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CJES > SEC Filings for CJES > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for C&J ENERGY SERVICES, INC.

Form 10-Q for C&J ENERGY SERVICES, INC.


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements and the related notes thereto included elsewhere in this Form 10-Q together with the audited consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2011. Unless the context otherwise requires, "we," "us," the "Company," "C&J" or like terms refers to C&J Energy Services, Inc. and its subsidiaries, including the financial results of Total and Casedhole (each as described below) from their respective acquisition dates.

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 those described in the section titled "Cautionary Note Regarding Forward-Looking Statements" of this Form 10-Q.

Overview

We are an independent provider of premium hydraulic fracturing, coiled tubing, pressure pumping, wireline and other complementary services with a focus on complex, technically demanding well completions. These services, which are offered through our Stimulation and Well Intervention Services and Wireline Services segments, are provided in conjunction with both unconventional and conventional well completions as well as stimulation and workover operations for existing wells. Through our Equipment Manufacturing segment, we also manufacture and repair equipment to fulfill our internal needs and for third party companies in the energy services industry.

We commenced our Wireline Services business with the acquisition of Casedhole Holdings, Inc. (including its operating subsidiary, Casedhole Solutions, Inc., "Casedhole") on June 7, 2012. See Note 3 - Acquisitions to the accompanying consolidated financial statements for further discussion regarding the Casedhole acquisition. The acquisition of Casedhole provided us with an expanded geographic presence in areas where we previously did not have a presence, such as the Williston and Uinta basins and the Marcellus, Utica, Avalon and Bone Springs shale formations. We moved coiled tubing equipment into the Bakken shale and commenced operations in August 2012. We are evaluating additional opportunities with existing and new customers to expand our operations into new areas throughout the United States with completion and stimulation requirements similar to those where we have historically provided Stimulation and Well Intervention Services.

With the acquisition of Total E&S, Inc. ("Total") on April 28, 2011, we commenced our Equipment Manufacturing business. In addition to manufacturing hydraulic fracturing, coiled tubing, pressure pumping, wireline and other equipment used in the energy services industry, we also provide equipment repair services and sell oilfield parts and supplies to third-party customers in the energy services industry, as well as to meet our own internal needs. On August 2, 2012, Total acquired 10 acres of land with an approximate 123,200 square foot warehouse in Greenville, Texas, which we intend to use to centralize company-wide inventory management.

Recent Developments

The Company's Board of Directors appointed Mr. Randall C. McMullen, Jr. to the position of President of the Company effective October 29, 2012 and appointed Mr. Donald J. Gawick to the position of Chief Operating Officer effective as of October 31, 2012. Mr. McMullen has served, and will continue to serve, as our Chief Financial Officer and Treasurer, as well as a member of the Board. Mr. Joshua E. Comstock resigned as President but will continue to serve in his role as the Company's Chief Executive Officer and Chairman of the Board. Mr. Bretton W. Barrier resigned from his position as Chief Operating Officer of the Company, effective October 31, 2012. Mr. Gawick has

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served as President of Casedhole since its acquisition in June 2012 and previously served as Casedhole's President and Chief Executive Officer from March 2010 through June 2012. These changes to the composition of our executive management primarily resulted from the Board's ongoing review and implementation of the Company's management development and succession planning program and are intended to continue to position the Company for its long-term success. Please read our Current Report on Form 8-K filed on October 31, 2012 for further discussion.

Our Business

Stimulation and Well Intervention Services Segment

Our Stimulation and Well Intervention Services segment encompasses three related service lines providing hydraulic fracturing, coiled tubing and pressure pumping services, with a focus on complex, technically demanding well completions.

Hydraulic Fracturing. Approximately 73% of our consolidated revenues for the nine months ended September 30, 2012 were derived from hydraulic fracturing services. We currently operate seven modern, 15,000 pounds per square inch pressure-rated hydraulic fracturing fleets with an aggregate 242,000 horsepower. We have taken delivery of our eighth fleet and expect to deploy it into Western Oklahoma during the latter part of the fourth quarter of 2012, subject to market conditions. Our ninth fleet is currently being winterized in preparation for work in the Bakken shale and we expect the fleet to be delivered and deployed in the first quarter of 2013. The addition of these two fleets will increase our total capacity to more than 300,000 horsepower.

