Enservco Corp - Quarter Report: 2018 June (Form 10-Q)

 

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		June 30,				December 31,
ASSETS		2018				2017
		(Unaudited)
Current Assets
Cash and cash equivalents		$	235			$	391
Accounts receivable, net			5,131				11,761
Prepaid expenses and other current assets			657				868
Inventories			494				576
Income tax receivable, current			57				57
Total current assets			6,574				13,653
Property and equipment, net			27,456				29,417
Income tax receivable, noncurrent			57				57
Other assets			1,191				1,123
TOTAL ASSETS		$	35,278			$	44,250
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities		$	2,350			$	5,465
Current portion of long-term debt			142				182
Total current liabilities			2,492				5,647
Long-Term Liabilities
Senior revolving credit facility			21,729				27,066
Subordinated debt			1,808				2,229
Long-term debt, less current portion			225				252
Warrant liability			-				831
Total long-term liabilities			23,762				30,378
Total liabilities			26,254				36,025
Commitments and Contingencies (Note 8)
Stockholders' Equity
Preferred stock, $.005 par value, 10,000,000 shares authorized, no shares issued or outstanding			-				-
Common stock, $.005 par value, 100,000,000 shares authorized, 54,464,829 and 51,197,989 shares issued, respectively; 103,600 shares of treasury stock; and 54,361,229 and 51,094,389 shares outstanding, respectively			272				255
Additional paid-in capital			21,594				19,571
Accumulated deficit			(12,842	)			(11,601	)
Total stockholders' equity			9,024				8,225
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	35,278			$	44,250

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		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Revenues
Well enhancement services		$	7,005			$	5,819			$	26,290			$	17,803
Water transfer services			929				306				1,924				1,058
Water hauling services			858				881				1,699				1,766
Other			-				100				-				254
Total revenues			8,792				7,106				29,913				20,881
Expenses
Well enhancement services			5,900				4,325				18,991				12,774
Water transfer services			979				616				1,936				1,292
Water hauling services			953				1,192				1,901				2,105
Functional support and other			181				300				326				641
Sales, general, and administrative expenses			1,241				1,290				2,611				2,284
Patent litigation and defense costs			55				24				75				67
Severance and transition costs			593				768				633				768
Depreciation and amortization			1,597				1,675				3,186				3,251
Total operating expenses			11,499				10,190				29,659				23,182
(Loss) Income from Operations			(2,707	)			(3,084	)			254				(2,301	)
Other (Expense) Income
Interest expense			(511	)			(500	)			(1,011	)			(1,210	)
Gain on disposals			53				-				53				-
Other (expense) income			(85	)			38				(505	)			42
Total other expense			(543	)			(462	)			(1,463	)			(1,168	)
Loss Before Tax Benefit (Expense)			(3,250	)			(3,546	)			(1,209	)			(3,469	)
Income Tax (Expense) Benefit			(32	)			1,019				(32	)			992
Net Loss		$	(3,282	)		$	(2,527	)		$	(1,241	)		$	(2,477	)
Earnings per Common Share - Basic		$	(0.06	)		$	(0.05	)		$	(0.02	)		$	(0.05	)
Earnings per Common Share – Diluted		$	(0.06	)		$	(0.05	)		$	(0.02	)		$	(0.05	)
Basic weighted average number of common shares outstanding			51,677				51,068				51,413				51,068
Add: Dilutive shares			-				-				-				-
Diluted weighted average number of common shares outstanding			51,677				51,068				51,413				51,068

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		For the Six Months Ended
		June 30,
		2018				2017
OPERATING ACTIVITIES
Net loss		$	(1,241	)		$	(2,477	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and amortization			3,186				3,251
Deferred income taxes			-				(879	)
Gain on disposal of equipment			(53	)			-
Stock-based compensation			188				446
Change in fair value of warrant			540				-
Amortization of debt issuance costs and discount			126				298
Provision for bad debt expense			33				49
Changes in operating assets and liabilities
Accounts receivable			6,598				729
Inventories			82				(3	)
Prepaid expense and other current assets			241				152
Income taxes receivable			-				224
Other assets			(60	)			(32	)
Accounts payable and accrued liabilities			(3,115	)			260
Net cash provided by operating activities			6,525				2,018
INVESTING ACTIVITIES
Purchases of property and equipment			(1,470	)			(971	)
Proceeds from insurance claims			122				-
Proceeds from disposal of equipment			145				121
Net cash used in investing activities			(1,203	)			(850	)
FINANCING ACTIVITIES
Net line of credit payments			(5,386	)			(2,000	)
Proceeds from issuance of long-term debt			-				1,000
Repayment of long-term debt			(66	)			(168	)
Other financing			(26	)			-
Net cash used in financing activities			(5,478	)			(1,168	)
Net Increase (Decrease) in Cash and Cash Equivalents			(156	)			-
Cash and Cash Equivalents, beginning of period			391				621
Cash and Cash Equivalents, end of period		$	235			$	621
Supplemental cash flow information:
Cash paid for interest		$	863			$	36
Cash paid (received) for taxes		$	32			$	(222	)
Supplemental Disclosure of Non-cash Investing and Financing Activities:
Non-cash proceeds from revolving credit facilities		$	49			$	815
Cashless exercise of stock options		$	994			$	-
Non-cash proceeds from warrant exercise		$	500			$	-
Non-cash subordinated debt principal repayment		$	(500	)		$	-
Non-cash conversion of warrant liability to equity		$	1,371				-
Non-cash proceeds from subordinated debt borrowings		$	-			$	1,500
Non-cash repayment of revolving credit facility		$	-			$	(1,500	)

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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 frac water heating, hot oiling and acidizing (well enhancement services); water transfer and water treatment services (water transfer services); and water hauling, fluid disposal, frac tank rental (water hauling services).

 

The accompanying unaudited condensed consolidated financial statements have been derived from the accounting records of Enservco Corporation, Heat Waves Hot Oil Service LLC (“Heat Waves”), Dillco Fluid Service, Inc. (“Dillco”), Heat Waves Water Management LLC (“HWWM”), HE Services LLC (“HES”), and Real GC LLC (“Real GC”) (collectively, the “Company”) as of June 30, 2018 and December 31, 2017 and the results of operations for the three and six months ended June 30, 2018 and 2017.

 

The below table provides an overview of the Company’s current ownership hierarchy:

 

 

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 for complete financial statements. In the opinion of management, all of the 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 operating results of a full year or of future years.

 

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“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, 2017. All inter-company balances and transactions have been eliminated in the accompanying condensed consolidated financial statements.

 

 

 

Note 2 - Summary of Significant Accounting Policies

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. The Company continually monitors its positions with, and the credit quality of, the financial institutions with which it invests. Enservco maintains its excess cash in various financial institutions, where deposits may exceed federally insured amounts at times.

 

Accounts Receivable 

 

Accounts receivable are stated at the amounts billed to customers, net of an allowance for uncollectible accounts. The Company provides an allowance for uncollectible accounts based on a review of outstanding receivables, historical collection information and existing economic conditions. The allowance for uncollectible amounts is continually reviewed and adjusted to maintain the allowance at a level considered adequate to cover future losses. The allowance is management's best estimate of uncollectible amounts and is determined based on historical collection experience related to accounts receivable coupled with a review of the current status of existing receivables. The losses ultimately incurred could differ materially in the near term from the amounts estimated in determining the allowance. As of June 30, 2018, and December 31, 2017, the Company had an allowance for doubtful accounts of approximately $65,000 and $70,000, respectively. For the three months ended June 30, 2018, the Company recorded less than $1,000 of bad debt expense. For the six months ended June 30, 2018, the Company recorded bad debt expense (net of recoveries) of approximately $33,000. For the three and six months ended June 30, 2017, the Company recorded bad debt expense (net of recoveries) of approximately $20,000 and $49,000, respectively. 

 

Inventories

 

Inventory consists primarily of propane, diesel fuel and chemicals that are used in the servicing of oil wells and is carried at the lower of cost or net realizable value in accordance with the first in, first out method (FIFO). The Company periodically reviews the value of items in inventory and provides write-downs or write-offs, of inventory based on its assessment of market conditions. Write-downs and write-offs are charged to cost of goods sold. For the three and six months ended June 30, 2018 and 2017, no amounts were expensed for write-downs and write-offs.

 

Property and Equipment

 

Property and equipment consists of (i) trucks, trailers and pickups; (ii) water transfer pumps, pipe, lay flat hose, trailers, and other support equipment; (iii) real property which includes land and buildings used for office and shop facilities and wells used for the disposal of water; and (iv) other equipment such as tools used for maintaining and repairing vehicles, office furniture and fixtures, and computer equipment. Property and equipment is stated at cost less accumulated depreciation. The Company capitalizes interest on certain qualifying assets that are undergoing activities to prepare them for their intended use. Interest costs incurred during the fabrication period are capitalized and amortized over the life of the assets. The Company charges repairs and maintenance against income when incurred and capitalizes renewals and betterments, which extend the remaining useful life, expand the capacity or efficiency of the assets. Depreciation is recorded on a straight-line basis over estimated useful lives of 5 to 30 years.

 

Any difference between net book value of the property and equipment and the proceeds of an assets’ sale or settlement of an insurance claim is recorded as a gain or loss in the Company’s earnings.

