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Executives

Anne Pearson – IR, DRG&E

Stacy Locke – President and CEO

Lorne Phillips – EVP, CFO

Joe Eustace – President, Production Services Division

Analysts

John Keller – Stephens

John Daniel – Simmons & Company

Shawn Boyd – Westcliff Capital Management

Pioneer Drilling Company (PDC) Q3 2010 Earnings Conference Call November 4, 2010 11:00 AM ET

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Pioneer Drilling third quarter earnings conference call. During today’s presentation all parties will in a listen only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, November 4, 2010. I would now like to turn the conference over to Miss Anne Pearson, Senior Vice President with DRG&E. Please go ahead ma’am.

Anne Pearson

Thank you and good morning everybody. Before management makes their formal remarks, I have a few of the usual items to cover. First, a replay of today’s call will be available and can be accessed by webcast by going to the investor relations section of Pioneer’s website and also by telephone replay, and you can find all of the replay information in today’s news release.

Information on this call speaks only as of today, November 4, 2010, so any time sensitive information may no longer be accurate as of the time of any replay.

Management may make forward-looking statements today that are based on beliefs and assumptions and information currently available to it. Although management believes the expectations in these statements are reasonable, they can give no assurance they will prove to be correct. The statements are subject to certain risks, uncertainties and assumptions that are described in this morning’s release and also in most recent filings with the SEC. Should one or more of these risks materialize, or should underlying assumptions prove to be incorrect, actual results may differ materially.

Also please note in this conference call, may contain certain references to non-GAAP measures. You can find reconciliations to the GAAP measures in Form 8-K as well as in today’s news release.

Now with that, I’ll turn it over to Stacy Locke, Pioneer President and CEO.

Stacy Locke

Thank you Ann and good morning. Joining me on the call this morning is Red West, President of our Land Drilling division, Joe Eustace, President of our Production Services division and Lorne Phillips, our Chief Financial Officer.

As you can see from the press release, we had another very solid quarter in the third quarter. Total revenues were up 16%. However, when you correct revenues Q2 to Q3 for turnkey activity, the baseline revenue growth was actually 24%, so an excellent quarter for us.

EBITDA was also up substantially, 56% to $34 million and EBITDA as a percentage of revenues grew from 19% to 25% of revenues.

Revenues derived from work in oil, mostly the oil shelf plays was also up. You may recall last quarter was the first quarter that we had oil related revenues in excess of 50%. In the third quarter, our oil related revenues were over 60% in both our drilling division and our production services division. Strategically, as you may recall, we have pushed both assets, both drilling and production service assets into oil over the last five years.

In addition, strategically we have upgraded and repositioned our drilling fleet into the shale plays and secured that activity with term contracts. Today, approximately 70% of our working rigs are under term protection.

Turning now to the drilling division, play by play, in the Marcellus we have seven active rigs there. We are installing the final three skid package systems on rigs there in the Marcellus. All are under term and before the stronger winter months hit, all seven rigs will have skid packages.

Turning to the Bakken, we’ve added our ninth rig there in October, so eight of the nine rigs are operating under term, and our performance in the Bakken has been superb. We have multiple rigs drilling sub 20 day, 20,000 for laterals on a consistent basis.

In the Eagleford , we continue to have a commanding market position with 12 active rigs there. In the Iberia we have two rigs under term and just as a note, one of our 1,000 hp mechanical top drive rigs on a walking system is outperforming some of the latest technology rigs on a consistent basis in both penetration rate and cost per foot, which gets back to something you’ve heard me comment on in that past, that at the end of the day, the drilling crews and the way we run our operations is more important than the technology.

In Columbia, we have eight rigs under term. We anticipate that in Columbia we will install or begin installing our final walking system on the rig there by the end of this quarter.

Currently, we’re turning our focus on more successfully working our remaining 20 or so conventional rigs, and we’re seeing some hope and opportunity in that regard.

