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Precision Drilling Trust (NYSE:PDS)

Q2 2010 Earnings Call

July 22, 2010 02:00 pm ET

Executives

David Wehlmann - EVP, IR

Doug Strong - President, Completion and Production Services

Kevin Neveu - President and CEO

Gene Stahl - President, Drilling Operations

Analysts

John Daniel - Simmons & Company

Mike Urban - Deutsche Bank

Victor Marchon - RBC Capital Markets

Kevin Lo - FirstEnergy

Dana Benner - Stifel Nicolaus

Mike Mazar - BMO Capital Markets

Roger Serin - TD Securities

John Tasdemir - Canaccord Adams

Jeff Fetterly - CIBC World Markets

Jeff Mochoruk - Cormark Securities

Brian Purdy - National Bank Financial

Todd Garman - Peters & Company

Mike Clark - Star Capital

Operator

Good afternoon ladies and gentlemen and welcome to the Precision Drilling Corporation Second Quarter 2010 Conference Call and webcast. I would now like to turn the meeting over to Mr. David Wehlmann, Executive Vice President, Investor Relations. Please go ahead.

David Wehlmann

Thank you. Good afternoon everyone. I’d also like to welcome you to Precision Drilling Corporation second quarter 2010 conference call and webcast. Participating today on the call with me are Kevin Neveu, our Chief Executive Officer and Doug Strong, our President of Completion and Production Services.

Also with us here today is Gene Stahl, the President of our Drilling and Operations and our new Executive Vice President and Chief Financial Officer, Rob McNally. Due to news releases earlier today, Precision Drilling Corporation reported on the second quarter 2010 results.

Please note that the financial figures are in Canadian Dollars unless otherwise indicated. Some of our comments today will refer to non-GAAP measures such as EBITDA and operating earnings.

Please see our press release for additional disclosure on these non-GAAP measures. Our comments today will also include statements reflecting Precision’s views about events and their potential impact on the corporation’s business, operations, structure and financial results which are forward-looking statements.

There are risks and uncertainties that could cause actual results to differ materially from those indicated by such forward-looking information and statements. Please see our press release and other regulatory filings for more information on forward-looking statements and these risk factors.

After I give a brief review of the second quarter operating results, Doug Strong will review the changes to Precision’s debt during the quarter and summarize our capital expenditure plans for 2010 as he transitions out of his role as CFO.

Kevin Neveu will then provide an operations update on our outlook and after that, we will open up the call for questions. On June 1, 2010, as a result of a plan of arrangement approved by the holders of trust units of Precision Drilling Trust on May 11, the trust converted into Precision Drilling Corporation.

More information is available in our press release and in our website at precisiondrilling.com under the investor center tab about this conversion.

Precision reported the net loss of CAD67 million or CAD0.24 per share for the second quarter. These results include a CAD26 million foreign exchange loss related to our debt being U.S. dollar denominated. Also, with the financing amendment that Doug will detail in a minute, Precision had non-cash charges of CAD24 million during the quarter related to this amendment. For more on the quarter, please see the details in our press release.

Also, during the quarter, Precision strengthened its term contract position. We now expect to average 78 rigs on term in 2010, up from 75 average rigs when we reported last quarter. For 2011, Precision increased four average rig years to 45, from 41 at our last report. Two of these are related to the new bill contracts and others are for the rigs that had been upgraded for the US Bakken.

Current market conditions have Precision’s Canadian rig count at 77 working this morning with 20 rigs waiting to move to location once the ground dries. A year ago at this time, Precision was working 51 rigs in Canada. Oil drilling is leading the way in areas like the Cardium where Precision has 11 rigs running and the Viking where we have nine rigs running.

Today, we have 91 rigs working in the U.S. two in Mexico and one rig that is contracted but stacked that we are still receiving margin payments on. This last stacked contracted rig is expected to return to work in the next few weeks.

A year ago, in the U.S. we were working 52 rigs. So you can see the improvements in utilization that Precision has achieved. Kevin will detail some of the major resource plays that led to these improvements.

Now, I’m going t turn it over to Doug for his comments.

Doug Strong

Thanks David. Precision’s financial position continued to strengthen in the second quarter of 2010 as the recovering customer demand experienced in Q1 carried through the second quarter, strengthened oil fundamentals, improved the capital markets and Precisions debt reduction focus over the past year led to favorable opportunities to enhance liquidity, reduced debt servicing cost and secured new rig build and upgrade opportunities with customers.

These developments enhance future cash flow visibility and reinforced Precision’s brand promise to provide high performance, high valued customer service. Specifically Precisions pleased to highlight the following developments consistent with our team to seize market opportunities.

First, we were able to amend our existing secured debt facility to lower current interest rate spreads on term loan B, on the term loan B by almost 3%. This was accomplished through 1.5% reduction in the LIBOR floor to 1.75% and a 1.45 reduction in the weighted average LIBOR margin to 5%.

This in combination with the $74 million repayment associated with non-consenting debt holders lowers annual debt service cost by over CAD15 million. Second, we were able to increase liquidity by $150 million by adding borrowing capacity in our secured facility revolver.

This in combination with cash on hand of CAD186 million as of June 30, 2010 provides Precision with liquidity in excess of CAD600 million at quarter end. Third, as we plan forward, we have expanded our capital expenditure program by CAD122 million. That’s announced in our news release this morning and we expect a vast majority, if not all of the spending to be funded from operating cash flow.

