FTK 10-Q Quarter ended March 31, 2011

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2011

or

For the transition period from              to

Commission File Number 1-13270

FLOTEK INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

(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 ¨ 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” and “smaller reporting company” in Rule 12b-2 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 May 6, 2011, there were 46,265,275 outstanding shares of Flotek Industries, Inc. common stock, $0.0001 par value.

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TABLE OF CONTENTS

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FLOTEK INDUSTRIES, INC.

(in thousands, except share data)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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FLOTEK INDUSTRIES, INC.

(in thousands, except per share data)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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FLOTEK INDUSTRIES, INC.

(in thousands)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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FLOTEK INDUSTRIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(in thousands)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Flotek Industries, Inc. (“Flotek” or the “Company”) is a diversified global developer and supplier of drilling and production related products and services. The Company’s strategic focus includes oilfield specialty chemicals and logistics, down-hole drilling tools and down-hole production tools used in the oil, gas and mining industries. The Company also provides automated material handling, loading facilities and blending capabilities for a variety of bulk materials. The Company’s products and services enable customers to drill wells more efficiently, increase production from existing wells and decrease well operating costs. Major customers include leading oilfield service providers, major and independent oil and gas exploration and production companies, and onshore and offshore drilling contractors.

The Company is headquartered in Houston, Texas, and maintains operational locations in Colorado, Louisiana, New Mexico, North Dakota, Oklahoma, Pennsylvania, Texas, Utah, Wyoming and the Netherlands and actively markets products domestically and internationally in over 20 countries. The Company was originally incorporated on May 17, 1985 under the laws of the Province of British Columbia. On October 23, 2001, the Company transferred the corporate domicile to the state of Delaware.

Basis of Presentation

The accompanying Unaudited Condensed Consolidated Financial Statements (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 considered to be of a normal recurring nature. The Financial Statements, including selected notes, have been prepared in accordance with applicable rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting and do not include all information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for comprehensive financial statements. These interim Financial Statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “Annual Report”). A copy of the Annual Report can be obtained by visiting the SEC website, www.sec.gov , and conducting a search of the Company’s Ticker Symbol (FTK) or alternatively by visiting the Company’s website, www.flotekind.com . The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Financial Statements and accompanying notes. Actual results could differ materially from these estimates.

Supplemental cash flow information (in thousands):

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

The Company distinguishes revenue and cost of revenue by product sales, rental or service activity (in thousands):

Inventory includes (in thousands):

Property and equipment includes (in thousands):

Depreciation expense, including that captured in cost of revenue, totaled $2.0 million and $2.9 million for the three months ended March 31, 2011 and 2010, respectively.

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

Other intangible assets include (in thousands):

Amortization of intangible assets is calculated on a straight-line basis over two to 20 years. Amortization of intangible assets acquired totaled $0.5 million and $0.6 million during the three months ended March 31, 2011 and 2010, respectively. Recurring amortization of deferred financing costs for the same periods totaled $1.0 million and $0.5 million, respectively. Deferred financing costs increased $0.4 million in the first quarter of 2011 due to common stock exchanged, at the lender’s election, for repayment of a portion of the term loan principal outstanding. See Note 7 – Convertible Notes and Long-Term Debt below.

Convertible notes and long-term debt includes (in thousands):

Convertible Notes

Convertible notes consist of Convertible Senior Unsecured Notes (the “2008 Notes”) and Convertible Senior Secured Notes (the “2010 Notes”).

On February 14, 2008, the Company issued the 2008 Notes at par, in an aggregate principal amount of $115 million. Net proceeds from issuance of the 2008 Notes totaled $111.8 million. The 2008 Notes bear interest at 5.25% and mature on February 15, 2028.

On March 31, 2010, the Company executed an exchange agreement (the “Exchange Agreement”) with Whitebox Advisors, LLC; the administrative agent for a syndicate of lenders, in order to refinance the Company’s existing term loan (See Term Loan below). The Exchange Agreement permitted each lender to exchange 2008 Notes, in proportion to the lender’s principal amount of participation in the refinanced term loan, for 2010 Notes and shares of the Company’s common stock. On March 31, 2010, in accordance with the terms of the Exchange Agreement, investors received, for each $1,000 principal amount of 2008 Notes exchanged: (a) $900 principal amount of 2010 Notes and (b) $50 worth of shares of the Company’s common stock (based on the greater of 95% of (1) the volume-weighted average price of the common stock for the preceding ten trading days or (2) the closing price of the common stock on the day before the closing). The 2010 Notes carry the same maturity date, interest rate, conversion rights, conversion rate, redemption rights and guarantees as the 2008 Notes. The only difference in the terms of the notes is that the 2010 Notes are secured by a second priority lien on substantially all of the Company’s assets, while the 2008 Notes remain unsecured.

