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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM
10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 1-13270
FLOTEK INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)
Delaware
 
90-0023731
(State of other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
 
 
8846 N. Sam Houston Parkway W.
Houston,
TX

77064
 
 
 
 
 
(Address of principal executive offices)
(Zip Code)
(713) 849-9911
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.0001 par value
FTK
New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
 
Accelerated Filer
 
 
 
 
 
 
 
 
Non-accelerated filer
 
 
Smaller reporting company
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  
As of November 13, 2020, there were 73,094,901 outstanding shares of Flotek Industries, Inc. common stock, $0.0001 par value.





TABLE OF CONTENTS
 
 
 
 
Note About Forward-Looking Statements
 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Balance Sheets at September 30, 2020 and December 31, 2019
 
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019
 
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019
 
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019
 
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2020 and 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




2




Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”), and in particular, Part I, Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains “forward-looking statements” within the meaning of the safe harbor provisions, 15 U.S.C. § 78u-5, of the Private Securities Litigation Reform Act of 1995 (“Reform Act”). Forward-looking statements are not historical facts, but instead represent the current assumptions and beliefs regarding future events of Flotek Industries, Inc., (“Flotek” or the “Company”), many of which, by their nature, are inherently uncertain and outside the Company’s control. Such statements include estimates, projections, and statements related to the Company’s business plan, objectives, expected operating results, and assumptions upon which those statements are based. The forward-looking statements contained in this Quarterly Report are based on information available as of the date of this Quarterly Report.
The forward-looking statements relate to future industry trends and economic conditions, forecast performance or results of current and future initiatives and the outcome of contingencies and other uncertainties that may have a significant impact on the Company’s business, future operating results and liquidity. These forward-looking statements generally are identified by words including, but not limited to, “anticipate,” “believe,” “estimate,” “continue,” “intend,” “expect,” “plan,” “forecast,” “project,” and similar expressions, or future-tense or conditional constructions such as “will,” “may,” “should,” “could,” etc. The Company cautions that these statements are merely predictions and are not to be considered guarantees of future performance. Forward-looking statements are based upon current expectations and assumptions that are subject to risks and uncertainties that can cause actual results to differ materially from those projected, anticipated, or implied.
A detailed discussion of potential risks and uncertainties that could cause actual results and events to differ materially from forward-looking statements is included in Part I, Item 1A — “Risk Factors” of the Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report”), as amended by the Amendment No. 1 on Form 10-K/A to the 2019 Annual Report, filed with the SEC on March 16, 2020 (the “Amendment No. 1”) and Amendment No. 2 on Form 10-K/A to the 2019 Annual Report, filed with the SEC on June 11, 2020 (collectively with the 2019 Annual Report and the Amendment No. 1, the “Annual Report”) and periodically in subsequent reports filed with the Securities and Exchange Commission (“SEC”). The Company has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events, except as required by law.



3






PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
September 30, 2020
 
December 31, 2019
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
49,193

 
$
100,575

Restricted cash
664

 
663

Accounts receivable, net of allowance for doubtful accounts of $1,150 and $1,527 at September 30, 2020 and December 31, 2019, respectively
10,629

 
15,638

Inventories, net
14,370

 
23,210

Income taxes receivable
754

 
631

Other current assets
3,427

 
13,191

Total current assets
79,037

 
153,908

Property and equipment, net
8,694

 
39,829

Operating lease right-of-use assets
2,368

 
16,388

Goodwill
8,092

 

Deferred tax assets, net
249

 
152

Other intangible assets, net

 
20,323

Other long-term assets
33

 

TOTAL ASSETS
$
98,473

 
$
230,600

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
6,201

 
$
16,231

Accrued liabilities
13,084

 
24,552

Income taxes payable
25

 

Interest payable
22

 

Current portion of long-term debt
3,462

 

Current portion of operating lease liabilities
651

 
486

Current portion of finance lease liabilities
58

 
55

Total current liabilities
23,503

 
41,324

Long-term debt, less current portion
2,201

 

Deferred revenue, long-term
104

 

Long-term operating lease liabilities
8,408

 
16,973

Long-term finance lease liabilities
114

 
158

Deferred tax liabilities, net
14

 
116

Total liabilities
34,344

 
58,571

Commitments and contingencies (See Note 19)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.0001 par value, 100,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.0001 par value, 140,000,000 shares authorized; 77,972,135 shares issued and 73,323,001 shares outstanding at September 30, 2020; 63,656,897 shares issued and 59,511,416 shares outstanding at December 31, 2019
7

 
6

Additional paid-in capital
358,726

 
347,564

Accumulated other comprehensive income
11

 
181

Accumulated deficit
(261,008
)
 
(142,238
)
Treasury stock, at cost; 4,649,134 and 4,145,481 shares at September 30, 2020 and December 31, 2019, respectively
(33,607
)
 
(33,484
)
Total stockholders’ equity
64,129

 
172,029

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
98,473

 
$
230,600


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4




FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
    
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Revenue
$
12,739

 
$
21,879

 
$
41,035

 
$
99,827

Costs and expenses:
 
 
 
 
 
 
 
Operating expenses (excluding depreciation and amortization)
29,466

 
23,622

 
63,939

 
105,711

Corporate general and administrative
2,679

 
5,685

 
12,568

 
19,020

Depreciation and amortization
518

 
2,058

 
3,177

 
6,437

Research and development
1,480

 
2,297

 
5,673

 
6,658

(Gain) loss on disposal of long-lived assets
(37
)
 
3

 
(92
)
 
1,096

Impairment of goodwill
11,706

 

 
11,706

 

Impairment of fixed and long-lived assets
12,521

 

 
69,975

 

Total costs and expenses
58,333

 
33,665

 
166,946

 
138,922

Loss from operations
(45,594
)
 
(11,786
)
 
(125,911
)
 
(39,095
)
Other (expense) income:
 
 
 
 
 
 
 
Gain on lease termination

 

 
576

 

Interest expense
(19
)
 
(1
)
 
(40
)
 
(2,014
)
Other income, net
291

 
436

 
322

 
1,238

Total other income (expense), net
272

 
435

 
858

 
(776
)
Loss before income taxes
(45,322
)
 
(11,351
)
 
(125,053
)
 
(39,871
)
Income tax benefit
81

 
191

 
6,282

 
694

Loss from continuing operations
(45,241
)
 
(11,160
)
 
(118,771
)
 
(39,177
)
Income from discontinued operations, net of tax

 
117

 

 
44,583

Net (loss) income
$
(45,241
)
 
$
(11,043
)
 
$
(118,771
)
 
$
5,406

 
 
 
 
 
 
 
 
Basic earnings (loss) per common share:
 
 
 
 
 
 
Continuing operations
$
(0.66
)
 
$
(0.19
)
 
