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Item 7. Management’s Discussion and Analysis

2024-03-15 compared with 2023-03-23 · 107 added, 93 removed, 92 unchanged (68% of the section changed)

9 unchanged sentences

Flotek creates unique solutions to reduce the environmental impact of energy on air, water, land and people.

A technology-driven, specialty green chemistry and data company, Flotek helps customers across industrial and commercial markets improve their environmental performance.

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, CT and DA, which are both supported by the Company’s continuing Research and Innovation advanced laboratory capabilities.

The Company’s CT segment develops, manufactures, packages, distributes, delivers, and markets green, specialty chemicals that help their customers meet their ESG and operational goals, and aim to enhance the profitability of hydrocarbon producers.

The Company’s DA segment enables users to maximize the value of their hydrocarbon associated processes by providing real-time data and analytics associated with the 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.

During 2022 the Company entered into the ProFrac Agreement, (see Note 10, “Debt and Convertible Notes Payable” and Note 18, “Related Party Transactions”) which has resulted in a significant increase in revenue for the year ended December 31, 2022.

During 2022 the Company entered into the ProFrac Agreement, (see Note 9, “Debt and Convertible Notes Payable” and Note 17, “Related Party Transactions”) which has resulted in a significant increase in revenue for the years ended December 31, 2023 and 2022.

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 ESG performance, lowering operational costs, and delivering improved return on invested capital.

We believe that the Company’s CT segment provides sustainable, optimized chemistry solutions that maximize our customers’ value by improving return on invested capital, lowering operational costs, and providing tangible environmental benefits.

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.

The Company’s CT segment 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 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.

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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.

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, allowing for the use of lower cost field gas instead of diesel to generate power and protect equipment, 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.

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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.

R&I supports 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.

ProFrac Supply Agreement

On February 2, 2022, the Company entered into the Initial ProFrac Agreement, which was subsequently amended on May 17, 2022 and February 1, 2023 (collectively, the “ProFrac Agreement”).

The ProFrac Agreement contains minimum requirements for chemistry purchases.

If the minimum volumes are not achieved within the applicable measurement period, ProFrac Services, LLC is required to 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 the measurement period (“Contract Shortfall Fees”).

The current measurement period for Contract Shortfall Fees is June 1, 2023 through December 31, 2023.

The minimum purchase requirements were not met during the current measurement period, and as a result, related party revenues for the year ended December 31, 2023 reflect Contract Shortfall Fees of $20.1 million, of which $10.0 million was collected through March 11, 2024 with the remainder due on or before April 8, 2024.

Consolidated Results of Operations (in thousands)

11 unchanged sentences

Research and development 2,486 4,438

Severance costs (46) —

Gain on disposal of property and equipment (38) (2,916)

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Impairment of goodwill — —

Loss from operations (35,421) (31,456)

Income (loss) from operations 23,223 (35,421)

Operating margin % 12.3 % (26.0) %

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Interest expense and other income, net (2,883) (6,906)

Loss before income taxes (42,327) (30,566)

Income tax benefit 22 40

Net loss $ (42,305) $ (30,526)

Net loss % (31.1) % (70.6) %

Income (loss) before income taxes 24,862 (42,327)

Income tax (expense) benefit (149) 22

Net income (loss) $ 24,713 $ (42,305)

Net income (loss) % 13.1 % (31.1) %

Consolidated revenue for the year ended December 31, 2023 increased $52.0 million, or 38%, versus the same period of 2022.

The significant increase in revenue during the year ended December 31, 2022 is driven primarily by activity under the ProFrac Agreement which commenced in the second quarter of 2022 and continued increased activity with new and existing customers both domestic and international, particularly in the CT segment.

Consolidated cost of sales for the year ended December 31, 2022, increased $102.8 million, or 257% versus the same period of 2021 .The increase is primarily driven by the activity with ProFrac Services, LLC and higher freight and equipment rental costs due to the increased volume of business.

Cost of sales in 2021 was positively impacted by the release of accrued costs of $7.6 million subsequent to the agreement of a settlement with ADM, see Note 13, “Commitments and Contingencies”.

The significant increase in revenue during the year ended December 31, 2023 was driven primarily by a full year of activity under the ProFrac Agreement which commenced in the second quarter of 2022.

In addition, revenues increased due to continued increased activity with new and existing domestic customers particularly in the CT segment, partially offset by reduced international activity.

Consolidated cost of sales for the year ended December 31, 2023 increased $21.0 million, or 15%, versus the same period of 2022.

The increase is primarily driven by the activity with ProFrac Services, LLC and higher freight and equipment rental costs due to the increased volume of business.

The reduction in cost of sales as a percentage of revenue in 2023 was the result of revenue from Contract Shortfall Fees, which have no associated costs, and numerous initiatives to reduce the cost of freight and logistics and secure better pricing of materials.

Selling general and administrative (“SG&A”) expenses are not directly attributable to products sold or services provided.

SG&A expenses for the year ended December 31, 2023, increased $0.7 million, or 3%, versus the same period of 2022.

The increase in SG&A expenses is driven primarily by higher personnel costs to facilitate the increase in operational activity, and professional fees.

For the year ended December 31, 2021, personnel costs were lower due to the receipt of a $2.9 million payroll tax credit from the Employee Retention Credit, (“ERC”) a provision set up to assist employers during the pandemic.

The increase in professional fees of $1.8 million is attributable mainly to fees incurred in assessing alternative strategies to raise capital, partially offset by lower legal fees.

Depreciation expense decreased $0.3 million, or 27% for the year ended December 31, 2022, versus the same period of 2021 partially driven by the assets held for sale that were ultimately sold during the year ended December 31, 2022 and also by assets becoming fully depreciated.

Research and development (“R&D”) costs decreased $1.1 million, or 20% for the year ended December 31, 2022, versus the same period of 2021 driven by lower personnel costs as a result of headcount reductions from 2021 to 2022.

Loss from operations increased by $4.0 million, or 13% for the year ended December 31, 2022, versus the same period in 2021.

Loss from operations for the year ended December 31, 2021 was positively impacted by the release of accrued costs of $7.6 million subsequent to the agreement of a settlement with ADM, see Note 13, “Commitments and Contingencies”.

Excluding the ADM credit, loss from operations decreased $3.6 million, or 9% year on year.

The improvement is driven by increased revenue and gross margin, the gain on disposal of property and equipment from the sale of the Waller, Texas and Monahans, Texas facilities and the gain on lease termination partially offset by increased SG&A expenses.

Loss before income taxes for the year ended December 31, 2022, was impacted by interest charges of $7.1 million compared to $0.1 million for the same period in 2021.

The increased interest cost is driven by paid-in-kind interest on the Convertible Notes Payable issued in connection with the PIPE transaction conducted in February 2022 and the Contract Consideration Convertible Notes Payable.

Loss before income taxes for the year ended December 31, 2021was positively impacted by a $0.9 million gain from the forgiveness of the JP3 Paycheck Protection Program (“PPP”) loan.

Research and development (“R&D”) costs decreased $2.0 million, or 44%, for the year ended December 31, 2023, versus the same period of 2022 driven by lower personnel costs resulting from headcount optimization.

Operating income increased by $58.6 million to $23 million for the year ended December 31, 2023, versus an operating loss of $35 million during the same period in 2022.

The improvement was driven primarily by an increased gross profit of $31.0 million resulting from increased related party and external customer revenue, including accrued Contract Shortfall Fees, the gain in fair value of the Contract Consideration Convertible Notes Payable of $30.0 million compared to the same period of 2022, and a $2.0 million decrease in research and development costs.

The improvement was partially offset by an increase in

SG&A expenses of $0.7 million and a decrease in gains on the sale of assets and lease termination of $2.9 million and $0.6 million, respectively.

Interest expense and other income for the year ended December 31, 2023 increased $8.5 million, driven primarily by a $4.5 million gain for the forgiveness of the Flotek PPP loan and a $4.2 million decrease in interest expense related to the maturity of the Contract Consideration Convertible Notes Payable in the first half of 2023.

Results by Segment (in thousands):

3 unchanged sentences

Revenue from related party 120,903 81,618

Loss from operations (14,729) (5,466)

CT revenue from external customers for the year ended December 31, 2022, increased $13.7 million, or 39%, compared to 2021 due to increased domestic and international sales with both new and existing customers.

Revenue from related parties increased $78.0 million, or 2,142% driven by the ProFrac Agreement which commenced in the second quarter of 2022.

Loss from operations for the CT segment for the year ended December 31, 2022 increased $9.3 million, or 169%, compared to 2021.

The decline is driven by the low gross margin due to amortization of the contract asset, early payment discounts given to customers, start up costs relating to the ProFrac Agreement and a one time inventory write down of $1.0 million relating to the decision to cease the manufacture and sale of hand sanitizers.

Cost of sales for the year ended December 31, 2021 benefited

from the release of accrued costs relating to the ADM settlement of $7.6 million, see Note 13, “Commitments and Contingencies”.

Income (loss) from operations 39,043 (14,729)

CT revenue from external customers for the year ended December 31, 2023, increased $10.1 million, or 21%, compared to 2022 due to increased domestic sales with both new and existing customers.

Revenue from related parties, including accrued Contract Shortfall Fees, increased $39.3 million, or 48%, driven by the ProFrac Agreement which commenced in the second quarter of 2022.

Income from operations for the CT segment for the year ended December 31, 2023 increased $53.8 million, compared to 2022.

The increase was driven by an increase in gross profit of $27.7 million attributable to increased activity and accrued Contract Shortfall Fees along with an increase in the gain in fair value of the Contract Consideration Convertible Notes Payable of $30.0 million for the year ended December 31, 2023 compared to $0.1 million for the same period in 2022.

Data Analytics Results of Operations:

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Loss from operations (53) (2,877)

DA revenue for the year ended December 31, 2022, increased $1.0 million, or 24%, compared to revenue for 2021.

The increase is driven by significant revenues with three new customers and several existing customers.

Related party revenue has increased by $0.1 million compared to 2021 relating to services provided to ProFrac Services, LLC.

DA external customer revenue for the year ended December 31, 2023, increased $2.1 million, or 39%, compared to revenue for 2022.

The increase was driven by increased product sales.

Related party revenue increased by $0.6 million compared to 2022 relating to services provided to ProFrac Services, LLC outside of the ProFrac Agreement.

Loss from operations for the DA segment for the year ended December 31, 2023 decreased $2.8 million, or 98%, compared to 2022.

The improvement is primarily due to 2021 being impacted by a goodwill impairment charge of $8.1 million and the increase in revenue and gross margin for the year ended December 31, 2022.

The improvement was primarily due to increased activity and decreased R&D expense and personnel costs.

Corporate and Other Results of Operations:

1 unchanged sentence

Loss from operations $ (15,767) $ (17,815)

Loss from operations for the year ended December 31, 2022 increased by $4.0 million, or 29% compared to 2021 attributable to an increase in personnel costs and professional fees.

Personnel costs in 2021 included a $2.9 million payroll tax credit from the ERC provision.

Increased professional fees were driven by fees incurred in assessing alternative strategies to raise capital, partially offset by lower legal fees.

Loss from operations for the year ended December 31, 2023 decreased by $2.0 million, or 11%, compared to the same period of 2022, due to decreased salaries and benefits from reduced headcount, including lower stock compensation costs.

Capital Resources and Liquidity

The Company’s ongoing capital requirements relate to the acquisition and maintenance of equipment and to the funding of working capital requirements.

During 2022, the Company funded working capital requirements with net cash proceeds from the issuance of Convertible Notes Payable for $20.1 million, prefunded warrants issued for $19.5 million, and cash on hand.

The Company’s ongoing capital requirements relate to the acquisition and maintenance of equipment and funding of working capital.

During 2023, the Company funded working capital requirements with cash on hand and borrowings under the ABL (as defined below) entered into in August 2023.

As of December 31, 2023, the Company had unrestricted cash and cash equivalents of $5.9 million, as compared to $12.3 million at December 31, 2022.

During the year ended December 31, 2022, the Company had an operating loss of $35.4 million, $44.6 million of cash used in operating activities, $5.3 million of cash provided by investing activities and $38.3 million of cash provided by 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 consolidated financial statements.

The availability of capital is dependent on the Company’s operating cash flow currently expected to be principally derived from the ProFrac Agreement (see Note 18, “Related Party Transactions”).

certain that the Company’s cash and other current assets and our forecasted operating cash flows currently expected to be generated from the ongoing execution of the ProFrac Agreement will provide the Company with sufficient financial resources to fund operations and meet our capital requirements and anticipated obligations as they become due in the next twelve months.

The Company may require additional liquidity to continue its operations over the next twelve months to sufficiently alleviate or mitigate the conditions and events noted above, which results in substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued.

The Company is evaluating strategies to obtain additional funding for future operations.

These strategies may include, but are not limited to, obtaining equity financing, issuing debt or entering into other financing arrangements, obtaining higher prices for its products and services, increasing the percentage of its sales from higher margin products, monetizing non-core assets, and reducing expenses.

However, the Company may be unable to access further equity or debt financing when needed.

As such, there can be no assurance that the Company will be able to obtain additional liquidity when needed or under acceptable terms, if at all.

The consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if the Company were unable to continue as a going concern.

I n addition , at March 11, 2024, the Company had approximately $0.5 million in borrowings outstanding under its ABL, as compared to $7.5 million at December 31, 2023.

During the year ended December 31, 2023, the Company had operating income of $23.2 million, $11.3 million of cash used in operating activities, $1.0 million of cash used in investing activities and $5.9 million of cash provided by financing activities.

Asset Based Loan

On August 14, 2023, the Company entered into a 24-month revolving loan and security agreement in connection with an Asset Based Loan (the “ABL”).

The ABL provides up to $10 million of initial credit availability, which is limited by a borrowing base consisting of (i) 85% of eligible accounts receivable, plus (ii) 60% of the value of eligible inventory not to exceed 100% of the eligible accounts receivable.

On October 5, 2023, the ABL was amended to increase its maximum borrowing base from $10.0 million to a total of $13.8 million.

As of December 31, 2023, the Company had $7.5 million outstanding under the ABL.

During the year ended December 31, 2023, the Company incurred $0.5 million in interest and fees related to the ABL, which included the annual fee of $0.1 million.

As of December 31, 2023, the Company had incurred origination costs of $0.5 million related to the ABL that was recorded as deferred financing costs to be amortized over the term of the ABL.

Borrowings under the ABL bear interest at the Wall Street Journal Prime Rate (subject to a floor of 5.50%) plus 2.5% per annum.

The interest rate under the ABL was 11% as of December 31, 2023.

The ABL contains an annual commitment fee equal to 1.0% of the ABL’s borrowing base.

Additionally, the Company will be assessed a non-usage fee of 0.25% per quarter based on the difference between the average daily outstanding balance and the borrowing base limit of the ABL.

If the ABL is terminated prior to the end of its 24-month term, the Company is required to pay an early termination fee of 2.50% of the borrowing base limit of the ABL (if terminated with more than 12 months remaining until the maturity date) or 1.50% of the borrowing base limit of the ABL (if terminated with less than 12 months remaining until the maturity date).

The ABL contains customary representations, warranties, covenants and events of default, the occurrence of which would permit the lender to accelerate the payment of any amounts borrowed.

The ABL requires the Company to maintain a minimum Tangible Net Worth (as defined in the ABL) of not less than $11 million.

In addition, the ABL provides the lender a blanket security interest on all or substantially all of the Company’s assets.

The Company was in compliance with all of the covenants under the ABL as of December 31, 2023.

Sources and Uses of Liquidity

The Company currently funds its operations with cash on hand, availability under the ABL (see Note 9, “Debt and Convertible Notes Payable” in Part II, Item 8 of this Annual Report) and other liquid assets.

Although the Company has a history of negative cash flows from operations and losses, the Company recognized $24.3 million and $24.7 million of gross profit and net income, respectively, during the year ended December 31, 2023.

While we believe that our cash, liquid assets, and availability under the ABL will provide us with sufficient financial resources to fund operations to meet our capital requirements and anticipated obligations as they become due, uncertainty surrounding the long term stability and strength of the oil and gas markets could have a negative impact on our liquidity.

As discussed in Note 17, “Related Party Transactions” in Part II, Item 8 of this Annual Report, the ProFrac Agreement contains minimum requirements for chemistry purchases.

If the minimum volumes are not achieved within the applicable measurement period, ProFrac Services LLC is required to pay to the Company, as liquidated damages (“Contract Shortfall Fees”), 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 the measurement period.

The current measurement period for Contract Shortfall Fees is June 1, 2023 through December 31, 2023.

The minimum purchase requirements were not met during the current measurement period, and as a result, related party revenues and receivables for the year ended and as of December 31, 2023 include $20.1 million in Contract Shortfall Fees of which $10.0 million has been collected through March 11, 2024.

The Company expects to receive the remaining $10.1 million on or before April 8, 2024.

For 2024, the measurement period will be January 1, 2024 through December 31, 2024.

If the minimum purchase requirements are not met during the year ended December 31, 2024, there will be additional Contract Shortfall Fees due during the first quarter of 2025.

Based upon the improvement in our outlook for future cash flows from operations that includes the collection of the Contract Shortfall Fees related to 2023 of $20.1 million, combined with cash on hand and availability under the ABL, the Company believes it has sufficient financial resources to fund operations and meet its capital requirements and anticipated obligations as they become due in the next twelve months.

However, the Company cannot guarantee a sufficient level of cash flows in the future.

The Company had previously disclosed in the consolidated financial statements as of and for the year ending December 31, 2022, that substantial doubt about the Company’s ability to continue as a going concern existed.

As described, the Company

has concluded that those conditions and events raising the substantial doubt no longer exist.

The consolidated financial statements have been prepared assuming that the Company will continue as a going concern.

Consolidated cash flows by type of activity are noted below (in thousands):

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Net cash used in operating activities $ (11,297) $ (44,632)

Net cash provided by investing activities 5,331 112

Net cash provided by (used in) financing activities 38,267 (372)

Net cash (used in) provided by investing activities (1,014) 5,331

Net cash provided by financing activities 5,928 38,267

Effect of changes in exchange rates on cash and cash equivalents (54) 100

1 unchanged sentence

Operating Activities

Net cash used in operating activities was $44.6 million and $25.8 million during the year ended December 31, 2022 and 2021, respectively.

Consolidated net loss for the year ended December 31, 2022 and 2021, were $42.3 million and $30.5 million, respectively.

During the year ended December 31, 2022, non-cash positive adjustments to net loss totaled $12.8 million as compared to $4.2 million for the same period of 2021.

• For the year ended December 31, 2022, non-cash positive adjustments included paid-in-kind interest on the Convertible Notes Payable and Contract Consideration Convertible Notes Payable of $6.0 million, amortization of contract assets and convertible note issuance costs of $3.4 million and $1.0 million, respectively and stock compensation expense of $3.3 million.

Net cash used in operating activities was $11.3 million and $44.6 million during the years ended December 31, 2023 and 2022, respectively.

Consolidated net income for the year ended December 31, 2023 was $24.7 million compared to a net loss of $42.3 million for the same period of 2022.

During the year ended December 31, 2023, non-cash adjustments to net income totaled $22.8 million as compared to $12.8 million for the same period of December 31, 2022.

• For the year ended December 31, 2023, non-cash adjustments included a $30.0 million gain on the fair value valuation of the Contingent Convertible Notes, a gain of $4.5 million for the Flotek PPP loan forgiveness, paid-in-kind interest on the Convertible Notes Payable and Contract Consideration Convertible Notes Payable of $2.3 million, amortization of contract assets and convertible note issuance costs of $5.0 million and $0.1 million, respectively, and stock compensation expense of $0.3 million.

The non-cash adjustment for the provision for excess and obsolete inventory was $1.0 million and depreciation was $0.7 million.

These were offset by adjustments for the gain on sale of property and and equipment of $2.9 million, attributable to the facility sales and the gain on lease termination of $0.6 million relating to the early termination of a lease on a Canadian facility.

• For the year ended December 31, 2021, non-cash adjustments included a $7.6 million benefit related to the ADM settlement and $8.1 million of impairment charges.

The non-cash adjustment for the provision of excess and obsolete inventory was $0.6 million and depreciation was $1.0 million.

Other non-cash adjustments included stock based compensation of $3.8 million, JP3 PPP loan forgiveness of $0.9 million and $0.8 million related to the change in fair value of contingent consideration.

During the year ended December 31, 2022, changes in working capital used $15.2 million of cash as compared to providing $0.5 million for the same period of 2021.

• For the year ended December 31, 2022, changes in working capital resulted primarily from increases in accounts receivable including related party and inventories of $28.7 million and $7.9 million, respectively, due to the significant increase in revenues.

Contract assets increased $3.6 million related to transaction fees paid, associated with Contract

Consideration Notes Payable.

This is partially offset by an increase of accounts payable of $25.8 million, attributable to the increase in activity.

• For the year ended December 31, 2021, changes in working capital resulted primarily from increases in accounts receivable and other current assets of $2.0 million and accounts payable of $1.8 million.

This has been offset by decreases in inventories and income taxes receivable of $2.1 million and accrued liabilities of $1.4 million.

Non-cash lease expense was $3.0 million primarily due to ROU Asset amortization for equipment leases which were added in 2022.

• For the year ended December 31, 2022, non-cash adjustments included paid-in-kind interest on the Convertible Notes Payable and Contract Consideration Convertible Notes Payable of $6.0 million, amortization of contract assets and convertible note issuance costs of $3.4 million and $1.0 million, respectively, and stock compensation expense of $3.3 million.

During the year ended December 31, 2023, changes in working capital used $13.2 million of cash as compared to using $15.2 million for the same period of 2022.

• For the year ended December 31, 2023, changes in working capital resulted primarily from increases in accounts receivable, including related party of $6.5 million, and a decrease in inventories of $1.9 million due to reduced ProFrac sales in late 2023.

Accounts payable and accrued liabilities decreased $1.7 million and $2.6 million, respectively.

The decrease in accrued liabilities is primarily due to accrued severance, sales taxes and professional fees, partially offset by higher bonus accruals.

Operating lease liabilities decreased $3.4 million primarily due to payments on equipment leases.

• For the year ended December 31, 2022, changes in working capital resulted primarily from increases in accounts receivable and inventories of $28.7 million and $7.9 million, respectively, due to the significant increase in revenues.

Contract assets increased $3.6 million related to transaction fees paid associated with Contract Consideration Notes Payable.

This was partially offset by an increase of accounts payable of $25.8 million, attributable to the increase in activity.

Investing Activities

Net cash provided by investing activities for the year ended December 31, 2022 was $5.3 million primarily from the sale of the facilities in Waller, Texas and Monahans, Texas which closed on April 18, 2022 and December 22, 2022, respectively, resulting in cash proceeds of $5.8 million, partially offset by capital additions.

Net cash provided by investing activities for the year ended December 31, 2021 was immaterial.

Net cash used by investing activities for the year ended December 31, 2023 was $1.0 million primarily due to system enhancements and capital additions.

Net cash provided by investing activities for the year ended December 31, 2022 was $5.3 million primarily related to the sale of assets.

Financing Activities

Net cash provided by financing activities was $5.9 million for the year ended December 31, 2023, primarily from net proceeds from the ABL.

Net cash provided was partially offset by severance payments attributed to former CEO’s forfeited vested stock options, loan origination fees, and payments for shares withheld for taxes.

Net cash provided by financing activities was $38.3 million for the year ended December 31, 2022, primarily from the proceeds of the issuance of convertible notes of $21.2 million and prefunded warrants of $19.5 million, partially offset by issuance costs of $2.3 million.

Net cash used in financing activities was $0.4 million for the year ended December 31, 2021, primarily for purchases of common stock related to tax withholding requirements.

Critical Accounting Policies and Estimates

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with U.S.

generally accepted accounting principles 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.

Significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” in Part II, Item 8 — “Financial Statements and Supplementary Data,” of this Annual Report.

The Company believes the following accounting policies are critical due to the significant subjective and complex judgments and estimates required when preparing the consolidated financial statements.

The Company regularly reviews judgments, assumptions and estimates related to the critical accounting policies.

Our most significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” in Part II, Item 8 — “Financial Statements and Supplementary Data,” of this Annual Report.

The Company believes the following accounting estimates are critical due to the significant subjective and complex judgments and estimates required when preparing the consolidated financial statements.

The Company regularly reviews judgments, assumptions and estimates related to the critical accounting estimates.

Contract Assets

The Company’s contract assets represent consideration issued in the form of convertible notes (Contract Consideration Convertible Notes Payable as discussed in Note 10, “Debt and Convertible Notes Payable”) and other incremental costs related to obtaining the ProFrac Agreement.

The contract assets are amortized over the term of the ProFrac Agreement (10 years) based on forecasted revenues.

The Company’s contract assets represent consideration which was issued in the form of convertible notes (Contract Consideration Convertible Notes Payable as discussed in Note 9, “Debt and Convertible Notes Payable” in Part II, Item 8) and other incremental costs related to obtaining the ProFrac Agreement in 2022.

The contract assets are amortized over the term of the ProFrac Agreement based on forecasted revenues.

As goods are transferred to ProFrac Services, LLC, the amortization is presented as a reduction of the transaction price included in related party revenue in the consolidated statements of operations.

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Fair Value of Contract Consideration Convertible Notes Payable

The Company accounts for the Contract Consideration Convertible Notes Payable as discussed in Note 10, “Debt and Convertible Notes Payable” issued related to obtaining the ProFrac Agreement, as liability classified convertible instruments in accordance with FASB ASC 718, “Stock Compensation”.

The Company accounted for the Contract Consideration Convertible Notes Payable, which was issued related to obtaining the ProFrac Agreement, as liability classified convertible instruments in accordance with FASB ASC 718, “Stock Compensation” (see Note 9, “Debt and Convertible Notes Payable” in Part II, Item 8 of this Annual Report).

Under ASC 718, liability classified convertible instruments are measured at fair value at the grant date and at each reporting date with the change in fair value included in the consolidated statements of operations.

The Company estimates the fair value of the Contract Consideration Convertible Notes Payable by means of a Monte Carlo simulation which utilizes key inputs such as the risk-free interest rate, stock price, expected volatility and term until liquidation.

At each reporting date preceding the date of maturity, the Contract Consideration Convertible Notes Payable were remeasured by means of a Monte Carlo simulation which utilized key inputs such as the risk-free interest rate, stock price, expected volatility and term until liquidation.

Significant changes to the key inputs such as the Company’s stock price and volatility would impact the estimated fair value.

The Contract Consideration Convertible Notes matured and were converted during the year ended December 31, 2023 in accordance with their terms.

Recent Accounting Pronouncements

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What changed 10-K

Item 7. Management’s Discussion and Analysis