Looking at production services, wireline and well services performed very well in the quarter while fishing and rentals remain challenged. Wireline, we’re on track to grow 33% in unit growth this year, ending the year with 84 units, up 21 from 63 at the end of 2009. We continue to position our wireline operations in every significant shale play the in country. We will soon be placing orders for six more units to be deployed mostly in the first quarter of 2011.

On the wells services front, all 14 of the wells service rigs that had been cold stacked are back to work, and while we averaged 81% utilization in the third quarter, we’ve operated at 90% plus since the beginning of September.

Our hourly rate was up 2% Q2 to Q3 to $464 per hour and is currently running up another 5% or so. We will be adding four to six new well service units to the fleet by May of 2011.

All in all across the company, things are going very well. I would like to turn the call over to Lorne at this point to give a financial overview.

Lorne Phillips

Thanks Stacy. Morning everyone. In the third quarter, Pioneer had a net loss of $2.6 million or $0.05 per share compared to a net loss of $10.1 million or $0.19 per share in the second quarter of this year. Consolidated revenue was $135.5 million, which was up $18.5 million from the prior quarter. EBITDA increased to $34.2 million, up from $22 million in the second quarter.

On a division basis, total drilling revenues for the quarter were $85.7 million, which was an increase of 13% sequentially. So that total revenue from our Columbian operations accounted for $24.8 million. The Columbian revenue increase of $4.5 million is primarily a result of having all eight rigs working throughout the quarter.

Turnkey revenues represented less than $1 million in the third quarter compared to $8.6 million in the prior period. We do expect to continue to see some turnkey work going forward, probably two to three jobs a quarter.

The drilling services gross margin increased 30% from 23% in the second quarter and this margin improvement was the result of increased rig utilization and increased revenues per day in both the U.S. and Columbia. As a result of those increases in utilization and revenue, our margin per day increased 35% to $6,267.

As of today, we have 31 rigs under contracts with another one expected to start in late November. This compared to 27 at the time of our last quarterly call. Of the 31 rigs on term, 23 are operating in the U.S. and eight are operating in Columbia.

Measured as of September the average term for the U.S. contract was eight months, the same as on our call three months ago. As we renew these contracts, we are pushing and usually achieving 12 month term on the U.S. contracts. In Columbia, six of the eight rigs are on term through the end of 2012 and two are up for renewal in April, 2011.

In production services, our business was up in all segments of this division, and gross profit from this group represented almost 45% of our company wide gross profit in the third quarter. Revenues were $49.9 million, which is a sequential increase of almost 22%.

Gross margin increased 5% from 40% in the second quarter. Similar to drilling, this increase in production services and margin was driven by utilization and higher rates. Well servicing utilization was 81% and the hourly rate was $464. Those numbers compare to 74% utilization and $456 per hour in the prior quarter.

Additionally, as Stacy mentioned, all 74 of our work over units have crews assigned and are actively marketed with current utilization of slightly over 90% today.

Companywide SG&A costs were $13 million versus $12.3 million in the second quarter. The increase was driven primarily by increased compensation related costs. SG&A costs will increase next year, probably to the $55 to $57 million range for the full year 2011. I’ll give more guidance on that number on our next call.

Depreciation and amortization costs were $30.8 million, up about $1.3 million from the prior quarter. The increase reflects the increase in our CapEx for top drives, skidding and walking systems, higher horsepower pump packages, other rig upgrades and wireline units.

For the year, we now expect G&A to be in the range of $121 to $123 million. We are still finalizing our CapEx plans for 2011, but right now the expectation would be for our G&A to be flat year over year.

Our interest expense was $7.6 million which is up $.5 million from the prior quarter, which reflects an increase in the drawdown on our revolver to fund the increased CapEx and overall growth.

At this point, I would like to discuss one item mentioned in the 10-Q, which is a charge that we expect to take in the first quarter of 2011 related to our Columbian operations. The Columbian government is assessing a one-time special tax based on an entity’s net equity measured on a tax basis as of January 1, 2011.

