Note 2 – Liquidity and Managements’ Plans

As of June 30, 2017, the Company’s available liquidity was approximately $2.1 million, which was substantially comprised of $1.5 million of availability under our credit facility (the "Prior Credit Facility") provided pursuant to the Amended and Restated Revolving Credit and Security Agreement with PNC Bank, N.A. (the “2014 Credit Agreement”) and approximately $621,000 in cash. During the six months ended June 30, 2017, the Company repaid approximately $3.5 million under the Prior Credit Facility using proceeds from subordinated debt borrowings and net cash provided by our operations (partially offset by interest expense accrued to the borrowing balance). 

On March 31, 2017, the Company entered into the Tenth Amendment to the 2014 Credit Agreement that among other things (i) required the Company to raise $1.5 million in subordinated debt or post a letter of credit in favor of the bank by March 31, 2017; (ii) raise an additional $1 million of subordinated debt by May 15, 2017; (iii) reduced the maturity date of the loan from September 12, 2019 to April 30, 2018; (iv) changed the definition of Adjusted EBITDA to include proceeds from subordinated debt; and (v) changed the calculation of fixed charge and leverage ratio from a trailing four-quarter basis to a quarterly build from the quarter ended December 31, 2016. As described in more detail in Note 5, the Company complied with such requirements. However, upon entering the Tenth Amendment, the Company determined that the Prior Credit Facility did not provide sufficient liquidity on an ongoing basis, and that cash flow from operations and other sources would not generate sufficient cash to cover current obligations, most notably the maturity of the Prior Credit Facility provided under the 2014 Credit Agreement in April 2018. Due to the decreased term and restrictions imposed by the lender upon entering the 10th Amendment, during the six months ended June 30, 2017, the Company began exploring alternative financing to provide ongoing liquidity with more favorable terms with regards to availability of credit, borrowing costs, and covenants. 

As described in more detail in Note 13, Subsequent Events , subsequent to June 30, 2017, the Company entered into a Loan and Security Agreement (the "2017 Credit Agreement")  with East West Bank, a California banking corporation  ("East West Bank"),  which provides for a three-year $30 million senior secured revolving credit facility (the “New Credit Facility”) . On August 10, 2017 we repaid all amounts due under the Prior Credit Facility using proceeds from New Credit Facility, and therefore have classified the $20.4 million loan balance outstanding under the Prior Credit Facility as a long-term liability in the accompanying consolidated balance sheet. Upon entering the 2017 Credit Agreement and repaying all amounts due pursuant to the 2014 Credit Agreement, we had availability of approximately $4.7 million under the New Credit Facility. 

Note 3 - Summary of Significant Accounting Policies

Cash and Cash Equivalents

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

Accounts Receivable  

Accounts receivable are stated at the amounts billed to customers, net of an allowance for uncollectible accounts. The Company provides an allowance for uncollectable accounts based on a review of outstanding receivables, historical collection information and existing economic conditions. The allowance for uncollectible amounts is continually reviewed and adjusted to maintain the allowance at a level considered adequate to cover future losses. The allowance is management's best estimate of uncollectible amounts and is determined based on historical collection experience related to accounts receivable coupled with a review of the current status of existing receivables. The losses ultimately incurred could differ materially in the near term from the amounts estimated in determining the allowance. As of June 30, 2017 and December 31, 2016, the Company had an allowance for doubtful accounts of approximately $83,000 and $34,000, respectively. For the three and six months ended June 30, 2017, the Company recorded bad debt expense (net of recoveries) of approximately $20,000 and $49,000, respectively. For the three and six months ended June 30, 2016, the Company recorded bad debt expense (net of recoveries) of approximately $48,000 and $87,000, respectively.

Inventories

Inventory consists primarily of propane, diesel fuel and chemicals that are used in the servicing of oil wells and is carried at the lower of cost or market in accordance with the first in, first out method (FIFO). The Company periodically reviews the value of items in inventory and provides write-downs or write-offs, of inventory based on its assessment of market conditions. Write-downs and write-offs are charged to cost of goods sold. For the three and six months ended June 30, 2017 and 2016, no amounts were expensed for write-downs and write-offs.

