Enservco Corp - Quarter Report: 2016 September (Form 10-Q)

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number 001-36335 

ENSERVCO CORPORATION

(Exact Name of registrant as Specified in its Charter)

Registrant’s telephone number: (303) 333-3678

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Enservco was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  X  No  ☐ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  X  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

                                                                                

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).               Yes ☐    No X

Indicate the number of shares outstanding of each of the Issuer's classes of common stock as of the latest practicable date.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ENSERVCO CORPORATION

Condensed Consolidated Balance Sheets

See notes to condensed consolidated financial statements.

ENSERVCO CORPORATION

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(Unaudited)

See notes to condensed consolidated financial statements.

ENSERVCO CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

See notes to condensed consolidated financial statements.

ENSERVCO CORPORATION

Notes to the Condensed Consolidated Financial Statements

The following discussion provides information regarding the results of operations for the three and nine month periods ended September 30, 2016 and 2015, and our financial condition, liquidity and capital resources as of September 30, 2016, and December 31, 2015. 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:      

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 and in Part II, Item 1A of this Quarterly Report. 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, 2015. 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.

BUSINESS OVERVIEW

The Company, through its subsidiaries, provides well enhancement and fluid management services to the domestic onshore oil and natural gas industry. These services include frac water heating, hot oiling and acidizing (well enhancement services), and water transfer, water treatment, water hauling, fluid disposal, frac tank rental (fluid management services) and other general oilfield services. The Company owns and operates through its subsidiaries a fleet of more than 340 specialized trucks, trailers, frac tanks and other well-site related equipment and serves customers in several major domestic oil and gas fields including the DJ Basin/Niobrara field in Colorado, the Bakken field in North Dakota, the Marcellus and Utica Shale fields in Pennsylvania and Ohio, the Jonah Field, Green River and Powder River Basins in Wyoming, the Eagle Ford Shale in Texas and the Mississippi Lime and Hugoton Fields in Kansas and Oklahoma.

In January 2016, the Company took advantage of the recent industry downturn and acquired various water transfer assets and other equipment from WET and HIIT for approximately $4 million dollars. These assets, which include high and low volume pumps, piping, manifolds, and other support equipment, as well as the exclusive U.S. rights to an environmentally friendly, innovative technology for the treatment of bacteria and scaling in the oil and gas industry, were purchased at an average of approximately 20% to 25% of their original cost. These strategic acquisitions, funded through our PNC credit facility, gave us the opportunity to acquire a sizable amount of assets that enabled us to launch a new water management division that can provide water transfer services in several markets. We believe the opportunity to bundle these services with our existing services including our frac water heating services will give us a competitive advantage over our competitors. Although we believe our ability to launch this division and enter into new markets will be challenging in the near term due to the current industry downturn, we believe these acquisitions will position us for substantial growth once commodity prices recover and well completion activity picks up.

The Company expects to continue to pursue its growth strategies of exploring additional acquisitions, potentially expanding the geographic areas in which it operates, and diversifying the products and services it provides to customers, as well as making further investments in its assets and equipment provided it can do so on reasonable terms and conditions. The Company will most likely require additional debt or equity financing to fund the costs necessary to expand the services it offers. There can be no assurance that the Company will be able to raise outside capital or have access to outside funding on reasonable terms, if at all. 

RESULTS OF OPERATIONS

The following table shows selected financial data and operating results for the periods noted. Following the table, please see management’s discussion of significant changes.

Executive Summary

Market conditions continued to negatively impact our business during the third quarter of 2016, which is traditionally one of our slowest quarters of the year due to the normal seasonal decline in heating revenues during the warm summer months. Reduced drilling, completion and service activity throughout the industry due to low crude oil and natural gas prices continued to result in lower demand for our services during the third quarter of 2016 as compared to the same quarter last year. We continued to offer pricing concessions/discounts to customers with the intent to maintain existing service volumes and offset the drop in demand. The combination of these factors resulted in a decline in third quarter well enhancement revenues of $370,000, or 11%, from the same quarter last year. In addition to the factors discussed above, unseasonably warm weather in our two largest heating markets during the first half of 2016 resulted in an $11.9 million or 48% decline in well enhancement revenues for the nine months ended September 30, 2016 as compared to the same period last year. Incremental revenues from our geographic expansion into the Eagle Ford Shale helped to offset some of the decline in revenues in other markets. In addition, $1.4 million of additional revenues from a dirt hauling project in Colorado helped to offset these declines.