$
(1.75
)
 
$
(0.67
)
Discontinued operations, net of tax

 

 

 
0.76

Basic earnings (loss) per common share
$
(0.66
)
 
$
(0.19
)
 
$
(1.75
)
 
$
0.09

 
 
 
 
 
 
 
 
Diluted earnings (loss) per common share:
 
 
 
 
 
 
Continuing operations
$
(0.66
)
 
$
(0.19
)
 
$
(1.75
)
 
$
(0.67
)
Discontinued operations, net of tax

 

 

 
0.76

Diluted earnings (loss) per common share
$
(0.66
)
 
$
(0.19
)
 
$
(1.75
)
 
$
0.09

 
 
 
 
 
 
 
 
Weighted average common shares:
 
 
 
 
 
 
 
Weighted average common shares used in computing basic earnings (loss) per common share
68,217

 
58,608

 
68,063

 
58,491

Weighted average common shares used in computing diluted earnings (loss) per common share
68,217

 
58,608

 
68,063

 
58,491



See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5





FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
    
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Loss from continuing operations
$
(45,241
)
 
$
(11,160
)
 
$
(118,771
)
 
$
(39,177
)
Income from discontinued operations, net of tax

 
117

 

 
44,583

Net (loss) income
(45,241
)
 
(11,043
)
 
(118,771
)
 
5,406

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(40
)
 
36

 
(168
)
 
154

Comprehensive (loss) income
$
(45,281
)
 
$
(11,007
)
 
$
(118,939
)
 
$
5,560



See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
6





FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 
Nine months ended September 30,
 
2020
 
2019
Cash flows from operating activities:
 
 
 
Net (loss) income
$
(118,771
)
 
$
5,406

Less: Income from discontinued operations, net of tax

 
44,583

Loss from continuing operations
(118,771
)
 
(39,177
)
Adjustments to reconcile loss from continuing operations to net cash (used in) provided by operating activities:
 
 
 
Change in fair value of contingent consideration
3,200

 

Depreciation and amortization
3,177

 
6,437

Amortization of deferred financing costs

 
1,428

Provision for doubtful accounts
494

 
426

Provision for excess and obsolete inventory
10,465

 

Impairment of goodwill
11,706

 

Impairment of right-of-use assets
7,434

 

Impairment of fixed assets
30,178

 

Impairment of intangible assets
32,363

 

(Gain)/loss on disposal of long-lived assets
(668
)
 
1,096

Non-cash lease expense
299

 
813

Stock compensation expense
2,208

 
2,829

Deferred income tax provision
(199
)
 
17,983

Reduction in tax benefit related to share-based awards

 
24

Changes in current assets and liabilities:
 
 
 
Accounts receivable, net
4,714

 
21,629

Inventories, net
3,186

 
3,000

Income taxes receivable
(140
)
 
2,853

Other current assets
823

 
(4,036
)
Other long-term assets
(16
)
 
3,286

Accounts payable
(11,906
)
 
(4,434
)
Accrued liabilities
(17,689
)
 
(14,205
)
Income taxes payable
25

 
595

Interest payable
22

 
(8
)
Net cash (used in) provided by operating activities
(39,095
)
 
539

Cash flows from investing activities:
 
 
 
Capital expenditures
(836
)
 
(1,869
)
Proceeds from sale of business
9,907

 
155,498

Proceeds from sale of assets
86

 
234

Purchase of JP3, net of cash acquired
(26,284
)
 

Purchase of patents and other intangible assets
(8
)
 
(590
)
Net cash (used in) provided by investing activities
(17,135
)
 
153,273

Cash flows from financing activities:
 
 
 
Borrowings on revolving credit facility

 
42,984

Repayments on revolving credit facility

 
(92,613
)
Proceeds from Paycheck Protection Program loan
4,788

 

Purchase of treasury stock related to share-based awards
(123
)
 
(207
)
Proceeds from sale of common stock
416

 
7

Payments for finance leases
(152
)
 
(51
)
Net cash provided by (used in) financing activities
4,929

 
(49,880
)
Discontinued operations:
 
 
 
Net cash used in operating activities

 
(321
)
Net cash provided by investing activities

 
337

Net cash flows provided by discontinued operations

 
16

Effect of changes in exchange rates on cash and cash equivalents
(80
)
 
2

Net (decrease) increase in cash and cash equivalents and restricted cash
(51,381
)
 
103,950

Cash and cash equivalents at the beginning of period
100,575

 
3,044

Restricted cash at the beginning of period
663

 

Cash and cash equivalents and restricted cash at beginning of period
101,238

 
3,044

Cash and cash equivalents at end of period
49,193

 
106,994

Restricted cash at the end of period
664

 
663

Cash and cash equivalents and restricted cash at the end of period
$
49,857

 
$
107,657


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
7






FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)

 
Three months ended September 30, 2020
 
Common Stock
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity
 
Shares
Issued
 
Par
Value
 
Shares
 
Cost
 
Balance, June 30, 2020
77,626

 
$
7

 
4,459

 
$
(33,566
)
 
$
357,981

 
$
51

 
$
(215,767
)
 
$
108,706

Net loss

 

 

 

 

 

 
(45,241
)
 
(45,241
)
Foreign currency translation adjustment

 

 

 

 

 
(40
)
 

 
(40
)
Stock issued under employee stock purchase plan

 

 
(25
)
 

 
58

 

 

 
58

Restricted stock granted
346

 

 

 

 

 

 

 

Restricted stock forfeited

 

 
179

 

 

 

 

 

Treasury stock purchased

 

 
36

 
(41
)
 

 

 

 
(41
)
Stock compensation expense

 

 

 

 
687

 

 

 
687

Balance, September 30, 2020
77,972

 
$
7

 
4,649

 
$
(33,607
)
 
$
358,726

 
$
11

 
$
(261,008
)
 
$
64,129


 
Three months ended September 30, 2019
 
Common Stock
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity
 
Shares
Issued
 
Par
Value
 
Shares
 
Cost
 
Balance, June 30, 2019
62,956

 
$
6

 
3,948

 
$
(33,378
)
 
$
345,217

 
$
149

 
$
(91,874
)
 
$
220,120

Net income

 

 

 

 

 

 
(11,043
)
 
(11,043
)
Foreign currency translation adjustment

 

 

 

 

 
36

 

 
36

Stock issued under employee stock purchase plan

 

 
(7
)
 

 
15

 

 

 
15

Restricted stock granted
82

 

 

 

 

 

 

 

Restricted stock forfeited

 

 
159

 

 

 

 

 

Treasury stock purchased

 

 
30

 
(66
)
 

 

 

 
(66
)
Stock compensation expense

 

 

 

 
1,160

 

 

 
1,160

Balance, September 30, 2019
63,038

 
$
6

 
4,129

 
$
(33,444
)
 
