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Executives

Lisa Ottmann - Vice President, Investor Relations

Lyle Whitmarsh - Chief Executive Officer

Brent Conway - President

Lesley Bolster - Chief Financial Officer

Analysts

Dan MacDonald - RBC Capital Markets

Scott Treadwell - TD Securities

Kevin Lo - FirstEnergy

Greg Colman - National Bank Financial

Jon Morrison - CIBC World Markets

Dana Benner - AltaCorp Capital

Jeff Fetterly - Peters & Co.

Trinidad Drilling Ltd. (OTCPK:TDGCF) Q2 2014 Earnings Conference Call August 7, 2014 11:00 AM ET

Operator

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Trinidad Drilling Limited second quarter results conference call. (Operator Instructions) Ms. Lisa Ottmann, Vice President of Investor Relations, you may begin your conference.

Lisa Ottmann

Thank you. And thank you for joining us today. We'll be discussing Trinidad Drilling, Limited second quarter and year-to-date 2014 financial and operating results, which we released yesterday. A full copy of the MD&A and financial statements along with the presentation outlining the quarter highlights are available on our website at trinidaddrilling.com. Our full second quarter results are also available at sedar.com.

Please note that during the call we will be discussing forward-looking information relating to various areas of our business, including, but not limited to the completion of reconstruction programs on a timely and economic basis; the assumption that Trinidad's customers will honor their take-or-pay contracts; the ability for Trinidad to attract and retain qualified crews to operate their rigs; assumptions respecting capital expenditure programs by oil and gas exploration and production companies; assumptions made about future performance or operations of the joint venture agreement; and other expectations about future events or performance.

Such information and statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking information or statements. And you are cautioned to not unduly rely on such forward-looking statements. For a copy of our full forward-looking disclaimer, please refer to the disclaimer included in yesterday's press release and our MD&A.

To discuss our results, our view on the drilling sector, and Trinidad's opportunities going forward are Lyle Whitmarsh, Chief Executive Officer; Brent Conway, President; and Lesley Bolster, Chief Financial Officer.

I'll now turn the call over to Lyle.

Lyle Whitmarsh

Thank you, Lisa. Good morning, everybody. The second quarter of 2014 was a transitional period for Trinidad. Our profitability lowered in the quarter due to several factors, which were largely temporary. I will get into more details on these factors, as I discussed the results, but was mostly relating to the reactivation cost and our change in rig mix in the U.S., the redeployment of our Mexico rigs to Canada and the continuing growth of our joint venture operations.

Industry conditions across all areas of operations have strengthened. We are seeing increased demand for equipment and we expect that Trinidad will perform well in the second half of 2014.

During the second quarter, Trinidad's revenue totaled $169 million, up 2% from the same quarter last year. Revenue increased as result of higher dayrates in our Canadian operations and a positive foreign currency translation on our U.S. division. This was offset by no activity from our Mexican rigs and a weaker contribution from our U.S. and barge operations. As well, revenue increased as a result of an increased manufacturing revenue in 2014.

Operating income, net percentage or operating margin was 28% in the second quarter, down from the 36% in the same quarter last year and 41% in the first quarter of 2014. Operating margin decreased compared to the same quarter last year, because of higher external rig manufacturing for our joint venture operation, which generates lower margins. Lower operating income from the U.S. and international division also lowered operating margins compare to the same quarter last year and the first quarter of 2014.

Adjusted EBITDA was $316 million in the quarter, down from $40 million in the second quarter last year and $79 million in the first quarter of 2014. Adjusted EBITDA was lower than the previous comparable quarters, largely as a result of the factors affecting operating income.

G&A cost, excluding stock-based compensation and third-party costs in the quarter, were approximately $15 million, in line with the second quarter of 2013 and the first quarter of 2014. We expect that this is a reasonable quarterly run rate for G&A, excluding stock-based compensation expense and expect full year G&A to be about $60 million in 2014.

Net earnings were a loss of $25 million in the quarter, down from an earnings of $0.3 million in the same quarter last year. Net earnings were lower than last year as a result of an impairment of property and equipment, lower adjusted EBITDA, higher stock-based compensation expenses and partly offset by lower income taxes and a gain on sale from the three rigs we sold to the joint venture.

At the end of the second quarter, we transferred out seven rigs from our fleet and recorded an impairment of $21 million related to this equipment and some previously decommissioned equipment. Of these rigs, five are in our Canadian operations and two were in our U.S. operations.

These rigs are older mechanical style rigs, and have generated limited activity or operating margin over the past few years. The other equipment from previously decommissioned rigs that we had initially intended to sell, the market for this kind of equipment is now oversupplied and we do not expect to sell the equipment for the values originally estimated.

The industry as a whole is changing. Customers are more often demanding high-spec equipment and are less likely to return to older less-efficient equipment, even if the dayrates are lower. This is a trend that we saw starting many years ago and we began to assemble our high-performance fleet.

Our accelerated upgrade program this year addresses the issue of keeping the rigs that are five to eight years old competitive and able to generate strong dayrates. Following the rigs we decommissioned this quarter, we have a total of 124 rigs, including new build under construction and our joint venture rigs.

Of this fleet, approximately 85% is considered high-performance with advance drilling control and high mobility. We have been keeping a close eye on the increasing number of rigs built in the North American market.

A much broader group of customers are now demanding high-performance equipment for the expanding number of plays. However, a large portion of the existing North American market is still made up of older style equipment. We feel that these new rigs will largely replace older assets and that no long are relevant in the market rather than adding incremental rigs to the industry.

