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Pioneer Energy Services (NYSE:PES)

Q3 2013 Earnings Call

October 30, 2013 11:00 a.m. ET

Executives

Anne Pearson - Dennard-Lascar Associates

Stacy Locke - President and Chief Executive Officer

Lorne Phillips - Executive Vice President and Chief Financial Officer

Red West - President, Drilling Services

Analysts

Brian Uhlmer - Global Hunter Securities

John Daniel - Simmons & Company

Mike Urban - Deutsche Bank

Michael Cerasoli - Goldman Sachs

Daniel Burke - Johnson Rice & Company

Brad Handler - Jefferies

Jason Wrangler - Wunderlich Securities

David Wilson - Howard Weil

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Pioneer Energy Services Third Quarter Earnings Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions) This conference is being recorded today, October 30, 2013.

I would now like to turn the conference over to Anne Pearson. Please go ahead ma'am.

Anne Pearson

Thank you, George, and good morning everyone. Before I turn the call over to Stacy Locke and Lorne Phillips for their formal remarks, I have a few of the usual items I need to cover.

First of all, a replay of today’s call will be available and accessible by webcast by going to the IR section of Pioneer’s website and also by telephone replay. You can find all the replay information for both in this morning’s news release. Also as a reminder, information recorded on this call speaks only as of today, October 30, 2013, so any time sensitive information may no longer be accurate at the time of a replay.

Management may make forward-looking statements today that are based on their beliefs and assumptions and information that’s currently available to them. While they think these expectations reflected in these statements are reasonable, they can give no assurance they’ll prove to be correct. They are subject to certain risks and uncertainties and assumptions described in the news release, and also in recent public filings with the SEC. If one or more materializes or should underlying assumptions prove to be incorrect, actual results may differ materially. Also, please note that this conference call may contain certain references to non-GAAP measures. You’ll find a reconciliation to GAAP measures in this morning’s news release.

And now I’d like to turn the call over to Stacy Locke, Pioneer’s President and CEO. Stacy?

Stacy Locke

Thank you, Anne, and good morning. I appreciate everyone joining our third quarter call. Joining me here in the conference room is Red West, President of our Drilling Services segment and Lorne Phillips, our Chief Financial Officer.

As you can see from this morning's press release, we had a very solid third quarter. Revenue of $244 million, EBITDA of $60 million and breakeven net earnings when you net out the impairment on the drilling rigs. We made progress on several of our key initiatives during the quarter. We kept a very tight rein on capital spending allowing us to further reduce indebtedness since the beginning of the quarter and including our October payments by another $25 million.

We also saw another quarter of relative stability in our coil tubing business. Still nowhere near where we wanted it to be but directionally it is getting subtly better and we are still optimistic that we will continue to improve that business. And then also during the quarter we were -- or just after the quarter we were able to successfully sell another eight of our mechanical rig fleet. These were rigs that had been stacked for a pretty good period of time that we felt like we were not going to have an opportunity to put to work in the near term and so we just recently sold those, thus the impairment.

So that now is a total of 18 mechanical rigs including a lot of our lower horsepower rigs that have been sold in the last two years. As we sit today with the remaining 82 rig fleet -- excuse me, 62 rig fleet, 74% of those remaining rigs are capable of drilling the horizontal plays and the majority of those are contracted in doing exactly that. Looking down at our production services segment. Both wireline and well services had record quarters in terms of revenue, helping our production service segment overall achieve a 3% increase in revenue on a stable 36% operating margin.

Wireline has had a very steady couple of quarters in a row with higher average revenue per job which is in part as a result of a changing mix of the business to in an increased amount of plug and perf completion work as opposed to pricing improvement. However, I would say companywide pricing is stable in wireline.

On the well servicing front, we continue to perform very, very well. Another quarter of high utilization and 90% with actually a modestly improved average hourly rate of $628 an hour which was up from $606 in the second quarter. And they achieved not only their greatest revenue in any quarter but their greatest EBITDA ever in this quarter. So we are really pleased with that success. Coil tubing was actually off a little bit in revenue and EBITDA relative to the second quarter, but utilization was an improved 53%. We have had to adjust some pricing in the onshore market which has helped utilization and that’s also helping us build up a steady client base in that market that we feel like is important.

We have taken some of that pricing power back and some modest increases and we will continue to try to do that. Soon, probably in December, we will be operating our two and three-eighths coil in the offshore market and we believe that space is considerably less oversupplied than the two inch coil market. So we are excited about those prospects for 2014.

Turning now to the drilling services segment. It was off 5% in revenue and over 10% in EBITDA quarter-over-quarter but that is in a large part due to having a tough comparative quarter. You know as we talked about in the second quarter call, we had some one time benefits that materially helped the second quarter in that you had the earning and not working rigs and some fuel reimbursement done in Colombia that for the most part dropped right to the bottom line. But outside of that, drilling had a very solid quarter both in the U.S. and in Colombia. Utilization was down a bit and that was mostly due to the stacked mechanical rigs the majority of which were in West Texas though we had a few sprinkled at other places, and those have now been sold.

