FLOTEK INDUSTRIES INC/CN (FTK) Business, 2008

General

Flotek Industries, Inc. is a diversified global supplier of drilling and production related products and services to the oil and gas industry. In 2008, we sold $226.1 million of products and services to customers through our three business segments: Chemicals and Logistics, Drilling Products and Artificial Lift. Our core focus is oilfield specialty chemicals and logistics, downhole drilling tools and downhole production tools. Flotek offers its products primarily through its sales organizations, as well as through independent distributors and agents. Flotek was founded in 1985 and is headquartered in Houston, Texas. On December 27, 2007, our common stock began trading on the New York Stock Exchange (“NYSE”) under the stock ticker symbol “FTK”. Prior to this date and since July 27, 2005, our common stock was traded on the American Stock Exchange (“AMEX”) under the stock ticker symbol “FTK”. Prior to this date, our common stock was traded on the OTC Bulletin Board under the stock ticker symbol “FLTK” or “FLTK.OB”. Our website is located at http://www.flotekind.com. We make available free of charge on or through our internet website our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission (“SEC”). Information contained in our website or links contained on our website are not part of this filing. As used herein, “Flotek,” “Company,” “we,” “our” and “us” may refer to Flotek Industries, Inc. and/or its subsidiaries. The use of these terms is not intended to connote any particular corporate status or relationships. Additional information regarding our business segments is presented below and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 (“MD&A”) and in Note 17 of the Notes to our Consolidated Financial Statements in Item 8 (“Note 17”). We sold approximately $208 million, $150 million and $94 million of products and services in the United States for the years ended December 31, 2008, 2007 and 2006, respectively. The remainder of our sales are generated internationally in approximately 20 countries and accounted for approximately 8%, 5% and 7% of our consolidated revenues for each of the last three years, respectively. No single country outside of the United States accounted for more than 10% of our total revenues in any of the past three years.

Historical Developments

Flotek was originally incorporated under the laws of the Province of British Columbia on May 17, 1985. On October 23, 2001, we approved a change in our corporate domicile to the state of Delaware and a reverse stock split of 120 to 1. On October 31, 2001, we completed a reverse merger with CESI Chemical, Inc. (“CESI”). Since that date, we have grown through a series of acquisitions.

Description of Operations

Our business is organized into three strategic business units or segments: Chemicals and Logistics, Drilling Products and Artificial Lift. Each segment is managed independently, offers various products and services and requires different technology and marketing strategies. All three segments market products domestically and internationally.

Chemicals and Logistics

The chemical business offers a full spectrum of oil gas field specialty chemicals used for drilling, cementing, stimulation, and production designed to maximize recovery from both new and mature fields. Our specialty chemicals, with enhanced performance characteristics are manufactured to withstand a wide range of downhole pressures, temperatures and other well-specific conditions, are key to the success of this business segment. We operate two laboratories, a technical services laboratory and a research and development laboratory, which focus

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on design, development and testing of new chemical formulations and enhancement of existing products, often in cooperation with our customers.

Our logistics business designs, project manages and operates automated bulk material handling and loading facilities for oilfield service companies. These bulk facilities handle oilfield products, including sand and other materials for well-fracturing operations, dry cement and additives for oil and gas well cementing, and supplies and materials used in oilfield operations, which we blend to customer specification.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included it in the results of this segment from the date of acquisition:

• acquired Sooner Energy Services, Inc. (“Sooner”) which develops, produces and distributes specialty chemical products and services for drilling and production of natural gas, on August 31, 2007.

Annual revenues for this segment totaled approximately $109 million, $86 million and $51 million in 2008, 2007 and 2006, respectively. Our proprietary biodegradable “green” chemicals sales amounted to $77 million, $56 million and $26 million for the years ended December 31, 2008, 2007 and 2006, respectively. These sales increased 37% in 2008 from the 2007 period and 115% in 2007 from the 2006 period.

