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Executives

Dave Wallace – Chairman and CEO

Tom Stoelk – VP and CFO

Analysts

Byron Pope – Tudor Pickering Holt

Stephen Gengaro – Jefferies & Company

Victor Marchon – RBC Capital

Jack Aydin – Keybanc Capital Management

Joe Agular – Johnson Rice

Michael Mazar – BMO Capital Markets

Stephen Gengaro – Jefferies & Company

Superior Well Services, Inc. (SWSI) Q3 2008 Earnings Call Transcript November 4, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Superior Wells Services, Inc. earnings conference call. My name is Erica, and I’d be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Dave Wallace, Chairman and Chief Executive Officer. You may proceed, sir.

Dave Wallace

Thanks, Erica. Good morning, everyone, and welcome to the Superior Well Services third quarter 2008 earnings call. Joining me today is Tom Stoelk, our Chief Financial Officer. I would like to remind all those participating on the call today that a replay of our conference call will be available to listen to through November 18, 2008 by dialing 888-286-8010 and referencing the conference ID number 88050296. The webcast will be archived for replay on the company's website for 15 days. Additionally, our Form 10-Q was filed this morning and will be posted on the company's website.

Before I begin with comments on our third quarter operating performance, I would like to make the following disclaimer regarding our call today. Except for historical information, statements made in this presentation, including those relating to acquisition or expansion opportunity, future earnings, cash flow and capital expenditures are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934.

All statements, other than statements of historical facts, included in this presentation that address activities, events or developments that Superior expects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on certain assumptions made by Superior based on our management's experience and reception of historical trends, current conditions, expected future developments and other factors that are believed appropriate in the circumstances.

Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond Superior’s control, which may cause Superior’s actual results to differ materially from those implied or expressed by the forward-looking statements. These risks are detailed in Superior's Securities and Exchange Commission filings. The company undertakes no obligation to publicly update or review any forward-looking statements.

I will now provide an overview of our third quarter operation. The third quarter was very strong and we generated a new quarterly revenue record of $146 million, a 22% sequential increase over the second quarter and a 55% increase year-over-year. Third quarter EBITDA was $35.6 million, a sequential increase of 37% over the second quarter and a year-over-year increase of 39%. In response to increasing commodity prices in the first half of the year, many of our customers significantly increased their drilling budget, driving demand higher for a well completion and stimulation services, increasing utilization and spreading fixed cost over more jobs.

The (inaudible) used US land rig count increased 12% in the fourth quarter 2007 to the third quarter of this year, with the biggest increases occurring in our core markets. On the cost side, we were also successful in passing along material cost increases and fuel surcharges, helping alleviate some of the pressure of cost increases on margins that we experienced over the past few quarters.

Operating margins were 17% for the third quarter, up 320 basis points sequentially from the second quarter of 2008. Our stimulation job count for the quarter is up 46% year-over-year. Higher overall activity, improved pricing, stronger utilization, maturing of our new service centers and high service quality throughout all of our locations combined to improve profitability.

Although the overall pricing environment has improved from earlier this year, each market is different depending on job type and competitive factors. In response to lower natural gas prices and the credit crisis, some operators have announced reductions in their drilling budget and we’re expecting a reduction in the overall rig count, although we believe some regions will be softer than others. As a result, we anticipate a reduction in this industry demand and the potential for near-term pricing pressure. However, we believe our current operational footprint is good exposure to the most profitable and technical plays in the country, which plays to our strength and competitive differentiation regardless of the cycle.

We have made significant strides in improving our capability for completing and stimulating the high pressure wells throughout the year. Today we don’t believe there is any customer that we could not work for capably. Investments in new and reliable equipment coupled with our technical fluid pumping expertise gives us an edge in the more technical plays that are seeing significant increases in activity.

I will now briefly run through some operational highlights by region and then turn the call over to Tom for a financial overview. In Appalachia, third quarter is traditionally the strongest quarter in terms of revenue for Appalachia. Our home market, and this year is no exception. This quarter Appalachia contributed 37% of total revenues. Revenues in the region are up 18% year-over-year and 17% sequentially.

