UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~September 30, 2017



¨	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 or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

10603 W. Sam Houston Parkway N., Suite 300 Houston, TX		77064
(Address of principal executive offices)		(Zip Code)

(713) 849-9911

(Registrant’s telephone number, including area code)

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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting 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	x

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	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 x

As of ~~July 28,~~October 31, 2017, there were ~~57,332,720~~56,825,819 outstanding shares of Flotek Industries, Inc. common stock, $0.0001 par value.

TABLE OF CONTENTS




PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements	3
	Unaudited Condensed Consolidated Balance Sheets at ~~June~~September 30, 2017 and December 31, 2016	3
	Unaudited Condensed Consolidated Statements of Operations for the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016	4
	Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016	5
	Unaudited Condensed Consolidated Statements of Cash Flows for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016	6
	Unaudited Condensed Consolidated Statement of Equity for the ~~six~~nine months ended ~~June~~September 30, 2017	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31

Item 4.	Controls and Procedures	32

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	3334

Item 3.	Defaults Upon Senior Securities	34

Item 4.	Mine Safety Disclosures	34

Item 5.	Other Information	34

Item 6.	Exhibits	3435

SIGNATURES		3536

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	June 30, 2017			December 31, 2016			September 30, 2017			December 31, 2016
ASSETS
Current assets:
Cash and cash equivalents	$	3,422		$	4,823		$	4,942		$	4,823
Accounts receivable, net of allowance for doubtful accounts of $994 and $664 at June 30, 2017 and December 31, 2016, respectively	60,089			47,152
Accounts receivable, net of allowance for doubtful accounts of $1,089 and $664 at September 30, 2017 and December 31, 2016, respectively							56,008			47,152
Inventories	78,410			58,283			70,716			58,283
Income taxes receivable	3,872			12,752			2,649			12,752
Assets held for sale	7,197			43,900			4,135			43,900
Other current assets	6,079			21,708			10,881			21,708
Total current assets	159,069			188,618			149,331			188,618
Property and equipment, net	74,396			74,691			73,711			74,691
Goodwill	56,660			56,660			56,660			56,660
Deferred tax assets, net	19,972			12,894			21,190			12,894
Other intangible assets, net	49,080			50,352			48,851			50,352
TOTAL ASSETS	$	359,177		$	383,215		$	349,743		$	383,215
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	28,554		$	29,960		$	21,725		$	29,960
Accrued liabilities	8,488			12,170			12,323			12,170
Interest payable	21			24			30			24
Liabilities held for sale	2,416			4,961			1,586			4,961
Current portion of long-term debt	42,716			40,566			40,589			40,566
Total current liabilities	82,195			87,681			76,253			87,681
Long-term debt, less current portion	—			7,833			—			7,833
Total liabilities	82,195			95,514			76,253			95,514
Commitments and contingencies
Equity:
Cumulative convertible preferred stock, $0.0001 par value, 100,000 shares authorized; no shares issued and outstanding	—			—			—			—
Common stock, $0.0001 par value, 80,000,000 shares authorized; 60,504,613 shares issued and 57,313,766 shares outstanding at June 30, 2017; 59,684,669 shares issued and 56,972,580 shares outstanding at December 31, 2016	6			6
Common stock, $0.0001 par value, 80,000,000 shares authorized; 60,621,786 shares issued and 56,802,456 shares outstanding at September 30, 2017; 59,684,669 shares issued and 56,972,580 shares outstanding at December 31, 2016							6			6
Additional paid-in capital	331,126			318,392			334,490			318,392
Accumulated other comprehensive income (loss)	(970		)	(956		)	(822		)	(956		)
Retained earnings (accumulated deficit)	(25,633		)	(9,830		)	(28,736		)	(9,830		)
Treasury stock, at cost; 2,709,680 and 2,028,847 shares at June 30, 2017 and December 31, 2016, respectively	(27,905		)	(20,269		)
Treasury stock, at cost; 3,354,344 and 2,028,847 shares at September 30, 2017 and December 31, 2016, respectively							(31,806		)	(20,269		)
Flotek Industries, Inc. stockholders’ equity	276,624			287,343			273,132			287,343
Noncontrolling interests	358			358			358			358
Total equity	276,982			287,701			273,490			287,701
TOTAL LIABILITIES AND EQUITY	$	359,177		$	383,215		$	349,743		$	383,215

FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)


	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	85,177		$	64,079		$	165,131		$	127,890		$	79,458		$	64,337		$	244,589		$	192,227
Cost of revenue	59,086			42,361			111,298			82,379			57,718			41,983			169,016			124,362
Gross profit	26,091			21,718			53,833			45,511			21,740			22,354			75,573			67,865
Expenses:
Corporate general and administrative	11,155			9,557			23,426			20,096			10,346			10,302			33,773			30,398
Segment selling and administrative	9,386			8,067			19,695			17,105			9,277			9,775			28,972			26,879
Depreciation and amortization	2,479			1,905			4,924			3,806			2,540			2,217			7,464			6,024
Research and development	4,109			2,048			7,250			3,995			2,691			2,327			9,940			6,323
Loss (gain) on disposal of long-lived assets	214			(15		)	412			(15		)
(Gain) loss on disposal of long-lived assets													(11		)	(14		)	401			(29		)
Total expenses	27,343			21,562			55,707			44,987			24,843			24,607			80,550			69,595
(Loss) income from operations	(1,252		)	156			(1,874		)	524
Loss from operations													(3,103		)	(2,253		)	(4,977		)	(1,730		)
Other (expense) income:
Interest expense	(549		)	(610		)	(1,145		)	(1,018		)	(574		)	(518		)	(1,718		)	(1,536		)
Other (expense) income, net	237			(47		)	391			(53		)	273			(41		)	664			(94		)
Total other expense	(312		)	(657		)	(754		)	(1,071		)	(301		)	(559		)	(1,054		)	(1,630		)
Loss before income taxes	(1,564		)	(501		)	(2,628		)	(547		)	(3,404		)	(2,812		)	(6,031		)	(3,360		)
Income tax benefit	442			390			762			407
Income tax (expense) benefit													(17		)	942			746			1,349
Loss from continuing operations	(1,122		)	(111		)	(1,866		)	(140		)	(3,421		)	(1,870		)	(5,285		)	(2,011		)
Loss from discontinued operations, net of tax	(2,704		)	(2,169		)	(13,937		)	(32,325		)
Income (loss) from discontinued operations, net of tax													319			(876		)	(13,621		)	(33,200		)
Net loss	$	(3,826	)	$	(2,280	)	$	(15,803	)	$	(32,465	)	$	(3,102	)	$	(2,746	)	$	(18,906	)	$	(35,211	)

Basic earnings (loss) per common share:
Continuing operations	$	(0.02	)	$	—		(0.03		)	—			$	(0.06	)	$	(0.03	)	$	(0.09	)	$	(0.04	)
Discontinued operations, net of tax	(0.05		)	(0.04		)	(0.24		)	(0.59		)	0.01			(0.02		)	(0.24		)	(0.60		)
Basic earnings (loss) per common share	$	(0.07	)	$	(0.04	)	$	(0.27	)	$	(0.59	)	$	(0.05	)	$	(0.05	)	$	(0.33	)	$	(0.64	)
Diluted earnings (loss) per common share:
Continuing operations	$	(0.02	)	$	—		(0.03		)	—			$	(0.06	)	$	(0.03	)	$	(0.09	)	$	(0.04	)
Discontinued operations, net of tax	(0.05		)	(0.04		)	(0.24		)	(0.59		)	0.01			(0.02		)	(0.24		)	(0.60		)
Diluted earnings (loss) per common share	$	(0.07	)	$	(0.04	)	$	(0.27	)	$	(0.59	)	$	(0.05	)	$	(0.05	)	$	(0.33	)	$	(0.64	)
Weighted average common shares:
Weighted average common shares used in computing basic earnings (loss) per common share	57,854			54,910			57,764			54,827			57,602			56,899			57,709			55,523
Weighted average common shares used in computing diluted earnings (loss) per common share	57,854			54,910			57,764			54,827			57,602			56,899			57,709			55,523

FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)


	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Loss from continuing operations	$	(1,122	)	$	(111	)	$	(1,866	)	$	(140	)	$	(3,421	)	$	(1,870	)	$	(5,285	)	$	(2,011	)
Loss from discontinued operations, net of tax	(2,704		)	(2,169		)	(13,937		)	(32,325		)
Income (loss) from discontinued operations, net of tax													319			(876		)	(13,621		)	(33,200		)
Net loss	(3,826		)	(2,280		)	(15,803		)	(32,465		)	(3,102		)	(2,746		)	(18,906		)	(35,211		)
Other comprehensive income (loss):
Foreign currency translation adjustment	(5		)	7			(14		)	324			148			(68		)	134			256
Comprehensive income (loss)	$	(3,831	)	$	(2,273	)	$	(15,817	)	$	(32,141	)	$	(2,954	)	$	(2,814	)	$	(18,772	)	$	(34,955	)

FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Six months ended June 30,						Nine months ended September 30,
	2017			2016			2017			2016
Cash flows from operating activities:
Net loss	$	(15,803	)	$	(32,465	)	$	(18,906	)	$	(35,211	)
Loss from discontinued operations, net of tax	(13,937		)	(32,325		)	(13,621		)	(33,200		)
Loss from continuing operations	(1,866		)	(140		)	(5,285		)	(2,011		)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
Adjustments to reconcile loss from continuing operations to net cash provided by (used in) operating activities:
Depreciation and amortization	6,023			4,651			9,091			7,380
Amortization of deferred financing costs	253			205			376			308
Loss (gain) on sale of assets	412			(15		)	401			(29		)
Stock compensation expense	6,653			5,128			9,679			8,591
Deferred income tax benefit	(7,329		)	(8,076		)	(8,290		)	(6,309		)
Reduction in tax benefit related to share-based awards	315			954			915			883
Changes in current assets and liabilities:
Accounts receivable, net	(12,874		)	(51		)	(8,704		)	(7,572		)
Inventories	(20,023		)	(7,624		)	(12,213		)	(2,959		)
Income taxes receivable	8,619			(11,535		)	9,254			(13,687		)
Other current assets	14,185			(414		)	12,649			(51		)
Accounts payable	(1,418		)	3,622			(8,262		)	5,959
Accrued liabilities	(180		)	11,685			1,561			10,434
Income taxes payable	(10		)	(1,759		)	—			(1,807		)
Interest payable	(3		)	74			6			45
Net cash used in operating activities	(7,243		)	(3,295		)
Net cash provided by (used in) operating activities							1,178			(825		)
Cash flows from investing activities:
Capital expenditures	(4,508		)	(8,238		)	(6,155		)	(10,618		)
Proceeds from sales of businesses	17,490			—			18,490			—
Proceeds from sale of assets	310			24			321			38
Payments for acquisition, net of cash acquired							—			(7,863		)
Purchase of patents and other intangible assets	(247		)	(140		)	(817		)	(311		)
Net cash provided by (used in) investing activities	13,045			(8,354		)	11,839			(18,754		)
Cash flows from financing activities:
Repayments of indebtedness	(9,833		)	(3,571		)	(9,833		)	(15,398		)
Borrowings on revolving credit facility	224,757			171,397			310,021			256,738
Repayments on revolving credit facility	(220,607		)	(153,460		)	(307,998		)	(249,324		)
Debt issuance costs	(106		)	(147		)	(106		)	(147		)
Reduction in tax benefit related to share-based awards	—			(954		)	—			(883		)
Purchase of treasury stock related to share-based awards	(1,335		)	(609		)	(1,500		)	(925		)
Proceeds from sale of common stock	368			446			530			30,610
Repurchase of common stock	(487		)	—			(4,174		)	—
Proceeds from exercise of stock options	20			134			21			134
Net cash (used in) provided by financing activities	(7,223		)	13,236			(13,039		)	20,805
Discontinued operations:
Net cash used in operating activities	(794		)	(59		)	(695		)	(82		)
Net cash provided by investing activities	794			51			708			74
Net cash flows used in discontinued operations	—			(8		)
Net cash flows provided by (used in) discontinued operations							13			(8		)
Effect of changes in exchange rates on cash and cash equivalents	20			53			128			48
Net (decrease) increase in cash and cash equivalents	(1,401		)	1,632
Net increase in cash and cash equivalents							119			1,266
Cash and cash equivalents at the beginning of period	4,823			2,208			4,823			2,208
Cash and cash equivalents at the end of period	$	3,422		$	3,840		$	4,942		$	3,474

FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(in thousands)


