ENSV ENSERVCO Corporation

Note 1 – Basis of Presentation

Enservco Corporation ("Enservco") through its wholly-owned subsidiaries (collectively referred to as the "Company", "we" or "us") provides various services to the domestic onshore oil and natural gas industry. These services include hot oiling and acidizing ("Production Services") and frac water heating ("Completion and Other Services").

The accompanying unaudited condensed consolidated financial statements have been derived from the accounting records of Enservco Corporation and its wholly-owned subsidiary, Heat Waves Hot Oil Service LLC ("Heat Waves"), (collectively, the "Company"). 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the disclosures required by generally accepted accounting principles in the United States of America ("GAAP") for complete financial statements. In the opinion of management, all normal and recurring adjustments necessary to fairly present the interim financial information set forth herein have been included. The results of operations for interim periods are not necessarily indicative of the expected operating results of a full year or of future years.

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with GAAP and follow the same accounting policies and methods of their application as the most recent annual financial statements. These interim financial statements should be read in conjunction with the financial statements and related footnotes included in the Annual Report on Form 10-K of Enservco Corporation for the year ended December 31, 2022. All intercompany balances and transactions have been eliminated in the accompanying condensed consolidated financial statements.

Note 2 – Summary of Significant Accounting Policies

Liquidity and Capital Resources

Our condensed consolidated financial statements have been prepared on the going concern basis, which contemplates the continuity of normal business activities and the realization of assets and settlement of liabilities in the normal course of business. For the three and six months ended June 30, 2023, we generated net losses of approximately $2.6 million and $3.6 million, respectively. Our loss from operations decreased to approximately $2.5 million for the six months ended June 30, 2023, compared with a loss from operations of approximately $4.6 million for the six months ended June 30, 2022. As of June 30, 2023, we had cash and cash equivalents of $431,000 and a working capital deficit of approximately $2.7 million.

The Company received net proceeds of $3.0 million from the February 2023 Offering (see Note 8 - Stockholders' Equity). Recent conversions of convertible debt to equity (see Note 5 - Debt) by Cross River Partners, L.P. ("Cross River"), a related party entity controlled by Richard Murphy, the Company's CEO and Chairman, have reduced our indebtedness and associated interest costs, which has substantially improved our financial position. Nonetheless, the Company will need to raise additional capital for its ongoing operations. As the Company seeks additional sources of financing, there can be no assurance that such financing would be available to the Company on favorable terms, or at all. The Company’s ability to obtain additional financing in the debt and equity capital markets, whether public or private, is subject to several factors including market and economic conditions, the Company’s performance, and investor sentiment with respect to the Company and its industry.

Note 3 – Property and Equipment

Property and equipment consist of the following (in thousands):

For the three and six months ended June 30, 2023, the Company recorded depreciation expense of approximately $0.9 million and $1.9 million, respectively. For the three and six months ended June 30, 2022, the Company recorded depreciation expense of approximately $1.0 million and $2.1 million, respectively.

Note 4 – Intangible Assets 

The components of our intangible assets are as follows (in thousands):

The useful lives of our intangible assets are estimated to be five years at inception. For the three and six months ended June 30, 2023 and 2022, amortization expense was approximately $54,000 and $109,000, respectively. The intangible assets are expected to be fully amortized within the next twelve months.

Note 5 – Debt

Notes Payable

Long-term debt consists of the following (in thousands):

Aggregate contractual principal maturities of debt for the twelve months ending June 30 are as follows (in thousands):

Refinancing

On  March 24, 2022, the Company completed a refinancing transaction (the "Refinancing") in which it terminated an existing 2017 Amended Credit Facility with East West Bank, which had an outstanding principal balance of $13.8 million at the time of extinguishment. Pursuant to the pay-off letter dated as of  March 18, 2022 by the Company, certain wholly owned subsidiaries of the Company and East West Bank, in full satisfaction of the Company’s obligations under the 2017 Amended Credit Facility, the Company paid East West Bank $8.4 million in cash and agreed to pay East West Bank 5% of the net proceeds that the Company receives under the Receivables Financing (as defined below), up to a maximum of $1.0 million (the "EWB Obligation"). The Company has since paid off and satisfied the $1.0 million EWB Obligation, subsequent to March 31, 2023 and prior to the filing date of this report.

As part of the Refinancing, Heat Waves entered into a Master Lease Agreement (the "Utica Facility") with Utica Leaseco, LLC ("Utica"), pursuant to which Utica provided an equipment-collateralized loan to the Company in the amount of $6.225 million. Under the Utica Facility, the Company is required to make 51 monthly payments with initial payments beginning at $168,075 each and a surcharge of 1% of the monthly payment amount per month for every 0.25% that the prime rate of Comerica Bank exceeds 3.25%. The Company's current minimum payment as of June 30, 2023 under the Utica Facility is $198,000 per month and the loan bears interest at 15.5% per annum. The aforementioned surcharge is discretionary on the part of Utica and was calculated on July 1, 2022 and January 1, 2023, and on each July 1 and January 1 thereafter. This surcharge is added to the monthly Basic Rent (as such term is defined in the Master Lease Agreement) due under the Utica Facility, and is due and payable with the next regularly scheduled Basic Rent payment under such schedule and on each payment date thereafter. Upon its maturity on June 24, 2026, the Company is required to make a residual payment to Utica between 1% and 10% of the initial principal amount, or between $62,250 and $622,500 depending upon the Company’s ratio of EBITDA to the sum of interest payments, cash paid for taxes and current debt and capital lease payments during the period. The Utica Facility is secured by all the Company’s equipment and proceeds from such equipment should the incumbered equipment be sold. The Company also has the option, after twelve months, to prepay $1.0 million of the Utica Facility in exchange for a reduced payment schedule. The Company has agreed to guarantee the obligations of Heat Waves under the Utica Facility pursuant to an unsecured Master Lease Guaranty with Utica.

Further, as part of the Refinancing, Heat Waves entered into an Invoice Purchase Agreement (the "Receivables Financing" or "LSQ Facility," and together with the Utica Facility, the "2022 Financing Facilities") with LSQ Funding Group, LLC ("LSQ") pursuant to which LSQ provides receivables factoring to Heat Waves. Under the Receivables Financing, LSQ advances up to 85% on accounts receivable factored by Heat Waves, up to a maximum of $10.0 million. LSQ receives fees equal to 0.1% of the receivables purchased in addition to a funds usage daily fee of 0.021% of the outstanding balance purchased. The Receivables Financing initially has an 18-month term that can be terminated upon payment of certain fees. The Receivables Financing is secured by a security interest in Heat Wave’s accounts receivables and proceeds from such accounts receivable. Heat Wave’s obligations under the Receivables Financing are guaranteed by the Company pursuant to an unsecured Entity Guaranty.

The Utica Facility and the LSQ Facility are subject to an Intercreditor Agreement dated on or about  March 24, 2022 by and among Utica, LSQ, Heat Waves, and the Company (the "Intercreditor Agreement").

Lastly, as part of the Refinancing, the Company issued a $1.2 million convertible subordinated note (the "March 2022 Convertible Note") to Cross River. The March 2022 Convertible Note had a six-year term and accrued interest at 7% per annum.

As a result of the Refinancing, the Company recorded a $4.3 million gain on this transaction, as recorded in the line item "Gain on debt extinguishment" in the condensed consolidated statement of operations for the three months ended March 31, 2022.

In accordance with ASC 470-60, the Company assessed whether or not the Refinancing met the criteria of a troubled debt restructuring ("TDR"). Management's assessment of TDR accounting treatment for the Refinancing determined that the 2017 Amended Credit Facility was extinguished as the result of a TDR; however, TDR accounting did not apply to the 2022 Financing Facilities as the 2017 Amended Credit Facility was settled in full and therefore accounted for as a debt extinguishment.

Subordinated Debt with Related Party

On  December 21, 2021, the Company issued a subordinated non-convertible promissory note to Cross River for $220,000, which amount was subsequently reduced to $162,000 and then fully repaid in 2022.

On July 15, 2022, the Company entered into a convertible subordinated promissory note (the "July 2022 Convertible Note") with Cross River whereby the Company received $1.2 million of capital for general working capital purposes. The July 2022 Convertible Note was set to mature six years from the date of issuance and carried interest at the rate of 7.75% per annum. The Company was required to make quarterly interest-only payments for the first year starting September 30, 2022, followed by principal and interest payments for the remaining five years based upon a ten-year amortization schedule. The July 2022 Convertible Note was unsecured and junior and subordinate to indebtedness which the Company may now or at any time hereafter owe to any lender. Subject to any required stockholder approval, all or some of the outstanding principal and accrued but unpaid interest under the July 2022 Convertible Note was convertible at the option of Cross River into (i) common stock of the Company at a conversion price of $1.69 per share; or (ii) equity securities issued by the Company in an equity offering with minimum offering proceeds to the Company (net of any related placement agent or underwriting fees) of $1.2 million at the conversion price per equity security issued in such equity offering.

On September 22, 2022, the Company entered into a revolving credit facility with Cross River pursuant to which the Company issued a $750,000 revolving promissory note to Cross River (the "Cross River Revolver Note"). On November 3, 2022, the Company entered into a note exchange agreement with Cross River, pursuant to which Cross River loaned an additional $450,000 to the Company and exchanged the Cross River Revolver Note for a $1.2 million convertible secured subordinated promissory note (the "November 2022 Convertible Note") and received a five-year warrant to acquire 568,720 shares of Company common stock at $2.11 per share. These warrants are subject to limitation such that the number of shares that may be issued shall not exceed obligations under rules of regulations of the principal market. The November 2022 Convertible Note has a two-year term and accrues interest at 10.00% per annum, payable quarterly starting March 30, 2023 at the option of the Company in cash or the Company’s common stock. Subject to any shareholder approval required by any exchange upon which the Company’s common stock is then listed, the principal and accrued interest of the November 2022 Convertible Note is convertible into the Company’s common stock at a conversion price equal to the lower of $2.11 per share or the price and terms the Company receives on its next public offering, which was indexed with the completion of the Company's February 2023 Offering (see Note 8 - Stockholders' Equity). The November 2022 Convertible Note is secured by two Company-owned parcels of real property located in North Dakota. On December 13, 2022, the Company sold one of these two parcels for a combination of cash and a promissory note/mortgage totaling $550,000. As consideration for Cross River releasing its security interest on such parcel, the Company agreed that it will enter into a collateral assignment of the security on such parcel back to Cross River in the event the buyer defaults on their promissory note/mortgage to the Company.

On March 28, 2023, Cross River converted approximately $1.1 million principal amount of the March 2022 Convertible Note into 2,275,000 shares of Company common stock. On June 13, 2023, the stockholders approved at the Company's 2023 Annual Meeting of Stockholders the issuance to Cross River of up to 5,122,402 additional shares of Company common stock, including 2,400,000 shares of common stock issuable upon exercise of a five-year warrant, issuable to Cross River upon its conversion of certain convertible notes pursuant to a Note Conversion Agreement dated March 28, 2023 between the Company and Cross River.

On June 30, 2023, Cross River: 1) converted the remaining $148,950 principal balance of the March 2022 Convertible Note into 322,402 shares of Company common stock; 2) converted the entire $1,200,000 principal balance of the July 2022 Convertible Note into 2,400,000 shares of Company common stock; and 3) received a five-year warrant to acquire 2,400,000 shares of Company common stock with an exercise price of $0.55 per share.

During the three months ended June 30, 2023, the Company renewed certain of its insurance policies. As part of this renewal, the Company financed $1.5 million of the insurance payments to be made over future periods. This financed insurance liability is contained in the line item "Accounts payable and accrued liabilities," with a corresponding financed insurance asset contained in the line item "Prepaid expenses and other current assets," both presented on our condensed consolidated balance sheet as of June 30, 2023.

Debt Discount and Debt Issuance Costs

We capitalized certain debt discount and debt issuance costs incurred in connection with the various debt facilities executed by the Company. These costs were amortized to interest expense over the terms of the facilities on a straight-line basis. The remaining balance of the unamortized debt discount and debt issuance costs was $409,000 as of June 30, 2023. For the three and six months ended June 30, 2023, the Company amortized approximately $69,000 and $139,000, respectively, of these costs to "Interest expense" in the condensed consolidated statements of operations. For the three and six months ended June 30, 2022, the Company amortized approximately $20,000 and $27,000, respectively, of these costs to "Interest expense" in the condensed consolidated statements of operations.

Note 6 – Income Taxes 

Income tax expense during interim periods is based on applying an estimated annual effective income tax rate to year-to-date income, plus any significant unusual or infrequently occurring items which are recorded in the interim period. The provision for income taxes for the three and six months ended June 30, 2023 and 2022 differs from the amount that would be provided by applying the statutory USA federal income tax rate of 21% to pre-tax income primarily because of state income taxes and estimated permanent differences. 

Based on management's judgement, the Company estimated that as of June 30, 2023 the amount of deferred tax liabilities that could reverse without an offsetting deferred tax asset was $257,000. Due to this, the Company recognized a $16,000 deferred tax benefit for the six months ended June 30, 2023. For the six months ended June 30, 2022, the Company's income tax benefit of $0.2 million was adjusted by the valuation allowance which resulted in a net tax provision of zero.

Note 7 – Commitments and Contingencies 

As of June 30, 2023, the Company leases facilities and certain equipment under lease commitments that expire through June 2026. Future minimum lease payments for these operating and finance lease commitments for the twelve months ending June 30 are as follows (in thousands):

The following table summarizes the components of our gross operating and finance lease costs (in thousands):

Our weighted-average lease term and discount rate used for leases were are as follows:

Litigation

On May 22, 2022, Ali Safe, acting individually and on behalf of others, filed a class action complaint in United States District Court for the District of Colorado alleging that the Company and certain of its officers violated securities laws in relation to certain of its SEC Form 10-Q filings in 2021 which required amendments and restatements to such filings. On November 28, 2022, the plaintiff amended their complaint primarily to add Jan Lambert as lead plaintiff and to include Cross River Partners, L.P. and Cross River Capital Management, LLC as defendants.

On February 10, 2023, the Company filed a motion in the United States District Court of Colorado to dismiss the class action complaint, citing a lack of specific facts and evidence brought by the plaintiffs in alleging the Company and certain of its officers committed securities fraud. As described in the motion requesting dismissal, the Company cites a lack and failure by the plaintiffs to bring significant and specific evidence in claiming that the Company and certain of its officers acted in an intentionally fraudulent or misleading manner, in connection with the Company restating its Form 10-Q financial filings for the first, second, and third fiscal quarters of 2021, due to errors relating to complex and technical tax and accounting issues, which did not have an impact on revenue, operating expenses, operating loss, or adjusted EBITDA for the three 2021 quarterly financial restatements.

We believe the class action complaint is baseless and without merit and have engaged counsel to vigorously defend the Company against the claim. The Company has Director’s and Officer’s insurance coverage to defend against such claims and the Company's insurance carriers have been notified about the lawsuit. While we believe the claim is without merit, there can be no assurances that a favorable final outcome will be obtained, and defending any lawsuit can be costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle such lawsuit on similarly unfavorable terms, either of which could materially adversely affect our business, financial condition, or results of operations. Furthermore, there can be no assurances that our insurance coverage will be available in sufficient amounts to cover such claim, or at all.

Note 8 – Stockholders’ Equity

February 2023 Offering of Common Stock and Warrants

On February 22, 2023, the Company entered into a Securities Purchase Agreement with certain investors, pursuant to which the Company agreed to issue and sell to the investors in a best-efforts public offering (i) 3,900,000 shares of Company common stock, (ii) pre-funded warrants to purchase 3,100,000 shares of Company common stock and (iii) common warrants to purchase 7,000,000 shares of  Company common stock (the "February 2023 Offering"). The shares of common stock, or pre-funded warrants in lieu thereof, and the common warrants were sold in units, with each unit consisting of one share of common stock or one pre-funded warrant in lieu thereof and one common warrant. Each unit comprised of common stock and common warrants were sold at a per unit price of $0.50. Each unit comprised of pre-funded warrants and common warrants were sold at a per unit price of $0.495, which represents the same per unit price less the $0.005 per share exercise price of the pre-funded warrants. The common warrants are exercisable at a price of $0.55 per share, and have a five-year term. The net proceeds from the offering were $3.0 million, after deducting Placement Agent fees and other offering expenses. Offering expenses totaling $534,000 were charged to stockholders' equity and are recorded as a reduction of the proceeds from the February 2023 Offering. The Company used the net proceeds for general corporate purposes.

 Conversion of Subordinated Debt to Equity (see Note 5 - Debt)

On March 28, 2023, Cross River converted approximately $1.1 million principal amount of the March 2022 Convertible Note into 2,275,000 shares of Company common stock. On June 30, 2023, Cross River: 1) converted the remaining $148,950 principal balance of the March 2022 Convertible Note into 322,402 shares of Company common stock; 2) converted the entire $1,200,000 principal balance of the July 2022 Convertible Note into 2,400,000 shares of Company common stock; and 3) received a five-year warrant to acquire 2,400,000 shares of Company common stock with an exercise price of $0.55 per share.