Activity in the emerging Marcellus shale continues to pick up, and we see no indication that activity associated with that play is going to slow any time soon. We began catching Marcellus jobs in the first quarter of 2008, and our job count keeps increasing. Our work in Southern Appalachia continues to grow steadily. Our existing presence in the region with cost saving infrastructure gives us an operational edge here.

Revenues in the Southeast region are up 21% year-over-year and 4% sequentially as a result of increased drilling activity in the Cotton Valley Trend and the emerging Haynesville Shale plays. Based on the initial data we’ve seen, the Haynesville Shale play possesses excellent well economics and we expect the activity in this play to be resilient to softer natural gas prices.

The Haynesville is tailor-made for us, as it requires our technical pumping expertise for submitting and stimulating deeper, harder and higher pressure formation. These wells demonstrate the move in our industry towards applying more technology and services to each completion to maximize the productive capacity of a well on its reserve. The use of multi-stage fracs and specialized fluid for stimulation means the average revenue per well for Haynesville work is above average.

High strength prop and shortages have been an issue in the Hayneville and deep lifter [ph] plays and have limited our ability to increase our share of this market. We have taken steps to try to secure additional supplies, but we expect this will be an issue for us and other pressure pumpers until additional product is brought into the country and/or increased production capacity is placed on line.

Revenues in the Southwest region are up 129% year-over-year and 43% sequentially. Most of our work in this area is associated with the continued development of the Barnett Shale. We continued to see strong price competition in this low tech market, but work has been steady although activity could drop if operators lay down rig figure as a result of low natural gas prices.

Our Artesia service center had a very good quarter with revenues up 89% over the second quarter. We made operational efficiency improvement over the past two quarters in this area. We should start to benefit from those if we can maintain our utilization here. Revenues in the Mid-Continent region have increased 109% year-over-year and 27% sequentially. We service the Anadarko and Arkoma Basins, as well as the Woodford Shale from our five service centers in this region.

While high price differentials have caused some operators in these regions to lay down rig, we have yet to experience a significant reduction in demand for our services. We’ve been using one of our crews from our Van Buren, Arkansas service center to assist us in the Marcellus when needed.

Revenues in the Rocky Mountain region have increased 190% year-over-year and 36% sequentially. Despite seasonally soft regional gas prices, we have continued to pick up new work in the Rocky. We are very happy with the performance of our new service centers in the region and are working to commission our cement bulk plant in Rock Springs some time in the fourth quarter.

I’ll now turn the call over to Tom for a few of our financial results.

Tom Stoelk

Thanks, Dave. Net income for the third quarter of 2008 was $14.9 million or $0.64 per diluted share compared to $11.6 million or $0.50 per diluted share in the third quarter of 2007 and $9.6 million or $0.41 per diluted share sequentially from the second quarter of 2008.

Third quarter revenue was $146 million. That was up 55% year-over-year and up 22% sequentially. The sequential increase in revenues can be attributed to strong activity increases in our stimulation and cementing services. Approximately $25.2 million or 49% of the total increase in year-over-year revenues was attributable to service centers that have less than one year of operating activity with Superior.

Stimulation, nitrogen, cementing and down-hole surveying revenues amounted to 65%, 8%, 18% and 10% of revenue in the third quarter of 2008, respectively. Cost of revenue increased to $109.7 million. That was up 66% from the third quarter of 2007 and up 19% sequentially. Approximately $20.8 million or 48% of the total increase in year-over-year costs was attributable to the establishment of new service centers, with the balance related to higher material, labor, fuel and transportation expenses that could not be passed to our customers as price increases because of the current competitive environment.

As a result of those increases, total cost of revenue as a percentage of revenue increased to 75% for the third quarter of 2008 compared to 70% in the same quarter last year, but it was down from 77% in the second quarter of 2008. Here is some additional information on those costs. Material costs as a percentage of revenues increased 5.5% in the third quarter of 2008 compared to the same quarter last year and 1.1% sequentially due to higher proppant, chemical and cement costs as well as transportation expenses associated with the delivery of those materials.

Labor expense as a percentage of revenue decreased 2.4% in both the third quarter of 2008 compared to the same quarter last year and sequentially due to increased utilization on a higher revenue base. Diesel prices as a percentage of revenue increased by 2% in the third quarter of 2008 compared to the same quarter last year and decreased seven-tenths of 1% sequentially.

As a percentage of revenue, non-cash depreciation expense increased one-tenth of 1% in the third quarter of 2008 compared to the same quarter last year due to the investments we made to expand our national fleet. Depreciation expense as a percentage of revenues decreased point – eight-tenths of 1% in the third quarter of ‘08 compared to the second quarter of 2008 as a result of spreading the fixed cost component of these expenses over a higher revenue base. Increased capacity and increased competition in certain operating areas resulted in downward pricing pressure on our service prices.

As a percentage of revenue, sales discounts increased by 6.1% in the third quarter of 2008 as compared to the same period in 2007. During the third quarter of 2008 we saw the positive impact from fuel surcharges negotiated with several of our customers earlier in the year. Discounts remained relatively steady when compared to the second quarter of 2008.

Our margins improved significantly over the second quarter, but we still have some room for improvement, as not all of our service centers opened in 2007 are operating in the black yet, although they are all showing improvements.

SG&A expenses increased to $11.4 million. That was up 22% as compared to the third quarter of 2007 and up 7% sequentially. Labor increased $1.5 million in the third quarter of 2008 compared to the third quarter of 2007. The majority of that increase was really due to the hiring of additional personnel to manage the growth in our operations and service centers.

Operating income for the third quarter of 2008 came in at $24.9 million compared to $18.9 million a year ago and $16.6 million in the second quarter of 2008. This translates into increases of 32% and 50% respectively. EBITDA for the third quarter of 2008 came in at $35.6 million, an increase of $10 million or 39% from the same quarter last year.

Net income for the third quarter of 2008 increased to $14.9 million. That’s an increase of $3.3 million from the third quarter of 2007 due to the increased activity levels I just described. We ended the quarter with approximately $72 million of working capital. Total debt at the end of the quarter was approximately $51.6 million, and the company's debt-to-book capitalization was 15%. At September 30, 2008, we had approximately $194.4 million of availability under our syndicated credit facility.

Capital expenditures for the quarter were approximately $30.9 million, and $81.5 million on a year-to-date basis. Presently, we have approximately $19.8 million of capital expenditure commitments for 2008 or 2009 equipment orders that have been placed but the equipment is yet to be delivered.

At this point I’m going to turn the call back over to Dave for some additional comments.

Dave Wallace

At this point, I’d like to give an update on our acquisition of certain assets from Diamondback Holdings, which we announced in the middle of September. Both companies are working diligently to get the deal closed as soon as possible. Despite the turmoil in the financial markets, the deal’s strategic rationale still makes sense with this potential to significantly expand our operations without adding industry capacity. Diamondback’s high quality assets and people will fit well with our organization and enhance our operational footprint in an accretive way. We hope to make an announcement before the end of this month.

To summarize the quarter, an upswing in commodity prices brought an increase in drilling activity and greater demand for our services. The result was higher revenues, margins and operating income. Our new service centers opened in 2007 continued to mature nicely and show improvements in customer acceptance, utilization, and now starting to contribute to the bottom line.

New and more technical plays are beginning to show strong increases in development drilling activity, further driving demand for our technical fluid pumping expertise. While we can’t predict where natural gas prices will go, we like where we are sitting today. Our large and diversified geographic footprint gives us added flexibility to weather a downturn or take advantage of an upswing. Even with the growth we have exhibited over the past years, we still have locations that are asking for additional equipment and people, and we plan to cautiously backfill those needs as 2009 comes in a greater focus.

We are strategically positioned in the most attractive development drilling markets in the country and we will continue to focus on maintaining high service quality for earning more higher tech, higher margin completion work. We are concurrently performing deeper, higher pressure, higher temperature job in the Rockies, Mid-Con and Southwest regions, and we expect to add the Southeast region to this list before year-end.

Our crews continue to build our reputation one job at a time, and I’d like to take this opportunity to thank our people for all of their hard work. Our internal goal in 2005 was to achieve $500 million in revenues by 2010. We are well on our way to achieving that goal ahead of schedule. Despite the uncertainty about the economy, commodity prices and rig counts, we believe we have the right people, equipment, operational footprint, and technical fluids expertise to be the provider of choice for the best customers regardless of the cycle.

That concludes our prepared remarks. I’ll now open the call for questions. Erica?

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Byron Pope from Tudor Pickering Holt. You may proceed.

Byron Pope – Tudor Pickering Holt

Good morning, guys.

Dave Wallace

Good morning, Byron.

Byron Pope – Tudor Pickering Holt

I wanted to get your thoughts, particularly given the strength of your Q3 revenues across regions, your thought on where you guys generally are in terms of equipment utilization because it’s obviously a fluid situation and what’s going on with North American natural gas. I was hoping you could help give us some feel for and where you guys are in terms of equipment utilization as we try to dial [ph] in numbers over the next several quarters.

Tom Stoelk

Okay. Yes, we’ve – obviously we had a very strong quarter, and the biggest impact was the ramp-up in our new service centers from 2006, 2007 that we’ve added. So they are not quite as full capacity than these centers, but they are getting pretty close. So when we look at the overall utilization for the quarter, it was probably in the 75% to 80% range. And we usually shoot for 85% roughly. Actually some service centers were even higher than that. And then again, our newer service centers have made great progress in picking up their utilization. And there is still little more to pick up with those places, but very strong quarter.

Byron Pope – Tudor Pickering Holt

Okay. And then based on your commentary, fair to say that probably the Barnett Shale is the one region where pricing is – it sounded like that was the one region where pricing is little tough, not really seeing that in the other regions at this point.

Dave Wallace

I think we see again it’s kind of back to areas that we see that kind of get commodities, then it’s slick water jobs, and there's a lot of competition there. There is still pricing pressure there. It’s just a matter of how active they got, how much they ramped up once rig count started picking back up. And then if there is a little supply imbalance in those areas, then pricing is a little strong.

Byron Pope – Tudor Pickering Holt

Okay. And then last question for me. It sounds like you guys are holding off on answering detailed questions about Diamondback. Is that fair?

Tom Stoelk

Yes, that’s fair.

Byron Pope – Tudor Pickering Holt

Okay.

Tom Stoelk

Basically what Dave said in his comments is really where it’s at. We continued to negotiate and we see a lot of value in the transaction. But since the transaction hasn’t been fully negotiated, we really can’t publicly comment on it.

Byron Pope – Tudor Pickering Holt

Okay. So then – last question for me then would be, for you guys to stand alone, how do you think about ’09 CapEx? I think you mentioned roughly the $20 million that’s still to be spent, but trying to get a feel for ’09 CapEx and for stand-alone Superior as you all are thinking about it right now.

Dave Wallace

We’ve had $50 million pre-approved. We have not placed all those orders yet, but we are kind of waiting to see how the market shapes up. We see the lead-times that dropped off, and therefore we can pick up equipment a little faster than in the past. So we’re staying cautious at this point. And so we’ll know more here in the next month.

Byron Pope – Tudor Pickering Holt

Okay. Thanks, guys. Appreciate it.

Dave Wallace

Thanks, Byron.

Operator

Your next question comes from the line of Stephen Gengaro from Jefferies & Company. You may proceed.

Stephen Gengaro – Jefferies & Company

Thank you. Good morning, gentlemen.

Dave Wallace

Good morning, Stephen.

Stephen Gengaro – Jefferies & Company

Can you give us a sense – if you would look at the regions right now, can you give us any sense for two things? One, just how – what you’re seeing kind of in October from an activity level perspective, is there any changes that have occurred or that you would expect? And then, two, how should we think about pricing on a regional basis? I mean, I’m assuming plays like the Haynesville we should assume things will be stronger in the commoditized markets, potentially softness. Can you add any color to that?