	Common Stock			Treasury Stock					Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Retained Earnings (Accumulated Deficit)			Non-controlling Interests		Total Equity			Common Stock			Treasury Stock					Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Retained Earnings (Accumulated Deficit)			Non-controlling Interests		Total Equity
	Shares Issued	Par Value		Shares		Cost			Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Retained Earnings (Accumulated Deficit)			Non-controlling Interests		Total Equity			Shares Issued	Par Value		Shares		Cost			Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Retained Earnings (Accumulated Deficit)			Non-controlling Interests		Total Equity
Balance, December 31, 2016	59,685	$	6	2,029		$	(20,269	)	$	318,392	$	(956	)	$	(9,830	)	$	358	$	287,701		59,685	$	6	2,029		$	(20,269	)	$	318,392	$	(956	)	$	(9,830	)	$	358	$	287,701
Net loss	—	—		—		—			—		—			(15,803		)	—		(15,803		)	—	—		—		—			—		—			(18,906		)	—		(18,906		)
Foreign currency translation adjustment	—	—		—		—			—		(14		)	—			—		(14		)	—	—		—		—			—		134			—			—		134
Stock issued under employee stock purchase plan	—	—		(40	)	—			368		—			—			—		368			—	—		(81	)	—			530		—			—			—		530
Common stock issued in payment of accrued liability	—	—		—		—			188		—			—			—		188			—	—		—		—			188		—			—			—		188
Stock options exercised	651	—		—		—			5,834		—			—			—		5,834			663	—		—		—			5,884		—			—			—		5,884
Stock surrendered for exercise of stock options	—	—		470		(5,814		)	—		—			—			—		(5,814		)	—	—		478		(5,863		)	—		—			—			—		(5,863		)
Restricted stock granted	169	—		—		—			—		—			—			—		—			274	—		—		—			—		—			—			—		—
Restricted stock forfeited	—	—		76		—			—		—			—			—		—			—	—		97		—			—		—			—			—		—
Treasury stock purchased	—	—		125		(1,335		)	—		—			—			—		(1,335		)	—	—		151		(1,500		)	—		—			—			—		(1,500		)
Stock compensation expense	—	—		—		—			6,344		—			—			—		6,344			—	—		—		—			9,496		—			—			—		9,496
Repurchase of common stock	—	—		50		(487		)	—		—			—			—		(487		)	—	—		680		(4,174		)	—		—			—			—		(4,174		)
Balance, June 30, 2017	60,505	$	6	2,710		$	(27,905	)	$	331,126	$	(970	)	$	(25,633	)	$	358	$	276,982
Balance, September 30, 2017																						60,622	$	6	3,354		$	(31,806	)	$	334,490	$	(822	)	$	(28,736	)	$	358	$	273,490

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 global, diversified, technology-driven company that develops and supplies ~~chemistry~~chemistries and services to the oil and gas industries, and high value compounds to companies that make food and beverages, cleaning products, cosmetics, ~~food and beverages,~~ and other products that are sold in consumer and industrial markets.

The Company’s oilfield business includes specialty chemistries and logistics which enable its customers in pursuing improved efficiencies in the drilling and completion of their wells. The Company also provides automated bulk material handling, loading facilities, and blending capabilities. The Company processes citrus oil to produce (1) high value compounds used as additives by companies in the flavors and fragrances markets and (2) environmentally friendly chemistries for use in numerous industries around the world, including the oil and gas (“O&G”) industry.

Flotek operates in over 20 domestic and international markets. Customers include major integrated O&G companies, oilfield services companies, independent O&G companies, pressure-pumping service companies, national and state-owned oil companies, and international supply chain management companies. The Company also serves customers who purchase non-energy-related citrus oil and related products, including household and commercial cleaning product companies, fragrance and cosmetic companies, and food manufacturing companies.

Flotek was initially incorporated under the laws of the Province of British Columbia on May 17, 1985. On October 23, 2001, Flotek changed its corporate domicile to the state of Delaware.

Basis of Presentation

The accompanying Unaudited Condensed Consolidated Financial Statements and accompanying footnotes (collectively the “Financial Statements”) reflect all adjustments, in the opinion of management, necessary for fair presentation 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 Securities and Exchange Commission (“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 on Form 10-K for the fiscal year ended December 31, 2016 (“Annual Report”). A copy of the 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. The results of operations for the three and ~~six~~nine months ended ~~June~~September 30, 2017, are not necessarily indicative of the results to be expected for the year ending December 31, 2017.

During the fourth quarter of 2016, the Company classified the Drilling Technologies and Production Technologies segments as held for sale based on management’s intention to sell these businesses. The Company’s historical financial statements have been revised to present the operating results of the Drilling Technologies and Production Technologies segments as discontinued operations. The results of operations of Drilling Technologies and Production Technologies are presented as “Loss from discontinued operations” in the statement of operations and the related cash flows of these segments has been reclassified to discontinued operations for all periods presented. The assets and liabilities of the Drilling Technologies and Production Technologies segments have been reclassified to “Assets held for sale” and “Liabilities held for sale”, respectively, in the consolidated balance sheets for all periods presented.

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.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation. The reclassifications did not impact net income (loss).

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 — Recent Accounting Pronouncements

Application of New Accounting Standards

Effective January 1, 2017, the Company adopted the accounting guidance in Accounting Standards Update (“ASU”) No. 2015-11, “Simplifying the Measurement of Inventory.” This standard requires management to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.

Effective January 1, 2017, the Company adopted the accounting guidance in ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes.” This standard eliminated the requirement for organizations to present deferred tax assets and liabilities as current and noncurrent in a classified balance sheet. Instead, organizations are now required to classify all deferred tax assets and liabilities as noncurrent. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures. The Company applied this standard retrospectively and, therefore, prior periods presented were adjusted.

Effective January 1, 2017, the Company adopted the accounting guidance in ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This standard simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new guidance requires excess tax benefits and deficiencies to be recognized in the income statement rather than in additional paid-in capital. As a result of applying this change, the Company recognized ~~$0.3~~a $0.9 million ~~of excess~~reduction in tax benefit in the provision for incomes taxes during the ~~six~~nine months ended ~~June~~September 30, 2017. The Company applied this standard prospectively, where applicable, and, therefore, prior periods presented were not adjusted.

New Accounting Requirements and Disclosures

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers.” The ASU will supersede most of the existing revenue recognition requirements in U.S. GAAP and will require entities to recognize revenue at an amount that reflects the consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer. The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of an entity’s nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date by one year to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016, the FASB issued ASU No. 2016-08, which improves the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, which clarifies identifying performance obligations and the licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, effective upon adoption of ASU 2014-09, and ASU No. 2016-12, which reduces the potential for diversity in practice at initial application and reduces the cost and complexity of applying Topic 606 both at transition and on an ongoing basis. In December 2016, the FASB issued ASU No. 2016-20, which provides technical corrections and improvements to the original guidance issued. The Company intends to adopt the new standard in the first quarter of 2018 ~~using~~and is still evaluating which method to implement based on continued review of past and anticipated revenue streams given the ~~modified retrospective method.~~change in strategic focus of the business during 2017. The Company has identified key contract types representative of its business for comparing historical accounting policies and practices to the new standard and is continuing to evaluate the impact these pronouncements will have on the consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, “Leases.” This standard requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. The pronouncement is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and should be applied using a modified retrospective transition approach, with early application permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

In June 2016, 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 fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption for the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments.” This standard addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The pronouncement is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-01, “Clarifying the Definition of a Business.” This standard provides additional guidance on whether an integrated set of assets and activities constitutes a business. The pronouncement is effective for annual periods beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted in specific instances. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” This standard eliminates Step 2 from the goodwill impairment test. An entity will now recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The pronouncement is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

In May 2017, the FASB issued ASU No. 2017-09, “Scope of Modification Accounting.” This standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. The pronouncement is effective for annual periods beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

Note 3 — Discontinued Operations

During the fourth quarter 2016, the Company initiated a strategic restructuring of its business to enable a greater focus on its core businesses in energy chemistry and consumer and industrial chemistry. The Company executed a plan to sell or otherwise dispose of the Drilling Technologies and Production Technologies segments. An investment banking advisory services firm was engaged and actively marketed these segments.

The Company met all of the criteria to classify the Drilling Technologies and Production Technologies segments’ assets and liabilities as held for sale in the fourth quarter 2016. Effective December 31, 2016, the Company classified the assets, liabilities, and results of operations for these two segments as “Discontinued Operations” for all periods presented.

Disposal of the Drilling Technologies and Production Technologies reporting segments represented a strategic shift that would have a major effect on the Company’s operations and financial results. Management expects the sale or disposal of the assets of these segments to be completed by the end of 2017.

On May 22, 2017, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of the Company’s Drilling Technologies segment to National Oilwell Varco, L.P. (“NOV”) for $17.0 million in cash consideration, subject to normal working capital adjustments, with $1.5 million held back by NOV for up to 18 months to satisfy potential indemnification claims.

On May 23, 2017, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of the Company’s Production Technologies segment to Raptor Lift Solutions, LLC (“Raptor Lift”) for $2.9 million in cash consideration, with $0.4 million held back by Raptor Lift to satisfy potential indemnification claims.

On August 16, 2017, the Company completed the sale of substantially all of the remaining assets of the Company’s Drilling Technologies segment to Galleon Mining Tools, Inc. for $1.0 million in cash consideration and a note receivable of $1.0 million due in one year.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following summarized financial information has been segregated from continuing operations and reported as Discontinued Operations for the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016 (in thousands):


	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Drilling Technologies
Revenue	$	4,737		$	6,372		$	11,534		$	12,829		$	—		$	7,197		$	11,534		$	20,026
Cost of revenue	(2,603		)	(4,155		)	(7,259		)	(9,587		)	—			(4,290		)	(7,259		)	(13,876		)
Selling, general and administrative	(2,740		)	(3,495		)	(5,771		)	(8,155		)	(791		)	(3,568		)	(6,562		)	(11,723		)
Depreciation and amortization	—			(337		)	—			(1,085		)	—			(340		)	—			(1,425		)
Research and development	(6		)	(22		)	(6		)	(65		)	—			—			(6		)	(65		)
Gain (loss) on disposal of long-lived assets	(12		)	19			62			16
Gain on disposal of long-lived assets													36			77			97			92
Impairment of inventory and long-lived assets	—			—			—			(36,522		)	—			—			—			(36,522		)
Loss from operations	(624		)	(1,618		)	(1,440		)	(42,569		)	(755		)	(924		)	(2,196		)	(43,493		)
Other expense	(46		)	(69		)	(117		)	(243		)
Loss on sale of businesses	(1,365		)	—			(1,365		)	—
Other income (expense)													26			(77		)	(91		)	(320		)
Gain (loss) on sales of businesses													463			—			(902		)	—
Loss on write-down of assets held for sale	(272		)	—			(6,831		)	—			—			—			(6,831		)	—
Loss before income taxes	(2,307		)	(1,687		)	(9,753		)	(42,812		)	(266		)	(1,001		)	(10,020		)	(43,813		)
Income tax benefit	158			456			3,147			14,881			581			592			3,473			15,673
Net loss from discontinued operations	$	(2,149	)	$	(1,231	)	$	(6,606	)	$	(27,931	)
Net income (loss) from discontinued operations													$	315		$	(409	)	$	(6,547	)	$	(28,140	)

Production Technologies
Revenue	$	849		$	1,868		$	4,002		$	3,889		$	—		$	2,145		$	4,002		$	6,034
Cost of revenue	(707		)	(1,882		)	(3,189		)	(3,793		)	—			(2,040		)	(3,189		)	(5,833		)
Selling, general and administrative	(802		)	(897		)	(1,675		)	(2,051		)	(64		)	(878		)	(1,739		)	(2,929		)
Depreciation and amortization	—			(149		)	—			(298		)	—			(149		)	—			(447		)
Research and development	(92		)	(201		)	(363		)	(467		)	—			(204		)	(364		)	(671		)
Loss on disposal of long-lived assets	—			—			—			(59		)
Gain (loss) on disposal of long-lived assets													—			8			—			(51		)
Impairment of inventory	—			—			—			(3,913		)	—			—			—			(3,913		)
Loss from operations	(752		)	(1,261		)	(1,225		)	(6,692		)	(64		)	(1,118		)	(1,290		)	(7,810		)
Other expense	(16		)	(23		)	(52		)	(44		)	—			(24		)	(52		)	(68		)
Gain on sale of businesses	171			—			171			—			61			—			233			—
Loss on write-down of assets held for sale	—			—			(9,718		)	—			—			—			(9,718		)	—
Loss before income taxes	(597		)	(1,284		)	(10,824		)	(6,736		)	(3		)	(1,142		)	(10,827		)	(7,878		)
Income tax benefit	42			346			3,493			2,342			7			675			3,753			2,818
Net loss from discontinued operations	$	(555	)	$	(938	)	$	(7,331	)	$	(4,394	)
Net income (loss) from discontinued operations													$	4		$	(467	)	$	(7,074	)	$	(5,060	)