Management continued to take actions to reduce variable operating costs in line with the decrease in revenues and to reduce fixed expenses where possible. However, the decline in higher margin well enhancement services, price concessions, and carrying costs from our water management division resulted in a decline in gross profit of $411,000 and a corresponding decline in Adjusted EBITDA of $418,000 for the three months ended September 30, 2016 as compared to the same quarter last year. For the nine months ended September 30, 2016, gross profits declined $7.7 million and Adjusted EBITDA declined $7.4 million as compared to the same period last year. For further details on the calculation of Adjusted EBITDA, see Adjusted EBITDA section below.

Declines in patent litigation costs of 38% reduced operating costs by approximately $21,000 during the quarter ended September 30, 2016 as compared to the same quarter last year. These declines were partially offset by a $114,000, or 8%, increase in noncash depreciation and amortization expense during the quarter related to the purchase of approximately $4 million of water transfer assets in January 2016. For the nine months ended September 30, 2016, general and administrative expenses and patent litigation defense costs decreased $605,000, or 17%. This decrease in cash operating expenses was offset by an increase in noncash depreciation and amortization expense of $716,000, or 17%, due to the purchase of water transfer assets discussed above.

Net loss for the three months ended September 30, 2016 was $2.4 million or ($0.06 per share) as compared to net loss of $1.6 million or ($0.04 per share) for the comparable quarter last year. For the nine months ended September 30, 2016, net loss was $5.8 million or ($0.15 per share) as compared to a net loss of $371,000 or ($0.01) per diluted share for the comparable period last year.

Industry Overview

Crude oil prices dropped below $30 per barrel twice in the first quarter and then gradually improved to just over $50 per barrel in early June and seems to have settled into the $45 to $50 per barrel range. The overall decline in crude oil prices since July 2014 has resulted in our customers scaling back drilling and completion programs, shifting capital resources to higher margin basins, requesting pricing concessions from vendors, and reducing or delaying certain maintenance related work to save costs. Further, the overall reduction in drilling, completion and service work has resulted in more service vendors chasing fewer jobs putting even further downward pressure on the pricing of services. Some competitors have responded by pricing work at negative margins. The Company has been able to partially mitigate the impact of these decisions by deploying resources to more active customers and basins.

Earlier this year, many customers announced reduced capital spending programs for 2016 and some customers suspended drilling and completion programs altogether until oil and natural gas prices recover and stabilize at an economical price for continuing such operations. In addition, some customers delayed their routine hot oiling and acidizing maintenance work. Similar to the last down cycle, once prices stabilize at a profitable level we anticipate a rebound in routine hot oiling and acidizing maintenance as the deferred maintenance needs to be done to maintain production levels and protect the integrity of a well.  

Revenues

Although the Company does not have segmented business operations, which would require segment reporting within the notes of its financial statements per accounting standards, we believe that revenues by service offering may be useful to readers of our financial statements. The following tables set forth revenue by service offering and geographic region during the three and nine months ended September 30, 2016 and 2015:

The Company has also determined that an understanding of the diversity of its operations by geography is important to an understanding of its business operations. The Company only does business in the United States in three geographically diverse regions. The following tables set forth revenue by service offering and geographic region during the three and nine months ended September 30, 2016 and 2015:

Notes to tables:

Well Enhancement Services

For the three months ended September 30, 2016, well enhancement service revenue declined $370,000 or 11% from the same period last year. The decline was primarily due to the year over year decline in demand for our hot oil services in several markets with the most significant declines noted in the Bakken and Wyoming Basins. This decline was partially offset by incremental hot oil and acidizing revenues from our geographic expansion into the Eagle Ford Shale in Texas.