Average margin per day was also off a little bit compared to the second quarter, mostly for the reasons that we have already talked about, the fuel reimbursement and the earning but not working rigs. Colombia was actually off quarter-over-quarter in margin as well and that was largely due to cost associated with stacking out a couple of rigs. One on a temporary basis that is actually on a contract and expected to go out in the next week or so, and then the other one is stacked looking for work at the present time.

Seven of the eight rigs in Colombia are contracted including the rig that is about to go out is waiting on location to be completed. And we operated at 90% utilization for the quarter in Colombia. Six of the rigs in [indiscernible] field are up for renewal at the end of this year and we are in the, kind of customary negotiations to renew these rigs. However, this year our client is desiring all of its contractors to enter a new contract form that runs more services through the contractor which is making this current process a little bit more challenged. But I would say we are still optimistic about the outcome. We have been through the renewal process many, many times over our six years in Colombia and it's always turned out pretty favorably. So we are hopeful that that will be the results again this year.

Looking at the rest of the United States. Our rigs are performing extremely. We are 100% utilized in the Marcellus Shale with four rigs. We are 100% utilized in the Bakken with 11 rigs. We are 92% utilized in our South Texas division which incorporates the Eagle Ford Shale with 13 rigs. Therefore we have just one rig down in that market today. 89% utilized in the Permian Basin with 18 rigs which means two rigs are down. 71% utilized in the Uinta Basin with a total of seven rigs. There again two rigs down. And then we have one stacked rig in East Texas.

So in total seven of our 62 rigs are currently stacked as of today and 69% of those working rigs are operating on a term contract. So at this point I would like to turn the call over to Lorne to go over some financials and then I will end it with some guidance.

Lorne Phillips

Thanks, Stacy. This morning we reported consolidated revenues of $244 million and adjusted EBITDA of $59.4 million. We reported a net loss of $6.2 million or $0.10 a share in the third quarter which includes a $9.5 million impairment primarily on the sale of eight idle mechanical drilling rigs. As Stacy mentioned, if you exclude the impairment we had an adjusted net loss of $0.2 million or breakeven earnings per share.

Revenues in the drilling segment were down 5% from the second quarter to $131 million driven by the two items Stacy discussed. There was a reduction of $4.4 million quarter-over-quarter and revenue related to rigs that were earning standby day rates but not working. Second, in the second quarter we also had the benefit of $1.8 million of fuel cost reimbursements in Colombia that we did not have in the third quarter. If you eliminate the impact of those two items from the second quarter, our drilling revenues would have been down approximately $1 million quarter-over-quarter.

Average drilling rig utilization in the third quarter was 80%. Removing the eight rigs we sold from the third quarter calculation, that number would have been 89% which is also our current utilization. Drilling margin per day was 8056 and the decline in margin per day is mainly due to the same two items that impacted revenue. With the sale of the eight rigs we now have 62 drilling rigs. Of these 55 are earning revenues and 38 are under term contract.

Breaking out more detail on the term contracts. Six are in Colombia under contract to the end of 2013 and as Stacy mentioned we are negotiating to renew those rigs. In the U.S., five rigs are up for renewal in the fourth quarter, ten in the first quarter of next year and three in the second quarter of 2014 and 14 expire beyond that point. The percentage of the total company's gross margin from non-top drive mechanical rigs in the third quarter was approximately 5%. If you include all mechanical rigs that number is approximately 11%.

Looking at production services. Revenues increased 3% to $112.9 million. Gross profit was $41 million, also up 3% from the second quarter. Gross margin was 36.3% flat with the prior quarter. Looking now at companywide expenses for the third quarter. Interest expense was flat at $12.3 million. We expect the fourth quarter interest expense to be approximately $12 million. G&A expense was flat at $23.9 million and is expected to be in the $23 million to $24 million range again in the fourth quarter.

Depreciation and amortization expense was $47.4 million also flat versus the prior quarter. In this fourth quarter, this expense is estimated to be around $47 million to $48 million. Our effective tax rate for the third quarter was 36.7% and excluding the impact of currency gains or losses we continue to expect the tax rate in the neighborhood of 38% to 40%.

Turning now to the balance sheet. Cash totaled $17.1 million at the end of the third quarter and we had $115 million outstanding on our revolving credit facility as of September 30. An additional $10 million was paid in October which puts our current total outstanding under our revolver at $105 million. Since the beginning of June, we have reduced the outstanding balance under our credit facility by $35 million and we are positioned to continue to make meaningful reductions in our debt level over the next several quarters.

Capital spending in the third quarter totaled $26 million, down from $41 million in the prior quarter. We expect full year CapEx to be the in $165 million range, up from our previous guidance of $140 million to $160 million. To help secure term drilling contracts, we invested in additional walking systems and other upgrades for certain drilling rigs which lead to slightly more 2013 CapEx than originally forecasted. We are still developing our capital spending plan for next year but it should be substantially lower than in 2013. Our preliminary expectation is for the 2014 CapEx budget to be approximately $100 million or a little higher with around $65 million to $75 million representing routine and maintenance spending.

And with that I will turn it back over to Stacy.

Stacy Locke

Thank you, Lorne. I think as we look out into 2014, I think we believe that unquestionably it will be a very active year barring some unexpected decline in oil prices. I think the question that exists out there is what's going to happen with capital spending. I think we are of the belief that capital spending on average will be greater in '14 than it was in '13 and possibly will cause rig count to improve. I think we lean in that direction. It's hard to know at this point. We did not see that occur in '13 but with improved spending and from what we are hearing from a number of our clients, we have a number that are planning to pickup in rig counts. Some going lower but I think the majority are holding the same or increasing the rig count for '14. So we are cautiously optimistic. And if that occurs, we feel like that will lead to some pricing improvement opportunities in not only just drilling but all of our core businesses.

You know and I would I tell you that generally in the production service side, I think it's pretty indisputable that that’s going to be very active side of the market as well for '14. So for our fourth quarter I think our guidance leans a little to the conservative side but we do have some unknowns in the quarter and that’s why we have guided where we have guided. If you look at drilling, we are guiding 84% to 87% in the fourth quarter as opposed to the 89% that we have today. And that’s largely because we feel that there is some risk for one or two more rigs in West Texas possibly going down. Another rig possibly going down Utah. But we are currently marketing these rigs and things change on a regular basis there and overall, I would say in the Permian the market is pretty solid right now.

In terms of margin per day, we are forecasting 7500 to 7900 in margin per day versus the 8059 that we experienced in the third quarter. And that would be the result of downward movements in some rigs on pricing. One area that we had pricing pressure has been in the Bakken, mostly due to peers competing on pricing there very very aggressively. Trying to kind of buy market share. We have not had to lower our pricing anything close to what they are bidding but we have had to come down some. And we continue to perform very well. We haven't lost any rigs there, we don’t anticipate losing any rigs there. But it has put a little bit of a downward pressure on the pricing. Hopefully that will become more favorable next year, but.

And then in few select cases in other parts of the country we have had some of the pricing adjustments. But that’s what we are forecasting for the margin that it will come down due to the full realization of some of the downshifts we have made on pricing. Looking on the production services side. We are forecasting a decline in revenue which is customary for the fourth quarter. 79% in total with a margin decline of perhaps 1% to 2%. I would say 5% to 6% of that is normal seasonality. But we have added a couple of few percent on top of that because we had some cases where clients have discussed that they front-end loaded their budgets in '13 and we have seen a few indications of clients starting to slow down into this fourth quarter already which we fear could impact it a little, or exacerbate it a little greater than the normal seasonality.

So that’s the logic behind our forecasting. I hope it proves to be conservative but I feel like we have got it fairly well covered. So that concludes our prepared remarks. We would be happy to entertain any questions that you have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Brian Uhlmer with Global Hunter. Please go ahead.

Brian Uhlmer - Global Hunter Securities

I had a couple of quick ones. First one, on your decrease in production services for Q4, is that primarily utilization or is that going to have some price effect as well on your hourly rate?

Stacy Locke

I would say it's mostly utilization with some modest price deterioration.

Brian Uhlmer - Global Hunter Securities

Okay. And following up on that cue, was there a mix impact to help you on price in this quarter? Was there a specific basin or is there something that led to this nice price increase, number one? And number two, how do you see that holding up as we go through '14 on that hourly rate?

Stacy Locke

Well, on well servicing, the hourly rate has run very very high. In this quarter, the third quarter, it was the highest we have seen ever. There that is a mix. There is mix associated with that and if that mix changes, which we would anticipate that it would during the quarter just as people slowdown some of that 24-hour work. That that we could see a little bit of pricing pull -- what would appear to be a pricing pullback which in reality is more of a mix adjustment. But we also see a utilization pullback there in this quarter which is seasonal. And then as I mentioned previously, there could be a little early spending on budget that may cause it to pull back a little further than normal.

On the wireline front, I think that the same is true. We probably increased our mix here of late in the plug and perf market which causes revenues to go up, costs go up too. But we have seen a little bit more of that in this third quarter in particular and that will probably continue into the fourth quarter.

Brian Uhlmer - Global Hunter Securities

Okay. Then for 2014 do you think you can hold above 620 or even go above that for '14 as we get through the year or get back on the...?

Stacy Locke

On the well servicing front I think...

Brian Uhlmer - Global Hunter Securities

On the [indiscernible]?

Stacy Locke

Yeah, on the well servicing front I think that I would say that -- I would say on average we think that the low 600s would be a floor and that there is a lot more upside than there is downside. You know the space is still underserved. We want to add more equipment to that market but we are trying to get some debt paid down first. But it's a very, very strong market. We think it will probably be stronger in '14 than '13 which would allow us to move the pricing a little bit.

Brian Uhlmer - Global Hunter Securities

Perfect. And a quick question. My second question is on Colombia. Curious on the contract. Does that imply that your revenues are going to go up and your margins are going to go down? You are going to have more pass-throughs or what were you trying to point us to in regards to the contract negotiations with more services being included?