Drilling Technologies and Production Technologies
Loss from discontinued operations, net of tax	$	(2,704	)	$	(2,169	)	$	(13,937	)	$	(32,325	)
Income (loss) from discontinued operations, net of tax													$	319		$	(876	)	$	(13,621	)	$	(33,200	)

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The assets and liabilities held for sale on the Consolidated Balance Sheets as of ~~June~~September 30, 2017 and December 31, 2016 are as follows (in thousands):


	Drilling Technologies						Production Technologies					Drilling Technologies						Production Technologies
	June 30, 2017			December 31, 2016			June 30, 2017		December 31, 2016			September 30, 2017			December 31, 2016			September 30, 2017		December 31, 2016
Assets:
Accounts receivable, net	$	2,448		$	5,072		$	539	$	1,784		$	1,749		$	5,072		$	201	$	1,784
Inventories	1,942			9,078			—		8,115			5			9,078			5		8,115
Other current assets	1,595			278			697		370			1,585			278			699		370
Long-term receivable	—			—			—		4,179			—			—			—		4,179
Property and equipment, net	880			11,277			—		3,978			—			11,277			—		3,978
Goodwill	—			15,333			—		1,689			—			15,333			—		1,689
Other intangible assets, net	—			7,395			—		484			—			7,395			—		484
Assets held for sale	6,865			48,433			1,236		20,599			3,339			48,433			905		20,599
Valuation allowance	(904		)	(18,971		)	—		(6,161		)	(109		)	(18,971		)	—		(6,161		)
Assets held for sale, net	$	5,961		$	29,462		$	1,236	$	14,438		$	3,230		$	29,462		$	905	$	14,438
Liabilities:
Accounts payable	$	388		$	2,472		$	40	$	914		$	15		$	2,472		$	10	$	914
Accrued liabilities	1,607			1,190			381		385			1,419			1,190			142		385
Liabilities held for sale	$	1,995		$	3,662		$	421	$	1,299		$	1,434		$	3,662		$	152	$	1,299

Note 4 — Impairment of Inventory and Long-Lived Assets for Discontinued Operations

During the three months ended March 31, 2016, as a result of changes in the oil and gas industry that occurred since the beginning of 2016 and the corresponding impact on the Company’s business outlook, the Company evaluated the direction of its business activities. Crude oil prices, which appeared to have stabilized during the fourth quarter of 2015, fell further during the first quarter of 2016, decreasing approximately 21% from average prices seen in the fourth quarter of 2015. The U.S. drilling rig count declined from 698 at December 31, 2015 to 450 at April 1, 2016, a decline of 35.5%.

Due to the decreased rig activity and its impact on management’s expectations for future market activity, the Company further refocused operations of its Drilling Technologies segment. The Company decided to exit the business of building and repairing motors in all domestic markets. In addition, changes in drilling technique, including further escalation of the move to a dominance of pad drilling, reduced the marketability of certain other inventory items. The focus of the Production Technologies segment was shifted to its new technologies for electric submersible pumps for the oil and gas industry and for hydraulic pumping units. Inventory associated with older technologies for these items has been evaluated for impairment. As a result of these changes in focus and projected declines in asset utilization, the Company recorded a pre-tax impairment of inventories as noted below.

Changes in the business climate noted above and increasing operating losses experienced within the Drilling Technologies and Production Technologies segments during the three months ended March 31, 2016, caused the Company to test asset groups within these two segments for recoverability. Recoverability of the carrying value of the asset groups was based upon estimated future cash flows while taking into consideration various assumptions and estimates, including future use of the assets, remaining useful life of the assets, and eventual disposition of the assets. Undiscounted estimated cash flows of two asset groups associated with domestic operations in the Drilling Technologies segment did not exceed the carrying value of the respective asset groups. Therefore, the Company performed an analysis of discounted future cash flows to determine the fair value of each of these two asset groups. As a result of this testing, the Company recorded a pre-tax impairment of long-lived assets as noted below.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company recorded impairment charges during the three months ended March 31, 2016, as follows (in thousands):



Drilling Technologies:
Inventories	$	12,653
Long-lived assets:
Property and equipment	14,642
Intangible assets other than goodwill	9,227
Production Technologies:
Inventories	3,913
Total impairment	$	40,435

Based on the changes in the business climate discussed above and continuing operating losses experienced during the three months ended March 31, 2016, June 30, 2016, and ~~June~~September 30, 2016, goodwill within the Teledrift and Production Technologies reporting units was tested for impairment during these periods. However, no impairments of goodwill were recorded based upon this testing.

Note 5 — Acquisitions

On July 27, 2016, the Company acquired 100% of the stock and interests in International Polymerics, Inc. (“IPI”) and related entities for $7.9 million in cash consideration, net of cash acquired, and 247,764 shares of the Company’s common stock. IPI is a U.S. based manufacturer of high viscosity guar gum and guar slurry for the oil and gas industry with a wide selection of stimulation chemicals.

Note 6 — Supplemental Cash Flow Information

Supplemental cash flow information is as follows (in thousands):


	Six months ended June 30,					Nine months ended September 30,
	2017		2016			2017		2016
Supplemental non-cash investing and financing activities:
Value of common stock issued in acquisition						$	—	$	3,268
Value of common stock issued in payment of accrued liability	$	188	$	—		188		—
Exercise of stock options by common stock surrender	5,814		—			5,863		50
Supplemental cash payment information:
Interest paid	$	1,069	$	921		$	1,511	$	1,459
Income taxes received, net of payments (paid, net of refunds)	9,489		(3,429		)	10,081		(1,663		)

Note 67 — Revenue

The Company differentiates revenue and cost of revenue based on whether the source of revenue is attributable to products or services. Revenue and cost of revenue by source are as follows (in thousands):

Three months ended June 30, Six months ended June 30,
2017 2016 2017 2016
Revenue:
Products $ 83,835
$ 62,561
$ 162,350
$ 124,560
Services 1,342
1,518
2,781
3,330
$ 85,177
$ 64,079
$ 165,131
$ 127,890
Cost of revenue:
Products $ 57,052
$ 41,692
$ 107,741
$ 80,936
Services 1,522
172
2,458
598
Depreciation 512
497
1,099
845
$ 59,086
$ 42,361
$ 111,298
$ 82,379

~~Note 7 — Inventories~~

~~Inventories are as follows (in thousands):~~

June 30, 2017 December 31, 2016
Raw materials $ 42,668
$ 28,626
Work-in-process 2,933
2,918
Finished goods 32,809
26,739
Inventories $ 78,410
$ 58,283



	Three months ended September 30,				Nine months ended September 30,
	2017		2016		2017		2016
Revenue:
Products	$	77,956	$	62,562	$	240,306	$	187,122
Services	1,502		1,775		4,283		5,105
	$	79,458	$	64,337	$	244,589	$	192,227
Cost of revenue:
Products	$	55,846	$	41,117	$	163,587	$	122,055
Services	1,345		354		3,802		950
Depreciation	527		512		1,627		1,357
	$	57,718	$	41,983	$	169,016	$	124,362

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 8 — Inventories

Inventories are as follows (in thousands):



	September 30, 2017		December 31, 2016
Raw materials	$	37,961	$	28,626
Work-in-process	3,042		2,918
Finished goods	29,713		26,739
Inventories	$	70,716	$	58,283

Note 9 — Property and Equipment

Property and equipment are as follows (in thousands):


	June 30, 2017			December 31, 2016			September 30, 2017			December 31, 2016
Land	$	6,551		$	5,837		$	6,748		$	5,837
Buildings and leasehold improvements	43,052			42,986			43,431			42,986
Machinery, equipment and rental tools	38,213			36,187
Machinery and equipment							38,862			36,187
Equipment in progress	5,091			3,235			5,475			3,235
Furniture and fixtures	2,026			1,969			2,029			1,969
Transportation equipment	2,449			3,059			2,307			3,059
Computer equipment and software	12,069			11,844			12,168			11,844
Property and equipment	109,451			105,117			111,020			105,117
Less accumulated depreciation	(35,055		)	(30,426		)	(37,309		)	(30,426		)
Property and equipment, net	$	74,396		$	74,691		$	73,711		$	74,691

Depreciation expense, including expense recorded in cost of revenue, totaled ~~$2.3~~$2.4 million and ~~$1.7~~$2.1 million for the three months ended ~~June~~September 30, 2017 and 2016, respectively, and ~~$4.7~~$7.0 million and ~~$3.2~~$5.3 million for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, respectively.

During the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, no impairments were recognized related to property and equipment.

Note 910 — Goodwill

Changes in the carrying value of goodwill for each reporting unit are as follows (in thousands):


	Energy Chemistry Technologies		Consumer and Industrial Chemistry Technologies		Total		Energy Chemistry Technologies		Consumer and Industrial Chemistry Technologies		Total
Balance at December 31, 2016	$	37,180	$	19,480	$	56,660	$	37,180	$	19,480	$	56,660
Goodwill impairment recognized	—		—		—		—		—		—
Balance at June 30, 2017	$	37,180	$	19,480	$	56,660
Balance at September 30, 2017							$	37,180	$	19,480	$	56,660

During the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, no impairments of goodwill were recognized.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1011 — Other Intangible Assets

Other intangible assets are as follows (in thousands):

June 30, 2017 December 31, 2016
Cost Accumulated Amortization Cost Accumulated Amortization
Finite-lived intangible assets:
Patents and technology $ 17,099
$ 5,060
$ 16,815
$ 4,537
Customer lists 30,877
7,343
30,877
6,518
Trademarks and brand names 1,517
1,092
1,467
1,069
Total finite-lived intangible assets acquired 49,493
13,495
49,159
12,124
Deferred financing costs 1,822
370
1,804
117
Total amortizable intangible assets 51,315
$ 13,865
50,963
$ 12,241
Indefinite-lived intangible assets:
Trademarks and brand names 11,630
11,630

Total other intangible assets $ 62,945
$ 62,593

Carrying value:
Other intangible assets, net $ 49,080
$ 50,352

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~



	September 30, 2017				December 31, 2016
	Cost		Accumulated Amortization		Cost		Accumulated Amortization
Finite-lived intangible assets:
Patents and technology	$	17,236	$	5,323	$	16,815	$	4,537
Customer lists	30,877		7,745		30,877		6,518
Trademarks and brand names	1,544		1,105		1,467		1,069
Total finite-lived intangible assets acquired	49,657		14,173		49,159		12,124
Deferred financing costs	2,230		493		1,804		117
Total amortizable intangible assets	51,887		$	14,666	50,963		$	12,241
Indefinite-lived intangible assets:
Trademarks and brand names	11,630				11,630
Total other intangible assets	$	63,517			$	62,593

Carrying value:
Other intangible assets, net	$	48,851			$	50,352

Finite-lived intangible assets acquired are amortized on a straight-line basis over two to 20 years. Amortization of finite-lived intangible assets acquired totaled $0.7 million and $0.7 million for the three months ended ~~June~~September 30, 2017 and 2016, respectively, and ~~$1.4~~$2.0 million and ~~$1.4~~$2.1 million for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, respectively.

Amortization of deferred financing costs was $0.1 million and $0.1 million for the three months ended ~~June~~September 30, 2017 and 2016, respectively, and ~~$0.3~~$0.4 million and ~~$0.2~~$0.3 million for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, respectively.

Note 1112 — Long-Term Debt and Credit Facility

Long-term debt is as follows (in thousands):


	June 30, 2017			December 31, 2016			September 30, 2017			December 31, 2016
Long-term debt:
Borrowings under revolving credit facility	$	42,716		$	38,566		$	40,589		$	38,566
Term loan	—			9,833			—			9,833
Total long-term debt	42,716			48,399			40,589			48,399
Less current portion of long-term debt	(42,716		)	(40,566		)	(40,589		)	(40,566		)
Long-term debt, less current portion	$	—		$	7,833		$	—		$	7,833

Credit Facility

On May 10, 2013, the Company and certain of its subsidiaries (the “Borrowers”) entered into an Amended and Restated Revolving Credit, Term Loan and Security Agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC Bank”). The Company may borrow under the Credit Facility for working capital, permitted acquisitions, capital expenditures and other corporate purposes. The Credit Facility, as amended, continues in effect until May 10, ~~2020.~~2022. Under terms of the Credit Facility, as amended, the Company has total borrowing availability ~~of $65 million; initially, up to $55 million~~ under a revolving credit facility ~~with borrowing~~ of $10 million under a term loan. The revolving credit facility limit will increase by each term loan principal payment, therefore, total borrowing capacity will remain at $65 million throughout the term of the Credit Facility.$75 million.

The Credit Facility is secured by substantially all of the Company’s domestic real and personal property, including accounts receivable, inventory, land, buildings, equipment and other intangible assets. The Credit Facility contains customary representations, warranties, and both affirmative and negative covenants. The Company was in compliance with all debt covenants at ~~June~~September 30, 2017. ~~The Credit Facility restricts the payment of cash dividends on common stock and limits the amount that may be used to repurchase common stock and preferred stock.~~ In the event of default, PNC Bank may accelerate the maturity date of any outstanding amounts borrowed under the Credit Facility.

The Credit Facility contains financial covenants to maintain a fixed charge coverage ratio and a leverage ratio, as well as establishes an annual limit on capital expenditures. The fixed charge coverage ratio is the ratio of (a) earnings before interest, taxes, depreciation, and amortization (“EBITDA”), adjusted for non-cash stock-based compensation and the loss from discontinued operations, less

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

cash paid for taxes during the period to (b) all debt payments during the period. The fixed charge coverage ratio requirement began for the quarter ended March 31, 2017 at 1.00 to 1.00 and increases to 1.10 to 1.00 for the year ending December 31, 2017, and for each fiscal quarter thereafter. The leverage ratio (funded debt to adjusted EBITDA) requirement ~~begins~~began for the six months ~~ending~~ended June 30, 2017, at not greater than 5.50 to 1.10 and reduces to not greater than ~~4.00~~3.00 to 1.00 ~~for the year ending March 31,~~as of September 30, 2018, and for each fiscal quarter thereafter. The annual limit on capital expenditures for 2017 is $20 million. The annual limit on capital expenditures for ~~2017~~2018 and each fiscal year thereafter is $26 million. The annual limit on capital expenditures is reduced if the undrawn availability under the revolving credit facility falls below ~~$10 million at month-end for April, May, or June 2017 or below~~ $15 million at any ~~other~~ month-end.

The Credit Facility restricts the payment of cash dividends on common stock and limits the amount that may be used to repurchase common stock and preferred stock.

Beginning with fiscal year 2017, the Credit Facility includes a provision that 25% of EBITDA minus cash paid for taxes, dividends, debt payments, and unfunded capital expenditures, not to exceed $3.0 million for any year, be paid on the outstanding balance within 60 days of the fiscal year end.

Each of the Company’s domestic subsidiaries is fully obligated for Credit Facility indebtedness as a borrower or as a guarantor.

(a) Revolving Credit Facility

Under the revolving credit facility, the Company may ~~initially~~ borrow up to ~~$55~~$75 million through May 10, ~~2020.~~2022. This includes a sublimit of ~~$10~~$10 million that may be used for letters of credit. ~~As of May 22, 2017, the revolving credit facility limit increased to $65 million upon payment in full of the outstanding term loan principal balance.~~ The revolving credit facility is secured by substantially all of the Company’s domestic accounts receivable and inventory.

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

At ~~June~~September 30, 2017, eligible accounts receivable and inventory securing the revolving credit facility provided total borrowing capacity of ~~$64.9~~$74.9 million under the revolving credit facility. Available borrowing capacity, net of outstanding borrowings, was ~~$22.2~~$34.3 million at ~~June~~September 30, 2017.

The interest rate on advances under the revolving credit facility varies based on the fixed charge coverage ratio. Rates range (a) between PNC Bank’s base lending rate plus 1.5% to 2.0% or (b) between the London Interbank Offered Rate (LIBOR) plus 2.5% to 3.0%. PNC Bank’s base lending rate was 4.25% at ~~June~~September 30, 2017. The Company is required to pay a monthly facility fee of 0.25% per annum, on any unused amount under the commitment based on daily averages. At ~~June~~September 30, 2017, ~~$42.7~~$40.6 million was outstanding under the revolving credit facility, with ~~$7.7~~$2.6 million borrowed as base rate loans at an interest rate of 5.75% and ~~$35.0~~$38.0 million borrowed as LIBOR loans at an interest rate of ~~3.73%~~3.74%.

Borrowing under the revolving credit agreement is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration clause.

(b) Term Loan

The amount borrowed under the term loan was reset to $10 million effective as of September 30, 2016. Monthly principal payments of $0.2 million were required. On May 22, 2017, the Company repaid the outstanding balance of the term ~~loan and the liens on land, buildings, equipment, and other intangible assets were released.~~loan.

Note 1213 — 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 ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, since including them would have an anti-dilutive effect on loss per share due to the net loss incurred during the period. Securities convertible into shares of common stock that were not considered in the diluted loss per share calculations were ~~12,100 stock options and~~ 1.3 million restricted stock units for the three and ~~six~~nine months ended ~~June~~September 30, 2017, and 0.7 million stock options and 0.8 million restricted stock units for the three and ~~six~~nine months ended ~~June~~September 30, 2016.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Basic and diluted earnings (loss) per common share are as follows (in thousands, except per share data):


	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Loss from continuing operations	$	(1,122	)	$	(111	)	$	(1,866	)	$	(140	)	$	(3,421	)	$	(1,870	)	$	(5,285	)	$	(2,011	)
Loss from discontinued operations, net of tax	(2,704		)	(2,169		)	(13,937		)	(32,325		)
Income (loss) from discontinued operations, net of tax													319			(876		)	(13,621		)	(33,200		)
Net loss - Basic and Diluted	$	(3,826	)	$	(2,280	)	$	(15,803	)	$	(32,465	)	$	(3,102	)	$	(2,746	)	$	(18,906	)	$	(35,211	)

Weighted average common shares outstanding - Basic	57,854			54,910			57,764			54,827			57,602			56,899			57,709			55,523
Assumed conversions:
Incremental common shares from stock options	—			—			—			—			—			—			—			—
Incremental common shares from restricted stock units	—			—			—			—			—			—			—			—
Weighted average common shares outstanding - Diluted	57,854			54,910			57,764			54,827			57,602			56,899			57,709			55,523

Basic earnings (loss) per common share:
Continuing operations	$	(0.02	)	$	—		$	(0.03	)	$	—		$	(0.06	)	$	(0.03	)	$	(0.09	)	$	(0.04	)
Discontinued operations, net of tax	(0.05		)	(0.04		)	(0.24		)	(0.59		)	0.01			(0.02		)	(0.24		)	(0.60		)
Basic earnings (loss) per common share	$	(0.07	)	$	(0.04	)	$	(0.27	)	$	(0.59	)	$	(0.05	)	$	(0.05	)	$	(0.33	)	$	(0.64	)
Diluted earnings (loss) per common share:
Continuing operations	$	(0.02	)	$	—		$	(0.03	)	$	—		$	(0.06	)	$	(0.03	)	$	(0.09	)	$	(0.04	)
Discontinued operations, net of tax	(0.05		)	(0.04		)	(0.24		)	(0.59		)	0.01			(0.02		)	(0.24		)	(0.60		)
Diluted earnings (loss) per common share	$	(0.07	)	$	(0.04	)	$	(0.27	)	$	(0.59	)	$	(0.05	)	$	(0.05	)	$	(0.33	)	$	(0.64	)

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

Note 1314 — 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, accounts payable, and accrued expenses, approximate fair value due to the short-term nature of these accounts. The Company had no cash equivalents at ~~June~~September 30, 2017 or December 31, 2016.

The carrying value and estimated fair value of the Company’s long-term debt are as follows (in thousands):


	June 30, 2017				December 31, 2016				September 30, 2017					December 31, 2016
	Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value			Fair Value		Carrying Value		Fair Value
Term loan	$	—	$	—	$	9,833	$	9,833	$	—		$	—	$	9,833	$	9,833
Borrowings under revolving credit facility	42,716		42,716		38,566		38,566		40,589		��	40,589		38,566		38,566

The carrying value of the term loan and borrowings under the revolving credit facility approximate their fair value because the interest rates are variable.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Assets Measured at Fair Value on a Nonrecurring Basis

The Company’s non-financial assets, including property and equipment, goodwill, and other intangible assets are measured at fair value on a non-recurring basis and are subject to fair value adjustment in certain circumstances. No impairments of any of these assets were recognized during the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016.

Note 1415 — 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 June 30,				Six months ended June 30,				Three months ended September 30,				Nine months ended September 30,
	2017		2016		2017		2016		2017		2016		2017		2016
U.S. federal statutory tax rate	(35.0	)%	(35.0	)%	(35.0	)%	(35.0	)%	(35.0	)%	(35.0	)%	(35.0	)%	(35.0	)%
State income taxes, net of federal benefit	(4.8	)	(4.8	)	(3.8	)	(4.7	)	14.3		12.0		6.7		9.2
Non-U.S. income taxed at different rates	(0.1	)	(40.8	)	0.1		(37.2	)	8.9		16.4		5.4		7.7
Excess tax benefit related to stock-based awards	13.4		—		10.7		—
Reduction in tax benefit related to stock-based awards									15.8		—		14.1		—
Other	(1.8	)	2.8		(1.0	)	2.5		(3.5	)	(26.9	)	(3.6	)	(22.0	)
Effective income tax rate	(28.3	)%	(77.8	)%	(29.0	)%	(74.4	)%	0.5	%	(33.5	)%	(12.4	)%	(40.1	)%

Fluctuations in effective tax rates have historically been impacted by permanent tax differences with no associated income tax impact, changes in state apportionment factors, including the effect on state deferred tax assets and liabilities, and non-U.S. income taxed at different rates. Changes in the effective tax rate during the three and ~~six~~nine months ended ~~June~~September 30, 2017, included the Company implementing ASU No. 2016-09 which requires accounting for excess tax benefits and tax deficiencies related to stock-based awards as discrete items in the period in which they occur.

In January 2017, the Internal Revenue Service notified the Company that it will examine the Company’s federal tax returns for the year ended December 31, 2014. No adjustments have been asserted, and management believes that sustained adjustments, if any, would not have a material effect on the Company’s financial position, results of operations, or liquidity.

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

Note 1516 — Common Stock

The Company’s Certificate of Incorporation, as amended November 9, 2009, authorizes the Company to issue up to 80 million shares of common stock, par value $0.0001 per share, and 100,000 shares of one or more series of preferred stock, par value $0.0001 per share.

A reconciliation of changes in common shares issued during the ~~six~~nine months ended ~~June~~September 30, 2017 is as follows:



Shares issued at December 31, 2016	59,684,669
Issued as restricted stock award grants	~~168,756~~273,829
Issued upon exercise of stock options	~~651,188~~663,288
Shares issued at ~~June~~September 30, 2017	~~60,504,613~~60,621,786

Stock Repurchase Program

In November 2012, the Company’s Board of Directors authorized the repurchase of up to $25 million of the Company’s common stock. Repurchases may be made in the open market or through privately negotiated transactions. During the three ~~and six~~ months ended ~~June~~September 30, 2017, the Company repurchased ~~50,000~~630,000 shares of its outstanding common stock on the open market at a cost of ~~$0.5~~$3.7 million, inclusive of transaction costs, or an average price of ~~$9.76~~$5.85 per share. During the nine months ended September 30, 2017, the Company repurchased 680,000 shares of its outstanding common stock on the open market at a cost of $4.2 million, inclusive of transaction costs, or an average price of $6.14 per share. During the three and ~~six~~nine months ended ~~June~~September 30, 2016, the Company did not repurchase any shares of its outstanding common stock.

In June 2015, the Company’s Board of Directors authorized the repurchase of up to an additional $50 million of the Company’s common stock. Repurchases may be made in the open market or through privately negotiated transactions. Through ~~June~~September 30, 2017, the Company has not repurchased any of its common stock under this authorization.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of ~~June~~September 30, 2017, the Company has ~~$54.4~~$50.7 million remaining under its share repurchase programs. A covenant under the Company’s Credit Facility limits the amount that may be used to repurchase the Company’s common stock. As of ~~June~~September 30, 2017, this covenant limits additional share repurchases to ~~$4.4~~$10.7 million.

Note 1617 — Business Segment, Geographic and Major Customer Information

Segment Information

Operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by chief operating decision-makers in deciding how to allocate resources and assess performance. The operations of the Company are categorized into two reportable segments: Energy Chemistry Technologies and Consumer and Industrial Chemistry Technologies.

Energy Chemistry Technologies designs, develops, manufactures, packages, and markets specialty chemistries used in oil and natural gas well drilling, cementing, completion, and stimulation. In addition, the Company’s chemistries are used in specialized enhanced and improved oil recovery markets. Activities in this segment also include construction and management of automated material handling facilities and management of loading facilities and blending operations for oilfield services companies.

