UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

(Mark One)

For the fiscal year ended December 31, 2014

or

For the transition period from                      to                     

Commission File Number 0-22664

 

Patterson-UTI Energy, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(281) 765-7100

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x or    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨ or    No  x

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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  x or No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $5.0 billion, calculated by reference to the closing price of $34.94 for the common stock on the Nasdaq Global Select Market on that date.

As of February 5, 2015, the registrant had outstanding 146,458,290 shares of common stock, $0.01 par value, its only class of common stock.

Documents incorporated by reference:

Portions of the registrant’s definitive proxy statement for the 2015 Annual Meeting of Stockholders are incorporated by reference into Part III of this report.

 

 

 

 

 

 

 

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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (this “Report”) and other public filings and press releases by us contain “forward-looking statements” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”), the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, as amended. These “forward-looking statements” involve risk and uncertainty. These forward-looking statements include, without limitation, statements relating to: liquidity; revenue and cost expectations and backlog; financing of operations; oil and natural gas prices; source and sufficiency of funds required for building new equipment and additional acquisitions (if further opportunities arise); impact of inflation; demand for our services; competition; equipment availability; government regulation; and other matters. Our forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “anticipates,” “believes,” “budgeted,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “project,” “strategy,” or “will,” or the negative thereof and other words and expressions of similar meaning. The forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Forward-looking statements may be made orally or in writing, including, but not limited to, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Report and other sections of our filings with the United States Securities and Exchange Commission (the “SEC”) under the Exchange Act and the Securities Act.

Forward-looking statements are not guarantees of future performance and a variety of factors could cause actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, volatility in customer spending and in oil and natural gas prices that could adversely affect demand for our services and their associated effect on rates, utilization, margins and planned capital expenditures, global economic conditions, excess availability of land drilling rigs and pressure pumping equipment, including as a result of reactivation or construction, equipment specialization and new technologies, adverse industry conditions, adverse credit and equity market conditions, difficulty in building and deploying new equipment and integrating acquisitions, shortages, delays in delivery and interruptions in supply of equipment, supplies and materials, weather, loss of key customers, liabilities from operations for which we do not have and receive full indemnification or insurance, ability to effectively identify and enter new markets, governmental regulation, ability to realize backlog, ability to retain management and field personnel and other factors. Refer to “Risk Factors” contained in Item 1A of this Report for a more complete discussion of factors that might affect our performance and financial results. You are cautioned not to place undue reliance on any of our forward-looking statements. These forward-looking statements are intended to relay our expectations about the future, and speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, changes in internal estimates or otherwise, except as required by law.

 

 

 

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PART I

 

 

Item 1. Business

Available Information

This Report, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge through our internet website (www.patenergy.com) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.  The information contained on our website is not part of this Report or other filings that we make with the SEC.  You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains an internet site (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.  

Overview

We own and operate in the United States one of the largest fleets of land-based drilling rigs and a large fleet of pressure pumping equipment.  The Company was formed in 1978 and reincorporated in 1993 as a Delaware corporation.  Patterson Energy, Inc. and UTI Energy Corp. merged in 2001 to form Patterson-UTI Energy, Inc. In 2008, the corporate headquarters was moved from Snyder, Texas to Houston, Texas.  

Our contract drilling business operates in the continental United States, and western and northern Canada.  As of December 31, 2014, we had a drilling fleet that consisted of 239 marketable land-based drilling rigs.  A drilling rig includes the structure, power source and machinery necessary to cause a drill bit to penetrate the earth to a depth desired by the customer.  A drilling rig is considered marketable at a point in time if it is operating or can be made ready to operate without significant capital expenditures.  We also have a substantial inventory of drill pipe and drilling rig components that support our ongoing drilling operations.  

We provide pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region.  Pressure pumping services consist primarily of well stimulation services (such as hydraulic fracturing) and cementing services for completion of new wells and remedial work on existing wells.  As of December 31, 2014, we had approximately 1.0 million hydraulic horsepower to provide these services.  Our pressure pumping operations are supported by a fleet of other equipment, including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite.

We also own and invest in oil and natural gas assets as a non-operating working interest owner.  Our oil and natural gas working interests are located primarily in Texas and New Mexico.

Recent Developments

Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015.  The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration).  As a result of the decline in oil prices, our industry is now experiencing a severe downturn.  Market conditions remain very dynamic and are changing quickly.  Although the magnitude as well as the duration of this downturn are not yet known, we believe that 2015 will be a challenging year for our industry.  

We believe the vast majority of exploration and production companies, including our customers, have significantly reduced their 2015 capital spending plans.   The initial impact of these spending reductions is evidenced by the published rig counts which have declined more 25% since their recent peak in October 2014.  

Our rig count has also declined.  During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States.  We have received indications of customers’ intent to early terminate a number of term contracts and many of our drilling customers are seeking price reductions.  We expect the number of our drilling rigs operating in the United States to decline at least another 20% during the next 90 days. 

Our pressure pumping business is also beginning to see the effects of reduced spending by customers.  Some previously scheduled pressure pumping jobs have been cancelled or deferred and many customers are also seeking price reductions.  

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In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014.  In 2015, we have continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate slightly higher than the reduction in our rig count.  We have also reduced our capital expenditure plans for 2015.  Along with other reductions, we now plan to only build new drilling rigs that are currently committed under term contracts.  We plan to continue to adjust our cost structure in line with our level of operating activity.  

We expect that our term contract coverage and scalability with respect to labor and other operating costs should position us to weather this downturn.  In the event oil prices remain depressed for a sustained period, or decline further, however, we may experience further, significant declines on both drilling activity and spot dayrate pricing, and on pressure pumping activity and pricing, which could have a material adverse effect on our business, financial condition and results of operations.

Industry Segments

Our revenues, operating profits and identifiable assets are primarily attributable to three industry segments:

All of our industry segments had operating profits in 2012 and 2013.  In 2014, our contract drilling services and our pressure pumping services segments had operating profits and our oil and natural gas exploration and production segment had an operating loss.  Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014.  

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 14 of Notes to Consolidated Financial Statements included as a part of Items 7 and 8, respectively, of this Report for financial information pertaining to these industry segments.  

Contract Drilling Operations

General — We market our contract drilling services to major and independent oil and natural gas operators.  As of December 31, 2014, we had 239 marketable land-based drilling rigs based in the following regions:

Our marketable drilling rigs have rated maximum depth capabilities ranging from 10,000 feet to 25,000 feet.  Of these drilling rigs, 195 are electric rigs and 44 are mechanical rigs.  An electric rig differs from a mechanical rig in that the electric rig converts the power from its diesel engines (the sole energy source for a mechanical rig) into electricity to power the rig.  We also have a substantial inventory of drill pipe and drilling rig components, which may be used in the activation of additional drilling rigs or as replacement parts for marketable rigs.  

Drilling rigs are typically equipped with engines, drawworks, masts, pumps to circulate the drilling fluid, blowout preventers, drill pipe and other related equipment.  Over time, components on a drilling rig are replaced or rebuilt.  We spend significant funds each year as part of a program to modify, upgrade and maintain our drilling rigs to ensure that our drilling equipment is competitive.  We have spent over $2.0 billion during the last three years on capital expenditures to (1) build new land drilling rigs and (2) modify, upgrade and extend the lives of components of our drilling fleet.  During fiscal years 2014, 2013 and 2012, we spent approximately $772 million, $505 million and $745 million, respectively, on these capital expenditures.  

Depth and complexity of the well and drill site conditions are the principal factors in determining the specifications of the rig selected for a particular job.  

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Our contract drilling operations depend on the availability of drill pipe, drill bits, replacement parts and other related rig equipment, fuel and other materials and qualified personnel.  Some of these have been in short supply from time to time.  

Drilling Contracts — Most of our drilling contracts are with established customers on a competitive bid or negotiated basis.  Our bid for each job depends upon location, equipment to be used, estimated risks involved, estimated duration of the job, availability of drilling rigs and other factors particular to each proposed contract.  Our drilling contracts are either on a well-to-well basis or a term basis.  Well-to-well contracts are generally short-term in nature and cover the drilling of a single well or a series of wells.  Term contracts are entered into for a specified period of time (frequently six months to three years) and provide for the use of the drilling rig to drill multiple wells.  During 2014, our average number of days to drill a well (which includes moving to the drill site, rigging up and rigging down) was approximately 20 days.  

Our drilling contracts obligate us to provide and operate a drilling rig and to pay certain operating expenses, including wages of our drilling personnel and necessary maintenance expenses.  Most drilling contracts are subject to termination by the customer on short notice and may or may not contain provisions for an early termination payment to us in the event that the contract is terminated by the customer.  We believe that our drilling contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each drilling contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors.  

Our drilling contracts provide for payment on a daywork basis.  Under daywork contracts, we provide the drilling rig and crew to the customer.  The customer supervises the drilling of the well.  Our compensation is based on a contracted rate per day during the period the drilling rig is utilized.  We often receive a lower rate when the drilling rig is moving or when drilling operations are interrupted or restricted by adverse weather conditions or other conditions beyond our control.  Daywork contracts typically provide separately for mobilization of the drilling rig.  All of the wells we drilled in 2014, 2013 and 2012 were under daywork contracts.  

From time to time more than five years ago, we contracted to drill some wells to a certain depth under specified conditions for a fixed price per foot (on a footage basis) or for a fixed fee (on a turnkey basis).  We generally assume greater operational and economic risk drilling on a turnkey basis than on a footage basis and greater operational and economic risk drilling on a footage basis than on a daywork basis.  

 

Contract Drilling Activity — Information regarding our contract drilling activity for the last three years follows:

 

 

Drilling Rigs and Related Equipment — We have made significant upgrades during the last several years to our drilling fleet to match the needs of our customers.  While conventional wells remain an important source of oil and natural gas, our customers have expanded the development of shale and other unconventional wells to help supply the long-term demand for oil and natural gas in North America.  

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To address our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays, we have expanded our areas of operation and improved the capability of our drilling fleet.  We have delivered new APEX^® rigs to the market and have made performance and safety improvements to existing high capacity rigs.  APEX 1500^® rigs are 1,500 horsepower electric rigs with advanced electronic drilling systems, 500 ton top drives, iron roughnecks, hydraulic catwalks, and other highly automated pipe handling equipment.  APEX 1000^® rigs are 1,000 horsepower electric rigs with advanced technology equipment similar to the APEX 1500^® rigs, but with a more compact design to fit on smaller locations.  APEX WALKING^® rigs are designed to efficiently drill multiple wells from a single pad, by “walking” between the wellbores without requiring time to lower the mast and lay down the drill pipe.  Many APEX 1500^® and APEX 1000^® rigs have also been equipped with walking systems as noted below.  As of December 31, 2014, our drilling fleet was comprised of the following:

 

 

 

At December 31, 2014, we owned and operated 286 trucks and 323 trailers used to rig down, transport and rig up our drilling rigs.  

We perform repair and/or overhaul work to our drilling rig equipment at our yard facilities located in Texas, Oklahoma, Wyoming, Colorado, North Dakota, Pennsylvania and western Canada.  

Pressure Pumping Operations

General — We provide pressure pumping services to oil and natural gas operators primarily in Texas (Southwest Region) and the Appalachian region (Northeast Region).  Pressure pumping services consist of well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells.  Wells drilled in shale formations and other unconventional plays require well stimulation through hydraulic fracturing to allow the flow of oil and natural gas.  This is accomplished by pumping fluids under pressure into the well bore to fracture the formation.  Many wells in conventional plays also receive well stimulation services.  The cementing process inserts material between the wall of the well bore and the casing to support and stabilize the casing.  

Pressure Pumping Contracts – Our pressure pumping operations are conducted pursuant to a work order for a specific job or pursuant to a term contract.  The term contracts are generally entered into for a specified period of time and may include minimum revenue, usage or stage requirements.  We are compensated based on a combination of charges for equipment, personnel, materials, mobilization and other items.  We believe that our pressure pumping contracts generally provide for indemnification rights and obligations that are customary for the markets in which we conduct those operations; however, each pressure pumping contract contains the actual terms setting forth our rights and obligations and those of the customer, any of which rights and obligations may deviate from what is customary due to particular industry conditions, customer requirements or other factors.  

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Equipment — We have pressure pumping equipment used in providing hydraulic and nitrogen fracturing services as well as nitrogen, cementing and acid pumping services, with a total of approximately 1.0 million hydraulic horsepower as of December 31, 2014.  Pressure pumping equipment at December 31, 2014 included:

 

 

Our pressure pumping operations are supported by a fleet of other equipment including blenders, tractors, manifold trailers and numerous trailers for transportation of materials to and from the worksite as well as bins for storage of materials at the worksite.  

Materials – Our pressure pumping operations require the use of acids, chemicals, proppants, fluid supplies and other materials, any of which can be in short supply, including severe shortages, from time to time.  We purchase these materials from various suppliers.  These purchases are made in the spot market or pursuant to other arrangements that do not cover all of our required supply and that sometimes require us to purchase the supply or pay liquidated damages if we do not purchase the material.  Given the limited number of suppliers of certain of our materials, we may not always be able to make alternative arrangements if we are unable to reach an agreement with a supplier for delivery of any particular material or should one of our suppliers fail to timely deliver our materials.  

Oil and Natural Gas Interests

We own and invest in oil and natural gas assets as a non-operating working interest owner.  Our oil and natural gas working interests are located primarily in producing regions of Texas and New Mexico.  Our oil and natural gas assets constituted approximately 1% of our consolidated assets as of December 31, 2014.  

Customers

The customers of each of our contract drilling and pressure pumping business segments are oil and natural gas operators.  Our customer base includes both major and independent oil and natural gas operators.  With respect to our consolidated operating revenues in 2014, we received approximately 41% from our ten largest customers, 28% from our five largest customers and 16% from our two largest customers.  The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations.  During 2014, no single customer accounted for more than 10% of our consolidated operating revenues.  

Competition

The contract drilling and pressure pumping businesses are highly competitive.  Historically, available equipment used in these businesses has frequently exceeded demand.  The price for our services is a key competitive factor, in part because equipment used in our businesses can be moved from one area to another in response to market conditions.  In addition to price, we believe availability, condition and technical specifications of equipment, quality of personnel, service quality and safety record are key factors in determining which contractor is awarded a job.  We expect that the market for land drilling and pressure pumping services will continue to be highly competitive.  

Government and Environmental Regulation

All of our operations and facilities are subject to numerous federal, state, foreign, regional and local laws, rules and regulations related to various aspects of our business, including:

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To date, applicable environmental laws and regulations in the places in which we operate have not required the expenditure of significant resources outside the ordinary course of business.  We do not anticipate any material capital expenditures for environmental control facilities or extraordinary expenditures to comply with environmental rules and regulations in the foreseeable future.  However, compliance costs under existing laws or under any new requirements could become material, and we could incur liability in any instance of noncompliance.  

Our business is generally affected by political developments and by federal, state, foreign, regional and local laws, rules and regulations that relate to the oil and natural gas industry.  The adoption of laws, rules and regulations affecting the oil and natural gas industry for economic, environmental and other policy reasons could increase costs relating to drilling, completion and production, and otherwise have an adverse effect on our operations.  Federal, state, foreign, regional and local environmental laws, rules and regulations currently apply to our operations and may become more stringent in the future.  Any suspension or moratorium of the services we or others provide, whether or not short-term in nature, by a federal, state, foreign, regional or local governmental authority, could have a material adverse effect on our business, financial condition and results of operation.  

We believe we use operating and disposal practices that are standard in the industry.  However, hydrocarbons and other materials may have been disposed of, or released in or under properties currently or formerly owned or operated by us or our predecessors, which may have resulted, or may result, in soil and groundwater contamination in certain locations.  Any contamination found on, under or originating from the properties may be subject to remediation requirements under federal, state, foreign, regional and local laws, rules and regulations.  In addition, some of these properties have been operated by third parties over whom we have no control of their treatment of hydrocarbon and other materials or the manner in which they may have disposed of or released such materials.  We could be required to remove or remediate wastes disposed of or released by prior owners or operators.  In addition, it is possible we could be held responsible for oil and natural gas properties in which we own an interest but are not the operator.  

Some of the environmental laws and regulations that are applicable to our business operations are discussed in the following paragraphs, but the discussion does not cover all environmental laws and regulations that govern our operations.  

