Precision Drilling Corp (PDS) 2006 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Precision Drilling Trust fourth quarter 2006 earnings conference call and webcast. I would now like to turn the meeting over to Mr. Hank Swartout, Executive Chairman of Precision Drilling Trust. Mr. Swartout, please go ahead.

Thank you very much. Doug, could you please proceed?

Ladies and gentlemen, through a news release this morning Precision reported 2006 fourth quarter and record annual earnings from continuing operations. The news release included the unaudited consolidated financial statement of Precision Drilling Trust consisting of the statement of earnings and regained earnings or deficit the balance sheet, statement of cash flows as well as business segment information and operating statistics for Precision Canadian Contract Drilling Division.

Please note that the financial figures that follow are in Canadian dollars, unless stated otherwise.We advise our audience that some of today's comments will include forward-looking information and statements reflecting Precision view about events and their potential impact on our performance and capital structure, including planned capital expenditures, projected growth of the contract drilling and completion of production services business segments, projected equipment utilization projected customer revenue rates, the projected cash distribution policy of Precision Drilling Trust and tax announcements by the government of Canada on income trust. These expectations 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 nonGAAP measures and we refer our listeners to disclosure in the news release. Audited financial statements and managements discussion and analysis will be filed with regulators, mailed to certain unit holders and made available on the Internet at CDAR.com next month. Once again we confirmed that with Precision's conversion to income trust on November 7, 2005 Precision Drilling Trust as the successor in interset to Precision Drilling Drilling Corporation has been accounted for as a continuity of interest. 2006 marked Precision first complete year as an income trust and the 21st year as a publicly traded company.

Precision Drilling declared 2006 cash distribution of C447 million to unit holders or C$3.56 per unit excluding the special inkind year end distribution of C25 million. For January, 2007, a distribution cut of 39% was made to the prior monthly rate of C$0.31 for C$0.19 per unit. At C$0.19 per unit the annualized current rate represents a yield of 9% based on yesterday unit price close of C$25.50 on the [Toronto] Stock Exchange. As many of our listeners know Precision operates within a cyclical sector and with this concentration of services in Canada is subject to seasonal volatility for equipment utilization in addition to the underline commodity price fundamentals. These business risks play an important role in Precision's past and future performance and we encourage our investor to examine the business risk write up on page 70 of our 2005 annual report.

Financial highlights for the 2006 fourth quarter include net earnings of C127 million, cash distributions declared of C117 million and a special year end inkind distribution of C24.5 million for deficit increase of C14 million for the 2006 fourth quarter. On a per diluted unit basis Precision reported C$1.01 in per unit net earnings and cash distribution declared of C$0.093 per unit. The special year end inkind distribution was required to distribute remaining taxable income at the trust entity level. The decision to not pay in cash but rather settle in units which were immediately reconsolidated means that a unit holder does not receive cash or additional units the cash was retained in the company to preserve balance sheet strength.

Investing activities in the quarter led to C $72 million in capital expenditures for additions to property, plant and equipment and consisted of C$26 million in maintenance capital and C$46 million in expansion capital. Precision Drilling's organic growth program to expand the drilling rig fleet commissioned four new rigs in the quarter. During 2006 13 new rigs were completed with the 14th activated early in January, 2007.

Financial highlights for the year ended December 31, 2006, include record net earnings from continuing operations of C$573 million even though fourth quarter 2006 earnings were 32% lower than prior year adjusted results for one time charges. On a per diluted unit basis Precision reported C$4.62 per unit in net earnings and cash distribution declared of C$3.56 per unit.

Investing activities during 2006 led to C$263 million in capital expenditures for additions to property, plant and equipment and consisted of C$92 million in productive capacity maintenance and C$171 million in expansion or gross capital. The long business acquisition was the C$60 million Terra Water acquisition during the third quarter.

Compared to basis to 2005 the record 2006 earnings from continuing operations for the year was overshadowed by the 2005 earnings from discontinued operations of C$1.41 billion with the gain recorded on the sale of the former energy services segment and international contract drilling business as well as the industrial service division, [CEDA].