Consumer and Industrial Chemistry Technologies designs, develops, and manufactures products that are sold to companies in the flavor and fragrance industry and the specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.

The Company evaluates performance based upon a variety of criteria. The primary financial measure is segment operating income. Various functions, including certain sales and marketing activities and general and administrative activities, are provided centrally by the corporate office. Costs associated with corporate office functions, other corporate income and expense items, and income taxes are not allocated to reportable segments.

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

Summarized financial information of the reportable segments is as follows (in thousands):

As of and for the three months ended June 30, Energy Chemistry Technologies Consumer and Industrial Chemistry Technologies Corporate and Other Total
2017
Net revenue from external customers $ 65,875
$ 19,302
$ —
$ 85,177
Gross profit 22,804
3,287
—
26,091
Income (loss) from operations 9,299
1,216
(11,767 ) (1,252 )
Depreciation and amortization 1,795
583
613
2,991
Capital expenditures 1,956
397
278
2,631

2016
Net revenue from external customers $ 43,385
$ 20,694
$ —
$ 64,079
Gross profit 17,660
4,058
—
21,718
Income (loss) from operations 7,584
2,686
(10,114 ) 156
Depreciation and amortization 1,237
608
557
2,402
Capital expenditures 3,685
204
559
4,448


As of and for the six months ended June 30,	Energy Chemistry Technologies		Consumer and Industrial Chemistry Technologies		Corporate and Other			Total
For the three months ended September 30,											Energy Chemistry Technologies		Consumer and Industrial Chemistry Technologies		Corporate and Other			Total
2017
Net revenue from external customers	$	126,640	$	38,491	$	—		$	165,131		$	61,167	$	18,291	$	—		$	79,458
Gross profit	45,106		8,727		—			53,833			18,733		3,007		—			21,740
Income (loss) from operations	17,848		4,921		(24,643		)	(1,874		)	6,867		985		(10,955		)	(3,103		)
Depreciation and amortization	3,644		1,162		1,217			6,023			1,863		590		615			3,068
Capital expenditures	2,470		897		1,141			4,508			324		682		641			1,647

2016
Net revenue from external customers	$	88,064	$	39,826	$	—		$	127,890		$	45,030	$	19,307	$	—		$	64,337
Gross profit	36,429		9,082		—			45,511			18,180		4,174		—			22,354
Income (loss) from operations	15,597		6,075		(21,148		)	524			6,196		2,433		(10,882		)	(2,253		)
Depreciation and amortization	2,480		1,118		1,053			4,651			1,582		567		581			2,730
Capital expenditures	6,699		346		1,193			8,238			2,005		148		227			2,380

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



For the nine months ended September 30,	Energy Chemistry Technologies		Consumer and Industrial Chemistry Technologies		Corporate and Other			Total
2017
Net revenue from external customers	$	187,807	$	56,782	$	—		$	244,589
Gross profit	63,840		11,733		—			75,573
Income (loss) from operations	24,715		5,906		(35,598		)	(4,977		)
Depreciation and amortization	5,507		1,752		1,832			9,091
Capital expenditures	2,794		1,580		1,781			6,155

2016
Net revenue from external customers	$	133,094	$	59,133	$	—		$	192,227
Gross profit	54,609		13,256		—			67,865
Income (loss) from operations	21,793		8,508		(32,031		)	(1,730		)
Depreciation and amortization	4,062		1,685		1,633			7,380
Capital expenditures	8,704		494		1,420			10,618

Assets of the Company by reportable segments are as follows (in thousands):


	June 30, 2017		December 31, 2016		September 30, 2017		December 31, 2016
Energy Chemistry Technologies	$	195,963	$	184,328	$	187,623	$	184,328
Consumer and Industrial Chemistry Technologies	117,037		98,105		113,434		98,105
Corporate and Other	38,980		56,882		44,551		56,882
Total segments	351,980		339,315		345,608		339,315
Held for sale	7,197		43,900		4,135		43,900
Total assets	$	359,177	$	383,215	$	349,743	$	383,215

Geographic Information

Revenue by country is based on the location where services are provided and products are used. No individual country other than the United States (“U.S.”) accounted for more than 10% of revenue. Revenue by geographic location is as follows (in thousands):


	Three months ended June 30,				Six months ended June 30,				Three months ended September 30,				Nine months ended September 30,
	2017		2016		2017		2016		2017		2016		2017		2016
U.S.	$	71,836	$	49,381	$	136,485	$	101,987	$	66,638	$	52,545	$	203,123	$	154,532
Other countries	13,341		14,698		28,646		25,903		12,820		11,792		41,466		37,695
Total	$	85,177	$	64,079	$	165,131	$	127,890	$	79,458	$	64,337	$	244,589	$	192,227

Long-lived assets held in countries other than the U.S. are not considered material to the consolidated financial statements.

Major Customers

Revenue from major customers, as a percentage of consolidated revenue, is as follows:


	Three months ended June 30,				Six months ended June 30,				Three months ended September 30,				Nine months ended September 30,
	2017		2016		2017		2016		2017		2016		2017		2016
Customer A	13.3	%	17.5	%	12.7	%	20.7	%	13.3	%	12.5	%	12.9	%	17.9	%
Customer B	10.1	%	13.3	%	9.9	%	12.8	%	8.8	%	14.8	%	9.6	%	13.5	%

Over ~~95%~~90% of the revenue from these customers was for sales in the Energy Chemistry Technologies segment.

FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1718 — Commitments and Contingencies

Class Action Litigation

On March 30, 2017, the U.S. District Court for the Southern District of Texas granted the Company’s motion to dismiss the four consolidated putative securities class action lawsuits that were filed in November 2015, against the Company and certain of its officers. The lawsuits were previously consolidated into a single case, and a consolidated amended complaint had been filed. The consolidated amended complaint asserted that the Company made false and/or misleading statements, as well as failed to disclose material adverse facts about the Company’s business, operations, and prospects. The complaint sought an award of damages in an unspecified amount on behalf of a putative class consisting of persons who purchased the Company’s common stock between October 23, 2014 and November 9, 2015, inclusive. The lead plaintiff appealed the District Court’s decision granting the motion to dismiss.

In January 2016, three derivative lawsuits were filed, two in the District Court of Harris County, Texas (which have since been consolidated into one case) and one in the United States District Court for the Southern District of Texas, on behalf of the Company against certain of its officers and its current directors. The lawsuits allege violations of law, breaches of fiduciary duty, and unjust enrichment against the defendants.

The Company believes the lawsuits are without merit and intends to vigorously defend against all claims asserted. Discovery has not yet commenced. At this time, the Company is unable to reasonably estimate the outcome of this litigation.

In addition, as previously disclosed, the U.S. Securities and Exchange Commission ~~has~~had opened an inquiry related to similar issues to those raised in the above-described litigation.

~~FLOTEK INDUSTRIES, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

On August 21, 2017, the Company received a letter from the staff of the SEC stating that the inquiry has been concluded and that the staff does not intend to recommend an enforcement action against the Company.

Other Litigation

The Company is subject to routine litigation and other claims that arise in the normal course of business. Management is not aware of any pending or threatened lawsuits or proceedings that are expected to have a material effect on the Company’s financial position, results of operations or liquidity.

Concentrations and Credit Risk

The majority of the Company’s revenue is derived from the oil and gas industry. Customers include major oilfield services companies, major integrated oil and natural gas companies, independent oil and natural gas companies, pressure pumping service companies, and state-owned national oil companies. This concentration of customers in one industry increases credit and business risks.

The Company is subject to concentrations of credit risk within trade accounts receivable, as the Company does not generally require collateral as support for trade receivables. In addition, the majority of the Company’s cash is maintained at a major financial institution and balances often exceed insurable amounts.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 Flotek Industries, Inc.’s (“Flotek” or “Company”) current assumptions and beliefs regarding future events, 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, 2016 (“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.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto of this Quarterly Report, as well as the Annual Report. Phrases such as “Company,” “we,” “our,” and “us” refer to Flotek Industries, Inc. and its subsidiaries.

Basis of Presentation

~~In May~~By the end of August 2017, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of each of the Drilling Technologies and Production Technologies segments.

Executive Summary

Flotek is a global, diversified, technology-driven company that develops and supplies chemistries and services to the oil and gas industries, and high value compounds to companies that make food and beverages, cleaning products, cosmetics, ~~food and beverages,~~ and other products that are sold in consumer and industrial markets. Flotek operates in over 20 domestic and international markets.

The Company’s oilfield business includes specialty chemistries and logistics. Flotek’s technologies enable its customers in pursuing improved efficiencies in the drilling and completion of their wells. Customers include major integrated oil and gas (“O&G”) companies, oilfield services companies, independent O&G companies, pressure-pumping service companies, national and state-owned oil companies, and international supply chain management companies. The Company also produces non-energy-related citrus oil and related products including (1) high value compounds used as additives by companies in the flavors and fragrances markets and (2) environmentally friendly chemistries for use in numerous industries around the world, including the O&G industry. The Company sources citrus oil domestically and internationally and is one of the largest processors of citrus oil in the world. Additionally, the Company also provides automated bulk material handling, loading facilities, and blending capabilities.

Continuing Operations

The operations of the Company are categorized into two reportable segments: Energy Chemistry Technologies (“ECT”) and Consumer and Industrial Chemistry Technologies (“CICT”).

Energy Chemistry Technologies designs, develops, manufactures, packages, and markets specialty chemistries used in O&G well drilling, cementing, completion, and stimulation. These technologies developed by Flotek’s Research and Innovation team enable customers to pursue improved efficiencies in the drilling and completion of wells.

Consumer and Industrial Chemistry Technologies designs, develops, and manufactures products that are sold to companies in the flavor and fragrance industries and specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.

Discontinued Operations

The Drilling Technologies and Production Technologies segments are classified as discontinued operations.

Drilling Technologies assembles, rents, sells, inspects, and markets downhole drilling equipment used in energy, mining, and industrial drilling activities.

Production Technologies assembles and markets production-related equipment, including pumping system components, electric submersible pumps (“ESP”), gas separators, valves, and services that support natural gas and oil production activities.

Market Conditions

The Company’s success is sensitive to a number of factors, which include, but are not limited to, drilling and well completion activity, customer demand for its advanced technology products, market prices for raw materials, and governmental actions.

Drilling and well completion activity levels are influenced by a number of factors, including the number of rigs in operation and the geographical areas of rig activity. Additional factors that influence the level of drilling and well completion activity include:

Historical, current, and anticipated future O&G prices,

Federal, state, and local governmental actions that may encourage or discourage drilling activity,

Customers’ strategies relative to capital funds allocations,

Weather conditions, and

Technological changes to drilling and completion methods and economics.

Historical North American drilling activity is reflected in “TABLE A” on the following page.

Customers’ demand for advanced technology products and services provided by the Company are dependent on their recognition of the value of:

Chemistries that improve the economics of their O&G operations,

Chemistries that meet the need of consumer product markets, and

Chemistries that are economically viable, socially responsible, and ecologically sound.

Market prices for commodities, including citrus oils and guar, can be influenced by:

Historical, current, and anticipated future production levels of the global citrus (primarily orange) and guar crops,

Weather related risks,

Health and condition of citrus trees and guar plants (e.g., disease and pests), and

International competition and pricing pressures resulting from natural and artificial pricing influences.

Governmental actions may restrict the future use of hazardous chemicals, including, but not limited to, the following industrial applications:

O&G drilling and completion operations,

O&G production operations, and

Non-O&G industrial solvents.


TABLE A	Three months ended June 30,				Six months ended June 30,				Three months ended September 30,				Nine months ended September 30,
	2017	2016	% Change		2017	2016	% Change		2017	2016	% Change		2017	2016	% Change
Average North American Active Drilling Rigs
U.S.	895	422	112.1	%	819	483	69.6	%	946	479	97.5	%	861	482	78.6	%
Canada	117	48	143.8	%	206	108	90.7	%	208	121	71.9	%	207	112	84.8	%
Total	1,012	470	115.3	%	1,025	591	73.4	%	1,154	600	92.3	%	1,068	594	79.8	%
Average U.S. Active Drilling Rigs by Type
Vertical	77	51	51.0	%	73	57	28.1	%	70	62	12.9	%	72	58	24.1	%
Horizontal	751	326	130.4	%	681	377	80.6	%	799	372	114.8	%	720	376	91.5	%
Directional	67	45	48.9	%	65	49	32.7	%	77	45	71.1	%	69	48	43.8	%
Total	895	422	112.1	%	819	483	69.6	%	946	479	97.5	%	861	482	78.6	%
Average North American Drilling Rigs by Product
Oil	771	350	120.3	%	763	433	76.2	%	874	452	93.4	%	800	440	81.8	%
Natural Gas	241	120	100.8	%	262	158	65.8	%	280	148	89.2	%	268	154	74.0	%
Total	1,012	470	115.3	%	1,025	591	73.4	%	1,154	600	92.3	%	1,068	594	79.8	%

Source: Rig counts are per Baker Hughes, Inc. (www.bakerhughes.com). Rig counts are the averages of the weekly rig count activity.