Stacy Locke

Well, that was more a truth and lending clause. You know they are just a change here. We have had the same contract for a number of years down there and it's what we know and has worked well for us. And this is quite a bit of different and I don’t know whether in the end that this contract is going to be the form that people sign, because it is extremely complex and adds a number of variables in there and other services that we are not -- we don’t customarily run through our side of the business. And I think there is a lot of resistance to the contract for them.

And so I wanted to point it out because it is something new and different. We have faced challenging negotiations in the past in the country. This is no different than the past but it does involve this new contract form. But to answer your question specifically, if we do move to the form, for sure revenues will go up significantly but I don’t yet know what margins would do. You know because of increased cost and potentially even risk to the contractor, the margins could go up. We are just in that stage of trying to -- there is a lot of Q&A going back and forth between the various contractors and Ecopetrol on this contract from and so we don’t -- it's so complex that to me it's hard to see how it can be resolved prior to year-end. But I don’t know. It possibly could. They say that’s what they would like. So that’s the way we are proceeding on it.

Operator

Thank you. And next we have Dave Wilson with Howard Weil. Please go ahead.

David Wilson - Howard Weil

I know you guys have been very focused on debt reduction, but given the asset sales, the underutilized rigs and competitors that continue to build new rigs, how far are you guys in the process of evaluating further newbuilds? Is that something on the docket for 2014, especially given, Lorne, your comments on CapEx? The difference between maintenance and what you all [probably] expect to spend next year?

Stacy Locke

Well, I would say that we have had opportunities to bid newbuilds and we have basically passed on them. I think the opportunity for us due to the performance of the rigs that we have put out is a good opportunity. But we need to get some debt reduced before we are ready to start signing contracts. So we don’t know the timing of that yet but I would say at the earliest it will be kind of the middle of next year or later, if at all, in '14. And the terms and conditions too aren't quite as favorable presently due to a lot of our peers offering equipment, as I mentioned earlier in my comment about the Bakken, there is a number of our peers that are trying to gain their market share back and they are bidding very competitively. So we don’t have as many bullets to fire so want to make sure that each one counts, and we have a very good contract with excellent terms and conditions in order for us to spend that kind of money.

So I think it's going to be a more favorable pricing or contracting environment late in '14 and into '15 than it is today. So I don’t feel like we have missed a lot but we certainly could have probably been building on a rig or two or three already just due to the success of our newbuild program. Lorne do you want to add any -- to that on the debt?

Lorne Phillips

Well, I just think we are extremely focused on that, to your point David. And we definitely view probably the whole year but definitely the first half of the year as the primary focus being reducing the debt. And so I would just second Stacy's comments.

David Wilson - Howard Weil

Great. Thanks for that guys. And then also you have been providing guidance for the quarters immediately ahead. And I know fourth quarter has some seasonality, in particular on the production service side. So wanted to go a little further out and see if you accept that seasonal weakness to extend into the first quarter of next year as well?

Lorne Phillips

I think the way we see it is that, as Stacy said, we expect 2014 to be very active. First quarter does have seasonality in it as well, just like Q4. But I guess, we expect it to be improving in the first quarter. But also in past years there has been times when people have expected it to -- the first week of January to kick off with a bang. And we think that that’s usually the exception so we wouldn’t expect that to happen this year where it just takes off. It's typically a gradual improvement. But we are very positive about the outlook for '14 and we think that will start in the first quarter but it will be gradual and not immediate at the turn of the new year.

Stacy Locke

And that’s only for half of our business as you know, because drilling has almost no seasonality to it.

Lorne Phillips

Right.

Stacy Locke

Maybe a little bit in the fourth quarter, as I mentioned earlier, relating to rigs on spot as they come to the budget year-end. But really very minimally. So Lorne is really referring about the production service side of the business.

David Wilson - Howard Weil

Right. And then one last one, if I could sneak one in. Off the assets that were sold, were any of those, the Series 60 rigs?

Stacy Locke

No.

Operator

Thank you. And next is John Daniel with Simmons & Company. Please go ahead.

John Daniel - Simmons & Company

Any chance we can get a little bit of color on the margin differences between the three production service business segments.

Stacy Locke

Well...

John Daniel - Simmons & Company

[Indiscernible] I am asking.

Stacy Locke

I would just give you, the strong businesses in production services are wireline and well service. Historically wireline has been the strongest but due to the improvements we have seen in well servicing in 2013, I would say from a margin perspective it's definitely right there with wireline. Wireline has come down, well servicing has improved. Wireline is a down 10 or so percentage points of margin relative to revenues over about a year, little in a year and a quarter maybe. Whereas well servicing has just been steadily improving.

So those have become pretty neck and neck. Wireline is still a little bit larger than well service but those are two big powerful core businesses of ours that are getting close to being neck and neck. Coil on the other hand is considerably less in revenue and margins. We don’t want to -- we don’t really put a lot of color around that but it's just not even comparable in terms of margin. But we do -- hopefully that’s going to improve as we offer two and three-eighths and we maybe get a little bit -- we seem to see some settling out in the coil market and so we hope that will pickup. At the time we purchased it we fully anticipated it to be on par with wireline at the time.

John Daniel - Simmons & Company

Sure. Okay. You did provide -- I am just going through the release again -- utilization for the well servicing business and from the coil business. Can you just give us some color on utilization and then wireline this quarter versus last quarter? Like how do you track on 24-hour day, 5-day week, what's the measure -- how do you measure that?

Lorne Phillips

The measurements we -- we look at lots of different things as you know but one of the primary ones that is the number of jobs we have completed and the revenue per job, and then try and dig into the revenue per job to sort out mix versus pricing. But in terms of utilization I think it was flat to slightly up. So it was a busy quarter as you would expect. Third quarter is typically strong for wireline. And utilization was there and as Stacy said, pricing was pretty stable and we saw a little more emphasis on the plug and perf and then helped cause the revenues to go up a little higher. It brings cost up as well but that was contributing to the overall performance of production services.

John Daniel - Simmons & Company

Okay.

Stacy Locke

And I think that evolution to more pad work is why the mix change. We are going out on a number of pads in certain markets where we are doing two-way, three-way, even four-ways zipper fracs. So you are out there with -- well, we are even doing it on coil where we have two coil units out on one location at the same time on different wells. Wireline, we are out and we are servicing four different well bores at a time. So you are out there for a very concentrated period of time. 24 hours a day for a week or longer.

John Daniel - Simmons & Company

Okay. All right. And then just last one from me on the capital structure, and I am sure this is in the 10-K but just to save me the trouble, when are the senior notes callable and at what point do you start [portraying] to bring those down. I think that I [indiscernible] end of the call, that it was March of '14?

Lorne Phillips

That is correct. It's early March of '14. And from a timing perspective I think we are just going to be continuing to evaluate it. We talked about the fact that we would like to get a lower coupon but we would also like to reduce the total amount outstanding out of the bonds. And so the timing is going to be dependent or in fact variable and the timing is going to be how quickly we are able to pay down on the revolver. And so we are going to evaluate that as it goes. We would like to do it as early as we can but we also want to make sure that we reach that outcome of having reduced total debt on the bonds and that requires a certain level of capacity on your revolver.

Operator

Thank you. And our next question is from Mike Urban with Deutsche Bank. Please go ahead.

Mike Urban - Deutsche Bank

Stacy, you talked a little bit about, if you do see the rig count improve next year you ought to be able to get a little bit of pricing really across your businesses and that I think you included the drilling rig business in there. But right you are, I guess are actually still seeing a little bit of net pricing pressure. What's kind of the threshold there or the point at which that flips positive if you kind of maintain this flat market or maybe it's up a little bit. I mean would you still expect to see that pricing where is it kind of stabilizing. Just trying to get a sense for the order of magnitude improvement we would need to see before you think you can begin to see these prices back in the right direction.

Stacy Locke

Well, that’s somewhat dependent on what the peer group does. But I would say in the normal environments when -- you know it's a very active market that we are in, for sure. Average rig count across the country and our fleet and others fleet is still is high. So it's still a, it's good solid market except that we have had just a slightly declining rig count which puts the leverage in the hands of the operators. And typically if you could just change that and add a little bit more demand and have that leverage just shift slightly towards the contractors as if there is a more need for rigs, then you can start getting that pricing power back. As soon as someone feels a little bit of a scarcity or difficulty of getting a rig, that price can start moving. And we are so close to equilibrium that that can happen fairly easily.

The issue out there that we have seen in 2013 is that in a declining rig count market certain of our peer group have been continuing to put a number of newbuilds out. And in order to do so they have had to materially lower their day rates and their terms and conditions for the newbuilds. In other words the longer ten-year of churn that we had in the '11 and '12 environment has really shortened. So these guys are essentially buying market share back with newbuild which is their individual strategy.

I think that’s going to continue into 2014 and that there will be more newbuilds at it for sure. So it's a little complex. You need demand enough to absorb those newbuilds in addition to causing little bit more demand on the existing rigs. So it's tough. But I think if you get a 50 to 100-150 rig improvement in the overall market, that will be sufficient to drive a little bit of pricing. But just time will tell. I mean we have disagreements right here at our camp about what will happen or won't happen, it's tough to figure out. You got a lot of moving pieces. But in the years past what I have observed is, if you can get this a little bit of incremental demand over the market, you will get some pricing power back.

And of course any rig count improvement will assist all of our other production service sides of the business, particularly on the completion side of their mix, which varies amongst those businesses but it does have an impact on it which will help that pricing.

Mike Urban - Deutsche Bank

Great. That’s....

Stacy Locke

Did I do a good job of not answering your question?

Mike Urban - Deutsche Bank

Excellent as always. Actually that was very very helpful. And then on the production services side of the business. You guys seem to hold up much better than what we have seen from some of your larger peers in this segment. And I don’t have a feel for this because again you don’t have insight into their business, but do you think that’s a function of just where you are and where you have located equipment. Is it that you generally have newer, better equipment because you have the -- and cut price in certain instances. Just trying to get a sense for them. There has been a clear divergence in your performance in that business versus others.

Stacy Locke

Well, we have had -- it's a little bit like the H&P story in the land drilling market. We have had the chance to come out with a newer, modern fleet, all at the high end of the market. And it just happened to be in the sweet spot of where the activity has gone to. You know all of the deeper, horizontal, high decline rate oil on the conventional plays. And of course we are doing still a lot of the deeper gas but a lot of the new growth has come from the new shale plays.

So we were just -- we built the right fleet for what's evolved as a marketplace and we just are in the sweet spot and our people are extremely good. Our safety is off the charts good in well servicing. PRIR of well under 1, which I am sure is the best in the industry by a pretty good margin. Management is superb. We would put them up against any management team out there. So it's just -- they are doing everything right. They watch your cost. They have the right equipment. They maintain the equipment. They are very safe. And we just get -- once we get in with the client, they typically just want more of our rigs. So it's just -- that team is just doing a very, very good job. And I would say the same for wireline. That wireline group is stellar. They are just first rate and we have, in both of those business lines we have completely blue chip customer base. We have pretty much all repeat customers and we are taking on new, big independents and super majors on a pretty regular basis. So they are both doing an excellent job.

Operator

Thank you. And next is Michael Cerasoli with Goldman Sachs. Please go ahead.

Michael Cerasoli - Goldman Sachs

Just a follow up on the debt pay down strategy. Looks like that story is on track. When you talk about always being able to go after new organic growth in mid-2014, are you sort of implying there is a way that you can accelerate those pay down without losing any competitive advantages or are you comfortable with the current pace?

Stacy Locke

That’s a good question. I think as we have discussed in the past, Mike, is that we are exploring ways to accelerate the debt payment. We are looking for any assets that we view as non-core to our strategic direction to monetize. Good example of these, drilling rigs. But we have other things that we are looking at. We don’t know that anything will happen on any of these other ideas. But if they all happened, it could put us in a position where we could accelerate that debt repayment. But we are not planning for it. We are hopeful but the plan, as Lorne said, is to keep blocking and tackling and building cash flow and plowing it towards the debt. And we will do it at the first opportunity that we can lower the total amount of the bond indebtedness.

Michael Cerasoli - Goldman Sachs

That’s great. And then kind of thinking about the sales of the mechanical rigs more recently. These were all idle rigs. Would you consider selling any of the mechanical rigs that are currently working or is that not in the cards as they are just too much of a gap between the bid and ask to get that done.

Stacy Locke

Well, you hit it on the last point there. There is just really no incentive to sell a rig that’s working because it is generating EBITDA and a return on that asset. And a number of these rigs that we sold were rigs that we recently fixed up, added some equipment and deployed into the West Texas oil market. And that’s why this batch had a higher impairment. You know if you look at the 18 rigs across the board as a whole, the impairment is somewhere on the order of $0.5 million a rig, I think. So it's a lot less when you take it in total. But this batch, a number of them were recently upgraded. And so time is our friend in terms of depreciation. Every year down the road further that we can keep these rigs working since that upgrade process recently as we more rigs to West Texas, the depreciation is steep. And so our preference is to continue working them and let the market determine that outcome.

If we do stack rigs, if there is some change, say for instance in West Texas that we today don’t foresee, and some of our key clients discontinue their vertical program and we stack some rigs out and they are stacked for a while and we don’t see an opportunity to put the rigs back to work, then we will do what we did here and turn that into cash and help it reduced our indebtedness. But we are not seeing that right now. I would say, in fact just yesterday I was reviewing with our head of marketing four of our rigs, I think all of them were in West Texas, that are just renewing for another six month term.

So I think that we are still seeing a fairly good market. But that can change. It changed on us rather abruptly about a year ago. It could happen again, but we don’t have any knowledge of it at this point, so we are optimistic we would rather work them then sell them like we did in this recent sale. We would rather have them contribute to EBITDA than not.

Michael Cerasoli - Goldman Sachs

Okay. And then kind of thinking about the other end on the conversation, you talked about opportunities to build more new rigs. Were these opportunities more general in nature? Were they specific to a single client or a single region?

Stacy Locke

Well, these were not specific. One of the clients is someone that we don’t do drilling for but we do other services for them. They are very very big, independent that one or more of our rigs in their program, which is a pretty massive program in the Eagle Ford, solely because of the performance they have heard about of the rig that we have down the Eagle Ford. So that’s the best. When you can have someone hear how good a rig is performing and say, we would like one of those. Because our rigs are a little different than the rigs that are being offered out there by our peers.

The same are in two other markets. We have the same type situation where the existing client either wants more of the newbuild or someone in that market is seeing and hearing what our rigs are doing in that market and they too would like some. So I would just say that I am really pleased with how well those newbuilds have performed and it's opening up these doors and opportunities to us that we will walk through at some point and we are eager to get back to building but we were just committed to get in our balance sheet in a spot that we are comfortable with and then we can start building on a more selective basis going forward out of cash flow. So our indebtedness improves over time as opposed to it gets worse.

Michael Cerasoli - Goldman Sachs

Yeah, I am all for concentrating on the balance sheet, but just to kind of press the newbuild point. I am curious, if your talks ever went this far but was the customer thinking two-year, three-year contracts or did they never really -- did you never get that far with the conversation?

Stacy Locke

Well, I would say that -- well, I can tell you for certain that there are a number of folks out there doing one-year and two-year and maybe getting some three-year done. We would not do one that’s not three-year. We are going to stick to the terms and conditions that we have had in the recent past and we would require a three-year term. Because these rigs are costly and the cash payout is actually north of four year. So we just like to get at least two-thirds of that cost of the rig paid back in the primary term. And equally important for us is the rate which gives us the internal rate of return. You know our internal threshold is about a 20% IRR. So we would like to achieve at a minimum of that.

So we are going to stick to that. And as I mentioned earlier in the call, it's a little tougher to achieve that in today's market. So we did not get to that point with our clients but I feel like with our clients that at the right time that we will be able to get that.

Operator

(Operator Instructions) Next up is Daniel Burke with Johnson Rice. Please go ahead.

Daniel Burke - Johnson Rice & Company

Lorne, I thought when you sketched out what the CapEx budget for next year could look like, it looked like there could be $30 million or $40 million in discretionary spending. What makes the cut given the debt pay down prioritization?

Lorne Phillips

Yeah, what would not be in that is new units. So what could possibly be in that number would be really just some -- if there is probably two or three more rigs that if needed, if desired and it made sense we could put walking systems on. I think there are some cases where there is some bi-fuel opportunities on the engine. Things like that that are not new units but they might be investments that are needed to keep the rigs active and working on term. And then in that also would be some replenishment of some, probably some down hole tools on the wireline side potentially, then some IT.

And so, like I said, we are still sketching that out but it would be -- it's discretionary in the sense that we could choose not to spend that and we don’t want to spend. What we would like to spend is the absolute minimum which we think is that routine maintenance around $65 million to $75 million. But if the right opportunities are there and it's required and we feel like we can get a return on it, then we may need to spend more and that would be it. The majority of it would be on the drilling side of that discretionary piece. But again, we are still sketching that out and I wanted to give a preliminary indication and we firm it out more when we have our next call.

Stacy Locke

The only thing I would add to that is, I think that for sure the discretionary chunk of CapEx is less in '14 than '13 because we did put four walking systems this year, 7500 psi fluid into a -- I think we put on a few automatic [cat] walks. Most of the rigs are in pretty good shape so there is not much left that we can do on rigs that we are willing to do it on. So even if everything happened that we are anticipating in '14, I still think that discretionary piece would be smaller than '14. But I don’t think everything will in '13 -- I mean, I don’t think everything will be reflective of it or that we will want to do it. So we are in better shape. The fleet overall is in very very good shape.

Daniel Burke - Johnson Rice & Company

Okay. Great. And then, Stacy, maybe one more on Colombia. There is a little bit of uncertainty out there right now. I think last year you had some year-end contract expiries and early on into this year you were rolling those rigs month-to-month. Is there anything different right now about the expiries you are facing in Colombia? In other words, is there a harder cliff that you are in if you don’t get a formal contract resigned or is it just tough to tell exactly how this shakes out.

Stacy Locke

Well, I would say that it's definitely tough to tell how it shakes out at this moment. But we have never really rolled them month-to-month ever. We have rolled them in chunks. You know the rigs came off three-year term contracts at 12/31 last year and we rolled it for one quarter. You know Ecopetrol is pretty big and there is lots of people there to negotiate with. And they can't always come to terms at the deadline and so we rolled it for a quarter. And then kind of the same thing happened as we moved to the end of March 31, so we rolled it for nine months and that’s where we are today.

The only thing I would say that’s different, rather two things that are different about this renewal is, one is the contract form is vastly different than what contractors have signed in the past. So that’s causing everybody a lot of exercising on that because it's complex. There is I think, the fellow that heads Colombia was telling me there is over 70 annex pages of details, or annex sections. It's just a lot of details to go through. So us and the other people that are working in [indiscernible] field and then a few other invitees are pouring over that. So it's just very complex. And it's going to be a challenge to have that fully understood and clarified even by 12/31, I think. So I think it is a possibility that these may get extended again while there is more thinking on this contract form. But I don’t know, I am speculating.

The other wrinkle in this particular renewal is it is an election year in 2014 there. And the government oil company is not allowed, and I am going to tell you my understanding of it and I maybe off by a month or two and I have heard different interpretations of this. But our current understanding is that if the contracts are not renewed by December 31, then you have to wait for four months roughly till the election is over before you can enter into a contract of this nature. And then if there is a run-off that could extend it another two months. So theoretically, if you don’t have something inked up by December 31, you could, if there is a run-off, be on the sidelines for six months into the new year because they don’t want contracts made for the new regime before it comes in.

Carlos Pena, that’s basically he is in here as a General Counsel [indiscernible] I think more or less accurate. Now what does all that mean? Well, what that means is that we are aligned with Ecopetrol in their desire to renew these contracts this year. Because they certainly don’t want -- we have been one of the primary providers in [indiscernible] field and they certainly don’t want to not continue drilling and establishing production for what could be half of a year. That would derail their production goal. So I feel like everybody is aligned that they definitely want to get that drilling done but we have these issues that we need to deal with with this contract form and/or an extension of the existing contract, however it works out.

Operator

Thank you. And next is Brad Handler with Jefferies. Please go ahead.

Brad Handler - Jefferies

May I will just focus on a small point, but as we try to fine tune our cash flow expectations for you guys, can you help with deferred tax kind of roll offs. Where do you -- it has been a use of cash for you in the beginning first nine months of the year. Where do you expect that for the fourth quarter Lorne and maybe some commentary around '14?

Lorne Phillips

Well, from a tax perspective we are not going to be a cash tax payer this year in the U.S. really, or in Colombia, is our expectation. This year or in 2014. We have quite a bit of NOLs to work through and so to the extent that -- well, that’s what we are going to be working through. So I don’t think when you look at cash forecasting, there is some very minimal cash taxes that would be paid in each quarter primarily related to Colombia. And that’s all I think I would be thinking about from a cash tax perspective.

Brad Handler - Jefferies

Maybe just to press the point but maybe I am not looking at this right, but in your cash flows has it not been a use of $21 million to date?

Lorne Phillips

Well, I think what you are looking at it is when you have a loss, a net earnings loss that the book is a -- you show the book taxes the net benefit but you are not getting that cash back. It shows up as a net benefit but it really is just an NOL that you will use in the future. So what you do with the cash flows and you add it back, you have to show that as a -- not as a cash benefit.

Brad Handler - Jefferies

I see, okay. Maybe we will take that offline. Just maybe a quick follow up on Colombia also. I am just curious, Stacy, some of your comments sort of made it sound like there was almost a collective push back. Is that at all part of the dynamic? Is there is a consortium of you all involved or is this just an individual negotiation you have with Ecopetrol?

Stacy Locke

No, it's an individual negotiation that we have with Ecopetrol. But I think there is a total of seven people invited to participate in the drilling there in [indiscernible] field. And there a lot of this give and take is online and so we see the questions asked by others as they will see the questions asked by us and the answers from Ecopetrol on our question. So that’s where we can gain some of that information

Brad Handler - Jefferies

I see. That probably has some influence on the whole process what everyone else is pushing on. That’s interesting.

Operator

Thank you. And next is Jason Wrangler with Wunderlich Security. Please go ahead.

Jason Wrangler - Wunderlich Securities

Just curious on, obviously you talked about the Bakken and I think you said 11 rigs up there. Do you have an idea or do you just have offhand, how many of those are in term contract versus once that are at least I guess potentially going to get targeted by the guys kind of cutting price.

Stacy Locke

Well, they are hundred percent on term. And so what I was referring to is the term renewal.

Jason Wrangler - Wunderlich Securities

Right. Okay. And then just off the, I think if my math is right there is 17 rigs I guess that are vertically focused. I assume that obviously eight are in Colombia. Can you just have a breakdown of where those all kind of live right now?

Stacy Locke

Well, the actual numbers. The eight in Colombia are mostly drilling high angle if not horizontal wells, and those are all top drive walking rigs. So those are 100% vertical in Colombia. And that market in fact is going that way gradually. But our rigs are kind of ahead of the game and that they all have 500 ton top drives and they all have walking systems of some sort on them. What we have in the U.S. market that is vertical is 14 total rigs. And that’s it. Then we have nine mechanical rigs that are drilling horizontally that all have top drives. And half of those are under term contracts, the others are just contracted.

Operator

Thank you. And next is John Daniel with Simmons & Company. Please go ahead.

John Daniel - Simmons & Company

I just had one question. Stacy, in equal world, as you look to first half '14 and consider the contract expirations and where spot pricing is today, how would you see cash margins evolving in the Q1 and Q2 in the Q4 guidance.

Stacy Locke

For drilling?

John Daniel - Simmons & Company

Yes.

Stacy Locke

That’s a good question. I guess I would say, to be safe, flattish. I don’t see after we kind of adjust in this fourth quarter the guidance we have given and depending on where we actually end up there. I don’t see much change in the first quarter. If you start getting pricing power back you probably really wouldn’t see that much even in the second quarter. I think that would be more evident in the third and fourth quarters of the year because not as much will happen in the first quarter. It just typically doesn’t, I don’t think. But I would say we are more constructive on that in the back half of the year.

Operator

Thank you. And I am showing no further questions, I will turn the call back to Stacy Locke for closing comments.

Stacy Locke

Great. Well, I appreciate everyone joining the call and enjoyed all of the good questions today and we will look forward to having this call again in February. Thank you very much.

Operator

Ladies and gentlemen, this concludes our conference for today. Thank you for your participation, you may now disconnect.

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