Precision’s marketing teams and operating performance continues to build customer demand for high performance, super series drilling rigs. We also continue to generate upgrade opportunities to enhance horizontal drilling capabilities.

The adjusted capital expenditure plan is now estimated to aggregate CAD244 million with 2010 spending of CAD189 million and a carry-forward of CAD55 million to the first half of 2011.

In a moment, Kevin will speak to regional deployment of the new Super Series rig build program which now stands at nine rigs. As emphasized last quarter, we continue to carry a flexible approach to strike the right balance between new investment towards organic upgrade in growth while working within operating cash flow to carry strong liquidity. Further debt reduction remains an important priority for Precision as we bounce capital allocation with accretive organic growth economics.

As the recently appointed President of Completion and Production Services, I look forward to transitioning the CFO office with Rob McNally and working with the tremendous people of Precision in my new role. Kevin, that concludes my remarks.

Kevin Neveu

Thank you, Doug. I’d like to start by congratulating Doug on his new appointment. Most of you on the call well know Doug’s passion for excellence and his focus on Precision’s business. I am very excited to see Doug now apply his expertise to operations for Precision’s Production to Completion business and you can expect to hear a lot more about this business segment in the future.

I also ask you that join me in welcoming Rob McNally to Precision Drilling as our new Executive Vice President and Chief Financial Officer. As with all Precision new recruits, Rob has met Precision’s internal requirements and besides his comprehensive finance and operations background, he has also passed a physical testing and drug screening. I can assure Rob that with his operations background, should the position of CFO not work out, we will have a position for him on one of our Super Series rigs.

Now on a more serious note, Rob’s experience both in finance and operations combined with his extensive personal network and his visibility in the US capital markets will prove invaluable for Precision as we continue our US growth plans. We will work out our schedule with all of you to ensure you get a chance to meet Rob in person over the next few weeks.

Now turning to the quarter. Reporting loss for the second quarter, be it cash or non cash is very disappointing for me. Clearly, our operating margins have room for improvement. And while some of the developments I’ll describe later in this call bode well looking forward. I’m confident that our people are well focused on the current business and we expect to improve these margins going forward.

Yes for several months, I’ve been talking about ongoing conversations and opportunities of customers, both in Canada and the United States to provide new build rigs. But for a variety of reasons, the economics were well below our range to lock in contracts. I want to complement our sales team for pushing two of those over the line with signed contracts and of the remaining five, we clearly would not be announcing the planned spend.

We’ve got a high degree of confidence that our economically acceptable contracts are expected shortly.

As is our policy, we will not spend the funds until the contracts are finalized and all these contracts will fall within our expectations for term and economic return. Turning back to the second quarter, in our views looking forward, there should be no doubt in anyone’s mind that oil-based drilling is very strong indeed. We continue to see additional demand for rigs in the US Bakken, to the Saskatchewan-Manitoba Bakken, the Cardium Viking heavy oil plays in Alberta and particularly, the recent revisions to the Alberta provincial royalties have proven very helpful and continues to stimulate customer interest in horizontal and multi-lateral drilling which from Precision’s perspective is right down our fair way.

We expect to be very active drilling Cardium and the Viking wells through the summer and for that matter, through the course of 2011. That is of course, once the monsoon rains in Alberta and Saskatchewan abate. One of the new super singles we announced today will be deployed for oil drilling in Alberta through the next year.

Looking for a moment in the US Bakken, Precision has activated four additional rigs during the second quarter, bringing our total to 16. The Bakken is proving to be our fastest growth area in US and we see further expansion potential as high performance rigs become available.

And despite the continuing soft natural gas prices and recent concerns of potential gas drilling slowdown, during the second quarter, we added three rigs in the Barnett region and three rigs in the Haynesville, bringing our total to eight and 18 respectively

In early July, one of our rigs completed its drilling commitment in the Haynesville, but was immediately redeployed to the Eagle Ford without missing a beat. This seems to support our view that the strong demand for Tier 1 and Tier 2 rigs for oil and gas liquids should help mitigate potentially softer demand for high performance rigs currently targeting dry gas.

Three of the seven new builds we mentioned earlier will be going to Eagle Ford for two different customers targeting natural gas liquids. All three are Precisions Super triple 1,500 horsepower rigs with AC power systems, pipe handling mechanization and most importantly, Range III drill pipe to ensure high performance horizontal drilling.

The first rig should be deployed later this year in the balance in the first quarter of 2011. We are confident these super series rigs will perform very well in Eagle Ford and we’ll see further demand as we have ongoing discussions with several customers.

Now we’ve talked about the Marcellus on many occasions. Today, we have 10 rigs in operation. Two of the new build super singles announced, they are both fully contracted and will be deployed in the Marcellus for a new Precision customer. These rigs are sequenced for deployment late this year and early 2011. It’s our view that these contracts show how tight the available supply is for rigs capable of economically drilling in the Marcellus.

On that note, included in Precision’s new build plans is a new design Marcellus Super triple, configured specifically for pad drilling and designed for the compact mode restrictions needed for transportation in Pennsylvania. Notably, the rig will have benchmark mobility with pad-to-pad relocations of under three and a half days and well-to-well moves of under two hours.

We believe no other pad walling rig will come close to this benchmark. And of course like other super series rigs, this rig is equipped with an AC drilling suite, high paneling mechanization Range III drill pipe to ensure predictable, high performance horizontal drilling.