Our upgraded rigs are competing well with the new builds entering the market. Until recently, the new build contracts available have not met our internal hurdles, and we have been disciplined in not accepting these terms.

In the past few months, the industry conditions have improved and we are seeing more opportunities that we are interested in pursuing, particularly in our U.S. and international operations. We will provide an update to the market once we have more definite information.

Now, let's turn more specifically to our Canadian operations. Utilization levels in the first quarter averaged 26%, unchanged from the same quarter last year and down from 74% in the first quarter of 2014. Activity lowered from the first quarter as a result of spring break up, when wet weather typically reduces the activity levels in the industry.

In the second quarter of 2014, industry activity improved over the previous year, while Trinidad remained stable. Our strong activity level in the second quarter of last year combined with some customer specific delays, the timing of rig certifications and some flooding in certain parts of our operations during the current quarter, left our activity levels stable quarter-over-quarter.

Revenue in the second quarter was $38 million, up 3% from the same quarter last year, as dayrates increased reflecting growing demand in Canada. Revenue decreased by $66 million compared to the first quarter of 2014, as a result of lower activity levels in the current quarter due to seasonality.

Operating margin was 25% in our in our Canadian operations, up from 23% in the second quarter of 2013 due to higher dayrates, but down from 48% in the first quarter of 2014 as a result of seasonality. Activity levels are increasing sharply as we move into the summer. We currently have approximately 65% of our fleet working, with more rigs scheduled to startup in the coming weeks. This is ahead of where we were last year.

Industry is currently just over 50% utilized. At the end of the second quarter, we moved three rigs that have been idle in Mexico, back to our Canadian operations. These rigs did not meet the specifications currently required in Mexico. These rigs are currently being upgraded with top drives, catwalks and increased hook load, and we expect them to be working in the coming months.

In addition, at the beginning of the third quarter, we moved two more U.S. based rigs, up to our Canadian operations. One is a heavy double and is better suited to the Canadian market, and then another a modern triple moved across the border from the northern U.S. to the southern Alberta area, where it will be working in the Alberta Bakken play. We are seeing increased demand for equipment, particularly modern high-spec rigs. Dayrates are moving up and we are seeing growing demand from customers to sign up rigs before the winter drilling season.

We expect that this winter will be busy for Trinidad and that our results will reflect the strength. There has been a lot of discussion about the LNG and how developing Canada's natural gas resources for the international export will impact the Canadian oil field services sector. We believe that this is an important growth opportunity for Trinidad and for Canada.

However, we do not expect the full impact of this growth to be felt for sometime yet. The remaining obstacles to overcome before the projects can proceed, some of which are complicated and most likely time consuming. We are carefully watching this process and believe that as the timeline firms up, Trinidad will benefit from the LNG growth in Canada, most likely in 2015 and beyond.

We have a reputation for building equipment and drilling the type of wells needed for this development and already worked for most of the key players. We expect to fully participate in incremental demand driven by LNG in the coming years.

Now, let's turn to our U.S. and international operations. Results in our U.S. and international operations were lower than the same quarter last year and the previous quarter, largely due to a number of temporary factors.

Revenue in the quarter was $110 million, down from a $119 million in the same quarter last year and $115 million in the first quarter of 2014. Revenue in the second quarter was lower than the same quarter last year, partly because of the three idle rigs in Mexico.

These rigs worked in the second quarter of 2013 and contributed approximately US$6 million more revenue last year than in the current quarter. These rigs have since been moved to our Canadian operations where they are being readied for the coming busy drilling season. Of the three rigs, one has already been contracted and the others are generating strong interest from a number of customers.

Lower dayrates in the current quarter also led to lower revenue generation. Dayrates in the second quarter of 2014 were US$1,617 lower per day than the same quarter last year. In the current quarter, several rates that have been previously working at some of the highest dayrates did not work or worked only towards the end of the quarter.

We had received early termination revenues for these rigs in late 2013 and early 2014. Having received over year's worth of revenue for each of these rigs as a lump sum, we were willing to wait for the right contract terms before putting them back to work. The impact of these rigs not working was approximately US$9 million, less revenue in the current quarter. All of these rates are now working for new customers.

In addition, activity levels in our barge operations were lower in the second quarter of 2013 due to projects delayed to later periods, reducing the revenue contribution to the division in the current quarter. Compared to the first quarter of 2014, revenue was lower mostly because of lower dayrates in the current quarter. Dayrates were down US$1,822 per day compared to the first quarter.

Dayrates lowered in the current quarter, largely due to a change in rig mix and lower early termination revenue. During the quarter, our activity levels increased as lower spec rigs were reactivated. These rigs typically generate lower dayrate and reduce the average dayrate.

In addition, we received early termination revenue in the first quarter of 2014, which temporarily increased the dayrates, as the revenue has no associated operating days. The number of operating days declined by a 137 days in the second quarter compared to the same quarter last year.

This reduction was mainly due to the three idle rigs in Mexico, I mentioned earlier. Excluding these rigs, our operating days would have actually been higher quarter-over-quarter. Operating days were up 130 days from the first quarter, as we reactivated rigs to meet the growing customer demand.

Operating margin in the U.S. and international division was 32% in the quarter, down from 40% in the same quarter last year and 38% in the first quarter of 2014. Operating margin decreased due to the factors affecting revenue, I just discussed, and also as a result of higher cost in the current quarter. As we reactivated rigs, we incurred higher repairs and maintenance expenses and cost to move rigs to new place. In addition, we also incurred cost to move the Mexican rigs back to Canada.

