ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information regarding the results of operations for the three and nine
months ended September 30, 2018 and 2017, and our financial condition, liquidity and capital resources as of September 30, 2018, and December 31, 2017. The financial statements and the notes thereto contain detailed information that should be referred to in conjunction with this discussion.
Forward
-Looking Statements
The information discussed in this Quarterly Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). All statements, other than statements of historical facts, included herein concerning, among other things, planned capital expenditures, future cash flows and borrowings, pursuit of potential acquisition opportunities, our financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. These forward-looking statements are identified by their use of terms and phrases such as “may,” “expect,” “estimate,” “project,” “plan,” “believe,” “intend,” “achievable,” “anticipate,” “will,” “continue,” “potential,” “should,” “could,” and similar terms and phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties. Our results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, among others:
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●
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Our capital requirements and the uncertainty of being able to obtain additional funding on terms acceptable to us;
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●
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The financial constraints imposed as a result of our indebtedness, including restrictions imposed on us under the terms of our credit facility agreement and our need to generate sufficient cash flows to repay our debt obligations;
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●
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The volatility of domestic and international oil and natural gas prices and the resulting impact on production and drilling activity, and the effect that lower prices may have on our customers
’ demand for our services, the result of which may adversely impact our revenues and financial performance;
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The broad geographical diversity of our operations which, while expected to diversify the risks related to a slow-down in one area of operations, also adds to our costs of doing business;
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Our history of losses and working capital deficits which, at times, were significant;
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Adverse weather and environmental conditions;
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Our reliance on a limited number of customers;
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Our ability to retain key members of our senior management and key technical employees;
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The potential impact of environmental, health and safety, and other governmental regulations, and of current or pending legislation with which we and our customers must comply;
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Developments in the global economy;
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The effects of competition;
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The risks associated with the use of intellectual property that may be claimed by others and actual or potential litigation related thereto;
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The effect of unseasonably warm weather during winter months; and
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The effect of further sales or issuances of our common stock and the price and volume volatility of our common stock.
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Finally, our future results will depend upon various other risks and uncertainties, including, but not limited to, those detailed in our filings with the SEC. For additional information regarding risks and uncertainties, please read our filings with the SEC under the Exchange Act and the Securities Act, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this paragraph and elsewhere in this Quarterly Report. Other than as required under securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.
OVERVIEW
The Company, through its subsidiaries, provides the following services to the domestic onshore oil and natural gas industry – (i) frac water heating, hot oiling and acidizing (well enhancement services); (ii) water transfer and water treatment services (water transfer services); and (iii) water hauling, fluid disposal, frac tank rental (water hauling services). The Company owns and operates through its subsidiaries a fleet of more than
630
specialized trucks, trailers, frac tanks and other well-site related equipment and serves customers in several major domestic oil and gas areas including the DJ Basin/Niobrara area in Colorado, the Bakken area in North Dakota, the Marcellus and Utica Shale areas in Pennsylvania and Ohio, the Jonah area, Green River and Powder River Basins in Wyoming, the Eagle Ford Shale and Austin Chalk in Texas and the Mississippi Lime, Scoop/Stack, and Hugoton areas in Kansas and Oklahoma.
RESULTS OF OPERATIONS
Executive Summary
The nine months ended September 30, 2018 featured fairly stable commodity prices and increased demand for our services compared to the like period in 2017. Overall demand for our services increased due to improved industry conditions in several of our heating markets compared to the same period in 2017. In addition, we increased services for our five largest customers and expanded our frac water heating business. Factors for our increased services include fairly stable crude oil prices which led to increased activity by our customers. Despite the increase in revenue, we experienced various increases in costs (in certain cases, not related to the increase in activity) that negatively impacted our profitability. Subsequent to September 30, 2018, we completed the acquisition of Adler Hot Oil Service, LLC ("Adler"), which we believe will solidify our position among our competitors for our primary service offerings, and increase the scope and breadth of our service offerings for leading exploration and production companies operating in the basins we serve.
Revenues for the nine months ended September 30, 2018 increased approximately $7.8 million, or 29%, from the comparable period last year due to a 35% increase in our core well enhancement revenue. Higher frac water heating revenues in our Rocky Mountain region, improved demand for hot oil services in the Bakken, and continued expansion of hot oiling and acidizing services in the Eagle Ford all contributed to the increase in well enhancement revenues. Water transfer revenues for the nine months ended September 30, 2018 were approximately $702,000, or 38% higher than the comparable period last year due to continued expansion of services.
For the nine-month period ended September 30, 2018, segment profits increased by approximately $2.0 million, due primarily to an increase in revenue from our core well enhancement services. Sales, general & administrative expenses increased by approximately $380,000 for the nine months ended September 30, 2018, compared to the same period in 2017, due primarily to an increase in personnel costs at the corporate level and additional costs related to the business development team. Interest expense for the nine months ended September 30, 2018 decreased approximately $327,000 from the first nine months of 2017 primarily due to accelerated amortization of deferred financing costs in the nine months ended September 30, 2017 which in turn was due to the accelerated maturity date on our previous revolving credit facility.
For the nine months ended September 30, 2018, the Company recognized net loss of approximately $5.3 million or ($0.10) per share compared to a net loss of approximately $5.0 million or ($0.10) per share in 2017 primarily due to the factors above.
Adjusted EBITDA for the nine months ended September 30, 2018 was approximately $2.3 million, compared to approximately $959,000 for the comparable period in 2017. See the section titled
Adjusted EBITDA*
within this Item for definition of Adjusted EBITDA.
Industry Overview
During 2018, improved commodity prices and an increase in active rigs in North America resulted in an increase in production and completion activities by our customers, which led to an increase in demand for our services. We believe current activity levels should support continued modest improvement in both metrics. The Company has reacted to increases in demand by allocating resources to our most active customers and basins, as we continue to focus on increasing utilization levels and optimizing the deployment of our equipment and workforce, and maintaining a high service quality and safety record. The market recovery has also allowed us to compete on the basis of the quality and breadth of our service offerings.
Crude oil prices and the North American rig count have increased since the low points in early 2016. The United States rig count bottomed out at approximately 400 in the spring of 2016 and increased to approximately 1,054 as of September 30, 2018, which resulted in increased operations and revenues for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.
Segment Overview
Enservco’s reportable business segments are Well Enhancement Services, Water Transfer Services, and Water Hauling Services. These segments have been selected based on management’s resource allocations and performance assessment in making decisions regarding Enservco.
The following is a description of the segments:
Well Enhancement Services: This segment utilizes a fleet of frac water heating units, hot oil trucks and acidizing units to provide well enhancement and completion services to the domestic oil and gas industry. These services include frac water heating, hot oil services, pressure testing, and acidizing services.
Water Transfer Services: This segment utilizes high and low volume pumps, lay flat hose, aluminum pipe and manifolds and related equipment to move fresh and/or recycled water from a water source such as a pond, lake, river, stream, or water storage facility to frac tanks at drilling locations to be used in connection with well completion activities.
Water Hauling Services: This segment utilizes a fleet of trucks and related assets, including specialized tank trucks, vacuum trailers, storage tanks, and disposal facilities to provide various water hauling services. These services are primarily provided by Dillco in the Hugoton area in Kansas and Oklahoma. On October 29, 2018, Enservco announced that it would be selling or closing the Dillco water hauling business, its associated facilities, and real estate.
Segment Results
:
The following tables set forth revenue from operations and segment profits for the Company
’s business segments for the three and nine months ended September 30, 2018 and 2017 (in thousands):
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Well enhancement services
|
|
$
|
3,200
|
|
|
$
|
4,033
|
|
|
$
|
29,490
|
|
|
$
|
21,836
|
|
Water transfer services
|
|
|
634
|
|
|
|
798
|
|
|
|
2,558
|
|
|
|
1,856
|
|
Water hauling services
|
|
|
638
|
|
|
|
911
|
|
|
|
2,337
|
|
|
|
2,677
|
|
Unallocated and other
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
254
|
|
Total Revenues
|
|
$
|
4,472
|
|
|
$
|
5,742
|
|
|
$
|
34,385
|
|
|
$
|
26,623
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
SEGMENT PROFIT:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Well enhancement services
|
|
$
|
(746
|
)
|
|
$
|
(129
|
)
|
|
$
|
6,553
|
|
|
$
|
4,900
|
|
Water transfer services
|
|
|
(16
|
)
|
|
|
(24
|
)
|
|
|
(28
|
)
|
|
|
(258
|
)
|
Water hauling services
|
|
|
(95
|
)
|
|
|
110
|
|
|
|
(297
|
)
|
|
|
(229
|
)
|
Unallocated and other
|
|
|
(141
|
)
|
|
|
(216
|
)
|
|
|
(467
|
)
|
|
|
(603
|
)
|
Total Segment Profit
|
|
$
|
(998
|
)
|
|
$
|
(259
|
)
|
|
$
|
5,761
|
|
|
$
|
3,810
|
|
Well Enhancement Services
Well Enhancement Services
, which accounted for
72
% of total revenues for the three months ended September 30, 2018,
decreased $833,000, or 21%, to $3.2 million compared to $4.0 million for the three months ended September 30, 2017. This segment
, which accounted for
86
% of total segment revenues for the nine months ended September 30, 2018,
and its revenues increased $7.7 million, or 35%, to $29.5 million compared to $21.8 million for the nine months ended September 30, 2017. For the three month period, a significant amount of rainfall in South Texas negatively impacted our revenue and segment profit results. For the nine month period, increased demand for services due to improved industry conditions led to increased activity with our customer base.
