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EX-12.1 - EX-12.1 - Seventy Seven Energy Inc.ex12120150930.htm
EX-32.1 - EX-32.1 - Seventy Seven Energy Inc.ex32120150930.htm
EX-32.2 - EX-32.2 - Seventy Seven Energy Inc.ex32220150930.htm



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File No. 001-36354
 
Seventy Seven Energy Inc.

(Exact name of registrant as specified in its charter)
 
Oklahoma
 
45-3338422
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
777 N.W. 63rd Street
Oklahoma City, Oklahoma
 
73116
(Address of principal executive offices)
 
(Zip Code)
(405) 608-7777
(Registrant’s telephone number, including area code)
______________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, non-accelerated filer, or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

As of October 23, 2015, there were 56,746,769 shares of our $0.01 par value common stock outstanding.

 





TABLE OF CONTENTS
 





PART I. FINANCIAL INFORMATION
 
Item 1.
Financial Statements

SEVENTY SEVEN ENERGY INC.
Condensed Consolidated Balance Sheets
(Unaudited) 
 
September 30,
2015
 
December 31,
2014
 
(In thousands, except share amounts)
Assets:
 
 
 
Current Assets:
 
 
 
Cash
$
156,219

 
$
891

Accounts receivable, net of allowance of $4,646 and $3,311 at September 30, 2015 and December 31, 2014, respectively
162,059

 
421,555

Inventory
16,096

 
25,073

Deferred income tax asset
1,992

 
7,463

Prepaid expenses and other
20,120

 
19,072

Total Current Assets
356,486

 
474,054

Property and Equipment:
 
 
 
Property and equipment, at cost
2,626,044

 
2,749,886

Less: accumulated depreciation
(1,056,558
)
 
(982,833
)
Property and equipment held for sale, net
6,600

 

Total Property and Equipment, Net
1,576,086

 
1,767,053

Other Assets:
 
 
 
Equity method investment
8,806

 
7,816

Goodwill
27,434

 
27,434

Intangible assets, net

 
5,420

Deferred financing costs
26,138

 
23,851

Other long-term assets
33,419

 
6,924

Total Other Assets
95,797

 
71,445

Total Assets
$
2,028,369

 
$
2,312,552

Liabilities and Stockholders’ Equity:
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
42,259

 
$
45,657

Current portion of long-term debt
5,000

 
4,000

Other current liabilities
140,561

 
215,752

Total Current Liabilities
187,820

 
265,409

Long-Term Liabilities:
 
 
 
Deferred income tax liabilities
79,347

 
159,273

Long-term debt, excluding current maturities
1,589,500

 
1,594,500

Other long-term liabilities
1,600

 
2,347

Total Long-Term Liabilities
1,670,447

 
1,756,120

Commitments and Contingencies (Note 8)


 


Stockholders’ Equity:
 
 
 
Common stock, $0.01 par value: authorized 250,000,000 shares; issued and outstanding 56,908,357 and 51,158,968 shares at September 30, 2015 and December 31, 2014, respectively
569

 
512

Paid-in capital
341,466

 
301,644

Accumulated deficit
(171,933
)
 
(11,133
)
Total Stockholders’ Equity
170,102

 
291,023

Total Liabilities and Stockholders’ Equity
$
2,028,369

 
$
2,312,552


The accompanying notes are an integral part of these condensed consolidated financial statements.

1




SEVENTY SEVEN ENERGY INC.
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands, except per share data)
Revenues:
 
 
 
 
 
 
 
Revenues
$
213,541

 
$
526,773

 
$
938,456


$
1,585,948

Operating Expenses:

 
 
 



Operating costs
160,889

 
392,138

 
731,627


1,208,312

Depreciation and amortization
68,854

 
73,855

 
226,779


218,149

General and administrative
26,709

 
32,723

 
95,436


72,977

Loss on sale of a business

 

 
34,989

 

Losses (gains) on sales of property and equipment, net
1,804

 
454

 
15,023


(7,532
)
Impairments and other
1,566

 
7,751

 
16,720


30,731

Total Operating Expenses
259,822

 
506,921

 
1,120,574


1,522,637

Operating (Loss) Income
(46,281
)
 
19,852

 
(182,118
)

63,311

Other (Expense) Income:

 
 
 



Interest expense
(25,480
)
 
(23,606
)
 
(73,964
)

(55,913
)
Gains on early extinguishment of debt
4,975

 

 
18,061

 

(Loss) income from equity investee
(230
)
 
(347
)
 
877


(5,764
)
Other income (expense)
942

 
(134
)
 
1,889


623

Total Other Expense
(19,793
)
 
(24,087
)
 
(53,137
)

(61,054
)
(Loss) Income Before Income Taxes
(66,074
)
 
(4,235
)
 
(235,255
)

2,257

Income Tax (Benefit) Expense
(17,544
)
 
(2,465
)
 
(74,455
)

873

Net (Loss) Income
$
(48,530
)
 
$
(1,770
)
 
$
(160,800
)

$
1,384

 
 
 
 
 
 
 
 
(Loss) Earnings Per Common Share (Note 4)
 
 
 
 
 
 
 
Basic
$
(0.95
)
 
$
(0.04
)
 
$
(3.24
)
 
$
0.03

Diluted
$
(0.95
)
 
$
(0.04
)
 
$
(3.24
)
 
$
0.03

 
 
 
 
 
 
 
 
Weighted Average Common Shares Outstanding (Note 4)
 
 
 
 
 
 
 
Basic
51,117

 
47,331

 
49,627

 
47,139

Diluted
51,117

 
47,331

 
49,627

 
47,143


The accompanying notes are an integral part of these condensed consolidated financial statements.

2




SEVENTY SEVEN ENERGY INC.
Condensed Consolidated Statement of Changes in Equity
(Unaudited)
 
 
Common Stock
 
Paid-in Capital
 
Accumulated Deficit
 
Total Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
(In thousands)
Balance at December 31, 2014
51,159

 
$
512

 
$
301,644

 
$
(11,133
)
 
$
291,023

Net loss

 

 

 
(160,800
)
 
(160,800
)
Share-based compensation
5,749

 
57

 
39,822

 

 
39,879

Balance at September 30, 2015
56,908

 
$
569

 
$
341,466

 
$
(171,933
)
 
$
170,102


The accompanying notes are an integral part of these condensed consolidated financial statements.

3




SEVENTY SEVEN ENERGY INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited) 
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
NET (LOSS) INCOME
$
(160,800
)

$
1,384

ADJUSTMENTS TO RECONCILE NET (LOSS) INCOME TO CASH PROVIDED BY OPERATING ACTIVITIES:



Depreciation and amortization
226,779


218,149

Amortization of sale/leaseback gains


(5,401
)
Amortization of deferred financing costs
3,381


5,048

Gains on early extinguishment of debt
(18,061
)


Loss on sale of a business
34,989



Losses (gains) on sales of property and equipment, net
15,023


(7,532
)
Impairments and other
16,720


21,030

(Income) loss from equity investee
(877
)

5,764

Provision for doubtful accounts
1,930


2,062

Non-cash compensation
43,646


27,763

Deferred income tax benefit
(74,455
)

(1,197
)
Other
(810
)

106

Changes in operating assets and liabilities
176,197


(115,130
)
Net cash provided by operating activities
263,662


152,046

CASH FLOWS FROM INVESTING ACTIVITIES:



Additions to property and equipment
(151,799
)

(313,441
)
Proceeds from sales of assets
18,573


68,537

Proceeds from sale of a business
15,000



Additions to investments
(112
)

(213
)
Other
3,434


63

Net cash used in investing activities
(114,904
)

(245,054
)
CASH FLOWS FROM FINANCING ACTIVITIES:



Borrowings from revolving credit facility
160,100


930,900

Payments on revolving credit facility
(210,600
)

(1,292,300
)
Proceeds from issuance of senior notes, net of offering costs


493,825

Payments to extinguish senior notes
(31,305
)


Proceeds from issuance of term loan, net of issuance costs
94,481


393,879

Payments on term loan
(3,500
)

(1,000
)
Deferred financing costs
(784
)

(3,546
)
Distributions to CHK


(421,920
)
Other
(1,822
)

(3,175
)
Net cash provided by financing activities
6,570


96,663

Net increase in cash
155,328


3,655

Cash, beginning of period
891


1,678

Cash, end of period
$
156,219


$
5,333


The accompanying notes are an integral part of these condensed consolidated financial statements.




4




SEVENTY SEVEN ENERGY INC.
Condensed Consolidated Statements of Cash Flows — (Continued)
(Unaudited) 

Supplemental disclosures to the condensed consolidated financial statements of cash flows are presented below:

SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:



(Decrease) increase in other current liabilities related to purchases of property and equipment
$
(9,459
)

$
39,197

Note receivable received as consideration for sale of a business
$
27,000


$

Property and equipment distributed to CHK at spin-off
$


$
(792
)
Property and equipment contributed from CHK at spin-off
$


$
190,297

SUPPLEMENTAL DISCLOSURE OF CASH PAYMENTS:



Interest paid, net of amount capitalized
$
69,181

 
$
28,930


The accompanying notes are an integral part of these condensed consolidated financial statements.

5

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



1. Basis of Presentation and Spin-off

Basis of Presentation

The accompanying condensed consolidated financial statements and related notes present the financial position of Seventy Seven Energy Inc. (“SSE,” “we,” “us,” “our” or “ours”) as of September 30, 2015 and December 31, 2014, results of operations for the three and nine months ended September 30, 2015 and 2014, changes in equity for the nine months ended September 30, 2015 and cash flows for the nine months ended September 30, 2015 and 2014. These notes relate to the three and nine months ended September 30, 2015 (the “Current Quarter” and “Current Period,” respectively) and the three and nine months ended September 30, 2014 (the “Prior Quarter” and “Prior Period,” respectively). All significant intercompany accounts and transactions within SSE have been eliminated.

Seventy Seven Finance Inc. (“SSF”) is a 100% owned finance subsidiary of SSE that was incorporated for the purpose of facilitating the offering of SSE’s 2019 Notes (see Note 6). SSF does not have any operations or revenues.

The accompanying condensed consolidated financial statements were prepared using accounting principles generally accepted in the United States (“GAAP”) for interim financial information. All material adjustments (consisting solely of normal recurring adjustments) which, in the opinion of management, are necessary for a fair statement of the results for the interim periods have been reflected. Certain footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been appropriately condensed or omitted. Therefore, these interim condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2014 contained in our Annual Report on Form 10-K (Commission File No. 001-36354) filed with the U.S. Securities and Exchange Commission (“SEC”) on March 2, 2015.

Spin-off

On June 9, 2014, Chesapeake Energy Corporation (“CHK”) announced that its board of directors approved the spin-off of its oilfield services division through the pro rata distribution of 100% of the shares of common stock of SSE to CHK’s shareholders of record as of the close of business on June 19, 2014. On June 30, 2014, each CHK shareholder received one share of SSE common stock for every fourteen shares of CHK common stock held by such shareholder on the record date, and SSE became an independent, publicly traded company as a result of the distribution. The transactions in which SSE became an independent, publicly traded company, including the distribution, are referred to collectively as the “spin-off”. Prior to the spin-off, we conducted our business as Chesapeake Oilfield Operating, L.L.C. (“COO”), a wholly owned subsidiary of CHK. Following the spin-off, CHK retained no ownership interest in SSE, and each company has separate public ownership, boards of directors and management. A registration statement on Form 10, as amended through the time of its effectiveness, describing the spin-off was filed by SSE with the SEC and was declared effective on June 17, 2014. On July 1, 2014, SSE stock began trading the “regular-way” on the New York Stock Exchange under the ticker symbol of “SSE”. For a detailed description of the transactions completed and agreements entered into as part of the spin-off, please read Note 1 to our consolidated financial statements contained in our Annual Report on Form 10-K.

2. Sale of Hodges Trucking Company, L.L.C.

On June 14, 2015, we sold Hodges Trucking Company, L.L.C. (“Hodges”), our previously wholly-owned subsidiary that provided drilling rig relocation and logistics services, to Aveda Transportation and Energy Services Inc. (“Aveda”) for aggregate consideration of $42.0 million. At the time of the sale, Hodges owned 270 rig relocation trucks and 65 cranes and forklifts. The sale did not include the land and buildings used in Hodges’ operations.

The consideration received consisted of $15.0 million in cash and a $27.0 million secured promissory note due June 15, 2020 (the “Note Receivable”). The Note Receivable bears a fixed interest rate of 9.00% per annum, which is payable quarterly in arrears beginning on June 30, 2015. Aveda can, at any time, make prepayments of principal before the maturity date without premium or penalty. The Note Receivable is secured by a second lien on substantially all of Aveda’s fixed assets and accounts receivable. The Note Receivable is presented in other long-term assets on our condensed consolidated balance sheet. During the Current Quarter and Current Period, we recognized interest income of $0.6 million and $0.7 million, respectively, related to the Note Receivable.


6

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We recognized a loss of $35.0 million on the sale of Hodges in the Current Period. Additionally, during the Current Period, we recognized $2.1 million of additional stock-based compensation expense related to the vesting of restricted stock held by Hodges employees and $0.6 million of severance-related costs.

Hodges was included in our oilfield trucking segment. The sale of Hodges did not qualify as discontinued operations because the sale did not represent a strategic shift that had or will have a major effect on our operations or financial results.

3. Change in Accounting Estimate

We review the estimated useful lives of our property and equipment on an ongoing basis. Based on this review in the first quarter of 2015, we concluded that the estimated useful lives of certain drilling rig components and certain drilling rigs were shorter than the estimated useful lives used for depreciation in our consolidated financial statements. As a result, effective January 1, 2015, we changed our estimate of the useful lives of these components and the drilling rigs to better reflect the estimated periods during which these drilling rig components and drilling rigs will remain in service. The effect of the drilling rig component change in estimate resulted in an increase to depreciation expense of $10.9 million, pre-tax, during the Current Period. The effect of the change in estimate of certain drilling rigs was an increase of $0.6 million and $2.7 million, pre-tax, to depreciation expense during the Current Quarter and Current Period, respectively. For the Current Quarter and the Current Period, these changes increased our net loss by $0.4 million and $9.3 million, respectively, and increased our basic and diluted loss per share by $0.01 and $0.19, respectively.


7

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

4. Earnings Per Share

Basic earnings per share is computed using the weighted average number of shares of common stock outstanding and includes the effect of any participating securities as appropriate. Participating securities consist of unvested restricted stock issued to our employees and non-employee directors that provide nonforfeitable dividend rights and are required to be included in the computation of our basic earnings per share using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Diluted earnings per share is computed using the weighted average shares outstanding for basic earnings per share, plus the dilutive effect of stock options. The dilutive effect of unvested restricted stock and stock options is determined using the treasury stock method, which assumes the amount of unrecognized compensation expense related to unvested share-based compensation awards is used to repurchase shares at the average market price for the period.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands, except per share data)
Basic earnings per share(a):
 
 
 
 
 
 
 
Allocation of earnings:
 
 
 
 
 
 
 
Net (loss) income
$
(48,530
)
 
$
(1,770
)
 
$
(160,800
)
 
$
1,384

 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Weighted average shares outstanding, excluding unvested shares of restricted stock
51,117

 
47,331

 
49,627

 
47,139

Restricted stock(b)

 

 

 

Weighted average shares outstanding, basic
51,117

 
47,331

 
49,627

 
47,139

 
 
 
 
 
 
 
 
Basic (loss) earnings per share
$
(0.95
)
 
$
(0.04
)
 
$
(3.24
)
 
$
0.03

 
 
 
 
 
 
 
 
Diluted earnings per share(a):
 
 
 
 
 
 
 
Allocation of earnings:
 
 
 
 
 
 
 
Net (loss) income
$
(48,530
)
 
$
(1,770
)
 
$
(160,800
)
 
$
1,384

 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Weighted average shares outstanding, basic
51,117

 
47,331

 
49,627

 
47,139

Stock options(c)

 

 

 
4

Weighted average shares outstanding, diluted
51,117

 
47,331

 
49,627

 
47,143

 
 
 
 
 
 
 
 
Diluted (loss) earnings per share
$
(0.95
)
 
$
(0.04
)
 
$
(3.24
)
 
$
0.03


(a)
46,932,433 shares of our common stock were distributed to CHK shareholders on June 30, 2014 in conjunction with the spin-off. For comparative purposes, and to provide a more meaningful calculation for weighted average shares, we have assumed this amount to be outstanding for periods prior to the spin-off presented in the calculation of weighted average shares.
(b)
3,164,944 unvested restricted shares were excluded from both the Prior Quarter and Prior Period and 2,949,770 unvested restricted shares were excluded from the Current Period because these shares are not obligated to participate in our losses. No incremental shares of potentially dilutive restricted stock awards or units were included for the Current Quarter as their effect was antidilutive under the treasury stock method.
(c)
The exercise price of stock options exceeded the average market price of our common stock during the Current Quarter, Prior Quarter and Current Period. Therefore, the stock options were not dilutive.

8

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

5. Asset Sales and Impairments and Other

Asset Sales

During the Current Period, we sold our water hauling assets, which consisted of property and equipment that had a total carrying amount of $12.3 million, for $6.5 million. During the Prior Period we sold 15 Tier 3 drilling rigs and ancillary drilling equipment for $13.7 million. We sold our crude hauling assets, which included 124 fluid handling trucks and 122 trailers that had a total carrying amount of $20.7 million, for $43.8 million in the Prior Period. During the Current Period and Prior Period, we sold other ancillary equipment for $12.1 million and $11.0 million, respectively. We recorded net losses (gains) on sales of property and equipment of approximately $15.0 million and ($7.5) million related to these asset sales during the Current Period and Prior Period, respectively.

Impairments and Other

A summary of our impairments and other is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
Drilling rigs held for use
$

 
$

 
$
3,290

 
$
8,366

Drilling rigs held for sale

 
5,523

 

 
11,237

Lease termination costs

 
1,253

 

 
9,701

Drilling-related services equipment

 

 
8,687

 

Trucking and water disposal equipment

 

 
2,737

 

Other
1,566

 
975

 
2,006

 
1,427

Total impairments and other
$
1,566

 
$
7,751

 
$
16,720

 
$
30,731


We recognized $3.3 million and $8.4 million of impairment charges during the Current Period and Prior Period, respectively, for certain drilling rigs that we deemed to be impaired based on our assessment of future demand and the suitability of the identified rigs in light of this demand. Estimated fair value for these drilling rigs was determined using significant unobservable inputs (Level 3) based on a market approach.

We recognized $8.7 million of impairment charges during the Current Period for drilling-related services equipment that we deemed to be impaired based on the expected future cash flows of this equipment. The estimated fair value for the drilling-related services equipment was determined using significant unobservable inputs (Level 3) based on a market approach.

We recognized $2.7 million of impairment charges during the Current Period for certain trucking and water disposal equipment that we deemed to be impaired based on expected future cash flows of this equipment. Estimated fair value for the trucking and fluid disposal equipment was determined using significant unobservable inputs (Level 3) based on an income approach.

We recognized $5.5 million and $11.2 million of impairment charges during the Prior Quarter and Prior Period for certain drilling rigs and spare equipment we had identified to sell as part of our broader strategy to divest of non-essential drilling rigs. We are required to present such assets at the lower of carrying amount or fair value less the anticipated costs to sell at the time that they met the criteria for held-for-sale accounting. Estimated fair value was based on the expected sales price, less costs to sell.

During the Prior Quarter and Prior Period, we purchased 2 and 33 of our leased drilling rigs for approximately $3.0 million and $134.0 million, respectively, and paid lease termination costs of approximately $1.3 million and $9.7 million, respectively. We subsequently sold ten of these drilling rigs.

We identified certain other property and equipment during the Current Quarter, Prior Quarter, Current Period, and Prior Period that we deemed to be impaired based on our assessment of the market value and expected future cash flows of the long-lived asset. We recorded impairment charges of $1.6 million, $1.0 million, $2.0 million and $1.4 million during the Current Quarter, Prior Quarter, Current Period and Prior Period, respectively, related to these assets. Estimated fair value for this property and equipment was determined using significant unobservable inputs (Level 3) based on an income approach.

9

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 
The assumptions used in the impairment evaluation for long-lived assets are inherently uncertain and require management’s judgment. A prolonged period of low oil and natural gas prices or continued reductions in capital expenditures by CHK or our other customers would likely have an adverse impact on our utilization and the prices that we receive for our services. This could result in the recognition of future material impairment charges on the same, or additional, property and equipment if future cash flow estimates, based upon information then available to management, indicate that their carrying values are not recoverable.

6. Debt

As of September 30, 2015 and December 31, 2014, our long-term debt consisted of the following:

 
September 30,
2015
 
December 31,
2014
 
(In thousands)
6.625% Senior Notes due 2019
$
650,000


$
650,000

6.50% Senior Notes due 2022
450,000


500,000

Term Loans
494,500


398,000

Credit Facility


50,500

Total debt
1,594,500


1,598,500

Less: Current portion of long-term debt
5,000


4,000

Total long-term debt
$
1,589,500


$
1,594,500


2019 Senior Notes

In October 2011, we and SSF co-issued $650.0 million in aggregate principal amount of 6.625% Senior Notes due 2019 (the “2019 Notes”). The 2019 Notes will mature on November 15, 2019 and interest is payable semi-annually in arrears on May 15 and November 15 of each year. The 2019 Notes are guaranteed by all of our existing subsidiaries, other than certain immaterial subsidiaries and SSF, which is a co-issuer of the 2019 Notes.

Prior to November 15, 2015, we may redeem some or all of the 2019 Notes at a price equal to 100% of the principal amount plus a make-whole premium determined pursuant to a formula set forth in the indenture governing the 2019 Senior Notes, plus accrued and unpaid interest. On or after November 15, 2015, we may redeem all or part of the 2019 Senior Notes at the following prices (as a percentage of principal), plus accrued and unpaid interest, if redeemed during the 12-month period beginning on November 15 of the years indicated below:
 
Year
Redemption
Price
2015
103.313
%
2016
101.656
%
2017 and thereafter
100.000
%

The 2019 Notes are subject to covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to: (1) sell assets; (2) declare dividends or make distributions on our equity interests or purchase or redeem our equity interests; (3) make investments or other specified restricted payments; (4) incur or guarantee additional indebtedness and issue disqualified or preferred equity; (5) create or incur certain liens; (6) enter into agreements that restrict the ability of our restricted subsidiaries to pay dividends and make intercompany loans or transfer assets to us; (7) effect a merger, consolidation or sale of all or substantially all of our assets; (8) enter into transactions with affiliates; and (9) designate subsidiaries as unrestricted subsidiaries. The 2019 Senior Notes also have cross default provisions that apply to other indebtedness of SSE and any of its guarantor subsidiaries. If the 2019 Senior Notes achieve an investment grade rating from either Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Rating Services (“S&P”), our obligation to comply with certain of these covenants will be suspended, and if the 2019 Senior Notes achieve an investment grade rating from both Moody’s and S&P, then all such covenants will terminate. 


10

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

2022 Senior Notes

In June 2014, we issued $500.0 million in aggregate principal amount of 6.50% Senior Notes due 2022 (the “2022 Notes”). The 2022 Notes will mature on July 15, 2022 and interest is payable semi-annually in arrears on July 15 and January 15 of each year. Prior to the full repayment or refinancing of the 2019 Notes, the 2022 Notes will become fully and unconditionally guaranteed on a senior unsecured basis by each of our domestic subsidiaries, if any, that has outstanding indebtedness or guarantees in an aggregate principal amount greater than $15.0 million, other than (i) guarantors of the 2019 Notes, (ii) Seventy Seven Operating LLC (“SSO”) or (iii) subsidiaries of SSO. We do not have any such subsidiaries currently; therefore, the 2022 Notes are not guaranteed. Upon the full repayment of the 2019 Notes, the 2022 Notes will be fully and unconditionally guaranteed on a senior unsecured basis by each of our domestic subsidiaries that has outstanding indebtedness or guarantees in an aggregate principal amount greater than $15.0 million.

We may redeem up to 35% of the 2022 Notes with proceeds of certain equity offerings at a redemption price of 106.5% of the principal amount plus accrued and unpaid interest prior to July 15, 2017, subject to certain conditions. Prior to July 15, 2017, we may redeem some or all of the 2022 Notes at a price equal to 100% of the principal amount plus a make-whole premium determined pursuant to a formula set forth in the indenture governing the 2022 Notes, plus accrued and unpaid interest. On or after July 15, 2017, we may redeem all or part of the 2022 Notes at the following prices (as a percentage of principal), plus accrued and unpaid interest, if redeemed during the 12-month period beginning on July 15 of the years indicated below:
 
Year
Redemption
Price
2017
104.875
%
2018
103.250
%
2019
101.625
%
2020 and thereafter
100.000
%

The 2022 Notes are subject to covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to: (1) sell assets; (2) declare dividends or make distributions on our equity interests or purchase or redeem our equity interests; (3) make investments or other specified restricted payments; (4) incur or guarantee additional indebtedness and issue disqualified or preferred equity; (5) create or incur certain liens; (6) enter into agreements that restrict the ability of our restricted subsidiaries to pay dividends and make intercompany loans or transfer assets to us; (7) effect a merger, consolidation or sale of all or substantially all of our assets; (8) enter into transactions with affiliates; and (9) designate subsidiaries as unrestricted subsidiaries. The 2022 Notes also have cross default provisions that apply to other indebtedness of SSE and certain of our subsidiaries. If the 2022 Notes achieve an investment grade rating from either Moody’s or S&P, our obligation to comply with certain of these covenants will be suspended, and if the 2022 Notes achieve an investment grade rating from both Moody’s and S&P, then all such covenants will terminate.

During the Current Quarter, we repurchased and cancelled $10.0 million in aggregate principal amount of the 2022 Notes for $4.9 million. We recognized gains on extinguishment of debt of $5.0 million, which included accelerated amortization of deferred financing costs of $0.1 million. During the Current Period, we repurchased and cancelled $50.0 million in aggregate principal amount of the 2022 Notes in multiple transactions for $31.3 million. We recognized gains on extinguishment of debt of $18.1 million, which included accelerated amortization of deferred financing costs of $0.6 million.


11

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Term Loans

In June 2014, we entered into a $400.0 million seven-year term loan credit agreement (the “Term Loan”). Borrowings under the Term Loan bear interest at our option at either (i) the Base Rate, calculated as the greatest of (1) the Bank of America, N.A. prime rate, (2) the federal funds rate plus 0.50% and (3) a one-month London Interbank Offered Rate (“LIBOR”) rate adjusted daily plus 1.00% or (ii) LIBOR, with a floor of 0.75%, plus, in each case, an applicable margin. The applicable margin for borrowings is 2.00% for Base Rate loans and 3.00% for LIBOR loans, depending on whether the Base Rate or LIBOR is used, provided that if and for so long as the leverage ratio is less than a certain level and the term loans have certain ratings from each of S&P and Moody’s, such margins will be reduced by 0.25%. The Term Loan is repayable in equal consecutive quarterly installments equal to 0.25% (1.00% per annum) of the original principal amount of the Term Loan and will mature in full on June 25, 2021.

Obligations under the Term Loan are guaranteed jointly and severally by all of our present and future direct and indirect wholly-owned material domestic subsidiaries, other than certain excluded subsidiaries. Amounts borrowed under the Term Loan are secured by liens on all of our equity interests in our current and future subsidiaries, and all of our subsidiaries’ present and future real property, equipment (including drilling rigs and frac spread equipment), fixtures and other fixed assets.

We may prepay all or a portion of our Term Loan at any time. Borrowings under our Term Loan may be subject to mandatory prepayments with the net cash proceeds of certain issuances of debt, certain asset sales and other dispositions and certain condemnation events, and with excess cash flow in any calendar year in which our leverage ratio exceeds 3.25 to 1.00. The Term Loan contains various covenants and restrictive provisions which limit our ability to (1) enter into asset sales; (2) incur additional indebtedness; (3) make investments or loans and create liens; (4) pay certain dividends or make other distributions and (5) engage in transactions with affiliates.

On May 13, 2015, we entered into an incremental term supplement to the Term Loan and borrowed $100.0 million in aggregate principal amount (the “Incremental Term Loan”) and received net proceeds of $94.5 million. Borrowings under the Incremental Term Loan bear interest at our option at either (i) LIBOR, with a floor of 1.00% or (ii) the Base Rate, calculated as the greatest of (1) the Bank of America, N.A. prime rate, (2) the federal funds rate plus 0.50% and (3) a one-month LIBOR rate adjusted daily plus 1.00%, plus, in each case, an applicable margin. The applicable margin for borrowings is 9.00% for LIBOR loans and 8.00% for Base Rate loans, depending on whether the Base Rate or LIBOR is used. The Incremental Term Loan is payable in equal consecutive quarterly installments equal to 0.25% (1.00% per annum) of the original principal amount of the Incremental Term Loan and will mature in full on June 25, 2021.

Obligations under the Incremental Term Loan are guaranteed jointly and severally by all of our present and future direct and indirect wholly-owned material domestic subsidiaries, other than certain excluded subsidiaries. Amounts borrowed under the Incremental Term Loan are secured by liens on all of our equity interests in our current and future subsidiaries, and all of our subsidiaries’ present and future real property, equipment (including drilling rigs and frac spread equipment), fixtures and other fixed assets.

We may prepay all or a portion of our Incremental Term Loan at any time. Borrowings under our Incremental Term Loan may be subject to mandatory prepayments with the net cash proceeds of certain issuances of debt, certain asset sales and other dispositions and certain condemnation events, and with excess cash flow in any calendar year in which our leverage ratio exceeds 3.25 to 1.00. The Incremental Term Loan contains various covenants and restrictive provisions which limit our ability to (1) enter into asset sales; (2) incur additional indebtedness; (3) make investments or loans and create liens; (4) pay certain dividends or make other distributions and (5) engage in transactions with affiliates. All prepayments of the Incremental Term Loan, except for mandatory prepayments described above, if made on or prior to the 42-month anniversary of the Incremental Term Loan, are subject to a prepayment premium equal to (i) a make-whole premium determined pursuant to a formula set forth in the Incremental Term Loan if made on or prior to the 18-month anniversary of the Incremental Term Loan, (ii) 5.00% of such principal amount if made after the 18-month anniversary and on or prior to the 30-month anniversary of the Incremental Term Loan, or (iii) 3.00% of such principal amount if made after the 30-month anniversary and on or prior to the 42-month anniversary of the Incremental Term Loan.


12

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Credit Facility

In June 2014, we, through SSO, entered into a five-year senior secured revolving bank credit facility (the “Credit Facility”) with total commitments of $275.0 million. The maximum amount that we may borrow under the Credit Facility is subject to the borrowing base, which is based on a percentage of eligible accounts receivable, subject to reserves and other adjustments. As of September 30, 2015, the Credit Facility had availability of $152.7 million, net of letters of credit of $10.2 million. All obligations under the Credit Facility are fully and unconditionally guaranteed jointly and severally by SSE, and all of our present and future direct and indirect material domestic subsidiaries. Borrowings under the Credit Facility are secured by liens on cash and accounts receivable of the borrowers and the guarantors, and bear interest at our option at either (i) the Base Rate, calculated as the greatest of (1) the rate of interest publicly announced by Wells Fargo Bank, National Association, as its “prime rate,” subject to each increase or decrease in such prime rate effective as of the date such change occurs, (2) the federal funds effective rate plus 0.50% and (3) the one-month LIBOR Rate plus 1.00%, each of which is subject to an applicable margin, or (ii) LIBOR, plus, in each case, an applicable margin. The applicable margin ranges from 0.50% to 1.00% per annum for Base Rate loans and 1.50% to 2.00% per annum for LIBOR loans. The unused portion of the Credit Facility is subject to a commitment fee that varies from 0.250% to 0.375% per annum, according to average unused amounts. Interest on LIBOR loans is payable at the end of the selected interest period, but no less frequently than quarterly. Interest on Base Rate loans is payable monthly in arrears.

The Credit Facility contains various covenants and restrictive provisions which limit our ability to (1) enter into asset sales; (2) incur additional indebtedness; (3) make investments or loans and create liens; (4) pay certain dividends or make other distributions and (5) engage in transactions with affiliates. The Credit Facility requires maintenance of a fixed charge coverage ratio based on the ratio of consolidated EBITDA (minus unfinanced capital expenditures) to fixed charges, in each case as defined in the Credit Facility agreement, at any time availability is below a certain threshold and for a certain period of time thereafter. If we fail to perform our obligations under the agreement, the Credit Facility could be terminated and any outstanding borrowings under the Credit Facility may be declared immediately due and payable. The Credit Facility also contains cross default provisions that apply to our other indebtedness.

7. Other Current Liabilities

Other current liabilities as of September 30, 2015 and December 31, 2014 are detailed below:
 
 
September 30,
2015
 
December 31,
2014
 
(In thousands)
Other Current Liabilities:
 
 
 
Accrued expenses
$
47,061

 
$
88,538

Payroll related
30,694

 
47,711

Insurance reserves
11,835

 
14,521

Interest
26,437

 
25,035

Income, property, sales, use and other taxes
7,983

 
13,937

Property and equipment
16,551

 
26,010

Total Other Current Liabilities
$
140,561

 
$
215,752


8. Commitments and Contingencies

Operating Leases

As of September 30, 2015, we were party to five lease agreements with various third parties to utilize 745 lease rail cars for initial terms of five to seven years. Additional rental payments are required for the use of rail cars in excess of the allowable mileage stated in the respective agreement.

As of September 30, 2015, we were also party to various lease agreements for other property and equipment with varying terms.



13

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




Aggregate undiscounted minimum future lease payments under our operating leases at September 30, 2015 are presented below:
 
Rail Cars
 
Other
 
Total
 
(In thousands)
Remainder of 2015
$
1,362

 
$
562

 
$
1,924

2016
5,447

 
951

 
6,398

2017
2,168

 
553

 
2,721

2018
1,445

 
182

 
1,627

2019
722

 
3

 
725

Total
$
11,144

 
$
2,251

 
$
13,395


Rent expense for drilling rigs, real property, rail cars and other property and equipment for the Current Quarter, Prior Quarter, Current Period and Prior Period was $2.2 million, $5.6 million, $6.2 million and $33.2 million, respectively, and was included in operating costs in our condensed consolidated statements of operations.

Other Commitments

Much of the equipment we purchase requires long production lead times. As a result, we usually have outstanding orders and commitments for such equipment. As of September 30, 2015, we had $106.6 million of purchase commitments related to future capital expenditures that we expect to incur in the fourth quarter of 2015 and the first half of 2016. These commitments relate primarily to the construction of the remaining contracted PeakeRigs™.

Litigation

We are involved in various lawsuits and disputes incidental to our business operations, including commercial disputes, personal injury claims, property damage claims and contract actions. We record an associated liability when a loss is probable and the amount is reasonably estimable. Although the outcome of litigation cannot be predicted with certainty, management is of the opinion that no pending or threatened lawsuit or dispute incidental to our business operations is likely to have a material adverse effect on our consolidated financial position, results of operations or cash flows. The final resolution of such matters could exceed amounts accrued and actual results could differ materially from management’s estimates.

Self-Insured Reserves

We are self-insured up to certain retention limits with respect to workers’ compensation and general liability matters. We maintain accruals for self-insurance retentions that we estimate using third-party data and claims history. Included in operating costs is workers’ compensation (credit) expense of ($0.6) million, $2.5 million, $4.2 million and $7.6 million during the Current Quarter, Prior Quarter, Current Period and Prior Period, respectively.


14

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

9. Stock-Based Compensation

Our stock-based compensation program consists of restricted stock available to employees and stock options. The restricted stock awards and stock options are equity-classified awards. We also recognize compensation expense (benefit) related to performance share units granted by CHK to our chief executive officer.

Included in operating costs and general and administrative expenses is stock-based compensation expense of $9.9 million, $21.2 million, $32.4 million and $16.2 million for the Current Quarter, Prior Quarter, Current Period and Prior Period, respectively. Prior to the spin-off, we reimbursed CHK for these costs in accordance with the administrative services agreement. To the extent compensation cost related to employees indirectly involved in oilfield services operations, such amounts were charged to us through an overhead allocation and are reflected as general and administrative expenses.

Equity-Classified Awards

Restricted Stock. The fair value of restricted stock awards is determined based on the fair market value of SSE common shares on the date of the grant. This value is amortized over the vesting period.

A summary of the status and changes of unvested shares of restricted stock is presented below.
 
 
Number of
Unvested
Restricted Shares
 
Weighted Average
Grant-Date
Fair Value
 
(In thousands)
 
 
Unvested shares as of January 1, 2015
3,933

 
$
24.02

Granted
4,003

 
$
4.58

Vested
(1,480
)
 
$
21.81

Forfeited
(480
)
 
$
18.17

Unvested shares as of September 30, 2015
5,976

 
$
12.02


As of September 30, 2015, there was $45.9 million of total unrecognized compensation cost related to the unvested restricted stock. The cost is expected to be recognized over a weighted average period of approximately 28 months.

Stock Options. CHK granted stock options to our chief executive officer under CHK’s Long-Term Incentive Plan for incentive and retention purposes. The incentive-based stock options vest ratably over a three-year period and our retention-based stock options will vest one-third on each of the third, fourth and fifth anniversaries of the grant date of the original CHK award, in the case of a replacement award. Outstanding options expire ten years from the date of grant of the original CHK award, in the case of a replacement award. We have not issued any new stock options, other than the replacement awards, since the spin-off.