Dave Wallace

October looks like it’s going to be, again, a real strong month. Rig count, we’ve seen a little bit of drop-off, but very minimal at this point. Usually what we see in fourth quarter is stronger October, first half November stays strong, and then we start seeing little seasonality, holiday, hunting season, weather-related, people kind of catching up on their CapEx. So we usually see a little dip in the second half of the fourth quarter. But first half, we expect to be really strong. As far as pricing by region, I think you pretty well hit is, again, we got some niche areas that are kind of isolated from other markets that pricing differentiates there. When you get into Barnett Shale, some of the slick water areas, they can get pretty high discount, pretty low margins. The higher the tech, we still continue to see it. You may still have to have a higher discount to do it, but the margins are still better even in those areas. So as we’ve mentioned earlier, we’ve performed super high-tech jobs in three regions so far; Rockies, Southwest and Mid-Con. We expect to have the Southeast Haynesville in fourth quarter. And that’s really where we are focused. We continue to move up the ladder. We can work in deeper, harder, higher pressure. And really our service quality has been really strong. And we feel comfortable that we can work for just about any operator in the US at this point.

Stephen Gengaro – Jefferies & Company

Thank you. And then just as a follow-up, the Complete Production acquired a company up in Appalachia, I think it was from Allegheny Well Services. How do you think about that some of the other kind of maybe larger players getting involved and how that could potentially impact you in that large market Appalachia?

Dave Wallace

It’s obvious that Marcellus is getting a lot of interest these days because it’s very large geographically and there are a lot of Western E&P companies looking to expand into this area. So we expect that there is going to be interest from other companies. The advantage we have, again, is we have the home court advantage. We’ve been here a long time. We have a very good infrastructure system in place. Our job quality, service quality is second to none in this region. And there are other people that are going to be trying to enter the market, but they are going to go through a learning curve. It’s going to take one to two years to kind of get through that debugging process. And so we still see we have a home court advantage.

Stephen Gengaro – Jefferies & Company

Very good. Thank you.

Tom Stoelk

Thanks, Stephen.

Dave Wallace

Thanks, Stephen.

Operator

(Operator instructions) Your next question comes from the line of Victor Marchon from RBC Capital. You may proceed.

Victor Marchon – RBC Capital

Thank you. Good morning, guys.

Dave Wallace

Hi, Victor.

Victor Marchon – RBC Capital

First question I had just on the cost side, I just want to see on the proppant tightness or supply tightness for proppants, I wanted to see if that was in any other regions outside of the two that you had mentioned, the Woodford and Haynesville. Is that more broad in the lower 48 or is it pretty much regulated to those two areas?

Dave Wallace

It’s really – those areas require the high strength ceramic or bauxite type materials. And there is a supply imbalance for that material at this time. With the ramp-up in those areas and that conventional sand hasn’t been strong enough, they made it to go to the higher strength. It has really gotten the supply out of balance at this point. So we see the suppliers for this are ramping up. There is more product coming in from international side. And there is just a little shortfall at this point that is going to take to catch up with that. As far as the sand goes, we talked about in the past that we’ve had really good sand contracts, probably had a few logistics, maybe delayed a few jobs during the third quarter just for sand. But we have a really strong position with the sand suppliers, and this has been a strength for us.

Victor Marchon – RBC Capital

Okay. And you guys locked in pretty well on the sand side looking out into ’09?

Dave Wallace

Yes, looks pretty well going into ’09.

Victor Marchon – RBC Capital

Okay. I just wanted to follow up on the pricing side and maybe ask question this way. Is there a way to define how much of your business you would say is exposed to the pricing weakness or potential pricing weakness going forward on the lower end type of work?

Dave Wallace

It’s back to – it’s a bidding process, usually at annual bids for a lot of the stuff. We have some contracts already in place, but we know at this time of year that we’re going to be negotiating for pieces of activity plans for 2009. We expect at this point as typical years that you gain some contracts, you may not get as much of certain contracts as you had previously just due to pricing. But if you look at our track record in the softer market years, 2002, 2003 and 1999, we’ve actually grown our revenue even in the down-cycle years. Margins may dip a little bit. So we may have to give up a little pricing power to maintain volume. But as a general rule, we’ve shown that we can continue to grow our revenue base even in the soft markets.

Victor Marchon – RBC Capital

And last one, just as it relates to the CapEx that you have on your books now, that is all four existing centers, correct? There is no news of centers on the books or plans.

Tom Stoelk

No, as I think Dave mentioned in his comments, we’re opening up Rock Springs in the fourth quarter. But that’s been an existing center. We’ve just delayed the opening in that center a little bit.

Dave Wallace

Of course, an example could be like the Bakken in Williston, North Dakota where we bought a wireline company, established the presence there. And then it’s – we’re going to backfill with pressure pumping equipment in that region. So it’s kind of new business as far as the pressure pumping side goes, but we had considered an established location that we are backfilling with extra services. There will be some of that. We’re focused on backfilling first and then expanding our footprint second.

Victor Marchon – RBC Capital

Okay, great. That’s all I had and congratulations on the quarter.

Tom Stoelk

Thanks.

Dave Wallace

Thanks, Victor.

Operator

Your next question comes from the line of Jack Aydin from Keybanc Capital Management. You may proceed.

Jack Aydin – Keybanc Capital Management

Hi, Dave. Hi, everybody.

Dave Wallace

Good morning, Jack.

Jack Aydin – Keybanc Capital Management

Good morning. The question I have is, what percentage of your revenue is basically your business comes from high tech and super high tech?

Dave Wallace

We announced that at the end of ’07 it was about 50/50, and we thought 2008 would probably dip and would be more like 40% high tech, super high tech, and then a little increase in the lower tech part. And we think that it’s probably not been that much of a shift. If anything, we seem like we’re picking up more momentum in the super high tech part of the business. So we see that as growing a little more. So it’s probably still closer to 50/50. And if anything, we’re seeing it starting to shift more to the super high tech and higher tech part. So we expect 2009 to actually shift higher in that upper end of the scale.

Jack Aydin – Keybanc Capital Management

Dave, regarding the proppant, some – I was talking to an E&P company that said about 90% of the proppant is basically controlled by the prop C-4 [ph] companies. And then the 10% is basically available for everybody else. Is that what your impression, or that is easing a little bit more? Or are you doing something more to increase your share?

Dave Wallace

I would say it’s really tight even for the tough guys. But we see the shift starting to occur. We think it’s going to take a few months to actually for the proppant guys to continue to expand their capabilities. So it’s pretty tight right now, but we see in the next quarter or so that it’s going to start shifting where we can have access to even more of that.

Jack Aydin – Keybanc Capital Management

Final question from me. You hear companies that are talking about laying off rigs. I mean, I hear anywhere from 200 up to 500. Let us assume that we get rigs laid about three for 100 rigs down next year. What kind of impact it will have on your business?

Dave Wallace

Yes. It’s hard to tell because we don’t see that the rig count drop will be uniform. And again, our expanded footprint really gives us the opportunity to kind of shift resources. I mean, we see some areas that we expect to see increased rig count. Again, Marcellus activity, we still see that ramping up. So that’s an area in our backyard that we think will continue to increase. And we’ll look at – again, trucks have wheels, we talked about that before. But we will shift resources from one area to another. We talked about Van Buren is assisting Pennsylvania with the Marcellus work going on right now. We can see some of our other locations shifting resources, assisting with personnel and equipment to really help the busy spot in the future. So, it’s hard to get a good handle on that right now, Jack.

Jack Aydin – Keybanc Capital Management

Yes, thanks.

Dave Wallace

Thank you.

Operator

Your next question comes from the line of Joe Agular from Johnson Rice. You may proceed.

Joe Agular – Johnson Rice

Thank you. You all have covered a lot of ground already. So maybe I’ll just ask you a very general question. If we think back I guess two years ago or so, towards the end of 2006, there was a lot of concern over the market heading into 2007 with respect to natural gas drilling specifically. Obviously we’re in that same position right now. I was just wondering if you had any thoughts on the differences maybe between then and now, either in terms of capacity, the type of market you’re serving today versus then. Everybody is trying to guess to figure out exactly where this thing is heading. But I was wondering if you had any thoughts on that sort of general overview of that market, today versus maybe a couple of years ago?

Dave Wallace

Yes. We hear all the discussion right now. And a lot of that’s due to the financial markets and the tightening of credit, and it’s going to impact our E&P guys. We look at it, the gas price now versus a year ago is actually a little higher. We look at the storage level, it’s actually a little lower than a year ago. And probably the biggest driver is just the deflation rate of a lot of these shale wells. And they declined really rapidly, so we think that there is going to be some dip. And it’s probably going to be more customer-focused maybe versus basin-focused. And again that’s due to the ability to raise capital. But we think that it’s going to be a short-term dip. And again, once they stop drilling, gas reserves start dropping off and then gas price starts going back up and then there is some need to ramp back up to get the gas levels back up. We feel like we’re sitting a lot better than we were two years ago. One, we’ve been very aggressive the last two years expanding our footprint. And now we’re at the point now that a lot of these service centers are really starting to mature, our service quality is good. And they are starting to have a real impact. The other thing we see too is, two year ago we were really viewed as a fairly small regional service company. Now with our footprint, our fluids, our equipment, we are really viewed as a large service company that can work for majors as well as super large independents and also small independents. So we’re a lot more attractive to a lot larger customer base, and we’re in a lot more regions. So we really like our position going into this year despite the choppiness that you hear in maybe E&P cutbacks. So –

Joe Agular – Johnson Rice

It sounds almost like we shouldn’t really use what happened in 2007 – 2006, 2007 as a roadmap for you because that was at the point at which you all were still building out and had a lot of upfront cost associated with your growth, whereas today you have everything in place and maybe the economics are going to be a little bit different this time around for you.

Dave Wallace

Yes. The utilization is a lot better. We made pricing improvements and utilization improvements in our new service centers. And that’s part of the maturity process that they go through. When you look at us fourth quarter last year, we just had four new service centers coming on line. And it’s pretty challenging when they’re coming on line in a tough environment. Now those service centers have been on line for about a year. Their activity levels are up. As Tom mentioned earlier, they are starting to contribute on the revenue and contributing profit to the company. So they are sitting in a better position now, and customer acceptance is really good. So we’re little less growthy. As we mentioned, our CapEx is going to be focused more for backfill, existing service centers, and then new startups as kind of a secondary play.

Joe Agular – Johnson Rice

Okay.

Dave Wallace

So, should be better going into it.

Joe Agular – Johnson Rice

And just again, the other thing that I just was wondering if you had an opinion on was obviously 2007 was a year everybody sort of ratcheting down their capacity expansion. We ended 2008 with less new equipment coming in market, then we had the big run in gas prices earlier in the year. Maybe some thoughts of even adding more capacity, but this has changed pretty quickly. What’s your take overall on the industry-wide situation with capacity specifically? Thank you.

Dave Wallace

There were some capacity adds this year, 2008, but a lot less than we saw in 2007. The other thing is you’re starting to see a few consolidations occur. And again, it’s back to – puts more resources under one company, less competitors out there to kind of some of those low economic markets. So we see a tightening effect with all this that’s occurred.

Joe Agular – Johnson Rice

Okay, great. Thank you.

Dave Wallace

Thanks, Joe.

Operator

Your next question comes from the line of Michael Mazar from BMO Capital Markets. You may proceed.

Michael Mazar – BMO Capital Markets

Hey, good morning, guys.

Dave Wallace

Hi, Mike.

Tom Stoelk

Hi, Mike.

Michael Mazar – BMO Capital Markets

Just kind of quick strategic question I guess. Just given kind of your focus on the unconventional plays and your expertise there and the way you've kind of grown the business with that model, any thoughts on expanding outside of the US? Specifically, I guess I’m thinking about peer – (inaudible) more in river-type plays, or is it a question of kind of being too late to that game?

Dave Wallace

We are pretty focused on the US at this point. I mean, we’ve looked at Canada probably more through a strategic acquisition than maybe organic startup, because there is a lot of competition in Canada at this point. So we’ve been pretty focused on the US. We can continue to grow here. We are a very small part of the US market, but we still have a lot of opportunity here. But we kind of keep our eye on that market and think that we can enter through a strategic acquisition some day.

Michael Mazar – BMO Capital Markets

Sure. Okay, that’s great. Thanks.

Dave Wallace

Thanks, Mike.

Operator

Your next question is a follow-up question from the line of Stephen Gengaro from. You may proceed.