We believe this rig is a real winner and like our super singles, it has the potential to become a category leader for shale drilling. We’re very excited about the rig design and have several interested customers. We expect this rig to be ready to deployment in the second quarter of 2011. On the pricing front, we see pricing continuing to firm up particularly for the top tier rigs. We continue to see strong interest for upgrades on Tier 3 and Tier 2 rigs. In the United States, our pricing is either fixed by a term contract or negotiated on a rig-by-rig basis.

As a result, we have continual opportunities to inch up pricing on the negotiated rigs particularly in the more active geographic regions like Eagle Ford, Marcellus and the Bakken. As our rigs rollout term contracts, the renewal rates are not as strong as those signed back a couple of years ago. But again, the prices have rebounded well of the lows of 2009 and we believe the blended average of our day rates and margins have dropped.

In Canada, our largest customers negotiate pricing arrangements on a yearly basis each fall. The opportunity to increase pricing during the year are fewer and limited to smaller customers with less-developed drilling programs. As I said before, our customers benefited last winter with pricing far below what the actual utilization would have suggested.

As we look forward to 2011 and consider our pricing strategies and based on the current strong demand for high performance rigs, we expect substantive pricing pressure this fall which will set us up nicely for 2011. The international market continues to be a focus for Precision, but as all of you know, it’s very competitive. We remain active pursuing high-performance opportunities. Currently, we are in the running for a deep high pressure, multi-rig bid in the Middle East. We are not the low bidder and we would not intend to be.

The customer has indicated a strong desire to bring in a high-performance international drilling contractor. We believe our pricing is appropriate. This process has lasted six months so far and maybe several more months before the contract is awarded and deployment will follow approximately 18 months later.

Our two rigs in Villahermosa Mexico continue to operate for a major service company and have not been directly impacted by the uncertainties evident in the (inaudible) field. We were actively pursuing several other North American opportunities but have nothing to report at this time. In our productions and completions business activity continues to improve in oil plays with conventional specialty and heavy oil in unconventional particularly the Bakken and the price emerging in the Cardium and the Viking Plays.

Earlier this year we initiated plans to capital on the unconventional trends. And we redeployed about 14 rigs the two areas that were previously under service by Precision. Not withstanding the difficult weather so far in the summer of 2010 activities running about 30% ahead of 2009 and more importantly stock market rates have began to improve and helped with our Canadian drilling business we expect to see material margin improvements in Q4 following annual pricing agreements from our large clients.

At Precision we remain poised to respond and cease opportunities as we have during the second quarter with the new billed-in investments. We continue to reinforce the high performance high value reputation of our customers over 80% of the world Precision drilled during the second quarter were forged on rig directionally. And importantly Precisions liquidity and debt reduction focus remains paramount. The step we take to re-price debt, reduce debt and increase our revolver capacity during the second quarter both reduces precisions ongoing carrying expense which further strengthens our balance sheet and while we have doubled our capital plan in second quarter debt reduction arrangements for key considerations.

As a closing note I would recognized Precision team both in Canada and Unites States for their efforts and hard work to ensure that we continue to deliver the high performance high value services our customers desire across America. And with that I will open the call for questions.

Question-and-Answer Session

Operator

Thank you, we will now take questions from the telephone lines. (Operator Instructions) Our first question is from John Daniel from Simmons & Company. Please go ahead.

John Daniel - Simmons & Company

Hey guys, couple of questions for you first on the Canadian drilling market, you talked about pricing opportunities as you head into the winter season, can you give us just a sense of, what the magnitude might be? Is there any talk right now with customers?

Kevin Neveu

John thank you for the question. I really don’t work with all the guidance out on our strategies, or pricing this fall. We get back to our customers very quickly and just makes the conversations that much tougher. Certainly the utilization’s often to a point just to where we think things will be this winter and they were substantially lower than the market with expected to having known, we would see that much activity. So, it will be an interesting October for our sales team, we will do the best we can to get the rigs pushed up for us progressively.

John Daniel - Simmons & Company

Well, how about look at it this way, can we look and say what happened in the US market somewhere say rates dropped to where they are today as an indication of possible change up in the Canadian market?

Kevin Neveu

I’m going to have to leave it to you guys to draw your models on that, I’m sorry John.

John Daniel - Simmons & Company

Okay, the completion of production services segment if you would look back in 08 and 09 revs were up about 50% quarter-over-quarter and Q2 to Q3 I think you said you are tracking 30% above now, is that fair with 30% on revs or just on activity?

Doug Strong

Yeah, John, it’s Doug, we like the momentum we are carrying out in the month of June, and the activity pickup would be higher than the 30% currently.

John Daniel - Simmons & Company

Okay. Alright, and then I guess just one more from me. Can you remind us how many of the rigs in your capital program are, how many do you have upgraded? 15, this year on the drilling side?

Kevin Neveu

John, we guided originally to something in the range of 10 to 15.

John Daniel - Simmons & Company

Yes.

Kevin Neveu

Lucky the scope of the upgrade that number might come in closer to 10.

Operator

Thank you, our next question is from Mike Urban from Deutsche Bank.

Mike Urban - Deutsche Bank

I had a question on the C&P side obviously Doug already as you said kind of indicated an increased focus on that business, should we expect to see in that emphasis is that to imply a geographic exposure? Sounds like you’ve already moved some asset, is it organic growth? Do you need to add or want to add some product and service lines, or all of the above?

Kevin Neveu

Mike tomorrow is probably Doug’s first official day on the job. We’ll let him get settled first. Certainly we understand that our position in Canada is very strong and our productions and completions business. And I think there’s a lot of challenges in the U.S. market. So I wouldn’t want reasons to believe that we have immediate growth plans to the U.S. That’s not on the short progression force.

Mike Urban - Deutsche Bank

Are there opportunities to do more within Canada where you already have a strong market position, again as you said moving some assets or again adding products just as you stay with focus only in Canada?

Doug Strong

We’ve got a core focus on our existing business lines and we see rising momentum opportunities there to ensure that we continue to provide safe and reliable service. The completion production is a little bit more of a call out service, and its got the 24 hour momentum if you will that drilling has, so the industry over the past couple years really contracted hard, and we’ll be sticking to our selling here in the short term to bolster both the human capital and any equipment within our C&P business.

Mike Urban - Deutsche Bank

That makes sense and maybe difficult to answer this point but as you look down the road and then this maybe more of the big picture strategic kind of question, but do you think that alternately Precision can remain more or less a drilling focus contract or do you see a need somewhere on the horizon to be more integrated to offer more services or customers requiring that or are you seeing more requirements for bundling the services maybe even the higher in place or just stay focused on the drilling market by now?

Doug Strong

Good question, Mike and it really depends geographically where you are thinking. Outside North America the integrated services more than has lot of traction in countries and places where the interim groups of the national oil companies maybe don’t have the depth, that they have in North America. But, North America, the drilling departments have most of our customers have a lot of depth, and if there isn’t depth then it is a local third party group that usually provides that type of service in Canada.

So, the business room that has remained quite fractured and even those drillers that have your drilling rigs and service rigs and some even have pressure pumps, a very small wedge of that is actually combined in any kinds of integrated service business in North America. I think our customers are quite comfortable keeping the business fractured and if one plus one equals two, and they can save a lot of money then we put them together.

Operator

Thank you, our next question is from Victor Marchon from RBC Capital Markets.

Victor Marchon - RBC Capital Markets

Thank you, good afternoon guys. First question is on new bills, Kevin let me get your sense as into, we have seen a couple of the other publicly trading companies talk about adding some rigs in the U.S. and I just wanted to see if you had a sense as into what the total industry order book looks like right now and what’s your sense in the demand that you see for these Tier 1 assets as into the opportunity set for the industry say over the next six to 12 months?

Kevin Neveu

Victor so first all, are you referring to the full order book across the sector?

Victor Marchon - RBC Capital Markets

That’s right.

Kevin Neveu

That’s a tough one to give you [sum] exactly because some people are building rigs on specs, some people are building inventory items they can turn into rigs quickly and then some of us have announced full rig builds. I know we have and a couple of our US peers have discussed full rig builds. So what I would kind of point you first of all that the clearly announced rig builds that appear to have customer targets probably less than 25 or 30.

Now there maybe more rigs in process either as spec or loosely specked rigs or parts, don’t know for sure and again it’s a real tough number to get your arms around, but you would thinking 25 to 50 in the range. No I don’t think I can argue that it is going to be less than 25 or maybe not a lot more than 50.

Now what I see for demand going forward. I think it’s rather remarkable that considering what we have been through that there is even one new rig being talked about here. So I think these are all good signs about just how effective the Tier 1 and Tier 2 assets are in the marketplace, but more importantly whether it’s tight oil or conventional oil in the horizontal drilling or unconventional gas or shale gas, clearly the Tier 1 and Tier 2 rigs are required.

And the Tier 2 rigs really are still heavily over supplied. We have opportunities for maybe regional rig drilling opportunities or maybe some vertical wells or low cost wells. But the growth areas in North America will continue to be unconventional style drilling. So the game on new build rigs is far from being finished.

Victor Marchon - RBC Capital Markets

You had mentioned the interest in upgrading some of the Tier 2 assets. Is that driven by customer demand where that would be back by a contract or is that just, you guys doing it, in anticipation or just in looking at how tight the Tier 1 market is?

Kevin Neveu

We generally try to tie all CapEx improvements for the rig to customer contracts. We have a fair amount of discipline in insuring that they’re getting, certainly near full payout terms of new rigs, but even on the upgrades we are doing, we are looking for big contractors that insure we get back most of all of our capital. In very broad terms, virtually all of our upgrades will be contracted rigs.

Victor Marchon - RBC Capital Markets

Just switching to pricing, to something you had mentioned earlier on the blended margins in the US have troughed. And I was just trying to get the sense as into how that looks coming out of the other side, just given your guidance mix of term contracts and the spot market today. If the blended average were at or near the low, what is your thought as into the progression going forward given the mix between term contracts, the spot market and as some of these terms rollover? Is it something that we are looking for some improvement in the say fourth quarter, first quarter of 2011. And is it look more of a gradual improvement or is it something more, not a hockey stick, but something that’s more significant based on the mix?

Kevin Neveu

Our view on how the rigs might move up on the aggregate going forward is, it is as visible as we see our customers drilling plans right now. Frankly their plans are going to run out at the end of this year with the 2011 budgets yet to be announced. So that’s one factor that makes it hard for us to guide forward on day rates. The trough in activity, kind of lagged or dragged on from some time in April through pretty much July. It was almost a two quarter type lag. So as you know the day rate will stagger a little bit in aggregate, wouldn’t surprise me but we are working hard to push them up, clearly the top the tier rigs are doing very well right now.

We talked it before in the past of CAD2,500 to CAD3,500 any types step ups in top tier rigs. We talked about a little less on the Tier 2s, maybe a 1,000 to 2,000, we will also do a tier upgrade. Now that’s kind of magnitude we’re looking for. Again we’re rolling out contracts from 2007; there were some very good contracts even at the lower tiered rigs. So it takes a while to wash this out. I think by the end of the third quarter, when we report earnings in third quarter we’ll start to see some of the front end of that curve that, I ask for some time on this and come back to you in October.

Victor Marchon - RBC Capital Markets

And just the last one, any guidance to provide on the G&A side as well as tax rate going forward

Kevin Neveu

First of all, on the G&A, side, we’re still running this business, and I’ll use the word like it’s June 2009. We are running lean and keeping things right on the G&A side.

Doug Strong

On the tax rate side is the corporation now. Our statutory tax rate, take an average between our Canadian and US operations, as we guided last quarter is in that 25% to 30% range. As we’ve seen to get down to our underlying effective tax rate there are some, there is variables in play that reduce it. But on a long-term basis continue to guide in that 25% to 30% range. Not all of which is cash, obviously. And as we continue in what is really a pretty low pricing environment, you’ll find very little of that is cash.

Operator

Thank you the next question is from Kevin Low from FirstEnergy.

Kevin Lo - FirstEnergy

Just looking at your balance sheets, can you kind of talk about why you thought you needed to explain your bank line?

Doug Strong

The short answer on it Kevin is, we’re getting back to liquidity that we saw back in Q4 2008. And broadening of our lending relationships, the markets opened considerably since then and there is a great opportunity at very little cost to get the relationships that quite frankly match our underlying market and platform for growth going forward.

Kevin Lo - FirstEnergy

A round about way of asking a different question would be do you see those as being a little more aggressive in terms of spending capital if there's opportunities available, I guess, in the next six to 12 months.

Doug Strong

Not at all, we think the size of our credit line is right in line with the scope of our operations.

Kevin Lo - FirstEnergy

In terms of what Kevin was talking about in terms of the Middle East and South America. It sounds like just from maybe tone it sounds like you are a little more enthusiastic or optimistic that the Middle East is a little more imminent or the probability is a little bit higher, would that be safe to say?

Kevin Neveu

I wouldn’t go that far Kevin, that particular bit I was mentioning was the public opening in the Middle East and I don’t want to give a lot of specifics, but we are in public record in Middle East on a particular bid as having been one of a qualified bidders that delivered a compliant bid. And what’s happening right now in Latin America, until we have something substantial to report, I don't really want to give a lot more detail right now.

Kevin Lo - FirstEnergy

I guess, if we look at the cycle right now, and you know you are saying that the rates have troughed and we should see a little improvement from these levels, how far away do you think we are from mid-cycle pricing?

Kevin Neveu

On a bi-tier basis, the fact we are announcing some new builds right now. It might be fair that those Tier I rigs are not far off of above mid-cycle pressure. Replacement pricing on those contracts, our discipline on contracts.

Kevin Lo - FirstEnergy

Okay and the remainder is below like material below or?

Kevin Neveu

No, it’s the Q3 rigs are CAD2000 to EBITDA margins that’s about it. Q2 rigs are doing well and if we can update this to tier 1, it's investing range. So we got to do the past to be thinking about your steps and the tiers being at CAD3000 to CAD5000 a day of soft of the EBITDA step range. That guidance nothing still stands.

Kevin Lo - FirstEnergy Capital

Okay and last question is, you guys have put down a few rigs and you are hearing if guys with drill rigs in there what do you guys see in terms of rig de-commission other from yourself or the industry in Canada?

Doug Strong

We de-commissioned lots of rigs back in December as you all know. We do it when we think the time is right. We look at our fate and look at our utilization and things like that. Look at opportunities down the road. I can’t speak to our competitors and have the reanalyzed difference.

Operator

Thank you. Our next question is from Dana Benner from Stifel Nicolaus. Please go ahead.

Dana Benner - Stifel Nicolaus

I wanted to follow-up, I think it was Victor’s question with respect to day rates and margins mine is on the day rate side. You’d given some day rate delta's for Q1 and 2 rates principally and so I wanted to maybe put a finer point on it and that is if you look at your second quarter results, can you give us a sense for how much of those rates may have moved by tier in the second quarter in the US. Can you give us may be a bit more color there?

David Wehlmann

The rates on the tier 1 rigs from the bottom of the cycle in mid 2009 to today have probably moved in CAD2500 to CAD5000 range. This last quarter they are up a little bit of that increment not, I would say probably 10 to 15% what happened in the second quarter, they are still moving up. Obviously we got due replacement cost, economic because we are building new rigs. Does that answer your question?

Dana Benner - Stifel Nicolaus

Right, so that would be tier 1, what about tier 2?

David Wehlmann

Tier 2 were probably up CAD1,500 to CAD3,000 bottom of cycle to today and again some of that took place earlier I would say 10 to 15% of that increase is in this last quarter as well, I think that’s a pretty standard across the tiers.

Keven Neveu

Firmer utilization plays into that.

Dana Benner - Stifel Nicolaus

I guess as we think about Q3 leading edge rates, would that more in keeping with the trend line established in Q2. Do you see any type acceleration or is there too much uncertainty with respect to stronger oil drilling and a backing off of gas?

David Wehlmann

Yeah, as Kevin said earlier, we have as much visibility as we have with our customers and so we don’t want to get into projecting Q3 right now, we are running 91 rigs in the US and 77 in Canada which is well above last year’s pace and we don’t see anything to tell this today that number is going to shrink but, it’s a long time to the end of the third quarter.

Dana Benner - Stifel Nicolaus

The second and final question, relates to the I guess the trepidation that you and so many others feel right now on the natural gas side, and not withstanding the cautiousness that you and other oil service companies have had on the gas market this year, the gas rig count continues to move higher and I wonder if you could maybe give us your sense as to why you think it has moved as high as it has given gas prices stalling out?

Lots of reasons out there we all know about, but how would you prioritize those reasons for why the gas rig count has moved higher than the service companies and even analysts and PMs would have thought?

Kevin Neveu

There’s no question that Marcellus probably makes sense of these pricing levels. So I think that Marcellus continues to have good fundamental value. When you move into the other shale plays in the U.S. particularly, obviously hedging and land position drove the hold our drivers no question about it.

And one view might be that eventually the drilled holes run out. Another view might be that the drilled up holes continue on because there’s other lines being bought that has to be held. So these are hard things for us to model, and there’s also talk about how inventory wells that drill are not completed and not tied in, those are hard to model too.

Now we’re in touch with our customers and we work closely with them. We’re drilling fully in those shales we are drilling for large Cap companies with solid hedging programs.

Some of those companies seem to be going against the green on their plans for CapEx spending around gas. And we’re part of that play with them.

Dana Benner - Stifel Nicolaus

Well it’s good to see the utilization, but it’s still been an interesting year, so I’ll turn it back. Thank you.

Operator

Thank you. Our next question is from Mike Mazar from BMO Capital Markets. Please go ahead.

Mike Mazar - BMO Capital Markets

Just before I get to a couple of quick questions, I missed something earlier. What are the specks on the Eagle Ford rig? The rig moved to the Eagle Ford was that a super single?

Kevin Neveu

The Eagle Ford was a super triple 1,500 horsepower, three of them. The new built rig for the Marcellus was a 1,200 horsepower Marcellus super triple.

David Wehlmann

The one that moved from Haynesville to Eagle Ford was the 1,500 horsepower that’s what he is after. 1500 horsepower super triple.

Mike Mazar - BMO Capital Markets

Okay, that’s terrific. Secondly here was there something weird in depreciation this quarter?

Doug Strong

Not particularly, Mike what’s your observation?

Mike Mazar - BMO Capital Markets

It’s about $11 million higher than Q2 ’09, I realize utilization was little bit better but it's actually more than what Q4 or Q ’09 were too.

Doug Strong

There were some plays I think you till you model up the activity increases and where we experience the increase between U.S. and Canada. It’s based on linear production method.

Mike Mazar - BMO Capital Markets

Right. So I would have thought with lower utilization Q2 it would have been lower, but okay. So but there is not a write off or anything in there?

Doug Strong

No.

Mike Mazar - BMO Capital Markets

The directional business, can you give us bit of an update on that?

Kevin Neveu

Sure can, I think I commented the last call we just wanted to progress so far and right now we have several rigs in Canada on two customers specifically that we partnered with, they are important customers, they are strategic, we are going through and frankly we are convincing the customers, we can do a great job.

And this is going well so far. In U.S. we are doing the same thing focusing over couple of customers, establishing close report, close relationship and we are changing one drilling image turning at this point.

Mike Mazar - BMO Capital Markets

Okay. So you haven’t materially expanded the capacity in that business yet?

Kevin Neveu

We are recording some more tools and things like that along the way but no acquisitions, nothing major.

Mike Mazar - BMO Capital Markets

Okay. And then finally just because I guess I have to ask any update on the thoughts on the dividend? Or reinstating a dividend or what were your views on potential dividend there?

Kevin Neveu

Mike, the answer is yes, it remains the same. Our debt level isn’t where we want it to be ultimately. Until we get there we will just hold that in conversation about how we deal with the cash after that

Operator

Thank you. Our next question is from Roger Serin from TD Securities. Please go ahead.

Roger Serin - TD Securities

I have most of my questions have been answered. I have one question and it relates to, if you can look at Q2 '09, I didn't knows and say Q2 '10 margins, 5% to 6%, if you can break it down, you gave language in the Press Release, but what portion was comprised, of lower day-rates what you know higher cost can you break it out a little bit?

Doug Strong

The biggest piece of the difference was Q2, 2009 still has a lot of 2008 contracts was mainly in US. So it really was just the exceedingly strong contract position we had coming into the downturn that help support Q2’s margins.

Kevin Neveu

Roger you are also seeing our U.S. operation that we had significant out of the contracted revenue and we also have been amounted CAD15 million and we also had CAD6 million of lump sum rig payouts in Q2, ‘09.

Roger Serin - TD Securities

So would I add those and say that CAD20 million of rate to the bottom line numbers that didn’t show up this year?

Kevin Neveu

21 million that’s right.

Operator

Thank you. Our next question is from John Tasdemir from Canaccord. Please go ahead.

John Tasdemir - Canaccord Adams

Hey. So I guess just looking at the rig count in Canada, and seeing how the staggering growth we seen in the Cardium and looking at what's going on in the Viking and lower shale and upper Bakken, there has been a pretty big reemergence up there. Kevin, what inning you think we are in with that stuff and is that reshaping what's going on in Canada?

Kevin Neveu

First sitting was last summer, it went from handful of rigs drilling in Cardium to maybe 85 rigs last winter industry wide. That’s a pretty good jump in six months and right now today I think we actually have more rigs drilling in Viking than we have drilling Cardium, both coming up nicely. But, as I’ve listened to a few of the E&P companies talk about their line positions and how long they can drill for. They are talking about years and years, not Q1 2011, but they are talking about year and years. So I think we are very early in this game.

John Tasdemir - Canaccord Adams

When you look at those plays today versus what was driving the Canadian activity three or four years ago. Obviously we need to get some more rigs utilized before you see major changes in pricing, but how is it different, are those more profitable or they are same type of rigs? Is that changed at all?

Kevin Neveu

John, if you look back three or four years ago, the oil drilling that was horizontal was only the heavy oil, say [D-type] wells, virtually every other oil well being drilled in North America, three or four years ago would have been a vertical well, would have been a tier three rig.

Today, these are tier two and tier one rigs required to drill these ten, 11 and 12- stage horizontal fracs, even for the conventional Cardium and Viking type wells. So it’s really helping with line up for the Precision’s rig drill right now.

John Tasdemir - Canaccord Adams

So a bit of a transformation in the sense of what's going on in Canada right now.

Operator

Our next question is from Jeff Fetterly from CIBC World Markets.

Jeff Fetterly - CIBC World Markets

On the CapEx side the CAD CAD121 million, how does that split between upgrade and maintenance?

Doug Strong

Of the additional capital that we announced, CAD CAD106 million of that is expansion, the balance is upgrade.

Jeff Fetterly - CIBC World Markets

If you put it pro forma the number of rig upgrades coming back to about ten rather than toward the 15 side. So do you have a sense in terms of the overall component, what would be upgrade versus maintenance?

Doug Strong

Yes, that 10 upgrade number, those are significant rig upgrades refurbishments that does not include some of the top drive additions that are within that upgrade capital number. So bare that in mind as you think about a rig count.

Jeff Fetterly - CIBC World Markets

The rig builds, that are coming in, do you have a sense whether those are incremental additions for producers to their programs or whether they're displacements?

Kevin Neveu

Our sense would be they are all incremental.

Jeff Fetterly - CIBC World Markets

Do you have a sense in terms of what percentage of your fleet today would be running on a lease retention or drill to keep basis?

Kevin Neveu

I commented earlier, I think I said 8 and 18 rigs drilling in the Haynesville and the Marcellus. Some percentage of those rigs, but it’s not a big number relative to the activity we have across the fleet.

Jeff Fetterly - CIBC World Markets

In the numbers you listed off earlier, I counted just over 70 rigs that are operating in resource plays, do you know what that number is in total for your fleets? And then maybe contrast that in terms of the type of drilling they're doing within those resource plays?

Kevin Neveu

We did comment earlier that I think over the course of the quarter more than 80% of rigs drilled horizontal directional type wells. And that’s probably not a bad proxy for resource plays and heavy oil combined.

Jeff Fetterly - CIBC World Markets

And lastly, your comment Kevin about debt repayment with the doubling in the CapEx program, and the working capital requirements for the business in the back half of the year, do you believe you have the capacity to pay off debt in the second half of 2010?

Kevin Neveu

What I can tell you is we are paying for our CapEx completely within our means. And I will also tell you that we still have optionality on how we decide to pay down our debt. If you have noticed though in past payments we have made, the notes and payments we made. Each time we have done that, we have used it to seek some form of amendment to the debt terms or some further relaxation of some further space.

And I think we have been very strategic about where we apply that cash to the debt. So it is not just pay down debt, but pay down debt intelligently and improve our banking terms, and it’s worked well for us so far. We are not backing off on that.

Jeff Fetterly - CIBC World Markets

Outside of using the balance sheet do you believe you’re going to have some free cash flow to continue debt repayment or is that a 2011 initiative?

Doug Strong

I think for 2010, I think we are balanced. We are deploying our free cash flow against debt and it will go towards our expanded capital expenditure program. 2011 comes down to where we’ll see what kind of momentum we carry out of Q4 that. We have got a flexible plan, we have got CAD55 million committed on expansion capital and a lot of flexibility around our maintenance upgrade capital for next year to continue to carry significant free cash flow to apply against debt.

Operator

Our next question is from Jeff Mochoruk from Cormark Securities

Jeff Mochoruk - Cormark Securities

Most of my questions had been answered but could you provide us with the timing on the new rigs?

Kevin Neveu

I did through the course of the conference call. David do you have it on your fingertips?

David Wehlmann

Yes, basically they start here, the earliest rigs will go out in the third quarter. I think we have one and a couple more in the fourth quarter and then they will spread out over the first half of next year.

Jeff Mochoruk - Cormark Securities

On the cost, things are heating up a little bit. Are you seeing any cost pressures particularly in the US market, I noticed that, it looks like your costs on a sequential basis were up about CAD CAD500, are you seeing any cost on where those are coming from?

Gene Stahl

Sure, yes. I mean as we’ve grown our rig count up from the low 40 in the US upto 91 here today. We are putting rigs to work that some of them haven’t worked in a little bit and as such there is some startup costs associated with that, but something as we project for don’t intend to see rising.

Jeff Mochoruk - Cormark Securities

Is there any incremental costs or more costs working in some of these new regions such as the Marcellus, even backing off the start-up costs?

Gene Stahl

Not particularly, Jeff.

Operator

Our next question is from Brian Purdy from National Bank Financial. Please go ahead.

Brian Purdy - National Bank Financial

I was wondering if you can give us maybe any guidance on what the payback period is for these new rigs. Would it be under four years?

Kevin Neveu

Brian, our guidelines are in the four to five year range and contracts that generally cover between three quarters and full paybacks. That’s the guidance on the contract.

Brian Purdy - National Bank Financial

Okay, perfect and then just on the completions and production side, I am just wondering what the pricing trends there are. It seems like prices have still slipped from a year ago levels?

Doug Strong

Brian if you look hard at the second quarter results, you will see our margins are relatively flat, Q2 09 over the current quarter. And as we come out of June, we’ve had some delays, we are carrying a strong momentum, we saw activity act significantly in the quarter, we are carrying higher levels of activity compared to last year at this point so the industry went through significant rate reductions and that we are working with our customers to get some of the value back and to have opportunities to reinvest back in the equipment and bring some technology back in, into play as well.

Brian Purdy - National Bank Financial

Okay. So it sounds like that's a bit of a work in progress for a while.

Doug Strong

It’ll take time.

Operator

Thank you. Our next question is from Todd Garman from Peters & Company. Please go ahead.

Todd Garman - Peters & Company

In the US on the cost per day side, if I look at the sequential in U.S. operating costs per day, of say CAD400 to CAD500, is that entirely related to the reactivation of the rigs because I am, the turn-key revenues are also up say 50% and I'm wondering what the cost impact there would be on a per day basis.

David Wehlmann

Turn-key does effect that we had more rigs operating in this quarter of 10 over second quarter of 9 so in turn-key cost always going to be higher because you pay more well cost of course you have offsetting revenue.

Todd Garman - Peters & Company

So if I look at want to expand the Q2 2010 is that that a cost increase all turn-key revenue because of turn-key costs, or is it rig reactivation cost?

David Wehlmann

There’s a little bit of both in there but turn-key is a big component of it.

Todd Garman - Peters & Company

And then if we just flip over to Canada, what would be Precision’s sense of Sag D activity in Q1 of 11 and then what percentage of the tier 1 assets that you have might be applicable to that type of activity?

David Wehlmann

I’m sorry I didn’t catch your question, could you repeat it?

Todd Garman - Peters & Company

Based on what you see for sag D activity in Q1 2011, how many tier 1 rigs do you think you can put to work as it stands right now? Based on what you see.

Kevin Neveu

I think in tier 1 11 every tier 1 rig Precision has been running.

Todd Garman - Peters & Company

My mistake guys the tier 3 rigs, excuse me.

Kevin Neveu

The real question might be how many more tier 3 rigs might we consider upgrading for Q1 2011. That might be probably more helpful because, frankly if it’s a horizontal well, unless it's an exception it likely will get a lot of work.

We do have a couple of tier 3 during horizontal wells. So it’s not an absolute, but our tier 3 fleet of very such rigs, I think 18 or 19 are working right now. We could double that in recent demands, we can put twice as many of those to work, or more. But we’re not so much on that being something we need to worry about for Q1.

Operator

Thank you. Our next question is from Mike Clark, Star Capital. Please go ahead.

Mike Clark - Star Capital

Sorry, guys, the questions were answered. Thanks.

Operator

(Operator Instructions). And we have a follow-up question from Jeff Mochoruk from Cormark Securities. Please go ahead.

Jeff Mochoruk - Cormark Securities

I just wanted to touch on the service remark; you didn’t really talk about it very much. What are you seeing there with the change in the oil and gas mix in Canada, and how is that impacting your utilization? How you see that going forward? And what else are you seeing any opportunities to increase prices in that market?

Kevin Neveu

I had commented earlier during the call that we had redeployed 14 rigs to areas that we were under servicing, that was specifically for oil and the activity is summing up nicely right now, both in the Cardium, Viking and heavy oil, all oil driven. What we are missing is the old deep gas completions where it is used to be really good for that business. That’s not coming back right and we don’t see it coming back anywhere on the short horizon, but we all started business, little lower margins, a little less sophisticated work, but we aren’t complaining. It’s going to work for us.

Jeff Mochoruk - Cormark Securities

How do you see pricing playing out in that market as the year progress and we head into the winter and fall of this year?

Gene Stahl

Jeff, I would add that on the service rig market, our customers are seizing the opportunity right now. Rates are comparatively low for where they have been. As we came out of the second quarter, we’ve seen some nice activity in the north and west part of the western camp sedimentary basin. No question oil is carrying the day, but we are seeing customers do think like working over abandonment type wells and so, you see that momentum continuing and as drilling persists, we expect our completion work to gradually improve, as we saw in the second quarter of ‘10 versus ‘09.

Operator

Thank you, this concludes the question-and-answer session. I’d now like to turn the meeting back over to Mr. Wehlmann.

David Wehlmann

Just like to thank everybody for participating on the call with us today and have a great day. Thank you.

Operator

Thank you. The conference has now ended. Please disconnect your line at this time and we thank you for your participation.

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Source: Precision Drilling Trust Q2 2010 Earnings Call Transcript
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