$
346,392

 
$
185

 
$
(102,917
)
 
$
210,222


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
8




FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)

 
Nine months ended September 30, 2020
 
Common Stock
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained Earnings (Accumulated Deficit)
 
Total Stockholders’ Equity
 
Shares
Issued
 
Par
Value
 
Shares
 
Cost
 
Balance, December 31, 2019
63,657

 
$
6

 
4,145

 
$
(33,484
)
 
$
347,565

 
$
179

 
$
(142,237
)
 
$
172,029

Net loss

 

 

 

 

 

 
(118,771
)
 
(118,771
)
Foreign currency translation adjustment

 

 

 

 

 
(168
)
 

 
(168
)
Stock issued under employee stock purchase plan

 

 
(50
)
 

 
78

 

 

 
78

Restricted stock granted
2,815

 

 

 

 
338

 

 

 
338

Restricted stock forfeited

 

 
457

 

 

 

 

 

Treasury stock purchased

 

 
97

 
(123
)
 

 

 

 
(123
)
Stock compensation expense

 

 

 

 
2,208

 

 

 
2,208

Stock issued in JP3 acquisition
11,500

 
1

 

 

 
8,537

 

 

 
8,538

Balance, September 30, 2020
77,972

 
$
7

 
4,649

 
$
(33,607
)
 
$
358,726

 
$
11

 
$
(261,008
)
 
$
64,129


 
Nine months ended September 30, 2019
 
Common Stock
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained Earnings (Accumulated Deficit)
 
Total Stockholders’ Equity
 
Shares
Issued
 
Par
Value
 
Shares
 
Cost
 
Balance, December 31, 2018
62,163

 
$
6

 
3,770

 
$
(33,237
)
 
$
343,536

 
$
31

 
$
(108,323
)
 
$
202,013

Net income

 

 

 

 

 

 
5,406

 
5,406

Foreign currency translation adjustment

 

 

 

 

 
154

 

 
154

Stock issued under employee stock purchase plan

 

 
(7
)
 

 
15

 

 

 
15

Restricted stock granted
875

 

 

 

 

 

 

 

Restricted stock forfeited

 

 
292

 

 

 

 

 

Treasury stock purchased

 

 
74

 
(207
)
 

 

 

 
(207
)
Stock compensation expense

 

 

 

 
2,841

 

 

 
2,841

Balance, September 30, 2019
63,038

 
$
6

 
4,129

 
$
(33,444
)
 
$
346,392

 
$
185

 
$
(102,917
)
 
$
210,222



See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
9


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note 1 — Organization and Significant Accounting Policies
Organization and Nature of Operations

Flotek Industries, Inc. (“Flotek” or the “Company”) is a technology-driven, specialty chemistry and data company that serves customers across industrial, commercial and consumer markets. Flotek’s Chemistry Technologies segment develops, manufactures, packages, distributes, delivers, and markets high-quality sanitizers and disinfectants for commercial, governmental and personal consumer use. Additionally, Flotek empowers the energy industry to maximize the value of their hydrocarbon streams and improve return on invested capital through its real-time data platforms and chemistry technologies. Flotek serves downstream, midstream and upstream customers, both domestic and international.
During the second quarter of 2020, the Company acquired JP3 Measurement, LLC (“JP3”) and evaluated segment information. The Company identified two operating segments: Chemistry Technologies and Data Analytics, which are both supported by its continuing Research & Innovation advanced laboratory capabilities. For further discussion of our operations and segments, refer to Note 18, “Business Segment, Geographic and Major Customer Information.” For further discussion of the JP3 acquisition, refer to Note 3, “JP3 Acquisition.”
The Company was initially incorporated under the laws of the Province of British Columbia in 1985. In October 2001, the Company changed its corporate domicile to the state of Delaware.
Basis of Presentation
The accompanying unaudited Financial Statements reflect all adjustments, in the opinion of management, necessary for fair statement of the financial condition and results of operations for the periods presented. All such adjustments are normal and recurring in nature. The Financial Statements, including selected notes, have been prepared in accordance with applicable rules and regulations of the SEC regarding interim financial reporting and do not include all information and disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for comprehensive financial statement reporting. These interim Financial Statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report. A copy of the 2019 Annual Report is available on the SEC’s website, www.sec.gov, under the Company’s ticker symbol (“FTK”) or on Flotek’s website, www.flotekind.com.
All significant intercompany accounts and transactions have been eliminated in consolidation. The Company does not have investments in any unconsolidated subsidiaries.
Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and reported amounts of revenue and expenses. Actual results could differ from these estimates.

Impact of COVID-19

On March 11, 2020, the World Health Organization declared the outbreak of the novel coronavirus (“COVID-19”) a global pandemic, which continues to exist throughout the United States and around the world. While this outbreak continues to severely impact global economic activity, during the third quarter of 2020 many countries and many states within the United States began to develop a plan to gradually re-open businesses and schools and lift some restrictions related to quarantines and travel with guidance from federal, state and local legislators.

The current resurgence of COVID-19 could have a negative impact upon both our digital and oil field chemical business. The November 2020 announcement by Pfizer of a potential COVID-19 vaccine could reduce the demand for our janitorial and sanitizer products.

The effects of the COVID-19 pandemic, including actions taken by businesses and governments, have resulted in a significant and continued reduction in international and U.S. economic activity. These effects and the volatility in oil prices have materially and adversely affected, and may continue to materially and adversely affect, the demand for oil and natural gas as well as for our services and products. In the second and third quarters of 2020, these conditions and the related financial impact have continued and, in some cases, worsened. The Company’s primary markets in the U.S. are particularly subject to the financial impact of a collapse in oil prices. As a result, the Company recorded an impairment to property, plant and equipment, intangible assets, and


10


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

operating right-of-use assets during the first quarter of 2020 and additional impairment charges to goodwill and intangible assets in the third quarter of 2020. See Note 10, “Impairment of Fixed and Long-lived Assets”. In addition, the Company adopted social distancing and work-from-home procedures, which have had and may continue to have an impact on the ability of employees and management of the Company to communicate and work efficiently.

In response to the deteriorating market conditions and anticipating ongoing volatility, the Company has also reduced its cost structure to meet anticipated market activity and reduce the Company’s break-even levels. Among other cost-cutting and cash preservation initiatives:

• The Company’s CEO, John W. Gibson, Jr., reduced his base salary by 20%, and each of the other executive officers reduced his or her salary by 10%, through December 31, 2020 in exchange for restricted stock, effective as of April 1, 2020.
• The board of directors of Flotek approved a 20% reduction in the fees to be paid to the directors, effective as of April 1, 2020.
• The Company consolidated office space by moving all employees at its corporate headquarters into the Houston Global Resource and Innovation Center, (“GRIC”) facility and buying out the remaining term of the corporate headquarters lease for a significant discount, with the move completed by the end of June 2020.
The Company decreased discretionary spending across all business operations.
The Company reduced overall headcount by 35% on March 30, 2020. Additionally, the Company reduced the headcount of the Data Analytics segment by 35% in October 2020.