For the nine months ended September 30, 2016, well enhancement service revenue declined $11.9 million, or 48%, from the comparative period last year to $12.7 million. A significant decline in demand for our frac water heating services due to unseasonably warm weather in our two largest frac water heating markets (D-J/Niobrara and Marcellus/Utica) during the first half of 2016 and the overall decline in drilling and completions activity related to falling oil and natural gas price were the primary reason for the decline in revenues. These declines were partially offset by incremental revenues from our geographic expansion into the Eagle Ford Shale basin in Texas.

Frac water heating revenues for the three months ended September 30, 2016 and 2015 were minimal due to normal seasonal decline in heating revenues during the warm summer months. For the nine months ended September 30, 2016, frac water heating revenues declined 68%, or $9.6 million, from 2015 due to the aforementioned unseasonably warm weather and industry wide declines in drilling and completion programs. Our Eastern USA region was hit particularly hard as cold temperatures never materialized during the first half of 2016 resulting in a $3.6 million, or 86%, decline in heating revenues in the Marcellus/Utica Shale Basin.

Hot oil revenues for the three months ended September 30, 2016 decreased 30% to $1.8 million as compared to $2.6 million in 2015. Incremental hot oil service revenues from our geographic expansion into Texas offset lower equipment utilization and price concessions in several markets. Hot oil equipment utilization fell from last year as customers in several locations scaled back frequency of service and reduced service hours in an effort to reduce costs. During the last two years, the Company has granted pricing concessions to customers in several markets in order to retain or increase market share.

Acidizing revenues for the three months ended September 30, 2016 increased 55% from the same period last year to $1.1 million. The Company’s continued efforts to aggressively pursue customers and partner with chemical suppliers to develop new cost effective acid programs has allowed us to expand our acidizing services into the Eagle Ford Shale basin in Texas resulting in an increase in quarter-over-quarter acidizing revenues. For the nine months ended September 30, 2016, acidizing revenues increased 16% from the same period last year.

Fluid Management and Other:

Fluid management services and other revenues increased $564,000 or 29% during the three months ended September 30, 2016 as compared to same quarter last year primarily due to $1.5 million of incremental revenues attributable to a dirt hauling project in Colorado which began in May 2016. This increase was partially offset by an $718,000 or 45% decline in water hauling revenues which was primarily attributable to lower water hauling revenues in our Central US region due to scaled back service work, pricing concessions and declining to perform certain low margin business.

Geographic Areas:

Revenues in the Rocky Mountain Region increased $421,000 or 17%, for the three months ended September 30, 2016 primarily due to incremental dirt hauling revenues described above. This increase was partially offset by a decline in hot oiling services in the Bakken and Wyoming basins. For the nine months ended September 30, 2016, revenues in the Rocky Mountain Region decreased $7.8 million, or 44%, primarily due to decreased frac water heating activity in the Niobrara Shale/DJ Basin attributable to the unseasonably warm weather and reduced drilling activity in the region as discussed above and decreased hot oiling due to delayed maintenance programs by our customers.

Revenues in the Eastern USA declined $96,000, or 51% to $93,000 during the third quarter ended September 30, 2016 primary due to decline in service activities and cessation of certain water hauling activities. For the nine months ended September 30, 2016, revenues decreased $3.7 million, or 77%, primarily due to lower frac water heating activity in the Marcellus and Utica shale basins. Similar to our most recent fourth quarter, the unseasonably warm weather throughout the first quarter of 2016 heating season essentially eliminated most of our frac water heating revenue during the first half of 2016. In addition, reduced drilling and completion activities due to falling prices also contributed to the overall decline in revenues.