Frac water heating revenues decreased for the three months ended September 30, 2018 by $93,000, or 65%, to $49,000 compared to $142,000 for the three months ended September 30, 2017. Frac water heating revenues increased for the nine months ended September 30, 2018 by $6.8 million, or 63%, to $17.7 million compared to $10.8 million for the nine months ended September 30, 2017. The third quarter is historically the weakest quarter for this service line, which depends on colder temperatures more than our other service offerings. For the nine months ended September 30, 2018, improved industry conditions including relatively stable commodity prices and increased drilling rig activity increased demand for our services. Particularly strong gains occurred from the Marcellus Shale and Utica Shale formations in Pennsylvania, due to increased activity and colder temperatures as well as general industry activity in the region.
Hot oil revenues for the three months ended
September 30, 2018 decreased approximately
$205,000, or 8%, to $2.2 million compared to $2.4 million for the three months ended September 30, 2017. Hot oil revenues for the nine months ended September 30, 2018 increased approximately $628,000, or 8%, to $8.7 million from $8.1 million compared to $8.0 million for the nine months ended September 30, 2017. Results during the three months ended September 30, 2018 were impacted by significant rainfall in South Texas. Hot oil service revenues from our expansion of service in the Eagle Ford combined with increased revenues in the DJ Basin and North Dakota due to improved commodity prices were the primary reasons for the increases in revenue in the nine months ended September 30, 2018, over last year.
Acidizing revenues for the three months ended September 30, 2018 decreased by approximately $203,000, or 25%, due to delays in establishing a presence in new markets, following a reallocation of our equipment out of certain basins where we believe demand was waning. Acidizing revenues for the nine months ended September 30, 2018 increased by approximately $385,000, or 19%, due to an overall increase in demand for service work, in addition to our performing several large individual projects for a customer in Texas.
Segment profits for our core well enhancement services decreased by $617,000, to a loss of $746,000 for the three months ended September 30, 2018 compared to a segment loss of approximately $129,000 in
the same period in 2017,
due primarily to a reduction in revenue for the segment described above, and was also negatively impacted by an approximate $267,000 increase is costs related to our previous, partially self-insured employee health insurance plan. The significant majority of this increase related to actual claims costs incurred pursuant to claims covered by our previous insurance company, which resulted in increases in reserve requirements and cash payments by us. Previously, we had deferred a portion of such reserve payments, and incremental claim activity during the three months ended September 30, 2018 caused us to expense a portion of the deferred amount. Segment profits for our core well enhancement services increased by $1.7 million, to a profit of $6.6 million for the nine months ended September 30, 2018 compared to a segment profit of approximately $4.9 million in the same period in 2017, due primarily to increased revenues, as described above, which were achieved without a corresponding increase in our fixed costs, but offset by costs related to the workers compensation claim described above.
Water Transfer Services
For the three months ended September 30, 2018, Water Transfer Services account
ed for 14% of total revenue, and decreased by approximately $164,000, or 21%, to $634,000. The decrease in revenue was attributable to continued challenges in in finding adequate work for our water transfer assets throughout the period. For the nine months ended September 30, 2018, Water Transfer Services accounted for 7% of total revenue, and increased by approximately $702,000, or 38%, to $2.6 million. We consider the water transfer services segment to be an opportunity to grow our business with both new and existing customers and believe it offers opportunity to alleviate the level of seasonality we have historically experienced despite the decrease in revenue experienced quarter over quarter in the third quarter of 2018 versus the third quarter of 2017.
Water Transfer segment loss for the three months ended September 30, 2018 was approximately $16,000, compared to a loss of approximately $24,000 for the comparable period in 2017. Water Transfer segment loss for the nine months ended September 30, 2018 was approximately $28,000, compared to a loss of approximately $258,000 for the comparable period in 2017. The decrease in the loss was due to significantly higher revenues as we obtained new customer projects in 2018 without a corresponding increase in fixed costs.
Water Hauling Services
For the three months ended Septemb
er 30, 2018
, water hauling service revenues decreased approximately $273,000, or 30%, for the nine months ended September 30, 2018, water hauling service revenues decreased approximately $340,000, or 13% primarily due to lower water hauling revenues in our Central USA region due to scaled back service work and the cessation of certain low margin accounts.
Enservco incurred segment loss of approximately $95,000 for the three months ended September 30, 2018 compared to segment profit of approximately $110,000 for the comparable period in 2017. The Company recorded a segment loss of approximately $297,000 for the nine months ended September 30, 2018 compared to segment loss of approximately $229,000 for the comparable period in 2017. The three and nine months ended September 30, 2017 included a $250,000 accrual for costs related to a workers' compensation claim related to an injury sustained by an employee in our water hauling subsidiary. Segment revenues during the three months ended September 30, 2017 were also negatively impacted by heavy rains.
Unallocated and Other
Unallocated and other costs include costs which are not specifically allocated to the business segments above including labor, travel, and operating costs for regional managers and safety compliance with responsibilities for all segments. These costs also include costs relating to our construction services work in 2017, which we no longer consider a reportable segment.