While the full impact and duration of the COVID-19 outbreak is not yet known, we are closely monitoring the effects of the pandemic on commodity demands and on our customers, as well as on our operations and employees. Any future development and effects are highly uncertain and cannot be predicted, including the scope and duration of the pandemic; further adverse revenue, accounts receivable aging and collections, and net income effects; disruptions to our operations; third-party providers’ ability to support our operations; customer shutdowns of oil and gas exploration and production; the effectiveness of our work from home arrangements; employee impacts from illness, school closures and other community response measures; any actions taken by governmental authorities and other third parties in response to the pandemic; and temporary closures of our facilities or the facilities of our customers and suppliers.

Restricted Cash
 
The Company’s restricted cash consists of cash that the Company is contractually obligated to maintain in accordance with the terms of its credit card program with a financial institution.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation. The reclassifications did not impact previously reported net loss and stockholders’ equity.


11


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 — Recent Accounting Pronouncements
Application of New Accounting Standards
Effective January 1, 2019, the Company adopted the accounting guidance in Accounting Standards Update (“ASU”) No. 2016-02, “Leases,” including subsequent amendments. This standard (ASC 842) requires the recognition of Right-Of-Use (“ROU”) assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP (ASC 840). Upon adoption, the Company recorded operating lease ROU assets and corresponding operating lease liabilities, net of deferred rent, representing the present value of future lease payments under operating leases with terms of greater than twelve months. The adoption of this standard did not have a material impact on the consolidated statements of operations or cash flows. Refer to Note 5 — “Leases” for further information surrounding adoption of this new standard.
Effective January 1, 2019, the Company adopted ASU No. 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This standard allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
Effective January 1, 2019, the Company adopted ASU No. 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting.” This standard expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
New Accounting Requirements and Disclosures
Effective January 1, 2020, the Company adopted ASU No. 2018-13, “Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement.” This standard removes, modifies, and adds additional requirements for disclosures related to fair value measurement in ASC 820. The pronouncement is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted in any interim period. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
New Accounting Standards to be Adopted
The Financial Accounting Standards Board (“FASB”) issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This standard removes specific exceptions to the general principles in Topic 740. The pronouncement is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years, with early adoption permitted for public companies for periods in which financial statements have not yet been issued. The Company is currently evaluating the impact of this standard on the consolidated financial statements and related disclosures.
The FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This standard replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The pronouncement is effective for smaller reporting companies for fiscal years beginning after December 15, 2022. The Company is currently evaluating the impact of this standard, including subsequent amendments, on the consolidated financial statements and related disclosures.


12


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 3 — JP3 Acquisition
During the second quarter of 2020, the Company acquired 100% ownership of JP3, a privately-held data and analytics technology company, in a cash-and-stock transaction. JP3’s real-time data platforms combine the energy industry’s only field-deployable, inline optical analyzer with proprietary cloud visualization and analytics, targeting an increase of processing efficiencies and valuation of natural gas, crude oil, and refined fuels. The transaction was valued at approximately $36.6 million, as of the transaction closing date, comprised of $25.0 million in cash, subject to certain adjustments and contingent consideration as described below, and 11.5 million shares in Flotek common stock with an estimated fair value of $8.5 million, net of a discount for marketability due to a lock-up period. The payment of $25.0 million was subject to certain purchase price adjustments, and the total non-equity consideration at closing was comprised of $25.0 million plus net working capital in excess of the target net working capital of $1.9 million. Additionally, the Company was subject to contingent consideration estimated at $1.2 million for two potential earn-out provisions totaling $5.0 million based on certain stock performance targets. The first and second earn-out provisions occur if the ten-day volume-weighted average share price equals or exceeds $2 per share and $3 per share, respectively, before May 18, 2025.

The following table summarizes the fair value of JP3’s assets acquired as of the closing date of May 18, 2020 (in thousands):
Tradenames and trademarks
 
$
1,100

Technology and know-how
 
5,000

Customer lists
 
6,800

Inventory
 
7,100

Cash
 
604

Net working capital, net of cash and inventory
 
(1,063
)
Fixed assets
 
426

Long-term debt assumed and other assets (liabilities)
 
(893
)
Goodwill
 
17,522

Net assets acquired
 
$
36,596



13


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


The Company recorded transaction costs of $0.5 million for professional services including legal, accounting, and other professional or consulting fees in connection with the JP3 acquisition to the Company’s operating expenses (excluding depreciation and amortization) in the consolidated statements of operations during the second quarter of 2020.
During the third quarter of 2020, the Company made certain measurement period adjustments to inventory, resulting in an increase of goodwill of $2.3 million. See Note 8 - “Inventories”.
As discussed in Note 10-“Impairment of Fixed and Long-lived Assets”, during the third quarter of 2020, the Company identified a triggering event under ASC 350, Intangibles — Goodwill and Other, and completed an impairment analysis at the Data Analytics reporting unit level. During the three months ended September 30, 2020, the Company recognized a goodwill impairment charge of $11.7 million and finite-lived intangible assets impairment charge of $12.5 million in the Data Analytics reporting unit, which resulted from the extended impact of COVID-19 and subsequent decline in oil and gas and lower performance than expected by the reporting unit. As a result of these factors, the Company concluded that sufficient indicators existed to require an interim quantitative assessment of goodwill for that reporting unit as of September 30, 2020. The fair value of the reporting unit was estimated based on an analysis of the present value of future discounted cash flows. The significant estimates used in the discounted cash flows model included the Company’s weighted average cost of capital, projected cash flows and the long-term rate of growth.
During the third quarter of 2020, the first stock performance target was achieved, and the Company recorded a liability of $2.5 million for the first earn-out payment, which is included in accrued liabilities in the accompanying balance sheet as of September 30, 2020. The Company also estimated the fair value of the remaining stock performance earn-out provision. At September 30, 2020, the estimated fair value of the remaining contingent liability was $1.9 million, an increase of $0.7 million during the quarter. As the achievement of earn-out provisions and changes in fair value estimates are not acquisition adjustments, the Company recorded $3.2 million of expense for achievement of the first stock performance target and the increase in the fair value of the contingent consideration as a component of operating income for continuing operations for the periods ended September 30, 2020.