We are seeing strengthening in industry conditions in the U.S. with strong demand for equipment. Dayrates are trending up, contract terms are extending, and activity levels are increasing across our U.S. operations. In fact, every one of our U.S. rigs is now working. We expect these stronger conditions will generate improved results for the remainder of 2014 and into 2015. The majority of the factors that affected our U.S. and international operations in the quarter are now complete and we expect margins to increase moving forward.

Moving on to our U.S. barge operations now. Conditions in the barge market continue to be a little softer in the quarter. Dayrates remain strong at US$34,599, but activity levels remained lower at 57% in the quarter, down from the 98% in the second quarter last year, and up slightly from 54% in the first quarter of 2014. Activity levels began to improve towards the end of the quarter and we expect the activity to average in the 70% to 75% range for the second half of 2014.

And now let's look at our joint venture operations. The joint venture, we signed the Halliburton last year is progressing well. To date we have agreed to have eight rigs operating under the joint venture, four in Mexico and four in Saudi Arabia. The first three rigs are in Saudi now, with two rigs beginning their first wells during the quarter. The third rig is expected to startup soon. Well, the fourth rig, a new build is being rigged up in Dubai and is expected to begin operations towards the end of the third quarter.

The rigs for Mexico are being built in Houston through a combination of third-party outsourcing and Trinidad design and manufacturing. These rigs are expected to be completed towards the end of 2014 or early 2015. Overall, the joint venture has been progressing well with both companies contributing to the operation as expected.

Our initial plan has been to start with operations in Saudi and Mexico and later to expand in areas where Halliburton has operations. Halliburton has bought us a number of opportunities, since we signed the joint venture. However, we have not added any additional rigs to the joint ventures yet.

There are a variety of reasons why we have not chosen to pursue these opportunities. Some due to timing requirements we could not meet, economics that did not meet our hurdles, and growing demand in the North America that keep rigs active in competitive margins.

We expect to grow our international business at a measured pace making sure that our operations are well-established and running smoothly before adding new operating areas. To date, this plan has been unfolding as expected and we see the joint venture as an increasingly important part of our business moving forward.

Our 2014 capital budget is unchanged and is expected to total $315 million. This total includes our portion of the joint venture rigs, our internal capital projects and its net proceeds we received from the joint venture for existing rigs sold to the joint venture.

This year we have six new builds, one for the LNG development in the Liard Basin and five for the joint venture. We will also be spending about a $140 million, upgrading about 30 of our existing rigs and $40 million on maintenance capital. We spent $80 million on capital projects including the joint venture in the second quarter and $118 million year-to-date.

Our projects were largely made up of Trinadad's LNG rig that is being built for the Liard Basin, our Saudi new build and our upgrade program. As for the upgrades, we have started work on most of the rigs scheduled for upgrade this year, some of the invoices, the purchase or construction of the equipment that will be added to the rigs, such as top drives and moving systems. We typically time these kinds of upgrades, so that the majority of work is done ahead of time and then install the equipment as the unit between wells to minimize downtime.

In addition, we have begun pump upgrades and AC conversions on a number of the rigs in the fleet. There maybe some impact on activity levels and margins going forward, as these rigs complete their final upgrade, but we expect they'll keep this to a minimum.

At the end of the quarter, our total debt to bank EBITDA was 1.93x slightly up from the end of 2013, because of lower EBITDA compared to the second quarter of 2013, and a slight increase of the U.S. dollar translation as our debt is U.S. dollar-based. It is also important to note that this metric ignores the cash on hand, which totaled $264 million at the end of the quarter. Including cash on hand, this metric would be 0.88x.

Our revolving facility was undrawn throughout the quarter. And our outstanding debt was made up solely of the senior notes, which are due in 2019. Part of our strategy is to maintain a contract base that protects the portion of our revenue stream and the variability of the industry. This strategy allows us to participate in the upside of the market when pricing increases, while limiting the impact of the down cycle.

We currently have approximately 45% of our total fleet under long-term take-or-pay contract with an average term of approximately 1.6 years remaining. Well, a number of the temporary factors lowered our second quarter results, the majority of these are now behind us. Activity is picking up, both in Canada and the U.S. and dayrates are trending up.

Contract terms and dayrates for new build equipment have improved and now meet our internal hurdles, which could lead to additional new builds, particularly for our U.S. operations. In addition, we are also currently evaluating several international growth opportunities. We expect that these improving industry conditions and our in-demand high-performance fleet will allow Trinidad to perform well in the second half of 2014.

Before I conclude, I would like to take a moment to thank the people at Trinidad for their hard work and commitment. Safety is very important part of our business and a good example of the ongoing commitment and focus our people have to putting their best into every job they do everyday. Our safety performance is better than the industry. And each month we continue to generate company records in the lowest number of recordable incidents, a huge achievement for our company with growing operations like ours.

I want to thank our crews for keeping safety at the forefront, where it needs to be and looking out for themselves and their coworkers. Thank you for listening. I will now pass the call back to the operator and take any questions that may be on the line.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dan MacDonald from RBC Capital Markets.

Dan MacDonald - RBC Capital Markets

Just wondering, if we look at your U.S. operations, could you give us a bit more color on what portion of that fleet has contracts coming up for renewal over, say, the next 18 months or so?

Lesley Bolster

Dan, in the U.S. we've got 16 rigs that will come up next year and five for this year.

Dan MacDonald - RBC Capital Markets

And then looking specifically at the couple of high-spec ones that are early termination payments, but since then put to work. Were you able to put them back to work at rates above what the terminated contracts have been at?