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

The 2008 Notes may settle with cash upon conversion. The Company accounted for both the liability and equity components of the 2008 Notes using the Company’s 11.5% nonconvertible debt borrowing rate and the five-year expected amortization term of the associated debt discount. The five-year term represents the period from inception until contractual call/put options contained in the 2008 Notes become exercisable on February 2013. The Company assumed an effective tax rate of 38.0%. At the date of issuance, the discount on the 2008 Notes was $27.8 million, with an associated deferred tax liability of $10.6 million. At March 31, 2010, the unamortized discount related to the proportionate amount of the 2008 Notes exchanged was allocated to the 2010 Notes and is accreted over the same period using the effective interest method at an assumed rate of 9.9%. The remaining 2008 Notes discount is accreted over the same term and recognized as additional non-cash interest expense. Accretion of the discount totaled $1.3 million for each of the three months ended March 31, 2011 and 2010.

The Company exchanged $40 million of 2008 Notes for aggregate consideration of $36 million of 2010 Notes and $2.0 million worth of shares of common stock. On March 31, 2010, the Company issued 1,568,867 shares of common stock to satisfy the common stock component of the Exchange Agreement. The transaction was recorded as an exchange of debt. Accordingly, no gain or loss was recognized and the difference between the debt exchanged and the net carrying value of the debt was recorded as a reduction of previously recorded debt discount. The remaining discount is amortized over the period the convertible debt is expected to remain outstanding. Capitalized commitment fees of $7.3 million associated with the Exchange Agreement are amortized using the effective interest method over the period the convertible debt is expected to remain outstanding. Third-party transaction costs of $0.8 million incurred in conjunction with the Exchange Agreement were expensed as incurred.

Interest on the 2008 and 2010 Notes accrues at 5.25% per annum and is payable semiannually in arrears on February 15 and August 15. The Company is obligated to pay contingent interest to holders of the 2008 and 2010 Notes during any six-month period from an interest payment date to, but excluding, the following interest payment date, commencing with the six-month period beginning on February 15, 2013, if the trading price of a note for each of the five trading days ending on the third trading day immediately preceding the first day of the relevant six-month period equals 120% or more of the principal amount of the note. Contingent interest payable per note, with respect to any such period, will be equal to 0.5% per annum of the average trading price of the applicable note for the five trading days referenced above.

The 2008 and 2010 Notes mature on February 15, 2028. On or after February 15, 2013, the Company may redeem, for cash, all or a portion of the 2008 and 2010 Notes at a price equal to 100% of the outstanding principal note amount, plus associated accrued and unpaid interest, including any contingent interest. Holders of either 2008 or 2010 Notes can require the Company to purchase all, or a portion, of the holder’s outstanding notes on each of February 15, 2013, February 15, 2018, and February 15, 2023.

If the Company engages in certain types of corporate transactions, note holders can require the Company to purchase all or a portion of the note holder’s outstanding notes. Any repurchase of the 2008 and 2010 Notes pursuant to the aforementioned provisions must be for a cash price equal to 100% of the principal amount of the notes to be purchased in addition to associated accrued and unpaid interest, including any contingent interest.

The 2008 and 2010 Notes are convertible into shares of the Company’s common stock at the option of the note holders, subject to certain contractual conditions. The conversion rate is equal to 43.9560 shares per $1,000 principal note amount (equal to a conversion price of approximately $22.75 per share), subject to adjustment, as contractually defined. Upon conversion, the Company may deliver, at the Company’s option, either cash or shares of common stock or a combination of cash and shares of common stock.

Term Loan

On March 31, 2010, the Company executed an Amended and Restated Credit Agreement (the “Senior Credit Facility” or “term loan”) for a $40.0 million term loan with Whitebox Advisors, LLC, the administrative agent for a syndicate of lenders. The term loan repaid the existing Wells Fargo senior credit facility and provided net proceeds of $6.1 million to use for general corporate purposes.

The term loan indebtedness matures November 1, 2012 and has scheduled quarterly principal payments of $1,000,000. Interest is paid quarterly and any remaining unpaid principal balance is due at maturity. The Company has the option to pay interest due in cash or to pay a portion of the interest due in cash and capitalize the remaining unpaid interest due. Any capitalization of interest results in an increase in the term loan principal amount due. The annualized cash interest rate is 12.5% when the principal balance exceeds $30 million, 11.5% when the principal balance is $20 million or more but not in excess of $30 million, and 10.5% when the principal balance is less than $20 million. If the Company elects to capitalize a portion of the interest due, the annualized cash interest rate applied is 8% and additional interest is capitalized and added to the remaining term loan principal amount at an annualized rate of 6% when the principal balance exceeds $30 million, 4.5% when the principal balance is $20 million or more but not in excess of $30 million, and 3.5% when the principal balance is less than $20 million.

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

The Senior Credit Facility requires additional mandatory principal payments of (a) 50% of EBITDA (earnings before interest, taxes, depreciation and amortization, and other contractually identified non-cash items) in excess of $4.5 million in any fiscal quarter, (b) 50% of cash proceeds in excess of $5 million and up to $15 million for some contractually specified asset disposals, plus 75% of any cash proceeds in excess of $15 million from certain specified types of asset disposals, (c) 75% of any Federal income tax refunds received, and (d) upon election by the lenders, of up to $1 million of additional principal repayment on quarterly payment dates, when the volume-weighted average price of the Company’s common stock price is equal to or greater than $1.3419 per share, payable by issuance of common stock (based on 95% of the volume-weighted average price of the common stock for the preceding ten trading days).

On March 25, 2011, the Senior Credit Facility lenders elected to receive an additional principal payment of $1,000,000 in shares of the Company’s common stock payable on March 31, 2011. As a result, the Company issued the lenders 171,154 shares of the Company’s common stock on March 31, 2011. The $0.4 million difference between the fair value of the stock at the date of the election, March 25, 2011, and the $1.0 million principal repayment was recorded as additional debt discount and is being amortized over the remaining period the term loan is expected to remain outstanding.

The Senior Credit Facility provided for a commitment fee of $7.3 million. At closing on March 31, 2010, $0.9 million was paid in cash and $4.4 million was paid via the issuance of 3,431,133 shares of common stock. Deferred commitment fees of $2.0 million were settled with an issuance of 611,108 shares of common stock and a $0.3 million cash payment on September 30, 2010 and with a $1.0 million cash payment on March 31, 2011. The Company allocated one-half of the commitment fees to the term loan and one-half to the Exchange Agreement. Commitment fees capitalized as deferred financing costs are amortized as additional interest expense over the periods the term loan and convertible debt are expected to remain outstanding.

Senior Credit Facility borrowings are secured by substantially all of the Company’s present and future assets. The Senior Credit Facility does not contain a revolving line of credit facility nor require quarterly or annual financial covenant compliance; however, the Senior Credit Facility does restrict any Company payments of common stock dividends without the lender’s prior written consent and limits the Company’s amount of capital investment.

Convertible Notes and Term Loan Guarantees

The 2008 and 2010 Notes, as well as the term loan, are guaranteed by substantially all of the Company’s wholly owned subsidiaries. Flotek Industries, Inc., the parent company, is a holding company with no independent assets or operations. The guarantees provided by the Company’s subsidiaries are full and unconditional, and joint and several. Any subsidiaries of the Company that are not guarantors are deemed to be “minor” subsidiaries in accordance with SEC Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.” The agreements governing the Company’s long-term indebtedness do not contain any significant restrictions on the ability of the Company, or any guarantor, to obtain funds from subsidiaries by dividend or loan.

Share Lending Agreement

Concurrent with the 2008 Notes offering, the Company entered into a share lending agreement (the “Share Lending Agreement”) with Bear Stearns International Limited (the “Borrower”). The Borrower subsequently became an indirect, wholly owned subsidiary of JP Morgan Chase & Company. In accordance with the terms of the Share Lending Agreement, the Company loaned 3,800,000 shares of common stock (the “Borrowed Shares”) to the Borrower for a period commencing February 11, 2008 and ending February 15, 2028. The Company may terminate the Share Lending Agreement earlier, upon written notice to the Borrower, if the principal balance of the 2008 Notes has been repaid or upon agreement with the Borrower. The Borrower is permitted to use the Borrowed Shares only for the purpose of directly or indirectly facilitating the sale of the 2008 Notes and for the establishment of hedge positions by holders of the 2008 Notes. The Company did not require collateral to mitigate any inherent or associated risk of the Share Lending Agreement.

In February 2008, the Borrower borrowed all 3,800,000 shares available under the Share Lending Agreement. The shares are subject to adjustments for stock dividends, stock splits or reverse stock splits. The Company did not receive any proceeds for the Borrowed Shares, but did receive a nominal loan fee of $0.0001 for each share loaned. The Borrower retained all proceeds from the sale of Borrowed Shares pursuant to the Share Lending Agreement. Upon conversion, the number of Borrowed Shares proportionate to the conversion rate for the 2008 Notes must be remitted to the Company. Any borrowed shares returned to the Company cannot be re-borrowed.

Borrowed Shares are issued and outstanding for corporate law purposes; accordingly, holders of Borrowed Shares possess all of the rights of a holder of the Company’s outstanding shares, including the right to vote the shares on all matters submitted to a vote of stockholders and the right to receive any dividends or other distributions declared or paid on outstanding shares of common stock. Under the Share Lending Agreement, the Borrower agreed to pay to the Company, within one business day after a payment date, an amount equal to any cash dividends that the Company paid on the Borrowed Shares, and to pay or deliver to the Company, upon termination of the loan of Borrowed Shares, any other distribution, in liquidation or otherwise, that the Company made on the Borrowed Shares.

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

To the extent the Borrowed Shares loaned under the Share Lending Agreement were not sold or returned to the Company, the Borrower agreed not to vote such Borrowed Shares of which it is the owner of record. The Borrower also agreed not to transfer or dispose of any Borrowed Shares, other than to Borrower’s affiliates, unless such transfer or disposition was pursuant to a registration statement effective under the Securities Act. Investors that purchased shares from the Borrower, and all subsequent transferees of such purchasers, are entitled to the same voting rights, with respect to those shares, as any other holder of common stock.

Contractual undertakings of the Borrower had the effect of substantially eliminating the economic dilution that otherwise would result from the issuance of the Borrowed Shares. Further, all shares outstanding under the Share Lending Agreement are required to be returned to the Company at a future date. Consequently, shares of the Company’s stock loaned under the Share Lending Agreement are not considered outstanding for the purpose of computing and reporting earnings per share.

The Company determined that the fair value of the share lending arrangement was $0.5 million at the date of issuance. The fair value was recorded as debt issuance cost and is amortized as additional interest expense over the period from the date of issuance through February 15, 2013, the earliest put date of the related debt. At March 31, 2011 and December 31, 2010, unamortized debt issuance cost relating to the share lending arrangement totaled $0.2 million. The Company estimates that this unamortized value approximates the fair value of the loaned shares outstanding at March 31, 2011 and December 31, 2010. The fair value of similar common shares not subject to the share lending arrangement based on the closing price of the Company’s common stock on March 31, 2011, totaled $32.0 million.

Capital Lease Obligations

The Company leases equipment and vehicles under capital leases. At March 31, 2011 and December 31, 2010, the Company had $1.0 million of capital lease obligations.

Fair value is the amount at a measurement date that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company categorizes financial assets and liabilities into the three-tiered levels of the fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value and bases the categorization within the hierarchy on the lowest level of input that is available and significant to the fair value measurement.

Liabilities Measured at Fair Value on a Recurring Basis

Liabilities required to be measured at fair value on a recurring basis, including identification of the fair value hierarchy of the valuation techniques used by the Company to determine these fair values, are as follows (in thousands):

There were no significant transfers in or out of either Level 1 or Level 2 fair value measurements during the three months ended March 31, 2011 or 2010. During the three months ended March 31, 2011, $7.6 million of non-cash gain was recognized as a fair value adjustment within level three of the fair value measurement hierarchy. The change was primarily due to the conversion of 0.8 million Exercisable Warrants and 2.5 million Contingent Warrants at a fair value of $7.35 and $7.37 per warrant, respectively. During the twelve months ended December 31, 2010, $21.5 million

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FLOTEK INDUSTRIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

of non-cash fair value loss adjustment were recognized within level three of the fair value measurement hierarchy. The fluctuation was primarily due to an increase in the price and volatility of the Company’s common stock partially offset by the conversion of 1.0 million Exercisable Warrants and 3.6 million Contingent Warrants with weighted average fair values of $1.30 and $1.30 per warrant, respectively. The fair value price per each Exercisable and Contingent Warrant for each period presented ranged from a low of $0.61 to a high $4.46 and from a low of $0.63 to a high of $4.48 per warrant, respectively. During the periods presented there were no new issuances of warrants or transfers in or out of the Level 3 hierarchy.

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 March 31, 2011 or December 31, 2010.

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