UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2018

 

or

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission File Number 001-36909

 

ECO-STIM ENERGY SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)

 

Nevada   20-8203420

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification Number)

 

2930 W. Sam Houston Pkwy N., Suite 275, Houston, TX   77043
(Address of principal executive offices)   (Zip Code)

 

281-531-7200

(Registrant’s telephone number, including area code)

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Registration S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [  ] Accelerated filer [  ]
   
Non-accelerated filer [  ] Smaller reporting company [X]
   
  Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. [  ]

 

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

 

The registrant had 75,376,877 shares of common stock and 10,600 shares of Series A Convertible Preferred Stock outstanding at November 9, 2018. Excluded from the number of shares of common stock outstanding are 21,850 shares of common stock held as treasury stock.

 

 

 

   
 

 

TABLE OF CONTENTS

 

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS 1
   
PART I – FINANCIAL INFORMATION 4
     
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4
     
  CONDENSED CONSOLIDATED BALANCE SHEETS 4
     
  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 5
     
  CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY 6
     
  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 7
     
  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 8
     
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 24
     
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 33
     
ITEM 4. CONTROLS AND PROCEDURES 33
     
PART II – OTHER INFORMATION 34
     
ITEM 1. LEGAL PROCEEDINGS 34
     
ITEM 1A. RISK FACTORS 34
     
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 36
     
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 36
     
ITEM 4. MINE SAFETY DISCLOSURES 36
     
ITEM 5. OTHER INFORMATION 36
     
ITEM 6. EXHIBITS 37
     
SIGNATURES 39

 

 i 
 

 

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q (this “Form 10-Q”) 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-Q that address activities, events or developments that we expect, project, believe or anticipate will or may occur in the future are forward-looking statements. When used in this Form 10-Q, the words “could,” “would,” “should,” “believe,” “anticipate,” “plan,” “intend,” “estimate,” “expect,” “project” and other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. Our forward-looking statements are based on our current expectations and assumptions and currently available information. Forward-looking statements may include statements that relate to, among other things:

 

  our intentions to provide pump down and miscellaneous pumping services in the U.S. market;
     
  our efforts to pursue asset sales and the use of proceeds from any such sales;
     
  our evaluation of strategic alternatives, including potential strategic alternatives for our Argentina business;
     
  our future financial and operating performance and results, including estimated revenue, margins, earnings or losses, or growth rates;
     
  our business strategy and budgets;
     
  our prospects and the plans and objectives of our management;
     
  future pricing and other conditions in the markets we serve;
     
  our efforts and ability to obtain future contracts and customers;
     
  our technology;
     
  our financial strategy;
     
  the amount, nature and timing of capital expenditures;
     
  competition and government regulations;
     
  future operating costs and other expenses;
     
  our cash flow and anticipated liquidity;
     
  our property and equipment acquisitions and sales; and
     
  our plans, forecasts, objectives, expectations and intentions.

 

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 customers to backward-integrate by starting their own well service operations or otherwise reduce the use of our services;
     
  the potential for excess capacity in the oil and natural gas service industry;

 

 1 
 

 

  dependence on the spending and drilling activity by the onshore oil and natural gas industry;
     
  competition within the oil and natural gas service industry;
     
  our ability to maintain pricing and obtain contracts;
     
  deterioration of the credit markets;
     
  our ability to raise additional capital to fund future working capital requirements and repayment of debt and liabilities;
     
  increased vulnerability to adverse economic conditions due to our incurrence of indebtedness;
     
  our limited operating history;
     
  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;
     
  the control of Fir Tree Partners (together with its affiliated funds, “Fir Tree”) over matters subject to stockholder approvals;
     
  loss of key executives;
     
  the ability to employ and retain 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;

  

  legislation and regulations affecting the oil and natural gas industry or aspects of our business, including future legislative and regulatory developments;
     
  legislation and regulatory initiatives relating to well stimulation;
     
  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 if commodity prices decrease;

 

 2 
 

 

  risks of doing business in Argentina and the United States;

 

  risks associated with the start-up of new business operations in new markets, such as the inability to hire sufficient qualified employees, obtain necessary machinery and equipment needed to conduct our operations and meet the needs of our customers, and our ability to obtain operating permits in time; and
     
  costs and liabilities associated with labor, employment, environmental, health and safety laws, including any changes in the interpretation or enforcement thereof.

 

For additional information regarding known material factors that could affect our operating results and performance, please read (1) “Risk Factors” in Part II—Item 1A of this Form 10-Q and “Part I—Item 1A—Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and (2) “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I—Item 2 of this Form 10-Q, as well as in Part II—Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Should one or more of these known material risks occur, or should the underlying assumptions prove incorrect, our actual results, performance, achievements or other events could differ materially from those expressed or implied in any forward-looking statement. There also may be risks of which we are currently unaware.

 

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. When considering our forward-looking statements, you should keep in mind the cautionary statements in this Form 10-Q, 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 revise or 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-Q.

 

You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only of our expectations based on known factors as of the date of the particular statement.

 

 3 
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

ECO-STIM ENERGY SOLUTIONS, INC.

 CONDENSED CONSOLIDATED BALANCE SHEETS

 

    September 30, 2018     December 31, 2017  
      (Unaudited)          
Assets                
Current assets:                
Cash and cash equivalents   $ 3,909,775     $ 8,826,076  
Accounts receivable     4,765,965       10,167,044  
Inventory     2,456,229       3,699,245  
Prepaids     2,563,698       4,363,064  
Other assets     741,048       787,846  
Total current assets     14,436,715       27,843,275  
                 
Property, plant and equipment, net     48,370,089       75,825,539  
Total assets   $ 62,806,804     $ 103,668,814  
                 
Liabilities and stockholders’ equity                
Current liabilities:                
Accounts payable   $ 20,077,456     $ 17,110,691  
Accrued expenses     6,819,864       4,820,774  
Short-term notes payable     12,320,337       7,047,020  
Current portion of capital lease payable     3,518,323       836,855  
Total current liabilities     42,735,980       29,815,340  
                 
Non-current liabilities:                
Long-term notes payable     591,782       1,172,712  
Total non-current liabilities     591,782       1,172,712  
                 
Commitment and contingencies                
                 
Stockholders’ equity                
Preferred stock, $0.001 par value, 50,000,000 shares authorized, 30,000 designated as Series A Convertible Preferred Stock, 10,000 of Series A Preferred issued and outstanding at September 30, 2018 and none issued or outstanding at December 31, 2017     10        
Common stock, $0.001 par value, 200,000,000 shares authorized, 75,169,868 issued and 75,148,018 outstanding at September 30, 2018 and 74,599,749 issued and 74,577,899 outstanding at December 31, 2017     75,149       74,578  
Additional paid-in capital     155,504,491       144,071,119  
Treasury stock, at cost; 21,850 common shares at September 30, 2018 and at December 31, 2017     (57,469 )     (57,469 )
Accumulated deficit     (136,043,139 )     (71,407,466 )
Total stockholders’ equity     19,479,042       72,680,762  
                 
Total liabilities and stockholders’ equity   $ 62,806,804     $ 103,668,814  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 4 
 

 

ECO-STIM ENERGY SOLUTIONS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(Unaudited)

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2018     2017     2018     2017  
Revenues   $ 14,932,506     $ 13,120,229     $ 50,922,478     $ 24,210,545  
                                 
Operating cost and expenses:                                
Cost of services     17,181,673       14,874,958       59,194,660       29,935,216  
Selling, general, and administrative expenses     4,081,031       2,785,138       10,774,498       6,796,512  
Depreciation and amortization expense     6,073,723       1,936,324       16,768,305       4,700,835  
Impairment of fixed assets     19,665,000             23,350,445        
Total operating costs and expenses     47,001,427       19,596,420       110,087,908       41,432,563  
                                 
Operating loss     (32,068,921 )     (6,476,191 )     (59,165,430 )     (17,222,018 )
                                 
Other income (expense):                                
Interest expense     (556,302 )     (60,566 )     (1,505,014 )     (1,767,181 )
Interest forgiven                       634,477  
Foreign currency loss     (183,252 )     (64,190 )     (1,233,158 )     (64,173 )
Other income (expense)     (2,390,221 )     (39,116 )     (2,748,446 )     (31,286 )
Total other expense     (3,129,775 )     (163,872 )     (5,486,618 )     (1,228,163 )
Net loss before income taxes     (35,198,696     (6,640,063     (64,652,048     (18,450,181
Benefit (provision) for income taxes                 16,375       633,259  
                                 
Net loss   $ (35,198,696 )   $ (6,640,063 )   $ (64,635,673 )   $ (17,816,922 )
Basic and diluted loss per share   $ (0.47 )   $ (0.10 )   $ (0.86 )   $ (0.30 )
Weighted average number of common shares outstanding – basic and diluted     74,880,072       66,579,514       74,778,657       58,692,699  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 5 
 

 

ECO-STIM ENERGY SOLUTIONS, INC.

 

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY 

(Unaudited)

 

   

 

Preferred Stock

    Common Stock     Additional
Paid-in
    Treasury     Accumulated        
    Shares     Amount     Shares     Amount     Capital     Stock     Deficit     Total  
Balance at December 31, 2017         $       74,577,899     $ 74,578     $ 144,071,119     $ (57,469 )   $ (71,407,466 )   $ 72,680,762  
Common stock-based compensation, net of costs                 570,119       571       2,330,589                   2,331,160  
Preferred stock issuance, net of costs     10,000       10                   9,702,783                   9,702,793  
Preferred Dividends                             (600,000 )                 (600,000 )
Net loss                                         (64,635,673 )     (64,635,673 )
Balance at September 30, 2018     10,000     $ 10       75,148,018     $ 75,149     $ 155,504,491     $ (57,469 )   $ (136,043,139 )   $ 19,479,042  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 6 
 

 

ECO-STIM ENERGY SOLUTIONS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Nine Months Ended
September 30,
 
   2018   2017 
Operating Activities          
Net loss  $(64,635,673)  $(17,816,922)
Adjustments to reconcile net loss to net cash flows used in operating activities:          
Depreciation and amortization   16,768,305    4,700,835 
Impairment of fixed assets   23,350,445     
Amortization of debt discount and loan origination cost   52,625    442,255 
Stock based compensation   2,331,158    1,130,113 
Gain on sale of fixed assets   (291,978)    
Changes in operating assets and liabilities:          
Accounts receivable   5,401,079    (5,646,734)
Inventory   1,243,018    (2,588,791)
Prepaids and other assets   2,050,143    (2,238,350)
Accounts payable and accrued expenses   (1,462,587)   8,593,714 
Net cash used in operating activities   (15,193,465)   (13,423,880)
           
Investing Activities          
Purchases of equipment   (6,138,763)   (24,696,048)
Proceeds from sale of equipment   2,927,538     
Net cash used in investing activities   (3,211,225)   (24,696,048)
           
Financing Activities          
Proceeds from sale of common stock, net       41,789,604 
Proceeds from notes payable   11,537,417    18,875,292 
Proceeds from sale of preferred stock, net   9,702,793     
Payments on notes payable   (7,083,524)   (2,000,000)
Payments on capital lease   (668,297)   (581,461)
Net cash provided by financing activities   13,488,389    58,083,435 
           
Net increase (decrease) in cash and cash equivalents   (4,916,301)   19,963,507 
Cash and cash equivalents, beginning of period   8,826,076    1,731,364 
           
Cash and cash equivalents, end of period  $3,909,775   $21,694,871 
           
Supplemental Disclosure of Cash Flow Information          
Cash paid during the period for interest  $1,014,043   $279,850 
Cash paid during the period for income taxes  $319,543   $215,544 
           
Non-cash transactions          
Property, plant and equipment additions in accounts payable  $5,828,455   $9,351,016 
Conversion of debt to equity  $   $41,354,301 
Notes payable settled through recapitalization  $   $22,000,000 
Interest forgiven from convertible debt  $   $634,477 
Equipment purchased with notes payable  $44,503   $2,573,612 
Preferred dividend accrued  $600,000     

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 7 
 

 

ECO-STIM ENERGY SOLUTIONS, INC.

 

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2018

(Unaudited)

 

1 – Organization and Nature of Business

 

Eco-Stim Energy Solutions, Inc. (together with its subsidiaries, the “Company,” “Eco-Stim,” “we” or “us”) is a technology-driven independent oilfield services company that has historically offered well stimulation, coiled tubing and field management services to the upstream oil and gas industry. In September 2018, we completed work under our pressure pumping contract with our primary U.S. customer. Given the current weakness of the U.S. well stimulation market, in September 2018 we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. We are actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations. We currently intend to use the proceeds from any such sales to reduce our outstanding liabilities and improve our liquidity, however, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales. We are also actively pursuing strategic alternatives, including alternatives for our operations in Argentina.

 

2 – Basis of Presentation and Significant Accounting Policies

 

The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The accompanying condensed consolidated financial statements are unaudited and have been prepared from our books and records in accordance with Rule 10-1 of Regulation S-X for interim financial information. Accordingly, they do not include all the information and notes required by U.S. GAAP for complete financial statements. In the opinion of our management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of results of operations for a full year. These condensed consolidated financial statements should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

In the second quarter 2017, we began start-up of operations in the U.S. We now manage our business through operating segments aligned with our two geographical operating regions; Argentina and the U.S. We also report certain corporate and other non-operating activities under the heading “Corporate and Other”, which primarily reflects corporate personnel and activities, incentive compensation programs and other non-operational allocable costs. For financial information about our segments, see Note 9 - Segment Reporting.

 

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. Our wholly-owned subsidiaries include: Viking Rock Holding, AS (100%), Viking Rock, AS (100% owned), Cherokee Rock, Inc. (100% owned), EcoStim, Inc. (100% owned), and Eco-Stim Energy Solutions Argentina, SA (100% owned).

 

Going Concern

 

Under Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern, the Company is required to evaluate whether there is a substantial doubt about its ability to continue as a going concern each reporting period, including interim periods. In evaluating the Company’s ability to continue as a going concern, management has considered conditions and events that could raise substantial doubt about the Company’s ability to continue as a going concern for 12 months following the date the Company’s financial statements are issued (November 14, 2018), including the Company’s current financial condition and liquidity sources, including current cash balances, forecasted cash flows, the Company’s obligations due before November 14, 2019, including the Company’s obligations described in Note 6 (Commitments and Contingencies), and the other conditions and events described below.

 

 8 
 

 

The Company has incurred substantial net losses and losses from operations since inception. As of September 30, 2018, the Company had cash and cash equivalents of approximately $3.9 million and a working capital deficit of approximately $28.3 million. The Company does not have access to a working capital facility and may not have access to other sources of external capital on reasonable terms or at all. In September 2018, the Company elected to suspend its U.S. well stimulation operations and significantly reduce its U.S. workforce in alignment with potential near-term opportunities. As a result, as of November 14, 2018, the Company was only conducting pump down operations in the U.S. and the Company does not currently expect to generate any material revenue from its U.S. operations in the fourth quarter of 2018. In addition, the Company does not expect that its U.S. operations will generate any material revenue in future periods unless the Company is able to obtain access to additional third party capital to fund its future operations on reasonable terms or is otherwise able to consummate a strategic transaction. In Argentina, the Company has been operating under a transition agreement with its primary customer since May 2018. Following the third quarter of 2018, the Company has not provided any services to its primary customer in Argentina under the transition agreement or otherwise, and the Company did not generate any revenue from its Argentina operations in October 2018. The Company is currently pursuing new work with multiple operators in Argentina, including its primary customer, however, there can be no assurance that the Company obtains additional work in Argentina on favorable terms or at all. If the Company does not obtain new work either from its current customer or new customers, it does not expect to generate any material revenue from its Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods. As of September 30, 2018, the outstanding aggregate principal amount of the Company’s outstanding Negotiable Demand Promissory Note was approximately $8.5 million. If the Company’s obligations under the Negotiable Demand Promissory Note are accelerated pursuant to its terms, there can be no assurance that the Company will have sufficient funds to repay such obligations or the Company’s other obligations.

 

Management’s plans to alleviate substantial doubt include: (i) pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to the Company’s U.S. operations; (ii) using the proceeds from asset sales to reduce the Company’s outstanding liabilities and improve its liquidity; (iii) pursuing strategic alternatives, including alternatives for the Company’s operations in Argentina which could include selling, reducing the scale of, or shutting down the Company’s operations in Argentina; (iv) significantly reducing the Company’s U.S. workforce in alignment with potential near-term opportunities, which actions have been substantially implemented; (v) pursuing new work for the Company’s operations in Argentina; and (vi) taking other steps to reduce costs and liabilities. However, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales or other actions. Based on the uncertainty of achieving these items and the significance of the factors described above, there is substantial doubt as to the Company’s ability to continue as a going concern for a period of 12 months following November 14, 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, tax valuation allowance and stock-based compensation. The accounting estimates used in the preparation of the condensed 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 in both Argentina and the U.S. Funds held in the U.S. 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.

 

 9 
 

 

Revenue

 

The Company adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers, effective January 1, 2018, using the modified retrospective method. As there was no material impact on the Company’s current revenue recognition processes, no retrospective adjustments were necessary. Further, there were no significant changes to the Company’s internal control over revenue recognition due to the Company’s adoption of ASU 2014-09.

 

Revenue is earned at a point in time when services are rendered, which is generally on a per stage basis for our well stimulation business or fixed daily rate for the Company’s coiled tubing operations. All revenue is recognized when a contract with a customer exists, the performance obligations under the contract have been satisfied, the amount to which the Company has the right to invoice has been determined and collectability of amounts subject to invoice is probable. The Company does not incur contract acquisition and origination costs. Taxes collected from customers and remitted to governmental authorities are accounted for on a net basis and, therefore, are excluded from revenues in the unaudited condensed consolidated statements of operations and net cash provided by operating activities in the unaudited condensed consolidated statements of cash flows.

 

The Company has elected the practical expedient to recognize revenue based upon the transactional value it has the right to invoice upon completion of each performance obligation per the contract terms, as the Company believes its right to consideration corresponds directly with the value transferred to the customer, and this expedient does not lend itself to the application of significant judgment. As a result of electing these practical expedients, there was no material impact on the Company’s current revenue recognition processes and no retrospective adjustments were necessary.

 

The Company’s obligations for refunds as well as the warranties and related obligations stated in its contracts with its customers are standard to the industry and are related to the correction of any defectiveness in the execution of its performance obligations.

 

The Company expenses sales costs and any commissions when incurred as the amortization period would have been one year or less.

 

Well Stimulation Revenue

 

The Company has historically provided well stimulation services based on contractual arrangements, such as term contracts and pricing agreements, or on a spot market basis. Revenue is recognized upon completion of stimulation stages and includes the components of the services and the chemicals and proppants consumed while performing the well stimulation services. For our U.S. business, our performance obligations are defined as stages. In the case of our Argentina business, our performance obligations have been defined as stages plus specific defined services noted within the contract. For both businesses, customers are invoiced upon the completion of each job, which consist of multiple 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 agreed-upon spot market rates.

 

Coiled Tubing Revenue

 

For our coiled tubing services, performance obligations are satisfied within a day, in line with day rates established by the contract. Jobs for these services are typically short term in nature, lasting anywhere from a few hours to a few 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.

 

 10 
 

 

Disaggregation of Revenue

 

Revenue activities during the three and nine months ended September 30, 2018 and 2017, respectively were as follows:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2018   2017   2018   2017 
                 
Revenues by service type:                    
Well stimulation  $14,389,076   $12,940,800   $49,541,336   $22,489,017 
Coiled tubing   543,430    179,429    1,381,142    1,721,528 
Total  $14,932,506   $13,120,229   $50,922,478   $24,210,545 

 

Contract Balances

 

In line with industry practice, the Company bills its customers for its services in arrears, typically when the stage or well is completed or at month-end. The majority of the Company’s jobs are completed in less than 14 days. Furthermore, it is currently not standard practice for the Company to execute contracts with prepayment features. As such, the Company’s contract liabilities with its customers are immaterial to its unaudited condensed consolidated balance sheets.

 

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 Reporting 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 Company’s Norwegian and Argentine subsidiaries is the U.S. Dollar. The condensed consolidated financial statements are presented in U.S. Dollars, which is the Company’s reporting currency.

 

Net Loss per Common Share

 

For the nine months ended September 30, 2018 and 2017, the weighted average shares outstanding excluded shares of common stock issuable upon the exercise of certain stock options and shares of common stock issuable upon the conversion of outstanding shares of Series A Preferred totaling 11,927,142 and 725,657, respectively, from the calculation of diluted earnings per share because these shares would be anti-dilutive. As of June 20, 2017, the Company’s convertible debt was converted into common stock at $1.40 per share and therefore the Company no longer has any convertible debt outstanding. Anti-dilutive warrants of 100,000 for each of the nine months ended September 30, 2018 and 2017 were also excluded from the weighted average share outstanding calculation.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the 2018 presentation, with no material effect on the presentation of December 31, 2017 or September 30, 2017, and no impact on revenue or net loss.

 

 11 
 

 

Accounts Receivable

 

Accounts receivable are stated at amounts management expects to collect from outstanding balances both billed and unbilled (unbilled accounts receivable represents 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. The Company evaluated all accounts receivable and determined that no reserve for doubtful accounts was necessary at September 30, 2018 or December 31, 2017.

 

Prepaids and Other Assets

 

Prepaid expenses and other assets are primarily comprised of prepaid insurance, Argentinian value added tax and deposits made on equipment purchases.

 

Inventory

 

Inventories are stated at the lower of cost or net realizable value using the average cost 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   13 months-7 years
Vehicles   5 years
Leasehold improvements   5 years (or the life of the lease)
Furniture and office equipment   3-5 years

 

In September 2018, we sold certain of our non-core U.S. equipment for $2.9 million, recognizing a gain of $0.3 million. The proceeds were used to fund the general operations of the business.

 

Leases

 

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 shorter of the asset life or lease term. Amortization of assets under capital leases are included in depreciation expense.

 

Stock-Based Compensation

 

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.

 

 12 
 

 

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 the second quarter of 2018, the Company concluded it had a triggering event requiring assessment of impairment for certain of its long-lived assets in conjunction with our decision to move from providing services operating two well stimulation fleets in the U.S. to providing a single well stimulation fleet in the U.S. providing pumping services to a single customer. As a result, crew and staff reductions were taken. Further, the Company reviewed the long-lived assets for impairment and recorded a $3.7 million impairment expense. The full amount is related to our U.S. segment. The impairment was measured using the market approach utilizing an appraisal to determine fair value of the impaired assets.

 

During the third quarter of 2018, the Company concluded it had a triggering event requiring assessment of impairment for certain of its long-lived assets in conjunction with our decision to pursue the sale of a substantial majority of our U.S. equipment and suspension of its U.S. well stimulation operations. The Company reviewed the long-lived assets for impairment and recorded a $19.7 million impairment expense. The full amount is related to our U.S. segment. The impairment was measured using the market approach utilizing current bid values being obtained for the assets.

 

Major Customers and Concentration of Credit Risk

 

The majority of the Company’s business from inception through the first quarter of 2017 was conducted with major and independent oil and natural gas companies in Argentina. For the nine months ending September 30, 2018, 79% or $40.2 million and 21% or $10.7 million of our revenue is from the U.S. and Argentina, respectively. The Company evaluates the financial strength of its customers and provides allowances for probable credit losses when deemed necessary. The Company has historically derived a large amount of revenue from a small number of national and independent oil and natural gas companies. At September 30, 2018, the Company had a concentration of receivables with two customers.

 

For the nine months ended September 30, 2018 and 2017, two major customers accounted for approximately 95% and 99% of our services revenue, respectively. For the year ended December 31, 2017, two major customers represented 74% of our services revenue. Our accounts receivable at September 30, 2018 and 2017 were concentrated with two major customers representing 98% and 100%, respectively. The Company does not expect to generate any material revenue from these customers following the third quarter of 2018.

 

Income Taxes

 

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.

 

 13 
 

 

The Company is subject to U.S. federal and foreign income taxes along with state corporate income taxes in Texas and Oklahoma. The Company can and does pay taxes as some taxes are based on revenues or other basis other than net income. 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. At September 30, 2018, there are no recorded liabilities associated with our U.S. federal or foreign income taxes. Additionally, at September 30, 2018, a full valuation allowance has been established reducing any deferred tax asset as it was determined that it is more likely than not that the deferred tax asset will not be realized.

 

Further, the Fir Tree Transaction (see Item 2: “‒Liquidity and Capital Resources” for more information on the Fir Tree Transaction), resulted in a change in control and will likely limit the Company’s ability to utilize net operating loss tax benefits due to limitations pursuant to Section 382 of the U.S. Tax Code. As of September 30, 2018 and December 31, 2017, there was no tax asset benefit recorded as a provision was made to fully reserve the benefit.

 

Recently Issued and Adopted Accounting Guidance

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when modification accounting should be applied for changes to terms or conditions of a share-based payment award. This ASU is applied prospectively and is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. We adopted ASU 2017-09 in the first quarter of 2018, with such adoption having no material impact on the accompanying condensed consolidated financial statements.

  

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which replaced most existing revenue recognition guidance in U.S. GAAP when it became effective. This new standard 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. We adopted the new standard using the modified retrospective application in the first quarter of 2018, with such adoption having no impact on the accompanying condensed consolidated financial statements and no cumulative effect adjustment was recognized.

 

Accounting Guidance Issued But Not Adopted as of September 30, 2018

 

On February 25, 2016, the FASB issued 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. ASU 2016-02 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 future condensed consolidated financial statements and related disclosures.

 

3 – Accounts Receivable

 

Accounts receivable by category were as follows:

 

   September 30, 2018   December 31, 2017 
Billed  $3,229,362   $4,439,637 
Unbilled   1,536,603    5,727,407 
Total accounts receivable  $4,765,965   $10,167,044 

 

As of September 30, 2018, all of the unbilled accounts receivable related to Argentina. Subsequent to September 30, 2018, a majority of the unbilled accounts receivable from Argentina had been invoiced.

 

 14 
 

 

Receivables Agreement. On February 8, 2018, we entered into a Recourse Receivables Purchase & Security Agreement (the “Receivables Agreement”) with Porter Capital Corporation (“Porter Capital”). Under the terms of the Receivables Agreement, we have been able, from time to time, to sell accounts receivable (“Accounts”) to Porter Capital in exchange for funds in an amount equal to 80% (or less as percentage is subject to credit limits established by Porter Capital) of the face amount of the applicable Account at the time of sale of the Account, with the remaining 20% of the face amount of the applicable Account to be held back as a required reserve amount to be paid to us following Porter Capital’s receipt of payment on the Account by the account debtor, less applicable fees and interest charges. The total face amount of outstanding Accounts purchased by Porter Capital under the Receivables Agreement could not exceed $12.5 million.

 

Under the terms of the Receivables Agreement, we have been obligated to pay interest on the face amount of the outstanding and unpaid Accounts purchased by Porter Capital, less the amount of the reserve account, at an interest rate equal to the Prime Rate (as defined in the Receivables Agreement) plus 8.25%. We have also been obligated under the Receivables Agreement to pay certain fees, including a fee (the “Minimum Term Fee”) payable upon termination of the agreement in an amount equal to: (i) the monthly interest rate multiplied by $5 million, multiplied by the number of months in the agreement term, less the amount of actual interest paid during the term of the agreement; or (ii) following the occurrence of an Event of Default (as defined below) that has not been cured within the time periods contemplated under the agreement, $1.8 million, less the amount of actual interest paid during the term of the agreement. The Minimum Term Fee was also subject to reduction under certain circumstances if Porter Capital did not purchase certain eligible Accounts that are presented for purchase by us.

 

All of our obligations under the Receivables Agreement have been secured by liens on certain of our assets, including the accounts receivable, chattel paper, inventory relating to our U.S. operations and certain equipment used for our U.S. operations (excluding equipment subject to vendor financing) (collectively, the “Collateral”). The Receivables Agreement further provided for customary events of default (“Events of Default”), including but not limited to the failure to make payments when due; insolvency events; the failure to comply with covenant obligations arising under the agreement or other agreements with Porter Capital or its affiliates; and breaches of representations and warranties. Upon the occurrence of an Event of Default, Porter Capital could terminate the Receivables Agreement and declare all of our outstanding obligations under the Receivables Agreement to be due and payable. The Receivables Agreement had an initial term of one year and would renew for successive one-year terms unless we provided notice of cancellation in accordance with the terms of the Receivables Agreement. We were also able to terminate the Receivables Agreement prior to the expiration of the term upon written notice and payment of our obligations thereunder. Following the end of the third quarter of 2018, we terminated the Receivables Agreement. See Note 10 -- Subsequent Events.

 

For sales of our receivable under this Receivables Agreement, the Company applies the guidance in ASC 860, “Transfers and Servicing – Sales of Financial Assets”, which requires the derecognition of the carrying value of those accounts receivable in the Condensed Consolidated Balance Sheets. For the quarter ended September 30, 2018, $15.3 million of accounts receivable transferred pursuant to the Receivables Agreement qualified as sales of receivables and the carrying amounts were derecognized. There was no loss associated with the sales of these receivables. At September 30, 2018, we are owed $0.5 million representing the held back required reserve amount to be paid to us following Porter Capital’s receipt of payment on the Account by the account debtor. This balance is included in accounts receivable on the Condensed Consolidated Balance Sheets.

 

4 – Prepaids

 

Prepaids by category were as follows:

 

   September 30, 2018   December 31, 2017 
Prepaid insurance  $747,496   $142,531 
VAT and other taxes   1,282,419    2,935,351 
Vehicle registration   133,428    606,218 
Prepaid other   240,355    678,964 
Total prepaids  $2,563,698   $4,363,064 

 

 15 
 

 

A majority of the decrease in Prepaids is attributable to VAT and other taxes being reduced attributable to reductions in purchases over time in turn attributable to the unbundling of third party services provided to our customer in Argentina. The decrease was also attributable to a write-off of an equipment purchase deposit that the Company never utilized. The decrease was offset by insurance premium payments being recorded at the first of the year for annual coverage that have been subsequently amortized during the year.

 

5 – 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, restricted stock and phantom stock awards 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 of common stock to be issued under the 2013 Plan. The 2015 Plan, f/k/a “the 2014 Stock Incentive Plan,” was adopted in 2014 and was amended in 2015 and 2016 to authorize a total of 700,000 additional shares, resulting in a maximum of 1,200,000 shares of common stock being authorized for issue under the modified 2015 Plan. Both the 2013 Plan and the 2015 Plan have been approved by the stockholders of the Company. On June 15, 2017, at our annual meeting of stockholders (the “2017 Annual Meeting”), our stockholders approved an increase to the aggregate maximum number of shares of common stock available under the 2015 Plan by 5,000,000 shares (from 1,200,000 shares to 6,200,000 shares). On June 20, 2018, at our annual meeting of stockholders (the “2018 Annual Meeting”), our stockholders approved an increase to the aggregate maximum number of shares of common stock available under the 2015 Plan by 3,000,000 shares (from 6,200,000 shares to 9,200,000 shares). As of September 30, 2018, 256,991 shares of common stock were available for grant under the 2013 Plan and 2,041,698 shares of common stock 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. 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 ASC Topic 718, giving consideration to the contractual terms, vesting schedules, and pre-vesting and post-vesting forfeitures.

  

During the nine months ended September 30, 2018 and 2017, the Company recorded $2,331,160 and $1,130,113, respectively, of stock-based compensation, of which $1,910,666 and $831,208 was included in selling, general and administrative expense for the nine months ended September 30, 2018 and 2017, respectively, and $420,494 and $298,905 was included in cost of sales for the nine months ended September 30, 2018 and 2017, respectively, in the accompanying condensed consolidated statement of operations. Total unamortized stock-based compensation expense at September 30, 2018 was $2,078,951 compared to $3,247,370 at December 31, 2017 and will be fully expensed through 2020.

 

6 – Commitments and Contingencies

 

Capital Lease Obligations

 

The Company leases certain equipment from a third party with certain prepayments being made securing the final six months of payments on the lease. Lease payments are $81,439 per month, with the final three months of prepaid payments being shown as other non-current assets in the consolidated balance sheets with a balance of $244,317. The minimum present value of the lease payments is $0.7 million with terms of sixty months and implied interest of 14%.

 

The Company also leases certain other equipment through an equipment lease purchase agreement with a third party. Lease payments range between $261,240 per month to $1,077,615 per month based on the agreement. The minimum present value of the lease payment is $3.3 million with an initial term of six months and implied interest rate of 8%. We continue to accrue interest for the unpaid balance at 8% per annum.

 

 16 
 

 

The next five years of lease payments are:

 

   Principal   Interest  

Total Capital Lease

Payments

 
2018  $3,535,865   $51,102   $3,586,968 
2019            
Total future payments   3,535,865    51,102    3,586,968 
Less debt discount due to warrants             (17,543)
Less amount representing interest             (51,102)
                
Less current portion of capital lease obligations             (3,518,323)
Capital lease obligations, excluding current installments            $ 

 

Operating Leases

 

The Company’s operating leases correspond to equipment facilities and office space in Argentina and the U.S. The operating leases also correspond to operational equipment utilized by the Company’s U.S. operations. The combined future minimum lease payments as of September 30, 2018 are as follows:

 

    Operating Leases  
2018   $ 105,240  
2019     69,000  
Thereafter      
Total   $ 174,240  

 

Commitments

 

Historically, in the course of operations, we entered into certain long-term raw material supply agreements for the supply of proppant to be used in hydraulic well stimulation in our U.S. operations. As part of these agreements, we are subject to minimum tonnage purchase requirements and may pay penalties in the event of any shortfall. Additionally, we have entered into certain long-term transportation agreements for the transportation of raw material from the vendors’ point of delivery to the well site to support our U.S. operations. Per the agreements with these vendors, we are subject to certain minimum commitments under the long-term transportation agreements.

 

In September 2018, we completed work under our pressure pumping contract with our primary U.S. customer. Given the current weakness of the U.S. well stimulation market, in September 2018 we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. With this decision, we believe it is probable that we will not fulfill our commitments within the requirements under U.S. GAAP Contingencies (Topic 450) regarding certain of the above noted supply and transportation agreements. As such, we have recorded accruals related to what we believe to be reasonable estimates related to the future settlements of these contingencies of $2.0 million recorded in Accrued expenses in our Consolidated Financial Statements. We intend to seek to negotiate with the counterparties to these agreements and therefore, the amount of ultimate settlement may be higher or lower than what we have recorded, with the maximum aggregate potential liability estimated by us to be approximately $5.5 million, including estimated litigation expenses. Payment terms would also be established upon settlement with these counterparties.

 

Legal Proceedings

 

From time to time, we may be a party or otherwise subject to legal or regulatory proceedings or other claims incidental to or arising in the ordinary course of our business. While the ultimate outcome of these matters cannot be predicted at this time, we do not expect that the resolution of these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

 17 
 

 

On May 1, 2018, a collective action lawsuit was filed against Eco-Stim Energy Solutions, Inc. and certain of its subsidiaries by a former employee in the United States District Court for the Southern District of Texas (Houston Division) alleging that we failed to pay a class of workers in compliance with the Fair Labor Standards Act and seeking recovery of such wages, attorney’s fees, costs, interest and other related damages. In September 2018, this case was stayed pending resolution through arbitration proceedings among the parties. We dispute the allegations and intend to vigorously contest the matter. We are currently not able to predict the outcome of this matter or whether it will have a material impact on our financial position, results of operations or cash flows.

 

In addition, four of our vendors have filed lawsuits against us in four separate Texas state court actions seeking to collect an aggregate of approximately $2.4 million of damages for amounts alleged to be owed by us for various goods, equipment or services alleged to have been provided by such vendors, as well as pre-judgment and post-judgment interest and attorney’s fees. In addition, certain of our vendors have filed, or have threatened to file, liens against certain assets of our former customers with respect to amounts alleged to be owed by us for various goods, equipment or services alleged to have been provided by such vendors in an aggregate amount of approximately $3.8 million. We intend to vigorously contest these matters or seek mutually agreeable settlements of the claimed amounts, and we may incur material expenses in connection with the resolution of these lawsuits and claims.

 

7 – Debt

 

The carrying values of our debt obligations, net of unamortized debt issuance costs of $347,005 and $0 as of September 30, 2018 and December 31, 2017, respectively, are as follows:

 

   September 30, 2018   December 31, 2017 
   Short Term   Long Term   Short Term   Long Term 
Demand Promissory Note  $8,189,013   $   $   $ 
Vendor equipment financing   3,995,190    591,782    7,047,020    1,172,712 
Insurance financing   136,134             
Total  $12,320,337   $591,782   $7,047,020   $1,172,712 

 

Negotiable Demand Promissory Note

 

On June 8, 2018, the Company executed a Negotiable Demand Promissory Note (the “Demand Note”) in the principal amount of up to $15.0 million in favor of Eco-Lender, LLC (the “Lender”), a Delaware limited liability company and an affiliate of one or more funds that are managed by Fir Tree Capital Management LP (together with its affiliated funds, “Fir Tree”) and/or its affiliates, which affiliated funds collectively hold a majority of the outstanding shares of capital stock of the Company. Pursuant to the Demand Note, on June 8, 2018, the Lender advanced approximately $5.5 million of gross proceeds and $5.1 million of net proceeds after transaction expenses to the Company (the “Initial Advance”) and on August 16, 2018 the Lender advanced an additional $3.0 million of gross proceeds and $2.97 million of net proceeds to the Company. The Company does not have any right to re-borrow any amounts that have been advanced and repaid under the Demand Note. In addition, the Lender is not obligated to make any additional advances under the Demand Note. As of September 30, 2018, the aggregate principal amount outstanding under the Demand Note was approximately $8.5 million.

 

Interest on the unpaid principal balance of the Note accrues at an annual rate of 10%, subject to a default interest rate of 14.00% or 24.00%, depending on the payment date following the occurrence of a default. All payments of principal, interest and other amounts under the Demand Note are payable immediately upon written demand by the Lender to the Company; provided, however, the Lender cannot make any demand for payment under the Demand Note until the earlier of (A) 45 days after the date of the Demand Note, (B) the occurrence of a material adverse change as defined in the Note and determined by the Lender in its sole and absolute discretion, (C) the occurrence of any default or event of default under any material agreement of the Company or any of its subsidiaries, and (D) the date upon which the Company or any of its subsidiaries ceases operating for any reason.

 

 18 
 

 

The Company may prepay, in whole or in part, at any time, the principal, interest and other amounts owing under the Demand Note subject to a prepayment premium of 4.00% of the aggregate amount of such prepayment (inclusive of interest and other amounts due and owing under the Demand Note), provided that the minimum amount of any such prepayment is equal to the lesser of $1 million and the then outstanding balance of the Demand Note.

 

All of the Company’s obligations under the Demand Note are guaranteed by EcoStim, Inc., a Texas corporation and a wholly owned subsidiary of the Company (“EcoStim”), and secured by a security interest (subject to permitted liens) in substantially all of the personal property of the Company and EcoStim, including 100% of the outstanding equity of the Company’s U.S. subsidiaries (including EcoStim) and 65% of the outstanding equity of the Company’s non-U.S. subsidiaries; provided, however, that the Lender had a subordinate lien on those assets of the Company and EcoStim that were subject to the lien of Porter Capital pursuant to the Receivables Agreement. See Note 10 – Subsequent Events.

 

Vendor Equipment Financing

 

During various dates beginning in late September through November 2017, the Company purchased equipment through a financing arrangement with an international equipment manufacturer at an interest rate of 8% for 12 months. At September 30, 2018, the Company had a loan balance of $2,850,523 and accrued interest of $18,743 with monthly payments of $570,113. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $4,600,000.

 

Beginning August 23, 2017 through September 28, 2017, the Company purchased trucks through a financing arrangement with an auto finance group at an interest rate of 4.99% annual interest for 36 months. At September 30, 2018, the Company had a loan balance of $676,408 and accrued interest of $0, with monthly payments of $29,168. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $806,594.

 

Beginning September 21, 2017 through September 29, 2017, the Company purchased tractors through a financing arrangement with an auto finance group at an interest rate of 8.59% for 24 months. At September 30, 2018, the Company had a loan balance of $563,427 and accrued interest of $0 with monthly payments of $45,625. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $943,567.

 

On December 20, 2017, the Company purchased tractors through a financing arrangement with an auto finance group at an interest rate of 8.9% for 36 months. At September 30, 2018, the Company had a loan balance of $286,050 and accrued interest of $0 with monthly payments of $11,729. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $389,532.

 

On February 21, 2018, the Company purchased a truck through a financing arrangement with an auto finance group at an interest rate of 7.49% for 48 months. At September 30, 2018, the Company had a loan balance of $39,764 and accrued interest of $0 with monthly payments of $1,079. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $34,200.

 

During various dates beginning April 12 through April 23, 2018, the Company purchased equipment through a financing arrangement with an equipment manufacturer at an implied interest rate of 8% for 8 months. At September 30, 2018, the Company had a loan balance of $170,800 and accrued interest of $0 with monthly payments of $57,328. Carrying value at September 30, 2018 for the equipment purchased through this financing arrangement was $35,000.

 

The total future minimum payments due on our vendor equipment financings as of September 30, 2018 are noted as follows:

 

2018  $3,258,082 
2019   896,736 
2020   416,743 
2021   12,209 
2022 and thereafter   3,202 
Total payments  $4,586,972 

 

 19 
 

 

Insurance Financing

 

On January 1, 2018, the Company financed its operations insurance premiums with an insurance financing company for a total of $2,522,158 at an interest rate of 3.95% for ten months. As of September 30, 2018, the Company had a balance of $136,134 and accrued interest of $701.

 

8 – Equity

 

The Company has 50,000,000 shares of preferred stock authorized at $0.001 par value, 30,000 of which have been designated as Series A Convertible Preferred Stock (“Series A Preferred”). At September 30, 2018 and December 31, 2017, the Company had 10,000 shares of Series A Preferred and no shares of preferred stock issued or outstanding, respectively. The Company has 200,000,000 shares of Common Stock authorized at $0.001 par value per share, of which 75,148,018 shares were issued and 75,126,168 shares were outstanding as of September 30, 2018 and of which 74,599,749 shares were issued and 74,577,899 shares were outstanding as of December 31, 2017.

  

On March 29, 2018, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Fir Tree, its majority stockholder, pursuant to which Fir Tree agreed to purchase 10,000 shares of the Company’s newly-designated Series A Preferred, at a price of $1,000 per share. An initial closing was conducted on April 2, 2018 providing $10.0 million of gross proceeds and $9.7 million of net proceeds after expenses to the Company.

 

Each share of Series A Preferred ranks senior to the Company’s common stock with respect to dividend rights and rights upon the liquidation, winding-up or dissolution of the Company and has a stated value of $1,000 per share (the “Stated Value”). In the event the Company is liquidated, wound up or dissolved, or if the Company effects any Deemed Liquidation Event (as defined below), the holders of Series A Preferred are entitled to receive in respect thereof the greater of (i) the Stated Value plus any accrued and unpaid dividends thereon, (ii) the amount the holder thereof would receive if such shares of Series A Preferred were converted into common stock immediately prior to such liquidation, dissolution, winding up or Deemed Liquidation Event or (iii) a liquidating distribution equal to 1.5 times the Stated Value. A “Deemed Liquidation Event” includes certain merger or consolidation transactions, a sale of all or substantially all of the Company’s assets, a change of control transaction or similar event.

 

Holders of Series A Preferred are entitled to vote with holders of the Company’s common stock and are entitled to one vote per share of common stock into which a share of Series A Preferred is then-convertible on any matter on which holders of the capital stock of the Company are entitled to vote. Each share of Series A Preferred was initially and as of September 30, 2018 convertible, at the option of the holder at any time, into a number of shares of common stock determined by dividing the Stated Value plus any dividends accrued but unpaid thereon by the conversion price of $1.15 (subject to adjustment for stock splits, combinations, certain distributions or similar events). In addition, for so long as shares of Series A Preferred are outstanding, the affirmative vote or consent of holders of a majority of the outstanding shares of Series A Preferred, voting together as a separate class, is necessary before taking certain actions, including but not limited to (i) amending the articles of incorporation, the bylaws or the Certificate of Designation for the Series A Preferred in a manner that would materially and adversely or disproportionately affect the powers, preferences or rights of the Series A Preferred, (ii) liquidating, dissolving or winding up the Company or entering into a Deemed Liquidation Event, (iii) creating or issuing any class of capital stock unless it ranks junior to the Series A Preferred with respect to the distribution of assets on the liquidation, dissolution or winding up of the Company or any Deemed Liquidation Event, payment of dividends and rights of redemption, (iv) reclassifying, altering or amending any existing security that is pari passu or junior to the Series A Preferred with respect to the distribution of assets on the liquidation, dissolution or winding up of the Company or any Deemed Liquidation Event, payment of dividends and rights of redemption if such reclassification, alteration or amendment would render such other security senior or pari passu with the Series A Preferred in respect of any such right, preference or privilege, (v) subject to certain exceptions, purchasing or redeeming any shares of capital stock or paying any dividend or making any distribution thereon and (vi) issuing any shares of Series A Preferred to anyone other than the original holders of the Series A Preferred. Holders of Series A Preferred are entitled to cumulative dividends payable semi-annually in arrears at a rate of (i) 10% per year, if paid in cash, or (ii) 12% per year, if, at the election of the Company, paid through the issuance of additional shares of Series A Preferred. In addition to the dividend rights described above, holders of Series A Preferred are entitled to receive dividends or distributions declared or paid on common stock on an as-converted basis. Following the end of the third quarter of 2018, the Company paid the initial preferred dividend on all outstanding shares of Series A Preferred through the issuance of additional shares of Series A Preferred. See Note 10 -- Subsequent Events.

 

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The Company may redeem shares of Series A Preferred at any time in cash at a price per share equal to the greater of (i) the Stated Value plus any accrued and unpaid dividends thereon and (ii) the product of 1.5 times the Stated Value.

 

9 – Segment Reporting

 

We report the results of each of our two reportable segments, beginning with the second quarter of 2017, in accordance with ASC 280, Segment Reporting. Our Chief Executive Officer evaluates the results of operations on a consolidated as well as a segment level and is the person responsible for the final assessment of performance and making key operating decisions. Discrete financial information is available for each of the segments, and the operating results of each of the operating segments are used for performance evaluation and resource allocations.

 

Our two operating segments are managed through operating segments that are aligned with our geographic operating locations of Argentina and the U.S. We also report certain corporate and other non-operating activities under the heading “Corporate and Other”, which primarily reflects corporate personnel and activities, incentive compensation programs and other costs.

 

We account for intersegment sales at prices that we generally establish by reference to similar transactions with unaffiliated customers. Reporting segments are measured based on gross margin, which is defined as revenues reduced by total cost of services. Cost of services excludes depreciation and amortization expense.

 

 21 
 

 

Summarized financial information is shown in the following tables:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
    2018     2017     2018     2017  
                         
Revenues(1):                                
Argentina   $ 2,428,907     $ 5,750,853     $ 10,720,007     $ 13,748,447  
United States     12,503,599       7,369,376       40,202,471       10,462,098  
Total revenues   $ 14,932,506     $ 13,120,229     $ 50,922,478     $ 24,210,545  
                                 
Cost of services(1,2):                                
Argentina   $ 2,423,860     $ 7,054,471     $ 10,890,367     $ 17,225,253  
United States     14,757,813       7,820,487       48,304,293       12,709,963  
Total cost of services   $ 17,181,673     $ 14,874,958     $ 59,194,660     $ 29,935,216  
                                 
Gross margin(1,2):                                
Argentina   $ 5,047     $ (1,303,618 )   $ (170,360 )   $ (3,476,806 )
United States     (2,254,214 )     (451,111 )     (8,101,822 )     (2,247,865 )
Total gross margin   $ (2,249,167 )   $ (1,754,729 )   $ (8,272,182 )   $ (5,724,671 )
                                 
Corporate and Other:   $ 7,210,806     $ 2,949,010     $ 16,261,116     $ 8,024,675  
                                 
Capital expenditures:                                
Argentina   $     $ 230,826     $ 2,846     $ 1,584,444  
United States     620,570       16,561,322       6,134,877       22,917,672  
Corporate and Other           61,365       1,040       193,932  
Total capital expenditures   $ 620,570     $ 16,853,513     $ 6,138,763     $ 24,696,048  
                                 
Depreciation and amortization:                                
Argentina   $ 1,553,562     $ 1,338,187     $ 4,333,808     $ 3,947,056  
United States     4,488,313       555,348       12,144,340       631,017  
Corporate and Other     31,848       42,789       290,157       122,762  
Total depreciation and amortization   $ 6,073,723     $ 1,936,324     $ 16,768,305     $ 4,700,835  
                                 
Impairment:                                
Argentina   $     $     $     $  
United States     19,665,000             23,350,445        
Corporate and Other                        
Total impairment   $ 19,665,000     $     $ 23,350,445     $  

 

1) U.S. activity began in February 2017 with start-up expenses being incurred. The Company began recognizing U.S. revenue in late May 2017. Intersegment transactions included in revenues were not significant for any of the periods presented.
   
(2) Gross margin is defined as revenues less costs of services. Cost of services excludes selling, general and administrative expenses, and depreciation and amortization expense.

 

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10 – Subsequent Events

 

On October 1, 2018, we paid the initial dividend on our outstanding shares of Series A Preferred through the issuance of an aggregate of 600 additional shares of Series A Preferred to the holders of outstanding shares of Series A Preferred. Holders of Series A Preferred are entitled to cumulative dividends payable semi-annually in arrears at a rate of (i) 10% per year if we elect to pay the dividend in cash, or (ii) 12% per year if we elect to pay the dividend through the issuance of additional shares of Series A Preferred.

 

On October 19, 2018, the Company terminated its Recourse Receivables Purchase & Security Agreement (“Receivables Agreement”) with Porter Capital Corporation (“Porter”). The Receivables Agreement had an initial term of one-year, with the Company permitted to terminate the Receivables Agreement prior to expiration of the initial term upon written notice to Porter and payment of the Company’s outstanding obligations under the Receivables Agreement, including amounts owed as a minimum term fee calculated in accordance with the terms of the Receivables Agreement. On October 19, 2018, the Company delivered a notice to Porter of our intent to terminate the Receivables Agreement following initial term upon written notice to Porter and payment of our outstanding obligations under the Receivables Agreement, including a minimum term fee of approximately $0.2 million. As a result, the Company will no longer be able to obtain funds under the Receivables Agreement and the collateral has been released from liens that had secured the Company’s obligations under the Receivables Agreement.

 

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ITEM 2. 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 the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Form 10-Q, together with the audited consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2017. Unless the context otherwise requires, “we,” “us,” the “Company” or like terms refer to Eco-Stim Energy Solutions, Inc. and its subsidiaries.

 

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-Q.

 

 Background and Recent Developments

 

U.S. Operations. We are a technology-driven independent oilfield services company that has historically offered well stimulation, coiled tubing and field management services to the upstream oil and gas industry. In September 2018, we completed work under our pressure pumping contract with our primary U.S. customer. Given the current weakness of the U.S. well stimulation market, in September 2018 we elected to suspend our U.S. stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. We are currently conducting one pump down operation for a customer in the Permian basin.

 

We are actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations and do not currently expect to conduct any well stimulation operations in the U.S. following the third quarter of 2018. As a result, we do not expect to generate any material revenue from our U.S. operations in the fourth quarter of 2018. In addition, we do not currently expect that our U.S. operations will generate any material revenue in future periods unless we are able to obtain access to additional third party capital to fund our future operations on reasonable terms or are otherwise able to consummate a strategic transaction. We currently intend to use the proceeds from any such asset sales to reduce our outstanding liabilities and improve our liquidity, however, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales. If we are unable to obtain a sufficient amount of proceeds from asset sales or funds from other sources, we may not be able to satisfy our working capital requirements, indebtedness and other obligations. We have also retained an investment bank to assist us in evaluating our strategic alternatives.

 

Argentina Operations. In Argentina, we have been operating under a transition agreement with our primary customer since May 2018 and continued to provide services under that agreement during the third quarter of 2018. Subsequent to the third quarter of 2018, we have not provided any services to our primary customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. We are currently pursuing new work with multiple operators in Argentina, including our primary customer, however, there can be no assurance that we obtain additional work in Argentina on favorable terms or at all. If we do not obtain any new work either from our current customer or new customers, we do not expect to generate any material revenue from our Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods. In addition, we are considering whether to sell, reduce the scale of, or shut down our operations in Argentina, which could result in the incurrence of material losses and expenses. We have retained an investment bank to assist us in evaluating our strategic alternatives for our Argentina business.

 

September 2018 Sale of Certain Non-Core Equipment. In September 2018, we sold certain of our non-core U.S. equipment for $2.9 million for a gain of approximately $0.3 million.

 

Termination of Receivables Agreement. In October 2018, we delivered a notice to Porter Capital Corporation (“Porter Capital”) of our election to terminate the Recourse Receivables Purchase & Security Agreement we had entered into with Porter Capital in February 2018 (the “Receivables Agreement”). All of our obligations under the Receivables Agreement have been secured by liens on certain of our assets, including our accounts receivable, chattel paper, inventory and substantially all of our equipment for our U.S. operations (excluding equipment subject to vendor financing) (collectively, the “Collateral”). In connection with the termination of the Receivables Agreement, we paid a minimum term fee to Porter Capital of approximately $0.2 million. As a result, we are no longer able to obtain funds under the Receivables Agreement and the Collateral has been released from the liens that had secured our obligations under the Receivables Agreement.

 

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Overview of Our Business Services

 

Historically, our customers have utilized 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 has historically been contracted by E&P companies 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.

 

Historically, our customers have utilized 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 natural gas as well as customers’ expenditure budgets, which is usually also tied to the price of oil and natural gas.

 

Business Segments

 

Since the second quarter of 2017, we have managed our business through operating segments that are aligned with our two geographic regions, the United States and Argentina. We also report certain corporate and other non-operating activities under the heading “Corporate and Other”, which primarily reflects corporate personnel and activities, incentive compensation programs and other non-operational allocable costs. For financial information about our segments, see Note 9 (Segment Reporting) to the condensed consolidated financial statements included in this Form 10-Q.

 

Our segment operating results are frequently influenced by the number of active customers we have in the area and the level of our customers’ well activity which dictates the amount of activity we have in any given period. This directly effects our revenue, but also the level of expenses we incur.

 

United States Segment. Beginning operations in May 2017, our U.S. segment has historically served the needs of our independent E&P customers’ U.S. based operations by offering pressure pumping and field management operations services primarily operating in the Sooner Trend Anadarko Basin Canadian and Kingfisher Counties (STACK) play. Our U.S. based operations started with one U.S. based fleet. We added an additional fleet in October 2017 to accommodate an additional customer, however, upon negotiating an early release of our first U.S. fleet from our contract with our first U.S. customer due to low pricing and lower planned activity, our first spread did not provide services to customers until late April 2018. We subsequently ceased to provide services to this customer and in late May 2018, we agreed to provide our primary U.S. customer with additional dedicated horsepower and equipment, including certain of our natural gas-powered pumping units, to create what we referred to as a “super fleet” in support of a collaborative plan to improve the efficiency of our U.S. operations. As a result, in May 2018, we transitioned from operating two well stimulation fleets in the U.S. to operating a single well stimulation fleet in the U.S. providing pumping services to a single customer. In September 2018, we completed work under our pressure pumping contract with our primary U.S. customer. Given the current weakness of the U.S. well stimulation market, in September 2018 we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. We are currently conducting one pump down operation for a customer in the Permian basin. We are actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations.

 

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Argentina Segment. Through our Argentina segment, we have historically served the needs of our Argentine customers by providing pressure pumping and coiled tubing services. We began our service offerings in late 2014 in Argentina with our base of operation located in Neuquén City, Argentina. The majority of our revenues since inception and through the end of the third quarter of 2017 came from the Neuquén Basin and a majority of that revenue has come from our pressure pumping operations.

 

In the second quarter of 2017, we entered into a two-year contract based on a proposal submitted in November 2016 with the largest operator in Argentina to provide services for their tight gas completions program. During the course of providing services under that contract, we have incurred losses due to lower than expected utilization of our assets, higher than expected third-party costs incurred in order to provide the bundled services contemplated under the contract, and other factors. We engaged in negotiations with our primary customer in Argentina to improve the terms of the agreement, and in June 2018, we finalized the terms of a transition agreement with improved commercial terms. We have been operating under the transition agreement with our primary customer in Argentina since May 2018 and we continued to provide services under that agreement during the third quarter of 2018. Subsequent to the third quarter of 2018, we have not provided any services to our primary customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. We are currently pursuing new work with multiple operators in Argentina, including our primary customer, however, there can be no assurance that we obtain additional work in Argentina on favorable terms or at all. If we do not obtain any new work either from our current customer or new customers, we do not expect to generate any material revenue from our Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods.

 

We are considering whether to sell, reduce the scale of, or shut down our operations in Argentina, and we have retained an investment bank to assist us in evaluating our strategic alternatives for our Argentina business. A sale, reduction in scale or shut down of our operations in Argentina could result in the incurrence of material losses and expenses.

 

Impairment. In accordance with ASC Topic 360, the Company reviews its long-lived assets for impairment when changes in circumstances indicate that 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 the second quarter of 2018, the Company concluded it had a triggering event requiring assessment of impairment for certain of its long-lived assets in conjunction with our decision to move from providing services operating two well stimulation fleets in the U.S. to providing a single well stimulation fleet in the U.S. providing pumping services to a single customer. As a result, the Company reviewed the long-lived assets for impairment and recorded a $3.7 million impairment expense. The full amount is related to our U.S. segment. The impairment was measured using the market approach utilizing an appraisal to determine fair value of the impaired assets.

 

During the third quarter of 2018, the Company concluded it had a triggering event requiring assessment of impairment for certain of its long-lived assets in conjunction with our decision to pursue the sale of a substantial majority of our U.S. equipment and suspension of its U.S. well stimulation operations. The Company reviewed the long-lived assets for impairment and recorded a $19.7 million impairment expense. The full amount is related to our U.S. segment. The impairment was measured using the market approach utilizing current bid values being obtained for the assets.

 

Results of Operations

 

For the Three Months Ended September 30, 2018 and 2017

 

U.S. revenue for the three months ended September 30, 2018 increased $5.1 million to $12.5 million, compared to $7.4 million for the three months ended September 30, 2017. This increase was attributable to higher well stimulation stages completed in the third quarter of 2018 compared with the third quarter of 2017. In addition, the stage rate was higher in the third quarter of 2018 compared with the third quarter of 2017.

 

Argentina revenue for the three months ended September 30, 2018 decreased $3.4 million to $2.4 million, compared to $5.8 million for the three months ended September 30, 2017. This decrease was attributable to fewer well stimulation stages completed and fewer coiled tubing jobs completed in the third quarter of 2018 compared with the third quarter of 2017. In addition, revenues were lower in the third quarter of 2018 due to lower revenue from non-core third-party services that were sourced directly by our customer from those service providers beginning in February 2018 and thus no longer billable to our customer by us. These non-core services resulted in the majority of our Argentina losses during 2017.

 

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U.S. cost of services was $14.8 million for the third quarter of 2018, compared to $7.8 million for the third quarter of 2017, an increase of $7.0 million. This increase was primarily due to our third quarter of 2018 costs being higher as a result of the higher number of well stimulation stages being completed compared with the third quarter of 2017. Our negative gross margin for the quarter ended September 30, 2018 was attributable to overall higher costs during the third quarter of 2018 related to repairs and maintenance, fuel, transportation and salaries.

 

Argentina cost of services was $2.4 million for the third quarter of 2018, compared to $7.1 million for the third quarter of 2017, a decrease of $4.7 million. This decrease was attributable to lower activity levels in both well stimulation and coiled tubing, as well as reductions in costs incurred attributable to non-core third party services that our customer sourced directly from those providers beginning in February 2018.

 

Depreciation expense increased $4.2 million to $6.1 million for the third quarter of 2018, compared to $1.9 million for the third quarter of 2017. The increase was due to the Company’s addition of assets during the third quarter of 2017 and continuing through the third quarter of 2018.

 

Selling, general, and administrative expenses increased $1.3 million to $4.1 million for the third quarter of 2018, compared to $2.8 million for the third quarter of 2017. The increase is attributable to increases in non-cash stock compensation, salaries, director compensation, severance related costs, and certain legal and other professional expenses. These increases were offset by a gain recognized in the sale of fixed assets during the third quarter of 2018.

 

Net total other expense increased $2.9 million from net total other expense of $0.2 million for the third quarter of 2017 to net total other expense of $3.1 million for the third quarter of 2018. This increase in expense was primarily a result of a contingency loss recorded reflecting estimated future settlement amounts with respect to our contractual commitments under certain long-term supply and transportation agreements, foreign currency exchange losses from our Argentina business, and increases in interest expense associated with both our outstanding demand note payable and vendor debt related to equipment purchases made during 2017 and 2018.

 

For the Nine Months Ended September 30, 2018 and 2017

 

U.S. revenue for the nine months ended September 30, 2018 increased $29.7 million to $40.2 million, compared to $10.5 million for the nine months ended September 30, 2017. The first nine months of 2018 was a full period of operations compared with the same period of 2017, which included a partial period of activity. We began operations under our first contract in the U.S. in the latter half of the second quarter 2017. Also, during 2018, we completed a higher number of well stimulation stages at a higher per stage rate.

 

Argentina revenue for the nine months ended September 30, 2018 decreased $3.0 million to $10.7 million, compared to $13.7 million for the nine months ended September 30, 2017. Revenues decreased due to lower revenue from non-core third-party services that were sourced directly by our customer from those service providers beginning in February 2018 and thus no longer billable to our customer by us. These non-core services resulted in the majority of our Argentina losses during 2017. This decrease was offset slightly by having completed a higher number of well stimulation stages during the period ended September 30, 2018 compared with the period ended September 30, 2017.

 

U.S. cost of services was $48.3 million for the nine months ended September 30, 2018, compared to $12.7 million for the nine months ended September 30, 2017, an increase of $35.6 million. This increase was due to our first nine months of 2018 being a full operational period whereas for the same period of 2017, we had only a partial period for our operational activity as we did not begin our U.S. operations until the latter half of the second quarter of 2017. Our negative gross margin for the period ended September 30, 2018 was attributable to one of our fleets being inactive during a portion of the period, includes $0.4 million of non-recurring costs associated with employees terminated following the combination of our two U.S. fleets, and overall higher costs in repairs and maintenance, fuel, transportation and salaries. 

 

Argentina cost of services was $10.9 million for the nine months ended September 30, 2018, compared to $17.2 million for the nine months ended September 30, 2017, a decrease of $6.3 million. This decrease was attributable to non-core third party services which our customer sourced directly from those providers beginning in February 2018, offset by increases in costs associated with increases in well stimulation stages completed period over period.

 

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Depreciation expense increased $12.1 million to $16.8 million for the nine months ended September 30, 2018, compared to $4.7 million for the nine months ended September 30, 2017. The increase was due to the Company’s operational start-up in the U.S. in May 2017, and the Company’s continued addition of assets continuing through the third quarter of 2018.

 

Selling, general, and administrative expenses increased $4.0 million to $10.8 million for the nine months ended September 30, 2018, compared to $6.8 million for the nine months ended September 30, 2017. This increase was a result of the startup of the U.S. operations in May 2017. There were also increases in non-cash stock compensation, salaries, director compensation, severance related costs and certain legal and other professional expenses.

 

Net total other expense increased $4.3 million to $5.5 million for the nine months ended September 30, 2018 compared to a net total other expense of $1.2 million for the nine months ended September 30, 2017. The increase in expense was primarily a result of the Company recognizing a contingency loss reflecting estimated future settlement amounts with respect to our contractual commitments under certain long term supply and transportation agreements, an increase in our foreign currency exchange loss from our Argentina business as well as increases in interest expense associated with both demand note payable and vendor debt related to equipment purchases made during 2017 and 2018.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity to date have been proceeds from various equity and debt offerings and asset sales.

 

Going Concern. Under Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern, we are required to evaluate whether there is a substantial doubt about our ability to continue as a going concern each reporting period, including interim periods. In evaluating our ability to continue as a going concern, management has considered conditions and events that could raise substantial doubt about our ability to continue as a going concern for 12 months following the date our financial statements are issued (November 14, 2018), including our current financial condition and liquidity sources, including current cash balances, forecasted cash flows, our obligations due before November 14, 2019, including our obligations described in Note 6 (Commitments and Contingencies) to the condensed consolidated financial statements included in Part I – Item 1 of this Form 10-Q, and the other conditions and events described below.

 

We have incurred substantial net losses and losses from operations since inception. As of September 30, 2018, we had cash and cash equivalents of approximately $3.9 million and a working capital deficit of approximately $28.3 million. We do not have access to a working capital facility and may not have access to other sources of external capital on reasonable terms or at all. In September 2018, we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities. As a result, as of November 14, 2018, we were only conducting pump down operations in the U.S. and we do not currently expect to generate any material revenue from our U.S. operations in the fourth quarter of 2018. In addition, we do not expect that our U.S. operations will generate any material revenue in future periods unless we are able to obtain access to additional third party capital to fund our future operations on reasonable terms or are otherwise able to consummate a strategic transaction. In Argentina, we have been operating under a transition agreement with our primary customer since May 2018. Following the third quarter of 2018, we have not provided any services to our primary customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. We are currently pursuing new work with multiple operators in Argentina, including our primary customer, however, there can be no assurance that we obtain additional work in Argentina on favorable terms or at all. If we do not obtain new work either from our current customer or new customers, we do not expect to generate any material revenue from our Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods. As of September 30, 2018, the outstanding aggregate principal amount of our outstanding Negotiable Demand Promissory Note was approximately $8.5 million. If our obligations under the Negotiable Demand Promissory Note are accelerated pursuant to its terms, there can be no assurance that we will have sufficient funds to repay such obligations or our other obligations.

 

Management’s plans to alleviate substantial doubt include: (i) pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations; (ii) using the proceeds from asset sales to reduce our outstanding liabilities and improve our liquidity; (iii) pursuing strategic alternatives, including alternatives for our operations in Argentina which could include selling, reducing the scale of, or shutting down our operations in Argentina; (iv) significantly reducing our U.S. workforce in alignment with potential near-term opportunities, which actions have been substantially implemented; (v) pursuing new work for our operations in Argentina; and (vi) taking other steps to reduce costs and liabilities. However, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales or other actions. Based on the uncertainty of achieving these items and the significance of the factors described above, there is substantial doubt as to our ability to continue as a going concern for a period of 12 months following November 14, 2018.

 

The Fir Tree Transaction. On March 6, 2017, we closed a financing transaction with Fir Tree, (the “Fir Tree Transaction”) that was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all of our debt, subject to stockholder approval and satisfaction of certain other conditions. In connection with the Fir Tree Transaction, we entered into an Amended and Restated Convertible Note Facility Agreement with Fir Tree (the “A&R Note”), which replaced the convertible note previously issued by us to certain funds affiliated with Albright Capital Management (collectively “ACM”), which Fir Tree purchased from ACM. In addition, we issued to Fir Tree a new convertible note with a principal amount of $19.4 million, (the “New Convertible Note”), representing an additional $17 million aggregate principal amount of convertible notes issued by us 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 acquired by Fir Tree from ACM. The unpaid principal amount of the New Convertible Note accrued interest at a rate of 20% per annum and was scheduled to mature on May 28, 2018. Approximately $2.1 million of the proceeds of the additional $17 million aggregate principal amount of New Convertible Note issued to Fir Tree was used to repay existing debt under a Loan Agreement that was entered into on November 30, 2016 between us and two of our largest stockholders, with the balance of the proceeds used for equipment purchases, other approved capital expenditures incurred in accordance with an approved operating budget, and other working capital purposes. After giving effect to the Fir Tree Transaction, we had approximately $41.4 million of outstanding convertible notes which were all held by Fir Tree.

 

As part of the Fir Tree Transaction, Fir Tree agreed to convert the A&R Note and the New Convertible Note into common stock at a conversion price of $1.40 per share, subject to receipt of stockholder approval and satisfaction of certain other conditions. On June 15, 2017, stockholder approval was received, and all the outstanding convertible notes were converted into approximately 29.5 million shares of common stock.

 

Equity Offerings. On July 6, 2017, we closed on a private placement of shares of our common stock providing gross proceeds of $15 million, and net of cost proceeds of $14.9 million. As part of the offering, we issued 10,000,000 shares of our common stock for $1.50 per share to certain existing shareholders. The proceeds from the offering were used to finance capital expenditures to support contracts in both Oklahoma and Argentina, for working capital and for other general corporate purposes.

 

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On August 8, 2017, we closed on a private placement of shares of our common stock providing gross proceeds of $28 million, and net of cost proceeds of $26.8 million. As part of the offering, we issued an aggregate of 19,580,420 shares of our common stock for $1.43 per share to two existing stockholders and several new institutional investors. The proceeds from this offering were used to finance capital expenditures to support customer contracts in Oklahoma, for working capital and for other general corporate purposes.

 

On March 29, 2018, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Fir Tree, pursuant to which Fir Tree agreed to purchase 10,000 shares of our newly-designated Series A Convertible Preferred Stock, par value $0.001 per share (the “Series A Preferred”), at a price of $1,000 per share. The transaction closed on April 2, 2018 providing for our sale and issuance of 10,000 shares of Series A Preferred, providing $10.0 million of gross proceeds and $9.7 million of net proceeds after expenses to us. Holders of Series A Preferred are entitled to cumulative dividends payable semi-annually in arrears at a rate of (i) 10% per year if we elect to pay the dividend in cash, or (ii) 12% per year if we elect to pay the dividend through the issuance of additional shares of Series A Preferred. On October 1, 2018, we paid the initial dividend on the outstanding shares of Series A Preferred through the issuance of an aggregate of 600 additional shares of Series A Preferred to the holders of outstanding shares of Series A Preferred.

 

All of the equity offerings with the exception of the April 2, 2018 private placement noted above are as discussed in our Annual Report on Form 10-K for the year ended December 31, 2017, Part II – Item 8 – Financial Statements and Supplemental Data – Notes to consolidated financial statements – Note 11 – “Equity Offerings.” See Note 8 (Equity) to the condensed consolidated financial statements included in this Form 10-Q for information regarding the April 2, 2018 private placement noted above.

