SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 2016
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-36273
|ECO-STIM ENERGY SOLUTIONS, INC.|
|(Exact name of registrant as specified in its charter)|
|(State or other jurisdiction of||(Commission||(IRS Employer|
|incorporation or organization)||File Number)||Identification Number)|
|2930 W. Sam Houston Pkwy N., Suite 275, Houston TX||77043|
|(Address of principal executive offices)||(Zip Code)|
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Name of each exchange on which registered|
|Common Stock, par value $0.001 per share||The NASDAQ Stock Market LLC|
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
|Large accelerated filer||[ ]||Accelerated filer [ ]|
|Non-accelerated filer||[ ] (Do not check if a smaller reporting company)||Smaller reporting company [X]|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 30, 2016, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the closing price of that date, was $13,643,288.
The registrant had 15,049,690 shares of common stock outstanding at March 10, 2017.
Documents Incorporated by Reference: None
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (this “Form 10-K”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this Form 10-K that address activities, events or developments that we expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These forward-looking statements are based on management’s current belief, based on currently available information, as to the outcome and timing of future events. Forward-looking statements may include statements that relate to, among other things, our:
|●||future financial and operating performance and results;|
|●||business strategy and budgets;|
|●||amount, nature and timing of capital expenditures;|
|●||competition and government regulations;|
|●||operating costs and other expenses;|
|●||cash flow and anticipated liquidity;|
|●||property and equipment acquisitions and sales; and|
|●||plans, forecasts, objectives, expectations and intentions.|
All statements, other than statements of historical fact included in this Form 10-K, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this Form 10-K, the words “could,” “believe,” “anticipate,” “budget’, “intend,” “estimate,” “expect,” “plan”, “may”, “predict”, “project”, “projections”, “continue”, “seek”, “will”, “should” and similar expressions or the negative of such terms are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. These forward-looking statements are based on our current expectations and assumptions about future events and are based on currently available information as to the outcome and timing of future events.
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from the anticipated future results or financial condition expressed or implied by the forward-looking statements. These risks, uncertainties and other factors include but are not limited to:
|●||the cyclical nature of the oil and natural gas industry;|
|●||the potential for our oil-company customers to backward-integrate by starting their own well service operations;|
|●||the potential for excess capacity in the oil and natural gas service industry;|
|●||dependence on the spending and drilling activity by the onshore oil and natural gas industry;|
|●||competition within the oil and natural gas service industry;|
|●||concentration of our customer base and fulfillment of existing customer contracts;|
|●||our ability to maintain pricing and obtain contracts;|
|●||deterioration of the credit markets;|
|●||our ability to raise additional capital to fund future and committed capital expenditures;|
|●||increased vulnerability to adverse economic conditions due to indebtedness;|
|●||our limited operating history on which investors may evaluate our business and prospects;|
|●||our ability to obtain raw materials and specialized equipment;|
|●||technological developments or enhancements;|
|●||asset impairment and other charges;|
|●||our ability to identify, make and integrate acquisitions;|
|●||FT SOF VII Holdings, LLC (together with Fir Tree Partners, collectively “Fir Tree”) and management control over stockholder voting;|
|●||loss of key executives;|
|●||the ability to employ skilled and qualified workers;|
|●||work stoppages and other labor matters;|
|●||hazards inherent to the oil and natural gas industry;|
|●||inadequacy of insurance coverage for certain losses or liabilities;|
|●||delays in obtaining required permits;|
|●||ability to import equipment or spare parts into Argentina on a timely basis;|
|●||regulations affecting the oil and natural gas industry;|
|●||legislation and regulatory initiatives relating to well stimulation;|
|●||future legislative and regulatory developments;|
|●||foreign currency exchange rate fluctuations;|
|●||effects of climate change;|
|●||volatility of economic conditions in Argentina;|
|●||market acceptance of turbine pressure pumping technology;|
|●||the profitability for our customers of shale oil and gas as commodity prices decrease;|
|●||risks of doing business in Argentina and the United States; and|
|●||costs and liabilities associated with environmental, occupational health and safety laws, including any changes in the interpretation or enforcement thereof.|
We believe that it is important to communicate our expectations of future performance to our investors. However, events may occur in the future that we are unable to accurately predict, or over which we have no control. We caution you against putting undue reliance on forward-looking statements or projecting any future results based on such statements. When considering our forward-looking statements, you should keep in mind the cautionary statements in this Form 10-K, which provide examples of risks, uncertainties and events that may cause our actual results to differ materially from those contained in any forward-looking statement.
All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section and any other cautionary statements that may accompany such forward-looking statements. Except as otherwise required by applicable law, we disclaim any duty to update any forward-looking statements, all of which are expressly qualified by the statements in this section, to reflect events or circumstances after the date of this Form 10-K.
You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement.
TABLE OF CONTENTS
|Item 1A.||Risk Factors||9|
|Item 1B.||Unresolved Staff Comments||25|
|Item 3.||Legal Proceedings||26|
|Item 4.||Mine Safety Disclosures||26|
|Item 5.||Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity securities||27|
|Item 6.||Selected Financial Data||28|
|Item 7.||Management’s Discussion and Analysis of Financial Condition and Results of Operations||28|
|Item 7A.||Quantitative and Qualitative Disclosures About Market Risk||36|
|Item 8.||Financial Statements and Supplemental Data||37|
|Item 9.||Changes in and Disagreements with Accountants on Accounting and Financial Disclosure||58|
|Item 9A.||Controls and Procedures||58|
|Item 9B.||Other Information||59|
|Item 10.||Directors, Executive Officers and Corporate Governance Directors and Executive Officers||60|
|Item 11.||Executive Compensation||65|
|Item 12.||Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters||71|
|Item 13.||Certain Relationships and Related Transactions, and Director Independence||72|
|Item 14.||Principal Accounting Fees and Services||74|
|Item 15.||Exhibits, Financial Statement Schedules||75|
Except when the context otherwise requires or where otherwise indicated, throughout this Annual Report on Form 10-K, we use the terms “Eco-Stim,” “EcoStim,” “Company,” “we,” “us” and “our” to refer to Eco-Stim Energy Solutions, Inc.
Item 1. Business
Eco-Stim Energy Solutions, Inc. is a technology-driven, growth-oriented independent oilfield services company providing well stimulation, coiled tubing and field management services to the domestic and international upstream oil and gas industry. We are focused on reducing the ecological impact and improving the economic performance of the well stimulation process in ‘unconventional’ drilling formations. We serve major, national and independent oil and natural gas exploration and production companies around the world and we offer products and services with respect to the various phases of a well’s economic life cycle. Our focus is to bring these technologies and processes to the most active shale resource basins both domestically and outside of North America using our technology to differentiate our service offerings.
For information about our operating segments and financial information by operating segment and geographic area, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of this Annual Report on Form 10-K and note 8 to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Products and Services
We offer a wide variety of specialized oilfield services and equipment generally categorized by their typical use during the economic life of a well. A description of the products and services offered by each of our three services is as follows:
Our customers utilize our pressure pumping services to enhance the production of oil and natural gas from formations with low permeability, which restricts the natural flow of hydrocarbons. The technique of well stimulation consists of pumping a fluid into a cased well at sufficient pressure to create new channels in the rock, which can increase the extraction rates and the ultimate recovery of the hydrocarbons. Our equipment is contracted by oil and gas producers to provide this pressure-pumping service, which is referred to as a well stimulation fleet. We offer a state-of-the-art pumping fleet, including well-stimulation pumps, nitrogen pumping units and cranes, in both trailer-mounted and skid-mounted configurations. We expect to have the capability of providing a variety of pressure-pumping services, including work-over pumping, well injection, and wireline pump downs.
A portion of our pressure pumping equipment consists of our TPUs, which are powered by remanufactured turbine engines previously used in military applications. Each turbine engine generates approximately 4,000 horsepower and therefore when operating at 2,000 HHP, the engine is running at approximately 50% of its capacity. As a result, these turbine engines have a reputation for reliability and durability. They also weigh less than 10% of the typical reciprocating engine of comparable horsepower. The weight differential allows for better use of space on a trailer and more efficient operations. We believe the TPUs are more cost effective to operate and maintain than conventional diesel-powered equipment when run on natural gas. Prior field operations with our current TPUs have demonstrated compliance with emission standards for nitrogen oxides (“NOx”) and carbon monoxide under the EPA’s Tier 4 standards that regulate emissions from certain off-road diesel engines. Turbine engines also have significantly lower methane leakage compared to reciprocating engines.
Our customers utilize our coiled tubing services to perform various functions associated with well-servicing operations and to facilitate completion of horizontal wells. Coiled tubing services involve the insertion of steel tubing into a well to convey materials and/or equipment to perform various applications as part of a new completion or the servicing of existing wells, including wellbore maintenance, nitrogen services, thru-tubing services, and formation stimulation using acid and other chemicals. Coiled tubing has become a preferred method of well completion, workover and maintenance projects due to speed, ability to handle heavy-duty jobs across a wide spectrum of pressure environments, safety and ability to perform services without having to shut-in a well. Our coiled tubing capabilities cover a wide range of applications for horizontal completion, work-over and well-maintenance projects.
We recognize that energy companies are under intense pressure to increase reserves at reduced finding costs while simultaneously coming under heightened environmental scrutiny. We have taken steps to create an innovative methodology for reducing costs, improving efficiencies and increasing resource recovery rates, which incorporates geophysics, geology and geomechanical properties and various downhole diagnostics tools, including fiber optic acoustic and temperature measurements as well as downhole pressure gauges. Our suite of advanced but fully commercialized technologies can be combined to provide both highly efficient predictive models to our customers and downhole diagnostic measurements to confirm the accuracy of those predictions while providing a full suite of other information about well integrity, stimulation results, production flow properties and long term monitoring well production characteristics.
Our proprietary technologies are used to reduce the number of stages required to optimize production, which can result in a substantial reduction of the environmental footprint and costs of completing a well, particularly in high-cost areas. Based on many predictive models executed in several North American shale basins, we believe that the best and most productive stages often occur in brittle and naturally fracture rock formations (“micro-fracture swarms”). These micro-fracture swarms are too small to detect with 3D seismic, but their location can be inferred using a proven attribute analysis combined with core analysis and well diagnostic information. We believe that stimulation efforts in these areas tend to be more effective and frequently result in a better stimulation effort, which in turn can produce more hydrocarbons. We also have the capability to monitor the cementing and stimulation operation and the ongoing production results in real time over the life of the well, measuring the type and quantity of inflow from each stimulation stage. This data allows our customers to confirm and refine the predictability of our Geo-Predict® technology and related field services. Once the Geo-Predict® technology and our services are demonstrated to be accurate and reliable in a given area, it then offers compelling opportunities to lower production costs while simultaneously reducing the environmental impact as a result of completing fewer, better targeted stages with less horsepower and less water. In cases where the fiber optic diagnostic system is permanently installed in a well, we believe the information provided allows for proactive management of the well’s performance over the life of the well, including the ability to actively shut off zones with unwanted water flow.
Our customers consist primarily of international oil and gas exploration and production companies including national oil companies, local privately-held exploration and production companies and, on occasion, other service companies that have contractual obligations to provide well stimulation and completion services. Demand for our services depends primarily upon the capital and operating spending of oil and gas companies and the level of drilling activity in the oil and gas markets. To date, substantially all our revenue generated is attributable to a few customers, including YPF, S. A. (“YPF”) and several smaller local exploration and production companies.
We provide products and services in Argentina and the U.S., both highly competitive markets, with competitors comprised of both small and large companies. Our revenues and earnings can be affected by several factors, including changes in competition, fluctuations in drilling and completion activity, perceptions of future prices of oil and gas, government regulation, disruptions caused by weather and general economic conditions. We believe that the principal competitive factors are price, performance, product and service quality, safety, response time and breadth of products and services. We believe our primary competitors in Argentina include Schlumberger, Halliburton, Weatherford, Baker Hughes, Calfrac, Well Services, San Antonio International and other oilfield service companies. Domestically, we compete against many of the same competitors as in Argentina but in addition, we also face strong competition from several independent pressure pumping companies. We also compete with various other regional and local providers within each of our geographic markets for products and services.
We have been operating an oilfield services business in Argentina since December 2014. Our first full year of operations was 2015. The market for our services in Argentina can be broken into three service offerings, (1) Pressure pumping, (2) Coiled Tubing and (3) Field management. The majority of our revenue comes from the pressure pumping market which can be broken into three sub-markets, (1) conventional wells, (2) tight gas wells and (3) unconventional wells. Generally, the conventional wells can be serviced with 3-5 pumping units whereas the tight gas wells require 8-10 pumping units. The unconventional wells in Argentina require anywhere from 16 to 24 pumping units. In 2015, EcoStim only had sufficient pumping capacity to participate in the conventional well market. In 2016, we expanded our capacity and now have experience working in the tight gas market. We anticipate that as the market in Argentina recovers and activity increases, there will be opportunities to secure long term agreements and add additional pumping capacity to service all three markets.
Our Coiled Tubing business involves services to support our pressure pumping business including the drill out of frac plugs, wash-downs, chemical treatments and workover activity. We provide this service to the conventional, tight gas and unconventional well markets.
Our Field Management business consists of various degrees of subsurface analysis derived from the data received from clients or otherwise acquired. The different forms of data include geophysical, geo-mechanical, core samples and other information provided by our customers and data acquired, processed and interpreted by our team including real time fiber optic information data gathered from pressure gauges installed in the wells. This market is driven by exploration and step-out development in new regions or in mature areas where our customers are looking to better understand the production associated with older wells. The market for these services is limited but complements our primary business lines and brings expertise and value to our customers.
The drilling rig count in Argentina peaked at 113 in 2014 and bottomed at 52 in January 2017. The rig count is a reasonable indicator of activity in Argentina and the level of activity will affect the utilization and pricing of our services. Additionally, as wells become more complex and move from conventional to unconventional wells, pressure pumping demand is expected to grow.
In January 2017, the Company signed a one year contract to provide pressure pumping services in north central Oklahoma. The market in this region is concentrated around wells being drilled in the Woodford, Mississippian Lime, Stack, Scoop and Springer plays. Activity in this region has accelerated in late 2016 and according to Baker Hughes’ North America Rotary Rig Count data, in March 2017 there were 101 rigs operating in Oklahoma as compared 67 rigs operating in March 2016. We have established a base of operations in Fairview, Oklahoma and expect to service all the surrounding basins going forward.
Potential Liabilities and Insurance
Our operations involve a high degree of operational risk and expose us to significant liabilities. An accident involving our services or equipment, or the failure of a product sold by us, could result in personal injury, loss of life, and damage to property, equipment or the environment. Litigation arising from a catastrophic occurrence, such as fire, explosion, or well blowout, may result in substantial claims for damages.
We maintain insurance coverage of types and amounts that we believe to be customary and reasonable for companies of our size and with similar operations. In accordance with industry practice, however, we do not maintain insurance coverage against all of the operating risks to which our business is exposed. Therefore, there is a risk our insurance program may not be sufficient to cover any particular loss or all losses. Currently, our insurance program includes, among other things, general liability, umbrella liability, sudden and accidental pollution, personal property, vehicle, workers’ compensation, and employer’s liability coverage. Our insurance includes various limits and deductibles or retentions, which must be met prior to or in conjunction with recovery.
Our business is significantly affected by federal, state, provincial and local laws and other regulations. These laws and regulations relate to, among other things:
|●||worker safety standards;|
|●||the protection of the environment;|
|●||the handling and transportation of hazardous materials;|
|●||the protection of natural and cultural resources; and|
|●||the mobilization of our equipment to, and operations conducted at, our work sites.|
Numerous permits are required for the conduct of our business and operation of our various facilities and equipment, including our trucks and other heavy equipment. These permits can be revoked, modified or renewed by issuing authorities based on factors both within and outside our control.
We cannot predict the level of enforcement of existing laws and regulations or how such laws and regulations may be interpreted by enforcement agencies or court rulings in the future. We also cannot predict whether additional laws and regulations will be adopted, including changes in regulatory oversight, increase of federal, state or local taxes, increase of inspection costs, or the effect such changes may have on us, our businesses or our financial condition.
Our operations, and those of our customers, are subject to extensive laws, regulations and treaties relating to air and water quality, generation, storage and handling of hazardous materials, and emission and discharge of materials into the environment, and the protection of natural resources. Compliance with these environmental laws and regulations may expose us to significant costs and liabilities and cause us to incur significant capital expenditures in our operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, imposition of investigatory and remedial obligations, and the issuance of injunctions delaying or prohibiting operations. Historically, our expenditures in furtherance of our compliance with these laws, regulations and treaties have not been material, and we do not expect the cost of compliance to be material in the future; however, we can provide no guarantee that this will not change.
The primary U.S. federal environmental laws to which our operations are subject include the federal Clean Air Act (“CAA”) and regulations thereunder, which regulate air emissions; the Clean Water Act (“CWA”) and regulations thereunder, which regulate the discharge of pollutants in industrial wastewater and storm water runoff; the Resource Conservation and Recovery Act and regulations thereunder, which regulate the management and disposal of hazardous and non-hazardous solid wastes; and the Comprehensive Environmental Response, Compensation, and Liability Act and regulations thereunder, known more commonly as “Superfund,” which imposes liability for the remediation of releases of hazardous substances in the environment. We are also subject to regulation under the U.S. federal Occupational Safety and Health Act and regulations thereunder, which regulate the protection of the safety and health of workers. Analogous state and local laws and regulations may also apply. Similar laws and regulations exist at the national and provincial level in Argentina.