We anticipate this cost for Pioneer will be between $5.3 million and $6.3 million. Although it will be paid out semi-annually over a four year period beginning in 2011, we expect to take a charge for the full amount in the first quarter of next year. This tax is not deductible for tax purposes.

The Columbian government has assessed similar taxes in prior years before we were operating in Columbia and we cannot predict if similar assessments will not be made in the future.

For the first nine months of 2010, our effective tax rate was 35.9% and for the full year of 2010, we expect it to be in that range, around 35% to 36%.

Looking at the balance sheet, as of September 30, we had $39.8 million drawn under our $225 million revolving credit facility. That is an increase of $17 million of borrowings on the revolver during the quarter, driven by growth and CapEx.

We borrowed an additional $8 million in October, so we now have $47.8 million outstanding and $9.2 million in committed letters of credit, leaving $168 million of borrowing capacity on the line. Our cash and cash equivalents were $16.9 million at the end of September.

As of the end of the third quarter, we were in compliance with our financial covenants under the facility. Our total consolidated leverage ratio was 3.44 to 1. Our senior consolidated leverage ratio was .56 to 1, and our interest coverage ratio was 3.92 to 1.

We spend $36.1 million on capital expenditures in the third quarter with the majority of those expenditures in the drilling business. We added six top drives, five walking or skidding systems and six wireline units during the quarter.

Based on the growth opportunities we see today, our Board approved an additional $15 million for 2010 CapEx budgeted commitments, bringing the total year budget to $141 million. Of the $15 million increase, we expect that approximately $6 million will be spent in the fourth quarter of 2010 primarily related to routine expenditures driven by the higher activity levels.

The remaining $9 million will be spent in the first half of 2011 and will be focused on delivering four to six new work over rigs and up to six wireline units in the first half of the year.

As previously mentioned, we are still finalizing our CapEx plans for 2011. For now I can tell you that assuming the market remains strong, we do expect to use all of our free cash flow to invest in the business next year.

And with that, I’ll turn it back over to Stacy.

Stacy Locke

Thank you Lorne. Our key markets continue to look strong despite natural gas prices. During 2011, we anticipate that we will be successful in putting additional conventional rigs to work without top drives, but at lower margins. We also anticipate that we will be successful in placing two to three new builds during the second half of the year, 2011.

With respect to Q4 guidance, average drilling margins should increase an additional $300 to $500 per day and utilization improve modestly, perhaps in the 2% to 3% range.

On the production service side of the business, we’re obviously having a strong start to the quarter; however, we will have the holiday season beginning later this month, and we are already experiencing the shortened days, so we anticipate revenues flat to slightly down in Q4 relative to Q3, and margin as a percentage of revenues roughly flat to Q3.

That concludes our prepared remarks and we would like to open to questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from John Keller with Stephens. Please go ahead.

John Keller – Stephens

Hi Stacy and Lorne.

Stacy Locke

Good morning.

Lorne Phillips

Good morning.

John Keller – Stephens

Just a quick question on the production services business. I mean clearly you’re putting some capital into that business as we look out to next year, but do you think that given continued strength in unit additions, that you can get back to kind of your peak ‘08 sort of – well I guess you’re at your peak revenue levels, but kind of EBITDA levels?

Stacy Locke

Well, in the third quarter for example in the wells services division, that was our highest quarter in history in rig hours, so we are seeing substantial improvement in activity and our number of jobs is up significantly in the wireline area as well.

What we’re lacking is pricing, but as – our utilization really can’t go much higher in the production service side, but as other competitors’ activity levels pick up, it’s going to allow the whole group to bring their pricing up and we’re starting to see that. We’re seeing it pretty clearly in the well service area right now, but we have a long way to go to get back to the $600 plus an hour that we were in ‘08 at one or so quarters.

But we see that. It’s definitely heading in that direction. We’re pushing $490 today, and so we’ll just see if the market will allow us to do it, but it’s heading in that direction.

John Keller – Stephens

And maybe you could just help understand, I think we’ve talked about this in the past, but I can’t recall exactly. The majority of those assets are located where and what type of work are they really doing, particularly on the wells services side.

Stacy Locke

Well the wells services fleet is spread in lots of different areas. We have nine units up in the Bakken. We’ve got four units in the Eagleford. We have some in Mississippi, some in Louisiana, and then a pretty heavy concentration in east Texas and in Arkansas as well, so we’re spread pretty wide and far and they’re doing different things in different markets, but I think that in some cases we’re doing a lot of clean outs. Joe, you want to shed any light on any specifics?

Joe Eustace

Well we tend to work in areas where we’re able to do more work over’s and more equipment so we’re currently not in the areas where there are just rigs by themselves. We tend to have the overall packages which give you a higher rate.

John Keller – Stephens

OK. I was under the impression that maybe you were doing a lot of completion related work with those assets.

Joe Eustace

We’re doing a lot of completion work, but there’s a lot of work over’s, existing production. I think that’s where we’re going back into old oil wells that might have been inactive earlier, but with the price of oil versus natural gas, we seem to – we’re doing more oil work.

John Keller – Stephens

Got it. Well that’s pretty positive then because most of your competitors in that business have sort of been lamenting about the lack of work over activity, so I guess that’s a positive. And then just one quick question on the new build front. Stacy, you mentioned a couple, three builds in the back half of ‘11. Would that be you think you’ll secure contracts in the back half of ‘11 and you’ll deliver those sometime in ‘12 or would that be something that you’ll actually put those into the active fleet in the back half of next year?

Stacy Locke

It would be putting it the active fleet in the back half of the year. We’re already negotiating with customers right now on securing contracts and then once that contract is secured, we would begin the building process. We’re not ones to – with our limited capital, we’re not ones to speculate so we need a signed contract before we start ordering equipment.

John Keller – Stephens

That makes a lot of sense. Care to elaborate or give us any insight on what the terms are looking like?

Stacy Locke

Well I would say across the board generally, new build rates, if I was to give a range, I would say kind of in the 24 to 27 a day and two to three year terms. I think we’ll be looking for a minimum of three year terms, but I would say generally that’s kind of where the rates are. Joe, would you agree with it?

Joe Eustace

Yes.

John Keller – Stephens

Perfect guys. Appreciate it. Keep up the good work.

Stacy Locke

You bet. Thank you.

Operator

Thank you. And our next question is from the line of John Daniel with Simmons & Company. Please go ahead.

John Daniel – Simmons & Company

We’ll go to Joe if that’s okay on the wells service space, and you mentioned that pricing is moving up clearly right now. Can you give us a sense as to the magnitude and can you give us a sense as to when the – I presumably the increases are being made by the larger companies. When they made those increases to customers, things like that.

Joe Eustace

Yeah John, I would say it’s been about 5%, and interestingly enough, the rig rates stayed relatively flat through the first half of the year and we’ve just seen this increase in this last quarter primarily, so I’d say that’s a good sign.

John Daniel – Simmons & Company

OK. And Stacy, you mentioned you’re running sort of in the $490 per hour today and I understand the seasonality of the business and that we could very well see hours and utilization dip once we get into Thanksgiving and late December. But from a modeling standpoint, one shouldn’t really expect to see that $490 dip. I mean it should stay pretty consistent, is that a fair statement?

Stacy Locke

I think that is fair.

John Daniel – Simmons & Company

OK. Just two more if I may. The one has to do with this increasing length of laterals, Joe. One of your larger competitors is now investing in a bunch of 1,000 horsepower rigs. Do you think that the industry will need to invest more and higher horsepower equipment for these laterals or I would think that a 500 horsepower rig could go and do the work.

Joe Eustace

I think that up until the last few years, most of the rigs in the United States were 300 class. All of ours are 500 to 600 class, and we’re probably looking at maybe some taller derricks in this next order.

John Daniel – Simmons & Company

OK. Fair enough. And last one for me, Stacy, any chance you could give us a little color on sort of a blended average cash margin on your contracted rigs versus the non-contracted rigs?

Stacy Locke

Well, let’s see. I would say that most of the non-contracted rigs are the conventional rigs and I would say the average margin range, $2,000 to $4,000. Don Lacombe is sitting here with me, and that sounds about right.

The contracted more term rigs I would say probably $7,000 to $17,000 in that range in margin.

John Daniel – Simmons & Company

$17,000 day cash margin?

Stacy Locke

No, $7,000. They range – they’re broad range, but $7,000 to $17,000 a day.

John Daniel – Simmons & Company

Right. All right. That’s all for me. Thanks guys, good quarter.

Stacy Locke

You bet.

Operator

Our next question is from the line of Shawn Boyd with Westcliff Capital Management. Please go ahead.

Shawn Boyd – Westcliff Capital Management

Hi. Thanks for taking the question. Just a couple quick ones here. Stacy, I think I heard you mention wireline is on track for roughly 33% unit growth, but is that, I’m sorry, but is that fourth quarter over fourth quarter last year? What’s that metric?

Stacy Locke

Well, it’s exit ‘09 which was 63 units versus exit ‘10 at 84 units.

Shawn Boyd – Westcliff Capital Management

Got it. OK. So what I’m trying to do, I’m thinking here about next year and I’m trying to think of the overall unit growth in production services, so I’m doing two things. I’m going out to next year and I’m kind of generalizing in a very broad sense. Can you speak just briefly to the different segments of production services and how just in general what you see the unit growth for each to be? I know it’s very preliminary, but in broad terms, I’m trying to see how much we’re increasing our equipment next year.

Stacy Locke

Right. Well as Lorne mentioned, we’re right in the middle of our capital budgeting process. Although we have already – we were just about to go ahead and order additional work over and wireline equipment so it can be in the field working in the first three to five months of the new year.

But broadly speaking, I think it would be safe to say that we anticipate growing both work over and wireline at least 10% to 20% unit growth next year.

Shawn Boyd – Westcliff Capital Management

Got it.

Stacy Locke

We will finalize that this year and we can talk on the next call and give you a little more color on that.

Shawn Boyd – Westcliff Capital Management

OK. That’s helpful. And within production services, just breaking that down a little bit, what percentage of that would be right now work over versus wireline?

Stacy Locke

Well, what I would say is that we would grow the number of wireline units at least 10% to 20% and the number of work over units the same.

Shawn Boyd – Westcliff Capital Management

OK. Very helpful. And Lorne, on the SG&A, I know you made comments there about fourth quarter and a preliminary look on next year. Could you just repeat those again.

Lorne Phillips

SG&A, what I said is that for next year we would probably be in the $55 to $57 million range for the year, and I actually didn’t talk about the fourth quarter. I think it will be up maybe $300,000 to $500,000 quarter over quarter in that range maybe in Q4 to Q3.

Shawn Boyd – Westcliff Capital Management

Got it. OK. Very helpful. And then just last one for me, Stacy, going back to your comments on oil, when you say we’ve got over 60% of our rigs targeting oil work, I assume you’re including liquid rich gas plays. Is that correct or no?

Stacy Locke

Yes.

Shawn Boyd – Westcliff Capital Management

OK. Very good. Keep up the good work guys. Thanks.

Stacy Locke

Thanks Shawn.

Operator

Thank you. And that does conclude the question and answer session. I would now like to turn the call back over to management for closing remarks.

Stacy Locke

Right. Well, we appreciate everyone participating on the call this morning and we’ll look forward to visiting at the next quarterly call. Thank you.

Operator

Ladies and gentlemen this concludes the Pioneer Drilling third quarter earnings conference call. If you’d like to listen to a replay of today’s conference, the information can be found on today’s news release. ACT would like to thank you for your participation. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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