FLOTEK INDUSTRIES INC/CN/ 10-Q

Item 1. Financial Statements FLOTEK INDUSTRIES INC, UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data) March 31, 2023 December 31, 2022 ASSETS Current assets: Cash and cash equivalents $ 12,433 $ 12,290 Restricted cash 101 100 Accounts receivable, net of allowance for credit losses of $ 645 and $ 623 at March 31, 2023 and December 31, 2022, respectively 15,609 19,136 Accounts receivable, related party 26,230 22,683 Inventories, net 15,904 15,720 Other current assets 4,516 4,045 Current contract assets 7,066 7,113 Total current assets 81,859 81,087 Long-term contract assets 71,372 72,576 Property and equipment, net 4,807 4,826 Operating lease right-of-use assets 4,923 5,900 Deferred tax assets, net 410 404 Other long-term assets 17 17 TOTAL ASSETS $ 163,388 $ 164,810 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 41,929 $ 33,375 Accrued liabilities 9,870 8,984 Income taxes payable 11 97 Interest payable — 130 Current portion of operating lease liabilities 3,050 3,328 Current portion of finance lease liabilities 36 36 Current portion of long-term debt 179 2,052 Convertible notes payable — 19,799 Contract Consideration Convertible Notes Payable 43,800 83,570 Total current liabilities 98,875 151,371 Deferred revenue, long-term 35 44 Long-term operating lease liabilities 7,133 8,044 Long-term finance lease liabilities 13 19 Long-term debt 194 2,736 TOTAL LIABILITIES 106,250 162,214 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; 94,613,664 shares issued and 88,170,936 shares outstanding at March 31, 2023 ; 83,915,918 shares issued and 77,788,391 shares outstanding at December 31, 2022 9 8 Additional paid-in capital 421,596 388,177 Accumulated other comprehensive income 160 181 Accumulated deficit ( 330,176 ) ( 351,519 ) Treasury stock, at cost; 6,442,728 and 6,127,527 shares at March 31, 2023 and December 31, 2022 , respectively ( 34,451 ) ( 34,251 ) Total stockholders’ equity 57,138 2,596 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 163,388 $ 164,810 The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements. 4 FLOTEK INDUSTRIES, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Three months ended March 31, 2023 2022 Revenue: Revenue from external customers $ 11,652 $ 10,382 Revenue from related party 36,355 2,497 Total revenues 48,007 12,879 Cost of sales 46,127 13,358 Gross profit (loss) 1,880 ( 479 ) Operating costs and expenses: Selling, general, and administrative 6,451 4,886 Depreciation 176 195 Research and development 614 1,415 Severance costs 2,223 ( 7 ) Loss on sale of property and equipment — 8 Gain on lease termination — ( 584 ) (Gain) loss in fair value of Contract Consideration Convertible Notes Payable ( 26,095 ) 3,892 Total operating costs and expenses ( 16,631 ) 9,805 Income (loss) from operations 18,511 ( 10,284 ) Other income (expense): Payment protection plan loan forgiveness 4,522 — Interest expense ( 1,672 ) ( 668 ) Other income (expense), net ( 9 ) 224 Total other income (expense) 2,841 ( 444 ) Income (loss) before income taxes 21,352 ( 10,728 ) Income tax (expense) benefit ( 9 ) 4 Net income (loss) $ 21,343 $ ( 10,724 ) Income (loss) per common share: Basic $ 0.22 $ ( 0.15 ) Diluted (see Note 14, “Earnings (Loss) Per Share”) $ ( 0.02 ) $ ( 0.15 ) Weighted average common shares: Weighted average common shares used in computing basic income (loss) per common share 98,808 73,858 Weighted average common shares used in computing diluted loss per common share 158,441 73,858 The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements. 5 FLOTEK INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) Three months ended March 31, 2023 2022 Net income (loss) $ 21,343 $ ( 10,724 ) Other comprehensive income (loss): Foreign currency translation adjustment ( 21 ) 8 Comprehensive income (loss) $ 21,322 $ ( 10,716 ) The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements. 6 FLOTEK INDUSTRIES, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands) Three months ended March 31, 2023 2022 Cash flows from operating activities: Net income (loss) $ 21,343 $ ( 10,724 ) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Change in fair value of contingent consideration ( 359 ) 94 Change in fair value of Contract Consideration Convertible Notes Payable ( 26,095 ) 3,892 Amortization of convertible note issuance cost 83 166 Paid-in-kind interest expense 1,571 485 Amortization of contract assets 1,251 — Depreciation 176 195 Provision for credit losses, net of recoveries 23 238 Provision for excess and obsolete inventory 258 310 Gain on sale of property and equipment — 8 Gain on lease termination — ( 584 ) Non-cash lease expense 977 56 Stock compensation expense ( 1,112 ) 739 Deferred income tax benefit ( 6 ) ( 4 ) Paycheck protection plan loan forgiveness ( 4,522 ) — Changes in current assets and liabilities: Accounts receivable 3,504 ( 194 ) Accounts receivable, related party ( 3,546 ) 14 Inventories ( 441 ) ( 999 ) Income taxes receivable — ( 10 ) Other assets ( 470 ) ( 220 ) Accounts payable 8,554 616 Accrued liabilities 1,236 ( 2,350 ) Operating lease liabilities ( 1,190 ) ( 214 ) Income taxes payable ( 87 ) — Interest payable ( 8 ) 12 Net cash provided by (used in) operating activities 1,140 ( 8,474 ) Cash flows from investing activities: Capital expenditures ( 157 ) — Proceeds from sale of assets — 24 Net cash (used in) provided by investing activities ( 157 ) 24 Cash flows from financing activities: Payment for forfeited stock options ( 617 ) — Payments on long term debt ( 15 ) — Proceeds from issuance of