Stephen Gengaro – Jefferies & Company

Thank you. Gentlemen, I’m going to back to the margin question, but – last year you had a first quarter which was very impacted I believe it was by heavy rains and you had a lot of inefficiencies I think in your core market in Appalachia. If I sort of ignore first quarter level and I look at us going forward, can you give us any framework to think about from a margin perspective? I mean, is it – on a gross margin level, if we said you’re going to lose 300 rigs in the US, I mean, any sense for how far down margins might get for a couple of quarters?

Tom Stoelk

Stephen, it’s really hard to kind of project that because what Dave was trying to answer on one of them is that, that dip isn’t going to be uniform across all of our different operating segments and things like that. So it’s a question that’s real difficult. If it impacted and it was perceived to be a long-term drop in rig count, you'd see us take actions like reduced headcount and things like that with respect to it. Our view right now I think is that it looks like there is going to be a rig drop on the horizon. It’s just a question of how long it’s going to be because the reserve replacement ratios continue to go up. So I guess at least it’s hard thinking right now that it’s not going to be real long. But given the number of dynamics and plus what’s complicating a little bit now is just the turmoil in the credit markets. And right now David mentioned, in October we’re not really seeing a decline in our activity and we’re starting to head into where you’re going to have some seasonal holiday kind of shutdowns. And I think it’s still going to be – the visibility is still going to be difficult because we won’t know at that point whether it’s maybe customers not having the CapEx budgets, whether it’s declining pricing, or whether it’s just seasonality to really be able to project that. I’m not trying to sidestep your question. I just – I don’t think there is an answer to it.

Stephen Gengaro – Jefferies & Company

Okay. No, no, I understand that it’s – I know it’s not an easy answer. Is there – are you willing to guess if ’09 is up, down or flat?

Tom Stoelk

Well, I think that – I mean, if ’09 we’re kind of flat, I think that you’re going to see our margins continue to increase because there is a fixed cost component depreciation, our SG&A and things like that. You saw SG&A, like in this quarter you saw as a percentage of revenues, a fairly significant drop in that. And I think you’d continue to kind of see that impacted in our numbers. The other – we talked about the potential Diamondback asset purchase, and that obviously will have an impact on us too if we’re able to consummate that transaction just as we kind of transitioned for the first couple of quarters. But I would think if we're – all things being equal, sitting the way we are now and if it was just steady, I think you’d see an improvement in operating margins because we have the ability to spend it over a larger revenue base. I mean, we are not fully utilized at all of our centers. We are – as David mentioned, our job mix is continually changing. He mentioned in his comments that three of the regions performed super high tech work. That’s our focus. There is higher margins in that type of work. I don’t know if you have anything to add.

Dave Wallace

Yes. I think also – one thing we look at too is whether rig counts are going to dip. And with our expanded footprint, we think there are still some areas that we still have very good margins. And they are looking for backfill crews at this point. So at this point, the decision may be made to reduce CapEx and then shift resources from some of the areas that are just super low margins to markets that have better margins. So again, just our past track record says we’ve been able to grow revenues even when there's been dips in rig count. And sometimes you take a little margin drop, but usually earnings have been staying pretty steady.

Stephen Gengaro – Jefferies & Company

Thank you. And just one final small follow-up. Can you give us a sense for the range of margins on a low-end job today versus the higher end jobs?

Dave Wallace

They can vary quite a bit based on kind of a couple things, is one, the maturity of a service center has a big impact on that too. So if they are 20%, 30% utilized initially and then ramp up to 70% utilization, over a year period, there can be a 30% increase in margins, just mainly due to better utilization of people, equipment, and starting to get the cost structure kind of into place.

Tom Stoelk

It’s different regionally too. I mean, a lower tech job in Appalachia, just a Clinton-Medina sands-type deal is, you've got a higher price market there and your Op margins vary by region too even though it’s on the lower tech side.

Stephen Gengaro – Jefferies & Company

Okay, thank you.

Dave Wallace

Thanks, Stephen.

Operator

This concludes the question-and-answer portion of the call. I would now like to turn it back over to Dave Wallace for closing remarks.

Dave Wallace

Thanks, Erica. Well, I appreciate everybody joining us today and we look forward to our next call on the fourth quarter. Thanks.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect, and everyone have a wonderful day.

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Source: Superior Well Services, Inc. Q3 2008 Earnings Call Transcript
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