Aly Energy Services, Inc. - Annual Report: 2018 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K

x Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the

Period Ended December 31, 2018

or

¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the Transition Period From _____________to _____________

Commission File Number 33-92894

(713)-333-4000

(Registrant’s Telephone Number, including area code.)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes x No ¨

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

The aggregate market value of common stock held by non-affiliates of the registrant was approximately $3.1 million as of June 30, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing sales price of the registrant’s common stock on that date.

At April 1, 2019, the registrant had 3,822,329 shares of common stock, $0.001 par value, outstanding.

Documents Incorporated by Reference: None

ALY ENERGY SERVICES, INC.

(A Delaware Corporation)

INDEX

Cautionary Note Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains certain statements and information that may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements which are not historical in nature, including the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” “may,” “project,” “plan” or “continue,” and similar expressions are intended to identify forward-looking statements.

Forward-looking statements are not assurances of future performance and actual results could differ materially from our historical experience and our present expectations or projections. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us, that may cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. These forward-looking statements are based on our current plans and expectations and are subject to a number of uncertainties and risks that could significantly affect current plans and expectations and our future financial condition and results. Known material factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, volatility in the price of oil, fluctuations in the domestic rig count, intense competition in our industry and the other risk factors described in Part I, Item 1A “Risk Factors” of this Form 10-K.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report on Form 10-K might not occur. We qualify any and all of our forward-looking statements entirely by these cautionary factors. You are cautioned not to place undue reliance on these statements which speak only as of the date of this Annual Report on Form 10-K.

PART I

Item 1. Business

General

Aly Energy Services, Inc., together with its subsidiaries (“Aly Energy” or the “Company”), is a provider of oilfield services to leading oil and gas exploration and production (“E&P”) companies operating in unconventional plays in the United States (“U.S.”). Generally, the services we offer fall within two broad categories: surface rental and solids control. Our surface rental equipment includes a wide variety of large capacity tanks with circulating systems, associated pumps, separators, gas busters, mud mix plants and ancillary equipment. We also provide environmental containment berms to safeguard against spills from mud systems on the drilling rig site. Our solids control equipment includes large centrifuges, shakers, cuttings dryers and ancillary components that can be integrated into a closed loop mud system. We operate in the U.S., primarily in Texas, Oklahoma, and New Mexico.

Throughout this report, we refer to Aly Energy and its subsidiaries as “we”, “our” or “us”.

History

On July 17, 2012, Munawar “Micki” Hidayatallah founded Aly Energy with the strategic objective of creating an oilfield services company that would serve E&P companies operating in unconventional plays. From 2012 through 2014, we grew our business substantially both through the strategic acquisition of certain businesses operating in our industry and through organic growth. We have fully integrated the completed acquisitions and we operate as a single provider which offers our customers a comprehensive solution for their drilling fluid management needs.

General Trends and Outlook

Our business depends to a significant extent on the level of unconventional resource development activity and corresponding capital spending by E&P companies onshore in the U.S. These activity and spending levels are strongly influenced by current and expected oil prices. Oil prices have been and will continue to be volatile as the major drivers determining the price of oil, including the rate of GDP growth in consuming nations and the political stability of oil-producing countries, are unpredictable. From 2016 throughout most of 2018, oil prices and the U.S. land-based drilling rig count (“Rig Count”), an indicator of overall drilling activity of our customers, steadily increased. As a result, we experienced increases in demand for our equipment and services when comparing 2018 to 2017.

Looking forward into the remainder of 2019, we believe oil prices will remain fairly stable at current levels, but we anticipate a potential decline in the Rig Count of up to 10% as E&P companies cut back on capital expenditures for drilling programs. In order to mitigate the impact of a declining Rig Count, we will focus on maintaining current pricing levels and increasing activity and utilization of our equipment, particularly with existing customers who are not reducing the number of rigs they operate.

We will continue to expand our business through a low risk strategy of growing organically by replacing our sub-rented equipment with newly purchased, refurbished or fabricated equipment. We will also evaluate transaction opportunities that would provide geographic diversification, expand our products and services and introduce us to new customers.

Recapitalization

In September 2016, certain of the Company’s principal stockholders formed Permian Pelican, Inc. (“Pelican”), formerly Permian Pelican, LLC, with the objective of consummating a recapitalization transaction (the “Recapitalization”) whereby (i) our obligations under our then existing credit facility and various capital leases would be restructured and, (ii) the Company’s then outstanding redeemable preferred stock, subordinated note payable and contingent payment liability would be exchanged into common stock resulting in a gain on extinguishment of debt and other liabilities of $2.4 million. The Recapitalization, completed on January 31, 2017, had a significant impact on our capital structure and on our consolidated financial statements for the year ended December 31, 2017.

Products and Services

We are a provider of solids control systems and surface rental equipment. Our equipment and services are primarily designed for and used in land-based horizontal drilling. Our equipment includes centrifuges and auxiliary solids control equipment, mud circulating tanks (400 and 500-barrel capacity) and auxiliary surface rental equipment (e.g. portable mud mixing plants, and containment systems). In conjunction with the rental of some of our solids control packages, we provide personnel at the customer’s well site to operate our equipment. We also provide personnel to rig-up/rig-down and haul our equipment to and from the customer's location.

Our Rental Products:

Centrifuges: We currently own over 45 centrifuges. We provide two different sizes of centrifuges to meet varying client specifications (SS1000 and SS2000). We believe our centrifuges provide a competitive advantage because the rotating assembly within each centrifuge can be removed and replaced on a customer’s well site within 45 minutes if it fails thereby minimizing downtime. Certain customers rent centrifuges with auxiliary equipment such as shakers, vertical dryers, waste removal units, and/or various tanks.

Mud Circulating Tanks (“MCTs”): We currently own 54 vertical 400-barrel MCTs and 127 500-barrel MCTs. We developed vertical 400-barrel MCTs as an innovative solution that minimizes location size, which we believe is an attractive feature for customers. The majority of our 500-barrel MCTs are highly mobile with rounded bottoms and customized jet-lines to ensure more consistent mud and easier cleanout at the completion of a job. In addition to the 500-barrel MCTs we own, we sub-rent 500-barrel MCTs (approximately 240 sub-rented as of December 31, 2018) in order to satisfy demand for our services. MCTs are typically rented to customers with auxiliary equipment such as diesel or electric mud pumps, hoses, and wooden mats.

Mud Mixing Plants (“MMPs”): We own 12 MMPs ranging in size from 100-barrel capacity to 500-barrel capacity. We believe that the large 400-barrel and 500-barrel capacity MMPs, which are designed and fabricated in-house, are unique and offer significant advantages to our customers.

Containment Systems: Containment systems consist of berms and plastic linings constructed to ensure that all products and chemicals present on the well site, particularly those which might be environmentally undesirable if spilled, are contained. We believe the demand for containment systems will continue to increase as environmental regulations tighten.

Our Service Offerings Which Include Personnel:

Solids Control Services: When a customer’s solids control operations are complex, we provide operators on-site 24 hours a day at an additional day rate. In these instances, we typically rent a full package of solids control equipment to the customer, which may include two centrifuges, shakers, vertical dryers, waste removal units, and/or various tanks.

Hauling of Equipment and Rig-Up/Rig-Down Services: We offer hauling of our rental equipment to the well site and rig-up/rig-down of such equipment.

Fabricating Capabilities

We fabricate certain equipment in our rental fleet, including various pumps (diesel mud pumps, diesel transfer pumps, etc.), open top tanks and MMPs. Fabrication primarily takes place in our facility in Giddings, Texas. We believe our ability to fabricate such products in-house provides us with cost efficiencies that result in a competitive advantage.

Geographic Markets

We operate in the U.S., primarily in Texas, Oklahoma, and New Mexico. Within these states, we have a very strong footprint in the Permian Basin, one of the largest and most prolific shale plays in the U.S., and we also provide services in the Scoop/Stack region and Eagle Ford shale.

Competition

We experience significant competition in our business. The markets in which we operate are highly fragmented and there are a large number of companies in these markets offering rental equipment and services that overlap with our offerings. We believe the principal differentiators among competitors in the sectors and markets in which we operate are safety record, service quality, existence of unique attributes of equipment that benefit the customer, customer relationships, response time and price.

The level of our revenue, earnings and cash flows are substantially dependent upon, and affected by, the level of U.S. oil and natural gas exploration, development and production activity, as well as the equipment capacity in any particular region.

Customers

We cultivate and maintain strong relationships with our customers which include some of the largest independent oil and gas E&P companies operating in the U.S. shale basins. During 2018, we serviced 49 customers, including leading companies such as EOG Resources, Inc., Pioneer Natural Resources, XTO Energy Inc., Sanchez Oil and Gas Corporation and Devon Energy Corporation.

During the year ended December 31, 2018 and 2017, our significant customers, customers which individually generate more than 10.0% of our revenue, collectively represented approximately 62.5% and 56.3% of our revenue, respectively.

If we are unable to continue to provide services to our primary customers and sales to new or other existing customers do not increase sufficiently, our business and operations could be materially adversely affected.

Raw Materials

We purchase a wide variety of raw materials, parts and components that are made by other manufacturers and suppliers for our use. We are not dependent on any single source of supply for those parts, supplies or materials.

Safety

Our record and reputation for safety is important to all aspects of our business. In the oilfield services industry, an important competitive factor in establishing and maintaining long-term customer relationships is having an experienced, skilled and well-trained work force. In recent years, many of our larger customers have placed an added emphasis on the safety records and quality management systems of their vendors.

We commit substantial resources toward employee safety and quality management. We believe our policies and procedures provide a solid framework to ensure our employees minimize the hazards inherent in our work environment, meet regulatory requirements and exceed customer expectations.

Employees

As of March 8, 2019, we employed approximately 58 individuals. The corporate cost center employs five individuals, including the chairman and Chief Executive Officer, the Chief Operating Officer and the Chief Financial Officer, approximately 47 individuals work primarily in the field, and the remaining six employees provide selling, general, and administrative services. We believe we have good relationships with our employees.

Seasonality

We have historically experienced a slowdown during the Thanksgiving and Christmas holiday seasons and demand in the fourth quarter sometimes slows as our customers exhaust their annual spending budgets.

Intangibles

We are not dependent on any significant patents, trademarks, licenses, franchises, concessions, royalty agreements or labor contracts. In the last two years, we have not spent or incurred a material amount on research and development activities.

Governmental Regulation

Our business is impacted by federal, state and local laws and other regulations relating to the oil and natural gas industry, as well as laws and regulations relating to worker safety and environmental protection. 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, whether additional laws and regulations will be adopted, or the effect such changes may have on us, our business or financial condition.

In addition, our customers are impacted by laws and regulations relating to the exploration for and production of natural resources such as oil and natural gas. These regulations are subject to change, and new regulations may curtail or eliminate our customers’ activities in certain areas where we currently operate. We cannot determine the extent to which new legislation may impact our customers’ activity levels, and ultimately, the demand for our services.

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. We believe we are in substantial compliance with all regulations affecting our business. 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.

Access to Company Reports

We make available, free of charge, on our website, www.alyenergy.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports on the same day as they are filed with the Securities and Exchange Commission.

Item 1A. Risk Factors

We face numerous risk factors. The following list contains risk factors that we believe are significant to our current and future operations. Additional risk factors that are either not known by us or that we currently deem immaterial may also impact our current and future operating results and financial condition.

Risks Related to Our Business

Our business depends on domestic drilling activity and spending by the oil and natural gas industry in the United States.

We depend on our customers’ willingness to make expenditures to explore for and to develop and produce oil and natural gas in the United States. Our customers’ willingness to undertake these activities depends largely upon prevailing industry conditions that are influenced by numerous factors over which management has no control, such as:

Current and anticipated oil and natural gas prices, the related level of drilling activity, and general production spending in the areas in which we have operations are the primary drivers of demand for our services. The level of oil and natural gas exploration and production activity in the United States is volatile and this volatility could have a material adverse effect on the level of activity by our customers. In addition, any prolonged substantial reduction in oil and natural gas prices would likely affect oil and natural gas production levels and, therefore, affect demand for the services we provide. Moreover, a decrease in the development rate of oil and natural gas reserves in our market areas, whether due to increased governmental regulation of or limitations on exploration and drilling activity or other factors, may also have an adverse impact on our business, even in an environment of stronger oil and natural gas prices.

Competition within the oilfield services industry may adversely affect our ability to market our services.

The oilfield services industry is competitive and fragmented and includes numerous small companies capable of competing in our markets on a local basis as well as several large companies that possess substantially greater financial and other resources than us. Some of our competitors hold significant market share in the markets in which we operate, which may make it difficult for us to successfully sell competing products and services. The principal competitive factors in our markets are product and service quality and availability, responsiveness, experience, reputation for safety and price. The competitive environment may intensify if mergers among exploration and production companies reduce the number of available customers. The fact that drilling rigs and other vehicles and oilfield services equipment are mobile and can be moved from one market to another in response to market conditions heightens the competition in the industry. Our larger competitors may have greater resources which could allow them to compete more effectively than us and they may benefit from economies of scale which enable them to offer products and services at a lower cost than us. Our operations may be adversely affected if our current competitors or new market entrants introduce new products or services with better features, performance, prices or other characteristics, or that better address environmental concerns, than our products and services.

We may be unable to implement price increases or maintain existing prices on our core services.

We periodically seek to increase the prices of our services to offset rising costs and to generate higher returns for our stockholders. Even when industry conditions are favorable, we operate in a very competitive industry and, as a result, we are not always successful in raising, or maintaining, our existing prices. Additionally, during periods of increased market demand, a significant amount of new surface rental and solids control equipment may enter the market, which also puts pressure on the pricing of our services and limits our ability to increase or maintain prices. Furthermore, during periods of declining pricing for our services, we may not be able to reduce our costs accordingly, which could further adversely affect our profitability. Even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset such rising costs. In periods of high demand for oilfield services, a tighter labor market and a tighter supply of equipment available to sub-rent may result in higher costs. During such periods, our costs could increase at a greater rate than our ability to raise prices for our services. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our prices or to increase our prices as costs increase could have a material adverse effect on our business, financial position and results of operations.

Increased prices charged by suppliers and/or interruptions in deliveries of products could adversely affect our profitability, margins, and revenue.

We depend upon a number of vendors for supplies and equipment. Increased prices charged by these suppliers could materially and adversely impact our results of operations. In addition, interruptions or a work stoppage by our suppliers could adversely affect our operations until arrangements with alternate suppliers could be made. Such alternate arrangements may be less favorable to us and could further adversely affect our results of operations. We have experienced a substantial increase in third-party services as the primary surface rental products in our inventory have been fully utilized since early 2017 and the vast majority of incremental rental revenue since 2017 has been derived from equipment which we sub-rent. The availability of supply of sub-rental equipment, as well as the prices charged by such suppliers, are factors beyond our control that could significantly impact our results of operations.

We may not be able to grow successfully through future acquisitions or to integrate the businesses we do acquire effectively.

Our long-term business strategy includes growth through the acquisition of other businesses. However, we may not be able to identify attractive acquisition opportunities or successfully acquire identified targets on terms favorable to us. Competition for acquisition opportunities may be substantial and may cause us to refrain from making acquisitions. In addition, we may not be successful in integrating future acquisitions into our existing operations, which may result in unforeseen operational difficulties, diminished financial performance or our inability to report financial results and may require a disproportionate amount of our management’s attention. If we fail to manage future acquisitions effectively, our results of operations could be adversely affected.

Acquisitions that we complete could present a number of risks, including but not limited to:

We may not realize the anticipated benefits of acquisitions or divestitures.

We continually seek opportunities to increase efficiency and value through various transactions, including purchases or sales of assets or businesses. These transactions are intended to result in the offering of new services or products, the entry into new markets, the generation of income or cash, the creation of efficiencies or the reduction of risk. Whether we realize the anticipated benefits from an acquisition, or any other transactions depends, in part, upon our ability to timely and efficiently integrate the operations of the acquired business, the performance of the underlying product and service portfolio, and the management team and other personnel of the acquired operations. Accordingly, our financial results could be adversely affected from unanticipated performance issues, legacy liabilities, transaction-related charges, amortization of expenses related to intangibles, charges for impairment of long-term assets, credit guarantees, partner performance and indemnifications. In addition, the financing of any future acquisition completed by us could adversely impact our capital structure or increase our leverage. While we believe that we have established appropriate and adequate procedures and processes to mitigate these risks, there is no assurance that these transactions will be successful. We also may make strategic divestitures from time to time. These transactions may result in continued financial involvement in the divested businesses, such as guarantees or other financial arrangements, following the transaction. Nonperformance by those divested businesses could affect our future financial results through additional payment obligations, higher costs or asset write-downs. Except as required by law or applicable securities exchange listing standards, we do not expect to ask our shareholders to vote on any proposed acquisition or divestiture. Moreover, we generally do not announce our acquisitions or divestitures until we have entered into a preliminary or definitive agreement.

We may require additional capital in the future, which may not be available to us or the terms of such financings may negatively impact our business.

We may need to raise funds through debt or equity financings in the future. Adequate funds may not be available when needed or may not be available on favorable terms. If funding is insufficient at any time in the future, we may be unable to support and grow our ongoing operations, meet our debt obligations, fund acquisitions, take advantage of business opportunities or respond to competitive pressures, any of which could materially and adversely affect our business.

Existing and future debt service requirements may impose a significant burden on us, which may adversely affect our results of operations and financial condition. In the future, we may incur debt which requires us to meet or maintain certain financial ratios, which could limit our flexibility and adversely affect our business.

Our near-term capital requirements will primarily depend on our ability to maintain adequate working capital levels and to maintain and refurbish our equipment fleet. Future capital requirements will primarily depend on the frequency, timing, size and success of future equipment purchases and business acquisitions.

We depend on significant customers for a substantial portion of our revenue.

We derive a significant amount of our revenue from exploration and production companies that are active in our markets. For the year ended December 31, 2018, significant customers, customers which individually generated more than 10.0% of total revenue, collectively accounted for approximately 62.5% of total revenue. If we fail to retain a number of our large existing customers or if we incur significant price reductions in order to retain the business of key customers, our business and operations could be adversely affected. Moreover, if any of these customers fails to remain competitive in their respective markets, encounters financial or operational problems or consolidates with a third party, our revenue and profitability may decline.

We are subject to the credit risk of our customers.

We provide credit to our customers in the normal course of business and generally do not require collateral in extending such credit. This exposure, coupled with material instances of default, could have an adverse effect on our business, financial condition, results of operations and cash flows. In addition, we may need to undertake collection efforts that could cause our business from certain customers to decline, or the collection of certain receivables could become impossible, requiring us to write them off.

Historically, we have experienced a high employee turnover rate. Any difficulty we experience replacing or adding workers could adversely affect our business.

We believe that the high turnover rate in our industry is attributable to the nature of oilfield services work, which is physically demanding and performed outdoors. As a result, workers may choose to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive with ours. The potential inability or lack of desire by workers to commute to our facilities and job sites, as well as the competition for workers from competitors or other industries, are factors that could negatively affect our ability to attract and retain workers. We may not be able to recruit, train and retain an adequate number of workers to replace departing workers. The inability to maintain an adequate workforce could have a material adverse effect on our business, financial condition and results of operations.

If we are unable to attract and retain senior management, qualified sales personnel, and a sufficient number of field personnel, our operations, financial condition and prospects will be materially adversely affected.

Our future success depends in part on the contributions of our existing management team and key personnel and on our ability to attract and retain qualified new personnel. We cannot assure you that we will be able to retain our key senior managerial and sales personnel or that we will be able to attract, integrate and retain other such personnel that we may require in the future. If we are unable to attract and retain key personnel in the future, our business, operations, financial condition, results of operations and prospects could be materially adversely affected.

Companies in our industry, including us, are dependent upon the available labor pool of skilled employees. We compete with other oilfield services businesses and other employers to attract and retain qualified personnel with the technical skills and experience required to provide our customers with the highest quality service. We are also subject to the Fair Labor Standards Act, which governs such matters as minimum wage, overtime and other working conditions, and which can increase our labor costs or subject us to liabilities to our employees. A shortage in the labor pool of skilled workers or other general inflationary pressures or changes in applicable laws and regulations could make it more difficult for us to attract and retain personnel and could require us to enhance our wage and benefits packages. Labor costs may increase in the future or we may not be able to reduce wages when demand and pricing falls, and such changes could have a material adverse effect on our business, financial condition and results of operations.

Our future financial results could be adversely impacted by a reduction in value of our assets or other charges.

We have recorded reductions in the value of our assets in the past. We periodically evaluate our long-lived assets, including our property and equipment and intangible assets for impairment. In performing these assessments, we project future cash flows on an undiscounted basis and compare these cash flows to the carrying amount of the related assets. These cash flow projections are based on our current operating plans, estimates and other judgmental assumptions. We perform the assessment of potential impairment for our property and equipment whenever facts and circumstances indicate that the carrying value of those assets may not be recoverable due to various external or internal factors. If conditions in our industry worsen, we could record impairment charges in future periods, which could have a material adverse effect on our financial position and results of operations.

Severe weather could have a material adverse effect on our business.

Our business could be materially and adversely affected by severe weather. Our customers’ oil and natural gas operations located in parts of Texas may be adversely affected by hurricanes and tropical storms, resulting in reduced demand for our services. Furthermore, our customers’ operations may be adversely affected by seasonal weather conditions. Adverse weather can also directly impede our own operations. Repercussions of severe weather conditions may include:

These constraints could delay our operations and materially increase our operating and capital costs.

Our operations are subject to hazards inherent in the oil and natural gas industry.

The operational risks inherent in our industry could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages. The frequency and severity of such incidents will affect our operating costs, insurability and relationships with customers, employees and regulators. In particular, our customers may elect not to retain our services if they view our safety record as unacceptable, which could cause us to lose substantial revenue.

We do not have insurance against all foreseeable risks, either because insurance is not available or because of the high premium costs. We evaluate certain of our risks and insurance coverage annually. After carefully weighing the costs, risks, and benefits of retaining versus insuring various risks, we occasionally opt to retain certain risks not covered by our insurance policies. The occurrence of an event not fully insured against, or the failure of an insurer to meet its insurance obligations, could result in substantial losses. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable and there can be no assurance that insurance will be available to cover any or all of these risks, or, even if available, that it will be adequate or that insurance premiums or other costs will not rise significantly in the future, so as to make such insurance costs prohibitive. In addition, our insurance is subject to coverage limits and some policies exclude coverage for damages resulting from environmental contamination.

We are subject to federal, state and local regulation regarding issues of health, safety and protection of the environment. Under these regulations, we may become liable for penalties, damages or costs of remediation. Any changes in laws and government regulations could increase our costs of doing business.

Our operations and the operations of our customers are subject to extensive and frequently changing regulation. More stringent legislation or regulation or taxation of drilling activity could directly curtail such activity or increase the cost of drilling, resulting in reduced levels of drilling activity and therefore reduced demand for our services. Numerous federal, state and local departments and agencies are authorized by statute to issue, and have issued, rules and regulations binding upon participants in the oil and gas industry. Our operations and the markets in which we participate are affected by these laws and regulations and may be affected by changes to such laws and regulations in the future, which may cause us to incur materially increased operating costs or realize materially lower revenue, or both.

Laws protecting the environment generally have become more stringent over time and are expected to continue to do so, which could lead to material increases in costs for future environmental compliance and remediation. The modification or interpretation of existing laws or regulations, or the adoption of new laws or regulations, could curtail exploratory or developmental drilling for oil and natural gas and could limit well site services opportunities. Additionally, environmental groups have advocated increased regulation in certain areas in which we currently operate or in which we may operate in the future. These initiatives could lead to more stringent permitting requirements, increased regulation, possible enforcement actions against the regulated community, and a moratorium or delays on permitting, which could adversely affect our well site service opportunities.

Some environmental laws and regulations may impose strict liability, which means that in some situations we could be exposed to liability as a result of our conduct that was lawful at the time it occurred as a result of conduct of, or conditions caused by, prior operators or other third parties. Clean-up costs and other damages, arising as a result of environmental laws, and costs associated with changes in environmental laws and regulations could be substantial and could have a material adverse effect on our financial condition. In addition, the occurrence of a significant event not fully insured or indemnified against could have a material adverse effect on our financial condition and operations.

We may be subject to litigation, which, if adversely determined, could result in substantial losses.

We may be, from time-to-time, during the ordinary course of business, subject to various litigation claims and legal disputes, including contract, lease, employment, and regulatory claims. Certain litigation claims may not be covered entirely or at all by our insurance policies or our insurance carriers may seek to deny coverage or impose significant deductibles. In addition, litigation claims can be expensive to defend and may divert our attention from the operations of our business. Further, litigation, even if without merit, can attract adverse media attention. As a result, litigation can have a material adverse effect on our business, financial condition, results of operations, and cash flows and, because we cannot predict the outcome of any action, it is possible that adverse judgments or settlements could significantly reduce our earnings or result in losses.

Governmental taxation policies could adversely affect our business, financial condition, and results of operations.

We are subject to income and other taxes in the U.S. Changes in applicable U.S. tax laws and regulations, such as the December 2017 enactment of Federal legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”), or their interpretation and application, including the possibility of retroactive effect and changes to state tax laws that may occur in response to the Tax Act, could affect our tax expense and profitability. In addition, the final determination of any tax audits or related litigation could be materially different from our historical income tax provision and accruals. Changes in our tax provision or an increase in our tax liability, whether due to changes in applicable laws and regulation, the interpretation or application thereof, or a final determination of tax audits or litigation, could materially adversely affect our financial performance.

If we fail to maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence in our company and the market price of our common stock may be adversely affected.

Our reporting obligations as a public company place a significant strain on our management, operational and financial resources and systems. We may experience difficulty in maintaining management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices required for us as a publicly traded and reporting company. It may be difficult to design and implement effective internal control over financial reporting for combined operations following the addition of other businesses which we may acquire in the future. In addition, differences in existing controls of acquired businesses may result in weaknesses that require remediation when internal controls over financial reporting are combined. For further details on our internal controls over financial reporting see Item 9A of this annual report.

We depend on computer and telecommunications systems and failures in our systems or cyber security attacks could significantly disrupt our business operations.

We have entered into agreements with third parties for hardware, software, telecommunications and other information technology services in connection with our business. In addition, we have developed management reporting and other information which requires software licensed from third parties. It is possible we could incur interruptions from cyber security attacks, computer viruses or malware. We believe that we have positive relations with our related vendors and maintain adequate anti-virus and malware software and controls; however, any interruptions to our arrangements with third parties to our computing and communications infrastructure or our information systems could significantly disrupt our business operations.

Future indebtedness could restrict our operations and make us more vulnerable to adverse economic conditions.

We will likely incur future indebtedness, the terms of which could have important consequences to our stockholders. For example, agreements relating to such future indebtedness could:

We may not be able to generate sufficient cash flow to meet future debt service and other obligations.

Our ability to make payments in respect of any existing or future indebtedness and to fund planned capital expenditures depends on our ability to generate cash flow. Due to the cyclical nature of the industry we operate in, our cash flow from operations can vary significantly from year to year. Consequently, our cash flow may be insufficient to service our debt and that could negatively impact our business, financial condition and results of operations. If our cash flow from operations is insufficient to service our debt, we might need to sell assets, seek additional equity or change our business direction to service our debt and there can be no assurance that we could execute these actions in a timely manner sufficient to allow us to service our debt.

Any existing or future variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Risks Related to Ownership of our Common Stock

The Recapitalization resulted in substantial dilution to our stockholders, and future issuances will result in additional dilution.

Consummation of the Recapitalization in January 2017 resulted in substantial dilution to our then existing stockholders, whose aggregate fully diluted percentage ownership declined from 100% to 9.9%.

In the future, we may need to raise significant additional funds through equity financings to repay debt, to expand our operations or to execute our acquisition strategy, which would result in even further dilution. Our future capital requirements will primarily depend on our ability to service our debt from operating cash flow and the frequency, timing, and size of future growth opportunities.

Because we have no current plans to pay dividends on our common stock, investors must look solely to stock appreciation for a return on their investment in us.

We have not historically paid, nor do we currently pay, any cash dividends on our common stock. We currently intend to retain all future earnings to service debt and fund the development and growth of our business. Any payment of future dividends will be at the discretion of our board of directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that the board of directors deems relevant. For example, our credit agreement limits our ability to pay dividends. Investors may need to rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize a return on their investment. Investors seeking cash dividends should not purchase our common stock.

Because our common stock is subject to the “penny stock” rules, brokers cannot generally solicit the purchase of our common stock, which adversely affects its liquidity and market price.

The SEC has adopted regulations, which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock on the Over-The-Counter Bulletin Board (“Bulletin Board”) is substantially less than $5.00 per share and therefore we are considered a “penny stock” according to SEC rules. This designation requires any broker-dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules limit the ability of broker-dealers to solicit purchases of our common stock and therefore reduce the liquidity of the public market for our shares.

Moreover, as a result of apparent regulatory pressure from the SEC and the Financial Industry Regulatory Authority, a growing number of broker-dealers decline to permit investors to purchase and sell or otherwise make it difficult to sell shares of penny stocks. This may have a depressive effect upon our common stock price.

Certain provisions of our corporate documents and Delaware law, as well as change of control provisions in our debt agreements, could delay or prevent a change of control, even if that change would be beneficial to stockholders, or could have a material negative impact on our business.

Certain provisions in our certificate of incorporation, bylaws and debt agreements may have the effect of deterring transactions involving a change in control, including transactions in which stockholders might receive a premium for their shares.

Our certificate of incorporation provides authorization to issue up to 4,980,000 shares of preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors. The authorization of preferred shares empowers our board, without further stockholder approval, to issue preferred shares with dividend, liquidation, conversion, voting or other rights which could adversely affect the voting power or other rights of the holders of the common stock. If issued, the preferred stock could also dilute the holders of our common stock and could be used to discourage, delay or prevent a change of control.

We are also a Delaware corporation subject to Section 203 of the Delaware General Corporation Law (the “DGCL”). In general, Section 203 of the DGCL prevents an “interested stockholder” (as defined in the DGCL) from engaging in a “business combination” (as defined in the DGCL) with us for three years following the date that person becomes an interested stockholder unless one or more of the following occurs:

The DGCL generally defines “interested stockholder” as any person who, together with affiliates and associates, is the owner of 15% or more of our outstanding voting stock or is our affiliate or associate and was the owner of 15% or more of our outstanding voting stock at any time within the three-year period immediately before the date of determination.

All of these factors could materially adversely affect the price of our common stock.

The market price of our common stock may decline.

Fluctuations in the price of the common stock could contribute to the loss of all or part of our stockholders’ investment. During the time period following our reverse merger in 2013 and through the present, trading in our common stock has been limited. The trading price of the common stock is and could be volatile and subject to wide fluctuations in response to various factors, some of which are beyond our control. Any of the factors listed below could have a material adverse effect on the common stock price. In such circumstances, the trading price of the common stock may not recover and may experience a further decline.

Factors affecting the trading price may include:

Many of the factors listed above are beyond our control. In addition, broad market and industry factors may materially harm the market price of the common stock irrespective of our operating performance. The stock market has experienced price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. A loss of investor confidence in the market for securities of other companies which investors perceive to be similar to us could depress the price of the common stock regardless of our business, prospects, financial conditions or results of operations. A decline in the market price of the common stock also could adversely affect our ability to issue additional securities and our ability to obtain additional financing in the future.

Our governing instruments provide indemnification for officers, directors and employees.

Our governing instruments provide that officers, directors, employees and other agents and their affiliates shall only be liable to us for losses, judgments, liabilities and expenses that result from matters involving intentional misconduct, fraud or a knowing violation of law. Thus, certain alleged errors or omissions might not be actionable by us. The governing instruments also provide that, under the broadest circumstances allowed under law, we must indemnify our officers, directors, employees and other agents and their affiliates for losses, judgments, liabilities, expenses and amounts paid in settlement of any claims sustained by them in connection with the Company, including liabilities under applicable securities laws.

Item 1B: Unresolved Staff Comments

None.

Item 2. Properties

Our corporate headquarters are located at 3 Riverway, Suite 920, Houston, Texas, 77056 and consist of approximately 2,291 square feet of office space under a lease that expires on January 31, 2020. This facility accommodates our executive offices.

We lease facilities and administrative offices in the various geographic areas in which we operate. We believe that our existing facilities are suitable and adequate and that we have sufficient capacity to meet our current anticipated needs. As of March 31, 2019, we leased properties in Texas and Oklahoma as follows:

Item 3. Legal Proceedings

We are subject to various legal proceedings and claims incidental to or arising in the ordinary course of our business. While many of these matters involve inherent uncertainty, we believe that the liability, if any, ultimately incurred with respect to such proceedings and claims will not have a material adverse effect on our consolidated financial position as a whole or on our liquidity, capital resources or results of operations. We will continue to evaluate proceedings and claims involving us on a quarter-by-quarter basis and will establish and adjust any reserves as appropriate to reflect our assessment of the then-current status of the matters. (See further discussion in “Note 6 – Commitments and Contingencies” in the notes to our consolidated financial statements included elsewhere in this document.)

Item 4. Mine Safety Disclosures

Not Applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is listed on the OTCQB under the symbol "ALYE".

Holders

The number of holders of record of our common stock as of March 13, 2019 was 61. This number does not include an undetermined number of stockholders whose stock is held in “street” or “nominee” name.

Dividends

In the past, we have not distributed earnings to our common stockholders. Our board of directors has complete discretion on whether to pay dividends and, as such, will make any future decisions regarding dividends. We currently intend to retain and use any future earnings for servicing our debt and for developing and expanding our business. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

Item 6. Selected Financial Data

As a smaller reporting company, we are not required to provide the information required by this Item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations is intended to assist you in understanding our business and results of operations together with our present financial condition. This section should be read in conjunction with the audited consolidated financial statements and the related notes thereto included elsewhere in “Item 8. Financial Statements and Supplementary Data” in this Form 10-K. This section contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in any forward-looking statement because of various factors, including, without limitation, those described in the sections titled “Cautionary Note Regarding Forward-Looking Statements” and Part I, Item 1A “Risk Factors” of this Form 10-K.

Overview of Our Business

Aly Energy Services, Inc., together with its subsidiaries (“Aly Energy” or the “Company”), is a provider of oilfield services to leading oil and gas exploration and production (“E&P”) companies operating in unconventional plays in the United States (“U.S.”). Generally, the services we offer fall within two broad categories: surface rental and solids control. Our surface rental equipment includes a wide variety of large capacity tanks with circulating systems, associated pumps, separators, gas busters, mud mix plants and ancillary equipment. We also provide environmental containment berms to safeguard against spills from mud systems on the drilling rig site. Our solids control equipment includes large centrifuges, shakers, cuttings dryers and ancillary components that can be integrated into a closed loop mud system. We operate in the U.S., primarily in Texas, Oklahoma, and New Mexico.

We cultivate and maintain strong relationships with our customers which include some of the largest independent oil and gas E&P companies operating in the U.S. shale basins. During 2018, we serviced 49 customers, including leading companies such as EOG Resources, Inc., Pioneer Natural Resources, XTO Energy Inc., Sanchez Oil and Gas Corporation and Devon Energy Corporation.

History

On July 17, 2012, Munawar “Micki” Hidayatallah founded Aly Energy with the strategic objective of creating an oilfield services company that would serve E&P companies operating in unconventional plays. Previously, Mr. Hidayatallah had followed a similar strategy at Allis-Chalmers Energy Inc., a company which he founded in 2001. Allis-Chalmers Energy Inc. grew organically and through acquisitions over a ten-year period and generated over $675 million in revenue during 2011. We have created a public platform to pursue a similar strategy at Aly Energy.

From 2012 through 2014, we grew our business substantially both through the strategic acquisition of certain businesses operating in our industry and through organic growth. We have fully integrated the completed acquisitions and we operate as a single provider which offers our customers a comprehensive solution for their drilling fluid management needs.

Beginning in the fourth quarter of 2014, in conjunction with depressed commodity prices and a substantial decrease in the U.S. land-drilling rig count (“Rig Count”), there was a massive decline in demand for oilfield services which continued through the first half of 2016. The industry downturn negatively impacted our financial results in both 2015 and 2016 and we had very limited liquidity throughout both years.

By January 31, 2017, we had successfully navigated through the industry downturn by implementing an operational restructuring, including severe cost cutting measures, and we had significantly deleveraged the business by successfully entering into a capital restructuring transaction (“Recapitalization”).

Subsequent to the Recapitalization in January 2017, there has been a substantial improvement in industry conditions and a corresponding improvement in our financial results. Two of the most significant drivers of demand for our services, the price of oil and the Rig Count, increased approximately 45% and 35%, respectively, when comparing the first quarter of 2017 to the third quarter of 2018. Throughout both years, we have experienced strong demand which has facilitated our ability to raise prices significantly and has provided us the opportunity to increase activity when we have available equipment or access to cost effective third-party equipment. As we move into 2019, we are operating with strong margins and healthy cash flow and we have sufficient liquidity to invest in new equipment to further improve our operating results.

How We Generate Revenue and the Costs of Conducting Our Business

We generate our revenue by providing drilling-related support services to E&P companies operating in some of the major onshore unconventional basins in the U.S. Our revenue streams include: (i) rental services - revenue derived from the rental of equipment and on-site operators of such equipment, (ii) rig-up/rig down services – revenue derived from the rig-up/rig-down of our equipment at the customer site, (iii) transportation services – revenue derived from the hauling of our equipment to and from the customer site, and (iv) other - revenue derived from the sale of consumable items, including chemicals. Fluctuations in the mix of services are driven primarily by the timing of and frequency with which our respective customers move their rigs from well to well and by the number of mobilizations and demobilizations of our equipment. The contribution of each revenue stream to total revenue is shown in the table below:

Our total revenue fluctuates with the utilization of and the prices we charge for our equipment and services. Utilization of our equipment is generally determined by the Rig Count as it is typically representative of the level of activity of E&P companies. The prices we charge for our products and services depend on the relationship between the level of activity of E&P companies, or the demand of our potential and existing customers, and the supply of equipment and services available to such E&P companies from us and our competitors.

Our operating expenses consist primarily of variable costs, such as labor and third-party expenses. Labor-related expenses typically fluctuate with the utilization of our equipment and services. Expenses associated with services provided by third-parties typically increase with activity as well. Demand for our equipment has increased so significantly over the past two years that most of our available owned equipment has been fully utilized since early 2017 and we have been required to increase our available equipment fleet and our available labor resources to meet the demand from our customers. To date, we have primarily increased our available resources by sub-renting surface rental equipment and by using sub-contractors to operate our solids control equipment. With increased demand for oilfield services, the demand for sub-rental equipment has also increased and, effective January 1, 2019, we have experienced significant increases in costs for third-party equipment which will increase third-party expenses and reduce operating margins until we are able to reduce our utilization of third-party equipment and personnel.

In order to mitigate increases in third-party expenses and our overall reliance on third-party vendors, we initiated a capital expenditure plan in early 2018 to invest in new rental and transportation equipment, some of which was fabricated in-house. During the year ended December 31, 2018, we took delivery of forklifts, completed the fabrication of open top tanks and diesel transfer pumps, and refurbished diesel mud pumps and 500bbl MCTs. Once all of the incremental equipment purchased in 2018 is in service, beginning in the second quarter of 2019, we project that the aggregate annual cost savings from the 2018 capital expenditure program will be approximately $1.0 million. (These cost savings are calculated using the vendor day rates in effect in 2018).

In 2019, we plan to continue to focus on investing in equipment which will replace sub-rented equipment resulting in additional cost savings and reduced reliance on third-party vendors. To date, we have approved the purchase of 50 new 500bbl round-bottom MCTs during the first half of 2019 for an aggregate purchase price of approximately $2.3 million. The 2019 capital expenditure plan also includes pumps and open top tanks, among other items. In aggregate, we project we will spend approximately $2.8 million during the year ended December 31, 2019 on equipment which, when in service, could replace equipment which is currently sub-rented.

The aggregate capital expenditures completed during the year ended December 31, 2018 and projected for the year ended December 31, 2019 on items which could replace sub-rented equipment is $4.9 million. The combined potential annual cost savings of these expenditures is approximately $1.5 million (calculated using the vendor day rates in effect in 2018), assuming all the incremental owned equipment is used to replace sub-rented units. As of today, we believe that demand is strong enough that the new tanks, among other items, could be used to service incremental jobs (as opposed to replacing sub-rented equipment). Although we may not reduce third-party expenses if we choose to add jobs instead of replacing sub-rented equipment, the gross margin generated from the additional work will far exceed the cost savings of returning sub-rented equipment and the investment will have a much greater positive impact on our financial results.

How We Evaluate Our Operations

We utilize multiple metrics to evaluate the results of our operations and efficiently allocate personnel, equipment and capital resources, including, but not limited to, the following:

The following table provides the detailed components of EBITDA and Adjusted EBITDA as we define that term for the years ended December 31, 2018 and 2017 (in thousands):

Adjusted EBITDA increased by approximately $2.1 million to $4.6 million for the year ended December 31, 2018 from approximately $2.5 million for the year ended December 31, 2017. The improved performance was driven primarily by increases in gross margin resulting from price increases and slight decreases in operating expenses partially offset by increases in selling, general and administrative expenses resulting from returning certain employees to contractual wage rates and increasing headcount to strengthen internal controls and processes.

General Trends and Outlook

Our business depends to a significant extent on the level of unconventional resource development activity and corresponding capital spending of E&P companies onshore in the U.S. These activity and spending levels are strongly influenced by the current and expected oil price. Oil prices have been and will continue to be volatile as major drivers determining the price of oil, including the rate of GDP growth in consuming nations and the political stability of oil-producing countries, are unpredictable. From 2016 throughout most of 2018, oil prices steadily increased from a low of approximately $26.00 in February 2016 to a high of approximately $75.00 in October 2018. The consistent improvement in oil price stimulated an increase in onshore drilling and completion activity: the Rig Count increased from a low of approximately 375 rigs in May 2016 to a high of approximately 1,060 rigs in November 2018. As a result of the increases in both oil prices and Rig Count, we experienced increases in demand for our services when comparing 2018 to 2017. Although our year-over-year activity did not increase as significantly as demand, primarily because our owned equipment was fully utilized and it was difficult to source third-party equipment at a reasonable cost, we benefitted from the strong demand by significantly increasing pricing on our products and services.

During the fourth quarter of 2018, oil prices declined almost 40.0%. Although oil prices started to rebound in 2019 and have increased by more than 20.0% since January, the Rig Count has declined by almost 5.0% during that same period. Looking forward into the remainder of 2019, we believe oil prices will remain fairly stable at current levels, but we anticipate a potential decline in the Rig Count of up to 10% as E&P companies cut back on capital expenditures for drilling programs. In order to mitigate the impact of a declining Rig Count, we will focus on maintaining current pricing levels and increasing activity and utilization of our equipment, particularly with existing customers who are not reducing the number of rigs they operate. Although we did not significantly increase utilization of our products and services in 2018 compared to 2017, our 2019 capital expenditure plan, particularly our investment in 500bbl MCTs, will enable us to increase activity with new and/or existing customers in 2019 if the demand exists. To the extent our new equipment is not required for incremental work, we will replace similar sub-rented pieces of equipment with the new equipment as quickly as possible. The replacement of sub-rented equipment will minimize our dependence on third-party providers and, more importantly, will decrease expenses substantially.

Recapitalization

In September 2016, certain of the Company’s principal stockholders formed Permian Pelican, Inc. (“Pelican”), formerly Permian Pelican, LLC, with the objective of consummating a recapitalization transaction (the “Recapitalization”) whereby (i) our obligations under our then existing credit facility and various capital leases would be restructured and, (ii) the Company’s then outstanding redeemable preferred stock, subordinated note payable and contingent payment liability would be exchanged into common stock resulting in a gain on extinguishment of debt and other liabilities of $2.4 million. The Recapitalization, completed on January 31, 2017, had a significant impact on our capital structure and on our consolidated financial statements for the year ended December 31, 2017.

Results of Operations

The following table summarizes the change in our results of operations for the year ended December 31, 2018 when compared to the year ended December 31, 2017 (in thousands). The December 31, 2017 financial statements have been restated due to an accounting error in conjunction with the assets sold in 2016. (See further discussion in “Note 12 – Restatement of Prior Year Financial Statements” in the notes to our consolidated financial statements included elsewhere in this document).

Results for the Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

Overview. Our results of operations, excluding the one-time gain on extinguishment of debt and other liabilities, improved significantly when comparing the year ended December 31, 2018 to the year ended December 31, 2017 due to significant price increases on the products and services we offer and effective management of variable and fixed costs. Two of the most significant drivers of demand for our services, the price of oil and the Rig Count, increased substantially when comparing the two periods: the average price of oil increased over 25.0% and the Rig Count increased almost 20.0%. We experienced incremental demand for our surface rental equipment; however, it became more difficult for us, and other competitors, to service this demand as access to third-party surface rental equipment at reasonable costs began to diminish. Although our surface rental activity remained fairly flat year-over-year, the incremental demand combined with the tight supply of equipment enabled us to increase prices substantially. Demand for our solids control services was also strong although the service mix shifted away from full package jobs, including centrifuges, auxiliary equipment and personnel, towards centrifuge-only rental jobs. Throughout 2017 and 2018, we maintained a lean cost structure and were able to improve operating margins as a result of pricing to our customers increasing more quickly than costs from our vendors.

Revenue. Our revenue for the year ended December 31, 2018 was $17.3 million, an increase of 18.9%, compared to $14.6 million for the year ended December 31, 2017. The key drivers of revenue are pricing and utilization or activity. Increased pricing on our tanks, pumps, centrifuges and non-rental services was the primary driver of the year-over-year increase in revenue. When comparing the year ended December 31, 2018 to the year ended December 31, 2017, pricing on tanks and pumps, our lead surface rental products, increased by over 15% and 35%, respectively. Price increases on our rig-up/rig-down and hauling services were in a similar range. Although robust demand for our tanks and non-rental services enabled us to increase pricing to our customers, surface rental activity remained fairly flat period-over-period because our tanks and pumps were fully utilized and, in certain circumstances, we determined that it was not cost effective to sub-rent additional equipment in order to take advantage of the increased demand. The increases in revenue from pricing of lead surface rental products and non-rental services was partially offset by a decrease in revenue generated from other surface rental products. Rental of auxiliary equipment is customer specific and fluctuates as our customers’ needs vary. Revenue generated by solids control products and services remained fairly flat year-over-year as slightly increased activity and pricing on centrifuges as a standalone rental product were offset by a decline in demand for complete solids control packages which typically include centrifuges, auxiliary equipment and personnel to operate the equipment.

Operating Expenses. Our operating expenses for the year ended December 31, 2018 decreased slightly to $9.7 million, or 55.8% of revenue, from $9.9 million, or 68.1% of revenue, for the year ended December 31, 2017. Operating expenses include primarily variable costs, such as payroll and related costs, third-party expenses (sub-rental of equipment, hauling of equipment, washout of equipment), and repair and maintenance expenses. Payroll and related costs remained relatively flat year-over-year reflecting a minimal increase in operating activity and our ability to maintain a strong focus on maximizing labor productivity. Third-party expenses decreased primarily due to the replacement of sub-rented equipment with newly purchased or fabricated equipment partially offset by increases in day rates on sub-rented equipment while repair and maintenance expenses increased due to the aging of certain of our equipment, particularly vehicles. Aggregate operating expenses remained fairly flat; however, the benefit of increased pricing on most products and services resulted in operating expenses decreasing significantly as a percentage of revenue.

Depreciation and Amortization. Depreciation and amortization decreased slightly to $3.4 million for the year ended December 31, 2018 from $3.6 million for the year ended December 31, 2017 due primarily to the impact of certain assets becoming fully depreciated and amortized partially offset by the purchase and fabrication of new assets.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $3.5 million, or 20.2% of revenue, for the year ended December 31, 2018 compared to $2.9 million, or 20.2% of revenue, for the year ended December 31, 2017. Selling, general and administrative expenses consist of overhead costs which we generally consider to be fixed. The year-over-year increase of approximately $0.6 million, or 19.4%, is primarily due to increases in compensation to return executive management to their contractual levels and by an increase in headcount of selling, general and administrative employees to an average of 15 employees during the year ended December 31, 2018 from 11 employees during the year ended December 31, 2017. The improved financial results achieved in 2018 when compared to 2017 enabled us to increase headcount in order to improve our ability to segregate duties and strengthen our internal controls. In addition, there was a slight decrease in non-recurring and non-cash expenses to $0.5 million from $0.7 million for the years ended December 31, 2018 and 2017, respectively (see further discussion in “How We Evaluate Our Operations” section above).

Interest Expense, Net. Interest expense, net, consisting primarily of interest on insurance financing and other miscellaneous interest expense, was approximately $21,000 and $24,000 for the years ended December 31, 2018 and 2017, respectively.

Interest Expense – Related Party. During the years ended December 31, 2018 and 2017, we recorded $0.4 million of interest expense on borrowings under the credit facility with Permian Pelican, Inc., a related party (“Related Party Credit Facility”).

Debt Modification Fee – Related Party. During the year ended December 31, 2017, we recorded a debt modification fee of $0.3 million which reflects the value of 1,200 shares of our Series A convertible preferred stock issued to Pelican in exchange for an amendment to our Related Party Credit Facility in May 2017.

Gain on Extinguishment of Debt and Other Liabilities. During the year ended December 31, 2017, we recorded a gain on extinguishment of debt and other liabilities of $2.4 million in connection with the Recapitalization.

Income Taxes. From our evaluation as of December 31, 2018 and 2017, the Company has concluded that based on the weight of available evidence, it is more likely than not that the Company will not realize the benefit of its deferred tax assets. As such, a valuation allowance of $1.9 million and $2.7 million is included on the consolidated balance sheet for the years ended December 31, 2018 and 2017, respectively. Income tax expense was approximately $15,000 and $59,000 for the years ended December 31, 2018 and 2017, respectively, which primarily reflects Texas Franchise Tax. The difference in the effective tax rate from the statutory rate is due to our continued full valuation allowance on net deferred tax assets. The Company has sufficient NOL carryforwards to offset federal income tax and other state income taxes.

Liquidity and Capital Resources

Net Cash Provided by Operating Activities. During the year ended December 31, 2018 and 2017, operating activities generated $3.9 million and $0.4 million in cash, respectively. The increase in cash flows from operating activities is partially due to an improvement in operating results when comparing the two periods. In addition, changes in operating assets and liabilities provided $0.2 million of cash during the year ended December 31, 2018 compared to using $1.6 million during the year ended December 31, 2017. The primary driver of the increase in cash provided by operating activities is the change in receivables which provided $1.0 million in cash during the year ended December 31, 2018 compared to using $2.5 million during the year ended December 31, 2017. The significant favorable impact in the change of receivables during the year ended December 31, 2018 is primarily a result of successfully decreasing the lag time between the end of jobs and invoicing (“Lapse Days”) to 16 days for the three months ended December 31, 2018 compared to 39 days for the three months ended December 31, 2017. In addition to high Lapse Days, the change in receivables during the year ended December 31, 2017 was negatively impacted by a rapid increase in revenue during the period as monthly revenue increased in excess of 50% from the beginning of the period to the end of the period compared to the year ended December 31, 2018 when monthly revenue remained fairly flat throughout the year. With projected improved operating results and a shorter billing cycle, we believe we will continue to generate positive cash flows from operating activities during 2019.

Capital Expenditures. Capital expenditures are the main component of our investing activities. Cash capital expenditures for the year ended December 31, 2018 and 2017 were $2.9 million and $1.7 million, respectively. Our primary spending focus was on purchasing and fabricating equipment which would replace equipment we are currently sub-renting from third-party vendors. During the year ended December 31, 2018, we paid approximately $2.1 million for forklifts, the fabrication of open top tanks and diesel transfer pumps, and the refurbishment of diesel mud pumps and 500bbl MCTs. Other capital expenditures during the year ended December 31, 2018 included refurbishments of rotating assemblies, liners, hoses, vehicles and similar assets which are required to support the ongoing operations. We anticipate continuing our capital expenditure program throughout 2019 with a focus on purchasing and fabricating equipment to replace items which we are currently sub-renting. The successful implementation of our capital expenditure plan will enable us to service additional customers and rigs if demand continues to grow and, even if there is no incremental demand for our services, our investment in items which we sub-rent, such as tanks and pumps, will reduce our expenses and reduce our reliance on third-party vendors.

Although we do not budget acquisitions, mergers or similar transactions in the normal course of business, we are currently engaged in multiple discussions related to potential transactions. We would anticipate requiring additional debt and/or equity financing in order to complete some of the transactions being evaluated.

Liquidity and Credit Facility. As of December 31, 2018, we had a cash balance of approximately $1.6 million and aggregate related party debt of $6.2 million. Because the lender under our credit facility is a related party, we benefit from a credit facility which is structured with no financial covenants and we have significant flexibility to modify our credit facility, if, and when, needed.

On June 30, 2018, the Company entered into the Third Amended and Restated Credit Agreement which, among other things, (i) combined the outstanding balances on the delayed draw term loan and the term loan and initiated a required monthly principal payment of approximately $83,000 on the aggregate outstanding balance of the term loan, (ii) expanded availability on the revolving credit facility by $0.7 million while simultaneously reducing the aggregate availability under the other lines of the facility by the same amount, and (iii) extended the maturity date of the facility to June 30, 2021. In addition, effective June 30, 2018, Pelican assigned and transferred its rights under the credit agreement to an affiliated entity, Permian Pelican Financial, LLC (“PPF”). The members and membership interests of PPF are the same as Pelican and PPF is a related party.

The table below reflects our liquidity as of December 31, 2018 (in thousands):

_____________ 

⁽¹⁾ With Permian Pelican Inc., our controlling shareholder as of 12/31/18. 

In February 2019, we borrowed the remaining $0.7 million available under the revolving credit facility to partially fund the purchase of 50 new 500bbl MCTs. Our existing capital expenditure plan for 2019 focuses primarily on reducing sub-rental expense; however, if demand remains strong, new equipment may be used to service incremental jobs for which the incremental gross margin generated will exceed the projected cost savings of replacing sub-rented equipment on existing jobs. As of April 1, 2019, we have purchased 37 new 500bbl MCTs for which the remaining payments aggregate to approximately $0.7 million.

As of April 1, 2019, we had approximately $0.7 million of cash on hand and we believe that this cash combined with our cash flow from operations will be sufficient to fund our working capital needs, the 2019 capital expenditure plan, principal and interest payments, and other contractual obligations for the next twelve months.

Contractual Obligations

The table below indicates our contractual obligations as of December 31, 2018 (in thousands):

Off-Balance Sheet Arrangements

As of December 31, 2018, we did not, and we currently do not, have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources notwithstanding any impact of ASU 2016-02, Leases (Topic 842). See further discussion contained within the Recent Accounting Pronouncements section of “Note 2 – Summary of Significant Accounting Policies” in the notes to our consolidated financial statements included elsewhere in this document.

Net Operating Losses

As of December 31, 2018 and 2017, we had approximately $32.8 million and $31.5 million, respectively, of federal net operating loss carryforwards. Based on the weight of all available evidence including the future reversal of existing U.S. taxable temporary differences as of December 31, 2018 and 2017, we believe that it is more likely than not that the benefit from certain federal and state net operating loss carryforwards and other deductible temporary differences will not be realized. In recognition of this risk, we have a valuation allowance of approximately $1.7 million and $2.4 million as of December 31, 2018 and 2017, respectively, on the net deferred tax asset as a result of the Company being in a cumulative three-year pre-tax book loss position and absence of other objectively verifiable positive evidence including reversal of existing taxable temporary differences in certain state tax jurisdictions.

Critical Accounting Policies and Estimates

The accounting policies described below are considered critical in obtaining an understanding of our consolidated financial statements because their application requires significant estimates and judgments by management in preparing our consolidated financial statements. Management’s estimates and judgments are inherently uncertain and may differ significantly from actual results achieved. Management considers an accounting estimate to be critical if the following conditions apply:

It is management’s view that the current assumptions and other considerations used to estimate amounts reflected in our consolidated financial statements are appropriate. However, actual results can differ significantly from those estimates under different assumptions and conditions.

We have identified the following critical accounting policies that require a significant amount of estimation or judgment to accurately present our financial position, results of operations and cash flows:

For a detailed discussion on the application of these and other accounting policies, see “Note 2 – Summary of Significant Accounting Policies” in the notes to our consolidated financial statements included elsewhere in this document.

Revenue Recognition: The Company accounts for revenue under Accounting Standards Codification (ASC) Topic - 606 - Revenue from Contracts with Customers of which the core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of revenue and cash flow arising from contracts with customers. We adopted the standard effective January 1, 2018 using the full retrospective method. Other than additional required disclosures, adoption of the new standard did not have a significant impact on our consolidated financial statements.

Our revenue is generated by services which are consumed as provided to our customers on the job site. Contracts for our services are negotiated at the corporate level and are frequently approved on a per job basis in the field, with jobs being completed in a short period of time, usually measured in days or months, and generally less than a year. Revenue is recognized as performance obligations have been completed on a daily basis either as Accounts Receivable or Unbilled Receivables.

Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of some of our customers to make required payments. These estimated allowances are periodically reviewed on a case by case basis, analyzing the customer’s payment history and information regarding the customer’s creditworthiness known to us. In addition, we provide an allowance for doubtful accounts which is based upon a review of outstanding receivables, historical collection information and existing economic conditions. Provisions for doubtful accounts are recorded when it is deemed probable that the customer will not make the required payments. If the financial condition of our customers deteriorates, resulting in their inability to make payments, additional allowances may be required.

Estimates of Depreciable Lives: We use the estimated depreciable lives of our long-lived assets to compute depreciation expense, to estimate future asset retirement obligations and to conduct impairment tests. We base the estimates of our depreciable lives on a number of factors, such as the environment in which the assets operate, industry factors including forecasted prices and competition, and the assumption that we provide the appropriate amount of capital expenditures while the asset is in operation to maintain economical operation of the asset and prevent untimely demise to scrap. The useful lives of our intangible assets are determined by the years over which we expect the assets to generate a benefit based on legal, contractual or other expectations.

We depreciate our operational assets over their depreciable lives to their salvage value, which is generally 20% of the acquisition cost. Typically, these assets contain a large amount of iron in their construction. We recognize a gain or loss upon ultimate disposal of the asset based on the difference between the carrying value of the asset on the disposal date and any proceeds we receive in connection with the disposal. Maintenance and repairs, which do not improve or extend the life of the related assets, are charged to expense when incurred. Refurbishments and renewals are capitalized when the value of the equipment is enhanced for an extended period.

We periodically analyze our estimates of the depreciable lives of our fixed assets to determine if the depreciable periods and salvage value continue to be appropriate. We also analyze useful lives and salvage value when events or conditions occur that could shorten the remaining depreciable life of the asset. We review the depreciable periods and salvage values for reasonableness, given current conditions. As a result, our depreciation expense is based upon estimates of depreciable lives of the fixed assets, the salvage value and economic factors, all of which require management to make significant judgments and estimates. If we determine that the depreciable lives should be different than originally estimated, depreciation expense may increase or decrease and impairments in the carrying values of our fixed assets may result, which could negatively impact our earnings.

Valuation of Long-lived Assets: Our property and equipment and intangibles are tested for potential impairment when circumstances or events indicate a possible impairment may exist. These circumstances or events are referred to as “trigger events” and examples of such trigger events include, but are not limited to, an adverse change in market conditions, a significant decrease in benefits being derived from an acquired business, a change in the use of an asset, or a significant disposal of a particular asset or asset class.

If a trigger event occurs, an impairment test is performed based on an undiscounted cash flow analysis. To perform an impairment test, we make judgments, estimates and assumptions regarding long-term forecasts of revenue and expenses relating to the assets subject to review. Market conditions, energy prices, estimated depreciable lives of the assets, discount rate assumptions and legal factors impact our operations and have a significant effect on the estimates we use to determine whether our assets are impaired. If the results of the undiscounted cash flow analysis indicate that the carrying value of the assets being tested for impairment are not recoverable, then we record an impairment charge to write the carrying value of the assets down to their fair value. Using different judgments, assumptions or estimates, we could potentially arrive at a materially different fair value for the assets being tested for impairment, which may result in an impairment charge.

Contingencies: In the ordinary course of business, we are subject to various claims, suits and complaints. We, in consultation with our external legal advisors, will provide for a contingent loss in the consolidated financial statements if, at the date of the consolidated financial statements, it is probable that a liability has been incurred and the amount can be reasonably estimated. If it is determined that the reasonable estimate of the loss is a range and that there is no best estimate within that range, a provision will be made for the lower amount of the range. Legal costs are expensed as incurred.

Income Taxes: We account for deferred income taxes using the asset and liability method and provide income taxes for all significant temporary differences in accordance with enacted tax laws and rates. Valuation allowances are established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. To assess the likelihood, we use estimates and judgment regarding our future taxable income, as well as the jurisdiction in which this taxable income is generated, to determine whether a valuation allowance is required. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character and in the related jurisdiction in the future. Evidence supporting this ability can include our current financial position, our results of operations, both actual and forecasted results, the reversal of deferred tax liabilities, and tax planning strategies as well as the current and forecasted business economics of our industry. Additionally, we record uncertain tax positions in the financial statements at their net recognizable amount, based on the amount that management deems is more likely than not to be sustained upon ultimate settlement with the tax authorities in the tax jurisdictions in which we operate. Due to its recent history of losses, the Company maintains a full valuation allowance for its deferred tax assets.

Cash Flow Estimates: Our estimates of future cash flow are based on the most recent available market and operating data for the applicable asset base at the time we made the estimate. Significant management judgment is necessary to evaluate the impact of operating and macroeconomic changes on us. Critical assumptions include projected revenue growth, gross profit margins, selling, general and administrative expenses, working capital fluctuations, capital expenditures, discount rates and terminal growth rates. Our cash flow estimates are used for all our valuation-based estimates detailed above.

Recently Issued Accounting Standards

For a discussion of new accounting standards, see “Note 2 – Summary of Significant Accounting Policies” in the notes to our consolidated financial statements included elsewhere in this document.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

As a smaller reporting company, we are not required to provide the information required by this Item.

Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

To the Stockholders and the Board of Directors of Aly Energy Services, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Aly Energy Services, Inc. and its subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Restatement of Prior Year Financial Statements

As discussed in Note 12 to the financial statements, the 2017 financial statements have been restated to correct a misstatement.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ RSM US LLP

We have served as the Company's auditor since 2015.

Houston, Texas

April 15, 2019

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

NOTE 1 — NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Nature of Operations

Aly Energy Services, Inc., together with its subsidiaries (“Aly Energy” or the “Company”), is a provider of oilfield services to leading oil and gas exploration and production (“E&P”) companies operating in unconventional plays in the United States (“U.S.”). Generally, the services we offer fall within two broad categories: surface rental and solids control. Our surface rental equipment includes a wide variety of large capacity tanks with circulating systems, associated pumps, separators, gas busters, mud mix plants and ancillary equipment. We also provide environmental containment berms to safeguard against spills from mud systems on the drilling rig site. Our solids control equipment includes large centrifuges, shakers, cuttings dryers and ancillary components that can be integrated into a closed loop mud system. We operate in the U.S., primarily in Texas, Oklahoma, and New Mexico.

Throughout this report, we may also refer to Aly Energy and its subsidiaries as “we”, “our” or “us”.

Basis of Presentation

Aly Energy has two wholly-owned subsidiaries with continuing operations: Aly Operating, Inc. and Aly Centrifuge Inc. Aly Operating, Inc. has one wholly-owned subsidiary, Austin Chalk Petroleum Services Corp. We operate as one business segment which services customers within the U.S.

The consolidated financial statements have been prepared in conformity with U.S. GAAP and include the accounts of Aly Energy and each of its subsidiaries in the consolidated balance sheets as of December 31, 2018 and 2017 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years ended December 31, 2018 and 2017. All significant intercompany transactions and account balances have been eliminated upon consolidation.

Reverse Stock Split

On August 7, 2018, the Company effected a 1-for-20 reverse stock split of its common stock (“Reverse Split”), as approved by its Board of Directors and stockholders. All information contained in these consolidated financial statements relating to the number of common shares, price per share and per share amounts, including such information related to options and the conversion feature of the Series A convertible preferred stock, have been retroactively restated to give effect to the Reverse Split. See Note 9 – Stockholders’ Equity for further detail.

Recapitalization

In September 2016, certain of the Company’s principal stockholders formed Permian Pelican, Inc. (“Pelican”), formerly Permian Pelican, LLC, with the objective of consummating a recapitalization transaction (the “Recapitalization”) whereby (i) our obligations under our then existing credit facility and various capital leases would be restructured and, (ii) the Company’s then outstanding redeemable preferred stock, subordinated note payable and contingent payment liability would be exchanged into common stock resulting in a gain on extinguishment of debt and other liabilities of $2.4 million. The Recapitalization, completed on January 31, 2017, had a significant impact on our capital structure and on our consolidated financial statements for the year ended December 31, 2017. See Note 13 – Recapitalization for further detail.

Reclassifications

Certain reclassifications have been made to prior period consolidated financial statements to conform to the current period presentation. These reclassifications had no effect on our consolidated financial position, results of operations or cash flows.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the balance sheet date and the amounts of revenue and expenses recognized during the reporting period. Areas where critical accounting estimates are made by management include:

The Company analyzes its estimates based on historical experience and various other indicative assumptions that it believes to be reasonable under the circumstances. Under different assumptions or conditions, the actual results could differ, possibly materially, from those previously estimated. Many of the conditions impacting these assumptions are outside of the Company’s control.

Major Customers and Concentration of Credit Risk

The Company’s assets that are potentially exposed to concentrations of credit risk consist primarily of cash and trade receivables.

The financial institutions in which the Company transacts business are large, investment grade financial institutions which are “well capitalized” under applicable regulatory capital adequacy guidelines, thereby minimizing its exposure to credit risks for deposits in excess of federally insured amounts.

The majority of the Company’s trade receivables are due from major and independent oil and gas companies operating within the U.S. land-based oil and gas industry. The industry has been, and will likely continue to be, characterized by significant volatility which may negatively impact our customers from time-to-time. The Company evaluates the financial strength of its customers quarterly and provides allowances for probable credit losses when deemed necessary.

During the year ended December 31, 2018, the Company derived revenue from 49 customers. Significant customers, customers which individually generated more than 10.0% of total revenue, collectively accounted for approximately $10.8 million, or 62.5% of our revenue. Amounts due from these customers included in accounts receivable and unbilled receivables as of December 31, 2018 aggregate to $1.2 million.

During the year ended December 31, 2017, the Company derived revenue from over 40 customers. Significant customers, customers which individually generated more than 10.0% of total revenue, collectively accounted for approximately $8.2 million, or 56.3% of our revenue. Amounts due from these customers included in accounts receivable and unbilled receivables as of December 31, 2017 aggregate to $1.8 million.

Cash

For purposes of the consolidated statements of cash flows, cash is defined as cash on-hand and balances in operating bank accounts. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. As of December 31, 2018 and 2017, we have no cash equivalents. Restricted cash serves as collateral for the Company's corporate credit card program.

Accounts Receivable, Unbilled Receivables and Allowance for Doubtful Accounts

Accounts receivable and unbilled receivables are stated at the amount which has been or will be billed to customers. Once billed, customer payments are typically due within 30 days. We provide an allowance for doubtful accounts based upon a review of outstanding receivables, historical collection information, existing economic conditions and specific identification. Provisions for doubtful accounts are recorded when it is deemed probable that the customer will not make the required payments. As of December 31, 2018 and 2017, the allowance for doubtful accounts was approximately $70,000 and $73,000, respectively.

Property and Equipment

Property and equipment are recorded at cost less accumulated depreciation and amortization. The cost of property and equipment currently in service less its residual value is depreciated on a straight-line basis over the estimated useful lives of the related assets. A residual value of 20% is used for asset types deemed to have a salvage value. Typically, these assets contain a large amount of iron in their construction. Leasehold improvements are amortized on a straight-line basis over the shorter of their economic lives or the lease term.

Estimated useful lives of property and equipment are as follows: