Aly Energy Services, Inc. - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

Form 10-Q

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

Period Ended June 30, 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 033-92894

(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 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 ☒

At August 14, 2018, the registrant had 690,918 shares of common stock, $0.001 par value, outstanding.

Documents Incorporated by Reference: None

ALY ENERGY SERVICES, INC.

(A Delaware Corporation)

INDEX

PART I – FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

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

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

The accompanying notes are an integral part of these condensed 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 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 condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of Aly Energy and each of its subsidiaries in the condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017, in the condensed consolidated statements of operations for the three and six months ended June 30, 2018 and 2017, and in the condensed consolidated statements of cash flows for the six months ended June 30, 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 in this Quarterly Report on Form 10-Q relating to the number of shares, price per share and per share amounts have been retroactively restated to give effect to the Reverse Split.

Interim Financial Information

The condensed consolidated balance sheet as of December 31, 2017 has been derived from our audited financial statements and the unaudited condensed consolidated financial statements of the Company are prepared in conformity with U.S. GAAP for interim financial reporting. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Therefore, these condensed consolidated financial statements should be read along with the annual audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented. Interim results for the three and six months ended June 30, 2018 may not be indicative of results that will be realized for the full year ending December 31, 2018.

Recapitalization

In September 2016, certain of the Company’s principal stockholders formed Permian Pelican, LLC (“Pelican”) 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. The Recapitalization, completed on January 31, 2017, had a significant impact to our capital structure and to our consolidated financial statements for the years ended December 31, 2017 and 2016. Please see our Annual Report on Form 10-K for the year ended December 31, 2017 for a complete description of the Recapitalization and the impact on our consolidated financial statements.

Use of Estimates

The preparation of condensed 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.

Reclassifications

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

NOTE 2 — LONG-LIVED ASSETS

Property and Equipment

Major classifications of property and equipment are as follows (in thousands):

Depreciation and amortization expense related to property and equipment for the three months ended June 30, 2018 and 2017 was $0.7 million. Depreciation and amortization expense related to property and equipment for the six months ended June 30, 2018 and 2017 was $1.4 million.

Intangible Assets

Intangible assets consist of the following (in thousands):

Total amortization expense for the three months ended June 30, 2018 and 2017 was approximately $0.2 million. Total amortization expense for the six months ended June 30, 2018 and 2017 was approximately $0.4 million.

NOTE 3 — LONG-TERM DEBT – RELATED PARTY

Long-term debt – related party consists of the following (in thousands):

As of December 31, 2017, subsequent to multiple amendments, the Company’s credit facility with Pelican consisted of a term loan, a revolving credit facility and a delayed draw term loan. The obligations under the credit facility are guaranteed by all of our subsidiaries and secured by substantially all of our assets. The credit facility contains customary events of default and covenants including restrictions on our ability to incur additional indebtedness, pay dividends or make other distributions, grant liens and sell assets. Borrowings under the credit facility are subject to monthly interest payments at an annual base rate of the six-month LIBOR rate on the last day of the calendar month plus a margin of 3.0%. The credit facility does not include any financial covenants. We were in full compliance with the credit facility as of June 30, 2018.

On January 22, 2018, the Company entered into Amendment No. 4 to the credit facility which provided for a swing line without changing the aggregate available borrowings under the facility. The Company had the ability to borrow up to $0.6 million under the swing line until June 30, 2018 at which time the swing line matured. Simultaneous to the maturity of the swing line, the Company entered into the Third Amended and Restated Credit Agreement which, among other things, (i) combines the outstanding balances on the delayed draw term loan and the term loan and requires monthly principal payments of approximately $83,000 on the aggregate outstanding balance, (ii) expands availability on the revolving credit facility by $0.7 million while simultaneously reducing the aggregate availability under the swing line and the delayed draw term loan by the same amount, and (iii) extends the maturity date 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.