The following table provides information related to stock option activity for the Current Period:
 
 
Number of
Shares Underlying
Options
 
Weighted Average
Exercise Price
Per Share
 
Weighted Average
Contract  Life
in Years
 
Aggregate
Intrinsic
Value(a)
 
(in thousands)
 
 
 
 
 
(in thousands)
Outstanding at January 1, 2015
348

 
$
16.19

 
9.24

 
$

Granted

 
$

 

 
$

Exercised

 
$

 

 
$

Outstanding at September 30, 2015
348

 
$
16.19

 
7.49

 
$

Exercisable at September 30, 2015
89

 
$
16.46

 
7.53

 
$

 
(a)
The intrinsic value of a stock option is the amount by which the current market value or the market value upon exercise of the underlying stock exceeds the exercise price of the option.


15

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

As of September 30, 2015, there was $0.5 million of total unrecognized compensation cost related to stock options. The cost is expected to be recognized over a weighted average period of approximately 14 months.

Other

Performance Share Units. CHK granted performance share units (“PSUs”) to our chief executive officer under CHK’s Long-Term Incentive Plan that includes both an internal performance measure and external market condition as it relates to CHK. Following the spin-off, compensation expense is recognized through the changes in fair value of the PSUs over the vesting period with a corresponding adjustment to equity and any related cash obligations are the responsibility of CHK. We recognized (credits) of ($0.1) million, ($0.6) million, ($1.3) million, and ($0.4) million for the Current Quarter, Prior Quarter, Current Period, and Prior Period, respectively.

10. Income Taxes
Through the effective date of the spin-off, our operations were included in the consolidated federal income tax return and other state returns for CHK. The income tax provision for the period before the spin-off has been prepared on a separate return basis for us and all of our subsidiaries. Accordingly, we have recognized deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases for all our subsidiaries as if each entity were a corporation, regardless of its actual characterization for U.S. federal income tax purposes. Our effective tax rate was 27%, 58%, 32% and 39% for the Current Quarter, Prior Quarter, Current Period and Prior Period, respectively. Our effective tax rate can fluctuate as a result of the impact of state income taxes, permanent differences and changes in pre-tax income. Effective with the spin-off, we entered into a tax sharing agreement with CHK which governs the respective rights, responsibilities and obligations of each company, for tax periods prior to the spin-off, with respect to the payment of taxes, filing of tax returns, reimbursement of taxes, control of audits and other tax proceedings, liability for taxes that may be triggered as a result of the spin-off and other matters regarding taxes. Following the spin-off, we are not entitled to federal income tax net operating loss (“NOL”) carryforwards that were generated prior to the spin-off and that have historically been reflected in our net deferred income tax liabilities on our consolidated balance sheet. As of the spin-off date, we made an adjustment to our deferred tax liabilities of approximately $178.8 million to reflect the treatment of NOLs under the tax sharing agreement. In connection with the spin-off, we received a one-time step-up in tax basis of our assets due to the tax gain recognized by CHK related to the spin-off in the tax affected amount of approximately $202.6 million.

A valuation allowance for deferred tax assets, including NOLs, is recognized when it is more likely than not that some or all of the benefit from the deferred tax asset will not be realized. To assess that likelihood, we use estimates and judgment regarding our future taxable income, as well as the jurisdiction in which such taxable income is generated, to determine whether a valuation allowance is required. Such evidence can include our current financial position, our results of operations, both actual and forecasted, the reversal of deferred tax liabilities, and tax planning strategies as well as the current and forecasted business economics of our industry. We had no valuation allowance at September 30, 2015 and December 31, 2014. However, some or all of these NOLs could expire unused if we are unable to generate sufficient taxable income in the future to utilize them or we enter into transactions that limit our right to use them. If it became more likely than not that NOLs will expire unused, we would have to record a valuation allowance to reflect this fact, which could materially increase our income tax expense, and therefore, adversely affect our results of operations in the period in which it is recorded. We will continue to assess the need for a valuation allowance in the future.

The benefit of an uncertain tax position taken or expected to be taken on an income tax return is recognized in the consolidated financial statements at the largest amount that is more likely than not to be sustained upon examination by the relevant taxing authority. Interest and penalties, if any, related to uncertain tax positions would be recorded in interest expense and other expense, respectively. There were no uncertain tax positions at September 30, 2015 and December 31, 2014.

11. Equity Method Investment 

We own 49% of the membership interest in Maalt Specialized Bulk, L.L.C. (“Maalt”). We use the equity method of accounting to account for our investment in Maalt, which had a carrying value of $8.8 million as of September 30, 2015. We recorded equity method adjustments to our investment of ($0.2) million, ($0.3) million, $0.9 million and ($1.3) million for our share of Maalt’s income (loss) for the Current Quarter, Prior Quarter, Current Period and Prior Period, respectively. We also made additional investments of $0.1 million and $0.2 million in the Current Period and Prior Period, respectively. As of September 30, 2015, the carrying value of our investment in Maalt is in excess of the underlying equity in Maalt’s net assets by approximately $8.9 million.


16

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We review our equity method investment for impairment whenever certain impairment indicators exist, including the absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A loss in value of an investment which is other than a temporary decline should be recognized. We estimated that the fair value of our investment in Maalt was approximately $7.9 million as of June 30, 2014, which was below the carrying value of the investment and resulted in a non-cash impairment charge of $4.5 million in the Prior Period, which is included in loss from equity investee on our condensed consolidated statements of operations. Estimated fair value for our investment in Maalt was determined using significant unobservable inputs (Level 3) based on an income approach.

Similar to our property and equipment, a prolonged period of low oil and natural gas prices would likely have an adverse impact on Maalt's financial condition, results of operations and cash flows. This could result in the recognition of future impairment charges related to our investment in Maalt.

12. Fair Value Measurements

The fair value measurement standard defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (referred to as an “exit price”). Authoritative guidance on fair value measurements and disclosures clarifies that a fair value measurement for a liability should reflect the entity’s non-performance risk. In addition, a fair value hierarchy is established that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are:

Level 1- Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2- Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3- Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources.

Fair Value on Recurring Basis

The carrying values of cash, trade receivables and trade payables are considered to be representative of their respective fair values due to the short-term nature of these instruments.

Fair Value on Non-Recurring Basis

Fair value measurements were applied with respect to our non-financial assets and liabilities measured on a non-recurring basis, which consist primarily of long-lived asset impairments based on Level 3 inputs. See Note 5 for additional discussion.
 

17

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Fair Value of Other Financial Instruments

The fair values of the Note Receivable and our debt are the estimated amounts a market participant would have to pay to purchase the Note Receivable or our debt, including any premium or discount attributable to the difference between the stated interest rate and market rate of interest at the balance sheet date. Fair values are based on quoted market prices or average valuations of similar debt instruments at the balance sheet date for those debt instruments for which quoted market prices are not available. Estimated fair values are determined by using available market information and valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
 
 
September 30, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair Value
(Level 2)
 
Carrying
Amount
 
Fair Value
(Level 2)
 
(In thousands)
Financial assets:
 
 
 
 
 
 
 
Note Receivable
$
27,000

 
$
23,992

 
$

 
$

 
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
6.625% Senior Notes due 2019
$
650,000

 
$
414,401

 
$
650,000

 
$
519,188

6.5% Senior Notes due 2022
$
450,000

 
$
180,000

 
$
500,000

 
$
296,250

Term Loans
$
494,500

 
$
426,106

 
$
398,000

 
$
379,095

Credit Facility
$

 
$

 
$
50,500

 
$
47,407


13. Concentration of Credit Risk and Major Customers

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and trade receivables. Accounts receivable from CHK and its affiliates were $100.5 million and $326.7 million as of September 30, 2015 and December 31, 2014, or 60% and 77%, respectively, of our total accounts receivable. Revenues from CHK and its affiliates were $136.0 million, $418.7 million, $656.5 million and $1,296.6 million for the Current Quarter, Prior Quarter, Current Period, and Prior Period, or 64%, 79%, 70% and 82%, respectively, of our total revenues. We believe that the loss of this customer would have a material adverse effect on our operating results as there can be no assurance that replacement customers would be identified and accessed in a timely fashion. See Note 14 for further discussion of agreements entered into as part of the spin-off, including a services agreement and rig-specific daywork drilling contracts.

14. Transactions with CHK

Prior to the completion of our spin-off on June 30, 2014, we were a wholly owned subsidiary of CHK, and transactions between us and CHK (including its subsidiaries) were considered to be transactions with affiliates. Subsequent to June 30, 2014, CHK and its subsidiaries are not considered affiliates of us or any of our subsidiaries. We have disclosed below agreements entered into between us and CHK prior to the completion of our spin-off.

On June 25, 2014, we entered into a master separation agreement and several other agreements with CHK as part of the spin-off. The master separation agreement entered into between CHK and us governs the separation of our businesses from CHK, the distribution of our shares to CHK shareholders and other matters related to CHK’s relationship with us, including cross-indemnities between us and CHK. In general, CHK agreed to indemnify us for any liabilities relating to CHK’s business and we agreed to indemnify CHK for any liabilities relating to our business.

On June 25, 2014, we entered into a tax sharing agreement with CHK, which governs the respective rights, responsibilities and obligations of CHK and us with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings, and certain other matters regarding taxes.

On June 25, 2014, we entered into an employee matters agreement with CHK providing that each company has responsibility for our own employees and compensation plans. The agreement also contains provisions concerning benefit protection for both SSE and CHK employees, treatment of holders of CHK stock options, restricted stock, restricted stock units

18

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

and performance share units, and cooperation between us and CHK in the sharing of employee information and maintenance of confidentiality.

On June 25, 2014, we entered into a transition services agreement with CHK under which CHK provides or makes available to us various administrative services and assets for specified periods beginning on the distribution date. In consideration for such services, we pay CHK fees, a portion of which is a flat fee, generally in amounts intended to allow CHK to recover all of its direct and indirect costs incurred in providing those services. These charges from CHK were $8.3 million and $9.3 million for the Current Period and Prior Period, respectively. This agreement was terminated during the second quarter of 2015.

We are party to a master services agreement with CHK pursuant to which we provide drilling and other services and supply materials and equipment to CHK. Drilling services are typically provided pursuant to rig-specific daywork drilling contracts similar to those we use for other customers. The specific terms of each request for other services are typically set forth in a field ticket, purchase order or work order. The master services agreement contains general terms and provisions, including minimum insurance coverage amounts that we are required to maintain and confidentiality obligations with respect to CHK’s business, and allocates certain operational risks between CHK and us through indemnity provisions. The master services agreement will remain in effect until we or CHK provides 30 days written notice of termination, although such agreement may not be terminated during the term of the services agreement described below.

Prior to the spin-off, we were party to a services agreement with CHK under which CHK guaranteed the utilization of a portion of our drilling rig and hydraulic fracturing fleets during the term of the agreement. In connection with the spin-off, we entered into new services agreements with CHK which supplements the master services agreement. Under the new services agreement, CHK is required to utilize the lesser of (i) seven, five and three of our pressure pumping crews in years one, two and three of the agreement, respectively, or (ii) 50% of the total number of all pressure pumping crews working for CHK in all its operating regions during the respective year. CHK is required to utilize our pressure pumping services for a minimum number of stages as set forth in the agreement. CHK is entitled to terminate the agreement in certain situations, including in the event we fail to materially comply with the overall quality of service provided by similar service providers. Additionally, CHK’s requirement to utilize our services may be suspended under certain circumstances, such as if we are unable to timely accept and supply services ordered by CHK or as a result of a force majeure event.

In connection with the spin-off, we entered into rig-specific daywork drilling contracts with CHK for the provision of drilling services. The drilling contracts had a commencement date of July 1, 2014 and terms ranging from three months to three years. CHK has the right to terminate the drilling contracts under certain circumstances.
 
Prior to the spin-off, we were party to a facilities lease agreement with CHK pursuant to which we leased a number of the storage yards and physical facilities out of which we conduct our operations. We incurred $8.2 million of lease expense for the Prior Period under this facilities lease agreement. In connection with the spin-off, we acquired the property subject to the facilities lease agreement, and the facilities lease agreement was terminated.

Prior to the spin-off, CHK provided us with general and administrative services and the services of its employees pursuant to an administrative services agreement. These services included legal, accounting, treasury, environmental, safety, information technology and other corporate services. In return for the general and administrative services provided by CHK, we reimbursed CHK on a monthly basis for the overhead expenses incurred by CHK on our behalf in accordance with its allocation policy, which included costs and expenses incurred in connection with the provision of any of the services under the agreement, including the wages and benefits of CHK employees who perform services on our behalf. The administrative expense allocation was determined by multiplying revenues by a percentage determined by CHK based on the historical average of costs incurred on our behalf. All of the administrative cost allocations were based on assumptions that management believes are reasonable; however, these allocations are not necessarily indicative of the costs and expenses that would have resulted if we had been operating as a stand-alone entity. These charges from CHK were $26.8 million for the Prior Period. In connection with the spin-off, we terminated the administrative services agreement and entered into the transition services agreement.

15. Segment Information

As of September 30, 2015, our revenues, income (loss) before income taxes and identifiable assets are primarily attributable to three reportable segments. During the Current Period, we sold the remaining business and assets included in the oilfield trucking segment. Our former oilfield trucking segment’s historical results for periods prior to the sales continue to be included in our historical financial results as a component of continuing operations as reflected in the tables below.


19

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Each of these segments represents a distinct type of business. These segments have separate management teams which report to our chief operating decision maker. The results of operations in these segments are regularly reviewed by the chief operating decision maker for purposes of determining resource allocation and assessing performance. Management evaluates the performance of our segments based upon earnings before interest, taxes and depreciation and amortization. The following is a description of our segments and other operations:
 
Drilling. Our drilling segment provides land drilling and drilling-related services, including directional drilling for oil and natural gas exploration and development activities. As of September 30, 2015, we owned a fleet of 92 land drilling rigs.

Hydraulic Fracturing. Our hydraulic fracturing segment provides hydraulic fracturing and other well stimulation services. As of September 30, 2015, we owned 10 hydraulic fracturing fleets with an aggregate of 400,000 horsepower.

Oilfield Rentals. Our oilfield rentals segment provides premium rental tools for land-based oil and natural gas drilling, completion and workover activities.

Former Oilfield Trucking. Our oilfield trucking segment historically provided drilling rig relocation and logistics services as well as fluid handling services. During the Current Period, we sold Hodges, which provided drilling rig relocation and logistics services (see Note 2), and sold our water hauling assets. As part of the spin-off, we sold our crude hauling assets to a third party.

Other Operations. Prior to the spin-off, our other operations consist primarily of our compression unit manufacturing business and corporate functions, including our 2019 Notes, 2022 Notes, Term Loans and Credit Facility. As part of the spin-off, we distributed our compression unit manufacturing business to CHK.


20

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 
Drilling
 
Hydraulic
Fracturing
 
Oilfield
Rentals
 
Former Oilfield
Trucking
 
Other
Operations
 
Intercompany
Eliminations
 
Consolidated
Total
 
(In thousands)
For The Three Months Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
80,782

 
$
118,137

 
$
15,122

 
$

 
$
2,112

 
$
(2,612
)
 
$
213,541

Intersegment revenues
(434
)
 

 
(75
)
 

 
(2,103
)
 
2,612

 

Total revenues
$
80,348

 
$
118,137

 
$
15,047

 
$

 
$
9

 
$

 
$
213,541

Depreciation and amortization
38,197

 
17,833

 
8,912

 

 
3,912

 

 
68,854

Losses (gains) on sales of property and equipment, net
1,952

 
172

 
(329
)
 

 
9

 

 
1,804

Impairments and other

 

 

 

 
1,566

 

 
1,566

Interest expense

 

 

 

 
(25,480
)
 

 
(25,480
)
Gains on early extinguishment of debt

 

 

 

 
4,975

 

 
4,975

Loss from equity investee

 
(230
)
 

 

 

 

 
(230
)
Other income
402

 
102

 
27

 

 
411

 

 
942

Loss Before Income Taxes
$
(8,703
)
 
$
(10,855
)
 
$
(10,028
)
 
$

 
$
(36,488
)
 
$

 
$
(66,074
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For The Three Months Ended September 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
197,082

 
$
245,128

 
$
39,139

 
$
42,865

 
$
12,049

 
$
(9,490
)
 
$
526,773

Intersegment revenues
3,312

 

 
(221
)
 
(1,664
)
 
(10,917
)
 
9,490

 

Total revenues
$
200,394

 
$
245,128

 
$
38,918

 
$
41,201

 
$
1,132

 
$

 
$
526,773

Depreciation and amortization
36,062

 
17,524

 
12,812

 
5,230

 
2,227

 

 
73,855

Losses (gains) on sales of property and equipment, net
331

 
(19
)
 
(771
)
 
907

 
6

 

 
454

Impairments and other(a)
6,796

 

 
955

 

 

 

 
7,751

Interest expense

 

 

 

 
(23,606
)
 

 
(23,606
)
Loss from equity investee

 
(347
)
 

 

 

 

 
(347
)
Other (expense) income
(146
)
 
6

 
135

 
96

 
(225
)
 

 
(134
)
Income (Loss) Before Income Taxes
$
24,234

 
$
37,076

 
$
(1,096
)
 
$
(5,636
)
 
$
(58,813
)
 
$

 
$
(4,235
)

(a)
Includes lease termination costs of $1.3 million for the Prior Quarter.
















21

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


 
Drilling
 
Hydraulic
Fracturing
 
Oilfield
Rentals
 
Former Oilfield
Trucking
 
Other
Operations
 
Intercompany
Eliminations
 
Consolidated
Total
 
(In thousands)
For The Nine Months Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
347,311

 
$
483,565

 
$
65,808

 
$
45,512

 
$
6,285

 
$
(10,025
)
 
$
938,456

Intersegment revenues
(465
)
 

 
(511
)
 
(2,773
)
 
(6,276
)
 
10,025

 

Total revenues
$
346,846

 
$
483,565

 
$
65,297

 
$
42,739

 
$
9

 
$

 
$
938,456

Depreciation and amortization
125,936

 
51,915

 
31,659

 
8,787

 
8,482

 

 
226,779

Loss on sale of a business

 

 

 

 
34,989

 

 
34,989

Losses (gains) on sales of property and equipment
9,903

 
171

 
(777
)
 
5,728

 
(2
)
 

 
15,023

Impairments and other
12,417

 

 

 
2,737

 
1,566

 

 
16,720

Interest expense

 

 

 

 
(73,964
)
 

 
(73,964
)
Gains on early extinguishment of debt

 

 

 

 
18,061

 

 
18,061

Income from equity investee

 
877

 

 

 

 

 
877

Other income
395

 
1,099

 
33

 
16

 
346

 

 
1,889

Loss Before Income Taxes
$
(22,984
)
 
$
(2,893
)
 
$
(30,008
)
 
$
(38,420
)
 
$
(140,950
)
 
$

 
$
(235,255
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For The Nine Months Ended September 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
570,147

 
$
672,860

 
$
114,743

 
$
156,626

 
$
100,263

 
$
(28,691
)
 
$
1,585,948

Intersegment revenues
(143
)
 

 
(906
)
 
(3,779
)
 
(23,863
)
 
28,691

 

Total revenues
$
570,004

 
$
672,860

 
$
113,837

 
$
152,847

 
$
76,400

 
$

 
$
1,585,948

Depreciation and amortization
105,362

 
53,484

 
39,527

 
16,588

 
3,188

 

 
218,149

Losses (gains) on sales of property and equipment
16,126

 
(19
)
 
(1,696
)
 
(21,964
)
 
21

 

 
(7,532
)
Impairments and other(a)
29,569

 
207

 
955

 

 

 

 
30,731

Interest expense

 

 

 

 
(55,913
)
 

 
(55,913
)
Loss from equity investee

 
(5,764
)
 

 

 

 

 
(5,764
)
Other income (expense)
399

 
42

 
162

 
133

 
(113
)
 

 
623

Income (Loss) Before Income Taxes
$
36,028

 
$
57,445

 
$
(3,905
)
 
$
8,929

 
$
(96,240
)
 
$

 
$
2,257

 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Assets
$
1,172,483

 
$
312,375

 
$
104,330

 
$

 
$
439,181

 
$

 
$
2,028,369

As of December 31, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Assets
$
1,322,160

 
$
449,966

 
$
155,683

 
$
138,909

 
$
247,013

 
$
(1,179
)
 
$
2,312,552


(a)
Includes lease termination costs of $9.7 million for the Prior Period.