14


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 4 — Discontinued Operations
On January 10, 2019, the Company entered into a Share Purchase Agreement with Archer-Daniels-Midland Company (“ADM”) for the sale of all of the shares representing membership interests in its wholly owned subsidiary, Florida Chemical Company, LLC (“FCC”), which represented the Consumer and Industrial Chemistry Technologies (“CICT”) segment.
Effective February 28, 2019, the Company completed the sale of FCC to ADM for $175.0 million in cash consideration, with $4.4 million temporarily held in escrow by ADM for post-closing working capital adjustments for up to 90 days and $13.1 million temporarily held in escrow to satisfy potential indemnification claims by ADM with anticipated releases at 6 months, 12 months, and 15 months. Pursuant to the terms of the Share Purchase Agreement, Flotek Chemistry, LLC (“Flotek Chemistry”), a wholly owned subsidiary of the Company, entered into a supply agreement with FCC who will supply terpene at specified prices for specified quantities. The agreement will expire on December 31, 2023.
As of December 31, 2019, the Company concluded that the original long-term supply agreement met the definition of a loss contract. As such, the Company recognized a loss of $19 million as of December 31, 2019, capped by the price paid for the terpene supply agreement amendment, executed in February 2020, which aligned purchase commitments to expected usage for blended products as of December 31, 2019. The Company has classified the assets, liabilities, and results of operations for this segment as “Discontinued Operations” for all periods presented.
Pursuant to the post-closing working capital dispute resolution procedures set forth in the Share Purchase Agreement, the Company and ADM engaged a neutral third party auditor to help reach agreement on the final post-closing working capital adjustment. In February 2020, the third-party auditor ruled in favor of awarding ADM the entire disputed amount. As a result, the working capital adjustment escrow balance was released to ADM and a corresponding reduction was made to the gain on sale of business as of December 31, 2019.
On February 26, 2020, Flotek Chemistry entered into an amendment to the terpene supply agreement between Flotek Chemistry and FCC. Pursuant to the terms and conditions of the amendment, the terpene supply agreement was amended to, among other things, (a) reduce the minimum quantity of terpene that Flotek Chemistry is required to purchase by approximately 3/4ths in 2020 and by approximately half in each of 2021, 2022 and 2023, (b) provide a fixed per pound price for terpene in 2020, (c) reduce the maximum amount of terpene subject to the terpene supply agreement by approximately 1/3rd, and (d) change the payment terms to net 45 days. In order to make the terms and conditions of the amendment to the terpene supply agreement effective, Flotek Chemistry made a one-time payment in February 2020 of $15.8 million to ADM. The expense associated with the terpene supply agreement amendment payment was recorded as a loss on contract purchase commitments, reported in operating expenses in continuing operations in December 2019.
For the nine months ended September 30, 2020, the Company recognized a loss of $0.8 million associated with the amended terpene supply agreement due to adjustments in the Company’s expected usage of terpene in blended products in 2020.
During the first quarter of 2020, as scheduled, $3.3 million of the indemnity escrow was released to the Company. During the second quarter of 2020 the remaining indemnity escrow of $6.6 million was released to the Company.
The following summarized financial information has been segregated from continuing operations and reported as Discontinued Operations for the three and nine months ended September 30, 2020 and 2019 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Consumer and Industrial Chemistry Technologies
 
 
 
 
 
 
 
Revenue
$

 
$

 
$

 
$
11,031

Operating expenses

 

 

 
(11,572
)
Research and development

 

 

 
(69
)
Loss from operations

 

 

 
(610
)
Other income

 

 

 
35

Gain on sale of business

 
148

 

 
67,842

Income before income taxes

 
148

 

 
67,267

Income tax expense

 
(31
)
 

 
(22,684
)
Net income from discontinued operations
$

 
$
117

 
$

 
$
44,583

 



15


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 5 — Leases
During the first quarter of 2020, the Company made the decision to cease use of the corporate headquarters leased offices and move corporate employees to the Global Research and Innovation Center (“GRIC”) during second quarter of 2020. In addition, the lease liability and corresponding ROU assets for the corporate headquarters and GRIC were remeasured to remove the anticipated term extensions as the Company determined it was no longer reasonably certain to utilize the extension at the GRIC. The remeasurement resulted in adjustments to lease liabilities and ROU assets totaling of $6.2 million each as of March 31, 2020.
In addition, during the three months ended March 31, 2020, the Company recorded an impairment of the ROU assets totaling $7.4 million. For further discussion, refer to Note 10, “Impairment of Fixed and Long-lived Assets.”
During the second quarter of 2020, the Company terminated the lease of the corporate headquarters office in exchange for a one-time payment of $1.0 million and moved all employees to the GRIC facility effective as of June 29, 2020. As a result of terminating the corporate headquarters office lease and making the one-time payment, the Company recorded a gain on lease termination of $0.6 million recorded in gain on lease termination.
The components of lease expense and supplemental cash flow information are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Operating lease expense
$
258

 
$
652

 
$
1,112

 
$
1,958

Finance lease expense:
 
 
 
 
 
 
 
Amortization of right-of-use assets
4

 
357

 
13

 
577

Interest on lease liabilities
5

 
3

 
14

 
6

Total finance lease expense
9

 
360

 
27

 
583

Short-term lease expense
57

 
22

 
145

 
97

Total lease expense
$
324

 
$
1,034

 
$
1,284

 
$
2,638

 
 
 
 
 
 
 
 
Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
 
 
 
 
Operating cash flows from operating leases
$
317

 
$
584

 
$
2,312

 
$
1,749

Operating cash flows from finance leases
5

 
3

 
13

 
6

Financing cash flows from finance leases
51

 
6

 
152

 
51


Maturities of lease liabilities are as follows (in thousands):
Years ending December 31,
 
Operating Leases
 
Finance Leases
2020 (excluding the nine months ended September 30, 2020)
$
311

 
$
17

2021
 
1,330

 
70

2022
 
1,283

 
47

2023
 
1,311

 
39

2024
 
1,341

 
23

Thereafter
 
8,185

 

Total lease payments
 
$
13,761

 
$
196

Less: Interest
 
(4,702
)
 
(24
)
Present value of lease liabilities
 
$
9,059

 
$
172




16


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Supplemental balance sheet information related to leases is as follows (in thousands):
 
September 30, 2020
December 31, 2019
Operating Leases
 
 
Operating lease right-of-use assets
$
2,368

$
16,388

 
 
 
Current portion of operating lease liabilities
$
651

$
486

Long-term operating lease liabilities
8,408

16,973

Total operating lease liabilities
$
9,059

$
17,459

 
 
 
Finance Leases
 
 
Property and equipment
$
147

$
293

Accumulated depreciation
(18
)
(28
)
Property and equipment, net
$
129

$
265

 
 
 
Current portion of finance lease liabilities
$
58

$
55

Long-term finance lease liabilities
114

158

Total finance lease liabilities
$
172

$
213

 
 