Under the revolving credit facility, the Company has the ability to borrow the lesser of 80% of eligible receivables, as defined in the credit agreement, and $1.7 million. As of June 30, 2018, there was $1.0 million outstanding under the revolving credit facility and the Company had the ability to borrow an incremental $0.7 million.

NOTE 4 — STOCK-BASED COMPENSATION

As of June 30, 2018 and December 31, 2017, we had two stock-based compensation plans with outstanding options. Only one of our plans is currently available to grant incentive stock options, non-qualified stock options and restricted stock to employees and non-employee members of the board of directors.

2017 Stock Option Plan

Effective April 4, 2017, the 2017 Stock Option Plan (the “2017 Plan”) was approved by the board of directors. On May 30, 2017, we granted options to purchase approximately 843,094 shares of common stock under the 2017 Plan which was the maximum amount authorized. The option contract term is 10 years and the exercise price is $2.00. The options vested and became exercisable immediately upon grant. The fair value of the award was estimated using a Black-Scholes fair value model. The valuation of stock options requires us to estimate the expected term of award, which was estimated using the simplified method, as the Company does not have sufficient historical exercise information. The valuation of stock option awards is also dependent on historical stock price volatility. In view of our limited trading volume, volatility was calculated based on historical stock price volatility of the Company’s peer group.

Options to purchase 843,094 common shares under the 2017 Plan were outstanding and fully vested as of June 30, 2018 and December 31, 2017. We expensed stock-based compensation of $0.6 million for the full fair value of the award in May 2017.

Included in the options outstanding as of June 30, 2018 are options to purchase 252,928 common shares which were issued to our former chief executive officer, Shauvik Kundagrami. In accordance with the terms of the 2017 Plan, if Mr. Kundagrami does not exercise his options on or prior to August 23, 2018, the options will be forfeited.

Omnibus Incentive Plan

The Omnibus Incentive Plan (the “2013 Plan”) was approved by the board of directors on May 2, 2013. The option contract term is 10 years and the exercise price is $80.00. The options vest and are exercisable if a liquidity event, as defined in the 2013 Plan, occurs and certain conditions are met.

On May 2, 2013, we granted 16,921 common shares under the 2013 Plan. Options to purchase 11,706 common shares under the 2013 Plan were outstanding as of June 30, 2018 and December 31, 2017. Subsequent to the adoption of the 2017 Plan, options are no longer are permitted to be granted under the 2013 Plan and no options were vested as of June 30, 2018 and December 31, 2017. The aggregate unrecognized compensation cost related to these non-vested stock option awards was approximately $0.3 million (see Note 13 – Stock-Based Compensation in our Annual Report on Form 10-K for the year ended December 31, 2017 for additional detail). Such amount will be recognized in the future upon occurrence of an event that results in a vesting of the options. During the three and six months ended June 30, 2018 and the three months ended June 30, 2017, there were no forfeited options. There were 418 forfeited options during the six months ended June 30, 2017.

NOTE 5 – STOCKHOLDERS’ EQUITY AND SUBSEQUENT EVENT

On August 7, 2018, the Company effected the Reverse Split, a 1-for-20 reverse stock split of its common stock, as approved by its Board of Directors and stockholders. Under the terms of the Reverse Split, each 20 shares of common stock issued and outstanding as of such effective date, was automatically reclassified and changed into one share of common stock without further action by the stockholder. In lieu of issuing fractional shares in connection with the Reverse Split, holders received the proportionate fraction of $7.00 per share in cash. All share and per share amounts on this Quarterly Report on Form 10-Q have been retroactively restated to reflect the Reverse Split.

We filed an amendment to our certificate of formation, effective August 7, 2018, reducing our authorized common stock from 25 million to 15 million shares and reducing our authorized preferred stock from 10 million to 5 million shares.

Shares of common stock previously issued and held as treasury shares were escheated to applicable governmental authorities and, in connection with the Reverse Split, were reinstated as outstanding shares of common stock.

