Description
Filed with the SEC from July 19 to July 25:
C&J Energy Services (CJES)
Venture-capital firm General Atlantic Partners increased its holdings in the drilling equipment maker to 5,248,508 shares (10.1%) following its purchase of 1,047,714 shares in the period from May 30 through July 25; over that span, it paid from $16.94 to $17.75 apiece for the shares.
BUSINESS OVERVIEW
Our History and Structure
We were formed in 1997 as a partnership pursuant to the laws of the State of Texas and reorganized as a Texas corporation in 2006. In connection with our initial public offering (“IPO”), we converted to a Delaware corporation on December 15, 2010. On July 28, 2011, our registration statement on Form S-1 (File No. 333-173177) relating to our IPO was declared effective by the SEC and on July 29, 2011 we began trading on the New York Stock Exchange (“NYSE”) under the symbol “CJES.”
C&J Energy Services, Inc. (“C&J”) is a holding company and substantially all of its operations are conducted through, and substantially all of its assets are held by C&J Spec-Rent Services, Inc., an Indiana corporation (“Spec-Rent”), and Total E&S, Inc., an Indiana corporation (“Total”). C&J owns 100% of the outstanding capital stock of Spec-Rent and in April 2011 Spec-Rent acquired 100% of the outstanding capital stock of Total, a manufacturer of hydraulic fracturing, coiled tubing, pressure pumping and other equipment used in the energy services industry and one of our largest suppliers of machinery and equipment. C&J, Spec-Rent and Total are herein collectively referred to as the “Company,” or “we,” “us,” or “our” and Spec-Rent and Total are herein collectively referred to as the “Subsidiaries.”
Our principal executive offices are located at 10375 Richmond Avenue, Suite 2000, Houston, Texas 77042 and our main telephone number at that address is (713) 260-9900. Our Website is available at www.cjenergy.com. We make available free of charge through our Website all reports filed with or furnished to the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Exchange Act, including our annual report on Form 10-K, quarterly reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Information contained on or available through our Website is not a part of or incorporated into this or any other report that we may file with or furnish to the SEC.
Our Business
We are an independent provider of premium hydraulic fracturing, coiled tubing and pressure pumping services with a focus on complex, technically demanding well completions. These services, which are offered through our Stimulation and Well Intervention Services segment, are provided in conjunction with both unconventional and conventional well completions as well as stimulation and workover operations for existing wells. In addition, our Equipment Manufacturing segment, which is conducted through Total, manufactures and repairs equipment for our internal needs as well as for third-party companies in the energy services industry.
We provide our Stimulation and Well Intervention Services in what we believe to be some of the most geologically challenging basins in South Texas, East Texas/North Louisiana, Western Oklahoma and West Texas/East New Mexico. We currently operate six modern, 15,000 pounds per square inch, pressure rated hydraulic fracturing fleets with an aggregate 210,000 horsepower, and we currently have on order three additional hydraulic fracturing fleets, which, upon delivery, will increase our total capacity to more than 300,000 horsepower by the end of 2012. Our hydraulic fracturing equipment is specially designed to handle well completions with long lateral segments and multiple fracturing stages in high-pressure formations.
We also operate a fleet of 18 coiled tubing units and we have six new coiled tubing units on order, which we expect to be delivered and deployed by the end of 2012. Additionally, we have 21 double pumps and nine single pumps in our standalone pressure pumping line. In anticipation of the delivery and deployment of this new equipment in 2012, we are evaluating opportunities with existing and new customers to expand our operations into new areas throughout the United States with similarly demanding completion and stimulation requirements.
With the acquisition of Total on April 28, 2011, we commenced our Equipment Manufacturing business. In addition to manufacturing hydraulic fracturing, coiled tubing, pressure pumping and other equipment used in the energy services industry, through Total 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. Following our acquisition of Total, we acquired approximately ten acres of property adjacent to Total’s current facility and constructed an approximate 36,000 square foot manufacturing facility, which was completed in December 2011. By significantly increasing Total’s manufacturing capacity, we expect to further increase its ability to service our Stimulation and Well Intervention Services segment and existing and future third-party customers, and to enhance our research and development efforts around equipment and innovation.
Our Operating Segments
Prior to the acquisition of Total in April 2011, we had one operating segment with three related service lines: hydraulic fracturing, coiled tubing and pressure pumping. During the second quarter of 2011, we reevaluated our business and concluded that, with the acquisition of Total, two operating and reportable segments exist: (1) Stimulation and Well Intervention Services and (2) Equipment Manufacturing, each of which is described in more detail below. For financial information about our segments, including revenues from external customers and total assets by segment, see “Note 11 – Segment Information” to our consolidated financial statements.
Stimulation and Well Intervention Services
Hydraulic Fracturing . Our customers utilize our hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, which restricts the natural flow of hydrocarbons. Hydraulic fracturing involves pumping a fluid down a well casing or tubing at sufficient pressure to cause the underground producing formation to crack, allowing the oil or natural gas to flow more freely. A propping agent, or proppant, is suspended in the fracturing fluid and pumped into the cracks (fractures) created by the fracturing process in the underground formation to prop the fractures open. Proppants generally consist of sand, bauxite, resin-coated sand or ceramic particles and other engineered proprietary materials. The extremely high pressure required to stimulate wells in the regions in which we operate presents a challenging environment for achieving a successfully fractured horizontal well. As a result, an important element of the services we provide to producers is designing the optimum well completion, which includes determining the proper fluid, proppant and injection specifications to maximize production. Our engineering staff also provides technical evaluation, job design and fluid recommendations for our customers as an integral element of our fracturing service. The aggregate volume of hydraulic fracturing fluid (not including proppants or other additional substances) used in our hydraulic fracturing services to our customers varies significantly among each well completion or workover depending on the number of fracturing stages requested by our customers. During the year ended December 31, 2011, we performed individual well completions ranging from a minimum of one fracturing stage to a maximum of 33 fracturing stages, with the average well completion consisting of 11 fracturing stages. Our hydraulic fracturing business contributed $619.8 million to our revenue for the year ended December 31, 2011 and completed 3,713 fracturing stages during the year ended December 31, 2011.
Coiled Tubing . Our customers utilize our coiled tubing services to perform various functions associated with well-servicing operations and to facilitate completion of horizontal wells. Coiled tubing services involve the insertion of steel tubing into a well to convey materials and equipment to perform various applications on either a completion or workover assignment. We believe coiled tubing has become a preferred method of well completion, workover and maintenance projects due to the speed, ability to handle heavy-duty jobs across a wide spectrum of pressure environments, safety and ability to perform services without having to shut-in a well. We have successfully leveraged our existing relationships with coiled tubing customers to expand our fracturing business. Our coiled tubing operations contributed $97.2 million to our revenue for the year ended December 31, 2011 and we completed 3,183 coiled tubing jobs during the year ended December 31, 2011.
Pressure Pumping . Our customers utilize our stand-alone pressure pumping services primarily in connection with completing new wells and remedial and production enhancement work on existing wells. Our pressure pumping services include well injection, cased-hole testing, workover pumping, mud displacement, wireline pumpdowns and pumping-down coiled tubing. Our pressure pumping services often provide us with advance knowledge of a customer’s need for coiled tubing services, and are often used in conjunction with our coiled tubing services. Our pressure pumping business generated $19.4 million of revenue for the year ended December 31, 2011.