Completions are per the U.S. Energy Information Administration (https://www.eia.gov/petroleum/drilling/) as of ~~July 17,~~October 16, 2017.

Average U.S. rig activity increased by ~~112.1%~~97.5% and ~~69.6%~~78.6% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, when compared to the same periods of 2016, and sequentially, increased by ~~20.6%~~5.7% when compared to the ~~first~~second quarter of 2017.

According to data collected by the U.S. Energy Information Administration (“EIA”) as reported on ~~July 17,~~October 16, 2017, completions in the seven most prolific areas in the lower 48 states increased ~~44.1%~~47.3% and ~~28.6%~~37.0% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, when compared to the same periods of 2016. Sequentially, completions increased ~~21.4%~~12.2% when compared to the ~~first~~second quarter of 2017.

Company Outlook

After a continuous decline in U.S. drilling rig activity beginning in mid-2014, the market began to gradually recover in the second quarter of 2016. Although a continuing recovery appears to be underway, the level of drilling and completion activity is still depressed compared to historical levels. Assuming the price for crude oil remains relatively stable and regulatory impediments are reduced, the Company expects U.S. oilfield activity to ~~improve modestly throughout 2017.~~remain dependent on commodity prices.

During the ~~second~~third quarter of 2017, the Company continued to ~~successfully~~ promote the efficacy of its Complex nano-Fluid^® (“CnF^®”) chemistries resulting in a ~~43.1%~~23.1% increase in CnF^® sales volumes compared to the ~~second~~third quarter of 2016. ~~Second~~Third quarter 2017 CnF^® volumes ~~increased 1.6%~~decreased 12.9% compared to the ~~first~~second quarter of 2017. Although quarter to quarter performance may vary, the Company expects its Energy Chemistry Technologies sales to outperform market activity metrics over time by continuing to demonstrate the efficacy of its CnF^® chemistries through comparative analysis of wells with and without CnF^® chemistries, field validation results conducted by E&P companies, and the continuation of its direct-to-operator sales program known as the Flotek Store^®. Whether operators purchase directly from Flotek or continue to purchase from oilfield distribution and service companies, E&P operators are benefiting from increased transparency in pricing and a more direct relationship with Flotek’s technical expertise and supply chain.

The Company’s success in promoting its patented and proprietary chemistries is supported through its industry leading research and innovation staff who provide customer responsive product innovation, as well as development of new products which are expected to expand the Company’s future product lines. During the third quarter of 2016, the Company completed its new Global Research & Innovation Center in Houston. This state-of-the-art facility allows for the development of next-generation innovative energy chemistries, as well as expanded collaboration between clients, leaders from academia, and Company scientists. These collaborative opportunities are an important and distinguishing capability within the industry.

The outlook for the Company’s consumer and industrial chemistries will be driven by the availability and demand for citrus oils, industrial solvents, and flavor and fragrance ingredients. Although current inventory and crop expectations are sufficient to meet the Company’s needs to supply its flavor and fragrance business, as well as both internal and external industrial markets, the market supply of citrus oils has declined in recent years due to the reduction in citrus crops caused by the citrus greening disease. This reduced supply has resulted in higher citrus oil prices and increased price volatility. However, the Company expects its strong market position to enable it to maintain a stable supply of citrus oils for internal use and external sales. The Company expects to manage the impact of volatile terpene costs through the development of new product formulations and pricing strategies.

During the fourth quarter 2016, the Company implemented a strategic restructuring of its business to enable a greater focus on its core businesses in energy chemistry and consumer and industrial chemistry and initiated a process to identify potential buyers for its Drilling Technologies and Production Technologies segments. ~~During~~By the ~~second quarter~~end of August 2017, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of the Drilling Technologies and Production Technologies segments.

Capital expenditures for continuing operations totaled ~~$4.5~~$6.2 million and ~~$8.2~~$10.6 million for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, respectively. The Company expects capital spending to be between $9 million and ~~$12~~$11 million in ~~2017.~~2017, but anticipates to be towards the lower end of the range. The Company will remain nimble in its core capital expenditure plans, adjusting as market conditions warrant.

Changes to geopolitical, global economic, and industry trends could have an impact, either positive or negative, on the Company’s business. In the event of significant adverse changes to the demand for oil and gas production, the market price for oil and gas, and/or the availability of citrus crops, the market conditions affecting the Company could change rapidly and materially. Should such adverse changes to market conditions occur, management believes the Company has access to adequate liquidity to withstand the impact of such changes while continuing to make strategic capital investments and acquisitions, if opportunities arise. In addition, management believes the Company is well-positioned to take advantage of significant increases in demand for its products should market conditions improve dramatically in the near term.

Results of Continuing Operations (in thousands):


	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	85,177		$	64,079		$	165,131		$	127,890		$	79,458		$	64,337		$	244,589		$	192,227
Cost of revenue	59,086			42,361			111,298			82,379			57,718			41,983			169,016			124,362
Gross profit	26,091			21,718			53,833			45,511			21,740			22,354			75,573			67,865
Gross margin %	30.6		%	33.9		%	32.6		%	35.6		%	27.4		%	34.7		%	30.9		%	35.3		%
Corporate general and administrative	11,155			9,557			23,426			20,096			10,346			10,302			33,773			30,398
Corporate general and administrative %	13.1		%	14.9		%	14.2		%	15.7		%	13.0		%	16.0		%	13.8		%	15.8		%
Segment selling and administrative	9,386			8,067			19,695			17,105			9,277			9,775			28,972			26,879
Segment selling and administrative %	11.0		%	12.6		%	11.9		%	13.4		%	11.7		%	15.2		%	11.8		%	14.0		%
Depreciation and amortization	2,479			1,905			4,924			3,806			2,540			2,217			7,464			6,024
Research and innovation costs	4,109			2,048			7,250			3,995			2,691			2,327			9,940			6,323
Loss on disposal of long-lived assets	214			(15		)	412			(15		)
(Loss) income from operations	(1,252		)	156			(1,874		)	524
(Gain) loss on disposal of long-lived assets													(11		)	(14		)	401			(29		)
Loss from operations													(3,103		)	(2,253		)	(4,977		)	(1,730		)
Operating margin %	(1.5		)%	0.2		%	(1.1		)%	0.4		%	(3.9		)%	(3.5		)%	(2.0		)%	(0.9		)%
Interest and other expense, net	(312		)	(657		)	(754		)	(1,071		)	(301		)	(559		)	(1,054		)	(1,630		)
Loss before income taxes	(1,564		)	(501		)	(2,628		)	(547		)	(3,404		)	(2,812		)	(6,031		)	(3,360		)
Income tax benefit	442			390			762			407
Income tax (expense) benefit													(17		)	942			746			1,349
Loss from continuing operations	(1,122		)	(111		)	(1,866		)	(140		)	(3,421		)	(1,870		)	(5,285		)	(2,011		)
Loss from discontinued operations, net of tax	(2,704		)	(2,169		)	(13,937		)	(32,325		)
Income (loss) from discontinued operations, net of tax													319			(876		)	(13,621		)	(33,200		)
Net loss	$	(3,826	)	$	(2,280	)	$	(15,803	)	$	(32,465	)	$	(3,102	)	$	(2,746	)	$	(18,906	)	$	(35,211	)

Consolidated Results of Operations: Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017, Compared to the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2016

Consolidated revenue for the three and ~~six~~nine months ended ~~June~~September 30, 2017, increased ~~$21.1~~$15.1 million, or ~~32.9%~~23.5%, and ~~$37.2~~$52.4 million, or ~~29.1%~~27.2%, respectively, versus the same periods of 2016. These increases in revenue were driven by increased sales within the Energy Chemistry Technologies segment due to the increased oilfield activity beginning in the latter half of 2016.

Consolidated gross profit for the three and ~~six~~nine months ended ~~June~~September 30, 2017, ~~increased $4.4~~decreased $0.6 million, or ~~20.1%~~2.7%, and ~~$8.3~~increased $7.7 million, or ~~18.3%~~11.4%, respectively, compared to the same periods of 2016. Gross margin decreased to ~~30.6%~~27.4% and ~~32.6%~~30.9% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, from ~~33.9%~~34.7% and ~~35.6%~~35.3% in the same periods of 2016, primarily due to increased volumes of lower margin product sales in all segments.

Corporate general and administrative (“CG&A”) expenses are not directly attributable to products sold or services provided. CG&A costs remained relatively flat for the three months ended September 30, 2017, and increased ~~$1.6~~$3.4 million, or ~~16.7%, and $3.3 million, or 16.6%~~11.1%, for the ~~three and six~~nine months ended ~~June~~September 30, 2017, ~~respectively,~~ versus the same periods of ~~2016; however, as~~2016. As a percentage of revenue, CG&A decreased ~~1.8%~~3.0% and ~~1.5%~~2.0% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively. ~~These increases were~~The increase in CG&A costs was primarily due to costs associated with executive retirement, ~~and~~ stock compensation expense, and information technology costs, partially offset by decreased legal ~~expenses related to ongoing litigation.~~expenses.

Segment selling and administrative (“SS&A”) expenses are not directly attributable to products sold or services provided. SS&A costs remained relatively flat for the three months ended September 30, 2017, and increased ~~$1.3~~$2.1 million, or ~~16.4%, and $2.6 million, or 15.1%~~7.8%, for the ~~three and six~~nine months ended ~~June~~September 30, 2017, ~~respectively,~~ versus the same periods of ~~2016; however, as~~2016. As a percentage of revenue, SS&A decreased ~~1.6%~~3.5% and ~~1.5%~~2.2% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively. ~~These increases were~~The increase in SS&A costs was primarily due to increased headcount in the Energy Chemistry Technologies and Consumer and Industrial Chemistry Technologies sales and support staff for expansion and growth in new business and related higher sales and marketing expenses.

Depreciation and amortization expense increased ~~$0.6~~$0.3 million, or ~~30.1%~~14.6%, and ~~$1.1~~$1.4 million, or ~~29.4%~~23.9%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016, primarily attributable to the completion and equipping of the Global Research & Innovation Center in August 2016, along with other improvements to manufacturing facilities.

Research and Innovation (“R&I”) expense increased ~~$2.1~~$0.4 million, or ~~100.6%~~15.6%, and ~~$3.3~~$3.6 million, or ~~81.5%~~57.2%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, compared to the same periods of 2016. These increases in R&I are primarily attributable

to increased personnel for new product development and Flotek’s commitment to remaining responsive to customer needs, increased demand, continued growth and refining of existing product lines, and the development of new chemistries which are expected to expand the Company’s intellectual property portfolio.

Interest and other expense decreased $0.3 million, or ~~52.5%~~46.2%, and ~~$0.3~~$0.6 million, or ~~29.6%~~35.3%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016, primarily due to the repayment of the term loan onin May ~~27,~~ 2017.

The Company recorded an income tax ~~benefits~~provision of ~~$0.4~~less than $0.1 million, yielding an effective tax rate of (0.5)%, and ~~$0.8~~an income tax benefit of $0.7 million, yielding an effective tax benefit ~~rates~~rate of ~~28.3% and 29.0%~~12.4%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, compared to income tax benefits of ~~$0.4~~$0.9 million and ~~$0.4~~$1.3 million, yielding effective tax benefit rates of ~~77.8%~~33.5% and ~~74.4%~~40.1%, for the comparable periods in 2016.

As part of the Company’s strategic restructuring of its business to enable a greater focus on its core businesses in energy chemistry and consumer and industrial chemistry, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of the Drilling Technologies and Production Technologies segments ~~in May~~through August 2017. The Company recorded a net gain from discontinued operations of $0.3 million for the three months ended September 30, 2017, and a net loss from discontinued operations of ~~$2.7 million and $13.9~~$13.6 million for the ~~three and six~~nine months ended ~~June~~September 30, ~~2017, respectively.~~2017.

Results by Segment


Energy Chemistry Technologies (“ECT”)
(dollars in thousands)	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	65,875		$	43,385		$	126,640		$	88,064		$	61,167		$	45,030		$	187,807		$	133,094
Gross profit	22,804			17,660			45,106			36,429			18,733			18,180			63,840			54,609
Gross margin %	34.6		%	40.7		%	35.6		%	41.4		%	30.6		%	40.4		%	34.0		%	41.0		%
Income from operations	9,299			7,584			17,848			15,597			6,867			6,196			24,715			21,793
Operating margin %	14.1		%	17.5		%	14.1		%	17.7		%	11.2		%	13.8		%	13.2		%	16.4		%

ECT Results of Operations: Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017, Compared to the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2016

ECT revenue for the three and ~~six~~nine months ended ~~June~~September 30, 2017, increased ~~$22.5~~$16.1 million, or ~~51.8%~~35.8%, and ~~$38.6~~$54.7 million, or ~~43.8%~~41.1%, respectively, versus the same periods of 2016. CnF^® sales ~~volumes~~revenues increased ~~43.1% (revenues~~28.7% (volumes increased ~~51.1%~~23.1%), compared to the three months ended ~~June~~September 30, 2016. Increased well completion activity by customers lead to the increased CnF^® chemistry sales during the ~~second~~third quarter of ~~2017 was due to increased well completion activity by customers.~~2017. Quarterly non-CnF revenues rose approximately ~~62.8%~~49.8%, compared to the three months ended ~~June~~September 30, 2016, due to increased customer demand as a result of oilfield market conditions.

Sequentially, revenues ~~increased $5.1~~decreased $4.7 million, or ~~8.4%~~7.1%, versus the ~~first~~second quarter of 2017. CnF^® sales ~~volumes increased 1.6% (revenues increased 1.2%~~revenues decreased 11.2% (volumes decreased 12.9%) on a sequential basis. Impacts related to Hurricane Harvey and certain customer delays affected the quarter.

ECT gross profit increased ~~$5.1~~$0.6 million, or ~~29.1%~~3.0%, and ~~$8.7~~$9.2 million, or ~~23.8%~~16.9%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016. Gross margin decreased to ~~34.6%~~30.6% and ~~35.6%~~34.0% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, from ~~40.7%~~40.4% and ~~41.4%~~41.0% in the same periods of 2016. The gross margin decreases over the periods were primarily due to product mix ~~with~~and higher raw material ~~costs associated with the higher sales volume of CnF~~^® ~~chemistries.~~costs. Sequentially, gross profit ~~increased $0.5~~decreased $4.1 million, or ~~2.3%~~17.9%, versus the ~~first~~second quarter of 2017.

Income from operations for the ECT segment increased ~~$1.7~~$0.7 million, or ~~22.6%~~10.8%, and ~~$2.3~~$2.9 million, or ~~14.4%~~13.4%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016. These increases were primarily attributable to the increase in CnF^® sales.


Consumer and Industrial Chemistry Technologies (“CICT”)	Consumer and Industrial Chemistry Technologies (“CICT”)												Consumer and Industrial Chemistry Technologies (“CICT”)
(dollars in thousands)	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	19,302		$	20,694		$	38,491		$	39,826		$	18,291		$	19,307		$	56,782		$	59,133
Gross profit	3,287			4,058			8,727			9,082			3,007			4,174			11,733			13,256
Gross margin %	17.0		%	19.6		%	22.7		%	22.8		%	16.4		%	21.6		%	20.7		%	22.4		%
Income from operations	1,216			2,686			4,921			6,075			985			2,433			5,906			8,508
Operating margin %	6.3		%	13.0		%	12.8		%	15.3		%	5.4		%	12.6		%	10.4		%	14.4		%

CICT Results of Operations: Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017, Compared to the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2016

CICT revenue decreased ~~$1.4~~$1.0 million, or ~~6.7%~~5.3%, and ~~$1.3~~$2.4 million, or ~~3.4%~~4.0%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016. These decreases were due to reduced volumes, partially offset by higher prices. Sequentially, quarterly revenues ~~remained flat.~~decreased $1.0 million, or 5.2%, versus the second quarter of 2017 due to reduced volumes.

CICT gross profit for the three and ~~six~~nine months ended ~~June~~September 30, 2017, decreased ~~$0.8~~$1.2 million, or ~~19.0%~~28.0%, and ~~$0.4~~$1.5 million, or ~~3.9%~~11.5%, respectively, versus the same periods of 2016. Gross margin decreased to ~~17.0%~~16.4% and ~~22.7%~~20.7% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, from ~~19.6%~~21.6% and ~~22.8%~~22.4% in the same periods of ~~2016, as~~2016. These decreases were a result of ~~decreased~~lower margins ~~associated with~~caused by higher material costs and product ~~mix and a slight increase in direct costs.~~mix. Sequentially, gross profits decreased by ~~$2.2~~$0.3 million, and gross margins decreased to ~~17.0%~~16.4% from ~~28.3%~~17.0% in the ~~first~~second quarter of 2017 due to product mix and increased raw material costs.

Income from operations for the CICT segment decreased ~~$1.5~~$1.4 million, or ~~54.7%~~59.5%, and ~~$1.2~~$2.6 million, or ~~19.0%~~30.6%, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, respectively, versus the same periods of 2016. Sequentially, quarterly operating profits decreased by ~~$2.5~~$0.2 million. These decreases are primarily attributable to product mix and increased raw material and indirect costs.

Discontinued Operations

During the fourth quarter of 2016, the Company classified the Drilling Technologies and Production Technologies segments as held for sale based on management’s intention to sell these businesses. ~~In May~~By the end of August 2017, the Company completed the sale of substantially all of the assets and transfer of certain specified liabilities and obligations of the Drilling Technologies and Production Technologies segments. The Company’s historical financial statements have been revised to present the operating results of the Drilling Technologies and Production Technologies segments as discontinued operations. The information below is presented for informational purposes only.


Drilling Technologies
(dollars in thousands)	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	4,737		$	6,372		$	11,534		$	12,829		$	—		$	7,197		$	11,534		$	20,026
Gross profit	2,134			2,217			4,275			3,242
Gross profit (loss)													—			2,907			4,275			6,150
Gross margin %	45.0		%	34.8		%	37.1		%	25.3		%	—		%	40.4		%	37.1		%	30.7		%
Loss from operations	(624		)	(1,618		)	(1,440		)	(42,569		)	(755		)	(924		)	(2,196		)	(43,493		)
Loss from operations - excluding impairment	(624		)	(1,618		)	(1,440		)	(6,047		)	(755		)	(924		)	(2,196		)	(6,971		)
Operating margin % - excluding impairment	(13.2		)%	(25.4		)%	(12.5		)%	(47.1		)%	—		%	(12.8		)%	(19.0		)%	(34.8		)%


Production Technologies
(dollars in thousands)	Three months ended June 30,						Six months ended June 30,						Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016			2017			2016			2017			2016
Revenue	$	849		$	1,868		$	4,002		$	3,889		$	—		$	2,145		$	4,002		$	6,034
Gross profit	142			(14		)	813			96
Gross profit (loss)													—			105			813			201
Gross margin %	16.7		%	(0.7		)%	20.3		%	2.5		%	—		%	4.9		%	20.3		%	3.3		%
Loss from operations	(752		)	(1,261		)	(1,225		)	(6,692		)	(64		)	(1,118		)	(1,290		)	(7,810		)
Loss from operations - excluding impairment	(752		)	(1,261		)	(1,225		)	(2,779		)	(64		)	(1,118		)	(1,290		)	(3,897		)
Operating margin % - excluding impairment	(88.6		)%	(67.5		)%	(30.6		)%	(71.5		)%	—		%	(52.1		)%	(32.2		)%	(64.6		)%

Off-Balance Sheet Arrangements

There have been no transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose entities” (“SPEs”), established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of ~~June~~September 30, 2017, the Company was not involved in any unconsolidated SPEs.

The Company has not made any guarantees to customers or vendors nor does the Company have any off-balance sheet arrangements or commitments that have, or are reasonably likely to have, a current or future effect on the Company’s financial condition, change in financial condition, revenue, expenses, results of operations, liquidity, capital expenditures, or capital resources that would be material to investors.

Critical Accounting Policies and Estimates

The Company’s Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Preparation of these statements requires management to make judgments, estimates, and assumptions that affect the amounts reported in the financial statements and accompanying footnotes. Part II, Item 8 — Financial Statements and Supplementary Data, Note 2 of “Notes to Consolidated Financial Statements” and Part II, Item 7 — Management’s Discussion and Analysis of Financial Conditions and Results of Operations, “Critical Accounting Policies and Estimates” of the Company’s Annual Report, and the “Notes to Unaudited Condensed Consolidated Financial Statements” of this Quarterly Report describe the significant accounting policies and critical accounting estimates used to prepare the consolidated financial statements. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of the Company’s financial condition and results of operations and require management’s most subjective judgments. The Company regularly reviews and challenges judgments, assumptions, and estimates related to critical accounting policies. The Company’s estimates and assumptions are based on historical experience and expected changes in the business environment; however, actual results may materially differ from the estimates. There have been no significant changes in the Company’s critical accounting estimates during the ~~six~~nine months ended ~~June~~September 30, 2017.

Recent Accounting Pronouncements

Recent accounting pronouncements which may impact the Company are described in Note 2 — “Recent Accounting Pronouncements” in Part I, Item 1 — “Financial Statements” of this Quarterly Report.

Capital Resources and Liquidity

Overview

The Company’s ongoing capital requirements arise from the Company’s need to service debt, acquire and maintain equipment, fund working capital requirements, and when the opportunities arise, to make strategic acquisitions and repurchase Company stock. During the first ~~six~~nine months of 2017, the Company funded capital requirements primarily with cash on hand and debt financing.

The Company’s primary source of debt financing is its Credit Facility with PNC Bank. This Credit Facility contains provisions for a revolving credit facility ~~and a term loan~~ secured by substantially all of the Company’s domestic real and personal property, including accounts receivable, inventory, land, buildings, equipment, and other intangible assets. ~~On May 22, 2017, the Company repaid the outstanding balance of the term loan and the liens on land, buildings, equipment, and other intangible assets were released.~~ As of ~~June~~September 30, 2017, the Company had ~~$42.7~~$40.6 million in outstanding borrowings under the revolving debt portion of the Credit ~~Facility and no outstanding balance under the term loan.~~Facility. At ~~June~~September 30, 2017, the Company

was in compliance with all debt

covenants. Significant terms of the Credit Facility are discussed in Note 1112 — “Long-Term Debt and Credit Facility” in Part I, Item 1 — “Financial Statements” of this Quarterly Report.

The Company believes it has access to adequate liquidity to fund its ongoing operations and capital expenditures. As of ~~June~~September 30, 2017, the Company had available borrowing capacity under its revolving line of credit of ~~$22.2~~$34.3 million and available cash of ~~$3.4~~$4.9 million, resulting in total liquidity of ~~$25.6~~$39.2 million. For the remainder of 2017, the Company plans to spend between ~~$4.5~~$2.8 million and ~~$7.5~~$4.8 million for committed and planned capital expenditures. The Company may pursue external financing to increase its liquidity position and/or fund acquisitions when strategic opportunities arise.

Any excess cash generated may be used to pay down the level of debt or retained for future use.

Net Debt

Net debt represents total debt less cash and cash equivalents and combines the Company’s indebtedness and the cash and cash equivalents that could be used to repay that debt. Components of net debt are as follows (in thousands):


	June 30, 2017			June 30, 2016			September 30, 2017			September 30, 2016
Cash and cash equivalents	$	3,422		$	3,840		$	4,942		$	3,474
Current portion of long-term debt	(42,716		)	(50,228		)	(40,589		)	(34,562		)
Long-term debt, less current portion	—			(14,684		)	—			(8,000		)
Net debt	$	(39,294	)	$	(61,072	)	$	(35,647	)	$	(39,088	)

Cash Flows

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


	Six months ended June 30,						Nine months ended September 30,
	2017			2016			2017			2016
Net cash used in operating activities	$	(7,243	)	$	(3,295	)
Net cash provided by (used in) operating activities							$	1,178		$	(825	)
Net cash provided by (used in) investing activities	13,045			(8,354		)	11,839			(18,754		)
Net cash (used in) provided by financing activities	(7,223		)	13,236			(13,039		)	20,805
Net cash flows used in discontinued operations	—			(8		)
Net cash flows provided by (used in) discontinued operations							13			(8		)
Effect of changes in exchange rates on cash and cash equivalents	20			53			128			48
Net (decrease) increase in cash and cash equivalents	$	(1,401	)	$	1,632
Net increase in cash and cash equivalents							$	119		$	1,266

Operating Activities

Net cash ~~used in~~provided by (used in) operating activities was ~~$7.2~~$1.2 million and ~~$3.3~~$(0.8) million during the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, respectively. Consolidated net loss for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, totaled ~~$1.9~~$5.3 million and ~~$0.1~~$2.0 million, respectively.