Drilling Products

We are a leading provider of downhole drilling tools used in the oilfield, mining, water-well and industrial drilling sectors. We manufacture, sell, rent and inspect specialized equipment for use in drilling, completion, production and workover activities. Through internal growth and acquisitions, we have increased the size and breadth of our rental tool inventory and geographic scope of operations so that we now conduct tool rental operations throughout the United States and in select international markets. Our rental tools include stabilizers, drill collars, reamers, wipers, jars, shock subs, wireless survey, measurement while drilling (“MWD”) tools and mud-motors, while equipment sold includes centralizers and drill bits. We focus our product marketing efforts primarily in the Gulf of Mexico, Mid-Continent and Rocky Mountain regions of the United States, with international sales currently conducted through third party agents and employees.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included them in the results of this segment from their respective dates of acquisition:

• acquired the assets of Can-Ok Oil Field Services, Inc. and Stabilizer Technology, Inc. (collectively “Can-Ok”), a downhole oilfield tool company located in Chickasha, Oklahoma on January 2, 2006,

• acquired the assets of Triumph Drilling Tools (“Triumph”), a downhole tool company with rental, inspection and manufacturing operations throughout the Gulf Coast and Mid-Continent regions, on January 4, 2007,

• acquired a 50% partnership interest in CAVO Drilling Motors Ltd Co. (“CAVO”) on January 31, 2007, a downhole mud-motor company with domestic rental and international sales operations and acquired the remaining 50% partnership interest in CAVO on November 15, 2007, and

• acquired the assets of Teledrift Inc. (“Teledrift”), which designs and manufactures wireless survey and MWD tools, on February 14, 2008.

Annual revenues for this segment totaled approximately $98 million, $57 million and $37 million in 2008, 2007 and 2006, respectively.

In 2008, we introduced the Teleshot, an all electronic wire-line drift indicator, that is capable of taking multiple surveys per run and incorporates the ability to download quickly the information. We provide the Teleshot to our

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customers through direct sales or on a rental basis. The TelePulse fully steerable MWD system, featuring proprietary state-of-the-art surface software, is expected to be completed with all field-testing and released for production in the second half of 2009. The Telepulse will offer a positive pulse system with a gamma sensor module that will allow directional drilling companies to maintain integrity of their technical requirements. Additionally, we intend to combine our rental efforts with the CAVO downhole motor in order to provide us with an opportunity to increase our presence in the offshore market both domestically and internationally.

Artificial Lift

We provide pumping system components, including electric submersible pumps, or ESPs, gas separators, production valves and services. Our products address the needs of coal bed methane and traditional oil and gas production to efficiently move gas, oil and other fluids from the producing horizon to the surface. Several of our artificial lift products employ unique technologies to improve well performance. Our patented Petrovalve product optimizes pumping efficiency in horizontal completions, heavy oil and wells with high gas to liquids ratios. This unique valve can be placed horizontally, results in increased flow per stroke, and eliminates gas locking by replacing the traditional ball and seat valve that requires more maintenance. Furthermore, our patented gas separation technology is particularly applicable for coal bed methane production as it efficiently separates gas and water downhole, ensuring solution gas is not lost in water production. Because gas is separated downhole, it reduces the environmental impact of escaped gas at the surface. The majority of our products for Artificial Lift are manufactured in China, assembled domestically and distributed globally.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included them in the results of this segment from their respective dates of acquisition:

• acquired the tangible assets and licensed the rights to exercise the exclusive worldwide rights to a patented gas separator used in coal bed methane production in the Powder River Basin from Total Well Solutions, LLC. (“TWS”) on April 3, 2006 and

• acquired the assets of LifTech, LLC (“LifTech”) which markets and services electric submersible pumps and downhole gas/water separators primarily to coal bed methane gas producers in the Powder River Basin on June 6, 2006.

Annual revenues for this segment totaled approximately $18 million, $15 million and $13 million in 2008, 2007 and 2006, respectively.

Seasonality

On an overall basis, our operations are not generally affected by seasonality. Certain working capital components may build and recede during the year reflecting established selling cycles and business cycles can impact our operations and financial position when compared to other periods, but we do not consider our operations to be highly-seasonal. Additionally, weather and natural phenomena can temporarily affect the performance of our services. Examples of how such phenomena can impact our business include:

• the severity and duration of the winter in North America can have a significant impact on gas storage levels and drilling activity for natural gas;

• the timing and duration of the spring thaw in Canada directly affects activity levels due to road restrictions;

• hurricanes can disrupt coastal and offshore operations.