22

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

16. Condensed Consolidating Financial Information

In October 2011, we issued and sold the 2019 Notes with an aggregate principal amount of $650.0 million (see Note 6). In connection with the spin-off, COO transferred all of its assets, operations and liabilities, including the 2019 Notes, to SSO, which has been reflected retrospectively in the condensed consolidating financial information. Pursuant to the Indenture governing the 2019 Notes, such notes are fully and unconditionally and jointly and severally guaranteed by SSO’s parent, SSE, and all of SSO’s subsidiaries, other than SSF, which is a co-issuer of the 2019 Notes, and certain immaterial subsidiaries. Each of the subsidiary guarantors is 100% owned by SSO and there are no material subsidiaries of SSO other than the subsidiary guarantors. SSF and Western Wisconsin Sand Company, LLC are minor non-guarantor subsidiaries whose condensed consolidating financial information is included with the subsidiary guarantors. SSE and SSO have independent assets and operations. There are no significant restrictions on the ability of SSO or any subsidiary guarantor to obtain funds from its subsidiaries by dividend or loan.

Set forth below are condensed consolidating financial statements for SSE (“Parent”) and SSO (“Subsidiary Issuer”) on a stand-alone, unconsolidated basis, and their combined guarantor subsidiaries as of September 30, 2015 and December 31, 2014 and for the three and nine months ended September 30, 2015 and 2014. The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the subsidiaries operated as independent entities.
 


23

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Balance Sheet
 
September 30, 2015
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
Cash
$
78

 
$
156,141

 
$

 
$

 
$
156,219

Accounts receivable, net

 
186

 
161,873

 

 
162,059

Inventory

 

 
16,096

 

 
16,096

Deferred income tax asset

 
214

 
1,778

 

 
1,992

Prepaid expenses and other

 
35,228

 
11,613

 
(26,721
)
 
20,120

Total Current Assets
78

 
191,769

 
191,360

 
(26,721
)
 
356,486

Property and Equipment:
 
 
 
 
 
 
 
 
 
Property and equipment, at cost

 
31,446

 
2,594,598

 

 
2,626,044

Less: accumulated depreciation

 
(3,560
)
 
(1,052,998
)
 

 
(1,056,558
)
Property and equipment held for sale, net

 

 
6,600

 

 
6,600

Total Property and Equipment, Net

 
27,886

 
1,548,200

 

 
1,576,086

Other Assets:
 
 
 
 
 
 
 
 
 
Equity method investment

 

 
8,806

 

 
8,806

Goodwill

 

 
27,434

 

 
27,434

Deferred financing costs, net
5,479

 
20,659

 

 

 
26,138

Other long-term assets
724

 
107,931

 
5,807

 
(81,043
)
 
33,419

Investments in subsidiaries and intercompany advances
620,639

 
1,463,821

 

 
(2,084,460
)
 

Total Other Assets
626,842

 
1,592,411

 
42,047

 
(2,165,503
)
 
95,797

Total Assets
$
626,920

 
$
1,812,066

 
$
1,781,607

 
$
(2,192,224
)
 
$
2,028,369

Liabilities and Equity:
 
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
58

 
$
1,304

 
$
40,897

 
$

 
$
42,259

Current portion of long-term debt

 
5,000

 

 

 
5,000

Other current liabilities
6,760

 
45,010

 
115,512

 
(26,721
)
 
140,561

Total Current Liabilities
6,818

 
51,314

 
156,409

 
(26,721
)
 
187,820

Long-Term Liabilities:
 
 
 
 
 
 
 
 
 
Deferred income tax liabilities

 

 
160,390

 
(81,043
)
 
79,347

Long-term debt, excluding current maturities
450,000

 
1,139,500

 

 

 
1,589,500

Other long-term liabilities

 
613

 
987

 

 
1,600

Total Long-Term Liabilities
450,000

 
1,140,113

 
161,377

 
(81,043
)
 
1,670,447

Total Stockholders’ Equity
170,102

 
620,639

 
1,463,821

 
(2,084,460
)
 
170,102

Total Liabilities and Stockholders’ Equity
$
626,920

 
$
1,812,066

 
$
1,781,607

 
$
(2,192,224
)
 
$
2,028,369


24

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Balance Sheet
 
December 31, 2014
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
Cash
$
77

 
$
733

 
$
81

 
$

 
$
891

Accounts receivable, net

 
4

 
421,551

 

 
421,555

Inventory

 

 
25,073

 

 
25,073

Deferred income tax asset

 
2,091

 
6,029

 
(657
)
 
7,463

Prepaid expenses and other

 
5,309

 
13,763

 

 
19,072

Total Current Assets
77

 
8,137

 
466,497

 
(657
)
 
474,054

Property and Equipment:
 
 
 
 
 
 
 
 
 
Property and equipment, at cost

 
22,397

 
2,727,489

 

 
2,749,886

Less: accumulated depreciation

 
(643
)
 
(982,190
)
 

 
(982,833
)
Total Property and Equipment, Net

 
21,754

 
1,745,299

 

 
1,767,053

Other Assets:
 
 
 
 
 
 
 
 
 
Equity method investment

 

 
7,816

 

 
7,816

Goodwill

 

 
27,434

 

 
27,434

Intangible assets, net

 

 
5,420

 

 
5,420

Deferred financing costs, net
6,740

 
17,111

 

 

 
23,851

Other long-term assets

 
38,950

 
5,731

 
(37,757
)
 
6,924

Investments in subsidiaries and intercompany advances
803,383

 
1,853,480

 

 
(2,656,863
)
 

Total Other Assets
810,123

 
1,909,541

 
46,401

 
(2,694,620
)
 
71,445

Total Assets
$
810,200

 
$
1,939,432

 
$
2,258,197

 
$
(2,695,277
)
 
$
2,312,552

Liabilities and Stockholders’ Equity:
 
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$

 
$
6,579

 
$
39,078

 
$

 
$
45,657

Current portion of long-term debt

 
4,000

 

 

 
4,000

Other current liabilities
18,032

 
29,776

 
168,601

 
(657
)
 
215,752

Total Current Liabilities
18,032

 
40,355

 
207,679

 
(657
)
 
265,409

Long-Term Liabilities:
 
 
 
 
 
 
 
 
 
Deferred income tax liabilities
1,145

 

 
195,885

 
(37,757
)
 
159,273

Long-term debt, excluding current maturities
500,000

 
1,094,500

 

 

 
1,594,500

Other long-term liabilities

 
1,194

 
1,153

 

 
2,347

Total Long-Term Liabilities
501,145

 
1,095,694

 
197,038

 
(37,757
)
 
1,756,120

Total Stockholders’ Equity
291,023

 
803,383

 
1,853,480

 
(2,656,863
)
 
291,023

Total Liabilities and Stockholders’ Equity
$
810,200

 
$
1,939,432

 
$
2,258,197

 
$
(2,695,277
)
 
$
2,312,552



25

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statement of Operations
 
Three Months Ended September 30, 2015
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(in thousands)
Revenues:
 
 
 
 
 
 
 
 
 
Revenues
$

 
$
3

 
$
214,713

 
$
(1,175
)
 
$
213,541

Operating Expenses:
 
 
 
 
 
 
 
 
 
Operating costs

 

 
160,889

 

 
160,889

Depreciation and amortization

 
2,010

 
66,845

 

 
68,854

General and administrative
12

 
10,533

 
17,338

 
(1,175
)
 
26,709

Losses on sales of property and equipment, net

 

 
1,804

 

 
1,804

Impairments and other

 

 
1,566

 

 
1,566

Total Operating Expenses
12

 
12,543

 
248,442

 
(1,175
)
 
259,822

Operating Loss
(12
)
 
(12,540
)
 
(33,729
)
 

 
(46,281
)
Other (Expense) Income:
 
 
 
 
 
 
 
 
 
Interest expense
(7,583
)
 
(17,897
)
 

 

 
(25,480
)
Gains on early extinguishment of debt
4,975

 

 

 

 
4,975

Loss from equity investee

 

 
(230
)
 

 
(230
)
Other income

 
223

 
719

 

 
942

Equity in net loss of subsidiary
(47,142
)
 
(24,175
)
 

 
71,317

 

Total Other (Expense) Income
(49,750
)
 
(41,849
)
 
489

 
71,317

 
(19,793
)
Loss Before Income Taxes
(49,762
)
 
(54,389
)
 
(33,240
)
 
71,317

 
(66,074
)
Income Tax Benefit
(1,232
)
 
(7,247
)
 
(9,065
)
 

 
(17,544
)
Net Loss
$
(48,530
)
 
$
(47,142
)
 
$
(24,175
)
 
$
71,317

 
$
(48,530
)


26

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statement of Operations
 
Three Months Ended September 30, 2014
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
Revenues
$

 
$
1,264

 
$
526,754

 
$
(1,245
)
 
$
526,773

Operating Expenses:
 
 
 
 
 
 
 
 
 
Operating costs

 
1,037

 
392,344

 
(1,243
)
 
392,138

Depreciation and amortization

 
86

 
73,769

 

 
73,855

General and administrative
148

 
32,149

 
426

 

 
32,723

Losses on sales of property and equipment, net

 
6

 
448

 

 
454

Impairments and other

 

 
7,751

 

 
7,751

Total Operating Expenses
148

 
33,278

 
474,738

 
(1,243
)
 
506,921

Operating (Loss) Income
(148
)
 
(32,014
)
 
52,016

 
(2
)
 
19,852

Other (Expense) Income:
 
 
 
 
 
 
 
 
 
Interest expense
(8,358
)
 
(15,248
)
 

 

 
(23,606
)
Loss from equity investee

 

 
(347
)
 

 
(347
)
Other (expense) income

 
(284
)
 
150

 

 
(134
)
Equity in net earnings of subsidiary
2,669

 
32,387

 

 
(35,056
)
 

Total Other (Expense) Income
(5,689
)
 
16,855

 
(197
)
 
(35,056
)
 
(24,087
)
(Loss) Income Before Income Taxes
(5,837
)
 
(15,159
)
 
51,819

 
(35,058
)
 
(4,235
)
Income Tax (Benefit) Expense
(4,067
)
 
(17,829
)
 
19,432

 
(1
)
 
(2,465
)
Net (Loss) Income
$
(1,770
)
 
$
2,670

 
$
32,387

 
$
(35,057
)
 
$
(1,770
)



27

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statement of Operations
 
Nine Months Ended September 30, 2015
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(in thousands)
Revenues:
 
 
 
 
 
 
 
 
 
Revenues
$

 
$
3

 
$
941,302

 
$
(2,849
)
 
$
938,456

Operating Expenses:
 
 
 
 
 
 
 
 
 
Operating costs

 

 
731,627

 

 
731,627

Depreciation and amortization

 
2,872

 
223,907

 

 
226,779

General and administrative
39

 
36,505

 
61,741

 
(2,849
)
 
95,436

Loss on sale of a business

 
34,989

 

 

 
34,989

(Gains) losses on sales of property and equipment, net

 
(19
)
 
15,042

 

 
15,023

Impairments and other

 

 
16,720

 

 
16,720

Total Operating Expenses
39

 
74,347

 
1,049,037

 
(2,849
)
 
1,120,574

Operating Loss
(39
)
 
(74,344
)
 
(107,735
)
 

 
(182,118
)
Other (Expense) Income:
 
 
 
 
 
 
 
 
 
Interest expense
(24,134
)
 
(49,830
)
 

 

 
(73,964
)
Gains on early extinguishment of debt
18,061

 

 

 

 
18,061

Income from equity investee

 

 
877

 

 
877

Other income

 
170

 
1,719

 

 
1,889

Equity in net loss of subsidiary
(157,215
)
 
(73,895
)
 

 
231,110

 

Total Other (Expense) Income
(163,288
)
 
(123,555
)
 
2,596

 
231,110

 
(53,137
)
Loss Before Income Taxes
(163,327
)
 
(197,899
)
 
(105,139
)
 
231,110

 
(235,255
)
Income Tax Benefit
(2,527
)
 
(40,684
)
 
(31,244
)
 

 
(74,455
)
Net Loss
$
(160,800
)
 
$
(157,215
)
 
$
(73,895
)
 
$
231,110

 
$
(160,800
)


























28

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statement of Operations
 
Nine Months Ended September 30, 2014
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
Revenues
$

 
$
3,527

 
$
1,585,885

 
$
(3,464
)
 
$
1,585,948

Operating Expenses:
 
 
 
 
 
 
 
 
 
Operating costs

 
4,644

 
1,208,359

 
(4,691
)
 
1,208,312

Depreciation and amortization

 
152

 
217,997

 

 
218,149

General and administrative
148

 
44,366

 
28,463

 

 
72,977

Losses (gains) on sales of property and equipment, net

 
6

 
(7,538
)
 

 
(7,532
)
Impairments and other

 

 
30,731

 

 
30,731

Total Operating Expenses
148

 
49,168

 
1,478,012

 
(4,691
)
 
1,522,637

Operating (Loss) Income
(148
)
 
(45,641
)
 
107,873

 
1,227

 
63,311

Other (Expense) Income:
 
 
 
 
 
 
 
 
 
Interest expense
(8,810
)
 
(47,103
)
 

 

 
(55,913
)
Loss from equity investee

 

 
(5,764
)
 

 
(5,764
)
Other (expense) income

 
(136
)
 
759

 

 
623

Equity in net earnings of subsidiary
6,104

 
63,374

 

 
(69,478
)
 

Total Other (Expense) Income
(2,706
)
 
16,135

 
(5,005
)
 
(69,478
)
 
(61,054
)
(Loss) Income Before Income Taxes
(2,854
)
 
(29,506
)
 
102,868

 
(68,251
)
 
2,257

Income Tax (Benefit) Expense
(4,238
)
 
(34,849
)
 
39,494

 
466

 
873

Net Income
$
1,384

 
$
5,343

 
$
63,374

 
$
(68,717
)
 
$
1,384




29

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statements of Cash Flows
 
Nine Months Ended September 30, 2015
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Cash Flows From Operating Activities:
$
(34,101
)
 
$
179,172

 
$
437,550

 
$
(318,959
)
 
$
263,662

Cash Flows From Investing Activities:
 
 
 
 
 
 
 
 
 
Additions to property and equipment

 
(11,060
)
 
(140,739
)
 

 
(151,799
)
Proceeds from sales of assets

 
(172
)
 
18,745

 

 
18,573

Proceeds from sale of a business

 
15,000

 

 

 
15,000

Additions to investments

 

 
(112
)
 

 
(112
)
Distributions from affiliates
65,407

 

 

 
(65,407
)
 

Other

 

 
3,434

 

 
3,434

Net cash provided by (used in) investing activities
65,407

 
3,768

 
(118,672
)
 
(65,407
)
 
(114,904
)
Cash Flows From Financing Activities:
 
 
 
 
 
 
 
 
 
Borrowings from revolving credit facility

 
160,100

 

 

 
160,100

Payments on revolving credit facility

 
(210,600
)
 

 

 
(210,600
)
Payments to extinguish senior notes
(31,305
)
 

 

 

 
(31,305
)
Proceeds from issuance of term loan, net of issuance costs

 
94,481

 

 

 
94,481

Payments on term loan

 
(3,500
)
 

 

 
(3,500
)
Deferred financing costs

 
(784
)
 

 

 
(784
)
Distributions to affiliates

 
(65,407
)
 
(318,959
)
 
384,366

 

Other

 
(1,822
)
 

 

 
(1,822
)
Net cash (used in) provided by financing activities
(31,305
)
 
(27,532
)
 
(318,959
)
 
384,366

 
6,570

Net increase (decrease) in cash
1

 
155,408

 
(81
)
 

 
155,328

Cash, beginning of period
77

 
733

 
81

 

 
891

Cash, end of period
$
78

 
$
156,141

 
$

 
$

 
$
156,219



30

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Consolidating Statements of Cash Flows
 
Nine Months Ended September 30, 2014
 
Parent
 
Subsidiary Issuer
 
Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
(In thousands)
Cash Flows From Operating Activities:
$
60,339

 
$
(14,288
)
 
$
207,622

 
$
(101,627
)
 
$
152,046

Cash Flows From Investing Activities:
 
 
 
 
 
 
 
 
 
Additions to property and equipment

 
(9,351
)
 
(304,090
)
 

 
(313,441
)
Proceeds from sale of assets

 

 
68,537

 

 
68,537

Additions to investment

 

 
(213
)
 

 
(213
)
Contributions to affiliates
(127,999
)
 
(70,422
)
 

 
198,421

 

Other

 

 
63

 

 
63

Net cash used in investing activities
(127,999
)
 
(79,773
)
 
(235,703
)
 
198,421

 
(245,054
)
Cash Flows From Financing Activities:
 
 
 
 
 
 
 
 
 
Borrowings from revolving credit facility

 
930,900

 

 

 
930,900

Payments on revolving credit facility

 
(1,292,300
)
 

 

 
(1,292,300
)
Proceeds from issuance of senior notes, net of offering costs
493,825

 

 

 

 
493,825

Proceeds from issuance of term loan, net of offering costs

 
393,879

 

 

 
393,879

Payment of term loans

 
(1,000
)
 

 

 
(1,000
)
Deferred financing costs
(981
)
 
(2,565
)
 

 

 
(3,546
)
Distributions to CHK
(421,920
)
 

 

 

 
(421,920
)
Contributions from affiliates

 
68,691

 
28,103

 
(96,794
)
 

Other
(3,175
)
 

 

 

 
(3,175
)
Net cash provided by financing activities
67,749

 
97,605

 
28,103

 
(96,794
)
 
96,663

Net increase in cash
89

 
3,544

 
22

 

 
3,655

Cash, beginning of period

 
1,615

 
63

 

 
1,678

Cash, end of period
$
89

 
$
5,159

 
$
85

 
$

 
$
5,333



31

SEVENTY SEVEN ENERGY INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

17. Recently Issued Accounting Standards

In August 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-15, “Interest—Imputation of Interest,” which allows for line-of-credit arrangements to be handled consistently with ASU 2015-03. ASU 2015-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.  In August 2015, the FASB deferred the effective date of ASU No. 2014-09 to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and allows for early adoption for annual reporting periods beginning after December 15, 2016. We are currently evaluating what impact this standard will have on our consolidated financial statements. 

