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C&J Energy Services, Inc. (NYSE:CJES)

Wells Fargo Securities 2013 Energy Symposium Conference Transcript

December 11, 2013 10:20 AM ET

Executives

Randy McMullen - Chief Financial Officer

John Fitzpatrick - Head, Business Development

Analysts

Unidentified Analyst

We have C&J [presenting] with us. C&J is $1.3 billion market cap company, have about $100 million of net debt, asset debt, I would add that they had last year, when they were here. So generating some good free cash flow and taking that debt down. They have about 300,000 hydraulic horsepower of frac capacity and they have surprised the market a little bit that they are constructing some more for early 2014 delivery. They also operate 24 coiled tubing units and have been realizing about 25% growth from the Casedhole wireline division that they purchased in the middle -- mid 2012, which has been a terrific acquisition.

So we have Randy McMullen, the CFO of the company with us. Also John Fitzpatrick, Head of Business Development was here. There he is. And so thank you very much guys for coming up and joining our conference again this year.

And I’d just want to again start off, obviously, with the frac market. What’s the state of the spot market these days and are you getting any less competitive is this, how are you able to look at 2014 and add more capacity?

Randy McMullen

Well, from a market perspective I would not characterize it is less competitive. It’s still very competitive as there are still over capacity in the industry. The reason for adding additional horsepower, it just based on demand that we are seeing from our services.

As we look out into 2014, we saw the need for additional horsepower. As you may or may not be aware, we own our manufacturing business where we construct all of our horsepower and so we do that at a reduce rate versus buying it from the third-party vendor.

And so, when we were looking at needing additional horsepower, obviously there is horsepower on the market for sale. But when we sort of run the numbers, it made a lot more sense to build versus buy, simply due to the fact that we are controlling the process, controlling the costs, delivery time is very, very short and it’s the asking price for some of the existing horsepower that’s out there, believe it or not when you add into a car refurbishment to bring it up to par with our operating standards, it actually would be more expensive. And at the end of the day, you will have a used piece of equipment versus the new. So for us it makes sense to go the build route.

Unidentified Analyst

So the incongruity here that we are all rapping our heads around, is that -- there is over capacity in the market and yet you are saying that you see the demand trends for C&J that you could use more horsepower, you could put it work. So if you could explain that incongruity, we have too much capacity and you are adding capacity because you don’t have enough?

Randy McMullen

We are still a very small percentage of the market share and all we are adding is 20 horsepower. It’s not a significant amount of horsepower. And actually given that we’ve got some excess equipment with our existing fleet spread, this is actually -- we are actually able to roll this others in new fleet without spending what would be typically $25 million, $30 million mainly fleet because we have some additional blending equipment and the hydration equipment that we can’t combine with these pumps with some existing pumps to form a new fleet.

But I do think for us obviously, we are a growth company. We are growing in the other two service lines organically for coiled and wireline, and we are doing that by taking market share. We’ve got the same focus on the frac side. And obviously in the past, we were heavily contracted and very concentrated on the customer side. We’ve been working hard in 2013 to broaden our customer base and lately we’ve had some success of having some new customers.

We’ve seen a sharpening of the focus on the operator side on putting the focus -- a lot of the focus on home services as opposed to just purely price. And a lot of that has do with the fact that the pricing of the market has stabilized and has been fairly flat recently. So we are seeing lot of emphasis on services and quality of execution, which is right now in our fairway.

And so have had some success recently, bringing all sorts of new customers and they have been improving our utilizations as we look out to 2014. We have more visibility than we’ve had in quite sometime spot market and so we are optimistic that with this new equipment that we can put it to work.

But we’ve been open in saying and we addressed this on the call that if the market moves against us, if some of the success that we’ve either been having or accounting on doesn’t come to fruition given the fact that we are building this equipment internally, we can turn it into inventory. And, so most of the items that we are building are just components of our existing equipment and we can simply consume them as part of our maintenance CapEx. And then in fact it becomes a negative working capital at that point.