Property and Equipment

Property and equipment consists of (1) trucks, trailers and pickups; (2) water transfer pumps, pipe, lay flat hose, trailers, and other support equipment; (3) real property which includes land and buildings used for office and shop facilities and wells used for the disposal of water; and (4) other equipment such as tools used for maintaining and repairing vehicles, office furniture and fixtures, and computer equipment. Property and equipment is stated at cost less accumulated depreciation. The Company capitalizes interest on certain qualifying assets that are undergoing activities to prepare them for their intended use. Interest costs incurred during the fabrication period are capitalized and amortized over the life of the assets. The Company charges repairs and maintenance against income when incurred and capitalizes renewals and betterments, which extend the remaining useful life, expand the capacity or efficiency of the assets. Depreciation is recorded on a straight-line basis over estimated useful lives of 5 to 30 years.

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

Leases

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

The Company has leased equipment in the normal course of business, which are recorded as operating leases. The Company recorded rental expense on equipment under operating leases over the lease term as it becomes payable; there were no rent escalation terms associated with these equipment leases. The equipment leases contain purchase options that allow the Company to purchase the leased equipment at the end of the lease term, based on the market price of the equipment at the time of the lease termination. There are no significant equipment leases outstanding as of June 30, 2017.

Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recovered. The Company reviews both qualitative and quantitative aspects of the business during the analysis of impairment. During the quantitative review, the Company reviews the undiscounted future cash flows in its assessment of whether or not long-lived assets have been impaired. No impairments were recorded during the three or six months ended June 30, 2017 and 2016.

Revenue Recognition

The Company recognizes revenue when evidence of an arrangement exists, the fee is fixed or determinable, services are provided, and collection is reasonably assured.

Earnings (Loss) Per Share

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

As of June 30, 2017 and 2016, there were outstanding stock options and warrants to acquire an aggregate of 5,749,433 and 5,120,669 shares of Company common stock , respectively, which have a potentially dilutive impact on earnings per share. For the three and six months ended June 30, 2017, the diluted share instruments did not have an intrinsic value, as a result, were not included in the diluted share calculation. Dilution is not permitted if there are net losses during the period. As such, the Company does not show dilutive earnings per share for the three and six months ended June 30, 2017 and 2016.

Loan Fees and Other Deferred Costs

In the normal course of business, the Company enters into loan agreements and amendments thereto with its primary lending institutions. The majority of these lending agreements and amendments require origination fees and other fees in the course of executing the agreements. For all costs associated with the execution of the lending agreements, the Company recognizes these as capitalized costs and amortizes these costs over the term of the loan agreement. All other costs not associated with the execution of the loan agreements are expensed as incurred. As of June 30, 2017, we had approximately $197,000 in unamortized loan fees and other deferred costs associated with the 2014 Credit Agreement, which we expect to charge to expense upon the termination of that agreement. 

Income Taxes  

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

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

Interest and penalties associated with tax positions are recorded in the period assessed as general and administrative expenses. The Company files tax returns in the United States and in the states in which it conducts its business operations. The tax years 2012 through 2016 remain open to examination in the taxing jurisdictions to which the Company is subject.

Fair Value

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

Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The Company did not change its valuation techniques nor were there any transfers between hierarchy levels during the six months ended June 30, 2017. The financial and nonfinancial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.

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

Stock-based Compensation

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

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

The Company also uses the Black-Scholes valuation model to determine the fair value of warrants. Expected volatility is based upon the weighted average of historical volatility over the contractual term of the warrant and implied volatility. The risk-free interest rate is based upon implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the contractual term of the warrants. The dividend yield is assumed to be none.

Management Estimates  

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

Reclassifications

Certain prior-period amounts have been reclassified for comparative purposes to conform to the fiscal 201 7 presentation. These reclassifications have no effect on the Company’s consolidated statement of operations.

Accounting Pronouncements  

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers”, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In August 2015 the FASB agreed to defer the effective date by one year, the new standard becomes effective for us on January 1, 2018. Early adoption is permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently determining the impact of the new standard on revenue from the services we provide. Our approach includes performing a detailed review of key contracts representative of our different subsidiary businesses and comparing historical accounting policies and practices to the new standard. Our services are primarily short-term in nature, and our assessment at this stage is that we do not expect the new revenue recognition standard will have a material impact on our financial statements upon adoption. We expect that the new standard will require more robust disclosure of details surrounding our revenue from contracts with customers. We currently intend to adopt the new standard as of January 1, 2018.

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

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force) (ASU 2016-15)”, that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted. The Company is evaluating the effect of ASU 2016-15 on its consolidated financial statements.

Recently Adopted

In March 2016, the FASB issued ASU 2016-09 “Compensation – Stock Compensation (Topic 718)”, which simplifies several aspects of the accounting for share-based payments, including immediate recognition of all excess tax benefits and deficiencies in the income statement, changing the threshold to qualify for equity classification up to the employees' maximum statutory tax rates, allowing an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur, and clarifying the classification on the statement of cash flows for the excess tax benefit and employee taxes paid when an employer withholds shares for tax-withholding purposes. The adoption of this guidance did not impact the Company’s consolidated financial position, results of operations, or cash flows.

Effective January 1, 2016, HWWM acquired various water transfer assets from WET Oil Services, LLC (“WET”) and HII Technologies, Inc. (“HIIT”) for approximately $4 million. These assets include high and low volume pumps, aluminum pipe, manifolds, lay flat hose, generators, other support equipment including vehicles and trailers. As part of the HIIT acquisition, HWWM also acquired a new water treatment technology utilized in devices sold under the name of HydroFLOW. In accordance with FASB Accounting Standards Codification 805, Business Combinations, the Company has accounted for the transactions with both HIIT and WET as asset acquisitions.

Note 5 – Revolving Credit Facilities

PNC Revolving Credit Facility

In September 2014, the Company entered into an Amended and Restated Revolving Credit and Security Agreement (the "2014 Credit Agreement") with PNC Bank, National Association ("PNC") which provided for a five-year $30 million senior secured revolving credit facility. The 2014 Credit Agreement allowed the Company to borrow up to 85% of eligible receivables and up to 75% of the appraised value of trucks and equipment. Under the 2014 Credit Agreement, there are no required principal payments until maturity and the Company has the option to pay variable interest rate based on (i) 1, 2 or 3 month LIBOR plus an applicable margin ranging from 4.50% to 5.50% for LIBOR Rate Loans or (ii) interest at PNC Base Rate plus an applicable margin of 3.00% to 4.00% for Domestic Rate Loans. Interest is calculated monthly and added to the principal balance of the loan. Additionally, the Company incurs an unused credit line fee of 0.375%. The revolving credit facility is collateralized by substantially all of the Company’s assets and subject to financial covenants. The outstanding principal loan balance matures on April 30, 2018.

The Company has entered into various amendments to the 2014 Credit Agreement that among other things, (i) modified certain financial covenants, (ii) increased the then applicable margin for Domestic Rate Loans and LIBOR Rate Loans; (iii) modified the advance rates on appraised equipment (iv) reinstated a full cash dominion requirement; and (iv) change various administrative terms under the agreement. As of June 30, 2017, the Company is subject to the following financial covenants:

On March 31, 2017, the Company entered into the Tenth Amendment to the 2014 Credit Agreement that among other things (i) required the Company to raise $1.5 million in subordinated debt or post a letter of credit in favor of the bank by March 31, 2017; (ii) raise an additional $1 million of subordinated debt by May 15, 2017; (iii) reduced the maturity date of the loan from September 12, 2019 to April 30, 2018; (iv) changed the definition of Adjusted EBITDA to include proceeds from subordinated debt; and (v) changed the calculation of fixed charge and leverage ratio from a trailing four-quarter basis to a quarterly build from the quarter ended December 31, 2016. On March 31, 2017, the Company’s largest shareholder, Cross River Partners, L.P. ("Cross River"), whose managing member is the chairman of our Board of Directors, posted a letter of credit in the amount of $1.5 million in accordance with the terms of the Tenth Amendment. The letter of credit was converted into subordinated debt with a maturity date of June 28, 2022 with a stated interest rate of 10% per annum and a five-year warrant to purchase 967,741 shares of our common stock at an exercise price of $.31 per share. On May 10, 2017, Cross River also provided $1.0 million in subordinated debt to the Company as required under the terms of our Tenth Amendment to the PNC Credit Agreement. This subordinated debt has a stated annual interest rate of 10% and maturity date of June 28, 2022. In connection with this issuance of subordinated debt, Cross River was granted a five-year warrant to purchase 645,161 shares of our common stock at an exercise price of $0.31 per share. We accounted for the warrants issued in connection with the subordinated debt as a liability in the accompanying consolidated balance sheet as of June 30, 2017.