In July 2015, the FASB issued Accounting Standards Update (“ASU”) No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” which changes inventory measured using any method other than LIFO or the retail inventory method (for example, inventory measured using first-in, first-out (FIFO) or average cost) at the lower of cost and net realizable value. ASU 2015-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

In April 2015, the FASB issued Accounting Standards Update (“ASU”) No. 2015-03, “Interest—Imputation of Interest,” which simplifies the presentation of debt issuance costs by requiring debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with debt discounts. ASU 2015-03 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements—Going Concern,” which requires management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). ASU 2014-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early application permitted. We are currently evaluating what impact this standard will have on our consolidated financial statements.


32




Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations relates to the three and nine months ended September 30, 2015 (the “Current Quarter” and “Current Period,” respectively), the three and nine months ended September 30, 2014 (the “Prior Quarter” and “Prior Period,” respectively), and the three months ended June 30, 2015 (the “Previous Quarter”) and should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this quarterly report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2014.

Comparability of Historical Results

The historical results discussed in this section prior to June 30, 2014 are those of COO, which is our predecessor. The transactions in which SSE became an independent, publicly traded company, including the distribution of our common stock on June 30, 2014, are referred to collectively as the “spin-off”. The historical results discussed in this section prior to the spin-off do not purport to reflect what the results of operations, financial position, equity or cash flows would have been had we operated as an independent public company prior to June 30, 2014 and do not give effect to certain spin-off transactions on our consolidated statements of operations. For a detailed description of the transactions completed and agreements entered into as part of the spin-off, please read Note 1 to our consolidated financial statements contained in our Annual Report on Form 10-K.

Overview

We are a diversified oilfield services company providing a wide range of wellsite services to U.S. land-based E&P customers. We offer services and equipment that are strategic to our customers’ oil and natural gas operations. We conduct our business through three operating segments: Drilling, Hydraulic Fracturing and Oilfield Rentals. Our operations are geographically diversified across many of the most active oil and natural gas plays in the onshore United States, including the Anadarko and Permian Basins and the Eagle Ford, Haynesville, Marcellus, Niobrara and Utica Shales.

Since we commenced operations in 2001, we have actively grown our business and modernized our asset base. As of September 30, 2015, our marketed rig fleet of 92 rigs consisted of 32 Tier 1 rigs (including 21 proprietary PeakeRigs™), 57 Tier 2 rigs and three Tier 3 rigs. As of September 30, 2015, we also owned 10 hydraulic fracturing fleets with an aggregate of 400,000 horsepower and a diversified oilfield rentals business. We continue to modernize our asset base and are currently building five additional PeakeRigs™. For additional information regarding our business and strategies, please read “Business” in Item 1 of our Annual Report on Form 10-K.

Cyclical Nature of Industry

We operate in a highly cyclical industry. The main factor influencing demand for oilfield services is the level of drilling and completions activity by E&P companies, which in turn depends largely on current and anticipated future crude oil and natural gas prices and production depletion rates. The most critical factors in assessing the outlook for the industry are the worldwide supply and demand for oil and the domestic supply and demand for natural gas. Demand for oil and natural gas is cyclical and is subject to large and rapid fluctuations. When oil and natural gas price increases occur, producers increase their capital expenditures, which generally results in greater revenues and profits for oilfield service companies. The increased capital expenditures also ultimately result in greater production, which historically has resulted in increased supply and reduced prices that, in turn, tends to reduce demand for oilfield services. For these reasons, our results of operations may fluctuate from quarter-to-quarter and from year-to-year.

The recent decline in commodity prices has reduced the level of United States drilling and completion activity and, consequently, the demand for our services. Since mid-2014, NYMEX WTI oil prices have declined by more than 50% to their lowest levels since 2009, as global production growth led by unconventional resource development onshore in the United States outpaced demand. In addition, NYMEX natural gas prices have fallen from multi-year highs in early 2014 as sustained production growth has outpaced domestic demand. We believe our modern, high-quality asset base, diversified footprint, strong relationship with CHK and contractual backlog will partially offset the consequences of decreasing drilling and completions activity levels; however, we expect reduced equipment utilization and pricing across each of our operating segments until there is a sustained recovery in commodity prices. The extent and length of the current down cycle is uncertain. If it is prolonged or worsens, it would likely have a material adverse impact on our business, financial condition, results of operations, and cash flows.
 

33




Backlog

We maintain a backlog of contract revenues under our contracts for the provision of drilling and hydraulic fracturing services. Our drilling and hydraulic fracturing backlogs as of September 30, 2015 were approximately $505.3 million and $387.6 million, respectively, with average durations of 16 months and 14 months, respectively. We calculate our drilling backlog by multiplying the day rate under our contracts by the number of days remaining under the contract. We calculate our hydraulic fracturing backlog by multiplying the (i) rate per stage, which varies by operating region and is, therefore, estimated based on current customer activity levels by region and current contract pricing, by (ii) the number of stages remaining under the contract, which we estimate based on current and anticipated utilization of our crews. With respect to our hydraulic fracturing backlog, our contracts provide for periodic adjustments of the rates we may charge for our services, which will be negotiated based on then-prevailing market pricing and in the future may be higher or lower than the current rates we charge and utilize in calculating our backlog. Our drilling backlog calculation does not include any reduction in revenues related to mobilization or demobilization, nor does it include potential reductions in rates for unscheduled standby or during periods in which the rig is moving, on standby or incurring maintenance and repair time in excess of what is permitted under the drilling contract. In addition, many of our drilling contracts are subject to termination by the customer on short notice and provide for an early termination payment to us in the event that the contract is terminated by the customer. We calculate our contract drilling early termination value assuming each rig remains stacked for the remainder of the term of the terminated contract. As a result of the foregoing, revenues could differ materially from the backlog and early termination amounts presented.

As of September 30, 2015, we expect to recognize revenues from backlog as follows (in millions): 
 
2015
 
2016
 
Thereafter
Backlog
$
124.9

 
$
473.4

 
$
294.6


As of September 30, 2015, our total contract early termination value related to our drilling backlog was as follows (in millions):
 
2015
 
2016
 
Thereafter
Drilling contract early termination value
$
50.0

 
$
162.4

 
$
83.9

 
How We Evaluate Our Operations

Our management team uses a variety of tools to monitor and manage our operations in the following eight areas: (a) segment gross margin, (b) equipment maintenance performance, (c) customer satisfaction, (d) asset utilization, (e) safety performance, (f) Adjusted EBITDA, (g) Adjusted Revenues and (h) Adjusted Operating Costs.

Segment Gross Margin. We define segment gross margin as segment revenues less segment operating costs, excluding depreciation and amortization, general and administrative expenses, net gains or losses on sales of property and equipment and impairments and other. We view segment gross margin as one of our key management tools for managing costs at the segment level and evaluating segment performance. Our management tracks segment gross margin both as an absolute amount and as a percentage of revenues compared to prior periods.

Equipment Maintenance Performance. Equipment reliability (“uptime”) is an important factor to the success of our business. Uptime is beneficially impacted through preventive maintenance on our equipment. We have formal preventive maintenance procedures which are regularly monitored for compliance. Further, management monitors maintenance expenses as a percentage of revenue. This metric provides a leading indicator with respect to the execution of preventive maintenance and ensures that equipment reliability issues do not negatively impact operational uptime.

Customer Satisfaction. Upon completion of many of our services, we encourage our customers to provide feedback on the services provided. The evaluation of our performance is based on various criteria and our customer comments are indicative of their overall satisfaction level. This feedback provides us with the necessary information to reinforce positive performance and remedy negative issues and trends.
 
Asset Utilization. By consistently monitoring our operations’ activity levels, pricing and relative performance of each of our rigs and fleets, we can more efficiently allocate our personnel and equipment to maximize revenue generation. We measure our activity levels by the total number of jobs completed by each of our drilling rigs and hydraulic fracturing fleets on a

34




periodic basis. We also monitor the utilization rates of our drilling rigs. We define utilization of our drilling rigs as the number of rigs that have operated in the past 30 days divided by the number of rigs that have operated in the last 90 days.

Safety Performance.  Maintaining a safe and incident free workplace is a critical component of our operational success. Our management team uses both lagging and leading indicators to measure and manage safety performance. Total Recordable Incident Rate (“TRIR”), Lost Time Incident Rate (“LTIR”) and Motor Vehicle Crash Rate (“MVCR”) are key lagging indicators reviewed by management. We also review leading indicators such as safety observations, training completion, and action item completion to enhance our view of safety performance. Safety performance data is reported, tracked, and trended in a centralized database, which allows us to efficiently focus our incident prevention efforts.

Adjusted EBITDA. The primary financial and operating measurement that our management uses to analyze and monitor the operating performance of our business is Adjusted EBITDA, which we define as net income before interest expense, income tax expense, depreciation and amortization, as further adjusted to add back non-cash stock compensation, impairments and other, gain or loss on sale of property and equipment, rig rent expense and certain non-recurring items, such as the sale of our drilling rig relocation and logistics business, the distribution of our compression manufacturing and geosteering businesses to CHK and the sale of our crude and water hauling assets. The table below shows our Adjusted EBITDA for the three and nine months ended September 30, 2015 and 2014 and the three months ended June 30, 2015.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Adjusted EBITDA:
 
 
 
 
 
 
 
 
 
Consolidated
$
41,059

 
$
129,042

 
$
44,321

 
$
178,723

 
$
327,544

Drilling
$
33,911

 
$
82,362

 
$
38,342

 
$
136,262

 
$
213,575

Hydraulic Fracturing
$
8,229

 
$
54,504

 
$
18,206

 
$
52,695

 
$
118,322

Oilfield Rentals
$
(857
)
 
$
13,691

 
$
(4,102
)
 
$
2,835

 
$
37,511


Adjusted Revenues and Adjusted Operating Costs. Key financial and operating measurements that our management uses to analyze and monitor our period-over-period operating performance are “Adjusted Revenues” and “Adjusted Operating Costs”, which we define as revenues and operating costs before revenues and operating costs associated with our rig relocation and logistics business and water hauling assets that were sold in the Current Period, our compression unit manufacturing business and geosteering businesses that were distributed to CHK and our crude hauling assets that were sold to a third party as part of the spin-off. Adjusted operating costs are further adjusted to subtract rig rent expense and remove the non-recurring portion of expense related to unvested restricted stock that was cancelled and reissued as part of the spin-off.

Non-GAAP Financial Measures

“Adjusted EBITDA”, “Adjusted Revenues” and “Adjusted Operating Costs” are non-GAAP financial measures. Adjusted EBITDA, adjusted revenues and adjusted operating costs as used and defined by us, may not be comparable to similarly titled measures employed by other companies and are not measures of performance calculated in accordance with generally accepted accounting principles (“GAAP”).

Adjusted Revenues and Adjusted Operating Costs should not be considered in isolation or as a substitute for revenues and operating costs, respectively, prepared in accordance with GAAP. However, our management uses Adjusted Revenues and Adjusted Operating Costs to evaluate our period-over-period operating performance because our management believes these measures improve the comparability of our continuing business and for the same reasons believes these measures may be useful to an investor in evaluating our operating performance. A reconciliation of Adjusted Revenues and Adjusted Operating Costs to the GAAP measures of revenues and operating costs, respectively, is provided below in “—Results of Operations” for each period discussed.

Adjusted EBITDA should not be considered in isolation or as a substitute for operating income, net income or loss, cash flows provided by operating, investing and financing activities, or other income or cash flow statement data prepared in accordance with GAAP. However, our management uses Adjusted EBITDA to evaluate our performance and liquidity and believes Adjusted EBITDA may be useful to an investor in evaluating our operating performance and liquidity because this measure:

35





is widely used by investors in the oilfield services industry to measure a company’s operating performance without regard to items excluded from the calculation of such measure, which can vary substantially from company to company depending upon accounting methods, book value of assets, capital structure and the method by which assets were acquired, among other factors;

is a financial measurement that is used by rating agencies, lenders and other parties to evaluate our creditworthiness; and

is used by our management for various purposes, including as a measure of performance of our operating entities and as a basis for strategic planning and forecasting.

There are significant limitations to using Adjusted EBITDA as a measure of performance, including the inability to analyze the effect of certain recurring and non-recurring items that materially affect our net income or loss. Additionally, because Adjusted EBITDA excludes some, but not all, items that affect net income and is defined differently by different companies in our industry, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.

On a consolidated basis, the following tables present a reconciliation of Adjusted EBITDA to the GAAP financial measures of net loss and cash provided by operating activities. The following tables also present a reconciliation of Adjusted EBITDA to the GAAP financial measure of net income or loss for each of our operating segments.

36





Consolidated
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Net (loss) income
$
(48,530
)
 
$
(1,770
)
 
$
(74,670
)
 
$
(160,800
)
 
$
1,384

Add:
 
 
 
 
 
 
 
 
 
Interest expense
25,480

 
23,606

 
24,968

 
73,964

 
55,913

Gains on extinguishment of debt
(4,975
)
 

 
(13,085
)
 
(18,061
)
 

Income tax (benefit) expense
(17,544
)
 
(2,465
)
 
(40,679
)
 
(74,455
)
 
873

Depreciation and amortization
68,854

 
73,855

 
72,950

 
226,779

 
218,149

Loss on sale of a business and exit costs
1,355

 

 
34,989

 
36,344

 

Losses (gains) on sales of property and equipment, net
1,804

 
454

 
9,010

 
15,023

 
(7,532
)
Impairments and other
1,566

 
7,751

 
8,882

 
16,720

 
30,731

Impairment of equity method investment

 

 

 

 
4,500

Non-cash compensation
12,160

 
27,763

 
13,131

 
43,646

 
27,763

Severance-related costs
1,517

 
361

 
3,102

 
6,023

 
651

Rent expense on buildings and real estate transferred from CHK(a)

 

 

 

 
8,187

Rig rent expense(b)

 
3,608

 

 

 
18,683

Interest income
(628
)
 

 
(108
)
 
(736
)
 

Less:
 
 
 
 
 
 
 
 
 
Drilling rig relocation and logistics Adjusted EBITDA

 
4,898

 
(5,886
)
 
(9,745
)
 
13,115

Water hauling Adjusted EBITDA

 
(777
)
 
55

 
(4,531
)
 
(851
)
Geosteering Adjusted EBITDA



 




957

Crude hauling Adjusted EBITDA

 

 

 

 
(5,066
)
Compression unit manufacturing Adjusted EBITDA

 

 



 
13,073

Non-recurring credit to share-based compensation expense(c)

 

 

 

 
10,530

Adjusted EBITDA
$
41,059

 
$
129,042

 
$
44,321

 
$
178,723

 
$
327,544


(a)
Rent on buildings and real estate transferred from CHK as part of the spin-off is included in operating costs and general and administrative expenses on the condensed consolidated statements of operations included in Item 1 of this report. Our operating costs include $8.0 million of rent expense associated with our lease of these facilities for the Prior Period. Our general and administrative expenses include $0.2 million of rent expense associated with our lease of these facilities for the Prior Period.
(b)
Rig rent expense associated with our lease of drilling rigs is included in operating costs on the condensed consolidated statements of operations included in Item 1 of this report. As of December 31, 2014, we had repurchased all of our leased drilling rigs.
(c)
We recorded a non-recurring credit to operating costs and general and administrative expenses during the second quarter of 2014 as a result of the cancellation and reissuance of unvested restricted stock awards related to the spin-off.

37




 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Cash provided by operating activities
$
103,984

 
$
30,113

 
$
132,164

 
$
263,662

 
$
152,046

Add:
 
 
 
 
 
 
 
 
 
Changes in operating assets and liabilities
(89,828
)
 
74,976

 
(121,471
)
 
(176,197
)
 
115,130

Interest expense
25,480

 
23,606

 
24,968

 
73,964

 
55,913

Lease termination costs

 
1,253

 

 

 
9,701

Amortization of sale/leaseback gains

 
262

 

 

 
5,401

Amortization of deferred financing costs
(1,246
)
 
(1,076
)
 
(1,107
)
 
(3,381
)
 
(5,048
)
(Loss) income from equity investees
(230
)
 
(347
)
 
136

 
877

 
(1,264
)
Provision for doubtful accounts
654

 
(947
)
 
(4
)
 
(1,930
)
 
(2,062
)
Current tax expense

 
1,374

 

 

 
2,070

Exit costs of Former Oilfield Trucking
1,355

 

 

 
1,355

 

Severance-related costs
1,517

 
361

 
3,102

 
6,023

 
651

Rent expense on buildings and real estate transferred from CHK(a)

 

 

 

 
8,187

Rig rent expense(b)

 
3,608

 

 

 
18,683

Interest income
(628
)
 

 
(108
)
 
(736
)
 

Other

 
(18
)
 
810

 
810

 
(106
)
Less:
 
 
 
 
 
 
 
 
 
Drilling rig relocation and logistics Adjusted EBITDA

 
4,898

 
(5,886
)
 
(9,745
)
 
13,115

Water hauling Adjusted EBITDA

 
(777
)
 
55

 
(4,531
)
 
(851
)
Geosteering Adjusted EBITDA

 

 

 

 
957

Crude hauling Adjusted EBITDA

 

 

 

 
(5,066
)
Compression unit manufacturing Adjusted EBITDA

 

 

 

 
13,073

Non-recurring credit to share-based compensation expense(c)

 

 

 

 
10,530

Adjusted EBITDA
$
41,059

 
$
129,042

 
$
44,321

 
$
178,723

 
$
327,544


(a)
Rent on buildings and real estate transferred from CHK as part of the spin-off is included in operating costs and general and administrative expenses on the condensed consolidated statements of operations included in Item 1 of this report. Our operating costs include $8.0 million of rent expense associated with our lease of these facilities for the Prior Period. Our general and administrative expenses include $0.2 million of rent expense associated with our lease of these facilities for the Prior Period.
(b)
Rig rent expense associated with our lease of drilling rigs is included in operating costs on the condensed consolidated statements of operations included in Item 1 of this report. As of December 31, 2014, we had repurchased all of our leased drilling rigs.
(c)
We recorded a non-recurring credit to operating costs and general and administrative expenses during the second quarter of 2014 as a result of the cancellation and reissuance of unvested restricted stock awards related to the spin-off.