In the United States, the Federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, commonly known as CERCLA, and comparable state statutes impose strict liability on:

The Federal Resource Conservation and Recovery Act (“RCRA”), as amended, and comparable state statutes and implementing regulations govern the disposal of “hazardous wastes.” Although CERCLA currently excludes petroleum from the definition of “hazardous substances,” and RCRA also excludes certain classes of exploration and production wastes from regulation, such exemptions by Congress under both CERCLA and RCRA may be deleted, limited, or modified in the future.  If such changes are made to CERCLA and/or RCRA, we could be required to remove and remediate previously disposed of materials (including materials disposed of or released by prior owners or operators) from properties (including ground water contaminated with hydrocarbons) and to perform removal or remedial actions to prevent future contamination.  

The Federal Water Pollution Control Act and the Oil Pollution Act of 1990, as amended, and implementing regulations govern:

The Oil Pollution Act imposes strict liability for a comprehensive and expansive list of damages from an oil spill into jurisdictional waters from facilities.  Liability may be imposed for oil removal costs and a variety of public and private damages.  Penalties may also be imposed for violation of federal safety, construction and operating regulations, and for failure to report a spill or to cooperate fully in a clean-up.  

The Oil Pollution Act also expands the authority and capability of the federal government to direct and manage oil spill clean-up and operations, and requires operators to prepare oil spill response plans in cases where it can reasonably be expected that substantial

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harm will be done to the environment by discharges on or into navigable waters.  Failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party, such as us, to civil or criminal actions.  Although the liability for owners and operators is the same under the Federal Water Pollution Act, the damages recoverable under the Oil Pollution Act are potentially much greater and can include natural resource damages.  

The U.S. Occupational Safety and Health Administration (“OSHA”) promulgates and enforces laws and regulations governing the protection of the health and safety of employees.  The OSHA hazard communication standard, U.S. Environmental Protection Agency (“EPA”) community right-to-know regulations under Title III of CERCLA and similar state statutes require that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governments and citizens.  Also, OSHA has established a variety of standards related to workplace exposure to hazardous substances and employee health and safety.  

Our activities include the performance of hydraulic fracturing services to enhance the production of oil and natural gas from formations with low permeability, such as shale and other unconventional formations.  Due to concerns raised relating to potential impacts of hydraulic fracturing on groundwater quality, legislative and regulatory efforts at the federal level and in some state and local jurisdictions have been initiated to render permitting and compliance requirements more stringent for hydraulic fracturing or prohibit the activity altogether.  Such efforts could have an adverse effect on oil and natural gas production activities, which in turn could have an adverse effect on the hydraulic fracturing services that we render for our exploration and production customers.  See “Item 1A. Risk Factors – Potential Legislation and Regulation Covering Hydraulic Fracturing Could Increase Our Costs and Limit or Delay Our Operations.”

In Canada, a variety of federal, provincial and municipal laws, rules and regulations impose, among other things, restrictions, liabilities and obligations in connection with the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and wastes and in connection with spills, releases and emissions of various substances to the environment.  Other jurisdictions where we may conduct operations have similar environmental and regulatory regimes with which we would be required to comply.  These laws, rules and regulations also require that facility sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities.  In addition, new projects or changes to existing projects may require the submission and approval of environmental assessments or permit applications.  These laws, rules and regulations are subject to frequent change, and the clear trend is to place increasingly stringent limitations on activities that may affect the environment.  

Our operations are also subject to federal, state, foreign, regional and local laws, rules and regulations for the control of air emissions, including those associated with the Federal Clean Air Act and the Canadian Environmental Protection Act.  We and our customers may be required to make capital expenditures in the future for air pollution control equipment in connection with obtaining and maintaining operating permits and approvals for air emissions.  For more information, please refer to our discussion under “Item 1A. Risk Factors – Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof, Could Materially Adversely Affect Our Operating Results.”

We are aware of the increasing focus of local, state, national and international regulatory bodies on greenhouse gas (“GHG”) emissions and climate change issues.  We are also aware of legislation proposed by United States lawmakers and the Canadian legislature to reduce GHG emissions, as well as GHG emissions regulations enacted by the EPA and the Canadian provinces of Alberta and British Columbia.  We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary.  Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition.  See “Item 1A. Risk Factors – Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business.”

Risks and Insurance

Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution and reservoir damage.  These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages.  These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages.  

We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance.  In general, our drilling and pressure pumping contracts typically contain provisions requiring our customer to indemnify us for, among other things, reservoir and certain pollution damage.  Our right to indemnification may, however, be unenforceable or limited due to negligent or willful acts or omissions by us, our subcontractors and/or suppliers.  Our customers may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons.  Accordingly, we may be unable to transfer these risks

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to our customers by contract or indemnification agreements.  Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs.  The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks.  We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us.  While we carry insurance to cover physical damage to, or loss of, our drilling rigs and certain other assets, such insurance does not cover the full replacement cost of the rigs or other assets.  We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies.  For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation and equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage.  We self-insure a number of other risks, including loss of earnings and business interruption, and do not carry a significant amount of insurance to cover risks of underground reservoir damage.  

Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations.  Our coverage includes aggregate policy limits and exclusions.  As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage.  There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive or that our coverage will cover a specific loss.  Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage.  

If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations.  See “Item 1A. Risk Factors – Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims.  We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.”

Employees

We had approximately 7,900 full-time employees as of February 10, 2015.  The number of employees fluctuates depending on the current and expected demand for our services.  We consider our employee relations to be satisfactory.  None of our employees are represented by a union.  

Seasonality

Seasonality has not significantly affected our overall operations.  However, our drilling operations in Canada are subject to slow periods of activity during the annual spring thaw.  Additionally, toward the end of some years, we experience slower activity in our pressure pumping operations in connection with the holidays and as customers’ capital expenditure budgets are depleted.  Occasionally, our operations have been negatively impacted by severe weather conditions.  

Raw Materials and Subcontractors

We use many suppliers of raw materials and services.  Although these materials and services have historically been available, there is no assurance that such materials and services will continue to be available on favorable terms or at all.  We also utilize numerous independent subcontractors from various trades.  

Item 1A. Risk Factors.

You should consider each of the following factors as well as the other information in this Report in evaluating our business and our prospects. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, cash flows and results of operations could be harmed. You should also refer to the other information set forth in this Report, including our consolidated financial statements and the related notes.  

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We Are Dependent on the Oil and Natural Gas Industry and Market Prices for Oil and Natural Gas. Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results.

We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in North America.  If these expenditures decline, our business may suffer. Our customers’ willingness to explore, develop and produce depends largely upon prevailing industry conditions that are influenced by numerous factors over which we have no control, such as:

 

In particular, our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices.  For many years, oil and natural gas prices and markets have been extremely volatile.  Prices are affected by factors such as:

All of these factors are beyond our control.  During the nine months ended September 30, 2014, oil prices averaged $99.96 per barrel, natural gas prices averaged $4.59 per Mcf and demand for drilling activities increased.  During the three months ended December 31, 2014, drilling activity slowed as oil prices averaged $73.16 per barrel and natural gas prices averaged $3.80 per Mcf.  Drilling activity has significantly decreased since December 31, 2014, as oil prices averaged $47.22 per barrel and natural gas prices averaged $2.99 per Mcf during January 2015.  Our average number of rigs operating remains well below the number of our available rigs, and given current oil pricing and existing market trends, we expect our average number of rigs operating to continue to decline through at least the first quarter of 2015.  

We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital.  Continued low market prices for oil and natural gas will likely result in decreased demand for our drilling rigs and pressure pumping services and adversely affect our operating results, financial condition and cash flows.  Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our drilling rigs and pressure pumping services.  

Global Economic Conditions May Adversely Affect Our Operating Results.  

Global economic conditions and volatility in commodity prices may cause our customers to reduce or curtail their drilling and well completion programs, which could result in a decrease in demand for our services.  In addition, uncertainty in the capital markets, whether due to global economic conditions, low commodity prices or otherwise may result in reduced access to financing by us, our customers and our suppliers and reduced demand for our services.  Furthermore, these factors may result in certain of our customers experiencing an inability to pay suppliers, including us.  The global economic environment in the past has experienced significant deterioration in a relatively short period, and there is no assurance that the global economic environment will not quickly deteriorate again due to one or more factors, including a decline in the price for oil or natural gas.  A deterioration in the global economic environment could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

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A General Excess of Operable Land Drilling Rigs, Increasing Rig Specialization and Excess Pressure Pumping Equipment May Adversely Affect Our Utilization and Profit Margins.  

The North American oil and natural gas services industry has experienced downturns in demand during the last decade, including a downturn that started late in 2014.  During these periods, there have been substantially more drilling rigs and pressure pumping equipment available than necessary to meet demand.  As a result, drilling and pressure pumping contractors have had difficulty sustaining profit margins and, at times, have incurred losses during the downturn periods.  

Construction of new technology drilling rigs has increased in recent years.  The addition of new technology drilling rigs to the market, combined with a reduction in the drilling of vertical wells, has resulted in excess capacity of conventional drilling rigs.  Similarly, the substantial recent increase in unconventional resource plays has led to higher demand for pressure pumping services and there has been a significant increase in the construction of new pressure pumping equipment across the industry.  As a result of low oil and natural gas prices and the construction of new equipment, there is currently an excess of drilling rigs and pressure pumping equipment available.  In circumstances of excess capacity, providers of contract drilling and pressure pumping services have difficulty sustaining profit margins and may sustain losses during downturn periods.  We cannot predict the future level of demand for our contract drilling or pressure pumping services or future conditions in the oil and natural gas contract drilling or pressure pumping businesses.  

In addition, unconventional resource plays have substantially increased and some drilling rigs are not capable of drilling these wells efficiently.  Accordingly, the utilization of some older technology drilling rigs may be hampered by their lack of capability to successfully compete for this work.  Other ongoing factors which could continue to adversely affect utilization rates and pricing, even in an environment of high oil and natural gas prices and increased drilling activity, include:

Shortages, Delays in Delivery and Interruptions in Supply of Drill Pipe, Replacement Parts, Other Equipment, Supplies and Materials Adversely Affect Our Operating Results.  

During periods of increased demand for drilling and pressure pumping services, the industry has experienced shortages of drill pipe, replacement parts, other equipment, supplies and materials, including, in the case of our pressure pumping operations, proppants, acid, gel and water.  These shortages can cause the price of these items to increase significantly and require that orders for the items be placed well in advance of expected use.  In addition, any interruption in supply could result in significant delays in delivery of equipment and materials or prevent operations.  Interruptions may be caused by, among other reasons:

These price increases, delays in delivery and interruptions in supply may require us to increase capital and repair expenditures and incur higher operating costs.  Severe shortages, delays in delivery and interruptions in supply could limit our ability to construct and operate our drilling rigs and pressure pumping equipment and could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

Our Operations Are Subject to a Number of Operational Risks, Including Environmental and Weather Risks, Which Could Expose Us to Significant Losses and Damage Claims.  We Are Not Fully Insured Against All of These Risks and Our Contractual Indemnity Provisions May Not Fully Protect Us.  

Our operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution, exposure and reservoir damage.  These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages.  These risks could expose us to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages.  

We have indemnification agreements with many of our customers, and we also maintain liability and other forms of insurance.  In general, our drilling and pressure pumping contracts typically contain provisions requiring our customers to indemnify us for, among other things, reservoir and certain pollution damage.  Our right to indemnification may, however, be unenforceable or limited due to

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negligent or willful acts or omissions by us, our subcontractors and/or suppliers.  Our customers and other third parties may dispute, or be unable to meet, their indemnification obligations to us due to financial, legal or other reasons.  Accordingly, we may be unable to transfer these risks to our customers and other third parties by contract or indemnification agreements.  Incurring a liability for which we are not fully indemnified or insured could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

We maintain insurance coverage of types and amounts that we believe to be customary in the industry, but we are not fully insured against all risks, either because insurance is not available or because of the high premium costs.  The insurance coverage that we maintain includes insurance for fire, windstorm and other risks of physical loss to our rigs and certain other assets, employer’s liability, automobile liability, commercial general liability, workers’ compensation and insurance for other specific risks.  We cannot assure, however, that any insurance obtained by us will be adequate to cover any losses or liabilities, or that this insurance will continue to be available or available on terms that are acceptable to us.  While we carry insurance to cover physical damage to, or loss of, our drilling rigs and certain other assets, such insurance does not cover the full replacement cost of the rigs or other assets.  We have also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies.  For example, we generally maintain a $1.5 million per occurrence deductible on our workers’ compensation and equipment insurance coverage and a $2.0 million per occurrence self-insured retention on our general liability coverage and a $2.0 million per occurrence deductible on our automobile liability insurance coverage.  We self-insure a number of other risks, including loss of earnings and business interruption, and do not carry a significant amount of insurance to cover risks of underground reservoir damage.  

Our insurance will not in all situations provide sufficient funds to protect us from all liabilities that could result from our operations.  Our coverage includes aggregate policy limits and exclusions.  As a result, we retain the risk for any loss in excess of these limits or that is otherwise excluded from our coverage.  There can be no assurance that insurance will be available to cover any or all of our operational risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive or that our coverage will cover a specific loss.  Further, we may experience difficulties in collecting from insurers or such insurers may deny all or a portion of our claims for insurance coverage.  Incurring a liability for which we are not fully insured or indemnified could materially adversely affect our business, financial condition, cash flows and results of operations.  

If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a third party, it could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

New Technologies May Cause Our Operating Methods and Equipment to Become Less Competitive, and Higher Levels of Capital Expenditures May Be Necessary to Remain Competitive in our Industry.  

The market for our services is characterized by continual technological and process developments that have resulted in, and will likely continue to result in, substantial improvements in the functionality and performance of rigs and equipment.  Our customers are increasingly demanding the services of newer, higher specification drilling rigs.  Accordingly, a higher level of capital expenditures may be required to maintain and improve existing rigs and equipment and purchase and construct newer, higher specification drilling rigs to meet the increasingly sophisticated needs of our customers.  In addition, technological changes, process improvements and other factors that increase operational efficiencies could result in oil and natural gas wells being drilled and completed more quickly, which could reduce the number of revenue earning days.  Technological and process developments in the pressure pumping business could have similar effects.  

In recent years, we have added drilling rigs to our fleet through new construction, and we have purchased new pressure pumping equipment.  Although we take measures to ensure that we use advanced oil and natural gas drilling technology, changes in technology or improvements in competitors’ equipment could make our equipment less competitive.  

If we are not successful in building new rigs and pressure pumping equipment or upgrading our existing rigs and pressure pumping equipment in a timely and cost-effective manner, we could lose market share.  One or more technologies that we implement in the future may not work as we expect, and we may be adversely affected.  Additionally, new technologies, services or standards could render some of our services, drilling rigs or pressure pumping equipment obsolete, which could have a material adverse impact on our business, financial condition, cash flows and results of operation.  

Our Current Backlog of Contract Drilling Revenue May Not Ultimately Be Realized as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.  

As of December 31, 2014, our contract drilling backlog for future revenues under term contracts, which we define as contracts with a fixed term of six months or more, was approximately $1.5 billion.  Fixed-term drilling contracts customarily provide for termination at the election of the customer, with an early termination payment to us if a contract is terminated prior to the expiration of the fixed term.  However, in certain circumstances, for example, destruction of a drilling rig that is not replaced within a specified period of

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time, our bankruptcy, or a breach of our contract obligations, the customer may not be obligated to make an early termination payment to us.  Additionally, during depressed market conditions or otherwise, customers may be unable to satisfy their contractual obligations or may seek to terminate, renegotiate or fail to honor their contractual obligations.  In addition, we may not be able to perform under these contracts due to events beyond our control, and our customers may seek to cancel or negotiate our contracts for various reasons, including those described above.  As a result, we may be unable to realize all of our current contract drilling backlog.  In addition, the renegotiation or termination of fixed-term contracts without the receipt of early termination payments could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

The Oil Service Business Sectors in Which We Operate Are Highly Competitive with Excess Capacity, which Adversely Affects Our Operating Results.  

The land drilling and pressure pumping businesses are highly competitive.  At times, particularly in low commodity price environments, available land drilling rigs and pressure pumping equipment exceed the demand for such equipment.  This excess capacity has resulted in substantial competition for drilling and pressure pumping contracts.  The ability to move drilling rigs and pressure pumping equipment from one market to another in response to market conditions heightens the competition in the industry.  

We believe that price competition for drilling and pressure pumping contracts will continue to be intense due to the existence of available rigs and pressure pumping equipment.  As a result of competition, our utilization may decrease and/or we may be unable to maintain or increase prices for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

Reliance on Management and Competition for Experienced Personnel May Negatively Impact Our Financial Condition and Results of Operations

We greatly depend on the efforts of our key employees to manage our operations.  The loss of members of management could have a material adverse effect on our business.  In addition, we utilize highly skilled personnel in operating and supporting our businesses.  In times of increasing demand for our services, it may be difficult to attract and retain qualified personnel.  During periods of high demand for our services, wage rates for operations personnel are also likely to increase, resulting in higher operating costs.  The loss of key employees, the failure to obtain or attract and retain qualified personnel and increased wage rates could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

The Loss of Large Customers Could Have a Material Adverse Effect on Our Financial Condition and Results of Operations.  

With respect to our consolidated operating revenues in 2014, we received approximately 41% from our ten largest customers, 28% from our five largest customers and 16% from our two largest customers.  The loss of, or reduction in business from, one or more of our larger customers could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

Growth Through the Building of New Rigs and Pressure Pumping Equipment and Rig and Other Acquisitions Are Not Assured.  

We have increased our drilling rig fleet and pressure pumping horsepower in the past through mergers, acquisitions and new construction.  There can be no assurance that acquisition opportunities will be available in the future or that we will be able to execute timely or efficiently any plans for building new rigs and pressure pumping equipment.  We are also likely to continue to face intense competition from other companies for available acquisition opportunities.  In addition, because improved technology has enhanced the ability to recover oil and natural gas, contract drillers may continue to build new, high technology rigs and providers of pressure pumping services may continue to build new, high horsepower equipment.  

There can be no assurance that we will:

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We may incur substantial indebtedness to finance future acquisitions, build new drilling rigs or build new pressure pumping equipment and also may issue equity, convertible or debt securities in connection with any such acquisitions or building program.  Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders.  Also, continued growth could strain our management, operations, employees and other resources.  

Environmental and Occupational Health and Safety Laws and Regulations, Including Violations Thereof Could Materially Adversely Affect Our Operating Results.  

Our business is subject to numerous federal, state, foreign, regional and local laws, rules and regulations governing the discharge of substances into the environment, protection of the environment and worker health and safety, including, without limitation, laws concerning the containment and disposal of hazardous substances, oil field waste and other waste materials, the use of underground storage tanks, and the use of underground injection wells.  The cost of compliance with these laws and regulations could be substantial.  A failure to comply with these requirements could expose us to:

In addition, environmental laws and regulations in the countries in which we operate impose a variety of requirements on “responsible parties” related to the prevention of spills and liability for damages from such spills.  As an owner and operator of land-based drilling rigs and pressure pumping equipment, we may be deemed to be a responsible party under these laws and regulations.  

Changes in environmental laws and regulations occur frequently and such laws and regulations tend to become more stringent over time.  Stricter laws, regulations or enforcement policies could significantly increase compliance costs for us and our customers and have a material adverse effect on our operations or financial position.  For example, on August 16, 2012, the EPA issued final rules that establish new air emission control requirements for natural gas and NGL production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds and National Emissions Standards for Hazardous Air Pollutants (“NESHAPS”) to address hazardous air pollutants frequently associated with gas production and processing activities.  Among other things, these final rules require the reduction of volatile organic compound emissions from natural gas wells through the use of reduced emission completions or “green completions” on all hydraulically fractured wells constructed or refractured after January 1, 2015.  In addition, gas wells are now required to use completion combustion device equipment (i.e., flaring) if emissions cannot be directed to a gathering line.  Further, the final rules under NESHAPS include Maximum Achievable Control Technology standards for “small” glycol dehydrators that are located at major sources of hazardous air pollutants and modifications to the leak detection standards for valves.  These rules may require the implementation of new operating standards which may impact our business.  In 2012, seven states sued the EPA to compel the agency to make a determination as to whether setting standards of performance limiting methane emissions from oil and natural gas sources is appropriate and, if so, to promulgate performance standards for methane emissions from existing oil and natural gas sources.  In April 2014, the EPA released a set of five white papers analyzing methane emissions from the industry. In January 2015, EPA announced plans to issue a proposed rule in summer 2015 governing methane emissions from the oil and natural gas industry.  If these or other initiatives result in an increase in regulation, it could increase costs to us and our customers or reduce demand for our services, which could have a material adverse effect on our business, financial condition, cash flows and results of operations.  

Potential Legislation and Regulation Covering Hydraulic Fracturing Could Increase Our Costs and Limit or Delay Our Operations.  

Members of the U.S. Congress and the EPA are reviewing proposals for more stringent regulation of hydraulic fracturing, a technology employed by our pressure pumping business, which involves the injection of water, sand and chemicals under pressure into rock formations to stimulate oil and natural gas production.  For example, the EPA is conducting a study of the potential environmental effects of hydraulic fracturing on drinking water and groundwater.  As part of this study, the EPA sent requests to a number of companies, including our company, for information on their hydraulic fracturing practices.  We have responded to the inquiry.  The EPA released a progress report on December 21, 2012 outlining work currently underway and is expected to release a draft final report in early 2015.  This and other ongoing or proposed studies, depending on their course, and any meaningful results obtained, could spur initiatives to further regulate hydraulic fracturing under the Safe Drinking Water Act (“SDWA”) or other regulatory mechanism. In addition, legislation has been proposed in the U.S. Congress to amend the SDWA to require the disclosure of chemicals used by the oil and gas industry in the hydraulic fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process

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are impairing ground water or causing other damage.  These bills, if adopted, could establish an additional level of regulation at the federal or state level that could limit or delay operational activities or increase operating costs and could result in additional regulatory burdens that could make it more difficult to perform or limit hydraulic fracturing and increase our costs of compliance and doing business.  

Regulatory efforts at the federal level and in many states have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations.  The EPA has asserted federal regulatory authority over hydraulic fracturing using fluids that contain “diesel fuel” under the SWDA Underground Injection Control Program and has released a revised guidance regarding the process for obtaining a permit for hydraulic fracturing involving diesel fuel.  In May 2014, the EPA issued an Advanced Notice of Proposed Rulemaking, seeking comment on the development of regulations under the Toxic Substances Control Act to require companies to disclose information regarding the chemicals used in hydraulic fracturing.  These regulatory initiatives could each spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities.  Certain states where we operate have adopted or are considering disclosure legislation and/or regulations.  For example, Colorado, North Dakota, Montana, Texas, Louisiana, and Wyoming have adopted a variety of well construction, set back and disclosure regulations limiting how fracturing can be performed and requiring various degrees of chemical disclosure.  Additional regulation could increase the costs of conducting our business and could materially reduce our business opportunities and revenues if our customers decrease their levels of activity in response to such regulation.  

Finally, some jurisdictions have taken steps to enact hydraulic fracturing bans or moratoria.  New York announced in December 2014 that it will ban high volume fracturing activities combined with horizontal drilling.  Certain communities in Colorado have also enacted bans on hydraulic fracturing.  Voters in the city of Denton, Texas also recently approved a moratorium on hydraulic fracturing.  These actions have been the subject of legal challenges.  

The adoption of any future federal, state, foreign, regional or local laws that impact permitting requirements for, result in reporting obligations on, or otherwise limit or ban, the hydraulic fracturing process could make it more difficult to perform hydraulic fracturing and could increase our costs of compliance and doing business and reduce demand for our services.  Regulation that significantly restricts or prohibits hydraulic fracturing could have a material adverse impact on our business, financial condition, cash flows and results of operations.  

Legislation and Regulation of Greenhouse Gases Could Adversely Affect Our Business

We are aware of the increasing focus of local, state, regional, national and international regulatory bodies on GHG emissions and climate change issues.  Legislation to regulate GHG emissions has periodically been introduced in the U.S. Congress, and there has been a wide-ranging policy debate, both in the United States and internationally, regarding the impact of these gases and possible means for their regulation.  Some of the proposals would require industries to meet stringent new standards that would require substantial reductions in carbon emissions.  Those reductions could be costly and difficult to implement.  The EPA has adopted rules requiring the reporting of GHG emissions from specified large GHG emission sources on an annual basis.  Further, following a finding by the EPA that certain GHGs represent an endangerment to human health, the EPA finalized a rule to address permitting of GHG emissions from stationary sources under the Clean Air Act’s New Source Review Prevention of Significant Deterioration (“PSD”) and Title V programs.  This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting.  Several states and geographic regions in the United States have also adopted legislation and regulations to reduce emissions of GHGs.  Additional legislation or regulation by these states and regions, the EPA, and/or any international agreements to which the United States may become a party, that control or limit GHG emissions or otherwise seek to address climate change could adversely affect our operations.  The cost of complying with any new law, regulation or treaty will depend on the details of the particular program.  We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary.  Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition.  Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws or regulations related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws or regulations reduce demand for oil and natural gas.  

Legal Proceedings Could Have a Negative Impact on our Business.  

The nature of our business makes us susceptible to legal proceedings and governmental investigations from time to time.  Lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations. Any legal proceedings or claims, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future.  

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Political, Economic and Social Instability Risk and Laws Associated with Conducting International Operations Could Adversely Affect our Opportunities and Future Business.  

We currently conduct operations in Canada, and we have incurred selling, general and administrative expenses related to the evaluation of and preparation for other international opportunities.  International operations are subject to certain political, economic and other uncertainties generally not encountered in U.S. operations, including increased risks of social and political unrest, strikes, terrorism, war, kidnapping of employees, nationalization, forced negotiation or modification of contracts, difficulty resolving disputes and enforcing contractual rights, expropriation of equipment as well as expropriation of oil and gas exploration and drilling rights, changes in taxation policies, foreign exchange restrictions and restrictions on repatriation of income and capital, currency rate fluctuations, increased governmental ownership and regulation of the economy and industry in the markets in which we may operate, economic and financial instability of national oil companies, and restrictive governmental regulation, bureaucratic delays and general hazards associated with foreign sovereignty over certain areas in which operations are conducted.  

There can be no assurance that there will not be changes in local laws, regulations and administrative requirements or the interpretation thereof which could have a material adverse effect on the cost of entry into international markets, the profitability of international operations or the ability to continue those operations in certain areas.  Because of the impact of local laws, any future international operations in certain areas may be conducted through entities in which local citizens own interests and through entities (including joint ventures) in which we hold only a minority interest or pursuant to arrangements under which we conduct operations under contract to local entities.  While we believe that neither operating through such entities nor pursuant to such arrangements would have a material adverse effect on our operations or revenues, there can be no assurance that we will in all cases be able to structure or restructure our operations to conform to local law (or the administration thereof) on terms we find acceptable.  

There can be no assurance that we will:

In addition, the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business.  Some of the parts of the world where contract drilling and pressure pumping activities are conducted have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practice and could impact business.  Any failure to comply with the FCPA or other anti-bribery legislation could subject to us to civil, criminal and/or administrative penalties or other sanctions, which could have a material adverse impact on our business, financial condition and results of operation.  We could also face fines, sanctions and other penalties from authorities in the relevant foreign jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions and the seizure of drilling rigs, pressure pumping equipment or other assets.  

We may incur substantial indebtedness to finance an international transaction or operations and also may issue equity, convertible or debt securities in connection with any such transactions or operations.  Debt service requirements could represent a significant burden on our results of operations and financial condition, and the issuance of additional equity or convertible securities could be dilutive to existing stockholders.  Also, international expansion could strain our management, operations, employees and other resources.  

The occurrence of one or more events arising from the types of risks described above could have a material adverse impact on our business, financial condition and results of operation.  

Our Business Is Subject to Cybersecurity Risks and Threats.  

Threats to information technology systems associated with cybersecurity risks and cyber incidents or attacks continue to grow.  It is possible that our business, financial and other systems could be compromised, which might not be noticed for some period of time.  Risks associated with these threats include, among other things, loss of intellectual property, disruption of our and customers’ business operations and safety procedures, loss or damage to our worksite data delivery systems, unauthorized disclosure of personal information, and increased costs to prevent, respond to or mitigate cybersecurity events.

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We Are Dependent Upon Our Subsidiaries to Meet our Obligations Under Our Long Term Debt

We have borrowings outstanding under our senior notes, term loan facility and, from time to time, revolving credit facility.  These obligations are guaranteed by each of our existing U.S. subsidiaries other than immaterial subsidiaries.  Our ability to meet our interest and principal payment obligations depends in large part on dividends paid to us by our subsidiaries.  If our subsidiaries do not generate sufficient cash flows to pay us dividends, we may be unable to meet our interest and principal payment obligations.  

Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Debt Service Obligations to Increase Significantly.  

We have in place a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility.  Interest is paid on the outstanding principal amount of borrowings under the credit facility at a floating rate based on, at our election, LIBOR or a base rate.  The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio.  At December 31, 2014, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%.  Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015.  As of December 31, 2014, we had $303 million outstanding under our revolving credit facility at a weighted average interest rate of 2.65% and $82.5 million outstanding under our term credit facility at an interest rate of 2.50%.  A one percent increase in the interest rate on the borrowings outstanding under our revolving credit facility and term credit facility as of December 31, 2014 would increase our annual cash interest expense by approximately $3.8 million.  Interest rates could rise for various reasons in the future and increase our total interest expense, depending upon the amounts borrowed.  

Anti-takeover Measures in Our Charter Documents and Under State Law Could Discourage an Acquisition and Thereby Affect the Related Purchase Price.  

We are a Delaware corporation subject to the Delaware General Corporation Law, including Section 203, an anti-takeover law.  Our restated certificate of incorporation authorizes our Board of Directors to issue up to one million shares of preferred stock and to determine the price, rights (including voting rights), conversion ratios, preferences and privileges of that stock without further vote or action by the holders of the common stock.  It also prohibits stockholders from acting by written consent without the holding of a meeting.  In addition, our bylaws impose certain advance notification requirements as to business that can be brought by a stockholder before annual stockholder meetings and as to persons nominated as directors by a stockholder.  As a result of these measures and others, potential acquirers might find it more difficult or be discouraged from attempting to effect an acquisition transaction with us.  This may deprive holders of our securities of certain opportunities to sell or otherwise dispose of the securities at above-market prices pursuant to any such transactions.  

 

 

Item 1B. Unresolved Staff Comments.

None.

 

 

Item 2. Properties

Our property consists primarily of drilling rigs, pressure pumping equipment and related equipment.  We own substantially all of the equipment used in our businesses.  

Our corporate headquarters is in leased office space and is located at 450 Gears Road, Suite 500, Houston, Texas.  Our telephone number at that address is (281) 765-7100.  Our primary administrative office, which is located in Snyder, Texas, is owned and includes approximately 37,000 square feet of office and storage space.  

Contract Drilling Operations — Our drilling services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Oklahoma, Colorado, North Dakota, Wyoming, Pennsylvania and western Canada.  

Pressure Pumping — Our pressure pumping services are supported by several offices and yard facilities located throughout our areas of operations, including Texas, Pennsylvania, Ohio, West Virginia and Kentucky.  

Oil and Natural Gas Working Interests — Our interests in oil and natural gas properties are primarily located in Texas and New Mexico.  

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We own our administrative offices in Snyder, Texas, as well as several of our other facilities.  We also lease a number of facilities, and we do not believe that any one of the leased facilities is individually material to our operations.  We believe that our existing facilities are suitable and adequate to meet our needs.  

We incorporate by reference in response to this item the information set forth in Item 1 of this Report and the information set forth in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Report.  

 

 

Item 3. Legal Proceedings.  

In May 2013, the U.S. Equal Employment Opportunity Commission (“EEOC”) notified us of cause findings related to certain of our employment practices.  The cause findings relate to allegations that we tolerated a hostile work environment for employees based on national origin and race.  The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation.  We and the EEOC engaged in the statutory conciliation process.  In March 2014, the EEOC notified us that this matter will be forwarded to its legal unit for litigation review.  In November 2014, we and the EEOC participated in a mediation to resolve the matter.  Discussions are ongoing.  If no resolution is reached, we believe that litigation will ensue, and we intend to defend ourselves vigorously.  Based on the information available to us at this time, we do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter.  

In October 2014, we were notified by EPA region 6 that it intends to seek civil penalties for alleged RCRA administrative violations at a former facility of one of our subsidiaries in Midland, Texas.  The EPA subsequently alleged RCRA administrative violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million.  We are in negotiations with the EPA regarding the scope and amount of any potential settlement.  We do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows.  

Other than the matters described above, the Company is party to various other legal proceedings arising in the normal course of its business; the Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows.  

 

 

Item 4. Mine Safety Disclosure.

Not applicable.  

PART II

 

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.  

(a) Market Information

Our common stock, par value $0.01 per share, is publicly traded on the Nasdaq Global Select Market and is quoted under the symbol “PTEN.” Our common stock is included in the S&P MidCap 400 Index and several other market indices.  The following table provides high and low sales prices of our common stock for the periods indicated:

 

 

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(b) Holders

As of February 5, 2015, there were approximately 1,300 holders of record of our common stock.  

(c) Dividends

We paid cash dividends during the years ended December 31, 2013 and 2014 as follows:

 

 

On February 4, 2015, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015.  The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our credit facilities and other factors.  

(e) Issuer Purchases of Equity Securities

The table below sets forth the information with respect to purchases of our common stock made by us during the quarter ended December 31, 2014.  

 

 

 

(e) Performance Graph

The following graph compares the cumulative stockholder return of our common stock for the period from December 31, 2009 through December 31, 2014, with the cumulative total return of the Standard & Poors 500 Stock Index, the Standard & Poors MidCap Index, the Oilfield Service Index and a peer group determined by us.  Our peer group consists of Helmerich & Payne, Inc., Nabors Industries, Ltd., Pioneer Energy Services Corp. and Precision Drilling Corp. All of the companies in our peer group are providers of

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land-based drilling services.  Nabors Industries, Ltd. also is a provider of pressure pumping services.  The graph assumes investment of $100 on December 31, 2009 and reinvestment of all dividends.  

 

 

 

The foregoing graph is based on historical data and is not necessarily indicative of future performance.  This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C under the Exchange Act or to the liabilities of Section 18 under such Act.  

 

 

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Item 6. Selected Financial Data.  

Our selected consolidated financial data as of December 31, 2014, 2013, 2012, 2011 and 2010, and for each of the five years in the period ended December 31, 2014 should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes thereto, included as Items 7 and 8, respectively, of this Report.  Due to the sale of our drilling and completion fluids business in January 2010 and the sale of our electric wireline business in January 2011, the results of operations for those businesses have been reclassified and are presented as discontinued operations for all periods presented.  

 

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Recent Developments — Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015.  The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late

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January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration).  As a result of the decline in oil prices, our industry is now experiencing a severe downturn.  Market conditions remain very dynamic and are changing quickly.  Although the magnitude as well as the duration of this downturn are not yet known, we believe that 2015 will be a challenging year for our industry.  

We believe the vast majority of exploration and production companies, including our customers, have significantly reduced their 2015 capital spending plans.   The initial impact of these spending reductions is evidenced by the published rig counts which have declined more 25% since their recent peak in October 2014.  

Our rig count has also declined.  During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States.  We have received indications of customers’ intent to early terminate a number of term contracts and many of our drilling customers are seeking price reductions.  We expect the number of our drilling rigs operating in the United States to decline at least another 20% during the next 90 days. 

Our pressure pumping business is also beginning to see the effects of reduced spending by customers.  Some previously scheduled pressure pumping jobs have been cancelled or deferred and many customers are also seeking price reductions.  

In anticipation of this downturn, we began reducing our cost structure in the fourth quarter of 2014.  In 2015, we have continued to reduce our cost structure and, to date, we have reduced our drilling headcount at a rate slightly higher than the reduction in our rig count.  We have also reduced our capital expenditure plans for 2015.  Along with other reductions, we now plan to only build new drilling rigs that are currently committed under term contracts.  We plan to continue to adjust our cost structure in line with our level of operating activity.  

We expect that our term contract coverage and scalability with respect to labor and other operating costs should position us to weather this downturn.  In the event oil prices remain depressed for a sustained period, or decline further, however, we may experience further, significant declines on both drilling activity and spot dayrate pricing, and on pressure pumping activity and pricing, which could have a material adverse effect on our business, financial condition and results of operations.

Management Overview — We are a leading provider of services to the North American oil and natural gas industry. Our services primarily involve the drilling, on a contract basis, of land-based oil and natural gas wells and pressure pumping services. In addition to these services, we also invest, on a non-operating working interest basis, in oil and natural gas properties.

As of December 31, 2014, we had a drilling fleet that consisted of 239 land-based drilling rigs.  There continues to be uncertainty with respect to the global economic environment, and oil and natural gas prices are volatile. Oil prices declined significantly during the second half of 2014 and have continued to decline in 2015. The closing price of oil was as high as $105.68 per barrel during the third quarter of 2014, as low as $44.08 per barrel in late January 2015 and around $50 per barrel during the first week in February 2015 (WTI spot price as reported by the United States Energy Information Administration). In response, many of our customers have announced significant reductions in their 2015 capital spending budgets. During October 2014, the number of our drilling rigs operating in the United States was as high as 214, and as of February 10, 2015 we had 173 drilling rigs operating in the United States. We expect the number of our drilling rigs operating in the United States to continue to decline at least through the first quarter of 2015.  

We have addressed our customers’ needs for drilling horizontal wells in shale and other unconventional resource plays by expanding our areas of operation and improving the capabilities of our drilling fleet during the last several years. As of December 31, 2014, we have completed 145 new APEX^® rigs and made performance and safety improvements to existing high capacity rigs. We have plans to complete 16 additional new APEX^® rigs in 2015.

In connection with horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs. As of December 31, 2014, we had approximately 1.0 million hydraulic horsepower in our pressure pumping fleet. This is a net increase of approximately 866,000 horsepower since the end of 2009. In recent years, low natural gas prices and the industry-wide addition of new pressure pumping equipment to the marketplace led to an excess supply of pressure pumping equipment in North America.

We maintain a backlog of commitments for contract drilling revenues under term contracts, which we define as contracts with a fixed term of six months or more. Our backlog as of December 31, 2014 was approximately $1.5 billion. We expect approximately $953 million of our backlog to be realized in 2015. We generally calculate our backlog by multiplying the dayrate under our term drilling contracts by the number of days remaining under the contract. The calculation does not include any revenues related to other fees such as for mobilization, demobilization and customer reimbursables, 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

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what is permitted under the drilling contract. In addition, generally our term 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. For contracts for which we have received an early termination notice, our backlog calculation includes the early termination rate, instead of the dayrate, for the period we expect to receive the lower rate. See “Item 1A. Risk Factors – Our Current Backlog of Contract Drilling Revenue May Not Ultimately Be Realized as Fixed-Term Contracts May in Certain Instances Be Terminated Without an Early Termination Payment.”

For the three years ended December 31, 2014, our operating revenues consisted of the following (dollars in thousands):

 

 

Generally, the profitability of our business is impacted most by two primary factors in our contract drilling segment: our average number of rigs operating and our average revenue per operating day. During 2014, our average number of rigs operating was 203 in the United States and 8 in Canada compared to 184 in the United States and 8 in Canada in 2013 and 214 in the United States and 7 in Canada in 2012. Our average revenue per operating day was $23,880 in 2014 compared to $24,020 in 2013 and $22,540 in 2012. We had consolidated net income of $163 million for 2014 compared to $188 million for 2013. This decrease in consolidated net income was due to a charge of $77.9 million related to the retirement of 55 mechanical drilling rigs and the write-off of excess spare components for the now reduced size of our mechanical rig fleet. Also, revenues in 2013 included early termination revenues totaling approximately $65.2 million related to early contract terminations.  

Our revenues, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas. During periods of improved commodity prices, the capital spending budgets of oil and natural gas operators tend to expand, which generally results in increased demand for our services. Conversely, in periods when these commodity prices deteriorate, the demand for our services generally weakens and we experience downward pressure on pricing for our services. Oil and natural gas prices and our monthly average number of rigs operating have declined from recent highs. In December 2014, our average number of rigs operating was 208 in the United States and 8 in Canada. In January 2015, our average number of rigs operating decreased to 198.

We are also highly impacted by operational risks, competition, the availability of excess equipment, labor issues and various other factors that could materially adversely affect our business, financial condition, cash flows and results of operations. Please see “Risk Factors” in Item 1A of this Report.

Critical Accounting Policies

In addition to established accounting policies, our consolidated financial statements are impacted by certain estimates and assumptions made by management. The following is a discussion of our critical accounting policies pertaining to property and equipment, goodwill, revenue recognition, the use of estimates and oil and natural gas properties.

Property and equipment — Property and equipment, including betterments which extend the useful life of the asset, are stated at cost. Maintenance and repairs are charged to expense when incurred. We provide for the depreciation of our property and equipment using the straight-line method over the estimated useful lives. Our method of depreciation does not change when equipment becomes idle; we continue to depreciate idled equipment on a straight-line basis. No provision for salvage value is considered in determining depreciation of our property and equipment. We review our long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying values of certain assets may not be recovered over their estimated remaining useful lives. In connection with this review, assets are grouped at the lowest level at which identifiable cash flows are largely independent of other asset groupings. The cyclical nature of our industry has resulted in fluctuations in rig utilization over periods of time. Management believes that the contract drilling industry will continue to be cyclical and rig utilization will continue to fluctuate. Based on management’s expectations of future trends, we estimate future cash flows over the life of the respective assets or asset groupings in our assessment of impairment. These estimates of cash flows are based on historical cyclical trends in the industry as well as management’s expectations regarding the continuation of these trends in the future. Provisions for asset impairment are charged against income when estimated future cash flows, on an undiscounted basis, are less than the asset’s net book value. Any provision for impairment is measured at fair value.

On a periodic basis, we evaluate our fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional vertical wells versus drilling longer horizontal wells using high capacity rigs). The components comprising rigs that will

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no longer be marketed are evaluated, and those components with continuing utility to our other marketed rigs are transferred to other rigs or to our yards to be used as spare equipment. The remaining components of these rigs are retired. In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed. We recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of our mechanical fleet. In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating. Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs. We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. In 2012, we identified 36 rigs that it determined would no longer be marketed and recorded a charge of $5.2 million related to the retirement of these rigs.

We also evaluate our fleet of marketable pressure pumping equipment and in 2012 identified approximately 37,000 horsepower of pressure pumping equipment that would be retired. The net book value of these assets of $7.3 million was expensed in our consolidated statements of operations. There were no similar charges in 2014 or 2013.

In light of the significant decline in oil and natural gas commodity prices beginning in the fourth quarter of 2014 and continuing into 2015, we deemed it necessary to assess the recoverability of long-lived assets within our contract drilling and pressure pumping segments. With respect to these assets, we estimated future cash flows over the expected life of the assets, and determined that, on an undiscounted basis, expected cash flows exceeded the carrying value of the long-lived assets. Based on this assessment, no impairment was indicated. Impairment considerations related to our oil and natural gas segment are discussed below.

Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized. We evaluate goodwill at least annually on December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level. Our reporting units for impairment testing have been determined to be the same as our operating segments. We currently have goodwill in our contract drilling and pressure pumping operating segments. We first determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors. If so, then goodwill impairment is determined using a two-step impairment test. From time to time, we may perform the first step of quantitative testing for goodwill impairment in lieu of performing a qualitative assessment. The first step is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall.

We performed a quantitative impairment assessment of our goodwill as of December 31, 2013. In completing the first step of the analysis, we used a three-year projection of discounted cash flows, plus a terminal value determined using the constant growth method to estimate the fair value of the reporting units. In developing this fair value estimate, we applied key assumptions including an assumed discount rate of 11.87% for the contract drilling reporting unit and an assumed discount rate of 12.40% for the pressure pumping reporting unit. An assumed long-term growth rate of 3.00% was used for both reporting units. Based on the results of the first step of the impairment test in 2013, we concluded that no impairment was indicated in our contract drilling or pressure pumping reporting units, as the estimated fair value of each reporting unit exceeded its carrying value.

In connection with our annual goodwill impairment assessment as of December 31, 2014, we determined based on an assessment of qualitative factors that it was more likely than not that the fair values of our reporting units were greater than their carrying amounts and further testing was not necessary. In making this determination, we considered the continued demand experienced during 2014 for our services in the contract drilling and pressure pumping businesses. We also considered the current and expected levels of commodity prices for oil and natural gas, which influence the overall level of business activity in these operating segments. Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account. Our overall market capitalization and the large amount of calculated excess of the fair values of our reporting units over their carrying values from our 2013 quantitative Step 1 assessment of goodwill were also considered.

We have undertaken extensive efforts in the past several years to upgrade our fleet of equipment and believe that we are well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells.  In the event that market conditions were to remain weak for a protracted period, we may be required to record an impairment of goodwill in our contract drilling or pressure pumping reporting units in the future, and such impairment could be material.  

Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed.  Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs.  All of the wells we drilled in 2014, 2013 and 2012 were drilled under daywork contracts.  

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Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from such estimates.  

Key estimates used by management include:

Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting.  Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well.  Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made.  Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known.  We review wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects.  If no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, we consider the well costs to be impaired and recognize the costs as expense.  Geological and geophysical costs, including seismic costs and costs to carry and retain undeveloped properties, are charged to expense when incurred.  The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field.  Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field.  

We review our proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices.  Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on our expectation of future pricing over the lives of the respective fields.  These cash flow estimates are reviewed by an independent petroleum engineer.  If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value.  The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (level 3 inputs in the fair value hierarchy of fair value accounting).  The expected future net cash flows are discounted using an annual rate of 10% to determine fair value.  We review unproved oil and natural gas properties quarterly to assess potential impairment.  Our impairment assessment is made on a lease-by-lease basis and considers factors such as our intent to drill, lease terms and abandonment of an area.  If an unproved property is determined to be impaired, the related property costs are expensed.  Impairment expense related to proved and unproved oil and natural gas properties totaled approximately $20.9 million, $4.0 million and $1.9 million for the years ended December 31, 2014, 2013 and 2012, respectively, and is included in depreciation, depletion, amortization and impairment in the consolidated statements of operations.  

For additional information on our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included as a part of Item 8 of this Report.  

Liquidity and Capital Resources

Our liquidity as of December 31, 2014 included approximately $341 million in working capital and approximately $157 million available under our $500 million revolving credit facility.  Subsequent to December 31, 2014, we received an $82 million federal income tax refund related to 2014.  The refund, along with other cash generated from our cash management efforts, were used to repay $103 million outstanding under our revolving credit facility during 2015.  As of February 10, 2015, availability under the revolving credit facility was $260 million.  In an attempt to further increase availability under our revolving credit facility, we are working with a lender to move $39.8 million of letters of credit currently outstanding under our revolving credit facility into a new separate facility to be used only for letters of credit.  

We believe our current liquidity together with cash expected to be generated from operations, should provide us with sufficient ability to fund our current plans to build new equipment, make improvements to our existing equipment, service our debt and pay cash dividends.  If under current market conditions we desire to pursue opportunities for growth that require capital, we believe we would

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likely require additional debt or equity financing. However, there can be no assurance that such capital will be available on reasonable terms, if at all.

As of December 31, 2014, we had working capital of $341 million, including cash and cash equivalents of $43 million, compared to working capital of $454 million and cash and cash equivalents of $250 million at December 31, 2013.  

During 2014, our sources of cash flow included:

During 2014, we used $176 million to acquire pressure pumping operations, $58.3 million to pay dividends on our common stock, $13.6 million to repurchase shares of our common stock, $10.0 million to repay long-term debt and $1.1 billion:

We paid cash dividends during the year ended December 31, 2014 as follows:

 

 

On February 4, 2015, our Board of Directors approved a cash dividend on our common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015.  The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of our credit facilities and other factors.  

On August 1, 2007, our Board of Directors approved a stock buyback program authorizing purchases of up to $250 million of our common stock in open market or privately negotiated transactions.  On July 25, 2012, our Board of Directors terminated the remaining authority under the 2007 stock buyback program, and approved a new stock buyback program authorizing purchases of up to $150 million of our common stock in open market or privately negotiated transactions.  On September 6, 2013, the Company’s Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions.  As of December 31, 2014, we had remaining authorization to purchase approximately $187 million of our outstanding common stock under the new stock buyback program.  Shares purchased under a buyback program are accounted for as treasury stock.  

We acquired shares of stock from employees during 2014, 2013 and 2012 that are accounted for as treasury stock.  Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees.  The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock.  These shares were acquired at fair market value.  These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc.  2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc.  2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback program.  

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Treasury stock acquisitions during the year ended December 31, 2014, 2013 and 2012 were as follows (dollars in thousands):

 

 

On September 27, 2012, we entered into a credit agreement (the “Credit Agreement”).  The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility.  The Credit Agreement replaced a previous senior unsecured revolving credit facility.  

The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time.  The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time.  

The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012.  The term loan facility is payable in quarterly principal installments which commenced December 27, 2012.  The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for the final four quarterly installments.  