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

In the fourth quarter of 2006 the deterioration continued. Pricing held up well but significantly lower rig activity reduced earnings. As compared to Q4 '05, 2006 drilling activity was lower by 33% and service rig activity was lower by 22%. During the fourth quarter of 2006 as compared to Q4 '05 precision generated revenue of C$328 million a decrease of C$100 million or 23%. Operating earnings for the quarter was C$132 million, a decrease of C$44 million or 25%.

The financial reduction over 2005 is consistent with pricing trends established in the first half of 2006. Let me back up on that. The financial improvement over 2005 is consistent with pricing trends established in the first half of 2006. Consistent with the trend established during the third quarter of '06 a declining natural gas commodity price during '06 has adversely impacted demand as monthly activity in both the drilling rig and service rig divisions weakened slightly as the quarter progressed.

In terms of pricing both drilling rigs and well servicing entered the quarter with strong rates and held on to those pricing levels as well as to commence the seasonally strong first quarter level of activity in 2007. During the quarter pricing and overall revenue rate increases over Q4 last year were 8% for the drilling division and 14% for the service rig division. The pricing gains were encouraging; however, excess industry equipment capacity has weakened the spot market and as is traditional in Canada, bidding for work will be competitive in the second quarter of '07.

In the fourth quarter of 2006 the operating earnings margin as a percentage of revenue equates to 40%. A decline of one percentage point over the comparable fourth quarter of 2005. As we mentioned on the third quarter call margin growth for '06 third quarter on a year over year basis was slowing. This quarter margin growth has stalled due to the decline in demand and resulting activity decrease.

The emergence of industrial industry equipment supply and fiscal reality of our customers of 2006 natural gas price weakness are the primary considerations for the weakening price environment in Canada. Operating costs as a percentage of revenue in the third quarter of 2006 were 47% an increase of two percentage points from Q4 '05. The percentage increases is due to cost increases which out way the favorable impact of revenue rate increases actual operating costs in Q4 in 2006 on a daily and hourly basis for the drilling and service rig divisions were higher by 13% and 15% respectively; or approximately C$1,200 per drilling rig operating day and C$55 per service rig operating hour.

To start the quarter fuel labor increases were in the 4 to 5% range and in many instances precision was not able to cover through higher customer rates. Consistent with Q3 2006 the drilling division carried over higher major repair expense due to shop capacity constraints earlier in the year. Included in our earnings releases a segmented financial disclosure of our continuing operations Precision has two operating segments in addition to corporate and other.

The contract and services segment contains our contract drilling, camp and catering, oil field supply and manufacturing division, the completion of production services segments contains our service rig, snubbing, rental, rental and for the first year wastewater treatment division. Please refer to the press release earnings information regarding performance of the segment level.

During the fourth quarter of 2006 general and administrative expenses reported C$22 million, and 6.8% as a percent of revenue. For the year G&A expense was 5.6% versus 6% for 2005. Accrued employee compensation associated with the long-term incentive plan was the main underlying reason for the increase in Q4 '06. Below the operating earnings line for the quarter interest expense in the a amount of C$1.9 million remains low due to the repayment of Precision's indentures in October 2005.

Operating statistics and average revenue rate information for Q4 '06 and YTD as compared to last year for Precision rig division is noted in earnings announcement released this morning. Turning to the statement of cash flow. Cash flow provided by operating activities in Q4 2006 was C$154 million, and a nominal source of cash from changes to non-cash working capital balances. For 2006 cash provided by operating activities was C$610 million including a use of cash of C$39 million for changes in non-cash working capital balances.

Precision's continues to make the long-term investment with sites on or about the North American market presence our capital expenditures for the fourth quarter of 2006 were C$72 million, an increase of 60% over Q4 '05. In 2006 standing increase was due to our new drilling rig build program which is secured by long-term work arrangements.

Turning to the balance sheet, as of December 31, 2006, Precision's was in strong financial position with working capital of C166 million and long-term debt of C141 million. Compared to 2005, these balances represent a working capital decrease of C14 million and a long-term debt increase of C44 million. For an increase of net debt of C30 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 Drilling continues to work with well within its expanded C$700 million bank loan facility and C$50 million operating line. Unit holders book equity increased during the fourth quarter of 2006 by C$0.12 a unit or C$14 million, and net earnings in the amount of C127 million plus C$4 million in drip proceeds was higher than declared cash distributions to unit holders of C117 million in the quarter.