38




Drilling
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Net (loss) income
$
(6,392
)
 
$
15,146

 
$
(9,689
)
 
$
(15,710
)
 
$
22,328

Add:
 
 
 
 
 
 
 
 
 
Income tax (benefit) expense
(2,311
)
 
9,088

 
(5,279
)
 
(7,274
)
 
13,700

Depreciation and amortization
38,197

 
36,062

 
38,202

 
125,936

 
105,362

Losses on sales of property and equipment, net
1,952

 
331

 
3,564

 
9,903

 
16,126

Impairments and other

 
6,796

 
8,688

 
12,417

 
29,569

Non-cash compensation
2,273

 
11,331

 
2,344

 
9,942

 
11,331

Severance-related costs
192

 

 
512

 
1,048

 
63

Rent expense on buildings and real estate transferred from CHK

 

 

 

 
1,688

Rig rent expense

 
3,608

 

 

 
18,683

Less:
 
 
 
 
 
 
 
 
 
Geosteering Adjusted EBITDA

 

 

 

 
957

Non-recurring credit to share-based compensation expense

 

 

 

 
4,318

Adjusted EBITDA
$
33,911

 
$
82,362

 
$
38,342

 
$
136,262

 
$
213,575


Hydraulic Fracturing
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Net (loss) income
$
(7,973
)
 
$
21,173

 
$
(457
)
 
$
(1,977
)
 
$
35,490

Add:
 
 
 
 
 
 
 
 
 
Income tax (benefit) expense
(2,882
)
 
13,904

 
(248
)
 
(916
)
 
21,956

Depreciation and amortization
17,833

 
17,524

 
17,804

 
51,915

 
53,484

Losses (gains) on sales of property and equipment, net
172

 
(19
)
 
4

 
171

 
(19
)
Impairments and other

 

 

 

 
207

Impairment of equity method investment

 

 

 

 
4,500

Non-cash compensation
952

 
1,922

 
1,043

 
3,234

 
1,922

Severance-related costs
127

 

 
60

 
268

 

Rent expense on buildings and real estate transferred from CHK

 

 

 

 
1,259

Less:
 
 
 
 
 
 
 
 
 
Non-recurring credit to share-based compensation expense

 

 

 

 
477

Adjusted EBITDA
$
8,229

 
$
54,504

 
$
18,206

 
$
52,695

 
$
118,322



39




Oilfield Rentals
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
June 30,
 
September 30,
 
2015
 
2014
 
2015
 
2015
 
2014
 
(In thousands)
Net loss
$
(7,365
)
 
$
(686
)
 
$
(9,682
)
 
$
(20,511
)
 
$
(2,481
)
Add:
 
 
 
 
 
 
 
 
 
Income tax benefit
(2,663
)
 
(411
)
 
(5,275
)
 
(9,497
)
 
(1,424
)
Depreciation and amortization
8,912

 
12,812

 
10,575

 
31,659

 
39,527

Gains on sales of property and equipment, net
(329
)
 
(771
)
 
(277
)
 
(777
)
 
(1,696
)
Impairments

 
955

 

 

 
955

Non-cash compensation
483

 
1,792

 
523

 
1,868

 
1,792

Severance-related costs
105

 

 
34

 
93

 
24

Rent expense on buildings and real estate transferred from CHK

 

 

 

 
1,415

Less:
 
 
 
 
 
 
 
 
 
Non-recurring credit to share-based compensation expense

 

 

 

 
601

Adjusted EBITDA
$
(857
)
 
$
13,691

 
$
(4,102
)
 
$
2,835

 
$
37,511


Liquidity and Capital Resources

We require capital to fund ongoing operations, including operating expenses, organic growth initiatives, investments, acquisitions and debt service. We expect our future capital needs will be funded by cash flows from operations, borrowings under our Credit Facility, access to capital markets and other financing transactions. We believe we will have adequate liquidity over the next twelve months to operate our business and meet our cash requirements.

As of September 30, 2015, we had cash of $156.2 million and working capital of $168.7 million. As of December 31, 2014, we had cash of $0.9 million and working capital of $208.6 million. As of October 23, 2015, we had cash of $126.8 million.

Long-Term Debt

The following table presents our long-term debt as of September 30, 2015 and December 31, 2014:

 
September 30,
2015
 
December 31, 2014
 
(in thousands)
6.625% Senior Notes due 2019
$
650,000

 
$
650,000

6.50% Senior Notes due 2022
450,000

 
500,000

Term Loans
494,500

 
398,000

Credit Facility

 
50,500

Total debt
1,594,500

 
1,598,500

Less: Current portion of long-term debt
5,000

 
4,000

Total long-term debt
$
1,589,500

 
$
1,594,500


During the Previous Quarter, we entered into an incremental $100.0 million junior lien financing under the Incremental Term Loan and received net proceeds of $94.5 million.


40




During the Current Period, we repurchased and cancelled $50.0 million in aggregate principal amount of the 2022 Notes in multiple transactions for $31.3 million. We recognized gains on extinguishment of debt of $18.1 million, which included the accelerated amortization of deferred financing costs of $0.6 million.

As of September 30, 2015, we had no outstanding borrowings under our revolving bank credit facility, letters of credit of $10.2 million, and availability of $152.7 million.

For further information on our long-term debt, please read Note 6 to our condensed consolidated financial statements included Item 1 of this report.

Capital Expenditures

Our business is capital-intensive, requiring significant investment to maintain, upgrade and purchase equipment to meet our customers’ needs and industry demand. Prior to 2015, our capital requirements consisted primarily of:

growth capital expenditures, which are defined as capital expenditures made to acquire additional equipment and other assets, increase our service lines, expand geographically or advance other strategic initiatives for the purpose of growing our business;
maintenance capital expenditures, which are defined as capital expenditures that are necessary to maintain the service capability of our existing assets and include the replacement of components and equipment which are worn or obsolete; and
the purchase of leased drilling rigs.
Our capital requirements in 2015 will consist of growth capital expenditures and maintenance capital expenditures.
Total capital expenditures were $151.8 million and $313.4 million for the Current Period and Prior Period, respectively. During the Prior Period, we purchased 33 of our leased drilling rigs for approximately $134.0 million. We currently expect our total capital expenditures to be under $200.0 million for 2015. We may increase, decrease or reallocate our anticipated capital expenditures during any period based on industry conditions, the availability of capital or other factors, and a significant component of our anticipated capital spending is discretionary. In addition, from time to time we may use cash on hand in excess of our budgeted capital expenditures to repurchase and cancel our outstanding long-term debt or our common stock, subject to approval by our Board of Directors.

Cash Flow

Our cash flow depends in large part on the level of spending by our customers on exploration, development and production activities. Sustained increases or decreases in the price of oil or natural gas could have a material impact on these activities, thus materially affecting our cash flows. The following is a discussion of our cash flow for the Current Period and Prior Period. 
 
Nine Months Ended September 30,
 
2015
 
2014
 
(Unaudited)
(In thousands)
Cash Flow Statement Data:
 
 
 
Net cash provided by operating activities
$
263,662

 
$
152,046

Net cash used in investing activities
$
(114,904
)
 
$
(245,054
)
Net cash provided by financing activities
$
6,570

 
$
96,663

Cash, beginning of period
$
891

 
$
1,678

Cash, end of period
$
156,219

 
$
5,333


Operating Activities. Cash provided by operating activities was $263.7 million and $152.0 million for the Current Period and Prior Period, respectively. Changes in working capital items increased cash provided by operating activities by $176.2 million for the Current Period and decreased cash provided by operating activities by $115.1 million for the Prior Period. During the Current Period, the increase in cash provided by operating activities due to changes in working capital items was impacted by the timing of collection of accounts receivable and the decline in overall operational activity. Factors affecting

41




changes in operating cash flows are largely the same as those that affect net income, with the exception of non-cash expenses such as depreciation and amortization, amortization of sale-leaseback gains, gains or losses on sales of property and equipment, impairments, non-cash compensation, income or losses from equity investees and deferred income taxes.

Investing Activities. Cash used in investing activities was $114.9 million and $245.1 million for the Current Period and Prior Period, respectively. Capital expenditures are the main component of our investing activities. The majority of our capital expenditures for the Current Period and Prior Period were related to our investment in new PeakeRigs™ and the purchase of certain leased drilling rigs. We purchased 33 leased drilling rigs for approximately $134.0 million during the Prior Period. Cash used in investing activities was partially offset by proceeds from the sale of Hodges of $15.0 million during the Current Period and proceeds from asset sales in the amounts of $18.6 million and $68.5 million for the Current Period and Prior Period, respectively.

Financing Activities. Net cash provided by financing activities was $6.6 million and $96.7 million for the Current Period and Prior Period, respectively. We had borrowings and repayments under our credit facility of $160.1 million and $210.6 million, respectively, during the Current Period, and $930.9 million and $1,292.3 million, respectively, during the Prior Period. We paid deferred borrowing costs of $0.8 million and $3.5 million during the Current Period and Prior Period, respectively. During the Current Period, we borrowed $100.0 million under the Incremental Term Loan and received net proceeds of $94.5 million. We also repurchased and cancelled $50.0 million in aggregate principal amount of the 2022 Notes in multiple transactions for $31.3 million during the Current Period. During the Prior Period, we (i) entered into a $400.0 million seven-year term loan credit agreement and received net proceeds of $393.9 million, which we used to repay and terminate an existing credit facility in connection with the spin-off, and (ii) we issued $500.0 million in aggregate principal amount of 6.50% Senior Notes due 2022 and used the net proceeds of $493.8 million from the 2022 Notes issuance to make a distribution of approximately $391.0 million to Chesapeake and for general corporate purposes. We made term loan repayments of $3.5 million and $1.0 million during the Current Period and Prior Period, respectively.

42




Results of Operations

Results of Operations—Three Months Ended September 30, 2015 vs. June 30, 2015

The following table sets forth our condensed consolidated statements of operations for the Current Quarter and Previous Quarter.
 
 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
 
(In thousands)
Revenues:
 
 
 
Revenues
$
213,541

 
$
295,128

Operating Expenses:
 
 
 
Operating costs
160,889

 
239,127

Depreciation and amortization
68,854

 
72,950

General and administrative
26,709

 
34,815

Loss on sale of a business

 
34,989

Losses on sales of property and equipment, net
1,804

 
9,010

Impairments and other
1,566

 
8,882

Total Operating Expenses
259,822

 
399,773

Operating Loss
(46,281
)
 
(104,645
)
Other (Expense) Income:
 
 
 
Interest expense
(25,480
)
 
(24,968
)
Gains on extinguishment of debt
4,975

 
13,085

(Loss) income from equity investee
(230
)
 
136

Other income
942

 
1,043

Total Other Expense
(19,793
)
 
(10,704
)
Loss Before Income Taxes
(66,074
)
 
(115,349
)
Income Tax Benefit
(17,544
)
 
(40,679
)
Net Loss
$
(48,530
)
 
$
(74,670
)


43




Revenues. Revenues and Adjusted Revenues for the Current Quarter decreased $81.6 million and $68.1 million, respectively, from the Previous Quarter due to decreased utilization, increased number of rigs under contract being idled and increased pricing pressure during the Current Quarter. The majority of our revenues have historically been derived from CHK and its working interest partners. The percentage of our revenues derived from CHK was 64% and 69% for the Current Quarter and the Previous Quarter, respectively.

 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
Revenue:
(In thousands)
Drilling
$
80,348

 
$
100,444

Hydraulic fracturing
118,137

 
163,411

Oilfield rentals
15,047

 
17,762

Former oilfield trucking

 
13,511

Other operations
9

 

Total
$
213,541

 
$
295,128

 
 
 
 
Adjusted Revenue(a):
 
 
 
Revenue
$
213,541

 
$
295,128

Less:
 
 
 
Drilling rig relocation and logistics revenues

 
10,578

Water hauling revenues

 
2,933

Adjusted Revenue
$
213,541

 
$
281,617


(a)
“Adjusted Revenue” is a non-GAAP financial measure of revenues that excludes revenues associated with the drilling rig relocation and logistics business and water hauling assets sold during the Previous Quarter. For a description of our calculation of adjusted revenues and the reasons why our management uses this measure to evaluate our business, please read “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

44





Operating Costs. Operating costs and Adjusted Operating Costs for the Current Quarter decreased $78.2 million and $59.9 million, respectively, from the Previous Quarter primarily due to a decrease in labor-related costs and a decrease in product costs in our hydraulic fracturing segment. As a percentage of adjusted revenues, adjusted operating costs were 75% and 78% for the Current Quarter and Previous Quarter, respectively. The decrease was due to declines in labor-related costs partially offset by increases in repairs and maintenance.

 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
Operating Costs:
(In thousands)
Drilling
$
41,387

 
$
57,148

Hydraulic fracturing
103,941

 
141,225

Oilfield rentals
14,037

 
20,224

Former oilfield trucking

 
18,382

Other operations
1,524

 
2,148

Total
$
160,889

 
$
239,127

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating Costs
$
160,889

 
$
239,127

Less:
 
 
 
Drilling rig relocation and logistics operating costs

 
15,596

Water hauling operating costs

 
2,786

Adjusted Operating Costs
$
160,889

 
$
220,745


(a)
“Adjusted Operating Costs” is a non-GAAP financial measure of operating costs that excludes operating costs associated with the drilling rig relocation and logistics business and water hauling assets sold during the Previous Quarter. For a description of our calculation of adjusted operating costs and the reasons why our management uses this measure to evaluate our business, please read “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

Drilling
 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
 
(In thousands)
Revenues
$
80,348

 
$
100,444

Operating costs
41,387

 
57,148

Gross margin
$
38,961

 
$
43,296


Drilling revenues for the Current Quarter decreased $20.1 million, or 20%, from the Previous Quarter. This decrease was primarily due to a 21% decline in revenue days. Average revenue per revenue day decreased 6% due to an increase in the number of rigs generating idle contract fees in the Current Quarter. Revenues from non-CHK customers increased to 42% of total segment revenues in the Current Quarter, comparing favorably to 36% for the Previous Quarter.

Drilling operating costs for the Current Quarter decreased $15.8 million, or 28%, from the Previous Quarter, primarily due to decreases in labor-related costs. Average operating costs per revenue day in the Current Quarter decreased 11% from the Previous Quarter, primarily due to a decrease in labor-related costs. As a percentage of drilling revenues, drilling operating costs were 52% and 57% for the Current Quarter and the Previous Quarter, respectively. The decrease was due to declines in labor-related costs partially offset by increases in repairs and maintenance expenses.


45




Hydraulic Fracturing
 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
 
(In thousands)
Revenues
$
118,137

 
$
163,411

Operating costs
103,941

 
141,225

Gross margin
$
14,196

 
$
22,186


Hydraulic fracturing revenues for the Current Quarter decreased $45.3 million, or 28%, from the Previous Quarter. This decrease was due to a 11% decline in revenues per stage and a 19% decline in stages completed during the Current Quarter. Revenues from non-CHK customers increased to 27% of total segment revenues in the Current Quarter, comparing favorably to 21% for the Previous Quarter.

Hydraulic fracturing operating costs for the Current Quarter decreased $37.3 million, or 26% from the Previous Quarter, primarily due to an 11% decrease in product costs per stage, which is the result of reducing proppant and fracturing fluid costs by leveraging our logistics infrastructure competitive advantage. As a percentage of hydraulic fracturing revenues, hydraulic fracturing operating costs were 88% and 86% for Current Quarter and Previous Quarter, respectively. The increase was due to increases in repairs and maintenance.

Oilfield Rentals
 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
 
(In thousands)
Revenues
$
15,047

 
$
17,762

Operating costs
14,037

 
20,224

Gross margin
$
1,010

 
$
(2,462
)

Oilfield rental revenues for the Current Quarter decreased $2.7 million, or 15%, from the Previous Quarter. The decrease was primarily due to a decline in utilization attributable to reductions in drilling and completions activity by our customers. Revenues from non-CHK customers increased $0.7 million during the Current Quarter as compared to the Previous Quarter. As a percentage of total segment revenues, revenues from non-CHK customers increased to 77% of total segment revenues in the Current Quarter, comparing favorably to 62% for the Previous Quarter.

Oilfield rental operating costs for the Current Quarter decreased $6.2 million, or 31%, from the Previous Quarter. The decrease was primarily due to a decline in labor-related costs and subcontracting services. As a percentage of oilfield rental revenues, oilfield rental operating costs were 93% and 114% for the Current Quarter and Previous Quarter, respectively. The decrease was due to declines in labor-related costs and sub-contracting services.

Former Oilfield Trucking
 
Three Months Ended
 
September 30, 2015
 
June 30, 2015
 
(In thousands)
Revenues
$

 
$
13,511

Operating costs

 
18,382

Gross margin
$

 
$
(4,871
)

During the Previous Quarter, we sold our drilling rig relocation and logistics business and water hauling assets. As of June 30, 2015, there were no remaining assets or operations in the oilfield trucking segment.



46






Other Financial Statement Items

Depreciation and Amortization. Depreciation and amortization for the Current Quarter and Previous Quarter were $68.9 million and $73.0 million, respectively. The decrease is primarily due to the elimination of $3.7 million of depreciation expense related to the Former Oilfield Trucking segment. As a percentage of revenues, depreciation and amortization expense was 32% and 25% for the Current Quarter and Previous Quarter, respectively.

General and Administrative Expenses. General and administrative expenses for the Current Quarter and Previous Quarter were $26.7 million and $34.8 million, respectively. We incurred non-cash compensation expenses of $8.3 million and $8.6 million and severance-related costs of $1.5 million and $3.1 million during the Current Quarter and Previous Quarter, respectively. We incurred charges of $2.7 million for services provided by CHK pursuant to the transition services agreement during the Previous Quarter. As a percentage of revenues, general and administrative expenses were 13% and 12% for the Current Quarter and Previous Quarter, respectively. As of June 30, 2015, we terminated all remaining services being provided by CHK under the transition services agreement.

Losses on Sales of Property and Equipment, Net. We recorded losses on sales of property and equipment of $1.8 million and $9.0 million during the Current Quarter and Previous Quarter, respectively. During the Current Quarter, we sold certain drilling rig components and spare equipment that we had identified to sell as part of our broader strategy to divest of non-essential assets. During the Previous Quarter, we sold our water hauling assets.

Impairments and Other. During the Current Quarter, we recognized impairment charges of $1.6 million for non-strategic real property under contract to be sold. During the Previous Quarter, we recognized impairment charges of $8.7 million and $0.2 million related to drilling-related services equipment and trucking and fluid disposal equipment, respectively, that we deemed to be impaired based on expected future cash flows of this equipment.

Interest Expense. Interest expense for the Current Quarter and Previous Quarter was $25.5 million and $25.0 million, respectively, related to borrowings under our senior notes, term loans, and credit facility. The increase in interest expense from the Previous Quarter to the Current Quarter was primarily due to borrowings under the Incremental Term Loan incurred in the Previous Quarter.

Gains on Extinguishment of Debt. During the Current Quarter, we repurchased and cancelled $10.0 million in aggregate principal amount of the 2022 Notes for $4.9 million. We recognized a gain on extinguishment of debt of $5.0 million, which includes accelerated amortization of deferred financing costs of $0.1 million. During the Previous Quarter, we repurchased and cancelled $40.0 million in aggregate principal amount of the 2022 Notes in multiple transactions for $26.4 million. We recognized gains on extinguishment of debt of $13.1 million, which includes accelerated amortization of deferred financing costs of $0.5 million.
 
(Loss) income from Equity Investee. (Loss) income from equity investee was ($0.2) million and $0.1 million for the Current Quarter and Previous Quarter, respectively, which was a result of our 49% membership interest in Maalt.

Other Income. Other income was $0.9 million and $1.0 million for the Current Quarter and Previous Quarter, respectively.

Income Tax Benefit. We recorded income tax benefit of $17.5 million and $40.7 million for the Current Quarter and Previous Quarter, respectively. The $23.2 million decrease in income tax benefit recorded for the Current Quarter was primarily the result of a decrease in net loss before taxes of $49.3 million from the Previous Quarter to the Current Quarter. Our effective income tax rate for the Current Quarter and Previous Quarter was 27% and 35%, respectively. The decrease in our effective tax rate was due to higher permanent differences and their impact on a lower pre-tax loss in the Current Quarter compared to the Previous Quarter.


47




Three Months Ended September 30, 2015 vs. September 30, 2014

The following table sets forth our condensed consolidated statements of operations for the Current Quarter and Prior Quarter.
 
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues:
 
 
 
Revenues
$
213,541

 
$
526,773

Operating Expenses:
 
 
 
Operating costs
160,889

 
392,138

Depreciation and amortization
68,854

 
73,855

General and administrative
26,709

 
32,723

Losses on sales of property and equipment, net
1,804

 
454

Impairments and other
1,566

 
7,751

Total Operating Expenses
259,822

 
506,921

Operating (Loss) Income
(46,281
)
 
19,852

Other (Expense) Income:
 
 
 
Interest expense
(25,480
)
 
(23,606
)
Gains on extinguishment of debt
4,975

 

Loss from equity investee
(230
)
 
(347
)
Other income (expense)
942

 
(134
)
Total Other Expense
(19,793
)
 
(24,087
)
Loss Before Income Taxes
(66,074
)
 
(4,235
)
Income Tax Benefit
(17,544
)
 
(2,465
)
Net Loss
$
(48,530
)
 
$
(1,770
)


48




Revenues. Revenues and Adjusted Revenues for the Current Quarter decreased $313.2 million and $272.0 million, respectively, from the Prior Quarter. The decrease was primarily due to decreased utilization, increased number of rigs under contract being idled and increased pricing pressure. The percentage of our revenues derived from CHK was 64% and 79% for the Current Quarter and Prior Quarter, respectively.

 
Three Months Ended September 30,
 
2015
 
2014
Revenue:
(In thousands)
Drilling
$
80,348

 
$
200,394

Hydraulic fracturing
118,137

 
245,128

Oilfield rentals
15,047

 
38,918

Former oilfield trucking

 
41,201

Other operations
9

 
1,132

Total
$
213,541


$
526,773

 
 
 
 
Adjusted Revenue(a):
 
 
 
Revenue
$
213,541

 
$
526,773

Less:
 
 
 
Drilling rig relocation and logistics revenues

 
29,520

Water hauling revenues

 
11,681

Adjusted Revenue
$
213,541

 
$
485,572


(a)
“Adjusted Revenue” is a non-GAAP financial measure of revenues that excludes revenues associated with our rig relocation and logistics business and water hauling assets that were sold in the Previous Quarter. For a description of our calculation of adjusted revenues and the reasons why our management uses this measure to evaluate our business, please read “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”
 


49





Operating Costs. Operating costs and Adjusted Operating Costs for the Current Quarter decreased $231.2 million and $181.2 million, respectively, from the Prior Quarter. The decrease was due to declines in labor-related costs, a decline in utilization in each of our segments and a decrease in product costs in our hydraulic fracturing segment. As a percentage of adjusted revenues, adjusted operating costs were 75% and 70% for the Current Quarter and Prior Quarter, respectively. The increase was due primarily to declines in utilization.
 
Three Months Ended September 30,
 
2015
 
2014
Operating Costs:
(In thousands)
Drilling
$
41,387

 
$
133,042

Hydraulic fracturing
103,941

 
190,730

Oilfield rentals
14,037

 
26,963

Former oilfield trucking

 
40,264

Other operations
1,524

 
1,139

Total
$
160,889

 
$
392,138

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating Costs
$
160,889

 
$
392,138

Less:
 
 
 
Drilling rig relocation and logistics operating costs

 
27,475

Water hauling operating costs

 
12,788

Rig rent expense

 
3,608

Non-recurring debit to share-based compensation expense

 
6,178

Adjusted Operating Costs
$
160,889

 
$
342,089


(a)
“Adjusted Operating Costs” is a non-GAAP financial measure of operating costs that excludes operating costs associated with our drilling rig relocation and logistics business and water hauling assets that were sold in the Previous Quarter and less rig rent expense and a non-recurring debit to share-based compensation expense related to the spin-off. For a description of our calculation of adjusted operating costs and the reasons why our management uses this measure to evaluate our business, see “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”


50




Drilling
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
80,348

 
$
200,394

Operating costs(a)
41,387

 
133,042

Gross margin
$
38,961

 
$
67,352

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating costs
$
41,387

 
$
133,042

Less:
 
 
 
Non-recurring debit to share-based compensation expense

 
3,726

Rig rent expense

 
3,608

Adjusted Operating Costs(a)
$
41,387

 
$
125,708


(a)
“Adjusted Operating Costs” is a non-GAAP financial measure of operating costs less rig rent expense and a non-recurring debit to share-based compensation expense related to the spin-off. For a description of our calculation of adjusted revenues and adjusted operating costs and the reasons why our management uses this measure to evaluate our business, see “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

Drilling revenues for the Current Quarter decreased $120.0 million, or 60%, from the Prior Quarter, which was primarily due to a 67% decrease in utilization. The average revenue per day for the Current Quarter decreased 6% from the Prior Quarter primarily due to an increase in the number of rigs generating idle contract fees in the Current Quarter. The share of revenues from non-CHK customers increased to 42% of total segment revenues in the Current Quarter, comparing favorably to 35% for the Prior Quarter.

Drilling operating costs for the Current Quarter decreased $91.7 million, or 69%, from the Prior Quarter, due primarily to a decrease in labor-related costs and lower fleet utilization. As a percentage of drilling revenues, drilling operating costs were 52% and 66% for the Current Quarter and the Prior Quarter, respectively. The decrease was due to declines in labor-related costs.

Hydraulic Fracturing
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
118,137

 
$
245,128

Operating costs
103,941

 
190,730

Gross margin
$
14,196

 
$
54,398


Hydraulic fracturing revenues for the Current Quarter decreased $127.0 million, or 52%, from the Prior Quarter, which was primarily due to a 46% decrease in revenues per stage, in addition to a 10% decrease in completed stages. Revenues from non-CHK customers increased $19.6 million to 27% of total segment revenues in the Current Quarter, comparing favorably to 5% in the Prior Quarter.

Hydraulic fracturing operating costs for the Current Quarter decreased $86.8 million, or 46% from the Prior Quarter, primarily due to a 49% decrease in product costs and reduced labor-related costs. As a percentage of hydraulic fracturing revenues, hydraulic fracturing operating costs were 88% and 78% for the Current Quarter and Prior Quarter, respectively. The increase was due to increases in transportation and repairs and maintenance.

51





Oilfield Rentals
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
15,047

 
$
38,918

Operating costs
14,037

 
26,963

Gross margin
$
1,010

 
$
11,955


Oilfield rental revenues for the Current Quarter decreased $23.9 million, or 61%, from the Prior Quarter, which was primarily due to a decline in utilization by CHK and pricing pressure. Revenues from non-CHK customers increased $3.8 million to 77% of total segment revenues in the Current Quarter, comparing favorably to 20% for the Prior Quarter.

Oilfield rental operating costs for the Current Quarter decreased $12.9 million, or 48%, from the Prior Quarter, which was primarily due to lower utilization, decreases in labor-related costs and lower repairs and maintenance expenses. As a percentage of oilfield rental revenues, oilfield rental operating costs were 93% and 69% for the Current Quarter and Prior Quarter, respectively. The increase was due to significant declines in fleet utilization and increased pricing pressure.

Former Oilfield Trucking
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$

 
$
41,201

Operating costs

 
40,264

Gross margin
$

 
$
937


During the Current Period, we sold our drilling rig relocation and logistics business and water hauling assets. As of June 30, 2015, there were no remaining assets or operations in the oilfield trucking segment.

Other Operations
 
Three Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
9

 
$
1,132

Operating costs
1,524


1,139

Gross margin
$
(1,515
)
 
$
(7
)

Other Financial Statement Items

Depreciation and Amortization. Depreciation and amortization for the Current Quarter and Prior Quarter was $68.9 million and $73.9 million, respectively. The decrease is primarily due to the Prior Quarter including $5.2 million related to the Former Oilfield Trucking segment. As a percentage of revenues, depreciation and amortization expense was 32% and 14% for the Current Quarter and Prior Quarter, respectively.

General and Administrative Expenses. General and administrative expenses for the Current Quarter and Prior Quarter were $26.7 million and $32.7 million, respectively. During the Prior Quarter, we incurred charges of $9.3 million pursuant to the administrative services agreement provided by CHK. Services provided by CHK pursuant to the transition services agreement were terminated in the Previous Quarter. We incurred non-cash compensation expenses of $8.3 million and $9.2 million and severance-related costs of $1.5 million and $0.4 million during the Current Quarter and Prior Quarter, respectively. As a percentage of revenues, general and administrative expenses were 13% and 6% for the Current Quarter and Prior Quarter, respectively.


52




Losses on Sales of Property and Equipment, Net. We recorded losses on sales of property and equipment of $1.8 million and $0.5 million during the Current Quarter and Prior Quarter, respectively. During the Current Quarter, we sold certain drilling rig components and spare equipment that we had identified as part of our broader strategy to divest of non-essential assets. During the Prior Quarter, we sold ancillary equipment not utilized in our business.

Impairments and Other. During the Current Quarter and Prior Quarter, we recognized impairments of $1.6 million and $7.8 million, respectively. During the Prior Quarter, we recorded $5.5 million of impairment charges for certain drilling rigs and spare equipment we identified to sell as part of our broader strategy to divest of non-essential drilling rigs and we also purchased 2 leased drilling rigs and paid lease termination costs of approximately $1.3 million. We also identified certain other property and equipment during the Current Quarter and Prior Quarter that we deemed to be impaired based on our assessment of the market value and expected future cash flows of the related equipment and recognized impairments of $1.6 million and $1.0 million related to this equipment.

Interest Expense. Interest expense for the Current Quarter and Prior Quarter was $25.5 million and $23.6 million, respectively, related to borrowings under our senior notes, term loans, and credit facility. The increase in interest expense from the Prior Quarter to the Current Quarter was primarily due to the additional debt issued in conjunction with the spin-off in addition to the Incremental Term Loan, partially offset by the repurchase and cancellation of $50.0 million principal amount of 6.50% Senior Notes due 2022.

Gains on Extinguishment of Debt. During the Current Quarter, we repurchased and cancelled $10.0 million in aggregate principal amount of the 2022 Notes for $4.9 million. We recognized a gain on extinguishment of debt of $5.0 million, which includes accelerated amortization of deferred financing costs of $0.1 million.

Loss from Equity Investee. Loss from equity investee was $0.2 million and $0.3 million for the Current Quarter and Prior Quarter, respectively, which was a result of our 49% membership interest in Maalt.

Other Income (Expense). Other income was $0.9 million and ($0.1) million for the Current Quarter and Prior Quarter, respectively.

Income Tax Benefit. We recorded an income tax benefit of $17.5 million and $2.5 million for the Current Quarter and Prior Quarter, respectively. The $15.0 million increase in income tax benefit recorded for the Current Quarter was primarily the result of an increase in net loss before taxes of $61.8 million from the Prior Quarter to the Current Quarter. Our effective income tax rate for the Current Quarter and Prior Quarter was 27% and 58%, respectively. The decrease in our effective tax rate from the Prior Quarter to the Current Quarter was primarily the result of permanent differences having a greater impact on our effective tax rate in the Prior Quarter due to lower pre-tax loss.
 

53




Results of Operations—Nine Months Ended September 30, 2015 vs. September 30, 2014

The following table sets forth our condensed consolidated statements of operations for the Current Period and Prior Period.
 
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues:
 
 
 
Revenues
$
938,456

 
$
1,585,948

Operating Expenses:
 
 
 
Operating costs
731,627

 
1,208,312

Depreciation and amortization
226,779

 
218,149

General and administrative
95,436

 
72,977

Loss on sale of a business
34,989

 

Losses (gains) on sales of property and equipment, net
15,023

 
(7,532
)
Impairments and other
16,720

 
30,731

Total Operating Expenses
1,120,574

 
1,522,637

Operating (Loss) Income
(182,118
)
 
63,311

Other (Expense) Income:
 
 
 
Interest expense
(73,964
)
 
(55,913
)
Gains on extinguishment of debt
18,061

 

Income (loss) from equity investee
877

 
(5,764
)
Other income
1,889

 
623

Total Other Expense
(53,137
)
 
(61,054
)
(Loss) Income Before Income Taxes
(235,255
)
 
2,257

Income Tax (Benefit) Expense
(74,455
)
 
873

Net (Loss) Income
$
(160,800
)
 
$
1,384



54




Revenues. Revenues and Adjusted Revenues for the Current Period decreased $647.5 million and $458.8 million, respectively, from the Prior Period primarily due to decreased utilization, increased number of rigs under contract being idled and increased pricing pressure. The percentage of our revenues derived from CHK was 70% and 82% for the Current Period and Prior Period, respectively.
 
Nine Months Ended September 30,
 
2015
 
2014
Revenue:
(In thousands)
Drilling
$
346,846

 
$
570,004

Hydraulic fracturing
483,565

 
672,860

Oilfield rentals
65,297

 
113,837

Former oilfield trucking
42,739

 
152,847

Other operations
9

 
76,400

Total
$
938,456

 
$
1,585,948

 
 
 
 
Adjusted Revenue(a):
 
 
 
Revenue
$
938,456

 
$
1,585,948

Less:
 
 
 
Drilling rig relocation and logistics revenues
34,408

 
92,558

Water hauling revenues
8,331

 
36,460

Compression unit manufacturing revenues

 
74,650

Geosteering revenues

 
3,940

Crude hauling revenues

 
23,829

Adjusted Revenue
$
895,717

 
$
1,354,511


(a)
“Adjusted Revenue” is a non-GAAP financial measure of revenues that excludes revenues associated with our drilling rig relocation and logistics business and water hauling assets that were sold in the Previous Quarter, our compression unit manufacturing and geosteering businesses that were distributed to CHK, and our crude hauling assets that were sold to a third party as part of the spin-off. For a description of our calculation of adjusted revenues and the reasons our why management uses this measure to evaluate our business, please read “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

 


55





Operating Costs. Operating costs and Adjusted Operating costs decreased $476.7 million and $305.0 million, respectively, in the Current Period compared to the Prior Period. The decrease was primarily due to a decrease in labor-related costs, a decline in utilization in our drilling and oilfield rental segments and a decrease in product costs in our hydraulic fracturing segment. As a percentage of adjusted revenues, Adjusted Operating Costs were 76% and 72% for the Current Period and Prior Period, respectively. The increase was due to declines in utilization.

 
Nine Months Ended September 30,
 
2015
 
2014
Operating Costs:
(In thousands)
Drilling
$
196,675

 
$
375,855

Hydraulic fracturing
416,472

 
547,025

Oilfield rentals
57,880

 
77,446

Former oilfield trucking
54,674

 
145,328

Other operations
5,926

 
62,658

Total
$
731,627

 
$
1,208,312

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating Costs
$
731,627

 
$
1,208,312

Add:
 
 
 
Non-recurring credit to share-based compensation expense

 
7,314

Less:
 
 
 
Drilling rig relocation and logistics operating costs
42,577

 
80,649

Water hauling operating costs
12,097

 
37,425

Rig rent expense

 
18,683

Geosteering operating costs

 
2,895

Crude hauling operating costs

 
27,254

Compression unit manufacturing operating costs

 
60,616

Non-recurring debit to share-based compensation expense

 
6,178

Adjusted Operating Costs(a)
$
676,953

 
$
981,926


(a)
“Adjusted Operating Costs” is a non-GAAP financial measure of operating costs that excludes operating costs associated with our rig relocation and logistics business and water hauling assets that were sold in the Previous Quarter, our compression unit manufacturing and geosteering businesses that were distributed to CHK, and our crude hauling assets that were sold to a third party as part of the spin-off, further adjusted to add a non-recurring credit to share-based compensation expense that resulted from the cancellation of CHK awards at spin-off and subtract rig rent expense and a non-recurring debit to share-based compensation expense related to the spin-off. For a description of our calculation of adjusted operating costs and the reasons why our management uses this measure to evaluate our business, see “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”



56




Drilling
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
346,846

 
$
570,004

Operating costs
196,675


375,855

Gross margin
$
150,171

 
$
194,149

 
 
 
 
Adjusted Revenues(a):
 
 
 
Revenues
$
346,846

 
$
570,004

Less:
 
 
 
Geosteering revenues

 
3,940

Adjusted Revenues(a)
$
346,846

 
$
566,064

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating costs
$
196,675

 
$
375,855

Add:
 
 
 
Non-recurring credit to share-based compensation expense

 
4,318

Less:
 
 
 
Rig rent expense

 
18,683

Geosteering operating costs

 
2,895

Non-recurring debit to share-based compensation expense

 
3,726

Adjusted Operating Costs(a)
$
196,675

 
$
354,869


(a)
“Adjusted Revenues” and “Adjusted Operating Costs” are non-GAAP financial measures of revenues and operating costs that excludes revenues and operating costs associated with the geosteering business distributed to CHK. Operating costs are further adjusted add a non-recurring credit to share-based compensation expense that resulted from the cancellation of CHK awards at spin-off and subtract rig rent expense and a non-recurring debit to share-based compensation expense related to the spin-off. For a description of our calculation of adjusted revenues and adjusted operating costs and the reasons why our management uses this measure to evaluate our business, see “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

Drilling revenues for the Current Period decreased $223.2 million, or 39%, from the Prior Period, which was primarily due to a 44% decrease in revenue days associated with rigs under contract being idled. Average revenue per revenue day for the Current Period remained unchanged from the Prior Period. Revenues from non-CHK customers decreased $45.4 million during the Current Period as compared to the Prior Period. However, revenues from non-CHK customers increased to 40% of total segment revenues in the Current Period, comparing favorably to 32% for the Prior Period.

Drilling operating costs for the Current Period decreased $179.2 million, or 48%, from the Prior Period primarily due to a decrease in labor-related costs, lower repairs and maintenance expense and the elimination of rig rent expense. As a percentage of drilling revenues, drilling operating costs were 57% and 66% for the Current Period and Prior Period, respectively. The decrease was due to declines in labor-related costs.

Hydraulic Fracturing
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
483,565

 
$
672,860

Operating costs
416,472


547,025

Gross margin
$
67,093

 
$
125,835



57




Hydraulic fracturing revenues for the Current Period decreased $189.3 million, or 28%, from the Prior Period, which was primarily due to a 39% decrease in revenues per stage, partially offset by an 18% increase in stages completed. Revenues from non-CHK customers increased $64.7 million to 17% of total segment revenues in the Current Period, comparing favorably to 3% for the Prior Period.

Hydraulic fracturing operating costs for the Current Period decreased $130.6 million, or 24%, from the Prior Period, which was primarily due to a 25% decrease in product costs. As a percentage of hydraulic fracturing revenues, hydraulic fracturing operating costs were 86% and 81% for the Current Period and Prior Period, respectively. The increase was due to increases in transportation and repairs and maintenance.

Oilfield Rentals
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
65,297

 
$
113,837

Operating costs
57,880

 
77,446

Gross margin
$
7,417

 
$
36,391


Oilfield rental revenues for the Current Period decreased $48.5 million, or 43%, from the Prior Period, which was primarily due to a decline in utilization and pricing pressure. Revenues from non-CHK customers increased $19.0 million to 56% of total segment revenues in the Current Period, comparing favorably to 16% for the Prior Period.

Oilfield rental operating costs for the Current Period decreased $19.6 million, or 25%, from the Prior Period. The decrease was primarily due to a decrease in repairs and maintenance expenses due to lower utilization and a decrease in labor-related costs. As a percentage of oilfield rental revenues, oilfield rental operating costs were 89% and 68% for the Current Period and Prior Period, respectively. The increase was due to one-time labor-related costs in the Current Period and significant declines in fleet utilization.

Former Oilfield Trucking
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
42,739

 
$
152,847

Operating costs
54,674

 
145,328

Gross margin
$
(11,935
)
 
$
7,519


During the Current Period, we sold our drilling rig relocation and logistics business and water hauling assets. As of June 30, 2015, there were no remaining assets or operations in the oilfield trucking segment.

58





Other Operations
 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Revenues
$
9

 
$
76,400

Operating costs
5,926

 
62,658

Gross margin
$
(5,917
)
 
$
13,742

 
 
 
 
Adjusted Revenue(a):
 
 
 
Revenue
$
9

 
$
76,400

Less:
 
 
 
Compression unit manufacturing revenues

 
74,650

Adjusted Revenue(a)
$
9

 
$
1,750

 
 
 
 
Adjusted Operating Costs(a):
 
 
 
Operating Costs
$
5,926

 
$
62,658

Add:
 
 
 
Non-recurring credit to share-based compensation expense(a)

 
138

Less:
 
 
 
Non-recurring debit to share-based compensation expense(a)

 
101

Compression unit manufacturing operating costs

 
60,616

Adjusted Operating Costs(a)
$
5,926

 
$
2,079


(a)
“Adjusted Revenues” and “Adjusted Operating Costs” are non-GAAP financial measures of revenues before revenues and operating costs associated with the compression unit business distributed to CHK. Operating costs are further adjusted add a non-recurring credit to share-based compensation expense that resulted from the cancellation of CHK awards at spin-off and a non-recurring debit to share-based compensation expense related to the spin-off. For a description of our calculation of adjusted revenues and adjusted operating costs and the reasons why our management uses this measure to evaluate our business, see “—How We Evaluate Our Operations” and “—Non-GAAP Financial Measures.”

Our other operations currently consists of corporate functions. As part of the spin-off, we distributed our compression manufacturing business to CHK, which was historically included in our other operations results.


59




Other Financial Statement Items

Depreciation and Amortization. Depreciation and amortization for the Current Period and Prior Period was $226.8 million and $218.1 million, respectively. The increase is primarily due to a change in accounting estimate for estimated useful lives of certain components of drilling rigs and certain drilling rigs. Please see Note 3 to our condensed consolidated financial statements in Item 1 of this report. As a percentage of revenues, depreciation and amortization expense was 24% and 14% for the Current Period and Prior Period, respectively.

General and Administrative Expenses. General and administrative expenses for the Current Period and Prior Period were $95.4 million and $73.0 million, respectively. The increase was primarily due to an increase in labor-related costs and secondarily, the incremental costs of being a stand-alone public entity. Prior to the spin-off, we were allocated corporate overhead from CHK which covered costs of functions such as legal, accounting, treasury, environmental safety, information technology and other corporate services. Under this allocation, we incurred charges of $26.8 million in the Prior Period. In connection with the spin-off, we terminated the administrative services agreement and entered into the transition services agreement under which CHK provided or made available to us various administrative services and assets for specified periods beginning on the distribution date. During the Current Period and Prior Period, we incurred charges of $8.3 million and $9.3 million, respectively, for services provided by CHK pursuant to the transition services agreement. As of June, 30, 2015, SSE terminated all remaining services being provided by CHK. We incurred non-cash compensation expenses of $26.5 million and $9.2 million in addition to severance-related costs of $6.0 million and $0.7 million during the Current Period and Prior Period, respectively. Included in the non-cash compensation expenses and severance-related costs for the Current Period are $2.1 million and $0.6 million, respectively, related to the sale of Hodges. As a percentage of revenues, general and administrative expenses were 10% and 5% for the Current Quarter and Prior Quarter, respectively.

Loss on Sale of a Business. On June 14, 2015, we sold Hodges, previously our wholly-owned subsidiary that provided drilling rig relocation and logistics services, for aggregate consideration of $42.0 million. We recognized a loss of $35.0 million on the sale during the Current Period.

Losses (Gains) on Sales of Property and Equipment, Net. We recorded losses (gains) on sales of property and equipment of approximately $15.0 million and ($7.5) million during the Current Period and Prior Period, respectively. During the Current Period, we sold our water hauling assets and ancillary equipment not utilized in our business. During the Prior Period, we sold 15 drilling rigs and ancillary equipment that were not utilized in our business, as well as our crude hauling fleet, which included 124 fluid handling trucks and 122 trailers.

Impairments and Other. During the Current Period and Prior Period, we recognized impairments of $16.7 million and $30.7 million, respectively. During the Current Period, we recognized impairment charges of $12.0 million and $2.7 million related to certain drilling rigs and drilling-related services equipment and trucking and fluid disposal equipment, respectively, that we impaired based on expected future cash flows of these rigs and equipment. During the Prior Period, we recognized impairment charges of $8.4 million related to drilling rigs we deemed to be impaired based on our assessment of future demand and the suitability of the identified rigs in light of this demand. We paid lease termination costs of $9.7 million during the Prior Period. During the Prior Period, we recognized impairments of $11.2 million related to certain drilling rigs and spare equipment that we had identified as held for sale.

We identified certain other property and equipment during the Current Period and Prior Period that we deemed to be impaired based on our assessment of the market value and expected future cash flows of the long-lived asset. We recorded impairment charges of $2.0 million and $1.4 million during the Current Period and Prior Period, respectively, related to these assets.

Interest Expense. Interest expense for the Current Period and Prior Period was $74.0 million and $55.9 million, respectively, related to borrowings under our senior notes, term loans, and credit facility. The increase in interest expense from the Prior Period to the Current Period was primarily due to additional debt issued in conjunction with the spin-off in addition to the $100.0 million Incremental Term Loan. These debt increases were partially offset by the repurchase and cancellation of $50.0 million in aggregate principal amount of 6.50% Senior Notes due 2022.

Gains on Extinguishment of Debt. During the Current Period, we repurchased and cancelled $50.0 million in aggregate principal amount of the 2022 Notes in multiple transactions for $31.3 million. We recognized gains on extinguishment of debt of $18.1 million, which included accelerated amortization of deferred financing costs of $0.6 million.
 


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Income (Loss) from Equity Investee. Income (loss) from equity investee was $0.9 million and ($1.3) million for the Current Period and Prior Period, respectively, which was a result of our 49% of the membership interest in Maalt. We recognized an impairment of $4.5 million during the Prior Period, which was a result of our investment in Maalt.

Other Income. Other income was $1.9 million and $0.6 million for the Current Period and Prior Period, respectively.

Income Tax (Benefit) Expense. We recorded income tax (benefit) expense of ($74.5) million and $0.9 million for the Current Period and Prior Period, respectively. The $75.4 million decrease in income tax expense recorded for the Current Period was primarily the result of a decrease in net income before taxes of $237.5 million from the Prior Period to the Current Period. Our effective income tax rate for the Current Period and Prior Period was 32% and 39%, respectively. The decrease in our effective tax rate from the Prior Period to the Current Period was primarily the result of permanent differences having a greater impact on our effective income tax rate in the Current Period compared to the Prior Period.

Off-Balance Sheet Arrangements

Operating Leases

As of September 30, 2015, we were party to five lease agreements with various third parties to utilize 745 lease rail cars for initial terms of five to seven years. Additional rental payments are required for the use of rail cars in excess of the allowable mileage stated in the respective agreement. We account for these leases as operating leases.

As of September 30, 2015, we were also party to various lease agreements for other property and equipment with varying terms. We account for these leases as operating leases.

Aggregate undiscounted minimum future lease payments as of September 30, 2015 under our operating leases are presented below: 
 
Rail Cars
 
Other
 
Total
 
(In thousands)
Remainder of 2015
$
1,362

 
$
562

 
$
1,924

2016
5,447

 
951

 
6,398

2017
2,168

 
553

 
2,721

2018
1,445

 
182

 
1,627

2019
722

 
3

 
725

Total
$
11,144

 
$
2,251

 
$
13,395


Other Commitments

Much of the equipment we purchase requires long production lead times. As a result, we usually have outstanding orders and commitments for such equipment. As of September 30, 2015, we had $106.6 million of purchase commitments related to future inventory and capital expenditures that we expect to incur in 2015 and 2016.

Critical Accounting Policies

We consider accounting policies related to property and equipment, impairment of long-lived assets, goodwill, intangible assets and amortization, revenue recognition and income taxes to be critical policies. These policies are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K (Commission File No. 001-36354) filed with the SEC on March 2, 2015.

Forward-Looking Statements

All references in this report to “SSE”, the “Company”, “us”, “we”, and “our” are to Seventy Seven Energy Inc. and its consolidated subsidiaries. Certain statements contained in this report constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. These statements relate to future events or our future performance. All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of words such as “seek,” “anticipate,” “plan,” “continue,” “estimate,” “expect,” “may,” “project,” “predict,” “potential,” “targeting,” “intend,” “could,” “might,” “should,”

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“believe” and similar expressions. These statements involve known and unknown risks and uncertainties and involve assumptions that may cause actual results or events to differ materially from those anticipated in such forward-looking statements. Seventy Seven Energy Inc. believes the expectations reflected in these forward-looking statements are reasonable, but we cannot assure you that these expectations will prove to be correct. We caution you not to place undue reliance on the forward-looking statements contained in this report, which speak only as of the filing date.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, including the following factors:

dependence on Chesapeake Energy Corporation (“CHK”) and its working interest partners for a majority of our revenues and our ability to secure new customers or provide additional services to existing customers;

our customers’ expenditures for oilfield services;

the limitations that our level of indebtedness may have on our financial flexibility and restrictions in our debt agreements;

the cyclical nature of the oil and natural gas industry;

changes in supply and demand of drilling rigs, hydraulic fracturing fleets and other equipment;

our credit profile;

access to and cost of capital;

hazards and operational risks that may not be fully covered by insurance;

increased labor costs or the unavailability of skilled workers;

competitive conditions; and

legislative or regulatory changes, including changes in environmental regulations, drilling regulations and liability under federal and state environmental laws and regulations.

If one or more events related to these or other risks and uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may differ materially from what we anticipate. Except as may be required by law, we do not intend, and do not assume any obligation, to update any forward-looking statements.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Historically, we have provided substantially all of our oilfield services to CHK and its working interest partners. For the Current Period and Prior Period, CHK accounted for approximately 70% and 82% of our revenues, respectively. The decline in commodity prices since mid-2014 has had an adverse effect on CHK’s and our other customers’ capital spending, which has adversely impacted our cash flows and financial position. The extent and length of the current down cycle is uncertain. If it is prolonged or worsens, it could have a further adverse effect on our customers’ capital spending. This would likely have a material adverse impact on our cash flows and financial position and could adversely affect our ability to comply with the financial covenant under our credit facility and limit our ability to fund our planned capital expenditures.

Changes in interest rates affect the amount of interest we earn on our cash, cash equivalents and short-term investments and the interest rate we pay on borrowings under our credit facility and term loans. We have borrowings outstanding under our term loans and may in the future borrow under fixed rate and variable rate debt instruments that give rise to interest rate risk. For fixed rate debt, changes in interest rates generally affect the fair value of the debt instrument, but not our earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not impact the fair value of the debt instrument, but may affect our future earnings and cash flows. Our primary exposure to interest rate risk results from outstanding borrowings under our credit facility and term loans.



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The following table provides information about our debt instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based on effective rates at September 30, 2015.
Expected Maturity Date
 
Fixed Rate Maturity
 
Average Interest Rate
 
Floating Rate Maturity
 
Average Interest Rate
 
 
(in thousands)
 
 
 
(in thousands)
 
 
2015
 
$

 

 
$
1,250

 
5.000
%
2016
 

 

 
5,000

 
5.000
%
2017
 

 

 
5,000

 
5.000
%
2018
 

 

 
5,000

 
5.000
%
2019
 
650,000

 
6.625
%
 
5,000

 
5.000
%
After 2019
 
450,000

 
6.500
%
 
473,250

 
5.008
%
Total
 
$
1,100,000

 
 
 
$
494,500

 
 
Fair value
 
$
594,401

 
 
 
$
426,106

 
 

Our fuel costs, which consist primarily of diesel fuel used by our various trucks and other equipment, can expose us to commodity price risk and our hydraulic fracturing operations expose us to risks associated with the prices of materials used in hydraulic fracturing, such as sand and chemicals. The prices for fuel and these materials can be volatile and are impacted by changes in supply and demand, as well as market uncertainty and regional shortages. We currently do not hedge our exposure to these risks.

Item 4.
Controls and Procedures

Disclosure Controls and Procedures

As required by Rule 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective at a reasonable level of assurance as of September 30, 2015.


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Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
 
Item 1.
Legal Proceedings

From time to time we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We are not currently a party to any legal proceedings that we believe would have a material adverse effect on our financial position, results of operations or cash flows.

Item 1A.
Risk Factors

Security holders and potential investors in our securities should carefully consider the risk factors set forth in our Annual Report on Form 10-K (Commission File No. 001-36354) filed with the SEC on March 2, 2015, together with other information in this report and other reports and materials we file with the SEC. We have identified these risk factors as important factors that could cause our actual results to differ materially from those contained in any written or oral forward-looking statements made by us or on our behalf.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Period
 
Total Number
of Shares
Purchased(a)
 
Average
Price Paid
per Share
 
Total Number
of Shares
Purchased as
Part of Publicly
Announced Plans 
or Programs
 
Maximum
Number of
Shares that May
Yet Be Purchased
under the Plans or
Program
July 1, 2015 - July 31, 2015
 
148,284

 
$
4.04

 

 

August 1, 2015 - August 31, 2015
 
420

 
2.87

 

 

September 1, 2015 - September 30, 2015
 
301

 
1.46

 

 

Total
 
149,005

 
$
4.03

 

 


(a)
Reflects shares surrendered as payment for statutory withholding taxes upon the vesting of restricted stock issued pursuant to the Seventy Seven Energy Inc. 2014 Incentive Plan and the Seventy Seven Energy Inc. Amended and Restated 2014 Incentive Plan.

Item 5.
Other Information

Not applicable.

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Item 6.
Exhibits

The following exhibits are filed as a part of this report:
 
 
 
 
 
Incorporated by Reference
 
 
 
 
Exhibit
Number
 
Exhibit Description
 
Form
 
Commission
File No.
 
Exhibit
 
Filing Date
 
Filed
Herewith
 
Furnished
Herewith
4.1

 
Third Supplemental Indenture, dated August 31, 2015, by and among Seventy Seven Operating LLC, Seventy Seven Finance Inc., the guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as trustee.
 
 
 
 
 
 
 
 
 
X
 
 
12.1

 
Schedule of Computation of Ratio of Earnings to Fixed Charges.
 
 
 
 
 
 
 
 
 
X
 
 
31.1

 
Certification of Chief Executive Officer pursuant to Rule 13(a)-14 and 15(d)-14 under the Securities Exchange Act of 1934.
 
 
 
 
 
 
 
 
 
X
 
 
31.2

 
Certification of Chief Financial Officer pursuant to Rule 13(a)-14 and 15(d)-14 under the Securities Exchange Act of 1934.
 
 
 
 
 
 
 
 
 
X
 
 
32.1

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
X
32.2

 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
X
101.1

 
Interactive data files pursuant to Rule 405 of Regulation S-T.
 
 
 
 
 
 
 
 
 
 
 
 
Pursuant to Rule 406T of Regulation S-T, interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of sections 11 and 12 of the Securities Act of 1933, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under those sections.


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
October 28, 2015
SEVENTY SEVEN ENERGY INC.
 
By:
/s/ Jerry Winchester
 
 
Jerry Winchester
 
 
Director, President and Chief Executive Officer
 
 
 
 
By:
/s/ Cary Baetz
 
 
Cary Baetz
 
 
Chief Financial Officer and Treasurer


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INDEX TO EXHIBITS
 
 
 
 
Incorporated by Reference
 
 
 
 
Exhibit
Number
 
Exhibit Description
 
Form
 
Commission
File No.
 
Exhibit
 
Filing Date
 
Filed
Herewith
 
Furnished
Herewith
4.1

 
Second Supplemental Indenture, dated June 15, 2015, by and among Seventy Seven Operating LLC, Seventy Seven Finance Inc., the guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as trustee.
 
 
 
 
 
 
 
 
 
X
 
 
12.1

 
Schedule of Computation of Ratio of Earnings to Fixed Charges.
 
 
 
 
 
 
 
 
 
X
 
 
31.1

 
Certification of Chief Executive Officer pursuant to Rule 13(a)-14 and 15(d)-14 under the Securities Exchange Act of 1934.
 
 
 
 
 
 
 
 
 
X
 
 
31.2

 
Certification of Chief Financial Officer pursuant to Rule 13(a)-14 and 15(d)-14 under the Securities Exchange Act of 1934.
 
 
 
 
 
 
 
 
 
X
 
 
32.1

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
X
32.2

 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
X
101.1

 
Interactive data files pursuant to Rule 405 of Regulation S-T.
 
 
 
 
 
 
 
 
 
 
 

Pursuant to Rule 406T of Regulation S-T, interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of sections 11 and 12 of the Securities Act of 1933, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under those sections.

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