Subject to customary conditions, we may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million.  The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility.  

Loans under the Credit Agreement bear interest by reference, at our election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate.  The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon our debt to capitalization ratio.  As of December 31, 2014, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%.  Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015.  A letter of credit fee is payable by us equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit.  The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%.  

Each of our U.S. subsidiaries, other than one domestic holding company and certain immaterial subsidiaries, has unconditionally guaranteed all existing and future indebtedness and liabilities of the other guarantors and us arising under the Credit Agreement and other loan documents.  Such guarantees also cover obligations of us and any of our subsidiaries arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement.  

The Credit Agreement requires compliance with two financial covenants.  We must not permit our debt to capitalization ratio to exceed 45%.  The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter.  We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00.  The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period.  We were in compliance with these covenants at December 31, 2014.  The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants.  We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise.  

Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events.  If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require us to repay all the outstanding

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amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy such acceleration is automatic), and (iii) require us to cash collateralize any outstanding letters of credit.  

As of December 31, 2014, we had $82.5 million principal amount outstanding under the term loan facility at an interest rate of 2.50% and $303 million outstanding under the revolving credit facility at a weighted interest rate of 2.65%. We had $39.8 million in letters of credit outstanding at December 31, 2014 and, as a result, had available borrowing capacity of approximately $157 million at that date.  

On October 5, 2010, we completed the issuance and sale of $300 million in aggregate principal amount of our 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum.  We will pay interest on the Series A Notes on April 5 and October 5 of each year.  The Series A Notes will mature on October 5, 2020.

On June 14, 2012, we completed the issuance and sale of $300 million in aggregate principal amounts of our 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement.  The Series B Notes bear interest at a rate of 4.27% per annum.  We will pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022.  

The Series A Notes and Series B Notes are our senior unsecured obligations, which rank equally in right of payment with all of our other unsubordinated indebtedness.  The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of our existing domestic subsidiaries other than immaterial subsidiaries.  

The Series A Notes and Series B Notes are prepayable at our option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements.  We must offer to prepay the notes upon the occurrence of any change of control.  In addition, we must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets.  If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date.  

The respective note purchase agreements require compliance with two financial covenants.  We must not permit our debt to capitalization ratio to exceed 50% at any time.  The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter.  We also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00.  The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior quarters to interest charges for the same period.  We were in compliance with these covenants at December 31, 2014.  We do not expect that the restrictions and covenants will impair, in any material respect, our ability to operate or react to opportunities that might arise.

Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events.  If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable.  

Commitments and Contingencies — As of December 31, 2014, we maintained letters of credit in the aggregate amount of $39.8 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts.  These letters of credit expire annually at various times during the year and are typically renewed.  As of December 31, 2014, no amounts had been drawn under the letters of credit.  

As of December 31, 2014, we had commitments to purchase approximately $512 million of major equipment for our drilling and pressure pumping businesses.  

Our pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors.  These agreements expire in 2016, 2017 and 2018.  As of December 31, 2014, the remaining obligation under these agreements was approximately $71.8 million, of which materials with a total purchase price of approximately $15.4 million were

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required to be purchased during 2015.  In the event that the required minimum quantities are not purchased during any contract year, we could be required to make a liquidated damages payment to the respective vendor for any shortfall.  

In November 2011, our pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance its construction of certain processing facilities.  This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%.  Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017.  As of December 31, 2014, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $8.6 million had been received resulting in a balance outstanding of approximately $3.2 million.  

In May 2013, the EEOC notified us of cause findings related to certain of our employment practices.  The cause findings relate to allegations that we tolerated a hostile work environment for employees based on national origin and race.  The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation.  We and the EEOC engaged in the statutory conciliation process. In March 2014, the EEOC notified us that this matter will be forwarded to its legal unit for litigation review.  In November 2014, we and the EEOC participated in a mediation to resolve the matter.  Discussions are ongoing.  If no resolution is reached, we believe that litigation will ensue, and we intend to defend ourselves vigorously.  Based on the information available to us at this time, we do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter.  

In October 2014, we were notified by EPA Region 6 that it intends to seek civil penalties for alleged RCRA violations at a former facility on one of our subsidiaries in Midland, Texas.  The EPA subsequently alleged RCRA violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million.  We are in negotiations with the EPA regarding the scope and amount of any potential settlement.  We do not expect the outcome of this matter to have a material adverse effect on our financial condition, results of operations or cash flows.

Trading and Investing — We have not engaged in trading activities that include high-risk securities, such as derivatives and non-exchange traded contracts.  We invest cash primarily in highly liquid, short-term investments such as overnight deposits and money market accounts.  

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Contractual Obligations

The following table presents information with respect to our contractual obligations as of December 31, 2014 (dollars in thousands):

 

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements at December 31, 2014.  

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Results of Operations

Comparison of the years ended December 31, 2014 and 2013

The following tables summarize operations by business segment for the years ended December 31, 2014 and 2013:

 

  

The demand for our contract drilling services is impacted by the market price of oil and natural gas.  The reactivation and construction of new land drilling rigs in the United States in recent years has contributed to an excess capacity of land drilling rigs compared to demand.  Also in recent years, customer demand has shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs.  The average market price of oil and natural gas for each of the fiscal quarters and full year in 2014 and 2013 follows:

 

 

Revenues and direct operating costs increased in 2014 compared to 2013 as a result of an increase in the number of rigs operating.  Revenues in 2013 included approximately $65.2 million of early termination revenues.  Average revenue per operating day and average margin per operating day were higher in 2013 due to the early termination revenue.  Capital expenditures were incurred in 2014 and 2013 to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional equipment including top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment.  In 2014, we identified 55 mechanical rigs that we determined would no longer be marketed.  We recorded additional depreciation, amortization and impairment expense of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of our mechanical fleet.  In 2013, we identified 48 rigs that would no longer be marketed.  Also, we had 55 additional mechanical rigs that were not operating.  Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs.  We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating. Significant capital expenditures incurred in recent years to add new rig capacity also contributed to the increase in depreciation expense.  

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Revenues and direct operating costs increased primarily due to an increase in the size of our jobs and the size of our pressure pumping fleet.  Our customers have continued the development of unconventional reservoirs resulting in an increase in larger multi-stage fracturing jobs associated therewith.  In connection with the horizontal shale and other unconventional resource plays, we have added equipment to perform service intensive fracturing jobs, including the June 2014 acquisition of an East Texas-based pressure pumping operation and the October 2014 acquisition of a Texas-based pressure pumping operation.  As a result, we have continued to experience an increase in the number of these larger multi-stage fracturing jobs as a proportion of the total fracturing jobs we performed.  Additionally, the average size of the multi-stage fracturing jobs has increased.  Average revenue per fracturing job and average direct operating costs per total job increased as a result of this increase in the proportion of larger multi-stage fracturing jobs and the increased size of the jobs in 2014 as compared to 2013.  Depreciation expense increased due to capital expenditures.  

 

 

Oil revenues decreased as a result of lower average oil prices and lower production.  Natural gas and liquids revenue increased due to higher average prices, partially offset by lower production.  Direct operating costs and depletion expense increased primarily due to the addition of new wells.  Depletion and impairment expense in 2014 includes approximately $20.9 million of oil and natural gas property impairments, compared to approximately $4.0 million of oil and natural gas property impairments in 2013.  The impairment in 2014 is primarily the result of lower oil prices.  

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Selling, general and administrative expense for 2014 increased primarily due to higher personnel costs.  Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group.  The net gain on the disposal of assets in 2014 resulted primarily from miscellaneous sales of drilling equipment and sales of certain oil and natural gas properties.  

Comparison of the years ended December 31, 2013 and 2012

The following tables summarize operations by business segment for the years ended December 31, 2013 and 2012:

 

 

The demand for our contract drilling services is impacted by the market price of oil and natural gas.  The reactivation and construction of new land drilling rigs in the United States in recent years contributed to an excess capacity of land drilling rigs compared to demand.  Customer demand shifted away from mechanically powered drilling rigs to electric powered drilling rigs, reducing the utilization rates of our mechanically powered drilling rigs.  The average market price of oil and natural gas for each of the fiscal quarters and full year in 2013 and 2012 follows:

 

  

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Revenues and direct operating costs decreased in 2013 compared to 2012 as a result of a decrease in the number of rigs operating.  A greater proportion of our high specification APEX^® rigs working combined with early contract termination revenues caused an increase in the average revenue per operating day.  Capital expenditures were incurred in 2013 and 2012 to build new drilling rigs, to modify and upgrade existing drilling rigs and to acquire additional equipment including top drives, drill pipe, drill collars, engines, fluid circulating systems, rig hoisting systems and safety enhancement equipment.  In 2013, we identified 48 rigs that would no longer be marketed. Also, we had 55 additional mechanical rigs that were not operating.  Although these 55 rigs remained marketable at the time, we had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs.  We recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating.  In 2012, we identified 36 rigs that we determined would no longer be marketed and recorded additional depreciation, amortization and impairment expense of $5.2 million related to the retirement of these rigs.  Significant capital expenditures incurred in recent years to add new rig capacity also contributed to the increase in depreciation expense.  

 

 

In connection with the development of unconventional reservoirs, customers continued to increase the average size of the fracturing jobs.  As a result, we experienced an increase in the size of these multi-stage fracturing jobs resulting in higher revenues and costs.  Average revenue per fracturing job increased as a result of this increase in the larger multi-stage fracturing jobs in 2013 as compared to 2012.  Average direct operating costs per total job increased primarily as a result of increased amounts of materials and labor used on the larger multi-stage fracturing jobs.  Depreciation, amortization and impairment expense increased in 2013 due primarily to significant capital expenditures incurred to add capacity.  In 2012, depreciation, amortization and impairment expenses included approximately $7.3 million related to the retirement of certain pressure pumping equipment.  There were no comparable charges in 2013.  

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Oil revenues decreased as a result of lower production partially offset by higher average oil prices.  Natural gas and liquids revenue increased due to higher average prices and higher production.  Direct operating costs and depletion expense also increased primarily due to the addition of new wells.  Depletion and impairment expense in 2013 includes approximately $4.0 million of oil and natural gas property impairments compared to approximately $1.9 million of oil and natural gas property impairments in 2012.  

 

 

Selling, general and administrative expense for 2013 increased primarily due to higher costs associated with stock-based compensation and expenses to evaluate and prepare for international growth opportunities.  Selling, general and administrative expense in 2012 included a reduction in personnel costs related to the final determination of payouts under the 2009 Performance Unit Awards upon the completion of the performance period.  There was no similar reduction in 2013.  Gains and losses on the disposal of assets are treated as part of our corporate activities because such transactions relate to corporate strategy decisions of our executive management group.  The gain on the disposal of assets in 2012 includes a gain of approximately $22.6 million associated with the sale of our flowback operations and a $4.5 million gain from the auction sale of certain excess drilling assets.  An additional provision for bad debts was recorded in 2012 with no similar increase in 2013.  Interest expense increased in 2013 primarily due to a full year of interest charges related to the $300 million of Series B Senior Notes issued and sold on June 14, 2012.  

Adjusted EBITDA

Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) is not defined by U.S. GAAP.  We define Adjusted EBITDA as net income plus net interest expense, income tax expense and depreciation, depletion, amortization and impairment expense. We present Adjusted EBITDA (a non-U.S. GAAP measure) because we believe it provides to both management and investors additional information with respect to both the performance of our fundamental business activities and our ability to meet our capital expenditures and working capital requirements.  Adjusted EBITDA should not be construed as an alternative to the U.S. GAAP measures of net income or operating cash flow.  

 

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Income Taxes

 

  

The effective tax rate is a result of a federal rate of 35.0% adjusted as follows:

 

 

The Domestic Production Activities Deduction was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income.  The permanent difference for 2012 does not include any deduction as it is limited to taxable income and we did not have taxable income in 2012 due to the utilization of net operating loss carryforwards.  The permanent difference for 2013 includes a deduction of $10.0 million as we fully utilized our remaining net operating loss carryforwards. The permanent difference for 2014 includes a deduction of $8.8 million.  

We record deferred federal income taxes based primarily on the temporary differences between the book and tax bases of our assets and liabilities.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be settled.  As a result of fully recognizing the benefit of our deferred income taxes, we incur deferred income tax expense as these benefits are utilized.  We recognized deferred tax expense of approximately $44 million in 2014, $51 million in 2013 and $160 million in 2012.  

On January 1, 2010, we converted our Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes.  Because the statutory tax rates in Canada are lower than those in the United States, this transaction triggered a $5.1 million reduction in deferred tax liabilities, which is being amortized as a reduction to deferred income tax expense over the weighted average remaining useful life of the Canadian assets.  

As a result of the above conversion, our Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada.  Effective January 1, 2010, we have elected to permanently reinvest these unremitted earnings in Canada, and intend to do so for the foreseeable future.  As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $47.5 million as of December 31, 2014.  The unrecognized deferred tax liability associated with these earnings was approximately $7.2 million, net of available foreign tax credits.  This liability would be recognized if we received a dividend of the unremitted earnings.  

Volatility of Oil and Natural Gas Prices and its Impact on Operations and Financial Condition

Our revenue, profitability and cash flows are highly dependent upon prevailing prices for oil and natural gas and expectations about future prices.  For many years, oil and natural gas prices and markets have been extremely volatile.  Prices are affected by many factors beyond our control. Please see “Risk Factors – We are Dependent on the Oil and Gas Industry and Market Prices for Oil and Natural Gas.  Declines in Customers’ Operating and Capital Expenditures and in Oil and Natural Gas Prices May Adversely Affect Our Operating Results” in Item 1A of this Report.  During the nine months ended September 30, 2014, oil prices averaged $99.96 per barrel, natural gas prices averaged $4.59 per Mcf and demand for drilling activities increased.  During the three months ended December 31, 2014, drilling activity slowed as oil prices averaged $73.16 per barrel and natural gas prices averaged $3.80 per Mcf.  Drilling activity has significantly decreased since December 31, 2014, as oil prices averaged $47.22 per barrel and natural gas prices averaged $2.99 per Mcf during January 2015.  Our average number of rigs operating remains well below the number of our available rigs, and given current oil pricing and existing market trends, we expect our average number of rigs operating to continue to decline through at least the first quarter of 2015.

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We expect oil and natural gas prices to continue to be volatile and to affect our financial condition, operations and ability to access sources of capital. Continued low market prices for oil and natural gas will likely result in decreased demand for our drilling rigs and pressure pumping services and adversely affect our operating results, financial condition and cash flows.  Even during periods of high prices for oil and natural gas, companies exploring for oil and natural gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons, which could reduce demand for our drilling rigs and pressure pumping services.  

Impact of Inflation

Inflation has not had a significant impact on our operations during the three years ended December 31, 2014.  We believe that inflation will not have a significant near-term impact on our financial position.  

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers.  Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services.  This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers.  The requirements in this update are effective during interim and annual periods beginning after December 15, 2016.  We are currently evaluating the impact this guidance will have on our consolidated financial statements.  

In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.  The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition.  The requirements in this update are effective during interim and annual periods beginning after December 15, 2015.  The adoption of this update is not expected to have a material impact on our consolidated financial statements.  

 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We currently have exposure to interest rate market risk associated with any borrowings that we have under our term credit facility or our revolving credit facility.  Interest is paid on the outstanding principal amount of borrowings at a floating rate based on, at our election, LIBOR or a base rate.  The margin on LIBOR loans ranges from 2.25% to 3.25% and the margin on base rate loans ranges from 1.25% to 2.25%, based on our debt to capitalization ratio.  At December 31, 2014, the margin on LIBOR loans was 2.25% and the margin on base rate loans was 1.25%.  Based on our debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015.  As of December 31, 2014, we had $303 million outstanding under our revolving credit facility at a weighted interest rate of 2.65% and $82.5 million outstanding under our term credit facility at an interest rate of 2.50%.  The interest rate on the borrowing outstanding under our term credit facility is variable and adjusts at each interest payment date based on our election of LIBOR or the base rate.  A one percent increase in the interest rate on the borrowings outstanding under our revolving credit facility and term credit facility as of December 31, 2014 would increase our annual cash interest expense by approximately $3.8 million.  

We conduct a portion of our business in Canadian dollars through our Canadian land-based drilling operations. The exchange rate between Canadian dollars and U.S. dollars has fluctuated during the last several years.  If the value of the Canadian dollar against the U.S. dollar weakens, revenues and earnings of our Canadian operations will be reduced and the value of our Canadian net assets will decline when they are translated to U.S. dollars.  This currency risk is not material to our results of operations or financial condition.  

The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items.  

 

 

Item 8. Financial Statements and Supplementary Data.

Financial Statements are filed as a part of this Report at the end of Part IV hereof beginning at page F-1, Index to Consolidated Financial Statements, and are incorporated herein by this reference.  

 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

 

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Item 9A. Controls and Procedures.

Disclosure Controls and Procedures:

Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report.  Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2014, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and reported to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.  

Management’s Report on Internal Control over Financial Reporting:

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f).  Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014, based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2014.  

The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on page F-2 of this Report and which is incorporated by reference into Item 8 of this Report.  

Changes in Internal Control over Financial Reporting:

There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  

 

 

Item 9B. Other Information.

None.

 

 

 

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PART III

Certain information required by Part III is omitted from this Report because we expect to file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934 no later than 120 days after the end of the fiscal year covered by this Report and certain information included therein is incorporated herein by reference.  

 

 

Item 10. Directors, Executive Officers and Corporate Governance.  

The information required by this Item is incorporated herein by reference to the Proxy Statement.  

We have adopted a Code of Business Conduct and Ethics for Senior Financial Executives, which covers, among others, our principal executive officer and principal financial and accounting officer.  The text of this code is located on our website under “Governance.” Our Internet address is www.patenergy.com.  We intend to disclose any amendments to or waivers from this code on our website.  

 

 

Item 11. Executive Compensation.  

The information required by this Item is incorporated herein by reference to the Proxy Statement.  

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.  

The information required by this Item is incorporated herein by reference to the Proxy Statement.  

 

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.  

The information required by this Item is incorporated herein by reference to the Proxy Statement.  

 

 

Item 14. Principal Accounting Fees and Services.  

The information required by this Item is incorporated herein by reference to the Proxy Statement.  

 

 

 

 

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PART IV

 

 

Item 15. Exhibits and Financial Statement Schedule.  

(a)(1) Financial Statements

See Index to Consolidated Financial Statements on page F-1 of this Report.  

(a)(2) Financial Statement Schedule

Schedule II — Valuation and qualifying accounts is filed herewith on page S-1.  

All other financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto.  

(a)(3) Exhibits

The following exhibits are filed herewith or incorporated by reference herein.  

 

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41

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

F-1

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Patterson-UTI Energy, Inc.:

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Patterson-UTI Energy, Inc. and its subsidiaries (the “Company”) at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.  

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.  

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  

/s/ PricewaterhouseCoopers LLP

Houston, Texas

February 12, 2015

 

 

 

 

F-2

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

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

 

 

 

F-3

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

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

 

 

 

 

F-4

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

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

 

 

 

 

F-5

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

 

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

 

 

 

F-6

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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

 

 

F-7

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. Description of Business and Summary of Significant Accounting Policies

A description of the business and basis of presentation follows:

Description of business — Patterson-UTI Energy, Inc., through its wholly-owned subsidiaries (collectively referred to herein as “Patterson-UTI” or the “Company”), provides onshore contract drilling services to major and independent oil and natural gas operators in the continental United States, and western and northern Canada.  The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region.  The Company also invests in oil and natural gas properties on a non-operating working interest basis.  

Basis of presentation — The consolidated financial statements include the accounts of Patterson-UTI and its wholly-owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated.  Except for wholly-owned subsidiaries, the Company has no controlling financial interests in any other entity which would require consolidation.  

The U.S. dollar is the functional currency for all of the Company’s operations except for its Canadian operations, which use the Canadian dollar as its functional currency.  The effects of exchange rate changes are reflected in accumulated other comprehensive income, which is a separate component of stockholders’ equity.  

A summary of the significant accounting policies follows:

Management estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from such estimates.  

Revenue recognition — Revenues from daywork drilling and pressure pumping activities are recognized as services are performed.  Expenditures reimbursed by customers are recognized as revenue and the related expenses are recognized as direct costs.  All of the wells the Company drilled in 2014, 2013 and 2012 were drilled under daywork contracts.  

Accounts receivable — Trade accounts receivable are recorded at the invoiced amount.  The allowance for doubtful accounts represents the Company’s estimate of the amount of probable credit losses existing in the Company’s accounts receivable.  The Company reviews the adequacy of its allowance for doubtful accounts at least quarterly.  Significant individual accounts receivable balances and balances which have been outstanding greater than 90 days are reviewed individually for collectability.  Account balances, when determined to be uncollectable, are charged against the allowance.  

Inventories — Inventories consist primarily of sand and other products to be used in conjunction with the Company’s pressure pumping activities.  The inventories are stated at the lower of cost or market, determined under the average cost method.  

Property and equipment — Property and equipment is carried at cost less accumulated depreciation.  Depreciation is provided on the straight-line method over the estimated useful lives.  The method of depreciation does not change whenever equipment becomes idle.  The estimated useful lives, in years, are shown below:

 

 

Long-lived assets, including property and equipment, are evaluated for impairment when certain triggering events or changes in circumstances indicate that the carrying values may not be recoverable over their estimated remaining useful life.  

 

Oil and natural gas properties — Working interests in oil and natural gas properties are accounted for using the successful efforts method of accounting.  Under the successful efforts method of accounting, exploration costs which result in the discovery of oil and natural gas reserves and all development costs are capitalized to the appropriate well.  Exploration costs which do not result in discovering oil and natural gas reserves are charged to expense when such determination is made.  Costs of exploratory wells are initially capitalized to wells-in-progress until the outcome of the drilling is known.  The Company reviews wells-in-progress quarterly to determine whether sufficient progress is being made in assessing the reserves and economic viability of the respective projects.  If

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no progress has been made in assessing the reserves and economic viability of a project after one year following the completion of drilling, the Company considers the well costs to be impaired and recognizes the costs as expense.  Geological and geophysical costs, including seismic costs, and costs to carry and retain undeveloped properties are charged to expense when incurred.  The capitalized costs of both developmental and successful exploratory type wells, consisting of lease and well equipment and intangible development costs, are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved developed oil and natural gas reserves for each respective field.  Oil and natural gas leasehold acquisition costs are depreciated, depleted and amortized using the units-of-production method, based on engineering estimates of total proved oil and natural gas reserves for each respective field.  

The Company reviews its proved oil and natural gas properties for impairment whenever a triggering event occurs, such as downward revisions in reserve estimates or decreases in expected future oil and natural gas prices.  Proved properties are grouped by field and undiscounted cash flow estimates are prepared based on management’s expectation of future pricing over the lives of the respective fields.  These cash flow estimates are reviewed by an independent petroleum engineer.  If the net book value of a field exceeds its undiscounted cash flow estimate, impairment expense is measured and recognized as the difference between net book value and fair value.  The fair value estimates used in measuring impairment are based on internally developed unobservable inputs including reserve volumes and future production, pricing and operating costs (level 3 inputs in the fair value hierarchy of fair value accounting).  The expected future net cash flows are discounted using an annual rate of 10% to determine fair value.  The Company reviews unproved oil and natural gas properties quarterly to assess potential impairment.  The Company’s impairment assessment is made on a lease-by-lease basis and considers factors such as management’s intent to drill, lease terms and abandonment of an area.  If an unproved property is determined to be impaired, the related property costs are expensed.  

Goodwill — Goodwill is considered to have an indefinite useful economic life and is not amortized.  The Company assesses impairment of its goodwill at least annually as of December 31, or on an interim basis if events or circumstances indicate that the fair value of goodwill may have decreased below its carrying value.  

Maintenance and repairs — Maintenance and repairs are charged to expense when incurred.  Renewals and betterments which extend the life or improve existing property and equipment are capitalized.  

Disposals — Upon disposition of property and equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in the consolidated statement of operations.  

Net income per common share — The Company provides a dual presentation of its net income per common share in its consolidated statements of operations: Basic net income per common share (“Basic EPS”) and diluted net income per common share (“Diluted EPS”).  

Basic EPS excludes dilution and is computed by first allocating earnings between common stockholders and holders of non-vested shares of restricted stock.  Basic EPS is then determined by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding non-vested shares of restricted stock.  

Diluted EPS is based on the weighted average number of common shares outstanding plus the dilutive effect of potential common shares, including stock options, non-vested shares of restricted stock and restricted stock units.  The dilutive effect of stock options and restricted stock units is determined using the treasury stock method.  The dilutive effect of non-vested shares of restricted stock is based on the more dilutive of the treasury stock method or the two-class method, assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than non-vested shares of restricted stock.  

 

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The following table presents information necessary to calculate income from continuing operations per share and net income per share for the years ended December 31, 2014, 2013 and 2012, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive (in thousands, except per share amounts):

 

 

Income taxes — The asset and liability method is used in accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.  If applicable, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.  The Company’s policy is to account for interest and penalties with respect to income taxes as operating expenses.  

Stock-based compensation — The Company recognizes the cost of share-based payments under the fair-value-based method.  Under this method, compensation cost related to share-based payments is measured based on the estimated fair value of the awards at the date of grant, net of estimated forfeitures.  This expense is recognized over the expected life of the awards (See Note 10).  

Statement of cash flows — For purposes of reporting cash flows, cash and cash equivalents include cash on deposit and money market funds.  

Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to provide guidance on the recognition of revenue from customers.  Under this guidance, an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services.  This guidance also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing and uncertainty, if any, of revenue and cash flows arising from contracts with customers.  The requirements in this update are effective during interim and annual periods beginning after December 15, 2016.  The Company is currently evaluating the impact this guidance will have on its consolidated financial statements.  

In June 2014, the FASB issued an accounting standards update to provide guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.  The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a

performance condition.  The requirements in this update are effective during interim and annual periods beginning after December 15, 2015.  The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements.  

 

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2. Acquisitions

During 2014, the Company completed two pressure pumping acquisitions. In June 2014, a subsidiary of the Company acquired the East Texas-based pressure pumping assets of a privately held company. This acquisition included 31,500 horsepower of hydraulic fracturing equipment. In October 2014, a subsidiary of the Company completed the acquisition of the Texas-based pressure pumping assets of a privately held company. This acquisition included 148,250 horsepower of hydraulic fracturing equipment.  

In total, the Company paid $176 million in cash for these two acquisitions plus the assumption of property leases and other contractual obligations. The purchase price was allocated to the assets acquired based on fair value. A summary of the purchase price allocation follows (in thousands):

 

 

Results of operations of the acquired businesses are included in the Company’s consolidated results of operations from their respective dates of acquisition. Revenues of $80.8 million and income from operations of $13.7 million from the acquired businesses are included in the consolidated statement of operations for the year ended December 31, 2014.  

The following represents pro-forma unaudited financial information for the years ended December 31, 2014 and 2013 as if the acquisitions had been completed on January 1, 2013 (in thousands, except per share amounts):

 

 

 

3. Property and Equipment

Property and equipment consisted of the following at December 31, 2014 and 2013 (in thousands):

 

 

Depreciation, depletion, amortization and impairment — The following table summarizes depreciation, depletion, amortization and impairment expense related to property and equipment and intangible assets for 2014, 2013 and 2012 (in thousands):

 

 

The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable (a “triggering event”). In light of the significant decline in oil and natural gas commodity prices beginning in the fourth quarter of 2014 and continuing into 2015, management deemed it necessary to assess the recoverability

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of long-lived assets within its contract drilling and pressure pumping segments. With respect to the long-lived assets in the Company’s oil and natural gas exploration and production segment, the Company assesses the recoverability of long-lived assets at the end of each quarter due to revisions in its oil and natural gas reserve estimates and expectations about future commodity prices.

Long-lived assets are evaluated for impairment at the lowest level for which identifiable cash flows can be separated from other long-lived assets. The Company performs the first step of its impairment assessments by comparing the undiscounted cash flows for each long-lived asset or asset group to its respective carrying value. In 2014, the Company’s analysis indicated that the carrying amounts of long-lived assets in the contract drilling and pressure pumping segments were recoverable.  The Company’s analysis indicated that the carrying amounts of certain oil and natural gas properties were not recoverable at various testing dates in 2014, 2013 and 2012. The Company’s estimates of expected future net cash flows from impaired properties are used in measuring the fair value of such properties. The Company recorded impairment charges of $20.9 million, $4.0 million and $1.9 million in 2014, 2013 and 2012, respectively, related to its oil and natural gas properties.  

On a periodic basis, the Company evaluates its fleet of drilling rigs for marketability based on the condition of inactive rigs, expenditures that would be necessary to bring them to working condition and the expected demand for drilling services by rig type (such as drilling conventional vertical wells versus drilling longer horizontal wells using high capacity rigs).  The components comprising rigs that will no longer be marketed are evaluated, and those components with continuing utility to the Company’s other marketed rigs are transferred to other rigs or to its yards to be used as spare equipment.  The remaining components of these rigs are retired.  In 2014, the Company identified 55 mechanical rigs that it determined would no longer be marketed.  The Company recorded a charge of $77.9 million related to the retirement of these mechanical rigs and the write-off of excess spare components for the now reduced size of the Company’s mechanical fleet.  In 2013, the Company identified 48 rigs that would no longer be marketed.  Also, the Company had 55 additional mechanical rigs that were not operating.  Although these 55 rigs remained marketable at the time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs.  The Company recorded a charge of $37.8 million related to the retirement of the 48 rigs and the 55 mechanical rigs that remained marketable but were not operating.  In 2012, the Company identified 36 rigs that it determined would no longer be marketed and recorded a charge of $5.2 million related to the retirement of these rigs.  

In 2013, due to a shift in customer demand away from mechanically powered drilling rigs to electric powered drilling rigs, the Company recorded in its consolidated statement of operations a charge of $29.9 million related to 55 mechanical rigs that were not under contract.  Although these 55 rigs remained marketable at the time, the Company had lower expectations with respect to utilization of these rigs due to the industry shift to electric powered drilling rigs.  There were no similar charges in 2014 or 2012.

The Company also evaluates its fleet of marketable pressure pumping equipment and in 2012 identified approximately 37,000 horsepower of pressure pumping equipment that would be retired.  The net book value of these assets of $7.3 million was expensed in the Company’s consolidated statements of operations.  There were no similar charges in 2014 or 2013.

During 2012, the Company sold its flowback operations in a cash transaction.  The sale price was $42.5 million and the Company recognized a gain on disposal of $22.6 million.

 

 

 

4. Goodwill and Intangible Assets

Goodwill — Goodwill by operating segment as of December 31, 2014 and 2013 and changes for the years then ended are as follows (in thousands):

 

 

There were no accumulated impairment losses as of December 31, 2014 or 2013.  

Goodwill is evaluated at least annually on December 31, or when circumstances require, to determine if the fair value of recorded goodwill has decreased below its carrying value. For purposes of impairment testing, goodwill is evaluated at the reporting unit level.  The Company’s reporting units for impairment testing have been determined to be its operating segments. The Company first

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determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying value after considering qualitative, market and other factors.  If so, then goodwill impairment is determined using a two-step impairment test. From time to time, the Company may perform the first step of quantitative testing for goodwill impairment in lieu of performing a qualitative assessment. The first step is to compare the fair value of an entity’s reporting units to the respective carrying value of those reporting units. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed whereby the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets and liabilities with any remaining fair value representing the fair value of goodwill. If this resulting fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized in the amount of the shortfall.  

The Company performed a quantitative impairment assessment of its goodwill as of December 31, 2013.  In completing the first step of the analysis, the Company used a three-year projection of discounted cash flows, plus a terminal value determined using the constant growth method to estimate the fair value of the reporting units. In developing this fair value estimate, the Company applied key assumptions including an assumed discount rate of 11.87% for the contract drilling reporting unit and an assumed discount rate of 12.40% for the pressure pumping reporting unit. An assumed long-term growth rate of 3.00% was used for both reporting units.  Based on the results of the first step of the impairment test in 2013, the Company concluded that no impairment was indicated in its contract drilling or pressure pumping reporting units as the estimated fair value of each reporting unit exceeded its carrying value.  

In connection with its annual goodwill impairment assessment as of December 31, 2014, the Company determined based on an assessment of qualitative factors that it was more likely than not that the fair values of the Company’s reporting units were greater than their carrying amounts and further testing was not necessary.  In making this determination, the Company considered the continued demand experienced during 2014 for its services in the contract drilling and pressure pumping businesses.  The Company also considered the current and expected levels of commodity prices for oil and natural gas, which influence its overall level of business activity in these operating segments.  Additionally, operating results for 2014 and forecasted operating results for 2015 were also taken into account.  The Company’s overall market capitalization and the large amount of calculated excess of the fair values of the Company’s reporting units over their carrying values from its 2013 quantitative impairment assessment were also considered.  

The Company has undertaken extensive efforts in the past several years to upgrade its fleet of equipment and believes that it is well positioned from a competitive standpoint to satisfy demand for high technology drilling of unconventional horizontal wells, which should help mitigate decreases in demand for drilling conventional vertical wells that has resulted primarily from currently low oil and natural gas prices.  In the event that market conditions were to remain weak for a protracted period, the Company may be required to record an impairment of goodwill in its contract drilling or pressure pumping reporting units in the future, and such impairment could be material.  

Intangible Assets — Intangible assets were recorded in the pressure pumping operating segment in connection with the fourth quarter 2010 acquisition of the assets of a pressure pumping business.  As a result of the purchase price allocation, the Company recorded intangible assets related to a non-compete agreement and the customer relationships acquired. These intangible assets were recorded at fair value on the date of acquisition.  

 

The non-compete agreement had a term of three years from October 1, 2010. The value of this agreement was estimated using a with and without scenario where cash flows were projected through the term of the agreement assuming the agreement is in place and compared to cash flows assuming the non-compete agreement was not in place. The intangible asset associated with the non-compete agreement was amortized on a straight-line basis over the three-year term of the agreement.  Amortization expense of $350,000 and $467,000 was recorded in the years ended December 31, 2013 and 2012, respectively, associated with the non-compete agreement. The non-compete agreement expired in 2013.  

The value of the customer relationships was estimated using a multi-period excess earnings model to determine the present value of the projected cash flows associated with the customers in place at the time of the acquisition and taking into account a contributory asset charge. The resulting intangible asset is being amortized on a straight-line basis over seven years. Amortization expense of $3.6 million was recorded in each of the years ended December 31, 2014, 2013 and 2012, associated with customer relationships.  

The Company concluded no triggering events necessitating an impairment assessment of the non-compete agreement had occurred in 2013 or 2012.  The Company concluded no triggering events necessitating an impairment assessment of the customer relationships had occurred in 2014, 2013 or 2012.  

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The following table presents the gross carrying amount and accumulated amortization of the customer relationships as of December 31, 2014 and 2013 (in thousands):

 

 

 

5. Accrued Expenses

Accrued expenses consisted of the following at December 31, 2014 and 2013 (in thousands):

 

 

 

6. Asset Retirement Obligation

The Company records a liability for the estimated costs to be incurred in connection with the abandonment of oil and natural gas properties in the future. This liability is included in the caption “other” in the liabilities section of the consolidated balance sheet. The following table describes the changes to the Company’s asset retirement obligations during 2014 and 2013 (in thousands):

 

 

 

7. Long Term Debt

Credit Facilities—On August 19, 2010, the Company entered into a committed senior unsecured Credit Agreement (the “2010 Credit Agreement”) which included a revolving credit facility that permitted aggregate borrowings of up to $400 million and a $100 million term loan facility. The term loan facility was fully drawn on August 19, 2010. The term loan facility was payable in quarterly principal installments commencing November 10, 2010. The installment amounts were scheduled to vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments and 5.00% of the original principal amount for the next subsequent three quarterly installments, with the balance due on the maturity date of August 19, 2014. The outstanding balance of the term loan facility was paid in full on June 14, 2012.

On September 27, 2012, the Company entered into a Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, N.A., as administrative agent, letter of credit issuer, swing line lender and lender, and each of the other lenders party thereto. The Credit Agreement is a committed senior unsecured credit facility that includes a revolving credit facility and a term loan facility. The Credit Agreement replaced the 2010 Credit Agreement.

The revolving credit facility permits aggregate borrowings of up to $500 million outstanding at any time. The revolving credit facility contains a letter of credit facility that is limited to $150 million and a swing line facility that is limited to $40 million, in each case outstanding at any time.

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The term loan facility provides for a loan of $100 million, which was drawn on December 24, 2012. The term loan facility is payable in quarterly principal installments, which commenced December 27, 2012. The installment amounts vary from 1.25% of the original principal amount for each of the first four quarterly installments, 2.50% of the original principal amount for each of the subsequent eight quarterly installments, 5.00% of the original principal amount for the subsequent four quarterly installments and 13.75% of the original principal amount for the final four quarterly installments.

Subject to customary conditions, the Company may request that the lenders’ aggregate commitments with respect to the revolving credit facility and/or the term loan facility be increased by up to $100 million, not to exceed total commitments of $700 million. The maturity date under the Credit Agreement is September 27, 2017 for both the revolving facility and the term facility.

Loans under the Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 2.25% to 3.25% and the applicable margin on base rate loans varies from 1.25% to 2.25%, in each case determined based upon the Company’s debt to capitalization ratio. As of December 31, 2014, the applicable margin on LIBOR rate loans was 2.25% and the applicable margin on base rate loans was 1.25%. Based on the Company’s debt to capitalization ratio at December 31, 2014, the applicable margin on LIBOR loans will be 2.75% and the applicable margin on base rate loans will be 1.75% as of April 1, 2015.  A letter of credit fee is payable by the Company equal to the applicable margin for LIBOR rate loans times the amount available to be drawn under outstanding letters of credit. The commitment fee rate payable to the lenders for the unused portion of the credit facility is 0.50%.  

Each U.S. subsidiary of the Company, other than one domestic holding company and certain immaterial subsidiaries, has unconditionally guaranteed all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the Credit Agreement and other loan documents. Such guarantees also cover obligations of the Company and any subsidiary of the Company arising under any interest rate swap contract with any person while such person is a lender or an affiliate of a lender under the Credit Agreement.

The Credit Agreement requires compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 45%. The Credit Agreement generally defines the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 3.00 to 1.00. The Credit Agreement generally defines the interest coverage ratio as the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2014. The Credit Agreement also contains customary representations, warranties and affirmative and negative covenants.

Events of default under the Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, loan document enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then a majority of the lenders have the right, among others, to (i) terminate the commitments under the Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any loan document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit.

As of December 31, 2014, the Company had $82.5 million principal amount outstanding under the term loan facility at an interest rate of 2.50% and $303 million principal amount outstanding under the revolving credit facility at a weighted average interest rate of 2.65%. The Company had $39.8 million in letters of credit outstanding at December 31, 2014 and, as a result, had available borrowing capacity of approximately $157 million at that date.

 

Senior Notes – On October 5, 2010, the Company completed the issuance and sale of $300 million in aggregate principal amount of its 4.97% Series A Senior Notes due October 5, 2020 (the “Series A Notes”) in a private placement. The Series A Notes bear interest at a rate of 4.97% per annum. The Company will pay interest on the Series A Notes on April 5 and October 5 of each year. The Series A Notes will mature on October 5, 2020.

On June 14, 2012, the Company completed the issuance and sale of $300 million in aggregate principal amounts of its 4.27% Series B Senior Notes due June 14, 2022 (the “Series B Notes”) in a private placement. The Series B Notes bear interest at a rate of 4.27% per annum. The Company will pay interest on the Series B Notes on April 5 and October 5 of each year. The Series B Notes will mature on June 14, 2022.

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The Series A Notes and Series B Notes are senior unsecured obligations of the Company which rank equally in right of payment with all other unsubordinated indebtedness of the Company. The Series A Notes and Series B Notes are guaranteed on a senior unsecured basis by each of the existing domestic subsidiaries of the Company other than immaterial subsidiaries.

The Series A Notes and Series B Notes are prepayable at the Company’s option, in whole or in part, provided that in the case of a partial prepayment, prepayment must be in an amount not less than 5% of the aggregate principal amount of the notes then outstanding, at any time and from time to time at 100% of the principal amount prepaid, plus accrued and unpaid interest to the prepayment date, plus a “make-whole” premium as specified in the note purchase agreements. The Company must offer to prepay the notes upon the occurrence of any change of control. In addition, the Company must offer to prepay the notes upon the occurrence of certain asset dispositions if the proceeds therefrom are not timely reinvested in productive assets. If any offer to prepay is accepted, the purchase price of each prepaid note is 100% of the principal amount thereof, plus accrued and unpaid interest thereon to the prepayment date.

The respective note purchase agreements require compliance with two financial covenants. The Company must not permit its debt to capitalization ratio to exceed 50% at any time. The note purchase agreements generally define the debt to capitalization ratio as the ratio of (a) total borrowed money indebtedness to (b) the sum of such indebtedness plus consolidated net worth, with consolidated net worth determined as of the last day of the most recently ended fiscal quarter. The Company also must not permit the interest coverage ratio as of the last day of a fiscal quarter to be less than 2.50 to 1.00. The note purchase agreements generally define the interest coverage ratio as the ratio of EBITDA for the four prior fiscal quarters to interest charges for the same period. The Company was in compliance with these covenants at December 31, 2014.

Events of default under the note purchase agreements include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, a cross default event, a judgment in excess of a threshold event, the guaranty agreement ceasing to be enforceable, the occurrence of certain ERISA events, a change of control event and bankruptcy and other insolvency events. If an event of default under the note purchase agreements occurs and is continuing, then holders of a majority in principal amount of the respective notes have the right to declare all the notes then-outstanding to be immediately due and payable. In addition, if the Company defaults in payments on any note, then until such defaults are cured, the holder thereof may declare all the notes held by it pursuant to the note purchase agreement to be immediately due and payable.

The Company incurred approximately $10.8 million in debt issuance costs during 2010 in connection with the 2010 Credit Agreement and the Series A Notes. The Company incurred approximately $7.6 million in debt issuance costs during 2012 in connection with the Series B Notes and the Credit Agreement. These costs were deferred and are recognized as interest expense over the term of the underlying debt. Interest expense related to the amortization of debt issuance costs for the 2010 Credit Agreement, the Series A Notes, the Series B Notes and the Credit Agreement was approximately $2.2 million, $2.2 million and $3.4 million for the years ended December 31, 2014, 2013 and 2012, respectively. The amount for the year ended December 31, 2012 includes $978,000 of costs related to the early termination of the 2010 Credit Agreement.

Presented below is a schedule of the principal repayment requirements of long-term debt by fiscal year as of December 31, 2014 (in thousands):

 

 

 

8. Commitments, Contingencies and Other Matters

Commitments – As of December 31, 2014, the Company maintained letters of credit in the aggregate amount of $39.8 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which could become payable under the terms of the underlying insurance contracts. These letters of credit expire annually at various times during the year and are typically renewed.  As of December 31, 2014, no amounts had been drawn under the letters of credit.  

As of December 31, 2014, the Company had commitments to purchase approximately $512 million of major equipment for its drilling and pressure pumping businesses.  

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The Company’s pressure pumping business has entered into agreements to purchase minimum quantities of proppants and chemicals from certain vendors. These agreements expire in 2016, 2017 and 2018. As of December 31, 2014, the remaining obligation under these agreements was approximately $71.8 million, of which materials with a total purchase price of approximately $15.4 million are required to be purchased during 2015. In the event that the required minimum quantities are not purchased during any contract year, the Company could be required to make a liquidated damages payment to the respective vendor for any shortfall.  

In November 2011, the Company’s pressure pumping business entered into an agreement with a proppant vendor to advance up to $12.0 million to such vendor to finance the construction of certain processing facilities. This advance is secured by the underlying processing facilities and bears interest at an annual rate of 5.0%. Repayment of the advance is to be made through discounts applied to purchases from the vendor and repayment of all amounts advanced must be made no later than October 1, 2017. As of December 31, 2014, advances of approximately $11.8 million had been made under this agreement and repayments of approximately $8.6 million had been received resulting in a balance outstanding of approximately $3.2 million.  

Contingencies – In May 2013, the U.S. Equal Employment Opportunity Commission (“EEOC”) notified the Company of cause findings related to certain of its employment practices. The cause findings relate to allegations that the Company tolerated a hostile work environment for employees based on national origin and race. The cause findings also allege, among other things, failure to promote, subjecting employees to adverse employment terms and conditions and retaliation. The Company and the EEOC engaged in the statutory conciliation process. In March 2014, the EEOC notified the Company that this matter will be forwarded to its legal unit for litigation review. In November 2014, the Company and the EEOC participated in a mediation to resolve the matter.  Discussions are ongoing.  If no resolution is reached, the Company believes that litigation will ensue, and the Company intends to defend itself vigorously.  Based on the information available to the Company at this time, the Company does not expect the outcome of this matter to have a material adverse effect on its financial condition, results of operations or cash flows; however, there can be no assurance as to the ultimate outcome of this matter.  

In October 2014, the Company was notified by EPA Region 6 that it intends to seek civil penalties for alleged RCRA administrative violations at a former facility of one of the Company’s subsidiaries in Midland, Texas. The EPA subsequently alleged RCRA administrative violations at other facilities of that subsidiary and are seeking an aggregate monetary penalty of approximately $1.1 million. The Company is in negotiations with the EPA regarding the scope and amount of any potential settlement. The Company does not expect the outcome of this matter to have a material adverse effect on its financial condition, results of operations or cash flows.  

The Company’s operations are subject to many hazards inherent in the contract drilling and pressure pumping businesses, including inclement weather, blowouts, well fires, loss of well control, pollution and reservoir damage. These hazards could cause personal injury or death, work stoppage, and serious damage to equipment and other property, as well as significant environmental and reservoir damages. These risks could expose the Company to substantial liability for personal injury, wrongful death, property damage, loss of oil and natural gas production, pollution and other environmental damages.  

Any contractual right to indemnification that the Company may have for any such risk, may be unenforceable or limited due to negligent or willful acts of commission or omission by the Company, its subcontractors and/or suppliers. The Company’s customers may dispute, or be unable to meet, their contractual indemnification obligations to the Company due to financial, legal or other reasons. Accordingly, the Company may be unable to transfer these risks to its customers by contract or indemnification agreements. Incurring a liability for which the Company is not fully indemnified or insured could have a material adverse effect on its business, financial condition, cash flows and results of operations.  

 

The Company has insurance coverage for comprehensive general liability, automobile liability, workers’ compensation and employer’s liability, and certain other specific risks. The Company has also elected in some cases to accept a greater amount of risk through increased deductibles on certain insurance policies.  For example, the Company generally maintains a $1.5 million per occurrence deductible on its workers’ compensation and equipment insurance coverages and a $2.0 million per occurrence self-insured retention on its general liability coverage and $2.0 million per occurrence deductible on its automobile liability insurance coverage. The Company self-insures a number of other risks, including loss of earnings and business interruption, and does not carry a significant amount of insurance to cover risks of underground reservoir damage. If a significant accident or other event occurs and is not fully covered by insurance or an enforceable or recoverable indemnity from a customer, it could have a material adverse effect on the Company’s business, financial condition, cash flows and results of operations.  Accrued expenses related to insurance claims are set forth in Note 5.  

The Company is party to various legal proceedings arising in the normal course of its business. The Company does not believe that the outcome of these proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows.  

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Other Matters — The Company has Change in Control Agreements with its Chairman of the Board, Chief Executive Officer, two Senior Vice Presidents and its General Counsel (the “Key Employees”). Each Change in Control Agreement generally has an initial term with automatic twelve-month renewals unless the Company notifies the Key Employee at least ninety days before the end of such renewal period that the term will not be extended. If a change in control of the Company occurs during the term of the agreement and the Key Employee’s employment is terminated (i) by the Company other than for cause or other than automatically as a result of death, disability or retirement, or (ii) by the Key Employee for good reason (as those terms are defined in the Change in Control Agreements), then the Key Employee shall generally be entitled to, among other things:

Other than with respect to the Chief Executive Officer, each Change in Control Agreement provides the Key Employee with a full gross-up payment for any excise taxes imposed on payments and benefits received under the Change in Control Agreements or otherwise, including other taxes that may be imposed as a result of the gross-up payment.  

 

 

9. Stockholders’ Equity

Cash Dividends – The Company paid cash dividends during the years ended December 31, 2012, 2013 and 2014 as follows:

 

 

On February 4, 2015, the Company’s Board of Directors approved a cash dividend on its common stock in the amount of $0.10 per share to be paid on March 25, 2015 to holders of record as of March 11, 2015. The amount and timing of all future dividend payments, if any, are subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial condition, terms of the Company’s credit facilities and other factors.

On August 1, 2007, the Company’s Board of Directors approved a stock buyback program authorizing purchases of up to $250 million of the Company’s common stock in open market or privately negotiated transactions. On July 25, 2012, the Company’s Board of Directors terminated the remaining authority under the 2007 stock buyback program, and approved a new stock buyback program authorizing purchases of up to $150 million of common stock in open market or privately negotiated transactions. On September 6,

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2013, the Company’s Board of Directors terminated any remaining authority under the 2012 stock buyback program, and approved a new stock buyback program that authorizes purchase of up to $200 million of the Company’s common stock in open market or privately negotiated transactions. As of December 31, 2014, the Company had remaining authorization to purchase approximately $187 million of the Company’s outstanding common stock under the new stock buyback program. Shares purchased under a buyback program are accounted for as treasury stock.

The Company acquired shares of stock from employees during 2014, 2013 and 2012 that are accounted for as treasury stock. Certain of these shares were acquired to satisfy the exercise price in connection with the exercise of stock options by employees. The remainder of these shares was acquired to satisfy payroll tax withholding obligations upon the exercise of stock options, the settlement of performance unit awards and the vesting of restricted stock. These shares were acquired at fair market value. These acquisitions were made pursuant to the terms of the Patterson-UTI Energy, Inc. 2005 Long-Term Incentive Plan (the “2005 Plan”) or the Patterson-UTI Energy, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) and not pursuant to the stock buyback programs.

Treasury stock acquisitions during the years ended December 31, 2014, 2013 and 2012 were as follows (dollars in thousands):

 

 

 

10. Stock-based Compensation

The Company uses share-based payments to compensate employees and non-employee directors. The Company recognizes the cost of share-based payments under the fair-value-based method. Share-based awards consist of equity instruments in the form of stock options, restricted stock or restricted stock units and have included service and, in certain cases, performance conditions. The Company’s share-based awards have also included both cash-settled and share-settled performance unit awards. Cash-settled performance unit awards are accounted for as liability awards. Share-settled performance unit awards are accounted for as equity awards. The Company issues shares of common stock when vested stock options are exercised, when restricted stock is granted and when restricted stock units and share-settled performance unit awards vest.  

The Company’s shareholders have approved the 2014 Plan, and the Board of Directors adopted a resolution that no future grants would be made under any of the Company’s other previously existing plans. The Company’s share-based compensation plans at December 31, 2014 follow:

 

 

A summary of the 2014 Plan follows:

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Options granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 2005 Plan typically vested over one year for non-employee directors and three years for employees.

Options granted under the 1997 Plan typically vested over three or five years as dictated by the Compensation Committee. These options have terms of no more than ten years. All options were granted with an exercise price equal to the fair market value of the related common stock at the time of grant. Restricted stock awards granted under the 1997 Plan typically vested over four years.  

Stock Options—The Company estimates the grant date fair values of stock options using the Black-Scholes-Merton valuation model. Volatility assumptions are based on the historic volatility of the Company’s common stock over the most recent period equal to the expected term of the options as of the date the options are granted. The expected term assumptions are based on the Company’s experience with respect to employee stock option activity. Dividend yield assumptions are based on the expected dividends at the time the options are granted. The risk-free interest rate assumptions are determined by reference to United States Treasury yields. Weighted-average assumptions used to estimate grant date fair values for stock options granted in the years ended December 31, 2014, 2013 and 2012 follow:

 

 

Stock option activity for the year ended December 31, 2014 follows:

 

 

During 2014, the Company acquired 190,919 shares of treasury stock from employees upon the exercise of stock options. Shares having a market value of $4.6 million were withheld from employees and added to treasury stock to satisfy the exercise price in connection with the exercise of the stock options. Shares having a market value of $1.6 million were withheld from employees and added to treasury stock to satisfy payroll tax withholding obligations upon the exercise of the stock options.  

Options outstanding at December 31, 2014 have an aggregate intrinsic value of approximately $4.3 million and a weighted-average remaining contractual term of 4.92 years. Options exercisable at December 31, 2014 have an aggregate intrinsic value of approximately $4.2 million and a weighted-average remaining contractual term of 4.28 years. Additional information with respect to options granted, vested and exercised during the years ended December 31, 2014, 2013 and 2012 follows:

 

 

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As of December 31, 2014, options to purchase 862,000 shares were outstanding and not vested.  All of these non-vested options are expected to ultimately vest. Additional information as of December 31, 2014 with respect to these non-vested options follows:

 

 

Restricted Stock—For all restricted stock awards to date, shares of common stock were issued when the awards were made. Non-vested shares are subject to forfeiture for failure to fulfill service conditions and, in certain cases, performance conditions. Non-forfeitable dividends are paid on non-vested shares of restricted stock. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period.  

Restricted stock activity for the year ended December 31, 2014 follows:

 

 

As of December 31, 2014, approximately 1.4 million shares of non-vested restricted stock outstanding are expected to vest. Additional information as of December 31, 2014 with respect to these non-vested shares follows:

 

 

Restricted Stock Units—For all restricted stock unit awards made to date, shares of common stock are not issued until the units vest. Restricted stock units are subject to forfeiture for failure to fulfill service conditions. Non-forfeitable cash dividend equivalents are paid on certain non-vested restricted stock units. The Company uses the straight-line method to recognize periodic compensation cost over the vesting period.  

 

Restricted stock unit activity for the year ended December 31, 2014 follows:

 

 

Performance Unit Awards.  In 2009, the Company granted cash-settled performance unit awards to certain executive officers (the “2009 Performance Units”). The 2009 Performance Units provided for those executive officers to receive a cash payment upon the achievement of certain performance goals established by the Compensation Committee during a specified period. The performance period for the 2009 Performance Units was the period from April 1, 2009 through March 31, 2012. The performance goals for the 2009 Performance Units were tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals were considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the performance units. Generally, the recipients would receive a target payment if the Company’s total shareholder return was positive and, when compared to the peer group, was at or above the 50^th percentile but less than the 75^th percentile and two times the

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target if at the 75^th percentile or higher. If the Company’s total shareholder return was positive, and, when compared to the peer group, was at or above the 25^th percentile but less than the 50^th percentile, the recipients would only receive one-half of the target payment. The total target amount with respect to the 2009 Performance Units was approximately $3.4 million. Because the 2009 Performance Units were settled in cash at the end of the performance period, they were accounted for as liability awards and the Company’s pro-rated obligation was measured at estimated fair value at the end of each reporting period using a Monte Carlo simulation model. The performance period ended on March 31, 2012 and the Company’s total shareholder return was at the 46^th percentile. The resulting cash payments totaling $1.7 million were paid in April 2012.  For the year ended December 31, 2012, a compensation benefit of approximately $1.9 million was recognized.  

In 2010, 2011, 2012, 2013 and 2014 the Company granted stock-settled performance unit awards to certain executive officers (the “Stock-Settled Performance Units”). The Stock-Settled Performance Units provide for the recipients to receive a grant of shares of stock upon the achievement of certain performance goals established by the Compensation Committee during a specified period. The performance period for the Stock-Settled Performance Units is the three year period commencing on April 1 of the year of grant. For the 2012 and 2013 Stock-Settled Performance Units, the performance period can extend for an additional two years in certain circumstances. The performance goals for the Stock-Settled Performance Units are tied to the Company’s total shareholder return for the performance period as compared to total shareholder return for a peer group determined by the Compensation Committee. These goals are considered to be market conditions under the relevant accounting standards and the market conditions were factored into the determination of the fair value of the respective performance units. Generally, the recipients will receive a target number of shares if the Company’s total shareholder return is positive and, when compared to the peer group, is at the 50^th percentile and two times the target if at the 75^th percentile or higher. If the Company’s total shareholder return is positive, and, when compared to the peer group, is at the 25^th percentile, the recipients will only receive one-half of the target number of shares. The grant of shares when achievement is between the 25^th and 75^th percentile will be determined on a pro-rata basis. The performance period for the 2010 Stock-Settled Performance Units ended on March 31, 2013, and the Company’s total shareholder return was at the 93^rd percentile.  In April 2013, 357,500 shares were issued to settle the 2010 Stock-Settled Performance Units. The performance period for the 2011 Stock-Settled Performance Units ended on March 31, 2014, and the Company’s total shareholder return was at the 94^th percentile.  In April 2014, 288,750 shares were issued to settle the 2011 Stock-Settled Performance Units. The total target number of shares with respect to the Stock-Settled Performance Units is set forth below:

 

 

Because the Stock-Settled Performance Units are stock-settled awards, they are accounted for as equity awards and measured at fair value on the date of grant using a Monte Carlo simulation model. The fair value of the Stock-Settled Performance Units is set forth below (in thousands):

 

 

These fair value amounts are charged to expense on a straight-line basis over the performance period. Compensation expense associated with the Stock-Settled Performance Units is set forth below (in thousands):

 

 

Dividends on Equity Awards – Non-forfeitable cash dividends are paid on restricted stock awards and dividend equivalents are paid on certain restricted stock units. These payments are recognized as follows:

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11. Leases

The Company incurred rent expense of $51.9 million, $47.4 million and $39.0 million for the years ended December 31, 2014, 2013 and 2012, respectively.  Rent expense is primarily related to short-term equipment rentals that are generally passed through to customers.  

Future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 2014 are as follows:

 

 

 

12. Income Taxes

Components of the income tax provision applicable to federal, state and foreign income taxes for the years ended December 31, 2014, 2013 and 2012 are as follows (in thousands):

 

 

The difference between the statutory federal income tax rate and the effective income tax rate for the years ended December 31, 2014, 2013 and 2012 is summarized as follows:

 

 

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The Domestic Production Activities Deduction was enacted as part of the American Jobs Creation Act of 2004 (as revised by the Emergency Economic Stabilization Act of 2008) and allows a deduction of 9% in 2010 and thereafter on the lesser of qualified production activities income or taxable income. The permanent difference for 2012 does not include any deduction as it is limited to taxable income and the Company did not have taxable income in 2012 due to the utilization of net operating loss carryforwards. The permanent differences for 2013 include a deduction of $10.0 million as the Company fully utilized its remaining net operating loss carryforwards. The permanent difference for 2014 includes a deduction of $8.8 million.  

The tax effect of significant temporary differences representing deferred tax assets and liabilities and changes therein were as follows (in thousands):

 

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. The Company expects the deferred tax assets at December 31, 2014 and 2013 to be realized as a result of the reversal of existing taxable temporary differences giving rise to deferred tax liabilities and the generation of taxable income; therefore, no valuation allowance is considered necessary.

Other deferred tax assets consist primarily of the tax effect of various allowance accounts and tax-deferred expenses expected to generate future tax benefits of approximately $38.4 million. Other deferred tax liabilities consist primarily of the tax effect of receivables from insurance companies and tax-deferred income not yet recognized for tax purposes.

For income tax purposes, the Company has approximately $164 million of state net operating losses that can be carried forward as of December 31, 2014. The state net operating losses that can be carried forward, if unused, are scheduled to expire as follows: 2016—$6.8 million; 2025—$630,000; 2026—$16.9 million: 2029—$31.9 million; 2030—$25.7 million; 2031—$82.5 million.

As of December 31, 2014, the Company had no unrecognized tax benefits. The Company has established a policy to account for interest and penalties related to uncertain income tax positions as operating expenses. As of December 31, 2014, the tax years ended

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December 31, 2011 through December 31, 2013 are open for examination by U.S. taxing authorities. As of December 31, 2014, the tax years ended December 31, 2010 through December 31, 2013 are open for examination by Canadian taxing authorities.

On January 1, 2010, the Company converted its Canadian operations from a Canadian branch to a controlled foreign corporation for federal income tax purposes. Because the statutory tax rates in Canada are lower than those in the United States, this transaction triggered a $5.1 million reduction in deferred tax liabilities, which is being amortized as a reduction to deferred income tax expense over the weighted average remaining useful life of the Canadian assets.  

As a result of the above conversion, the Company’s Canadian assets are no longer directly subject to United States taxation, provided that the related unremitted earnings are permanently reinvested in Canada. Effective January 1, 2010, the Company has elected to permanently reinvest these unremitted earnings in Canada, and intends to do so for the foreseeable future. As a result, no deferred United States federal or state income taxes have been provided on such unremitted foreign earnings, which totaled approximately $47.5 million as of December 31, 2014. The unrecognized deferred tax liability associated with these earnings was approximately $7.2 million, net of available foreign tax credits. This liability would be recognized if the Company received a dividend of the unremitted earnings.

 

 

13. Employee Benefits

The Company maintains a 401(k) plan for all eligible employees. The Company’s operating results include expenses of approximately $7.2 million in 2014, $6.2 million in 2013 and $5.4 million in 2012 for the Company’s contributions to the plan.

 

 

14. Business Segments

The Company’s revenues, operating profits and identifiable assets are primarily attributable to three business segments: (i) contract drilling of oil and natural gas wells, (ii) pressure pumping services and (iii) the investment, on a non-operating working interest basis, in oil and natural gas properties. Each of these segments represents a distinct type of business. These segments have separate management teams which report to the Company’s 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.

Contract Drilling — The Company markets its contract drilling services to major and independent oil and natural gas operators. As of December 31, 2014, the Company had 239 land-based drilling rigs in the continental United States, and western and northern Canada.

For the years ended December 31, 2014, 2013 and, 2012, contract drilling revenue earned in Canada was $87.5 million, $86.6 million and $79.4 million, respectively. Additionally, long-lived assets within the contract drilling segment located in Canada totaled $57.6 million and $69.1 million as of December 31, 2014 and 2013, respectively.

Pressure Pumping — The Company provides pressure pumping services to oil and natural gas operators primarily in Texas and the Appalachian region. Pressure pumping services are primarily well stimulation services (such as hydraulic fracturing) and cementing services for the completion of new wells and remedial work on existing wells. Well stimulation involves processes inside a well designed to enhance the flow of oil, natural gas, or other desired substances from the well. Cementing is the process of inserting material between the hole and the pipe to center and stabilize the pipe in the hole.

Oil and Natural Gas — The Company owns and invests in oil and natural gas assets as a non-operating working interest owner. The Company’s oil and natural gas interests are located primarily in Texas and New Mexico.

Major Customer — No single customer accounted for 10% or more of consolidated operating revenue in 2014. During 2013, one customer accounted for approximately $286 million or 10.5% of the Company’s consolidated operating revenues. These revenues were earned in both the Company’s contract drilling and pressure pumping businesses. No single customer accounted for 10% or more of consolidated operating revenues in 2012.

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The following tables summarize selected financial information relating to the Company’s business segments (in thousands):

 

 

 

 

 

15. Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of demand deposits, temporary cash investments and trade receivables.  

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The Company believes it has placed its demand deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2014 and 2013, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands):

 

 

Concentrations of credit risk with respect to trade receivables are primarily focused on companies involved in the exploration and development of oil and natural gas properties. The concentration is somewhat mitigated by the diversification of customers for which the Company provides services.  As is general industry practice, the Company typically does not require customers to provide collateral.  No significant losses from individual customers were experienced during the years ended December 31, 2014, 2013 or 2012.  No provision for bad debts was recognized in 2014 or in 2013.  The Company recognized $1.1 million provision for bad debts in 2012.  

 

 

16. Fair Values of Financial Instruments

The carrying values of cash and cash equivalents, trade receivables and accounts payable approximate fair value due to the short-term maturity of these items. These fair value estimates are considered Level 1 fair value estimates in the fair value hierarchy of fair value accounting.

The estimated fair value of the Company’s outstanding debt balances (including current portion) as of December 31, 2014 and 2013 is set forth below (in thousands):

 

 

The carrying values of the balances outstanding under the revolving credit facility and the term loan facility approximate their fair values as these instruments have floating interest rates. The fair values of the Series A Notes and Series B Notes at December 31, 2014 and 2013 are based on discounted cash flows associated with the respective notes using current market rates of interest at those respective dates. For the Series A Notes, the current market rates used in measuring this fair value were 5.77% at December 31, 2014 and 4.52% at December 31, 2013. For the Series B Notes, the current market rates used in measuring this fair value were 6.00% at December 31, 2014 and 4.89% at December 31, 2013. These fair value estimates are based on observable market inputs and are considered Level 2 fair value estimates in the fair value hierarchy of fair value accounting.

 

 

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17. Quarterly Financial Information (in thousands, except per share amounts) (unaudited)

 

 

 

 

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PATTERSON-UTI ENERGY, INC. AND SUBSIDIARIES

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

 

 

 

 

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Patterson-UTI Energy, Inc. has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: February 12, 2015

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of Patterson-UTI Energy, Inc. and in the capacities indicated as of February 12, 2015.

 

 

 

 

 

 

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EXHIBIT INDEX

 

 

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