NOTE 6 — CONTROLLING SHAREHOLDER

Controlling Shareholder – Pelican

On January 31, 2017 upon completion of the Recapitalization, Pelican had the power to vote the substantial majority of the Company’s outstanding common stock. As of June 30, 2018, six of our seven board members, including two of our executive officers, and our chief financial officer hold an ownership interest in Pelican.

As of June 30, 2018 and December 31, 2017, Pelican owned Series A convertible preferred stock that represented approximately 80.7% of our common stock (excluding the impact of options), or 2,881,400 common shares (giving effect to the Reverse Split). The shares of Series A convertible preferred stock carry a liquidation preference of $1,000 per share or $17.3 million upon issuance.

In connection with our credit facility with Pelican, during the three and six months ended June 30, 2018, we recorded interest expense due to Pelican of approximately $92,000 and $0.2 million, respectively. During the three and six months ended June 30, 2017, we recorded interest expense due to Pelican of $0.4 million and $0.6 million, respectively. Approximately $0.3 million of the aggregate expense recorded during the three and six months ended June 30, 2017 related to a debt modification fee in connection with Amendment No. 2 to the credit facility which was entered into on May 23, 2017. The fee consisted of 1,200 shares of our Series A convertible preferred stock. Approximately $0.2 million of the aggregate expense recorded during the six months ended June 30, 2017 was included in the obligations exchanged as part of the Recapitalization. Please see our Annual Report on Form 10-K for the year ended December 31, 2017 for a complete description of the Recapitalization, including related party transactions with Pelican.

Our condensed consolidated balance sheet includes accrued interest due to Pelican of approximately $30,000 and $26,000 as of June 30, 2018 and December 31, 2017, respectively.

Effective June 30, 2018, Pelican assigned and transferred its rights under our credit agreement to PPF (see Note 3 – Long-Term Debt – Related Party for additional detail).

NOTE 7 — REVENUE FROM CONTRACTS WITH CUSTOMERS

Adoption of New Accounting Standards - ASU 2014-09, Revenue - Revenue from Contracts with Customers

On January 1, 2018, we adopted accounting standards update (“ASU”) 2014-09, Revenue from Contracts with Customers and all the related amendments (“new revenue standard” or “ASC 606”) to all contracts using the full retrospective method. The Company does not incur significant contract costs. The Company’s services and rental contracts are primarily short-term in nature, and therefore, based on management’s assessment, the impact of the adoption of the new revenue standard was not significant.

Revenue Recognition

The core principle of ASC 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This is accomplished by applying the following steps:

Our services are generally sold based upon quotes or contracts with customers that include fixed or determinable prices. Our typical payment terms are 30 days and our sales arrangements do not contain any significant financing component for our customers. Our customer arrangements do not generate contract assets or liabilities.

We have concluded that our performance obligations to provide equipment rental, rig-up/rig-down and transportation services constitute a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to our customer. The activities included in the “other revenue” stream are not distinct as our customers would not benefit from these activities separately.

Rental Services – We are a provider of solids control systems and surface rental equipment, including 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). We generate revenue primarily from renting this equipment at per-day rates. In connection with certain of our solids control operations, we also provide personnel to operate our equipment at the customer’s location at per-day rates. We recognize revenue on rental services upon completion of each day of services.

Transportation of Equipment and Rig-Up/Rig-Down Services – We offer transportation of our rental equipment to the well site and the rig-up/rig-down of such equipment. These services are charged to the client at flat rates per job or at an hourly rate. We recognize revenue on transportation and rig-up/rig-down services at the point in time when such services have been completed.

Other – Upon request, we sometimes sell chemicals, supplies and other consumables to our customers. We recognize revenue from the sale of consumables when they are used on site.

Chargeable Sales of Damaged Assets – Customer charges for damaged equipment for which there is a recovery under the contract are considered asset sales and are reported within selling, general and administrative expenses net of the associated net book value for the damaged asset.

Sales and Other Related Taxes – Taxes assessed on sales transactions are not included in revenue.