Equipment Manufacturing
Our Equipment Manufacturing segment constructs oilfield equipment, including hydraulic fracturing pumps, coiled tubing units, pressure pumping units and other equipment, for our Stimulation and Well Intervention Services segment as well as for third-party customers in the energy services industry. This business segment also provides equipment repair services and oilfield parts and supplies to the energy services industry, as well as to meet our own internal needs. Our Equipment Manufacturing segment, which we added with the acquisition of Total in April 2011, contributed $22.1 million in third-party revenue for the year ended December 31, 2011.
Our Industry
Our business depends on the capital spending programs of our customers. Our Stimulation and Well Intervention Services 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.
Ongoing Development of Existing and Emerging Unconventional Resource Basins. Over the past decade, exploration and production companies have focused on exploiting the vast resource potential available across many of North America’s unconventional resource plays, such as oil and natural gas shales. Two technologies that are critical to the recovery of oil and natural gas from unconventional resource plays are horizontal drilling and hydraulic fracturing. Horizontal drilling is used to provide greater access to the hydrocarbons trapped in the producing formation by exposing the well to more of the producing formation. Hydraulic fracturing unlocks the hydrocarbons trapped in formations by opening fractures in the rock and allowing hydrocarbons to flow from the formation into the well. We believe long-term capital for the continued development of these basins 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 of hydraulic fracturing equipment, may affect demand for our services.
Increased Horizontal Drilling and Greater Service Intensity in Unconventional Basins . We believe exploration and production companies have shown a preference for a customized approach to completing complex wells in unconventional basins. Even if overall market capacity of hydraulic fracturing equipment increases, we believe the required attention and experience to complete the most difficult fracturing jobs in these service-intensive basins will continue to increase. As a result of the higher specification equipment and increased service intensity associated with horizontal drilling, we view the U.S. horizontal rig count as a reliable indicator of the overall level of demand for our services and products. The increased level of horizontal drilling, which has largely targeted unconventional resource plays, is illustrated by the growing number of horizontal rigs active in the United States over the past three years. According to Baker Hughes Incorporated, the U.S. horizontal rig count has risen from approximately 335 at the beginning of 2007 to 1,165 as of February 24, 2012, and as of such date represented 58.8% of the total U.S. rig count. In addition, we have witnessed horizontal wells becoming longer and more complex, resulting in an increase in the number of fracturing stages, and amount of horsepower and proppant and chemicals used per well. Furthermore, we believe operators have become more efficient at drilling horizontal wells and have reduced the number of days required to reach total depth, which has increased the number of wells drilled and therefore the number of fracturing stages completed in a year. As we see additional hydraulic fracturing equipment enter the markets through both industry veterans and start-up companies, we believe that technical expertise, fleet capability and experience are the primary differentiating factors within the industry.
Enhanced Economics in Oily- and Liquids-Rich Formations . There is increasing horizontal drilling and completion related activity in oily- and liquids-rich formations such as the Eagle Ford Shale, Permian Basin, Granite Wash, Utica Shale, Bakken Shale and Niobrara Shale. We believe that the oil and liquids content in these plays significantly enhance the returns for our customers relative to opportunities in dry gas basins 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 mid-term resulting in increasing demand for services in oily- and liquids-rich basins. We expect to continue to benefit from increased horizontal drilling and completion-related activity in those complex unconventional resource plays that are oily- and liquids-rich, even as those areas absorb drilling and completion capacity moving from the gassier regions.
The Spread of Unconventional Drilling and Completion Techniques to the Redevelopment of Conventional Fields . Oil and natural gas companies have begun to apply the knowledge gained through the extensive development of unconventional resource plays to their existing conventional basins. Many of the techniques applied in unconventional development, when applied to conventional wells either through workover or recompletion, have the potential to enhance overall production or enable production from previously unproductive horizons and improve overall field economics. We believe that there are thousands of older conventional wells with the potential for the application of unconventional completion techniques in close proximity to the regions in which we operate. Many of our customers have begun to experiment with such techniques.
High Levels of Asset Utilization and Increased Attrition Should Positively Impact our Equipment Manufacturing Business . Existing hydraulic fracturing fleets are currently experiencing high levels of utilization as the result of a significant increase in the number of fracturing stages per horizontal well and increased pump pressure rates associated with the fracturing stages, which are designed to maximize shale oil and gas production. Additionally, advances such as pad drilling and zipper-fracs, whereby an operator drills two offset wells for simultaneous completion, have led to more wells being drilled per rig and, thus, have increased levels of asset utilization in the hydraulic fracturing industry. The higher level of operation is expected to accelerate the replacement cycle of equipment and result in increased attrition of existing hydraulic fracturing equipment.
Financial Information About Geographic Areas
During the three year period ended December 31, 2011, all of our revenues from external customers were derived from the United States and all of our long-lived assets were located in the United States.
Seasonality
Our results of operations have not historically reflected any material seasonal tendencies and we currently do not believe that seasonal fluctuations will have a material impact on either our Stimulation and Well Intervention Services or Equipment Manufacturing businesses in the foreseeable future.
Sales and Marketing
Our sales and marketing activities relating to our Stimulation and Well Intervention Services typically are performed through our local operations in each geographical region. We believe our local field sales personnel have an excellent understanding of region-specific issues and customer operating procedures and, therefore, can effectively target marketing activities. We also have multiple corporate sales representatives that supplement our field sales efforts and focus on large accounts and selling technical services. Our sales representatives work closely with our local managers and field sales personnel to target market opportunities. We facilitate teamwork among our sales representatives by basing a portion of their compensation on aggregate company sales targets rather than individual sales targets. We believe this emphasis on teamwork allows us to successfully expand our customer base and better serve our existing customers.
We have traditionally used our coiled tubing and pressure pumping services to expand our customer base and enter new markets, which in turn provides additional opportunities for our fracturing services. In many cases, our initial successful work with our customers in one particular basin has led to additional work in other resource positions in which the customer operates. Additionally, our ability to provide services in the spot market has allowed us to develop new customers. We will continue to leverage our existing customer base, as well as establish new relationships with additional operators, to selectively expand our hydraulic fracturing, coiled tubing and pressure pumping services to other basins that have similar characteristics to those in which we currently operate.
With respect to our Equipment Manufacturing business, we sell and market to oilfield services companies throughout the United States. During the fourth quarter of 2011, we completed the construction of a 36,000 square foot manufacturing facility adjacent to Total’s existing facility. This expansion positions Total to expand its customer base and meet a growing backlog of third-party orders. The expansion also enhances our research and development efforts around equipment and innovation and should also allow Total to continue to streamline our manufacturing capabilities and further lower our equipment costs, while shortening delivery times.
Customers
The majority of our revenues are generated from our fracturing services. Our customers served are primarily independent oil and natural gas exploration and production companies. In 2011, sales to Anadarko Petroleum, Penn Virginia, EOG Resources, Plains Exploration and EXCO Resources represented 23.1%, 18.2%, 15.9%, 13.2% and 10.4%, respectively, of our total sales. In 2010, sales to EOG Resources, Penn Virginia, Anadarko Petroleum and Apache accounted for 32.5%, 18.1%, 16.4% and 9.7%, respectively, of our total sales. In 2009, sales to Penn Virginia, Anadarko Petroleum and EnCana represented 25.9%, 11.7% and 11.0%, respectively, of our total sales. Our top ten customers in our Stimulation and Well Intervention Services segment accounted for approximately 92.7 %, 90.2% and 90.6% of our consolidated revenues for the years ended December 31, 2011, 2010 and 2009, respectively. We currently own six fracturing fleets and have ordered three additional fracturing fleets, which are expected to be delivered during 2012. Due to the large percentage of our revenues derived from our fracturing services and the limited number of fracturing fleets we possess, our customer concentration has historically been high. We believe our continued efforts to increase the number of fracturing fleets we operate will allow us to serve a larger number of customers and reduce customer concentration.
The customers served through our Equipment Manufacturing business are primarily oilfield services companies. As noted elsewhere in this Form 10-K, C&J historically has been, and continues to be, one of Total’s top customers. Since 2010, Total has constructed almost all of our hydraulic fracturing pressure pumps and is currently constructing the fracturing pumps on our three on-order fleets. Total has also constructed all of our coiled tubing and pressure pumping equipment since 2004. Our Equipment Manufacturing business did not generate a significant portion of our consolidated revenues for the year ended December 31, 2011.
Competition
The markets in which we provide our Stimulation and Well Intervention Services are highly competitive. We provide our services and products across South Texas, East Texas/North Louisiana, Western Oklahoma and West Texas/New Mexico, and we compete against different companies in each service and product line we offer. Our competition includes many large and small oilfield service companies, including the largest integrated oilfield services companies. Our major competitors for our fracturing services include Halliburton, Schlumberger, Baker Hughes, Weatherford International, RPC, Inc., Pumpco, an affiliate of Superior Energy Services, and Frac Tech. Our major competitors for our coiled tubing services include Halliburton, Schlumberger, Baker Hughes, RPC, Inc. and a significant number of regional businesses. The development of unconventional oil and gas resources is driving the need for complex, new technologies, completion techniques and equipment to help increase recovery rates, lower production costs and accelerate field development. We believe that the principal competitive factors in the market areas that we serve are technical expertise, fleet capability and experience. While we must be competitive in our pricing, we believe our customers select our services and products based on a high level of technical expertise, superior customer service and shale knowledge that our personnel use to deliver quality services and products.
In our Equipment Manufacturing Business we compete against numerous businesses, many of which are much larger and have greater financial and other resources. Major competitors for well stimulation equipment include Stewart & Stevenson, Enerflow Industries Inc., United Engines Manufacturing (a subsidiary of United Holdings LLC), Dragon Products (a division of Modern Group Inc.) and National Oilwell Varco, Inc. For our well servicing and coiled tubing products, our major competitors are National Oilwell Varco, Inc. and Stewart & Stevenson. We believe that our customers base their decisions to purchase equipment based on price, lead time and delivery, quality, and aftermarket parts and service capabilities.
Suppliers
We purchase the materials used in our Stimulation and Well Intervention Services, such as fracturing sand, fracturing chemicals, coiled tubing and fluid supplies, from various suppliers. We have established relationships with a limited number of suppliers of our raw materials and finished products. In general, we believe that we will be able to make satisfactory alternative arrangements in the event of interruption of supply. Should any of our current suppliers be unable to provide the necessary raw materials (such as proppant, guar, chemicals or coiled tubing) or finished products (such as fluid-handling equipment) or otherwise fail to deliver the products in a timely manner and in the quantities required, any resulting delays in the provision of services could have a material adverse effect on our business, financial condition, results of operations and cash flows. During the year ended December 31, 2011, we purchased 5% or more of our materials or equipment from each of Economy Polymers & Chemicals and Total. During the year ended December 31, 2010, we purchased 5% or more of our materials or equipment from each of Economy Polymers & Chemicals, Total, Weir SPM and Sintex Minerals & Services, Inc.
With respect to our Equipment Manufacturing business, in 2011 approximately 92.3% of our costs of goods sold consisted of raw materials and component parts, with the other 7.7% being labor and overhead. We currently depend on a limited number of suppliers for certain important raw materials and components parts for our products. In general, we believe that we will be able to make satisfactory alternative arrangements in the event of interruption of supply. During the year ended December 31, 2011, two of our vendors, Holt Caterpillar and Weir SPM, accounted for more than 10% of our raw materials and component parts purchases.
CEO BACKGROUND
Joshua E. Comstock
Mr. Comstock has served as our Chief Executive Officer and as one of our directors since May 1997. Mr. Comstock was given the additional title of President in December 2010 and the title of Chairman in February 2011. In 1997, Mr. Comstock founded our company. Mr. Comstock began working as a foreman on several specialized natural gas pipeline construction projects. Through this experience, Mr. Comstock gained extensive knowledge and understanding of the gathering and transporting of natural gas. In January 1990, Mr. Comstock began working for J4 Oilfield Service, a test pump services company. His primary responsibility was working in natural gas production as a service contractor for Exxon Mobil Corporation.
As a founder of our company, Mr. Comstock is one of the driving forces behind us and our success to date. Over the course of our history, Mr. Comstock has successfully grown our company through his leadership skills and business judgment and for this reason we believe Mr. Comstock is a valuable asset to our Board and is the appropriate person to serve as Chairman of our Board.
Randall C. McMullen, Jr .
Mr. McMullen has served as our Executive Vice President, Chief Financial Officer and Treasurer and director since joining us in August 2005. Prior to joining our company, Mr. McMullen held various positions with Credit Suisse First Boston, the GulfStar Group and Growth Capital Partners. Mr. McMullen graduated magna cum laude from Texas A&M University with a B.B.A. in Finance.
During Mr. McMullen’s tenure with us, we have grown rapidly. Mr. McMullen’s financial and investment banking expertise have been invaluable to us in our efforts to continue our growth through raising additional capital, and he is also extensively involved in our operations. For this reason, we believe Mr. McMullen is well suited to serve on our Board.
Darren M. Friedman
Mr. Friedman has served as one of our directors since December 2010. Mr. Friedman is a Partner of StepStone Group LLC, a global private equity firm that focuses on private equity partnership, equity and mezzanine investments. Prior to joining StepStone in 2010, Mr. Friedman was a Managing Partner of Citi Private Equity, a private equity firm, from 2001 to 2010, managing over $10 billion of capital across three private equity investing activities. Mr. Friedman sits or has sat on the board of directors or advisory boards of several portfolio companies, funds and a number of investment committees. Mr. Friedman currently serves on the board of directors of ServiceMaster Global Holdings, Educate Inc., Educate Online Inc. and Laureate Education, Inc. Prior to joining Citi Private Equity, Mr. Friedman worked in the Investment Banking division at Salomon Smith Barney. Mr. Friedman received an M.B.A. from the Wharton School at the University of Pennsylvania and a B.S. in Finance from the University of Illinois.
Mr. Friedman brings extensive business, financial and banking expertise to our Board from his background in investment banking and private equity fund management. Mr. Friedman also brings extensive prior board service experience to our Board from his service on numerous other board of directors/limited partnership advisory boards.
James P. Benson
Mr. Benson has served as one of our directors since October 2006. Mr. Benson is a founding shareholder and a Managing Partner of Energy Spectrum, which manages private equity through institutional partnerships styled as Energy Spectrum Partners and Energy Trust Partners, and also manages a Financial Advisory business focused on energy mergers and acquisitions and institutional financings named Energy Spectrum Advisors, Inc. Energy Spectrum was established in 1996. Prior to Energy Spectrum, Mr. Benson was a Managing Director of Reid Investments, Inc., a private investment banking firm focused on energy mergers and acquisitions and financial advisory services, joining the firm in mid-1987. He started his career at InterFirst Bank Dallas, and was a credit officer focused on energy lending and energy work-outs. Mr. Benson currently serves on the board of directors of several privately held companies related to Energy Spectrum. Mr. Benson graduated from the University of Kansas with a B.S. in Finance and earned his M.B.A. with a concentration in Finance from Texas Christian University.
Mr. Benson’s extensive financial and banking experience in the energy industry from his over 20 years of experience working at private equity firms specializing in the energy industry make him well qualified to serve on our Board.
Michael Roemer
Mr. Roemer has served as one of our directors since December 2010. Mr. Roemer previously served as the Chief Financial Officer of HKW, a private equity group, and as a partner in several affiliate funds of HKW from 2000 until January 2012. Upon his retirement from HKW, Mr. Roemer founded Roemer Financial Consulting, through which he provides financial accounting advice. Prior to joining HKW, Mr. Roemer served as a shareholder and Vice President of Flackman, Goodman & Potter, P.A., a certified public accounting firm, from 1988 to 2000. Mr. Roemer is a licensed CPA with over 30 years experience, and is a member of the American Institute of Certified Public Accountants and the New Jersey Society of Certified Public Accountants. Mr. Roemer received his B.S. in Accounting from the University of Rhode Island.
Mr. Roemer’s extensive background in public accounting combined with his subsequent experience as the chief financial officer of a private equity firm and his experience as a licensed CPA make him well qualified to serve on our Board.
H.H. “Tripp” Wommack, III
Mr. Wommack has served as one of our directors since December 2010. Mr. Wommack is currently the Chairman, President and Chief Executive Officer of Saber Oil and Gas Ventures, LLC, an oil and gas company that focuses on acquisition and exploitation efforts in the Permian Basin of West Texas and Southeast New Mexico. Mr. Wommack has served in this position since August 2008. Mr. Wommack also serves as the Chairman of Cibolo Creek Partners, LLC, which specializes in commercial real estate investments, a position he has held since January 1993, and as the Chairman of Globe Energy Services, LLC, an energy services company in the Permian Basin, a position he has held since May 2011. Prior to his current positions, Mr. Wommack was Chairman, President and Chief Executive Officer of Southwest Royalties, Inc. from August 1983 to August 2004 and Saber Resources from July 2004 until August 2008. Additionally, Mr. Wommack was the founder, Chairman and Chief Executive Officer of Basic Energy Services (formerly Sierra Well Services, Inc.), and following its initial public offering, Mr. Wommack continued to serve on the board of directors of Basic Energy Services through June 2009. Mr. Wommack graduated with a B.A. from the University of North Carolina, Chappell Hill, and earned a J.D. from the University of Texas.
Mr. Wommack adds extensive executive and management expertise to us from his background as chairman and/or chief executive officer of numerous companies. In addition, we believe Mr. Wommack’s knowledge from serving as chairman and chief executive officer of a company that went through an initial public offering is valuable to us as a newly public company. For these reasons, we believe Mr. Wommack to be an asset to our Board.
C. James Stewart III
Mr. Stewart has served as one of our directors since December 2010. Since 2003, Mr. Stewart has served as the President and Chairman of Stewart & Sons Holding, which is his wholly owned holding company for his family businesses, including Lime (formerly known as Supreme Electrical Services, Inc.) and Surefire. Mr. Stewart has served as the Chairman of Lime, a manufacturer of electrical/digital control systems for well servicing equipment and a provider of electrical services for drilling rigs, since its inception in September 2006. Since its inception in October 2010, Mr. Stewart has also served as the Chairman of Surefire, a joint venture company involved in the manufacturing of well servicing equipment for the oilfield services industry. From 1972 to 2003, Mr. Stewart worked at Stewart & Stevenson, a manufacturer of equipment used in the oilfield services industry, in multiple capacities, including serving as Executive Vice President and Director from 1999 to 2003. Mr. Stewart received a B.S. from Texas Christian University.
We believe Mr. Stewart’s extensive business and marketing experience at a large oil field services company make him a valuable member of our Board.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
We are an independent provider of premium hydraulic fracturing, coiled tubing and pressure pumping services with a focus on complex, technically demanding well completions. In addition, through our subsidiary Total, we manufacture and repair equipment for our internal needs as well as for third party companies in the energy services industry.
We operate in what we believe to be some of the most geologically challenging basins in South Texas, East Texas/North Louisiana, Western Oklahoma and West Texas/East New Mexico. We are in the process of acquiring additional hydraulic fracturing fleets and are evaluating opportunities with existing and new customers to expand our operations into new areas throughout the United States with similarly demanding completion and stimulation requirements.
Recent Developments
Delivery and Deployment of Fleet 6 . In December 2011, we took delivery of the first part of our sixth hydraulic fracturing fleet, which we call Fleet 6A, and deployed it immediately for operations in the Permian Basin pursuant to a two-year term contract on a full month take-or-pay basis. Fleet 6A, which consists of 16,000 horsepower, has been continuously utilized for vertical completions since deployment. Originally Fleet 6B, making up the other part of Fleet 6, was to be a 16,000 horsepower vertical fleet, but, at our customer’s request, was increased to 32,000 horsepower with the necessary ancillary equipment and deployed effective February 13, 2012 for horizontal completions in the Permian Basin.
New Equipment Purchases. We have ordered three new hydraulic fracturing fleets, Fleets 7, 8 and 9. We anticipate taking delivery of Fleet 7 in April 2012 and deploying it soon thereafter for work in the Permian Basin. Fleet 8 is anticipated for delivery in the third quarter of 2012 but may be accelerated based on market conditions. Due to the robust nature of our internal cash flow and the confidence we have in our ability to expand our customer base, we have ordered Fleet 9, which we expect to receive and deploy by the end of the fourth quarter of 2012. We are actively seeking to secure multi-year take-or-pay contracts for Fleets 7, 8 and 9; although, we believe that the equipment can attract solid demand in the spot market if long-term contracts are not secured.
During 2011, we increased our coiled tubing fleet and the associated ancillary equipment by approximately 40%, expanding from a fleet of 13 units at the beginning of the year to a fleet of 18 units by the end of the year. We have ordered six new coiled tubing units together with the related ancillary equipment, which we expect to deploy in 2012 in new basins. Historically, we have successfully leveraged our existing relationships with coiled tubing customers to expand our fracturing business and we hope to do the same as we expand our coiled tubing operations into new basins in 2012.
Initial Public Offering. On July 28, 2011, our registration statement on Form S-1 (File No. 333-173177) relating to our initial public offering of 13,225,000 shares of our common stock was declared effective by the SEC. The IPO closed on August 3, 2011, at which time we issued and sold 4,300,000 shares and selling stockholders sold 8,925,000 shares, including 1,725,000 shares sold by certain of the selling stockholders pursuant to the full exercise of the underwriters’ option to purchase additional shares. The shares were sold at a price to the public of $29.00 per share. We received cash proceeds of approximately $112.1 million from this transaction, net of underwriting discounts, commissions and transaction costs. We did not receive any proceeds from the sale of shares by the selling stockholders.
Expansion of Total. On April 28, 2011, we acquired Total, a manufacturer of hydraulic fracturing, coiled tubing, pressure pumping and other equipment used in the energy services industry and one of our largest suppliers of machinery and equipment. In addition to equipment manufacturing, through Total we also conduct equipment repair services and provide other oilfield parts and supplies for third-party customers in the energy services industry as well as to meet our own internal needs. Following our acquisition of Total, we acquired approximately 10 acres of property adjacent to Total’s current facility and began construction of an approximate 36,000 square foot manufacturing facility, which was completed in December 2011. The total cost of construction of the facility was approximately $2.0 million. We are currently utilizing the facility to manufacture new equipment and we expect to be at full capacity by mid-2012.
How We Generate Our Revenues
We seek to differentiate our services from those of our competitors by providing customized solutions for our customers’ most challenging well completions. We believe our customers value the experience, technical expertise, high level of customer service and demonstrated operational efficiencies that we bring to projects.
Our revenues are derived primarily from three sources:
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monthly payments for the committed hydraulic fracturing fleets under term contracts as well as prevailing market rates for spot market work, together with associated charges or handling fees for chemicals and proppants that are consumed during the fracturing process;
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prevailing market rates for coiled tubing, pressure pumping and other related well stimulation services, together with associated charges for stimulation fluids, nitrogen and coiled tubing materials; and
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sales of manufactured equipment, parts and supplies and repair services provided through our recently acquired subsidiary, Total, a manufacturer of hydraulic fracturing, coiled tubing, pressure pumping and other equipment used in the energy services industry.
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 82% of our consolidated revenues for the year ended December 31, 2011 were derived from hydraulic fracturing services. Each of our hydraulic fracturing fleets are currently working under term contracts: Fleets 1 and 2 are dedicated through mid-2012 to producers 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 Fleet 6 is dedicated through late 2013 to a producer operating in the Permian Basin. Fleet 4 remains under contract but has been redeployed to the Eagle Ford for committed work, with spot market availability for new customers working in the Eagle Ford Shale, as well as the Permian Basin. The customer relationship remains in place and this fleet may be redeployed to the Haynesville Shale at the election of the contract customer with timely notice. We are scheduled to take delivery of Fleets 7, 8 and 9 in April 2012, the third quarter of 2012 and the fourth quarter of 2012, respectively. We are seeking to secure multi-year take-or-pay contracts for Fleets 7, 8 and 9, and to renew the two contracts that are set to expire in mid-2012, although, we believe that the equipment can attract solid demand in the spot market if long-term contracts are not secured.
Our term contracts generally range from one year to three years. Under the term contacts, typically our customers are 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. Our term contracts typically 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.
Although our term contracts provide some visibility on anticipated future minimum asset utilization, they do not provide us with sufficient certainty to present backlog information on an ongoing basis. Unlike long-term contracts for equipment or services at fixed prices or on a day rate or turnkey basis, where future revenue or earnings can be reliably forecasted based on the dollar amount of backlog believed to be firm, future revenues generated from our term contracts are subject to a number of variables that prevent us from providing similar information with any degree of certainty. Under our term contracts, we derive revenues from:
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mandatory monthly payments for a specified minimum number of hours of service per month;
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preset amounts for each hour of service in excess of the contracted minimum number of hours of service per month; and
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preset service charges for chemicals and proppant materials that are consumed during the fracturing process.
Given these variables, revenues from our term contracts vary substantially from customer to customer and from month to month depending on the number of hours of services actually provided, the amount of chemicals and proppant materials consumed and whether we or the customer supplies the sand. Generally, when we exceed the number of hours of service included in our base monthly rate, we consume more chemicals and proppants and provide additional pumping and related services to complete the project, each of which will significantly impact our revenues. Mandatory monthly payments under our term contracts have historically accounted for less than half of our total revenues.
Although we have entered into term contracts for each of our existing hydraulic fracturing fleets, we also have the flexibility to pursue spot market projects. 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. 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 also source chemicals and proppants that are consumed during the fracturing process. We charge our customers a fee for materials consumed in the process and a handling fee for any chemicals and proppants supplied by the customer. Materials charges reflect the cost of the materials plus a markup and are based on the actual quantity of materials used in the fracturing process. Due to the flexibility of our operating model, our revenue can fluctuate without having a material impact to earnings when our customers elect to source their own sand. We believe our ability to provide services in the spot market allows us to take advantage of any favorable pricing that may exist in this market and allows us to develop new customer relationships.
Coiled Tubing and Pressure Pumping . 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 two 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.
Equipment Manufacturing Segment.
Our Equipment Manufacturing segment constructs oilfield equipment, including hydraulic fracturing pumps, coiled tubing units, pressure pumping units and other equipment, for our Stimulation and Well Intervention Services segment 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 our internal needs.
How We Manage Costs and Maintain Our Equipment
The principal expenses involved in conducting our business are costs for chemicals, proppants and other materials, labor expenses, costs for maintenance and repair of our equipment, costs to replace tubing on our coiled tubing units, depreciation expenses and fuel costs. Additionally, we incur freight costs to deliver and stage chemicals and proppants to the worksite. Proppant, chemical and associated freight costs represented approximately 31.8% and 34.7% of our revenues for the years ended December 31, 2011 and 2010, respectively. Direct labor costs represented approximately 8.7% and 10.7% of our revenues for the years ended December 31, 2011 and 2010, respectively. Repair and maintenance costs represented approximately 7.9% and 6.3% of our revenues for the years ended December 31, 2011 and 2010, respectively. Tubing replacement costs represented approximately 1.8% and 3.6% of our revenues for the years ended December 31, 2011 and 2010, respectively. Depreciation costs represented approximately 2.5% and 4.0% of our revenues for the years ended December 31, 2011 and 2010, respectively. We also incur significant fuel costs in connection with the operation of our hydraulic fracturing fleets and the transportation of our equipment and products.
We maintain and repair all equipment we use in our operations. We primarily purchase replacement components for our equipment, including engines, transmissions, radiators, motors and pumps, from third-party vendors. Our acquisition of Total in April 2011, which has historically been one of our largest suppliers of machinery and equipment, provides several strategic advantages, including a significant reduction in our exposure to third-party supply chain constraints, shorter cycle times for the delivery of new equipment and some replacement parts, a reduction in and greater control of the cost of new equipment, and enhanced operational control of our service offerings. Furthermore, the acquisition of Total is expected to help minimize downtime by enhancing our capabilities for maintenance and repair of our hydraulic fracturing equipment. Total is currently constructing the hydraulic fracturing pumps for all three of our on-order fleets and all six of our on-order coiled tubing units.
How We Manage Our Operations
Our management team uses a variety of tools to monitor and manage our operations in the following four areas: (1) asset utilization, (2) equipment maintenance performance, (3) customer satisfaction and (4) safety performance.
Asset Utilization. We measure our activity levels by the total number of jobs completed by each of our hydraulic fracturing fleets and coiled tubing units on a monthly basis. By consistently monitoring the activity level, pricing and relative performance of each of our fleets and units, we can more efficiently allocate our personnel and equipment to maximize revenue generation.
Our hydraulic fracturing business contributed $619.8 million of revenue and completed 3,713 fracturing stages during the year ended December 31, 2011, compared to $182.7 million of revenue and 1,038 fracturing stages for the previous year. During the year ended December 31, 2011, we averaged monthly revenue per unit of horsepower of $374 compared to $336 for the previous year.
Our coiled tubing business contributed $97.2 million of revenue and we completed 3,183 coiled tubing jobs during the year ended December 31, 2011, compared to $50.6 million of revenue and 2,084 coiled tubing jobs for the previous year. We entered 2011 with a fleet of 13 coiled tubing units, and took delivery of five units during the year, ending with a fleet of 18 coiled tubing units.
Our pressure pumping business generated $19.4 million of revenue during the year ended December 31, 2011, up from $10.9 million during the year ended December 31, 2010.
Equipment Maintenance Performance. Preventative maintenance on our equipment is an important factor in our profitability. If our equipment is not maintained properly, our repair costs may increase and, during periods of high activity, our ability to operate efficiently could be significantly diminished due to having trucks and other equipment out of service. Our maintenance crews perform regular inspections and preventative maintenance on each of our trucks and other mechanical equipment. Our management monitors the performance of our maintenance crews at each of our service centers by reviewing ongoing inspection and maintenance activity and monitoring the level of maintenance expenses as a percentage of revenue. A rising level of maintenance expenses as a percentage of revenue at a particular service center can be an early indication that our preventative maintenance schedule is not being followed. In this situation, management can take corrective measures to help reduce maintenance expenses as well as ensure that maintenance issues do not interfere with operations.
Customer Satisfaction. Upon completion of each job, we encourage our customers to provide feedback on their satisfaction level. Customers evaluate our performance under various criteria and comment on their overall satisfaction level. This feedback gives our management valuable information from which to identify performance issues and trends. Our management also uses this information to evaluate our position relative to our competitors in the various markets in which we operate.
Safety Performance. Maintaining a strong safety record is a critical component of our operational success. Many of our larger customers have safety standards we must satisfy before we can perform services for them. We maintain a safety database so that our customers can review our historical safety record. Our management also uses this safety database to identify negative trends in operational incidents so that appropriate measures can be taken to maintain and enhance our safety standards.
Our Challenges
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, we believe that we are well positioned to capitalize on the current growth opportunities available in the industry in which we operate. However, we may be unable to capitalize on our competitive strengths to achieve our business objectives and, consequently, our results of operations may be adversely affected. Please read the sections titled “Cautionary Note Regarding Forward-Looking Statements” and Part I, Item 1A “Risk Factors” for additional information about the known material risks that we face.
Equipment Supply. The overall number of equipment suppliers in the industry in which we operate is limited, and there has historically been high demand for this equipment. This limited capacity of supply increases the risk of delay and failure to timely deliver both our on-order equipment and any future equipment that may be necessary to grow our business. We expect to take delivery of three new hydraulic fracturing fleets, Fleets 7, 8 and 9, in April 2012, in the third quarter of 2012 and in the fourth quarter of 2012, respectively. In addition, we have ordered six new coiled tubing units along with related ancillary equipment and we expect to take delivery of each of these new units in 2012. To mitigate the risk of a potential delay in equipment delivery, we actively monitor the progression of the production schedule of our on-order equipment. Our recent acquisition of Total, a significant supplier of our hydraulic fracturing and coiled tubing equipment, has provided us with added monitoring capabilities and control over access to, and delivery of, new equipment.
Hydraulic Fracturing Legislation and Regulation. Congress has from time to time, including during the current session, considered legislation to provide for federal regulation of hydraulic fracturing and to require public disclosure of the chemicals used in the fracturing process. If such current or any future federal legislation becomes law, it could establish an additional level of regulation that could lead to operational delays or increased operating costs. The EPA also recently proposed rules that would establish new air emission controls for oil and natural gas production and natural gas processing operations. Among other controls, the rules would require operators to use “green completions” for hydraulic fracturing, meaning operators would have to recover rather than vent the gas and natural gas liquids that come to the surface during completion of the fracturing process. In addition, various state and local governments have implemented, or are considering, increased regulatory oversight of hydraulic fracturing, and Texas has adopted legislation that requires disclosure of information regarding the substances used in the hydraulic fracturing process to the Railroad Commission of Texas and the public.
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.
Financing Future Growth. Historically, we have funded our growth through bank debt, capital contributions and borrowings from our stockholders, and cash generated from our business. The successful execution of our growth strategy depends on our ability to raise capital as needed to, among other things, finance the purchase of additional hydraulic fracturing fleets. If we are unable to generate sufficient cash flows or to obtain additional capital on favorable terms or at all, we may be unable to sustain or increase our current level of growth in the future. However, we believe we are well positioned to finance our future growth. On April 19, 2011, we entered into a five-year $200.0 million senior secured revolving credit facility. In addition, our cash flows from operations have continued to increase, with cash flows from operations during the year ended December 31, 2011 increasing by $127.0 million from the same period in 2010. We believe that the combination of our cash on hand, which is $49.8 million as of February 24, 2012, our cash flows from operations and available borrowings under our credit agreement will be sufficient to allow us to sustain or increase our current growth through 2012.
Outlook
Demand for our services has increased significantly over the last two years in the markets in which we operate and we have made substantial investments in the acquisition of additional equipment in order to capitalize on this market opportunity, which has led to significant growth in our business. We believe the following trends impacting our industry have increased the demand for our services and will continue to support the sustained growth that we have experienced to date:
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ongoing development of existing and emerging unconventional resource basins;
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increased horizontal drilling and greater service intensity in unconventional resource basins, particularly in oily- and liquids-rich formations where we are seeing enhanced economics, through the application of completion technologies such as hydraulic fracturing;
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improved drilling efficiencies increasing the number of horizontal feet per day requiring completion services; and
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increased hydraulic fracturing intensity, particularly with increasingly longer laterals and a greater number of fracturing stages per well, in more demanding and technically complex formations.
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. Because we typically pass the cost of raw materials, such as proppants and chemicals, onto our customers, our profitability is not 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 have entered into term contracts covering each of our six existing fleets. We are seeking to secure multi-year take-or-pay contracts for Fleets 7, 8 and 9; although, we believe that the equipment can attract solid demand in the spot market if long-term contracts are not secured.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
We are an independent provider of premium hydraulic fracturing, coiled tubing and pressure pumping services with a focus on complex, technically-demanding well completions. These services, which are offered through our Stimulation and Well Intervention Services segment, are provided in conjunction with both unconventional and conventional well completions as well as stimulation and workover operations for existing wells. In addition, our Equipment Manufacturing segment, which is conducted through Total, manufactures and repairs equipment for our internal needs as well as for third-party companies in the energy services industry.
We provide our Stimulation and Well Intervention Services in what we believe to be some of the most geologically challenging basins in South Texas, East Texas/North Louisiana, Western Oklahoma and West Texas/East New Mexico. We currently operate seven modern, 15,000 pounds per square inch, pressure rated hydraulic fracturing fleets with an aggregate 242,000 horsepower, and we currently have on order two additional hydraulic fracturing fleets, which we expect to be delivered and deployed in the third quarter and fourth quarter of 2012, respectively. The acquisition of these two additional fleets will increase our total capacity to more than 300,000 horsepower by the end of 2012. We also operate a fleet of 18 coiled tubing units and we have six new coiled tubing units on order, which we expect to be delivered and deployed by the end of 2012. Additionally, we have 20 double pumps, three single pumps and five high pressure pump down units in our standalone pressure pumping line. In anticipation of the delivery and deployment of this new equipment in 2012, we are evaluating opportunities with existing and new customers to expand our operations into new areas throughout the United States with similarly demanding completion and stimulation requirements.
With the acquisition of Total on April 28, 2011, we commenced our Equipment Manufacturing business. In addition to manufacturing hydraulic fracturing, coiled tubing, pressure pumping and other equipment used in the energy services industry, through Total we also provide equipment repair services and sell oilfield parts and supplies to third-party customers in the energy services industry, and to meet our own internal needs. Following our acquisition of Total, we acquired approximately ten acres of property adjacent to Total’s current facility and constructed an approximate 36,000 square foot manufacturing facility, which was completed in December 2011. By significantly increasing Total’s manufacturing capacity, we expect to further increase its ability to service our Stimulation and Well Intervention Services segment and existing and future third-party customers, and to enhance our research and development efforts around equipment and innovation.
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 78% of our consolidated revenues for the three months ended March 31, 2012 were derived from hydraulic fracturing services. Six of our hydraulic fracturing fleets are currently working under term contracts: Fleet 1 has been extended, in accordance with provisions in the current contract, for 12 months through mid-2013 to a producer operating in the Eagle Ford shale; Fleet 2 has been extended, in accordance with provisions in the current contract, for three months through late 2012 to a producer operating in the Eagle Ford shale, with the possibility for a longer-term extension; 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 for committed work, with spot market availability for new customers working in the Eagle Ford shale, as well as the Permian Basin. The customer relationship remains in place and this fleet may be redeployed to the Haynesville shale at the election of the contract customer with timely notice.
We took full delivery of all pumps and initially ordered ancillary equipment for our seventh hydraulic fracturing fleet in April 2012. The 32,000 horsepower fleet was deployed in late-April for spot market work in the Eagle Ford shale in South Texas and the Permian Basin in West Texas. We are scheduled to take delivery of Fleets 8 and 9 in the third quarter of 2012 and the fourth quarter of 2012, respectively. We are seeking to secure multi-year take-or-pay contracts for Fleets 7, 8, and 9, although, we believe that the equipment can generate attractive returns in the spot market if long-term contracts are not secured.
Our term contracts generally range from one year to three years. Under the term contacts, typically our customers are 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. Our term contracts typically 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.
In addition to operating our recently deployed seventh hydraulic fracturing fleet in the spot market, 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, which is typically higher than the rates under our term contracts. We may also charge fees for setup and mobilization of equipment depending on the job. 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. This spot market activity not only has a positive impact on revenue and earnings, but also acts as a marketing tool, enabling us to introduce our services to new customers and strengthen our relationships with the existing customers.
Our hydraulic fracturing business contributed $186.4 million of revenue and completed 1,476 fracturing stages during the first quarter of 2012, compared to $172.6 million of revenue and 1,151 fracturing stages during the fourth quarter of 2011. During the three months ended March 31, 2012, we averaged monthly revenue per unit of horsepower of $319 compared to $343 for the previous quarter. Hydraulic fracturing revenue for the first quarter of 2011 was $104.9 million and 633 fracturing stages were completed. Average monthly revenue per unit of horsepower was $383 for the first quarter of 2011.
Coiled Tubing and Pressure Pumping. Approximately 17% of our consolidated revenues for the three months ended March 31, 2012 were derived from coiled tubing and pressure pumping services. 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 $35.5 million of revenue and we completed 908 coiled tubing jobs during the first quarter of 2012, compared to $32.0 million of revenue and 849 coiled tubing jobs during the previous quarter. Coiled tubing revenue for the first quarter of 2011 was $17.4 million and 638 jobs were completed. We currently have a fleet of 18 coiled tubing units with six new coiled tubing units on order that are expected to be deployed before the end of 2012 in new geographic basins. Our pressure pumping business generated $4.6 million of revenue during the first quarter of 2012, compared to $4.3 million during the fourth quarter of 2011 and $4.9 million for the prior year quarter.
Equipment Manufacturing Segment
Approximately 5% of our consolidated revenues for the three months ended March 31, 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 and other equipment, for our Stimulation and Well Intervention Services segment 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 segment.
Our Challenges
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, we believe that we are well positioned to capitalize on the current growth opportunities available in the industry in which we operate. However, we may be unable to capitalize on our competitive strengths to achieve our business objectives and, consequently, our results of operations may be adversely affected. Please read the section titled “Cautionary Note Regarding Forward-Looking Statements” of this Form 10-Q and the section titled “Risk Factors” in this Form 10-Q and in our Annual Report on Form 10-K for additional information about the risks we face.
Equipment Supply. The overall number of equipment suppliers in the industry in which we operate is limited, and there has historically been high demand for this equipment. This limited capacity of supply increases the risk of delay and failure to timely deliver both our on-order equipment and any future equipment that may be necessary to grow our business. We expect to take delivery of and deploy two new hydraulic fracturing fleets, Fleets 8 and 9, in the third quarter of 2012 and in the fourth quarter of 2012, respectively. In addition, we have ordered six new coiled tubing units along with related ancillary equipment, each of which we expect to take delivery of in 2012. To mitigate the risk of a potential delay in equipment delivery, we actively monitor the progression of the production schedule of our on-order equipment. Our acquisition of Total, a significant supplier of our hydraulic fracturing and coiled tubing equipment, has provided us with added monitoring capabilities and control over access to, and delivery of, new fracturing equipment.
Hydraulic Fracturing Legislation and Regulation. Congress has from time to time, including during the current session, considered legislation to provide for federal regulation of hydraulic fracturing and to require public disclosure of the chemicals used in the fracturing process. If such current or any future federal legislation becomes law, it could establish an additional level of regulation that could lead to operational delays or increased operating costs. The federal Environmental Protection Agency (“EPA”) also recently proposed rules that would establish new air emission controls for oil and natural gas production and natural gas processing operations. Among other controls, the rules would require operators to use “green completions” for hydraulic fracturing, meaning operators would have to recover rather than vent the gas and natural gas liquids that come to the surface during completion of the fracturing process. In addition, various state and local governments have implemented, or are considering, increased regulatory oversight of hydraulic fracturing, and Texas has adopted legislation that requires disclosure of information regarding the substances used in the hydraulic fracturing process to the Railroad Commission of Texas and the public.
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.
Financing Future Growth. Historically, we have funded our growth through bank debt, capital contributions and borrowings from our stockholders, and cash generated from our business. The successful execution of our growth strategy depends on our ability to raise capital as needed to, among other things, finance the purchase of additional hydraulic fracturing fleets. If we are unable to generate sufficient cash flows or to obtain additional capital on favorable terms or at all, we may be unable to sustain or increase our current level of growth in the future. However, we believe we are well positioned to finance our future growth. On April 19, 2011, we entered into our five-year $200.0 million Credit Facility and had no amounts outstanding as of May 4, 2012, leaving the entire $200.0 million available for borrowing. In addition, our cash flows from operations have continued to increase, with cash flows from operations during the three months ended March 31, 2012 increasing by $49.8 million from the same period in 2011 and we ended the quarter with $78.2 million cash on hand as of March 31, 2012. We believe that the combination of our cash on hand, which was $74.4 million as of May 4, 2012, our cash flows from operations and available borrowings under our credit agreement will be sufficient to allow us to sustain or increase our current growth through 2012.
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. Because we typically pass the cost of raw materials, such as proppants and chemicals, onto our customers, our profitability is generally not 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 have entered into term contracts covering six out of our seven existing fleets. We are seeking to secure multi-year take-or-pay contracts for Fleets 7, 8, and 9, although we believe that the equipment can generate attractive returns in the spot market if long-term contracts are not secured.
Our revenues and results of operations were positively impacted by: (1) the addition and deployment of Fleet 4 in April 2011; (2) the addition and deployment of Fleet 5 in August 2011; (3) the addition and deployment of Fleet 6A in December 2011 and Fleet 6B in February 2012; (4) the addition and deployment of five new coiled tubing units during 2011; and (5) the acquisition of Total in April 2011. In the near term, we also expect our revenues and results of operations to be positively impacted by the deployment of Fleets 7, 8 and 9 in April 2012, the third quarter of 2012 and the fourth quarter of 2012, respectively. We expect that our results of operations in 2012 compared to 2011 will be significantly impacted by the dramatic growth of our asset base over the last twelve months.
Revenue
Revenue increased $111.8 million, or 88%, to $239.1 million for the three months ended March 31, 2012, as compared to $127.2 million for the same period in 2011. This increase was primarily due to the deployment of additional hydraulic fracturing equipment in our Stimulation and Well Intervention Services segment. Fleets 4, 5, 6A and 6B, which were deployed in April 2011, August 2011, December 2011 and February 2012, respectively, contributed $93.2 million of incremental revenue in the first quarter of 2012. The additional increase in revenue was due to the addition of five coiled tubing units and the acquisition of Total in April 2011.
Cost of Sales
Cost of sales increased $74.3 million, or 106%, to $144.4 million for the three months ended March 31, 2012, compared to $70.0 million for the same period in 2011 primarily due to the significant quarter-over-quarter increase in revenue and to a lesser extent, increased costs associated with our Equipment Manufacturing business segment which we entered into with the acquisition of Total in the second quarter of 2011.
Selling, General and Administrative Expenses (“SG&A”)
SG&A increased $9.5 million, or 108%, to $18.3 million for the three months ended March 31, 2012, as compared to $8.8 million for the same period in 2011. The increase primarily related to $2.7 million in higher payroll and personnel costs associated with the continued hiring of personnel to support our growth, $1.9 million in higher long-term and short-term incentive costs, $0.7 million in higher professional fees and $0.4 million in higher property taxes. We also incurred $2.2 million in increased SG&A costs related to Total, which was acquired in April 2011.
Interest Expense
Interest expense decreased by $1.6 million, or 81%, to $0.4 million for the three months ended March 31, 2012 as compared to $2.0 million for the same period in 2011. The decrease was primarily attributable to lower average outstanding debt balances and, to a lesser extent, lower interest rates.
Income Taxes
We recorded a tax provision of $26.1 million for the three months ended March 31, 2012, at an effective rate of 34.6%, compared to a tax provision of $17.4 million for the three months ended March 31, 2011, at an effective rate of 37.4%. The decrease in our effective rate quarter over quarter is primarily attributable to certain qualifying deductions reflected in income tax provision for the first quarter of 2012 provision that were not included in the provision for the first quarter of 2011.
Liquidity and Capital Resources
Our primary sources of liquidity to date have been capital contributions from stockholders, the net proceeds that we received from our IPO, borrowings under our credit facilities and cash flows from operations. Our primary use of capital has been the acquisition and maintenance of equipment. During 2009, we spent significantly less on capital expenditures than we had in previous years. Our capital expenditures increased in 2010 and 2011 and we anticipate capital expenditures will continue to increase through 2012. We have ordered two new hydraulic fracturing fleets, Fleets 8 and 9, which are scheduled for delivery in the third quarter of 2012 and the fourth quarter of 2012, respectively. Fleet 8 has an aggregate cost of approximately $29 million, of which approximately $10.0 million had been funded as of May 4, 2012; and Fleet 9 has an aggregate cost of approximately $30 million, of which approximately $2.2 million had been funded as of May 4, 2012. In addition, we have ordered six new coiled tubing units along with related ancillary equipment for delivery in 2012 with a combined aggregate cost of approximately $20 million, of which approximately $0.9 million had been funded as of May 4, 2012. We intend to fund the remaining costs of the two hydraulic fracturing fleets and six coiled tubing units through a combination of cash on hand, which was $74.4 million as of May 4, 2012, cash flows from operations, and, to the extent necessary, borrowings under our credit facility.
On April 19, 2011, we entered into a five-year $200.0 million revolving credit facility. Proceeds from the closing of the Credit Facility were used to repay $49.6 million of indebtedness outstanding under our previous revolving credit facility and $29.9 million of indebtedness, accrued interest and early termination penalties under our subordinated term loan. The majority of proceeds we received from our IPO were used to pay down all amounts outstanding under our Credit Facility and, as such, we have no balance outstanding as of May 4, 2012.
We continually monitor potential capital sources, including equity and debt financings, in order to meet our planned capital expenditures and liquidity requirements. Our ability to fund operating cash flow shortfalls, if any, and to fund planned capital expenditures will depend upon our future operating performance, and more broadly, on the availability of equity and debt financing, which will be affected by prevailing economic conditions in our industry and financial, business and other factors, some of which are beyond our control. Based on our existing operating performance, we believe our cash flows and existing capital coupled with borrowings available under our Credit Facility will be adequate to meet operational and capital expenditure needs for at least the next 12 months.
Our Credit Facility contains covenants that require us to maintain an interest coverage ratio, to maintain a leverage ratio and to satisfy certain other conditions. These covenants are subject to a number of exceptions and qualifications set forth in the credit agreement that evidences such Credit Facility. We are currently in compliance with these covenants. In addition, our Credit Facility contains covenants that limit our ability to make capital expenditures in excess of $100.0 million in any fiscal year, provided that up to $50.0 million of such amount in any fiscal year may be rolled over to the subsequent fiscal year, and up to $50.0 million of such amount may also be pulled forward from the subsequent fiscal year. The capital expenditure restrictions do not apply to capital expenditures financed with proceeds from the issuance of our common stock or to maintenance capital expenditures. The Credit Facility also restricts our ability to incur additional debt or sell assets, make certain investments, loans and acquisitions, guarantee debt, grant liens, enter into transactions with affiliates, engage in other lines of business and pay dividends and distributions. For more information concerning the Credit Facility, please read “Description of Our Indebtedness” elsewhere in this Form 10-Q.
Capital Requirements
The energy services business is capital-intensive, requiring significant investment to expand, upgrade and maintain equipment. Our capital requirements have consisted primarily of, and we anticipate will continue to be:
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growth capital expenditures, such as those to acquire additional equipment and other assets or upgrade existing equipment to grow our business; and
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maintenance capital expenditures, which are capital expenditures made to extend the useful life of partially or fully depreciated assets.
We continually monitor new advances in hydraulic fracturing equipment and down-hole technology, as well as technologies that may complement our existing businesses, and commit capital funds to upgrade and purchase additional equipment to meet our customers’ needs. We expect our total 2012 capital expenditures to be approximately $145 to $160 million, of which $46.8 million has been incurred as of May 4, 2012. The remainder of our estimated capital expenditures for 2012 includes the purchase of Fleets 8 and 9, six new coil tubing units and maintenance capital expenditures.
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Fund Letters
