Item 1A. Risk Factors
The Company’s business, financial condition, results of operations, cash flows, liquidity and prospects are subject to various risks and uncertainties. Readers of this Annual Report should not consider any descriptions of these risk factors to be a complete set of all potential risks that could affect the Company. These factors should be carefully considered together with the other information contained in this Annual Report and the other reports and materials filed by the Company with the SEC. Further, many of these risks are interrelated and, as a result, the occurrence of certain risks could trigger and/or exacerbate other risks. Such a combination could materially increase the severity of the impact of these risks on the Company’s business, results of operations, financial condition, cash flows, liquidity or prospects.
This Annual Report contains “forward-looking statements,” as defined in the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Forward-looking statements discuss Company prospects, expected revenue, expenses and profits, strategic and operational initiatives, and other activities. Forward-looking statements also contain suppositions regarding future oil and natural gas industry and other conditions, both domestically and internationally. The Company’s results could differ materially from those anticipated in the forward-looking statements as a result of a variety of factors, including risks described below and elsewhere. See “Forward-Looking Statements” at the beginning of this Annual Report.
Risks Related to the Company’s Business
The Company’s business is largely dependent upon its customers’ spending in the oil and gas industry. Spending could be adversely affected by industry conditions or by new or increased governmental regulations; global economic conditions; lingering sentiment surrounding the pandemic; the availability of credit; and oil and natural gas prices.
Demand for and prices of the Company’s products are subject to a variety of factors, including, but not limited to:
•global demand for energy as a result of population growth, economic development, and general economic and business conditions;
•the timing and rate of economic recovery from the effects of the pandemic;
•the ability of the Organization of Petroleum Exporting Countries (“OPEC”) to set and maintain production levels and the impact of non-OPEC producers on global supply;
•availability and quantity of natural gas storage;
•import and export volumes and pricing of liquefied natural gas;
•domestic and international refining activity;
•pipeline capacity to critical markets and out of producing regions;
•political and economic uncertainty, sociopolitical unrest including the current conflict in Ukraine and ongoing sanctions imposed on Russia;
•cost of exploration, production and transport of oil and natural gas;
•sustained market adoption of green chemistry solutions;
•technological advances impacting energy production and consumption;
•interest rates;
•weather conditions; and
•foreign exchange rates.
The volatility of commodity prices and the consequential effect on the activities of the Company’s target customer base could adversely impact the activity levels of the Company’s customers.
Demand for the Company’s goods and services may be adversely impacted if volatile economic conditions weaken customer expenditures, specifically as it concerns the continued adoption of chemistry solutions with lower overall impact on the environment. It is difficult to predict the pace of industry growth, the direction of oil and natural gas prices, the direction and magnitude of economic activity, the demand for professional chemistry products, and to what extent these conditions could affect the Company. However, reduced cash flow and capital availability could adversely impact the financial condition of the
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Company’s customers, which could result in customer project modifications, delays or cancellations, general business disruptions, and delay in, or nonpayment of, amounts that are owed to the Company. This could cause a negative impact on the Company’s results of operations and cash flows.
Furthermore, if key suppliers were to experience significant cash flow constraints or become insolvent as a result of such conditions, a reduction or interruption in supplies or a significant increase in the price of supplies could occur, adversely impacting the Company’s results of operations and cash flows.
The Company’s inability to develop and/or introduce new products or differentiate existing products could have an adverse effect on its ability to be responsive to customers’ needs and could result in a loss of customers, as well as adversely affecting the Company’s future success and profitability.
The industries in which the Company does business are characterized by technological advancements that have historically resulted in, and will likely continue to result in, substantial improvements in the scope and quality of specialty chemistries and analytical services. Consequently, the Company’s future success is dependent, in part, upon the Company’s continued ability to timely develop innovative products and services. Successful introduction of new technology requires time and resources, and there is no assurance that the Company will be able to commercialize new technology in a timely manner. If the Company fails to successfully develop and introduce innovative products and services that appeal to customers, or if existing or new market competitors develop superior products and services, the Company’s revenue and profitability could deteriorate.
The Company’s inability to develop green alternatives to existing conventional products could result in loss of customers, as well as adversely affecting the Company’s future success and profitability.
The Company develops, markets and produces certain green alternatives to many existing products. If these green alternatives do not perform as well as existing conventional products, or if existing or new market competitors develop superior products, the Company’s revenue and profitability could be adversely affected.
Reduced unconventional oil and gas drilling could lessen the positive effects of a general recovery of the oil and gas industry.
The majority of the Company’s product offerings in its CT segment, other than professional chemistry products, are used in unconventional oil and gas operations. The Company has a small exposure to conventional oil and gas operations through activity in the Middle East and little or no exposure to the offshore sector. In the event that an industry recovery is disproportionately driven by conventional and offshore oil and gas operations, the Company may not have a resulting increase in its operational results.
The Company’s business, financial condition, operating results and ability to grow and compete may be affected adversely if adequate capital is not available.
The Company’s existing resources including cash on hand, may not be sufficient to finance operations and strategies. The Company may therefore need to rely on external financing sources, including commercial borrowings and issuances of debt and equity securities. The Company’s ability to procure debt financing, is dependent on, among other things, the willingness of banks and other financial institutions to lend into the Company’s industry and on their evaluation of the Company’s credit risk. There is no guarantee that the Company will be able to procure debt financing or, in the event that it is able to procure debt financing, that the financing will be on favorable terms and conditions or at favorable rates of interest. If the Company cannot access debt and equity financing on acceptable terms when required, the Company’s business, financial conditions and operating results may be adversely affected. Further the ability of the Company to grow and be competitive in the market place may be adversely impacted as the Company may not be able to finance strategic growth plans, take advantage of business opportunities, or respond to competitive pressures.
Increased competition could exert downward pressure on prices charged for the Company’s products and services.
The Company operates in a competitive environment populated by large and small competitors. Competitors with greater resources and lower cost structures or who are trying to gain market share may be successful in providing competing products and services to the Company’s customers at lower prices than the Company currently charges. The Company operates in an environment with relatively low barriers to entry; employees of the Company may leave and compete directly with the
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Company. This may require the Company to lower its prices, resulting in an adverse impact on revenues, margins, and operating results. Thus, competition could have a detrimental impact on the Company’s business.
If the Company is unable to adequately protect intellectual property rights or is found to infringe upon the intellectual property rights of others, or is unable to maintain the registrations and certifications of its products and facilities, the Company’s business is likely to be adversely affected.
The Company relies on a combination of patents, trademarks, copyrights, trade secrets, non-disclosure agreements and other methods to access markets and create a competitive advantage. Although the Company believes that existing measures are reasonably adequate to protect intellectual property rights, there is no assurance that the measures taken will prevent misappropriation of proprietary information or dissuade others from independent development of similar products or services. Moreover, there is no assurance that the Company will be able to prevent competitors from copying, reverse engineering, modifying or otherwise obtaining, infringing and/or using the Company’s technology, intellectual property or proprietary rights to create competitive products or services. The Company may not be able to enforce intellectual property rights outside of the U.S. Additionally, the laws of certain countries in which the Company’s products and services are manufactured or marketed may not protect the Company’s proprietary rights to the same extent as do the laws of the U.S. In each case, the Company’s ability to compete could be significantly impaired.
A portion of the Company’s products and services are without patent protection. The issuance of a patent does not guarantee validity or enforceability. Third parties may have blocking patents that could be used to prevent the Company from marketing the Company’s own patented products and services and utilizing the Company’s patented technology.
The Company is exposed and, in the future, may be exposed to allegations of patent and other intellectual property infringement from others. The Company may allege infringement of its patents and other intellectual property rights against others. Under either scenario, the Company could become involved in costly litigation or other legal proceedings regarding its patent or other intellectual property rights, from both an enforcement and defensive standpoint. Even if the Company chooses to enforce its patent or other intellectual property rights against a third party, there may be risk that the Company’s patent or other intellectual property rights become invalidated or otherwise unenforceable through legal proceedings. These could result in the Company having to discontinue the use, manufacture and sale of certain products and services, increase the cost of selling certain products and services, or result in damage to the Company’s reputation. An award of damages, including material royalty payments, or the entry of an injunction order against the use, manufacture and sale of any of the Company’s products and services found to be infringing, could have an adverse effect on the Company’s results of operations and ability to compete.
Certain of the Company’s products and facilities, especially those related to the professional chemistry products, have been registered with the EPA. The failure of the Company to maintain such EPA registrations could result in the inability of the Company to market or sell its products. In the event that the Company cannot maintain its registrations or licenses or is unable to procure new licenses or registrations for new products or in response to changes to regulatory requirements, the ability of the Company to sell its products and obtain revenue may be adversely affected.
The Company’s reliance on the ProFrac Agreement could adversely impact our financial condition, results of operations and cash flows.
The ProFrac Agreement, still in its first year, is a major source of the Company’s liquidity and we expect it to remain so over the term of the contract. If the Company became unable to execute the requirements of the agreement financially and operationally, from procuring inventory to meet the needs of ProFrac Services, LLC under the ProFrac Agreement and executing timely billing and collection, the Company’s liquidity could be adversely impacted. Further, our relationship with ProFrac Services, LLC may impact their competitors willingness to purchase products from the Company or to seek price concessions.
We are also dependent on ProFrac Services, LLC’s compliance in meeting their committed activity levels and paying for products provided in a timely basis, in accordance with the terms of the ProFrac Agreement. Our financial condition, results of operations and cash flows may be adversely impacted if ProFrac Services, LLC’s financial condition or its spending level under the ProFrac Agreement is negatively impacted.
ProFrac Services, LLC has the right to terminate the ProFrac Agreement, by providing written notice to the Company, after the occurrence of any of the following events: (i) the Company’s bankruptcy; (ii) the Company’s failure to produce and deliver the product in accordance with the specifications, or failure to timely deliver product, and the Company has been unable to cure
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such failure within a commercially reasonable period determined by ProFrac; (iii) the Company fails to meet pricing requirements set forth in the ProFrac Agreement; or (iv) the Company is affected by a force majeure event, and such force majeure event has not been remedied within 30 days of the initial occurrence of such event. ProFrac also has the right to terminate the ProFrac Agreement for any other material breach of the ProFrac Agreement by the Company, if capable of being cured, is not cured within 30 days after written notice. Termination of the ProFrac Agreement would have a material adverse impact on the Company’s financial condition, results of operations and cash flows.
The loss of key customers could have an adverse impact on the Company’s results of operations and could result in a decline in the Company’s revenue.
In the CT segment in aggregate, revenue derived from the Company’s three largest customers as a percentage of consolidated revenue for the years ended December 31, 2022 and 2021, totaled 73% and 44%, respectively. The Company has seen customer concentration risk increase due to the recent entry into the long-term supply agreement with ProFrac Services LLC. Outside the ProFrac Agreement customer relationships are substantially governed by purchase orders or other short-term contractual obligations as opposed to long-term contracts. Losses of customers also may occur due to product, service or pricing issues, as well as industry consolidation. The Company competes in a highly competitive environment and must work diligently to create and maintain productive customer relationships, and the failure to maintain those relationships could result in the loss of one or more key customers. The loss of one or more key customers could have an adverse effect on the Company’s results of operations and could result in a decline in the Company’s revenue.
Loss of key suppliers, the inability to secure raw materials on a timely basis, or the Company’s inability to pass commodity price increases on to its customers could have a material adverse effect on the Company’s ability to service its customers’ needs and could result in a significant loss of customers.
Materials used in servicing and manufacturing operations, as well as those purchased for sale, are generally available on the open market from multiple sources. Acquisition costs and transportation of raw materials to the Company’s facilities have historically been impacted by extreme weather conditions. Additionally, prices paid for raw materials could be affected by energy products and other commodity prices; weather and disease associated with our crop dependent raw materials; tariffs and duties on imported materials; evolving geopolitical risks; foreign currency exchange rates; and phases of the general business cycle and global demand.
The prices of key raw materials are subject to market fluctuations, which at times can be significant and unpredictable. Availability of key raw materials, weather events, natural disasters, and health epidemics in countries from which the Company sources raw materials may significantly impact prices. During a period of scarcity of supply the Company may also be negatively impacted by prioritization decisions enacted by its suppliers.
The Company may be unable to pass along price increases to its customers, which could result in a materially adverse impact on margins and operating profits. The Company currently does not hedge commodity prices, but may consider such strategies in the future, and there is no guarantee that the Company’s purchasing strategies will prevent cost increases from resulting in materially adverse impacts on margins and operating profits.
The Company’s DA segment is dependent on its ability to source appropriate technical components for its VeraxTM measurement system, certain of which are specialty products that are sole-sourced and are not easily replaceable with other sources. Any inability to source appropriate components in the future could result in significant difficulty supplying equipment or services to the Company’s customers.
Removal of members of management or directors may be difficult or costly.
The Company’s management and employees may have retention, employment or severance agreements in place. In the event that our employees, management or directors do not have the proper skills for management or operation of the Company, or the Company otherwise wishes to remove them from their position(s), the Company may be required to pay severance or similar payments. In addition, the loss of key management personnel or directors and the required transition may cause interruption in
the operations, governance, strategies or management of the Company, which may significantly reduce the Company’s ability to manage operations effectively and implement strategic business initiatives.
Failure to maintain effective disclosure controls and procedures and internal controls over financial reporting could have an adverse effect on the Company’s operations and the trading price of the Company’s common stock.
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Effective internal controls are necessary for the Company to provide reliable financial reports, effectively prevent fraud and operate successfully as a public company. If the Company cannot provide reliable financial reporting or effectively prevent fraud, the Company’s reputation and operating results could be harmed. If the Company is unable to maintain effective disclosure controls and procedures and internal controls over financial reports, the Company may not be able to provide reliable financial reporting, which in turn could affect the Company’s operating results or cause the Company to fail to meet its reporting obligations. Ineffective internal controls could also cause investors to lose confidence in reported financial information, which could negatively affect the trading price of the Company’s common stock, limit the ability of the Company to access capital markets in the future, and require additional costs to improve internal control systems and procedures.
Failure to collect for goods and services sold to key customers could have an adverse effect on the Company’s financial results, liquidity and cash flows.
The Company performs credit analysis on potential customers; however, credit analysis does not provide full assurance that customers will be willing and/or able to pay for goods and services purchased from the Company. Furthermore, collectability of international sales can be subject to the laws of foreign countries, which may provide more limited protection to the Company in the event of a dispute over payment. Because sales to domestic and international customers are generally made on an unsecured basis, there can be no assurance of collectability. The Company’s sales revenues are concentrated among customers operating in the oil and gas industry. Furthermore, the Company has seen an increase in concentration risk in 2022 which it anticipates to increase in 2023 and beyond as a result of the Company’s entry into the ProFrac Agreement. If one or more major customers are unwilling or unable to pay their debts to the Company, it could have an adverse effect of the Company’s financial results, liquidity and cash flows.
Failure to adapt to changing buying habits of the Company’s potential and existing customers could have a negative effect on the Company’s ability to attract and retain business.
The demographics and habits of the purchasing departments of many of the Company’s customers and potential customers is changing. Key decision makers may be less experienced and show different buying habits and approaches. Customers are increasingly requiring vendors to integrate with purchasing modules and are using advanced analytics to make purchasing decisions. If the Company does not adapt to these changing purchasing trends, the Company may not be able to attract or retain business.
Cyberattacks may have a significant and adverse impact on the Company’s operations and related financial condition.
The Company relies on access to information systems for operational, reporting and communication functions. Impairments of these systems, such as ransomware and network communications disruptions, could have an adverse effect on our ability to conduct operations and could directly impact consolidated reporting. Phishing attacks could result in sensitive or confidential information being released by the Company. Security breaches pose a risk to confidential data and intellectual property, which could result in damages to our competitiveness and reputation. The Company’s policies and procedures, system monitoring and data back-up processes may not prevent or detect potential disruptions or breaches in a timely or effective manner. There can be no assurance that existing or emerging threats will not have an adverse impact on our systems or communications networks. While the Company does carry cybersecurity insurance, the coverage and amount of such insurance may not be sufficient to adequately compensate the Company for cybersecurity loss.
Unforeseen contingencies such as litigation could adversely affect the Company’s financial condition.
The Company is, and from time to time may become, a party to legal proceedings incidental to the Company’s business involving alleged injuries arising from the use of Company products, exposure to hazardous substances, patent infringement, employment matters, commercial disputes, claims related to adverse physical reactions to the Company’s products such as rashes or allergic reactions and shareholder lawsuits. The defense of these lawsuits may require significant expenses, divert management’s attention, and may require the Company to pay damages that could adversely affect the Company’s financial condition. In addition, any insurance or indemnification rights that the Company may have might be insufficient or unavailable to protect against potential loss exposures.
The Company’s current insurance policies may not adequately protect the Company’s business from all potential risks.
The Company’s operations are subject to risks inherent in the specialty chemical industry, such as, but not limited to, accidents, explosions, fires, severe weather, oil and chemical spills, and other hazards. These conditions can result in personal injury or
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loss of life, damage to property, equipment and the environment, as well as suspension of customers’ oil and gas operations. These events could result in damages requiring costly repairs, the interruption of Company business, including the loss of revenue and profits, and/or the Company being named as a defendant in lawsuits asserting large claims. The Company does not have insurance against all foreseeable or unforeseeable risks. Consequently, losses and liabilities arising from uninsured or underinsured events could have an adverse effect on the Company’s business, financial condition and results of operations.
If the Company does not manage the potential difficulties associated with expansion successfully, the Company’s operating results could be adversely affected.
The Company believes future success will depend, in part, on the Company’s ability to adapt to market opportunities and changes, to successfully integrate the operations of any businesses acquired, to enhance existing product and service lines, and potentially expand into new product and service areas in which the Company may not have prior experience. Factors that could result in strategic business difficulties include, but are not limited to:
•failure to effectively integrate acquisitions, joint ventures or strategic alliances;
•failure to effectively integrate and perform on the ProFrac Agreement;
•failure to effectively plan for risks associated with expansion into areas in which management lacks prior experience;
•lack of experienced management personnel;
•increased administrative burdens;
•lack of customer retention;
•technological obsolescence; and
•infrastructure, technological, communication and logistical problems associated with large, expansive operations.
If the Company fails to manage potential difficulties successfully, the Company’s operating results could be adversely impacted.
The Company may pursue strategic acquisitions, joint ventures and strategic divestitures, which could have an adverse impact on the Company’s business.
The Company’s potential future acquisitions, joint ventures, and divestitures involve risks that could adversely affect the Company’s business. Negotiations of potential acquisitions, joint ventures, or other strategic relationships, integration of newly acquired businesses, and/or sales of existing businesses could be time consuming and divert management’s attention from other business concerns. Acquisitions and joint ventures could also expose the Company to unforeseen liabilities or risks associated with new markets or businesses. Unforeseen operational difficulties related to acquisitions and joint ventures could result in diminished financial performance or require a disproportionate amount of the Company’s management’s attention and resources. Additionally, acquisitions could result in the commitment of capital resources without the realization of anticipated returns. Divestitures could result in the loss of future earnings without adequate compensation and the loss of unrealized strategic opportunities.
The Company’s ability to use net operating losses and tax attribute carryforwards to offset future taxable income may be limited.
Under Section 382 of the Internal Revenue Code of 1986, as amended, a corporation that undergoes an “ownership change” is subject to limitations on the Company’s ability to utilize pre-change net operating losses (“NOLs”), and certain other tax attributes to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 50 percentage points over such stockholders’ lowest percentage ownership during the testing period (generally three years). An ownership change could limit the Company’s ability to utilize existing NOLs and tax attribute carryforwards for taxable years including or following an identified “ownership change.” Transactions involving the Company’s common stock, even those outside the Company’s control, such as purchases or sales by investors, within the testing period could result in an “ownership change.” Moreover, we believe the convertible notes and warrants transactions with ProFrac Holdings, LLC may substantially impact our ability to use NOLs.
In addition, under the 2017 Tax Act, the ability to carry back NOLs to prior taxable years is generally eliminated, and while NOLs arising in tax years beginning after 2017 may be carried forward indefinitely, these post-2017 NOLs may only reduce 80% of the Company’s taxable income in a tax year. Limitations imposed on the ability to use NOLs and tax credits to offset future taxable income could reduce or eliminate the benefit of the NOLs and tax attributes and could require the Company to pay U.S. federal income taxes in excess of that which would otherwise be required if such limitations were not in effect. Similar rules and limitations may apply for state income tax purposes.
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The Company is subject to complex foreign, federal, state and local environmental, health, and safety laws and regulations, which expose the Company to liabilities that could adversely affect the Company’s business, financial condition, and results of operations.
The Company’s operations are subject to foreign, federal, state, and local laws and regulations related to, among other things, the protection of natural resources, injury, health and safety considerations, chemical exposure assessment, waste management, and transportation of waste and other hazardous materials. The Company’s operations are exposed to risks of environmental liability that could result in fines, penalties, remediation, property damage, and personal injury liability. Sanctions for noncompliance with such laws and regulations could include assessment of administrative, civil and criminal penalties, revocation of permits, and issuance of corrective action orders.
The Company could incur substantial costs to ensure compliance with existing and future laws and regulations. Laws protecting the environment have generally become more stringent and are expected to continue to evolve and become more complex and restrictive in the future. Failure to comply with applicable laws and regulations could result in material expense associated with future environmental compliance and remediation. The Company’s costs of compliance could also increase if existing laws and regulations are amended or reinterpreted. Such amendments or reinterpretations of existing laws or regulations, or the adoption of new laws or regulations, could curtail exploratory or developmental drilling for, and production of, oil and natural gas which, in turn, could limit demand for the Company’s products and services. Some environmental laws and regulations could also impose joint and strict liability, meaning that the Company could be exposed in certain situations to increased liabilities as a result of the Company’s conduct that was lawful at the time it occurred or conduct of, or conditions caused by, prior operators or other third parties. Remediation expense and other damages arising as a result of such laws and regulations could be substantial and have a material adverse effect on the Company’s financial condition and results of operations.
The Company and the Company’s customers are subject to risks associated with doing business outside of the U.S., including political risk, foreign exchange risk, and other uncertainties.
Less than 10 % of the Company’s revenue for the year ended December 31, 2022 was from customers based outside of the U.S. The Company and its customers are subject to risks inherent in doing business outside of the U.S., including, but not limited to:
•governmental instability;
•corruption;
•war and other international conflicts;
•civil and labor disturbances;
•requirements of local ownership;
•cartel behavior;
•partial or total expropriation or nationalization;
•currency devaluation; and
•foreign laws and policies, each of which can limit the movement of assets or funds or result in the deprivation of contractual rights or appropriation of property without fair compensation.
Collections from international customers could also prove difficult due to inherent uncertainties in foreign law and judicial procedures. The Company could experience significant difficulty with collections or recovery due to the political or judicial climate in foreign countries where Company operations occur or in which the Company’s products are sold.
The Company’s international operations must be compliant with the Foreign Corrupt Practices Act and other applicable U.S. laws. The Company could become liable under these laws for actions taken by employees. Compliance with international laws and regulations could become more complex and expensive thereby creating increased risk as the Company’s international business portfolio grows. Further, the U.S. periodically enacts laws and imposes regulations prohibiting or restricting trade with certain nations. The current sanctions imposed on trade with Russia does not currently impact because the Company does not have any activity within that Region. The U.S. government could also change these laws or enact new laws that could restrict or prohibit the Company from doing business in identified foreign countries. The Company conducts, and will continue to conduct, business in currencies other than the U.S. dollar. Historically, the Company has not hedged against foreign currency fluctuations. Accordingly, the Company’s profitability could be affected by fluctuations in foreign exchange rates.
The Company has no control over and can provide no assurances that future laws and regulations will not materially impact the Company’s ability to conduct international business.
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Regulatory pressures, environmental activism, and legislation could result in reduced demand for the Company’s products and services, increase the Company’s costs, and adversely affect the Company’s business, financial condition and results of operations.
Regulations restricting volatile organic compounds (“VOC”) exist in many states and/or communities which limit demand for certain products. Although citrus oil is considered a VOC, its health, safety, and environmental profile is preferred over other solvents (e.g., benzene, toluene, ethylbenzene and xylene), which is currently creating new market opportunities around the world. Changes in the perception of citrus oils as a preferred VOC, increased consumer activism against hydraulic fracturing or other regulatory or legislative actions by governments could potentially result in materially reduced demand for the Company’s products and services and could adversely affect the Company’s business, financial condition, and results of operations.
Perceptions and related usage of chemistry solutions that are currently considered safe and acceptable, within specified parameters, may be subject to change in future periods as research and testing of environmental impacts mature.
Changes in laws and regulations relating to hydraulic fracturing may have a negative effect on the Company’s operations.
Much of the Company’s revenue in its CT segment is derived from customers engaged in hydraulic fracturing services. Some states have adopted regulations which require operators to publicly disclose certain non-proprietary information. These regulations could require the reporting and public disclosure of the Company’s proprietary chemistry formulas. The adoption of any future federal or state laws or local requirements, or the implementation of regulations imposing reporting obligations on, or otherwise limiting, the hydraulic fracturing process, could increase the difficulty of oil and natural gas production activity and could have an adverse effect on the Company’s future results of operations.
Climate change, environmental, social and governance and sustainability initiatives may result in regulatory or structural industry changes that could require significant operational changes and expenditures, reduce demand for the Company’s products and services and adversely affect the Company’s business, financial condition, results of operations, stock price or access to capital markets.
Climate change, environmental, social and governance (“ESG”) initiatives and sustainability are a growing global movement. Continuing political and social attention to these issues has resulted in both existing and pending international agreements and national, regional and local legislation, regulatory measures, reporting obligations and policy changes. Also, there is increasing societal pressure in some of the areas where the Company operates, to limit greenhouse gas emissions as well as other global initiatives. These agreements and measures, including the Paris Climate Accord, may require, or could result in future legislation, regulatory measures or policy changes that would require, significant equipment modifications, operational changes, taxes, or purchases of emission credits to reduce emission of greenhouse gases from the Company’s operations or those of our customers, which may result in substantial capital expenditures and compliance, operating, maintenance and remediation costs. As a result of heightened public awareness and attention to these issues as well as continued political and regulatory initiatives to reduce the reliance upon oil and natural gas, demand for hydrocarbons may be reduced, which could have an adverse effect on the Company’s business, financial condition, and results of operations. The imposition and enforcement of stringent greenhouse gas emissions reduction requirements could severely and adversely impact the oil and natural gas industry and therefore significantly reduce the value of the Company’s business.
Certain financial institutions, institutional investors and other sources of capital have begun to limit or eliminate their investment in financing of conventional energy-related activities due to concerns about climate change, which could make it more difficult for our customers and for the Company to finance our respective businesses. Increasing attention to climate change, ESG and sustainability has resulted in governmental investigations, and public and private litigation, which could increase the Company’s costs or otherwise adversely affect our business or results of operations.
In addition, some organizations that provide information to investors on corporate governance and related matters have developed ratings processes for evaluating companies on their approach to ESG matters. Such ratings are used by some investors to inform their investment and voting decisions. Unfavorable ESG ratings may lead to increased negative investor sentiment toward the Company and our industry and to the diversion of investment to other companies or industries, which could have a negative impact on the price of the Company’s securities and our access to and cost of capital.
Any or all of these ESG and sustainability initiatives may result in significant operational changes and expenditures, reduced demand for the Company’s products and services, and could materially adversely affect the Company’s business, financial condition, results of operations, stock price or access to capital markets.
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The persistence and/or emergence of new pandemic threats can significantly reduce demand for our services and adversely impact our financial condition, results of operations and cash flows.
Actions taken by businesses and governments in efforts to mitigate pandemic threats have the potential to negatively impact international and U.S. economic activity for an indeterminable duration. These effects can directly impact the demand for oil and natural gas, as well as our oil and gas related services and products. Furthermore, pandemic conditions can create disruptions in raw materials, logistics, and access to other critical resources such as human capital and financial markets.
Risks Related to the Company’s Industry
General economic declines or recessions, limits to credit availability, and industry specific factors could have an adverse effect on energy industry activity resulting in lower demand for the Company’s products and services.
Worldwide economic uncertainty can reduce the availability of liquidity and credit markets to fund the continuation and expansion of industrial business operations worldwide. The shortage of liquidity and credit combined with pressure on worldwide equity markets could continue to impact the worldwide economic climate. Geopolitical unrest around the world may also impact demand for the Company’s products and services both domestically and internationally.
Demand for many of the Company’s products and services is dependent on oil and natural gas industry activity and expenditure levels that are directly affected by trends in oil and natural gas prices. Demand for the Company’s products and services is particularly sensitive to levels of activity in the upstream, downstream and midstream sectors, and the corresponding capital spending by oil and natural gas companies, including national oil companies. While capital spending programs for domestic producers appear to be improving, uncertainties around the potential for longer-term weakness in oil and natural gas prices could reduce or defer major expenditures given the long-term nature of many large-scale development projects. Lower levels of activity could result in a corresponding decline in the demand for the Company’s oil and natural gas related products and services, which could have a material adverse effect on the Company’s revenue and profitability.
Events in global credit markets can significantly impact the availability of credit and associated financing costs for many of the Company’s customers. Many of the Company’s upstream customers finance their drilling and completion programs through third-party lenders or public debt offerings. Lack of available credit or increased costs of borrowing may cause customers to reduce spending on drilling programs, thereby reducing demand and potentially resulting in lower prices for the Company’s products and services. Also, the credit and economic environment could significantly impact the financial condition of some customers over a prolonged period, leading to business disruptions and restricted ability to pay for the Company’s products and services.
A continuous period of swings in oil and natural gas prices could result in further reductions in demand for the Company’s products and services and adversely affect the Company’s business, financial condition, and results of operations.
The markets for the Company’s products, especially oil and gas markets, have historically been volatile. Such volatility in oil and natural gas prices, or the perception by the Company’s customers of unpredictability in oil and natural gas prices, could adversely affect spending levels. The oil and natural gas markets may be volatile in the future. The demand for the Company’s products and services is, in large part, driven by general levels of exploration and production spending and drilling activity by its customers. Future declines in oil or gas prices could adversely affect the Company’s business, financial condition, and results of operations. The Company presently does not hedge oil and natural gas prices.
New and existing competitors within the Company’s industries could have an adverse effect on results of operations.
The industries in which the Company competes are highly competitive. The Company’s principal competitors include numerous small companies capable of competing effectively in the Company’s markets on a local basis, as well as a number of large companies that possess substantially greater financial and other resources. Larger competitors may be able to devote greater resources to developing, promoting, and selling products and services. The Company may also face increased competition due to the entry of new competitors including current suppliers that decide to sell their products and services directly to the Company’s customers. As a result of this competition, the Company could experience lower sales or greater operating costs, which could have an adverse effect on the Company’s margins and results of operations.
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The Company’s industry has a high rate of employee turnover. Difficulty attracting or retaining personnel or agents could adversely affect the Company’s business.
The Company operates in an industry that has historically been highly competitive in securing qualified personnel with the required technical skills and experience. The Company’s services require skilled personnel able to perform physically demanding work. Due to industry volatility, the demanding nature of the work, and the need for industry specific knowledge and technical skills, current employees could choose to pursue employment opportunities outside the Company that offer a more desirable work environment and/or higher compensation than is offered by the Company. As a result of these competitive labor conditions, the Company may not be able to find qualified labor, which could limit the Company’s growth. In addition, the cost of attracting and retaining qualified personnel has increased over the past several years due to competitive pressures. In order to attract and retain qualified personnel, the Company may be required to offer increased wages and benefits. If the Company is unable to increase the prices of products and services to compensate for increases in compensation including inflation, or is unable to attract and retain qualified personnel, operating results could be adversely affected.
Our DA segment may be materially and negatively affected by government regulations and/or facility disruptions.
The demand for our equipment and services offerings in our DA segment could be materially affected by additional regulations on the upstream, midstream, and downstream portions of the oil and gas sectors. Additional regulation on oil and gas production, transportation, or processing of hydrocarbons may result in significantly reduced demand for our offerings, either individually or as a result of a decline in the overall oil and gas markets in the United States and abroad. In addition, our products are subject to export control laws and regulations, and changes to those laws and regulations may negatively impact our ability to pursue international opportunities. Disruptions to pipelines and refineries, whether due to regulation, weather, demand, or other factors, may also have a materially adverse effect on our ability to derive revenue from our DA segment. Adjustments to our DA segment’s commercial strategy, with a shift towards subscription revenue and away from equipment sales, and the market’s response to that strategy, may materially and adversely affect revenues in the near term, even if the strategic shift is successful, due to longer payback periods on subscription models.
Investor sentiment and public perception related to the oil and natural gas industry and to ESG initiatives could increase costs of capital and reporting requirements and impact operations.
There are increasing financial risks for oil and natural gas producers, as stockholders and bondholders currently invested in oil and natural gas companies and concerned about the potential effects of climate change, ESG and other sustainability-related issues may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors, or into competitors who are perceived to have stronger ESG practices and disclosures. The Company’s ESG practices and disclosures may not satisfy investor requirements or their requirements may not be made known to the Company. The Company may continue to face increasing pressure regarding our ESG practices and disclosures, which pressures have intensified recently in connection with significant societal events and worldwide efforts to mitigate climate change.
The Company has developed, and will continue to develop, goals and other objectives related to ESG and sustainability matters. Statements related to these goals and objectives reflect the Company’s current plans and do not constitute a guarantee that they will be achieved. The Company’s ability to achieve any stated goal or objective is subject to numerous factors and conditions, some of which are outside of the Company’s control. The Company’s efforts to accurately report on ESG and sustainability matters, including our efforts to research, establish, accomplish and accurately report on goals and objectives, expose us to numerous operational, reputational, financial, legal, and other risks. Standards for tracking and reporting on ESG and sustainability matters, including climate-related matters, have not been harmonized and continue to evolve. The Company’s processes and controls for reporting on ESG and sustainability matters, including our goals and objectives, may not always comply with evolving and disparate standards for identifying, measuring, and reporting such metrics, including any climate change and sustainability-related public company disclosure requirements adopted by the SEC, and such standards may change over time, which could result in significant revisions to the Company’s current ESG practices and disclosures.
The lending and investment practices of institutional lenders and investors have been the subject of intensive lobbying efforts in recent years, oftentimes public in nature, not to provide funding for oil and natural gas producers, and some lenders and insurers have announced that they will not lend to or provide insurance for oil and natural gas companies. Limitation of investments in and financings for oil and natural gas could result in the restriction, delay, or cancellation of drilling and completion programs or development of production activities. An increasing number of the Company’s customers consider sustainability factors in awarding work. If the Company is unable to meet the ESG standards or investment criteria set by our customers, investors and other parties, which continue to evolve, if we are unable to successfully continue our sustainability enhancement efforts, or if,
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notwithstanding our own efforts, our industry becomes the focus of increasing ESG and sustainability related pressures, the Company may lose customers and investors and/or the Company’s cost of capital may increase.
Severe weather could have an adverse impact on the Company’s business.
The Company’s business could be materially and adversely affected by severe weather conditions. Hurricanes, tropical storms, flash floods, blizzards, cold weather, and other severe weather conditions could result in curtailment of services, damage to equipment and facilities, interruption in transportation of products and materials, and loss of productivity. If the Company’s customers are unable to operate or are required to reduce operations due to severe weather conditions, and as a result curtail purchases of the Company’s products and services, the Company’s business could be adversely affected.
A terrorist attack or armed conflict could harm the Company’s business.
Terrorist activities, anti-terrorist efforts, and other armed conflicts involving the U.S. could adversely affect the U.S. and global economies and could prevent the Company from meeting financial and other obligations. The Company could experience loss of business, delays or defaults in payments from payors, or disruptions of fuel supplies and markets if pipelines, production facilities, processing plants, or refineries are direct targets or indirect casualties of an act of terror or war. Such activities could reduce the overall demand for oil and natural gas which, in turn, could also reduce the demand for the Company’s products and services. Terrorist activities and the threat of potential terrorist activities and any resulting economic downturn could adversely affect the Company’s results of operations, impair the ability to raise capital, or otherwise adversely impact the Company’s ability to realize certain business strategies. The armed conflict in Ukraine could affect regions in which the Company does business directly or indirectly and could harm the Company’s ability to sell its good and services in those regions.
Risks Related to the Company’s Securities
The market price of the Company’s common stock has been and may continue to be volatile.
The market price of the Company’s common stock is subject to significant fluctuations. The following factors, among others, could cause the price of the Company’s common stock to fluctuate:
•variations in the Company’s quarterly results of operations;
•changes in market valuations of companies within the Company’s industry;
•fluctuations in stock market prices and volume;
•fluctuations in oil and natural gas prices;
•issuances of common stock or other securities in the future, including debt or warrants convertible into the Company’s common stock and earnings per share;
•additions or departures of key personnel;
•inability to perform the ProFrac Agreement
•announcements by the Company or the Company’s competitors of new business, acquisitions, or joint ventures; and
•negative statements made by external parties about the Company’s business in public forums.
The stock market has experienced significant price and volume fluctuations in recent years that have affected the price of common stock of companies within many industries including the oil and natural gas industry. The price of the Company’s common stock could fluctuate based upon factors that have little to do with the Company’s operational performance, and these fluctuations could materially reduce the Company’s stock price. The Company could be a defendant in a legal case related to a significant loss of value for the shareholders. This could be expensive and divert management’s attention and Company resources, as well as have an adverse effect on the Company’s business, operating results, cash flows, financial condition or securities.
An active market for the Company’s common stock may not continue to exist or may not continue to exist at current trading levels.
Trading volume for the Company’s common stock historically has been very volatile when compared to companies with larger market capitalization. The Company cannot presume that an active trading market for the Company’s common stock will continue or be sustained. Sales of a significant number of shares of the Company’s common stock in the public market could lower the market price of the Company’s stock.
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If the Company cannot meet the New York Stock Exchange (“NYSE”) continued listing requirements, the NYSE may delist the Company’s common stock.
The Company’s common stock is currently listed on the NYSE. In the future, if it is not able to meet the continued listing requirements of the NYSE, which require, among other things, that the average closing price of our common stock be above $1.00 over 30 consecutive trading days, the Company’s common stock may be delisted. If the Company is unable to satisfy the NYSE criteria for continued listing, its common stock would be subject to delisting. A delisting of its common stock could negatively impact the Company by, among other things, reducing the liquidity and market price of its common stock; reducing the number of investors willing to hold or acquire the Company’s common stock, which could negatively impact its ability to raise equity financing; decreasing the amount of news and analyst coverage of the Company; and limiting the Company’s ability to issue additional securities or obtain additional financing in the future. In addition, delisting from the NYSE might negatively impact the Company’s reputation and, as a consequence, its business, operating results, cash flows, financial condition or securities. As of the date of filing our consolidated financial statements, the Company’s common stock price is less than $1.00.
The Company’s relationship with ProFrac Services LLC and certain of its affiliates may create a conflict of interest.
The Company derived 59% of its revenue for the year ended December 31, 2022 from ProFrac Services LLC. In addition to being the Company’s largest customer, certain affiliates of ProFrac Services LLC, entered into various convertible debt transactions with the Company during 2022 (see Note 10, “Debt and Convertible Notes Payable” and Note 18, “Related Party Transactions,” in Part II, Item 8 - “Financial Statements and Supplementary Data” of this Annual Report). During 2023, the convertible debt instruments are expected to be converted into the Company’s common shares and pre-funded warrants. ProFrac Holdings, LLC also has the right to elect four out of seven Board members and currently consolidates Flotek in their financial results.
In connection with the conversion of the convertible debt, ProFrac Holdings, LLC or its affiliates are expected to become the Company’s largest shareholder during 2023. As a result of the operational and financial relationship with ProFrac Services LLC and its affiliates, as both a significant customer and a majority shareholder, certain conflicts of interest may occur.
Future issuance of additional shares of common stock could cause dilution of ownership interests and adversely affect the Company’s common stock price.
The Company is currently authorized to issue up to 240,000,000 shares of common stock. The Company may, in the future, issue previously authorized and unissued shares of common stock, which would result in the dilution of current stockholders’ ownership interests. Additional shares are subject to issuance through various convertible debt securities, equity compensation plans or through the exercise of currently outstanding equity awards. The potential issuance of additional shares of common stock may create downward pressure on the trading price of the Company’s common stock. The Company may also issue additional shares of common stock or other securities that are convertible into or exercisable for common stock in order to raise capital or effectuate other business purposes. Future sales of substantial amounts of common stock, or the perception that sales could occur, could have an adverse effect on the price of the Company’s common stock.
The Company may issue a substantial amount of securities in connection with future acquisitions, and the sale of those securities could adversely affect the trading price of our common stock or other securities.
As part of our growth strategy, we may issue additional securities, or securities that have rights, preferences, and privileges senior to our other securities. We may file future shelf registration statements with the SEC that we may use to sell securities from time to time in connection with acquisitions. To the extent that we are able to grow through acquisitions and are able to pay for such acquisitions with shares of our common stock or other securities, the number of outstanding shares of common stock or other securities that will be eligible for sale in the future is likely to increase substantially. Persons receiving shares of our common stock or other securities in connection with these acquisitions may be more likely to sell large quantities of their common stock or other securities, which may influence the price of our common stock or other securities. In addition, the potential issuance of additional shares of common stock or other securities in connection with anticipated acquisitions could lessen demand for our common stock or other securities and result in a lower price than would otherwise be obtained.
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The Company may issue shares of preferred stock or debt securities with greater rights than the Company’s common stock.
Subject to the rules of the NYSE, the Company’s certificate of incorporation authorizes the board of directors to issue one or more additional series of preferred stock and to set the terms of the issuance without seeking approval from holders of common stock. Currently, there are 100,000 preferred shares authorized, with no shares currently outstanding. Any preferred stock that is issued may rank senior to common stock in terms of dividends, priority and liquidation premiums, and may have greater voting rights than holders of common stock.
If securities or industry analysts do not publish research or reports about the Company’s business or publish negative reports, the Company’s securities prices and trading volumes could decline and affect the price at which investors could sell securities.
The trading market for the Company’s securities may be affected by the research and reports that industry or securities analysts publish about the Company or its business. The Company does not have any control over these analysts. If analysts do not cover the Company on a regular basis or if one or more analysts cease coverage of the Company or fail to regularly publish reports about the Company, the Company could lose visibility in the financial markets, which in turn could cause the Company’s securities prices or trading volumes to decline. If one or more of such analysts publish negative reports about the Company, the Company’s securities prices would likely decline. These occurrences could have an effect on the price investors could receive from the sale of the Company’s securities.
Certain anti-takeover provisions of the Company’s certificate of incorporation and applicable Delaware law could discourage or prevent others from acquiring the Company, which may adversely affect the market price of the Company’s common stock.
The Company’s certificate of incorporation and bylaws contain provisions that, among other things:
•permit the Company to issue, without stockholder approval, shares of preferred stock, in one or more series and, with respect to each series, to fix the designation, powers, preferences, and rights of the shares of the series;
•prohibit stockholders from calling special meetings;
•limit the ability of stockholders to act by written consent;
•prohibit cumulative voting; and
•require advance notice for stockholder proposals and nominations for election to the board of directors to be acted upon at meetings of stockholders.
In addition, Section 203 of the Delaware General Corporation Law limits business combinations with owners of more than 15% of the Company’s voting stock without the approval of the board of directors. Aforementioned provisions and other similar provisions make it more difficult for a third party to acquire the Company exclusive of negotiation. The Company’s board of directors could choose not to negotiate with an acquirer deemed not beneficial to or synergistic with the Company’s strategic outlook. If an acquirer were discouraged from offering to acquire the Company or prevented from successfully completing a hostile acquisition by these anti-takeover measures, stockholders could lose the opportunity to sell their shares at a favorable price.
The Company has no plans to pay dividends on the Company’s common stock, and, therefore, investors will have to look to stock appreciation for return on investments.
The Company does not anticipate paying any cash dividends on the Company’s common stock within the foreseeable future. Any payment of future dividends will be at the discretion of the Company’s board of directors and will depend, among other things, on the Company’s earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends, and other considerations deemed relevant by the board of directors. Investors must rely on sales of common stock held after price appreciation, which may never occur, in order to realize a return on their investment. The lack of plans for dividends may make the common stock of the Company an unattractive investment for investors who are seeking dividends.
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We identified a material weakness in our internal control over financial reporting. If we are unable to remediate this material weakness, or if we experience additional material weaknesses or other deficiencies in the future, or otherwise fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately or timely report our financial results, which could result in loss of investor confidence and adversely impact our stock price.
As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, the Dodd-Frank Act and other applicable securities rules and regulations. In particular, we are subject to reporting obligations under Section 404 of the Sarbanes-Oxley Act that require us to include a management report on our internal control over financial reporting in our annual report, which contains management’s assessment of the effectiveness of our internal control over financial reporting.
Internal controls must be evaluated continuously and be properly designed and executed by a sufficient level of properly trained staff to maintain adequate internal control over financial reporting. As disclosed in Part II, Item 9A, during the fourth quarter of 2022, management identified a material weakness in the design and operation of internal controls related to accounting for leases, prepaid assets and related-party revenues. We have begun designing and implementing measures to improve our internal controls over financial reporting and to remediate this material weakness. Our ability to comply with the annual internal control report requirements will depend on the effectiveness of our financial reporting controls across our company. We expect these systems and controls to involve significant expenditures and to may become more complex as our business grows. To effectively manage this complexity, we will need to continue to improve our operational, financial, and management controls, and our reporting systems and procedures. Our inability to successfully remediate our existing or any future material weaknesses or other deficiencies in our internal control over financial reporting or any failure to implement required new or improved controls, or difficulties encountered in the implementation or operation of these controls, could harm our operating results and cause us to fail to meet our financial reporting obligations or result in material misstatements in our financial statements, which could limit our liquidity and access to capital markets, adversely affect our business and investor confidence in our financial statements, and adversely impact our stock price.
General Risk Factors
If the Company loses the services of key members of management, the Company may not be able to manage operations and implement growth strategies.
The Board is currently searching for the Company’s next Chief Executive Officer and the length of time taken to select and appoint the appropriate person could adversely impact our operations and strategic business initiatives. The Company depends on the continued service of the President, and Chief Financial Officer and other key members of the executive management team, who possess significant expertise and knowledge of the Company’s business and industry. The Company has entered into employment agreements with certain of these key members. Any loss or interruption of the services of key members of the Company’s management could significantly reduce the Company’s ability to manage operations effectively and implement strategic business initiatives.
The Company’s tax returns are subject to audit by tax authorities. Taxing authorities may make claims for back taxes, interest and penalties. Changes in U.S. tax legislation may adversely affect our business, results of operations, financial condition and cash flows.
The Company is subject to income, property, excise, employment, and other taxes in the U.S. and a variety of other jurisdictions around the world. Tax rules and regulations in the U.S. and around the world are complex and subject to interpretation. From time to time, taxing authorities conduct audits of the Company’s tax filings and may make claims for increased taxes and, in some cases, assess interest and penalties. The assessments for back taxes, interest, and penalties could be significant. If the Company is unsuccessful in contesting these claims, the resulting payments could result in a drain on the Company’s capital resources and liquidity. In addition, there may be material adverse effects resulting from new or future U.S. tax reforms that have not been identified and that could have an adverse effect on the Company’s business, results of operations, financial condition and cash flows.
The Company maintains cash in excess of Federal Deposit Insurance Corporation (“FDIC”) protections therefore we may be at risk of losing cash on hand as a result of financial institution insolvency, which may be exacerbated by the recent unstable market and economic conditions and adverse developments with respect to the financial institutions.
The closures of Silicon Valley Bank (“SVB”) and Signature Bank and their placement into receivership with the FDIC created bank-specific and broader financial institution liquidity risk and concerns. The Department of the Treasury, the Federal
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Reserve, and the FDIC jointly released a statement that depositors at SVB and Signature Bank would have access to their funds, even those in excess of the standard FDIC insurance limits. As of the date of this Annual Report on Form 10-K, our exposure to SVB and Signature Bank is immaterial, however, we maintain cash balances at third-party financial institutions in excess of FDIC insurance protections. If the financial institution with which we deposit our cash were to become insolvent or were to be placed into receivership, we may be unable to access our capital or adequately fund our business for a prolonged period of time, or at all. If the equity and credit markets deteriorate, or if adverse developments are experienced by financial institutions, it may cause short-term liquidity risk and also make any necessary debt or equity financing more difficult, more costly and more dilutive. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our growth strategy, financial performance and stock price.
The consolidated financial statements included in this Annual Report 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 included in this Annual Report. 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” in Part II, Item 8 - “Financial Statements and Supplementary Data” of this Annual Report). It is not certain that the Company’s cash and other current assets and 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 contained in this Annual Report are issued.
Our independent registered public accounting firm has included an explanatory paragraph in its opinion on the Company’s consolidated financial statements with respect to the substantial doubt about the Company’s ability to continue as a going concern.
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.
Disclaimer of Obligation to Update
Except as required by applicable law or regulation, the Company assumes no obligation (and specifically disclaims any such obligation) to update these risk factors or any other forward-looking statement contained in this Annual Report to reflect actual results, changes in assumptions, or other factors affecting such forward-looking statements.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
As of December 31, 2022, the Company operates two manufacturing, warehouse and research facilities in the U.S. Internationally, the Company has a warehouse and research facility in Calgary, Alberta, Canada and a warehouse in Dubai, United Arab Emirates. The Company also has sales offices in Dubai, United Arab Emirates and Calgary, Alberta, Canada. The Company owns two of these facilities and the remainder are leased with lease terms that expire from 2023 through 2030. In
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addition, the Company’s corporate office is a leased facility located in Houston, Texas. The following table sets forth facility locations:
Segment Owned/Leased Location
Chemistry Technologies Owned Marlow, Oklahoma
Chemistry Technologies Owned Raceland, Louisiana
Chemistry Technologies Leased Dubai, United Arab Emirates
Chemistry Technologies Leased Calgary, Alberta
Chemistry Technologies Leased Raceland, Louisiana
Chemistry Technologies Leased Houston, Texas
Data Analytics Leased Austin, Texas
The Company sold its Waller, Texas facility on April 18, 2022 and its warehouse facility in Monahans, Texas on December 22, 2022.
Item 3. Legal Proceedings
Litigation
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.
On October 29, 2021, the Company reached an agreement (“the ADM Settlement) with Archer-Daniels-Midland Company (“ADM”), Florida Chemical Company (“FCC”) and other parties to pay $1.75 million and resolve all claims between the parties in relation to lawsuit claiming damages relating to the terpene supply agreement between Flotek Chemistry, LCC (“Flotek Chemistry”), a wholly owned subsidiary of the Company and FCC. The one-time payment of $1.75 million from Flotek to ADM was paid on January 3, 2022 and the terpene supply agreement is confirmed terminated, eliminating the prior obligation to purchase 10.5 million pounds of terpene through 2023.
The Company is subject to other routine litigation and other claims that arise in the normal course of business. 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.
See Note 13, “Commitments and Contingencies” in Part II, Item 8 – “Financial Statements and Supplementary Data” of this
Annual Report.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
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The Company’s common stock began trading on the NYSE on December 27, 2007, under the stock ticker symbol “FTK.” As of the close of business on March 13, 2023, there were approximately 8,782 holders of record. The Company’s closing sale price of the common stock on the NYSE on March 21, 2023 was $0.84. The Company has never declared or paid cash dividends on common stock. While the Company regularly assesses the dividend policy, the Company has no current plans to declare dividends on its common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
Equity compensation plan information relating to equity securities authorized for issuance under individual compensation agreements at December 31, 2022, is as follows:
(a) (b) (c)
(1) Includes shares for outstanding stock options (3,821,875 shares), restricted stock awards (2,299,679 shares), and restricted stock unit share equivalents (228,000 shares).
(2) The weighted-average exercise price is for outstanding stock options only and does not include outstanding restricted stock awards, restricted stock unit equivalents, and rights that have no exercise price.
Unregistered Sales of Equity Securities
The PIPE transaction, Contract Consideration Convertible Notes Payable and Prefunded Warrants (Note 10, “Debt and Convertible Notes Payable” and Note 14, “Stockholders’ Equity” of the Notes to Consolidated Financial Statements contained in Part II, Item 8) were exempted from the registration under the Securities Act of 1933, as amended (the “Securities Act”) in reliance on Section 4(a)(2) of the Securities Act and/or Regulation D promulgated thereunder, and in reliance on similar exemptions under applicable state securities laws.
Issuer Purchases of Equity Securities
The Company’s stock compensation plans allow employees to elect to have shares withheld to satisfy their tax liabilities related to non-qualified stock options exercised or restricted stock vested or to pay the exercise price of the options. When this settlement method is elected by the employee, the Company repurchases the shares withheld upon vesting of the award stock. Repurchases of the Company’s equity securities during the three months ended December 31, 2022, that the Company made or were made on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act are as follows:
Period Total Number of Shares Purchased (1) Average Price Paid per Share
(1) The Company purchases shares of its common stock (a) to satisfy tax withholding requirements and payment remittance obligations related to period vesting of restricted shares and exercise of non-qualified stock options and (b) to satisfy payments required for common stock upon the exercise of stock options.
Item 6. [Reserved]
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Not applicable.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes thereto, which have been prepared in accordance with U.S. GAAP, included elsewhere in this Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and is subject to the safe harbor created by those sections. As a result of many risks and uncertainties, including those factors set forth in Item 1A -Risk Factors of this Annual Report, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. For more information, see “Forward-Looking Statements.” These forward-looking statements are made as of the date of this report, and we do not intend, and do not assume any obligation, to update these forward-looking statements, except as required by applicable law. All dollar amounts stated herein are in U.S. dollars unless specified otherwise.
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 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.
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. 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-
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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 VeraxTM analyzers for deployment internationally which was certified for compliance in hazardous locations and harsh weather conditions.
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.
Consolidated Results of Operations (in thousands)
Years ended December 31,
Revenue
Gross profit (loss) % (4.9) % 7.5 %
Selling, general and administrative % 19.9 % 46.6 %
Gain on disposal of property and equipment (2,916) (94)
Gain on lease termination (584) —
Gain in fair value of contract consideration convertible notes payable (75) —
Impairment of goodwill — 8,092
Operating margin % (26.0) % (72.7) %
Paycheck protection plan loan forgiveness — 881
Interest expense and other income, net (6,906) 9
Income tax benefit 22 40
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Consolidated revenue for the year ended December 31, 2022, increased $92.8 million, or 215% versus the same period of 2021. 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”.
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, 2022, increased $7.0 million, or 35%, versus the same period of 2021. 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.
Results by Segment (in thousands):
Chemistry Technologies Results of Operations:
Years ended December 31,
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
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from the release of accrued costs relating to the ADM settlement of $7.6 million, see Note 13, “Commitments and Contingencies”.
Data Analytics Results of Operations:
Years ended December 31,
Revenue from external customers $ 5,384 $ 4,339
Revenue from related party 130 —
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.
Loss from operations for the DA segment for the year ended December 31, 2022 decreased $9.3 million, or 76%, compared to 2021. 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.
Corporate and Other Results of Operations:
Years ended December 31,
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.
Capital Resources and Liquidity
Overview
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.
As of December 31, 2022, the Company had unrestricted cash and cash equivalents of $12.3 million, as compared to $11.5 million at December 31, 2021. 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”). It is not
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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.
Cash Flows
Consolidated cash flows by type of activity are noted below (in thousands):
Years ended December 31,
Net cash used in operating activities $ (44,632) $ (25,840)
Net cash provided by investing activities 5,331 112
Net cash provided by (used in) financing activities 38,267 (372)
Effect of changes in exchange rates on cash and cash equivalents 100 100
Net change in cash, cash equivalents and restricted cash $ (934) $ (26,000)
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. The non-cash adjustment for the provision for excess and obsolete inventory was $1.7 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
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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.
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.
Financing Activities
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
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.
Contract Assets
The Company’s contract assets represent consideration issued in the form of convertible notes (Contract Consideration Convertible Notes Payable as discussed in Note 10, “Debt and Convertible Notes Payable”) and other incremental costs related to obtaining the ProFrac Agreement. The contract assets are amortized over the term of the ProFrac Agreement (10 years) based on forecasted revenues. As goods are transferred to ProFrac Services, LLC, 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 contract less the direct costs that relate to providing those goods in the future. Significant or unanticipated changes to our forecast could impact the recoverability of the contract assets.
Reserve for Excess and Obsolete Inventory
Inventories consist of raw materials and finished goods and are stated at the lower of cost, or market determined using the weighted-average cost method, or net realizable value. Finished goods inventories include raw materials, direct labor and production overhead.
The Company 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.
At December 31, 2022 and 2021, the reserve for excess and obsolete inventory was $8.2 million and $10.1 million, or 34.3% and 51.8% of inventory, respectively. Significant or unanticipated changes to our estimates and forecasts could impact the amount and timing of any additional provisions for excess and obsolete inventory.
Fair Value of Contract Consideration Convertible Notes Payable
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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”. 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. Significant changes to the key inputs such as the Company’s stock price and volatility would impact the estimated fair value.
Recent Accounting Pronouncements
Recent accounting pronouncements which may impact the Company are described in Note 2, “Summary of Significant Accounting Policies - Recent Accounting Pronouncements,” in Part II, Item 8 — “Financial Statements” of this Annual Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is primarily exposed to market risk from changes in raw material prices, freight costs, and foreign currency exchange rates. Market risk is measured as the potential negative impact on earnings, cash flows or fair values resulting from a hypothetical change in interest rates, commodity prices or foreign currency exchange rates over the next year. The Company manages exposure to market risks at the corporate level. The portfolio of interest-sensitive assets and liabilities is monitored and adjusted to provide liquidity necessary to satisfy anticipated short-term needs. The Company’s risk management policies allow the use of specified financial instruments for hedging purposes only. Speculation on interest rates or foreign currency rates is not permitted. The Company does not consider any of these risk management activities to be material.
Foreign Currency Exchange Risk
The Company’s functional currency is primarily the U.S. dollar. The Company operates principally in the United States and has limited exposure to foreign currency risk in its international operations. During 2022, approximately 0.74% of revenue was denominated in non-U.S. dollar currencies and substantially all assets and liabilities of the Company are denominated in U.S. dollars. However, as the Company expands its international operations, non-U.S. denominated activity is likely to increase. The Company has not historically used swaps or foreign currency hedges, however, the Company may utilize swaps or foreign currency hedges in the future.
Commodity Risk
The Company, and the CT segment in particular, primarily relies upon supply relationships to meet many of its raw material needs. Price increases are passed along to the Company’s customers, where applicable or possible. The Company presently does not utilize commodity derivative instruments but may consider utilizing forms of hedging to mitigate the effects of rising commodity prices on its supplies, in the future.
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Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors Flotek Industries, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Flotek Industries, Inc. and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, cash flows, and stockholders’ equity for each of the years in the two-year period ended December 31, 2022, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring operating losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for convertible instruments as of January 1, 2022 due to the adoption of ASU No. 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or
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disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Recoverability of contract assets
As described in Note 2 to the Company’s consolidated financial statements, the Company’s contract assets represent consideration issued in the form of convertible notes and other incremental costs related to obtaining a contract with ProFrac Services, LLC, a related party customer. The contract assets are tested for recoverability on a recurring basis and the Company will recognize an impairment loss to the extent that the carrying amount of the contract assets exceeds the amount of revenue the Company expects to receive in the future for the transfer of goods under the long-term supply agreement and the amendment to that agreement (collectively, the ProFrac Agreement) less the direct costs that relate to providing those goods in the future. As described in Note 4, the Company had recorded contract assets, net of $79.7 million as of December 31, 2022.
We identified the evaluation of the recoverability of contract assets as a critical audit matter. There was subjective auditor judgement in evaluating the key assumptions used in the Company’s contract asset recoverability assessment, specifically the forecasted product revenue and related forecasted costs to provide products over the term of the ProFrac Agreement.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design of certain internal controls related to the Company’s contract assets recoverability assessment, including controls over the development of forecasted revenue and costs over the term of the ProFrac Agreement. To assess the Company’s ability to forecast revenue and costs, we compared revenue and cost forecasts for the current year to actual results. We performed sensitivity analyses over the Company’s contract asset recoverability assessment by evaluating the effect of changes in the forecasted revenue and costs over the term of the ProFrac Agreement. We assessed the reasonableness of forecasted revenue and costs by considering whether such amounts were consistent with evidence obtained in other areas of the audit.
/s/ KPMG LLP
We have served as the Company’s auditor since 2021.
Houston, Texas
March 22, 2023
FLOTEK INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31,
ASSETS
Current assets:
Accounts receivable, related party 22,683 1,300
Current contract assets 7,113 —
Assets held for sale — 2,762
Long-term contract assets 72,576 —
Operating lease right-of-use assets 5,900 2,041
Deferred tax assets, net 404 279
Other long-term assets 17 29
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Income taxes payable 97 4
Current portion of operating lease liabilities 3,328 602
Current portion of finance lease liabilities 36 41
Current portion of long-term debt 2,052 1,436
Convertible notes payable 19,799 —
Contract consideration convertible notes payable 83,570 —
Deferred revenue, long-term 44 91
Long-term operating lease liabilities 8,044 7,779
Long-term finance lease liabilities 19 53
Stockholders’ equity:
Accumulated other comprehensive income 181 81
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 164,810 $ 50,244
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended December 31,
Revenue:
Operating costs and expenses:
Gain on disposal of property and equipment (2,916) (94)
Gain on lease termination (584) —
Gain on fair value of contract consideration convertible notes payable (75) —
Impairment of goodwill — 8,092
Other income (expense):
Paycheck protection plan loan forgiveness — 881
Total other income (expense) (6,906) 890
Income tax benefit 22 40
Loss per common share:
Weighted average common shares:
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
Years ended December 31,
Other comprehensive income:
Foreign currency translation adjustment 100 100
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash used in operating activities:
Change in fair value of contingent consideration (25) (808)
Change in fair value of contract consideration convertible notes payable (75) —
Amortization of convertible note issuance cost 1,002 —
Paid-in-kind interest expense 5,956 —
Amortization of contract assets 3,371 —
Provision for doubtful accounts, net of recoveries 203 (127)
Inventory purchase commitment settlement — (7,633)
Provision for excess and obsolete inventory 1,734 623
Impairment of goodwill — 8,092
Gain on sale of property and equipment (2,916) (94)
Gain on lease termination (584) —
Deferred income tax benefit (125) (56)
Paycheck protection plan loan forgiveness — (881)
Changes in current assets and liabilities:
Accounts receivable, related party (21,383) (1,300)
Income taxes receivable 14 381
Contract assets (3,600) —
Accrued liabilities (34) (860)
Operating lease liabilities (507) (603)
Income taxes payable 93 (17)
Interest payable 48 48
Net cash used in operating activities (44,632) (25,840)
Cash flows from investing activities:
Capital expenditures (421) (39)
Proceeds from sale of assets 5,752 151
Net cash provided by investing activities 5,331 112
Cash flows from financing activities:
Proceeds from issuance of convertible notes 21,150 —
Payment of issuance costs of convertible notes (1,084) —
Proceeds from issuance of warrants 19,500 —
Payment of issuance costs of stock warrants (1,170) —
Payments to tax authorities for shares withheld from employees (224) (390)
Proceeds from issuance of stock 133 80
Payments for finance leases (38) (62)
Net cash provided by (used in) financing activities 38,267 (372)
Effect of changes in exchange rates on cash and cash equivalents 100 100
Net change in cash, cash equivalents and restricted cash (934) (26,000)
Cash and cash equivalents at the beginning of period 11,534 38,660
Restricted cash at the beginning of period 1,790 664
Cash and cash equivalents at end of period 12,290 11,534
Restricted cash at the end of period 100 1,790
Cash, cash equivalents and restricted cash at end of period $ 12,390 $ 13,324
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2022 and 2021
(In thousands of U.S. dollars and shares)
SharesIssued ParValue Shares Cost
Foreign currency translation adjustment — — — — — 100 — 100
Stock issued under employee stock purchase plan — — (40) — 140 — — 140
Restricted stock granted 1,533 — — — — — — —
Restricted stock forfeited (3) — 30 — — — — —
Restricted stock units vested 144 — — — (31) — — (31)
Stock compensation expense — — — — 3,325 — — 3,325
Issuance of stock warrants, net of transaction fee — — — — 9,930 — — 9,930
Equity contribution — — — — 8,400 — — 8,400
Conversion of notes to common stock 2,793 — — — 3,038 — — 3,038
SharesIssued ParValue Shares Cost
Foreign currency translation adjustment — — — — — 100 — 100
Stock issued under employee stock purchase plan — — (136) — 80 — — 80
Restricted stock granted 1,702 — — — — — — —
Restricted stock forfeited (284) — 422 — — — — —
Restricted units vested 86 — — — — — — —
Stock compensation expense — — — — 3,757 — — 3,757
(1) See Note 14, “Stockholders’ Equity” for further discussion.
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — Organization and Nature of Operations
General
Flotek Industries, Inc. (“Flotek” or the “Company”) creates unique solutions to reduce the environmental impact of energy on air, water, land and people. A technology-driven, specialty green chemistry and data company, Flotek helps customers across industrial and commercial markets improve their environmental performance.
The Company’s Chemistry Technologies (“CT”) segment develops, manufactures, packages, distributes, delivers, and markets green specialty chemicals that aim to enhance the profitability of hydrocarbon producers.
The Company’s Data Analytics (“DA”) segment aims to enable users to maximize the value of their hydrocarbon associated processes by providing analytics associated with their hydrocarbon streams in seconds rather than minutes or days. The real-time access to information prevents waste, reduces reprocessing and allows users to pursue automation of their hydrocarbon streams to maximize their profitability.
The Company’s two operating segments, CT and DA, are both supported by its Research & Innovation advanced laboratory capabilities. For further discussion of our operations and segments, see Note 19, “Business Segment, Geographic and Major Customer Information.”
Going Concern
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) assuming the Company will continue as a going concern. The going concern assumption contemplates the realization of assets and satisfaction of liabilities in the normal course of business. However, substantial doubt about the Company’s ability to continue as a going concern exists.
The Company currently funds its operations from cash on hand and other current assets. The Company has a history of losses and negative cash flows from operations and expects to utilize a significant amount of cash within one year after the date of filing the consolidated financial statements. The availability of capital is dependent on the Company’s operating cash flow currently expected to be principally derived from the ProFrac Agreement (see Note 18, “Related Party Transactions”). It is not certain that the Company’s cash and other current assets and our forecasted operating cash flows currently expected to be generated from the ongoing execution of the ProFrac Agreement will provide the Company with sufficient financial resources to fund operations and meet our capital requirements and anticipated obligations as they become due in the next twelve months. The Company may require additional liquidity to continue its operations over the next twelve months to sufficiently alleviate or mitigate the conditions and events noted above, which results in substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued.
The Company is evaluating strategies to obtain additional funding for future operations. These strategies may include, but are not limited to, obtaining equity financing, issuing debt or entering into other financing arrangements, obtaining higher prices for its products and services, increasing the percentage of its sales from higher margin products, monetizing non-core assets, and reducing expenses. However, the Company may be unable to access further equity or debt financing when needed. As such, there can be no assurance that the Company will be able to obtain additional liquidity when needed or under acceptable terms, if at all.
The consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if the Company were unable to continue as a going concern.
Note 2 — Summary of Significant Accounting Policies
Basis of Presentation
The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP.The consolidated financial statements include the accounts of Flotek Industries, Inc. and subsidiaries it controls.
All significant intercompany accounts and transactions have been eliminated in consolidation. The Company does not have investments in any unconsolidated subsidiaries.
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FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash Equivalents
Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase.
Restricted Cash
The Company’s restricted cash is $0.1 million and $1.8 million as of December 31, 2022 and December 31, 2021, respectively. The Company’s restricted cash as of December 31, 2022 consists of cash that the Company is contractually obligated to maintain in accordance with the terms of its credit card program with a financial institution. The restricted cash balance as of December 31, 2021 included cash maintained in accordance with the credit card program and cash held in escrow of $1.75 million for amounts due under the terms of the legal settlement discussed in Note 13, “Commitments and Contingencies”.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable and Accounts receivable, related party, arise from product sales and services and are stated at estimated net realizable value. This value incorporates an allowance for doubtful accounts to reflect any loss anticipated on accounts receivable balances. The Company regularly evaluates its accounts receivable to estimate amounts that will not be collected and records the appropriate allowance for doubtful accounts as a charge to operating expenses. The allowance for doubtful accounts is based on a combination of the age of the receivables, individual customer circumstances, credit conditions, and historical write-offs and collections. The Company writes off specific accounts receivable when they are determined to be uncollectible. The recovery of accounts receivable previously written off is recorded as a reduction to the allowance for doubtful accounts charged to operating expense.
The majority of the Company’s customers are engaged in the energy industry. The cyclical nature of the energy industry may affect customers’ operating performance and cash flows, which directly impact the Company’s ability to collect on outstanding obligations. Additionally, certain customers are located in international areas that are inherently subject to risks of economic, political, and civil instability, which can impact the collectability of receivables.
Changes in the allowance for doubtful accounts are as follows (in thousands):
Years ended December 31,
Balance, beginning of year $ 659 $ 1,316
Charges to provision for doubtful accounts, net of recoveries 203 (127)
Balance, end of year $ 623 $ 659
As of December 31, 2022 and 2021 the Company has not recorded an allowance for doubtful accounts for the related party accounts receivable, including ProFrac Services, LLC.
Contract Assets
The Company’s contract assets represent consideration issued in the form of convertible notes (Contract Consideration Convertible Notes Payable as discussed in Note 10, “Debt and Convertible Notes Payable”) and other incremental costs related to obtaining the ProFrac Agreement. The contract assets are amortized over the term of the ProFrac Agreement (10 years) based on forecasted revenues as goods are transferred to ProFrac Services, LLC and the amortization is presented as a reduction of the transaction price included in related party revenue in the consolidated statements of operations.
The contract assets are tested for recoverability on a recurring basis and the Company will recognize an impairment loss to the extent that the carrying amount of the contract assets exceeds the amount of consideration the Company expects to receive in the future for the transfer of goods under the ProFrac Agreement less the direct costs that relate to providing those goods in the future. Based on our tests of recoverability, we did not identify an impairment of the contract assets during the year ended December 31, 2022.
Inventories
Inventories consist of raw materials and finished goods and are stated at the lower of cost determined using the weighted-average cost method, or net realizable value. Finished goods inventories include raw materials, direct labor and production overhead. The Company periodically reviews inventories on hand and current market conditions to determine if the cost of raw
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FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
materials and finished goods inventories exceed current market prices and impairs the cost basis of the inventory accordingly. Obsolete inventory or inventory in excess of management’s estimated usage requirement is written down to its net realizable value if those amounts are determined to be less than cost. Write-downs or write-offs of inventory are charged to cost of sales.
Property and equipment
Property and equipment are stated at cost. The cost of ordinary maintenance and repair is charged to operating expense, while replacement of critical components and major improvements are capitalized. Depreciation or amortization of property and equipment, including operating lease right-of-use assets (“ROU”), is calculated using the straight-line method over the shorter of the lease term or the asset’s estimated useful life as follows:
Buildings and leasehold improvements 2-30 years
Machinery and equipment 7-10 years
Furniture and fixtures 3 years
Land improvements 20 years
Transportation equipment 2-5 years
Computer equipment and software 3-7 years
Property and equipment, including ROU assets, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. If events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable, the Company first compares the carrying amount of an asset or asset group to the sum of the undiscounted future cash flows expected to result from the use and eventual disposal of the asset. If the carrying amount of an asset or asset group exceeds the sum of the undiscounted future cash flows expected to result from the use and eventual disposal of the asset, the Company will determine the fair value of the asset or asset group. The amount of impairment loss recognized is the excess of the asset or asset group’s carrying amount over its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary. There were no impairments of property and equipment and ROU assets during the years ended December 31, 2022 and 2021.
Assets to be disposed of are reported as assets held for sale at the lower of the carrying amount or the asset’s fair value less cost to sell and depreciation is ceased. Upon sale or other disposition of an asset, the Company recognizes a gain or loss on disposal measured as the difference between the net carrying amount of the asset and the net proceeds received.
Leases
The Company leases certain facilities, land, vehicles, and equipment. The Company determines if an arrangement is classified as a lease at inception of the arrangement.
ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the related lease. Finance leases are under the current and non-current liabilities and the underlying assets are included in property and equipment on the consolidated balance sheet.
As most of the Company’s leases do not provide an implicit rate of return, on a quarterly basis, the Company’s incremental borrowing rate is used, together with the lease term information available at commencement date of the lease, in determining the present value of lease payments. Operating lease liabilities include related options to extend or terminate lease terms that are reasonably certain of being exercised.
Leases with an initial term of 12 months or less (“short term leases”) are not recorded on the balance sheet; and the lease expense on short-term leases is recognized on a straight-line basis over the lease term.
Convertible Notes Payable and Liability Classified Contract Consideration Convertible Notes Payable
The Company accounts for the Convertible Notes Payable at amortized cost pursuant to Financial Accounting Standards Board (“FASB”) ASC Topic 470, Debt.
The Company accounts for the Contract Consideration Convertible Notes Payable issued as consideration related to a related party contract (see Note 10, “Debt and Convertible Notes Payable”), as liability classified convertible instruments in accordance with FASB ASC 718, “Stock Compensation” (“ASC 718”). Under ASC 718, liability classified convertible instruments are
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FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
measured at fair value at the grant date and at each reporting date (see Note 11, “Fair Value Measurements”) with the change in fair value included in the consolidated statements of operations.
Fair Value Measurements
The Company categorizes financial assets and liabilities using a three-tier fair value hierarchy, based on the nature of the inputs used to determine fair value. Inputs refer broadly to assumptions that market participants would use to value an asset or liability and may be observable or unobservable. When determining the fair value of assets and liabilities, the Company uses the most reliable measurement available. See Note 11, “Fair Value Measurements.”
Revenue Recognition
The Company only has revenue from customers. The Company recognizes revenue when it satisfies performance obligations under the terms of the contract with a customer, and control of the promised goods are transferred to the customer or services are performed, in an amount that reflects the consideration the Company expects to be entitled in exchange for those goods or services.
The Company recognizes revenue based on a five-step model when all of the following criteria have been met: (i) a contract with a customer exists, (ii) performance obligations have been identified, (iii) the price to the customer has been determined, (iv) the price to the customer has been allocated to the performance obligations, and (v) performance obligations are satisfied.
Products and services are sold with fixed or determinable prices. Certain sales include right of return provisions, which are considered when recognizing revenue and deferred accordingly, and discounts offered to customers for prompt payment. The Company does not act as an agent in any of its revenue arrangements.
In recognizing revenue for products and services, the Company determines the transaction price of contracts with customers, which may consist of fixed and variable consideration. Determining the transaction price may require judgment by management, which includes identifying performance obligations, estimating variable consideration to include in the transaction price, and determining whether promised goods or services can be distinguished in the context of the contract.
The majority of the CT segment revenue is chemical products that are sold at a point in time based on when control transfers to the customer determined by agreed upon delivery terms. Contracts with customers for the sale of products generally state the terms of the sale, including the quantity and price of each product purchased. Additionally, the CT segment offers various services associated to products sold which includes field services, installation, maintenance, and other functions. These services are recognized upon completion of commissioning and installation due to the short-term nature of the performance obligation when the Company has a right to invoice the customer.
The DA segment recognizes revenue for sales of equipment at the time of sale based on when control transfers to the customer based on agreed upon delivery terms. Additionally, the Company offers various services associated to products sold which includes field services, installation, maintenance, and other functions. Services are recognized upon completion of commissioning and installation due to the short-term nature of the performance obligation. There may be additional performance obligations related to providing ongoing or reoccurring maintenance. Revenue for these types of arrangements is recognized ratably over time throughout the contract period. Additionally, the Company may provide subscription-type arrangements with customers in which monthly reoccurring revenue is recognized ratably over time in accordance with agreed upon terms and conditions. Customers may be invoiced for such maintenance and subscription-type arrangements and revenue not yet recognizable is reported under accrued liabilities and deferred revenue on the consolidated balance sheets. Subscription-type arrangements were not a material revenue stream in the years ended December 31, 2022 and 2021.
Payment terms for both the CT and DA segments are customarily 30-60 days for domestic and 90-120 days for 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.
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FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
•In most service contracts, the Company has the right to consideration from a customer in an amount that corresponds directly with the value to the customer of the Company’s performance obligations completed to date and as such the Company recognizes revenue in the amount to which it has a right to invoice.
•The Company excludes from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer. Such taxes are included in accrued liabilities on our consolidated balance sheet until remitted to the governmental agency.
Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of sales in our consolidated statement of operations.
Foreign Currency Translation
The Company’s functional currency is primarily the U.S. dollar. The Company operates principally in the United States and substantially all assets and liabilities of the Company are denominated in U.S. dollars. Financial statements of foreign subsidiaries that are not U.S. dollar functional currency are prepared using the currency of the primary economic environment of the foreign subsidiaries as the functional currency. Assets and liabilities of those foreign subsidiaries are translated into U.S. dollars at exchange rates in effect as of the end of identified reporting periods. Revenue and expense transactions are translated using the average monthly exchange rate for the reporting period. Resultant translation adjustments are recognized as other comprehensive income (loss) within stockholders’ equity.
Comprehensive Loss
Comprehensive loss encompasses all changes in stockholders’ equity, except those arising from investments and distributions to stockholders. The Company’s comprehensive loss includes consolidated net loss and foreign currency translation adjustments.
Research and Development Costs
Expenditures for research activities relating to product development and improvement are charged to expense as incurred.
Income Taxes
Deferred tax assets and liabilities are recognized for temporary differences between financial statement carrying amounts and the tax bases of assets and liabilities and are measured using the tax rates expected to be in effect when the differences reverse. Deferred tax assets are also recognized for operating loss and tax credit carry forwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.