Unidentified Analyst

Okay. So as you say, you have more visibility than you’ve had looking out, are you expecting that utilization of your spot fleet is going to be higher in 2014 than 2013?

Randy McMullen

With the visibility that we have in the first quarter, we feel confident with the expectation that yes, utilization will be higher on our spot fleets. We’ve been very focused on really targeting a certain segment of the market where our services are both needed and the efficiency that we bring and the quality of execution that we bring is wanted. And our -- really how we did this, when we build this frac business it was all around the 24/7 horizontal completion process, getting as many stages done on a daily basis and moving from job, job, job.

And really focusing in on pad completions where the efficiency is demanded not the operator. And as that market has continued to growth, as the efficiencies have continued to grown specifically in the Eagle Ford, we benefited from that. And credit, as our contracts are rolling off, we didn’t have a lot of exposure to the open market.

There were a lot of the segment of the operators that, at least from a fracturing perspective, we didn’t have exposure to and that’s why we’ve been working on so hard to diversify our customer base where we are not so concentrated. But then also are doing that to specific segment of the market where you are working with the operator who just wants to put as many stages as he can. So he can really realize those cost savings from the efficiency.

Unidentified Analyst

I have spoken with some of your contracted customers who obviously realized and were very appreciative of the efficiency and the high quality service that C&J provided. Are you finding a similar response from your spot market customers that you’ve been expanding into?

Randy McMullen

Yes. And that’s part of the reason for the optimism as we look out into ’14. And our goal is -- our abilities once we get out and are able to perform the service, our success rate around continuing that relationship goes up significantly. Throughout the latter half of ‘12 and ’13, when the pricing and the market was declining so rapidly, we are never the service company that leads with price. We don’t buy work and we have margin expectations for all the work that we’ve been on and we had levels that we will go below.

And in the environment of how competitive the price environment was in 2013, our success rate on the open market and the spot market was at what we would have like it then. And from a utilization perspective, there was a lot of room for improvement. But lately, that success rate has been going up and again, it points back to the fact that pricing has and our lines stabilized and from what we’ve seen over the last few months have been fairly flat. And so the focus has sharpened back to just service and going with the proven service company and that’s where we thrive.

Unidentified Analyst

Okay. That’s very encouraging. And we talked about this in the past, guar prices have come down. Has that lower guar price encouraged your customers to use any more cross link product rather than slickwater?

Randy McMullen

We’ve seen some of that. It really depends on the basin and whether your liquids content but what we have seen more recently is we’ve been pumping more hybrid and gel fracs which is a combination of slickwater and gel throughout the frac stage. Some of that is driven by connectivity needs, some of that is driven by the concern about water supply, both existing and looking out into the future.

So that’s been a great movement for us. It puts a lot more complexity into the job than just pure water and sand, which is again an aspect of the market that we’ve always focused on. It’s really going after that, that complex service intensive work. So the more gel that we pump, typically that narrows the market a bit from the competitive landscape, who can actually go outperform that job which is good for us.

Unidentified Analyst

Okay. Are you seeing or believe that there -- how are the trends in sand and profit, is it accelerating up, is it going out at about the same pace?

Randy McMullen

Pricing?

Unidentified Analyst

No not so much of pricing.

Randy McMullen

Is it usage?

Unidentified Analyst

About usage. But you can talk about pricing too.

Randy McMullen

Pricing has been flat. We haven’t seen any change there. As we’ve been pumping, this dives into the gel question but as we’ve been pumping more hybrid and gel-based fracs, you are pumping a larger dry sand, when you’re doing that, a lot of that is driven by connectivity. But we -- really, I mean, for our presence right now, we’re primarily in the Eagle Ford and the Permian, we just put a spread in Western Oklahoma. We haven’t seen a dramatic change in the amount of sand that we’re pumping on per stage basis.

We have had a few customers start to pump more sand. But it hasn’t really moved for us significantly. I think if we were Bakken player that would be a different story. So really, really no change in both, the amount of sand that we’re pumping on a per stage basis as well as the pricing associated with it.