Term contracts are in place for five of our hydraulic fracturing fleets:
Fleet 1, which was recently extended for an additional 12 months, is dedicated through mid-2013 to a producer operating in the Eagle Ford shale; Fleet 3 is dedicated through early 2013 to a producer operating in the Eagle Ford shale; Fleet 4 is dedicated through mid-2014 to a producer operating in the Haynesville shale; Fleet 5 is dedicated through mid-2013 to a producer operating in the Eagle Ford shale; and Fleets 6A and 6B are dedicated through early 2014 to a producer operating in the Permian Basin. Fleet 4 remains under contract but has been redeployed to the Eagle Ford shale in the spot market. While Fleet 4 is being utilized by non-contractual customers, we are not collecting payment from the contract customer. The relationship with the contract customer remains in place, and this fleet may be redeployed to the Haynesville shale at the election of the contract customer with timely notice.

Our term contracts generally range from one year to three years. Under the term contracts, our customers are typically obligated to pay us on a monthly basis for a specified number of hours of service, whether or not those services are actually utilized. To the extent customers use more than the specified contract minimums, we will be paid a pre-agreed amount for the provision of such additional services. Some of our term contracts restrict the ability of the customer to terminate or require our customers to pay us a lump-sum early termination fee, generally representing all or a significant portion of the remaining economic value of the contracts to us.

Some of our term contracts allow us to supplement monthly contract revenue by deploying equipment on short term spot market jobs on those days when the contract customer does not require our services or is not entitled to our services under the applicable term contract. We charge prevailing market prices per hour for spot market work. We may also charge fees for setup and mobilization of equipment depending on the job, additional equipment used on the job, if any, and other miscellaneous consumables. Generally, these fees and other charges vary depending on the equipment and personnel required for the job and market conditions in the region in which the services are performed. We believe that one of the benefits of working our hydraulic fracturing fleets on a spot market basis is that it serves as a marketing tool, giving us the opportunity to introduce our services to new customers and strengthen our relationships with existing customers.

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Our hydraulic fracturing business contributed $196.0 million of revenue and completed 1,486 fracturing stages during the third quarter of 2012, compared to $216.4 million of revenue and 1,667 fracturing stages during the second quarter of 2012. During the three months ended September 30, 2012, we averaged monthly revenue per unit of horsepower of $270, compared to $307 for the previous quarter. Hydraulic fracturing revenue for the third quarter of 2011 was $191.8 million and 1,065 fracturing stages were completed. Average monthly revenue per unit of horsepower was $407 for the third quarter of 2011.

Coiled Tubing and Pressure Pumping. Approximately 14% of our consolidated revenues for the nine months ended September 30, 2012 were derived from coiled tubing and pressure pumping services. We currently operate a fleet of 18 coiled tubing units with six new coiled tubing units on order that are expected to be delivered and deployed between the fourth quarter of 2012 and early 2013 in new geographic basins. We also have a fleet of 33 pressure pumping units, primarily double pumps.

Our coiled tubing, pressure pumping and other related well intervention services are generally provided in the spot market at prevailing prices per hour, although we do have three contracts in place with major operators for dedicated coiled tubing and associated services. We may also charge fees for setup and mobilization of equipment depending on the job. The setup charges and hourly rates are determined by a competitive bid process and vary with the type of service to be performed, the equipment and personnel required for the job and market conditions in the region in which the service is performed. We also charge customers for the materials, such as stimulation fluids, nitrogen and coiled tubing materials that we use in each job. Materials charges reflect the cost of the materials plus a markup and are based on the actual quantity of materials used for the project.

Our coiled tubing business contributed $35.1 million of revenue and completed 935 coiled tubing jobs during the third quarter of 2012, compared to $31.1 million of revenue and 866 coiled tubing jobs during the previous quarter. Coiled tubing revenue for the third quarter of 2011 was $25.6 million, and 877 jobs were completed. Our pressure pumping business generated $3.8 million of revenue during the third quarter of 2012, compared to $4.5 million during the second quarter of 2012 and $5.3 million for the prior year quarter.

Wireline Services Segment

Our Wireline Services segment provides cased-hole wireline and other complementary services, including logging, perforating, pipe recovery, pressure testing and pumpdown services, which are critical throughout a well's lifecycle. Our services are generally provided at prevailing rates in the spot market on a job-by-job basis. The rates are determined by a competitive bid process and vary with the type of service to be performed, the equipment and personnel required for the job and market conditions in the region in which the service is performed. Casedhole has expertise in both horizontal and high-pressure, high-temperature completion applications and experience in the most complex and demanding operating environments, focusing on oily basins.

Approximately 9% of our consolidated revenues for the nine months ended September 30, 2012 were derived from our Wireline Services segment, which we commenced with the acquisition of Casedhole on June 7, 2012. Through Casedhole, we currently operate 58 wireline units and 15 pumpdown units, as well as pressure control equipment. We currently have seven new wireline units on order, all of which we expect to be delivered and deployed by the end of the first quarter of 2013.

Equipment Manufacturing Segment

Approximately 4% of our consolidated revenues for the nine months ended September 30, 2012 were derived from our Equipment Manufacturing segment. Our Equipment Manufacturing segment constructs oilfield equipment, including hydraulic fracturing pumps, coiled tubing units, pressure pumping units, wireline units and other equipment, for our Stimulation and Well Intervention Services and Wireline Services segments, as well as for third-party customers in the energy services industry. This segment also provides equipment repair services and oilfield parts and supplies to the energy services industry and to meet the needs of our Stimulation and Well Intervention Services and Wireline Services segments.

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See Note 7 - Segment Information to the accompanying consolidated financial statements for further discussion regarding the Company's reportable segments.

Outlook

We face many challenges and risks in the industry in which we operate. Although many factors contributing to these risks are beyond our ability to control, we continuously monitor these risks, and we have taken steps to mitigate them to the extent practicable. In addition, while we believe that we are well positioned to capitalize on the current growth opportunities available in the industry in which we operate, we may not be able to capitalize on our competitive strengths to achieve our business objectives and, consequently, our results of operations may be adversely affected. Please read this section in conjunction with the factors described in the sections titled "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors" in this Form 10-Q, as well as in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and subsequent quarterly reports on Form 10-Q.

Trends that we believe are affecting, and will continue to affect, our industry include:

Demand for Our Services. Our business depends on the capital spending programs of our customers. Our Stimulation and Well Intervention Services and Wireline Services segments are significantly driven by the exploration, development and production expenditures made by our customers, which also impacts sales by our Equipment Manufacturing business to third-party customers in the energy services industry, who have historically tended to delay capital equipment projects, including maintenance and upgrades, during industry downturns. The oil and gas industry has traditionally been volatile, is highly sensitive to supply and demand cycles and is influenced by a combination of long-term and cyclical trends including the current and expected future prices for oil and gas, and the perceived stability and sustainability of those prices, as well as production depletion rates and the resultant levels of cash flows generated and allocated by exploration and production companies to their drilling and workover budgets.

There is increasing horizontal drilling and completion related activity in oily and liquids-rich formations due to the significant disparity between oil and natural gas prices on a Btu basis. Further, based on industry data, we believe the price disparity will continue over the near-to-medium term resulting in increasing demand for the types of services that we offer in the unconventional formations with oily and liquids-rich content. The development of unconventional drilling environments requires more complex, technically demanding completion jobs than conventional drilling activity. Despite this increase in demand, pricing has nonetheless declined in some areas with the migration of drilling and completion capacity from the gassier regions, particularly for hydraulic fracturing where current capacity exceeds demand. We expect this pricing pressure to continue for the remainder of 2012 and into early 2013.

Over the long-term, we believe that the service-intensive nature of completion activities in unconventional resource formations in which we have a growing presence, will have a positive long-term impact on demand for our services. Additionally, we believe long-term capital for the continued development of oily formations will be provided in part by the participation of large well-capitalized domestic oil and gas companies that have made significant investments, as well as international oil and gas companies that continue to make significant capital commitments through joint ventures and direct investments in North America's unconventional basins. Although we believe these investments indicate a long-term commitment to development, ultimately oil and natural gas prices and capital expenditures by exploration and production companies, together with any significant future increase in overall market capacity completion services, may affect demand for our services.

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Competition. The markets in which we provide our Stimulation and Well Intervention Services and Wireline Services are highly competitive. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. During the third quarter we maintained our presence in oily basins, and have near-term plans to increase our presence in these areas since customer activity levels in natural gas-directed basins has substantially declined due to the low price of natural gas. We expect to continue to benefit from increased horizontal drilling and completion-related activity in those complex unconventional resource formations in oily regions. However, we remain concerned about the migration of drilling activity and completion capacity into the oily regions from the gas- and liquids-rich regions and the weakness in the price of natural gas and natural gas liquids, as this has continued to increase competition among oilfield service companies in the oily regions and has negatively affected the spot market pricing for some of our services.

Hydraulic Fracturing Legislation and Regulation. Hydraulic fracturing is an important and common practice that is used to stimulate production of natural gas and/or oil from dense subsurface rock formations. The hydraulic fracturing process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The federal Energy Policy Act of 2005 amended the Underground Injection Control provisions of the federal Safe Drinking Water Act ("SDWA") to exclude hydraulic fracturing from the definition of "underground injection" and thereby exclude the process from direct federal regulation under the SDWA. The hydraulic fracturing process is currently typically regulated by state oil and natural gas commissions. However, the U.S. Environmental Protection Agency ("EPA") has asserted federal regulatory authority over certain hydraulic fracturing activities involving the use of diesel, and has also adopted regulations requiring operators to capture rather than vent most gases that are brought to the surface during well completion activities, beginning in 2015. In addition, legislation has been introduced before Congress to provide for direct federal regulation of hydraulic fracturing and to require public disclosure of chemicals used in the hydraulic fracturing process. Also, many state governments have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, well construction, and operational requirements on hydraulic fracturing operations or otherwise seek to temporarily or permanently ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict or prohibit the performance of well drilling in general or hydraulic fracturing in particular.

In addition, certain governmental reviews are either underway or being proposed that focus on environmental aspects of hydraulic fracturing practices. The EPA has commenced a study of the potential environmental effects of hydraulic fracturing on water resources, with initial results expected to be available by late 2012 and final results by 2014. In the interim, however, the EPA has utilized existing statutory authority under the SDWA, the federal Clean Water Act, Comprehensive Environmental Response, Compensation, and Liability Act, and Clean Air Act to investigate and pursue actions against some oil and natural gas producers where EPA believes their activities may have impacted air quality or groundwater. Moreover, the EPA is developing effluent limitations for the treatment and discharge of wastewater resulting from hydraulic fracturing activities and plans to propose these standards by 2014. On April 13, 2012, President Obama issued an executive order creating a task force to coordinate federal oversight over domestic natural gas production and hydraulic fracturing. Other governmental agencies, including the U.S. Department of Energy, have evaluated or are evaluating various aspects of hydraulic fracturing. These reviews and studies, depending on their results, could spur initiatives to further regulate hydraulic fracturing under the SDWA or other regulatory programs. Finally, on May 4, 2012, the U.S. Department of Interior proposed rules that would require oil and natural gas producers to publicly disclose their hydraulic fracturing chemicals in connection with drilling wells on federal and Indian lands and would also strengthen standards for well-bore integrity and the management of fluids that return to the surface during and after fracturing operations on federal and Indian lands.

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The adoption of new laws or regulations imposing reporting obligations on, or otherwise limiting or regulating, the hydraulic fracturing process could make it more difficult to complete oil and natural gas wells in shale formations, increase our and our customers' costs of compliance, and adversely affect the hydraulic fracturing services that we render for our exploration and production customers. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, fracturing activities could become subject to additional permitting or regulatory requirements, and also to attendant permitting delays and potential increases in cost, which could adversely affect our business and results of operations.

Results of Operations

Our results of operations are driven primarily by four interrelated variables:
(1) drilling and stimulation activities of our customers, (2) the prices we charge for our services, (3) cost of products, materials and labor and (4) our service performance. We seek to pass the cost of raw materials, such as proppants and chemicals, on to our customers, and historically, our profitability has not been materially impacted by changes in the costs of these materials. To a large extent, the pricing environment for our services will dictate our level of profitability. To mitigate the volatility in utilization and pricing for the services we offer, we currently have term contracts covering five of our eight existing fleets.

Our 2012 revenues and results of operations to date have been positively impacted by: (1) the addition and deployment of our fourth hydraulic fracturing fleet in April 2011; (2) the addition and deployment of our fifth hydraulic fracturing fleet in August 2011; (3) the addition and deployment of the vertical portion of our sixth hydraulic fracturing fleet in December 2011 and the horizontal portion in February 2012; (4) the addition and deployment of our seventh hydraulic fracturing fleet in April 2012; (5) the addition and deployment of five new coiled tubing units during 2011; (6) the acquisition of Total in April 2011; and (7) the acquisition of Casedhole in June 2012.

Results for the Three Months Ended September 30, 2012 Compared to the Three
Months Ended September 30, 2011

The following table summarizes the change in our results of operations for the
three months ended September 30, 2012 when compared to the three months ended
September 30, 2011 (in thousands):



                                                            Three Months Ended September 30,
                                                        2012               2011           $ Change
Revenue                                              $   307,797         $ 229,027        $  78,770
Costs and expenses:
Direct Costs                                             188,530           133,615           54,915
Selling, general and administrative expenses              30,219            14,254           15,965
Depreciation and amortization                             14,111             6,653            7,458
Loss on disposal of assets                                    14                53              (39 )

Operating income                                          74,923            74,452              471
Other income (expense):
Interest expense, net                                     (1,920 )            (666 )         (1,254 )
Other income (expense), net                                  (48 )              (1 )            (47 )

Total other expenses, net                                 (1,968 )            (667 )         (1,301 )

Income before income taxes                                72,955            73,785             (830 )
Provision for income taxes                                23,689            27,511           (3,822 )

Net income                                           $    49,266         $  46,274        $   2,992

Revenue

Revenue increased $78.8 million, or 34%, to $307.8 million for the three months ended September 30, 2012, as compared to $229.0 million for the same period in 2011. This increase was primarily related to $61.6 million in Wireline Services revenue as a result of the acquisition of Casedhole

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in June 2012, $12.2 million in Stimulation and Well Intervention Services revenue due to the addition of hydraulic fracturing equipment and coiled tubing units and $4.8 million in Equipment Manufacturing revenue due to higher third party sales in the three months ended September 30, 2012 compared to the same period a year ago.

Direct Costs

Direct costs increased $54.9 million, or 41%, to $188.5 million for the three months ended September 30, 2012, compared to $133.6 million for the same period in 2011 primarily due to the significant quarter-over-quarter increase in revenue. As a percentage of revenue, direct costs increased from 58.3% for the three months ended September 30, 2011 to 61.3% for the three months ended September 30, 2012. Direct costs as a percentage of revenue increased due to a decline in utilization and pricing in our hydraulic fracturing service line as a result of excess equipment capacity coupled with a slight U.S. onshore rig count decline.

Selling, General and Administrative Expenses ("SG&A")

SG&A increased $16.0 million, or 112%, to $30.2 million for the three months ended September 30, 2012, as compared to $14.3 million for the same period in 2011. The increase primarily related to $9.5 million in increased costs related to Casedhole, which we acquired in June 2012, $2.0 million in higher payroll and personnel costs associated with the continued hiring of personnel to support our . . .

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