convertible notes — 21,150 Payment of issuance costs of convertible notes — ( 1,084 ) Payments to tax authorities for shares withheld from employees ( 200 ) ( 59 ) Proceeds from issuance of stock 20 — Payments for finance leases ( 6 ) ( 14 ) Net cash (used in) provided by financing activities ( 818 ) 19,993 Effect of changes in exchange rates on cash and cash equivalents ( 21 ) 8 Net change in cash and cash equivalents and restricted cash 144 11,551 Cash and cash equivalents at the beginning of period 12,290 11,534 Restricted cash at the beginning of period 100 1,790 Cash and cash equivalents and restricted cash at beginning of period 12,390 13,324 Cash and cash equivalents at end of period 12,433 24,835 Restricted cash at the end of period 101 40 Cash and cash equivalents and restricted cash at end of period $ 12,534 $ 24,875 The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements. 7 FLOTEK INDUSTRIES, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Three Months Ended March 31, 2023 and 2022 (In thousands of U.S. dollars and shares) Three months ended March 31, 2023 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, 2022 83,916 $ 8 6,127 $ ( 34,251 ) $ 388,177 $ 181 $ ( 351,519 ) $ 2,596 Net income — — — — — — 21,343 21,343 Foreign currency translation adjustment — — — — — ( 21 ) — ( 21 ) Stock issued under employee stock purchase plan — — ( 21 ) — 20 — — 20 Restricted stock granted 15 — — — — — — Restricted stock forfeited ( 40 ) — 165 — — — — — Restricted stock units vested 387 — — — — — — Forfeited stock options purchased — — — — ( 617 ) — — ( 617 ) Stock compensation expense — — ( 1,112 ) — — ( 1,112 ) Shares withheld to cover taxes — — 171 ( 200 ) — — — ( 200 ) Conversion of Initial ProFrac Agreement Contract Consideration Convertible Notes Payable to Pre-Funded Warrants — — — — 15,092 — — 15,092 Conversion of convertible notes payable to Pre-Funded Warrants — — — — 11,040 — — 11,040 Conversion of convertible notes payable to Common Stock 10,336 1 — — 8,996 — — 8,997 Balance, March 31, 2023 94,614 $ 9 6,442 $ ( 34,451 ) $ 421,596 $ 160 $ ( 330,176 ) $ 57,138 Three months ended March 31, 2022 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, 2021 79,484 $ 8 6,022 $ ( 34,100 ) $ 363,417 $ 81 $ ( 309,214 ) $ 20,192 Net loss — — — — — — ( 10,724 ) ( 10,724 ) Foreign currency translation adjustment — — — — — 8 — 8 Restricted stock granted 287 — — — — — — — Restricted stock forfeited — — 8 — — — — — Stock compensation expense — — — — 739 — — 739 Shares withheld to cover taxes — 43 ( 59 ) — — — ( 59 ) Conversion of convertible notes payable notes to common stock 2,793 — — — 2,948 — — 2,948 Balance, March 31, 2022 82,564 $ 8 6,073 $ ( 34,159 ) $ 367,104 $ 89 $ ( 319,938 ) $ 13,104 The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements. 8 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED 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 17, “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 unaudited condensed 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 9, “Debt and Convertible Notes Payable” and Note 16, “Related Party Transactions”). It is not certain that the Company’s cash and other current assets and the Company’s 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 the Company’s 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 unaudited condensed consolidated financial statements are filed. 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 unaudited condensed 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 accompanying unaudited condensed consolidated financial statements reflect all adjustments, in the opinion of management, necessary for the fair statement of the financial condition and results of operations for the periods presented. All such adjustments are normal and recurring in nature. The financial statements, including selected notes, have been prepared in accordance with applicable rules and regulations of the SEC regarding interim financial reporting and do not include all 9 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS information and disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for comprehensive financial statement reporting. These interim financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s 2022 Annual Report. A copy of the 2022 Annual Report is available on the SEC’s website, www.sec.gov or on Flotek’s website, www.flotekind.com. The information contained on the Company’s website does not form a part of this Quarterly Report. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company does not have investments in any unconsolidated subsidiaries. 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 $ 0.1 million as of March 31, 2023 and December 31, 2022, respectively. The Company’s restricted cash 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. Accounts Receivable and Allowance for Credit Losses 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 credit losses to reflect any loss anticipated on accounts receivable balances. The Company applies the current expected credit loss (CECL) model, which requires immediate recognition of expected credit losses over the contractual life of receivables and records the appropriate allowance for credit losses as a charge to operating expenses. The allowance for credit losses is based on a combination of the 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 credit losses 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. 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 9, “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. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost determined by 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 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 10 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 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. 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 9, “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 measured at fair value at the grant date and at each reporting date (see Note 10, “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 11 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 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 10, “Fair Value Measurements.” Revenue Recognition 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 discounts offered to customers for prompt payment and right of return provisions, which are considered when recognizing revenue and deferred accordingly. 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 with 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 three months ended March 31, 2023 and March 31, 2022. 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. • 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. 12 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 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 Income (Loss) Comprehensive income (loss) encompasses all changes in stockholders’ equity, except those arising from investments and distributions to stockholders. The Company’s comprehensive income loss includes consolidated net income (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 The Company evaluated the Pre-Funded Warrants issued in June 2022 (the “June 2022 Warrants”) and the Pre-Funded Warrants issued in February 2023 (the “February 2023 Warrants”) (see Note 13, “Stockholders’ Equity) in accordance with ASC 815-40, “Contracts in Entity’s Own Equity” and determined that the June 2022 Warrants and the February 2023 Warrants meet the criteria to be classified within stockholders’ equity and recorded the proceeds received for the June 2022 Warrants and the February 2023 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. 13 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Significant items subject to estimates and assumptions include the useful lives of property and equipment; long lived asset impairment assessments; stock-based compensation expense; allowance for credit losses for accounts receivable; valuation allowances for 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. 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, 2023 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 Company adopted this standard prospectively as of January 1, 2023 and the adoption did not have a material impact of the Company’s consolidated financial statements and related disclosures, and there was no cumulative effect on retained earnings. 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. Total revenue disaggregated by revenue source is as follows (in thousands): Three months ended March 31, 2023 2022 Revenue: Products (1) $ 46,767 $ 12,199 Services 1,240 680 $ 48,007 $ 12,879 (1) Product revenue includes sales to related parties as described in Note 16, “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): Three months ended March 31, 2023 2022 Cost of sales: Tangible goods sold $ 41,529 $ 9,788 Services 141 ( 53 ) Other 4,457 3,623 $ 46,127 $ 13,358 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 split between external and related party sales is as follows (in thousands): 14 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Three months ended March 31, 2023 2022 Cost of sales: Cost of sales for external customers $ 11,196 $ 10,768 Cost of sales for related parties 34,931 2,590 $ 46,127 $ 13,358 Note 4 - Contract Assets Contract assets are as follows (in thousands): March 31, 2023 December 31, 2022 Contract assets $ 83,060 $ 83,060 Less accumulated amortization ( 4,622 ) ( 3,371 ) Contract assets, net 78,438 79,689 Less current contract assets ( 7,066 ) ( 7,113 ) Contract assets, long term $ 71,372 $ 72,576 In connection with entering into the ProFrac Agreement on February 2, 2022 and May 17, 2022 as discussed in Note 9, “Debt and Convertible Notes Payable” and Note 16, “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 March 31, 2023 and December 31, 2022, $ 71.4 million and $ 72.6 million, respectively, 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. The Company’s estimate of the timing of the future contract revenues is evaluated on a quarterly basis. During the three months ended March 31, 2023 the Company recognized $ 1.3 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 (excluding the three months ended March 31, 2023) $ 4,924 2024 8,565 2025 8,961 2026 8,961 2027 8,961 Thereafter through May 2032 38,066 Total contract assets $ 78,438 Based on our tests of recoverability, we did not identify impairment of such contract assets as of March 31, 2023. 15 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 5 — Inventories Inventories are as follows (in thousands): March 31, 2023 December 31, 2022 Raw materials $ 6,503 $ 5,800 Finished goods 17,196 18,130 Inventories 23,699 23,930 Less reserve for excess and obsolete inventory ( 7,795 ) ( 8,210 ) Inventories, net $ 15,904 $ 15,720 The provision recorded in the three months ended March 31, 2023 and 2022 was $ 0.1 million and $ 0.3 million for the CT segme nt and $ 0.2 million and zero for the DA segment, respectively. Note 6 — Property and Equipment Property and equipment are as follows (in thousands): March 31, 2023 December 31, 2022 Land $ 886 $ 886 Land improvements 520 520 Buildings and leasehold improvements 5,356 5,356 Machinery and equipment 6,758 6,758 Furniture and fixtures 532 532 Transportation equipment 784 784 Computer equipment and software 1,582 1,425 Property and equipment 16,418 16,261 Less accumulated depreciation ( 11,611 ) ( 11,435 ) Property and equipment, net $ 4,807 $ 4,826 Depreciation expense totaled $ 0.2 million and $ 0.2 million for the three months ended March 31, 2023 a nd 2022. Note 7 — Leases Prior to their sale in 2022, the Company leased its facilities in Waller, Texas and Monahans, Texas and during the three months ended March 31, 2022 recognized rental income of $ 121 thousand and $ 185 thousand, respectively, which is included in other income on the unaudited condensed consolidated statement of operations. The lease agreements between the tenants and the Company were terminated on the sale of the facilities. The components of lease expense and supplemental cash flow information are as follows (in thousands): 16 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Three months ended March 31, 2023 2022 Operating lease expense $ 240 $ 228 Finance lease expense: Amortization of assets 4 4 Interest on lease liabilities 1 3 Total finance lease expense 5 7 Short-term lease expense 41 124 Total lease expense $ 286 $ 359 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows used in operating leases $ 1,365 $ 375 Operating cash flows from finance leases 10 10 Financing cash flows from finance leases 1 3 Maturities of lease liabilities as of March 31, 2023 are as follows (in thousands): Years ending December 31, Operating Leases Finance Leases 2023 (excluding the three months ended March 31, 2023) $ 2,992 $ 29 2024 2,394 23 2025 1,391 — 2026 1,418 — 2027 1,339 — Thereafter 3,443 — Total lease payments $ 12,977 $ 52 Less: Interest ( 2,794 ) ( 3 ) Present value of lease liabilities $ 10,183 $ 49 17 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Supplemental balance sheet information related to leases is as follows (in thousands): March 31, 2023 December 31, 2022 Operating Leases Operating lease right-of-use assets $ 4,923 $ 5,900 Current portion of operating lease liabilities 3,050 3,328 Long-term operating lease liabilities 7,133 8,044 Total operating lease liabilities $ 10,183 $ 11,372 Finance Leases Property and equipment $ 147 $ 147 Accumulated depreciation ( 59 ) ( 55 ) Property and equipment, net $ 88 $ 92 Current portion of finance lease liabilities $ 36 $ 36 Long-term finance lease liabilities 13 19 Total finance lease liabilities $ 49 $ 55 Weighted Average Remaining Lease Term Operating leases 5.3 years 5.3 years Finance leases 1.3 years 1.6 years Weighted Average Discount Rate Operating leases 9.3 % 9.3 % Finance leases 8.9 % 8.9 % Note 8 — Accrued Liabilities Current accrued liabilities are as follows (in thousands): March 31, 2023 December 31, 2022 Severance costs $ 4,375 $ 2,617 Payroll and benefits 919 684 Legal costs 1,312 447 Contingent liability for earn-out provision 225 583 Deferred revenue, current 502 655 Taxes other than income taxes 1,545 1,884 Other 992 2,114 Total current accrued liabilities $ 9,870 $ 8,984 18 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 — 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 that date of $ 0.1 million, was forgiven. The remaining principal amount of $ 0.4 million and accrued interest, is to be repaid in monthly installments of $ 15 thousand over the remaining term of the loan through April 15, 2025, beginning on March 15, 2023. The forgiveness of the Flotek PPP loan is accounted for as an extinguishment of the debt and the Company has recorded a $ 4.5 million gain in the three months ended March 31, 2023, comprising the principal amount forgiven of $ 4.4 million and accrued interest of $ 0.1 million. Long-term debt, including current portion, is as follows (in thousands): March 31, 2023 December 31, 2022 Flotek PPP loan $ 373 $ 4,788 Less current maturities ( 179 ) ( 2,052 ) Total long-term debt, net of current portion $ 194 $ 2,736 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 “Convertible Notes Payable”). 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, had a maturity of one year, and were convertible 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 per share, or $ 1.741 per share, for 20 trading days during a 30 consecutive trading day period, or (c) at maturity, at a price of $ 0.8705 . 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. The issuance cost of $ 1.1 million was amortized on a straight-line basis over the term of the Convertible Notes Payable and the amortization was included in interest expense in the unaudited condensed consolidated statements of operations. On February 2, 2023, the Convertible Notes Payable, excluding those held by ProFrac Holdings, LLC, with a carrying value of $ 9.0 million, including accrued paid-in-kind interest of $ 0.8 million, were converted, upon maturity, into 10,335,840 shares of common stock at a price of $ 0.8705 per share. The Convertible Notes Payable held by ProFrac Holding, LLC, with a carrying value of $ 11.0 million, including accrued paid-in-kind interest of $ 1.0 million, were converted, upon maturity, into 12,683,280 February 2023 Warrants with an exercise price of $ 0.0001 per share. 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 paid-in-kind interest at a rate of 10 % per annum and conversion features. The Initial ProFrac Agreement Contract Consideration Convertible Notes Payable were 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. 