In addition, historically due to higher spending near the end of the year by our customers, the results of operations of the Chemical and Logistics segment are generally stronger in the fourth quarter of the year than at

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the beginning of the year. Also, historically the results of operations of our Artificial Lift segment are generally weaker in the second quarter due to restrictions on drilling on federal lands because of the breeding season of certain bird species.

Product Demand and Marketing

The demand for our products and services is generally correlated to the level of oil and gas drilling activity, work-over activity and gas production levels, both in the United States and internationally. We market our products primarily through direct sales to our customers through sales employees with the assistance of operations and Company management. We have established customer relationships which provide for repeat sales in all of our segments. The majority of our marketing is currently conducted within the United States. Internationally, we operate primarily through agents in Canada, Mexico, Central and South America, the Middle East, Asia and Russia.

Customers

The customers for our products and services include major integrated oil and natural gas companies, independent oil and natural gas companies, pressure pumping service companies and state-owned national oil companies. One of our customers accounted for 12% of our consolidated revenues for each of the years ended December 31, 2008 and 2007. No single customer accounted for more than 10% of our consolidated revenues in the year ended December 31, 2006. Our top five customers accounted for 34% of our consolidated revenues for each of the years ended December 31, 2008 and 2007 and 30% of consolidated revenue for the year ended December 31, 2006.

The majority of the sales to our top five customers were in the Chemicals and Logistics segment and collectively accounted for approximately 63%, 52% and 47% of revenue for this segment for the years ended December 31, 2008, 2007 and 2006, respectively. Our top three customers accounted for 25%, 15% and 12% of the segment’s revenue for the year ended December 31, 2008, respectively. In 2007, these companies accounted for 21%, 14% and 10% of segment revenue, respectively, while in fiscal 2006 these companies accounted for 11%, 15% and 14% of segment revenue, respectively.

Two of our top customers also make purchases for another one of our top customers as part of their normal business operations. We cannot quantify the magnitude of purchases made by one of our customers on behalf of another entity. While these three customers are not under common control nor are they affiliates of each other or Flotek, combined they accounted for 40%, 38% and 28% of segment revenue for the years ended December 31, 2008, 2007 and 2006 respectively. A loss of this combined customer group would negatively impact the Company’s operating results.

One customer, accounted for 56%, 53% and 43% of the Artificial Lift segment revenue for the years ended December 31, 2008, 2007 and 2006, respectively.

None of these customers were a related party or affiliate of Flotek during any of the years ended December 31, 2008, 2007 or 2006.

Research and Development

We are engaged in research and development activities directed primarily toward the improvement of existing products and services, the design of specialized products to meet customer needs and the development of new products, processes and services. We incurred $1.9 million, $0.8 million and $0.7 million in research and development expenses for the years ended December 31, 2008, 2007 and 2006, respectively. In 2008, our research and development spending was approximately 1% of consolidated revenues. It is our intention to maintain Flotek’s future research and development investment at approximately 1% of consolidated revenues.

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Backlog

Due to the nature of our business and contracts with our customers, we do not experience any significant amount of backlog orders.

Intellectual Property

We have followed a policy of seeking patent protection both within and outside the United States for products and methods that appear to have commercial significance and qualify for patent protection. The decision to seek patent protection depends on whether such protection can be obtained on a cost-effective basis and is likely to be effective in protecting our commercial interests. We believe our patents and trademarks, together with our trade secrets and proprietary design, manufacturing and operational expertise, are reasonably adequate to protect our intellectual property and provide for the continued operation of our business. We maintain patents on our production valve design, casing centralizer design, and trade secrets and pending patents on certain specialty chemicals.

Competition

Our ability to compete in the oilfield services market is dependent on our ability to differentiate our products and services, provide superior quality and service, and maintain a competitive cost structure. Activity levels in our three segments are driven primarily by current and expected commodity prices, drilling rig count, oil and gas production levels, and customer capital spending allocated for drilling and production. The regions in which we operate are highly competitive. The competitive environment has intensified as recent mergers among oil and gas companies have reduced the number of available customers. Additionally, the recent downturn in the economy and commodity prices have caused the market for our services and that of our competitors, which may vary significantly by geographical region, to contract. Many other oil and gas service companies are larger than we are and have greater resources than we have. These competitors may be better able to withstand industry downturns, compete on the basis of price and acquire new equipment and technologies, all of which could affect our revenue and profitability. These competitors compete with us both for customers and for acquisitions of other businesses. This competition may cause our business to suffer. We believe that competition for contracts and margins will continue to be intense in the foreseeable future.

Raw Materials

The Company believes that materials and components used in its servicing and manufacturing operations and purchased for sales are generally available on the open market and from multiple sources, although collection and transportation of these raw materials to the Company’s facilities can be adversely affected by extreme weather conditions. However, certain raw materials used by the Chemical and Logistics segment in the manufacture of our proprietary, ‘green’ chemical sales are available from limited sources and disruptions to our suppliers could materially impact our sales. The prices paid by the Company for its raw materials may be affected by, among other things, energy, steel and other commodity prices; tariffs and duties on imported materials; foreign currency exchange rates; the general business cycle and global demand. The Company experienced greater difficulty in securing the necessary supplies of certain chemicals in 2008 than it experienced during the preceding several years. During 2008, the prices of many raw materials rose considerably above our forecast, but we began to see prices decline towards the end of 2008. Higher prices and lower availability of chemicals, steel and other raw materials the Company uses in its business may adversely impact future period sales and margins. The Drilling Products and Artificial Lift segments purchase their principal raw material and steel on the open market. Except for a few chemical additives, the raw materials are available in most cases from several suppliers at market prices. Where we can, we use multiple suppliers, both domestically and internationally, for our key raw materials purchases.

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We also maintain a three to six month supply of key mud-motor inventory parts that are primarily sourced from China as well as an equivalent amount of stock of parts within our Artificial Lift segment. This inventory stock position approximates the lead time required to secure these parts in order to avoid disruption of service to our customers.

Government Regulations

We are subject to federal, state and local environmental and occupational safety and health laws and regulations in the United States and other countries in which we do business. We are subject to numerous environmental, legal, and regulatory requirements related to our operations worldwide. We strive to comply fully with these requirements and are not aware of any material instances of noncompliance. In the United States, these laws and regulations include, among others:

• the Comprehensive Environmental Response, Compensation and Liability Act;

• the Resource Conservation and Recovery Act;

• the Clean Air Act;

• the Federal Water Pollution Control Act; and

• the Toxic Substances Control Act.

In addition to the federal laws and regulations, states and other countries where we do business may have numerous environmental, legal, and regulatory requirements by which we must abide. We evaluate and address the environmental impact of our operations by assessing and remediating contaminated properties in order to avoid future liabilities and comply with environmental, legal, and regulatory requirements. Many of the products within our Chemicals and Logistics segment are considered hazardous or flammable. If a leak or spill occurs in connection with our operations, we could incur material costs, net of insurance, to remediate any resulting contamination. On occasion, we are involved in specific environmental litigation and claims, including the remediation of properties we own or have operated, as well as efforts to meet or correct compliance-related matters. We do not expect costs related to these remediation requirements to have a material adverse effect on our consolidated financial position or our results of operations.

Employees

As of January 30, 2009, we had approximately 500 employees worldwide, with approximately 15 employed as part-time workers. None of our employees are covered by collective bargaining agreements and our labor relations are generally good. In certain international locations, changes in staffing or work arrangements may need approval of local works councils or other bodies.

Available Information

We maintain a web site at www.flotekind.com. We make available, free of charge, on the “Investor Relations” section of our web site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file or furnish such materials to the SEC. Additionally, our corporate governance materials, including governance guidelines; the charters of the Audit, Compensation, and Governance and Nominating Committees; and the code of conduct may also be found under the “Investor Relations” section of our web site at www.flotekind.com. A copy of the foregoing corporate governance materials is available upon written request.

You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549. You may obtain information regarding the Public Reference Room by calling the

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SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at www.sec.gov that contains reports and other information regarding registrants that file electronically with the SEC, including us.

We submitted our 2008 annual Section 12(a) CEO certification with the New York Stock Exchange (“NYSE”) on March 16, 2009. The certification was not qualified in any respect. Additionally, we filed with this Form 10-K the CEO and CFO certifications required under Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Information with respect to our executive officers and directors is incorporated herein by reference to information included in the Proxy Statement for our 2008 Annual Meeting of Shareholders.