Revenues in the Central USA region decreased $131,000, or 5%, to $2.6 million for the three months ended September 30, 2016. Incremental revenues from our geographic expansion into the Eagle Ford Shale were offset by a decline in well enhancement and fluid management service activity within the Hugoton Basin. Scaled back service work, price concessions and elimination of certain low margin water hauling business were the primary reasons for decline in fluid management service activity in the Hugoton Basin. For the nine months ended September 30, 2016, revenues in the Central USA region decreased $759,000 or 10%, to $7.0 million. Similar to our third quarter results, incremental revenues from our geographic expansion into the Eagle Ford Shale were offset by a decline in well enhancement and fluid management service activity within the Hugoton Basin.

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 what we call our “heating season”, are significantly higher than revenues earned 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) decrease as a percentage of total revenues and Fluid Management services and other services increase. Thus, the revenues recognized in our quarterly financials 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 72% of its 2015 revenues during the first and fourth quarters of 2015 compared to 28% during the second and third quarters of 2015. In 2014, the Company earned 77% of its 2014 revenues during the first and fourth quarters of 2014, compared 23% during the second and third quarters of 2014. While the Company is pursuing various strategies to lessen these quarterly fluctuations by increasing non-seasonal business opportunities, there can be no assurance that we will be successful in doing so.

Cost of Revenues:

Cost of revenues for the quarter ended September 30, 2016 increased $606,000, or 11%, from the comparable quarter last year primarily due to $1.6 million of incremental operating costs from our dirt hauling project in Colorado. Excluding these incremental costs, cost of revenues decline $1.0 million or 19% from the comparable quarter last year primarily due to management’s efforts to reduce operating costs such as direct labor, insurance and supplies in order to minimize the negative impact of reduced well enhancement and fluid management revenues. Managements’ efforts included reducing overtime and non-billable time, reducing indirect labor to correspond with lower activity, negotiating supplier discounts and implementing cost management tools. Although management makes every effort to manage labor costs during its seasonal fluctuations in revenue, it is difficult to fully reduce labor costs during our slower quarters in proportion with the decline in revenues as we must retain a number of experienced frac water heating operators for the upcoming heating season. In addition to managements’ efforts to reduce costs, lower propane and fuel costs also contributed to the decline in cost of revenues. The decline in cost of revenues above was partially offset by carrying costs from our new water management division and increased costs from our expanded operations in Texas. For the nine months ended September 30, 2016, cost of revenues decreased $4.5 million, or 20%, from the comparable period last year due to the same factors that impacted the third quarter cost of revenues discussed above.

Gross Profit:

Gross profit, which is typically lower during the third quarter due to the normal seasonal decline in frac water heating services, decreased $411,000 to negative $458,000 during the quarter ended September 30, 2016 as compared to a negative $47,000 for the same quarter last year. The decline in gross profits was primarily due to the decline in our higher margin well enhancement service revenues of approximately $370,000 as discussed above. In addition, gross profit was further decreased due to carrying costs of $254,000 related to our new water management division and $97,000 of incremental operating costs associated with the dirt hauling project which began in May 2016. For the nine months ended September 30, 2016, gross profit declined $7.7 million, or 97%, to $279,000 during the nine months ended September 30, 2016 as compared to $8.0 million for the same period last year. The decline in gross profits was primarily due to the $11.9 million decline in our higher margin well enhancement services attributable to lower frac water heating services related to the warm weather and reduced service activity discussed above. Also contributing to the decline in gross profit for the nine months ended September 30, 2016, were $1.1 million of carrying costs for our new water management division and $217,000 of startup/incremental costs for the dirt hauling project. Management continues to monitor the carrying costs associated with the new water management division and beginning July 2016 made staff reductions to reduce carrying costs by approximately 50%.

Gross profit as a percentage of revenues was negative 8% and 1% for the three months ended September 30, 2016 and 2015, respectively. Gross profit as a percentage of revenues was 2% and 26% for the nine months ended September 30, 2016 and 2015, respectively. The decrease in gross profit as a percentage of revenues was primarily due to the aforementioned impact from decline in higher margin well enhancement revenues and startup costs for our new water management division and dirt hauling project. Further, gross profits as a percentage of revenue also declined due to the fixed cost components in cost of goods sold such as indirect labor, property and equipment insurance, vehicle registration fees, and site overhead costs which do not fluctuate in proportion to revenues and therefore become a higher percentage of costs of revenues during our seasonal decline in revenues.