During the three months ended September 30, 2018, unallocated segment costs related to our regional managers decreased by approximately $75,000, or 35%, to approximately $141,000 compared to $216,000 for the comparable period in 2017, primarily due to the reclassification of costs relating to our formal business development efforts from functional support into selling, general and administrative expenses, and from the departure of one of our area managers during 2018. During the nine months ended September 30, 2018, unallocated segment costs related to our regional managers decreased by approximately $136,000, or 23%, to approximately $467,000 compared to $603,000 for the comparable period in 2017 due to the departure of one of our regional managers and the fact that expenses associated with personnel costs related to our sales effort are classified as Sales, general, and administrative expenses in the current year and were classified as functional support in the prior year.
Geographic Areas
The Company
operates solely in the United States, in what it believes are three geographically diverse regions. The following table sets forth revenue from operations for the Company’s three geographic regions during the three and nine months ended September 30, 2018 and 2017 (in thousands):
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
BY GEOGRAPHY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rocky Mountain Region (1)
|
|
$
|
2,049
|
|
|
$
|
2,797
|
|
|
$
|
20,230
|
|
|
$
|
18,011
|
|
Central USA Region (2)
|
|
|
2,236
|
|
|
|
2,665
|
|
|
|
11,012
|
|
|
|
7,935
|
|
Eastern USA Region (3)
|
|
|
187
|
|
|
|
280
|
|
|
|
3,143
|
|
|
|
677
|
|
Total Revenues
|
|
$
|
4,472
|
|
|
$
|
5,742
|
|
|
$
|
34,385
|
|
|
$
|
26,623
|
|
Notes to tables:
|
(1)
|
Includes the D-J Basin/Niobrara field (northeastern Colorado and southeastern Wyoming), the Powder River and Green River Basins (northeastern and southwestern Wyoming), the Bakken area (western North Dakota and eastern Montana). Heat Waves and HWWM operate in this region.
|
|
(2)
|
Includes the Eagle Ford Shale and Austin Chalk (southern Texas) and Mississippi Lime, Hugoton Field, and Scoop/Stack (southwestern Kansas, Oklahoma, and the Texas panhandle). Heat Waves, Dillco, and HWWM operate in this region
|
|
(3)
|
Consists of the southern region of the Marcellus Shale formation (southwestern Pennsylvania and northern West Virginia) and the Utica Shale formation (eastern Ohio). Heat Waves is the only Company subsidiary operating in this region.
|
Revenues in the Rocky Mountain Region decreased approximately $748,000, or 27%, to $2.0 million for the three months ended September 30, 2018 primarily due to personnel turnover in the business development function. Revenues in the Rocky Mountain Region increased approximately $2.2 million, or 12%, to $20.2 million for the nine months ended September 30, 2018. The increase in revenues were primarily driven by an increase in activity in the DJ Basin and Bakken area.
Revenues in the Central USA region for the three months ended September 30, 2018 decreased by approximately $429,000, or 16%, to $2.2 million, compared to the same period in 2017. Revenues in the Central USA region for the nine months ended September 30, 2018 increased by approximately $3.1 million, or 39%, to $11.0 million, compared to the same period in 2017 primarily due to equipment down time related to facilities realignment and associated turnover of hot oiling and acidizing personnel, as well as the impact of two weeks of record rainfall. The increase in revenues was primarily driven by the expansion of our services into the Eagle Ford Shale and Austin Chalk.
Revenues in the
Eastern USA region
decreased approximately $93,000, or 33%, to approximately $187,000 for the three months ended September 30, 2018 compared to the same period in 2017 primarily due to a reduction in services performed for a non-energy customer in 2017. Revenues in the Eastern USA region increased approximately $2.5 million, or 364%, to approximately $3.1 million for the nine months ended September 30, 2018 compared to the same period in 2017. The increase in revenues was driven by increased service work in the Marcellus Basin due to increas
ed activity levels and colder temperatures in 2018.
Historical Seasonality of Revenues
Because of the seasonality of our frac water heating and hot oiling business, revenues generated during the first and fourth quarters of our fiscal year, covering the months during our “heating season”, are significantly higher than our revenues during the second and third quarters of our fiscal year. In addition, the revenue mix of our service offerings also changes outside our heating season as our Well Enhancement services (which includes frac water heating and hot oiling) typically decrease as a percentage of total revenues which are in higher demand in the colder winter months, Water Transfer and
Water Hauling services and other services increase. Thus, the revenues recognized in our quarterly financial statements in any given period are not indicative of the annual or quarterly revenues through the remainder of that fiscal year.
As an indication of this quarter-to-quarter seasonality, the Company generated 69% of its 2017 revenues during the first and fourth quarters compared to 31% during the second and third quarters of 2017.
