ESOA

Business Context and Reporting Period

Company: Energy Services of America Corporation (Energy Services)

Filing Type: Form 10-Q (Unaudited)

Reporting Period: Quarter and six months ended March 31, 2010

Business Overview: The Company provides contracting services for energy-related companies, primarily in the gas, oil, and electrical industries. Operations focus on the construction, replacement, and repair of natural gas pipelines, storage facilities, and electrical installations. The Company operates as a single segment following the 2008 acquisitions of S.T. Pipeline, Inc. and C.J. Hughes Construction Company, Inc.

Key Financial Metrics

Liquidity and Balance Sheet Highlights (as of March 31, 2010)

• Cash and Cash Equivalents: $1.2 million (decreased from $2.8 million at Sept 30, 2009).
• Working Capital: $6.9 million.
• Total Assets: $98.2 million.
• Total Liabilities: $45.8 million.
• Stockholders' Equity: $52.4 million.
• Debt Structure:
  • Current maturities of long-term debt: $7.3 million.
  • Lines of credit and short-term borrowings: $8.4 million.
  • Long-term debt (less current): $9.1 million.
  • Long-term debt payable to shareholder: $5.1 million.
• Backlog: $136.0 million (down from $144.0 million at Sept 30, 2009).

Material Changes vs. Prior Period

• Revenue: Increased 7.1% for the quarter compared to the prior year due to project wrap-ups, but decreased 4.5% for the six-month period due to the completion of larger projects in the prior year that did not recur.
• Gross Profit: The Company reported a gross loss of $1.2 million for the quarter, a significant improvement from the $2.3 million loss in the prior year quarter. For the six-month period, the Company returned to profitability with $3.6 million in gross profit, compared to a $3.9 million loss in the prior year. The prior year loss was driven by two specific projects that incurred $3.2 million in losses due to customer delays and holiday work stoppages.
• Operating Expenses: Selling and administrative expenses increased 41.7% for the quarter and 68.6% for the six-month period, primarily due to increased accounting, professional fees, taxes, and insurance costs for regulatory compliance.
• Cash Flow: Net cash provided by operating activities was $2.4 million for the six months ended March 31, 2010, compared to $10.7 million in the prior year. Financing activities consumed $3.3 million, primarily due to principal payments on long-term debt.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Seasonality and Weather: The second quarter is typically slow due to weather. Severe winter weather in the Mid-Atlantic states caused work stoppages and equipment underutilization, contributing to the quarterly gross loss. Management does not expect these weather-related impacts to result in contract losses at completion.
• Future Performance: Management anticipates marked improvement in revenues and gross margins in the third and fourth fiscal quarters based on current backlog.
• Capital Expenditures: Anticipated CAPEX for fiscal 2010 is between $2.0 million and $4.0 million, though this could increase significantly if customer demand grows.
• Liquidity: The Company has a $15 million line of credit with $12.6 million available access as of March 31, 2010. Management believes current cash and credit facilities are sufficient for operating needs, though credit tightening could limit growth.

Risks and Contingencies

• Weather Dependency: Operations are heavily impacted by weather conditions, particularly in the second quarter.
• Customer Concentration: Three customers accounted for 38.3% of revenue for the six months ended March 31, 2010. One customer represented 12.5% of accounts receivable.
• Debt Covenants: The Company must maintain a current ratio of at least 1.1 (currently 1.27) and a debt-to-tangible net worth ratio not exceeding 3.5 (currently 3.29).
• Off-Balance Sheet Obligations: The Company has $161.9 million in performance bonds outstanding and $950,000 in letters of credit for insurance premiums.
• Goodwill Impairment: While no impairment was recorded in the last annual test, management monitors stock price and fair value trends. Market capitalization remains near book value.

Investor Verification Checklist

• Weather Impact: Verify the extent of work stoppages and the specific impact on the $1.2 million quarterly gross loss versus the $3.6 million six-month gross profit.
• Backlog Quality: Assess the composition of the $136 million backlog to confirm the anticipated improvement in Q3 and Q4 margins.
• Debt Covenants: Monitor the current ratio and debt-to-tangible net worth ratios to ensure continued compliance with the $15 million credit facility.
• Customer Concentration: Review the financial health of the top three customers representing 38.3% of revenue.
• Deferred Tax Asset: Confirm the realization of the $2.7 million deferred tax asset, which relies on future profitability to offset the $5.7 million net operating loss carryforward.