19 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On February 2, 2023, the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable, remeasured to and carried at a fair value of $ 15.1 million, were converted, upon maturity, into 12,683,281 February 2023 Warrants with an exercise price of $ 0.0001 per share (see Note 10, “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 with the Initial ProFrac Agreement, 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. 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. 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 $ 43.8 million as of March 31, 2023 which includes paid-in-kind interest of $ 4.6 million. The fair value adjustment resulted in an a $ 26.9 million decrease in the three months ended March 31, 2023 and is recognized as a gain in fair value Contract Consideration Convertible Notes Payable, net on the unaudited condensed consolidated statement of operations. See Note 10, “Fair Value Measurements”. Note 10 — 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. 20 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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): March 31, December 31, Level 1 Level 2 Level 3 2023 Level 1 Level 2 Level 3 2022 Contingent earnout consideration $ — $ — $ 225 $ 225 $ — $ — $ 583 $ 583 Initial ProFrac Agreement Contract Consideration Convertible Notes — — — — — — 14,220 14,220 Amended ProFrac Agreement Contract Consideration Convertible Notes — — 43,800 43,800 — — 69,350 69,350 Total $ — $ — $ 44,025 $ 44,025 $ — $ — $ 84,153 $ 84,153 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 March 31, 2023 and December 31, 2022. 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. March 31, 2023 December 31, 2022 Risk-free interest rate 4.03 % 4.34 % Expected volatility 90 % 100.0 % Term until liquidation (years) 2.13 2.38 Stock price $ 0.69 $ 1.12 Discount rate 10.92 % 9.95 % 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. On February 2, 2023, the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable were remeasured, at maturity, to a fair value of $ 15.1 million based on the closing price of the shares of common stock of $ 1.19 , on the date of conversion. The fair value adjustment was a $ 0.8 million increase and a $ 3.9 million decrease in the three months ended March 31, 2023 and 2022, respectively. 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: 21 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 March 31, 2023 and 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, as of March 31, 2023 and December 31, 2022 were as follows: March 31, 2023 December 31, 2022 Risk-free interest rate 4.77 % 4.59 % Expected volatility 90.0 % 100.0 % Term until liquidation (years) 0.13 0.38 Stock price $ 0.69 $ 1.12 Discount rate 4.77 % 4.59 % 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. 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 three months ended March 31, 2023 and 2022 classified as Level 3 (in thousands): 22 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Three months ended March 31, 2023 2022 Balance - beginning of period $ 84,153 $ 608 Transfer of ProFrac Agreement Contract Consideration Convertible Notes Payable from Level 2 — 10,000 Increase in principal of Initial ProFrac Agreement Contract Consideration Convertible Notes Payable for paid-in-kind interest 85 158 Increase in principal of Amended ProFrac Agreement Contract Consideration Convertible Notes Payable for paid-in-kind interest 1,331 — Change in fair value of contingent earnout consideration ( 358 ) 94 Change in fair value of Initial ProFrac Agreement Contract Consideration Convertible Notes Payable 786 3,892 Change in fair value of Amended ProFrac Agreement Contract Consideration Convertible Notes Payable ( 26,881 ) — Conversion of Initial ProFrac Agreement Contract Consideration Convertible Notes Payable on maturity ( 15,091 ) — Balance - end of period $ 44,025 $ 14,752 Note 11 — Income Taxes 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: Three months ended March 31, 2023 2022 U.S. federal statutory tax rate 21.0 % 21.0 % State income taxes, net of federal benefit — 0.1 Non-U.S. income taxed at different rates 0.1 0.2 Increase (reduction) in tax benefit related to stock-based awards 0.4 ( 0.1 ) Increase in valuation allowance ( 20.4 ) ( 20.8 ) Permanent differences ( 1.1 ) ( 0.4 ) Non-deductible expenses 0.1 — Effective income tax rate — % — % Internal Revenue Code (“IRC”) section 382 addresses company ownership changes and specifically limits the utilization of certain deductions and other tax attributes on an annual basis following an ownership change. During 2023, the Company converted various debt instruments into Company stock and warrants causing an ownership change within the meaning of IRC section 382 that subjected certain of the Company’s tax attributes, including net operating losses ("NOLs"), to an IRC section 382 limitation. As of March 31, 2023, the Company has an estimated $ 181.6 million in U.S. federal NOL carryforwards, $ 104.9 million in certain state NOL carryforwards, $ 7.5 million in section 163(j) interest limitation carryforwards and $ 3.8 million in tax credit carryforwards. As a result of the change of control experienced in 2023, the Company’s ability to use NOLs to reduce taxable income is generally limited to an annual amount which is currently estimated to be $ 3.5 million a year as a result of the section 382 limitation which may be revised based on further detailed analysis. NOLs that exceed the section 382 limitation in any year continue to be allowed as carryforwards until they expire and can be used to offset taxable income for years within the carryover period subject to the limitation in each year. Federal NOLs incurred prior to 2018 generally have a 20-year life until they expire in varying amounts between 2029 and 2037. Federal NOLs generated in 2018 and after are carried forward indefinitely. State NOLs have various carryforward periods depending on the legislation in the respective state jurisdiction. The Company’s use of new NOLs arising after the date of an ownership change would not be impacted by the 382 limitation. If the 23 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Company does not generate a sufficient level of taxable income prior to the expiration of the pre-2018 NOL carryforward periods, then the ability to apply those NOLs as offsets to future taxable income is lost. Based on the preliminary section 382 limitation, the Company estimates that $ 41.9 million of the state NOL carryforwards and $ 3.8 million of the tax credit carryforwards will expire unutilized. The tax effected amount of the estimated expirations is included in the Company’s valuation allowance. Note 12 — 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 (Flotek’s previous CEO) 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 or 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. 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. Note 13 — Stockholders’ Equity On February 2, 2023, the Convertible Notes Payable pursuant to the PIPE transaction discussed in Note 9, “Debt and Convertible Notes Payable”, excluding those held by ProFrac Holdings, LLC, were converted, upon maturity, into 10,335,840 shares of common stock at a price of $ 0.8705 per share. The Convertible Notes Payable converted into common stock shares had a carrying value of $ 9.0 million, including accrued paid-in-kind interest of $ 0.8 million and were recorded as additional paid-in-capital as of March 31, 2023. The Convertible Notes Payable held by ProFrac Holding, LLC, with a carrying value of $ 11.0 million, including accrued interest of $ 1.0 million, were converted, upon maturity, into 12,683,280 February 2023 Warrants with an exercise price of $ 0.0001 per share and were recorded as additional paid-in-capital. On February 2, 2023, the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable discussed in Note 9, “Debt and Convertible Notes Payable”, remeasured to and carried at a fair value of $ 15.1 million, were converted, upon maturity, into 12,683,281 February 2023 Warrants and were recorded as additional paid-in-capital. The February 2023 Warrants permit ProFrac Holdings II, LLC to purchase 25,366,561 shares of common stock of the Company at an exercise price equal to $ 0.0001 per share and may be exercised at any time. Since there are no contingent conditions to be satisfied prior to exercise, the February 2023 Warrants are included in calculation of basic earnings (loss) per share. (See Note 14, “Earnings (Loss) Per Share”). 24 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On June 21, 2022, ProFrac Holdings II, LLC paid $ 19.5 million for Pre-Funded Warrants (the “June 2022 Warrants”) of the Company. The June 2022 Warrants were recorded in equity at their fair value of $ 11.1 million, estimated using a Black-Scholes Option Pricing model, less $ 1.2 million of transaction costs paid. The remaining cash received of $ 8.4 million was recognized as an equity contribution. The June 2022 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, and a $ 4.5 million exercise fee 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 June 2022 Warrants. The June 2022 Warrants, net of transaction fees of $ 1.1 million, and the equity contribution of $ 8.4 million from ProFrac Holdings II, LLC were recorded as additional paid-in capital. The key inputs into the Black-Scholes Option Pricing Model used to estimate the fair value of the June 2022 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 June 2022 Warrants or the underlying shares of common stock 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. On March 21, 2022, the Convertible Notes Payable issued pursuant to the PIPE transaction discussed in Note 9, “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. Note 14 — Earnings (Loss) Per Share Basic earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period, which includes the February 2023 Warrants (See Note 9, “Debt and Convertible Notes Payable”, and Note 13, “Stockholders’ Equity”). Diluted earnings (loss) per common share is calculated by dividing the adjusted net income (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 Pre-Funded 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 earnings (loss) per share for the three months ended March 31, 2023 and 2022 is as follows (in thousands): 25 FLOTEK INDUSTRIES, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Three months ended March 31, 2023 2022 Numerator: Net income (loss) for basic earnings per share $ 21,343 $ ( 10,724 ) Adjustments to net income available to shareholders Paid-in-Kind interest expense on convertible notes payable and Contract Consideration Convertible Notes Payable 1,571 — Valuation (gain)/loss on Contract Consideration Convertible Notes Payable carried at FV ( 26,095 ) — Adjusted net income (loss) for diluted earnings per share $ ( 3,181 ) $ ( 10,724 ) Anti-dilutive adjustments to net income available to shareholders excluded from Numerator for Diluted Earnings calculation Paid-in-Kind interest expense on convertible notes payable and Contract Consideration Convertible Notes Payable — 485 Valuation (gain)/loss on Contract Consideration Convertible Notes Payable carried at FV — 3,892 Total numerator adjustment excluded from diluted earnings computation $ — $ 4,377 Denominator: Basic weighted average shares outstanding 98,808 73,858 Average number of diluted shares for convertible notes payable and Contract Consideration Convertible Notes Payable 59,633 — Diluted weighted average shares outstanding 158,441 73,858 Basic earnings (loss) per share $ 0.22 $ ( 0.15 ) Diluted loss per share $ ( 0.02 ) $ ( 0.15 ) Anti-dilutive incremental shares excluded from denominator for diluted earnings computation Average number of diluted shares for June 2022 stock warrants 8,997 — Average number of diluted shares for options and restricted stock 1,023 609 For the three months ended March 31, 2023 weighted average shares for the June 2022 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 as it would reduce the loss per share. For the three months ended March 31, 2022, paid-in-kind interest expense on convertible notes payable and Contract Consideration Convertible Notes Payable and the change in fair value related to the Contract Consideration Convertible Notes Payable, 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 three months ended March 31, 2022 weighted average shares for convertible notes payable and Contract Consideration Convertible Notes Payable 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 periods. 26 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 — Supplemental Cash Flow Information Supplemental cash flow information is as follows (in thousands): Three months ended March 31, 2023 2022 Supplemental cash flow information: Interest paid $ 18 $ 5 Supplemental non cash financing and investing activities: Issuance of convertible notes payable as consideration for ProFrac Agreements — 10,000 Conversion of convertible notes payable to common stock 8,996 2,948 Conversion of convertible notes payable to February 2023 Warrants 11,040 — Conversion of initial Contract Consideration Convertible Notes Payable to February 2023 Warrants 15,092 — Note 16 — Related Party Transactions 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 9, “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 the Amended ProFrac Agreement upon issuance of $ 50 million in aggregate principal amount of Contract Consideration Convertible Notes Payable (see Note 9, “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. On February 1, 2023, the Company entered into an amendment to the ProFrac Agreement (the “Amended ProFrac Agreement No. 2”) dated February 2, 2022. The Amended ProFrac Agreement No. 2 has an effective date of January 1, 2023. The ProFrac Agreement was amended to (1) provide a ramp-up period from January 1, 2023 to May 31, 2023 for ProFrac Services, LLC to increase the number of active hydraulic fracturing fleets to 30 fleets, (2) waive any liquidated damages payment relating to any potential order shortfall prior to January 1, 2023, (3) add additional fees to certain products, and (4) provide margin increases based on revenue percentages from non-ProFrac customers. The Company believes the net present value of the economic benefit attributable to the Amended ProFrac Agreement No. 2 will exceed the value of the liquidated damages payments that would have been received for the period from April 1, 2022 through December 31, 2022. On February 2, 2023, the Convertible Notes Payable held by ProFrac Holding, LLC, with a carrying value of $ 11.0 million, including accrued paid-in-kind interest of $ 1.0 million, were converted, upon maturity, into 12,683,280 February 2023 Warrants (see Note 9, “Debt and Convertible Notes Payable” and Note 13, “Stockholders’ Equity”). On February 2, 2023, the Initial ProFrac Agreement Contract Consideration Convertible Notes Payable, with a carrying value of $ 11.0 million, including accrued interest of $ 1.0 million, were converted, upon maturity, into 12,683,281 February 2023 Warrants (see Note 9, “Debt and Convertible Notes Payable” and Note 13, “Stockholders’ Equity”). The fair value of the Initial ProFrac Agreement Contact Consideration Convertible Notes Payable, as of February 2, 2023, was $ 15.1 million (see Note 10, “Fair Value Measurements”). During the three months ended March 31, 2023 and 2022, the Company’s revenues from ProFrac Services LLC were $ 36.4 million and $ 1.1 million , respectively. For the three months ended March 31, 2023 and 2022, these revenues were net of amortization of contract assets of $ 1.3 million and nil . Cost of sales attributable to these revenues were $ 34.9 million and 27 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $ 1.1 million, respectively for the three months ended March 31, 2023 and 2022. As of March 31, 2023 and December 31, 2022 our accounts receivable from ProFrac Services, LLC was $ 26.2 million and $ 22.7 million, respectively which is recorded in accounts receivable, related party on the consolidated balance sheet. Also, during 2023 and 2022, we had the following related party transactions with ProFrac Holdings, LLC and ProFrac Holdings II, LLC: • PIPE Transaction (see Note 9, “Debt and Convertible Notes Payable”) • June 2022 Warrants (see Note 13, “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. The Company’s revenues and related cost of sales for product sales to Confluence were $ 1.4 million and $ 1.4 million, for the three months ended March 31, 2022. As of June 9, 2022 Mr. Brown stepped down from being a Director of the Company and Confluence is no longer considered a related party as of June 9, 2022. Note 17 — Business Segment, Geographic and Major Customer 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 . 