Lyle Whitmarsh

They're slightly under, but very competitive. We were waiting patiently, as the rates were quite lower, when they first came off and got terminated with the early term payment. So we are being fairly disciplined in waiting, and in some case moved them to different customers. But they're competitive and very close, but they're not quite great at that rigs that they have been locked in.

Lesley Bolster

And also sometimes it depends on what's included in that dayrates. So those rigs had additional costs that were included in the dayrates, it kind of netted off, if you understand what I'm saying, so the margins will be similar to what they were before.

Dan MacDonald - RBC Capital Markets

And then just lastly, if you had to look at your new build, kind of where your next new build slot might be, sort of where would that be in the schedule today?

Lyle Whitmarsh

I think that when we look towards that just considering our joint venture commitments and the execution on some of the rigs here with Liard rig and such, I think we'll be talking about delivery into the 2015 market, starting probably Q2, somewhere in there.

Dan MacDonald - RBC Capital Markets

But you could still deliver in the first half of 2015 at this point?

Lyle Whitmarsh

Absolutely.

Operator

Your next question comes from the line of Scott Treadwell from TD Securities

Scott Treadwell - TD Securities

I guess to build on Dan's question, in terms of timing. Given the commitments you have for the joint venture, and then a pretty substantial upgrade program. How many new builds could you deliver through the end of 2015? Assuming the terms are there, and that you don't go and spend money to expand capacity.

Lyle Whitmarsh

Yes. I think there were still -- we're doing a lot more outsourcing today, because of the workload in the geographical locations that were deploying the rigs to, obviously, in our joint venture agreement with Halliburton. So I think on the North American side, I'm still pretty comfortable somewhere between six to 10 rigs are very achievable through there.

And as we grow on the international side, if there is some joint venture rigs, you look at us outsourcing some alignments with manufactures closer to the destination where the rigs might be, just to make sense obviously on execution and mobilization cost. So we're fairly comfortable that we can add a substantial amount of rigs into the market yet and still have capacity.

Scott Treadwell - TD Securities

And a number of competitors have talked about increasing their capacity to build and a lot of that revolves around long-lead items, pumps, engines, top drives and such. At this point, does Trinidad have anything like that on the goal? And is that something that you would look at as a risk, if you got a bunch of rig orders in front of you, it might be tough to catch up on the capital side or you're pretty comfortable with the availability?

Lyle Whitmarsh

Right now, I think we're pretty comfortable, because we've been fairly busy with our joint venture in some of the larger rigs that we're producing here. We've been consistently ordering and putting rigs together. So we're pretty comfortable right now. We're certainly cautious, watching the delivery date, as they start to extend, and I think we'll come back and let the shareholders know that our best management might be some long-lead items.

But right now, we've been managing it fairly closely. We're just starting now to see some pressure on some of the deliveries. But right now, we're still very comfortable on where we sit with our internalized ordering system through manufacturing, as it is fairly large orders we've been placing. So we're fairly comfortable right now, but we're definitely cautious and watching.

Scott Treadwell - TD Securities

The rigs from Mexico, they're in the shop getting upgraded. Do you expect any material contribution in Q3? You mentioned one of them under contract. Is that contract slated to start this year or is that more a sort of winter drilling program that might kick-off maybe in November?

Lyle Whitmarsh

Great question. It will be later in Q4. The rigs, it was long, getting them back through customs, and then obviously the long track back up to Nisku, Alberta. So we're looking towards the very tailend of Q4, and then into the winter drill. That was kind of our strategy, when we looked and really spend a bunch of time trying to resecure contracts in Mexico, and then just realizing that at some point we needed to remobilize them at very, very marketable rates. And so that was our plan, was to get them back, get them ready for work, and then deploy them in late Q4 into the winter drilling season.

Scott Treadwell - TD Securities

And the part, I'm assuming that the cost for the move and customs, were those fully booked in Q2 or is there still a little bit more to come in Q3?

Lesley Bolster

There is more to come in Q3. Probably, we had about $1 million worth of cost in Q2 and it's probably another $1 million to $1.5 million to come in Q3. And just be clear, because I know, we did say that we received the revenue, all those rigs were covered with demobilization clauses, and we did actually receive that revenue back in 2012 and 2013, when those rigs were operating as part of that revenue, so now we're just booking the cost.

Scott Treadwell - TD Securities

Last one for me. On the notes side, a good cash balance here, it obviously looks like there is a bunch of growth options for capital spending. But on the other side, if that doesn't materialize for whatever reason, is there an option to pre-pay some of those notes maybe in 2015 or 2016 without much of a penalty or is that something that's further out?

Lesley Bolster

So we have a callable date of January 2015 that we can pay at [indiscernible] so that's an option that we can look at.

Operator

Your next question comes from the line of Kevin Lo from FirstEnergy.

Kevin Lo - FirstEnergy

Of the rigs you moved out of U.S., how many of those would have been considered the higher-spec rigs of your fleet?

Lyle Whitmarsh

Sorry, Kevin, that was, the rigs that we moved out of the U.S.?

Kevin Lo - FirstEnergy

Yes, into Canada.

Lyle Whitmarsh

I think they both were considered high-spec, but certainly the triple was. There is a customer that works on both sides of the border that had that demand up in the Bakken that just felt it made some sense to move us up there. And the other rig was high-spec double that actually originally came out of Mexico that we deployed in there. We are having trouble finding a niche market down there in the double market, so it's also high-spec rig headed back into Canada. So I consider them both high spec.

Kevin Lo - FirstEnergy

And one of the things, Lyle, you were mentioning was that the rates, when those rigs came off contract, it wasn't as favorable and they're improving now. I mean what's your sense of the upside leverage in the current rigs right now? And how much more running room do you think dayrates have to go with the U.S., I guess is the question?