Propane Impact Discussion:

In connection with our frac water heating services and hot oil services, the Company provides propane to certain customers on a cost plus basis. Since the Company passes along the cost of propane to its customers on a cost plus mark-up basis, fluctuations in the price of propane will impact our revenues, cost of revenues and gross profit percentages. In general, decreases in propane prices will tend to reduce well enhancement revenues and cost of revenues and may increase our overall gross profit percentage as the dollar value of propane revenues and cost of revenue becomes a lower percentage of total revenues. Conversely, increases in propane prices will tend to increase well enhancement revenues and cost of revenues and may decrease our gross profit percentage, as the dollar value of lower margin propane revenues and cost of revenue becomes a higher percentage of total revenues. Propane prices during our first quarter declined approximately 33% from the comparable quarter last year and contributed to the overall decline in revenues, cost of revenues and gross profits discussed above. However, due to the significant decline in frac water heating services, the decline in propane prices, had a relatively minor impact on gross profit as a percentage of revenue.

The Company anticipates that propane prices will continue to fluctuate in the future based on the relative demand and availability of propane in different geographic areas across the United States and that more customers may utilize our bi-fuel capabilities.

General and Administrative Expenses:

For the quarter ended September 30, 2016, general and administrative expenses increased $12,000, or 1%, from the comparable quarter last year. Lower personnel costs attributable to reduction in staff and cost reductions from scaled back investor relations expenses and lower corporate travel were mitigated by higher professional fees, office rent, and bad debt expense from the comparable quarter last year.

For the nine months ended September 30, 2016, general and administrative expenses decreased $221,000, or 7%, from the comparable quarter last year primarily due to lower personnel costs attributable to reduction in staff and a $275,000 net decrease due to the timing of an annual bonus paid to management and key employees during the first quarter of 2015. These decreases were partially offset by higher stock based compensation, office rent, and bad debt expense over the comparable period last year. Bad debt expense was higher than the comparable period last year due to a partial write-off of pre-petition receivables from customers that went through Chapter 11 bankruptcy during 2016.

Patent Litigation and Defense Costs:

Patent litigation and defense costs for the three and nine months ended September 30, 2016 declined $21,000 and $384,000, respectively, from the comparable periods last year. As discussed below in Part II Item 1. – Legal Proceeding, 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 recent judgement by a North Dakota Court invalidating the ‘993 Patent. As a result of the stay, legal costs have been minimal since July 2015.

Enservco and Heat Waves deny that they are infringing upon 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 of these patents should the lawsuit resume. The Company expects associated legal fees to be minimal going forward until or if such time as the Colorado Case is resumed.

Depreciation and Amortization:

Depreciation and amortization expense for the three and nine months ended September 30, 2016 increased $114,000, or 8% and $716,000, or 17%, respectively from the comparable periods last year primarily due to the additional depreciation expense related to the $4.0 million purchase of water transfer assets from WET and HIIT. Depreciation and amortization expense during the third quarter of 2016 was partially offset by a reduction in depreciation expense due to older equipment being fully depreciated during the three months ended September 30, 2016.

Income from operations:

For the nine months ended September 30, 2016, the Company recognized a loss from operations of $7.7 million compared to an income from operations of $106,000 for the same period last year. The loss from operations as compared to the income from operations in the prior period is primarily due to the overall decline in well enhancement revenues and corresponding gross profits discussed above, as well as a $716,000 increase in depreciation and amortization expense related to the acquisition of water transfer assets in January 2016.  

