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ESA > SEC Filings for ESA > Form 10-K on 22-Dec-2011All Recent SEC Filings

Show all filings for ENERGY SERVICES OF AMERICA CORP

Form 10-K for ENERGY SERVICES OF AMERICA CORP


22-Dec-2011

Annual Report


ITEM 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations

You should read the following discussion of the financial condition and results of operations of Energy Services in conjunction with the historical financial statements and related notes contained elsewhere herein. Among other things, those historical consolidated financial statements include more detailed information regarding the basis of presentation for the following information.

Forward Looking Statements

Within Energy Services' consolidated financial statements and this discussion and analysis of the financial condition and results of operations, there are included statements reflecting assumptions, expectations, projections, intentions or beliefs about future events that are intended as "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as "anticipate," "estimate," "project," "forecast," "may," "will," "should," "could," "expect," "believe," "intend" and other words of similar meaning.

These forward-looking statements are not guarantees of future performance and involve or rely on a number of risks, uncertainties, and assumptions that are difficult to predict or beyond Energy Services' control. Energy Services has based its forward-looking statements on management's beliefs and assumptions based on information available to management at the time the statements are made. Actual outcomes and results may differ materially from what is expressed, implied and forecasted by forward-looking statements and that any or all of Energy Services' forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions and by known or unknown risks and uncertainties.


All of the forward-looking statements, whether written or oral, are expressly qualified by these cautionary statements and any other cautionary statements that may accompany such forward-looking statements or that are otherwise included in this report. In addition, Energy Services does not undertake and expressly disclaims any obligation to update or revise any forward-looking statements to reflect events or circumstances after the date of this report or otherwise.

Overview

Energy Services was formed on March 31, 2006, to serve as a vehicle to effect a merger, capital stock exchange, asset acquisition or other similar business combination with an operating business. It operated as a "blank check company" until August 15, 2008 at which time it completed the acquisitions of ST Pipeline, Inc. and C J Hughes Construction Company, Inc. S.T. Pipeline and CJ Hughes are considered predecessor companies to Energy Services. The Company acquired S.T. Pipeline for $16.2 million in cash and $3.0 million in a promissory note. The C J Hughes purchase price totaled $34 million, one half of which was in cash and one half in Energy Services common stock. The acquisitions were accounted for under the purchase method.

Energy Services is engaged in providing contracting services for energy related companies. Currently Energy Services primarily services the Gas, Oil and Electrical industries though it does some other incidental work. For the Gas industry, the Company is primarily engaged in the construction, replacement and repair of natural gas pipelines and storage facilities for utility companies and private natural gas companies. Energy Services is involved in the construction of both interstate and intrastate pipelines, with an emphasis on the latter. For the Oil industry the Company provides a variety of services relating to pipeline, storage facilities and plant work. For the Electrical industry, the Company provides a full range of electrical installations and repairs including substation and switchyard services, site preparation, packaged buildings, transformers and other ancillary work with regards thereto. Energy Services' other services include liquid pipeline construction, pump station construction, production facility construction, water and sewer pipeline installations, various maintenance and repair services and other services related to pipeline construction. The majority of the Company's customers are located in West Virginia, Virginia, Ohio, Pennsylvania, Kentucky and North Carolina. The Company builds, but does not own, natural gas pipelines for its customers that are part of both interstate and intrastate pipeline systems that move natural gas from producing regions to consumption regions as well as building and replacing gas line services to individual customers of the various utility companies. Our consolidated operating revenues for the year ended September 30, 2011 were $143.4 million which 74% was attributable to gas work, 18% to electrical services and 8% to water and sewer installations and other ancillary services. The Company had consolidated operating revenues of $218 million for the year ended September 30, 2010 of which 74% was attributable to gas work, 20% to electrical services customers, and 6% for water and sewer installation and other ancillary services.

Energy Services' customers include many of the leading companies in the industries it serves, including Marathon Ashland Petroleum LLC, Spectra Energy, Equitable Resources, Hitachi and Nisource. The Company enters into various types of contracts, including competitive unit price, cost-plus (or time and materials basis) and fixed price (lump sum) contracts. The terms of the contracts will vary from job to job and customer to customer though most contracts are on the basis of either unit pricing in which the Company agrees to do the work for a price per unit of work performed or for a fixed amount for the entire project. Most of the Company's projects are completed within one year of the start of the work. On occasion, the Company's customers will require the posting of performance and/or payment bonds upon execution of the contract, depending upon the nature of the work performed.

The Company generally recognizes revenue on unit price and cost-plus contracts when units are completed or services are performed. Fixed price contracts usually results in recording revenues as work on the contract progresses on a percentage of completion basis. Under this accounting method, revenue is recognized based on the percentage of total costs incurred to date in proportion to total estimated costs to complete the contract. Many contracts also include retainage provisions under which a percentage of the contract price is withheld until the project is complete and has been accepted by the customer.


Seasonality: Fluctuation of Results

Our revenues and results of operations can and usually are subject to seasonal variations. These variations are the result of weather, customer spending patterns, bidding seasons and holidays. The first quarter of the calendar year is typically the slowest in terms of revenues because inclement weather conditions causes delays in production and customers usually do not plan large projects during that time. While usually better than the first quarter, the second quarter often has some inclement weather which can cause delays in production, reducing the revenues the Company receives and/or increasing the production costs. The third quarter usually is least impacted by weather and usually has the largest number of projects underway. The fourth quarter is usually lower than the third due to the various holidays. Many projects are completed in the fourth quarter and revenues are often impacted by customers seeking to either spend their capital budget for the year or scale back projects due to capital budget overruns.

In addition to the fluctuations discussed above, the pipeline industry can be highly cyclical, reflecting variances in capital expenditures in proportion to energy price fluctuations. As a result, our volume of business may be adversely affected by where our customers are in the cycle and thereby their financial condition as to their capital needs and access to capital to finance those needs.

Accordingly, our operating results in any particular quarter or year may not be indicative of the results that can be expected for any other quarter or any other year. You should read "Understanding Gross Margins" and "Outlook" below for discussions of trends and challenges that may affect our financial condition and results of operations.

Understanding Gross Margins

Our gross margin is gross profit expressed as a percentage of revenues. Cost of revenues consists primarily of salaries, wages and some benefits to employees, depreciation, fuel and other equipment costs, equipment rentals, subcontracted services, portions of insurance, facilities expense, materials and parts and supplies. Various factors, some controllable, some not impact our gross margin on a quarterly or annual basis.

Seasonal. As discussed above, seasonal patterns can have a significant impact on gross margins. Usually, business is slower in the winter months versus the warmer months.

Weather. Adverse or favorable weather conditions can impact gross margin in a given period. Periods of wet weather, snow or rainfall, as well as severe temperature extremes can severely impact production and therefore negatively impact revenues and margins. Conversely, periods of dry weather with moderate temperatures can positively impact revenues and margins due to the opportunity for increased production and efficiencies.

Revenue Mix. The mix of revenues between customer types and types of work for various customers will impact gross margins. Some projects will have greater margins while others that are extremely competitive in bidding may have narrower margins.

Service and Maintenance versus installation. In general, installation work has a higher gross margin than maintenance work. This is due to the fact that installation work usually is more of a fixed price nature and therefore has higher risks involved. Accordingly, a higher portion of the revenue mix from installation work typically will result in higher margins.

Subcontract work. Work that is subcontracted to other service providers generally has lower gross margins. Increases in subcontract work as a percentage of total revenues in a given period may contribute to a decrease in gross margin.

Materials versus Labor. Typically materials supplied on projects have lower margins than labor. Accordingly, projects with a higher material cost in relation to the entire job will have a lower overall margin.


Depreciation. Depreciation is included in our cost of revenue. This is a common practice in our industry, but can make comparability to other companies difficult.

Margin risk. Failure to properly execute a job including failure to properly manage and supervise a job could decrease the profit margin.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of compensation and related benefits to management, administrative salaries and benefits, marketing, communications, office and utility costs, professional fees, bad debt expense, letter of credit fees, general liability insurance and miscellaneous other expenses.

Results of Operations

The following table sets forth the Consolidated Statement of Operations for the years ended September 30, 2011 and 2010.

                                                              Year Ended September 30,
                                                         2011                          2010
                                                               (Dollars in thousands)
                                                Amount        Percent         Amount        Percent
Contract Revenues                              $ 143,426          100.0 %    $ 218,288          100.0 %
Cost of Revenues                                 136,585           95.2        193,916           88.8
Gross Profit                                       6,841            4.8         24,372           11.2
Selling, general and administrative expenses      13,269            9.3         12,733            5.8
Income (loss) from operations before taxes        (6,428 )         (4.5 )       11,639            5.3
Interest Income                                        3            0.0             56            0.0
Interest Expense                                  (1,821 )         (1.3 )       (1,842 )         (0.8 )
Other Income                                          24            0.0            292            0.1
Income (loss) before Income Taxes                 (8,222 )         (5.7 )       10,145            4.6
Income taxes                                      (2,946 )         (2.1 )        4,373            2.0
Net Income (Loss)                              $  (5,276 )         (3.7 )%   $   5,772            2.6 %

Earnings (loss) Per Share-Basic                    (0.44 )                        0.48
Earnings (loss) Per Share-Diluted                  (0.44 )                        0.48

2011 compared to 2010

Revenues. Revenue decreased $74.9 million or 34.3% to $143.4 million for the year ended September 30, 2011. The decrease was primarily driven by two major factors. The weather during this period was extreme. We experienced more rain in areas where projects were on-going this year than we have in the prior fifteen years. As a result many projects were delayed or canceled. One major project was delayed until 2012. The second major factor was that in 2010 we completed two major projects that were not replaced by similar projects in 2011.

Costs of Revenues. Cost of revenues decreased by $57.3 million or 29.6% to $136.6 million for the year ended September 30, 2011. Cost of revenues decrease was driven by the factors mentioned above. Costs of revenues were greater than expected due to lower productivity reflecting weather delays, causing losses on some projects.

Gross Profit. Gross profits decreased by $17.5 million or 71.9% to $6.8 million for the year ended September 30, 2011. The decrease was due to the items mentioned above.

Selling, general and administrative expenses. Selling, general and administrative expenses increased by $536,000 or 4.2% to $13.3 million for the year ended September 30, 2011. The increase was primarily driven by the increase in professional fees related to the warrant conversion.

Income from operations. Income from operations decreased by $18.1 million or 155.2% to a loss of $6.4 million for the year ended September 30, 2011. The decrease in net income reflects the effects of the items mentioned above.


Interest Expense. Interest expense decreased by $20,000 or 1.1% to $1.82 million for the year ended September 30, 2011. The decrease was due to a minor decrease in borrowings to fund operating costs.

Income Taxes. Income tax benefit for the period ending September 30, 2011 was $2.9 million as compared to an expense of $4.4 million for the period ending September 30, 2010. The Company's effective tax rate was 35.8% for the period ending September 30, 2011 and 43.1% for the period ending September 30, 2010.

Net Income(Loss). We incurred a net loss of $5.3 million for the year ended September 30, 2011 compared with net income of $5.8 million in fiscal 2010.

Comparison of Financial Condition

The Company had total assets of $111.0 million at September 30, 2011 a decrease of $17.9 million from the prior fiscal year end balance. Some primary components of the balance sheet were accounts receivable which totaled $19.1 million, a decrease of $6.7 million from the prior year end balances and estimated earnings in excess of billings of $12.6 million, a decrease of $7.7 million from the prior year end. Other major categories of assets at September 30, 2011 included cash of $3 million, an increase of $389,000 from the prior year balance as well as net fixed assets of $23.8 million, a decrease of $3.3 million from prior year balance.

Liabilities totaled $56.1 million a decrease of $12.7 million from the prior year balance. Current maturities of long-term debt was reduced by $2.0 million. Accounts payable and accrued expenses decreased by $13.4 million as a result of the decreases in expenses discussed above. Stockholders' equity was $54.9 million a decrease of $5.2 million from the prior year due to the net loss generated by the Company in 2011.

Liquidity and Capital Resources

Cash Requirements

We anticipate that our cash and cash equivalents on hand at September 30, 2011 which totaled $3.0 million along with our credit facilities available to us and our anticipated future cash flows from operations will provide sufficient cash to meet our operating needs. However, with the increased demand for our services, we could be faced with needing significant additional working capital. We are currently working to secure additional working capital. Limited access to additional working capital could limit the Company's ability to grow and affect the Company's overall liquidity.

Sources and Uses of Cash



  As of September 30, 2011, we had $3.0 million in cash, working capital of
$14.9 million and long term debt net of current maturities of $13.6 million. The
maturities of the total long term debt are as follows.

                              2012          $4,823,076
                              2013           5,553,976
                              2014           2,980,812
                              2015           2,846,166
                              2016           2,232,779
                              Thereafter         7,453
                              Total        $18,444,262

Line of Credit

The Company has established a eighteen million ($18,000,000) Line of Credit agreement with a regional bank. Interest will accrue on the line of credit at an annual rate based on the "Wall Street Journal" Prime Rate (the Index) with a floor of six percent (6.0%). Cash available under the line is calculated based on a percentage of the Company's accounts receivable with certain exclusions. Major items excluded from calculation are certain percentages of receivables from bonded jobs and retainage as well as items greater than one hundred twenty (120) days old. At September 30, 2011 the Company had $4.1 million available on the line. A portion of the line of credit was used to repay other outstanding loan balances.


The following are the major covenants of the line:

1. Current Ratio must be not less than 1.5. As of September 30, 2011 our current ratio was 1.42 to 1. This covenant was waived for ninety days.

2. Debt to tangible net worth must not exceed 3.5. As of September 30, 2011 this ratio was 3.12 to 1.

3. Capital Expenditures (CAPEX) must not exceed $7.5 million per year. CAPEX from the loan date was approximately $320,000.

4. Dividends shall not exceed 50% of taxable income without prior bank approval. No dividends have been declared.

We were in compliance with, or have obtained waivers for all loan covenants as of the period ending September 30, 2011.

Off-Balance Sheet transactions

Due to the nature of our industry, we often enter into certain off-balance sheet arrangements in the ordinary course of business that result in risks not directly reflected in our balance sheets. Though for the most part not material in nature, some of these are:

Leases

Our work often requires us to lease various facilities, equipment and vehicles. These leases usually are short term in nature, one year or less though at times we may enter into longer term leases when warranted. By leasing equipment, vehicles and facilities, we are able to reduce our capital outlay requirements for equipment vehicles and facilities that we may only need for short periods of time. The Company currently rents two pieces of real estate from stockholders-directors of the company under long-term lease agreements. The one agreement calls for monthly rental payments of $5,000 and extends through August 15, 2014. The second agreement is for the Company's headquarter offices and is rented from a corporation in which two of the Company's directors are shareholders. The agreement began November 1, 2008 and runs through 2011 with options to renew. This agreement calls for a monthly rental of $7,500 per month. The Company also rents office and shop space from other independent lessors. The office space rental is $11,000 per month and extends to December 2012. The shop rental is $2,200 monthly and extends to October 2012.

Letters of Credit

Certain of our customers or vendors may require letters of credit to secure payments that the vendors are making on our behalf or to secure payments to subcontractors, vendors, etc. on various customer projects. At September 30, 2011, the Company had no outstanding Letters of Credit.


Performance Bonds

Some customers, particularly new ones or governmental agencies, require us to post bid bonds, performance bonds and payment bonds. These bonds are obtained through insurance carriers and guarantee to the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. If we fail to perform under a contract or to pay subcontractors and vendors, the customer may demand that the insurer make payments or provide services under the bond. We must reimburse the insurer for any expenses or outlays it is required to make. Depending upon the size and conditions of a particular contract, we may be required to post letters of credit or other collateral in favor of the insurer. Posting of these letters or other collateral will reduce our borrowing capabilities. Historically, the Company has never had a payment made by an insurer under these circumstances and does not anticipate any claims in the foreseeable future. At September 30, 2011, we had $111 million in performance bonds issued by the insurer outstanding.

Concentration of Credit Risk

In the ordinary course of business the company grants credit under normal payment terms, generally without collateral, to our customers, which include natural gas and oil companies, general contractors, and various commercial and industrial customers located within the United States. Consequently, we are subject to potential credit risk related to business and economic factors that would affect these companies. However, we generally have certain statutory lien rights with respect to services provided. Under certain circumstances such as foreclosure, we may take title to the underlying assets in lieu of cash in settlement of receivables. The company had only four customers that exceeded ten percent of revenues or receivables for the year ended September 30, 2011. The Company had two customers that represented 11.5% and 12.8% of revenues and two other customers that represented 13.4% and 18.2% of accounts receivable for the year ended September 30, 2011.

Litigation

The Company is a party from time to time to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. These actions typically seek, among other things, compensation for alleged personal injury, breach of contract and/or property damages, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. With respect to all such lawsuits, claims, and proceedings, we record reserves when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We do not believe that any of these proceedings, separately or in aggregate, would be expected to have a material adverse effect on our financial position, results of operations or cash flows.

Related Party Transactions

In the normal course of business, we enter into transactions from time to time with related parties. These transactions typically would not be material in nature and would usually relate to real estate, vehicle or equipment rentals.

Inflation

Due to relatively low levels of inflation during the years ended September 30, 2011 and 2010, inflation did not have a significant effect on our results.

New Accounting Pronouncements

In September 2011, the FASB issued ASU No. 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment", which amends the procedures for impairment testing of goodwill. This standard allows the use of qualitative factors in determining if goodwill impairment is more likely than not to exist. If qualitative information indicates that it is not more likely than not that impairment of goodwill exists, then the quantitative two step impairment test will not be required. The Company will adopt this standard in the fourth calendar quarter of 2011. Adoption of the new guidance, in itself, will not have an impact on the Company's statements of income and financial condition.


Critical Accounting Policies

The discussion and analysis of the Company's financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. We evaluate our estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates. Management believes the following accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Income Taxes

The Company and all subsidiaries file a consolidated federal and various state income tax returns on a fiscal year basis. With few exceptions, the company is no longer subject to U.S. federal, state, or local income tax examinations for years ending prior to September 30, 2008.

The Company follows the liability method of accounting for income taxes in accordance with the Income Taxes topic of the FASB ASC. Under this method, deferred tax assets and liabilities are recorded for future tax consequences of temporary differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that are expected to be in effect when the underlying assets or liabilities are recovered or settled. GAAP prescribes a comprehensive model for how companies should recognize, measure, present and disclose in their financial statements uncertain tax positions taken or to be taken on a tax return.

Goodwill

The Company has selected July 1 as the date of the annual goodwill impairment evaluation, which is the first day of our fourth fiscal quarter. Goodwill was assigned to the operating units at the time of acquisition. The reporting units to which goodwill was assigned are CJ Hughes ("CJ"), Contractors Rental Corp (a subsidiary of CJ Hughes)"CRC"), Nitro Electric (a subsidiary of CJ Hughes-"Nitro") and to ST Pipeline. The assignment to CJ consolidated and ST . . .

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