The primary method used to determine standalone selling prices for our services is a “cost plus margin” approach under which we forecast the aggregate cost of satisfying a performance obligation and then add an appropriate margin for that distinct good or service. The prices we are able to charge and the margins we require depend on the demand of our potential and existing customers and the supply of equipment and services available to such customers from us and our competitors. When the supply exceeds the demand, the competitive environment intensifies significantly, particularly because many of the products we supply are not differentiated from the products provided by our competitors. Our customers choose to use our equipment and services primarily based upon the pricing we offer and our ability to execute efficiently and safely.

The following table presents our service revenue disaggregated by revenue source (in thousands):

We maintain an allowance for doubtful accounts to reflect estimated losses resulting from the failure of customers to make required payments. On an ongoing basis, the collectability of accounts receivable is assessed based upon historical collection trends, current economic factors and the assessment of the collectability of specific accounts. We evaluate the collectability of specific accounts and determine when to grant credit to our customers using a combination of factors, including the age of the outstanding balances, evaluation of customers’ current and past financial condition, recent payment history, current economic environment, and discussions with our personnel and with the customers directly. Accounts are written off when it is determined the receivable will not be collected. If circumstances change, our estimates of the collectability of amounts could change by a material amount.

Arrangements with Multiple Performance Obligations

Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price.

Practical Expedients and Exemptions

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within selling, general and administrative expenses.

We do not incur any incremental costs to obtain or fulfill our customer contracts which require capitalization under ASC 606 and have elected the practical expedient afforded to expense such costs if incurred.

Adjustments to Previously Reported Financial Statements from the Adoption of ASC 606

In accordance with the new revenue standard requirements, there was no impact of adoption on our condensed consolidated balance sheet. The impact of adoption on our condensed consolidated statement of operations is reflected below (in thousands):

NOTE 8 – EARNINGS PER SHARE

Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed in the same manner as basic earnings per share except that the denominator is increased to include the number of additional shares of common stock that could have been outstanding assuming the exercise of outstanding stock options and restricted stock or other convertible instruments, as appropriate.

For the three months and six months ended June 30, 2018 and the three months ended June 30, 2017, the effect of incremental shares is antidilutive so the diluted earnings per share will be the same as the basic earnings per share. The calculations of basic and diluted earnings per share for the six months ended June 30, 2017 are shown below (in thousands, except for shares):

 __________ 

Securities excluded from the computation of basic and diluted earnings per share are shown below:

 ____________

NOTE 9 – NEW ACCOUNTING STANDARDS

Adoption of New Accounting Standards - ASU 2014-09, Revenue - Revenue from Contracts with Customers

On January 1, 2018, we adopted the new accounting standard ASC 606, Revenue from Contracts with Customers and all the related amendments to all contracts using the full retrospective method. Please see Note 7 – Revenue from Contracts with Customers for additional disclosure related to ASC 606.

Other Accounting Standards Recently Adopted

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting . The guidance in this ASU applies to all entities that change the terms or conditions of a share-based payment award. The amendments provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718, Compensation – Stock Compensation, to the modification of the terms and conditions of a share-based payment award. The amendments in ASU 2017-09 include guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The new standard is effective for the Company beginning on January 1, 2018 and should be applied prospectively to awards modified on or after the adoption date. The adoption of ASU 2017-09 did not have an impact on our financial condition or results of operations.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments affect all companies and other reporting organizations that must determine whether they have acquired or sold a business. The amendments are intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments provide a more robust framework to use in determining when a set of assets and activities is a business. The new standard is effective for the Company beginning on January 1, 2018. The adoption of ASU 2017-01 did not have an impact on our financial condition or results of operations.

In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements, which makes minor corrections and clarifications that affect a wide variety of topics in the Accounting Standards Codification, including an amendment to ASC Topic 820, Fair Value Measurement, which clarifies the difference between a valuation approach and a valuation technique when applying the guidance of that Topic. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. The transition guidance for the ASC Topic 820 amendment must be applied prospectively because it could potentially involve the use of hindsight that includes fair value measurements. The new guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those years. The Company adopted ASU 2016-19 on January 1, 2018. The adoption did not have an impact on our financial condition or results of operations.

Accounting Standards Not Yet Adopted

In January 2018, the FASB issued ASU 2018-02, Reporting Comprehensive Income (Topic 220). This ASU gives entities the option to reclassify to retained earnings the tax effects resulting from the Tax Reform Act related to items in AOCI that the FASB refers to as having been stranded in AOCI. The standard may be applied retrospectively to each period in the year of adoption. This ASU will also require new disclosures regarding our accounting policy for releasing the tax effects in AOCI. This ASU is effective in the first quarter of 2019, although early adoption is permitted. We are assessing the timing of adoption of the new standard and its potential impact on our future consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which will replace the existing lease guidance. The standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. Additional disclosure requirements include qualitative disclosures along with specific quantitative disclosures with the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for the Company for annual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The new standard is required to be applied with a modified retrospective approach to each prior reporting period presented. We are currently evaluating the standard to determine the impact of its adoption on the consolidated financial statements.

Item 2. 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 condensed consolidated financial statements and the related notes thereto included elsewhere in “Item 1. Condensed Consolidated Financial Statements” in this Form 10-Q.

Cautionary Note Regarding Forward-Looking Statements

This Current Report on Form 10-Q 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 our Annual Report on Form 10-K for the year ended December 31, 2017.

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 Current Report on Form 10-Q 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 Current Report on Form 10-Q.

Overview of Our Business

Aly Energy Services, Inc. (“Aly Energy”, the “Company”, or “we”) 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 internal circulating systems, associated pumps, separators, gas busters, mud mix plants and ancillary equipment necessary to manage the flow of mud in and out of the well bore during drilling operations. We also provide environmental containment berms to safeguard against spills from the mud system. Our solids control equipment and services remove low gravity formation particulates that accumulate in mud systems during the drilling process. Once processed, the mud can be reused which eliminates unnecessary waste and disposal. 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. 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 the Eagle Ford shale.

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. Our major customers include leading companies such as EOG Resources, Inc., Pioneer Natural Resources, XTO Energy Inc., Sanchez Oil and Gas Corporation and Devon Energy Corporation.

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. Commodity prices have increased significantly over the past two years stimulating an increase in onshore drilling and completion activity and a consequent increase in demand for our services. The average U.S. land-based drilling rig count was approximately 650 rigs in January 2017 and increased approximately 60.0% to more than 1,050 rigs by June 2018. The favorable impact of the recent increase in the rig count on demand for our services has been bolstered by a consistently high proportion of rigs drilling directional and horizontal wells. Rigs drilling directional and horizontal wells typically utilize oil-based or other sophisticated mud systems which creates demand for our specialized mud circulating tanks, pumps, containment systems, solids control and associated equipment. The proportion of rigs drilling directional and horizontal wells as a percentage of total U.S. land-based drilling rigs was approximately 89.0% and 94.3% in January 2017 and June 2018, respectively.

In the near-term, we believe that the existing commodity price environment will either hold or improve slightly supporting continued strong demand for our services and enabling us to continue to increase the prices for our equipment and services. Because our owned equipment is fully utilized, greater margins and increased margins as a percent of revenue resulting from incremental work and higher pricing will be partially offset to the extent we are required to use third-party providers of equipment and personnel to meet demand. In order to minimize the use of third-party providers, we are planning to invest in newly purchased, refurbished or fabricated equipment which will meet increased demand and/or replace existing sub-rented equipment. In July 2018, we committed to purchasing 6 telehandlers, or forklifts, to replace sub-rented telehandlers which will result in a reduction of cost of services of approximately $0.3 million annually. We believe our cash-on-hand, our positive operating cash flow, and our availability under our credit facility will be sufficient to fund our planned capital expenditure program.

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 - the rig-up/rig-down of our equipment at the customer site, (iii) transportation services – 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 aggregate revenue fluctuates with the utilization of and the prices we charge for our equipment and services. Utilization of our equipment is primarily determined by the U.S. land-based drilling 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. To the extent we have the opportunity to generate additional revenue from increased activity, we will require the use of third-party equipment and services and third-party expenses will increase as a percent of revenue. In addition, with increased demand for oilfield services, the demand for sub-rental equipment and labor will also increase and we may experience increases in costs for third-party equipment and personnel which would further increase third-party expenses as a percent of revenue.

In order to mitigate the potential increase 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 will be fabricated in-house. Our capital expenditure plan includes forklifts, for which we have already entered into a purchase commitment, open top tanks, mud mixing plants, and driveovers, among other items. We anticipate that, if implemented as planned, the completion of the capital expenditure program could result in an annual reduction of cost of services of at least $0.5 million annually.

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 three months and six months ended June 30, 2018 and 2017, respectively (in thousands):

Adjusted EBITDA increased by approximately $93,000 to $1.1 million for the three months ended June 30, 2018 from $1.0 million for the three months ended June 30, 2017 and increased by $0.7 million to $2.1 million for the six months ended June 30, 2018 from $1.4 million for the six months ended June 30, 2017. The improved performance was driven primarily by increases in gross margin as operating expenses, which are primarily variable, increased at a slower rate than revenue due to price increases, which increase revenue with no additional expense, and operating efficiencies achieved by maintaining a lean cost structure.

Results for the Three Months Ended June 30, 2018 Compared to the Three Months Ended June 30, 2017

The following table summarizes the change in our results of operations for the three months ended June 30, 2018 from the three months ended June 30, 2017 (in thousands):

Overview. Our results of operations improved significantly when comparing the three months ended June 30, 2018 to the three months ended June 30, 2017 due to a slight increase in revenue and a significant decrease in expenses. Two of the most significant drivers of demand for our services, the price of oil and the U.S. land-based drilling rig count, increased substantially when comparing the two periods: the price of oil increased over 40.0% and the U.S. land-based drilling rig count increased over 20.0%. As a result, demand for our products and services remained strong period-over-period. We maintained full utilization of our owned and sub-rented surface rental equipment and we increased utilization of our centrifuge fleet. Moreover, the increase in the price of oil, combined with strong demand, bolstered our ability to raise the prices we charge our new and existing customers. Despite slightly greater activity, we decreased expenses, when comparing the three months ended June 30, 2018 to the three months ended June 30, 2017, by maintaining a lean cost structure and benefitting from the elimination of certain non-recurring expenses.

Revenue. Our revenue for the three months ended June 30, 2018 was $4.4 million, an increase of 5.1%, compared to $4.2 million for the three months ended June 30, 2017. A combination of increased activity for centrifuges and increased pricing on lead surface rental products were the primary drivers of the increase in revenue. The count of revenue-generating days for our centrifuges increased approximately 20.0% period-over-period while utilization on other lead products remained fairly flat or decreased slightly. The increase in centrifuge activity was enabled by our ongoing centrifuge refurbishment plan which has expanded the number of centrifuges available to generate revenue. Although demand for our lead surface rental products increased period-over-period, our owned equipment was 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. When comparing the three months ended June 30, 2018 to the three months ended June 30, 2017, the pricing on our tanks and pumps, our lead surface rental products, increased by approximately 20% to 30% due primarily to significant price increases to existing customers in the beginning of 2018. Pricing for our primary solids control products increased slightly as we brought on incremental work at higher pricing. Increases in activity and pricing on certain lead products was partially offset by a decline of approximately 30% in revenue generated from the rental of auxiliary equipment. Demand for auxiliary equipment is customer specific and we believe the revenue stream will return to expected levels during the third quarter.

Operating Expenses. Our operating expenses for the three months ended June 30, 2018 decreased 3.4% to $2.5 million, or 57.6% of revenue, from $2.6 million, or 62.7% of revenue, for the three months ended June 30, 2017. The slight decrease in costs was due primarily to the reduction in third-party expense resulting from the impact of investing in diesel mud pumps to replace sub-rented pumps partially offset by an increase in repair and maintenance expenses. The decrease in operating expenses as a percent of revenue is primarily due to our discipline in maintaining a lean cost structure despite slight increases in activity and our ability to increase pricing to our customers more quickly than our costs increased.

Depreciation and Amortization. Due to minimal capital investment and insignificant asset disposals during 2017 and the first half of 2018, depreciation and amortization remained relatively flat year-over-year at $0.9 million for the three months ended June 30, 2018 and 2017.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $1.2 million, or 26.3% of revenue, for the three months ended June 30, 2018 compared to $1.3 million, or 30.4% of revenue, for the three months ended June 30, 2017. Selling, general and administrative expenses consist of overhead costs which we generally consider to be fixed. The year-over-year decrease of $0.1 million, or 8.9%, is primarily due to decreases in non-recurring and non-cash expenses to approximately $0.4 million during the three months ended June 30, 2018 from approximately $0.7 million for the three months ended June 30, 2017 (see further discussion in “How We Evaluate Our Operations” section above). These decreases were partially offset by increases in compensation to existing employees and by an increase in headcount of selling, general and administrative employees to an average of 15 employees during the three months ended June 30, 2018 from 11 employees during the three months ended June 30, 2017. With the improved financial results we are experiencing, we have increased headcount in order to facilitate the segregation of duties and to strengthen our internal controls as well as to manage the increased activity levels.

Interest Expense, Net. Interest expense, net, consisting of interest on insurance financing and other miscellaneous interest expense, was approximately $3,000 for the three months ended June 30, 2018 and June 30, 2017.

Interest Expense – Related Party. During the three months ended June 20, 2018, we recorded approximately $92,000 of interest expense due to Pelican, a related party. Interest expense due to Pelican for the three months ended June 30, 2017 was $0.4 million and included an amendment fee of $0.3 million related to our credit facility with Pelican.

Income Taxes. The difference in the effective tax rate from the statutory rate is due to our continued full valuation allowance on net deferred tax assets. Income tax expense is from Texas Margin Tax. The Company has sufficient Net Operating Losses carryforwards to offset federal income tax and other state income taxes.

Results for the Six Months Ended June 30, 2018 Compared to the Six Months Ended June 30, 2017

The following table summarizes the change in our results of operations for the six months ended June 30, 2018 from the six months ended June 30, 2017 (in thousands):

Overview. Our results of operations, excluding the one-time gain on extinguishment of debt and other liabilities, improved significantly when comparing the six months ended June 30, 2018 to the six months ended June 30, 2017 due to increased activity and pricing 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 U.S. land-based drilling rig count, increased substantially when comparing the two periods: the price of oil increased over 30.0% and the U.S. land-based drilling rig count increased over 25.0%. As a result of the increased demand during 2018, we were able to increase our count of revenue-generating days and we were able to increase the prices we charge to our customers. Because our variable costs increased at a rate slower than revenue and our fixed costs remained relatively flat over an increased revenue base, excluding the positive one-time impact of the Recapitalization in January 2017, we experienced stronger overall results for the six months ended June 30, 2018 when compared to the six months ended June 30, 2017. Please see our Annual Report on Form 10-K for the year ended December 31, 2017 for a complete description of the Recapitalization and the impact on our consolidated financial statements for the year ended December 31, 2017.

Revenue. Our revenue for the six months ended June 30, 2018 was $8.7 million, an increase of 24.4%, compared to $7.0 million for the six months ended June 30, 2017. Increased activity for our solids control services and increased pricing on our surface rental products were the primary drivers of the increase in revenue when comparing the six months ended June 30, 2018 to the six months ended June 30, 2017. The count of revenue-generating days for our solids control services increased over 30.0% when comparing the six months ended June 30, 2018 to the six months ended June 30, 2017 while utilization on surface rental products remained relatively flat. Although we experienced an increase in demand for all of our products and services, the centrifuge refurbishment program enabled us to increase our available fleet of centrifuges and add jobs while it became more difficult to access additional third-party surface rental equipment at reasonable pricing. When comparing the six months ended June 30, 2018 to the six months ended June 30, 2017, the pricing on our tanks and pumps, our lead surface rental products, increased by approximately 20% to 30% due primarily to significant price increases to existing customers in the beginning of 2018. Pricing for our primary solids control products increased slightly as we brought on incremental work at higher pricing.

Operating Expenses. Our operating expenses for the six months ended June 30, 2018 increased 12.7% to $5.1 million, or 58.9% of revenue, from $4.6 million, or 65.0% of revenue, for the six months ended June 30, 2017. Both payroll and related expenses and third-party expenses increased period-over-period due to the increase in activity; however, they increased at a slower rate than revenue as we minimized non-productive labor and effectively managed our sub-rental fleet. Repair and maintenance expenses also increased as we maximized the amount of available equipment in our fleet in order to meet demand.

Depreciation and Amortization. Due to minimal capital investment and insignificant asset disposals during 2017 and the first half of 2018, depreciation and amortization remained relatively flat year-over-year at $1.8 million for the six months ended June 30, 2018 and 2017.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased slightly to $1.9 million, or 21.7% of revenue, for the six months ended June 30, 2018 compared to $1.8 million, or 26.2% of revenue, for the six months ended June 30, 2017. Selling, general and administrative expenses consist of overhead costs which we generally consider to be fixed. The year-over-year increase of approximately $56,000, or 3.0%, is primarily due to non-recurring and non-cash expenses of $0.4 million and $0.8 million for the six months ended June 30, 2018 and 2017, respectively (see further discussion in “How We Evaluate Our Operations” section above). These decreases were partially offset by increases in compensation to executive management to return to contractual levels and by an increase in headcount of selling, general and administrative employees to an average of 15 employees during the six months ended June 30, 2018 from 11 employees during the six months ended June 30, 2017. With the improved financial results we are experiencing, we have increased headcount in order to improve our ability to segregate duties and strengthen our internal controls as well as to manage the increased activity levels.

Interest Expense, Net. Interest expense, net, consisting primarily of interest on insurance financing and other miscellaneous interest expense, was approximately $9,000 for the six months ended June 30, 2018. Interest expense, net was slightly higher during the six months ended June 30, 2017, approximately $16,000, due to interest expense of $13,000 which was eliminated in the Recapitalization. Please see our Annual Report on Form 10-K for the year ended December 31, 2017 for a complete description of the Recapitalization and the impact on interest expense.

Interest Expense – Related Party. During the six months ended June 20, 2018, we recorded $0.2 million of interest expense due to Pelican, a related party. Interest expense due to Pelican for the six months ended June 30, 2017 was $0.6 million and included an amendment fee of $0.3 million related to our credit facility with Pelican.

Income Taxes. The difference in the effective tax rate from the statutory rate is due to our continued full valuation allowance on net deferred tax assets. Income tax expense is from Texas Margin Tax. The Company has sufficient Net Operating Losses carryforwards to offset federal income tax and other state income taxes.

Liquidity and Capital Resources

Net Cash Provided by Operating Activities. During the six months ended June 30, 2018 and 2017, operating activities generated $2.0 million and $0.2 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 $0.5 million of cash during the six months ended June 30, 2018 compared to using $0.8 million during the six months ended June 30, 2017. During the six months ended June 30, 2018, we reduced lapse days, measured as the number of days elapsed from the last revenue generating day of the job to the creation of the invoice, by approximately 40 days which had a significant impact on collections. The benefit of strong collections during the six months ended June 30, 2018 was only partially offset by the increased vendor payments required to return to our typical payment terms of 60 days.