As of June 30, 2017, the Company had an outstanding principal loan balance under the 2014 Credit Agreement of approximately $20.4 million. The interest rate at June 30, 2017 ranged from 5.55% to 5.72% per year for the $18.5 million of outstanding LIBOR Rate Loans and 7.25% per year for the $1.9 million of outstanding Domestic Rate Loans. As of June 30, 2017, approximately $1.5 million was available under the 2014 Credit Agreement.

As of December 31, 2016, the Company had an outstanding principal loan balance under the 2014 Credit Agreement of $23.2 million. The interest rate at December 31, 2016 ranged from 5.21% to 5.27% per year for the $21.3 million of outstanding LIBOR Rate Loans and 6.75% per year for the $1.9 million of outstanding Domestic Rate Loans. As of December 31, 2016, approximately $4.5 million was available under the 2014 Credit Agreement.

As of June 30, 2017 and December 31, 2016, the Company was in compliance with its covenants under the 2014 Credit Agreement.

As described in more detail in Note 13, Subsequent Events , subsequent to June 30, 2017, the Company entered into a Loan and Security Agreement with East West Bank (the "2017 Credit Agreement"). On August 10, 2017 we repaid all amounts due under the 2014 Credit Agreement using proceeds from 2017 Credit Agreement, and therefore have classified the $20.4 million loan balance outstanding under the 2014 Credit Agreement as a long-term liability in the accompanying consolidated balance sheet.

Debt Issuance Costs

The Company has capitalized certain debt issuance costs incurred in connection with the PNC senior revolving credit facility discussed above and these costs are being amortized to interest expense over the term of the credit facility on a straight-line basis. As of June 30, 2017 and December 31, 2016, approximately $147,000 and $171,000, respectively of unamortized debt issuance costs were included in Prepaid Expenses and Other Current assets in the accompanying consolidated balance sheet. The remaining long-term portion of debt issuance costs of $51,000 and $259,000 is included in Other Assets in the accompanying consolidated balance sheets as of June 30, 2017 and December 31, 2016, respectively. During the three and six months ended June 30, 2017, the Company amortized approximately $37,000 and $292,000 of these costs to Interest Expense. During the three and six months ended June 30, 2016, the Company amortized approximately $39,000 and $74,000 of these costs to Interest Expense, respectively. Due to the maturity date moving from September 12, 2019 to April 30, 2018, the Company recognized an additional $217,000 of debt issuance amortization expenses during the six months ended June 30, 2017.

Upon the repayment of the 2014 Credit Agreement subsequent to June 30, 2017, we expect to write off all remaining debt issuance costs incurred in connection with the facility. Such unamortized debt issuance costs totaled approximately $197,000 as of June 30, 2017. 

Interest Rate Swap

On September 17, 2015, the Company entered into an interest rate swap agreement with PNC in order to hedge against the variability in cash flows from future interest payments related to the 2014 Credit Agreement. The terms of the interest rate swap agreement include an initial notional amount of $10.0 million, a fixed payment rate of 1.88% plus applicable a margin ranging from 4.50% to 5.50% paid by the Company and a floating payment rate equal to LIBOR plus applicable margin of 4.50% to 5.50% paid by PNC. The purpose of the swap agreement is to adjust the interest rate profile of the Company’s debt obligations and to achieve a targeted mix of floating and fixed rate debt.

During the three months ended June 30, 2017, the fair market value of the swap instrument decreased by approximately $11,000 and resulted in an increase to the liability and an increase in interest expense. During the six months ended June 30, 2017, the fair market value of the swap instrument increased by approximately $19,000 and resulted in a decrease to the liability and a reduction in interest expense. During the three and six months ended June 30, 2016, the fair market value of the swap instrument decreased by $74,000 and $172,000, respectively, and resulted in an increase in the liability and an increase in interest expense. The interest rate swap liability is included in accounts payable and accrued liabilities on the Company’s balance sheet. As of June 30, 2017 and December 31, 2016 the interest rate swap liability was $72,000 and $91,000, respectively.

In connection with the termination of the 2014 Credit Agreement, subsequent to June 30, 2017, we terminated the interest rate swap agreement with PNC. We expect to enter into a similar interest rate swap agreement in connection with the 2017 Credit Agreement.

Aggregate maturities of debt, (excluding borrowings under our 2014 Credit Agreement described in Note 5), are as follows:

The warrant liability as of June 30, 2017 consists of a liability of approximately $307,000 (classified within Warrant liability ). The interest rate swap as of June 30, 2017 consists of a liability of $72,000 (classified within Accounts payable and accrued liabilities ).

The Company's warrant liability was valued as a derivative instrument at issuance and at June 30, 2017 using the Black-Scholes option pricing model, using observable market inputs and management judgment based on the following assumptions: a risk-free interest rate of 1.51%, expected dividend yield of 0%, a term of 2.5 years, and a volatility of 96.39%. The valuation policies used are approved by the Chief Financial Officer who reviews and approves the inputs used in the fair value calculations and the changes in fair value measurements from period to period for reasonableness. Fair value measurements are discussed with the Company ’s Chief Executive Officer, as deemed appropriate.

The Company ’s interest rate swap is valued using models which require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, and correlations of such inputs. Some of the model inputs used in valuing the derivative instruments trade in liquid markets, and therefore the derivative instrument is classified within Level 2 of the fair value hierarchy. For applicable financial assets carried at fair value, the credit standing of the counterparties is analyzed and factored into the fair value measurement of those assets. The fair value estimates of our derivative financial instruments do not reflect their actual trading value.

Note 8 – Income Taxes

Income tax expense during interim periods is based on applying an estimated annual effective income tax rate to year-to-date income, plus any significant unusual or infrequently occurring items which are recorded in the interim period.   The provision for income taxes for the three months ended June 30, 2017 and 2016 differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 34% to pre-tax income primarily because of state income taxes and estimated permanent differences.

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

During the three and six months ended June 30, 2017, the Company recorded net income tax benefit of $1.0 million and $992,000, respectively, primarily due to our net operating losses during the three and six months ended June 30, 2017. As of June 30, 2017, the Company had recorded a deferred tax asset, net, of approximately $547,000. 

Note 9 – Commitments and Contingencies

Operating Leases

As of June 30, 2017, the Company leases facilities and certain equipment under lease commitments that expire through June 2022. Future minimum lease commitments for these operating lease commitments are as follows:

Rent expense under operating leases, including month-to-month leases, for the three and six months ended June 30, 2017 were approximately $191,000 and $405,000, respectively. Rent expense under operating leases, including month-to-month leases, for the three and six months ended June 30, 2016 were $200,000 and $404,000 respectively.

HydroFLOW Agreement

             Pursuant to a Sales Agreement with HydroFLOW USA, HWWM has the exclusive right to sell or rent patented hydropath devices in connection with bacteria deactivation and scale treatment services for treating injection and disposal wells, fracking water and recycled water in the oil and gas industry to HWWM customers in the United States. Pursuant to the sales agreement, HWWM is required to pay 3.5% royalties of its gross revenues on certain rental transactions and, in order to maintain the exclusivity provision under the agreement, the Company is required to purchase approximately $655,000 of equipment per year commencing in 2016 and ending 2025. In November 2016, the Company and HydroFLOW USA agreed to allocate $220,000 of the 2016 commitment to 2017, thereby increasing the minimum purchase requirement for 2017 to $875,000. During the six months ended June 30, 2017, the Company completed the purchase of $280,000 of equipment to fulfill its 2016 purchase commitment for exclusivity. During the three and six months ended June 30, 2017 and 2016, the Company did not accrue or pay any royalties to HydroFLOW. The Company has negotiated a release of all 2016 and 2017 purchase commitments, while leaving intact the exclusive right to sell or rent the patented hydropath devices through 2017. 

Self-Insurance

In June 2015, the Company became self-insured under its Employee Group Medical Plan for the first  $75,000 per individual participant. The Company had an accrued liability of approximately $63,000 and $23,000 as of June 30, 2017 and December 31, 2016, respectively, for insurance claims that it anticipates paying in the future related to claims that occurred prior to quarter end.

Effective April 1, 2015, the Company entered into a workers ’ compensation and employer’s liability insurance policy with a term through March 31, 2018. Under the terms of the policy, the Company is required to pay premiums in addition to a portion of the cost of any claims made by our employees, subject to a maximum of approximately $1.5 million over the term of the policy. In June, 2017, an employee of one of our subsidiaries sustained bodily injury while in the course of employment, and the projected cost of the claim exceeded the amount we had previously paid in under the policy. As a result, subsequent to June 30, 2017, we made a payment of approximately $612,000 under the terms of the policy. The amount was based on an estimate of the total cost of the claim, including costs that have not yet been incurred in connection with the claim. During the three and six months ended June 30, 2017, we recorded an accrual based on our estimate of amounts incurred under the claim of approximately $250,000, and recorded the remaining $362,000 of the payment as a long-term asset, which will be recognized as expense as claim costs are incurred in connection with the claim. As a result, expense of $250,000 is included within Expenses, Water hauling services in the accompanying statement of operations. Per the terms of our policy, subsequent to June 30, 2017, we had paid in approximately $1.4 million of the projected maximum plan cost of $1.5 million. Therefore, our contnued exposure to this and other workers' compensation claims through the term of our policy and additional policy premiums is approximately $163,000.

Litigation

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

The ‘993 Patent has undergone several reexaminations by the USPTO and in February 2015, the USPTO rejected all 99 claims of the ‘993 Patent in the latest reexamination.  However, in May 2016, the USPTO reversed its decision and confirmed all 99 claims as being patentable over the cited prior art in the reexamination proceeding. Further, in September 2016 and February 2017, HOTF was issued two additional patents, both of which could be asserted against the Company. Management believes that final findings of invalidity and/or unenforceability of the ‘993 Patent based on inequitable conduct could serve as a basis to affect the validity and/or enforceability of each of HOTF’s patents. If these Patents are ultimately held to be invalid and/or enforceable, the Colorado Case would become moot.

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

Note 10 – Stockholders ’ Equity

Warrants

In conjunction with a private placement transaction and subordinated debt conversion in November 2012, the Com pany granted warrants to purchase shares of the Company’s common stock, exercisable at $0.55 per share for a five year term. Each of the warrants may be exercised on a cashless basis. The warrants also provide that subject to various conditions, the holders have piggy-back registration rights with respect to the shares of common stock that may be acquired upon the exercise of the warrants. As of June 30, 2017, 150,001 of these warrants remain outstanding.

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

In June 2017, in connection with a subordinated loan agreement described in more detail in Note 2 and Note 5, the Company granted Cross River two five-year warrants to buy an aggregate total of 1,612,902 shares of the Company’s common stock at an exercise price of $0.31 per share, the average closing price of the Company’s common stock for the 20 day period ended May 11, 2017. The warrants had a grant-date fair value of $0.19 per share and vested in full on June 28, 2017. These warrants are accounted for as a liability in the accompanying balance sheet. As of June 30, 2017, all of these warrants remain outstanding.

A summary of warrant activity for the six months ended June 30, 2017 is as follows:

Stock Issued for Services

During the six months ended June 30, 2016, the Company issued 3,031 shares of common stock to a consultant as partial compensation for services provided to the Company. The shares were granted under the 2010 Stock Incentive Plan and were fully vested and unrestricted at the time of issuance. During the six months ended June 30, 2016, the Company recorded $1,700 of consulting expense for these services.

Note 1 1 – Stock Options

Stock Option Plans

On July 27, 2010, the Company’s Board of Directors adopted the 2010 Stock Incentive Plan (the “2010 Plan”). The aggregate number of shares of common stock that could be granted under the 2010 Plan was reset at the beginning of each year based on 15% of the number of shares of common stock then outstanding. As such, on January 1, 2016 the number of shares of common stock available under the 2010 Plan was reset to 5,719,069 shares based upon 38,127,129 shares outstanding on that date. Options were typically granted with an exercise price equal to the estimated fair value of the Company's common stock at the date of grant with a vesting schedule of one to three years and a contractual term of 5 years. As discussed below, the 2010 Plan has been replaced by a new stock option plan and no additional stock option grants will be granted under the 2010 Plan. As of June 30, 2016, there were options to purchase 2,251,168 shares outstanding under the 2010 Plan.

On July 18, 2016, the Board of Directors unanimously approved the adoption of the Enservco Corporation 2016 Stock Incentive Plan (the “2016 Plan”), which was approved by the stockholders on September 29, 2016. The aggregate number of shares of common stock that may be granted under the 2016 Plan is 8,000,000 shares plus authorized and unissued shares from the 2010 Plan totaling 2,391,711 for a total reserve of 10,391,711 shares. As of June 30, 2016, there were options to purchase 1,960,000 shares outstanding under the 2016 Plan.

A summary of the range of assumptions used to value stock options granted for the three and six months ended June 30, 2017 and 2016 are as follows:

During the six months ended June 30, 2017, the Company granted options to acquire 2,171,600 shares of common stock with a weighted-average grant-date fair value of $0.18 per share. During the six months ended June 30, 2017, no options were exercised. During the six months ended June 30, 2016, the Company granted options to acquire 1,565,000 shares of common stock with a weighted-average grant-date fair value of $0.33 per share. On July 18, 2016, the Company cancelled 875,000 of these stock option grants pursuant to letter agreements between the Company and option holders. The Company subsequently granted 875,000 of New Options under the 2016 Plan.

The following is a summary of stock option activity for all equity plans for the six months ended June 30, 2017:

The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the estimated fair value of the Company’s common stock on June 30, 2017, and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had they exercised their options on June 30, 2017.

During the three and six months ended June 30, 2017, the Company recognized stock-based compensation costs for stock options of approximately $311,000 and $446,000 respectively, in general and administrative expenses. During the three and six months ended June 30, 2016, the Company recognized stock-based compensation costs for stock options of approximately $167,000 and $318,000, respectively, in general and administrative expenses. The Company currently expects all outstanding options to vest. Compensation cost is revised if subsequent information indicates that the actual number of options vested due to service is likely to differ from previous estimates.

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

As of June 30, 2017, there was approximately $492,000 of total unrecognized compensation costs related to non-vested shares under the Company’s stock option plans which will be recognized over the remaining weighted-average period of 1.87 years.

Note 1 2 - Segment Reporting

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

The following is a description of the segments.

Well Enhancement Services : This segment utilizes a fleet of frac water heating units, hot oil trucks and acidizing units to provide well enhancement and completion services to the domestic oil and gas industry. These services include frac water heating, hot oil services, pressure testing, and acidizing services.

Water Transfer Services : This segment utilizes high and low volume pumps, lay flat hose, aluminum pipe and manifolds and related equipment to move fresh and/or recycled water from a water source such as a pond, lake, river, stream, or water storage facility to frac tanks at drilling locations to be used in connection with well completion activities. Also included in this segment are water treatment services whereby the Company uses patented hydropath technology under a sales agreement with HydroFLOW USA to remove bacteria and scale from water.

Water Hauling Services : This segment utilizes a fleet of trucks and related assets, including specialized tank trucks, vacuum trailers, storage tanks, and disposal facilities to provide various water hauling services. These services are primarily provided by Dillco in the Hugoton Field in Kansas.

Construction Services : This segment utilizes a fleet of trucks and equipment to provide excavation grading, and dirt hauling services to the oil and gas and construction industry. In 2016, the Company started utilizing these assets to provide dirt hauling services to a general contractor in Colorado.

Unallocated and other includes general overhead expenses and assets associated with managing all reportable operating segments which have not been allocated to a specific segment.

The following tables set forth certain financial information with respect to Enservco’s reportable segments:

The following table reconciles the segment profits reported above to the loss from operations reported in the consolidated statements of operations: