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Executives

Francis McGuire - President and Chief Executive Officer

Denis Larocque - Chief Financial Officer

Analysts

Michael Mills - Beacon Securities

Ben Jekic - Industrial Alliance Securities

Chris Lalor - GMP Securities

Sam Crittenden - RBC Capital Markets

Major Drilling Group International Inc. (OTCPK:MJDLF) Q1 2015 Earnings Conference Call September 4, 2014 9:00 AM ET

Operator

Good morning. My name is Tracy and I will be your conference operator today. At this time, I would like to welcome everyone to the Major Drilling Group International 2015 First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. And I will now turn the call over to Mr. Francis McGuire, President and CEO.

Francis McGuire

Thank you very much, operator. Good morning, everyone and welcome to Major Drilling’s conference call for the first quarter of fiscal 2015. With me is Denis Larocque, our Chief Financial Officer. You should have all received a copy of our results which were released yesterday evening. If not please contact our office or visit our website at www.majordrilling.com.

Before we get started, I would like to caution you as usual that during the course of this conference call, we will make forward-looking statements regarding future events or future financial performance of the company. Such statements are forward-looking in nature and actual events or results may differ materially.

In the quarter, revenue and margin reflected the impact of the lowest pricing that we have seen in the last 15 years. As senior mining houses focus on cost-cutting, they are more likely to differ specialized drilling projects, which are by their very nature more expensive. The company therefore finds itself competing more often on a pure price basis and management has to find the optimum balance between price on the one hand and volume on the other, but all the while making sure that all projects generate positive cash flow.

Additionally, in the number of jurisdictions such as Mongolia, Colombia and Indonesia, uncertainty as the government policy and land tenure issues continue to have an impact on activity levels. With decreasing prices, our margins continue to be affected as we struggle to improve productivity beyond the gains that we have already been able to make. These levels of pricing are not sustainable as it will affect the capacity over time of the industry to maintain the quality of its equipment. We should note that in this quarter our margins were also affected by higher than normal repair costs, which we expense and as we continue to prepare rigs in order to be able to respond rapidly to any customer request. In this environment, it is all the more important to respond to clients in a very timely manner. Despite the difficult environment, Major Drilling remains debt free with a net cash position of $42.8 million at the end of the quarter.

Denis will provide a more detailed review of our financial results before I return to discuss the outlook. Denis?

Denis Larocque

Thanks, Francis. Total revenue for the quarter was $67.6 million, down 38% from last year. When we look at revenue by region, revenue for the quarter from Canada U.S. drilling operations decreased 32% compared to the same period last year, with all of that decrease coming from Canada. Our U.S. operation was able to maintain activity at the same level as last year. South and Central American revenue was down 35% for the quarter as Mexico, Chile and Argentina were affected by a reduction in work by juniors, the cancellation of projects and general seasonal factors. Additionally, in Colombia and Argentina, geopolitical factors have slowed the exploration efforts of many mining companies. In Brazil, the company had its first month of operations although it is expected that it will take a few months to attain an adequate volume to become profitable.

Australian, Asian and African operations reported revenue down 49% from the same period last year. Three main factors affected the recent revenue: Australia, where the company has shutdown operations; Mongolia, which is affected by political uncertainty around mining laws; and Mozambique, where the cancellation of large project had a significant impact on that operation in the quarter.

The overall gross margin percentage for the quarter was 24.7%, down from 32.5% for the same period last year. Margins continue to be affected by reduced pricing due to increased competitive pressures. As well, margins were affected by higher than normal repair cost this quarter as the company continues to prepare rigs in order to be able to respond rapidly to customer requests.

General and administrative costs were down 16% from last year at $11 million for the quarter compared to $13 million in the same period last year. With the decrease in activity, the company has reduced its G&A cost by implementing reductions of salaried employees, restructuring certain branches and reducing management salaries. The company will continue to review the viability of all its operations and react as appropriate.

Net loss for the quarter was $7.3 million or $0.09 per share compared to earnings of $1.5 million or $0.02 per share for the prior year quarter. During the quarter, we spent $7.1 million in capital expenditures purchasing two rigs and support equipment as the company continued to diversify in energy, grade control and our new operation in Brazil. Also during the quarter, we retired 20 rigs, which included 15 rigs sold in Australia. This brings the total rig count to 690.

The new breakdown of our fleet annualization is as follows. At the end of the quarter, we had 364 specialized rigs with 26% utilization, 201 conventional rigs with 19% utilization, and 125 underground rigs with 34% utilization for overall utilization of 25% on the 690 rigs. This is the lowest utilization rate since the company has been tracking the stat. At current pricing levels, the company prefers to field only those projects which can generate cash.

As we have mentioned before though, specialized work in our definition is not solely conducted with a specialized drill. Therefore, we always give you breakdown of our revenue by type of work for the quarter. So, this quarter 66% of our revenue came from specialized project, 14% came from conventional and 20% of our revenue came from underground projects. Also with the slowdown of the juniors, seniors and intermediate represented 82% of our revenue in Q1 while juniors accounted for the rest.

In terms of commodities, our top three commodities this quarter were gold at 45% of our revenue, copper representing 16% and nickel at 13%. We should note that energy was at 6%, which is much lower than last quarter, but this is seasonal as we expect activity to pickup in the quarter coming up.

In terms of our financial position, as Francis mentioned, we have one of the most solid balance sheets in our industry and our debt free net of cash. At the end of the quarter, we had cash on hand of $65.5 million and total debt of $22.6 million for a total net cash position of $42.8 million. This is a decrease of $3.7 million as we paid our semi-annual dividend of $7.9 million during the quarter and spent $7.1 million in CapEx, which was offset by the sale of $9.7 million in equipment in Australia as the company exited that country.

With that overview, I will transfer the call now to back to Francis.

Francis McGuire

Thanks, Denis. Due to the uncertainty around economic matters impacting the mining market, it is very difficult to predict customer behavior as senior customers in particular are very cautious about investing in future projects. The company is currently reacting in three ways to current market conditions. First, we are managing our cost making adjustments as they are called for. Second, we continue to maintain a strong balance sheet and focus on projects that can generate – that are cash positive. Third, we are diversifying our activities within the drilling world, investing in energy, investing in new parts of the world such as Brazil and investing in production-related drilling activities such as we have done through the acquisition of Taurus Drilling. We are in a unique position to react quickly when the industry begins to recover as the company’s financial strength has allowed us to invest in safety and to maintain our equipment in excellent condition.

As a result of the Taurus acquisition the company has invested some of its cash in building for the future. We will continue to look to take advantage of current market conditions by using our strong balance sheet and to seek out strategic opportunities to further build our business. Based on our continuing strong balance sheet, the Board of Directors has declared 70th annual dividend of $0.10 per common share which will be paid on November 3, 2014 to shareholders of record as of October 10, 2014. The dividend is designated as eligible – as an eligible dividend for Canadian tax purposes.

As the market evolves the Board will however continue to closely monitor the company’s balance sheet and the market in general in determining the optimal use of its cash resources and finding the optimal balance between acquisitions, opportunities, capital expenditures and dividends. The company continues to have a variable cost structure whereby most of our direct costs including field staff will up and down with contract revenue. And a large part of the company’s other expenses relates to variable incentive compensation based on the company’s profitability.

Also during the quarter we were able to reduce our general – our G&A costs by $1.7 million of which $700,000 relates to the closedown of our Australian operation. We are continually reviewing the long-term viability of each of our operations. Despite the difficult environment, Major remains debt free with a net cash position of $42.8 million at the end of the quarter, while still spending on capital expenditures of $7.1 million and as the company continues to diversify in energy, grade control and other operations such as Brazil. These initiatives should generate revenue in the coming quarters.

Subsequent to the end of the quarter, the company spent $15 million in cash as part of the purchase price in relation to the Taurus acquisition. With this acquisition which closed on August 1, the company will add a new line of activity as well. Last year Taurus generated revenue of $38 million and EBITDA of $8 million and we feel that we will be able to expand these services beyond Canada, U.S. and Mexico where Taurus now operates. We can now provide an even wider range of complementary services offering both underground production drilling, as well as our existing underground core drilling. We are hopeful that geopolitical events in the new years in countries such as Mongolia, Colombia and Indonesia might improve in 2015.

Despite the lack of visibility and how the market will evolve, we feel that we are in one of the best positions to meet the challenges of our customer when urgent need of exploration drilling occurs. Long-term fundamental drivers of the business remain positive with worldwide supply of most metals expected to tighten. We believe that in the medium term a number of commodities could face the clean supply and demand and the need to develop areas – resources in areas that are difficult to access should increase. Our challenge in the meantime is to manage effectively.

Operator, that concludes our formal remarks and we will be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Michael Mills with Beacon Securities. Your line is open.

Michael Mills - Beacon Securities

Hi, good morning guys.

Francis McGuire

Good morning Mike.

Michael Mills - Beacon Securities

First question would be just looking back at Q1, when you look at it on a month-by-month basis, did you see any kind of sequential improvement as you went through the month or along the same line did you see any change in the either pace of cancellations or some of those delayed projects moving forward or was it kind of just a weak quarter overall?

Francis McGuire

It was a weak quarter overall, not much changed. Two things did have particularly impacted though was one, our energy business in the U.S. that has been working quite a bit was really half of our machines were not working for about six weeks because of the weather conditions our customers could not build pads for us to drill on. And so we should be picking that up in September. The pads are now being built and we are mobilizing on most of those. So, that was a weather-related thing.

The other thing is Chile had gone through a very difficult – and Argentina too, but particularly Chile a very difficult winter. As they came out of winter, the startup was a little bit slower, but – and so therefore in this particular quarter, very little revenue from Chile. That will pickup in September/October with contracts that we have in hand and there are still some contracts out there that are being built – have been on. So, it was particularly difficult and we haven’t seen any acceleration or change in the pace of delays. As we look forward, we have those two Chile and the U.S. that will pickup. We have Taurus that’s going to be added. The question that we don’t know is will some of the projects we have get canceled relatively earlier than we have – we believe they normally would, that did happen last year. We don’t have an indication one way or the other on whether that might or might not happen. So, we are just kind of operating on a week-by-week basis.

Michael Mills - Beacon Securities

Okay. And then second question would be just trying to get a bit more I guess information about your energy operations, where you are operating in the energy patch and where you see the gross opportunities for that division say over the next two to five years?

Francis McGuire

Yes. We are operating in most of our operations in North and South Dakota. We have several – two rigs that are in Wyoming. And we are hoping to expand into the southern part. So, you will look at the Arizona, West Texas area for some of these services. Part of the expansion is not just adding new drills. Our customers have been asking us to add services to existing drills, particularly in doing water management, return management. And so some of the units that we bought this quarter, they cost about $1.5 million, but they really to re-circulate the fluids coming out of the hole and to purify them. And so that’s a – it’s an expanded service on the same customer base and that’s where a lot of our expenditures went. And of course, the customers pay for that. And we are seeing more and more demand for customers saying we want a single – they used to have two contractors do that and there has been more and more general demand for these filtration systems if you would, but also a real push to have a single contractor. So, we are moving in that. We are testing out some units making sure they work effectively. And there is a possibility that we may have to buy some more again to push that business, but as you know, it is today certainly one of our best businesses that we have.

Michael Mills - Beacon Securities

Great. Thanks guys.

Francis McGuire

Thank you.

Operator

Your next question comes from Ben Jekic with Industrial Alliance Securities. Your line is now open.

Ben Jekic - Industrial Alliance Securities

Good morning. I have two quick questions. One is on the repair cost, you said that extra repair cost this quarter were expensed, could you quantify that or at least kind of indicate is that going to continue for the remaining quarters in the fiscal year?

Francis McGuire

This is a perplexing thing. It’s a good question. Usually, we try to run repair cost at 8% or 9% of our monthly cost. We have been running almost 4 points above that. Essentially what customers are often asking for new rigs and we have get to lot of those, but they are not prepared to wait and there is always three other competitors behind. So, we want to make sure that we have rigs ready. And it’s always a little bit difficult, because we have a variety of rigs and we are trying to repair the ones that we think the market will happen. Where we stand right now is as soon as we get one repaired, it seems to go out in the field. We hope that continues. We are not sure it will continue. So, for now, we would expect these higher repair costs to go on for a little while, but again as soon as we can get a few rigs that are absolutely ready to go on the shelf will stop. So far, the good news is we thought we have done it, we thought we are getting ahead and it’s gone out, but these are – we are talking two, three rigs on.

Ben Jekic - Industrial Alliance Securities

And so those costs would be reflected through the gross margin, correct?

Francis McGuire

Yes.

Denis Larocque

Yes.

Ben Jekic - Industrial Alliance Securities

Okay. And I guess just another question would be some of your niche kind of comps have recently ventured a little bit into saying that to second half of fiscal 2015 is where some form of whatever that means tangible improvement will occur, is there any indication that you as more of a kind of premium larger footprint company, you probably would have even more kind of tangible indications?

Francis McGuire

Things are really so volatile. They have changed on a weekly basis. Some weeks it’s positive, some weeks it’s not. I really – we just have no visibility. I think is the best way to put it. And so what we try to do is be as best prepared to react quickly. But certainly until the new budgets come out 2015 the next several months is extremely difficult to understand what will happen on a macro level. Again what we do know though is places like Chile that were down to – during the winter to minimum – minimal activities that’s picked up, so that’s good. The energy sides picked up. But in terms of who might cancel early or who might want an extra rig, it – I don’t think anybody should venture a forecast.

Denis Larocque

Yes. Basically on the micro level you have got – at the branch level, you have got the geo in the field that basically has all these plans and they will talk to our managers and so if you take away you come out feeling really positive because they have got all these plans. But then on the macro level it comes down to will they get the budget at the top and that’s where it’s going to play out and that’s we really don’t have a view because that’s only going to happen in December, even January that we are going to find out. And then it’s not just how much budget gets allocated, it’s how it gets allocated in terms of which project and what kind of work is going to get done. Is it going to be more production drilling or more exploration drilling, so it’s really tough to call because of that.

Ben Jekic - Industrial Alliance Securities

Right. Okay, thank you very much.

Francis McGuire

Thank you.

Operator

Your next question comes from the line of Chris Lalor with GMP Securities. Your line is now open.

Chris Lalor - GMP Securities

Hi guys. Can you comment a little bit more on what you are seeing on the pricing environment, I know you mentioned that you don’t think it is sustainable in the medium term but do you think that you have reached any kind of bottom here or do you expect there is potential to go further downward?

Francis McGuire

Well, just speaking for our company, we are pretty much as low as you can go and still hope to make some cash. Every one of these projects has some risk, in turn it’s the penetration, how much drilling you will get with the customer and we are being as everybody else pretty aggressive not putting in any much cushion for those things. And so you are really – we are stopping at the point and it goes contract by contract where we say the probability is we will make not a cent on this, generate no cash. But when we get there we just stop and just say that we have got to step aside and let somebody else think they can do better we will let them do it. There is no point in using up our assets if you are not generating cash, so it’s hard to see that how people go much lower.

Denis Larocque

And basically one of the reason we are saying its not sustainable as an industry is that what’s happening like Francis said we go as low as we think we can go from a cash perspective, but we are taking into account that we need to maintain our equipment, we need to keep our equipment up to par. And what’s happening in the market is that because you have got some pretty desperate competitors out there, especially the smaller guys that you have got bigger guys too that basically it’s the equipment, the depreciation is a non-cash item. So, if you just don’t price that put that in your price, you are still going to generate some cash, but there is not going to be any cash to put back in the equipment then. So, you are going to deplete your fleet and not have cash to…

Francis McGuire

For future repair.

Denis Larocque

Yes, future repairs or even just or replacement or anything and that’s why this is not sustainable, because it’s going to basically you are going to have the overall fleet in the industry start going down in terms of quality, but as we mentioned we are still investing in our – that’s the pressure we are having, our balance sheet is that we are able to reinvest in our equipment as we go forward.

Chris Lalor - GMP Securities

How long do you think some of the competitors could grind down using that machinery without reinvesting into it?

Francis McGuire

I think more a question for us is to what extent will customers let equipment that is not in good order get on their sites to be quite frank. It is our view that we have a quality product that we want to maintain and there are a number of customers who are very conscious of that and are insisting on still getting quality equipment. So, it will really be dependent on more customer behavior. At what point they say that rig is just not safe enough to come on our property and so we don’t know.

Chris Lalor - GMP Securities

Okay. And second question just on the Taurus acquisition, with respect to the underground percussive and long-haul drilling market, can you give a sense of just the size of this market and if you think there is further opportunity for acquisitions or organic growth aside from the international expansion that you talked about?

Francis McGuire

Really, we are two big players in this world, Taurus and Boart Longyear. The real competition though the decision for the mine on the production side is whether they want to attempt to do this in-house or outsource it. So, that’s really the view or the decision point. We do believe there is growth potential in Canada, Mexico and the U.S. Lot of these techniques are relatively efficient and so mines will try to increase. So, we believe that there is growth in the North America as well as elsewhere, but it is always comes down to in-source, outsource more than – and there is really nobody else in the industry.

Denis Larocque

And really lots of time it comes down to the size of the mining company. They typically – this business typically the customer base is more intermediates than seniors, because if it’s a medium size mine, they don’t necessarily have all the infrastructure. So, they will tend to outsource, but if it’s a bigger mine, they can have a department that can handle that in place. So, that’s – so the customer base tends to be more the medium size types of mines. And like Francis said, there is – we are already starting to see potential in branches, where we have operations abroad in South America, Africa and Asia.

Chris Lalor - GMP Securities

Great, thanks guys.

Operator

Your next question is from Kim (indiscernible). Your line is now open.

Unidentified Analyst

Good morning.

Francis McGuire

Good morning.

Denis Larocque

Hi, Kim.

Unidentified Analyst

Just a quick question circling back to Canada and U.S., you did note previously that energy got impacted by weather conditions in the U.S., but your U.S. revenues held up pretty well and Canada is where the decrease primarily occurred. Just wanted to get some more color on what the key differences between Canada and U.S. is? Is pricing competition more pronounced in Canada? Is it differences between the segments? Any color you could provide would be great.

Denis Larocque

Yes. Well, just on the U.S., it’s just compared to last year that revenue held up compared to just the previous quarter revenue was down a bit, because of the energy like we mentioned. So, the seasonal factor impacted the U.S. compared to just the previous quarter, but the seasonal factors that we saw were there last year as well. So just thought I would mention that. And on Canada, it’s really competitive pressures. There is less activity and a lot more competition. So, the pricing is a lot more competitive in Canada at the moment.

Francis McGuire

Yes, but although make no mistake, it’s very competitive in the U.S.

Unidentified Analyst

Okay. And then in your previous call you mentioned you highlighted labor issues and if the market picked up the market is a bit tight on drillers have you implemented any strategies or any initiatives to minimize that impact is it – if the pickup was to occur?

Francis McGuire

Yes. Actually it’s very high on our agenda. And it’s going everything from taken this opportunity to revamp and upgrade our training for new entrants, because that’s going to have be part of the solution keeping very close tabs on people that have been in the industry but appear to have left and whether we can bring it back, we are keeping very close tabs on those and then trying to provide at least some opportunity to work for people, but every branch has a written plan ready to look at that. It will vary – these plans vary branch by branch, but it is a very real concern. And yes, we are focusing a lot of energy on being able to cope with that. I mean, today it’s not it’s – it is a challenge already. We are just afraid though as things go – if hopefully things pickup, it’s going to become the number one issue. It’s not going to be a problem getting it drilled, we just won’t have anybody to operate it.

Unidentified Analyst

Okay, thanks. Those are the two questions I had.

Francis McGuire

Thanks.

Operator

(Operator Instructions) Your next question comes from Sam Crittenden with RBC Capital Markets. Your line is open.

Sam Crittenden - RBC Capital Markets

Thanks. Good morning guys.

Francis McGuire

Good morning Sam.

Sam Crittenden - RBC Capital Markets

Just a question on energy and I know in the past you have been talking about measured growth in that space, I am just curious if there is a thought to become more aggressive or make a more ambitious splash into the energy space?

Francis McGuire

I think we are but I think as you have seen in a progressive way I don’t think we see taking any leads into that market. We are trying to diversify our services within the existing framework. We are active in Canada as well. This will be our second year coming up. And so we don’t see expanding the pace. There can be for instance I mentioned these filtration systems. We might add another one or two per quarter as we go forward as we react to customers, but it’s more that, what do I call a nice sequential growth. I don’t expect any significant moves.

Sam Crittenden - RBC Capital Markets

Okay. That’s helpful. And then I am just curious if this cycle drags on I mean there are certain amount of capacity that will be permanently shutdown or is it a case where rigs will be parked and then if things get good again they can spring back in action, do you think there is some capacity that could come offline permanently as this drags on?

Francis McGuire

I think the startup is going to be very difficult for a lot of people. And the first big show point is going to be labor. And I would expect quite a bit of competition for labor and that’s going to be very difficult for people to compete and that will probably restrict people’s ability to come back into the market. The other thing is just the financial problems, if you need to just prepare a rig to go in the field depending on what you – what’s safe is it can cause you $20,000, $50,000 per rig plus you got to buy inventory that you have brought down. So I think a lot of the impediments for people are going to be more people and financial than the actual rigs. I mean the rigs you can literally park and grease them up, but where you are going to find those $20,000 to $50,000 to get it all lined up is going to be the issue.

Sam Crittenden - RBC Capital Markets

Okay, thanks. I appreciate the update this morning.

Francis McGuire

Thank you.

Operator

There are no further questions in queue. At this time, I turn the call back over to Mr. McGuire.

Francis McGuire

Great. Well, thank you everybody. Obviously, it’s a difficult situation, but we will be having our AGM this morning at the TSX at 11. If anybody would look here to join us we would be glad to see you and we thank you for your attention. Thank you. Thank you very much operator.

Operator

This concludes today’s conference call. You may now disconnect.

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