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General

Flotek Industries, Inc. is a diversified global supplier of drilling and production related products and services to the oil and gas industry. In 2008, we sold $226.1 million of products and services to customers through our three business segments: Chemicals and Logistics, Drilling Products and Artificial Lift. Our core focus is oilfield specialty chemicals and logistics, downhole drilling tools and downhole production tools. Flotek offers its products primarily through its sales organizations, as well as through independent distributors and agents. Flotek was founded in 1985 and is headquartered in Houston, Texas. On December 27, 2007, our common stock began trading on the New York Stock Exchange (“NYSE”) under the stock ticker symbol “FTK”. Prior to this date and since July 27, 2005, our common stock was traded on the American Stock Exchange (“AMEX”) under the stock ticker symbol “FTK”. Prior to this date, our common stock was traded on the OTC Bulletin Board under the stock ticker symbol “FLTK” or “FLTK.OB”. Our website is located at http://www.flotekind.com. We make available free of charge on or through our internet website our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission (“SEC”). Information contained in our website or links contained on our website are not part of this filing. As used herein, “Flotek,” “Company,” “we,” “our” and “us” may refer to Flotek Industries, Inc. and/or its subsidiaries. The use of these terms is not intended to connote any particular corporate status or relationships. Additional information regarding our business segments is presented below and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 (“MD&A”) and in Note 17 of the Notes to our Consolidated Financial Statements in Item 8 (“Note 17”). We sold approximately $208 million, $150 million and $94 million of products and services in the United States for the years ended December 31, 2008, 2007 and 2006, respectively. The remainder of our sales are generated internationally in approximately 20 countries and accounted for approximately 8%, 5% and 7% of our consolidated revenues for each of the last three years, respectively. No single country outside of the United States accounted for more than 10% of our total revenues in any of the past three years.

Historical Developments

Flotek was originally incorporated under the laws of the Province of British Columbia on May 17, 1985. On October 23, 2001, we approved a change in our corporate domicile to the state of Delaware and a reverse stock split of 120 to 1. On October 31, 2001, we completed a reverse merger with CESI Chemical, Inc. (“CESI”). Since that date, we have grown through a series of acquisitions.

Description of Operations

Our business is organized into three strategic business units or segments: Chemicals and Logistics, Drilling Products and Artificial Lift. Each segment is managed independently, offers various products and services and requires different technology and marketing strategies. All three segments market products domestically and internationally.

Chemicals and Logistics

The chemical business offers a full spectrum of oil gas field specialty chemicals used for drilling, cementing, stimulation, and production designed to maximize recovery from both new and mature fields. Our specialty chemicals, with enhanced performance characteristics are manufactured to withstand a wide range of downhole pressures, temperatures and other well-specific conditions, are key to the success of this business segment. We operate two laboratories, a technical services laboratory and a research and development laboratory, which focus

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on design, development and testing of new chemical formulations and enhancement of existing products, often in cooperation with our customers.

Our logistics business designs, project manages and operates automated bulk material handling and loading facilities for oilfield service companies. These bulk facilities handle oilfield products, including sand and other materials for well-fracturing operations, dry cement and additives for oil and gas well cementing, and supplies and materials used in oilfield operations, which we blend to customer specification.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included it in the results of this segment from the date of acquisition:

• acquired Sooner Energy Services, Inc. (“Sooner”) which develops, produces and distributes specialty chemical products and services for drilling and production of natural gas, on August 31, 2007.

Annual revenues for this segment totaled approximately $109 million, $86 million and $51 million in 2008, 2007 and 2006, respectively. Our proprietary biodegradable “green” chemicals sales amounted to $77 million, $56 million and $26 million for the years ended December 31, 2008, 2007 and 2006, respectively. These sales increased 37% in 2008 from the 2007 period and 115% in 2007 from the 2006 period.