Recently, there has been increased domestic and international scrutiny of hydraulic fracturing activities, resulting in additional regulation. Domestically, the U.S. Environmental Protection Agency (“EPA”) and other federal agencies, including the Bureau of Land Management (“BLM”) have finalized rules or made proposals that would subject hydraulic fracturing to further regulation and could restrict the practice of hydraulic fracturing. For example, the EPA has issued final regulations under the CAA establishing performance standards for oil and gas activities, including standards for the capture of air emissions released during hydraulic fracturing and finalized CWA regulations in June 2016 that prohibit the discharge of wastewater from hydraulic fracturing operations to publicly owned wastewater treatment plants. The BLM and several states have already adopted and more states are considering adopting laws and/or regulations that require disclosure of chemicals used in hydraulic fracturing and impose more stringent permitting, disclosure and well-construction requirements on hydraulic fracturing operations. In addition, some states and municipalities have significantly limited drilling activities and/or hydraulic fracturing, or are considering doing so. Also in Oklahoma, where we operate in the U.S., the Oklahoma Corporation Commission has taken steps to address the potential link between hydraulic fracturing activities and underground injection disposal well operations and induced seismic events. In Argentina, Neuquén Province has promulgated rules and procedures for the exploration and development of unconventional reservoirs, while other provinces have banned hydraulic fracturing altogether. Although it is not possible at this time to predict the final outcome of these proposals, any new federal, state or local restrictions on hydraulic fracturing that may be imposed in areas in which we conduct business could potentially result in increased compliance costs for us or our customers, or delays in development or restrictions on our operations or the operations of our customers, which in turn could have an adverse effect on our business and results of operations.
In addition, from time to time regulators in both the U.S. and Argentina have taken steps to restrict emissions of carbon dioxide, methane, and other greenhouse gases based on determinations by the scientific community that such emissions are contributing to climate change. Initiatives to date have generally focused on the development of cap-and-trade and/or carbon tax programs. A cap-and-trade program generally would cap overall greenhouse gas emissions on an economy-wide basis and require major sources of greenhouse gas emissions or major fuel producers to acquire and surrender emission allowances. Carbon taxes could likewise affect us by being based on emissions from our equipment and could indirectly affect us by increasing operating costs for our customers. Although it is not possible at this time to predict how legislation or new regulations that may be adopted to address greenhouse gas emissions would impact our business, any such future laws and regulations imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations could require us to incur costs to reduce emissions of greenhouse gases associated with our operations. Severe limitations on greenhouse gas emissions could also adversely affect demand for oil and natural gas, which could decrease demand for our services and have a material adverse effect our profitability, financial condition and liquidity.
We purchase various raw materials and component parts in connection with delivering our products and services. These materials are generally, but not always, available from multiple sources and may be subject to price volatility. While we generally do not experience significant long-term shortages of these materials, we have from time to time experienced temporary shortages of particular raw materials. We are always seeking ways to ensure the availability of resources, as well as manage costs of raw materials.
Seasonal weather and severe weather conditions can temporarily impair our operations by reducing our ability to operate for certain time periods, thereby reducing demand for our products and services.
At December 31, 2016, we had 87 employees, including 84 full-time, and 3 consultants.
Our principal executive offices are located at 2930 W. Sam Houston Parkway North, Suite 275, Houston, Texas 77043. In addition, we own or lease additional facilities in the various areas in which we operate.
We have registered with the United States Patent and Trademark Office for the following trademarks: Geo-Predict® and Geo-Iteration®. We have not filed any applications for the registration of our trademarks in foreign jurisdictions, but may do so in the future as we deem necessary to protect our business. In addition, we rely to a great extent on the technical expertise and know-how of our personnel to maintain our competitive position.
Research and Development
See Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – “Overview of Business Services.”
On July 13, 2016, the Company entered into an At-Market Issuance Sales Agreement (the “Agreement”) with FBR Capital Markets & Co. and MLV & Co. LLC (the “Distribution Agents”). Pursuant to the terms of the Agreement, the Company may sell from time to time through the Distribution Agents, shares of the Company’s common stock, par value $0.001 per share, with an aggregate sales price of up to $5,801,796 (the “Shares”). Sales of the Shares, if any, will need to be approved by the Company’s board of directors (the “Board”) and will be made by any method permitted that is deemed an “at the market offering” as defined in Rule 415 under the Securities Act, including sales made directly on or through the NASDAQ Capital Market, the existing trading market for our common stock or on any other existing trading market for our common stock, sales made to or through a market maker other than on an exchange or otherwise, in negotiated transactions at market prices, and/or any other method permitted by law. Sales of the Shares may be made at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices, and subject to such other terms as may be agreed upon at the time of sale including a minimum sales price that may be stipulated by the Board. During 2016, the Company sold 796,573 shares through the Agreement at an average price of $2.16 per share, for total proceeds of $1,722,596 before deducting approximately $164,000 of commissions.
Secured Loan Agreement
On November 30, 2016, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Bienville Argentina Opportunities Master Fund, LP (“Bienville”) and an individual. A portion of the $2 million proceeds from the Loan Agreement were used to pay the remaining amount payable (approximately $1 million) by the Company under an equipment purchase agreement dated October 10, 2014, as amended, with Gordon Brothers Commercial & Industrial, LLC for the purchase of certain turbine powered pressure pumping equipment (the “TPUs”). The indebtedness created under the Loan Agreement was repaid on March 6, 2017 with a portion of the proceeds of the New Convertible Note (as defined below) issued under the A&R Note Agreement as described below.
Purchase, Sale and Assignment
On March 3, 2017, the Company entered into a purchase, sale and assignment agreement (the “Purchase, Sale and Assignment Agreement”) with Fir Tree and ACM Emerging Markets Master Fund I, L.P. and ACM Multi-Strategy Delaware Holding LLC (collectively, the “ACM entities”), which became effective on March 6, 2017, pursuant to which, among other things, Fir Tree purchased from the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018 and approximately two million shares of common stock of the Company held by ACM Emerging Markets Master Fund I, L.P., or ACM, (the “Purchase, Sale and Assignment”). This transaction was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all of the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. The Purchase, Sale and Assignment closed on March 6, 2017.
Amended and Restated Convertible Note Facility Agreement
On March 3, 2017, the Company also entered into an Amended and Restated Convertible Note Facility Agreement (the “A&R Note Agreement”) with Fir Tree, which became effective on March 6, 2017 and replaced the previously existing convertible notes agreement by and among the Company and ACM entities (the “Existing Note Agreement”). Pursuant to the terms of the A&R Note Agreement, the Company issued to Fir Tree a secured promissory note (the “Amended and Restated Convertible Note”) in a principal amount of $22 million, which replaces the Existing ACM Note, and a secured promissory note (the “New Convertible Note”, and together with the Amended and Restated Convertible Note, the “Notes”) in a principal amount of approximately $19.4 million, representing an additional $17 million aggregate principal amount of convertible notes issued by the Company to Fir Tree on March 6, 2017 and approximately $2.4 million principal amount of convertible notes in payment of accrued and unpaid interest on the Existing ACM Note. The Notes are convertible into the common stock of the Company (the “Common Stock”) at a price of $1.40 per share, contingent upon the Company receiving shareholder approval of the conversion and satisfaction of certain other conditions. The Company has agreed with Fir Tree to seek prompt shareholder approval of the conversion of the Notes. The unpaid principal amount of the Notes bears an interest rate of 20% per annum and matures on May 28, 2018.
The proceeds of the A&R Note Agreement will be primarily used for equipment purchases and other approved capital expenditures incurred in accordance with an approved operating budget.
The A&R Note Agreement also provides for certain representations, warranties and affirmative covenants and negative covenants customary for transactions of this type, including limitations on the Company’s ability to incur certain types of additional debt, engage in transactions with affiliates, sell assets, and make unapproved capital expenditures.
The A&R Note Agreement further provides that all obligations thereunder are and will be, subject to certain terms and exceptions, jointly and severally guaranteed by certain of the Company’s subsidiaries. All obligations under the A&R Note Agreement are secured by liens on certain of the assets of the Company and the subsidiary guarantors.
The A&R Note Agreement further provides for customary Events of Defaults (as such term is defined in the A&R Note Agreement), including but not limited to: failure to make payment when due, default under other agreements, breach of warranty, failure to comply with negative covenants, bankruptcy, dissolution, impairments to Material Agreements (as such term is defined in the A&R Note Agreement), lack of enforceability of the Transaction Documents (as such term is defined in the A&R Note Agreement), certain ERISA events or environmental claims or nationalization resulting in a material taking of property. Upon the occurrence of any Event of Default, Fir Tree may declare all outstanding principal in respect of the Notes, accrued and unpaid interest thereon, premiums and other amounts outstanding under the A&R Note Agreement to be due and payable.
The foregoing description is a summary of the A&R Note Agreement, does not purport to be complete and is qualified in its entirety by reference to the full text of the A&R Note Agreement, which is filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K and incorporated herein by reference.
Stockholder Rights Agreement
On March 3, 2017 and as a condition precedent for the closing of the A&R Note Agreement, the Company entered into an Amended and Restated Stockholder Rights Agreement (the “A&R Stockholder Rights Agreement”) with Fir Tree and the certain other stockholders party thereto (the “Specified Stockholders”), which became effective on March 6, 2017.
Pursuant to the A&R Stockholder Rights Agreement, Fir Tree currently has the right to nominate at least three individuals for election to the board of directors of the Company (the “Board”) for so long as Fir Tree beneficially owns at least 5% of the issued and outstanding Common Stock (calculated on a fully diluted basis). On March 6, 2017, Messrs. David Proman, Andrew Teno and Andrew Colvin were appointed to the Board pursuant to the foregoing contractual requirements. The A&R Stockholder Rights Agreement provides that certain significant Board actions can be taken only with the affirmative vote or consent of at least two directors appointed by Fir Tree.
A director nominated by Fir Tree may only be removed, with or without cause, upon Fir Tree’s written request. Fir Tree also has the right to nominate a substitute designee should a vacancy on the Board occur due to the death, disability, retirement, resignation or removal of any of its previously appointed designees.
So long as Fir Tree beneficially owns at least 5% of the issued and outstanding Common Stock (calculated on a fully diluted basis), certain key actions of the Company, including but not limited to, changes in numbers of directors, sale of all or substantially all assets of the Company or issuance of a new class of capital stock, will require approval by a majority of the Board, including the affirmative vote of at least 2 directors appointed by Fir Tree.
So long as Fir Tree beneficially owns at least 5% of the issued and outstanding Common Stock (calculated on a fully diluted basis), the Company will have an audit committee, a compensation committee, and a nominating committee and will designate at least one director nominated by Fir Tree to each such committee. Mr. Teno was appointed by the Board as a member of the Company’s compensation committee, and Mr. Proman was appointed by the Board as a member of the Company’s nominating committee, pursuant to the foregoing contractual requirements. Fir Tree intends to appoint an individual who qualifies as an independent director under NASDAQ Capital Market and SEC rules to the Board and the audit committee no later than 180 days following March 7, 2017.
So long as Fir Tree beneficially owns at least 10% of the issued and outstanding Common Stock (calculated on a fully diluted basis), Fir Tree will have a pre-emptive right to purchase an amount of common stock, issued by the Company necessary to ensure Fir Tree’s beneficial ownership does not decrease as a result of such new issuance. Subject to the same conditions and certain exceptions, Fir Tree and the Specified Stockholders will have rights of first refusal and tag-along rights to any proposed transfer of Common Stock.
The foregoing description is a summary of the A&R Stockholder Rights Agreement, does not purport to be complete and is qualified in its entirety by reference to the full text of the A&R Stockholder Rights Agreement, which is filed as Exhibit 4.3 hereto.
Registration Rights Agreement
On March 3, 2017, the Company entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with Fir Tree which became effective on March 6, 2017, pursuant to which the Company granted certain registration rights to Fir Tree with respect to the shares of Common Stock held by Fir Tree (the “Registrable Securities”), including those shares of Common Stock issuable upon the conversion of the Convertible Note. Under the Registration Rights Agreement, Fir Tree will have certain customary registration rights, including demand rights and piggyback rights, subject to certain underwriter cutbacks and issuer blackout periods. The Company will pay all fees and expenses relating to the registration and disposition of the Registrable Securities in compliance with the Company’s obligations under the Registration Rights Agreement.
The foregoing description is a summary of the Registration Rights Agreement, does not purport to be complete and is qualified in its entirety by reference to the full text of the Registration Rights Agreement, which is filed as Exhibit 4.4 hereto.
We are a Nevada corporation. Our principal executive offices are located at 2930 W. Sam Houston Pkwy. N., Suite 275, Houston, Texas 77043, and our main telephone number at that address is (281) 531-7200. Our website is available at www.ecostim-es.com. Information contained on or available through our website is not part of or incorporated by reference into this Form 10-K or any other report we may file with the Securities and Exchange Commission (the “SEC”).
We file our reports, proxy statements and other information with the SEC. You can read and copy these reports, proxy statements and other information concerning Eco-Stim at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549, on official business days during the hours of 10 a.m. to 3 p.m. Please call the SEC at 1-800-SEC-0330 for further information about the operation of the SEC’s Public Reference Room. The SEC also maintains an internet site that contains all reports, proxy statements and other information that we file electronically with the SEC. The address of that website is http://www.sec.gov.
Investors should be aware that while we do, at various times, communicate with securities analysts, it is against our policy to disclose to them selectively any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by an analyst with respect to our past or projected performance. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
Item 1A. Risk Factors
An investment in our common stock involves a number of risks. You should carefully consider the risks described in “Risk Factors,” in addition to the other information contained in this Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before investing in our common stock. These risks could materially affect our business, financial condition and results of operations, and cause the trading price of our common stock to decline. You could lose part or all of your investment. You should bear in mind, in reviewing this Form 10-K, that past experience is no indication of future performance. You should read the section titled “Cautionary Statements Regarding Forward-Looking Statements” for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this Form 10-K.
Risks Related to Our Business
We have limited operating history and only minimum revenues.
We have a limited operating history and, accordingly, we are subject to substantial risks inherent in the commencement of a new business enterprise. We are a technology-driven independent oilfield service company providing well stimulation, coiled tubing and field management services to the upstream oil and gas industry with a focus on improving the ecological and economic aspects of the process. Our primary focus will be on the most active shale and unconventional oil and natural gas basins. We have commenced operations in Argentina and since 2014 through December 31, 2016, have only generated minimal revenue from our consulting and field management operations. There can be no assurance that we will be able to successfully generate additional revenues or attain operating profitability. Additionally, we have a very limited business history that investors can analyze to aid them in making an informed judgment as to the merits of an investment in our Company. Any investment in our Company should be considered a high-risk investment because the investor will be placing funds at risk in our Company with unforeseen costs, expenses, competition, and other problems to which new ventures are often subjected. Investors should not invest in our Company unless they can afford to lose their entire investment. As we are early in the revenue-generation process, our prospects must be considered in light of the risks, expenses, and difficulties encountered in establishing a new business in a highly competitive industry.
We have limited sources of liquidity.
We require substantial capital to pursue our operating strategy. As we have limited internal sources of liquidity, we will continue to rely on external sources for liquidity for the foreseeable future.
We participate in a capital-intensive industry, and we may have capital needs for which our internally generated cash flows and other sources of liquidity may not be adequate.
The oil and gas industry is capital intensive. We have substantial future capital requirements, including the need to fund growth through acquisition of additional equipment and assets, working capital and capital expenditures and debt service obligations. Since December 2013, our operation and growth has been funded primarily by proceeds from various equity and debt offerings and more recently by cash flows from operations. Our ability to fund future operations and our planned and committed 2017 capital expenditures will depend upon our future operating performance and, more broadly, on the availability of equity and debt financing. The availability of financing will be affected by prevailing economic conditions, market conditions in the exploration and production industry and financial, business and other factors, many of which are beyond our control. If we are unable to generate sufficient cash flows or to obtain additional capital on favorable terms or at all, we may be unable to continue growing our business or to sustain or increase our current level of profitability. Our inability to grow our business may adversely impact our ability to sustain or improve our profits. Moreover, if we cannot generate sufficient cash flows or otherwise secure sufficient liquidity to support our capital requirements, we may not be able to meet our payment obligations, which could have a material adverse effect on our results of operations or liquidity.
We may not be able to fulfill, renew or replace our existing agreements on attractive terms or at all, which could adversely impact our results of operations, financial condition and cash flows.
We can provide no assurance that we will be able to successfully fulfill, renew or replace our existing agreements with new agreements on or prior to their expiration on terms satisfactory to us or the operator or that we will be able to continue to provide services under those existing agreements without service interruption. We are dependent on entering into additional service agreements to grow our business. If we are not able to either renew or enter into additional service agreements, our results of operations, financial condition and cash flows could be adversely impacted.
We may have difficulty managing growth in our business, which could adversely affect our financial condition and results of operations.
As an emerging growth company, growth in accordance with our business plan, if achieved, could place a significant strain on our financial, technical, operational and management resources. As we expand the scope of our activities and our geographic coverage through both organic growth and acquisitions, there will be additional demands on our financial, technical, operational and management resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrences of unexpected expansion difficulties, including the failure to recruit and retain experienced managers, engineers and other professionals in the oilfield services industry, could have a material adverse effect on our business, financial condition, results of operations and our ability to successfully or timely execute our business plan.
If our intended expansion of our business is not successful, our financial condition, profitability and results of operations could be adversely affected, and we may not achieve increases in revenue and profitability that we hope to realize.
A key element of our business strategy involves the expansion of our services, geographic presence and customer base. These aspects of our strategy are subject to numerous risks and uncertainties, including:
|●||an inability to retain or hire experienced crews and other personnel;|
|●||a lack of customer demand for the services we intend to provide;|
|●||an inability to secure necessary equipment, raw materials (particularly sand and other proppants) or technology to successfully execute our expansion plans;|
|●||shortages of water used in our sand processing operations and our hydraulic fracturing operations;|
|●||unanticipated delays that could limit or defer the provision of services by us and jeopardize our relationships with existing customers and adversely affect our ability to obtain new customers for such services; and|
|●||competition from new and existing services providers.|
Encountering any of these or any unforeseen problems in implementing our planned expansion could have a material adverse impact on our business, financial condition, results of operations and cash flows, and could prevent us from achieving the increases in revenues and profitability that we hope to realize.
Our liquidity needs could restrict our operations and make us more vulnerable to adverse economic conditions.
Our future indebtedness, whether incurred in connection with acquisitions, operations or otherwise, may adversely affect our operations and limit our growth, and we may have difficulty making debt service payments on such indebtedness as payments become due. Our level of indebtedness may affect our operations in several ways, including the following:
|●||increasing our vulnerability to general adverse economic and industry conditions;|
|●||the covenants that are contained in the agreements governing our indebtedness could limit our ability to borrow funds, dispose of assets, pay dividends and make certain investments;|
|●||our debt covenants could also affect our flexibility in planning for, and reacting to, changes in the economy and in our industry;|
|●||any failure to comply with the financial or other covenants of our debt, including covenants that impose requirements to maintain certain financial ratios, could result in an event of default, which could result in some or all of our indebtedness becoming immediately due and payable;|
|●||our level of debt could impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or other general corporate purposes; and|
|●||our business may not generate sufficient cash flow from operations to enable us to meet our obligations under our indebtedness.|
We may be unable to maintain pricing on our core services.
Pressures stemming from fluctuating market conditions and oil and natural gas prices are making it increasingly difficult to maintain the pricing on our core services during the last quarter of 2015 and throughout 2016. We have faced, and will likely continue to face, reductions in our services being needed as well as pricing pressure from the competitors who are also competing for those same opportunities during 2017. If we are unable to maintain pricing on our core services, our financial results will be negatively impacted.
The activity level of our customers, spending for our products and services, and payment patterns may be impacted by low commodity prices and any deterioration in the credit markets.
Many of our potential customers finance their activities through cash flow from operations, the incurrence of debt or the issuance of equity. Beginning in late 2014 and continuing through 2015 and into early 2016, there was a significant decline in the word-wide benchmarked prices of oil and gas, resulting in reduced cash flow from our customers’ operations and a severe reduction in their access to the equity and credit markets. Additionally, during 2015 and 2016, many of our potential customers’ equity values substantially declined. The combination of a reduction of cash flow resulting from declines in commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of availability of debt or equity financing may result in a significant reduction in our potential customers’ spending for our products and services. Although during 2016 the price of WTI oil has increased to the mid $50s per barrel, drilling activity has increased modestly attributable to concerns about sustained price stability and price maintenance.
In addition, the same factors that may lead to a reduction in our potential customers’ spending also may increase the exposure to the risks of nonpayment and nonperformance by the customers. A significant reduction in our customers’ liquidity may result in a decrease in their ability to pay or otherwise perform their obligations to us. Any increase in nonpayment or nonperformance by our customers, either as a result of recent changes in financial and economic conditions or otherwise, could have an adverse impact on the operating results and adversely affect the liquidity.
In addition to the foregoing, because YPF is controlled by the Argentine state, its capital spending and other policies may be subject to political influence, particularly from the Secretary of Energy. Because we rely on a limited number of customers for the well stimulation services, the change in ownership and management of any such customer may adversely affect our business, financial condition and results of operations.
Our customers may choose to integrate their operations vertically by purchasing and operating their own well stimulation fleet, expanding the amount of well stimulation equipment they currently own or using alternative technologies for enhancing oil and gas production.
Our customers may choose to integrate their operations vertically by purchasing and operating their own well stimulation fleets in lieu of using our well stimulation services. In addition, there are other technologies available for the artificial enhancement of oil and natural gas production and our customers may elect to use these alternative technologies instead of the well stimulation services we provide. Such vertical integration, increases in vertical integration or use of alternative technologies could result in decreased demand for our well stimulation services, which may have a material adverse effect on our business, results of operations and financial condition.
Our customer base is concentrated within the oil and natural gas production industry, and loss of a significant customer or the existing customer contracts could cause our revenue to decline substantially and adversely affect our business.
Our business is and will be highly dependent on existing agreements and the relationships with potential customers and technology partners. Revenues from these potential customers and revenues from joint ventures are expected to represent a substantial portion of our total future revenues. A reduction in business from any of these arrangements resulting from reduced demand for their own products and services, a work stoppage, sourcing of products from other suppliers or other factors could materially impact our business, financial condition and results of operations. In addition, the inability of suppliers to timely deliver the required equipment for the new well stimulation fleets could have a material adverse impact on our ability to perform under the existing agreements. We expect that we will continue to derive a significant portion of our revenue from a relatively small number of customers in the future. Our existing agreements do not obligate any of those prospective customers to use our products and services. In addition, the existing agreements contain provisions whereby the customers may terminate the agreement in the event we are unable to perform under the terms of the contract or make adjustments to service and/or materials fees payable thereunder based on changing market conditions. The existing agreements are also subject to termination by customers under certain circumstances, and any such termination could have a material adverse effect on our business.
We may have difficulty managing growth in our business, which could adversely affect our financial condition and results of operations.
We do not have highly sophisticated systems to forecast our future revenue or profitability and therefore could experience difficulty in managing our growth and associated working capital needs.
Our ability to operate successfully depends on the availability of water.
Well stimulation, and pressure pumping more generally, can require a significant supply of water, and water supply and quality are important requirements to our operations. We intend to meet our water requirements from sources on or near the well sites, but there is no assurance that we will be able to obtain a sufficient supply of water from sources in these areas, some of which are prone to drought. For example, in December 2016, the Neuquén province in Argentina declared a 12-month state of emergency as a result of a severe drought. In response to this emergency, the Governor of Neuquén also established a special committee with broad powers to take any “urgent and immediate action deemed necessary to address the water emergency.” While we cannot predict what measures may be taken in response to drought conditions, limitations on water use or increased costs to obtain water from alternative sources has the potential to adversely affect our operations, financial position, and results of operations.
Any indebtedness we incur could restrict our operations and make us more vulnerable to adverse economic conditions.
We anticipate securing growth capital through lease financing or other long-term financing arrangements. Our expected future needs for financing for equipment acquisition and working capital may adversely affect operations and limit our growth, and we may have difficulty making debt service payments on our indebtedness as such payments become due.
Covenants in our debt agreements restrict our business in many ways.
We and Fir Tree are parties to the A&R Note Agreement. The A&R Note Agreement contains restrictive covenants. These covenants include, but are not limited to, requirements to reserve shares issuable for payment of the outstanding balance on the convertible note, maintain specific account balances, and comply with the operating budget. Additionally, the covenants include, but are not limited to, restrictions on incurring certain types of additional debt, engaging in transactions with affiliates, selling assets, making unapproved capital expenditures and entering into certain lease agreements.
A breach of any of these covenants could result in a default under our note facility. Upon the occurrence of an event of default under our convertible note facility, Fir Tree may accelerate payment under the A&R Note Agreement in accordance with its terms. If we were unable to repay those amounts, Fir Tree could, among other things, proceed against the collateral granted to them that secures that indebtedness.
We have pledged a significant portion of our and our subsidiaries’ assets as collateral under our note facility. If Fir Tree accelerates the repayment of borrowings under our note facility, we cannot assure you that we will have sufficient assets to repay indebtedness under such facilities and our other indebtedness.
We may not be able to provide services that meet the specific needs of oil and natural gas exploration and production companies at competitive prices.
The markets in which we operate are highly competitive and have relatively few barriers to entry, and the competitive environment has intensified as recent mergers among exploration and production companies have reduced the number of available customers. The principal competitive factors in the markets in which we operate are product and service quality and availability, responsiveness, experience, technology, equipment quality, reputation for safety and price. We compete with small companies capable of competing effectively in our markets on a local basis. We also compete with large national and multi-national companies that have longer operating histories, greater financial, technical and other resources and greater name recognition than we do. Our initial well stimulation fleet currently does not have sufficient HHP to enable us to participate in unconventional jobs as well as larger well stimulation jobs. See Part I – Item 1 – “Business—Market Segmentation.”
The inability to control the inherent risks of acquiring and integrating businesses in the future could adversely affect our operations.
As a part of our business strategy, we intend to pursue selected acquisitions or mergers. If we choose to grow our business through acquisitions or mergers, it is possible that companies acquired or merged into our Company may have associated risks including:
|●||Unanticipated costs and assumption of liabilities and exposure to unforeseen liabilities;|
|●||Inherent difficulties in integrating the operations and assets of the acquired business and personnel;|
|●||Potential losses of key employees and customers of the acquired business;|
|●||Internal control weaknesses or limitations on our ability to properly assess and maintain an effective internal control environment over an acquired business, in order to comply with public reporting requirements;|
|●||Risks of entering markets in which we have limited prior experience; and|
|●||Increases in our expenses and working capital requirements.|
Our business depends upon our ability to obtain specialized equipment from suppliers and key raw materials on a timely basis.
If our current suppliers are unable to provide the necessary raw materials (including, for example, proppant and chemicals) or finished products (such as the new equipment) or otherwise fail to deliver products timely and in quantities required, any resulting delays in the provision of services could have a material adverse effect on our business, financial condition, results of operations and cash flows. During the past few years, our industry faced sporadic proppant shortages associated with pressure pumping operations, requiring work stoppages that adversely impacted the operating results of several competitors.
The Chairman of the Board allocates part of his time to other companies.
Mr. Bjarte Bruheim, the chairman of the Board, is also a member of the board of directors of other companies. Mr. Bruheim allocates his time between the affairs of Eco-Stim and the affairs of these other companies. This situation presents the potential for a conflict of interest for Mr. Bruheim in determining the respective percentages of his time to be devoted to the affairs of Eco-Stim and the affairs of others. In addition, if the affairs of these other companies require him to devote more substantial amounts of his time to the affairs of the other companies in the future, it could limit his ability to devote sufficient time to our affairs and could have a negative impact on our business.
Unexpected equipment malfunctions, catastrophic events and scheduled maintenance may lead to decreased revenue and reduce our cash flows.
Our performance is primarily dependent upon the efficient and uninterrupted operation of our sole pressure pumping fleet, which commenced operation in Argentina in December 2014, and our sole coiled tubing equipment unit, which commenced operation in Argentina in February 2015. If our operation of such core equipment experiences unanticipated disruption due to an accident, mechanical failure or other unforeseen event such as a fire, explosion, violent weather conditions or unexpected operational difficulties, or if we have to schedule a temporary shutdown to perform maintenance on any of our core equipment, our ability to provide timely services to our customers could be negatively affected, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our inability to make satisfactory alternative arrangements in the event of an interruption in supply of certain key raw materials could harm our business, results of operations and financial condition.
We currently anticipate sourcing materials, such as guar gum, from one supplier. Given the limited number of suppliers of such key raw materials, we may not always be able to make alternative arrangements should our suppliers fail to timely deliver these key raw materials. Any resulting delays in the provision of services could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We may not be successful in implementing technology development and enhancements.
The market for our services and products is characterized by continual technological developments to provide better and more reliable performance and services. If we are not able to design, develop and produce commercially competitive products and to implement commercially competitive services in a timely manner in response to changes in technology, our business and revenues could be materially and adversely affected and the value of our intellectual property may be reduced. Likewise, if our proprietary technologies, equipment and facilities, or work processes become obsolete, we may no longer be competitive and our business and revenues could be materially and adversely affected.
We depend on the services of key executives, the loss of whom could materially harm our business.
The management of our Company is important to our success because they have been instrumental in setting our strategic direction, operating the business, identifying, recruiting and training key personnel, and identifying expansion opportunities. Losing the services of any of these individuals could adversely affect our business until a suitable replacement could be found. We do not maintain key man life insurance on any of our management. As a result, we are not insured against any losses resulting from the death of our key employees.
We may be unable to employ a sufficient number of skilled and qualified workers.
The delivery of our services and products requires personnel with specialized skills and experience who can perform physically demanding work. As a result of the volatility of the oilfield service industry and the demanding nature of the work, workers may choose to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive. The demand for skilled workers is high and the supply is limited.
We may be adversely impacted by work stoppages or other labor matters.
The petroleum and oil-service industries in Argentina, where we operate, and other countries are unionized, and it is likely that we may experience work stoppages or other labor disruptions from time to time. As of December 31, 2016, approximately 86% of our Argentine employees were represented by unions and they are working under the conditions stated in their collective bargaining agreements. No assurance can be given that the collective bargaining agreements will be successfully extended or renegotiated as they expire from time to time. If any collective bargaining agreement is not extended or renegotiated, if disputes with our unions arise, or if our unionized workers engage in a strike or other work stoppage or interruption, we could experience a significant disruption of, or inefficiencies in, our operations or incur higher labor costs, which could have a material adverse impact on our combined results of operations and financial condition by disrupting our ability to perform well stimulation or pressure pumping and other services for the customers under our service contracts.
If we become subject to warranty, similar claims or litigation, it could be time-consuming and costly to defend.
Errors, defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking damages from us for losses associated with these errors, defects or other performance problems.
Our business involves certain operating risks and our insurance coverage or proceeds, if any, may not be adequate to cover all losses or liabilities that we might incur in our operations.
The technical complexities of our operations are such that we are exposed to a wide range of significant worker health, safety and environmental risks. Our services involve production-related activities, radioactive materials, explosives and other equipment and services that are deployed in challenging exploration, development and production environments. An accident involving our services or equipment, or a failure of a product, could cause personal injury, loss of life, damage to or destruction of property, equipment or the environment, or suspension of operations. Our insurance policies may not protect us against liability for some kinds of events, including events involving pollution, or against losses resulting from business interruption. Moreover, we may not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate. Any damages caused by our services or products that are not covered by insurance, or are in excess of policy limits or are subject to substantial deductibles, could adversely affect our financial condition, results of operations and cash flows.
A terrorist attack or armed conflict could harm our business.
Geopolitical and terrorism risks continue to grow in a number of countries, including those where we do business. Geopolitical and terrorism risks could lead to, among other things, a loss of our investment in the country, impairment of the safety of our employees and impairment of our ability to conduct our operations.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As of December 31, 2016, we had approximately $43.7 million of U.S. federal net operating loss carryforwards (“NOLs”), which begin to expire in 2018. Utilization of these NOLs depends on many factors, including our future income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”), generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). An ownership change generally occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of our stock change their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual limitation under Section 382, determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382, subject to certain adjustments. Any unused annual limitation may be carried over to later years. We may have previously experienced and may in the future experience one or more “ownership changes”. As a result, if we earn net taxable income, our ability to use our pre-change NOL carryforwards to offset U.S. federal taxable income may be subject to limitations, which could potentially result in increased future tax liability to us. We believe that, due to our subsequent event noted in Note 19 regarding the Fir Tree transaction, we will have an impact due to the change in control, however, we have not yet evaluated the impact this will have on us.
Risks Related to Our Operations in Argentina and Other Foreign Jurisdictions
Our business is largely dependent upon economic conditions in Argentina.
Substantially all our initial operations and customers are located in Argentina, and, as a result, our business is to a large extent dependent upon economic conditions prevailing in Argentina. The Argentine economy has experienced significant volatility in past decades, including numerous periods of low or negative growth and high and variable levels of inflation and devaluation. Argentina’s gross domestic product grew at an average annual real rate of approximately 0.8% in 2012, recovering to 2.9% in 2013. In January, 2017 , the National Statistics Institute (Instituto Nacional de Estadística y Censos, or INDEC), which is the only institution in Argentina with the statutory power to produce official nationwide statistics, reported real gross domestic product during the third quarter of 2016 was 3.6% lower than the comparable figure for 2015. If economic conditions in Argentina continue to contract, or if the Argentine government’s measures to attract or retain foreign investment and international financing in the future are unsuccessful, such developments could affect our financial condition and results of operations.
Argentine economic results are dependent on a variety of factors, including (but not limited to) the following:
|●||international demand for Argentina’s principal exports;|
|●||international prices for Argentina’s principal commodity exports;|
|●||stability and competitiveness of the Argentine Peso against foreign currencies;|
|●||levels of consumer consumption and foreign and domestic investment and financing; and|
|●||the rate of inflation.|
In recent years, Argentina has confronted inflationary pressure. According to inflation data published by INDEC, in January 2017, the Argentine consumer price index increased by 1.3 % from the prior month. Increased rates of inflation in Argentina could increase our cost of operation, and may negatively impact our results of operations and financial condition. There can be no assurance that inflation rates will not be higher in the future.
In addition, Argentina’s economy is vulnerable to adverse developments affecting its principal trading partners. A significant decline in the economic growth of any of Argentina’s major trading partners, such as Brazil, China or the U.S., could have a material adverse impact on Argentina’s balance of trade and adversely affect Argentina’s economic growth and may consequently adversely affect our financial condition and results of operations. The Argentine Peso has been subject to significant devaluation in the past and may be subject to significant fluctuations in the future, consequently affecting our financial condition and results of operations (see additionally Part I – Item 1A. Risk Factors – “We may be exposed to fluctuations in foreign exchange rates.”). President Macri moved quickly in December 2015 after taking office to lift currency controls. This was effective at removing the large spread that previously existed between the so-called “blue market” rate of approximately 14 pesos to 1 dollar and the official exchange rate of 9 pesos to 1 dollar. Since currency controls were repealed, the Argentine Peso has traded between around 11.4 pesos to the U.S. dollar and 15.8 Argentine pesos to the U.S. dollar, and we believe is currently reasonably stable.
Moreover, this move was accompanied by a liberalization of capital controls, which we expect to improve the investment climate in Argentina by making it easier for our Company and our customers to repatriate future earnings in Argentina. However, this move could stall or reverse its favorable trend.
The Argentinian government has fixed oil and gas prices for domestic producers. Any decrease or removal of the fixed price could result in a corresponding reduction in our customers’ drilling activities, which could adversely impact our results of operations, financial condition and cash flows.
The Argentinian government has historically fixed the price of natural gas production for light sweet crude and for heavy oil. More recently, the government has been supportive of fixed prices for natural gas but has indicated a desire to allow the crude oil prices to adjust to international prices. We have no assurance that the government will not lower the fixed prices for natural gas in the future or remove them altogether. If the fixed price for natural gas were to be reduced or removed, our customers may drill less, which could have a corresponding effect on the demand for our products or services.
Certain risks are inherent in any investment in a company operating in an emerging market such as Argentina.
Argentina is an emerging market economy and investing in emerging markets generally carries risks. These risks include political, social and economic instability that may affect Argentina’s economic results which can stem from many factors, including the following:
|●||high interest rates;|
|●||abrupt changes in currency values;|
|●||high levels of inflation;|
|●||wage and price controls;|
|●||regulations to import equipment and other necessities relevant for operations;|
|●||changes in governmental economic or tax policies; and|
|●||political and social tensions.|
Any of these factors may adversely affect our financial condition and results of operation.
The Argentine economy has been adversely affected by economic developments in other markets.
Financial and securities markets in Argentina, and the Argentine economy, are influenced by economic and market conditions in other markets worldwide. Considering the current international turmoil, Argentina’s economy remains vulnerable to external shocks, including those relating to or similar to the global economic crisis that began in 2008 and the recent uncertainties surrounding European sovereign debt. Although economic conditions vary from country to country, investors’ perceptions of events occurring in one country may substantially affect capital flows into and investments in securities from issuers in other countries, including Argentina.
Consequently, there can be no assurance that the Argentine financial system and securities markets will not continue to be adversely affected by events in developed countries’ economies or events in other emerging markets, which could in turn, adversely affect the Argentine economy and, as a consequence, the Company’s results of operations and financial condition.
The implementation of new export duties, other taxes and import regulations could adversely affect our results.
In 2012, the Argentine government adopted an import procedure pursuant to which local authorities must pre-approve any import of products and services to Argentina as a precondition to allow importers access to the foreign exchange market for the payment of such imported products and services.
We cannot assure you that these taxes and import regulations will not continue or be increased in the future or that other new taxes or import regulations will not be imposed.
We may be exposed to fluctuations in foreign exchange rates.
Our results of operations are exposed to currency fluctuation and any devaluation of the Argentine Peso against the U.S. dollar and other hard currencies may adversely affect our business and results of operations. The value of the Argentine Peso has fluctuated significantly in the past and may do so in the future. We are unable to predict whether, and to what extent, the value of the Argentine Peso may further depreciate or appreciate against the U.S. dollar and how any such fluctuations would affect our business.
We are subject to exchange and capital controls.
In the past, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to retain foreign currency or make payments abroad. Although the Macri government lifted exchange controls and liberalized capital controls as described above, there can be no assurances regarding future modifications to exchange and capital controls. Exchange and capital controls could adversely affect our financial condition or results of operations and our ability to meet our foreign currency obligations and execute our financing plans.
Operating internationally subjects us to significant risks and regulations inherent in operating in foreign countries.
We plan to conduct operations in a number of countries. Our international operations will be subject to a number of risks inherent to any business operating in foreign countries, and especially those with emerging markets, including the following risks, among others:
|●||government instability, which can cause investment in capital projects by our potential clients to be withdrawn or delayed, reducing or eliminating the viability of some markets for our services;|
|●||potential expropriation, seizure, nationalization or detention of assets, such as the 2015 nationalization of Repsol S.A.’s interest in YPF;|
|●||difficulty in repatriating foreign currency received in excess of local currency requirements;|
|●||foreign currency exchange rate fluctuations, import/export tariffs and quotas;|
|●||civil uprisings, riots and war, which can make it unsafe to continue operations, adversely affect both budgets and schedules and expose us to losses;|
|●||availability of suitable personnel and equipment, which can be affected by government policy, or changes in policy that limit the importation of qualified crewmembers or specialized equipment in areas where local resources are insufficient;|
|●||decrees, laws, regulations, interpretation and court decisions under legal systems, which are not always fully developed and which may be retroactively applied and cause us to incur unanticipated and/or unrecoverable costs as well as delays which may result in real or opportunity costs; and|
|●||terrorist attacks, including kidnappings of our personnel.|
We cannot predict the nature and the likelihood of any such events. However, if any of these or other similar events should occur, it could have a material adverse effect on our financial condition and results of operation.
Certain of the equipment that we use in certain foreign countries may require prior U.S. government approval in the form of an export license and may otherwise be subject to tariffs and import/export restrictions. The delay in obtaining required governmental approvals could affect our ability to timely commence a project, and the failure to comply with all such controls could result in fines and other penalties.
We may be subject to taxation in many foreign jurisdictions and the final determination of our tax liabilities involves the interpretation of the statutes and requirements of taxing authorities worldwide. Our tax returns will be subject to routine examination by taxing authorities, and these examinations may result in assessments of additional taxes, penalties and/or interest.
Our overall success as an international company depends, in part, upon our ability to succeed in differing economic, social and political conditions. We may not continue to succeed in developing and implementing policies and strategies that are effective in each location where we do business, which could negatively affect our profitability.
Our international operations involve the use of foreign currencies, which subjects us to exchange rate fluctuations, difficulty in repatriating foreign currencies and other currency risks.
We and our foreign subsidiaries from time to time will hold foreign currencies. Exchange rate fluctuations will subject us to currency risk as well as to other risks sometimes associated with international operations. In the future, we could experience fluctuations in financial results from our operations outside the U.S., and there can be no assurance that payments received in foreign currencies can be repatriated to the U.S. or that we will be able, contractually or otherwise, to reduce the currency risks associated with our international operations.
We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar foreign anti-bribery laws.
The United States Foreign Corrupt Practices Act (the “FCPA”) and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making, offering or authorizing improper payments to non-U.S. government officials for the purpose of obtaining or retaining business. We do business and may do additional business in the future in countries or regions where strict compliance with anti-bribery laws may conflict with local customs and practices.
As a company subject to compliance with the FCPA, our business may suffer and we may be subject to competitive disadvantages because our efforts to comply with U.S. laws could restrict our ability to do business in foreign markets relative to our competitors who are not subject to U.S. law. Additionally, our business plan involves establishing close relationships with stakeholders in certain foreign markets. Any determination that we or foreign shareholders, directors or officer’s partners have violated the FCPA may adversely affect our business and operations.
Violations of anti-bribery laws (either due to our acts or our inadvertence) may result in criminal and civil sanctions and could subject us to other liabilities in the U.S. and elsewhere. Even allegations of such violations could disrupt our business and result in a material adverse effect on our business and operations.
Risks Related to the Oil and Natural Gas Industry
We may face intense competition in our industry and in the markets where we operate.
The industry in which we compete is highly competitive, and most of our potential competitors will have greater financial resources than we do. Our ability to renew or replace existing contracts with our customers at rates sufficient to maintain current revenue and cash flows could be adversely affected by the activities of our competitors and our customers. If our competitors substantially increase the resources they devote to the development and marketing of competitive services or substantially decrease the prices at which they offer their services, we may be unable to compete effectively. Some of these competitors may expand or construct newer, more powerful or more flexible well stimulation fleets that would create additional competition for us. Furthermore, recent reduction in drilling activity in markets such as North America may drive other oilfield services companies to relocate their equipment to the regions in which we operate or intend to operate. Such increase in supply relative to demand could negatively impact pricing and utilization of our services. All of these competitive pressures could have a material adverse effect on our business, results of operations and financial condition. There can be no assurance that additional competitors will not enter markets served or proposed to be served by us, that we will be able to compete successfully, or that we will have adequate funds to compete.
Because the oil and natural gas industry is cyclical, our operating results may fluctuate.
Oil and natural gas prices are volatile. Fluctuations in such prices may result in a decrease in the expenditure levels of oil and natural gas companies, which in turn may adversely affect us. For example, the substantial and extended decrease in commodity prices which started in 2014 and continuing through early 2016 has severely reduced most of our customer’s profitability. This situation may continue or worsen and could adversely affect our business, financial condition and results of operations.
Regulatory compliance costs and restrictions, as well as delays in obtaining permits by the customers for their operations, such as for well stimulation and pressure pumping, or by us for our operations, could impair our business.
Our operations and the operations of the customers are subject to or impacted by a wide array of regulations in the jurisdictions in which the operations are located. As a result of changes in regulations and laws relating to the oil and natural gas industry, including well stimulation, our operations or the operations of our customers could be disrupted or curtailed by governmental authorities. The high cost of compliance with applicable regulations may cause customers to discontinue or limit their operations, and may discourage companies from continuing development activities. As a result, demand for our services could be substantially affected by regulations adversely impacting the oil and natural gas industry.
Demand for the majority of our services is substantially dependent on the levels of expenditures by the oil and gas industry. A substantial or an extended decline in oil and gas prices could result in lower expenditures by the oil and gas industry, which could have a material adverse effect on our financial condition, results of operations and cash flows.
Demand for the majority of our services depends substantially on the level of expenditures by the oil and gas industry for the exploration, development and production of oil and natural gas reserves. These expenditures are generally dependent on the industry’s view of future oil and natural gas prices and are sensitive to the industry’s view of future economic growth and the resulting impact on demand for oil and natural gas. Declines, as well as anticipated declines, in oil and gas prices could also result in project modifications, delays or cancellations, general business disruptions, and delays in payment of, or nonpayment of, amounts that are owed to us. These effects could have a material adverse effect on our financial condition, results of operations and cash flows.
The prices for oil and natural gas have historically been volatile and can be affected by a variety of factors, including:
|●||worldwide and regional economic conditions impacting the global supply and demand for oil, natural gas and natural gas liquids;|
|●||the price and quantity of foreign imports;|
|●||political and economic conditions in or affecting other producing areas, including the Middle East, Africa, South America and Russia;|
|●||the ability of members of the Organization of the Petroleum Exporting Countries (“OPEC”) (and certain non-OPEC countries) to agree to and maintain oil price and production controls;|
|●||the level of global exploration and production activity;|
|●||the level of global inventories;|
|●||prevailing prices on local price indexes in the areas in which we operate;|
|●||the proximity, capacity, cost and availability of gathering and transportation facilities;|
|●||localized and global supply and demand fundamentals and transportation availability;|
|●||the cost of exploring for, developing, producing and transporting reserves;|
|●||weather conditions and other natural disasters;|
|●||technological advances affecting energy consumption;|
|●||the price and availability of alternative fuels;|
|●||expectations about future commodity prices; and|
|●||domestic, local and foreign governmental regulation and taxes.|
The oil and gas industry has historically experienced periodic downturns, which have been characterized by diminished demand for oilfield services and downward pressure on the prices we charge. The prices of crude oil, domestic natural gas and NGLs have declined substantially since June 2014. The price of WTI crude oil has decreased from over $100.00 per barrel in the middle of June 2014 to below $30.00 per barrel in January and February 2016. Henry Hub spot prices for natural gas declined below $1.80 per Mcf in December 2015 compared to more than $4.40 per Mcf in January 2014. The volatility in gas pricing was demonstrated in 2016 when in April and May, the average price was $1.92 per Mcf while the year ended with a December average of $3.59 per Mcf. The current downturn in the oil and gas industry has resulted in a reduction in demand for oilfield services and could adversely affect our financial condition, results of operations and cash flows.
Our operations are subject to hazards and environmental risks inherent in the oil and natural gas industry.
We are a provider of well stimulation and pressure pumping services, a process involving the injection of fluids—typically consisting mostly of water and also including several chemical additives—as well as sand in order to create fractures extending from the well bore through the rock formation to enable oil or natural gas to move more easily through the rock pores to a production well. In addition, we provide a range of services to onshore oil and natural gas exploration and production operations, consisting of, among other things, coiled tubing services. Risks inherent to our industry create the potential for significant losses associated with damage to the environment or natural resources, such as the potential for contamination of drinking water resources.
We are subject to extensive environmental, worker health and safety laws and regulations that may subject us to substantial liability or require us to take actions that will adversely affect our results of operations.
The oil and gas industry is significantly affected by stringent and complex federal, state and local laws and regulations concerning the discharge of substances into the environment or otherwise relating to environmental protection and worker health and safety matters. The cost of compliance with these laws can be significant. Failure to properly handle, transport or dispose of these materials or otherwise conduct our operations in accordance with these and other environmental laws could expose us to substantial liability for administrative, civil and criminal penalties, cleanup and site restoration costs and liability associated with releases of such materials, damages to natural resources and other damages, as well as potentially impair our ability to conduct our operations. We could be exposed to liability for cleanup costs, natural resource damages and other damages under these and other environmental laws. Such liability can be on a strict, joint and several liability basis, without regard to fault. Liability may be imposed as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, prior operators or other third parties. Environmental laws and regulations have changed in the past, and they are likely to change in the future. If existing environmental requirements or enforcement policies change and become more stringent, we may be required to make significant unanticipated capital and operating expenditures.
The adoption of climate change legislation or regulations restricting emissions of greenhouse gases could result in increased operating costs and reduced demand for oil and natural gas.
In recent years, many national, federal, state and local governments have taken steps to reduce emissions of greenhouse gases. For example, in the United States, the EPA has finalized a series of greenhouse gas monitoring, reporting and emissions control rules for the oil and natural gas industry, and the U.S. Congress has, from time to time, considered adopting legislation to reduce emissions including carbon dioxide and methane. In December 2015, the United States and Argentina participated in the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change in Paris, France. The resulting Paris Agreement calls for the parties to undertake “ambitious efforts” to limit the average global temperature, and to conserve and enhance sinks and reservoirs of greenhouse gases. The Agreement, which went into effect in November 2016, establishes a framework for the parties to cooperate and report actions to reduce greenhouse gas emissions. At this time, we cannot predict what additional steps, if any, the U.S. and Argentina may take as a result of participation in the Paris Agreement. Argentina has also passed a number of energy-efficiency related measures as well as requirements for the blending of ethanol and other biofuels with petroleum fuels. These measures could reduce demands for petroleum products, which in turn could have an adverse impact on demand for our services.
Moreover, climate change may cause more extreme weather conditions such as more intense hurricanes, thunderstorms, tornadoes and snow or ice storms, as well as rising sea levels and increased volatility in seasonal temperatures. Extreme weather conditions can interfere with our services and increase our costs and damage resulting from extreme weather. At this time, we are unable to determine the extent to which climate change may lead to increased storm or weather hazards affecting our operations.
New technology may cause us to become less competitive.
The oilfield services industry is subject to the introduction of new drilling and completion techniques and services using new technologies, some of which may be subject to patent protection. If competitors and others use or develop new technologies in the future that are more efficient or productive than ours, we may lose market share or be placed at a competitive disadvantage.
The industry is affected by excess equipment inventory levels.
Because of the long-life nature of oilfield service equipment and the lag between when a decision to build additional equipment is made and when the equipment is placed into service, the inventory of oilfield service equipment in the industry does not always correlate with the level of demand for service equipment.
Compliance with governmental regulations may impact our or our customers’ operations and may adversely affect our business and operating results.
Our operations are dependent on our customers’ decisions to develop and produce oil and natural gas reserves and on the regulatory environment in which our customers and we operate. The ability to produce oil and natural gas can be affected by the number and productivity of new wells drilled and completed, as well as the rate of production and resulting depletion of existing wells. Advanced technologies, such as horizontal drilling and well stimulation and pressure pumping, improve total recovery, but they also result in a more rapid production decline and may become subject to more stringent regulations in the future.
Access to prospects is also important to our customers and such access may be limited because host governments do not allow access to the reserves or because another oil and natural gas exploration company owns the rights to develop the prospect. Government regulations and the costs incurred by oil and natural gas exploration companies to conform to and comply with government regulations may also limit the quantity of oil and natural gas that may be economically produced. This could lead our customers to curtail their operations and result in a decrease in demand for our services, which in turn could adversely affect our financial position and results of operations.
Any of these factors could affect the supply of oil and natural gas and could have a material adverse effect on our results of operations.
Legislative and regulatory initiatives relating to well stimulation could result in increased costs and additional operating restrictions or delays for our operations or the operations of our customers.
Many national, provincial, and local governments and agencies have adopted laws and regulations or are evaluating proposed legislation and regulations that are focused on the extraction of shale gas or oil using well stimulation, which is part of the overall services we provide to our customers. Well stimulation is a treatment routinely performed on oil and gas wells in low-permeability reservoirs. Specially engineered fluids are pumped at high pressure and rate into the reservoir interval to be treated, causing cracks in the target formation. Proppant, such as sand of a particular size, is mixed with the treatment fluid to keep the cracks open when the treatment is complete. In response to concerns related to potential impacts to the environment and natural resources from well stimulation, governmental authorities have issued new rules and regulations governing the practice, and are also pursuing studies related to its potential effects. Also, some national, state, and local governments have adopted bans or other measures restricting well stimulation activities. For example, the Province of Neuquén in Argentina where we operate, has approved a set of rules regarding the extraction of shale oil and gas. These rules require, amongst other things, that operators performing well stimulation obtain permits prior to commencing drilling activities and file reports with the provincial government regarding the chemicals used in the well stimulation process and an analysis of the flowback water returning to the surface. In certain regions, the indigenous people have voiced their opposition to the increased shale development although to date these protests have been peaceful and have yet to disrupt activity in a meaningful way. In addition, several other provinces and local governments have voted to ban well stimulation within their borders, and some groups continue to advocate for a national ban on well stimulation in Argentina. The EPA and states, including Oklahoma, have also taken steps to regulate hydraulic fracturing. There has been increasing public controversy regarding hydraulic fracturing with regard to the use of fracturing fluids, induced seismic activity, impacts on drinking water supplies, use of water and the potential for impacts to surface water, groundwater and the environment generally. Legislative or regulatory changes could cause us or our customers to incur substantial compliance costs, and compliance or the consequences of any failure to comply by us could have a material adverse effect on our financial condition and results of operations. At this time, it is not possible to estimate the impact on our business of newly enacted or potential national, state or local laws governing hydraulic fracturing.
Future well stimulation-related legislation or regulations that further restrict or prohibit such activities could lead to operational delays and increased costs for our operations or the operations of our customers. Any adverse impacts on the operations of our customers could in turn reduce demand for our services. If such additional legislation or regulations are enacted and implemented, it could adversely affect our financial condition, results of operations and cash flows.
Risks Related to Ownership of Our Common Stock
We have incurred, and expect to continue to incur, increased costs and risks as a result of being a public company.
As a public company, we are required to comply with most, but not all, of the Sarbanes-Oxley Act of 2002 (“SOX”), as well as rules and regulations implemented by the SEC. Changes in the laws and regulations affecting public companies, including the provisions of SOX and rules adopted by the SEC, have resulted in, and will continue to result in, increased costs to us as we respond to these requirements. Given the risks inherent in the design and operation of internal controls over financial reporting, the effectiveness of our internal controls over financial reporting is uncertain. If our internal controls are not designed or operating effectively, we may not be able to issue an evaluation of our internal control over financial reporting as required or we or our independent registered public accounting firm may determine that our internal control over financial reporting was not effective. In addition, our registered public accounting firm may either disclaim an opinion as it relates to management’s assessment of the effectiveness of our internal controls or may issue an adverse opinion on the effectiveness of our internal controls over financial reporting. Investors may lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and which could affect our ability to run our business as we otherwise would like to. New rules could also make it more difficult or costlier for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the coverage that is the same or similar to our current coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our Board, the committees of our Board, and as executive officers. We cannot predict or estimate the total amount of the costs we may incur or the timing of such costs to comply with these rules and regulations.
Compliance with Section 404 of the SOX will continue to strain our limited financial and management resources.
We incur significant legal, accounting and other expenses in connection with our status as a reporting public company. SOX and rules subsequently implemented by the SEC have imposed various new requirements on public companies, including requiring changes in corporate governance practices. As such, our management and other personnel need to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and made some activities more time-consuming and costly. In addition, SOX requires, among other things, that we maintain effective internal controls for financial reporting and disclosure of controls and procedures. Our testing may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 of SOX requires that we incur substantial accounting expense and expend significant management efforts. We may need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 of SOX in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline, and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.
We do not intend to pay cash dividends on our common stock in the foreseeable future, and therefore only appreciation of the price of our common stock will provide a return to our stockholders.
We currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business. We do not intend to pay cash dividends in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our Board. In addition, the terms of the A&R Note Agreement restrict our ability to pay dividends and make other distributions. As a result, only appreciation of the price of our common stock, which may not occur, will provide a return to our stockholders.
We currently have a sporadic, illiquid, volatile market for our common stock, and the market for our common stock may remain sporadic, illiquid, and volatile in the future.
We currently have a highly sporadic, illiquid and volatile market for our common stock, which market is anticipated to remain sporadic, illiquid and volatile in the future and will likely be subject to wide fluctuations in response to several factors, including, but not limited to:
|●||actual or anticipated variations in our results of operations;|
|●||our ability or inability to generate revenues;|
|●||the number of shares in our public float;|
|●||increased competition; and|
|●||conditions and trends in the market for oil and gas and down-hole services.|
Furthermore, our stock price may be impacted by factors that are unrelated or disproportionate to our operating performance. These market fluctuations, as well as general economic, political and market conditions, such as recessions, interest rates or international currency fluctuations may adversely affect the market price of our common stock. Shareholders and potential investors in our common stock should exercise caution before making an investment in our Company, and should not rely on the publicly quoted or traded stock prices in determining our common stock value, but should instead determine the value of our common stock based on the information contained in our public reports, industry information, and those business valuation methods commonly used to value private companies.
Fir Tree may have significant influence over us, including influence over decisions that require stockholder approval, which could limit your ability to influence the outcome of key transactions, including a change of control.
Fir Tree currently has the right to nominate and appoint up to a total of three individuals to the Board. As a result, Fir Tree has influence over our decisions to certain corporate actions including those specified in the A&R Stockholder Rights Agreement.
Moreover, Fir Tree has a contractual right to maintain its percentage ownership in our Company. Specifically, under the terms of the Stockholder Rights Agreement, for so long as Fir Tree beneficially owns more than 10% of our issued and outstanding common stock (calculated on a fully diluted basis), Fir Tree, subject to certain exclusions, has a preemptive right to purchase any new securities we propose to issue or sell in an amount not to exceed the amount of such new securities that Fir Tree would need to beneficially own so that its beneficial ownership of our common Stock does not decrease as a result of such issuance or sale. As a result, Fir Tree’s preemptive right will apply to any securities we issue during an underwritten public offering. Therefore, while other holders of our stock would risk suffering a reduction in percentage ownership in connection with a new issuance of securities by us, Fir Tree would, through this preemptive right, have the opportunity to avoid a reduction in percentage ownership. As long as Fir Tree continues to hold a significant portion of our outstanding common stock, it will have the ability to influence the vote in any election of directors and over decisions that require stockholder approval. Please read Part III – Item 13 – “Certain Relationships and Related Party Transactions, and Director Independence.”
Convertible debt not converting to equity can have an adverse effect on the Company
On March 6, 2017, the Company closed a transaction with Fir Tree and the ACM entities pursuant to which, among other things, Fir Tree purchased from the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018. This transaction was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. As part of the transaction, the Company issued to Fir Tree an additional $19.4 million aggregate principal amount of convertible notes. After giving effect to these transactions, the Company now has approximately $41.4 million of outstanding convertible notes due May 28, 2018 which accrue interest at 20% per annum. Fir Tree has agreed to convert all the outstanding convertible notes into common stock at a conversion price of $1.40 per share, subject to receipt of shareholder approval at the next shareholder meeting, and satisfaction of certain other conditions. Based on commitments from some of the Company’s largest shareholders, we believe that the convertible notes will be exchanged for common stock at $1.40 per share at the next shareholder meeting, however, if the convertible notes remain outstanding following the next shareholder meeting, the Company will be required to make a semi-annual interest payment of approximately $3.7 million on August 15, 2017. At that time, we may not have sufficient cash to pay this interest payment, resulting in potential default of the loan.
We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.
Our certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations, preferences, limitations and relative rights, including preferences over our common stock respecting dividends and distributions, as our Board may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of the common stock.
Item 1B. Unresolved Staff Comments
Item 2. Properties
Our principal executive offices are located at 2930 W. Sam Houston Parkway North, Suite 275, Houston, Texas 77043, where we lease 6,577 square feet of general office space pursuant to a lease agreement expiring on September 30, 2017.
We own or lease facilities and administrative offices throughout the geographic regions in which we operate. As of December 31, 2016, we owned or leased the following principal properties:
|Location||Type of Facility||Size||Leased
|2930 W. Sam Houston Pkwy N., Suite 275, Houston, TX||Corporate Office||6,577
|Leased||$||17,312||September 30, 2017||Administrative Office|
|1600 Brittmoore Rd Houston, TX||Warehouse||13,125 sq. ft.|
|Leased||$||7,000||Month to month||US Operations|
|Uruguay 1134 Buenos Aires, Argentina||Administrative Offices||1,900 sq. ft.|
|Leased||$||4,500||September 30, 2017||Administrative Office|
|Leloir 451 |
|Administrative Offices||1,990 sq. ft.|
|Leased||$||4,500||June 30, 2017||Neuquén Operations|
|256946 E. |
County Road 49, Fairview,
|Yard and Office||Approx, 13 |
|Leased||$||22,500||March 7, 2019||US Operations|
|Plottier, Argentina||Land||12 acres||Owned||N/A||—||Future Neuquén Operations|
|Calle No 12|
|Warehouse||3,500 sq. ft.|
|Leased||$||6,900||August 31, 2017||Argentina Operations|
Neuquén, Argentina Lote 3, Manzana D, parque industrial
|Warehouse||8,073 sq. ft|
|Leased||$||7,000||November 30, 2018||Argentina Operations|
Argentina Lote 4, Manzana 2C, parque industrial
|Warehouse||129,167 sq. ft.|
|Leased||$||7,312||November 30, 2018||Argentina Operations|
Item 3. Legal Proceedings
We are not a party to and none of our property is the subject of any pending material legal proceedings. To our knowledge, no governmental authority is contemplating any such proceedings.
Item 4. Mine Safety Disclosures
|Item 5.||Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity securities|
Our common stock is currently listed on the NASDAQ Capital Market under the symbol “ESES.” Prior to April 10, 2015, our common stock was quoted in the over-the-counter bulletin board (or OTCBB) and the OTCQB marketplace operated by the OTC Market Group, Inc. The reported high and low last sale prices for our common stock are shown below for the periods indicated. The quotations reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not represent actual transactions. On March 10, 2017, the last reported sale price of our common stock was $1.08 per share.
|First quarter ended March 31, 2014||$||15.00||(1)||$||4.80|
|Second quarter ended June 30, 2014||$||7.75||$||6.50|
|Third quarter ended September 30, 2014||$||16.00||(2)||$||6.00|
|Fourth quarter ended December 31, 2014||$||7.04||$||4.30|
|First quarter ended March 31, 2015||$||6.50||$||4.31|
|Second quarter ended June 30, 2015||$||8.39||$||5.18|
|Third quarter ended September 30, 2015||$||6.79||$||2.99|
|Fourth quarter ended December 31, 2015||$||5.45||$||1.88|
|First quarter ended March 31, 2016||$||2.95||$||2.00|
|Second quarter ended June 30, 2016||$||3.12||$||2.14|
|Third quarter ended September 30, 2016||$||2.80||$||2.09|
|Fourth quarter ended December 31, 2016||$||2.19||$||0.96|
|(1)||Volume of shares traded at high price for the quarter was 2,339 shares.|
|(2)||Volume of shares traded at high price for the quarter was 400 shares.|
As of March 10, 2017, we had approximately 659 record holders of our common stock.
We currently intend to retain future earnings, if any, for use in the operation and expansion of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future following this offering. However, our Board, in its discretion, may authorize the payment of dividends in the future. Any decision to pay future dividends will depend upon various factors, including our results of operations, financial condition, capital requirements and investment opportunities. In addition, the A&R Note Agreement contains terms and covenants that restrict our ability to make distributions to our stockholders.
Securities Authorized for Issuance under Equity Compensation Plans
The Company has two stock incentive plans, the 2013 Stock Incentive Plan (the “2013 Plan”) and the 2015 Stock Incentive Plan (the “2015 Plan”), which provide for the granting of stock-based incentive awards, including incentive stock options, non-qualified stock options and restricted stock, to employees, consultants and members of the Board. The 2013 Plan was adopted in 2012 and amended in 2013 and authorizes 1,000,000 shares to be issued. The 2015 Plan, f/k/a “the 2014 Stock Incentive Plan,” was adopted in 2014; in 2015 and 2016 it was amended and a total of 700,000 additional shares were authorized, resulting in a maximum of 1,700,000 shares being authorized for issuance. Both the 2013 Plan and the 2015 Plan have been approved by the shareholders of the Company.
For additional information regarding the Stock Incentive Plans, as of December 31, 2016, please see Part II – Item 8 – Financial Statements and Supplemental Data – Notes to consolidated financial statements – Note 14 – “Stock-Based Compensation.”
|Equity Compensation Plan Information|
securities to be
price of outstanding
column (a)) (c)
|Equity compensation plans approved by security holders||1,174,464||$||5.45||759,328|
|Equity compensation plans not approved by security holders||—||—||—|
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
We did not have any sales of unregistered equity securities during the fiscal year ended December 31, 2016.
Purchases of Equity Securities by the Issuer
The following table discloses purchases of shares of the Company’s common stock made by us or on our behalf during the year ended December 31, 2016:
Price Paid |
as Part of Publicly
or Programs (2)
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans
|January 1, 2016 – January 31, 2016||12,096||$||2.57||19,035||$||4,948,630|
|February 1, 2016 – February 29, 2016||2,815||2.17||21,850||4,942,531|
|(1)||All shares were purchased pursuant to the publicly announced stock repurchase program described in footnote 2 below.|
|(2)||On December 15, 2015, the Board authorized the Company to repurchase, from time to time during the period from December 16, 2015 through December 16, 2017, up to $5 million in shares of its outstanding common stock. Beginning December 2015 through December 31, 2016, 21,850 shares of our common stock have been repurchased by us or on our behalf pursuant to such stock repurchase plan.|
Item 6. Selected Financial Data
|Item 7.||Management’s Discussion and Analysis of Financial Condition and Results of Operations|
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto included in this Form 10-K. This section contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in any forward-looking statement because of various factors, including those described in the section titled “Cautionary Statements Regarding Forward-Looking Statements” above.
This section contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in any forward-looking statement because of various factors, including those described in the section titled “Cautionary Statements Regarding Forward-Looking Statements” in this Form 10-K.
We provide well stimulation, coiled tubing and field management services to the upstream oil and gas industry. We serve major, national and independent oil and natural gas exploration and production companies globally and we offer our products and services with respect to the various phases of a well’s economic life cycle.
For both 2015 and 2016, our activity was concentrated in the Vaca Muerta in the Neuquén Basin in Argentina, the world’s third-largest shale resource basin as measured by technically recoverable reserves. With the beginning of 2016 marked by low oil prices at $26 per barrel culminating two years of decline in the oil and gas industry, global oil and gas prices began to stabilize in the third quarter of 2016.
During 2015, the Company, with its well stimulation operations and coiled tubing operations, completed 82 stimulation stages and 18 coiled tubing jobs. During 2016, the Company completed 75 stimulation stages and 37 coiled tubing jobs. Rig count in Argentina went from a monthly average high in December 2014 of 113 to a low of 52 in January 2017. During 2016, we generated $8,352,236 of revenue, down from $13,755,140 of revenue generated in 2015. The decrease in revenue was due to lower rig counts, lower pricing and customer budget constraints. Low oil and natural gas prices made 2016 an extremely challenging year due to significant reductions in activity and widespread pricing pressure.
Results of Operations
During 2016, we generated $8,352,236 of revenue, down from $13,755,140 of revenue generated in 2015. The decrease in revenue was due to lower rig counts, lower pricing and customer budget constraints.
During 2016, we incurred a net loss of $17,925,248, or a $1.32 loss per share, compared with a $13,394,751 net loss in 2015 or $1.35 loss per share. Cost of services were reduced in 2016 compared with 2015 in line with the revenue reductions, but in order to mitigate the unfavorable market environment during 2016, we continued to monitor and reduce certain non-essential and deferable services and expenditures within our selling, general and administrative and research and development costs.
The oil and gas industry is both cyclical and seasonal. The level of spending by oil and gas companies is highly influenced by current and expected demand and future prices of oil and natural gas. Changes in spending result in an increased or decreased demand for our services and products. Rig count is an indicator of the level of spending by oil and gas companies. Our financial performance is significantly affected by the rig count in Argentina as well as oil and natural gas prices, which are summarized in the table below.
|2016||2015||2016 to 2015 Change||2014||2015 to 2014 Change|
|Worldwide Rig Count (1)|
|U.S. Land (excl offshore)||486||943||-48||%||1,804||-48||%|
|Commodity Prices (average)|
|Crude Oil (West Texas Intermediate)||$||43.29||$||48.66||-11||%||$||93.17||-48||%|
|Natural Gas (Henry Hub)||$||2.52||$||2.62||-4||%||$||4.37||-40||%|
(1) Estimate of drilling activity as measured by average active drilling rigs based on Baker Hughes Incorporated rig count information.
(2) Total rig count for Argentina
At December 31, 2016, per Baker Hughes Incorporated rig count data, the U.S. land only rig count was 634 rigs, which represented a 5% decrease from the end of 2015 and a 70% increase from the lowest level during 2016 of 374.
At December 2016, per Baker Hughes Incorporated rig count data, the Argentinian monthly average rig count was 59 rigs, which represented a 54% decrease from December 2015 and a 6% decrease from the lowest monthly average level during 2016 of 63.
Overview of our business services
Our customers utilize our pressure pumping services to enhance the production of oil and natural gas from formations with low permeability, which restricts the natural flow of hydrocarbons. The technique of well stimulation consists of pumping a fluid into a cased well at sufficient pressure to create new channels in the rock, which can increase the extraction rates and the ultimate recovery of the hydrocarbons. Our equipment is contracted by oil and gas producers to provide this pressure-pumping service, which is referred to as well stimulation. Demand for these services can change quickly and is highly dependent on the number of oil and natural gas wells drilled and completed. Given the cyclical nature of these drilling and completion activities, coupled with the high labor intensity of these services, operating margins can fluctuate widely depending on supply and demand at a given point in the cycle.
Our customers utilize our coiled tubing services to perform various functions associated with well-servicing operations and to facilitate completion of horizontal wells. Coiled tubing services involve the insertion of steel tubing into a well to convey materials and/or equipment to perform various applications as part of a new completion or the servicing of existing wells, including wellbore maintenance, nitrogen services, thru-tubing services, and formation stimulation using acid and other chemicals. Coiled tubing has become a preferred method of well completion, workover and maintenance projects due to speed, ability to handle heavy-duty jobs across a wide spectrum of pressure environments, safety and ability to perform services without having to shut-in a well. Our coiled tubing capabilities cover a wide range of applications for horizontal completion, work-over and well-maintenance projects. As a result, coiled tubing services are less tied to active rig count and more tied to price of oil and gas as well as customers’ expenditure budgets – usually also tied to the price of oil and gas.
|Years Ended December 31,|
|Operating cost and expenses:||—|
|Cost of services||10,630,233||14,527,201||(3,896,968||)|
|Selling, general, and administrative expenses||5,892,235||7,011,765||(1,119,530||)|
|Research and development||486,128||979,893||(493,765||)|
|Depreciation and amortization expense||4,667,797||3,414,452||1,253,345|
|Total operating costs and expenses||21,676,393||25,933,311||(4,256,918||)|
|Other income (expense):||—|
|Gain on sale of trading securities||—||5,091,387||(5,091,387||)|
|Total other income (expense)||(4,295,771||)||(872,266||)||(3,423,505||)|
|Provision for income taxes||(305,320||)||(344,314||)||38,994|
For the Years Ended December 31, 2016 and 2015
Revenue for the year ended December 31, 2016 decreased $5,402,904 to $8,352,236 from $13,755,140 for the year ended December 31, 2015. This decrease was primarily due to reduced activity of our well stimulation and coiled tubing operations in Argentina in 2016 period as compared to 2015.
Costs of services decreased $3,896,968 to $10,630,233 for the year ended December 31, 2016 compared to $14,527,201 for the year ended December 31, 2015. This decrease was primarily due to reduced activity levels related to our well stimulation and coiled tubing operations in Argentina in line with revenue as compared to 2015
Our selling, general, and administrative expenses decreased $1,119,530 to $5,892,235 for the year ended December 31, 2016 compared to $7,011,765 for the year ended December 31, 2015. This decrease was a result of decreases in stock compensation of $506,928 for options and restricted stock granted in 2015 that did not occur in 2016; reductions of $478,872 in 2016 taken in legal costs and professional fees due to overall reductions in use of these services in 2016 compared with 2015, and; reductions in travel costs of $211,747 related to the reduced activity levels in 2016 when compared with 2015.
Research and development decreased $493,765 to $486,128 for the year ended December 31, 2016, compared to $979,893 for the year ended December 31, 2015. This decrease was due primarily to reductions taken in our research activities of fiber optics technology and the development of our TPU technology.
Net other expense increased $3,423,505 to $4,295,771 for the year ended December 31, 2016 compared to net other expense of $872,266 for the year ended December 31, 2015. This increase was a result of recognition in 2015 of a non-recurring gain on sale of trading securities of $5,091,387. These gains related to the capitalization of our subsidiary in Argentina, whereby we purchased and sold Argentine bonds in order to take advantage of the favorable spread in exchange rates between the U.S. dollar and Argentine peso. This increase in net other expense was offset by foreign currency loss decreases, which decreased by $754,240 to $926,083 for the year ended December 31, 2016 compared with $1,680,323 for the year ended December 31, 2015. Our foreign currency losses for both years 2016 and 2015 were a result of our revaluation of our net foreign currency positions into U.S. dollar equivalents using the market exchange rate between the peso and the dollar. In 2015, using the month end closing rates, the Argentine peso weakened against the U.S. dollar 33% (from 8.6 pesos per 1 U.S. dollar at the end of December 2014 to 11.4 pesos per U.S. dollar at the end of December 2015). In late 2015, the new President of Argentina removed currency controls. A significant amount of the pesos’ weakening in 2015 occurred in late 2015 after removal of the currency controls. During 2016, the peso continued to weaken against the dollar 39% (from 11.4 pesos per dollar at the end of December 2015 to 15.8 at the end of December 2016).
Also offsetting the net other expense increase was an increase in interest income, which increased $774,568 to $774,665 for the year ended December 31, 2016 compared with $97 for the year ended December 31, 2015. This increase in interest income is due primarily to short-term cash equivalent investments made with excess cash in Argentina that was not in place in 2015.
Liquidity and Capital Resources
Our primary sources of liquidity to date have been proceeds from various equity and debt offerings. We completed a public offering during the first quarter of 2015 and a second offering on July 15, 2015. In July 2016, the Company entered into an at-market issuance sales agreement with equity sales providing proceeds during the second half of 2016. All the above offerings are as discussed in Part II – Item 8 – Financial Statements and Supplemental Data – Notes to consolidated financial statements – Note 11 – “Equity Offerings”.
On March 6, 2017, the Company closed a transaction with Fir Tree and the ACM entities, pursuant to which, among other things, Fir Tree purchased from the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018. This transaction was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. As part of the transaction, the Company issued to Fir Tree an additional $19.4 million aggregate principal amount of convertible notes. After giving effect to these transactions, the Company now has approximately $41.4 million of outstanding convertible notes. Fir Tree has agreed to convert all the outstanding convertible notes into common stock at a conversion price of $1.40 per share, subject to receipt of shareholder approval and satisfaction of certain other conditions. Assuming all the outstanding convertible notes are converted into common stock, on a pro-forma basis, the Company would issue approximately 29.5 million shares to Fir Tree and would then have approximately 44.6 million shares outstanding and no outstanding debt.
We continually monitor potential capital sources, including equity and debt financings, in order to meet our planned capital expenditures and liquidity requirements. The successful execution of our growth strategy depends on our ability to raise capital as needed to, among other things, finance the purchase of additional equipment. If we are unable to obtain additional capital on favorable terms or at all, we may be unable to sustain or increase our current level of growth in the future. The availability of equity and debt financing will be affected by prevailing economic conditions in our industry and financial, business and other factors, many of which are beyond our control.
Sources and Uses of Cash
Net cash used in operating activities was $5,276,855 for the year ended December 31, 2016 and $18,615,159 for the year ended December 31, 2015. The decrease was primarily due to lower activity and pricing levels for the twelve months ended December 2016 compared to the same period ended December 31, 2015.
Net cash used in investing activities was $4,591,080 for the year ended December 31, 2016 and $7,020,081 for the year ended December 31, 2015. This decrease was primarily due to the absence of the gain on sale of trading securities of approximately $5,091,387 and a decrease in purchase of equipment of $8,881,156.
Net cash provided by (used in) financing activities was $(143,165) for the year ended December 31, 2016 and $30,364,173 for the year ended December 31, 2015. The decrease was primarily attributable to the sale of common stock of $32,229,119, net of issuance cost, during 2015.
The following table summarizes our cash flows for the years ended December 31, 2016 and 2015:
|Years Ended December 31,|
|Proceeds from sale of common stock||$||1,722,596||$||35,329,038|
|Sale of common stock issuance cost||(164,041||)||(3,099,919||)|
|Proceeds from notes payable||2,194,611||400,000|
|Payments on notes payable||(3,293,732||)||(1,647,246||)|
|Payments on capital lease||(565,449||)||(597,406||)|
|Purchase of treasury stock||(37,175||)||(20,294||)|
|Net cash provided by (used in) financing activities||$||(143,190||)||$||30,364,173|
On December 15, 2015, the Board authorized the Company to repurchase, from time to time, from December 16, 2015 through December 16, 2017, up to $5 million in shares of its outstanding common stock. As of December 31, 2015, the Company had purchased 6,939 shares at a cost of $20,294 under the buy-back program. Also under the buy-back program, for the year ended December 31, 2016, the Company purchased an additional 14,911 shares at a cost of $37,175.
On July 13, 2016, the Company entered into an At-Market Issuance Sale Agreement as disclosed in Note 11 – “Equity Offerings”. During 2016, the Company sold 796,573 shares through the Agreement for a total gross proceeds of $1,722,596 before deducting approximately $164,000 of commissions.
We had a net decrease in cash and cash equivalents of $10,011,125 for the year ended December 31, 2016, compared to a net increase in cash and cash equivalents of $4,728,933 during the year ended December 31, 2015 primarily resulting from our proceeds in stock issuances in 2015, offset by reductions in operating activities and capital expenditures for 2016 compared with 2015.
We do not generate positive cash flow at this time. Further, while we believe we will begin generating positive cash flow from operations in 2017, our liquidity provided by our existing cash and cash equivalents may not be sufficient to fund our full capital expenditure plan. Our current capital commitments may require us to obtain additional equity or debt financing, which may not be available to us on favorable terms or at all.
On March 6, 2017, the Company closed a transaction with Fir Tree and the ACM entities, pursuant to which, among other things, Fir Tree purchased from the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018. This transaction was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. As part of the transaction, the Company issued to Fir Tree an additional $19.4 million aggregate principal amount of convertible notes. After giving effect to these transactions, the Company now has approximately $41.4 million of outstanding convertible notes due May 28, 2018 which accrue interest at 20% per annum. Fir Tree has agreed to convert all the outstanding convertible notes into common stock at a conversion price of $1.40 per share, subject to receipt of shareholder approval at the next shareholder meeting, and satisfaction of certain other conditions. Assuming all the outstanding convertible notes are converted into common stock, on a pro-forma basis, the Company would issue approximately 29.5 million shares to Fir Tree and would then have approximately 44.6 million shares outstanding and no outstanding debt. Based on commitments from some of the Company’s largest shareholders, we believe that the convertible notes will be exchanged for common stock at $1.40 per share at the next shareholder meeting, however, if the convertible notes remain outstanding following the next shareholder meeting, the Company will be required to make a semi-annual interest payment of approximately $3.7 million on August 15, 2017. At that time, we may not have sufficient cash to pay this interest.
The energy services business is capital intensive, requiring significant investment to expand, upgrade and maintain equipment. Our primary uses of capital have been the acquisition of equipment, working capital to finance the start of our operations and general administrative expenses.
Going forward, we expect our capital requirements to consist primarily of:
|●||growth capital expenditures, such as those to acquire additional equipment and other assets to grow our business; and|
|●||maintenance capital expenditures, which are capital expenditures made to extend the useful life of our assets.|
Additionally, we continually monitor new advances in well stimulation equipment and down-hole technology as well as technologies that may complement our business and opportunities to acquire additional equipment to meet our customers’ needs. Our ability to make any significant acquisition for cash would likely require us to obtain additional equity or debt financing, which may not be available to us on favorable terms or at all.
Our ability to fund operations, and to fund planned and committed 2017 capital expenditures will depend upon our future operating performance, and more broadly, on the availability of equity and debt financing, which will be affected by prevailing economic conditions, market conditions in the exploration and production industry and financial, business and other factors, many of which are beyond our control.
Our ability to acquire equipment could require us to obtain additional equity or debt financing, which may not be available to us on favorable terms or at all.
We intend to incur approximately $10 million in capital expenditures during the first half of 2017 and will incur additional capital expenditures on a discretionary basis as necessary to meet customer demands and subject to satisfactory financing.
Impact of Inflation on Operations
Management is of the opinion that inflation has not had a significant impact on our business to date. We purchase our equipment and materials from suppliers who provide competitive prices and employ skilled workers from competitive labor markets. If inflation in the general economy increases, our costs for equipment, materials and labor could increase as well. Also, increases in activity in oilfields can cause upward wage pressures in the labor markets from which we hire employees as well as increases in the costs of certain materials and key equipment components used to provide services to our customers.
Off-Balance Sheet Arrangements
As of December 31, 2016, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. The term “off-balance sheet arrangements” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have (i) any obligation arising under a guarantee contract, derivative instrument or variable interest or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to select appropriate accounting principles from those available, to apply those principles consistently and to make reasonable estimates and assumptions that affect revenues and associated costs as well as reported amounts of assets and liabilities, and related disclosure of contingent assets and liabilities. Certain accounting policies involve judgments and uncertainties. We evaluate estimates and assumptions on a regular basis. We base our respective estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from the estimates and assumptions used in preparation of our consolidated financial statements. We consider the following policies to be the most critical to understanding the judgments that are involved and the uncertainties that could impact our results of operations, financial condition and cash flows.
Pursuant to the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), we are reporting in accordance with certain reduced public company reporting requirements permitted by this Act. As a result, our financial statements may not be comparable to companies that are not emerging growth companies or elect to avail themselves of this provision.
We believe the following critical accounting policies involve significant areas of management’s judgments and estimates in the preparation of its consolidated financial statements.
Property and Equipment. Fixed asset additions are recorded at cost less accumulated depreciation. Cost of units manufactured consists of products, components, labor and overhead. Expenditures for renewals and betterments that extend the lives of the assets are capitalized. An allocable amount of interest on borrowings is capitalized for self-constructed assets and equipment during their construction period. Amounts spent for maintenance and repairs are charged against operations as incurred. Costs of fixed assets are depreciated on a straight-line basis over the estimated useful lives of the related assets which range from one year and half to seven years for service equipment. Leasehold improvements will be depreciated over the lesser of the estimated useful life of the improvement or the remaining lease term. Management is responsible for reviewing the carrying value of property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to the amount by which the carrying value exceeds the fair value of assets. When making this assessment, the following factors are considered: current operating results, trends and prospects, as well as the effects of obsolescence, demand, competition and other economic factors.
Capital Lease Obligations. The Company leases certain equipment under lease agreements. The Company evaluates each lease to determine its appropriate classification as an operating or capital lease for financial reporting purposes. Any lease that does not meet the criteria for a capital lease is accounted for as an operating lease. The assets and liabilities under capital leases are recorded at the lower of the present value of the minimum lease payments or the fair market value of the related assets. Assets under capital leases are amortized using the straight-line method over the initial lease term. Amortization of assets under capital leases is included in depreciation expense.
Revenue Recognition. Revenues are recognized as services are completed and collectability is reasonably assured. With respect to hydraulic fracturing services, we expect to recognize revenue and invoice our customers upon the completion of each fracturing stage. In our industry, it is not uncommon for a service provider to complete multiple fracturing stages per day during the course of a job.
Stock-Based Payments. We account for stock incentive awards issued to employees and non-employees in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Stock Compensation. Accordingly, employee stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period, or upon the occurrence of certain vesting events. Additionally, stock-based awards to non-employees are expensed over the period in which the related services are rendered. The grant-date fair value of awards is estimated using the Black-Scholes option-pricing model, which requires the use of highly subjective assumptions such as the estimated market value of our stock, expected term of the award, expected volatility and the risk-free interest rate. Since some of our share options were not publicly traded at the time of issuance and have not been traded privately, the value of the shares is estimated based on significant unobservable inputs, primarily consisting of the estimated value of the start-up activities completed as of the grant date, as well as other inputs that are estimated based on similar entities with publicly traded securities. We continue to use judgment in evaluating the expected term, volatility and forfeiture rate related to our stock-based compensation on a prospective basis and incorporate these factors into our option-pricing model. Each of these inputs is subjective and generally requires significant management judgment. If, in the future, we determine that another method for calculating the fair value of our unit-based awards is more reasonable, or if another method for calculating these input assumptions is prescribed by authoritative guidance, and, therefore, should be used to estimate expected volatility or expected term, the fair value calculated for our employee unit-based awards could change significantly. Higher volatility and longer expected terms generally result in an increase to stock-based compensation expense determined at the date of grant.
Income Taxes. We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. 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 on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Our tax filings for various periods are subject to audit by the tax authorities in most jurisdictions where we conduct business. These audits may result in assessments of additional taxes that are resolved with the authorities or through the courts. We believe these assessments may occasionally be based on erroneous and even arbitrary interpretations of local tax law. Resolution of these situations inevitably includes some degree of uncertainty; accordingly, we provide taxes only for the amounts we believe will ultimately result from these proceedings. The resulting change to our tax liability, if any, is dependent on numerous factors including, among others, the amount and nature of additional taxes potentially asserted by local tax authorities; the willingness of local tax authorities to negotiate a fair settlement through an administrative process; the impartiality of the local courts; the number of countries in which we do business; and the potential for changes in the tax paid to one country to either produce, or fail to produce, an offsetting tax change in other countries. The potential exists that the tax resulting from the resolution of current and potential future tax controversies may differ materially from the amount accrued.
Valuation Allowance for Deferred Tax Assets. We record a valuation allowance to reduce the carrying value of our deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will expire before realization of the benefit or future deductibility is not probable. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character and in the related jurisdiction in the future. In evaluating our ability to recover our deferred tax assets, we consider the available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of future pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment.
Recent Accounting Pronouncements
See Part II, Item 8, Notes to consolidated financial statements – Note 2 – “Basis of Presentation and Significant Accounting Policies.”
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates and commodities that could impact our financial position, results of operations and cash flows. We manage our exposure to these risks through regular operating and financing activities.
Foreign Currency Risk
During the years ended December 31, 2015 and 2016, we conducted operations in Argentina. The functional currency for our Argentina operations is the U.S. dollar. We and our foreign subsidiaries from time to time will hold foreign currencies. Exchange rate fluctuations will subject us to foreign currency risk. In the future, we could experience fluctuations in financial results from our operations outside the U.S., and there can be no assurance that payments received in foreign currencies can be repatriated to the U.S. or that we will be able, contractually or otherwise, to reduce the foreign currency risks associated with our international operations.
Commodity Price Risk
Our revenues, profitability and future rate of growth significantly depend upon the market prices of oil and natural gas. Lower prices may also reduce the amount of oil and gas that can economically be produced.
Item 8. Financial Statements and Supplemental Data
|Report of Independent Registered Public Accounting Firm||38|
|Consolidated balance sheets||39|
|Consolidated statements of operations||40|
|Consolidated statements of cash flows||41|
|Consolidated statements of changes in stockholders’ equity||42|
|Notes to consolidated financial statements||43|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Eco-Stim Energy Solutions, Inc.
We have audited the accompanying consolidated balance sheets of Eco-Stim Energy Solutions, Inc. (the “Company”), as of December 31, 2016 and 2015, and the related consolidated statements of operations, cash flows and changes in stockholders’ equity for the years then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company, as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Whitley Penn LLP
March 17, 2017
ECO-STIM ENERGY SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
|December 31, 2016||December 31, 2015|
|Cash and cash equivalents||$||1,731,364||$||11,742,489|
|Total current assets||8,594,773||24,821,129|
|Property, plant and equipment, net||38,382,391||37,142,578|
|Other non-current assets||325,756||488,633|
|Liabilities and stockholders’ equity|
|Short-term notes payable||2,000,000||—|
|Current portion of long term notes payable||—||2,825,428|
|Current portion of capital lease payable||789,166||686,624|
|Total current liabilities||9,745,897||8,468,361|
|Long-term notes payable||21,737,404||21,737,403|
|Long-term capital lease payable||766,687||1,485,686|
|Total non-current liabilities||22,504,091||23,223,089|
|Preferred stock, $0.001 par value, 50,000,000 shares authorized, none issued||—||—|
|Common stock, $0.001 par value, 200,000,000 shares authorized, 14,485,937 issued and 14,464,087 outstanding at December 31, 2016 and 13,572,989 issued and 13,566,050 outstanding at December 31, 2015||14,485||13,572|
|Additional paid-in capital||59,556,505||57,302,953|
|Treasury stock, at cost; 21,850 common shares at December 31, 2016 and 6,939 common shares at December 31, 2015||(57,469||)||(20,294||)|
|Total stockholders’ equity||15,052,932||30,760,890|
|Total liabilities and stockholders’ equity||$||47,302,920||$||62,452,340|
See accompanying notes to consolidated financial statements.
ECO-STIM ENERGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
|Years Ended December 31,|
|Operating cost and expenses:|
|Cost of services||10,630,233||14,527,201|
|Selling, general, and administrative expenses||5,892,235||7,011,765|
|Research and development||486,128||979,893|
|Depreciation and amortization expense||4,667,797||3,414,452|
|Total operating costs and expenses||21,676,393||25,933,311|
|Other income (expense):|
|Gain on sale of trading securities||—||5,091,387|
|Total other expense||(4,295,771||)||(872,266||)|
|Provision for income taxes||(305,320||)||(344,314||)|
|Basic and diluted loss per share||$||(1.32||)||$||(1.35||)|
|Weighted average number of common shares outstanding-basic||13,615,428||9,888,191|
See accompanying notes to consolidated financial statements.
ECO-STIM ENERGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
|Years Ended December 31,|
|Depreciation and amortization||4,667,797||3,414,452|
|Amortization of debt discount and loan origination cost||255,530||255,535|
|Stock based compensation||695,910||1,480,435|
|Gain on the sale of trading securities||—||(5,091,387||)|
|Changes in operating assets and liabilities:|
|Prepaids and other assets||1,468,076||(860,538||)|
|Accounts payable and accrued expenses||772,223||3,656,899|
|Net cash used in operating activities||(5,276,855||)||(18,615,159||)|
|Purchases of equipment||(4,591,080||)||(13,472,236||)|
|Proceeds from sale of trading securities||—||19,435,956|
|Purchase of trading securities||—||(12,983,801||)|
|Net cash used in investing activities||(4,591,080||)||(7,020,081||)|
|Proceeds from sale of common stock||1,722,596||35,329,038|
|Sale of common stock issuance cost||(164,041||)||(3,099,919||)|
|Proceeds from notes payable||2,194,611||400,000|
|Payments on notes payable||(3,293,732||)||(1,647,246||)|
|Payments on capital lease||(565,449||)||(597,406||)|
|Purchase of treasury stock||(37,175||)||(20,294||)|
|Net cash provided by (used in) financing activities||(143,190||)||30,364,173|
|Net increase (decrease) in cash and cash equivalents||(10,011,125||)||4,728,933|
|Cash and cash equivalents, beginning of year||11,742,489||7,013,556|
|Cash and cash equivalents, end of year||$||1,731,364||$||11,742,489|
|Supplemental Disclosure of Cash Flow Information|
|Cash paid during the year for interest||$||3,448,408||$||3,104,129|
|Cash paid during the year for income taxes||$||140,341||$||252,725|
|Property plant and equipment additions in account payable||$||1,327,927||$||139,607|
|Interest converted to common stock||$||—||$||2,485,162|
See accompanying notes to consolidated financial statements.
ECO-STIM ENERGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY YEARS ENDED DECEMBER 31, 2016 AND 2015
|Common Stock||Additional Paid-in||Treasury||Accumulated|
|Balance at December 31, 2014||5,709,523||$||5,709||$||21,116,100||$||—||$||(13,140,590||)||$||7,981,219|
|Sale of common stock, net||7,216,066||7,216||32,221,902||—||—||32,229,118|
|Interest converted to common stock||523,192||523||2,484,640||—||—||2,485,163|
|Stock based compensation||124,208||124||1,480,311||—||—||1,480,435|
|Balance at December 31, 2015||13,566,050||$||13,572||$||57,302,953||$||(20,294||)||$||(26,535,341||)||$||30,760,890|
|Sale of common stock, net||796,573||797||1,557,758||—||—||1,558,555|
|Stock based compensation||116,375||116||695,794||—||—||695,910|
|Balance at December 31, 2016||14,464,087||$||14,485||$||59,556,505||$||(57,469||)||$||(44,460,589||)||$||15,052,932|
See accompanying notes to consolidated financial statements.
ECO-STIM ENERGY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016 and 2015
1. Nature of Business
Eco-Stim Energy Solutions, Inc. (the “Company,” “Eco-Stim,” “we” or “us”) is a technology-driven independent oilfield services company providing well stimulation, coiled tubing and field management services to the upstream oil and gas industry. We are focused on reducing the ecological impact and improving the economic performance of the well stimulation process. We have assembled technologies and processes that have the ability to (1) reduce the surface footprint, (2) reduce emissions, and (3) conserve fuel and water during the stimulation process. The Company will focus on the most active shale resource basins outside of the United States, using our technology to differentiate our service offerings. Our management team has extensive international industry experience. Our first operation is in Argentina, home to the Vaca Muerta, the world’s third-largest shale resource basin as measured by technically recoverable reserves. The Company may also explore opportunistic acquisitions and/or joint ventures with established companies in target markets.
2. Basis of Presentation and Significant Accounting Policies
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).
Principles of Consolidation
We consolidate all wholly-owned subsidiaries, controlled joint ventures and variable interest entities where the Company has determined it is the primary beneficiary. All material intercompany accounts and transactions have been eliminated in consolidation.
The Company has incurred losses since inception and will require additional capital to continue operating. As of December 31, 2016, the Company had cash and cash equivalents of approximately $1.7 million and working capital deficit of approximately $1.2 million. These factors raise substantial doubt about the Company’s ability to continue as a going concern. However, in March of 2017, the Company secured $17 million of additional cash from the Fir Tree transaction discussed in Note 19, which will be sufficient to fund operations into the second quarter of 2018.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP 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 revenue and expenses during the reporting period. Estimates are used in, but are not limited to, determining the following: allowance for doubtful accounts, recoverability of long-lived assets and intangibles, useful lives used in depreciation and amortization, income taxes and stock-based compensation. The accounting estimates used in the preparation of the consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company maintains deposits in several financial institutions, which may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation (“FDIC”). The Company has not experienced any losses related to amounts in excess of FDIC limits.
The Company’s revenue is heavily dependent on three major customers. All revenue is recognized when persuasive evidence of an arrangement exists, specific performance completed, the price is fixed or determinable, and collection is reasonably assured as follows:
Well Stimulation Revenue
The Company provides well stimulation services based on contractual arrangements, such as term contracts and pricing agreements, or on a spot market basis. Revenue is recognized and customers invoiced upon the completion of each job, which can consist of one or more stimulation stages.
Under term pricing agreement arrangements, customers commit to targeted utilization levels at agreed-upon pricing, but without termination penalties or obligations to pay for services not used by the customer. In addition, the agreed-upon pricing is typically subject to periodic review.
Spot market basis arrangements are based on an agreed-upon hourly spot market rate. The Company also charges fees for setup and mobilization of equipment depending on the job, additional equipment used on the job, if any, and materials that are consumed during the well stimulation process. Generally, these fees and other charges vary depending on the equipment and personnel required for the job and market conditions in the region in which the services are performed.
The Company also generates revenues from chemicals and proppants that are consumed while performing well stimulation services.
Coiled Tubing Revenue
The Company began providing coiled tubing and other well stimulation services in early 2015. Jobs for these services are typically short term in nature, lasting anywhere from a few hours to multiple days. Revenue is recognized upon completion of each job based upon a completed field ticket. The Company charges the customer for mobilization, services performed, personnel on the job, equipment used on the job, and miscellaneous consumables at agreed-upon spot market rates.
Field Management Revenue
The Company enters into arrangements to provide field management services. Field management revenue relates primarily to geophysical predictions and production monitoring, utilizing down-hole diagnostics tools. Revenue is recognized and customers are invoiced upon the completion of each job. The service invoices are for a set amount, which includes charges for the mobilization of the equipment to the location, the service performed, the personnel on the job, additional equipment used on the job, consumables used throughout the course of the service, and processing and interpretation of data acquired via down-hole diagnostic tools.
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses, capital lease obligations and notes payable. The recorded values of cash and cash equivalents, accounts receivable, other assets, accounts payable, and accrued expenses approximate their fair values based on their short-term nature. The carrying value of capital lease obligations and notes payable approximate their fair value, and the interest rates approximate market rates.
Functional and Presentation Currency
Items included in the financial statements of each of the Company’s entities are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The functional currency for the Norwegian and Argentine subsidiaries is the U.S. Dollar. The consolidated financial statements are presented in U.S. Dollars, which is the Company’s presentation currency.
Investments in marketable securities are classified as trading, available-for-sale or held-to-maturity. Our marketable equity investments are classified as trading and their cost basis is determined by the specific identification method. Realized and unrealized gains and losses on trading securities are included in net income.
During 2015, the Company purchased and sold Argentine bonds to capitalize its subsidiary in Argentina. This resulted in a realized gain on the sale of trading securities of $5,091,387. This gain was primarily due to the Company taking advantage of the favorable spread in exchange rates between the U.S. Dollar and Argentine Peso.
Net Loss per Common Share
For the years ended December 31, 2016 and 2015, the weighted average shares outstanding excluded certain stock options and potential shares from convertible debt of 4,478,507 and 4,253,381, respectively, from the calculation of diluted earnings per share because these shares would be anti-dilutive. Anti-dilutive warrants of 100,000 for each of the years ended December 31, 2016 and 2015 were also excluded from the calculation.
Certain prior year amounts have been reclassified to conform to the 2016 presentation.
Accounts receivable are stated at amounts management expects to collect from outstanding balances both billed and unbilled (unbilled accounts receivable represent amounts recognized as revenue for which invoices have not yet been sent to clients). Management provides for probable uncollectible amounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts. To date, the Company has not recognized any losses due to uncollectible accounts. Balances still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. The Company evaluated all accounts receivable and determined that no reserve for doubtful accounts was necessary at December 31, 2016 and 2015.
Included in the Accounts Receivable balance are certain unbilled receivables with a significant customer that relate to work performed before the company entered into its rotational on-call contract in 2016. Under this prior arrangement, the Company was required to go through an arduous process to collect the outstanding amounts and while the Company has a track record of collecting amounts billed under this prior arrangement, it has proven to take long period of time. At December 31, 2016 and 2015, there were approximately $855,706 and $5,768,401, respectively, in outstanding unbilled amounts due under this prior arrangement. Further, amounts billed to this significant customer under the rotational on-call contracts signed earlier this year have been collected within a more normal timeframe.
Prepaid expenses are primarily comprised of Argentinian value added tax and prepaid insurance. The prepaid value added tax will be reduced as the Company continues to invoice customers in Argentina.
Inventories are stated at the lower of cost or market (net realizable value) using the average method and appropriate consideration is given to deterioration, obsolescence and other factors in evaluating net realizable value.
Property, Plant and Equipment
Property, Plant and Equipment (“PPE”) is stated at historical cost less depreciation. Historical cost includes expenditures that are directly attributable to the acquisition of the items.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets for financial reporting purposes. Expenditures for major renewals and betterments that extend the useful lives are capitalized. Expenditures for normal maintenance and repairs are expensed as incurred. The cost of assets sold or abandoned and the related accumulated depreciation are eliminated from the accounts and any gains or losses are reflected in the accompanying consolidated statements of operations for the respective period.
The estimated useful lives of our major classes of PPE are as follows:
|Major Classes of PPE||Estimated Useful Lives|
|Machinery and equipment||2-7 years|
|Leasehold improvements||5 years (or the life of the lease)|
|Furniture and office equipment||3-5 years|
The Company leases certain equipment under lease agreements. The Company evaluates each lease to determine its appropriate classification as an operating or capital lease for financial reporting purposes. Any lease that does not meet the criteria for a capital lease is accounted for as an operating lease. The assets and liabilities under capital leases are recorded at the lower of the present value of the minimum lease payments or the fair market value of the related assets. Assets under capital leases are amortized using the straight-line method over the lease term. Amortization of assets under capital leases is included in depreciation expense.
The Company accounts for its stock options, warrants, and restricted stock grants under the fair value recognition provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718. The Company currently uses the straight-line amortization method for recognizing stock option and restricted stock compensation costs. The measurement and recognition of compensation expense for all share-based payment awards made to our employees, directors or outside service providers are based on the estimated fair value of the awards on the grant dates. The grant date fair value is estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost is recognized over the period during which an employee, director or outside service provider is required to provide service in exchange for the award, i.e., “the requisite service period” (which is usually the vesting period). The Company also estimates the number of instruments that will ultimately be earned, rather than accounting for forfeitures as they occur. For the years ended December 31, 2016 and 2015, the Company recorded $695,910 and $1,480,435, respectively, of stock-based compensation, which is included in cost of services, selling, general and administrative expense, and research and development in the statement of operations. Total unamortized stock-based compensation expense at December 31, 2016 was $928,786 compared to $1,382,711 at December 31, 2015, and will be fully expensed through 2020.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. ASC Topic 360 requires the Company to review long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or group of assets may not be recoverable. The impairment review includes a comparison of future cash flows expected to be generated by the asset or group of assets with their associated carrying value. If the carrying value of the asset or group of assets exceeds expected cash flows (undiscounted and without interest charges), an impairment loss is recognized to the extent that the carrying value exceeds the fair value. If estimated future cash flows are not achieved with respect to long-lived assets, additional write-downs may be required. During 2016, the Company evaluated its long-lived assets for impairment and determined no impairment was necessary.
Major Customers and Concentration of Credit Risk.
The majority of the Company’s business is conducted with major and independent oil and gas companies in Argentina. The Company evaluates the financial strength of its customers and provides allowances for probable credit losses when deemed necessary. The Company derives a large amount of revenue from a small number of major and independent oil and gas companies. At December 31, 2016, the Company had a concentration of receivables with two customers.
For the years ended December 31, 2016 and 2015, two major customers accounted for approximately 79% and 96% of our services revenue, respectively. Our accounts receivable at December 31, 2016 and 2015 were concentrated with one major customer representing 73% and 87%, respectively. YPF represents our largest customer.
The Company places its cash and cash equivalents with high credit quality financial institutions.
Deferred income taxes are determined using the asset and liability method in accordance with ASC Topic 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income taxes are measured using enacted tax rates expected to apply to taxable income in years in which such temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred income taxes is recognized in the consolidated statement of operations of the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.
The Company is subject to U.S. federal and foreign income taxes along with state income taxes in Texas. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Recent Accounting Pronouncements
The recent accounting standards that have been issued or proposed by the Financial Accounting Standards Board (“FASB”) or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires us to recognize the amount of revenue to which we expect to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective on January 1, 2018. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect ASU 2014-09 will have on our consolidated financial statements and related disclosures. The Company has performed an initial evaluation of this standard and its impact on the financial statements. This included tasks such as identifying contracts, identifying performance obligations and reviewing the applicable revenue streams. In this review, nothing has been identified that would require a change in the current accounting for revenue. The Company will continue to evaluate, particularly as we enter into new contracts.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which amends the guidelines for determining whether certain legal entities should be consolidated and reduces the number of consolidation models. The new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2015. Early adoption is permitted. We do not expect the impact of our pending adoption to have a material effect on our Consolidated Financial Statements.
In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs,” which amends the current presentation of debt issuance costs in the financial statements. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, instead of as an asset. The amendments are to be applied retrospectively and are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015, but early adoption is permitted. We adopted ASU 2015-03 during the quarter ended March 31, 2016 resulting in reclassification of short-term debt issuance cost of $185,362 as of December 31, 2015, and long-term debt issuance cost of $262,597 as of December 31, 2015. These reclassifications were made to our 2015 presentation in order to reflect our debt issuance costs consistently between periods.
In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires inventory not measured using either the last in, first out (LIFO) or the retail inventory method to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. The new standard will be effective for us beginning with the first quarter of 2017, and will be applied prospectively. Early adoption is permitted. We do not expect the impact of our pending adoption to have a material effect on our Consolidated Financial Statements.
In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which eliminates the current requirement to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, all deferred tax assets and liabilities will be required to be classified as noncurrent. The new standard will be effective for us beginning with the first quarter of 2017. Early adoption is permitted. We do not expect the impact of our pending adoption to have a material effect on our Consolidated Financial Statements.
On February 25, 2016, the FASB issued Accounting Standards Update (ASU) 2016-02 Leases (Topic 842), which requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases. The ASU will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect this standard will have on its Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of accounting for share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification on the statement of cash flows. Under this ASU, all excess tax benefits or deficiencies are recognized as income tax expense or benefit in the income statement and the pool of windfall tax benefits as a component of additional paid-in capital is eliminated. In regards to forfeitures, companies may make a one-time policy election to use forfeitures applies only to instruments with service conditions; the requirement to estimate the probability of achieving performance conditions remains. For statutory tax withholding requirements, this ASU allows for net settlement up to the employer’s maximum statutory tax withholding requirement. Formerly, only the minimum statutory tax withholding requirement was allowed to be met through net settlement while retaining equity classification. This ASU is effective for annual periods, and interim periods within those annual periods beginning after December 15, 2016. Earlier adoption is permitted in any interim or annual period for which financial statements have not yet been issued. The application of this ASU in regards to the accounting for income taxes, forfeitures and statutory tax withholding requirements should be applied using a modified retrospective application with a cumulative effect adjustment to additional paid-in capital as of the beginning of the period of adoption. The presentation of employee taxes paid on the statement of cash flows should be applied retrospectively. The new standard will be effective for us beginning with the first quarter of 2017. Early adoption is permitted. We are evaluating the impact this new standard will have on our Consolidated Financial Statements.
3. Accounts Receivable
Accounts receivable by category were as follows:
|Total accounts receivable||$||2,865,707||$||8,155,264|
Inventories by category were as follows:
Prepaid by category were as follows:
|Prepaid value added tax||993,502||2,519,496|
|Prepaid other taxes||690,386||510,002|
|Prepaid other vendors||139,554||89,436|
The Company will use the prepaid value added tax as it continues to invoice customers in Argentina.
6. Other Assets
|Other current assets:|
|Other current assets||21,157||44,696|
|Total other current assets||$||31,664||$||48,648|
|Other non-current assets|
|Long term deposits||$||325,756||$||488,633|
|Total other non-current assets||$||325,756||$||488,633|
7. Property, Plant and Equipment
Property, plant and equipment consists of the following:
|Computer hardware & software||547,428||478,655|
|Furniture & fixtures||210,941||129,995|
|Machinery & equipment||25,395,633||15,667,894|
|Machinery & equipment under construction||17,969,630||22,944,025|
|Work in progress||994,597||100,151|
|Property and equipment||46,444,590||40,536,979|
|Less accumulated depreciation||(8,062,199||)||(3,394,401||)|
|Property and equipment, net||$||38,382,391||$||37,142,578|
8. Accrued Expenses
Accrued expenses consist of the following:
|Accrued accounts payable trade expenses||1,449,139||976,155|
|Total accrued expenses||$||4,503,180||$||3,843,497|
On November 30, 2016, the Company entered into the Loan Agreement with two of the Company’s largest shareholders, one of which is currently the holder of approximately 20% of the Company’s outstanding shares of common stock. A portion of the proceeds from the Loan Agreement will be used to pay the remaining amount payable (approximately $1 million) by the Company under an equipment purchase agreement dated October 10, 2014, as amended, with Gordon Brothers Commercial & Industrial, LLC for the purchase of certain TPUs.
At December 31, 2016, the Company had a balance of $2,000,000 and accrued interest of $24,548. The indebtedness created under the Loan Agreement was repaid on March 6, 2017 with a portion of the proceeds of the credit facility extended by Fir Tree under the Amended and Restated Convertible Note Facility Agreement described below.
Long-Term Notes Payable
Convertible Note Facility
On May 28, 2014 (the “Closing Date”), the Company entered into a Convertible Note Facility Agreement (the “Existing Note Agreement”) with ACM entities. The proceeds from the Existing Note Agreement have been used primarily for capital expenditures, certain working capital needs and approved operating budget expenses.
The Existing Note Agreement allowed the Company to issue ACM entities a multiple draw secured promissory note with maximum aggregate principal amount of $22,000,000, convertible into Common Stock at a price of $6.00 per share at the option of ACM entities. The outstanding debt under the facility is convertible immediately and accrues interest at 14% per annum with interest payments due annually in arrears. The debt can be prepaid in full under certain conditions after the first anniversary of the Closing Date and matures on the date that is four years following the Closing Date.
As of December 31, 2016, and 2015, the Company had drawn down the full $22,000,000 available under the Existing Note Agreement, which was primarily used for capital expenditures, certain working capital needs and approved operating budget expenses. The accrued interest at December 31, 2016 was $1,831,123.
On May 28, 2015, the Company entered into an amendment with ACM entities. ACM entities and the Company agreed to give ACM entities the ability to have the $2,485,162 interest payment, which was due on May 28, 2015 (the “Deferred Interest”), paid in the form of shares of the Company’s common stock upon the consummation of a future equity offering, should one occur. On July 15, 2015, the Company issued 523,192 shares of unregistered common stock at a price of $4.74 per share to ACM entities as payment for the Deferred Interest.
All obligations under the Existing Note Agreement are secured by liens on substantially all of the assets of the company and have subsidiary guarantees and pledges of the capital stock of the subsidiary guarantors subject to certain terms and exception. From time to time, management has obtained amendments and waivers to the agreement to accommodate and adapt to the changing business environment. During 2015, the Company paid fees of $220,000 related to obtaining such amendments and waivers, which amount was recorded as additional financial charges. No additional fees were incurred during 2016.
At December 31, 2016, the Company was not in compliance with certain loan covenants under the Existing Note Agreement, nor had the Company received waivers or amendments to those covenants. In March 2017, the Company entered into a transaction with Fir Tree pursuant to which, among other things, Fir Tree purchased from ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018. In connection with this transaction, the Company’s non-compliance with the Existing Note Agreement was cured by replacing the Existing Note Agreement with the A&R Note Agreement. See Note 19 – Subsequent Events for further explanation of this transaction.
On March 6, 2017, the Company entered into a transaction with Fir Tree pursuant to which Fir Tree purchased from ACM entities $22 million aggregate principal amount of the Company’s outstanding 14% convertible notes due in 2018, and approximately two million shares of the Company’s outstanding common stock, par value $0.001 per share. This transaction was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. As part of the transaction and pursuant to the A&R Note Agreement, the Company issued to Fir Tree an additional $19.4 million aggregate principal amount of convertible notes, representing an additional $17 million aggregate principal amount of convertible notes issued by the Company to Fir Tree on March 6, 2017, and approximately $2.4 million principal amount of convertible notes in payment of accrued and unpaid interest on the Existing ACM Note. The unpaid principal amount of the Notes bears an interest rate of 20% per annum and matures on May 28, 2018.
After giving effect to these transactions, the Company now has approximately $41.4 million of outstanding convertible notes. Fir Tree has agreed to convert all the outstanding convertible notes into common stock at a conversion price of $1.40 per share, subject to receipt of shareholder approval and satisfaction of certain other conditions. Assuming all the outstanding convertible notes are converted into common stock, on a pro-forma basis, the Company would issue approximately 29.5 million shares to Fir Tree and would then have approximately 44.6 million shares outstanding and no outstanding debt.
Equipment Purchase Agreement
On October 10, 2014, the Company entered into an equipment purchase agreement for the turbine pump units equipment and related spare parts for a total purchase price of approximately $6,500,000, of which $4,100,000 was financed. The total amount financed, including any accrued interest, was to become due and payable on April 1, 2015. On March 12, 2015, the Company amended the agreement to add a blender, two data vans and a manifold at an increased cost of $400,000, and amended the due date of the final payment to March 31, 2016. The amended agreement provided for monthly installment payments of $50,000 beginning in May 2015. In February 2016, the agreement was further amended providing for a reduction in the principal amount of $2,000,000 and monthly installment payments of $25,000 beginning April 1, 2016, and to defer payment of the final $1,000,000 of the purchase price until December 15, 2016. The note accrued interest at a rate of 9% per annum until maturity on December 15, 2016. On November 30, 2016, the Company made full payment in settlement of this agreement.
The following is a summary of approximate scheduled long-term notes payable maturities by year:
|Total notes payable||$||22,000,000|
10. Deferred Debt Costs
The Company capitalizes certain costs in connection with obtaining its financings, such as lender’s fees and related attorney fees. These costs are amortized to interest expense using the straight-line method.
Deferred debt costs were approximately $262,596 and $447,959, net of accumulated amortization of $478,853 and $293,490, for the years ended December 31, 2016 and 2015, respectively. Deferred debt costs are presented net of related debt in long-term notes payable as of December 31, 2016.
11. Equity Offerings
On July 14, 2014 ACM acquired 1,333,333 shares of our Common Stock, resulting in net proceeds of $7,708,874 after deducting $291,126 in transaction related expenses.
On July 24, 2014, the Company sold 383,733 shares of its Common Stock in a private placement to 17 accredited investors resulting in net proceeds of $2,116,473.
On February 19, 2015, the Company sold 1,051,376 registered securities of common stock at a price of $5.75 per share for gross proceeds to the Company of $6,045,412. The Company used a portion of the net proceeds from the offering to finance capital expenditures, for working capital and for general corporate purposes and expects to use the remainder of the proceeds for additional capital expenditures and working capital.
On May 28, 2015, the Company entered into an amendment with ACM entities with the amendment giving ACM entities the ability to have the Deferred Interest of $2,485,162 paid in the form of shares of the Company’s common stock upon the consummation of a future equity offering, should one occur. On July 15, 2015, the Company issued 523,192 shares of unregistered common stock at a price of $4.75 per share to ACM entities as payment for the Deferred Interest.
On July 15, 2015, the Company sold 6,164,690 registered securities of common stock at a price of $4.75 per share for gross proceeds to the Company of $29,282,278. The Company used the net proceeds from the offering to finance capital expenditures, fund working capital and for general corporate purposes.
On July 13, 2016, the Company entered into an At-Market Issuance Sales Agreement (the “Agreement”) with FBR Capital Markets& Co. and MLV & Co. LLC (the “Distribution Agents”). Pursuant to the terms of the Agreement, the Company may sell from time to time through the Distribution Agents shares of the Company’s common stock, par value $0.001 per share, with an aggregate sales price of up to $5,801,796 (the “Shares”). Sales of the Shares, if any, will need to be approved by the Board and will be made by any method permitted that is deemed an “at the market offering” as defined in Rule 415 under the Securities Act, including sales made directly on or through the NASDAQ Capital Market, the existing trading market for our common stock or on any other existing trading market for our common stock, sales made to or through a market maker other than on an exchange or otherwise, in negotiated transactions at market prices, and/or any other method permitted by law. Sales of the shares may be made at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices, and subject to such other terms as may be agreed upon at the time of sale including a minimum sales price that may be stipulated by the Board. During 2016, the Company sold 796,573 shares through the Agreement for total gross proceeds of $1,722,596 before deducting approximately $164,000 of commissions.
12. Stockholders’ Equity
At December 31, 2016 and 2015 the Company had authorized 200,000,000 shares of common stock, of which 14,464,087 and 13,566,050 were outstanding with a par value of $14,485 and $13,572, respectively.
At December 31, 2016 and 2015, the Company had authorized 50,000,000 shares of preferred stock, of which there were zero shares of preferred stock outstanding.
On December 15, 2015, the Board authorized the Company to repurchase, from time to time during the period from December 16, 2015 through December 16, 2017, up to $5 million in shares of its outstanding common stock. As of December 31, 2016, the Company had purchased 21,850 shares at a cost of $57,469 under the buy-back program.
In the fourth quarter of 2013, the Company executed a sale-leaseback transaction with a related party that included an inducement payment of 100,000 common stock warrants. The exercise price per share of the common stock under the agreement is $7.00. The agreement expires five years after the date of issuance. The warrants can be exercised on a one for one basis starting July 1, 2014. See Note 16-Related Parties for additional information.
13. Employee Benefit Plan
The Company adopted a safe harbor defined contribution 401(k) plan effective January 1, 2012, covering all Company employees of the US headquarters. Under the plan the company contributes 5% towards the employee 401k. The contribution is fully vested at the time of contribution. The Company’s contributions for the years ended December 31, 2016 and 2015, were $81,326 and $100,518 respectively.
14. Stock-Based Compensation
The Company has two stock incentive plans, the 2013 Stock Incentive Plan (the “2013 Plan”) and the 2015 Stock Incentive Plan (the “2015 Plan”), (or collectively, “the Plans”), for the granting of stock-based incentive awards, including incentive stock options, non-qualified stock options and restricted stock, to employees, consultants and members of the Company’s Board. The 2013 Plan was adopted in 2012 and amended in 2013 and authorizes 1,000,000 shares to be issued under the 2013 Plan. The 2015 Plan, f/k/a “the 2014 Stock Incentive Plan,” was adopted in 2014; in 2015 and 2016 it was amended and a total of 700,000 additional shares were authorized, resulting in a maximum of 1,200,000 shares being authorized for issue under the modified 2015 Plan. Both the 2013 Plan and the 2015 Plan have been approved by the shareholders of the Company. As of December 31, 2016, 18,328 shares were available for grant under the 2013 Plan and 741,000 shares were available for grant under the 2015 Plan.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and restricted stock. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determined the initial expected life based on a simplified method in accordance with the FASB Accounting Standards Codification Topic 718, giving consideration to the contractual terms, vesting schedules, and pre-vesting and post-vesting forfeitures.
The Company recorded $695,910 and $1,480,435 for 2016 and 2015, respectively, of stock-based compensation, which is included in selling, general, and administrative expense and cost of sales in the accompanying consolidated statement of operations. Total unamortized stock-based compensation expense at December 31, 2016 was $928,786 compared to $1,382,711 at December 31, 2015, and will be fully expensed through 2020.
Options granted vest over a period of two to four years, subject to the optionee’s continued employment or service, and an option granted under the Plans may have an expiration date not longer than ten years following the date of grant. The Plans specify that the per share exercise price of an incentive stock option may not be less than 110% of the fair market value of the Company’s common stock on the date of grant, and the per share exercise price of a non-qualified stock option may not be less than the fair market value of the Company’s common stock on the date of grant. The Company’s general practice has been to grant options with a per share exercise price equal to the fair market value of the Company’s common stock on the date of grant.
A summary of the Company’s stock option activity for the years ended December 31, 2016 and 2015, is presented below:
|Awards||Shares||Weighted Average Exercise Price||Weighted Average Remaining Contractual Term|
|Options outstanding at December 31, 2014||669,297||$||5.55||8.79|
|Options outstanding at December 31, 2015||895,214||$||5.40||8.28|
|Options outstanding at December 31, 2016||
|Options exercisable at December 31, 2016||
As of December 31, 2016, the range of exercise prices for outstanding options was $0.33 – $7.00.
The following table presents the assumptions used in determining the fair value of option awards for the year ended December 31, 2016 and 2015:
|Weighted average grant date fair value per share of awards granted||1.80||1.13|
|Significant fair value assumptions:|
|Expected term (in years)||2.40||5.75|
|Risk-free interest rate||0.58||%||1.53||%|
A summary of award activity under the Plan for the years ended December 31, 2016 and 2015 is presented below:
Date Fair Value
|Non-vested at December 31, 2014||361,750|
|Non-vested at December 31, 2015||241,625|
|Non-vested at December 31, 2016||216,750|
The weighted average grant date fair value of awards of restricted stock is based on the market price of the Company’s common stock on the date of the grant.
15. Commitments and Contingencies
Capital Lease Obligations
In the fourth quarter of 2013, the Company purchased and upgraded equipment from non-related third parties, investing approximately $3.5 million. In December 2013, the Company sold the equipment to a related party leasing company, Impact Engineering, AS. Simultaneously, the equipment package was leased back to the Company as a capital lease for a 60-month period with payments beginning in February of 2014. The Company agreed to prepay one year of payments in the amount of approximately $1.0 million and maintain a balance of no less than six months of prepayments until the final six months of the lease.
These prepayments were made prior to December 31, 2013. Further lease payments are $81,439 per month and commenced on July 1, 2014. The final four months of prepaid is shown as other assets in the consolidated balance sheets with a balance of $325,755.
The minimum present value of the lease payments is $1.7 million with terms of sixty months and implied interest of 14%. The next five years of lease payments are:
|Capital Lease Payments|
|Total future payments||1,954,534|
|Less debt discount due to warrants||(140,335||)|
|Less amount representing interest||(258,346||)|
|Less current portion of capital lease obligations||(789,166||)|
|Capital lease obligations, excluding current installments||$||766,687|
The Company’s operating leases correspond to equipment facilities and office space in Argentina and the United States. The combined future minimum lease payments as of December 31, 2016 are as follows:
16. Related Party Transactions
In the fourth quarter of 2013, the Company purchased and upgraded equipment, from non-related third parties, for approximately $3.5 million. In December 2013, the Company sold the equipment to a third party leasing company controlled by two of its directors. Simultaneously, the equipment package was leased back to the Company, as a capital lease for a 60-month period with payments beginning in February 2014. The Company agreed to prepay one year of payments in the amount of approximately $1.0 million and maintain a balance of no less than six months of prepayments until the final six months of the lease. These prepayments were made prior to December 31, 2013. Further lease payments are approximately $81,000 per month and commenced on February 1, 2014
In connection with the sale lease back transaction, the Company issued 100,000 common stock warrants to the related party leasing company. The warrants were issued as an inducement payment and can be exercised on a one for one basis for common stock starting July 1, 2014. The exercise price is $7.00 with an expiration date of five years after the initial exercise date of July 1, 2014.
The estimated fair value of the warrants at issuance was approximately $0.4 million and was calculated using the Black Scholes method with the following weighted average assumptions being used.
|Expected lives years||5.75|
|Expected dividend yield||—|
|Risk free rates||1.75||%|
On November 30, 2016, the Company entered into the Loan Agreement with two of the Company’s largest shareholders, one of which is currently the holder of approximately 20% of the Company’s outstanding shares of common stock. A portion of the proceeds from the Loan Agreement will be used to pay the remaining amount payable (approximately $1 million) by the Company under an equipment purchase agreement dated October 10, 2014, as amended, with Gordon Brothers Commercial & Industrial, LLC for the purchase of certain TPUs. The indebtedness created under the Loan Agreement was repaid on March 6, 2017 with a portion of the proceeds of the credit facility extended by Fir Tree under the Amended and Restated Convertible Note Facility Agreement.
17. Income Taxes
The components of the expense for income taxes are as follows for the years ended December 31, 2016 and 2015:
|For the year ended December 31,|
|Total income tax provision||$||305,320||$||344,314|
The effective tax rate (as a percentage of income before taxes) is reconciled to the U.S. federal statutory rate as follows as of December 31, 2016 and 2015, respectively:
|For the year ended December 31,|
|Income tax benefit at the applicable federal rate (34%)||$||(5,990,776||)||$||(4,437,149||)|
|Change in valuation allowance||6,041,273||6,316,695|
|Effect of rate change||18,885||21,596|
|Foreign rate differential||(70,660||)||(52,229||)|
|Income tax expense (benefit)||$||305,320||$||344,314|
The tax effects of the temporary differences between financial statement income and taxable income are recognized as a deferred tax asset and liabilities. Significant components of the deferred tax asset and liability as of December 31, 2016 and 2015 respectively are:
|December 31, 2016||December 31, 2015|
|Total deferred tax assets||$||17,914,444||$||11,894,302|
|Property, plant and equipment t||(586,730||)||(606,220||)|
|Total deferred tax liabilities||$||(586,730||)||$||(607,861||)|
|Net deferred tax asset||17,327,714||11,286,441|
|Total net deferred tax assets|