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ENSV > SEC Filings for ENSV > Form 10-K on 20-Mar-2014All Recent SEC Filings

Show all filings for ENSERVCO CORP

Form 10-K for ENSERVCO CORP


20-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information regarding the results of operations for the years ended December 31, 2013 and 2012, and our financial condition, liquidity and capital resources as of December 31, 2013 and 2012. The financial statements and the notes thereto contain detailed information that should be referred to in conjunction with this discussion.

The following discussion and analysis should be read in conjunction with and our historical consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K, as well as the Risk Factors and the Cautionary Note Regarding Forward-Looking Statements included above.

OVERVIEW

The Company provides fluid management and well enhancement 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 hauling, fluid disposal, frac tank rental (fluid management services) and other general oilfield services. The Company owns and operates a fleet of more than 230 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 Green River and Powder River Basins in Wyoming and the Mississippi Lime and Hugoton Fields in Kansas and Oklahoma.

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. The Company may 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 for the periods noted. Please see information following the table for management's discussion of significant changes.

                                                          Years Ended December 31,
                                                             % of                            % of
                                              2013          Revenue           2012         Revenue
FINANCIAL RESULTS:
Revenues                                  $  46,473,902           100 %   $ 31,497,787          100 %
Cost of Revenue                              31,944,279            69 %     23,545,101           75 %
Gross Profit                                 14,529,623            31 %      7,952,686           25 %

Operating Expenses
General and administrative expenses           4,070,884             9 %      3,291,898           11 %
Depreciation and amortization                 2,088,767             4 %      2,960,153            9 %
Total operating expenses                      6,159,651            13 %      6,252,051           20 %

Income from Operations                        8,369,972            18 %      1,700,635            5 %
Interest Expense and Other                    (867,335)           (2) %      (872,368)          (3) %

Income From Continuing Operations
Before Tax                                    7,502,637            16 %        828,267            2 %
Income Tax Expense                          (3,126,937)           (7) %      (426,779)          (1) %
Income From Continuing Operations         $   4,375,700             9 %   $    401,488            1 %

Net Income (Loss)                         $   4,301,237             9 %   $   (85,070)            - %

Net Income (Loss) per Common Share -
Diluted                                   $        0.12                   $     (0.00)
Diluted weighted average number of
common shares
  outstanding                                37,113,017                     24,316,869

OTHER:
Adjusted EBITDA(a) From Continuing
Operations                                $  10,931,095                   $  4,940,150
Adjusted EBITDA(a) Margin                            24 %                           16 %

(a) Management believes that, for the reasons set forth below, adjusted EBITDA and adjusted EBITDA margin (even though 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 our industry. See further discussion of our use of EBITDA, the risks of non-GAAP measures, and the reconciliation to Net Income, in item 7.

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 revenue by service offering may be useful to readers of our financial statements. The following tables set forth revenue from continuing operations for the Company's three service offerings and geographic areas during the years ending December 31, 2013 and 2012 (for discussion around revenue from discontinued operations, see the Discontinued Operations section below as well as Note 3 to our consolidated financial statements within the Form 10K accompanying this report):

                                                      Years Ended December 31,
                                                        2013            2012
BY SERVICE OFFERING:
Well Enhancement Services (1)                       $  37,160,625   $ 21,601,870

Fluid Management (2)                                    9,014,182      9,503,952

Well Site Construction and Roustabout Services(3)         299,095        391,965

Total Revenues                                      $  46,473,902   $ 31,497,787

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 what it believes are three geographically diverse regions. The following table sets forth revenue from continuing operations for the Company's three geographic regions during the years ending December 31, 2013 and 2012 (again, for discussion around revenue from discontinued operations, see the Discontinued Operations section below as well as Note 3 to our consolidated financial statements within the Form 10K accompanying this report):

                              Years Ended December 31,
                                2013            2012
BY GEOGRAPHIC AREA:
Rocky Mountain Region (4)   $  26,059,306   $ 16,299,862

Central USA Region (5)         11,997,544     11,631,843

Eastern USA Region (6)          8,417,052      3,566,082

Total Revenues              $  46,473,902   $ 31,497,787

Notes to tables:
(1) Frac water heating, acidizing, hot oil services, and pressure testing.

(2) Water hauling/disposal and frac tank rental.

(3) Amounts herein represent our Dillco construction and roustabout services. During 2012, the Heat Waves' construction and roustabout service line was discontinued. See Note 3 to our consolidated financial statements accompanying the Form 10K within this report for more details.

(4) Consists of western Colorado, southeastern Wyoming, western North Dakota, and eastern Montana. Heat Waves is the only Company subsidiary operating in this region.

(5) Consists of southwestern Kansas, northwestern Oklahoma, Texas panhandle, and northern New Mexico. Both Dillco and Heat Waves engage in business operations in this region.

(6) Consists of the southern region of the Marcellus Shale formation (southwestern Pennsylvania and northern West Virginia) and the Utica Shale formation (eastern Ohio). Heat Waves is the only Company subsidiary operating in this region.

Revenues:

Revenues from continuing operations increased $15.0 million or 48% to $46.5 million for the year ended December 31, 2013. The record revenue growth for 2013 was primarily attributable to revenues from our flagship well enhancement services, which increased $15.6 million or 72% from 2012 and overcame a reduction of about $490,000 in revenues in our fluid management services.

Well Enhancement Services

Well enhancement service revenues, which includes frac water heating, hot oiling, and acidizing services continued to show record growth in 2013 increasing $15.6 million or 72% to $37.2 million for the year ended December 31, 2013. Increased customer demand particularly in the Rocky Mountain Region and Eastern USA Region combined with increased heating capacity from the addition of new frac water heating and hot oil equipment were the primary reason for our growth in 2013.

The following factors contributed to the increase in well enhancement revenues during 2013:

(1) During 2012 and 2013, the Company expanded its heating capacity by investing in additional trucks and equipment to meet the growing demand for our frac water heating and hot oiling services. As part of this expansion, the Company purchased and fabricated two new hot oil units and five double-burner frac water heating units which were deployed near the beginning of 2013. In addition, as part of our 2013 CAPEX program, four additional hot oil trucks were fabricated and deployed near the start of the fourth quarter of 2013 and three additional bobtail frac heaters and a double-burner frac heater deployed in December 2013;

(2) Increased horizontal drilling and completion activity in the Niobrara Shale/DJ Basin by several customers resulted in higher frac water heating service during 2013 as compared to the same period last year;

(3) Well Enhancement Service revenues during the first part of 2012 were affected by higher-than-average temperatures which reduced customer demand for heating services. Temperature and weather patterns during 2013 were more in line with historical averages, thus increasing demand for our frac water heating and hot oiling services; and

(4) Well Enhancement Service Revenues in the Eastern USA region increased by approximately $4.9 million from 2012 to 2013 due to continued expansion into the Utica Shale market where exploration and production activity and demand for our services increased over 2012.

Fluid Management Services

Fluid management service revenues, which represent about 19% of our consolidated revenues for 2013, declined $490,000 or 5% from 2012 to 2013. This decline was primarily attributable to the lost revenue from a low margin water hauling customer in the Central USA region which services had been declining since early 2013. The Company had been working to replace this business with higher margin business and finalized a service agreement with a new customer in September 2013 which replaced most of the monthly revenue lost from the previous customer. Fluid management revenues during the fourth quarter returned back to 2012 levels. The Company will continue to try to maintain it's pricing in this competitive market and prevent further dilution to its existing gross margins.

Well Site Construction and Roustabout Services

Well site construction and roustabout services, which represent less than 1% of 2013 revenues declined $93,000 or 24% from 2012. These services are not a significant part of our business and are provided as ancillary services with our other services.

Geographic Areas

Revenues in the Rocky Mountain Region, which primarily consist of well enhancement services, continued to show strong growth increasing $9.8 million or 60% to $26.1 million for the year ended December 31, 2013. Increased drilling and completion activity by several customers in the Niobrara Shale/DJ Basin combined with recent expansion of our service into Rock Springs contributed to this increase.

Revenues in the Central USA region increased $366,000 or 3% from 2012 to 2013 primarily due to increased well enhancement revenues from our Garden City yard, which more than offset the decline in water hauling services in this region.

Revenues in the Eastern USA region increased $4.9 million or 136% primarily due to the continued expansion of our services into the Utica Shale market where exploration and production activity and demand for our services increased over 2012. During 2013, the Company added to two sizable customers in addition to experiencing revenue growth with its two largest customers.

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 is known as 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 among quarters 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 revenues of $33.7 million (73%) during the first and fourth quarters of 2013 compared to $12.7 million (27%) during the second and third quarters of 2013. In 2012, the Company earned revenues of $20.8 million (66%) during the first and fourth quarters of 2012, compared to $10.7 million (34%) during the second and third quarters of 2012. 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.

Costs of Revenues and Gross Profit:

Cost of revenues for the year ended December 31, 2013 increased $8.4 million or 36% from the comparable period last year. As a percentage of revenues, cost of revenues for 2013 decreased to 69% of revenues as compared to 75% of revenues for 2012. Gross profit for the year ended December 31, 2013 increased to $14.5 million or 31% of revenues as compared to $8.0 million or 25% of revenues during 2012. Increased revenues from higher margin well enhancement services combined with improved labor efficiencies were the primary reasons for the corresponding increase in gross profits and gross margins. These increases were slightly tempered by a spike in propane prices in December 2013.

Below is a more detailed discussion of the factors that impacted gross margins:

(1) Well enhancement service revenues, which typically generate a higher gross profit margin than other services, increased to 80% of consolidated revenues for the year ended December 31, 2013 as compared to 68% during 2012. The increase in revenue from the higher margin well enhancement services increased the overall gross margin of the business;

(2) Labor costs as a percentage of revenue were higher during 2012 due to the unseasonably warm weather during the first half of the 2012, which resulted in lower utilization of field personnel;

(3) The Company's cost of revenues include certain fixed cost components which do not fluctuate in relationship to changes in revenues. Items such as field office costs, employee housing, and other site overhead costs remained relatively flat during 2013. Accordingly, the increase in revenues during 2013 resulted in a higher gross margin as compared to 2012; and

(4) In December 2013, a sudden spike in propane prices significantly impacted the gross margins our frac water heating business. At the time, approximately half of our frac water heating revenues were contractually priced on a fixed per barrel basis that included propane costs. As a result, gross margins significantly dropped on these contracts. Fortunately, these per barrel contracts contained a price adjustment clause that was triggered January 2014 and allowed us to move to a pricing schedule that allows us to bill propane on a cost plus basis. The increase in propane prices reduced gross margins for the fourth quarter of 2013 to 26% as compared to 32% in the fourth quarter of 2012. The Company anticipates that the revised pricing schedule will return margins to normal levels.

General and Administrative Expenses:

For the year ended December 31, 2013, general and administrative expenses increased $779,000 or 24% from 2012. Higher stock based compensation associated with stock option grants, higher investor relations costs, and higher professional fees all contributed to this increase. Bad debt expense, which is included in general and administrative expense, also contributed $192,000 to this increase as the Company increased its allowance for doubtful accounts due to the corresponding increase in receivables.

As a percentage of revenues, general and administrative expenses decreased from 11% of revenues in 2012 to 9% of revenues for the year ended December 31, 2013 as compared to last year.

Depreciation and Amortization:

Depreciation and amortization expense for the year ended December 31, 2013 decreased $871,000, or 29% from 2012 primarily due to the change in useful lives of trucks, equipment and disposal wells in March 2012. The Company reassessed the estimated useful lives of this equipment and increased the useful lives of its trucks and equipment from 5-7 years to 10 years, and increased the useful lives of its disposal wells from 7-10 years to 15 years. This change in accounting estimate reduced depreciation and amortization expense by approximately $800,000 for the year ended December 31, 2013 as compared to 2012. This decrease was partially offset by additional depreciation expense on new property and equipment added during 2012 and 2013. Lower amortization expense related to non-compete agreements also contributed to the overall decrease for 2013. The non-compete agreements were fully amortized in February 2013.

Income from Continuing Operations:

For the year ended December 31, 2013, the Company recognized income from continuing operations of approximately $8.4 million as compared to $1.7 million for the comparative period last year. As discussed above, increased revenue from well enhancement services contributed to a $15.6 million increase in revenues and a six percentage point improvement in gross margins (25% to 31%) as compared to the same period last year. Lower depreciation and amortization expense due to the change in useful lives also contributed to the improvement in income from continuing operations. These increases were partially offset by a $779,000 increase in general and administrative expenses.

Management believes that this improvement in our results of operations reflects the beneficial effect of our expanded and increased operations (as discussed throughout this report), a focus on obtaining profitability, and the benefit of the colder weather in the first and last quarters of the year. We believe that as long as we are able to control our costs and increase our revenues as a result of our expanding geographical regions and service areas, our financial performance will continue to improve over the long run, although 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.

Income Taxes:

For 2013, the Company recognized income tax expense of $3.1 million on pre-tax net income from continuing operations before taxes of approximately $7.5 million as compared to income tax expense of $427,000 on pre-tax income of $828,000. The effective tax rate on income from continuing operations for 2013 was approximately 42%. This rate is higher than the federal statutory corporate tax rate of 34% primarily due to state and local income taxes. During 2013, the company fully utilized the $2.4 million of prior year NOL carry forwards in 2013. See Note 11 Taxes on Income from Continuing Operations in the notes to the accompanying audited consolidated financial statements for further details.

Loss from Discontinued Operations, Net of Tax:

In December 2012, the Company made the decision to discontinue its Heat Waves well-site construction and roustabout line of service and immediately initiated efforts to close the North Dakota construction operations. The Company reclassified its construction assets to fixed assets held for sale and initiated efforts to terminate its construction equipment leases. Accordingly, the loss from discontinued operations, net of tax for the year ended December 31, 2013 was significantly lower at $74,000 as compared to $487,000 for 2012. Since operations ceased in early 2013, the loss from discontinued operations in 2013 primarily consisted remaining contractual lease obligations from construction equipment leases.

Adjusted EBITDA*:

         Management believes that, for the reasons set forth below, adjusted
EBITDA (even though 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 the Company's industry.  The following table
presents a reconciliation of net income to Adjusted EBITDA for each of the
periods indicated:

                                                              Years Ended December 31,
                                                                 2013           2012
EBITDA* From Continuing Operations:
Income From Continuing Operations                           $    4,375,700   $   401,488
Add (Deduct):
Interest expense                                                 1,072,912       902,152
Income tax expense                                               3,126,937       426,779
Depreciation and amortization                                    2,088,767     2,960,153
EBITDA* From Continuing Operations                              10,664,316     4,690,572
Add (Deduct):
Stock-based compensation                                           472,356       279,362
(Gain) loss on disposal of equipment                             (169,194)         5,739
Gain on sale of investments                                              -      (24,653)
Other income                                                      (36,383)      (10,870)
Adjusted EBITDA* From Continuing Operations                 $   10,931,095   $ 4,940,150

EBITDA* From Discontinued Operations:
Loss From Discontinued Operations                           $     (74,463)   $ (486,558)
Add (Deduct):
Interest expense                                                       963         1,770
Income tax benefit                                                (47,607)     (311,078)
Depreciation and amortization                                            -       128,935
EBITDA* And Adjusted EBITDA* From Discontinued Operations   $    (121,107)   $ (666,931)

*Note: See discussion to follow below for 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 within the schedules attached herein.

EBITDA is defined as net income plus interest expense, income taxes, and depreciation and amortization. Adjusted EBITDA excludes from EBITDA stock-based compensation and, when appropriate, other items that management does not utilize in assessing the Company's operating performance (see list of these items to follow below). 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. Management uses these non-GAAP measures in its operational and financial decision-making, believing that it is useful to eliminate certain items in order to focus on what it deems to be a more reliable indicator of ongoing operating performance and the company's ability to generate cash flow from operations. Management also believes that investors may find non-GAAP financial measures useful for the same reasons, although investors are cautioned that non-GAAP financial measures are not a substitute for GAAP disclosures.

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 operating performance (e.g., income taxes, gain on sale of investments, loss on disposal of assets, 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.

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 Continuing Operations increased $6.0 million or 121% to $10.9 million for the year ended December 31, 2013 as compared to $4.9 million for 2012. This increase was primarily due to an increase in revenues from our well enhancement services within our Rocky Mountain and Eastern USA regions. The increased revenue was generated from both new and existing frac water heating and hot oiling customers in those regions. In addition, well enhancement revenues also generate higher gross margins, which also contributed to the increase in EBITDA from Continuing Operations.

Adjusted EBITDA from Discontinued Operations for the year ended December 31, 2013 was a negative $121,000 as compared to a negative $667,000 in 2012. The improved EBITDA from discontinued operations was primarily due to a decline in loss from operations as operations were ramped down in early 2013. As noted above, most of the loss from operations and resulting negative EBITDA during 2013 was due to remaining equipment lease commitments paid in January and February 2013.

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