For those listeners Precision and the Canadian oil field services industry we would emphasize that Precision's activity is seasonal and highly dependent on oil and natural gas commodity price levels. Once again we recommend that listeners read Precision's regulatory filings. To close I would like to repeat the wording in our news release regarding the Canadian government tax announcement on income trust. On October 31, 2006, the government of Canada announced a tax fairness plan containing its intension to bring about new tax measures including a distribution tax on distributions from publicly trading income trust and limited partnerships.

The government is proposing a four year transition period for existing income trust and limited partnerships whereby the new measures will not apply until the 2011 taxation year. Under the proposal flow through entities will be taxed more like corporations and their investors will be treated more like shareholders. The proposed new tax measures will impair the flow through nature of Precision Drilling Trust current tax structure and will require in depth review, examination and assessment pending enactment into tax law.

Obviously we are monitoring the situation carefully in terms of what the best overall value maximization for unit holders will be. Thank you, that concludes our comments.

Thank you very much, Doug. Gene Stahl, please.

Thank you, Hank and thank you Doug, I'll be brief here. Just again on behalf of our 6500 employees and behalf of management of Precision, I want to say how pleased and proud we are of the record results we were able to deliver in 2006 especially consideration how the market has turned in the latter half of 2006.

Now we are staring at a different world in 2007. As we look forward to 2007 obviously it appears that it's going to be a more challenging year. And we see signs of that already you see it in our utilization as well we are starting to get signs that some of our operators are close to getting through their Q1 spending programs which will likely mean that within the next month more equipment will be hitting the spot market.

And that will then clearly soften the demands for our services and will get to the point to where we see what kind of pricing discipline is out there on the service sector. I want to be clear in making the point that at this point we don't have enough visibility to be able to predict exactly what's going to happen in 2007. And more importantly we don't know what's going to happen in the second half of 2007.

And I think for those that are new to this sector we need to remind you about the dynamics that happen in the second quarter and after spring break out each of the last 21 years rates have gone down in the second quarter so it's not a matter if they are going down or not, they are going to be going down it's just a matter of the magnitude. That being said Precision will continue to focus on our competitive advantages of providing value for service for our customers by taking pride in our equipment and our people and our world class systems which we know at the end of the day our customers truly appreciate and value.

Also the dynamics that we are staring at in 2007 are not new to Precision and we take comfort in our business model and we are clearly focused on delivering our down to earth strategy and our 2007 budget. In 2006 we continued to make great strides toward our drive to reduce our target zero frequency. Our recordable injuries were down 28% in 2006 from 2005. And a number of our groups have achieved target zero. We had 5589 people achieve target zero. We had 60% of our drilling and service rigs achieve target zero.

We had 90% of our service and drilling rigs run without a loss time incident and operation division of Columbia, Terra, our U.S. drilling operations, 12 of our shops, 20 of our snubbing units, 86 of our camps all achieved target zero. This safety success is the key to our success as we go forward and the key to that and maintaining the momentum as we've never been closer to achieving target zero at within Precision.

Just to make a few couple quick comments on our capital initiatives. We are committed to our capital program with anything that we do have long-term contracts on. On the Canadian side with the announcement today of two more 3000 meter super single rigs. We will have 14 rigs to construct through 2007 and 2008. Talk about our U.S. expansion of a contact drilling services into the U.S., thats proceeding we now have a rig working in Texas obviously and also one in Colorado.

Our previously announced five new super singles will be delivered into the U.S. by the end of this year. All of those rigs have long-term commitments. Our second set of five rigs that we previously announced have been deferred until we can find customer commitments for that equipment.

During the quarter we also looked to supplement our U.S. strategy by bidding a couple of existing Canadian rigs into the U.S. market. We've secured long-term contracts for these rigs and we will, are in further discussions about deploying other rigs from Canada to the U.S. and will make announcements if we secure contracts. After the completion of our CapEx program into the first quarter of '08, we expect to operate 260 drilling rigs, 253 in Canada and seven in the United States.

