LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
ATTORNEYS AT LAW
5335 WISCONSIN AVENUE, N.W., SUITE 780
WASHINGTON, D.C. 20015
TELEPHONE (202) 274-2000
FACSIMILE (202) 362-2902
www.luselaw.com
writer's direct dial number writer's e-mail
(202) 274-2008 aschick@luselaw.com
April 23, 2010
Via Overnight Delivery
John Hartz
Senior Assistant Chief Accountant
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Re: Energy Services of America Corporation
Form 10-K for the Fiscal Year Ended September 30, 2009
File No. 1-32998
Dear Mr. Hartz:
Set forth below are the Company's responses to the staff comment letter
dated March 15, 2010. For ease of reference the responses are keyed to the
staff's comments.
FORM 10-K FOR FISCAL YEAR ENDED SEPTEMBER 30, 2009
Item 7. Management's Discussion and Analysis, page 11 2009 Compared to 2008 -
Pro Forma Basis, page 17
1. We note your response to prior comment 1. For the contracts that you
recorded losses during the quarter ended December 31, 2008, please confirm
that when you anticipated the change orders you did so in compliance with
paragraphs 61-63 of SOP 81-1. Also, please revise future filings to
disclose your accounting policies for change orders and, if you anticipate
change orders in the future, please provide disclosures similar to those
required by paragraphs 65-67 of SOP 81-1.
The Company confirms that when it anticipated change orders, it did so in
compliance with paragraphs 61-63 of SOP 81-1. In addition, the Company will
revise future filings to disclose its accounting policies for change orders
as well as disclosure required by paragraphs 65-67 of SOP 81-1 as needed in
response to the Staff's comment.
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 2
Liquidity and Capital Resources, page 18
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2. We note your response to prior comment 2 and the disclosures in your
December 31, 2009 Form 10-Q. Please revise future annual and quarterly
filings to quantify the amount available under your line based on the
disclosed restrictions.
The Company will revise future filings to quantify the amount available
pursuant to its line of credit as of the relevant balance sheet date in
response to the Staff's comment.
Critical Accounting Policies -- Goodwill, page 22
- -------------------------------------------------
3. We have reviewed your responses to prior comments 3 through 5, including
the Valuation Report you provided. We note that in Exhibit D-l, p.l of the
Chaffe & Associates July 1, 2009 valuation report the discounted cash flow
model projects Total Contract Revenues of $165 million and pre-tax income
of $24 million for the fiscal year ended September 30, 2010. In your
quarter ended December 31, 2009, your revenues were $30 million with
pre-tax income of $l million. On a quarterly basis, this represents lower
revenue estimates of 27% and lower pre-tax income of 71 %. We also note
that your actual results for the quarter ended September 30, 2009 were
lower than those projected. Please provide us a supplemental explanation as
to the impact of seasonality and any other known factors that impacted the
lower results to-date. Also, please advise us as to your current
expectations regarding the accuracy of the significant assumptions in the
July 1, 2009 discounted cash flow analysis.
The Company acknowledges the Staff's comment concerning the operating
results for the quarter ended December 31, 2009 being below the annualized
rate projected by management and used in the valuation report. Please note
that the Company's second fiscal quarter (ending March 31) is the one most
impacted by weather and the impact thereof in the first fiscal quarter is
not consistent from year to year. The greatest impact on the operating
results for the quarter ended December 31, 2009 was the delay of the start
of several contracts due to the weakened economy. Moreover, our market area
was significantly and adversely effected by the severe winter weather this
past January and February which further delayed work into the next quarter.
However, based on the high current Company backlog it is anticipated that
the third and fourth fiscal quarters will improve, and it is anticipated
that contract revenue for the year ended September 30, 2010 will meet or
exceed the projection. The Company also expects that its gross profit
margin will be in line with the projection. The operating results for the
quarter ended December 31, 2009 was also impacted by its customers not
spending capital on discretionary expenditures.
The December 31, 2009 fiscal quarter was also negatively impacted by higher
than normal general and administrative costs. Many of these additional
costs were one time costs associated with the initial SOX assessment by
management, and other costs associated with the Company's initial full
fiscal year reporting as an operating company. The Company anticipates that
total G&A costs for the fiscal year will be in line with the projection.
The fiscal quarter ended September 30, 2009 also was impacted negatively by
the delay in the start of jobs under contract. However, the jobs have not
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LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 3
been cancelled and several have started this month, with others to follow
in May or June, attributing to the large backlog. Most jobs that the
Company performs can be completed in six to eight months, therefore it is
anticipated that much of the current backlog will be completed by fiscal
year end. During the quarter ended March 31, 2010, the Company had revenues
of approximately $20.1 million and, at March 31, 2010, the Company's
backlog was approximately $136.0 million.
4. We note the limitations noted in the Chaffe & Associates report on page 25
as to the comparability of the Company with the peer group due to
differences in size, diversification, access to debt and equity markets,
and growth prospects, yet we also note an equal weight was assigned to this
valuation methodology. We further note that the peer group includes a
multi-utility company and a construction and engineering company. Although
the peer companies have varying sales and operating profit trends they have
all experienced recent increases in their market capitalization. The stock
prices of the companies in the peer group have increased by 3% 56%, 71%,
82%, 122%, and 212%, since December 31, 2008, while your stock price has
declined by 33% during the same period. Based on these observations, please
help us understand why you believe all the companies in the peer group
experienced such stock price recoveries while you have not and please
explain how the weight given to the peer analysis was determined.
The Company notes the Staff's comment regarding its peer group performance.
The Company could only speculate on the market performance of any company,
including its own, particularly with the market uncertainty and volatility
of the past two years. As the Staff noted in Comment 6, the Company has
previously tried to disclose what it believes are some of the factors
related to its market performance. The Company is a relatively new public
company, and its entrance into the market as an operating company occurred
in the midst of a severe and adverse series of events initially in the
capital markets, and followed by a severe nationwide recession. The Company
believes these macro-economic factors had an adverse impact on the
Company's stock price. The Company's stock has not developed a following
and has very little trading volume, and again the Company can only
speculate on the reasons, although the Company believes that during the
severe recession many analysts and money managers preferred to focus on
higher capitalized companies with more liquid securities. Please note that
the Company's stock price has risen 22% since December 31 as of the date of
this response, which may reflect more attention being given to smaller
capitalized companies by investors. In fact, based on the current stock
price, the market capitalization of the Company, including the value of the
warrants, is approximately 102% of book value, without regard to a central
premium.
As noted, the Company's high level of insider ownership and low trading
volume has contributed to the Company's poor stock performance relative to
its peers. The following table provides the percent of shares held by
insiders for the Company and its peers.
<page>
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 4
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Percent of Outstanding Common Shares held by Insiders Based on the
latest available public data as of April 14, 2010
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Energy Services of America Corporation (ESA) 35.53%
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Chicago Bridge & Iron Company, N.V. (CBI) 1.51%
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Flint Energy Services (FES) 0.81%
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Matrix Service Co. (MTRX) 2.43%
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North American Energy Partners Inc. (NOA) 6.98%
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Willbros Group Inc. (WG) 4.02%
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Vectren Corporation (VVC) 0.51%
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In addition to their small size and limited trading history, the Company's
high level of insider ownership compared to its peers has caused low
trading volume and a higher degree of illiquidity.
- -----------------------------------------------------------------------------------------------------------------------------
Average Daily Trading Volume & Average Shares Outstanding
December 31, 2008 to March 5, 2009
- -----------------------------------------------------------------------------------------------------------------------------
Average Daily Trading Avg. Number of Shares Percent of
Volume (1) Outstanding Outstanding Shares
(Millions) (2) Traded per Day (1)/(2)
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Energy Services of America Corporation (ESA) 6,368 12.09 0.053%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Chicago Bridge & Iron Company, N.V. (CBI) 1,480,550 97.60 1.517%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Flint Energy Services (FES) 131,340 45.87 0.286%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Matrix Service Co. (MTRX) 262,537 26.52 0.990%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
North American Energy Partners Inc. (NOA) 162,784 36.05 0.452%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Willbros Group Inc. (WG) 509,594 39.44 1.292%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
Vectren Corporation (VVC) 400,592 81.07 0.494%
- --------------------------------------------------- ------------------------ ------------------------ -----------------------
On average from December 31, 2008 to March 5, 2010, only 0.053% of the
Company's outstanding shares were traded per day. The stock's low level of
liquidity is largely caused by the high level shares held by insiders who
less frequently trade their stock. Chaffe believes that the Company's stock
lacks the liquidity of its peers, and is therefore not necessarily
indicative of the Company's fair value.
As previously note, the Company's stock price has also been hindered by its
complex capital structure and overhang. the Company has a total of 20.3
million potentially dilutive warrants outstanding. Each warrant entitles
the holder to purchase from the Company one share of common stock at an
exercise price of $5.00 per share. If every option were exercised, the
Company would have a total of 32.39 million shares outstanding, an overhang
of 168% on the 12.09 million shares that are currently outstanding. The
Company's peers have outstanding warrants and/or employee stock options,
but none have more than three million outstanding combined. The risk of
potential dilution is much higher for the Company compared to its peers.
<page>
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 5
Unlike its peers, the Company stock has consistently traded below its book
value per share. The Company's market capitalization, including the market
cap of both the common stock and the outstanding warrants, continues to be
at a level below book value, and has been since shortly after the
acquisition of the operating companies and the associated redemption of
common shares. The Company believes that the low stock price is
attributable to discounts for minority shares and lack of marketability due
to the low trading volume and the complex capital structure that includes
warrants and a unit purchase option.
The Company believes its market capitalization reflects a thinly traded
non-controlling position in the company, not the true value of the Company.
5. We note that prior to our letter dated June 2, 2009 you had determined that
additional testing of the recoverability of your goodwill was unnecessary.
Please help us better understand how you made that determination. Also,
please explain to us what facts and circumstances you believe would warrant
a reassessment of your goodwill impairment analysis prior to your next
annual test.
The Company notes the Staff's question regarding its determination to not
perform additional testing of goodwill for impairment prior to its annual
testing date on July 1, 2009.
The Company did not believe, and continues to not believe, that during the
period prior to the SEC letter dated June 2, 2009, that there was a change
in the basic value or prospects of the operating companies subsequent to
their acquisition on August 15, 2009, or since the date of the fairness
opinion on March 18, 2009. As noted above in the response to Comment 4, it
is difficult to speculate on market performance of the stock. The Company's
short-term performance was adversely affected by the two contracts that
incurred losses, which has been well documented, and revenues in the short
term were down because of delays in the starting of contracts due to the
economic downturn. However, also as noted above, the backlog for the
Company for the last six months has been sustained at a very high level.
When the Company reviewed the factors in ASC 350-20-35-30, none of those
events, or similar events, occurred at the Company, and as the Company
stated there were no changes in the basic operating capacity or long-term
prospects of the Company, nor were there any changes in the long term
prospects for the demand for the Company's services or change in
competition that would force a change in bidding margins.
The Company also notes that the fairness opinion supported the value paid
for the operating companies, and that absent significant events it would be
unusual for there to be a write-off of goodwill so soon after the date of
consummation of a business combination. The Company did not believe that
any events of that magnitude had occurred. In addition, the Company notes
that the Staff indicated in a speech by Michael S. Thompson that while an
impairment of goodwill close to the acquisition date is possible, it is
expected to be a rare occurrence, and in fact should be pre-cleared by a
registrant with the SEC staff.
The facts and circumstances that the Company believes would warrant a
reassessment of its goodwill impairment analysis prior to the next annual
test would be those factors listed in ASC 350-20-35-20. Particularly
important to the Company would be a change in national policy that might
affect the demand for natural gas and therefore natural gas pipeline
expansion, or a basic shift in the pricing of natural gas that would make
expansion of delivery systems unprofitable. A significant and prolonged
decline in either backlog or anticipated gross profit margins would also be
considered a reason for reassessment. And finally, a loss of key management
would be a reason to reassess goodwill for impairment. A continued decline
<page>
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 6
in stock price not accompanied by a general decline in the overall stock
market would warrant consideration by management, but would not necessarily
result in a reassessment of goodwill for impairment, based on the
discussion in response to Comments 4 and 6.
6. In your February 19, 2010 letter, you stated that the fair value of your
total equity was higher than your trading value (including the value
assigned to outstanding warrants) due to a significant control premium. In
your November 24, 2009 letter, you stated that your stock price suffered
from low trading volume, a high level of insider ownership, and a complex
capital structure. Finally, in your May 6, 2009 letter, you stated that the
current market price of your stock was caused by volatility, illiquidity,
and instability in the marketplace and is not necessarily indicative of the
fair value of the company. Despite the recent recovery in equity markets,
your stock price has yet to show improvements that would support the
current book value of your equity. Please expand your proposed critical
accounting policy disclosures to provide a more robust explanation of how
you determined that no portion of your goodwill is impaired in light of the
significance and duration of the disparity between your equity book value
and market capitalization.
The Company notes the Staff's comment suggesting a more robust explanation
of how the Company determined that no portion of it goodwill is impaired in
light of the significance and duration of the disparity between its equity
book value and market capitalization.
The underlined text will be added to the proposed disclosure:
Goodwill. The Company has selected July 1 as the date of the annual
goodwill impairment evaluation, which is the first day of the Company's
fourth fiscal quarter. Goodwill was assigned to the operating units at the
time of acquisition. The reporting units to which goodwill was assigned are
CJ Hughes ("CJ") and its subsidiary Contractors Rental Corp ("CRC") as one
unit, Nitro Electric (a subsidiary of CJ Hughes-"Nitro") and to ST
Pipeline. The assignment to CJ consolidated and ST Pipeline was based on
the purchase price of each company. Both purchases were supported by
fairness opinions. The allocation of the goodwill arising from the purchase
of CJ was allocated between CJ/CRC and Nitro based on an internally
prepared analysis of the relative fair values of each unit.
CJ Hughes and its subsidiary CRC are considered one reporting unit
because CRC almost exclusively provides labor for CJ as a subcontractor.
There have been no material operational changes to any reporting units
since the date of acquisition. Although the Company uses a centralized
management approach, the reporting units have continued to perform similar
services to those performed prior to the acquisition. The have been no
sales of equipment, other than in the ordinary course of business, or
dispositions of lines of business by any of the operating units.
The Company's last annual impairment analysis indicated a control value for
the Company and for each of the reporting units in excess of their
respective book values. Accordingly, no loss from impairment was charged
against earnings. Management considered the fact that fair value
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LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 7
estimates contain assumptions, and note that a ten percent (10%) decline in
fair value of each reporting unit would not change the results of
management's assessment.
The Company's valuation was based on management's projected operating
results for the next fiscal year. The fair value of the reporting units was
determined using a weighted combination of market approach to value
utilizing pricing multiples of guideline publicly traded companies, a
market approach to value utilizing pricing multiples of guideline merger
and acquisition transactions, and an income approach to value utilizing a
discounted cash flow model.
The Company's market capitalization, including the market cap of both the
common stock and the outstanding warrants, continues to be at level below
book value, and has been since shortly after the acquisition of the
operating companies and the associated redemption of common shares. At
December 31, 2009, the market cap of the Company was at 87.8% of book
value. [to be updated in future filings] The Company believes that the low
stock price is attributable to larger than usual discounts for minority
shares and lack of marketability due to the low trading volume, high level
of insider ownership and the complex capital structure that includes
warrants and a unit purchase option. While stock price is generally viewed
as a representative indication of fair value (before application of a
control premium), for the reasons stated the Company believes it should not
place too much reliance on stock price alone as an indication of goodwill
impairment. For the last annual impairment testing management obtained a
valuation of the Company that indicated no impairment. The Company's stock
price since that date has been generally flat and trading has been
sporadic. However, the stock price has generally been above the level that
it was at during the period immediately before and after the testing date,
including at the quarterly reporting dates, which management believes is
indicative of no further deterioration in fair value of the Company.
Management will continue to assess at each reporting date the need for
a goodwill impairment test under the Accounting Standards Codification if
an event occurs or circumstances change that would more likely than not
reduce the fair value of a reporting unit below its carrying amount.
Management will also continue to monitor the stock price of the Company,
including trading volume, for any trends since the last annual impairment
test that might indicate a decline in fair value of the Company.
Consolidated Financial Statements Note 11. Income Taxes, page F-17
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7. As requested in prior comment 8, please provide your proposed disclosures
related to your critical accounting policy for income taxes and address
your material assumptions, including the amount/timeframe of taxable income
required to be earned, as well as the related uncertainties as noted in
your response.
The following was added to the Company's critical accounting policies
disclosure in its December 31, 2009 Form 10-Q. The Company apologizes for
not including it in the prior response:
Income Taxes. The Company has recorded a deferred tax asset of $2.7
million for the tax benefits attributable to deductible temporary
differences and carry forwards. The majority of the Company's deferred tax
<page>
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
John Hartz
Senior Assistant Chief Accountant
April 23, 2010
Page 8
asset relates to a net operating loss of $5.7 million incurred in the prior
year. The recorded deferred tax asset must be reduced by a valuation
allowance if it is more likely than not that some portion or all of the
deferred tax asset will not be realized. Management has determined that the
prior year operating loss was attributable in large part to losses on two
large contracts, and does not expect such losses to repeat. Current
operating profits and projected profits based on current backlog with
historical gross margins, will be more than sufficient to produce taxable
income in an amount equal to or greater than the operating loss carryover.
Additional work continues to be negotiated and bid at levels that should
maintain backlog at or near the current level. It is also noted that prior
to acquisition the operating companies had a history of strong operating
profits. Management also considered the deferred tax liability of $6.4
million associated with the book to tax differences in the basis of fixed
assets resulting from the purchase accounting adjustments at the time of
the acquisitions. This timing difference will reverse over the next seven
years. Management has concluded that no valuation allowance against the
deferred tax asset should be recorded at this time.
Management's conclusion that the realization of the net operating loss
carryover is more likely than not was based on all available evidence at
the balance sheet date, and will be reassessed at each reporting date.
Failure to maintain historical revenues and gross margins may call into
question the Company's ability to realize the deferred tax asset and a
valuation allowance may be established at that time.
* * * *
We request that any questions with regard to the foregoing should be
directed to the undersigned at 202-274-2008.
Very truly yours,
/s/ Alan Schick
-----------------
Alan Schick
cc: Edsel R. Burns, President and Chief Executive Officer
Larry A. Blount, Chief Financial Officer
Sam Lolan, CPA, Castaing Hussey Lolan LLC
Marc P. Levy, Esq.