Precision Drilling Corp (PDS) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Precision Drilling Trust third quarter 2006 earnings conference call and web cast. I would now like to turn the meeting over to Mr. Hank Swartout, Chairman and CEO of Precision Drilling Trust. Mr. Swartout, please go ahead.

Thank you very much. Good afternoon, ladies and gentlemen. Doug, our CFO, will start off with [INAUDIBLE] rendition of our analysis. Please, Doug.

Thank you, Hank. Ladies and gentlemen, through a press release this morning Precision reported record earnings from continuing operations for our third quarter. The news release included the unaudited consolidated financial statements of Precision Drilling Trust consisting of the statement of earnings, and retained earnings or deficits, the balance sheet, the statement cash flows, as well as business segment information and operating statistics for Precision's contract drilling rig business in Canada.

Before we address the financial results, we would like to remind our audience that some of today's comments will include forward-looking information and statements reflecting Precision's view about events and their potential impact on our performance, including planned capital expenditures, planned expenditures in the U.S., projected growth of the contract drilling and completion and production services business segments, projected equipment utilization, projected customer revenue rates, and the projected cash distribution policy of the Trust. These activities involve risks and uncertainties that could impact Precision's operations and financial results and cause actual results to differ from forward-looking statements and information.

In addition, some of today's comments may refer to non-GAAP measures and we refer our listeners to footnotes on page one and two of our news release. Once again, we confirm that Precision's conversion to an income trust on November 7, 2005, Precision Drilling Trust as the successor and interest to Precision Drilling Corporation has been accounted for as a continuity of interest. Of note, in 12 days time, Precision Drilling Trust will reach its first anniversary as an income trust.

In turn, Precision has achieved a one-year track record forecast distribution declared to unit holders of Canadian $3.50 for a trailing yield of 10.3% based on yesterday's unit price close of Canadian $34.02 on the Toronto Stock Exchange.

Financial highlights for the third quarter of 2006 include net earnings of $140 million and cash distributions of $117 million, for a retained earnings increase deficit reduction of $23 million for the period. On a per diluted unit basis, Precision reported $1.11 per unit in earnings, and cash distributions declared $0.93 per unit, or $0.31 per month.

Investing activities in the quarter led to $80 million in capital expenditures for additions to property, plant and equipment and consisted of $26 million in maintenance capital and $54 million in expansion capital. Precision's organic growth program to expand the drilling rig fleet is picking up momentum as 26 rigs of the 35 were at various stages of construction at September 30, 2006. Nine rigs to September 30 were completed and are in the field. An additional two rigs were finished in the first two weeks of October.

Also, Precision completed the business acquisition of Terra Water Group on August 17 for cash consideration of $16 million.

Financial highlights for the nine-month period ended September 30, 2006, include net earnings of $452 million and cash distributions of $330 million for a retained earnings increase deficit reduction of $122 million for the period. On a per diluted unit basis, Precision reported $3.60 per unit in earnings, and cash distributions declared of $2.63 per unit, or $0.27 per month for the first four months and $0.31 per month for the last five months.

Investing activities of the nine months of 2006 led to $191 million in capital expenditures for additions to property, plant and equipment and consisted of $125 million in maintenance capital and expansion capital, and $66 million in maintenance capital. This does not include the Terra Water acquisition.

On a comparative basis to 2005, the record 2006 earnings from continuing operations for the third quarter in the amount of $134 million was overshadowed by the 2005 earnings from discontinued operations of $1.38 billion with the gain recorded on the sale of former energy services segment, the industrial division and international contract drilling business.

Fiscal 2006 has proceeded on a record earnings pace for continuing operations well ahead of 2005. Through the first half of the year, the favorable performance has been two-pronged, higher equipment activities and higher pricing. Favorable third quarter performance in 2006 was different in that higher customer pricing carried throughout the quarter, the drilling activity was lowered by 7%, and service rig activity was marginally higher by 1%.

During the third quarter of 2006 as compared to Q3 '05, Precision generated revenue of $350 million, an increase of $50 million and 17%. Operating earnings for the quarter was $142 million, an increase of $30 million and 27%. The financial improvement over 2005 is consistent with pricing trends established in the first half of 2006.