Management believes that the decline in results of operations during 2016, particularly the decline in well enhancement revenues and gross profit, reflects a number of factors including the unseasonably warm weather in the DJ Basin and Marcellus/Utica shale play and decreased drilling, completion and service activity attributable to lower crude oil and natural gas prices should improve over time. We believe that as long as we are able to control our costs and increase our revenues as a result of our expanded fleet and service offerings as well as being able to quickly deploy our equipment from places of lesser utilization to places where they will be better utilized, our financial performance will improve over the long run. On a quarter-to-quarter basis, there may still be periods of loss due to the seasonality of our operations, as discussed several times herein.

Interest Expense:

Interest expense for the three months ended September 30, 2016 increased $193,000, or 53%, to $553,000 as compared to the same quarter last year. The increase was due to several factors including a $200,000 amendment fee charged in connection with the seventh amendment to the PNC credit agreement, an increase in our effective interest rate of 200 basis points due to amendments to our PNC credit facility, and a higher average debt balance from the comparable period last year. These increases were partially offset by a $233,000 reduction in interest expense from the comparable quarter last year related to the fair market adjustment on the PNC interest rate swap agreement.

Interest expense for the nine months ended September 30, 2016 increased $566,000, or 66%, to $1.4 million as compared to $861,000 for the same period last year. The increase in interest expense during the nine months was primarily due to same factors discussed above.

Income Taxes:

For the quarter ended September 30, 2016, the Company recognized an income tax benefit of $1.3 million on pre-tax net loss of approximately $3.6 million as compared to an income tax benefit of $1.2 million on pre-tax net loss of $2.9 million in 2015. The effective tax rate on income from operations was 35% for the quarter ended September 30, 2016 as compared to 43% for the same quarter last year. The difference in effective tax rates was primarily due to permanent tax differences related to stock based compensation.

For the nine months ended September 30, 2016, the Company recognized an income tax benefit of $3.1 million on pre-tax net loss of approximately $8.9 million as compared to an income tax benefit of $330,000 on pre-tax net loss of $701,000 in 2015. The effective tax rate on income from operations was 34% for the nine months ended September 30, 2016 compared to 47% for the same period last year. The difference in effective tax rates was primarily due to permanent tax differences related to stock based compensation

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:

*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, gain on sale of investments, loss on disposal of assets, patent litigation and defense costs, 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 leverage and fixed charge ratio covenants associated with our 2014 Credit Agreement require 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 from operations declined $418,000 to a negative $1.2 million for the quarter ended September 30, 2016 as compared to a negative $831,000 for the same quarter last year. This decrease was primarily due to the $411,000 decline in gross profit discussed above.

Adjusted EBITDA from operations declined $7.4 million to a negative $2.1 million for the nine months ended September 30, 2016 as compared to a positive $5.3 million for the same period last year. This decrease was primarily due to the $7.7 million decline in gross profit discussed above.

LIQUIDITY AND CAPITAL RESOURCES

 The following table summarizes our statements of cash flows for the three and nine months ended September 30, 2016

The following table sets forth a summary of certain aspects of our balance sheet at September 30, 2016 and December 31, 2015 and (combined with the working capital table and discussion below) is important for understanding our liquidity:

Overview:

We have relied on cash flow from operations, borrowings under our revolving credit facilities, and equipment financing 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, 2016, we had approximately $781,000 of cash and cash equivalents and approximately $1.3 million available under our asset based senior revolving credit facility.

In September 2014, the Company entered into the 2014 Credit Agreement with PNC which provides for a five-year $30 million senior secured revolving credit facility. The facility allows the Company to borrow up to 85% of eligible receivables, up to 85% of the appraised value of trucks and equipment, and 90% of the cost of new equipment. The Company had the option to pay variable interest rate based on (a) 1, 2 or 3 month LIBOR plus applicable margin ranging from 2.75% to 3.75% for LIBOR Rate Loans or (b) interest at PNC Base Rate plus applicable margin of 1.25% to 2.25% for Domestic Rate Loans. As a result of the Sixth Amendment entered into in March 2016, the interest rates we will be paying on our loans for the balance of 2016 and through the end of the term in September 2019 have increased by 1.75%.

The PNC credit facility has certain customary financial covenants which have been amended from time to time and consist of the following as of September 30, 2016 (as described below, effective October 4, 2016, these covenants have changed as a result of a Eighth Amendment to the facility):

On August 10, 2016, the Company entered into a Seventh Amendment to the 2014 Credit Agreement that among other things; (i) reset and extended the minimum monthly availability covenant from the date of amendment through September 30, 2017 at amounts ranging from $658,000 to $3.5 million, (ii) extended the period of time that the leverage ratio and fixed charge coverage ratio are springing covenants to July 1, 2017; (iii) provided for a 0.5% monthly reduction in the advance rate on the appraised value of equipment to 80% through February 2017; and (iv) included an amendment fee of $200,000.

On October 4, 2016, the Company entered into an Eighth Amendment to the 2014 Credit Agreement that among other things; (i) reset the minimum monthly availability covenant to $500,000 from September 1, 2016 through November 30, 2016 and $1 million thereafter; and (ii) reset the leverage ratio for each quarterly period as follows:

As of September 30, 2016, the Company had an outstanding loan balance of $25.3 million and approximately $1.3 million available under the revolving credit facility ($2.0 million gross availability less a minimum monthly availability requirement for September 2016 of $771,000) and was in compliance with applicable terms of the credit facility above. The interest rate at September 30, 2016 was 5.0% for the $25.2 million of outstanding LIBOR Rate Loans and 6.5% for the $68,584 of outstanding Domestic Rate Loans.

The Company intends to continue to use the PNC facility to fund working capital needs and supplement future capital expenditures. The financial covenants outlined above could restrict our ability to secure additional debt financing or access funds under our revolving credit facility.

Working Capital:

As of September 30, 2016, the Company had working capital of approximately $2.5 million, a decrease in working capital of approximately $3.6 million as compared to our 2015 fiscal year end. The decrease in working capital was primarily attributable to a decrease in accounts receivable of $3.7 million, or 52%, related to our seasonal decline in well enhancement revenues, specifically frac water heating revenues.

Cash flow from Operating Activities:

Cash flow used in operating activities during the quarter ended September 30, 2016 was $1.6 million as compared to $160,000 cash inflow during the comparable quarter last year. The decrease in cash flow from operations is primarily attributable to lower cash inflow from accounts receivable.

Cash flow from operating activities during the nine months ended September 30, 2016 was $4,000 as compared to $12.9 million during the comparable period last year. The decrease in cash flow from operations is primarily attributable to the overall decline in revenues and gross profits during the period as discussed above. Additionally, the decrease in cash flow from operations is due to lower cash inflow associated with the collection of accounts receivable.

Cash flow from Investing Activities:

Cash flow used in investing activities during the quarter ended September 30, 2016 was $232,000 as compared to $430,000 during the comparable quarter last year. The cash used in investing activities during the quarters ended September 30, 2016 and 2015 consists primarily of maintenance capital expenditures. Overall the Company has significantly reduced its capital expenditures as a result of lower activity and reduced revenues.

Cash flow used in investing activities during the nine months ended September 30, 2016 was $4.5 million as compared to $3.6 million during the comparable period last year. The increase in cash used in investing activities was primarily due to the $4.2 million purchase of water transfer assets and patented hydropath technology assets from WET and HIIT. The $3.1 million of capital expenditures for the comparable quarter last year included equipment purchases and payments for trucks in process under the Company’s 2014 CAPEX program and other routine maintenance capital expenditures.

Cash flow from Financing Activities:

Cash provided by financing activities for the quarter ended September 30, 2016 was $2.1 million as compared to $257,000 for the comparable period last year. The change was primarily due to the Company using cash flow in fiscal 2015 to pay down its revolving credit facility with PNC.