Lyle Whitmarsh

I think what we just really noticed was that they really returned and started to strengthen, based on some of the oversupply or maybe some of the spec rigs hitting the market, and then just I think some of the movements between plays. So I think they're moving nicely now. I think they're kind of peaking back out again. I think we're getting back to some of the higher rates we've seen in the industry.

So we'll have to wait and see how that demand balances that, but we're very excited about where the rates have moved to, but we do believe that they kind of are peaking where we're seeing them right now. We're not seeing -- I think what we're going to see -- I think what's driving that, when we look at it, we strategize over the next six and 12, 24 months, as why we're starting to believe they'll kind of peak here is we're starting to see the term extend a little bit more, which is a signal that for me that the rates have started to hit a plateau. And then we'll start to see the term extend.

And the second thing that I quantify that with is, now we're starting to see more demand again for new builds, which tells me that we're reaching back at a plateau now, where they're willing to commit longer term. And once we get a feel for how that will look, then I think we'll understand if the rates will even creep up a bit more.

Kevin Lo - FirstEnergy

Last thing is on the international side. I mean even with one rig, you guys were profitable. Has that kind of met the expectation and your profitability and how much do you expect the operating leverage to get better to compensate more for the fixed cost?

Brent Conway

Well, I think, Kevin, it's so early days right now to kind of project that based on one rig and one well. So I think we're focused on trying to get the rest of the rigs running. We're trying to make sure that we're efficient in what we do. And we obviously didn't go there to lose money. So I think we've kind of structured things the way that we think makes sense.

There has been certainly some wins and there has been some challenges, but I wouldn't go projecting out profitability based on one rig and one well. I think we told you what our profit expectations are, when we originally went down that path, since it was the whole project and we're still working towards that. So I think that's really our best indication of what the profit is going to look like, but its still very early days for us.

Lyle Whitmarsh

And Kevin I think one of the most important part that I thought really showed our strategic alliance, but also showed our ability to execute on, to give everybody a sense was that pretty much roughly from the time we were awarded the contract, even though in partly because we used existing rigs, within seven months we are actually in country looking and spotting our first well. So I was very happy with our response and being able to try to show to Halliburton of being a good joint venture partner.

And I think that as an industry standard surprised and really set the bar, where we believe we executed well on that. And at to Brent's point, I think we still have. It is a big step change for Trinidad. We've done good job of modeling and strategizing, but I think we still are continuing to learn. But we're very excited about the opportunities that lay in front of us there for growth and in other areas as well.

Operator

Your next question comes from the line of Greg Colman from National Bank Financial.

Greg Colman - National Bank Financial

A lot of mine has already been answered, but just a couple of quick ones. Lyle, at the beginning, you mentioned, just reminded us 85% of your fleet sitting in the high-quality bucket there. Just wondering what's the risk or what's the timing? When did you do the reviews of the remaining 15%? Should we be on the lookout for any other PP&E write-downs in the near term, is that an annual thing? Just wondering what the risk is on that side.

Lyle Whitmarsh

I think it's a great question. We took a good look at it, and I think it's fair to say that we looked at a lot of different conditions on what was driving these rates, what the response to the core recovery side of things, it was predominantly shallower rigs as well. So I think we're fairly comfortable that this isn't going to be a quarterly event.

Greg Colman - National Bank Financial

So we shouldn't be watching for any more write-downs, even though you've still got a bit of that stuff that would be classified as the lower tier.

Lyle Whitmarsh

No, I think right now, we're fairly happy. We are trying to find that balance on capital allocation to make sure that we're being very diligent on that. But I'm pretty comfortable, I mean with all the rigs up and running within the U.S. now and the majority of the Canadian rigs being prepared to return. I think there should be much more, not affecting the go-forward plan.

Greg Colman - National Bank Financial

And then secondly, at least, you gave some good color as to additional model costs that we should expect in Q3. I'm just wondering is there any other one-time or unusual costs that we should be looking for or modeling in the third, and then out into the fourth quarter this year, other than that sort of $1 million to $1.5 million?

Lyle Whitmarsh

When we look around, and as I think, there could be some minor slippage into this quarter, but I think this was a pretty unique quarter with a lot of moving parts, a lot of retransitions, as we use that word quite a bit throughout the presentation, but I think it's really for the most part behind us.

We had a lot of strategic reasons why we are moving rigs to certain areas. Some of it was term and contract, some of it is mobilizations that we had been paid for before, that are just hitting the expense right now. But I think for the line share, most of that are one-time events are behind us. And we look forward to moving onto more normalized balance sheet.

Greg Colman - National Bank Financial

And then this is the last one for me. Just wondering if you can give us a bit of an update on your pending Liard Basin rig that should be headed out at the end of Q3, I think. Is that still the plan? Has there been any change? Do you have any insights for us there?

Lyle Whitmarsh

Yes. We can't really give you much more color than that. We haven't -- obviously we have a very firm, very signed agreement on our liabilities and how the contract works. So we're very comfortable with that. Apache hasn't signaled anything to us at this point that changes our direction or focus on that. So we're going ahead as plan and we'll update you, if Apache changes on that status. But right now, we've called, and they said, no, continue on. We're waiting on the rigs. Let's continue on as planned at this time.

Operator

Your next question comes from the line of Jon Morrison from CIBC World Markets

Jon Morrison - CIBC World Markets

Just to follow on Greg's question, can you give any disclosure around the total number of operating days that those decommissioned rigs generate in 2013 or give us some broad strokes in terms of the utilization that those rigs received relative to the rest of your asset base?

Lesley Bolster

So the current rigs that we had, had a little bit of work during current season, but very minimal. And then margin contribution was quite small. And then the other rigs in Canada didn't contribute at all. One of the rigs in the U.S. contributed last year, but it hasn't went at all in 2014, and we're finding that the stakes are not really meeting what our customers are looking for now.

Lyle Whitmarsh

And when we really did look at it, some of it was a valuation of -- obviously, we waited a little bit. We were hopeful that with the consumption on the gas pricing we were kind of waiting to see on a couple of different front. We were waiting to see if the pricing on gas would spark any sort of shallow gas re-drilling, which these rigs in Canada, predominantly would target throughout the summer. And as we work through the summer and into this quarter, it really didn't materialize as we have hoped. And I think we needed to look at it.

And we want to make sure that we continue to evolve where the markets moving, and then we wanted to make sure we're making very accurate or very defined capital allocations for the shareholders' and not being caught in a cycle where we find that the capital allocations are in the older assets, which are going to have limited ability to produce results, as we look through changing markets.

So it was a very complex decision that was ongoing for many quarters now in evaluating, but with the price of the gas rising through the demand, we are hopeful that it would pick up, but it just hasn't materialized. And the core recovery side has been under pressure as well, and that's really affecting our decision on how much effort management puts on trying to run these rigs, trying to stop these seasonal rigs then trying to maintain high safety performance, puts all of the shareholders at risk. We really need to find that balance as we look forward.

Jon Morrison - CIBC World Markets

Do you plan to have any kind of focus or emphasis in the oil sands coring market come 2015?

Lyle Whitmarsh

No. We'll continue to evaluate. We have produced and been in that market a long time. It continues to be a very seasonal market, which is hard for management to look at and put resources at, because of the shortened windows of opportunity up there. And quite frankly, on the demands of the drilling rate and the demand on expertise and performance for an operation that at times can only be 45 days of the year.

I think as an industry, and as Trinidad, we have looked to be part of that solution, but I think we have to look at ways to keep that particular operation busier throughout the entire year. And we, as an industry, and as a company, haven't found solutions yet, because it is very expensive operation.

Jon Morrison - CIBC World Markets

What side of the, call it, remaining shallower rigs in some of the TDS fleet that you I believe still have on the books? Is there anything for the back half of the year, as we get into the winter season in Canada you don't believe is effectively spoken for by customers at this point?

Lyle Whitmarsh

Majority, I would say were fairly comfortable that we're going to have a high utilization rate. There is always risk as we move through the next few months, that some slip and some will change, but right now we're very comfortable. Last year, for example, we hit in 90-ish, 95 and in Canada and the U.S. now operating in at a 100. We're very comfortable as we move forward into barring any sort of event. I think we're very comfortable where we're headed.

Jon Morrison - CIBC World Markets

What's your current expectations for pricing in Canada in the back half of the year? And how much you had meaningfully, see this price visibility?

Lyle Whitmarsh

Yes. I think as we move through, as we came out of the fall -- out of the spring, and into where we are currently, we didn't see a lot of reduction. I know that there is a proposed wage increase, which won't be a pass-through. But I think that we're going to see, the nice thing for I think for Trinidad was, is that we didn't see a much of a retraction on the Canadian side of this point, where we see some fairly stable rate. So we're hoping if the demand stays there, we should be flat to slightly increase as we move into the winter.

Jon Morrison - CIBC World Markets

Lyle, with the start of the call, you mentioned new build economic turns coming in line with your thresholds in the last three months. One, is that comment more weighted to the U.S. market than Canada. And two, has that really been extension of duration of contracts that customers willing to sign or has there been core dayrate increases in terms of what producers are willing to pay for a new build rig?

Lyle Whitmarsh

I think that it is predominantly. At this time it does appear that the U.S. is slightly a step ahead of Canada. As we moved in and we started to look at it, definitely the economics and the turnaround, what we consider viable definitely changed. And I think it has a lot to do with certain customers and expanding a lot of these request for coming outside of, I would say, our existing base.

So it was people within the U.S. looking to get the efficiencies of these rigs and not being able to secure them potentially, and then just really wanting and realizing that these rigs are there as a whole. So there's been that fundamental shift. A lot more plays now looking forward for the high-spec, high built-for-purpose style rig.

And that really started to seem to come -- I think a lot of the rigs that are being built are being replacement-style rigs, so it did really seem to be driven by the smaller guys, some large ones as well, but predominantly guys that we didn't really worked for, that are looking for that expertise, and also the high-spec rigs. So I think it was a little bit of a combination, but it's definitely improved drastically.

Jon Morrison - CIBC World Markets

Last one just for me. On the upgrading side, if you think back over the past few months and what you message in your preamble, the expectation is that the activity interruption would be somewhat muted by pre-staging the upgrades and completing the work in the field in between wells.

As you work through the early upgrading that you've done to date, is it largely in line with your original expectations? Faster or slower than you're originally expecting? I guess has your view changed at all, as you worked through the early stages of upgrading to date?

Lyle Whitmarsh

The upgrades I think are going as planned and in the schedule. I think the positive note is that the operators, because of the tightening of the market have actually put the rigs and are working well with Trinidad to fine timing and help us get better prepared. And so I think it's actually on budget or slightly ahead of where we would have anticipated it as far as any additional cost or our cooperation has been even better with our customers, as we prepare to get these upgrades done. So we're very happy the way that's moving along right now.

Jon Morrison - CIBC World Markets

Has the activity interruption been largely in line with what you were expecting?

Lyle Whitmarsh

Yes.

Operator

Your next question comes from the line of Dana Benner from AltaCorp Capital.

Dana Benner - AltaCorp Capital

I guess, I wanted to pick up maybe where Jon left off with respect to U.S. new builds. And you've obviously had a lot on your plate by getting the eight rigs into the Halliburton joint venture, their new builds or upgrades. And if we think about the context, we've had some of your competitors announcing mostly U.S. new builds, others not.

And I wonder given that the economics seemed to have improved enough for at least some of your competitors to announce the U.S. new builds, has it been the case that you've simply had so much on the goal within the Halliburton JV that you wanted to make sure to nail that before you bit off anything else in the U.S. where the economics are maybe good enough, but just there's only so much you can do or has it been you're awaiting for the economics to improve sufficiently?

Lyle Whitmarsh

I think that it's a kind of a combination. I think that we realized early on that the 2014 schedule is getting incredibly full. Recognizing that we started out for us a little bit more, become a rig assembler than a pure rig manufacturer. And then I think secondly to that we really were very disciplined.

In some of the cases early on in the year, we could get to an internal rate of return hurdle that met our targets, but the problem was we were constantly faced with a term that was quite short compared to what we need for to secure our contracts at a board level.

So I think it was a kind of early on in the year that just was a lot of rigs on the market being built, with rates that didn't meet our hurdles under a very short term. As we progress through this year we start to see it, where the rates increase, the term increase. In the same time we had a better understanding of how our constructions was going to work over in different parts of our world with our alliances on our assembly plan. And we're very comfortable now in saying that we are looking at more opportunities today, and that we're very comfortable that the rates and returns and we're able to execute on manufacturing things.

So I think it was a little bit of a combination of wanting to ensure, because of the style of rigs we are building and the upgrades that we are doing, making sure we had that under control. But honestly, Dana, it had a lot to do with the rates and the terms that were being offered.

Dana Benner - AltaCorp Capital

I guess a natural follow-up that would focus more on the JV with Halliburton. How would you characterize the bid flow these days, in terms of new opportunities to put rigs into that joint venture versus where it may have been six months ago. Is bit flow better, about the same as, and maybe you look at it differently now.

Again, I know that you're wanting to make sure you really nail these for state to just get all the systems and resources in place, and show good results. And so maybe there is a crossover point, where an opportunity looked at today, you maybe move forward on versus, say, six months ago, you don't, because you're gearing up. So I'm trying to get a sense for the level of the opportunities that that you might have today versus prior and how you think about it?

Brent Conway

I think, Dana, that the opportunities that's probably is still I would say the same as where we were before. I think we're more focused or probably more willing to add rigs to markets that we're already in being specifically Saudi or Mexico. We are evaluating the markets working with Halliburton, and we continue to do that. I think just easier to add incremental rigs to areas where we've already got operations established. So I don't think that the deal flow or the project management/integrated projects that are being brought to us has really changed.

I think we're being very focused on what we chase, where the economics needs to be, how many different countries we go into, it's a lot easier to add incremental rigs to established countries. So I think it's a lot of the same stuff we talked about before. And in the backdrop of that is we've already got a sizable piece of business in the JV, we've got our U.S. operation that's most likely expanding and we're trying to balance all of those things as well.

So I think from our standpoint, it's just trying to balance that and make sure we can get ourselves to stretch to who we're committed, by taking on one or two other counties that we're not even in today. And I think Halliburton understands that too. They recognize that we don't want to go as TDI as a JV and try and jump into four or five different countries in six months. It's just too hard to manage for us and for them.

And we want to be pretty focusable on what we do, and just kind of take a bit more of a calculated approach to it. But I think we always had the outset process that that's what's supposed to happen and it's really just kind of playing out now, as it really start to get into operations.

Dana Benner - AltaCorp Capital

Well, it's all very sensible for sure. I guess just finally in Canada, thinking about your utilization. Of course, we're so used to all these years seeing Trinidad be at the top of the sheets, as it were. You've typically done so well in this country. And I wonder, do you think maybe just client mix in Q2 might have hurt a little bit just some of your clients were just busy as they maybe in the second half, so not just flooding and weather issues?

Lyle Whitmarsh

I think that one of our main customers in the Manitoba area was affected obviously by the heavy rains and flooding that I think most people on the line would be aware of. We lost around 75-plus days just alone there. Thankfully, things resumed back up there probably even quicker than what we had expected. So that was a fairly impactful part to that. I think with looking at that that was one of the major issues that we are faced with. So we're back up running with all the rigs now, so we're much more comfortable where we are, Dana, as far as we move though that.

Dana Benner - AltaCorp Capital

But in Alberta, BC, there wasn't a top decline that was a little slower that we'll see pick up or you guys will just run strong no matter what?

Lyle Whitmarsh

I think there was a not a lot of or any one concentration that affected us more than tundra. Some of it was just delays as we got out of the spring-break mode. It was not any concentrations, but again you can see that we're actually starting to get quite a bit -- we're starting to get back higher utilizations again, and we're starting to be very comfortable, But I don't think outside of the southern Manitoba operation, there was no one concentration. So we're pretty comfortable where we see the remainder of the year going. And thankfully everybody in Manitoba was safe and the rigs were undamaged and we're back operating there now.

Operator

Your next question comes from the line of Jeff Fetterly from Peters & Co.

Jeff Fetterly - Peters & Co.

On the U.S. side, how many rigs are you reactivating?

