FLOTEK INDUSTRIES INC/CN/ (FTK) FY 2022 MD&A

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 Verax™ 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)

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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:

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:

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:

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):

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.