Item
1. Business
General
Eco-Stim
Energy Solutions, Inc. is a technology-driven, growth-oriented independent oilfield services company providing well stimulation,
coiled tubing and field management services to the domestic and international upstream oil and gas industry. We are focused on
reducing the ecological impact and improving the economic performance of the well stimulation process in ‘unconventional’
drilling formations. We serve major, national and independent oil and natural gas exploration and production companies around
the world and we offer products and services with respect to the various phases of a well’s economic life cycle. Our focus
is to bring these technologies and processes to the most active shale resource basins both domestically and outside of North America
using our technology to differentiate our service offerings.
For
information about our operating segments and financial information by operating segment and geographic area, refer to “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of this Annual Report
on Form 10-K and note 8 to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Products
and Services
We
offer a wide variety of specialized oilfield services and equipment generally categorized by their typical use during the economic
life of a well. A description of the products and services offered by each of our three services is as follows:
Pressure
Pumping
Our
customers utilize our pressure pumping services to enhance the production of oil and natural gas from formations with low permeability,
which restricts the natural flow of hydrocarbons. The technique of well stimulation consists of pumping a fluid into a cased well
at sufficient pressure to create new channels in the rock, which can increase the extraction rates and the ultimate recovery of
the hydrocarbons. Our equipment is contracted by oil and gas producers to provide this pressure-pumping service, which is referred
to as a well stimulation fleet. We offer a state-of-the-art pumping fleet, including well-stimulation pumps, nitrogen pumping
units and cranes, in both trailer-mounted and skid-mounted configurations. We expect to have the capability of providing a variety
of pressure-pumping services, including work-over pumping, well injection, and wireline pump downs.
A
portion of our pressure pumping equipment consists of our TPUs, which are powered by remanufactured turbine engines previously
used in military applications. Each turbine engine generates approximately 4,000 horsepower and therefore when operating at 2,000
HHP, the engine is running at approximately 50% of its capacity. As a result, these turbine engines have a reputation for reliability
and durability. They also weigh less than 10% of the typical reciprocating engine of comparable horsepower. The weight differential
allows for better use of space on a trailer and more efficient operations. We believe the TPUs are more cost effective to operate
and maintain than conventional diesel-powered equipment when run on natural gas. Prior field operations with our current TPUs
have demonstrated compliance with emission standards for nitrogen oxides (“NOx”) and carbon monoxide under the EPA’s
Tier 4 standards that regulate emissions from certain off-road diesel engines. Turbine engines also have significantly lower methane
leakage compared to reciprocating engines.
Coiled
Tubing
Our
customers utilize our coiled tubing services to perform various functions associated with well-servicing operations and to facilitate
completion of horizontal wells. Coiled tubing services involve the insertion of steel tubing into a well to convey materials and/or
equipment to perform various applications as part of a new completion or the servicing of existing wells, including wellbore maintenance,
nitrogen services, thru-tubing services, and formation stimulation using acid and other chemicals. Coiled tubing has become a
preferred method of well completion, workover and maintenance projects due to speed, ability to handle heavy-duty jobs across
a wide spectrum of pressure environments, safety and ability to perform services without having to shut-in a well. Our coiled
tubing capabilities cover a wide range of applications for horizontal completion, work-over and well-maintenance projects.
Field
Management
We
recognize that energy companies are under intense pressure to increase reserves at reduced finding costs while simultaneously
coming under heightened environmental scrutiny. We have taken steps to create an innovative methodology for reducing costs, improving
efficiencies and increasing resource recovery rates, which incorporates geophysics, geology and geomechanical properties and various
downhole diagnostics tools, including fiber optic acoustic and temperature measurements as well as downhole pressure gauges. Our
suite of advanced but fully commercialized technologies can be combined to provide both highly efficient predictive models to
our customers and downhole diagnostic measurements to confirm the accuracy of those predictions while providing a full suite of
other information about well integrity, stimulation results, production flow properties and long term monitoring well production
characteristics.
Our
proprietary technologies are used to reduce the number of stages required to optimize production, which can result in a substantial
reduction of the environmental footprint and costs of completing a well, particularly in high-cost areas. Based on many predictive
models executed in several North American shale basins, we believe that the best and most productive stages often occur in brittle
and naturally fracture rock formations (“micro-fracture swarms”). These micro-fracture swarms are too small to detect
with 3D seismic, but their location can be inferred using a proven attribute analysis combined with core analysis and well diagnostic
information. We believe that stimulation efforts in these areas tend to be more effective and frequently result in a better stimulation
effort, which in turn can produce more hydrocarbons. We also have the capability to monitor the cementing and stimulation operation
and the ongoing production results in real time over the life of the well, measuring the type and quantity of inflow from each
stimulation stage. This data allows our customers to confirm and refine the predictability of our Geo-Predict® technology
and related field services. Once the Geo-Predict® technology and our services are demonstrated to be accurate and reliable
in a given area, it then offers compelling opportunities to lower production costs while simultaneously reducing the environmental
impact as a result of completing fewer, better targeted stages with less horsepower and less water. In cases where the fiber optic
diagnostic system is permanently installed in a well, we believe the information provided allows for proactive management of the
well’s performance over the life of the well, including the ability to actively shut off zones with unwanted water flow.
Customers
Our
customers consist primarily of international oil and gas exploration and production companies including national oil companies,
local privately-held exploration and production companies and, on occasion, other service companies that have contractual obligations
to provide well stimulation and completion services. Demand for our services depends primarily upon the capital and operating
spending of oil and gas companies and the level of drilling activity in the oil and gas markets. To date, substantially all our
revenue generated is attributable to a few customers, including YPF, S. A. (“YPF”) and several smaller local exploration
and production companies.
Competition
We
provide products and services in Argentina and the U.S., both highly competitive markets, with competitors comprised of both small
and large companies. Our revenues and earnings can be affected by several factors, including changes in competition, fluctuations
in drilling and completion activity, perceptions of future prices of oil and gas, government regulation, disruptions caused by
weather and general economic conditions. We believe that the principal competitive factors are price, performance, product and
service quality, safety, response time and breadth of products and services. We believe our primary competitors in Argentina include
Schlumberger, Halliburton, Weatherford, Baker Hughes, Calfrac, Well Services, San Antonio International and other oilfield service
companies. Domestically, we compete against many of the same competitors as in Argentina but in addition, we also face strong
competition from several independent pressure pumping companies. We also compete with various other regional and local providers
within each of our geographic markets for products and services.
Markets
Argentina
We
have been operating an oilfield services business in Argentina since December 2014. Our first full year of operations was 2015.
The market for our services in Argentina can be broken into three service offerings, (1) Pressure pumping, (2) Coiled Tubing and
(3) Field management. The majority of our revenue comes from the pressure pumping market which can be broken into three sub-markets,
(1) conventional wells, (2) tight gas wells and (3) unconventional wells. Generally, the conventional wells can be serviced with
3-5 pumping units whereas the tight gas wells require 8-10 pumping units. The unconventional wells in Argentina require anywhere
from 16 to 24 pumping units. In 2015, EcoStim only had sufficient pumping capacity to participate in the conventional well market.
In 2016, we expanded our capacity and now have experience working in the tight gas market. We anticipate that as the market in
Argentina recovers and activity increases, there will be opportunities to secure long term agreements and add additional pumping
capacity to service all three markets.
Our
Coiled Tubing business involves services to support our pressure pumping business including the drill out of frac plugs, wash-downs,
chemical treatments and workover activity. We provide this service to the conventional, tight gas and unconventional well
markets.
Our Field Management
business consists of various degrees of subsurface analysis derived from the data received from clients or otherwise acquired.
The different forms of data include geophysical, geo-mechanical, core samples and other information provided by our customers
and data acquired, processed and interpreted by our team including real time fiber optic information data gathered from
pressure gauges installed in the wells. This market is driven by exploration and step-out development in new regions or in mature
areas where our customers are looking to better understand the production associated with older wells. The market for these services
is limited but complements our primary business lines and brings expertise and value to our customers.
The
drilling rig count in Argentina peaked at 113 in 2014 and bottomed at 52 in January 2017. The rig count is a reasonable
indicator of activity in Argentina and the level of activity will affect the utilization and pricing of our
services. Additionally, as wells become more complex and move from conventional to unconventional wells, pressure pumping
demand is expected to grow.
Oklahoma
In
January 2017, the Company signed a one year contract to provide pressure pumping services in north central Oklahoma. The market
in this region is concentrated around wells being drilled in the Woodford, Mississippian Lime, Stack, Scoop and Springer plays.
Activity in this region has accelerated in late 2016 and according to Baker Hughes’ North America Rotary Rig Count
data, in March 2017 there were 101 rigs operating in Oklahoma as compared 67 rigs operating in March 2016. We have established
a base of operations in Fairview, Oklahoma and expect to service all the surrounding basins going forward.
Potential
Liabilities and Insurance
Our
operations involve a high degree of operational risk and expose us to significant liabilities. An accident involving our services
or equipment, or the failure of a product sold by us, could result in personal injury, loss of life, and damage to property, equipment
or the environment. Litigation arising from a catastrophic occurrence, such as fire, explosion, or well blowout, may result in
substantial claims for damages.
We
maintain insurance coverage of types and amounts that we believe to be customary and reasonable for companies of our size and
with similar operations. In accordance with industry practice, however, we do not maintain insurance coverage against all of the
operating risks to which our business is exposed. Therefore, there is a risk our insurance program may not be sufficient to cover
any particular loss or all losses. Currently, our insurance program includes, among other things, general liability, umbrella
liability, sudden and accidental pollution, personal property, vehicle, workers’ compensation, and employer’s liability
coverage. Our insurance includes various limits and deductibles or retentions, which must be met prior to or in conjunction with
recovery.
Government
Regulation
Our
business is significantly affected by federal, state, provincial and local laws and other regulations. These laws and regulations
relate to, among other things:
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worker
safety standards;
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the
protection of the environment;
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the
handling and transportation of hazardous materials;
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the
protection of natural and cultural resources; and
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the
mobilization of our equipment to, and operations conducted at, our work sites.
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Numerous
permits are required for the conduct of our business and operation of our various facilities and equipment, including our trucks
and other heavy equipment. These permits can be revoked, modified or renewed by issuing authorities based on factors both within
and outside our control.
We
cannot predict the level of enforcement of existing laws and regulations or how such laws and regulations may be interpreted by
enforcement agencies or court rulings in the future. We also cannot predict whether additional laws and regulations will be adopted,
including changes in regulatory oversight, increase of federal, state or local taxes, increase of inspection costs, or the effect
such changes may have on us, our businesses or our financial condition.
Environmental
Matters
Our
operations, and those of our customers, are subject to extensive laws, regulations and treaties relating to air and water quality,
generation, storage and handling of hazardous materials, and emission and discharge of materials into the environment, and the
protection of natural resources. Compliance with these environmental laws and regulations may expose us to significant costs and
liabilities and cause us to incur significant capital expenditures in our operations. Failure to comply with these laws and regulations
may result in the assessment of administrative, civil and criminal penalties, imposition of investigatory and remedial obligations,
and the issuance of injunctions delaying or prohibiting operations. Historically, our expenditures in furtherance of our compliance
with these laws, regulations and treaties have not been material, and we do not expect the cost of compliance to be material in
the future; however, we can provide no guarantee that this will not change.
The
primary U.S. federal environmental laws to which our operations are subject include the federal Clean Air Act (“CAA”)
and regulations thereunder, which regulate air emissions; the Clean Water Act (“CWA”) and regulations thereunder,
which regulate the discharge of pollutants in industrial wastewater and storm water runoff; the Resource Conservation and Recovery
Act and regulations thereunder, which regulate the management and disposal of hazardous and non-hazardous solid wastes; and the
Comprehensive Environmental Response, Compensation, and Liability Act and regulations thereunder, known more commonly as “Superfund,”
which imposes liability for the remediation of releases of hazardous substances in the environment. We are also subject to regulation
under the U.S. federal Occupational Safety and Health Act and regulations thereunder, which regulate the protection of the safety
and health of workers. Analogous state and local laws and regulations may also apply. Similar laws and regulations exist at the
national and provincial level in Argentina.
Recently,
there has been increased domestic and international scrutiny of hydraulic fracturing activities, resulting in additional regulation.
Domestically, the U.S. Environmental Protection Agency (“EPA”) and other federal agencies, including the Bureau of
Land Management (“BLM”) have finalized rules or made proposals that would subject hydraulic fracturing to further
regulation and could restrict the practice of hydraulic fracturing. For example, the EPA has issued final regulations under the
CAA establishing performance standards for oil and gas activities, including standards for the capture of air emissions released
during hydraulic fracturing and finalized CWA regulations in June 2016 that prohibit the discharge of wastewater from hydraulic
fracturing operations to publicly owned wastewater treatment plants. The BLM and several states have already adopted and more
states are considering adopting laws and/or regulations that require disclosure of chemicals used in hydraulic fracturing and
impose more stringent permitting, disclosure and well-construction requirements on hydraulic fracturing operations. In addition,
some states and municipalities have significantly limited drilling activities and/or hydraulic fracturing, or are considering
doing so. Also in Oklahoma, where we operate in the U.S., the Oklahoma Corporation Commission has taken steps to address the potential
link between hydraulic fracturing activities and underground injection disposal well operations and induced seismic events. In
Argentina, Neuquén Province has promulgated rules and procedures for the exploration and development of unconventional
reservoirs, while other provinces have banned hydraulic fracturing altogether. Although it is not possible at this time to predict
the final outcome of these proposals, any new federal, state or local restrictions on hydraulic fracturing that may be imposed
in areas in which we conduct business could potentially result in increased compliance costs for us or our customers, or delays
in development or restrictions on our operations or the operations of our customers, which in turn could have an adverse effect
on our business and results of operations.
In
addition, from time to time regulators in both the U.S. and Argentina have taken steps to restrict emissions of carbon dioxide,
methane, and other greenhouse gases based on determinations by the scientific community that such emissions are contributing to
climate change. Initiatives to date have generally focused on the development of cap-and-trade and/or carbon tax programs. A cap-and-trade
program generally would cap overall greenhouse gas emissions on an economy-wide basis and require major sources of greenhouse
gas emissions or major fuel producers to acquire and surrender emission allowances. Carbon taxes could likewise affect us by being
based on emissions from our equipment and could indirectly affect us by increasing operating costs for our customers. Although
it is not possible at this time to predict how legislation or new regulations that may be adopted to address greenhouse gas emissions
would impact our business, any such future laws and regulations imposing reporting obligations on, or limiting emissions of greenhouse
gases from, our equipment and operations could require us to incur costs to reduce emissions of greenhouse gases associated with
our operations. Severe limitations on greenhouse gas emissions could also adversely affect demand for oil and natural gas, which
could decrease demand for our services and have a material adverse effect our profitability, financial condition and liquidity.
Raw
Materials
We
purchase various raw materials and component parts in connection with delivering our products and services. These materials are
generally, but not always, available from multiple sources and may be subject to price volatility. While we generally do not experience
significant long-term shortages of these materials, we have from time to time experienced temporary shortages of particular raw
materials. We are always seeking ways to ensure the availability of resources, as well as manage costs of raw materials.
Seasonality
Seasonal
weather and severe weather conditions can temporarily impair our operations by reducing our ability to operate for certain time
periods, thereby reducing demand for our products and services.
Employees
At
December 31, 2016, we had 87 employees, including 84 full-time, and 3 consultants.
Facilities
Our
principal executive offices are located at 2930 W. Sam Houston Parkway North, Suite 275, Houston, Texas 77043. In addition, we
own or lease additional facilities in the various areas in which we operate.
Intellectual
Property
We
have registered with the United States Patent and Trademark Office for the following trademarks: Geo-Predict® and Geo-Iteration®.
We have not filed any applications for the registration of our trademarks in foreign jurisdictions, but may do so in the future
as we deem necessary to protect our business. In addition, we rely to a great extent on the technical expertise and know-how of
our personnel to maintain our competitive position.
Research
and Development
See
Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations –
Results of Operations – “Overview of Business Services.”
Recent
Developments
Equity
Offerings
On
July 13, 2016, the Company entered into an At-Market Issuance Sales Agreement (the “Agreement”) with FBR Capital Markets
& Co. and MLV & Co. LLC (the “Distribution Agents”). Pursuant to the terms of the Agreement, the Company may
sell from time to time through the Distribution Agents, shares of the Company’s common stock, par value $0.001 per share,
with an aggregate sales price of up to $5,801,796 (the “Shares”). Sales of the Shares, if any, will need to be approved
by the Company’s board of directors (the “Board”) and will be made by any method permitted that is deemed an
“at the market offering” as defined in Rule 415 under the Securities Act, including sales made directly on or through
the NASDAQ Capital Market, the existing trading market for our common stock or on any other existing trading market for our common
stock, sales made to or through a market maker other than on an exchange or otherwise, in negotiated transactions at market prices,
and/or any other method permitted by law. Sales of the Shares may be made at market prices prevailing at the time of sale, at
prices related to prevailing market prices or at negotiated prices, and subject to such other terms as may be agreed upon at the
time of sale including a minimum sales price that may be stipulated by the Board. During 2016, the Company sold 796,573 shares
through the Agreement at an average price of $2.16 per share, for total proceeds of $1,722,596 before deducting approximately
$164,000 of commissions.
Secured
Loan Agreement
On November 30, 2016,
the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Bienville Argentina Opportunities
Master Fund, LP (“Bienville”) and an individual. A portion of the $2 million proceeds from the Loan Agreement were
used to pay the remaining amount payable (approximately $1 million) by the Company under an equipment purchase agreement dated
October 10, 2014, as amended, with Gordon Brothers Commercial & Industrial, LLC for the purchase of certain turbine powered
pressure pumping equipment (the “TPUs”). The indebtedness created under the Loan Agreement was repaid on March 6, 2017
with a portion of the proceeds of the New Convertible Note (as defined below) issued under the A&R Note Agreement as described
below.
Purchase, Sale
and Assignment
On March 3, 2017, the
Company entered into a purchase, sale and assignment agreement (the “Purchase, Sale and Assignment Agreement”) with
Fir Tree and ACM Emerging Markets Master Fund I, L.P. and ACM Multi-Strategy Delaware Holding LLC (collectively, the “ACM
entities”), which became effective on March 6, 2017, pursuant to which, among other things, Fir Tree purchased from
the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018 and approximately
two million shares of common stock of the Company held by ACM Emerging Markets Master Fund I, L.P., or ACM, (the “Purchase,
Sale and Assignment”). This transaction was part of a comprehensive recapitalization designed to create a path to a potential
conversion to equity of substantially all of the Company’s debt, subject to shareholder approval and satisfaction of
certain other conditions. The Purchase, Sale and Assignment closed on March 6, 2017.
Amended
and Restated Convertible Note Facility Agreement
On March 3, 2017, the
Company also entered into an Amended and Restated Convertible Note Facility Agreement (the “A&R Note Agreement”)
with Fir Tree, which became effective on March 6, 2017 and replaced the previously existing convertible notes agreement
by and among the Company and ACM entities (the “Existing Note Agreement”). Pursuant to the terms of the A&R Note
Agreement, the Company issued to Fir Tree a secured promissory note (the “Amended and Restated Convertible Note”)
in a principal amount of $22 million, which replaces the Existing ACM Note, and a secured promissory note (the “New Convertible
Note”, and together with the Amended and Restated Convertible Note, the “Notes”) in a principal amount of approximately
$19.4 million, representing an additional $17 million aggregate principal amount of convertible notes issued by the Company to
Fir Tree on March 6, 2017 and approximately $2.4 million principal amount of convertible notes in payment of accrued and unpaid
interest on the Existing ACM Note. The Notes are convertible into the common stock of the Company (the “Common Stock”)
at a price of $1.40 per share, contingent upon the Company receiving shareholder approval of the conversion and satisfaction of
certain other conditions. The Company has agreed with Fir Tree to seek prompt shareholder approval of the conversion of the Notes.
The unpaid principal amount of the Notes bears an interest rate of 20% per annum and matures on May 28, 2018.
The
proceeds of the A&R Note Agreement will be primarily used for equipment purchases and other approved capital expenditures
incurred in accordance with an approved operating budget.
The
A&R Note Agreement also provides for certain representations, warranties and affirmative covenants and negative covenants
customary for transactions of this type, including limitations on the Company’s ability to incur certain types of additional
debt, engage in transactions with affiliates, sell assets, and make unapproved capital expenditures.
The
A&R Note Agreement further provides that all obligations thereunder are and will be, subject to certain terms and exceptions,
jointly and severally guaranteed by certain of the Company’s subsidiaries. All obligations under the A&R Note
Agreement are secured by liens on certain of the assets of the Company and the subsidiary guarantors
.
The
A&R Note Agreement further provides for customary Events of Defaults (as such term is defined in the A&R
Note Agreement), including but not limited to: failure to make payment when due, default under other agreements, breach of warranty,
failure to comply with negative covenants, bankruptcy, dissolution, impairments to Material Agreements (as such term is defined
in the A&R Note Agreement), lack of enforceability of the Transaction Documents (as such term is defined in the A&R
Note Agreement), certain ERISA events or environmental claims or nationalization resulting in a material taking of property.
Upon the occurrence of any Event of Default, Fir Tree may declare all outstanding principal in respect of the Notes, accrued
and unpaid interest thereon, premiums and other amounts outstanding under the A&R Note Agreement to be due and payable.
The
foregoing description is a summary of the A&R Note Agreement, does not purport to be complete and is qualified in its
entirety by reference to the full text of the A&R Note Agreement, which is filed as Exhibit 10.2 to the Company’s
Current Report on Form 8-K and incorporated herein by reference.
Stockholder
Rights Agreement
On
March 3, 2017 and as a condition precedent for the closing of the A&R Note Agreement, the Company entered into an Amended
and Restated Stockholder Rights Agreement (the “A&R Stockholder Rights Agreement”) with Fir Tree and the certain
other stockholders party thereto (the “Specified Stockholders”), which became effective on March
6, 2017.
Pursuant
to the A&R Stockholder Rights Agreement, Fir Tree currently has the right to nominate at least three individuals for election
to the board of directors of the Company (the “Board”) for so long as Fir Tree beneficially owns at least 5% of the
issued and outstanding Common Stock (calculated on a fully diluted basis). On March 6, 2017, Messrs. David Proman, Andrew Teno
and Andrew Colvin were appointed to the Board pursuant to the foregoing contractual requirements. The A&R Stockholder Rights
Agreement provides that certain significant Board actions can be taken only with the affirmative vote or consent of at least two
directors appointed by Fir Tree.
A
director nominated by Fir Tree may only be removed, with or without cause, upon Fir Tree’s written request. Fir Tree also
has the right to nominate a substitute designee should a vacancy on the Board occur due to the death, disability, retirement,
resignation or removal of any of its previously appointed designees.
So
long as Fir Tree beneficially owns at least 5% of the issued and outstanding Common Stock (calculated on a fully diluted basis),
certain key actions of the Company, including but not limited to, changes in numbers of directors, sale of all or substantially
all assets of the Company or issuance of a new class of capital stock, will require approval by a majority of the Board, including
the affirmative vote of at least 2 directors appointed by Fir Tree.
So
long as Fir Tree beneficially owns at least 5% of the issued and outstanding Common Stock (calculated on a fully diluted basis),
the Company will have an audit committee, a compensation committee, and a nominating committee and will designate at least one
director nominated by Fir Tree to each such committee. Mr. Teno was appointed by the Board as a member of the Company’s
compensation committee, and Mr. Proman was appointed by the Board as a member of the Company’s nominating committee, pursuant
to the foregoing contractual requirements. Fir Tree intends to appoint an individual who qualifies as an independent
director under NASDAQ Capital Market and SEC rules to the Board and the audit committee no later than 180 days following March
7, 2017.
So long as Fir Tree beneficially
owns at least 10% of the issued and outstanding Common Stock (calculated on a fully diluted basis), Fir Tree will have a pre-emptive
right to purchase an amount of common stock, issued by the Company necessary to ensure Fir Tree’s beneficial ownership does
not decrease as a result of such new issuance. Subject to the same conditions and certain exceptions, Fir Tree and the Specified
Stockholders will have rights of first refusal and tag-along rights to any proposed transfer of Common Stock.
The
foregoing description is a summary of the A&R Stockholder Rights Agreement, does not purport to be complete and is qualified
in its entirety by reference to the full text of the A&R Stockholder Rights Agreement, which is filed as Exhibit 4.3
hereto.
Registration
Rights Agreement
On
March 3, 2017, the Company entered into a Registration Rights Agreement (the “Registration Rights Agreement”)
with Fir Tree which became effective on March 6, 2017, pursuant to which the Company granted certain registration rights
to Fir Tree with respect to the shares of Common Stock held by Fir Tree (the “Registrable Securities”), including
those shares of Common Stock issuable upon the conversion of the Convertible Note. Under the Registration Rights Agreement, Fir
Tree will have certain customary registration rights, including demand rights and piggyback rights, subject to certain underwriter
cutbacks and issuer blackout periods. The Company will pay all fees and expenses relating to the registration and disposition
of the Registrable Securities in compliance with the Company’s obligations under the Registration Rights Agreement.
The
foregoing description is a summary of the Registration Rights Agreement, does not purport to be complete and is qualified in its
entirety by reference to the full text of the Registration Rights Agreement, which is filed as Exhibit 4.4 hereto.
Corporate
Information
We
are a Nevada corporation. Our principal executive offices are located at 2930 W. Sam Houston Pkwy. N., Suite 275, Houston, Texas
77043, and our main telephone number at that address is (281) 531-7200. Our website is available at www.ecostim-es.com. Information
contained on or available through our website is not part of or incorporated by reference into this Form 10-K or any other report
we may file with the Securities and Exchange Commission (the “SEC”).
We
file our reports, proxy statements and other information with the SEC. You can read and copy these reports, proxy statements and
other information concerning Eco-Stim at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549,
on official business days during the hours of 10 a.m. to 3 p.m. Please call the SEC at 1-800-SEC-0330 for further information
about the operation of the SEC’s Public Reference Room. The SEC also maintains an internet site that contains all reports,
proxy statements and other information that we file electronically with the SEC. The address of that website is
http://www.sec.gov
.
Investors
should be aware that while we do, at various times, communicate with securities analysts, it is against our policy to disclose
to them selectively any material non-public information or other confidential information. Accordingly, investors should not assume
that we agree with any statement or report issued by an analyst with respect to our past or projected performance. To the extent
that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
Item
1A. Risk Factors
An
investment in our common stock involves a number of risks. You should carefully consider the risks described in “Risk Factors,”
in addition to the other information contained in this Form 10-K, including “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before investing
in our common stock. These risks could materially affect our business, financial condition and results of operations, and cause
the trading price of our common stock to decline. You could lose part or all of your investment. You should bear in mind, in reviewing
this Form 10-K, that past experience is no indication of future performance. You should read the section titled “Cautionary
Statements Regarding Forward-Looking Statements” for a discussion of what types of statements are forward-looking statements,
as well as the significance of such statements in the context of this Form 10-K.
Risks
Related to Our Business
We
have limited operating history and only minimum revenues.
We
have a limited operating history and, accordingly, we are subject to substantial risks inherent in the commencement of a new business
enterprise. We are a technology-driven independent oilfield service company providing well stimulation, coiled tubing and field
management services to the upstream oil and gas industry with a focus on improving the ecological and economic aspects of the
process. Our primary focus will be on the most active shale and unconventional oil and natural gas basins. We have commenced operations
in Argentina and since 2014 through December 31, 2016, have only generated minimal revenue from our consulting and field management
operations. There can be no assurance that we will be able to successfully generate additional revenues or attain operating profitability.
Additionally, we have a very limited business history that investors can analyze to aid them in making an informed judgment as
to the merits of an investment in our Company. Any investment in our Company should be considered a high-risk investment because
the investor will be placing funds at risk in our Company with unforeseen costs, expenses, competition, and other problems to
which new ventures are often subjected. Investors should not invest in our Company unless they can afford to lose their entire
investment. As we are early in the revenue-generation process, our prospects must be considered in light of the risks, expenses,
and difficulties encountered in establishing a new business in a highly competitive industry.
We
have limited sources of liquidity.
We
require substantial capital to pursue our operating strategy. As we have limited internal sources of liquidity, we will continue
to rely on external sources for liquidity for the foreseeable future.
We
participate in a capital-intensive industry, and we may have capital needs for which our internally generated cash flows and other
sources of liquidity may not be adequate.
The
oil and gas industry is capital intensive. We have substantial future capital requirements, including the need to fund growth
through acquisition of additional equipment and assets, working capital and capital expenditures and debt service obligations.
Since December 2013, our operation and growth has been funded primarily by proceeds from various equity and debt offerings and
more recently by cash flows from operations. Our ability to fund future operations and our planned and committed 2017 capital
expenditures will depend upon our future operating performance and, more broadly, on the availability of equity and debt financing.
The availability of financing will be affected by prevailing economic conditions, market conditions in the exploration and production
industry and financial, business and other factors, many of which are beyond our control. If we are unable to generate sufficient
cash flows or to obtain additional capital on favorable terms or at all, we may be unable to continue growing our business or
to sustain or increase our current level of profitability. Our inability to grow our business may adversely impact our ability
to sustain or improve our profits. Moreover, if we cannot generate sufficient cash flows or otherwise secure sufficient liquidity
to support our capital requirements, we may not be able to meet our payment obligations, which could have a material adverse effect
on our results of operations or liquidity.
We
may not be able to fulfill, renew or replace our existing agreements on attractive terms or at all, which could adversely impact
our results of operations, financial condition and cash flows.
We
can provide no assurance that we will be able to successfully fulfill, renew or replace our existing agreements with new agreements
on or prior to their expiration on terms satisfactory to us or the operator or that we will be able to continue to provide services
under those existing agreements without service interruption. We are dependent on entering into additional service agreements
to grow our business. If we are not able to either renew or enter into additional service agreements, our results of operations,
financial condition and cash flows could be adversely impacted.
We
may have difficulty managing growth in our business, which could adversely affect our financial condition and results of operations.
As
an emerging growth company, growth in accordance with our business plan, if achieved, could place a significant strain on our
financial, technical, operational and management resources. As we expand the scope of our activities and our geographic coverage
through both organic growth and acquisitions, there will be additional demands on our financial, technical, operational and management
resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrences
of unexpected expansion difficulties, including the failure to recruit and retain experienced managers, engineers and other professionals
in the oilfield services industry, could have a material adverse effect on our business, financial condition, results of operations
and our ability to successfully or timely execute our business plan.
If
our intended expansion of our business is not successful, our financial condition, profitability and results of operations could
be adversely affected, and we may not achieve increases in revenue and profitability that we hope to realize.
A
key element of our business strategy involves the expansion of our services, geographic presence and customer base. These aspects
of our strategy are subject to numerous risks and uncertainties, including:
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an
inability to retain or hire experienced crews and other personnel;
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a
lack of customer demand for the services we intend to provide;
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an
inability to secure necessary equipment, raw materials (particularly sand and other proppants) or technology to successfully
execute our expansion plans;
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shortages
of water used in our sand processing operations and our hydraulic fracturing operations;
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unanticipated
delays that could limit or defer the provision of services by us and jeopardize our relationships with existing customers
and adversely affect our ability to obtain new customers for such services; and
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competition
from new and existing services providers.
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Encountering
any of these or any unforeseen problems in implementing our planned expansion could have a material adverse impact on our business,
financial condition, results of operations and cash flows, and could prevent us from achieving the increases in revenues and profitability
that we hope to realize.
Our
liquidity needs could restrict our operations and make us more vulnerable to adverse economic conditions.
Our
future indebtedness, whether incurred in connection with acquisitions, operations or otherwise, may adversely affect our operations
and limit our growth, and we may have difficulty making debt service payments on such indebtedness as payments become due. Our
level of indebtedness may affect our operations in several ways, including the following:
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increasing
our vulnerability to general adverse economic and industry conditions;
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the
covenants that are contained in the agreements governing our indebtedness could limit our ability to borrow funds, dispose
of assets, pay dividends and make certain investments;
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our
debt covenants could also affect our flexibility in planning for, and reacting to, changes in the economy and in our industry;
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any
failure to comply with the financial or other covenants of our debt, including covenants that impose requirements to maintain
certain financial ratios, could result in an event of default, which could result in some or all of our indebtedness becoming
immediately due and payable;
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our
level of debt could impair our ability to obtain additional financing in the future for working capital, capital expenditures,
acquisitions or other general corporate purposes; and
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our
business may not generate sufficient cash flow from operations to enable us to meet our obligations under our indebtedness.
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We
may be unable to maintain pricing on our core services.
Pressures
stemming from fluctuating market conditions and oil and natural gas prices are making it increasingly difficult to maintain the
pricing on our core services during the last quarter of 2015 and throughout 2016. We have faced, and will likely continue to face,
reductions in our services being needed as well as pricing pressure from the competitors who are also competing for those same
opportunities during 2017. If we are unable to maintain pricing on our core services, our financial results will be negatively
impacted.
The
activity level of our customers, spending for our products and services, and payment patterns may be impacted by low commodity
prices and any deterioration in the credit markets.
Many
of our potential customers finance their activities through cash flow from operations, the incurrence of debt or the issuance
of equity. Beginning in late 2014 and continuing through 2015 and into early 2016, there was a significant decline in the word-wide
benchmarked prices of oil and gas, resulting in reduced cash flow from our customers’ operations and a severe reduction
in their access to the equity and credit markets. Additionally, during 2015 and 2016, many of our potential customers’ equity
values substantially declined. The combination of a reduction of cash flow resulting from declines in commodity prices, a reduction
in borrowing bases under reserve-based credit facilities and the lack of availability of debt or equity financing may result in
a significant reduction in our potential customers’ spending for our products and services. Although during 2016 the price
of WTI oil has increased to the mid $50s per barrel, drilling activity has increased modestly attributable to concerns about sustained
price stability and price maintenance.
In
addition, the same factors that may lead to a reduction in our potential customers’ spending also may increase the exposure
to the risks of nonpayment and nonperformance by the customers. A significant reduction in our customers’ liquidity may
result in a decrease in their ability to pay or otherwise perform their obligations to us. Any increase in nonpayment or nonperformance
by our customers, either as a result of recent changes in financial and economic conditions or otherwise, could have an adverse
impact on the operating results and adversely affect the liquidity.
In
addition to the foregoing, because YPF is controlled by the Argentine state, its capital spending and other policies may be subject
to political influence, particularly from the Secretary of Energy. Because we rely on a limited number of customers for the well
stimulation services, the change in ownership and management of any such customer may adversely affect our business, financial
condition and results of operations.
Our
customers may choose to integrate their operations vertically by purchasing and operating their own well stimulation fleet, expanding
the amount of well stimulation equipment they currently own or using alternative technologies for enhancing oil and gas production.
Our
customers may choose to integrate their operations vertically by purchasing and operating their own well stimulation fleets in
lieu of using our well stimulation services. In addition, there are other technologies available for the artificial enhancement
of oil and natural gas production and our customers may elect to use these alternative technologies instead of the well stimulation
services we provide. Such vertical integration, increases in vertical integration or use of alternative technologies could result
in decreased demand for our well stimulation services, which may have a material adverse effect on our business, results of operations
and financial condition.
Our
customer base is concentrated within the oil and natural gas production industry, and loss of a significant customer or the existing
customer contracts could cause our revenue to decline substantially and adversely affect our business.
Our
business is and will be highly dependent on existing agreements and the relationships with potential customers and technology
partners. Revenues from these potential customers and revenues from joint ventures are expected to represent a substantial portion
of our total future revenues. A reduction in business from any of these arrangements resulting from reduced demand for their own
products and services, a work stoppage, sourcing of products from other suppliers or other factors could materially impact our
business, financial condition and results of operations. In addition, the inability of suppliers to timely deliver the required
equipment for the new well stimulation fleets could have a material adverse impact on our ability to perform under the existing
agreements. We expect that we will continue to derive a significant portion of our revenue from a relatively small number of customers
in the future. Our existing agreements do not obligate any of those prospective customers to use our products and services. In
addition, the existing agreements contain provisions whereby the customers may terminate the agreement in the event we are unable
to perform under the terms of the contract or make adjustments to service and/or materials fees payable thereunder based on changing
market conditions. The existing agreements are also subject to termination by customers under certain circumstances, and any such
termination could have a material adverse effect on our business.
We
may have difficulty managing growth in our business, which could adversely affect our financial condition and results of operations.
We
do not have highly sophisticated systems to forecast our future revenue or profitability and therefore could experience difficulty
in managing our growth and associated working capital needs.
Our
ability to operate successfully depends on the availability of water.
Well
stimulation, and pressure pumping more generally, can require a significant supply of water, and water supply and quality are
important requirements to our operations. We intend to meet our water requirements from sources on or near the well sites, but
there is no assurance that we will be able to obtain a sufficient supply of water from sources in these areas, some of which are
prone to drought. For example, in December 2016, the Neuquén province in Argentina declared a 12-month state of emergency
as a result of a severe drought. In response to this emergency, the Governor of Neuquén also established a special committee
with broad powers to take any “urgent and immediate action deemed necessary to address the water emergency.” While
we cannot predict what measures may be taken in response to drought conditions, limitations on water use or increased costs to
obtain water from alternative sources has the potential to adversely affect our operations, financial position, and results of
operations.
Any
indebtedness we incur could restrict our operations and make us more vulnerable to adverse economic conditions.
We
anticipate securing growth capital through lease financing or other long-term financing arrangements. Our expected future needs
for financing for equipment acquisition and working capital may adversely affect operations and limit our growth, and we may have
difficulty making debt service payments on our indebtedness as such payments become due.
Covenants
in our debt agreements restrict our business in many ways.
We
and Fir Tree are parties to the A&R Note Agreement. The A&R Note Agreement contains restrictive covenants.
These covenants include, but are not limited to, requirements to reserve shares issuable for payment of the outstanding balance
on the convertible note, maintain specific account balances, and comply with the operating budget. Additionally, the covenants
include, but are not limited to, restrictions on incurring certain types of additional debt, engaging in transactions with affiliates,
selling assets, making unapproved capital expenditures and entering into certain lease agreements.
A
breach of any of these covenants could result in a default under our note facility. Upon the occurrence of an event of default
under our convertible note facility, Fir Tree may accelerate payment under the A&R Note Agreement in accordance with
its terms. If we were unable to repay those amounts, Fir Tree could, among other things, proceed against the collateral
granted to them that secures that indebtedness.
We
have pledged a significant portion of our and our subsidiaries’ assets as collateral under our note facility. If Fir Tree
accelerates the repayment of borrowings under our note facility, we cannot assure you that we will have sufficient assets to repay
indebtedness under such facilities and our other indebtedness.
We
may not be able to provide services that meet the specific needs of oil and natural gas exploration and production companies at
competitive prices.
The
markets in which we operate are highly competitive and have relatively few barriers to entry, and the competitive environment
has intensified as recent mergers among exploration and production companies have reduced the number of available customers. The
principal competitive factors in the markets in which we operate are product and service quality and availability, responsiveness,
experience, technology, equipment quality, reputation for safety and price. We compete with small companies capable of competing
effectively in our markets on a local basis. We also compete with large national and multi-national companies that have longer
operating histories, greater financial, technical and other resources and greater name recognition than we do. Our initial well
stimulation fleet currently does not have sufficient HHP to enable us to participate in unconventional jobs as well as larger
well stimulation jobs. See Part I – Item 1 – “Business—Market Segmentation.”
The
inability to control the inherent risks of acquiring and integrating businesses in the future could adversely affect our operations.
As
a part of our business strategy, we intend to pursue selected acquisitions or mergers. If we choose to grow our business through
acquisitions or mergers, it is possible that companies acquired or merged into our Company may have associated risks including:
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Unanticipated
costs and assumption of liabilities and exposure to unforeseen liabilities;
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Inherent
difficulties in integrating the operations and assets of the acquired business and personnel;
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Potential
losses of key employees and customers of the acquired business;
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Internal
control weaknesses or limitations on our ability to properly assess and maintain an effective internal control environment
over an acquired business, in order to comply with public reporting requirements;
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Risks
of entering markets in which we have limited prior experience; and
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Increases
in our expenses and working capital requirements.
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Our
business depends upon our ability to obtain specialized equipment from suppliers and key raw materials on a timely basis.
If
our current suppliers are unable to provide the necessary raw materials (including, for example, proppant and chemicals) or finished
products (such as the new equipment) or otherwise fail to deliver products timely and in quantities required, any resulting delays
in the provision of services could have a material adverse effect on our business, financial condition, results of operations
and cash flows. During the past few years, our industry faced sporadic proppant shortages associated with pressure pumping operations,
requiring work stoppages that adversely impacted the operating results of several competitors.
The
Chairman of the Board allocates part of his time to other companies.
Mr.
Bjarte Bruheim, the chairman of the Board, is also a member of the board of directors of other companies. Mr. Bruheim allocates
his time between the affairs of Eco-Stim and the affairs of these other companies. This situation presents the potential for a
conflict of interest for Mr. Bruheim in determining the respective percentages of his time to be devoted to the affairs of Eco-Stim
and the affairs of others. In addition, if the affairs of these other companies require him to devote more substantial amounts
of his time to the affairs of the other companies in the future, it could limit his ability to devote sufficient time to our affairs
and could have a negative impact on our business.
Unexpected
equipment malfunctions, catastrophic events and scheduled maintenance may lead to decreased revenue and reduce our cash flows.
Our
performance is primarily dependent upon the efficient and uninterrupted operation of our sole pressure pumping fleet, which commenced
operation in Argentina in December 2014, and our sole coiled tubing equipment unit, which commenced operation in Argentina in
February 2015. If our operation of such core equipment experiences unanticipated disruption due to an accident, mechanical failure
or other unforeseen event such as a fire, explosion, violent weather conditions or unexpected operational difficulties, or if
we have to schedule a temporary shutdown to perform maintenance on any of our core equipment, our ability to provide timely services
to our customers could be negatively affected, which could have a material adverse effect on our business, financial condition,
results of operations and cash flows.
Our
inability to make satisfactory alternative arrangements in the event of an interruption in supply of certain key raw materials
could harm our business, results of operations and financial condition.
We
currently anticipate sourcing materials, such as guar gum, from one supplier. Given the limited number of suppliers of such key
raw materials, we may not always be able to make alternative arrangements should our suppliers fail to timely deliver these key
raw materials. Any resulting delays in the provision of services could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
We
may not be successful in implementing technology development and enhancements.
The
market for our services and products is characterized by continual technological developments to provide better and more reliable
performance and services. If we are not able to design, develop and produce commercially competitive products and to implement
commercially competitive services in a timely manner in response to changes in technology, our business and revenues could be
materially and adversely affected and the value of our intellectual property may be reduced. Likewise, if our proprietary technologies,
equipment and facilities, or work processes become obsolete, we may no longer be competitive and our business and revenues could
be materially and adversely affected.
We
depend on the services of key executives, the loss of whom could materially harm our business.
The
management of our Company is important to our success because they have been instrumental in setting our strategic direction,
operating the business, identifying, recruiting and training key personnel, and identifying expansion opportunities. Losing the
services of any of these individuals could adversely affect our business until a suitable replacement could be found. We do not
maintain key man life insurance on any of our management. As a result, we are not insured against any losses resulting from the
death of our key employees.
We
may be unable to employ a sufficient number of skilled and qualified workers.
The
delivery of our services and products requires personnel with specialized skills and experience who can perform physically demanding
work. As a result of the volatility of the oilfield service industry and the demanding nature of the work, workers may choose
to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive. The demand for
skilled workers is high and the supply is limited.
We
may be adversely impacted by work stoppages or other labor matters.
The
petroleum and oil-service industries in Argentina, where we operate, and other countries are unionized, and it is likely that
we may experience work stoppages or other labor disruptions from time to time. As of December 31, 2016, approximately 86% of our
Argentine employees were represented by unions and they are working under the conditions stated in their collective bargaining
agreements. No assurance can be given that the collective bargaining agreements will be successfully extended or renegotiated
as they expire from time to time. If any collective bargaining agreement is not extended or renegotiated, if disputes with our
unions arise, or if our unionized workers engage in a strike or other work stoppage or interruption, we could experience a significant
disruption of, or inefficiencies in, our operations or incur higher labor costs, which could have a material adverse impact on
our combined results of operations and financial condition by disrupting our ability to perform well stimulation or pressure pumping
and other services for the customers under our service contracts.
If
we become subject to warranty, similar claims or litigation, it could be time-consuming and costly to defend.
Errors,
defects or other performance problems in the products that we sell or services that we offer could result in our customers seeking
damages from us for losses associated with these errors, defects or other performance problems.
Our
business involves certain operating risks and our insurance coverage or proceeds, if any, may not be adequate to cover all losses
or liabilities that we might incur in our operations.
The
technical complexities of our operations are such that we are exposed to a wide range of significant worker health, safety and
environmental risks. Our services involve production-related activities, radioactive materials, explosives and other equipment
and services that are deployed in challenging exploration, development and production environments. An accident involving our
services or equipment, or a failure of a product, could cause personal injury, loss of life, damage to or destruction of property,
equipment or the environment, or suspension of operations. Our insurance policies may not protect us against liability for some
kinds of events, including events involving pollution, or against losses resulting from business interruption. Moreover, we may
not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate. Any damages caused by our
services or products that are not covered by insurance, or are in excess of policy limits or are subject to substantial deductibles,
could adversely affect our financial condition, results of operations and cash flows.
A
terrorist attack or armed conflict could harm our business.
Geopolitical
and terrorism risks continue to grow in a number of countries, including those where we do business. Geopolitical and terrorism
risks could lead to, among other things, a loss of our investment in the country, impairment of the safety of our employees and
impairment of our ability to conduct our operations.
Our
ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As
of December 31, 2016, we had approximately $43.7 million of U.S. federal net operating loss carryforwards
(“NOLs”), which begin to expire in 2018. Utilization of these NOLs depends on many factors, including our future
income, which cannot be assured. In addition, Section 382 of the Internal Revenue Code of 1986, as amended (“Section
382”), generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a
corporation has undergone an “ownership change” (as determined under Section 382). An ownership change generally
occurs if one or more shareholders (or groups of shareholders) who are each deemed to own at least 5% of our stock change
their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period.
In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual
limitation under Section 382, determined by multiplying the value of our stock at the time of the ownership change by the
applicable long-term tax-exempt rate as defined in Section 382, subject to certain adjustments. Any unused annual limitation
may be carried over to later years. We may have previously experienced and may in the future experience one or more
“ownership changes”. As a result, if we earn net taxable income, our ability to use our pre-change NOL
carryforwards to offset U.S. federal taxable income may be subject to limitations, which could potentially result in
increased future tax liability to us. We believe that, due to our subsequent event noted in Note 19 regarding the Fir
Tree transaction, we will have an impact due to the change in control, however, we have not yet evaluated the impact
this will have on us.
Risks
Related to Our Operations in Argentina and Other Foreign Jurisdictions
Our
business is largely dependent upon economic conditions in Argentina.
Substantially
all our initial operations and customers are located in Argentina, and, as a result, our business is to a large extent dependent
upon economic conditions prevailing in Argentina. The Argentine economy has experienced significant volatility in past decades,
including numerous periods of low or negative growth and high and variable levels of inflation and devaluation. Argentina’s
gross domestic product grew at an average annual real rate of approximately 0.8% in 2012, recovering to 2.9% in 2013. In January,
2017 , the National Statistics Institute (Instituto Nacional de Estadística y Censos, or INDEC), which is the only institution
in Argentina with the statutory power to produce official nationwide statistics, reported real gross domestic product during the
third quarter of 2016 was 3.6% lower than the comparable figure for 2015. If economic conditions in Argentina continue to contract,
or if the Argentine government’s measures to attract or retain foreign investment and international financing in the future
are unsuccessful, such developments could affect our financial condition and results of operations.
Argentine
economic results are dependent on a variety of factors, including (but not limited to) the following:
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international
demand for Argentina’s principal exports;
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international
prices for Argentina’s principal commodity exports;
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stability
and competitiveness of the Argentine Peso against foreign currencies;
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levels
of consumer consumption and foreign and domestic investment and financing; and
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the
rate of inflation.
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In
recent years, Argentina has confronted inflationary pressure. According to inflation data published by INDEC, in January 2017,
the Argentine consumer price index increased by 1.3 % from the prior month. Increased rates of inflation in Argentina could increase
our cost of operation, and may negatively impact our results of operations and financial condition. There can be no assurance
that inflation rates will not be higher in the future.
In
addition, Argentina’s economy is vulnerable to adverse developments affecting its principal trading partners. A significant
decline in the economic growth of any of Argentina’s major trading partners, such as Brazil, China or the U.S., could have
a material adverse impact on Argentina’s balance of trade and adversely affect Argentina’s economic growth and may
consequently adversely affect our financial condition and results of operations. The Argentine Peso has been subject to significant
devaluation in the past and may be subject to significant fluctuations in the future, consequently affecting our financial condition
and results of operations (see additionally Part I – Item 1A. Risk Factors – “
We may be exposed to fluctuations
in foreign exchange rates
.”). President Macri moved quickly in December 2015 after taking office to lift currency controls.
This was effective at removing the large spread that previously existed between the so-called “blue market” rate of
approximately 14 pesos to 1 dollar and the official exchange rate of 9 pesos to 1 dollar. Since currency controls were repealed,
the Argentine Peso has traded between around 11.4 pesos to the U.S. dollar and 15.8 Argentine pesos to the U.S. dollar, and we
believe is currently reasonably stable.
Moreover,
this move was accompanied by a liberalization of capital controls, which we expect to improve the investment climate in Argentina
by making it easier for our Company and our customers to repatriate future earnings in Argentina. However, this move could stall
or reverse its favorable trend.
The
Argentinian government has fixed oil and gas prices for domestic producers. Any decrease or removal of the fixed price could result
in a corresponding reduction in our customers’ drilling activities, which could adversely impact our results of operations,
financial condition and cash flows.
The
Argentinian government has historically fixed the price of natural gas production for light sweet crude and for heavy oil. More
recently, the government has been supportive of fixed prices for natural gas but has indicated a desire to allow the crude oil
prices to adjust to international prices. We have no assurance that the government will not lower the fixed prices for natural
gas in the future or remove them altogether. If the fixed price for natural gas were to be reduced or removed, our customers may
drill less, which could have a corresponding effect on the demand for our products or services.
Certain
risks are inherent in any investment in a company operating in an emerging market such as Argentina.
Argentina
is an emerging market economy and investing in emerging markets generally carries risks. These risks include political, social
and economic instability that may affect Argentina’s economic results which can stem from many factors, including the following:
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high
interest rates;
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abrupt
changes in currency values;
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high
levels of inflation;
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exchange
controls;
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wage
and price controls;
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regulations
to import equipment and other necessities relevant for operations;
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changes
in governmental economic or tax policies; and
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political
and social tensions.
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Any
of these factors may adversely affect our financial condition and results of operation.
The
Argentine economy has been adversely affected by economic developments in other markets.
Financial
and securities markets in Argentina, and the Argentine economy, are influenced by economic and market conditions in other markets
worldwide. Considering the current international turmoil, Argentina’s economy remains vulnerable to external shocks, including
those relating to or similar to the global economic crisis that began in 2008 and the recent uncertainties surrounding European
sovereign debt. Although economic conditions vary from country to country, investors’ perceptions of events occurring in
one country may substantially affect capital flows into and investments in securities from issuers in other countries, including
Argentina.
Consequently,
there can be no assurance that the Argentine financial system and securities markets will not continue to be adversely affected
by events in developed countries’ economies or events in other emerging markets, which could in turn, adversely affect the
Argentine economy and, as a consequence, the Company’s results of operations and financial condition.
The
implementation of new export duties, other taxes and import regulations could adversely affect our results.
In
2012, the Argentine government adopted an import procedure pursuant to which local authorities must pre-approve any import of
products and services to Argentina as a precondition to allow importers access to the foreign exchange market for the payment
of such imported products and services.
We
cannot assure you that these taxes and import regulations will not continue or be increased in the future or that other new taxes
or import regulations will not be imposed.
We
may be exposed to fluctuations in foreign exchange rates.
Our
results of operations are exposed to currency fluctuation and any devaluation of the Argentine Peso against the U.S. dollar and
other hard currencies may adversely affect our business and results of operations. The value of the Argentine Peso has fluctuated
significantly in the past and may do so in the future. We are unable to predict whether, and to what extent, the value of the
Argentine Peso may further depreciate or appreciate against the U.S. dollar and how any such fluctuations would affect our business.
We
are subject to exchange and capital controls.
In
the past, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to retain
foreign currency or make payments abroad. Although the Macri government lifted exchange controls and liberalized capital controls
as described above, there can be no assurances regarding future modifications to exchange and capital controls. Exchange and capital
controls could adversely affect our financial condition or results of operations and our ability to meet our foreign currency
obligations and execute our financing plans.
Operating
internationally subjects us to significant risks and regulations inherent in operating in foreign countries.
We
plan to conduct operations in a number of countries. Our international operations will be subject to a number of risks inherent
to any business operating in foreign countries, and especially those with emerging markets, including the following risks, among
others:
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government
instability, which can cause investment in capital projects by our potential clients to be withdrawn or delayed, reducing
or eliminating the viability of some markets for our services;
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potential
expropriation, seizure, nationalization or detention of assets, such as the 2015 nationalization of Repsol S.A.’s interest
in YPF;
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difficulty
in repatriating foreign currency received in excess of local currency requirements;
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foreign
currency exchange rate fluctuations, import/export tariffs and quotas;
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civil
uprisings, riots and war, which can make it unsafe to continue operations, adversely affect both budgets and schedules and
expose us to losses;
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availability
of suitable personnel and equipment, which can be affected by government policy, or changes in policy that limit the importation
of qualified crewmembers or specialized equipment in areas where local resources are insufficient;
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decrees,
laws, regulations, interpretation and court decisions under legal systems, which are not always fully developed and which
may be retroactively applied and cause us to incur unanticipated and/or unrecoverable costs as well as delays which may result
in real or opportunity costs; and
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terrorist
attacks, including kidnappings of our personnel.
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We
cannot predict the nature and the likelihood of any such events. However, if any of these or other similar events should occur,
it could have a material adverse effect on our financial condition and results of operation.
Certain
of the equipment that we use in certain foreign countries may require prior U.S. government approval in the form of an export
license and may otherwise be subject to tariffs and import/export restrictions. The delay in obtaining required governmental approvals
could affect our ability to timely commence a project, and the failure to comply with all such controls could result in fines
and other penalties.
We
may be subject to taxation in many foreign jurisdictions and the final determination of our tax liabilities involves the interpretation
of the statutes and requirements of taxing authorities worldwide. Our tax returns will be subject to routine examination by taxing
authorities, and these examinations may result in assessments of additional taxes, penalties and/or interest.
Our
overall success as an international company depends, in part, upon our ability to succeed in differing economic, social and political
conditions. We may not continue to succeed in developing and implementing policies and strategies that are effective in each location
where we do business, which could negatively affect our profitability.
Our
international operations involve the use of foreign currencies, which subjects us to exchange rate fluctuations, difficulty in
repatriating foreign currencies and other currency risks.
We
and our foreign subsidiaries from time to time will hold foreign currencies. Exchange rate fluctuations will subject us to currency
risk as well as to other risks sometimes associated with international operations. In the future, we could experience fluctuations
in financial results from our operations outside the U.S., and there can be no assurance that payments received in foreign currencies
can be repatriated to the U.S. or that we will be able, contractually or otherwise, to reduce the currency risks associated with
our international operations.
We
could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar foreign anti-bribery laws.
The
United States Foreign Corrupt Practices Act (the “FCPA”) and similar worldwide anti-bribery laws generally prohibit
companies and their intermediaries from making, offering or authorizing improper payments to non-U.S. government officials for
the purpose of obtaining or retaining business. We do business and may do additional business in the future in countries or regions
where strict compliance with anti-bribery laws may conflict with local customs and practices.
As
a company subject to compliance with the FCPA, our business may suffer and we may be subject to competitive disadvantages because
our efforts to comply with U.S. laws could restrict our ability to do business in foreign markets relative to our competitors
who are not subject to U.S. law. Additionally, our business plan involves establishing close relationships with stakeholders in
certain foreign markets. Any determination that we or foreign shareholders, directors or officer’s partners have violated
the FCPA may adversely affect our business and operations.
Violations
of anti-bribery laws (either due to our acts or our inadvertence) may result in criminal and civil sanctions and could subject
us to other liabilities in the U.S. and elsewhere. Even allegations of such violations could disrupt our business and result in
a material adverse effect on our business and operations.
Risks
Related to the Oil and Natural Gas Industry
We
may face intense competition in our industry and in the markets where we operate.
The
industry in which we compete is highly competitive, and most of our potential competitors will have greater financial resources
than we do. Our ability to renew or replace existing contracts with our customers at rates sufficient to maintain current revenue
and cash flows could be adversely affected by the activities of our competitors and our customers. If our competitors substantially
increase the resources they devote to the development and marketing of competitive services or substantially decrease the prices
at which they offer their services, we may be unable to compete effectively. Some of these competitors may expand or construct
newer, more powerful or more flexible well stimulation fleets that would create additional competition for us. Furthermore, recent
reduction in drilling activity in markets such as North America may drive other oilfield services companies to relocate their
equipment to the regions in which we operate or intend to operate. Such increase in supply relative to demand could negatively
impact pricing and utilization of our services. All of these competitive pressures could have a material adverse effect on our
business, results of operations and financial condition. There can be no assurance that additional competitors will not enter
markets served or proposed to be served by us, that we will be able to compete successfully, or that we will have adequate funds
to compete.
Because
the oil and natural gas industry is cyclical, our operating results may fluctuate.
Oil
and natural gas prices are volatile. Fluctuations in such prices may result in a decrease in the expenditure levels of oil and
natural gas companies, which in turn may adversely affect us. For example, the substantial and extended decrease in commodity
prices which started in 2014 and continuing through early 2016 has severely reduced most of our customer’s profitability.
This situation may continue or worsen and could adversely affect our business, financial condition and results of operations.
Regulatory
compliance costs and restrictions, as well as delays in obtaining permits by the customers for their operations, such as for well
stimulation and pressure pumping, or by us for our operations, could impair our business.
Our
operations and the operations of the customers are subject to or impacted by a wide array of regulations in the jurisdictions
in which the operations are located. As a result of changes in regulations and laws relating to the oil and natural gas industry,
including well stimulation, our operations or the operations of our customers could be disrupted or curtailed by governmental
authorities. The high cost of compliance with applicable regulations may cause customers to discontinue or limit their operations,
and may discourage companies from continuing development activities. As a result, demand for our services could be substantially
affected by regulations adversely impacting the oil and natural gas industry.
Demand
for the majority of our services is substantially dependent on the levels of expenditures by the oil and gas industry. A substantial
or an extended decline in oil and gas prices could result in lower expenditures by the oil and gas industry, which could have
a material adverse effect on our financial condition, results of operations and cash flows.
Demand
for the majority of our services depends substantially on the level of expenditures by the oil and gas industry for the exploration,
development and production of oil and natural gas reserves. These expenditures are generally dependent on the industry’s
view of future oil and natural gas prices and are sensitive to the industry’s view of future economic growth and the resulting
impact on demand for oil and natural gas. Declines, as well as anticipated declines, in oil and gas prices could also result in
project modifications, delays or cancellations, general business disruptions, and delays in payment of, or nonpayment of, amounts
that are owed to us. These effects could have a material adverse effect on our financial condition, results of operations and
cash flows.
The
prices for oil and natural gas have historically been volatile and can be affected by a variety of factors, including:
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worldwide
and regional economic conditions impacting the global supply and demand for oil, natural gas and natural gas liquids;
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the
price and quantity of foreign imports;
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political
and economic conditions in or affecting other producing areas, including the Middle East, Africa, South America and Russia;
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the
ability of members of the Organization of the Petroleum Exporting Countries (“OPEC”) (and certain non-OPEC countries)
to agree to and maintain oil price and production controls;
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the
level of global exploration and production activity;
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the
level of global inventories;
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prevailing
prices on local price indexes in the areas in which we operate;
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the
proximity, capacity, cost and availability of gathering and transportation facilities;
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localized
and global supply and demand fundamentals and transportation availability;
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the
cost of exploring for, developing, producing and transporting reserves;
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weather
conditions and other natural disasters;
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technological
advances affecting energy consumption;
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the
price and availability of alternative fuels;
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expectations
about future commodity prices; and
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domestic,
local and foreign governmental regulation and taxes.
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The
oil and gas industry has historically experienced periodic downturns, which have been characterized by diminished demand for oilfield
services and downward pressure on the prices we charge. The prices of crude oil, domestic natural gas and NGLs have declined substantially
since June 2014. The price of WTI crude oil has decreased from over $100.00 per barrel in the middle of June 2014 to below $30.00
per barrel in January and February 2016. Henry Hub spot prices for natural gas declined below $1.80 per Mcf in December 2015 compared
to more than $4.40 per Mcf in January 2014. The volatility in gas pricing was demonstrated in 2016 when in April and May, the
average price was $1.92 per Mcf while the year ended with a December average of $3.59 per Mcf. The current downturn in the oil
and gas industry has resulted in a reduction in demand for oilfield services and could adversely affect our financial condition,
results of operations and cash flows.
Our
operations are subject to hazards and environmental risks inherent in the oil and natural gas industry.
We
are a provider of well stimulation and pressure pumping services, a process involving the injection of fluids—typically
consisting mostly of water and also including several chemical additives—as well as sand in order to create fractures extending
from the well bore through the rock formation to enable oil or natural gas to move more easily through the rock pores to a production
well. In addition, we provide a range of services to onshore oil and natural gas exploration and production operations, consisting
of, among other things, coiled tubing services. Risks inherent to our industry create the potential for significant losses associated
with damage to the environment or natural resources, such as the potential for contamination of drinking water resources.
We
are subject to extensive environmental, worker health and safety laws and regulations that may subject us to substantial liability
or require us to take actions that will adversely affect our results of operations.
The
oil and gas industry is significantly affected by stringent and complex federal, state and local laws and regulations concerning
the discharge of substances into the environment or otherwise relating to environmental protection and worker health and safety
matters. The cost of compliance with these laws can be significant. Failure to properly handle, transport or dispose of these
materials or otherwise conduct our operations in accordance with these and other environmental laws could expose us to substantial
liability for administrative, civil and criminal penalties, cleanup and site restoration costs and liability associated with releases
of such materials, damages to natural resources and other damages, as well as potentially impair our ability to conduct our operations.
We could be exposed to liability for cleanup costs, natural resource damages and other damages under these and other environmental
laws. Such liability can be on a strict, joint and several liability basis, without regard to fault. Liability may be imposed
as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, prior operators
or other third parties. Environmental laws and regulations have changed in the past, and they are likely to change in the future.
If existing environmental requirements or enforcement policies change and become more stringent, we may be required to make significant
unanticipated capital and operating expenditures.
The
adoption of climate change legislation or regulations restricting emissions of greenhouse gases could result in increased operating
costs and reduced demand for oil and natural gas.
In
recent years, many national, federal, state and local governments have taken steps to reduce emissions of greenhouse gases. For
example, in the United States, the EPA has finalized a series of greenhouse gas monitoring, reporting and emissions control rules
for the oil and natural gas industry, and the U.S. Congress has, from time to time, considered adopting legislation to reduce
emissions including carbon dioxide and methane. In December 2015, the United States and Argentina participated in the 21st Conference
of the Parties of the United Nations Framework Convention on Climate Change in Paris, France. The resulting Paris Agreement calls
for the parties to undertake “ambitious efforts” to limit the average global temperature, and to conserve and enhance
sinks and reservoirs of greenhouse gases. The Agreement, which went into effect in November 2016, establishes a framework for
the parties to cooperate and report actions to reduce greenhouse gas emissions. At this time, we cannot predict what additional
steps, if any, the U.S. and Argentina may take as a result of participation in the Paris Agreement. Argentina has also passed
a number of energy-efficiency related measures as well as requirements for the blending of ethanol and other biofuels with petroleum
fuels. These measures could reduce demands for petroleum products, which in turn could have an adverse impact on demand for our
services.
Moreover,
climate change may cause more extreme weather conditions such as more intense hurricanes, thunderstorms, tornadoes and snow or
ice storms, as well as rising sea levels and increased volatility in seasonal temperatures. Extreme weather conditions can interfere
with our services and increase our costs and damage resulting from extreme weather. At this time, we are unable to determine the
extent to which climate change may lead to increased storm or weather hazards affecting our operations.
New
technology may cause us to become less competitive.
The
oilfield services industry is subject to the introduction of new drilling and completion techniques and services using new technologies,
some of which may be subject to patent protection. If competitors and others use or develop new technologies in the future that
are more efficient or productive than ours, we may lose market share or be placed at a competitive disadvantage.
The
industry is affected by excess equipment inventory levels.
Because
of the long-life nature of oilfield service equipment and the lag between when a decision to build additional equipment is made
and when the equipment is placed into service, the inventory of oilfield service equipment in the industry does not always correlate
with the level of demand for service equipment.
Compliance
with governmental regulations may impact our or our customers’ operations and may adversely affect our business and operating
results.
Our
operations are dependent on our customers’ decisions to develop and produce oil and natural gas reserves and on the regulatory
environment in which our customers and we operate. The ability to produce oil and natural gas can be affected by the number and
productivity of new wells drilled and completed, as well as the rate of production and resulting depletion of existing wells.
Advanced technologies, such as horizontal drilling and well stimulation and pressure pumping, improve total recovery, but they
also result in a more rapid production decline and may become subject to more stringent regulations in the future.
Access
to prospects is also important to our customers and such access may be limited because host governments do not allow access to
the reserves or because another oil and natural gas exploration company owns the rights to develop the prospect. Government regulations
and the costs incurred by oil and natural gas exploration companies to conform to and comply with government regulations may also
limit the quantity of oil and natural gas that may be economically produced. This could lead our customers to curtail their operations
and result in a decrease in demand for our services, which in turn could adversely affect our financial position and results of
operations.
Any
of these factors could affect the supply of oil and natural gas and could have a material adverse effect on our results of operations.
Legislative
and regulatory initiatives relating to well stimulation could result in increased costs and additional operating restrictions
or delays for our operations or the operations of our customers.
Many
national, provincial, and local governments and agencies have adopted laws and regulations or are evaluating proposed legislation
and regulations that are focused on the extraction of shale gas or oil using well stimulation, which is part of the overall services
we provide to our customers. Well stimulation is a treatment routinely performed on oil and gas wells in low-permeability reservoirs.
Specially engineered fluids are pumped at high pressure and rate into the reservoir interval to be treated, causing cracks in
the target formation. Proppant, such as sand of a particular size, is mixed with the treatment fluid to keep the cracks open when
the treatment is complete. In response to concerns related to potential impacts to the environment and natural resources from
well stimulation, governmental authorities have issued new rules and regulations governing the practice, and are also pursuing
studies related to its potential effects. Also, some national, state, and local governments have adopted bans or other measures
restricting well stimulation activities. For example, the Province of Neuquén in Argentina where we operate, has approved
a set of rules regarding the extraction of shale oil and gas. These rules require, amongst other things, that operators performing
well stimulation obtain permits prior to commencing drilling activities and file reports with the provincial government regarding
the chemicals used in the well stimulation process and an analysis of the flowback water returning to the surface. In certain
regions, the indigenous people have voiced their opposition to the increased shale development although to date these protests
have been peaceful and have yet to disrupt activity in a meaningful way. In addition, several other provinces and local governments
have voted to ban well stimulation within their borders, and some groups continue to advocate for a national ban on well stimulation
in Argentina. The EPA and states, including Oklahoma, have also taken steps to regulate hydraulic fracturing. There has been increasing
public controversy regarding hydraulic fracturing with regard to the use of fracturing fluids, induced seismic activity, impacts
on drinking water supplies, use of water and the potential for impacts to surface water, groundwater and the environment generally.
Legislative or regulatory changes could cause us or our customers to incur substantial compliance costs, and compliance or the
consequences of any failure to comply by us could have a material adverse effect on our financial condition and results of operations.
At this time, it is not possible to estimate the impact on our business of newly enacted or potential national, state or local
laws governing hydraulic fracturing.
Future
well stimulation-related legislation or regulations that further restrict or prohibit such activities could lead to operational
delays and increased costs for our operations or the operations of our customers. Any adverse impacts on the operations of our
customers could in turn reduce demand for our services. If such additional legislation or regulations are enacted and implemented,
it could adversely affect our financial condition, results of operations and cash flows.
Risks
Related to Ownership of Our Common Stock
We
have incurred, and expect to continue to incur, increased costs and risks as a result of being a public company.
As
a public company, we are required to comply with most, but not all, of the Sarbanes-Oxley Act of 2002 (“SOX”), as
well as rules and regulations implemented by the SEC. Changes in the laws and regulations affecting public companies, including
the provisions of SOX and rules adopted by the SEC, have resulted in, and will continue to result in, increased costs to us as
we respond to these requirements. Given the risks inherent in the design and operation of internal controls over financial reporting,
the effectiveness of our internal controls over financial reporting is uncertain. If our internal controls are not designed or
operating effectively, we may not be able to issue an evaluation of our internal control over financial reporting as required
or we or our independent registered public accounting firm may determine that our internal control over financial reporting was
not effective. In addition, our registered public accounting firm may either disclaim an opinion as it relates to management’s
assessment of the effectiveness of our internal controls or may issue an adverse opinion on the effectiveness of our internal
controls over financial reporting. Investors may lose confidence in the reliability of our financial statements, which could cause
the market price of our common stock to decline and which could affect our ability to run our business as we otherwise would like
to. New rules could also make it more difficult or costlier for us to obtain certain types of insurance, including directors’
and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the coverage that is the same or similar to our current coverage. The impact of these events could also
make it more difficult for us to attract and retain qualified persons to serve on our Board, the committees of our Board, and
as executive officers. We cannot predict or estimate the total amount of the costs we may incur or the timing of such costs to
comply with these rules and regulations.
Compliance
with Section 404 of the SOX will continue to strain our limited financial and management resources.
We
incur significant legal, accounting and other expenses in connection with our status as a reporting public company. SOX and rules
subsequently implemented by the SEC have imposed various new requirements on public companies, including requiring changes in
corporate governance practices. As such, our management and other personnel need to devote a substantial amount of time to these
compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and made
some activities more time-consuming and costly. In addition, SOX requires, among other things, that we maintain effective internal
controls for financial reporting and disclosure of controls and procedures. Our testing may reveal deficiencies in our internal
controls over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 of SOX requires that
we incur substantial accounting expense and expend significant management efforts. We may need to hire additional accounting and
financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to
comply with the requirements of Section 404 of SOX in a timely manner, or if we or our independent registered public accounting
firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the
market price of our stock could decline, and we could be subject to sanctions or investigations by the SEC or other regulatory
authorities, which would require additional financial and management resources.
We
do not intend to pay cash dividends on our common stock in the foreseeable future, and therefore only appreciation of the price
of our common stock will provide a return to our stockholders.
We
currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business. We
do not intend to pay cash dividends in the foreseeable future. Any payment of cash dividends will depend upon our financial condition,
capital requirements, earnings and other factors deemed relevant by our Board. In addition, the terms of the A&R Note
Agreement restrict our ability to pay dividends and make other distributions. As a result, only appreciation of the price of our
common stock, which may not occur, will provide a return to our stockholders.
We
currently have a sporadic, illiquid, volatile market for our common stock, and the market for our common stock may remain sporadic,
illiquid, and volatile in the future.
We
currently have a highly sporadic, illiquid and volatile market for our common stock, which market is anticipated to remain sporadic,
illiquid and volatile in the future and will likely be subject to wide fluctuations in response to several factors, including,
but not limited to:
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actual
or anticipated variations in our results of operations;
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our
ability or inability to generate revenues;
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the
number of shares in our public float;
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increased
competition; and
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conditions
and trends in the market for oil and gas and down-hole services.
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Furthermore,
our stock price may be impacted by factors that are unrelated or disproportionate to our operating performance. These market fluctuations,
as well as general economic, political and market conditions, such as recessions, interest rates or international currency fluctuations
may adversely affect the market price of our common stock. Shareholders and potential investors in our common stock should exercise
caution before making an investment in our Company, and should not rely on the publicly quoted or traded stock prices in determining
our common stock value, but should instead determine the value of our common stock based on the information contained in our public
reports, industry information, and those business valuation methods commonly used to value private companies.
Fir
Tree may have significant influence over us, including influence over decisions that require stockholder approval, which could
limit your ability to influence the outcome of key transactions, including a change of control.
Fir
Tree currently has the right to nominate and appoint up to a total of three individuals to the Board. As a result, Fir
Tree has influence over our decisions to certain corporate actions including those specified in the A&R Stockholder Rights
Agreement.
Moreover,
Fir Tree has a contractual right to maintain its percentage ownership in our Company. Specifically, under the terms of the Stockholder
Rights Agreement, for so long as Fir Tree beneficially owns more than 10% of our issued and outstanding common stock (calculated
on a fully diluted basis), Fir Tree, subject to certain exclusions, has a preemptive right to purchase any new securities we propose
to issue or sell in an amount not to exceed the amount of such new securities that Fir Tree would need to beneficially own
so that its beneficial ownership of our common Stock does not decrease as a result of such issuance or sale. As a result,
Fir Tree’s preemptive right will apply to any securities we issue during an underwritten public offering. Therefore, while
other holders of our stock would risk suffering a reduction in percentage ownership in connection with a new issuance of securities
by us, Fir Tree would, through this preemptive right, have the opportunity to avoid a reduction in percentage ownership. As long
as Fir Tree continues to hold a significant portion of our outstanding common stock, it will have the ability to influence the
vote in any election of directors and over decisions that require stockholder approval. Please read Part III – Item 13 –
“Certain Relationships and Related Party Transactions, and Director Independence.”
Convertible debt not converting to
equity can have an adverse effect on the Company
On March 6, 2017, the
Company closed a transaction with Fir Tree and the ACM entities pursuant to which, among other things, Fir Tree purchased from
the ACM entities $22 million aggregate principal amount of the Company’s outstanding convertible notes due 2018. This transaction
was part of a comprehensive recapitalization designed to create a path to a potential conversion to equity of substantially all
the Company’s debt, subject to shareholder approval and satisfaction of certain other conditions. As part of the
transaction, the Company issued to Fir Tree an additional $19.4 million aggregate principal amount of convertible notes. After
giving effect to these transactions, the Company now has approximately $41.4 million of outstanding convertible notes due May
28, 2018 which accrue interest at 20% per annum. Fir Tree has agreed to convert all the outstanding convertible notes into common
stock at a conversion price of $1.40 per share, subject to receipt of shareholder approval at the next shareholder meeting, and
satisfaction of certain other conditions. Based on commitments from some of the Company’s largest shareholders, we believe
that the convertible notes will be exchanged for common stock at $1.40 per share at the next shareholder meeting, however, if
the convertible notes remain outstanding following the next shareholder meeting, the Company will be required to make a semi-annual
interest payment of approximately $3.7 million on August 15, 2017. At that time, we may not have sufficient cash to pay this interest
payment, resulting in potential default of the loan.
We
may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.
Our
certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of
preferred stock having such designations, preferences, limitations and relative rights, including preferences over our common
stock respecting dividends and distributions, as our Board may determine. The terms of one or more classes or series of preferred
stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock
the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified
transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred
stock could affect the residual value of the common stock.