FLOTEK INDUSTRIES INC/CN/ 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations In this Quarterly Report on Form 10-Q, unless the context otherwise requires, the terms “Flotek,” the "Company," "we," "us" and "our" refer to Flotek Industries, Inc. and its wholly-owned subsidiaries. The following discussion should be read in conjunction with the Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (“Annual Report” or “2022 Annual Report”) filed with the U.S. Securities and Exchange Commission (the “SEC”) and the unaudited consolidated financial statements and accompanying notes included herein. Comparative segment revenues and related financial information are discussed herein and are presented in Note 17 to our unaudited consolidated financial statements. See “Forward Looking Statements” in this report and “Risk Factors” included in our filings with the SEC, including our Quarterly Reports on Form 10-Q and our 2022 Annual Report, for a description of important factors that could cause actual results to differ from expected results. Our historical financial information may not be indicative of our future performance. Executive Summary Flotek creates unique solutions to reduce the environmental impact of energy on air, water, land and people. A technology-driven, specialty green chemistry and data technology company, Flotek helps customers across industrial and commercial markets improve their environmental performance. The Company serves specialty chemistry needs for both domestic and international energy markets. The Company has two operating segments, Chemistry Technologies (“CT”) and Data Analytics (“DA”), which are both supported by the Company’s continuing Research and Innovation (“R&I”) advanced laboratory capabilities. Company Overview Chemistry Technologies We believe that the Company’s CT segment provides sustainable, optimized chemistry solutions that maximize our customer’s value by elevating their environmental, social and governance (“ESG”) performance, lowering operational costs, and delivering improved return on invested capital. The Company’s proprietary green chemistries, specialty chemistries, logistics, and technology services enable its customers to pursue improved efficiencies and performance throughout the life cycle of its desired chemical applications program. The Company designs, develops, manufactures, packages, distributes and markets optimized chemistry solutions that accelerate existing sustainability practices to reduce the environmental impact of energy on the air, water, land and people. Customers of the CT segment include those of energy related markets, such as our related party ProFrac Services, LLC, as well as consumer and industrial applications. Major integrated oil and gas companies, oilfield services companies, independent oil and gas companies, national and state-owned oil companies, geothermal energy companies, solar energy companies and advanced alternative energy companies benefit from our best-in-class technology, field operations, and continuous improvement exercises that go beyond existing sustainability practices. Data Analytics The DA segment delivers real-time information and insights to our customers to enable optimization of operations and reduction of emissions and their carbon intensity. Real-time composition and physical properties are delivered simultaneously on their refined fuels, natural gas liquids (“NGLs”), natural gas, crude oil, and condensates using the industry’s only field-deployable, in-line optical near-infra-red spectrometer that generates no emissions. The instrument's response is processed with advanced chemometrics modeling, artificial intelligence, and machine learning algorithms to deliver these valuable insights every 15 seconds. We believe customers using this technology have obtained significant benefits including additional profits by enhancing operations in crude/condensates stabilization, blending operations, reduction of transmix, increasing efficiencies and optimization of gas plants, and ensuring product quality while reducing giveaways i.e., providing higher value products at the lower value products prices. More efficient operations have the benefit of reducing their carbon footprint e.g., less flaring and reduction in energy expenditure for compression and re-processing. Our customers in North America include the supermajors, some of the largest midstream companies and large gas processing plants. We have developed a line of Verax™ analyzers for deployment internationally which was certified for compliance in hazardous locations and harsh weather conditions. 