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Executives

David Wallace - Chairman and Chief Executive Officer

Thomas Stoelk - Vice President and Chief Financial Officer

Analysts

Mark Thomas - Simmons & Company International

Victor Marchon - RBC Capital Markets

Byron Pope - Tudor, Pickering, Holt

Stephen Gengaro - Jefferies & Company

Bill McKenzie - Lafitte Capital

Superior Well Services, Inc (SWSI) Q1 2008 Earnings Call May 8, 2008 11:00 AM ET

Operator

Good day ladies and gentlemen, and welcome to the First Quarter 2008 Superior Wells Services, Inc. Earnings Conference Call. My name is Talisha, and I will be your coordinator for today. At this time, all participants are on 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 reply purposes.

I would now like to turn the call over to your host for today Mr. David Wallace, Chairman and Chief Executive Officer. Please proceed, sir.

Dave Wallace – Chairman and Chief Executive Officer

Thanks Talisha, good morning everyone and welcome to the Superior Well Services first 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 all will be available to listen to through May 23, 2008 by dialing 888-286-8010 and referencing the conference ID number 57388484. The webcast will be archived for replay on the Company website for 15 days. Additionally, our form 10-Q will be filed later today and will be posted on the company's website.

Before I begin with comments on our first quarter operating performance, I would like to make the following disclaimer regarding our call today. Except for historical information, statements made in the 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 in 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 development 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 management’s experience and reception of historical trend, currents 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 uncertainty 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 first quarter operations. The first quarter proved to be a difficult one. Even though we saw an increase in customer demand in most regions, as E&P companies went back to work drilling wells to replace and grow production, weather, aggressive price discounting, and rising costs combined to make a tough quarter. We saw rising rig counts in nearly all of our major markets, creating more phone calls and higher activity from the previous quarter. Despite the increased activity and inquiries, however, the first quarter was challenging on four major fronts.

First, poor weather extended the muddy season in Appalachia longer than average, which slowed the pace of drilling in the first quarter and operators delayed rig moves to avoid costly site preparations required by wet conditions. Appalachia is our largest region and the poor seasonal conditions negatively affected utilization.

Second, our nationwide expansion has relied on organic growth by opening new service centers in active drilling markets, and it usually takes 12 to 24 months for a new service center to reach profitability. As we noted in our last call, we expected delays in receiving equipment at new centers opened in the last half of 2007, which extended the ramp-up period for most of these centers. Although activity is improving in most of these new markets, our new service centers will continue to dampen margins and earnings while on the path to achieving profitability. These new centers represent long-term organic growth potential and are strategically located in multiple active drilling markets.

Third, the industry has experienced a rapid influx of new equipment and towards the back half of 2007 created supply and demand in the industry. New equipment entering the market, combined with horsepower moved down from Canada, resulted in an oversupply of capacity. Consequently, many of our competitors resorted to price, rather than service quality as their primary competitive tool in an effort to keep crews busy and maintain utilization. The result has been aggressive price competition over the last two quarters, in an effort to maintain or increase market share. Although we increased our pricing discounts to be competitive, we continued to differentiate on service quality, underpinned by a relatively new and reliable fleet, the expertise and responsiveness of our motivated and professional workforce, and the trust we've established with leading E&P companies through our long-lived customer relationships.

Fourth, we, like the industry, are experiencing significant cost increases for labor, fuel and materials. We've developed plans for mitigating the most serious cost increases and securing access to critical materials to maintain service quality and responsiveness. Here are some of the steps we've taken to date for mitigating cost inflation. We're currently installing bulk material handling facilities at several of our new service centers. In Clinton, construction of new cost saving facilities is underway, and in Artesia, New Mexico, we expect to obtain the required permits and commence construction of our bulk plant in the second quarter.

Once operational, these facilities will mitigate expenses associated with transporting and sorting large quantities of vital materials. We continue to focus on optimizing our transportation and logistics efficiencies and cost by increasing railcar access and enhancing our materials storage capabilities. We recently added a dedicated transportation specialist to further manage these activities.

Last year, we secured a ready supply of high-quality frac sand from a primary supplier. As a result, we have not had to turn down any jobs as a result of material shortages and we have avoided competition for somewhat limited sand supplies. We have a presence in all three well completion markets as we define them; the low-tech, high-tech and super-high-tech markets. We have previously discussed how we expect 2008 to be a transition year for Superior, as we increase our market share in higher margin, more technical plays, while demand for low-tech, lower-margin stimulation jobs and active resource plays grows.