Warrants

A summary of warrant activity for the six months ended June 30, 2023 is as follows (in thousands): 

NYSE Regulation Notice of Noncompliance 

On May 2, 2023, the Company received notice from the NYSE that its equity balance as of December 31, 2022 had fallen below $2.0 million and therefore the Company was not in compliance with the NYSE American's continued listing standards under Section 1003(a)(i) in the NYSE American Company Guide (the "Company Guide"). As previously reported, the Company is also noncompliant with Section 1003(a)(ii) and Section 1003(a)(iii) of the Company Guide, as a result of its stockholder’s equity being less than the required thresholds for each of the particular sections. The Company is now subject to the procedures and requirements set forth in Section 1009 of the Company Guide. The Company has until June 9, 2024 to regain compliance with the stockholders' equity continued listing standards or NYSE will initiate delisting proceedings. On January 10, 2023, the Company submitted a plan (the "Plan") in response to an earlier notice from the NYSE advising of actions the Company is taking to regain compliance with the continued listing standards by June 9, 2024, which Plan was accepted by the NYSE on February 14, 2023. If the Company is not in compliance with all stockholders’ equity standards by June 9, 2024 or does not make progress consistent with the plan during the plan period, NYSE  may initiate delisting proceedings as it deems appropriate.

The Company is taking steps to achieve compliance with the stockholders' equity standards of Section 1003(a) of the Company Guide by June 9, 2024. These steps include the conversions of convertible notes into equity as discussed in Note 5 - Debt. The Company anticipates being in compliance with the stockholders' equity continued listing standards of the NYSE American; however, there can be no assurance that the Company will ultimately regain compliance with all applicable NYSE American listing standards.

Note 9 – Restricted Stock

Restricted Stock

Restricted shares issued pursuant to restricted stock awards are restricted as to sale or disposition. These restrictions lapse periodically, generally over a period of three years. Restrictions may also lapse for early retirement and other conditions in accordance with our established policies. Upon termination of employment, shares on which restrictions have not lapsed must be returned to us, resulting in restricted stock forfeitures. The fair market value on the date of the grant of the stock with a service condition is amortized and charged to income on a straight-line basis over the requisite service period for the entire award. The fair market value on the date of the grant of the stock with a performance condition shall be accrued and recognized when it becomes probable that the performance condition will be achieved. Restricted shares that contain a market condition are amortized and charged over the life of the award.

A summary of the restricted stock activity is presented below:

For the three and six months ended June 30, 2023, the Company recognized stock-based compensation expense for restricted stock of approximately ($16,000) and $180,000, respectively, in "Sales, general, and administrative expenses" in the condensed consolidated statements of operations. For the three and six months ended June 30, 2022, the Company recognized stock-based compensation costs for restricted stock of approximately $475,000 and $496,000, respectively, in "Sales, general, and administrative expenses" in the condensed consolidated statements of operations. Compensation cost is revised if subsequent information indicates that the actual number of restricted stock vested due to service is likely to differ from previous estimates.

As of June 30, 2023, there is $88,000 of unamortized stock-based compensation expense for restricted stock to be amortized over the next six months.

The following table sets forth the weighted average outstanding of potentially dilutive instruments for the three and six months ended June 30, 2023 and 2022: 

The Company awarded 79,262 restricted shares for the 2023 Board of Directors fees and recognized expense of $21,000 and $41,000 related to the award of these shares for the three and six months ended June 30, 2023, respectively.

The Company issued 50,000 restricted shares during the three months ended June 30, 2022 as part of the severance agreement related to the resignation of a former Chief Financial Officer. This issuance had a grant date fair value of approximately $112,000 and the expense for this issuance was recognized within the line item "Severance and transition costs" in the condensed consolidated statement of operations for both the three and six months ended June 30, 2022. Unvested restricted performance share-based awards totaling 61,000 shares were forfeited as part of the severance agreement.

Note 10 – Segment Reporting

Enservco’s reportable operating segments are Production Services and Completion and Other Services. These segments have been selected based on management’s resource allocation and performance assessment in making decisions regarding the Company. The following is a description of the segments.

Production Services

This segment utilizes a fleet of hot oiling trucks and acidizing units to provide maintenance services to the domestic oil and gas industry. These services include hot oiling services and acidizing services. Hot oiling is utilized by customers to remove paraffins from wellbores, pipes and vessels. Acidizing services are utilized by customers to clean reservoir surfaces and increase flow rates.

Completion and Other Services

This segment utilizes a fleet of frac water heating units to provide frac water heating services and related support services to the domestic oil and gas industry. These services also include other services for other industries, which consist primarily of hauling and transport of materials and heat treating for customers. Frac water heating is utilized by customers during the completion of oil and gas wells.

Unallocated

This segment includes general overhead expenses and assets associated with managing all reportable operating segments which have not been allocated to a specific segment.

The following tables set forth certain financial information with respect to Enservco’s reportable segments (in thousands):