In terms of work volume or equipment activity, as mentioned, service rigs were 1% more active and drilling rigs were 7% lower. The third quarter of 2006 did not have the pent up demand rig-to-start the quarter, nor did it in general terms have the exceptional weather cooperation given the wet conditions in the latter half of September 2006.

In terms of pricing, both drilling rigs and service rigs achieved strong pricing and overall revenue rate increases over Q3 last year of 21%. Third quarter of 2006 operating earnings margin as a percentage of revenue equates to 41%, an improvement of four percentage points over the comparable third quarter 2005. The margin growth for the quarter on a year-over-year basis is slowing when compared to the nine percentage point improvement for the fist half of 2006.

The emergence of additional industry equipment supply and relative near-term natural gas price weakness resulting in less customer demand are the primary considerations for pricing growth compression. Year-over-year, labor expense accounted for approximately one half of operating cost increases over 2005.

Operating costs as a percentage of revenue in the third quarter of 2006 were 48%, a decrease of 5 percentage points from Q3 '05. The percentage reduction is due to the impact of revenue rate increases as actual costs in Q3 '06 on a daily and hourly basis for the drilling and service rig division were higher by 8% and 9%, respectively, or approximately $700 per drilling rig operating day, and $30 per service rig operating hour.

The drilling division carried over some major repair expense from the second quarter of 2006 as expected due to repair delays given shop capacity constraints in the industry. Included in our earnings release is a segmented financial disclosure of our continuing operations. Precision has two operating segments in addition to corporate and other. Contract drilling services segment contains our contract drilling, camp and catering, oil field supply and manufacturing divisions. The completion and production services segment contains our service rig snubbing rental, and for the first quarter, waste water treatment divisions.

Please refer to the press release for earnings information regarding performance at a segment level. During the third quarter of 2006 general and administrative expense was reported at $20 million and 5.7% as a percentage of revenue. This is an increase of $3.5 million over 2005 with the percentage of revenue essentially unchanged.

Employee compensation expense given the favorable financial performance is the main underlying reason for the increase. Below the operating earnings line for the quarter, earnings were reduced by interest expense in the amount of $1.7 million, a reduction of 76% over Q3 last year with the repayment of Precision's indentures in October 2005. Operating statistics and average revenue rate information for Q3 '06 and year-to-date as compared to last year's for Precision's rig division is noted in the earnings announcement released this morning.

Turning to the statement of cash flow. Cash provided by operating activities in Q3 2006 was reported at $79 million and $80 million was used for changes to non-cash working capital balances. To manage cash in the oil field service sector in Canada, one must always factor in the seasonal swings in equipment activity in resulting cash flow. Precision continues to invest in Canadian oil field service opportunities with sites on the broader North American market.

Our capital expenditures for the third quarter of 2006 were $80 million, an increase of 97% over Q3 '05. The 2006 spending increase is primarily associated with our new drilling rig build program, as mentioned earlier.

To the balance sheet. Precision began the quarter with a positive net debt position of $84 million based on working capital of $136 million, less long-term liabilities of $52 million. During the third quarter of 2006, this position was reduced by $58 million to a positive net debt position of $26 million based on September 30, 2006 working capital of $217 million, and long-term debt and other liabilities of $168 million.

We continue to carry a strong balance sheet and expect to add a conservative level of net debt as we proceed with our expansion plans. Precision continues to work well within it's expanded $700 million bank loan facility. Unit holders book equity increased during the third quarter of 2006 by $0.21 a unit, or $27 million, as net earnings in the amount of $140 million plus $4 million through the distribution reinvestment plan. Cash receipt of $4 million were higher than declared cash distributions to unit holders of $117 million in the quarter.

For those listeners that are new to Precision in the Canadian oil field service industry, we would emphasize that Precision's activity is seasonal and highly dependant on oil and natural gas commodity price levels.

Once again, we would recommend that listeners read Precision's regulatory filings, including our 2005 Annual Report and 2005 annual information form, as well as the Q3 2006 management discussion on the analysis report, including notes to the financial statements to be posted on www.cr.ca by November 15. Hank, that concludes our financial overview.

Thank you very much, Doug. Next to speak will be Gene Stahl, President and Chief Operating Officer. Gene?

Thank you, gentlemen. First off, on behalf of Precision's entire management team I would like to say how pleased we are with the results for the third quarter given the challenging operating environment that we've developed over the past two quarters. Overall, as Doug alluded to a little bit earlier, the third quarter can be attributed to what we thought were better than expected rates, with lower than expected utilization.

Obviously, we're in a much different operating environment now than we were at the beginning of 2006. The last two years have been exceptional in our sector with more demand for equipment than we could supply. We're really starting to expect that Q4 will be the crossover as we transition back to a more normal operating environment where you actually have to bid for work and you have to actually compete on price, which I think are all very healthy dynamics. I'm extremely confident that with Precision's technology, our standard of service and the relationships that we work very hard at every day, we will continue to deliver.

Fortunately we have a real down to earth strategy in place. I think it's flexible enough to be able to adapt to whatever the business environment is ahead. In the service business we can only do as well as our customers. As we plan our 2007 budgets, we're very mindful of the impact on commodity prices to our customers' budgets.

Part of our down to earth strategy is really focusing in on the basics, and that is customer relationships, allocation of capital and cost control, and the welfare of our people.

In the near term here the demand for our services has really been maintained because of the traditional winter drilling season and the respectable one-year trend on the one-year strip for natural gas. I think today there were reports that came out that injection levels were below expectations and that we could be potentially be drawing out of storage as early as next week.

Generally, our prices are holding with spot markets remaining competitive. We've got 90% plus of our drilling rigs spoken for. We'll work forward in the continuing months to firm up those obligations as we move forward. On the completions and production segment of our business, demand is such that it has put upward pressure on pricing in some areas, and as in all divisions, though, we're working very closely with all of our customers in order to meet not only their winter needs, but to be a significant part of their 2007 budgets and beyond.

One of the things we talked about as we look forward to 2007 is in the second quarter and I think that would be a critical time for us. We've got record amounts of equipment in the field in Canada. If we get a warm winter, that impact on gas supply will clearly impact the demand for our services. Pricing discipline exists in the service sector. From that I just want to make clear that we do not have enough visibility to date to competently predict what will happen with the gas storage issue.

To reconfirm our previous news release, we are comfortable with the $0.31distribution to the end of 2006. Distribution is, however, a product of our activities so we need to get better visibility about the winter gas situation. It will be difficult and dangerous to make predictions beyond 2006.

This quarter we made some huge gains towards our drive to reduce our frequency rate, our targeted zero mission. It's our fourth successive quarter of year-to-date safety performance improvement. Our recordable injuries are down 28% this year year-to-date versus last year. In the third quarter this year, we had three of our divisions achieve target zero, so, gentlemen, it is achievable. The key to our success going forward is maintaining our momentum.

Currently, obviously, with the softer gas prices we see some trends on the drilling side. Many of our shallow gas prospects are marginal. We've seen a reduction in our conventional single utilization as much as 20%. 40% of our activity is now coming from our deeper drilling rigs, the triples, the average day per well is up to 7.2 days in the third quarter as we shift towards deeper drilling.

On the completions and production segment side of the business, we see a chance for a little but better sustainment than we do on the drilling side given that two thirds of this work is linked to producing wells and one-third is linked to completing existing wells. There is probably around 180,000 producing wells to date and growing. Our most active regions in this group was in the oil regions of [Lloyd Minister's], southeast Saskatchewan, and into Manitoba. Supporting the strong demand for our services, we also haven't seen the same rates of capital additions to this group, which, again, lead us to believe that there's still more upside opportunity on the completions production business.

Today we've got, as a Company, probably 50% to 55% of our equipment out in the field working. We've got a number of jobs on hold waiting on weather. We'll see if those come to fruition in the coming weeks if the weather stays on our side.

Our labor situation, currently we're seeing different labor issues than we were a year ago. This year it is more about finding jobs for the people we have versus finding people for the jobs we have. We've got a number of rigs with the ability to run three crews on. And different than in the past two winters, we're going to experience a real steep winter ramp-up. That comes with its own challenges. It's nothing we haven't done before. It's just something we haven't had to do in a few years.

Doug has alluded to the growth issues, I'll touch lightly on them. Again, our previously announced capital expenditure program of $480 million has been increased by an additional $30 million. That's as a result of being awarded another two contracts for our 4,000 [INAUDIBLE] triple style of rig putting the total number of triple rigs that we're adding into the market at 11. That makes a total capital now of $510 million, $320 million will be expected to be spent this year, the remaining over the following 18 months.

Revising down a little on our maintenance capital, in 2006 we'll spend $100 million and the remainder -- the remaining $220 million will be for the expansion capital, that includes the Terra acquisition. Upon completion of the expansion program in 2008, we'll expect to operate 265 drilling rigs. That's 254 in Canada and 11 in the U.S. That's a 15% increase on a year-over-year basis from 2005. Over the next six months, our completions and production services segment expect to add two new service rigs to the fleet. We also expect to add 50 new wastewater treatment units to the fleet, bring that to 55, and we'll be adding four more stand alone snubbing units to bring that total fleet to 30.

Our expansion of the contract drilling service to the United States is going as planned with our Super Single drilling rigs working throughout the quarter. We've got five super single rigs to be delivered to the end of 2007. We're working at securing contracts for those remaining five rigs. We've even looked at supplementing our U.S. strategy by bidding a couple of our existing Canadian rigs into this market as we do anticipate the activity to remain strong in the U.S.

Just a general comment on the cost and timing of our construction program, we've experienced a few delays on some of the critical components. However, as a general overall comment, we are in line with our customer commitments to deliver rigs.

On closing, I just wanted to refresh people about the focus of management, which is about cost controls, putting our world class systems to work. It's about spending smart dollars at Precision, it's about our relationships that we have with our customers and as we go forward making sure that as we are working together to ensure mutual success. It's all about the welfare of our 6,500 employees, making sure that not only from a safety standpoint but from an employment standpoint that we're all working together to do the best we can. We're only going to do as well as our customers can do. So like you, we'll be focusing on understanding what their futures have in store. On that, I'll close and back to you, Hank.

Thank you, Gene. As everybody can hear, our new management team likes to talk a little bit more than in the past. So you're much more informed this time than you usually are. Things we have to be cognizant about, obviously, are the concerns going forward to 2007. None of us know for sure where we'll be at. Gene has expressed his thought process and Doug has commented on some of the things going forward. None of us know that answer.

We've also seen a huge decline in profitability in the last part of September, October. We're not sure where November will be as far as the gas market for some of our customers. Obviously, that softened up the market. And with the new build coming forward in 2007, none of us can tell you what's going to happen. Obviously, a warm winter would be a challenge for all of us going forward.

Precision is such a unique team and such a unique group of people and equipment, they're going to do very well no matter what happens. That's something I'm very comfortable with. Without further analysis, we'd like to open up for questions so you have a chance to chat about the potential future and any comments you have on the third quarter. We'll be open for questions, please.

Thank you. [OPERATOR INSTRUCTIONS] There will be a brief pause while participants register. Thank you for your patience. Our first question is from Alan Laws from Merrill Lynch. Please go ahead.

Good afternoon. Nice, frank, summary of what's going on, guys. First question I have is really, is the current softness you're seeing at all reminiscent of 2001 or does it feel more like a traditional 4Q ramp-up in western Canada?

No, it's 2001, starting to feel like that.

All right. You said about 90% booked for the winter. Is that the same as last year or is it below? I guess it's probably below.

It's less than last year. And I said spoken for.

My last year, Alan, we probably hit 120% requirement on our rigs, and now we have 90%. And not sure that 90% will all go to work. It depends on some of the customers' timing and the weather, as well.

So you guys are also kind of concerned maybe about the spot market, that's why you've been so cautious here?

We're very concerned about the spot market because we see it on a daily base and we see what some of our other competitors are doing. The other thing we've noticed, the [INAUDIBLE] for example, coil. We have a number of coil rigs which aren't operating period right now.

We don't see coil as a great viability going forward this winter. We're not sure we can man the rigs we have simply from the point of view that if we lose that group of people to put them back on the rig [INAUDIBLE]. They are hard to replace. And for two months, three months, that's a question we'll have to put to the operational group when it comes through.

The real shallow stuff with the non-conventional gas has been slowed to almost a halt with CBM and others things. That type of equipment doesn't look great for the future, that is for sure. Deep rigs, fine, we're in great shape. Mid-sized rigs are going to possibly have more than we want in Canada at this point in time. That makes the newer rigs, possibly better, not better, but the older equipment will be harder to put to work. We're fortunate we have great a crews. So we stand the test of time against virtually anything. So that's Precision's mindset and its ability to go forward.

That's a good answer there, Hank. On the triple side, the K market has mostly in the shallow to doubles. It looks like more investments going to the triples, is that an area of the market you still see as undersupplied with capacity?

Obviously, when we're getting contracts to build rigs in 2008 at 4,000-meter rigs for some large independent, or some multi-national companies in Canada, there certainly is enough to go around. We have a new AC-drive rig which is extremely unique and people have seen it and have fallen in love with it and they are stepping up. We'll still be building rigs in 2008 and that were just awarded in the last month, and it's for gas, not for oil.

Most excess capacity is in the shallow gas market, under 1500-meter thing?

Definitely.

You said there is, looks like the doubles, so somewhere above that to 2500 look a little weak or could be?

Well, you have some that, the old cantilevered style rigs, could be a challenge, there's no question.

Are you thinking of taking any rigs out of service there are in the fleet?

Obviously, we plan to retire some going forward because we're adding quite a few. Some of the older rigs, it just doesn't justify the refurbishing equipment. We'll take the pumps, the draw works, and some of the other working parts, the BOTs and augment that into our maintenance capital going forward. But as rigs are not in the condition to compete in this market, we'll take them out of operation.

Now, hopefully, some other people will and it will be interesting. I've been in this market for 20 some years, won't go into the details of all of that. I've seen some crazy things happen by some of our competitors. This time, nobody has any real debt. If there's some discipline in it, we'll all survive and be in great shape. All it takes is one or two of our competitors to go crazy. Unfortunately, the herd mentality follows just like sheep into whatever.

My last question here. What annual utilization level -- maybe you can think of it in a different way -- would lead you to maybe cut the distribution at all?

The trustees will look at the distribution going forward. Obviously, we have a new build program. We're comfortable with that. We're confident that if we looked at second quarter will be the clear vision of where we stand. Obviously, if we go into December and January, and January, for example, if we see January as warm as last year, we're going to enter storage about 300 [Bs] more than we were last year.

All it took was the 500 [Bs] that didn't burn in January last year, according to some other people that [INAUDIBLE] very cognizant of that. January we could have a total slowdown in the Canadian market as far as the shallow gas if we don't see something coming it's possible. It comes down to what happens in December and January.

If we get to a point where it would be, unimaginable, but if we ever finish storage with two [tees] still in the ground we're going to be in trouble, on the Canadian market more so, I can't talk on the American market. The Canadian market, a lot of people aren't going to be hedged going forward next year. All of us on the AP side that I was involved with in some of my directorships hedged. We were very comfortable with that. We knew we were going to see $3.50 gas. We saw it. Anybody that didn't see that really wasn't looking at what was coming.

All right. Last thing is you made a comment about the U.S. market staying strong and sort of wondered why would you expect the U.S. market to stay strong given what you're seeing in Canada?

Well, what we're seeing at this time is the northern projects in the United States, we're very comfortable with cold weather, obviously, our rigs are designed for it. We've had a lot of consolidation and a lot of the drilling managers and operational people from Canada have moved to the U.S. and they are very familiar with Precision Drilling. We have not made the effort to go down there, and now we're chatting with different people.

We have a team down there now that's got the rig availability from Canada down to the United States. We're being very well received and they are very familiar with Precision. A lot of these gentlemen have Canadian experience, know of us. Precision has a great name here, they like our safety record. We walk the talk every day. They understand that and they respect that and it's something that we are very proud of and that puts us ahead of the pack.

In some cases, we don't have rigs in certain areas, but I can assure you that we probably will have those rigs and some contracts that might surprise a few of the people from the U.S. But sometimes if you perform very well and are very professional, you can get into the market without any problem.

I'll leave it at that and let somebody else ask about the Port-O-Potties business. Thanks a lot.

Just on that, obviously, at our camp systems we have an internal need, which is unprecedented, and we can, belive it or not, they are super-duper whatevers. They're doing very well.

[LAUGHTER] Thanks, guys.

Thank you.

Thank you. The following question is from James Stone from UBS. Please go ahead.

Hi. I just want to clarify a couple things. One, on the CapEx spending for next year, if you just back out the 320 from the 510 it kind of implies that your overall spending over the next 18 months is only going to be $120 million next year. That seems low given the $80 million to $100 million of maintenance and the fact that you're going to deliver 14 rigs next year. Is the fact that the maintenance isn't really in that number that you've given?

Jamie, just to clarify, our total CapEx program for the 2006 inclusive through 2008 is $510 million, and we're anticipating $320 million of that in 2006, which leaves $190 million for 2007 and 2008.

Okay, so you really -- so maintenance CapEx next year $80 million to $100 million?

That would be reasonable.

Can't do anything about the maintenance CapEx, Jamie. If there ever was a slowdown, we have the ability to slow that down quickly. The other thing we look at is our numbers going forward. I think you can understand that.

The U.S. is still going to deliver a huge number of rigs in the fourth quarter. Not sure if it's going to be 300 to 500 rigs in 2007. We see drill pipe, top drive, POPs, all these things starting to increase at a price for delivery in 2007 at anywhere from 30% to 40%.

These numbers are something we certainly can't pass on to our customers. That will impact all of us on operations in Canada, every drilling contract. We're very fortunate that we have one of the largest inventories in the world and the most unique system for purchasing of anybody in North America, without question. We won't even try to even put anybody else in our bracket, and I'm being nice. We'll see, our costs going up as well.

It's just something we're cognizant of is that when we see a decrease in the price per day of a drilling rig, we have some increased costs on our operating costs, slight increase in labor, there will be a compression of margins.

Hank, my point would be I was surprised at how low the CapEx is for next year overall. I would have thought it would have been higher given the fact you're still drilling rigs all they way through the year. It's much lower than we were expecting.

Jamie, when you say $80 million to $100 million next year, that's the upgrade. That doesn't include the $190 million expansion we just spoke to. So that $510 million --

Does not include maintenance CapEx. That's my question.

That's correct, it does not.

Okay, so my question then is your going to spend, your gross capital spending next year is going to be over $200 million, that was the question I asked. I can subtract 190 from 510.

You're correct.

Secondly, without the rigs waiting on weather right now, what would be your utilization?

We have 122 rigs running or moving today. We have about 30 to 40 waiting on weather, depending on how you look at it.. We'd be about 160, and last year we were about 190 at this point in time and dry weather ahead of us and a full storm going into Christmas.

Okay.

But last year all of our coil were working. This year none of our coil are working.

Right.

But little things. The shallow was really, the CBM market has dried up dramatically.

Right. And then lastly, the fact that you're having such a mix shift away from coil and towards higher utilization or on the triples, shouldn't that imply that your revenue per day is shifting to a higher number, even though -- I mean the margin per day may not change very much, it should, but the revenue per day should be higher?

We've had an increase in revenue on a per day basis all the way through for the last six quarters. I can tell you that I think we've finally peaked in Canada and you'll see possibly a reduction. If I had to forecast now, I would tell you that we're going to reduce our rates in spring 2007, which we haven't done for, certainly didn't do it last year, we were able to raise them, but that's what it looks like at this point in time. We don't know for sure. On the coil rigs, we haven't built any for two years, we didn't think they would be a lasting phenomenon. We went to the Super Single [INAUDIBLE] drilling casing and these rigs are under 100% utilization, and everybody loves and wished they had more. But we can only produce so many at the time.

What is the -- what's the sort of year-over-year change in rates going into winter on the rigs that you've contracted?

Well, we're already ahead of where we were -- the contract rigs that we have we're ahead of where we were in 2005, obviously, with the increase that we put in in the spring of 2006. It's not --

So that holds then you'll cut rates in the second quarter?

Pardon me?

That rate is then going to hold through winter for the most part and then you'll cut rates in the second quarter, potentially?

Correct. If I had to look ahead and make an analysis now -- if we have a really cold winter and it heats up and gas is in double digits, $13 again, we're all going to ride the same horse and it's going to be straight up the hill.

Thanks. I'll let someone else ask.

Thank you, sir.

Thank you. The following question is from James Leon from Mackenzie Financial. Please go ahead.

Good afternoon, gentlemen. James from UBS has already asked my question on CapEx. Let me ask you about the taxes. I think in the previous call, you mentioned the tax rate would be about 8% for '06. Now this quarter, again, I think it's lower than that. Can you sort of give us some guidance as to how we should model your taxes?

Yes. Our effective tax rate, if you take a look at that, is for the nine-month period, is in that 2.5%. If you normalize it for our second quarter tax benefit from lower enacted tax rates here in Canada, our effective tax rate for 2006 is along the lines of 7%. Modeling going forward it's a level of profitability. It could be anywhere between zero and that number based on profitability levels.

Okay. And just revisiting the maintenance CapEx, now, how low are you willing to go if conditions -- some of the conditions that Hank has described persist into '07 well beyond Q1 and Q2? Are you willing to give us sort of a CapEx floor that --?

Well, James, we don't have to give you a floor because all of a sudden if there was a major change and we had a very warm winter and a number of rigs came down, obviously, we have ability to decide that we would rack or cold stack as the Americans like to say 20 or 30 rigs. And we do the inventory off that to survive. In reality we could take $80 million down to probably $20 million and still be quite comfortable with drill pipe and everything else.

We still plan for the future. I don't think anything that severe is going to happen. I can't perceive that. What we're trying to allude to you is that our capital allocation, we're smart enough to play the game as well as anybody and we will be in the best shape as anybody. If there's a downturn of any size, we can, obviously, take advantage of that because over time, every time there is a downturn Precision comes up much stronger and there will be some weaker people that will get tired of the game and will want to go on to some other illustrious enterprise. We'll take advantage of that and help them with their rolls and get them on the fold of Precision Drilling.

Thanks very much for your comments.

Thank you, James.

Thank you. [OPERATOR INSTRUCTIONS] The next question is from Dan Barrett from Fortis Bank. Please go ahead.

Good afternoon, guys. A couple of follow-ups. The rates in the spot market right now, you seem to allude that they are kind of weaker than you expected. What are they relative to last year at this time?

Dan, we're not going to go into that in particular, because that's -- we do hear what other people put their rigs to work, even in the spot market. Sometimes we can get surprised. Obviously, some people are trying to put the rigs to work to just keep the crews warm for the winter. There's different reasons why people make some of these decisions. We're not going to go into that to what can happen because it's not a normal basis.

It's a one-off in one well in a certain area. If the rigs vary, you can keep the crews busy. There's some merit to just keeping hands on the rigs at this point in time, as well. Obviously, it's come up a few times and as Gene alluded to the fact, we do have 90% of our rigs committed for the winter to where we're in a very comfortable situation, obviously, fourth quarter, we'll finish it off. We're already three quarters of the first month of the three months and we're comfortable.

We're just not sure what 2007 is going to bring in its entirety. None of us know for sure. None of you people can tell me the price of gas through all of 2007. If you can give me that, I can give you utilization that I'd be comfortable with. We're just being cautious and trying to give you the full disclosure that some other people don't seem to think there is going to be a downturn in the market and more power to them.

Following up on your 90% of your rigs contracted for winter, is that all you're comfortable with or do you want to keep the other 10% off the spot market? Or do you want to get it up to 100%?

We'd love to put the other 10% to work. We do not have a job for them.

One last question on labor. I think, correct me if I'm wrong, but did you say labor costs going into this winter are higher than last winter?

Yes. We raised them by 4% in the fall.

You also talked about the fact that there doesn't seem to be the labor shortage this year relative to last year. So I'm wondering what prompted you to raise wages when there's a more -- a larger labor pool out there to pull from?

Well, Dan, I'm going to tell you that Alberta is a very unique situation. We have something called Fort MacMurray, which is taking everybody that can walk, talk and whatever, and they are paying them a lot more money than we are, in a sense.

The association sits down and we have the people that actually run these rigs, all the companies work together and say what will be fair for our employees, and we realize that there's only a certain amount of money we can people to come to work for us. It's not the best life in the world. When you go and work two weeks at 40 below, you come home for a week to thaw out and you have to go back for two weeks, you have to pay for that. We're separating people from their families. There's a certain amount of -- it's cold weather. We're working at 40 below. This takes some pretty tough guys --

But at the end of the day, you're saying it's a Fort MacMurray effect that's affecting you. It gets to 40 below every year.

4% is small, but we respect our people and it's one thing we could never agree on what to charge a customer. But one thing we have done is we have looked after our people. Our rates in Canada are so much higher on an individual basis than in the United States for example. That's where you have the basis. And that's why we've been able to secure the people.

Our concern is that we hoped that we'd have two or three years of this ongoing activity so we could get people into an organized life where you could have sumner, you know, August, September, maybe July off a little bit, and have a real life working on the rigs, but if we have a slowdown all of a sudden we get cyclical again, as far as labor. And that will be a challenge. We're fine this fall, but if we had a slowdown of any period of time we have to go through back training, get everybody reestablished.

That's why one of the new initiatives this group has come forward with is an employee center up in [Nisku] which we're still going to go forward. That is to get employees to understand they are Precision Drilling. They are the most important thing we have.

One final question related to labor again. Since you're having less of a problem having three crews per rig, et cetera, is there going to be less overtime? What can we expect as far as sort of daily operating cost per rig relative to last year --

Well, you're not going to get less overtime because they all get the same amount. What happened when we look at it two years. If you go back to the winter of 2004, 2005. We had probably 90 rigs with two crews on it, okay?

Right.

In other words, those two crews had worked, we had run a rig for three weeks and then we shut the rig down for a week and let everybody go home. Last year there was only about 10 rigs in that rate. So we went from 90 to 10. That showed you that last year we did not have a labor problem. We're very pleased with it. We've got a tremendous focus on safety in this corporation. Everybody's doing a great job at target zero. We're actually achieving it in a massive amount of way throughout the corporation. What Gene alluded to is, obviously, if we're going to run less rigs to the extent that you're 25 rigs less and we have enough people to handle it last year, we do not have a labor challenge right now.

Okay, great. Good quarter, guys, thanks. That's all from me.

Appreciate it very much, Dan.

Thank you. [OPERATOR INSTRUCTIONS] The following question is from Todd Garman from Peters and Company. Please go ahead.

I was wondering if you could provide us with an estimate of how many rigs in the basin here in western Canada might be expect to be laid down if it did get slow?

Todd, I can't tell you that. I have no idea how slow it can get. Obviously, this winter we're not going to have the same utilization that we had last winter. We certainly don't have the weather cooperating, as well as the demand. If you can tell me what the MP companies are going to spend on an ongoing basis, we'll tell you the utilization of our assets.

Do you have any better visibility in the last few days, or two weeks to provide us with?

Well, Todd, what is encouraging is we're seeing the spot market go up as far as gas, as well. When [NaCo] got to 350, obviously, there are a few people start to panic. Back up to $7 in the spot market now. That's fine. Wintertime we usually do. Biggest thing will be what do we do with storage?

Storage is a killer. If you can out at 1.2, we're fine but if we finish it any higher than that it's going to be a dramatic effect going into 2007. But the other thing that will happen, with the number of rigs we have in North America, we had a slowdown in Canada, let's say for six months, that's going to be a huge drain on our ability to deliver gas. We still have our declines at the same rate and our 18 Bs that we're producing right now could go to 16. Those two Bs are extremely important to the United States.

We still have Mexico taking gas from the United States and the U.S. has to keep building their equipment, I guess, to keep going. But we're still a very unique situation in North America. We're land locked. L&G is nothing to speak of, 1.2 Bs a day. If there's a slowdown, it will be a short period of time. Maximum time would be one year. And then all of a sudden we have another race horse on the right racing track.

Thanks.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS] There are no further questions registered at this time. I would now like to turn the meeting over to Mr. Swartout..

Thank you very much. We appreciate the chance to chat with the ladies and gentlemen. Great questions. Don't have a full, clear view of the future, but it's certainly not the end of the world, by any means. If I could have more clarity from you people that are so smart to tell us what gas will do in 2007, we'd have a lot more clarity for you today. We appreciate it, look forward to talking to you at the first part of 2007. Have a great year and we'll talk to you next year. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation and have a great day.