Although we can't escape the macro forces affecting our business, we are actively executing our growth strategy and sticking to the things that differentiate us.

I will now briefly run through some of the operational highlights and then turn the call over to Tom for a financial overview.

Turning to Appalachia in the Marcellus Shale. Historically, the Appalachia region has generated over 45% of our company's total revenues, so when something happens in this region, it can have a large impact on the entire company. We continued to see poor weather impact activity from the fourth quarter last year, into the first quarter of 2008, as operators delayed rig move and reduced activities for most conventional and CBM drilling. Preparing a location for wet conditions can increase cost by up to 20%.

Total revenues from Appalachia were down 21.5% from the prior quarter and up 10.2% from the prior year. A bright spot in this region was the rapidly increasing activity related to the Marcellus Shale play. Many E&P companies are increasing their drilling activity in this emerging resource play and we are capturing much additional work. Marcellus stimulation jobs are currently being tested as single stage and as multistage fractures, and they both require more horsepower on site and more materials than typical conventional completions in Appalachia.

Superior has a long-standing operating history in this region and local expertise that should give us an edge. We believe our existing service center infrastructure and established workforce provides a competitive advantage for capturing more Marcellus work in the long run. During the first quarter, we began to see a ramp-up in the Marcellus Shale activity and performed 16 stimulation jobs.

Turning to the Southeast region, revenues in the Southeast region are up 30.6% year-over-year as a result of increasing drilling activities in the Cotton Valley and Floyd Shale trends and the emerging Hayneville Shale play. Other service companies have moved equipment into the area in anticipation of increasing Haynesville work. In the short-run, this has created what we believe is a temporary oversupply of capacity in the region.

The Haynesville Shale however, works to our advantage, because it is a more technical play than most typical shales. Haynesville wells are deeper and hotter than most resource play shales, requiring fracturing pressures at 10,000 to 12,000 PSI and also use crosslinked fluids at high bottom-hole temperatures.

We have an excellent record performing both stimulation and cementing jobs in these conditions and plan to leverage our existing service centers in this increasingly active area to move up market into this more technical and more profitable market segment.

In the Southwest region, revenues in the Southwest region are up 66.4% year-over-year and 35.8% sequentially. The Barnett Shale play continues to drive the majority of the activity in this region, as operators for both large and small, look to this resource play to drive production and reserves growth. The play has attracted a lot of competition and many pressure pumping companies have moved equipment into the region, from Canada and the Rockies. Most stimulation work in the Barnett is low-tech, multistage slickwater fracturing jobs, requiring a significant amount of sand, water and large amounts of horsepower on location. Because of the rapid pace of activity demanded by customers, service quality, reliability and responsiveness are important and our relatively new fleet provides confidence that we'll get the job right the first time, and our long-term sand supply agreements ensure that we'll have the materials on hand.

Our crews have worked hard to establish their reputations, and based on what we're hearing from our customers, our crews are now some of the best in this market. The long-term potential continues to improve as well, as we are seeing increases in inquiries for refrac, as operators seek to improve recoveries and leverage their existing investments. To improve operating efficiency and margins, we're in the process of obtaining the necessary permits for operating a cement bulk plant in Artesia, New Mexico in this region. We expect to obtain regulatory approval and commence construction of the bulk plant during the second quarter. Once this facility is operational, we expect our productivity in this area to improve.

Looking at the Mid-Continent region, revenues from the Mid-Con region have increased 24% year-over-year and 21.7% sequentially. Increasing drilling in plays located in the Anadarko and Arkoma Basins continue to drive service center activity in this region. Our stimulation crew service quality continues to be excellent and we're picking up more work from large active operators in the region. Our service centers are strategically positioned in the Anadarko and Cherokee Basins, in between the Fayetteville and Woodford Shale hotspots, where we're winning more cementing opportunities and job counts are increasing monthly. In addition, we are currently constructing a cement bulk plant in Clinton, Oklahoma in this region, which will increase efficiencies and improve margins in the region, once we place them in operations.

Revenues from the Rocky Mountain region have increased 5% year-over-year and 25.6% sequentially. We have a number of new service centers in the Rockies region and they're beginning to see increased demand with the increased gas prices in the region and the end of winter seasonality. We're also working to achieve preferred vendor certification in the region, with large E&P companies to facilitate our move up market in this region to more technical work. Several major oil companies have awarded us work and we've reported excellent service quality.

Our cementing capabilities differentiate us in the region and we expect improving utilizations to help new centers in the region advance towards profitability. We have a small wireline presence in the Bakken Shale from our acquisition last November, and expect to extend our service line up in this area over time. Now I'll turn it over to Tom.

Tom Stoelk – Vice President and Chief Financial Officer

Thanks, Dave. Net income from the quarter was $2.4 million, or $0.10 per diluted share, compared to $9 million or $0.39 per diluted share in the first quarter of 2007, and $7 million or $0.30 per diluted share sequentially from the fourth quarter of 2007.

First quarter revenue was $93.4 million. That was up 22% year-over-year, but it was down 2% sequentially. Approximately $13.5 million or 80% of the total increase in year-over-year revenue was attributable to new centers opened in 2007, with the balance of the increase related to our other activity centers. The sequential decline in revenues is primarily the result of winter weather experienced in our Appalachian region during the first quarter of 2008, which significantly impacted the region's utilization.

Partially offsetting the decline in Appalachia, were sequential revenue increases in the Mid-Continent, Rocky Mountain and Southwest regions that were primarily driven by growth from new centers established in 2007. During the first quarter of 2008, we experienced higher than anticipated pricing discounts required remain price competitive.

Stimulation and nitrogen cementing and downhole surveying revenues amounted to 59%, 7%, 23%, and 11% of the revenue in the first quarter of 2008, respectively. Cost of revenue increased to 78.8 million and that was up 46% for the first quarter compared to the first quarter of 2007, and up 8% sequentially.

Approximately 13.9 or 56% of the total increase in year-over-year cost was attributable to the establishment of new service centers, with the balance of the increase related to higher materials, labor, fuel and depreciation expenses. As a result of these cost increases, total cost of revenue as a percentage of revenue increased 84% for the first quarter of 2008, compared to 70% in the same quarter of last year.

Here's some additional comments on just the cost increases. Material cost as a percentage of revenues increased 4.3% in the first quarter of 2008, compared to the same quarter last year, and the increase was 3.5% sequentially. These increases were principally due to the higher cost of sand, chemicals and cement, as well as the transportation expenses associated with the delivery of these materials. Labor expenses as a percentage of revenues increased 2% in the first quarter of 2008, as compared to the same quarter last year and was up approximately four-tenths of 1% sequentially.

And these increases were due to wage inflation and lower personnel utilization at our new centers, as well as lower utilization of our Appalachian service centers due to the winter weather impact. Higher diesel prices as a percentage of revenue increased fuel cost by 3% in in the first quarter of 2008, compared to the same quarter last year, and there was a 1.9% sequentially. The increase in fuel costs is obviously driven by the increased cost of diesel year-over-year. Diesel costs were up about 40% per gallon.

As a percentage of revenue, non-cash depreciation expenses increased 2.7% to 9% in the first quarter of 2008 compared to the same quarter last year, due to the investments we made to expand our national fleet, combined with the lower crew utilization.

Depreciation expense as a percentage of revenues increased 1.2% in the first quarter of 2008 compared to the fourth quarter of 2007 as we placed new equipment into service combined with lower utilization in the Appalachian region. Additionally, higher sales discounts had the impact of both reducing net revenues and increasing the total cost of revenues as a percentage of revenues the first quarter of 2008, and as well as the sequential quarter of fourth quarter of 2007. Margins were hampered by more competitive pricing environment, as pressure pumping companies sought to maximize utilization in regions with excess capacity.

As a percentage of revenues, sales discount increases were in the mid single-digits in the first quarter of 2008, as compared to the same period in 2007, to remain price competitive. SG&A expenses increased to 9.5 million, that was up 13% as compared to the first quarter of 2007, and SG&A expenses were down 2% sequentially.

Approximately 1 million of the year-over-year increase is attributable to the cost of additional personnel to manage the growth in our operations at our new service centers.

Operating income for the first quarter of 2008, came in at 5.1 million compared to 14.3 million a year ago, and 12.2 million in the fourth quarter of 2007. This translates into decreases of 64% and 58% respectively. EBITDA for the first quarter of 2008, came in at 13.4 million, that's a decrease of 6.4 million or 32% from the same quarter last year. Net income in the first quarter of 2008 declined by 6.6 million compared to the same quarter last year and to 2.4 million as a result of the aforementioned increase cost and higher sales discounts.

Turning to the balance sheet for a moment we ended the year a strong with approximately 48.5 million working capital. Total debt at the end of the quarter was 28.3 million and the company's debt to capitalization was slightly less than 10%. Capital expenditures for the quarter were approximately 27.7 million, and our total 2008 capital expenditures budget remains at 65 million. At this point, I'll turn the call back to Dave for some additional comments.

David Wallace – Chairman and Chief Executive Officer

Thanks Tom. Although the first quarter was difficult, here's what's working for Superior. We have an established presence in Appalachia to serve existing business and to meet demand for the increasingly active Marcellus Shale plays. We've been working for many of the leading Appalachian E&P companies. They know us, they trust us, and based on our customer satisfaction surveys, our service quality is excellent.

We have inherent competitive advantages here as a result of successfully operating in this market for over a decade. We have an established presence for serving the emerging Haynesville Shale play, which is a more technical play where our strengths in performing high-pressure, high-temperature completions are valued.

Our larger national footprint gives us operational flexibility to move equipment from slower and lower margin markets to more active markets. Our organic growth strategy is the right one for creating and maintaining high service quality and trusted customer relationships, although new service centers will continue to impact profitability during their 12 to 24 month start up days.

Our comprehensive lineup of stimulations, cementing, nitrogen and wireline services give us a competitive advantage in being a one-stop shop for the most essential well completion services. The industry is learning how to compete in this time of overcapacity.

Longer-term, however, we believe the industry fundamentals are very strong, as declining well productivity will require increased drilling and service work just to keep natural gas production flat. Over time, we believe pressure pumping companies will discover that prices will have to stabilize and eventually rise in order to provide an acceptable return on capital. Although we don't know when that inflection point will occur, we have seen the pace and magnitude of discounts beginning to slow.

In our recent conversations with customers and prospects, there has been a greater emphasis on service quality over price, which is encouraging. In the short-run, we're experiencing the effects of seasonality, overcapacity and cost inflation and our new service centers are still in the process of reaching profitability. In the long-run however, these new centers represent growth opportunities, and we believe our organic growth strategy is the best one for maintaining service quality, increasing the mix of higher margin, more technical jobs and preserving valuable customer relationships.

That concludes our prepared remarks and now we'll open the call for questions. Talisha, we'll turn it over.

Questions-and-Answers Session

Operator

(Operator Instructions) And your first question comes from the line of Mark Thomas with Simmons & Company International. Please proceed.

David Wallace

Good morning Mark.

Mark Thomas

I was hoping I get some clarification in regards to outlook on pricing? You know, in today's release you state that the pricing appears to be stabilizing. However, in the closing comments you state the short-run expect pricing pressure for the remainder of the year. Could you help us understand that a little bit better?

David Wallace

Yes I think what we are seeing is - we are seeing that fourth '07 first quarter '08 there was a push in pricing and therefore we saw erosion during that time period. And I think the main reason was because going into fourth quarter, storage was looking pretty high. There were concerns about gas prices and what it was going to do to rig activity and things like that, therefore, we saw some competitors get pretty aggressive trying to pick up market share.

What we're seeing now is coming out of a strong winter, is we're seeing that storage got reduced, gas prices and oil prices are very high and therefore, E&P guys are starting to ramp up their budgets. And we're just seeing that activity is starting to increase. So we see second quarter that the pricing erosion has pretty well flattened and now it's a matter of third and fourth quarter, we think it's going to be in pricing improvement, but there's still going to be some people out there trying to pick up utilization. And in the past has been less important to low price. Now, with the ramp up in E&P activity, we're seeing that it's more of when you can get there and the service quality of your crews, which really fits into us. And therefore, there's still going to be a little pricing pressure, but we think that it's going to flatten and maybe start improving.

Mark Thomas

Okay, great. In terms of the Appalachia region, could you help us understand how much the winter weather actually impacted the EPS for this quarter?

David Wallace

Let me take a shot at that one. A little bit tough, but I'm going to try to give you a little bit of guidance on that. Last year, winter weather from the fourth quarter to the first quarter of '07 for Appalachia, was sequentially down about 6%. When you take a look at those same numbers and step back a year, sequentially there was an improvement of 17% sequentially in the '05 to '06 period. This year, sequentially we were down almost 22% on a sequential basis. If you sit there and take the position that last year was kind of normal sequential decline and place it at about 6%, so conversely saying that about 16% of that was weather, just kind of unusual winter weather, wetness and impact for us. Earnings were impacted in a range of around 12 to $14.

Mark Thomas

Okay, great. Thanks for the info. And then my last question, sticking with the Appalachian region, it appears you guys have done a good job of holding prices. However, we've heard rumors of new private entrants entering the Appalachian market. Have you seen any evidence of this, and if so, how much pricing pressure do you expect to see in this region as '08 unfolds?

David Wallace

Well, there's definitely a lot of interest in the Marcellus play. And one, because E&P companies are talking about the interest they have, they're trying to pick up acreage positions, trying to bring rigs in from other areas, and just overall just a lot of interest in this area. So with that, that means the other service companies, pressure pumping and the ancillary services are looking at how they can enter this market. We know there's people looking at this area. We have a very strong position in the Northeast and it's going to take people a while to go through the learning curve and kind of develop, so it's going to take a little while for them to position. They may try to buy some work to initially enter the market, but it's going to take them a while to prove that their service quality is where it needs to be to hold the cheap price.

Mark Thomas

Okay. So you don't expect very much pricing pressure as '08 unfolds?

David Wallace

I think we're going to see some, just because of the competitive environment, and again, more people looking at the area. So, as a natural transition you would expect to see some pricing pressure change in the area.

Mark Thomas

Okay, great that’s all have guys thanks.

David Wallace

Thanks you.

Operator

Your next question comes line of Victor Marchon with RBC Capital Markets. Please proceed.

Victor Marchon

Just wanted to follow-up on the pricing question. From the fourth quarter of '07 to the first quarter of '08, what was the decrement in pricing that you guys experienced?

David Wallace

One more time? You cut out on me.

Victor Marchon

I'm sorry. I was just asking, the pricing decrement from the fourth quarter to the first quarter of '08?

Tom Stoelk

The erosion or increase in discounts was in the 3% range.

Victor Marchon

Of 3% okay. And that just based on your prior commentary, will be flat in the second quarter from the first?

David Wallace

It might be up just slightly, and again, part of that's going to be mixed with the services as Appalachia comes on, which has been a little lower discount area. It's going to dampen some of the higher discount areas where we've been busy in the past. So it may look flat, but there could be a little bit of change. It kind of depends on the mix of the services.

Victor Marchon

But just on a pure pricing standpoint, flattish?

David Wallace

One of the things you're going to see, Victor, I think is that one of the things you need to think about maybe is that in the fourth quarter of '07, Appalachia region was about 48% of total revenues and in the first quarter of '08, it was about 38%, sao you had a 20% sequential drop, but on a total it comprised 10% less in the first quarter. And Appalachia is a higher margin area than our other regions, and when you change the mix like that, what it does is it averages you up sequentially, so your discount, because of your drop in utilization because of weather, gets impacted a little bit. So keep that in mind when you're looking at the sequential decrease, too.

Victor Marchon

Okay. And just sort of relating that then to margins going forward, Tom, I believe you said that the impact to earnings was about 12 to $0.14 in the first quarter on Appalachia due to weather. Is that correct?

Tom Stoelk

Correct.

Victor Marchon

As you guys look at the gross margins going forward through this year as the weather is behind you and take into account the pricing side and the cost side, can you provide any sort of metrics that we can look at, as it relates to gross margins for the second and third quarter?

Tom Stoelk

I think if you take a look and kind of do the math on the earnings, you're going to see that the impact on op income as a percentage of revenues, just exclusive to Appalachia, was a range of probably 5-6% sort of area, with respect to that.

David Wallace

I think also it's going to be -- there's been a lot of inflation that the service companies have absorbed in fourth quarter - first quarter, when you look at the labor and materials, fuel, things like that. So, we're working with our customers now, trying to mitigate some of that increase that we've had. And so the effectiveness of working with them to shift some of that cost back, plus also keep our utilization up, that's going to have a big driver on how the margin develop and improve over the rest of the year.

Tom Stoelk

Probably another factor too, I just pointed out is, we talked initially in our opening comments about the new centers and the impact that they have on earnings. You saw our impact on operating income and in the current quarter, those new centers were about 5 million operating loss. If you took a look at the fourth quarter of '07, they were about a $3.4-$3.3 million loss, as I remember. So, we had incremental improvement from the new centers and that's going to have an impact as they mature more and become better contributors, I guess.

Victor Marchon

Okay. Thank you. And last one, just quick, on the horsepower, I think you had mentioned 40,000 add this year. Is that the number that you guys are still looking at?

David Wallace

We're still at that point. We haven't changed our CapEx from the 65 million that we reported at the last call. We're still in that range at this point. Again, we're continuing to watch some of these plays that we're in, the Hayneville, the Marcellus, and if they continue to develop faster than we expect, we may look at shifting horsepower from other regions or expanding our horsepower to meet the demand.

Victor Marchon

Great. Thank you that’s all I have.

David Wallace

Thank you victor.

Operator

And now our next question comes from the line of Byron Pope with Tudor, Pickering, Holt. Please proceed.

Byron Pope

Good morning guys. We're basically a month into Q2, how did the quarter start off during the month of April in terms of Appalachia weather? I mean, was the rebound -- did you kind of see some rebounding activity early in Q2 so far?

David Wallace

What we saw is usually April is usually our softest month every year, but we actually saw a rebound -- a pretty good rebound in April, and the main reason is the Southern Appalachia finally dried out where they could start kicking into gear. Michigan and Northern Appalachia, there's still some road restrictions and some of those areas have been cold, late fall periods, but they're starting to kick in in May. So, we should be pretty well back to full strength going May up 'till Thanksgiving. So it looks pretty good from here on.

Byron Pope

Okay. And then just in terms of your fracturing horsepower, the incremental 40,000 that's on top of the 281 where you guys were at the end of the first quarter? I'm just trying to make sure I'm thinking about the incremental horsepower, where you guys would be once that's all on line?

David Wallace

There would be, based on our year-end, 266,000 horsepower. So it would be over 10,000 horsepower is what we're forecasting for this year.

Byron Pope

Okay. And then, based on your conversations with the vendors, I mean we've seen a couple of the Canadian pressure pumpers that have horsepower in the US, all of the sudden they're building new units for some of the BC shale plays up in Canada, so I'm just curious, based on your conversations with the vendors, do you worry at all that in the US market we could see some of these smaller players feel like the worst is over and then start to increase capacity, actually start to tick back up? I'm just curious as to what you're seeing based on your conversations with vendors?

David Wallace

From what we've heard from the pump guys and also the engine guys, that's kind of the two major components that go on the horsepower. We're hearing the 10% number is kind of an increased number of what we're hearing in '08. So that's kind of the information that we're getting back, 10 to 12% increase is what we're anticipating in the US.

Byron Pope

And then it sounded like what you're seeing in the Haynesville, I think you referred to is as kind of a temporary oversupply and that's just because we aren't at a point where well count is high enough to support the capacity that you're seeing in that market and I was curious as to whether or not -- how much capacity do you think, from a fracturing point of view, is currently addressing that market?

David Wallace

I don't know that have specifics for East Texas and Northern Louisiana. There's probably -- you know, it's pretty large in that area, 500,000 or 600,000 horsepower, maybe more, in the Barnett Shale.

Byron Pope

Okay thanks Wall.

Operator

And now our next question comes from the line of Stephen Gengaro with Jefferies & Company, please proceed.

Stephen Gengaro

Thank you, good morning gentlemen. Just one more quick question and I'll ride off and listen. The margin question going forward, you've addressed it pretty well. When you look at Appalachia should we assume despite the growth in other areas, we're going to go back to kind of close to a similar mix as far as revenue is concerned, as the Marcellus comes on?

David Wallace

The Marcellus is going to be a little different play, and again, heavier on material and it's going to change the mix a little bit. But the conventional stuff looks like it's going to bounce back and be pretty well comparable to what we've seen in the past. There could be a little bit more pressure there also. But Marcellus, depending on utilization and job sizes, nonmaterials, transportation, there's quite a few variables that can affect that at this point. So I think it's a little hard for us to kind of pinpoint how we see it. Again, we see it improving, just because we see utilization improving, but the job mix is definitely changing in this area.

Stephen Gengaro

So directionally when we adjust for obviously the cost inflation and the mix and the pricing you're seeing, should we anticipate margin improvements sequentially over the next couple of quarters? You think that's a valid expectation, given the way you played things out or the pull is going to be harder than the push?

David Wallace

think total company, we're going to see that and then also especially in Appalachia just due to the increased utilization we're going to see that as well.

Stephen Gengaro

Very good that’s helpful. Thank you.

Operator

(Operator Instructions) And our next question comes from line of Bill McKenzie with Lafitte Capital, please proceed.

Bill McKenzie

Hey, could you talk a little bit about the differential in pricing between the more commodity type of slickwater fracs versus some of the more complex work out there? Because it sounds to me like the Barnett and the areas where the slickwater fracs are going on are the more price intensive in the operating base out there. Is that correct?

David Wallace

Yes, that is correct. And what you see is kind of the slickwater market, there can be up to 12 to 14 competitors. All you need is horsepower and sand and decent service quality to compete in those markets, so they're really commoditized. So, we look at the three tiers, once you go from low-tech, it goes to high-tech, then it goes to super-high-tech, and the number of competitors in each of those markets reduces. You go from 14 competitors to about 4 or 5 in that high-tech market, and then when you get high-tech market, it really gets down to competing against the big-three. And that's where you need the expertise of fluids, being able to work in high-pressure, high-temperature, and it just gets to be a lot more complicated.

Bill McKenzie

Dave, if I were to try to just kind of ballpark would it say then that the slickwater business is seeing like 10% pricing cuts, middle market's 5%, and the high end has got nothing going on in price cuts or something of that magnitude?

David Wallace

It's still back to bookless discounting, but the difference is just there's a lot more fluids, a lot more chemistry involved and you get paid for that chemistry.

Bill McKenzie

Right

David Wallace

And you're right in that when you -- you may not see it on the discount line, but where you're going to see it is on the gross margins line. There's probably a 10% improvement in each of those tiers, so when you go from low-tech to high-tech, you may see a 10% margin. And that will vary, again, by regions and if there's certain little hotspots where there's less competition, you'll get an improvement over that. Then when you move up to the super high-tech, then you're going to see another 10% increase in margin also. That's why we see it as a long-term growth strategy. We talked about 2008 is kind of our transition year, that this year would be a little higher percentage in the low-tech, as we continue to transition to the high-tech and super-high-tech. And the reason is, is the service centers that we've opened the end of '07 are really in some of the high-tech, super-high-tech areas. And the first thing the customers are going to give us are less complicated jobs, so that we prove to them that we have good service quality, we have good equipment, good people. From there, they continue to give us more complicated jobs, and then they'll move us up into the super-high jobs.

Bill McKenzie

Alright. Then on that service center front, you talked about what the decline was in your operating loss from 3.3, 3.4 in Q4 to about 1.5 million in Q1. Kind of given your current schedule of over 14,000 horsepower left to deploy inside the company or so, where does that number go to break even and what kind of volumes will we need to be seeing down below the Appalachian Basin to get the margins somewhat comparable to what they are up in Appalachia?

David Wallace

You want to take the margins comparable at Appalachia.

Bill McKenzie

Yes.

David Wallace

I think that again, there's a little more headwind out there on our new service centers. We used to take the approach that we enter a market, we can reduce the price underneath the competitors in the area and then from there start working the price up. The thing that's changed is that the big-three basically have been reducing their prices, therefore, when you undercut the price, you're actually at close to starting off at breakeven or even below breakeven just with your pricing scenario. Then when you work it up, you're working it up to a lot lower margins than we've seen in the past. So, as far as the new service centers go, they're all on track. Revenues continue increase each month sequentially, so it's a matter of just kind of working the cost side and working the pricing utilization side to continue to improve the numbers.

Bill McKenzie

And Tom, if you were at 33 last quarter, 1.5 million this quarter, of operating loss, does that kind of imply that we're headed towards breakeven on these startup costs in Q2?

Tom Stoelk

I think breakeven would be aggressive in Q2 with respect to it. Let me give you a little bit more color maybe to kind of help you out. On the centers that we're established earlier, for example, we established one in Mid-Continent, that center right now is better than breakeven. When you look at the centers that we established late in the fourth quarter, the Southwest center, for example, it was approximately last quarter its drag on op income was around 1.9 million, it’s drag on op income this quarter is about 1.4 million. We're going to file our 10-Q later today and these numbers are in the 10-Q so you don't have to write them down so fast. Brighton, Colorado, that was a center that we started very late in January, but have been seeing some good momentum as Dave commented on, during the first quarter. Too early to call on just two months of operating history and to kind of project. So, I would caution you that I don't think they'll be breakeven as a group, but they're certainly headed in the right direction, Bill, if that helps.

Bill McKenzie

And two more questions if I might. VJ talked about being in the upper 80's in utilization in North America. You guys talked about, as has everybody else, about an inability to pass through the cost increases of fuel and sand and stuff like that. At what juncture do you think we see in terms of activity that the market has moved positive enough -- not so much just on the discounting side, but that the cost increases that you're experiencing right now from $4 a gallon of diesel and so forth, are ultimately passed back on in the price?

David Wallace

I think we're starting to see the change now, and again, fourth quarter and first quarter, when storage was looking pretty full and gas prices were looking pretty soft, at that point we saw competitors just out kind of lowballing the price, trying to get utilization. We're seeing the change now, because you know, gas price is really strong and we're seeing the rig count increase, we're seeing E&P budgets getting increased and basically the mindset has changed. It's not what's your cheapest price, it's more of do you have a good crew and what's their availability? And price has become less of a concern. Which means it's a good time for us to talk about, hey we've had all this inflation that we need to shift back the other way. And there's going to be some areas that we hit resistance and with our national footprint, the good thing is we can shift that equipment around. And if there's certain markets that just continue to be a little beat up, we'll shift that equipment to some of the better markets.

We said earlier that we shifted 30,000 horsepower to Appalachia. Basically we pulled it from some areas that the pricing was a little soft, and we moved it back here. So we can shift equipment very easily.

Bill McKenzie

And one last question then I'll turn it back over. I know that during the last conference call or some of our conversations, one or the other, it sounded like there was a fair amount of equipment that had been offered for sale, at least one full fleet, about 20,000 or 30,000 horsepower. Are you guys seeing much that's offered up for sale out there in the market right now, or conversely of companies that are looking to try to consolidate?

David Wallace

I think we're seeing, again, in the resource plays that the pricing got pretty soft and the return on capital wasn't very good in some of those areas. And some of the newer entrants, that's really all they were focused on, is working in those environments because they could generate big revenues, but it's getting very hard for them to make margins. I think they're seeing that this isn't quite working the way we thought, maybe it's time to shift that equipment, try to do something different. So we're actually seeing some stuff pop up out there that we'll continue to look at and see if it might fit what we want to do.

Bill McKenzie

Well, great. It sounds like it's going to be an interesting year as it unfolds. Thanks a lot.

David Wallace

Thanks Bill.

Operator

And now our next question comes as a follow up question from Byron Pope with Tudor, Pickering Holt. Please proceed.

Byron Pope

Hi, guys, I wanted to circle back on the pricing, but really on kind of the high end of the market. You addressed the competitive pressures and the commodity in slick water frac and as a market, but in the higher end where it's really just four or five players, I know historically you guys strategically get price and I guess call it 10-50% below the big-three. Given that it feels like those bigger guys are being a little more defensive of their markets here, are you guys still generally below where the big three are in the higher end markets or are we at price parity at this point?

David Wallace

We're still below, because we're still -- and I'll go more to the -- in the higher tech market we can be pretty comparable. It depends on the area and how long we've been there and if we've proven ourselves to be a strong competitor, then the gap is pretty close. In some of the super-high-tech areas that we are now entering into, we're still kind of building our book, kind of proving ourselves, so there's still a little pricing differential in those areas. But we're really encouraged, because we continue to do more and more of these jobs, our service quality is excellent, also we're getting recognized by more and more customers that we're a legitimate company to compete against the big three, which over time, all that does is just help us narrow that differential in the pricing between them and us. We're also encouraged that so far this year, we've picked up work from three of the majors in the US. And again, part of that trying to upgrade our capabilities, show that we have more technical expertise and can compete against those guys and now we're starting to be recognized by the bigger companies as well. But a little more differential on the super-high-tech end, a lot less differential on the better part of what we call the higher-tech part.

Byron Pope

Okay. Would it be fair then to say that your comment about pricing having stabilized, that comment would apply to the high-end of the market as well, in terms of not seeing further price discounting?

David Wallace

I think so.

Byron Pope

Okay. Thanks guys.

Thomas Stoelk

Thanks Wallace.

Operator

And there are no more questions at this time. I would now like to turn the call back over to Mr. Dave Wallace for any closing remarks

David Wallace

Thanks, Talisha. We thank everybody for their participation today and we look forward to talking to you on the next call. Thank you. Bye.

Operator

This concludes your presentation. You may now disconnect and have a great day.

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Source: Superior Well Services, Inc. Q1 2008 Earnings Call Transcript

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