During the ~~six~~nine months ended ~~June~~September 30, 2017, net non-cash contributions to net income totaled ~~$6.3~~$12.2 million. Contributory non-cash items consisted primarily of ~~$6.3~~$9.5 million for depreciation and amortization, ~~$6.7~~$9.7 million for stock-based compensation expense, $0.9 million for recognized incremental tax benefits related to the Company’s share based awards, and $0.4 million for net loss on sale of assets, partially offset by ~~$7.3~~$8.3 million for changes to deferred income taxes.

During the ~~six~~nine months ended ~~June~~September 30, 2016, net non-cash contributions to net income totaled ~~$2.8~~$10.8 million. Contributory non-cash items consisted primarily of ~~$4.9~~$7.7 million for depreciation and amortization, ~~$5.1~~$8.6 million for stock compensation expense, and ~~$1.0~~$0.9 million for recognized incremental tax benefits related to the Company’s share based awards, partially offset by ~~$8.1~~$6.3 million for changes to deferred income taxes.

During the ~~six~~nine months ended ~~June~~September 30, 2017, changes in working capital used ~~$11.7~~$5.7 million in cash, primarily resulting from increasing accounts receivable and inventory by ~~$32.9~~$20.9 million and decreasing accounts payable ~~and accrued liabilities,~~by $8.3 million, partially offset by decreasing income taxes receivable and other current assets by ~~$22.8~~$21.9 million and increasing accrued liabilities and interest payable by $1.6 million.

During the ~~six~~nine months ended ~~June~~September 30, 2016, changes in working capital used ~~$6.0~~$9.6 million in cash, primarily resulting from increasing accounts receivable, inventory, income taxes receivable, and other current assets by ~~$19.6~~$24.3 million and decreasing income taxes payable by $1.8 million, partially offset by increasing accounts payable, accrued liabilities, and interest payable by ~~$15.4~~$16.4 million.

Investing Activities

Net cash provided by investing activities was ~~$13.0~~$11.8 million for the ~~six~~nine months ended ~~June~~September 30, 2017. Cash provided by investing activities primarily included ~~$17.5~~$18.5 million of proceeds received from the sale of the Drilling Technologies and Production Technologies segments and $0.3 million of proceeds received from the sale of fixed assets, partially offset by ~~$4.5~~$6.2 million for capital expenditures and ~~$0.2~~$0.8 million for the purchase of various ~~patents.~~patents and other intangible assets.

Net cash used in investing activities was ~~$8.4~~$18.8 million for the ~~six~~nine months ended ~~June~~September 30, 2016. Cash used in investing activities primarily included ~~$8.2~~$10.6 million for capital expenditures and ~~$0.1~~$8.2 million ~~associated with~~for the purchase of IPI and various patents.

Financing Activities

Net cash used in financing activities was ~~$7.2~~$13.0 million for the ~~six~~nine months ended ~~June~~September 30, 2017, primarily due to using ~~$5.7~~$7.8 million for repayments of debt, net of borrowings, purchases of treasury stock for tax withholding purposes related to vesting of restricted stock awards of ~~$1.3~~$1.5 million, and ~~$0.5~~$4.2 million for the repurchase of common stock. Cash used in financing activities was partially offset by ~~$0.4~~$0.5 million in proceeds from the sale of common stock.

Net cash generated through financing activities was ~~$13.2~~$20.8 million for the ~~six~~nine months ended ~~June~~September 30, ~~2016. Cash generated through financing activities was~~2016, primarily due to receiving ~~$14.4~~$30.6 million ~~from borrowings of debt, net of repayments, and~~in proceeds from the sale of common stock, inclusive of ~~$0.4 million.~~$29.9 million, net of issuance costs, from the private placement of 2.5 million common shares on July 27, 2016. Cash generated through financing activities was partially offset by using $8.0 million for repayments of debt, net of borrowings, reductions in tax benefit related to stock-based compensation of ~~$1.0~~$0.9 million, and ~~$0.6 million for~~ purchases of treasury stock for tax withholding purposes related to vesting of restricted stock awards and the exercise of non-qualified stock ~~options.~~options of $0.9 million.

On August 1, 2017, the Company filed a registration statement on Form S-3 (the “Universal Shelf”) with the SEC to register for sale from time to time up to $350 million of common stock, preferred stock, senior and subordinated debt securities, warrants, units and guarantees. The Universal Shelf was declared effective by the SEC on October 11, 2017 and will remain effective for three years. Although the Company has no ~~immediate intention~~current plans to issue any securities under the Universal Shelf, it will remain available for use by the Company, subject to market conditions, to quickly access the capital markets the Company has prepared a “universal” shelf registration which will be filed with the Securities and Exchange Commission. This shelf registration statement will register the issuance and sale from time to time of various securities by the Company, including but not limited to senior notes, subordinated notes, preferred stock, common stock, warrants, units, and guarantees. Once this shelf registration statement is filed with the Securities and Exchange Commission and becomes effective, the Company will have the financial flexibility to access the capital markets quickly and efficiently from time to time asshould the need ~~may~~ arise.

Contractual Obligations

Cash flows from operations are dependent on a variety of factors, including fluctuations in operating results, accounts receivable collections, inventory management, and the timing of payments for goods and services. Correspondingly, the impact of contractual obligations on the Company’s liquidity and capital resources in future periods is analyzed in conjunction with such factors.

Material contractual obligations consist of repayment of amounts borrowed on the Company’s Credit Facility with PNC Bank and payment of operating lease obligations. Contractual obligations at ~~June~~September 30, 2017, are as follows (in thousands):


	Payments Due by Period										Payments Due by Period
	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years		Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Borrowings under revolving credit facility⁽¹⁾	$	42,716	$	42,716	$	—	$	—	$	—	$	40,589	$	40,589	$	—	$	—	$	—
Operating lease obligations	23,210		2,749		4,986		3,971		11,504		22,415		2,679		4,762		3,966		11,008
Total	$	65,926	$	45,465	$	4,986	$	3,971	$	11,504	$	63,004	$	43,268	$	4,762	$	3,966	$	11,008

(1) The borrowing is classified as current debt. The weighted-average interest rate is ~~4.09%~~3.86% at ~~June~~September 30, 2017.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk from changes in interest rates, commodity prices, and foreign currency exchange rates. There have been no material changes to the quantitative or qualitative disclosures about market risk set forth in Part II, Item 7A of the Company’s Annual Report.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Company’s disclosure controls and procedures are also designed to ensure such information is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance that control objectives are attained. The Company’s disclosure controls and procedures are designed to provide such reasonable assurance.

The Company’s management, with the participation of the principal executive and principal financial officers, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of ~~June~~September 30, 2017, as required by Rule 13a-15(e) of the Exchange Act. Based upon that evaluation, the principal executive and principal financial officers have concluded that the Company’s disclosure controls and procedures were effective as of ~~June~~September 30, 2017.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s system of internal control over financial reporting during the three months ended ~~June~~September 30, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Class Action Litigation

In addition, as previously disclosed, the U.S. Securities and Exchange Commission ~~has~~had opened an inquiry related to similar issues to those raised in the above-described litigation. On August 21, 2017, the Company received a letter from the staff of the SEC stating that the inquiry has been concluded and that the staff does not intend to recommend an enforcement action against the Company.

Other Litigation

Item 1A. Risk Factors

There have been no material changes to the risk factors set forth in Part I, Item 1A of the Company’s Annual Report.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Repurchases of the Company’s equity securities during the three months ended ~~June~~September 30, 2017, are as follows:

Period
Total Number of Shares Purchased ⁽¹⁾
Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs ^{(2) (3) (4)}
April 1, 2017 to April 30, 2017 497,391
$ 12.55
—
$ 54,907,862
May 1, 2017 to May 31, 2017 81,218
$ 9.74
50,000
$ 54,420,042
June 1, 2017 to June 30, 2017 56,191
$ 9.08
—
$ 54,420,042
Total 634,800
$ 11.89
50,000



Period	Total Number of Shares Purchased ⁽¹⁾	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs ^{(2) (3) (4)}
July 1, 2017 to July 31, 2017	1,880	$	8.94	—	$	54,420,042
August 1, 2017 to August 31, 2017	377,203	$	6.07	350,000	$	52,288,702
September 1, 2017 to September 30, 2017	286,009	$	5.55	280,000	$	50,733,939
Total	665,092	$	5.85	630,000


(1)	The Company purchases shares of its common stock (a) to satisfy tax withholding requirements and payment remittance obligations related to period vesting of restricted shares and exercise of non-qualified stock options, (b) to satisfy payments required for common stock upon the exercise of stock options, and (c) as part of a publicly announced repurchase program on the open market.


(2)	In November 2012, the Company’s Board of Directors authorized the repurchase of up to $25 million of the Company’s common stock. Repurchases may be made in open market or privately negotiated transactions. Through ~~June~~September 30, 2017, the Company has repurchased ~~$20.6~~$24.3 million of its common stock and ~~$4.4~~$0.7 million may yet be used to purchase shares.


(3)	In June 2015, the Company’s Board of Directors authorized the repurchase of up to an additional $50 million of the Company’s common stock. Repurchases may be made in open market or privately negotiated transactions. Through ~~June~~September 30, 2017, the Company has not repurchased any of its common stock under this authorization and $50.0 million may yet be used to purchase shares.


(4)	A covenant under the Company’s Credit Facility limits the amount that may be used to repurchase the Company’s common stock. ~~As of June~~At September 30, 2017, this covenant limits additional share repurchases to ~~$4.4~~$10.7 million.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits



Exhibit Number		Description of Exhibit
3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q for the quarter ended September 30, 2007).
3.2		Certificate of Amendment to the Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q for the quarter ended September 30, 2009).
3.3		Amended and Restated Bylaws, dated December 9, 2014 (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on December 10, 2014).
3.4		Second Amended and Restated Bylaws, dated October 11, 2017 (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on October 17, 2017).
4.1		Form of Certificate of Common Stock (incorporated by reference to Appendix E to the Company’s Definitive Proxy Statement filed on September 27, 2001).
4.2		Registration Rights Agreement, dated as of July 26, 2016, by and among the Company, Donald Bramblett, and Mark Kieper (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-3 (File No. 333-212864) filed on August 3, 2016).
10.1	*	~~Seventh Amendment to Amended and Restated Revolving Credit, Term Loan and Security Agreement and Sixth~~Eighth Amendment to Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated effective as of ~~March 31,~~June 7, 2017.
10.2	*	Ninth Amendment to Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated effective as of July 1, 2017.
10.3		Tenth Amendment to Amended and Restated Revolving Credit, Term Loan and Security Agreement, dated effective as of September 29, 2017 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on ~~May 1,~~October 3, 2017).
~~10.2~~10.4	*	~~Asset Purchase~~ Employment Agreement, dated ~~May 2,~~effective April 1, 2016, between the Company and Robert Bodnar.
10.5	*	Confidential Severance and Release Agreement, dated effective October 12, 2017, bybetween the Company and among National Oilwell DHT, L.P., Dreco Energy Services ULC, and National Oilwell Varco, L.P., the buyers, Teledrift Company, Turbeco, Inc., Flotek Technologies ULC, and Flotek Industries FZE, the sellers, and Flotek Industries, Inc.Robert Bodnar.
31.1	*	Rule 13a-14(a) Certification of Principal Executive Officer.
31.2	*	Rule 13a-14(a) Certification of Principal Financial Officer.
32.1	**	Section 1350 Certification of Principal Executive Officer.
32.2	**	Section 1350 Certification of Principal Financial Officer.
101.INS	+	XBRL Instance Document.
101.SCH	+	XBRL Schema Document.
101.CAL	+	XBRL Calculation Linkbase Document.
101.LAB	+	XBRL Label Linkbase Document.
101.PRE	+	XBRL Presentation Linkbase Document.
101.DEF	+	XBRL Definition Linkbase Document.

*		Filed herewith.
**		Furnished with this Form 10-Q, not filed.
+		Filed electronically with this Form 10-Q.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



FLOTEK INDUSTRIES, INC.

By:		/s/ JOHN W. CHISHOLM
		John W. Chisholm
		President, Chief Executive Officer and Chairman of the Board

Date:		November 8, 2017

~~Date: August 1, 2017~~



FLOTEK INDUSTRIES, INC.

By:		/s/ H. RICHARD WALTON
		H. Richard Walton
		Executive Vice President and Chief Financial Officer

Date:		November 8, 2017

~~Date: August 1, 2017~~

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