Lyle Whitmarsh

Approximately four were in the quarter that were heavily reactivated and R&M stuff completed on Jeff.

Jeff Fetterly - Peters & Co.

And what magnitude was the R&M cost be, either on an absolute or on a year-over-year basis?

Lyle Whitmarsh

About a change of EBITDA is about $2.5 million.

Lisa Ottmann

And then there was that additional cost that we mentioned earlier about moving the rigs to Mexico, from Mexico to Canada and moving rigs within the U.S. from one play to the next.

Jeff Fetterly - Peters & Co.

And that latter item, Lisa, how meaningful is that?

Lisa Ottmann

It's about a $1 million, supposedly.

Jeff Fetterly - Peters & Co.

And then do you expect to reactivate any incremental rigs in Q3 or Q4 in the U.S.?

Lyle Whitmarsh

They're all up and running now. We have a 100% utilization, so outside of that we should be good, Jeff.

Jeff Fetterly - Peters & Co.

On the Saudi side, when do you expect the fourth rig to become active?

Lyle Whitmarsh

Well, right now it's been rigged up in Dubai, so we're expecting to get through inspection. So it's kind of a September-October event, just depends on how quickly we can get through inspection. But obviously, we're trying to do it as quickly as we can. That's just kind of the timing right now.

Jeff Fetterly - Peters & Co.

So the third and fourth rigs will both become active in Q3?

Lyle Whitmarsh

Yes.

Lesley Bolster

Well, the fourth one might be in the fourth quarter potentially, beginning of the fourth quarter.

Lisa Ottmann

Yes, beginning of the fourth quarter.

Jeff Fetterly - Peters & Co.

The two rigs that were not working in Q2 in Saudi, were they paid standby?

Lyle Whitmarsh

Yes.

Lisa Ottmann

One was right.

Lyle Whitmarsh

Well, one was working. One was paid standby. The other was on a mobilization standby-type fleet. So they were all getting paid something. Yes.

Jeff Fetterly - Peters & Co.

And so for Q3, you will have two rigs running through most of, if not all of the quarter, plus two rigs that will be paid some form of standby or mobilization?

Lyle Whitmarsh

That's right.

Jeff Fetterly - Peters & Co.

And then on the Mexican side, when does the standby mobilization start to kick in for those rigs?

Lyle Whitmarsh

That doesn't start to kick in until we actually start to mobilize. And I think the first rig doesn't mobilize till kind of September, and then they roll out over the year. So it's going to be mostly mobilization revenue the year, as they get down there and get spudded.

Jeff Fetterly - Peters & Co.

And last thing, how many in the upgrade capital, as part of the 2014 program, how many rigs have you earmarked?

Lyle Whitmarsh

I think it is over approximately about 30 rigs. So it's a sizable amount, Jeff, to try to address. Again, we were trying to make sure we signaled everybody. That staying very competitive with the upgrades is mostly affecting a lot of the five to eight year old rigs that are now cycling through, really trying to make sure. And these rigs, we're finding very competitive. As we finish the upgrades, are being very competitive against.

Some of the reasons, we haven't had as many probably new builds as some of the peer group that we're seeing, is in fact the upgrades that are now being marketed and competing directly with the new builds. So that's why you're starting to see us get more comfortable, our utilization rates are climbing and our rates are coming back nicely.

In some cases, we haven't committed to the new build, because we're able to do the upgrade, and instead of doing that we've been spending less capital and securing long-term contracts, which are directly competing with some of our peer group on the new build. So I think it's a good use of the capital. We like it. The rigs just need the modifications to make that small step change generally, as mentioned on the moving system and the pumping pressure side generally. So we're very happy with the way that's going, but that should answer your question there.

Jeff Fetterly - Peters & Co.

So the number of rigs you've year marked has not changed materially from what you originally thought?

Lyle Whitmarsh

No, sir.

Jeff Fetterly - Peters & Co.

Previously, you guys talked about half of that CapEx having visibility in terms of customer contracts or some sort of backing, and the other half being on your call of the market. How does that mix look today for the upgrade portion of the CapEx?

Lyle Whitmarsh

Jeff, it's probably got a little bit better. We're still in the early stages, but I'd say that we would hope to kind of had both 50%. We're probably creeping closer to 60-and-plus now and it is getting better, it's getting easier to do because of the demand growing. So we're pretty comfortable as we exit through.

In the third quarter, we should be able to give you a better firmer number, but it is absolutely as we had modeled improving. And as they become more closer to completions, we should be getting a better idea, but it is going as planned. And potentially I would say, it's slightly better than even we anticipated at this point.

Jeff Fetterly - Peters & Co.

And just to follow-on to your point, just a minute ago. Until you get through these upgrades, do you expect that that will limit the number of new builds that you're willing to undertake or do the two progress down the similar path?

Lyle Whitmarsh

No, that won't limit us at all. That is a total different strategy and a total different agenda item for us. It's Trinidad and aboard and the shareholders, so we will be working equally hard on both of them, just being careful that they don't compete against each other. We're very careful not to put out a new build to displace ourselves.

So we're managing our fleet very well that way. But I can assure you that we're modeling and working on both sides of that agenda item. So we'll be looking and looking towards opportunities within the joint venture in North America as well as continuing on the upgrades.

Operator

And we have no further questions at this time. I'll turn the call back to Lisa Ottmann.

Lisa Ottmann

Thank you. And thanks for taking the time to participate in our conference call. We look forward to talking to you again in the future.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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Source: Trinidad Drilling's (TDGCF) CEO Lyle Whitmarsh on Q2 2014 Results - Earnings Call Transcript
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