Sales, General, and Administrative Expenses:
During the three months ended September 30, 2018, sales, general, and administrative expenses increased approximately $53,000, or 5% to $1.2 million compared to the same period in 2017 primarily due to an increase related to our business development team partially offset by a reduction in stock compensation expense. During the nine months ended September 30, 2018, sales, general, and administrative expenses increased approximately $380,000, or 11% to $3.8 million compared to $3.4 million in the same period in 2017, primarily due to increased personnel costs related to the buildout of the Company's business development team, partially offset by a decrease in stock compensation expense.
Patent Litigation and Defense Costs:
Patent litigation and defense costs decreased to $2,000 from $29,000 for the three months ended September 30, 2018. Patent litigation and defense costs decreased to $77,000 from $96,000 for the nine months ended September 30, 2018. As discussed in Part II, Item 1. – Legal Proceedings, the U.S. District Court for the District of Colorado issued a decision on July 20, 2015 to stay the Company’s case with HOTF pending an appeal of a 2015 judgment by a North Dakota Court invalidating the ‘993 Patent. In July of 2018, HOTF requested that the Federal Circuit reconsider its May 4, 2018 judgment. On August 6, 2018 the Federal Circuit Court denied HOTF's request for a rehearing. As a result, litigation and defense costs have been minimal since July 2015.
Enservco and Heat Waves deny that they are infringing any valid, enforceable claim of the asserted HOTF patents, and intend to continue to vigorously defend themselves in the Colorado Case and challenge the validity and/or enforceability of these patents should the lawsuit resume. The Company expects associated legal fees to be minimal going forward until the Colorado Case is resumed. If HOTF does not petition the U.S. Supreme Court, the Colorado Case will re-open and may resume.
Depreciation and Amortization:
Depreciation and amortization expense for the three months e
nded September 30, 2018 decreased $135,000, or 8%, from the same period in 2017 due to equipment becoming fully depreciated. Depreciation and amortization expense for the nine months ended September 30, 2018 decreased $200,000, or 4%, from the same period in 2017 due to equipment becoming fully depreciated.
Income (Loss) from operations:
For the three months ended September 30, 2018, the Company recognized loss from operations of $3.7 million compared to loss from operations of $3.1 million for the comparable period in 2017. For the nine months ended September 30, 2018, the Company recognized loss from operations of $3.4 million compared to a loss from operations of $5.4 million for the comparable period in 2017. The improvement of $2.0 million was primarily due to a $2.0 million increase in segment profits, partially offset by the increase in Sales, General, and Administrative Expenses.
Interest Expense:
Interest expense decreased approximately $128,000, or 21%, for the three months ended September 30, 2018, compared to the same period in 2017. Interest expense for the nine months ended September 30, 2018 decreased approximately $327,000 primarily due to $255,000 of accelerated amortization expense of debt issuance costs during the nine months ended September 30, 2017 related to the reduction in term of the PNC credit facility. Interest expense for the nine months ended September 30, 2018 included the acceleration of subordinated debt discount of approximately $48,000 related to a paydown of a portion of the subordinated debt balance.
Other expense (income):
Other income for the three months ended September 30, 2018 was approximately $38,000 compared with other expense of approximately $264,000 for the same period in 2017. The decrease was primarily driven by losses recognized on the change in fair value of our now-retired warrant liability, while 2018 was mostly comprised of an increase in the fair value of our interest rate swap. Other expense of approximately $467,000 during the nine months ended September 30, 2018 was comprised of the loss on the fair value of our now-retired warrant liability partially offset by an increase in the fair value of our derivative swap instrument and other income. Other expense of approximately $222,000 during the nine months ended September 30, 2017 was mostly comprised of the unrealized loss on the warrant liability.
Income Taxes:
As of December 31, 2017, the Company had recorded a full valuation allowance on a net deferred tax asset of $1.5 million. Our income tax provision of $420,000 for the nine months ended September 30, 2018 reduced the gross amount of the deferred tax asset and we reduced the valuation allowance by a like amount which resulted in a net tax provision of zero. During the nine months ended September 30, 2017, the Company recorded an income tax benefit of approximately $2.4 million. Our effective tax rate was approximately 0% for the nine months ended September 30, 2018, and 33% for the nine months ended September 30, 2017, respectively. Our effective tax expense in 2017 approximates the federal statutory rate at the time of the filing of our Form 10-Q for the three and nine months ended September 30, 2017.
Adjusted EBITDA*
Management believes that, for the reasons set forth below, Adjusted EBITDA (a non-GAAP measure) is a valuable measurement of the Company's liquidity and performance and is consistent with the measurements offered by other companies in Enservco's industry.
The following table presents a reconciliation of our net income to our Adjusted EBITDA for each of the periods indicated (in thousands):
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Adjusted EBITDA*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
(4,108
|
)
|
|
$
|
(2,509
|
)
|
|
$
|
(5,349
|
)
|
|
$
|
(4,986
|
)
|
Add Back (Deduct)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
471
|
|
|
|
599
|
|
|
|
1,482
|
|
|
|
1,809
|
|
Provision for income tax (benefit) expense
|
|
|
-
|
|
|
|
(1,415
|
)
|
|
|
32
|
|
|
|
(2,407
|
)
|
Depreciation and amortization
|
|
|
1,483
|
|
|
|
1,618
|
|
|
|
4,669
|
|
|
|
4,869
|
|
EBITDA*
|
|
|
(2,154
|
)
|
|
|
(1,707
|
)
|
|
|
834
|
|
|
|
(715
|
)
|
Add back (Deduct)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
103
|
|
|
|
126
|
|
|
|
291
|
|
|
|
572
|
|
Patent litigation and defense costs
|
|
|
2
|
|
|
|
29
|
|
|
|
77
|
|
|
|
96
|
|
Severance and transition costs
|
|
|
-
|
|
|
|
16
|
|
|
|
633
|
|
|
|
784
|
|
(Gain) on disposal of equipment
|
|
|
-
|
|
|
|
-
|
|
|
|
(53
|
)
|
|
|
-
|
|
Acquisition-related expenses
|
|
|
38
|
|
|
|
-
|
|
|
|
38
|
|
|
|
-
|
|
Other (income) expense
|
|
|
(38
|
)
|
|
|
264
|
|
|
|
467
|
|
|
|
222
|
|
Adjusted EBITDA*
|
|
$
|
(2,049
|
)
|
|
$
|
(1,272
|
)
|
|
$
|
2,287
|
|
|
$
|
959
|
|
*Note: See below for discussion of the use of non-GAAP financial measurements.
Use of Non-GAAP Financial Measures:
Non-GAAP results are presented only as a supplement to the financial statements and for use within management’s discussion and analysis based on U.S. generally accepted accounting principles (GAAP). The non-GAAP financial information is provided to enhance the reader's understanding of the Company’s financial performance, but no non-GAAP measure should be considered in isolation or as a substitute for financial measures calculated in accordance with GAAP. Reconciliations of the most directly comparable GAAP measures to non-GAAP measures are provided herein.
EBITDA is defined as net income (earnings), before interest expense, income taxes, and depreciation and amortization.
Adjusted EBITDA excludes stock-based compensation from EBITDA and, when appropriate, other items that management does not utilize in assessing the Company’s ongoing operating performance as set forth in the next paragraph. None of these non-GAAP financial measures are recognized terms under GAAP and do not purport to be an alternative to net income as an indicator of operating performance or any other GAAP measure.
All of the items included in the reconciliation from net income to EBITDA and from EBITDA to Adjusted EBITDA are either (i) non-cash items (e.g., depreciation, amortization of purchased intangibles, stock-based compensation, warrants issued, etc.) or (ii) items that management does not consider to be useful in assessing the Company’s ongoing operating performance (e.g., income taxes, severance and transition costs related to the executive management team, gain on sale of investments, loss on disposal of assets, patent litigation and defense costs, other expense (income), etc.). In the case of the non-cash items, management believes that investors can better assess the Company’s operating performance if the measures are presented without such items because, unlike cash expenses, these adjustments do not affect the Company’s ability to generate free cash flow or invest in its business.
We use, and we believe investors benefit from the presentation of, EBITDA and Adjusted EBITDA in evaluating our operating performance because it provides us and our investors with an additional tool to compare our operating performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our core operations. We believe that EBITDA is useful to investors and other external users of our financial statements in evaluating our operating performance because EBITDA is widely used by investors to measure a company
’s operating performance without regard to items such as interest expense, taxes, and depreciation and amortization, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired. Additionally, our fixed charge coverage ratio covenant associated with our 2017 Credit Agreement requires the use of Adjusted EBITDA in specific calculations.
Because not all companies use identical calculations, the Company’s presentation of non-GAAP financial measures may not be comparable to other similarly titled measures of other companies. However, these measures can still be useful in evaluating the Company’s performance against its peer companies because management believes the measures provide users with valuable insight into key components of GAAP financial disclosures.
Changes in Adjusted EBITDA*
Adjusted EBITDA for the three months ended September 30, 2018 decreased by approximately $777,000 due primarily to various increases in costs (in certain cases, not related to the increase in activity) that had a negative impact on our profitability. Adjusted EBITDA for the nine months ended September 30, 2018 increased by approximately $1.3 million, due primarily to the increase in segment profits from well enhancement and water transfer services partially offset by the increase in sales, general, and administrative expenses discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Update
As described in more detail in Note 4 to our financial statements included in “Item 1. Financial Statements” of this report, on August 10, 2017, we entered into the 2017 Credit Agreement with East West Bank (the "New Credit Facility") which provides for a three-year $30 million senior secured revolving credit facility, to replace the Prior Credit Facility provided under the 2014 Credit Agreement with PNC.
As of September 30, 2018, we were in compliance with all covenants contained in the 2017 Credit Agreement.
The following table summarizes our statements of cash flows for the nine months ended September 30, 2018 and 2017 (in thousands):
|
|
For the Nine
Months Ended
September 30
,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
Net cash
provided by (used in) operating activities
|
|
$
|
5,664
|
|
|
$
|
(552
|
)
|
Net cash used in investing activities
|
|
|
(1,363
|
)
|
|
|
(1,163
|
)
|
Net cash (used in) provided by financing activities
|
|
|
(4,653
|
)
|
|
|
1,574
|
|
Net Decrease in Cash and Cash Equivalents
|
|
|
(352
|
)
|
|
|
(141
|
)
|
|
|
|
|
|
|
|
|
|
Cash and Cash Equivalents, Beginning of Period
|
|
|
391
|
|
|
|
621
|
|
|
|
|
|
|
|
|
|
|
Cash and Cash Equivalents, End of Period
|
|
$
|
39
|
|
|
$
|
480
|
|
The following table sets forth a summary of certain aspects of our balance sheet at
September 30, 2018 and December 31, 2017:
|
|
September 30
,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
|
|
Current Assets
|
|
$
|
4,730
|
|
|
$
|
13,653
|
|
Total Assets
|
|
$
|
31,809
|
|
|
$
|
44,250
|
|
Current Liabilities
|
|
$
|
2,159
|
|
|
$
|
5,647
|
|
Total Liabilities
|
|
$
|
26,792
|
|
|
$
|
36,025
|
|
|
|
|
|
|
|
$
|
|
|
Stockholders
’ Equity
|
|
$
|
5,017
|
|
|
$
|
8,225
|
|
|
|
|
|
|
|
|
|
|
Working Capital (Current Assets net of Current Liabilities)
|
|
$
|
2,571
|
|
|
$
|
8,006
|
|
Overview:
We have relied on cash flow from operations, borrowings under our revolving credit agreements, and equity and debt offerings to satisfy our liquidity needs. Our ability to fund operating cash flow shortfalls, fund capital expenditures, and make acquisitions will depend upon our future operating performance and on the availability of equity and debt financing. At
September 30, 2018
, we had approximately $39,000 in cash and cash equivalents and approximately $2.8 million available under the New Credit Facility. Our capital requirements over the next 12 months are anticipated to include, but are not limited to, operating expenses, debt servicing, and capital expenditures including maintenance of our existing fleet of assets.
As of September 30, 2018, we had an outstanding principal loan balance under the 2017 Credit Agreement of approximately $22.6 million with a weighted average interest rate of 5.70% per year for $21.5 million of outstanding LIBOR Rate borrowings (which includes the effect of our interest rate swap agreement described below) and 7.0% per year for the approximately $1.1 of outstanding Prime Rate borrowings.
The 2017 Credit Agreement allows us to borrow up
to 85% of our eligible receivables and up to 85
% of the appraised value of our eligible equipment.
On March 31, 2017, our largest shareholder, Cross River Partners, L.P., posted a letter of credit in the amount of $1.5 million in accordance with the terms of the Tenth Amendment to the 2014 Credit Agreement. The letter of credit was converted into subordinated debt with a maturity date of June 28, 2022 with a stated interest rate of 10% per annum and a five-year warrant to purchase 967,741 shares of our common stock at an exercise price of $0.31 per share. On May 10, 2017, Cross River Partners, L.P. also provided $1 million in subordinated debt to us as required under the terms of the Tenth Amendment to the 2014 Credit Agreement. This subordinated debt has a stated annual interest rate of 10% and maturity date of June 28, 2022. In connection with this issuance of subordinated debt, Cross River Partners L.P. was granted a five-year warrant to purchase 645,161 shares of our common stock at an exercise price of $0.31 per share. On June 29, 2018 Cross River exercised both warrants and acquired 1,612,902 shares of our common stock. Proceeds from the exercise of the warrants in the amount of $500,000 were used to reduce the subordinated debt balance.
Interest Rate Swap
On February 23, 2018, we entered into an interest rate swap agreement with East West Bank (the "2018 Swap") in order to hedge against the variability in cash flows from future interest payments related to the New Credit Facility. The terms of the interest rate swap agreement included an initial notional amount of $10.0 million, a fixed payment rate of 2.52% paid by us, and a floating rate payment equal to LIBOR paid by East West Bank. The purpose of the swap agreement is to adjust the interest rate profile of our debt obligations.
On September 17, 2015, we entered into an interest rate swap agreement with PNC (the "2015 Swap") in order to hedge against the variability in cash flows from future interest payments related to the 2014 Credit Agreement. The terms of the interest rate swap agreement included an initial notional amount of $10.0 million, a fixed payment rate of 1.88% plus an applicable margin ranging from 4.50% to 5.50% paid by us and a floating payment rate equal to LIBOR plus an applicable margin of 4.50% to 5.50% paid by PNC. The purpose of the swap agreement was to adjust the interest rate profile of our debt obligations and to achieve a targeted mix of floating and fixed rate debt. In connection with the termination of the 2014 Credit Agreement, we terminated the interest rate swap agreement with PNC.
During the three months ended September 30, 2018, the fair market value of the swap instrument increased by approximately $33,000 and resulted in an increase in other income. During the nine months ended September 30, 2018, the fair market value of the swap instrument increased by approximately $64,000 and resulted in an asset being recorded and an increase in other income.
In connection with the termination of the 2014 Credit Agreement, during the three months ended September 30, 2017, we terminated the interest rate swap agreement with PNC. The cost to terminate the interest rate swap was approximately $90,000, and we recorded the difference between the cost to terminate the swap and the valuation of the swap of approximately $18,000, as of June 30, 2017, as additional interest expense during the three months ended September 30, 2017.
During the three months ended September 30, 2017, the fair market value of the 2015 Swap instrument decreased by approximately $11,000 and resulted in an increase to the liability and an increase in other expense. During the nine months ended September 30, 2017, the fair market value of the swap instrument increased by approximately $19,000 and resulted in a decrease to the liability and a reduction in interest expense.
Liquidity:
As of September 30, 2018, our available liquidity was $2.8 million, which was substantially comprised of $2.8 million of availability on the New Credit Facility (at certain times subject to a covenant requirement that we maintain $1.5 million of available liquidity) and $39,000 in cash. We utilize the New Credit Facility to fund working capital requirements, and during the nine months ended September 30, 2018, we made net cash payments to repay amounts due pursuant to the New Credit Facility of approximately $4.5 million, and additionally received approximately $103,000 in non-cash proceeds to fund costs incurred pursuant to the 2017 Credit Agreement.
Working Capital:
As of September 30, 2018, we had working capital of approximately $2.6 million compared to working capital of $8.0 million as of December 31, 2017, primarily attributable to the year-end accounts receivable balance which was higher due to higher frac water heating revenues in the fourth quarter of 2017.
As of September 30, 2018, the Company had recorded a valuation allowance to reduce its net deferred tax assets to zero.
Cash flow from Operating Activities:
For the nine months ended September 30, 2018, cash provided by operating activities was approximately $5.7 million compared to $552,000 in cash used in operating activities during the comparable period in 2017. The increase was attributable to (i) the increase in cash flows provided by the monetization of accounts receivable during the nine months ended September 30, 2018 compared to the comparable period in 2017, and (ii) the decrease in Loss Before Tax Expense (Benefit) related to improved operating results.
Cash flow from Investing Activities
:
Cash used in investing activities during the nine months ended September 30, 2018 was approximately $1.4 million, compared to $1.2 million during the comparable period in 2017, primarily due to an increase in the purchase of and maintenance to trucks and vehicles, and the purchase of water transfer equipment related to an increase in our pipeline of potential water transfer opportunities.
Cash flow from Financing Activities:
Cash used in financing activities for the nine months ended September 30, 2018 was $4.7 million compared to $1.6 million in cash provided by financing activities for the comparable period in 2017. During the nine months ended September 30, 2018, due to increased receipts of cash from operations, the Company made higher net payments to its revolving credit facility than during the comparable period in 2017.
Outlook:
We believe that the current oil and gas environment provides us an opportunity to increase our cash flows through the increased utilization of our asset base, due to industry dynamics and our focus on deploying our assets into areas where our services are in high demand. We have experienced an increase in such demand due to the fairly stable oil and natural gas commodity prices from 2016 lows, and increases in the level of production and development activities across the industry. Our 2018 financial results, to date, reflect our improved operational execution in response to this increased demand, and we are optimistic about the prospects for the remainder of 2018. Our long-term goals include driving increased utilization of our assets, an optimized deployment of our fleet, and the right-sizing of our balance sheet by paying down debt. We continue to seek opportunities to expand our business operations through organic growth, including increasing the volume of current services offered to our new and existing customers. We may identify additional services to offer to our customer base, and make related investments as capital and market conditions permits. We will continue to explore adding high margin services that diversify and expand our customer relationships while maintaining an appropriate balance between recurring maintenance work and drilling and completion related services.
Capital Commitments and Obligations:
Our capital obligations as of September 30, 2018 consist primarily of scheduled principal payments under certain term loans and operating leases. We repaid all amounts due under the 2014 Credit Agreement using proceeds from the 2017 Credit Agreement. We do not have any scheduled principal payments under the 2017 Credit Agreement until August 10, 2020; however, the Company may need to make future principal payments based upon collateral availability. General terms and conditions for amounts due under these commitments and obligations are summarized in the notes to the financial statements.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2018, we had no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our stockholders.
C
RITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies and estimates have not changed from those reported in Item 7 “
Management's Discussion and Analysis of Financial Condition and Results of Operations" in in our 2017 10-K.