 
Weighted Average Remaining Lease Term
 
 
Operating leases
9.9 years

16.6 years

Finance leases
3.8 years

4.6 years

 
 
 
Weighted Average Discount Rate
 
 
Operating leases
8.9
%
8.9
%
Finance leases
8.5
%
9.0
%

Note 6 — Revenue from Contracts with Customers
Revenues are recognized when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. In recognizing revenue for products and services, the Company determines the transaction price of purchase orders or contracts with customers, which may consist of fixed and variable consideration. Determining the transaction price may require significant judgment by management, which includes identifying performance obligations, estimating variable consideration to include in the transaction price, and determining whether promised goods or services are distinct within the context of the contract. Variable consideration typically consists of product returns and is estimated based on the amount of consideration the Company expects to receive. Revenue accruals are recorded on an ongoing basis to reflect updated variable consideration information.
The majority of the products from the Chemistry Technologies are sold at a point in time and service contracts are short term in nature. Sales are billed on a monthly basis with payment terms customarily 30-45 days for domestic and 60 days for international from invoice receipt. In addition, sales taxes are excluded from revenues.

The Data Analytics segment recognizes revenue for sales of equipment at the time of sale. Revenue related to service and support is recognized over time.
Disaggregation of Revenue
The Company has disaggregated revenues by product sales (point-in-time revenue recognition) and service revenue (over-time revenue recognition). Product sales accounted for over 90% of total revenue for the three and nine months ended September 30, 2020 and 2019.


17


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company differentiates revenue and operating expenses (excluding depreciation and amortization) based on whether the source of revenue is attributable to products or services. Revenue and operating expenses (excluding depreciation and amortization) disaggregated by revenue source are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Revenue:
 
 
 
 
 
 
 
Products
$
12,076

 
$
21,031

 
$
39,053

 
$
96,733

Services
663

 
848

 
1,982

 
3,094

 
$
12,739

 
$
21,879

 
$
41,035

 
$
99,827

Operating expenses (excluding depreciation and amortization):
 
 
 
 
 
 
Products
$
29,041

 
$
23,542

 
$
62,866

 
$
105,078

Services
425

 
80

 
1,073

 
633

 
$
29,466

 
$
23,622

 
$
63,939

 
$
105,711


Arrangements with Multiple Performance Obligations
The Company’s contracts with customers may include multiple performance obligations. For such arrangements, the total transaction price is allocated to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. Standalone selling prices are generally determined based on the prices charged to customers (“observable standalone price”) or an expected cost plus a margin approach. For combined products and services within a contract, the Company accounts for individual products and services separately if they are distinct (i.e. if a product or service is separately identifiable from other items in the contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer). The consideration is allocated between separate products and services within a contract based on the prices at the observable standalone price. For items that are not sold separately, the expected cost plus a margin approach is used to estimate the standalone selling price of each performance obligation.
Contract Balances
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 liabilities associated with incomplete performance obligations are not material.
Note 7 — Supplemental Cash Flow Information
Supplemental cash flow information is as follows (in thousands):
        
 
Nine months ended September 30,
 
2020
 
2019
Supplemental cash payment information:
 
 
 
Interest paid
$
20

 
$
595

Income taxes paid, net of refunds
(5,927
)
 
887

 
 
 
 
Supplemental schedule of non-cash investing and financing activities:
 
 
 
Equity issued - acquisition of JP3
$
8,538

 
$

Accrued capital expenditures
71


141




18


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 8 — Inventories
Inventories are as follows (in thousands):
 
September 30, 2020
 
December 31, 2019
Raw materials
$
7,413

 
$
4,339

Finished goods
18,451

 
24,569

Inventories
25,864

 
28,908

Less reserve for excess and obsolete inventory
(11,494
)
 
(5,698
)
Inventories, net
$
14,370

 
$
23,210


The provision recorded in the third quarter of 2020 includes charges of $5.7 million for the Chemistry Technologies segment and $3.9 million for the Data Analytics segment. The increase in excess and obsolescence is attributable to the Company’s product rationalization efforts, which included a reduction in the number of materials carried within the portfolio and identification of those materials for which the Company will no longer actively market or carry quantities in excess of current and estimated future usage requirements.

During the third quarter of 2020, the Company completed its review of inventory purchased in the JP3 acquisition. The Company identified measurement period adjustments reducing inventory by $2.3 million. For further discussion of the JP3 acquisition see Note 3, “JP3 Acquisition,” and for measurement period adjustments, see Note 11, “Goodwill.”
Note 9 — Property and Equipment
Property and equipment are as follows (in thousands):
 
September 30, 2020
 
December 31, 2019
Land
$
3,282

 
$
4,440

Buildings and leasehold improvements
6,067

 
38,741

Machinery and equipment
6,928

 
27,694

Fixed assets in progress
906

 

Furniture and fixtures
645

 
1,671

Transportation equipment
1,190

 
1,440

Computer equipment and software
1,296

 
3,348

Property and equipment
20,314

 
77,334

Less accumulated depreciation
(11,620
)
 
(37,505
)
Property and equipment, net
$
8,694

 
$
39,829


Fixed assets in progress are costs incurred during the third quarter of 2020 for capitalized sanitizer equipment upgrades.
Depreciation expense totaled $0.3 million and $1.6 million for the three months ended September 30, 2020 and 2019, respectively, and $2.3 million and $5.0 million for the nine months ended September 30, 2020 and 2019, respectively.
During the three months ended March 31, 2020, an impairment was recognized for $30.2 million. No impairment was recognized for the three months ended September 30, 2020.
Note 10 — Impairment of Fixed and Long-lived Assets

The Company recorded impairment charges of fixed and intangible assets during the following periods (in thousands):



19


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Three months ended September 30,
Nine months ended September 30,
 
2020
2020
Property and equipment, net
$

$
30,178

Operating lease right-of-use assets

7,434

 
 
 
Other Intangibles:
 
 
   Patents and technology
4,831

14,733

   Customer relationships
6,631

15,796

   Intangible assets in progress

596

   Trademarks and brand names
1,059

1,238

Total other intangibles
12,521

32,363

 
 
 
Total impairment of fixed, long-lived assets and intangibles
$
12,521

$
69,975


During the first quarter of 2020, the price of crude oil declined by over 50%, trading below $25 per barrel, causing a significant disruption across the industry, which began to negatively impact the Company’s results of operations. These declines of results of operations were driven by an oversupply of oil, insufficient storage, and demand destruction resulting from the reaction to COVID-19. Based on these factors, the Company concluded that a triggering event occurred and, accordingly, an interim quantitative impairment test was performed as of March 31, 2020.

Using the income approach, the fair value of the reporting unit was determined based on the present value of future cash flows. The Company utilized internal forecast trends and potential growth rates to estimate future cash flows of the asset group. Based on the results of the quantitative assessment, the Company concluded the carrying value of the asset group exceeded its fair value as of March 31, 2020 and an impairment loss of $57.5 million was recorded as a result of the adverse effect of the COVID-19 pandemic, estimated effect on the economy, and the related negative impact on oil and natural gas prices on projections of future cash flows.

During the second quarter of 2020, the Company purchased JP3 and formed the Data Analytics segment. The segment finished the third quarter with $0.7 million of revenue, most of which came from existing customers on minor project expansions. During the third quarter, revenue declined compared to the revenue after the date of acquisition in the second quarter. These declines were driven by reduced demand in the oil and gas sector because of capital spending reductions across our customer base, potential international markets addressed in original forecast were lower than anticipated, delayed start of the Company’s global sales business executive and continued impact of COVID-19. Although the site lockdowns and extreme caution to prevent the spread of COVID-19 that began in the first half of 2020 began to ease during the third quarter, the segment saw very little of the expected repeat business and almost none from new customers due to frozen budgets. Secondly, COVID-19 restrictions adversely impacted the Company’s ability to physically gain on-site access to customers’ operations, including laboratory and testing facilities, which is a critical component to JP3’s multi-phased sales approach.
In consideration of these events, management evaluated forecasted sales activity, expected margins and the long-term expectations of the Data Analytics segment. Based on these factors, the Company concluded a reduction in headcount was warranted and that a triggering event occurred in the Data Analytics segment and, accordingly, an interim quantitative impairment test was performed as of September 30, 2020.
Using the income approach, the fair value of the reporting unit was determined based on the present value of future cash flows. The Company utilized internal forecast trends and potential growth rates to estimate future cash flows of the asset group. Based on the results of the quantitative assessment, the Company concluded the carrying value of the asset group exceeded its fair value as of September 30, 2020 and an impairment loss of $12.5 million in the Data Analytics reporting unit, which resulted from reduced demand in the oil and gas sector, extended impact of the COVID-19 pandemic, and lower performance than expected by the reporting unit. See Note 3 - “JP3 Acquisition”.


20


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 11 - Goodwill
Goodwill from the acquisition of JP3 is as follows (in thousands):
Goodwill at December 31, 2019
 
$

Goodwill from acquisition of JP3
 
17,522

Measurement period adjustment
 
2,276

Impairment of goodwill
 
(11,706
)
Goodwill at September 30, 2020
 
$
8,092


During the third quarter of 2020, the Company made certain measurement period adjustments to inventory, resulting in an increase of goodwill of $2.3 million. See Note 8 - Inventories.
During the three months ended September 30, 2020, the Company recognized a goodwill impairment charge of $11.7 million in the Data Analytics reporting unit. See Note 3 - JP3 Acquisition.
Note 12 — Other Intangible Assets
Other intangible assets are as follows (in thousands):
 
September 30, 2020
 
December 31, 2019
 
Cost (1)
 
Accumulated Amortization
 
Cost
 
Accumulated Amortization
Finite-lived intangible assets:
 
 
 
 
 
 
 
Patents and technology
$

 
$

 
$
17,493

 
$
6,715

Customer relationships

 

 
15,367

 
6,013

Trademarks and brand names

 

 
1,351

 
1,160

Total finite-lived intangible assets
$

 
$

 
$
34,211

 
$
13,888

 
 
 
 
 
 
 
 
Carrying value:
 
 
 
 
 
 
 
Other intangible assets, net
$

 
 
 
$
20,323

 
 

(1) During the three months ended September 30, 2020, the Company recorded impairment charges to patents of $4.8 million, customer lists of $6.6 million, and trademarks and brand names of $1.1 million. See Note 10 - Impairment of Fixed and Long-lived Assets.
Amortization of finite-lived intangible assets acquired totaled $0.3 million and $0.5 million and $0.9 million and $1.5 million for the three months and nine months ended September 30, 2020 and 2019, respectively.



21


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 13 — Earnings (Loss) Per Share
Basic earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding combined with dilutive common share equivalents outstanding, if the effect is dilutive.
Potentially dilutive securities were excluded from the calculation of diluted loss per share for the three and nine months ended September 30, 2020 and 2019, since including them would have an anti-dilutive effect on loss per share due to the net loss incurred during the periods. Securities convertible into shares of common stock that were not considered in the diluted loss per share calculations were 0.1 million restricted stock units and 4.3 million stock options for the three and nine months ended September 30, 2020 and 0.5 million restricted stock units for the three and nine months ended September 30, 2019.
Note 14 — Fair Value Measurements
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company categorizes financial assets and liabilities into the three levels of the fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value and bases categorization within the hierarchy on the lowest level of input that is available and significant to the fair value measurement.
Level 1 — Quoted prices in active markets for identical assets or liabilities;
Level 2 — Observable inputs other than Level 1, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
Level 3 — Significant unobservable inputs that are supported by little or no market activity or that are based on the reporting entity’s assumptions about the inputs.
Fair Value of Other Financial Instruments
The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable approximate fair value due to the short-term nature of these accounts. The Payroll Protection Program (“PPP”) loans for Flotek and JP3 also approximate fair value due to maturity in less than two years.
Liabilities Measured at Fair Value on a Recurring Basis

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis and the level within the fair value hierarchy:
 
 
 
 
 
 
Balance at September 30,
 
 
 
 
 
 
 
Balance at December 31,
 
Level 1
 
Level 2
 
Level 3
2020
 
Level 1
 
Level 2
 
Level 3
 
2019
Contingent consideration
$

 
$

 
$
1,900

$
1,900

 
$

 
$

 
$

 
$


During the third quarter of 2020, the first stock performance target of the contingent consideration was achieved and the Company accrued a liability of $2.5 million, which was transferred out of Level 3 to a current liability. No other transfers occurred during three and nine month periods ending September 30, 2020. There were no transfers in or out of either Level 1, Level 2, or Level 3 fair value measurements during the period ending December 31, 2019.
Assets Measured at Fair Value on a Nonrecurring Basis
The Company’s non-financial assets, including property and equipment, and other intangible assets are measured at fair value on a non-recurring basis and are subject to fair value adjustment in certain circumstances. During the three months ended March 31, 2020, the Company recorded an impairment of $57.5 million for impairment on long-lived assets. Management inputs used in fair value measurements were classified as Level 3.
As noted in Note 3, the Company acquired JP3 in May 2020. The fair values of JP3’s long-lived assets, and intangibles were determined using the income approach. The fair value of the the Company’s inventory was determined using the comparative sales method. The fair value measurements were primarily based on significant inputs that are not observable in the market and thus


22


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

represent a Level 3 measurement, other than cash and working capital accounts, which carrying amounts were determined to approximate fair value due to their short-term nature.
During the three months ended September 30, 2020, the Company recorded an impairment charge on finite-lived assets of $12.5 million and an impairment charge on goodwill of $11.7 million. The fair value of the reporting unit was estimated based on an analysis of the present value of future discounted cash flows. The significant estimates used in the discounted cash flows model included the Company’s weighted average cost of capital, projected cash flows and the long-term rate of growth. The fair value measurements were primarily based on significant inputs that are not observable in the market and thus represent a Level 3 measurement.

Level 3 Rollforward for Assets and Liabilities Measured at Fair Value on a Recurring Basis
In conjunction with the May 2020 acquisition of JP3, the Company recorded contingent consideration of $1.2 million. Management inputs used in the fair value measurement were classified as Level 3. During the third quarter of 2020, the first stock performance target for the contingent consideration was achieved, resulting in an accrued liability of $2.5 million. The Company also estimated the fair value of the remaining stock performance earn-out provision at September 30, 2020, and increased the estimated fair value of the contingent liability to $1.9 million. The expense for achievement of the first stock performance target and the increase in the fair value of the contingent consideration are recorded in operating expenses in continuing operations for the periods ended September 30, 2020.
The following table presents the changes in contingent consideration balances classified as Level 3 balances for the three and nine months ended September 30, 2020 and 2019:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
Balance - beginning of period
$
1,200

 
$

 
$

 
$

Additions / issuances

 

 
1,200

 

Change in fair value
3,200

 

 
3,200

 

Transfer out of Level 3
(2,500
)
 

 
(2,500
)
 

Balance - end of period
$
1,900

 
$

 
$
1,900

 
$


Note 15 — Debt

In April 2020, the Company received a $4.8 million loan under the PPP, which was created through the Coronavirus Aid, Relief, and Economic Act (“CARES Act”) and is administered by the U.S. Small Business Administration (“SBA”). In connection with the acquisition of JP3 in May 2020, the Company assumed a PPP loan of $0.9 million obtained by JP3 in April 2020. The PPP loans have a fixed interest rate of 1%, mature in two years and no payments of principal or interest were due during the ten-month period beginning on the date of the PPP loans.

A portion of the loans are eligible for forgiveness by the SBA depending on the extent of proceeds used for payroll costs and other designated expenses incurred for up to 24 weeks following loan origination, subject to adjustments for headcount reductions and compensation limits and provided that at least 60% of the eligible costs incurred are used for payroll. Receipt of these funds required the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support ongoing operations of the Company. This certification further requires the Company to take into account current business activity and the ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. As of September 30, 2020, the Company has not applied for or estimated the potential forgiveness on the PPP loans. The receipt of these funds, and the forgiveness of the loans attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our future adherence to the forgiveness criteria. The term of each PPP loan is two years. The PPP loans are subject to any new guidance and new requirements released by the Department of the Treasury, which initially indicated that all companies that have received funds in excess of $2.0 million will be subject to a government (Small Business Administration) audit to further ensure PPP loans are limited to eligible borrowers in need.





23


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Long-term debt, including current portion, is as follows (in thousands):

 
September 30, 2020
Current portion of long-term debt
 
    Flotek PPP loan
$
2,926

    JP3 PPP loan
536

Total current portion of long-term debt
$
3,462

 

Long-term debt:
 
    Flotek PPP loan
$
1,862

    JP3 PPP loan
339

Total long-term debt, net of current portion
$
2,201


Note 16 — Income Taxes
A reconciliation of the U.S. federal statutory tax rate to the Company’s effective income tax rate is as follows:
 
Three months ended September 30,

Nine months ended September 30,
 
2020
 
2019
 
2020
 
2019
U.S. federal statutory tax rate
21.0
 %
 
21.0
 %
 
21.0
 %
 
21.0
 %
State income taxes, net of federal benefit
0.2

 
1.7

 
0.1

 
1.0

Non-U.S. income taxed at different rates
(0.2
)
 
0.7

 

 
1.0

Increase (reduction) in tax benefit related to stock-based awards
0.1

 
(1.1
)
 

 
(1.8
)
Non-deductible expenses
(0.1
)
 

 

 
(0.3
)
Research and development credit

 
0.4

 
0.1

 
0.6

Increase in valuation allowance
(20.8
)
 
(20.7
)
 
(17.9
)
 
(17.9
)
Effect of tax rate differences of NOL carryback

 

 
1.7

 

Other

 
(0.4
)
 

 
(0.3
)
Effective income tax rate
0.2
 %
 
1.6
 %
 
5.0
 %
 
3.3
 %


On March 27, 2020, the CARES Act was enacted in response to the COVID-19 pandemic. Among other things, the CARES Act provided the ability for taxpayers to carryback a net operating loss (“NOL”) arising in a taxable year beginning after December 31, 2017 and before January 1, 2021 to each of the five years preceding the year of the loss. Based on the Company’s analysis of the extended NOL carryback provision, it recorded a tax receivable of $6.1 million as of March 31, 2020, which was received in July 2020.
Fluctuations in effective tax rates have historically been impacted by permanent tax differences with no associated income tax impact, changes in the valuation allowance, changes in state apportionment factors, including the effect on state deferred tax assets and liabilities, and non-U.S. income taxed at different rates, except for the NOL carryback claim discussed above.
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted rates and laws that will be in effect when the differences are expected to reverse. ASC 740, Income Taxes, provides for the recognition of deferred tax assets if realization of such assets is more-likely-than-not. In assessing the need for a valuation allowance, the Company considers all available objective and verifiable evidence, both positive and negative, including historical levels of pre-tax income (loss) both on a consolidated basis and tax reporting entity basis, legislative developments, and expectations and risks associated with estimates of future pre-tax income.
As of December 31, 2019, the Company determined that it was more-likely-than-not that it would not realize the benefits of certain deferred tax assets and, therefore, it recorded a $19.9 million valuation allowance against the carrying value of net deferred tax assets, except for deferred tax liabilities related to certain state jurisdictions. As a result of the NOL carryback allowed by the


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FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CARES Act, the Company released a valuation allowance of $4.0 million related to its deferred tax assets attributable to its U.S. federal NOLs. The Company continues to have a full valuation allowance against net deferred tax assets as it is not more-likely-than-not they will be utilized.
Note 17 — Common Stock

On May 5, 2020, the shareholders of the Company approved an amendment to the Company’s Amended and Restated Certificate of Incorporation, as previously amended, to increase the authorized shares of common stock from 80,000,000 to 140,000,000, par value $0.0001 per share, and 100,000 of preferred stock, par value $0.0001 per share.  The additional authorized shares are available for corporate purposes, including acquisitions. 

A reconciliation of changes in common shares issued during the nine months ended September 30, 2020 is as follows:
Shares issued at December 31, 2019
63,656,897