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. 28 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Summarized financial information of the reportable segments is as follows (in thousands): As of and for the three months ended March 31, Chemistry Technologies Data Analytics Corporate and Other Total 2023 Revenue from external customers Products $ 8,561 $ 1,941 $ — $ 10,502 Services 664 486 — 1,150 Total revenue from external customers 9,225 2,427 — 11,652 Revenue from related party — Products 36,265 — — 36,265 Services — 90 — 90 Total revenue from related parties 36,265 90 — 36,355 Gross profit 434 1,446 — 1,880 Change in fair value of Contract Consideration Convertible Notes Payable ( 26,095 ) — — ( 26,095 ) Income (loss) from operations 23,379 457 ( 5,325 ) 18,511 Paid-in-kind interest on Contract Consideration Convertible Notes Payable 1,416 — — 1,416 Paid-in-kind interest on convertible notes payable — — 155 155 Depreciation 157 18 1 176 Additions to long-lived assets 30 95 32 157 2022 Revenue from external customers Products $ 8,909 $ 793 $ — $ 9,702 Services 402 278 — 680 Total revenue from external customers 9,311 1,071 — 10,382 Revenue from related party Products 2,497 — — 2,497 Services — — — — Total revenue from related parties 2,497 — — 2,497 Gross profit (loss) ( 662 ) 183 — ( 479 ) Change in fair value of Contract Consideration Convertible Notes Payable 3,892 — — 3,892 Loss from operations ( 6,057 ) ( 808 ) ( 3,419 ) ( 10,284 ) Paid-in-kind interest on Contract Consideration Convertible Notes Payable 158 — — 158 Paid-in-kind interest on convertible notes payable — — 327 327 Depreciation 178 16 1 195 Additions to long-lived assets — — — — 29 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets of the Company by reportable segments are as follows (in thousands): March 31, 2023 December 31, 2022 Chemistry Technologies $ 142,033 $ 146,542 Data Analytics 7,308 5,645 Corporate and Other 14,047 12,623 Total assets $ 163,388 $ 164,810 Geographic Information Revenue by country is based on the location where services are provided and products are sold. For the three months ended March 31, 2023 no individual countries other than the U.S. accounted for more than 10% of revenue. For the three months ended March 31, 2022 no individual countries other than the U.S. and the United Arab Emirates (“UAE”) accounted for more than 10% of revenue. Revenue by geographic location is as follows (in thousands): Three months ended March 31, 2023 2022 U.S. (1) $ 46,126 $ 10,334 UAE 1,403 1,311 Other countries 478 1,234 Total revenue $ 48,007 $ 12,879 (1) Includes revenue from related party Long-lived assets held in countries other than the U.S. are not considered material to the consolidated financial statements. Major Customers Revenue from major customers, as a percentage of consolidated revenue, is as follows (in thousands): Three months ended March 31, Revenue % of Total Revenue 2023 Customer A (Related Party) $ 36,355 75.7 % 2022 Customer B $ 2,607 20.2 % Customer C (Related Party) 1,389 10.8 % 30 FLOTEK INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Three months ended March 31, 2023 Supplier A $ 16,954 40.1 % Supplier B 7,145 16.9 % Supplier C 4,504 10.6 % 2022 Supplier B 2,117 27.0 % Supplier D 933 11.9 % Note 18 — Subsequent Events We have evaluated the effects of events that have occurred subsequent to March 31, 2023, and there have been no material events that would require recognition in the March 31, 2023 interim financial statements or disclosure in the notes to the consolidated financial statements, except as disclosed below. Sublease of Corporate Headquarters On April 1, 2023, the Company entered into an agreement to sublease the facility in Houston, Texas, which is currently the Company’s corporate headquarters, beginning September 1, 2023, or earlier, and ending October 30, 2030. The Company plans to lease a smaller facility to relocate the headquarters before September 1, 2023. New York Stock Exchange (“NYSE”) Continued Listing Requirements The Company’s common stock is currently listed on the NYSE. On April 12, 2023, the Company received written notice from the NYSE that the average closing price of the Company’s shares of common stock was below $ 1.00 per share over a period of 30 consecutive days, which is below the requirement for continued listing on the NYSE. In accordance with applicable NYSE procedures, the Company has notified the NYSE that it intends to cure the $1.00 per share deficiency. Based on the applicable NYSE procedures, the Company has six months following the receipt of the NYSE’s notice to cure the deficiency and regain compliance. The NYSE’s notice has no immediate impact on the listing of the Company’s common stock, which will continue to trade on the NYSE subject to the Company’s continued compliance with the other listing requirements of the NYSE. The common stock of the Company will continue to trade under the symbol “FTK” but will have an added designation of “.BC” to indicate that the status of the common stock is “below compliance” with the NYSE continued listing standards. The “.BC” indicator will be removed at such time as the Company is deemed to be in compliance. The Company intends to explore available options to regain compliance, which may include, if necessary, effectuating a reverse stock split. 31