 

Leases

 

The Company conducts a major part of its operations from leased facilities. Each of these leases is accounted for as an operating lease. Normally, the Company records rental expense on its operating leases over the lease term as it becomes payable. If rental payments are not made on a straight-line basis, per terms of the agreement, the Company records a deferred rent expense and recognizes the rental expense on a straight-line basis throughout the lease term. The majority of the Company’s facility leases contain renewal clauses and expire through August 2022. In most cases, management expects that in the normal course of business, leases will be renewed or replaced by other leases. The Company amortizes leasehold improvements over the shorter of the life of the lease or the life of the improvements. As of June 30, 2018, and December 31, 2017, the Company had a deferred rent liability of approximately $90,000 and $96,000, respectively.

 

The Company has leased equipment in the normal course of business, which are recorded as operating leases. The Company recorded rental expense on equipment under operating leases over the lease term as it becomes payable; there were no rent escalation terms associated with these equipment leases. The equipment leases contain purchase options that allow the Company to purchase the leased equipment at the end of the lease term, based on the market price of the equipment at the time of the lease termination. There are no significant equipment leases outstanding as of June 30, 2018.

 

 

Long-Lived Assets

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recovered. The Company reviews both qualitative and quantitative aspects of the business during the analysis of impairment. During the quantitative review, the Company reviews the undiscounted future cash flows in its assessment of whether or not long-lived assets have been impaired. No impairments were recorded during the three or six months ended June 30, 2018 and 2017.

 

Revenue Recognition

 

As described below, we adopted Accounting Standards Update 2014-09, Revenue - Revenue from Contracts with Customers, Accounting Standards Codification ("ASC") Topic 606, beginning January 1, 2018, using the modified retrospective approach, which we have applied to contracts within the scope of the standard. There was no material impact on the Company's condensed consolidated financial statements from adoption of this new standard. The Company evaluates revenue when we can identify the contract with the customer, the performance obligations in the contract, the transaction price, and we are certain that the performance obligations have been met. Revenue is recognized when the service has been provided to the customer, which includes estimated amounts for services rendered but not invoiced at the end of each accounting period. The vast majority of the Company's services and product offerings are short-term in nature.  The time between invoicing and when payment is due under these arrangements is generally 30 to 60 days.

 

Revenue is not generated from contractual arrangements that include multiple performance obligations.  

 

Revenue is recognized for certain projects that take more than one day projects over time based on the number of days during the reporting period and the agreed upon price as work progresses on each project. Revenue that has been earned but not yet invoiced at June 30, 2018 and December 31, 2017 was approximately $15,000 and $1.7 million, respectively. Such amounts are included within Accounts receivable, net in the Condensed Consolidated Balance Sheets.

 

Disaggregation of revenue

 

See Note 11 - Segment Reporting for disaggregation of revenue.

 

Earnings (Loss) Per Share

 

Earnings per Common Share - Basic is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Earnings per Common Share - Diluted earnings is calculated by dividing net income (loss) by the diluted weighted average number of common shares. The diluted weighted average number of common shares is computed using the treasury stock method for common stock that may be issued for outstanding stock options and warrants.

 

As of June 30, 2018, and 2017, there were outstanding stock options and warrants to acquire an aggregate of 2,662,766 and 5,749,433 shares of Company common stock, respectively, which have a potentially dilutive impact on earnings per share. As of June 30, 2018, the aggregate intrinsic value of outstanding stock options and warrants was approximately $1.5 million. For the three and six months ended June 30, 2017, the dilutive share instruments did not have an intrinsic value, as a result, were not included in the diluted share calculation. Dilution is not permitted if there is a net loss during the period. As such, the Company does not show dilutive earnings per share for the three and six months ended June 30, 2018 and 2017.

 

Loan Fees and Other Deferred Costs

 

In the normal course of business, the Company enters into loan agreements and amendments thereto with its primary lending institutions. The majority of these lending agreements and amendments require origination fees and other fees in the course of executing the agreements. For all costs associated with the execution of the line-of-credit arrangements, the Company recognizes these as capitalized costs and amortizes these costs over the term of the loan agreement. All other costs not associated with the execution of the loan agreements are expensed as incurred. As of June 30, 2018, we had approximately $210,000 in unamortized loan fees and other deferred costs associated with the Loan and Security Agreement (the "2017 Credit Agreement") with East West Bank, a California banking corporation ("East West Bank"), recorded in Other Assets which we expect to charge to expense ratably over the three-year term of that agreement. 

 

 

Derivative Instruments

 

From time to time, the Company has interest rate swap agreements in place to hedge against changes in interest rates. The fair value of the Company’s derivative instruments are reflected as assets or liabilities on the balance sheet. The accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative instrument and the resulting designation. Transactions related to the Company’s derivative instruments accounted for as hedges are classified in the same category as the item hedged in the consolidated statement of cash flows. The Company did not hold derivative instruments at June 30, 2018 or December 31, 2017, for trading purposes.

 

On February 23, 2018, we entered into an interest rate swap agreement with East West Bank in order to hedge against the variability in cash flows from future interest payments related to the 2017 Credit Agreement. The terms of the interest rate swap agreement included an initial notional amount of $10.0 million, a fixed payment rate of 2.52%. The purpose of the swap agreement is to adjust the interest rate profile of our debt obligations. The fair value of the interest rate swap agreement is recorded in Other Assets and changes to the fair value are recorded to Other Income (Expense).

 

On September 17, 2015, we entered into an interest rate swap agreement with PNC 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 applicable a margin ranging from 4.50% to 5.50% paid by us and a floating payment rate equal to LIBOR plus 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, on August 10, 2017, we terminated the interest rate swap agreement with PNC. Changes in the fair value of the interest rate swap agreement were recorded in earnings. The Company was not party to any derivative instruments as of December 31, 2017.

 

Income Taxes 

 

The Company recognizes deferred tax liabilities and assets based on the differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities will be recognized in income in the period that includes the enactment date. A deferred tax asset or liability that is not related to an asset or liability for financial reporting is classified according to the expected reversal date. The Company records a valuation allowance to reduce deferred tax assets to an amount that it believes is more likely than not to be realized.

 

The Company accounts for any uncertainty in income taxes by recognizing the tax benefit from an uncertain tax position only if, in the Company’s opinion, it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized in the financial statements from such a position based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous.  As such, the Company is required to make many subjective assumptions and judgments regarding income tax exposures. Interpretations of and guidance surrounding income tax law and regulations change over time and may result in changes to the Company’s subjective assumptions and judgments which can materially affect amounts recognized in the consolidated balance sheets and consolidated statements of income. The result of the reassessment of the Company’s tax positions did not have an impact on the consolidated financial statements.

 

 

Interest and penalties associated with tax positions are recorded in the period assessed as income tax expense. The Company files income tax returns in the United States and in the states in which it conducts its business operations. The Company’s United States federal income tax filings for tax years 2013 through 2017 remain open to examination. In general, the Company’s various state tax filings remain open for tax years 2013 to 2017.

 

Fair Value

 

The Company follows authoritative guidance that applies to all financial assets and liabilities required to be measured and reported on a fair value basis. The Company also applies the guidance to non-financial assets and liabilities measured at fair value on a nonrecurring basis, including non-competition agreements and goodwill. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date.  The guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

 

Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability based on the best information available in the circumstances.  Beginning in 2017 the Company valued its warrants using the Binomial Lattice model ("Lattice"). The Company did not have any transfers between hierarchy levels during the three and six months ended June 30, 2018 or 2017, respectively. The financial and nonfinancial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.

 

The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

 

Level 1:

Quoted prices are available in active markets for identical assets or liabilities;

Level 2:

Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability; or

Level 3:

Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flow models or valuations.

 

Stock-based Compensation

 

Stock-based compensation cost is measured at the date of grant, based on the calculated fair value of the award as described below, and is recognized over the requisite service period, which is generally the vesting period of the equity grant.

 

The Company uses the Black-Scholes pricing model as a method for determining the estimated grant date fair value for all stock options awarded to employees, independent contractors, officers, and directors. The expected term of the options is based upon evaluation of historical and expected further exercise behavior. The risk-free interest rate is based upon U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life of the grant. Volatility is determined upon historical volatility of our stock and adjusted if future volatility is expected to vary from historical experience. The dividend yield is assumed to be none as we have not paid dividends nor do we anticipate paying any dividends in the foreseeable future.

 

The Company uses a Lattice model to determine the fair value of certain warrants. The expected term used was the remaining contractual term. Expected volatility is based upon historical volatility over a term consistent with the remaining term. The risk-free interest rate is derived from the yield on zero-coupon U.S. government securities with a remaining term equal to the contractual term of the warrants. The dividend yield is assumed to be zero.

 

The Company used the market-value of Company stock to determine the fair value of the performance-based restricted stock awarded in June 2018. The fair-value is updated quarterly based on actual forfeitures.

 

The Company used a Monte Carlo simulation program to determine the fair value of market-based restricted stock awarded in June 2018.

 

Management Estimates 

 

The preparation of the Company’s financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the realization of accounts receivable, stock-based compensation expense, income tax provision, the valuation of derivative financial instruments (warrants and interest rate swaps), and the valuation of deferred taxes. Actual results could differ from those estimates.

 

 

Reclassifications

 

Certain prior-period amounts have been reclassified for comparative purposes to conform to the current presentation. These reclassifications have no effect on the Company’s consolidated statement of operations.

 

Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842)”, which requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Either a modified retrospective transition approach for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, or a prospective approach recognizing the cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption is required. We continue to evaluate the impact of this new standard on our consolidated financial statements. Once adopted, the Company expects to recognize additional assets and liabilities on its consolidated balance sheet related to operating leases with terms longer than one year.

 

Recently Adopted

 

In May 2014, the Financial Accounting Standards Board ("FASB") issued new revenue recognition guidance under Accounting Standards Update ("ASU") 2014-09 that superseded the existing revenue recognition guidance under GAAP. The new standard focuses on creating a single source of revenue guidance for revenue arising from contracts with customers for all industries. The objective of the new standard is for companies to recognize revenue when it transfers the promised goods or services to its customers at an amount that represents what the company expects to be entitled to in exchange for those goods or services. In July 2015, the FASB deferred the effective date by one year (ASU 2015-14). This ASU is now effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017. Since the issuance of the original standard, the FASB has issued several other subsequent updates including the following: 1) clarification of the implementation guidance on principal versus agent considerations (ASU 2016-08); 2) further guidance on identifying performance obligations in a contract as well as clarifications on the licensing implementation guidance (ASU 2016-10); 3) rescission of several SEC Staff Announcements that are codified in Topic 605 (ASU 2016-11); and 4) additional guidance and practical expedients in response to identified implementation issues (ASU 2016-12). The Company adopted the new guidance effective January 1, 2018 using the modified retrospective approach, which recognizes the cumulative effect of application recognized on that date. The adoption of this standard had no impact on our consolidated financial statements; however, our footnote disclosure was expanded.

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force) (ASU 2016-15)”, that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted. The Company adopted the new guidance effective on January 1, 2018 using a retrospective transition method to each period presented. The adoption of ASU 2016-15 did not result in any impact to the presentation of our statement of cash flows.

 

In January 2017, the FASB issued ASU 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business," that clarifies the definition of a business. This ASU provides a screen to determine whether a group of assets constitutes a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated as acquisitions. If the screen is not met, this ASU (1) requires that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create an output and (2) removes the evaluation of whether a market participant could replace missing elements. Although outputs are not required for a set to be a business, outputs generally are a key element of a business; therefore, the FASB has developed more stringent criteria for sets without outputs. We adopted this ASU in the first quarter of 2018 and the adoption of this ASU did not have a material impact on the consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting," which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The Company adopted this ASU on January 1, 2018, and the adoption did not have a material impact on the Company’s consolidated financial statements.

 

 

 

 

Note 3 - Property and Equipment

 

Property and equipment consists of the following (amounts in thousands):

 

 

Note 4 – Revolving Credit Facilities

 

PNC Revolving Credit Facility

 

On March 31, 2017, we entered into the Tenth Amendment to the Amended and Restated Revolving Credit and Security Agreement (the "2014 Credit Agreement") with PNC Bank, National Association ("PNC") that among other things (i) required us to raise $1.5 million in subordinated debt or post a letter of credit in favor of PNC by March 31, 2017; (ii) raise an additional $1 million of subordinated debt by May 15, 2017; (iii) reduced the maturity date of the loan from September 12, 2019 to April 30, 2018; (iv) changed the definition of Adjusted EBITDA to include proceeds from subordinated debt; and (v) changed the calculation of fixed charge and leverage ratio from a trailing four-quarter basis to a quarterly build from the quarter ended December 31, 2016.

 

On March 31, 2017, our largest shareholder, Cross River Partners, L.P. ("Cross River"), whose general partner's managing member is the chairman of our Board of Directors, 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 $.31 per share. On May 10, 2017, Cross River also provided $1.0 million in subordinated debt to us as required under the terms of our 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 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 $0.005 par value common stock. Proceeds from the exercise of the warrants in the amount of $500,000 were used to reduce the subordinated debt balance.

 

Debt Issuance Costs

 

We have capitalized certain debt issuance costs incurred in connection with the credit agreements discussed above and these costs are being amortized to interest expense over the term of the facility on a straight-line basis. The long-term portion of debt issuance costs of approximately $210,000 and $232,000 is included in Other Assets in the accompanying condensed consolidated balance sheets for June 30, 2018 and December 31, 2017, respectively. During the three and six months ended June 30, 2018, the Company amortized approximately $24,000 and $47,000 of these costs to Interest Expense. During the three and six months ended June 30, 2017, the Company amortized approximately $37,000 and $292,000 of these costs to Interest Expense. Due to the maturity date of the 2014 Credit Agreement moving from September 12, 2019 to April 30, 2018, the Company recognized an additional $217,000 of debt issuance amortization expenses during the six months ended June 30, 2017.

 

 

 

 

 

Note 5 – Long-Term Debt

 

Long-term debt (excluding borrowings under our 2017 Credit Agreement described in Note 4) consists of the following (in thousands):

 

 

Aggregate maturities of debt, (excluding borrowings under our 2017 Credit Agreement described in Note 4), are as follows (in thousands):

 

 

 

 

 

Note 6 – Fair Value Measurements 

 

The following table presents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis by level within the fair value hierarchy:

 

 

The Company's warrant liability was valued as a derivative instrument at issuance and using a combination of a Brownian Motion technique and a Lattice model, using observable market inputs and management judgment based on the following assumptions. On June 29, 2018, both warrants, entitling the Holder to acquire 1,612,902 shares of our $0.005 par value common stock were exercised, and proceeds in the amount of $500,000 were used to reduce the subordinated debt balance.

 

The fair value of the interest rate swap is estimated using a discounted cash flow model. Such models involve using market-based observable inputs, including interest rate curves. We incorporate credit valuation adjustments to appropriately reflect both our nonperformance risk and respective counterparty’s nonperformance risk in the fair value measurements, which we have concluded are not material to the valuation. Due to the interest rate swaps being unique and not actively traded, the fair value is classified as Level 2.

 

 Certain assets and liabilities are measured at fair value on a nonrecurring basis. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances. As of June 30, 2018, and December 31, 2017, the carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, and interest approximates fair value due to the short-term nature of such items. The carrying value of the Company’s credit agreements are carried at cost which are approximately the fair value of the debt as the related interest rate are at the terms that approximate rates currently available to the Company.

 

The Company did not have any transfers of assets or liabilities between Level 1, Level 2 or Level 3 of the fair value measurement hierarchy during the three and six months ended June 30, 2018 and 2017.

 

 

 

Note 7 – 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 months ended June 30, 2018 and 2017 differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 21% and 34%, respectively to pre-tax income primarily because of state income taxes and estimated permanent differences.

 

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in various jurisdictions, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year.  The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is obtained, additional information becomes known or as the tax environment changes.

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

 

Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management recorded a valuation allowance to reduce its net deferred tax assets to zero.

 

During the six months ended June 30, 2018, the Company recorded an income tax expense of approximately $32,000 related to state income taxes owed. During the six months ended June 30, 2017, the Company recorded an income tax benefit of approximately $992,000.

 

On December 22, 2017, the U.S. government enacted comprehensive tax legislation (the “Tax Act”), which significantly revises the ongoing U.S. corporate income tax law by lowering the U.S. federal corporate income tax rate from 35% to 21%, implementing a territorial tax system, imposing a one-time tax on foreign unremitted earnings and setting limitations on deductibility of certain costs, among other things.

 

The Company is subject to the provisions of the Financial Accounting Standards Board (“FASB”) ASC 740-10, Income Taxes, which requires that the effect on deferred tax assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. Due to the complexities involved in accounting for the recently enacted Tax Act, the U.S. Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 118 requires that the Company include in its financial statements the reasonable estimate of the impact of the Tax Act on earnings to the extent such estimate has been determined.

 

Pursuant to the SAB118, the Company is allowed a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. The final impact on the Company from the Tax Act’s transition tax legislation may differ from the aforementioned estimates due to the complexity of calculating and supporting with primary evidence such U.S. tax attributes such as accumulated foreign earnings and profits, foreign tax paid, and other tax components involved in foreign tax credit calculations for prior years back to 1998. Such differences could be material, due to, among other things, changes in interpretations of the Tax Act, future legislative action to address questions that arise because of the Tax Act, changes in accounting standards for income taxes or related interpretations in response to the Tax Act, or any updates or changes to estimates the Company has utilized to calculate the transition tax's reasonable estimate. The Company will continue to evaluate the impact of the U.S. Tax Act and will record any resulting tax adjustments during 2018.

 

 

 

 

Note 8 – Commitments and Contingencies

 

Operating Leases

 

As of June 30, 2018, the Company leases facilities and certain equipment under lease commitments that expire through August 2022. Future minimum lease commitments for these operating lease commitments are as follows (in thousands):

 

  

Rent expense under operating leases, including month-to-month leases, for the three and six months ended June 30, 2018, were approximately $209,000 and $437,000, respectively. Rent expense under operating leases, including month-to-month leases, for the three and six months ended June 30, 2017, were approximately $191,000 and $405,000, respectively. 

 

Self-Insurance

 

In June 2015, the Company became self-insured under its Employee Group Medical Plan, and currently is responsible to pay the first $50,000 in medical costs per individual participant up to a maximum of approximately $1.8 million in the aggregate based on enrollment. The Company had an accrued liability of approximately $74,000 and $102,000 as of June 30, 2018 and December 31, 2017, respectively, for insurance claims that it anticipates paying in the future related to claims that occurred prior to June 30, 2018.

 

Effective April 1, 2015, the Company had entered into a workers’ compensation and employer’s liability insurance policy with a term through March 31, 2018.  Under the terms of the policy, the Company was required to pay premiums in addition to a portion of the cost of any claims made by our employees, up to a maximum of approximately $1.8 million over the term of the policy (an amount that was variable with changes in annualized compensation amounts). As of June 30, 2018, a former employee of ours had an open claim relating to injuries sustained while in the course of employment, and the projected maximum cost of the policy included estimated claim costs that have not yet been paid or incurred in connection with the claim. During the year ended December 31, 2017, our insurance carrier formally denied the workers' compensation claim and is moving to close the claim entirely. Per the terms of our insurance policy, through June 30, 2018, we had paid in approximately $1.8 million of the projected maximum plan cost of $1.8 million, and had recorded approximately $1.3 million as expense over the term of the policy. We recorded the remaining approximately $505,000 in payments made under the policy as a long-term asset, which we expect will either be recorded as expense in future periods, or refunded to us by the insurance carrier, depending on the outcome of the claim and the final cost of any additional open claims incurred under the policy.  As of June 30, 2018, we believe we have paid all amounts contractually due under the policy. Effective April 1, 2018, we entered into a new workers’ compensation policy with a fixed premium amount determined annually, and therefore are no longer partially self-insured.

 

 

Litigation 

 

The Company and its subsidiary Heat Waves are defendants in a stayed civil lawsuit in federal court in Colorado, Civil Action No. 1:15-cv-00983-RBJ (“Colorado Case”), that alleges that Enservco and Heat Waves, in offering and selling frac water heating services, infringed and induced others to infringe two patents owned by Heat-On-The-Fly, LLC (“HOTF”). The complaint relates to only a portion of the frac water heating services provided by Heat Waves. The Colorado Case has been stayed pending a final resolution of an appeal by HOTF to the U.S. Court of Appeals for the Federal Circuit (“Federal Circuit”) of a North Dakota Court’s ruling that the primary patent (“the ‘993 Patent”) in the Colorado Case was invalid. Neither Enservco nor Heat Waves is a party to the North Dakota Case, which involves other energy companies.

 

In March of 2015, the North Dakota Court determined that the ‘993 Patent was invalid. The same Court also later found that the ‘993 Patent was unenforceable due to inequitable conduct by the Patent Owner and/or the inventor. As noted above, the Patent Owner appealed these judgments to the Federal Circuit as well as several other adverse judgments and orders by the North Dakota Court.  On May 4, 2018, among other things, the Federal Circuit, affirmed the North Dakota Court’s finding of inequitable conduct with regard to the ‘993 Patent; agreed with the North Dakota jury’s finding that HOTF acted in bad faith in connection with a tortious interference claim; set aside the North Dakota Court’s denial of the Energy Companies’ attorneys’ fees; and chose not to address the North Dakota Court’s finding of invalidity of the ‘993 Patent.  The case has been sent back to the North Dakota Court to determine the issue of the energy companies’ attorneys’ fees.  In July of 2018, HOTF requested that the three-judge panel of the Federal Circuit reconsider its May 4, 2018 judgement. On August 6, 2018 the Federal Circuit Court denied the HOTF request for a rehearing. In addition to the request made in July, HOTF can petition the U.S. Supreme Court or ask that these issues be heard by the entire bench of the Federal Circuit.

 

In September 2016 and February 2017, HOTF was issued two additional patents, both of which could be asserted against Enservco and/or Heat Waves. Management believes that final findings of invalidity and/or unenforceability of the ‘993 Patent based on inequitable conduct could serve as a basis to affect the validity and/or enforceability of each of HOTF’s patents. If all of these Patents are ultimately held to be invalid and/or unenforceable, the Colorado Case would become moot.

 

In the event that HOTF ultimately succeeds after exhausting all appeals and the ‘993 Patent is found to be valid and/or enforceable, the Colorado Case may resume. To the extent that Enservco and Heat Waves are unsuccessful in their defense of the Colorado Case, they could be liable for enhanced damages/attorneys’ fees (both of which may be significant) and Heat Waves could possibly be enjoined from using any technology that is determined to be infringing. Either result could negatively impact Heat Waves’ business and operations. At this time, the Company is unable to predict the outcome of this case, and accordingly has not recorded an accrual for any potential loss.

 

Note 9 – Stockholders’ Equity

 

Warrants

 

In June 2016, the Company granted a principal of the Company’s investor relations firm warrants to acquire 30,000 shares of the Company’s common stock in connection with a reduction of the firm's ongoing monthly cash service fees. The warrants had a grant-date fair value of $0.36 per share and vested over a one-year period, 15,000 on December 21, 2016 and 15,000 on June 21, 2017. As of June 30, 2018, all of these warrants remain outstanding and are exercisable until June 21, 2021 at $0.70 per share.

 

In June 2017, in connection with a subordinated loan agreement, the Company granted Cross River two five-year warrants to buy an aggregate total of 1,612,902 shares of the Company’s common stock at an exercise price of $0.31 per share, the average closing price of the Company’s common stock for the 20-day period ended May 11, 2017. The warrants had a grant-date fair value of $0.19 per share and vested in full on June 28, 2017. These warrants were accounted for as a liability in the accompanying balance sheet as of December 31, 2017. On June 29, 2018 Cross River exercised both warrants and acquired 1,612,902 shares of our $0.005 par value common stock. Proceeds from the exercise of the warrants in the amount of $500,000 were used to reduce the subordinated debt balance.

 

 

A summary of warrant activity for the six months ended June 30, 2018 is as follows (amounts in thousands): 

 

 

 

Stock Issued for Services

 

During the three and six months ended June 30, 2018 and 2017, respectively, the Company did not issue any shares of common stock as compensation for services provided to the Company. 

 

Note 10 – Stock Options and Restricted Stock

 

Stock Options

 

On July 27, 2010, the Company’s Board of Directors adopted the 2010 Stock Incentive Plan (the “2010 Plan”). The aggregate number of shares of common stock that could be granted under the 2010 Plan was reset at the beginning of each year based on 15% of the number of shares of common stock then outstanding. As such, on January 1, 2016 the number of shares of common stock available under the 2010 Plan was reset to 5,719,069 shares based upon 38,127,129 shares outstanding on that date. Options were typically granted with an exercise price equal to the estimated fair value of the Company's common stock at the date of grant with a vesting schedule of one to three years and a contractual term of 5 years. As discussed below, the 2010 Plan has been replaced by a new stock option plan and no additional stock option grants will be granted under the 2010 Plan. As of June 30, 2018, there were options to purchase 866,166 shares outstanding under the 2010 Plan.

 

On July 18, 2016, the Board of Directors unanimously approved the adoption of the Enservco Corporation 2016 Stock Incentive Plan (the “2016 Plan”), which was approved by the stockholders on September 29, 2016. The aggregate number of shares of common stock that may be granted under the 2016 Plan is 8,000,000 shares plus authorized and unissued shares from the 2010 Plan totaling 2,391,711 for a total reserve of 10,391,711 shares. As of June 30, 2018, there were options to purchase 1,766,600 shares outstanding under the 2016 Plan.

 

We have not granted any stock options during the three and six months ended June 30, 2018. During the six months ended June 30, 2017, the Company granted options to acquire 2,171,600 shares of common stock.

 

 

 

During the six months ended June 30, 2018 employees and former employees of the Company exercised 1,230,002 options to purchase shares of Company common stock on a cashless basis resulting in the issuance of 663,938 shares. During the six months ended June 30, 2017, no options were exercised. The following is a summary of stock option activity for all equity plans for the three months ended June 30, 2018 (amounts in thousands): 

 

 

The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the estimated fair value of the Company’s common stock on June 30, 2018, and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had they exercised their options on June 30, 2018.

 

During the three and six months ended June 30, 2018, the Company recognized stock-based compensation costs for stock options of approximately $61,000 and $134,000, respectively, in sales, general, and administrative expenses. The Company currently expects all outstanding options to vest. Compensation cost is revised if subsequent information indicates that the actual number of options vested due to service is likely to differ from previous estimates. During the three and six months ended June 30, 2017, the Company recognized stock-based compensation costs for stock options of approximately $311,000 and $446,000, respectively, in general and administrative expenses.

 

A summary of the status of non-vested shares underlying the options are presented below:

 

 

As of June 30, 2018, there was approximately $203,000 of total unrecognized compensation costs related to non-vested shares under the Company’s stock option plans which will be recognized over the remaining weighted-average period of 1.22 years.

 

Restricted Stock

 

Restricted shares issued pursuant to restricted stock awards under the 2016 Stock Plan 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.

 

On June 14, 2018, the Company's Board of Director's granted 990,000 shares of restricted stock to the Company's employees. The awards had an aggregate grant-date fair value of approximately $1.1 million. 

 

A summary of the restricted stock activity is presented below:

 

 

During the three and six months ended June 30, 2018, the Company recognized stock-based compensation costs for restricted stock of approximately $54,000 in sales, general, and administrative expenses. 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.

 

 

 

Note 11- Segment Reporting

 

Enservco’s reportable business segments are Well Enhancement Services, Water Transfer Services, and Water Hauling Services. These segments have been selected based on changes in management’s resource allocation and performance assessment in making decisions regarding the Company.

 

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 Field in Kansas.

 

Unallocated and other 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):

 

 

(1)

Identifiable assets is calculated by summing the balances of accounts receivable, net; inventories; property and equipment, net; and other assets.

 

 

(1)

Identifiable assets is calculated by summing the balances of accounts receivable, net; inventories; property and equipment, net; and other assets.

 

The following table reconciles the segment profits reported above to the income from operations reported in the consolidated statements of operations (in thousands):

 

 

 

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 June 30, 2018 and 2017 (in thousands):

 

 

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 and Hugoton Field (southwestern Kansas, north central 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.

 

 

 

 

 

 

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Hot oil revenues for the three months ended June 30, 2018 increased approximately $442,000, or 19%, compared to the same period in 2017. Hot oil revenues for the six months ended June 30, 2018 increased approximately $833,000, or 15%, compared to the same period in 2017. 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 over last year.

 

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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.

 

 

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