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ALY ENERGY SERVICES, INC. - 10-K - 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 this Form 10-K.

Beginning on April 16, 2014, our financial results include the financial results of the business acquired in the United Acquisition. Beginning on July 1, 2014, our financial results include the financial results of Evolution.

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.



History of Our Business



Since 2012, we have completed three acquisitions: the acquisition of Austin Chalk in October 2012, the acquisition of United and the leased fixed assets associated with that business in April 2014, and the acquisition of Evolution in July 2014.

Austin Chalk is a provider of high performance, explosion-resistant rental equipment used primarily in land-based horizontal drilling. Austin Chalk currently offers a robust inventory of surface rental equipment as well as roustabout services, including the rig-up and rig-down of equipment and the hauling of equipment to and from the customer's location.

United operates within the solids control sector of the oilfield services industry, offering its customers the option of renting centrifuges and auxiliary solids control equipment without personnel or the option of paying for a full-service solids control package which includes operators on-site 24 hours a day. United owns centrifuges which are differentiated from the competition due to the ability to remove the rotating assembly from a centrifuge within 45 minutes while on the rig site thereby minimizing customer down time.

Evolution specializes in providing MWD services. Subsequent to the acquisition, we expanded the Evolution service offering by adding full package directional drilling services. In addition, we fabricated five MWD kits that we believe provide a technological advantage over other MWD kits on the market.

Subsequent to the acquisition of each of these businesses, we have made significant investments to expand their operations and capitalize on organic growth opportunities in existing and expansion markets. We consistently seek opportunities to bundle product offerings and to cross sell services across markets and product lines, which we believe increases client retention and the utilization of our equipment.


Overview of Our Business


We are a provider of solids control systems, surface rental equipment, and directional drilling and MWD services. 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, portable mud mixing plants, containment systems, and MWD kits. In conjunction with the rental of some of our solids control packages and MWD kits, 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. We service the Permian Basin (in Texas and New Mexico), Eagle Ford Shale, Utica Shale, Marcellus Shale, Woodford Shale, Granite Wash, Mississippian Lime, and Tuscaloosa Marine Shale. Our primary operating yards, shop and repair facilities, and division management are located in Giddings, Texas, San Angelo, Texas, Prosper, Texas, and Houston, Texas.




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We derive the majority of our operating revenues from day rates or hourly rates charged for the rental of our equipment and for the services provided by our personnel. The price we charge for our services depends on both the level of activity within the geographic area in which we operate and also the competitive environment.

Our operating costs do not fluctuate in direct proportion to changes in revenues. Our operating expenses consist of both fixed and variable costs. Although most variable costs are highly correlated with revenues and activity, certain variable costs, such as sub-rental equipment expenses and third party trucking expenses, can be reduced as a percentage of revenues by our investment in new rental and transportation equipment.



Industry Trends and Outlook



We operate in the commodity-driven, cyclical oil and gas industry. From 2011 through mid-2014, the industry operated in an environment where crude oil prices were relatively stable and, except for comparatively short intervals, generally traded at prices at or in excess of $100 per barrel. However, subsequent to the third quarter of 2014, crude oil prices have declined significantly due to a variety of factors, including, but not limited to, continued growth in U.S. oil production, weakened outlooks for the global economy and continued strong international crude oil supply resulting in part from OPEC's unexpected decision to maintain oil production levels. As a result of the weaker crude oil price environment, many crude oil development prospects have become less economical for exploration and production operators, leading to a dramatic reduction in U.S. land drilling rig counts and weaker demand for oilfield services, such as the services we provide. This trend has continued into 2016, with further commodity price decreases and declines in U.S. land rig counts from 2015 levels experienced year-to-date. The chart below illustrates the significant decline in both the price of crude oil and the land-based drilling rig count in 2015 when compared to the prior four years:


                           Average Baker
                               Hughes
        WTI Cushing          U.S. Land
Year   Crude Oil(1)       Drilling Rigs(2)
2011   $       94.88                  1,846
2012   $       94.05                  1,871
2013   $       97.98                  1,705
2014   $       93.17                  1,804
2015   $       48.66                    943




(1)   Represents the average of the daily prices for each of the years presented.
      Source: U.S. Energy Information Administration, Bloomberg.

(2)   Represents the average of the weekly rig counts for each of the years
      presented. Source: www.bakerhughes.com





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In April 2015, in order to partially mitigate the significant declines in pricing and utilization of our equipment, we committed to a reorganization initiative to strengthen our sales and marketing efforts, consolidate support functions, and operate more efficiently. The reorganization effort included, but was not limited to, training our salesforce to enable the cross-selling of our product lines in certain geographical markets, sharing a common support services infrastructure across all reporting units, reducing headcount and wage rates, and rebranding and launching a new web site to increase awareness of our service lines.

In the second and third quarters of 2015, we moved forward aggressively with the initiative and implemented significant reductions in headcount, field wage rates, and salaries of the management team and support personnel. We experienced the impact of these cost cutting measures late in the third quarter and during the fourth quarter of 2015.

In October 2015, in response to additional anticipated revenue declines, we instituted another round of cost cutting measures, including further headcount and wage rate reductions. We believe that the impact of these initiatives will be fully recognized in the first quarter of 2016.

As a result of our cost cutting initiatives, we successfully decreased operating expenses as a percentage of revenue to 63.3% in the fourth quarter of 2015 compared to 71.8% for the first quarter of 2015 and decreased the monthly run rate for selling, general and administrative expenses, excluding both non-cash and non-recurring transactions, by approximately 40% when comparing the fourth quarter of 2015 to the first quarter of 2015. However, as we enter 2016, oil prices remain low and we expect further reductions in the rig count. We believe we may begin to see increases in activity in late 2016 and early 2017, but we do not anticipate any significant increases in rig count to occur until 2018. Although we have been successful at improving the efficacy of our sales organization, operating more efficiently, and implementing multiple rounds of cost cuts in 2015, we believe we will continue to face significant challenges over the next twelve to eighteen months due to depressed and uncertain market conditions. These challenges have resulted in a significant negative impact on our operations, financial results and ability to access capital during 2015 and we anticipate such challenges will continue in 2016 and beyond.


Results of Operations


Our results of operations depend on the demand for our services and our ability to provide high quality equipment and service to satisfy that demand while maintaining an efficient cost structure. During the fourth quarter of 2015, our revenues were $6.0 million, which was a decline of 58.9% when compared to revenues of $14.7 million during the fourth quarter of 2014. The decline in revenue was a result of both decreased activity, particularly in our surface rental offering where activity declined by 30 to 40%, and decreased pricing of our core products and services of approximately 25 to 35% when comparing the fourth quarter of 2015 to the fourth quarter of 2014. Despite significant declines in pricing, by the end of 2015, after implementing significant cost cutting measures, we returned to a cost structure in which operating expenses as a percentage of revenue were only slightly higher in the fourth quarter of 2015 when compared to the fourth quarter of 2014.

Results for the Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014



The following table summarizes the change in our results of operations for the
year ended December 31, 2015 when compared to the year ended December 31, 2014.
The year ended December 31, 2014 includes the financial results of both United
and Evolution (the "Acquisitions") beginning on April 16, 2014 and July 1, 2014,
respectively (in thousands):




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                                                       For the Years Ended
                                                           December 31,
                                                        2015           2014


Revenues                                             $    29,102     $ 42,504
Expenses:
Operating Expenses                                        19,427       23,351
Depreciation and Amortization                              6,730        4,959
Selling, General and Administrative Expenses               9,274        8,258
Goodwill Impairment                                       11,143            -

Total Expenses                                            46,574       36,568

Operating Income/(Loss)                                  (17,472 )      5,936

Interest Expense, Net                                      1,963        1,317

Income/(Loss) Before Income Taxes                        (19,435 )      4,619

Income Tax Expense/(Benefit)                              (3,541 )      2,006

Net Income/(Loss)                                        (15,894 )      2,613

Preferred Stock Dividends                                    687          467
Accretion of Preferred Stock, Net                           (127 )        (57 )

Net Income/(Loss) Available to Common Stockholders $ (16,454 ) $ 2,203




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Our revenues for the year ended December 31, 2015 were $29.1 million, a decrease of 31.5%, compared to $42.5 million for the year ended December 31, 2014. While the year ended December 31, 2014 included only 8.5 months and 6 months of operations for United and Evolution, respectively, the effect of a full year of activity for the Acquisitions was more than offset by significant declines in activity and pricing. Our activity is directly tied to drilling activity and, as mentioned in the industry trends and outlook section of this report, the average U.S. land drilling rig count for 2015 dropped 48% from the 2014 count. This decrease in activity resulted in intense competition in the oilfield services sector, which, in turn, required us to reduce pricing significantly in order to retain existing customers and attract new customers. Our surface rental business has suffered the most in this downturn with its activity decreasing approximately 30 to 40% year-over-year and its pricing decreasing approximately 25 to 35%. While our solids control business was also hit hard, experiencing pricing declines of approximately 15 to 20% year-over-year, our solids control activity level increased slightly due to its strong customer base, which continued drilling despite the downturn, and a slight gain in market share from attracting new customers in a decreased market.

Our operating expenses for the year ended December 31, 2015 decreased to $19.4 million, or 66.7% of revenues, compared to $23.4 million, or 54.9% of revenues, for the year ended December 31, 2014. The decrease of $4.0 million from the year ended December 31, 2014 is primarily due to the decline in activity described above, specifically the resulting decline in our reliance on third party sub-rental and trucking services, partially offset by a full year of direct costs from the Acquisitions during the year ended December 31, 2015. The increase in the percentage of direct costs to revenues between the years is primarily due to the significant decline in pricing and the inability to reduce our costs, particularly wage rates, to mirror the timing and magnitude of the reduction in customer pricing.

Depreciation and amortization expense increased 35.7% to $6.7 million for the year ended December 31, 2015 compared to $5.0 million for the year ended December 31, 2014. The increase is due primarily to the inclusion of depreciation expense and amortization expense associated with the Acquisitions and a bulk equipment purchase made in August 2014.

Goodwill impairment was recorded in connection with the annual test we performed in the fourth quarter. Our detailed impairment analysis involves the use of discounted cash flow models that rely on significant management judgment to evaluate the impact of operating and macroeconomic changes on our business. Management believes that significant increases in activity and pricing in the oilfield services industry may not occur until 2018 which was reflected in the 5 year projections used in the discounted cash flow analysis. The sustained decline in the price of oil and natural gas has affected, and is expected to continue to affect, the future demand for certain of our products and services. As a result, we impaired all of our goodwill related to our solids control business and our surface rental equipment business.

Selling, general and administrative expense increased 12.3% to $9.3 million for the year ended December 31, 2015 compared to $8.3 million for the year ended December 31, 2014. Selling, general and administrative expenses include expenses that are either non-recurring or non-cash with an aggregate value of $1.1 million and approximately $25,000 during the years ended December 31, 2015 and 2014, respectively. The non-recurring expenses for the year ended December 31, 2015 include, but are not limited to severance, litigation costs and costs related to an acquisition not completed. The non-cash expenses for the year ended December 31, 2015 include, but are not limited to bad debt expense, loss on sale of assets and the fair value adjustment to a contingent payment liability. Excluding the impact of expenses that are either non-recurring or non-cash, selling, general and administrative expenses were flat at $8.2 million for years ended December 31, 2015 and 2014. The impact of cost cutting initiatives were offset by the financial results related to the United acquisition and the Evolution acquisition for the full year ended December 31, 2015 compared to 8.5 months and 6 months, respectively, during the year ended December 31, 2014. Cost cutting initiatives, implemented in 2015 in response to the downturn in the industry, included headcount and wage rate decreases, the elimination of executive management salaries and bonuses, and significant reductions in travel, entertainment and office expense.



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Interest expense and amortization of deferred loan costs was $2.0 million for the year ended December 31, 2015 compared to approximately $1.3 million for the year ended December 31, 2014. The $0.7 million increase in interest expense is primarily due to the debt modification in September 2015, which resulted in a write-off of deferred loan costs and the accrual of a quarterly ticking fee. In addition, the year ended December 31, 2015 included a full year of interest on the subordinated note entered into in August 2014.

Our income tax benefit for the year ended December 31, 2015, was $3.5 million, or 18.2% of our loss before income taxes, compared to income tax expense of $2.0 million for the year ended December 31, 2014, or 43.4% of our income before income taxes. The drop in the effective tax rate between years is primarily due to the goodwill impairment recorded in 2015 which is non-deductible. Management analyzes the realizability of the deferred tax asset quarterly and makes a determination based on the determining factors. As of December 31, 2015, management has determined that it is more likely than not that the deferred tax asset will be realized. Income tax expense includes state income tax which is primarily revenue-based and disproportionately increases income tax expense as a percentage of income (loss) before income taxes.


Non-GAAP Financial Measures


We disclose and discuss EBITDA as a non-GAAP financial measure in our public releases, including quarterly earnings releases, investor conference calls and other filings with the Securities and Exchange Commission.

We define EBITDA as earnings (net income) before interest, income taxes, depreciation and amortization. Our measure of EBITDA may not be comparable to similarly titled measures presented by other companies, which may limit its usefulness as a comparative measure.

We also make certain adjustments to EBITDA for (i) non-cash charges, such as goodwill impairment, bad debt expense, share-based compensation expense, changes in fair value of our liability for contingent payments, and gains and losses on the disposal of assets, and (ii) non-recurring expenses, such as severance, legal settlements, and professional fees and other expenses related to transactions outside the ordinary course of business, to derive a normalized EBITDA run-rate ("Adjusted EBITDA"), which we believe is a useful measure of operating results and the underlying cash generating capability of our business.

Because EBITDA and Adjusted EBITDA are not measures of financial performance calculated in accordance with GAAP, these metrics should not be considered in isolation or as a substitute for operating income, net income or loss, cash flows provided by operating, investing and financing activities, or other income or cash flow statement data prepared in accordance with GAAP.

EBITDA and Adjusted EBITDA are widely used by investors and other users of our financial statements as supplemental financial measures that, when viewed with our GAAP results and the accompanying reconciliation, we believe provide additional information that is useful to gain an understanding of our ability to service debt, pay deferred taxes and fund growth and maintenance capital expenditures. We also believe the disclosure of EBITDA and Adjusted EBITDA helps investors meaningfully evaluate and compare our cash flow generating capacity from quarter-to-quarter and year-to-year.

EBITDA and Adjusted EBITDA are also financial metrics used by management as (i) supplemental internal measures for planning and forecasting and for evaluating actual results against such expectations; (ii) significant criteria for incentive compensation paid to our executive officers and management; (iii) reference points to compare to the EBITDA and Adjusted EBITDA of other companies when evaluating potential acquisitions; and, (iv) assessments of our ability to service existing fixed charges and incur additional indebtedness.



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The following table provides the detailed components of EBITDA and Adjusted EBITDA as we define that term for the years ended December 31, 2015 and 2014, respectively (in thousands):


                                                           Years Ended December 31,
                                                            2015               2014
Components of EBITDA:
Net Income/(Loss)                                       $     (15,894 )     $    2,613
Non-GAAP Adjustments:
Depreciation and Amortization                                   6,730            4,959
Interest Expense, Net                                           1,963            1,317
Income Tax Expense/(Benefit)                                   (3,541 )          2,006

EBITDA                                                  $     (10,742 )     $   10,895

Adjustments to EBITDA:
Impairment                                                     11,143                -
Stock-Based Compensation Expense                                  100                -
Bad Debt Expense                                                  434              122
Fair Value Adjustments to Contingent Payment
Liability                                                      (1,065 )           (408 )
Loss on Disposal                                                  265                -
Gain on Indemnification-Preferred Shares Holdback                (124 )              -
Non-Recurring Expenses                                          1,517              311
Adjusted EBITDA                                         $       1,528       $   10,920



Set forth below are the material limitations associated with using EBITDA and Adjusted EBITDA as non-GAAP financial measures compared to cash flows provided by and used in operating, investing and financing activities:


      ·     EBITDA and Adjusted EBITDA do not reflect growth and maintenance
            capital expenditures,
      ·     EBITDA and Adjusted EBITDA do not reflect the interest, principal
            payments and other financing-related charges necessary to service the
            debt that we have incurred to finance acquisitions and invest in our
            fixed asset base,
      ·     EBITDA and Adjusted EBITDA do not reflect the payment of deferred
            income taxes, and
      ·     EBITDA and Adjusted EBITDA do not reflect changes in our net working
            capital position.





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Management compensates for the above-described limitations in using EBITDA and Adjusted EBITDA as non-GAAP financial measures by only using EBITDA and Adjusted EBITDA to supplement our GAAP results.

Liquidity and Capital Resources

Our primary sources of liquidity and capital resources have been cash flows from operating activities, borrowings under our credit facility, equipment financings and the issuance of equity securities. We anticipate that continued volatility in oil and gas prices during 2016 will impact our overall financial results and our ability to generate cash from operations. Effective March 31, 2016, we no longer have access to borrow under our credit facility and we believe that continued low oil and natural gas prices will likely adversely affect our ability to incur additional indebtedness and/or access the capital markets in 2016 and beyond. Should our projected cash flow from operations not be sufficient, we may reduce capital expenditures and future investments; however, there is no guarantee that we will be able to service our debt and our working capital needs and we may need to file for protection under Chapter 11 of the U.S. Bankruptcy Code.

Our uses of capital are expenditures that arise primarily from our need to service our debt, to fund our working capital requirements, and to maintain and expand our rental fleet and service offerings. On October 13, 2015, we entered into an amendment to our credit facility which, among other things, defers all principal payments on the outstanding borrowings until March 31, 2017 decreasing our previous aggregate debt service requirements for the next eighteen months by $7.5 million.

Due to the significant downturn in the oilfield services industry throughout 2015, at December 31, 2015, we were not in compliance with certain financial covenants set forth in our credit agreement due to our poor financial results. We anticipate that we are unlikely to be in compliance with such covenants for the first quarter ending March 31, 2016. Therefore, on March 31, 2016 we completed the execution and delivery of a forbearance agreement and amendment to the credit agreement.

Among other provisions, the lenders have agreed to forbear from exercising their remedies under the credit agreement until the earlier of July 10, 2016 or the date on which forbearance is terminated due to specified events, including (i) the occurrence of other defaults under the credit agreement, (ii) our failure to hire an independent financial advisor prior to April 10, 2016 or (iii) our failure to present a detailed plan for asset sales or equity capital acceptable to the lenders yielding net cash proceeds to us of at least $2.5 million by May 25, 2016. We hired an independent financial advisor and such advisor commenced the engagement prior to the deadline of April 10, 2016. In conjunction with agreeing to forbear from exercising their remedies under the credit agreement, the lenders reduced the revolving credit portion of the credit facility to zero thereby eliminating our ability to borrow additional funds under the existing credit facility.

We are currently in discussions with various stakeholders and advisors to develop and execute a plan to satisfy the requirements of the forbearance agreement. There can be no assurance that our actions will be deemed sufficient by the lender to extend the forbearance agreement and, if our actions are deemed insufficient, our outstanding debt will become immediately due and payable. Therefore, we have classified our indebtedness under the credit agreement as a current liability. If the debt becomes due and payable, we do not have sufficient liquidity to repay all of the outstanding debt to the lender and we might need to file for protection under Chapter 11 of the U.S. Bankruptcy Code.



The net cash provided by or used in our operating, investing, and financing
activities during the years ended December 31, 2015 and 2014 is summarized below
(in thousands).




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                                                     For the Years Ended
                                                         December 31,
                                                      2015          2014

Cash Provided By/(Used In):
Operating Activities                               $    3,892     $   4,131
Investing Activities                                   (1,103 )     (27,805 )
Financing Activities                                   (4,342 )      24,284

Increase/(Decrease) in Cash and Cash Equivalents $ (1,553 ) $ 610



Operating Activities


For the year ended December 31, 2015, we generated $3.9 million of cash from operating activities. Our net loss for the period was $15.9 million. Non-cash additions to net loss totaled $14.4 million consisting primarily of an aggregate of $11.1 million in impairments, $7.1 million in depreciation, amortization of intangibles, amortization of deferred loan costs, and $0.4 million of bad debt expense, partially offset by $3.4 million in deferred taxes and a $1.1 million fair value adjustment to a contingent payment liability. During the year ended December 31, 2015, changes in working capital generated $5.4 million in cash primarily due to a decrease in accounts receivable and unbilled receivables of approximately $8.5 million and a decrease in inventory of $0.2 million offset by a net decrease in payables and accrued expenses of $3.3 million. The net decrease in working capital was due primarily to the significant decrease in activity resulting from the downturn in the oilfield services industry. The impact of such decrease in activity on working capital was the collection of old receivables more quickly than the creation of new receivables only partially offset by a reduction in old payables more quickly than the incurrence of new charges.

For the year ended December 31, 2014, we generated $4.1 million of cash from operating activities. Our net income for the period was $2.6 million. Non-cash additions to net income totaled $6.8 million consisting primarily of an aggregate of $5.2 million in depreciation, amortization of intangibles, amortization of deferred loan costs, $1.8 million in deferred taxes, and $0.1 million of bad debt expense, partially offset by a $0.4 million fair value adjustment to a contingent payment liability. During the year ended December 31, 2014, changes in working capital used $5.2 million in cash primarily due to a net increase in payables and accrued expenses of $1.3 million offset by an increase in accounts receivable and unbilled receivables of approximately $5.7 million, due primarily to an increase in revenues in connection with both our legacy business and the Acquisitions and, to a lesser extent, an increase in length of time between the issuance of invoices and collecting payment. Changes in other current assets resulted in an additional use of cash of $0.8 million.


Investing Activities


During the year ended December 31, 2015, we used $1.1 million in investing activities. We used $1.5 million of cash to invest in machinery and equipment, which was partially offset by $0.4 million of proceeds from disposals of underutilized assets. Our aggregate capital expenditures for the year ended December 31, 2015 were $2.6 million, which includes $1.5 million of cash expenditures primarily for maintenance capital expenditures and $1.1 million of expenditures for new vehicles financed through capital leases and equipment financing.

During the year ended December 31, 2014, we used $27.8 million in investing activities of which $15.1 million was the cash purchase price, net of cash acquired, associated with the United Acquisition. We used $12.9 million of cash to invest in machinery and equipment during the period, including $4.0 million for the cash portion of consideration for the Saskatchewan Equipment Purchase, approximately $1.8 million for the fabrication of 5 new MWD kits, approximately $0.7 million in vertical dryers which was a new rental offering in 2014, and $0.6 million in the fabrication of our unique 400 bbl mud mixing plants.



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 Financing Activities


During the year ended December 31, 2015, financing activities used $4.3 million of cash. We repaid an aggregate of $7.3 million in debt, consisting of a $5.7 million repayment on our term loan, a $0.5 million repayment on each of our delayed draw term loan and our subordinated note payable and $0.6 million of scheduled repayments on equipment financing and capital leases. We made the first cash installment payment on the contingent consideration related to the acquisition of United in the amount of $0.9 million. We partially funded these payments from $3.9 million in net proceeds from the issuance of common stock in private placements during the year.

During the year ended December 31, 2014, financing activities generated $24.3 million of cash. Net borrowings of $15.4 million during the period resulted from the expansion of our credit facility to finance the United Acquisition. We also issued common equity during the period raising $9.4 million in net proceeds through private placements of our common stock. Payment of deferred financing costs used $0.5 million of cash during the period.

On April 15, 2014, in connection with the United Acquisition, we entered into an Amended and Restated Credit Agreement with a maturity date of April 30, 2017. The new agreement increased the size of our credit facility to $30.0 million, consisting of a $25.0 million term loan and a revolving credit facility with a maximum availability of $5.0 million.

On November 26, 2014, we entered into Amendment No. 1 to the Amended and Restated Credit Agreement in order to, among other things, provide for a $5.0 million delayed draw term loan to be added to the credit facility. The delayed draw term loan was used in full to finance capital expenditures during the year ended December 31, 2014.

On October 13, 2015, we entered into Amendment No. 2 to the existing credit facility ("Amendment") which had an effective date of September 30, 2015. In connection with the execution of the Amendment, the Company used proceeds of $3.4 million from its recently closed private offering to make the regularly scheduled principal payments of $1.5 million on September 30, 2015 and to make a prepayment of $1.9 million on the term loan on October 13, 2015.

The Amendment modified multiple components of the credit facility including, but not limited to, the terms listed below. The Amendment:


    (i)   waived our covenant default as of June 30, 2015;

    (ii)  defers all further principal payments on outstanding borrowings under
          the credit facility until March 31, 2017;

    (iii) revised certain financial covenants to facilitate our compliance with
          such covenants during the current downturn in the oilfield services
          industry; and,

    (iv)  reduced the size of the revolving credit facility to $1.0 million.





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The obligations under the agreement are guaranteed by all of our subsidiaries and secured by substantially all of our assets. The credit agreement contains customary events of default and covenants including restrictions on our ability to incur additional indebtedness, make capital expenditures, pay dividends or make other distributions, grant liens and sell assets.

We are required to satisfy certain financial and reporting covenants in conjunction with our debt facilities. Our financial covenants include:


    ·   Our asset coverage ratio, defined as the ratio of 80% of eligible
        receivables plus 50% of eligible inventory plus 50% of net book value of
        any non-capital lease fixed assets as of the last day of such fiscal
        quarter to all debt owed to the lender, must be greater than 1.25 on the
        last day of a fiscal quarter.
    ·   Our leverage ratio, defined as the ratio of consolidated funded debt as of
        the last day of such fiscal quarter to EBITDA for the four fiscal quarter
        period then ended, for each fiscal quarter after March 31, 2017 cannot be
        greater than 4.0 to 1.0.
    ·   Our fixed charge coverage ratio is a ratio of EBITDA for the four-fiscal
        quarter period then ended minus cash taxes paid and capital expenditures
        paid during such four-fiscal quarter period to interest expense and
        scheduled principal payments of funded debt for such four-fiscal quarter
        period. The fixed charge coverage ratio requirement increases over time as
        follows:




                  · Not less than 1.25 to 1.0 at March 31, 2016
                  · Not less than 1.75 to 1.0 at June 30, 2016
                  · Not less than 2.25 to 1.0 at September 30, 2016
                  · Not less than 2.5 to 1.0 at December 31, 2016
                  · Not less than 3.0 to 1.0 at March 31, 2017




                        · Our minimum EBITDA requirement is:




      · Not less than $1.0 million for the three months ended March 31, 2016
      · Not less than $2.3 million for the six months ended June 30, 2016
      · Not less than $3.75 million for the nine months ended September 30, 2016
      · Not less than $5.25 million for the year ended December 31, 2016

Borrowings under the credit facility bear interest at the annual base rate which is (i) the greatest of Wells Fargo's Prime Rate, the Federal Funds Rate plus 0.5% and the one-month LIBOR rate on such day plus 1.00%, plus (ii) a margin of 1.75%. For the years ended December 31, 2015 and 2014, interest rates on our borrowings under the credit facility ranged from 4.24% to 5.75% and 3.75% to 4.75%, respectively.

At December 31, 2015, there was $15.6 million and $4.5 million of outstanding borrowings under the term loan and the delayed draw term loan, respectively, and no borrowings under the revolving credit facility. At December 31, 2014, there was $21.3 million of outstanding borrowings under the term loan, $5.0 million of outstanding borrowings under the delayed draw term loan, and no borrowings under the revolving credit facility. As of December 31, 2015, we had a maximum revolving credit commitment of $1.0 million that could be borrowed against if necessary. Pursuant to the terms of the forbearance agreement effective March 31, 2016, there is no present availability under the revolving credit facility.



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Subordinated Note Payable


On August 15, 2014, we completed a bulk equipment purchase (the "Saskatchewan Equipment Purchase"), consisting of centrifuges, shakers, service vehicles and other associated equipment, for total consideration of $10.3 million of which $2.0 million was in the form of a Subordinated Note Payable.

On March 18, 2015, the Subordinated Note Payable was amended to extend the final maturity date to June 30, 2017 and to increase the interest rate to 10% per annum. Subsequent to an aggregate principal and interest payment of approximately $0.6 million on March 31, 2015, additional payments of interest and principal are not required until June 30, 2017. Interest and principal payments may be paid in amounts determined by our board of directors on any date or dates prior to June 30, 2017, subject to approval of both our board of directors and our lenders. The Subordinated Note Payable is generally subordinated in right of payment to our indebtedness to our lenders.

Equipment Financing and Capital Leases

We finance the purchase of certain vehicles and equipment using long-term equipment loans and using non-cancelable capital leases. Repayment occurs over the term of the loan or lease, typically three to five years, in equal monthly installments which include principal and interest. At December 31, 2015 and 2014, we had $2.4 million and $2.0 million outstanding under equipment loans and capital leases, respectively.

The following table summarizes, as of December 31, 2015, our obligations and commitments to make future payments under our long-term debt and operating leases (in thousands):


                                      Less than 1         1-3           3-5          More than 5
                         Total           Year            Years         Years            Years

Contractual
Obligations
Long-Term Debt         $  21,573     $      20,073     $   1,500     $        -     $            -
Interest on
Long-Term Debt (1)         1,538             1,204           334              -                  -
Equipment Loans and
Capital Leases (2)         2,604               788         1,337            479                  -
Operating Leases             949               372           482             95                  -
Other Contractual
Obligations (3)            1,402               652           530            220                  -
Total                  $  28,066     $      23,089     $   4,183     $      794     $            -




(1)   Interest payments on credit facility and subordinated note calculated at
      5.25% and 10.0% per annum, respectively.

(2)   Capital lease amounts include approximately $0.2 million in interest
      payments.

(3)   Includes payment obligations associated with the acqisition of United for
      contingent consideration and equipment purchase obligations.





35
Critical Accounting Policies



We have identified the policies below as critical to our business operations and the understanding of our results of operations. For a detailed discussion on the application of these and other accounting policies, see Note 3 in the Notes to the Consolidated Financial Statements included elsewhere in this document. Our preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Revenue Recognition: We generate revenues primarily from renting equipment at per-day rates. In connection with certain of our solids control operations and in connection with our directional drilling and MWD operations, we also provide personnel to operate our equipment at the customer's location at per-day or per-hour rates. In addition, we may provide equipment transportation and rig-up/rig-down services to the customer at flat rates per job or at an hourly rate. Revenue is recognized when it is realized or realizable and earned and when collectability is reasonably assured.

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 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. At December 31, 2015 and 2014, the allowance for doubtful accounts was approximately $0.4 million and $0.2 million, respectively.

Property and Equipment: Property and equipment are recorded at cost less accumulated depreciation and amortization. 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. When property and equipment are sold or otherwise disposed of, the asset account and related accumulated depreciation account are relieved, and any gain or loss is included in operating income.

The cost of property and equipment currently in service is depreciated, on a straight-line basis, over the estimated useful lives of the related assets, which range from one to 20 years. 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.

Impairment of Long-Lived Assets: Long-lived assets, which include property and equipment and intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recorded in the period in which it is determined that the carrying amount is not recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows, excluding interest expense. The impairment loss is determined by comparing the fair value with the carrying value of the related assets. We determined that the drop in pricing and utilization that we experienced in 2015 constituted a triggering event. As a result of the triggering event, a recoverability test was performed where our estimated undiscounted net cash flow exceeded the carrying amount of the assets, and as such no impairment loss was recognized during 2015. We recorded no impairment for the years ended December 31, 2015 and 2014.

Goodwill and Intangible Assets: The carrying amount of goodwill is tested annually for impairment in the fourth quarter and whenever events or circumstances indicate its carrying value may not be recoverable. We conduct the impairment testing at the reporting unit level which is one level below our reporting segment level.

Our detailed impairment testing involves comparing the fair value of our reporting units to their respective carrying values, including goodwill. Fair value reflects the price a market participant would be willing to pay in a potential sale of us. If the fair value exceeds carrying value, then it is concluded that no goodwill impairment has occurred. If our carrying value exceeds our fair value, a second step is required to measure possible goodwill impairment loss. The second step includes valuing our tangible and intangible assets and liabilities as if we had been acquired in a business combination. Then, the implied fair value of our goodwill is compared to the carrying value of that goodwill. If the carrying value of our goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value.



36





Our detailed impairment analysis involves the use of discounted cash flow models. 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. We use the capital asset pricing model to estimate the discount rates used in the discounted cash flow models.

We completed the 2015 annual goodwill impairment testing during the fourth quarter and, as our fair value was less than our carrying value, we impaired our goodwill by $11.1 million which was all of the goodwill associated with the Austin Chalk and United acquisitions. The remaining goodwill of $0.3 million at December 31, 2015 is related to the acquisition of Evolution.

We have approximately $8.4 million of intangible assets, which is net of $4.2 million of amortization as of December 31, 2015. Our intangible assets have useful lives ranging from two to ten years and each intangible asset is amortized on a straight-line basis over the course of its useful life.

Income Taxes: We account for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In assessing the likelihood and extent that deferred tax assets will be realized, consideration is given to projected future taxable income and tax planning strategies. A valuation allowance is recorded when, in the opinion of management, it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. Management analyzes the realizability of the deferred tax asset quarterly and makes a determination based on the determining factors. As of December 31, 2015, management has determined that it is more likely than not that the deferred tax asset will be realized.

We recognize the financial statement effects of a tax position when it is more-likely-than-not, based on the technical merits, that the position will be sustained upon examination. A tax position that meets the more-likely-than-not recognition threshold is measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority. Previously recognized tax positions are reversed in the first period in which it is no longer more-likely-than-not that the tax position would be sustained upon examination.

Recently Issued Accounting Standards

For a discussion of new accounting standards, see Note 3 in the Notes to the Consolidated Financial Statements included elsewhere in this document.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements, other than normal operating leases and employee contracts, that have or are likely to have a current or future material effect on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures, or capital resources.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


Source: Equities.com News (April 15, 2016 - 9:50 AM EDT)

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