $ 1.3 million. The Company’s revenues and related cost of sales from chemical sales to Confluence for the year ended December 31, 2021 were $ 3.6 million and $ 3.4 million, respectively. Note 19 — Business Segment, Geographic and Major Customer and Supplier Information Segment Information Operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision-maker in deciding how to allocate resources and assess performance. The operations of the Company are categorized into the following reportable segments: Chemistry Technologies. The CT segment includes green specialty chemistries, logistics and technology services, which enable its customers to pursue improved efficiencies and performance throughout the life cycle of their wells, helping customers improve their ESG and operational goals. Customers of the CT segment include major integrated oil and gas companies, oilfield services companies, independent oil and gas companies, national and state-owned oil companies, and international supply chain management companies . 63 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Data Analytics. The DA segment includes the design, development, production, sale and support of equipment and services that create and provide valuable information on the composition and properties of energy customers’ hydrocarbon fluids. The company markets products and services that support in-line data analysis of hydrocarbon components and properties. Customers of the DA segment span across the entire oil and gas market, from upstream production to midstream facilities to refineries and distribution networks. Performance is based upon a variety of criteria. The primary financial measure is segment operating income (loss). Various functions, including certain sales and marketing activities and general and administrative activities, are provided centrally by the corporate office. Costs associated with corporate office functions, other corporate income and expense items, and income taxes are not allocated to the reportable segment. Summarized financial information of the reportable segments is as follows (in thousands): As of and for the years ended December 31, Chemistry Technologies Data Analytics Corporate and Other Total 2022 Revenue from external customers Products $ 47,004 $ 3,903 $ — $ 50,907 Services 1,956 1,481 — 3,437 Total revenue from external customers 48,960 5,384 — 54,344 Revenue from related party Products 81,614 — — 81,614 Services 4 130 — 134 Total revenue from related parties 81,618 130 — 81,748 Gross profit (loss) ( 7,317 ) 617 — ( 6,700 ) Change in fair value of contract consideration convertible notes ( 75 ) — — ( 75 ) Loss from operations ( 14,729 ) ( 2,877 ) ( 17,815 ) ( 35,421 ) Paid-in-kind interest on contract consideration convertible notes payable 4,185 — — 4,185 Paid-in-kind interest on convertible notes payable — — 1,771 1,771 Depreciation 668 63 3 734 Additions to long-lived assets 56 134 231 421 2021 Revenue from external customers Product $ 32,984 $ 3,640 $ — $ 36,624 Service 2,304 699 — 3,003 Total revenue from external customers 35,288 4,339 — 39,627 Revenue from related party Product 3,641 — — 3,641 Service — — — — Total revenue from related parties 3,641 — — 3,641 Gross profit (loss) 5,430 ( 2,174 ) — 3,256 Loss from operations (1) ( 5,466 ) ( 12,168 ) ( 13,822 ) ( 31,456 ) Depreciation 939 70 2 1,011 Additions to long-lived assets 39 — — 39 (1) CT loss from operations includes a credit of $ 7.6 million from the release of accrued costs relating to the ADM settlement, see Note 13, “Commitments and Contingencies”. 64 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets of the Company by reportable segments are as follows (in thousands): December 31, 2022 2021 Chemistry Technologies $ 146,542 $ 34,387 Data Analytics 5,645 7,329 Corporate and Other 12,623 8,528 Total assets $ 164,810 $ 50,244 The increase in Chemistry Technologies assets is primarily due to contract asset of $ 79.7 million Geographic Information Revenue by country is based on the location where services are provided and products are sold. For the year ended December 31, 2022 no individual countries other than the U.S accounted for more than 10% of revenue. For the year ended December 31, 2021 no individual countries other than the U.S and United Arab Emirates (“UAE”) accounted for more than 10% of revenue. Revenue by geographic location is as follows (in thousands): Years ended December 31, 2022 2021 U.S. (1) $ 124,399 $ 33,187 UAE 9,257 4,512 Other countries 2,436 5,569 Total revenue $ 136,092 $ 43,268 (1) Includes revenue from related parties of $ 81,748 and $ 3,641 , respectively. Long-lived assets held in countries other than the U.S. are not considered material to the consolidated financial statements. 65 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Major Customers Revenue from major customers, as a percentage of consolidated revenue, is as follows (in thousands): Revenue % of Total Revenue Year ended December 31, 2022 Customer A (related party - ProFrac Services, LLC) $ 80,359 59.0 % Customer B 14,395 10.6 % Year ended December 31, 2021 Customer B $ 11,632 26.0 % The concentration with ProFrac Services, LLC and in the oil and gas industry increases credit, commodity and business risk . Major Suppliers Expenditure with major suppliers, as a percentage of consolidated supplier expenditure, is as follows (in thousands): Expenditure % of Total Expenditure Year ended December 31, 2022 Supplier A $ 25,057 27.7 % Supplier B 15,302 16.9 % Supplier C 15,255 16.8 % Year ended December 31, 2021 Supplier C $ 3,643 17.0 % Supplier D 4,562 21.3 % 66 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20 — Subsequent Events We have evaluated the effects of events that have occurred subsequent to December 31, 2022, and there have been no material events that would require recognition in the 2022 consolidated financial statements or disclosure in the notes to the consolidated financial statements, except as disclosed below. 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. In connection with his separation, the Company and Mr. Gibson have entered into a Separation Agreement and General Release (the “Separation Agreement”) pursuant to which Mr. Gibson will receive $ 1,500,000 payable in four installments and being fully paid by April 2023. As part of the Separation Agreement, Mr. Gibson has agreed to forfeit all of his outstanding options and unvested restricted stock units. In addition, Mr. Gibson has agreed to a 6 -month lock up period with respect to 250,000 shares of common stock owned by Mr. Gibson, which will prohibit Mr. Gibson from selling those shares during the lock up period. On February 1, 2023, the Company entered into an amendment to the ProFrac Agreement (the “Amended ProFrac Agreement No. 2”) between Flotek Chemistry and ProFrac Services, LLC dated February 2, 2022. The Amended ProFrac Agreement No. 2 has an effective date of January 1, 2023. Pursuant to the Amended ProFrac Agreement No. 2, the Parties agree (1) to a ramp-up period from January 1, 2023 to May 31, 2023 for ProFrac Services, LLC to increase the number of active fleets to 30 fleets, (2) that the potential liquidated damages payment relating to order shortfall, prior to January 1, 2023 is waived for that period, (3) to add additional fees to certain products, and (4) to provide margin increases based on revenue percentages from non-ProFrac customers. On February 2, 2023, the Convertible Notes Payable and certain Contract Consideration Convertible Notes 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. 67 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not Applicable.