Unidentified Analyst

Okay. Let’s move onto your other businesses which are doing very well. The coiled tubing, you’re taking market share there. How are you taking share in a market that’s also oversupplied. What’s your strategy there?

Randy McMullen

Now, with coiled tubing, we’re in all the major basins. The coil is the original service company, the original servicer, the original service offering of C&J. We’ve been in coil since 2000 and started that business in South Texas. And that’s where the majority of our coil units are currently located. It’s in the Eagle Ford. We’ve done a good job with that business line similar to frac and wireline. We’ve always been focused there on complex work that the 24x7 horizontal drill outs and we’ve always had real high capacity units.

So as the market has continued to push the length of the laterals, we’ve been well positioned that we always had the units that can service that type of work. And recently, we’ve seen even more demand for larger size pipe and longer reach pipe. And we were able to quickly make some adjustments to our existing units and convert several of those so that they can meet that demand. And so we’ve seen some success recently and some increase.

In Q3, our revenues were up and the primary reason for that is we were capturing more of that larger pipe need in the market. And we’ve just -- we put a lot of emphasis on coiled tubing. It’s not a drilling service line for us. We really marketed it outside of our frac and outside of our wireline. We do on occasion bundle it with the frac and the wireline services.

But again that’s -- when we priced that, its price individually and it’s priced at market rates and for us it’s never a throw-in to get another service. And we’ve just -- we’ve been fairly insulated I think through out ‘13 and that’s -- we’ve done a really good job of keeping hold of our baseline customers.

And then on top of that, with the acquisition of Casedhole, it’s allowed us to expand our presence in CT to both the Bakken and the Marcellus as we’ve been able to take advantage of their infrastructure there both from a facility’s perspective but also from a customer perspective. And that’s been allowing us to take market share.

Unidentified Analyst

So when you have done some retrofits to your fleet, is that adding length or what the nature of the rich…

Randy McMullen

The majority of the changes there were retrofitting the units to hold 2 and 3-inch pipe effectively and we go after that market. We’ve seen more and more demand for the larger pipe including drill outs. The key there is to be able also have the link to be able to get to the end to the lateral. And so we’ve been focused on at least the last two units that we build out of getting as much reach as possible specifically in an area like the Bakken. There’s a lot of demand for longer reach core units.

Unidentified Analyst

What’s the upper limit of the length of the reach on the units now, is it 18,000 feet?

Randy McMullen

On the 2 and 3-inch, yeah, it’s around that. On the 2-inch, we’re trying to get where we can get 21,000 to 22,000 feet.

Unidentified Analyst

Okay. There you brought up Casedhole as having a broader footprint than coiled tubing or frac services. It’s been performing very well in its own right. Also how quickly can you use it to expand the footprint to move additional services into these new basins?

Randy McMullen

Well we’ve done it with coil. Now besides in Niobrara, everywhere where we have wireline, we have coil. And so the next, obviously the other service line to expand its frac. We did have plans in early ‘13 to expand our frac reach into the Bakken. Given what was going on in the market, our lower than expected utilization with our existing fleets and what we felt -- we felt our abilities to get the utilization up with the much higher maintaining in both the Eagle Ford and the Permian with a small expansion in the Western Oklahoma rather than taking on and moving a service into the Bakken.

Frac is a -- from growth perspective, at least on the startup it’s a lot different analysis than both coil and wireline because the fixed cost components were much greater for frac than for the other two. And we just felt like our opportunities to grow -- to improve utilization and to grow earnings within that service line was much higher stand in sort of our base but long term plans are to capitalize on the presence of both coiled tubing and wireline in the Bakken and Marcellus. When that will happen, market conditions will play into that as well as our own success around improvements in utilization.

And, I think if we get to where, we’re comfortable with our horsepower in each region that we currently operating in, as far as how much horsepower do you want to have in each, and we hit that point utilization, we are at 90 plus percent. I mean, I think, then we’re thinking hard about expansion into other bases.

Unidentified Analyst

Okay. Do you want to talk about the Casedhole business itself? You’ve been growing as I said revenues of about 25%. Is that geographic expansion, greater intensity, customers who just like you and want more of your business?