Drilling Products

We are a leading provider of downhole drilling tools used in the oilfield, mining, water-well and industrial drilling sectors. We manufacture, sell, rent and inspect specialized equipment for use in drilling, completion, production and workover activities. Through internal growth and acquisitions, we have increased the size and breadth of our rental tool inventory and geographic scope of operations so that we now conduct tool rental operations throughout the United States and in select international markets. Our rental tools include stabilizers, drill collars, reamers, wipers, jars, shock subs, wireless survey, measurement while drilling (“MWD”) tools and mud-motors, while equipment sold includes centralizers and drill bits. We focus our product marketing efforts primarily in the Gulf of Mexico, Mid-Continent and Rocky Mountain regions of the United States, with international sales currently conducted through third party agents and employees.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included them in the results of this segment from their respective dates of acquisition:

• acquired the assets of Can-Ok Oil Field Services, Inc. and Stabilizer Technology, Inc. (collectively “Can-Ok”), a downhole oilfield tool company located in Chickasha, Oklahoma on January 2, 2006,

• acquired the assets of Triumph Drilling Tools (“Triumph”), a downhole tool company with rental, inspection and manufacturing operations throughout the Gulf Coast and Mid-Continent regions, on January 4, 2007,

• acquired a 50% partnership interest in CAVO Drilling Motors Ltd Co. (“CAVO”) on January 31, 2007, a downhole mud-motor company with domestic rental and international sales operations and acquired the remaining 50% partnership interest in CAVO on November 15, 2007, and

• acquired the assets of Teledrift Inc. (“Teledrift”), which designs and manufactures wireless survey and MWD tools, on February 14, 2008.

Annual revenues for this segment totaled approximately $98 million, $57 million and $37 million in 2008, 2007 and 2006, respectively.

In 2008, we introduced the Teleshot, an all electronic wire-line drift indicator, that is capable of taking multiple surveys per run and incorporates the ability to download quickly the information. We provide the Teleshot to our

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customers through direct sales or on a rental basis. The TelePulse fully steerable MWD system, featuring proprietary state-of-the-art surface software, is expected to be completed with all field-testing and released for production in the second half of 2009. The Telepulse will offer a positive pulse system with a gamma sensor module that will allow directional drilling companies to maintain integrity of their technical requirements. Additionally, we intend to combine our rental efforts with the CAVO downhole motor in order to provide us with an opportunity to increase our presence in the offshore market both domestically and internationally.

Artificial Lift

We provide pumping system components, including electric submersible pumps, or ESPs, gas separators, production valves and services. Our products address the needs of coal bed methane and traditional oil and gas production to efficiently move gas, oil and other fluids from the producing horizon to the surface. Several of our artificial lift products employ unique technologies to improve well performance. Our patented Petrovalve product optimizes pumping efficiency in horizontal completions, heavy oil and wells with high gas to liquids ratios. This unique valve can be placed horizontally, results in increased flow per stroke, and eliminates gas locking by replacing the traditional ball and seat valve that requires more maintenance. Furthermore, our patented gas separation technology is particularly applicable for coal bed methane production as it efficiently separates gas and water downhole, ensuring solution gas is not lost in water production. Because gas is separated downhole, it reduces the environmental impact of escaped gas at the surface. The majority of our products for Artificial Lift are manufactured in China, assembled domestically and distributed globally.

During the periods covered by this report, we consummated the following transactions related to this business segment and have included them in the results of this segment from their respective dates of acquisition:

• acquired the tangible assets and licensed the rights to exercise the exclusive worldwide rights to a patented gas separator used in coal bed methane production in the Powder River Basin from Total Well Solutions, LLC. (“TWS”) on April 3, 2006 and

• acquired the assets of LifTech, LLC (“LifTech”) which markets and services electric submersible pumps and downhole gas/water separators primarily to coal bed methane gas producers in the Powder River Basin on June 6, 2006.

Annual revenues for this segment totaled approximately $18 million, $15 million and $13 million in 2008, 2007 and 2006, respectively.

Seasonality

On an overall basis, our operations are not generally affected by seasonality. Certain working capital components may build and recede during the year reflecting established selling cycles and business cycles can impact our operations and financial position when compared to other periods, but we do not consider our operations to be highly-seasonal. Additionally, weather and natural phenomena can temporarily affect the performance of our services. Examples of how such phenomena can impact our business include:

• the severity and duration of the winter in North America can have a significant impact on gas storage levels and drilling activity for natural gas;

• the timing and duration of the spring thaw in Canada directly affects activity levels due to road restrictions;

• hurricanes can disrupt coastal and offshore operations.