  

Negotiable Demand Promissory Note. On June 8, 2018, we executed a negotiable demand promissory note (the “Demand Note”) in the principal amount of up to $15.0 million in favor of Eco-Lender, LLC (the “Lender”), a Delaware limited liability company and an affiliate of Fir Tree. Pursuant to the Demand Note, on June 8, 2018, the Lender advanced approximately $5.5 million of gross proceeds and $5.1 million of net proceeds after expenses and on August 16, 2018 the Lender advanced an additional $3.0 million of gross proceeds and $2.97 million of net proceeds to us under the Demand Note. We do not have any right to re-borrow any amounts that have been advanced and repaid under the Demand Note. In addition, the Lender is not obligated to make any additional advances under the Note.

 

Interest on the unpaid principal balance of the Demand Note accrues at an annual rate of 10%, subject to a default interest rate of 14.00% or 24.00% depending on the payment date following the occurrence of a default. All payments of principal, interest and other amounts under the Demand Note are payable immediately upon written demand by the Lender to us; provided, however, the Lender cannot make any demand for payment under the Demand Note until the earlier of (A) 45 days after the date of the Demand Note, (B) the occurrence of a material adverse change as defined in the Demand Note and determined by the Lender in its sole and absolute discretion, (C) the occurrence of any default or event of default under any material agreement of ours or any of our subsidiaries, and (D) the date upon which we or any of our subsidiaries ceases operating for any reason.

 

We may prepay, in whole or in part, at any time, the principal, interest and other amounts owing under the Demand Note subject to a prepayment premium of 4.00% of the aggregate amount of such prepayment (inclusive of interest and other amounts due and owing under the Demand Note), provided that the minimum amount of any such prepayment is equal to the lesser of $1 million and the then outstanding balance of the Demand Note.

 

All of our obligations under the Note are guaranteed by our wholly owned subsidiary, EcoStim, Inc. (“EcoStim”), and secured by a security interest (subject to permitted liens) in substantially all of our personal property, including 100% of the outstanding equity of the our U.S. subsidiaries (including EcoStim) and 65% of the outstanding equity of our non-U.S. subsidiaries; provided, however, that the Lender had a subordinate lien on those of our assets that were subject to the lien of Porter Capital pursuant to the Receivables Agreement prior to the termination of such agreement as discussed elsewhere in this Form 10-Q.

 

Working Capital. As of September 30, 2018, our cash and cash equivalents were approximately $3.9 million, as compared to $1.9 million as of June 30, 2018 and $8.8 million as of December 31, 2017. Our working capital, which we define as the difference between our current assets and our current liabilities, is an indication of our liquidity and our potential requirements for short-term financing. Changes in our working capital are driven generally by changes in our accounts receivable, changes in our accounts payable, credit extended to and the timing of collections from our customers, and the level and timing of our capital expenditures. As of September 30, 2018, we had a working capital deficit of approximately $28.3 million, as compared to a working capital deficit of $20.8 million as of June 30, 2018 and a working capital deficit of $2.0 million as of December 31, 2017. This increase in working capital deficit occurred primarily as a result of decreases in cash used to pay debt, increases in liabilities and a reduction in accounts receivable as we completed work in the third quarter of 2018 with our two largest customers.

 

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Historically, we have managed our working capital requirements primarily with our existing cash balances, funds provided under the Receivables Agreement described below and external financings. We are actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations. We currently intend to use the proceeds from any such sales to reduce our outstanding liabilities and improve our liquidity, however, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales. If we are unable to obtain a sufficient amount of proceeds from asset sales or funds from other sources, we may not be able to satisfy our working capital requirements, indebtedness and other obligations.

 

Receivables Agreement. On February 8, 2018, we entered into a Recourse Receivables Purchase & Security Agreement (the “Receivables Agreement”) with Porter Capital Corporation (“Porter Capital”). Under the terms of the Receivables Agreement, we have been able, from time to time to sell accounts receivable (“Accounts”) to Porter Capital in exchange for funds in an amount equal to 80% (or less as percentage is subject to credit limits established by Porter Capital) of the face amount of the applicable Account at the time of sale of the Account, with the remaining 20% of the face amount of the applicable Account to be held back as a required reserve amount to be paid to us following Porter Capital’s receipt of payment on the Account by the account debtor, less applicable fees and interest charges. The total face amount of outstanding Accounts purchased by Porter Capital under the Receivables Agreement could not exceed $12.5 million.

 

Under the terms of the Receivables Agreement, we have been obligated to pay interest on the face amount of the outstanding and unpaid Accounts purchased by Porter Capital, less the amount of the reserve account, at an interest rate equal to the Prime Rate (as defined in the Receivables Agreement) plus 8.25%. We have also been obligated under the Receivables Agreement to pay certain fees, including a fee (the “Minimum Term Fee”) payable upon termination of the agreement in an amount equal to: (i) the monthly interest rate multiplied by $5 million, multiplied by the number of months in the agreement term, less the amount of actual interest paid during the term of the agreement; or (ii) following the occurrence of an Event of Default (as defined below) that has not been cured within the time periods contemplated under the agreement, $1.8 million, less the amount of actual interest paid during the term of the agreement. The Minimum Term Fee was also subject to reduction under certain circumstances if Porter Capital did not purchase certain eligible Accounts that were presented for purchase by us.

 

All of our obligations under the Receivables Agreement have been secured by liens on certain of our assets, including the accounts receivable, chattel paper, inventory relating to our U.S. operations and certain equipment used for our U.S. operations (excluding equipment subject to vendor financing) (collectively the “Collateral”). The Receivables Agreement had an initial one-year term, with us being permitted to terminate the Receivables Agreement prior to the expiration of the initial term upon written notice to Porter Capital and payment of our outstanding obligations under the Receivables Agreement, including the Minimum Term Fee. On October 19, 2018, we delivered a notice to Porter Capital of our election to terminate the Receivables Agreement following the payment of our remaining obligations thereunder, including a Minimum Term Fee of approximately $0.2 million. As a result, we will no longer be able to obtain funds under the Receivables Agreement and the Collateral has been released from the liens that had secured our obligations under the Receivables Agreement.

 

For sales of our receivable under this Receivables Agreement, the Company applies the guidance in ASC 860, “Transfers and Servicing – Sales of Financial Assets”, which requires the derecognition of the carrying value of those accounts receivable in the Consolidated Balance Sheets. For the nine months ended September 30, 2018, $42.0 million of accounts receivable transferred pursuant to the Receivables Agreement qualified as sales of receivables and the carrying amounts were derecognized. There was no loss associated with the sales of these receivables. At September 30, 2018, we were owed $0.5 million representing the held back required reserve amount to be paid to us following Porter Capital’s receipt of payment on the Account by the account debtor. This balance is included in accounts receivable on the Condensed Consolidated Balance Sheets. In connection with the termination of the Receivables Agreement in October 2018, we were refunded approximately $0.2 million from Porter Capital after payment of the Minimum Term Fee.

 

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Argentina Operations. As discussed under “Business Segments – Argentina Segment,” we have incurred losses under out two-year contract with our primary customer in Argentina. We have been operating under a transition agreement with our primary customer in Argentina since May 2018 and we continued to provide services under that agreement during the third quarter of 2018. Subsequent to the third quarter of 2018, we have not provided any services to our primary customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. We are currently pursuing new work with multiple operators in Argentina, including our primary customer, however, there can be no assurance that we obtain additional work in Argentina on favorable terms or at all. If we do not obtain any new work either from our current customer or new customers, we do not expect to generate any material revenue from our Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods. In addition, we are considering whether to sell, reduce the scale of, or shut down our operations in Argentina, and we have retained an investment bank to assist us in evaluating our strategic alternatives for our Argentina business. A sale, reduction in scale or shut down of our operations in Argentina could result in the incurrence of material losses and expenses. We may also incur additional losses associated with our Argentina operations, which could be substantial. As of September 30, 2018, the working capital associated with our Argentina operations was approximately $2.4 million, as compared to working capital of $2.4 million as of June 30, 2018 and $3.3 million as of December 31, 2017. As a result, our Argentina operations may require access to additional capital, which may not be available on reasonable terms or at all. If we are unable to obtain a sufficient amount of funds, we may not be able to satisfy the working capital requirements, indebtedness or other obligations of our operations in Argentina.

 

Capital Requirements

 

The energy services business is capital intensive, requiring significant investment to expand, upgrade and maintain equipment. Historically, our primary uses of capital have been the acquisition of equipment, working capital to finance our operations and general administrative expenses.

 

For the remainder of 2018, we expect our capital requirements to consist primarily of maintenance capital expenditures, which are capital expenditures made to extend or maintain the useful life of our assets.

 

During the second quarter of 2018, we decided to move from operating two well stimulation fleets in the U.S. to operating a single well stimulation fleet in the U.S. providing pumping services to a single customer. In connection with this transition, we reviewed our asset requirements for providing services to our customer and identified certain non-core assets. This review resulted in a $3.7 million impairment expense.

 

During the third quarter of 2018, we decided to suspend our U.S. well stimulation operations and pursue the sale of a substantial majority of our U.S. equipment. In connection with this transition and our resulting review of our long-lived assets for impairment, we recorded a $19.7 million impairment expense.

 

We intend to incur minimal capital expenditures during the remainder of 2018, and only those required to maintain our current assets being utilized in operations or as required for sale of an asset.

 

Impact of Inflation on Operations

 

Inflation can have a significant impact on operations. Historically, we have purchased 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. Inflation in Argentina has had a significant impact on our business, driving the weakening of the Argentine Peso against the U.S. dollar by over 90% during 2018. As a result, the Company has recognized significant foreign currency translation losses for the year to date 2018.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2018, we had no material off-balance sheet arrangements except for the operating leases and purchase commitments under supply and transportation agreements as disclosed under “Item 1. Consolidated Financial Statements ‒ Note 6 ‒ Commitments and Contingencies.” 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.

 

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Sources and Uses of Cash

 

Net cash used in operating activities increased $1.8 million to $15.2 million for the nine months ended September 30, 2018 compared to $13.4 million for the nine months ended September 30, 2017. The increase was due to losses incurred in our business and increases in accounts receivable due to increased operating activity for the nine months ended September 30, 2018 compared to the same period ended September 30, 2017, offset by a decrease in accounts payable.

 

Net cash used in investing activities decreased $21.5 million to $3.2 million for the nine months ended September 30, 2018 compared to $24.7 million for the nine months ended September 30, 2017. This decrease was due primarily to a decrease of purchases of machinery and equipment during the first nine months of 2018 when compared to the first nine months of 2017. Greater purchases of machinery and equipment were made during the nine months ended 2017 related to start-up of our operations in the U.S. The decrease was offset by proceeds received in September 2018 from the sale of equipment of $2.9 million.

 

Net cash provided by financing activities decreased by $44.6 million to $13.5 million for the nine months ended September 30, 2018, compared to $58.1 million for the nine months ended September 30, 2017. The decrease was primarily attributable to greater proceeds received from issuance of additional issuance of shares in two private placements occurring during the third quarter of 2017 and notes payable issued to Fir Tree issued during March 2017. This increase was offset by proceeds received from the issuance of Series A Preferred in April 2018, payments made on notes payable and the Receivables Agreement during 2018.

 

We had a net decrease in cash and cash equivalents of $4.9 million for the nine months ended September 30, 2018 primarily related to operating losses associated with our first U.S. spread being idle for a significant portion of the first six months of 2018, compared to a net increase in cash and cash equivalents of $20.0 million during the nine months ended September 30, 2017 primarily resulting from proceeds provided from the Fir Tree Transaction during the first quarter of 2017. Please see “‒Liquidity and Capital Resources” for more information on the Fir Tree Transaction.

 

We did not generate positive cash flow from operations for the nine months ended September 30, 2018. Further, our liquidity provided by our existing cash and cash equivalents will not be sufficient to fund our full capital expenditure plan, nor payments that might become due under our indebtedness. These commitments will require us to find alternative sources of liquidity from improvements in operating results, the sale of non-core assets or additional equity or debt financing, which may not be available to us on favorable terms or at all.

 

Certain Factors Affecting Our Future Financial Position, Results of Operations and Cash Flows

 

We face many challenges and risks in the industry in which we operate. For information on other developments, factors and trends that may have an impact on our future financial position, results of operations or cash flows, please read this section in conjunction with the factors described or otherwise referenced in the sections titled “Cautionary Statements Regarding Forward-Looking Statements” and “Risk Factors” in this Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), we are not required to provide the information required by this Item as we are a “smaller reporting company,” as defined by Rule 229.10(f)(1).

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act consisting of controls and other procedures designed to give reasonable assurance that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our chief executive officer and our chief financial officer, to allow timely decisions regarding such required disclosure. Based on their evaluation as of the end of the quarterly period covered by this Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as defined in Rules 13a-15 and 15d-15 under the Exchange Act, were effective as of September 30, 2018.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our system of internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

For a description of certain legal proceedings, please read Note 6 (Commitments and Contingencies – Legal Proceedings) to the condensed consolidated financial statements included in Part I – Item 1 of this Form 10-Q, which is incorporated herein by reference.

 

ITEM 1A. RISK FACTORS

 

Investors should carefully consider the risk factors included under Part I – Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II—Item 7 also on Form 10-K for the fiscal year ended December 31, 2017, together with all the other information included in this document and in our other public disclosures.

 

Other than with respect to the updated risk factors set forth below, there have been no material changes to the risk factors previously disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

 

In September 2018, we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. As a result, we are currently only conducting pump down operations in the U.S. and we do not currently expect to generate any material revenue from our U.S. operations in the fourth quarter of 2018.

 

In September 2018, we completed work under our pressure pumping contract with our primary U.S. customer. Given the current weakness of the U.S. well stimulation market, in September 2018 we elected to suspend our U.S. well stimulation operations and significantly reduce our U.S. workforce in alignment with potential near-term opportunities, including pump down and miscellaneous pumping services. We are currently conducting one pump down operation for a customer in the Permian basin. We are also actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations and do not currently expect to conduct any well stimulation operations in the U.S. in the fourth quarter of 2018. In addition, we do not expect that our U.S. operations will generate any material revenue in future periods unless we are able to obtain access to additional third party capital to fund our future operations on reasonable terms or are otherwise able to consummate a strategic transaction.

 

We have a significant working capital deficit and limited access to capital. We are actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations, and we currently intend to use the proceeds from any such sales to reduce our outstanding liabilities and improve our liquidity. However, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales. If we are unable to obtain a sufficient amount of proceeds from asset sales or funds from other sources, we may not be able to satisfy our working capital requirements, indebtedness and other obligations.

 

We have incurred significant operating losses during the first nine months of 2018, and as of September 30, 2018, we had a working capital deficit of $28.3 million. Following the suspension of our U.S. well stimulation operations, we have been actively pursuing the sale of a substantial majority of the equipment, inventory and other operating assets relating to our U.S. operations. We currently intend to use the proceeds from any such sales to reduce our outstanding liabilities and improve our liquidity, however, there can be no assurance as to the ultimate consummation, timing or amount of proceeds generated from any such asset sales. In addition, we do not have access to a working capital facility and may not have access to other sources of external capital on reasonable terms or at all. If we are unable to obtain a sufficient amount of proceeds from asset sales or funds from other sources, we may not be able to satisfy our working capital requirements, indebtedness and other obligations.

 

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Our obligations under the negotiable demand promissory note (the “Demand Note”) we executed in favor of Eco-Lender, LLC (the “Lender”), a Delaware limited liability company and an affiliate of Fir Tree (the “Lender”), are guaranteed by our wholly owned subsidiary, EcoStim, Inc., and are secured by a security interest (subject to permitted liens) in substantially all of our personal property and the personal property of EcoStim, Inc., including 100% of the outstanding equity of our U.S. subsidiaries (including EcoStim, Inc.) and 65% of the outstanding equity of our non-U.S. subsidiaries. As of September 30, 2018, the aggregate principal amount outstanding under the Demand Note was approximately $8.5 million. If our obligations under the Demand Note are accelerated pursuant to its terms, we cannot assure you that we will have sufficient funds to repay such obligations or our other obligations arising under our indebtedness or otherwise.

 

In Argentina, we have been operating under a transition agreement with our primary customer since May 2018. Following the third quarter of 2018, we have not provided any services to our customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. In addition, we are considering whether to sell, reduce the scale of, or shut down our operations in Argentina, any of which could result in the incurrence of material losses and expenses.

 

In Argentina, we have been operating under a transition agreement with our primary customer since May 2018 and continued to provide services under that agreement during the third quarter of 2018. Subsequent to the third quarter of 2018, we have not provided any services to our primary customer in Argentina under the transition agreement or otherwise, and we did not generate any revenue from our Argentina operations in October 2018. We are currently pursuing new work with multiple operators in Argentina, including our primary customer, however, there can be no assurance that we obtain additional work in Argentina on favorable terms or at all. If we do not obtain any new work either from our current customer or new customers, we do not expect to generate any material revenue from our Argentina operations in the fourth quarter of 2018 and may not generate any material revenue in future periods. In addition, we are considering whether to sell, reduce the scale of, or shut down our operations in Argentina, and we have retained an investment bank to assist us in evaluating our strategic alternatives for our Argentina business. A sale, reduction in scale or shut down of our operations in Argentina could result in the incurrence of material losses and expenses. As a result, our Argentina operations may require access to additional capital, which may not be available on reasonable terms or at all. If we are unable to obtain a sufficient amount of funds, we may not be able to satisfy the working capital requirements, indebtedness or other obligations of our operations in Argentina.

 

We are currently not in compliance with Nasdaq’s Listing Rule 5550(a)(2). Accordingly, we are at risk of Nasdaq delisting our common stock, which could have a material adverse effect on our business, financial condition, prospects, and liquidity and trading price of our common stock.

 

On June 21, 2018, we received a notice from The Nasdaq Stock Market (“Nasdaq”) that we are not in compliance with Nasdaq’s Listing Rule 5550(a)(2), since the minimum bid price of our common stock had been below $1.00 per share for 30 consecutive business days. Under applicable Nasdaq rules, we have until December 18, 2018, to achieve compliance with the minimum bid price requirement. To regain compliance, the minimum bid price of our common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days during this 180-day grace period. Our failure to regain compliance during this period could result in delisting.

 

At our 2018 annual meeting, our stockholders approved a proposal for the approval of a one-for-four reverse stock split of all of our outstanding shares of our common stock (the “reverse stock split”), to be effected at the discretion of our board of directors. The reverse stock split could be effected in order to attempt to regain compliance with Nasdaq’s Listing Rule 5550(a)(2); however, there can be no assurance that the minimum bid price for our common stock following the reverse stock split would be maintained at sufficient levels to regain compliance with Nasdaq requirements. If we fail to regain compliance, Nasdaq can initiate suspension and delisting procedures.

 

If our common stock ultimately were to be delisted for any reason, it could negatively impact us by: (i) reducing the liquidity and trading price of our common stock; (ii) reducing the number of investors willing to hold or acquire our common stock; and (iii) limiting our ability to use a registration statement to offer and sell freely tradeable securities, thereby preventing us from accessing the public capital markets.

 

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We could become subject to penny stock regulations and restrictions, which could make it difficult for our stockholders to sell their shares of stock in our company.

 

SEC regulations generally define “penny stocks” as equity securities that have a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. As of September 28, 2018 (the last trading day of the third quarter), the closing bid and asked prices for our common stock were $0.28 per share. Although we currently meet the net tangible assets and/or the minimum revenue exemptions from the “penny stock” definition, no assurance can be given that such exemption will be maintained. If we lose the exemption, our common stock may become subject to Rule 15g-9 under the Exchange Act, which regulations are commonly referred to as the “Penny Stock Rules.” The Penny Stock Rules impose additional sales practice requirements on broker-dealers prior to selling penny stocks, which may make it burdensome to conduct transactions in our shares. If our shares become subject to the Penny Stock Rules, it may be difficult to sell shares of our stock, and because it may be difficult to find quotations for shares of our stock, it may be impossible to accurately price an investment in our shares. There can be no assurance that our common stock will continue to qualify for an exemption from the Penny Stock Rules. In any event, even if our common stock continues to remain exempt from the Penny Stock Rules, we remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of a penny stock if the SEC determines that such a restriction would be in the public interest.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Except as previously reported on our Current Reports on Form 8-K, we did not have any sales of unregistered equity securities during the quarter ended September 30, 2018.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

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ITEM 6. EXHIBITS

 

  (a) Exhibits.

 

Exhibit Number   Description
3.1   Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on November 26, 2013).
     
3.2   Certificate of Designation of Preferences, Rights and Limitations (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on April 2, 2018).
     

3.3

 

  Second Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed March 9, 2017).
     

3.3(a)

 

  First Amendment to the Second Amended and Restated Bylaws of the Company adopted as of July 6, 2017 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on July 7, 2017).
     

3.3(b)

 

  Second Amendment to the Second Amended and Restated Bylaws of the Company adopted as of August 2, 2017 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on August 3, 2017).
     

3.3(c)

 

  Third Amendment to Second Amended and Restated Bylaws of the Company adopted as of August 25, 2017 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on August 25, 2017).
     

4.1

 

  Amended and Restated Stockholder Rights Agreement, dated as of March 3, 2017, by and among Eco-Stim Energy Solutions, Inc. and the parties named therein (incorporated by reference to Exhibit 4.3 of the Company’s Quarterly Report on Form 10-Q, filed March 9, 2017).
     

4.1(a)

 

  First Amendment to Amended and Restated Stockholder Rights Agreement, dated as of July 6, 2017, by and among the Company and the parties named therein (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on July 7, 2017).
     

4.1(b)

 

  Second Amendment to Amended and Restated Stockholder Rights Agreement, dated as of August 25, 2017, by and among the Company and the parties named therein (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 25, 2017).

  

4.2

 

  Amended & Restated Registration Rights Agreement, dated as of July 6, 2017, by and among the Company and the Purchasers named therein (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 7, 2017).
     
4.2(a)   First Amendment to Amended and Restated Registration Rights Agreement entered into as of August 2, 2017, by and among the Company and the parties named therein, to be effective upon the Closing Date (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on August 3, 2017).
     

4.3

 

  Registration Rights Agreement entered into as of August 2, 2017, by and among the Company and the Investors named therein, to be effective upon the Closing Date (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on August 3, 2017).
     
 † 10.1*   Form of Performance Share Unit Grant Notice under the Eco-Stim Energy Solutions, Inc. 2015 Stock Incentive Plan

 

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† 10.2*   Form of Phantom Stock Award Grant Notice (Change of Control Based Vesting) under the Eco-Stim Energy Solutions, Inc. 2015 Stock Incentive Plan
     
† 10.3*   Form of Phantom Stock Award Grant Notice (Argentina Sale Based Vesting) under the Eco-Stim Energy Solutions, Inc. 2015 Stock Incentive Plan
     
† 10.4*   Separation and Release Agreement, dated as of September 28, 2018, by and between the Company and J. Christopher Boswell
     
31.1*   Rule 13(a)-14(a) Certification of the Chief Executive Officer/Chief Financial Officer.
     
32.1**   Section 1350 Certification of the Chief Executive Officer/Chief Financial Officer.
     
101.INS**   XBRL Instance Document.
     
101.SCH**   XBRL Taxonomy Extension Schema Document.
     
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document.
     
101.DEF**   XBRL Taxonomy Extension Definition Linkbase Document.
     
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document.
     
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document.

 

* Filed herewith.
** Furnished herewith.
Indicates management contract or compensatory plan or arrangement.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: November 14, 2018 ECO-STIM ENERGY SOLUTIONS, INC.
     
  By: /s/ Alexander Nickolatos
    Alexander Nickolatos
    Interim President and Chief Executive Officer, Chief Financial Officer and Assistant Secretary

 

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