32 Research & Innovation R&I supports the acceleration of ESG solutions for both segments through green chemistry formulation, specialty chemical formulations, EPA regulatory guidance, technical support, basin and reservoir studies, data analytics and new technology projects. The purpose of R&I is to supply the Company’s segments with enhanced products and services that generate current and future revenues, while advising Company management on opportunities concerning technology, environmental and industry trends. The R&I facilities support advances in chemistry performance, detection, optimization and manufacturing. Outlook Our business is subject to numerous variables which impact our outlook and expectations given the shifting conditions of the industry and weather volatility. We have based our outlook on the market conditions we perceive today. Changes often occur. Energy We believe that we are in the early years of a tight supply cycle for oil and gas triggered by an extended period of underinvestment in energy development, infrastructure and new sources of oil and gas production. While the demand for oil and gas could fluctuate depending on the macroeconomic condition, we believe that this tight supply cycle could last and could provide support to high oil prices for multiple years. We expect that the strongest potential growth throughout 2023 will likely come from independent, rather than large major exploration and production companies. Independent exploration and production companies operate the majority of U.S. land rigs and react quickly to changing commodity prices. In the current commodity price environment, we expect these companies to increase activity and the larger companies to have modest spending increases in the year ahead. Digital Analytics The use of data and digital analytics is a growing trend in all industries where technology is leveraged to analyze large datasets of operational information to improve performance, as well as for predictive maintenance, advanced safety measures and reduced environmental impact of operations. We believe Verax™ analyzers have gained a foothold in North American markets for critical applications where compositional information is needed in real-time. The technology delivers insight on valuable operations data like vapor pressure, boiling point, flash point, octane level, API (American Petroleum Institute) gravity, viscosity, BTU (British Thermal Unit) and more, simultaneously. We continue to collaborate with our customers to identify further facilities and applications where our technology has the highest value. To drive recurring revenue, we continue to build on the modular nature of our sensor and analysis packages with new data processing techniques that enhance the value of our installations. AIDA (Automated Interface Detection Algorithm) provides real-time detection of interfaces in a liquids pipeline without the need for additional sampling or chemometric modeling. The application can identify products such as refined fuels, crude and NGLs with its advanced machine learning algorithms and detect interfaces real-time versus traditional lab analysis. We believe this allows customers to cut batches quickly and accurately, reduce transmix and minimize off-spec product that requires downgrades. We are also gaining traction leveraging the Verax™ in applications where operators and service companies are using field gas as a substitute for diesel in dual fuel engines as the market moves to Tier 4 equipment and eFleets. Analyzing this in real-time allows companies to maximize the substitution rate while lowering emissions, reducing fuel consumption/costs, and protecting the equipment from damage. ESG ESG-focused solutions continue to be an emphasis for the Company as the energy, industrial and consumer markets are seeking to accelerate their focus on sustainability and minimized impact on the environment. We anticipate the Company’s products and services could offer a significant benefit to businesses seeking to improve their ESG performance, including improving safety, reliability and efficiency of their operations. The Company offers sustainable chemistry solutions, tailoring product selection to enable operational efficiencies, improve water management and reduce greenhouse gas emissions for its customers in the exploration and production sector of the oil and gas industry. Further, the Company’s patented line of Complex nano-Fluid® (also known as CnF®) products are formulated with highly effective, plant-based solvents offering safer, renewable and sustainable alternatives to toxic BTEX-based (benzene, toluene, ethylbenzene and xylene) chemicals. Additionally, we believe the Company’s real-time sensor technology helps to enable process and operational efficiencies, minimize waste and processing and reduce emissions. We believe the industry focus on maintaining a “social license to operate” provides the platform to accelerate the sale of our products and services that we believe can help the customer achieve a greener goal. We believe the performance driven ESG focus of the Company assists in reducing environmental liabilities and improving returns for our customers. 33 Supply Chain The principal supply issues facing our industry for the next twelve months will include: • Fluctuating freight costs for shipping to our customers; • Availability of raw materials; • Delays due to port congestion; • Labor shortages; and • Demand forecasting. All bidding will require the risk of shipping costs and delays to be factored into proposals. Trucking availability and pricing will impact North American opportunities while sea-freight costs will impact sales of North American manufactured goods being delivered internationally for the foreseeable future. The import of raw materials from China will also incur price increases. Accelerating tensions between China and the U.S. could also result in supply disruption. 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. 34 Consolidated Results of Operations (in thousands) 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 Cost of sales % 96.1 % 103.7 % Gross profit (loss) 1,880 (479) Gross profit (loss) % 3.9 % (3.7) % Selling general and administrative 6,451 4,886 Selling general and administrative % 13.4 % 37.9 % 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 Income (loss) from operations 18,511 (10,284) Operating margin % 38.6 % (79.9) % Interest and other income, net 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) Net income (loss) % 44.5 % (83.3) % Consolidated revenue for the three months ended March 31, 2023 increased $35.1 million, or 273%, versus the same period of 2022, primarily driven by related party activity under the ProFrac Agreement which commenced in the second quarter of 2022 and continued increased activity across our customer base, particularly in the DA segment. Related party revenues in the CT segment are partially offset by $1.3 million of contract assets amortization for the three months ended March 31, 2023. Consolidated cost of sales for the three months ended March 31, 2023 increased $32.8 million, or 245%, versus the same period of 2022, primarily attributable to the increase in revenue. SG&A expenses for the three months ended March 31, 2023 increased $1.6 million, or 32%, versus the same period of 2022. The increase relates mainly to professional fees, driven by higher legal fees partially offset by a decrease in capital transaction related costs. Severance costs of $2.2 million were recorded in the three months ended March 31, 2023 compared to a credit of $7 thousand for the same period of 2022, and were attributable to senior management changes. Research and development (“R&D”) costs for the three months ended March 31, 2023, decreased $0.8 million or 57%, versus the same period of 2022 due to a reduction in sample testing in 2023 and lower personnel cost driven by headcount optimization. Income from operations increased by $28.8 million or 280% for the three months ended March 31, 2023, versus the same period in 2022. The improvement is primarily driven by the gain in fair value of the Contract Consideration Convertible Notes Payable of $26.1 million compared to a loss in fair value of $3.9 million for the same period of 2022. The improvement is partially offset by severance costs of $2.2 million. 35 Interest and other income for the three months ended March 31, 2023, increased $3.3 million or 740% driven by a $4.5 million gain for the forgiveness of the Flotek PPP loan (see Note 9, “Debt and Convertible Notes Payable”). This was partially offset by non-cash interest charges of $1.7 million in the three months ended March 31, 2023 versus $0.7 million for the same period in 2022. The increased interest cost relates to paid- in-kind interest expense on the convertible notes payable and the Contract Consideration Convertible Notes Payable. The Company’s income tax (expense) benefit for the three months ended March 31, 2023 and 2022 was minimal. Results by Segment (in thousands): Chemistry Technologies Results of Operations: Three months ended March 31, 2023 2022 Revenue from external customers $ 9,225 $ 9,311 Revenue from related party 36,265 2,497 Income (loss) from operations 23,379 (6,057) CT revenue from external customers for the three months ended March 31, 2023 decreased $0.1 million or 0.9%, compared to the same period of 2022. Revenue from related parties increased $33.8 million or 1352%, compared to the same period of 2022. The increased revenue in 2023 is driven by the ProFrac Agreement which commenced in the second quarter of 2022. Income from operations for the CT segment for the three months ended March 31, 2023 increased $29.4 million or 486% compared to the same period of 2022. The improvement is primarily attributable to the gain in fair value of the Contract Consideration Convertible Notes Payable of $26.1 million for the three months ended March 31, 2023 compared to a loss of $3.9 million for the same period of 2022. The improvement is partially offset by increased cost of sales, driven by activity, with notable, significant increased freight and equipment rental costs, and severance costs of $0.6 million, driven by changes in senior management. During the three months ended March 31, 2022, the loss from operations included a gain on lease termination of $0.6 million. Data Analytics Results of Operations: Three months ended March 31, 2023 2022 Revenue from external customers $ 2,427 $ 1,071 Revenue from related party 90 — Income (loss) from operations 457 (808) DA revenue from external customers for the three months ended March 31, 2023 increased $1.4 million or 127% compared to the same period of 2022 primarily due to significant products revenues from three new customers. Revenue from related party customers was $0.1 million relating to services provided to ProFrac Services, LLC. Income from operations for the DA segment for the three months ended March 31, 2023 increased $1.3 million or 157% compared to the same period for 2022 driven by increased activity and decreased R&D expense. Corporate and Other Results of Operations: Three months ended March 31, 2023 2022 Loss from operations $ (5,325) $ (3,419) Loss from operations for the three months ended March 31, 2023, increased $1.9 million, or 56%, compared to the same period of 2022 attributable to severance costs and increased professional fees. Severance costs of $1.6 million were recorded in the three months ended March 31, 2023, relating to senior management changes. The increase in professional fees relates mainly to higher legal fees partially offset by lower capital transaction related costs. 36 Capital Resources and Liquidity Overview The Company’s ongoing capital requirements relate to the acquisition and maintenance of equipment and funding working capital requirements. During the three months ended March 31, 2023, the Company funded working capital requirements with cash on hand. As of March 31, 2023, the Company had unrestricted cash and cash equivalents of $12.4 million, as compared to $12.3 million on December 31, 2022. During the three months ended March 31, 2023, the Company had an operating income of $18.5 million, $1.1 million of cash provided by operating activiti es, $0.2 million cash used in investing activities and $0.8 million o f cash used in financing activities. 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. Cash Flows Consolidated cash flows by type of activity are noted below (in thousands): Three months ended March 31, 2023 2022 Net cash provided by (used in) operating activities $ 1,140 $ (8,474) Net cash (used in) provided by investing activities (157) 24 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 37 Operating Activities Net cash provided by operating activities was $1.1 million during the three months ended March 31, 2023 compared to $8.5 million used in operating activities for the same period of 2022. Consolidated net income for the three months ended March 31, 2023 was $21.3 million compared to a net loss of $10.7 million for the three months ended March 31, 2022. During the three months ended March 31, 2023, non-cash adjustments to net income (loss) totaled $27.8 million as compared to $5.6 million for the same period of 2022. • For the three months ended March 31, 2023 non-cash adjustments included $26.1 million for the change in fair value of Contract Consideration Convertible Notes Payable, $4.5 million for PPP loan forgiveness and $1.1 million stock compensation adjustment. These were offset by non-cash positive adjustments of $1.6 million paid-in-kind interest expense, $1.3 million amortization of contract assets and $1.0 million non-cash lease expense. • For the three months ended March 31, 2022 non-cash adjustments included $3.9 million for the change in fair value of Contract Consideration Convertible Notes Payable, $0.7 million stock compensation expense, $0.5 million paid-in-kind interest expense and $0.3 million provision for excess and obsolete inventory. These were partially offset by $0.6 million for the gain on lease termination. During the three months ended March 31, 2023, changes in working capital provided $7.6 million of cash as compared to using $3.3 million for the same period of 2022. • For the three months ended March 31, 2023, changes in working capital resulted primarily from an increase in accounts payable of $8.6 million. • For the three months ended March 31, 2022, changes in working capital resulted primarily from a decrease in accrued liabilities of $2.4 million partially due to payment of a legal settlement accrued in 2021 and an increase in inventories of $1.0 million. Investing Activities Net cash used in investing activities for the three months ended March 31, 2023 was $0.2 million driven by capital additions. Net cash provided by investing activities for the three months ended March 31, 2022 was negligible. Financing Activities Net cash used in financing activities for the three months ended March 31, 2023 was $0.8 million, and relates primarily to payments for forfeited stock options and to tax authorities for shares withheld from employees. Net cash provided by financing activities was $20.0 million for the three months ended March 31, 2022, primarily from the proceeds from the issuance of convertible notes. Critical Accounting Policies and Estimates The preparation of financial statements and related disclosures in conformity with U.S. GAAP and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make judgments, assumptions, and estimates that affect the amounts reported. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Company’s 2022 Annual Report describes the critical accounting policies and estimates used in the preparation of the Company’s condensed consolidated financial statements. Note 2, “Summary of Significant Accounting Policies” of the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II, Item 8 of the 2022 Annual Report describe the significant accounting policies and methods used in the preparation of the Company’s condensed consolidated financial statements.