In addition, historically due to higher spending near the end of the year by our customers, the results of operations of the Chemical and Logistics segment are generally stronger in the fourth quarter of the year than at

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the beginning of the year. Also, historically the results of operations of our Artificial Lift segment are generally weaker in the second quarter due to restrictions on drilling on federal lands because of the breeding season of certain bird species.

Product Demand and Marketing

The demand for our products and services is generally correlated to the level of oil and gas drilling activity, work-over activity and gas production levels, both in the United States and internationally. We market our products primarily through direct sales to our customers through sales employees with the assistance of operations and Company management. We have established customer relationships which provide for repeat sales in all of our segments. The majority of our marketing is currently conducted within the United States. Internationally, we operate primarily through agents in Canada, Mexico, Central and South America, the Middle East, Asia and Russia.

Customers

The customers for our products and services include major integrated oil and natural gas companies, independent oil and natural gas companies, pressure pumping service companies and state-owned national oil companies. One of our customers accounted for 12% of our consolidated revenues for each of the years ended December 31, 2008 and 2007. No single customer accounted for more than 10% of our consolidated revenues in the year ended December 31, 2006. Our top five customers accounted for 34% of our consolidated revenues for each of the years ended December 31, 2008 and 2007 and 30% of consolidated revenue for the year ended December 31, 2006.

The majority of the sales to our top five customers were in the Chemicals and Logistics segment and collectively accounted for approximately 63%, 52% and 47% of revenue for this segment for the years ended December 31, 2008, 2007 and 2006, respectively. Our top three customers accounted for 25%, 15% and 12% of the segment’s revenue for the year ended December 31, 2008, respectively. In 2007, these companies accounted for 21%, 14% and 10% of segment revenue, respectively, while in fiscal 2006 these companies accounted for 11%, 15% and 14% of segment revenue, respectively.

Two of our top customers also make purchases for another one of our top customers as part of their normal business operations. We cannot quantify the magnitude of purchases made by one of our customers on behalf of another entity. While these three customers are not under common control nor are they affiliates of each other or Flotek, combined they accounted for 40%, 38% and 28% of segment revenue for the years ended December 31, 2008, 2007 and 2006 respectively. A loss of this combined customer group would negatively impact the Company’s operating results.

One customer, accounted for 56%, 53% and 43% of the Artificial Lift segment revenue for the years ended December 31, 2008, 2007 and 2006, respectively.

None of these customers were a related party or affiliate of Flotek during any of the years ended December 31, 2008, 2007 or 2006.

Research and Development

We are engaged in research and development activities directed primarily toward the improvement of existing products and services, the design of specialized products to meet customer needs and the development of new products, processes and services. We incurred $1.9 million, $0.8 million and $0.7 million in research and development expenses for the years ended December 31, 2008, 2007 and 2006, respectively. In 2008, our research and development spending was approximately 1% of consolidated revenues. It is our intention to maintain Flotek’s future research and development investment at approximately 1% of consolidated revenues.

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Backlog

Due to the nature of our business and contracts with our customers, we do not experience any significant amount of backlog orders.

Intellectual Property

We have followed a policy of seeking patent protection both within and outside the United States for products and methods that appear to have commercial significance and qualify for patent protection. The decision to seek patent protection depends on whether such protection can be obtained on a cost-effective basis and is likely to be effective in protecting our commercial interests. We believe our patents and trademarks, together with our trade secrets and proprietary design, manufacturing and operational expertise, are reasonably adequate to protect our intellectual property and provide for the continued operation of our business. We maintain patents on our production valve design, casing centralizer design, and trade secrets and pending patents on certain specialty chemicals.

Competition

Our ability to compete in the oilfield services market is dependent on our ability to differentiate our products and services, provide superior quality and service, and maintain a competitive cost structure. Activity levels in our three segments are driven primarily by current and expected commodity prices, drilling rig count, oil and gas production levels, and customer capital spending allocated for drilling and production. The regions in which we operate are highly competitive. The competitive environment has intensified as recent mergers among oil and gas companies have reduced the number of available customers. Additionally, the recent downturn in the economy and commodity prices have caused the market for our services and that of our competitors, which may vary significantly by geographical region, to contract. Many other oil and gas service companies are larger than we are and have greater resources than we have. These competitors may be better able to withstand industry downturns, compete on the basis of price and acquire new equipment and technologies, all of which could affect our revenue and profitability. These competitors compete with us both for customers and for acquisitions of other businesses. This competition may cause our business to suffer. We believe that competition for contracts and margins will continue to be intense in the foreseeable future.

Raw Materials

The Company believes that materials and components used in its servicing and manufacturing operations and purchased for sales are generally available on the open market and from multiple sources, although collection and transportation of these raw materials to the Company’s facilities can be adversely affected by extreme weather conditions. However, certain raw materials used by the Chemical and Logistics segment in the manufacture of our proprietary, ‘green’ chemical sales are available from limited sources and disruptions to our suppliers could materially impact our sales. The prices paid by the Company for its raw materials may be affected by, among other things, energy, steel and other commodity prices; tariffs and duties on imported materials; foreign currency exchange rates; the general business cycle and global demand. The Company experienced greater difficulty in securing the necessary supplies of certain chemicals in 2008 than it experienced during the preceding several years. During 2008, the prices of many raw materials rose considerably above our forecast, but we began to see prices decline towards the end of 2008. Higher prices and lower availability of chemicals, steel and other raw materials the Company uses in its business may adversely impact future period sales and margins. The Drilling Products and Artificial Lift segments purchase their principal raw material and steel on the open market. Except for a few chemical additives, the raw materials are available in most cases from several suppliers at market prices. Where we can, we use multiple suppliers, both domestically and internationally, for our key raw materials purchases.

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We also maintain a three to six month supply of key mud-motor inventory parts that are primarily sourced from China as well as an equivalent amount of stock of parts within our Artificial Lift segment. This inventory stock position approximates the lead time required to secure these parts in order to avoid disruption of service to our customers.

Government Regulations

We are subject to federal, state and local environmental and occupational safety and health laws and regulations in the United States and other countries in which we do business. We are subject to numerous environmental, legal, and regulatory requirements related to our operations worldwide. We strive to comply fully with these requirements and are not aware of any material instances of noncompliance. In the United States, these laws and regulations include, among others:

• the Comprehensive Environmental Response, Compensation and Liability Act;

• the Resource Conservation and Recovery Act;

• the Clean Air Act;

• the Federal Water Pollution Control Act; and

• the Toxic Substances Control Act.

In addition to the federal laws and regulations, states and other countries where we do business may have numerous environmental, legal, and regulatory requirements by which we must abide. We evaluate and address the environmental impact of our operations by assessing and remediating contaminated properties in order to avoid future liabilities and comply with environmental, legal, and regulatory requirements. Many of the products within our Chemicals and Logistics segment are considered hazardous or flammable. If a leak or spill occurs in connection with our operations, we could incur material costs, net of insurance, to remediate any resulting contamination. On occasion, we are involved in specific environmental litigation and claims, including the remediation of properties we own or have operated, as well as efforts to meet or correct compliance-related matters. We do not expect costs related to these remediation requirements to have a material adverse effect on our consolidated financial position or our results of operations.

Employees

As of January 30, 2009, we had approximately 500 employees worldwide, with approximately 15 employed as part-time workers. None of our employees are covered by collective bargaining agreements and our labor relations are generally good. In certain international locations, changes in staffing or work arrangements may need approval of local works councils or other bodies.

Available Information

We maintain a web site at www.flotekind.com. We make available, free of charge, on the “Investor Relations” section of our web site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file or furnish such materials to the SEC. Additionally, our corporate governance materials, including governance guidelines; the charters of the Audit, Compensation, and Governance and Nominating Committees; and the code of conduct may also be found under the “Investor Relations” section of our web site at www.flotekind.com. A copy of the foregoing corporate governance materials is available upon written request.

You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549. You may obtain information regarding the Public Reference Room by calling the

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SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at www.sec.gov that contains reports and other information regarding registrants that file electronically with the SEC, including us.

We submitted our 2008 annual Section 12(a) CEO certification with the New York Stock Exchange (“NYSE”) on March 16, 2009. The certification was not qualified in any respect. Additionally, we filed with this Form 10-K the CEO and CFO certifications required under Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Information with respect to our executive officers and directors is incorporated herein by reference to information included in the Proxy Statement for our 2008 Annual Meeting of Shareholders.

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