Cash provided by financing activities for the nine months ended September 30, 2016 was $4.5 million as compared cash used in financing activities of $9.5 million for the comparable period last year. The change was primarily due to additional borrowings by the Company in January of 2016 to fund the purchase of new water management and patented hydropath technology assets ($4.2 million) as discussed above, whereas during the nine months ended September 30, 2015, the Company utilized cash flow from operations to pay down its revolving credit facility with PNC.

Outlook:

The Company plans to continue to look for opportunities to expand its business operations through organic growth such as geographic expansion and increasing the volume and scope of services offered to our existing customers as capital permits. The Company will also look to expand its business operations through acquisitions. The Company plans to continue to focus on adding high margin services that reduce our seasonality, diversify our service offerings, and maintain a good balance between recurring maintenance work and drilling and completion related services.

As discussed above and as a result of the changes negotiated in the Seventh and Eighth Amendments, the Company believes that it will have sufficient capital resources and availability under the PNC revolving credit facility through the remainder of 2016 to fund working capital needs and future capital expenditures. However, the Company’s borrowing availability and ability to meet its debt covenants over the next twelve months will be heavily dependent upon the Company’s ability to generate positive cash flows and EBITDA during the Company’s upcoming heating season which occurs from November 2016 through April 2017. In the event the Company does not generate a sufficient amount of EBITDA to meet its debt covenants, the Company will need to negotiate further amendments to its credit facility and/or raise additional capital resources through debt or equity financing.

On April 16, 2014, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission (SEC) that was declared effective by the SEC on April 30, 2014. The Form S-3 provides for the sale of common stock by named selling security holders, and further provides the Company with the flexibility to offer and sell from time to time, up to $50 million of the Company’s common stock in order to supplement our cash flows from operations and financing activities. The Company plans to maintain the registration statement in the event there is a need to supplement its existing capital resources.

Capital Commitments and Obligations:

The Company’s capital obligations as of September 30, 2016 consist primarily of scheduled principal payments under certain term loans and operating leases.  The Company does not have any scheduled principal payments under its five-year, $30 million revolving credit facility with PNC Bank. However, the Company may need to make future principal payments based upon collateral availability and to maintain required availability and leverage ratios. General terms and conditions for amounts due under these commitments and obligations are summarized in the notes to the financial statements.    

Pursuant to a Sales Agreement with HydroFLOW USA, HWWM has the exclusive right to sell or rent patented hydropath devices in connection with bacteria deactivation and scale treatment services for treating injection and disposal wells, fracking water and recycled water in the oil and gas industry to HWWM customers in the United States. Pursuant to the sales agreement, HWWM is required to pay royalties on certain rental transactions and, in order to maintain the exclusivity provision under the agreement, the Company must purchase approximately $655,000 of equipment per year commencing in 2016 of which $155,000 has been paid as of September 30, 2016. In September 2016, the Company and HydroFLOW USA agreed to allocate $200,000 of the 2016 commitment to 2017, thereby reducing the remaining commitment for 2016 to $280,000.

OFF-BALANCE SHEET ARRANGEMENTS

Other than the guarantees made by Enservco (as the parent Company) on various loan agreements and operating leases disclosed in Note 8 to the Condensed Consolidated Balance Sheet, the Company 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.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with U. S. generally accepted accounting principles requires management to make a variety of estimates and assumptions that affect (i) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, and (ii) the reported amounts of revenues and expenses during the reporting periods covered by the financial statements.

Our management routinely makes judgments and estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the future resolution of the uncertainties increase, these judgments become even more subjective and complex. Although we believe that our estimates and assumptions are reasonable, actual results may differ significantly from these estimates. Changes in estimates and assumptions based upon actual results may have a material impact on our results of operation and/or financial condition. Our significant accounting policies are disclosed in Note 2 to the Condensed Consolidated Financial Statements included in this Form 10-Q.

While all of the significant accounting policies are important to the Company’s financial statements, the following accounting policies and the estimates derived there from have been identified as being critical:

For a discussion of the Company’s critical accounting policies, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015. There have been no material changes to the Company’s critical accounting policies as disclosed therein.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES