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CJES > SEC Filings for CJES > Form 10-Q on 7-May-2014All Recent SEC Filings

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

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


7-May-2014

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, 2013. 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 Solutions (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, wireline, pressure pumping and other complementary services with a focus on complex, technically demanding well completions. With the development of our specialty chemicals business and our strategic acquisitions during 2013, we now provide specialty chemicals for completion and production services, including the fluids used in our hydraulic fracturing operations, as well as downhole tools and related directional drilling technology and data control systems. These services are provided to oil and natural gas exploration and production companies throughout the United States. In addition to our suite of completion, stimulation and production enhancement services, we manufacture, repair and refurbish equipment and provide parts and supplies for third-party companies in the energy services industry, as well as to fulfill our internal needs.

We currently operate in three reportable segments: Stimulation and Well Intervention Services, Wireline Services, and Equipment Manufacturing. Our three segments are described in more detail under "Our Operating Segments." For additional financial information about our segments, including revenue from external customers and total assets by segment, see "Note 6 - Segment Information" in Item 1 "Financial Statements and Supplementary Data" in this Form 10-Q.

Strategic Initiatives and Growth Strategy

Growth of Core Service Lines, International Expansion

We are focused on growing our core service lines through the expansion of our assets, customer base and geographic reach, both domestically and internationally. On the domestic front, we expect to continue increasing market share by strengthening our presence within our existing geographic footprint and concentrating on targeted expansion of our hydraulic fracturing and coiled tubing operations into areas in which our wireline business already has a strong presence. As part of our strategy, we will continue to target high volume, high efficiency customers with service intensive, 24-hour work, which is where we believe that we better differentiate our services from our competitors.

With respect to our international expansion efforts, we intend to continue investing in the infrastructure needed to support our projected international expansion. During the first quarter of 2014 we were awarded our first international contract to provide coiled tubing services on a trial basis in Saudi Arabia. We have established coiled tubing equipment, crews and logistics on the ground in Saudi Arabia to service this contract, with operations scheduled to begin in the second quarter of 2014. Due to the size of this first project and the additional costs associated with establishing operations overseas, we do not

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expect to generate financial returns during this initial phase. Additionally, there is no guarantee that we will be able to obtain additional work with this customer beyond this provisional contract. However, we believe that this is a valuable opportunity to demonstrate our services outside of the United States. We are optimistic that our efforts can lead, over time, to a long-term relationship and additional opportunities with this new customer. We also hope that by demonstrating our capabilities in the region we may be able to secure opportunities with other potential customers in the Middle East.

Service Line Diversification, Vertical Integration & Technological Advancement

During the first quarter of 2014, we further advanced our strategic initiatives designed to strengthen, expand and diversify our business. As we continue to execute our long-term growth strategy, we remain focused on service line diversification, vertical integration and technological advancement. Our continued investment in our strategic initiatives has resulted in increased capital expenditures and additional costs, including $8.1 million of additional expenses for the first quarter of 2014. We expect that our costs and expenses will increase over the course of 2014 as we continue to invest in the further development of these projects. Our strategic initiatives have not contributed significant third-party revenue to date, and we do not expect that any will contribute meaningful third-party revenue during 2014. However, we believe that these investments will yield significant financial returns, as well as meaningful cost savings to us, over the long term. Our key strategic projects include the following:

Specialty Chemicals. During 2013, we organically developed a specialty chemicals business for completion and production services. We source many of the chemicals and fluids used in our hydraulic fracturing operations through this business, which over the long-term we expect will provide cost savings to us and also give us direct control over the design, development and supply of these products. We are also actively marketing this business to third-party customers. We intend to continue growing this business with the long-term goal of becoming a large-scale supplier of these products to the oil and gas industry.

Downhole Tools and Directional Drilling Technology. In April 2013, we acquired a provider of directional drilling technology and related downhole tools. During the first quarter of 2014, we began leasing premium drilling motors to our customers, and we are in the early stages of development with additional related products. We believe that this business has significant growth potential and we intend to continue investing in its growth.

Data Control Systems. In December 2013, we acquired a manufacturer of data control instruments used in our hydraulic fracturing operations. In addition to achieving cost savings through intercompany purchases over the long term, we are now selling these products to third-party energy services companies. We believe that this business has significant growth potential and we intend to continue investing in its growth.

Research and Technology Capabilities. Our Research and Technology division is currently focused on developing innovative, fit-for-purpose solutions that will enhance our core service offerings, increase completion efficiencies and add value for our customer. We intend to introduce several new products during 2014, which we expect to provide cost savings to our operations.

Our Operating Segments

We currently operate in three reportable segments: Stimulation and Well Intervention Services; Wireline Services; and Equipment Manufacturing. In line with the growth of our business, we routinely evaluate our reportable operating segments and we believe that these three segments are appropriate and consistent with how we manage our business and view the markets we serve. Each of our operating segments is described in more detail below. For additional financial information about our segments, including revenue from external customers and total assets by segment, see "Note 6 - Segment Information," in Item 1 "Financial Statements and Supplementary Data" in this Form 10-Q.

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Stimulation and Well Intervention Services Segment

Our Stimulation and Well Intervention Services segment provides hydraulic fracturing, coiled tubing and other well stimulation services, with a focus on complex, technically demanding well completions.

Hydraulic Fracturing Services. Our hydraulic fracturing business currently consists of more than 340,000 total hydraulic horsepower capacity. We recently deployed 20,000 new horsepower capacity and we plan to deploy an additional 40,000 new horsepower capacity in the third quarter of 2014. In response to the increase in demand from new and existing customers, and believing that activity levels have the potential to further improve during 2014, we recently committed to add 40,000 new horsepower capacity for deployment by the fourth quarter of 2014. We believe we are well-positioned to benefit from the current rise in completion activities across the United States and the industry's ongoing trends towards more service intensive jobs.

Our hydraulic fracturing operations contributed $186.9 million, or 59.0%, to our consolidated revenue and completed 2,225 fracturing stages during the first quarter of 2014, compared to $147.2 million of revenue and 1,408 fracturing stages during the fourth quarter of 2013 and $173.8 million of revenue and 1,698 fracturing stages during the first quarter of 2013. Revenue increased quarter over quarter due to higher utilization across our asset base throughout the first quarter, with January activity reaching record levels. An increase in sand volumes due to the job-mix also strengthened revenue. However, greater input costs associated with the larger volumes of certain proppants and other consumables used in our hydraulic fracturing services resulted in lower margins for our services for the first quarter of 2014. Stage count for the first quarter increased due to higher utilization coupled with an overall job mix that was weighted towards a higher number of smaller, more intense stages. The number of fracturing stages performed in any given period will fluctuate based on the job mix during that time. Accordingly, stage count is not necessarily indicative of utilization, pricing for our services or our financial and/or operational performance. Given that our job mix has broadened and become more varied with our increased spot market exposure, we do not intend to disclose stage count going forward.

Coiled Tubing and Other Well Stimulation Services. Our coiled tubing business currently consists of 27 coiled tubing units. We intend to increase our coiled tubing capacity over the course of 2014. Our coiled tubing services are well-established in some of the most active basins in the United States and we are committed to further grow this business in terms of capacity, geographic reach and market share.

Our coiled tubing operations contributed $40.0 million, or 12.6%, to our consolidated revenue, and we completed 1,201coiled tubing jobs during the first quarter of 2014, compared to $37.4 million of revenue and 1,055 coiled tubing jobs for the fourth quarter of 2013 and $36.4 million and 1,057 coiled tubing jobs for the first quarter of 2013. Our coiled tubing results improved sequentially due to higher utilization across our asset base from continued strong demand for our extended-reach, large-diameter coiled tubing units. We do not intend to disclose job count going forward.

Our other well stimulation services primarily include nitrogen, pressure pumping and thru-tubing services. Additionally, with the development of our specialty chemicals business and our strategic acquisitions during 2013, we now provide specialty chemicals for completion and production services, as well as downhole tools and related directional drilling technology and data control systems. After an evaluation of these businesses, it was determined that each is appropriately accounted for in our Stimulation and Well Intervention Services segment.

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Our other well stimulation services contributed $4.3 million, or 1.4% of our consolidated revenue, during the first quarter of 2014, compared to $4.5 million for the fourth quarter of 2013 and $2.5 million for the first quarter of 2013, the substantial majority of which was generated by our nitrogen, pressure pumping and thru-tubing services.

Wireline Services Segment

Our Wireline Services segment currently consists of 69 wireline units and 36 pumpdown units, as well as pressure control and other ancillary equipment. We have aggressively grown market share and produced strong results since our June 2012 acquisition of our wireline business. As we seek to continue growing this business and better capitalize on increasing demand for these services, we intend to bring online additional wireline and pumpdown capacity throughout 2014.

Our Wireline Services segment contributed $83.1 million, or 26.3%, to our consolidated revenue during the three months ended March 31, 2014, compared to $74.1 million in the fourth quarter of 2013 and $62.1 million in the first quarter of 2013. Revenue from wireline operations increased compared to the fourth quarter of 2013 due to higher utilization levels across our asset base from continued strong demand for our wireline and pumpdown services by high utilization customers.

Equipment Manufacturing Segment

Our Equipment Manufacturing segment constructs oilfield equipment, including hydraulic fracturing pumps, coiled tubing units, and pressure pumping units for third party customers in the energy services industry, as well as for our Stimulation and Well Intervention Services and Wireline Services segments. This segment also provides equipment refurbishment and repair services and oilfield parts and supplies to the energy services industry and to our Stimulation and Well Intervention Services and Wireline Services segments.

Our Equipment Manufacturing segment contributed $2.2 million, or 0.7%, to our consolidated revenue during the three months ended March 31, 2014, compared to $2.2 million of revenue for the fourth quarter of 2013 and $1.2 million of revenue for the first quarter of 2013. This business continues to provide us with cash flow savings from intercompany purchases, including equipment manufacturing, repair and refurbishment, and also supports active management of parts and supplies purchasing.

Industry Trends and 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 have taken steps to mitigate them to the extent practicable. In addition, while we believe that we are well positioned to capitalize on available growth opportunities, we may not be able 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 Part II, Item 1A of this Form 10-Q, as well as in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

General Industry Trends

Set out below is a discussion of the trends that we believe are affecting, and will continue to affect, our industry.

Our business is cyclical and dependent upon conditions in the oil and natural gas industry, which impact the level of exploration, development and production of oil and natural gas and capital expenditures by oil and natural gas companies. Revenue from our Stimulation and Well Intervention Services and Wireline Services segments is generated by providing products and services to oil and

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natural gas exploration and production companies throughout the United States. Demand for our products and services is a function of our customers' willingness to make operating and capital expenditures to explore for, develop and produce hydrocarbons in the United States. Our customers' willingness to undertake exploration and production activities depends largely upon prevailing industry conditions that are influenced by numerous factors which are beyond our control, including, among other things, current and expected levels of oil and natural gas prices. Any negative impact on the spending patterns of our customers may cause lower pricing and utilization for our core service lines. The level of exploration, development and production activities by these customers also impacts demand for our Equipment Manufacturing segment's services and products. Companies in the energy services industry have historically tended to delay capital equipment projects, including maintenance and upgrades, during industry downturns like the current one, which has been characterized by excess equipment capacity across the U.S. hydraulic fracturing market.

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 domestic and international supply and demand for oil and natural gas, current and expected future prices for oil and natural gas and the perceived stability and sustainability of those prices, production depletion rates and the resultant levels of cash flows generated and allocated by exploration and production companies to their drilling and workover budget. The industry is also impacted by domestic and international economic conditions, political instability in oil producing countries and merger, acquisition and divestiture activity among oil and natural gas exploration and production companies. The volatility of the oil and gas industry, and the consequent negative impact on the level of exploration, development and production activity by our customers, has adversely affected, and in the future may adversely affect, the demand for our services and our ability to negotiate pricing at levels generating desirable margins, especially in our hydraulic fracturing business.

There is significant potential for excess capacity in our industry, which could adversely affect our business and operating results. Natural gas prices declined in 2009 and remained depressed through 2013, which resulted in decreased activity in the natural gas-driven markets. However, oil prices increased during the first half of 2011 and remained relatively stable through 2013. The sustained price disparity between oil and natural gas on a Btu basis drove many companies operating in basins that were predominantly gas-related to relocate their equipment to more oily- and liquids-rich shale plays, such as the Eagle Ford Shale and Permian Basin. Much of the current horizontal drilling and completion related activity remains concentrated in oily- and liquids-rich formations. As drilling activity and completion capacity migrated into the oily- and liquids-rich regions, competition among energy service companies in those areas significantly increased. The resulting increase in supply relative to demand negatively affected utilization and pricing for our services.

During the first quarter of 2014, we experienced an increase in customer demand with the rise in completions activities in our core operating areas. We generated high utilization levels across our core service lines for the first quarter of 2014, with a strong improvement over the prior quarter. Based on current activity levels and visibility, we expect to maintain solid utilization across our service lines through the second quarter, and our outlook is positive for the remainder of 2014.

We are cautiously optimistic about the potential for further market improvement in 2014. We believe we are well-positioned to benefit from the increase in completion activities across the United States and the industry's ongoing trends towards more service intensive jobs. We expect to continue increasing market share by strengthening our presence within our existing geographic footprint and concentrating on targeted expansion of our hydraulic fracturing and coiled tubing operations into areas in which our wireline business already has a strong presence. As we drive the further expansion of our core service lines and growth in market share, we remain focused on generating higher utilization across our operations by leveraging our reputation for providing superior customer service, execution and efficiency. We will continue to target high volume, high efficiency customers with service intensive, 24-hour work, which is where we believe that we better differentiate our services from our competitors.

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Competition and Demand for Our Services

The markets in which we provide our core service offerings are highly competitive with significant potential for excess capacity. We provide these services across the continental United States and our competitors include many large and small energy service companies, including some of the largest integrated energy services companies.

We believe that the principal competitive factors in the markets that we serve are technical expertise, equipment capacity, work force capability, safety record, reputation and experience. Although we believe our customers consider all of these factors, price is often the primary factor in determining which service provider is awarded work. Additionally, projects are often awarded on a bid basis, which tends to further increase competition based primarily on price. While we must be competitive in our pricing, we believe many of our customers elect to work with us based on the safety, performance and quality of our crews, equipment and services. We seek to differentiate ourselves from our major competitors by our operating philosophy, which is focused on delivering the highest quality customer service and equipment, coupled with superior execution and operating efficiency. We target high volume, high efficiency customers with service intensive, 24-hour work, which is where we believe we can differentiate our services from our competitors.

The demand for our services fluctuates, primarily in relation to the price (or anticipated price) of oil and natural gas, which, in turn, is driven primarily by the supply of, and demand for, oil and natural gas. Generally, as supply of the commodities decreases and demand increases, service and maintenance requirements increase as oil and natural gas producers attempt to maximize the productivity of their wells in a higher priced environment. However, in a lower oil and natural gas price environment, demand for service and maintenance generally decreases as oil and natural gas producers decrease their activity. In particular, the demand for new or existing field drilling and completion work is driven by available investment capital for such work. Because these types of services can be easily "started" and "stopped," and oil and natural gas producers generally tend to be less risk tolerant when commodity prices are low or volatile, we may experience a more rapid decline in demand for well maintenance services compared with demand for other types of energy services. Further, in a low commodity price environment, fewer well service rigs are needed for completions, as these activities are generally associated with drilling activity.

Pressure on pricing for our hydraulic fracturing and other core services, including due to competition and industry and/or economic conditions, may impact, among other things, our ability to implement price increases or maintain pricing on our services. During periods of declining pricing for our services, we may not be able to reduce our costs accordingly, which could further adversely affect our results. Furthermore, even when we are able to increase our prices, we may not be able to do so at a rate that is sufficient to offset any rising costs. Also, we may not be able to successfully increase prices without adversely affecting our activity levels. The inability to maintain our prices or to increase our prices as costs increase could have a material adverse effect on our business, financial position and results of operations.

Results of Operations

Our results of operations are driven primarily by four interrelated, fluctuating variables: (1) the drilling and stimulation activities of our customers, which directly affects the demand for our services; (2) the prices we are able to charge for our services; (3) the cost of products, materials and labor, and our ability to pass those costs on to our customers; and (4) our service performance.

The majority of our revenue is generated from our hydraulic fracturing services. Historically, most of our hydraulic fracturing services were performed under long-term "take-or-pay" contracts, the last of which expired in February 2014. Currently, most of our hydraulic fracturing services, along with our other core services, are provided in the spot market. Accordingly, we are now more significantly affected, among other things, by the pricing pressures and other conditions of the markets in which we provide our services. For additional information about the factors impacting our business and results of operations, please see "Industry Trends and Outlook."

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Results for the Three Months Ended March 31, 2014 Compared to the Three Months
Ended March 31, 2013

The following table summarizes the change in our results of operations for the
three months ended March 31, 2014 when compared to the three months ended
March 31, 2013 (in thousands):



                                                     Three Months Ended March 31,
                                                  2014           2013         $ Change
 Revenue                                        $ 316,537      $ 276,051      $  40,486
 Costs and expenses:
 Direct Costs                                     230,544        187,100         43,444
 Selling, general and administrative expenses      40,386         31,878          8,508
 Research and Development                           2,791              9          2,782
 Depreciation and amortization                     21,870         16,556          5,314
 Loss on disposal of assets                            38             90            (52 )

 Operating income                                  20,908         40,418        (19,510 )
 Other income (expense):
 Interest expense, net                             (1,749 )       (1,660 )          (89 )
 Other income, net                                    166             66            100

 Total other expenses, net                         (1,583 )       (1,594 )           11

 Income before income taxes                        19,325         38,824        (19,499 )
 Provision for income taxes                         7,737         13,680         (5,943 )

 Net income                                     $  11,588      $  25,144      $ (13,556 )

Revenue

Revenue increased $40.5 million, or 14.7%, to $316.5 million for the three months ended March 31, 2014, as compared to $276.1 million for the same period . . .

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