Randy McMullen

Yeah. Less of the geographic expansion, we were in all the markets when we entered ’13. We’ve been adding units not to all of them, but into West Texas and the South Texas and then into Bakken over the past year. And we just -- it sounds simple but it’s really similar to call is that we have a really extreme focus on the 24/7 horizontal completions service. In terms of jobs, we’ve got a new fleet of equipment and we were excellent on the service execution on the wireline side.

And we’ve not only been able to protect our market share because of that but also grow it, which is not consistent with what generally what you hear in the market about CT and wireline. But just very similar to both frac and coil is that we leave with our services and we continue to see opportunities to grow market share because of that.

Unidentified Analyst

Okay. Great. Now you have highlighted previously some opportunities, perhaps move internationally. What are those opportunities looking like right now?

Randy McMullen

No real…

Unidentified Analyst

Saudi Arabia in particularly is one of the country you have mentioned.

Randy McMullen

No real update as far as both our status and the deployment of equipment. We mentioned that -- it missed initially. A lot of the interest has been around coiled tubing. But that’s obviously not our long-term plan of deploying coiled tubing. Our plans are to get all three services lines into the Middle East.

When that will happen, we will let the market know but I can say that we’re aggressively pursuing opportunities. And as we’ve mentioned in the past, we’ve had success getting to the pre-qualification process which is a big hurdle, especially for a company that doesn’t have an international presence, which says a lot. About our Middle East operating team that we’ve build that’s chasing those opportunities. But our expectation is over the future is to -- we’ve opened an office, administrative office in Dubai and our plans are to have an operational presence in the Middle East in the near future.

Unidentified Analyst

Okay. So you have got into the pre-qualification process.

Randy McMullen

Yes.

Unidentified Analyst

Excellent. Let’s turn to your capital deployment at this point. You paid down $100 million of debt over the last year or so? Are you looking to take that debt down to zero? What are you going to do with your free cash flow in 2014?

Randy McMullen

Well, we are continuing to look for opportunities. I mean, obviously, we do a really good job of -- on the organic approach as we’ve highlighted, taking market share. Specifically on the coiled and the wireline business we will continue to add units in 2014. And as we have highlighted, we were adding little bit of additional frac response in the first quarter of ’14.

Outside of just the organic CapEx, we are actively looking for M&A opportunities. We are very conservative in our approach and very thoughtful and smart as far as what we are looking at, what we are willing to pay for it.

Obviously, the Casedhole business was extremely complementary to what we did, but it wasn’t just the new service line, it was the geographic expansion. There was a lot of talent there in the management team that we have heavily integrated into the C&J team, so there were reasons above just getting into the new service line.

And so we have looked for similar type situations when we were looking at another M&A opportunities and not just buying equipment, because we can built it and we can built it fairly cheap, when you look at market rate.

So it does require us to really look into the opportunity and what else does the equipment come with, whether is it a geographic expansion, is it a customer expansion, is there something on top of just hedges the equipment. And we haven’t successfully found anything but we are actively looking.

And then, and that’s really as a relation to the existing service lines and then on top of that we are looking for other service lines to get into, specifically as it relates to completions.

We have been -- we have mentioned, we are looking for downhole tools opportunities, but if those don’t come above we plan to get into that organically and I have actually mentioned getting into through tubing recently. And so, for capital and how we are -- how we plan to use it in ’14, if nothing comes above on the M&A side, yeah, we will just continue to paydown debt like we have did.

Unidentified Analyst

Is it dividend under consideration at this point, did you think your growth opportunities are too broad?

Randy McMullen

Well, and with the last quarter’s earnings, we announced the share -- the approval of share buyback, so that’s an option for us if nothing comes about and that’s why we did that to have that option.

And really going back to M&A one thing that I failed to mention is, we are also actually looking for vertical integration opportunities and we did that with the purchase of total equipment and with a lot of our research technology build out that we have been doing a lot of those efforts around vertical integration.

How do we get a lot of our consumables that accompanying this equipment and accompanying this service, how do we get our cost down, how do we maintain high margins and how do we continue to offer, market rate and stay competitive.

And we are doing that and we are looking at various consumables that we are doing on the fracs on the coil side and on the wireline side where we can get our cost basis down, perhaps take market share to a little bit more competitive pricing but at improved margins. And again, with research and technology, we are planning to do that organically. But if we see a good platform to really accelerate that growth we will look at it.

Unidentified Analyst

Is something like sand on the table?

Randy McMullen

No.

Unidentified Analyst

More high-tech than that?

Randy McMullen

Yeah. No. Not sand, we don’t plan to give in the sand business. Fluids though is something that we have been building internally of getting our own fluids plan. Again, it’s just, it’s the same thought as we just mentioned with the vertical integration efforts, so it’s just getting our cost basis down.

Unidentified Analyst

Okay. We have a couple of more minutes, if there are any questions from the audience?

Question-and-Answer Session

Unidentified Analyst

What is your (inaudible) right now?

Randy McMullen

Utilizations rate?

Unidentified Analyst

Yeah..

Randy McMullen

Which service line, it’s…

Unidentified Analyst

In frac?

Randy McMullen

Yeah. In fracing generally it’s 75% to 80%, when we were operating in our peak in 2011, 2012 that was right at 100%. So there is room for improvement today.

Unidentified Analyst

Do you have any more long-term contracts coming off?

Randy McMullen

Yes. We have one legacy take-a-pay contract and that rolls in February of 2014.

Unidentified Analyst

Do you expect the customers continue to operate that fleet?

Randy McMullen

Our expectation is we will continue to work for that customer.

Unidentified Analyst

Any other questions?

Unidentified Analyst

(Inaudible)

Randy McMullen

We thought -- that’s a two year agreement that we have finalized in October of ’11 and we have for relationship reasons, we had to revisit that pricing couple times during the term due to the downward movement in pricing, so it’s very close to market rates. So unlike a few of the other contracts that we have roll-off or the pricing was fairly significantly higher than market rates, we are not expecting the same kind of a event with this roll-off.

Unidentified Analyst

Right.

Unidentified Analyst

Can you talk a little more about your plans for international expansion? You said in the Middle East but what countries and are you being led in there by one year current customers or like kind of struggling with understanding the expansion into the Middle East, I guess?

Randy McMullen

Yeah. For competitive reasons we are not highlighting the specific country but I can say that we are targeting virtually all of them. And your second question, no, there is not an existing customer that is pulling us there. But I will say our interest in pursuing that particularly was a pool versus a push, meaning that we did have demand for our services, I think a lot of the success we have had and others have had the smaller service companies have been noticed.

And I think really the interest for C&J is there is some movement there generally to the unconditional development and there is a demand for an alternative service provider and because of that we have been able to accelerate our plans there, get pre-qualified and look to put equipment over there.

Unidentified Analyst

Given a timeline and where there will be a meaningful investment or meaningful amount of your earnings and cash flow from there?

Randy McMullen

Not specifically, I can mention the initial interest is around coiled tubing, so obviously the capital outlay is much less then if it was frac fleet. And we have got some existing units where initially we can send existing equipment over there, so obviously really minimizing the capital outlay in the coiled. But I would expect that in 2014 you won't see anything significant from a capital outlay associated with international but as we continue to progress and we are more successful and break into those markets for fracing at that point we would attribute significant capital outlay.

Unidentified Analyst

And real quick….

Unidentified Analyst

(Inaudible) better way to put it, how flexible is pricing within one of those agreements both up and down?

Randy McMullen

When you fix pricing for the term, but obviously there is nothing that prevents the customer from either asking for relief or demand in relief. I mean the agreements, although, their papered up, for the most part they have got 30-day out provisions. So if you are not flexible, he can simply cancel that after 30 days.

Unidentified Analyst

Okay. Great. We are out of time but thank you very much Randy. We appreciate you coming up here again and hope the one-on-ones continue to go up.

Randy McMullen

Yeah. Thank you.

Unidentified Analyst

Thank you.

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