Again just my closing comments I'd like to reiterate that do we believe 2007 will be a challenging year, nothing that we haven't seen before and our focus will continue to be on the basics which is customers relationships, allocation of capital, cost control and, most importantly, the welfare of our people. Thanks, Hank.

Thank you very much, Gene. We are going to open up to questions at this point in time, please.

Thank you. [OPERATOR INSTRUCTIONS] First question, John Tasdemir, please go ahead.

Hey, guys. Question is, obviously, 2007 doesn't look particularly pretty at this point but you guys are in a pretty good position. Do you think that there will be consolidation opportunities for you guys or are you guys looking to opportunistically maybe take advantage of this in Canada or do you feel like you've got what you need?

John, it's a very good question. Obviously we are between we expand the trust or go back to a regular corporation much those are the things the board is evaluating and going forward at this point in time. It comes down to multiples. Obviously we are very comfortable that we have a world class team in place. There's a potential that we could be -- we have seven rigs in the United States. We could have ten, we could 12, maybe 14, possibly at the end of 2007, we're not sure but obviously we are very please when we put a rig to work , it performs very, very well. In Canada we have to keep in mind that most drilling contractors in Canada and the United States do not have a lot of debt. Without debt, people can do a lot of things until they have to look at alternatives. It's a process and none of us know in the summer of 2007 what's going to play. Obviously it does look week as we go forward. The extent of that is the dependence on some of those contracts that they are going to depend on utilization rather than profitability. We will see a challenge in the market as we go forward, been through it many times before and can probably tell you the gentlemen that are going to be the first once out in cutting their prices and one thing I'm comfortable within the people that cut their prices first do that because that's the only way they can operate and keep that in minds when you evaluate stocks in the future, gentlemen. But as far as consolidation always willing and ready to look at it when the time is right, we have that ability obviously we don't have any problems with combined act in Canada. We are down to 33, we could have a lot of rigs. But we are very proud of this new fleet that we are building and the team that we have, it's very first class.

Thanks, I just had one follow up for Doug. I always get confused on this. You talk about a C$300 million Capex plan for 2007. Does that mean, is that C$300 million spent in 2007?

Yes.

Okay. Thanks, guys. Appreciate it.

The following question is from Brian Purdy. Please go ahead.

Congratulations on the quarter. Just going back to the question of spending there, would you care to hazard a guess when your debt would peak during the year and what level that might be at?

Our debt level traditionally would peak as we come out of the first quarter and we have a pretty heavy load to carry our working capital, the receivables coming out of the active quarter. I think you'll find that that debt level will be consistent with where we were. It will moderate lower but it would be within a reasonable range of where we were last year.

Okay. And as far as spending goes, is that fairly evenly spread through, also?

Yes, it is.

Okay. Great. And just wanted to ask about, your change in strategy in the U.S. as far as the link construction of the second five rigs and transferring some instead. Do you think you can continue with this strategy or would you just given the state of the market in Canada continue to transfer rather than build?

Let's keep in minds that we've cancelled the five, we also picked up two more super singles in Canada that are being required that we are going to have to build and there's only so much equipment you can get in a time period and we are still getting contracts come in, full payout on contracts in Canada. There is no need to rush into the U.S. and our fit for purposes build that we have in certain areas. As they get to know us better they will like us better.

Okay. Great, and just one more thing I just wanted to ask. In terms of G&A, you mentioned sort of the one time long-term incentive plan cost. Can you hazard a guess on what you might look at in terms of something that's more normalized?

Yes, I think if you look at long-term incentive cost will you find that the cost of that plan for 2006 is represented in the other liability balance on the balance sheet which is a little over C22 million. And so if you were to normalize results for that approximately half of that goes to the G&A line. So C$11 million in 2006.

And would you expect something similar going forward?

There again that's performance based. That long-term incentive plan is over a three-year period so I think you'll find that to the extent that it added a lot of expense in '06 to the extent that our distributions are lower in '07 that you could very well see a cost recovery.

Interesting. Okay. Thanks very much.

Thank you. Brian?

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

Hi, guys, good afternoon. My question is, Hank or Gene, when you look out to the summertime, what are the conditions that you think your customers will focus on as to whether or not they will increase or decrease their activity levels? What are the things that you think they are paying most attention to, is it just the gas price, is it the cost situation in Canada, is it the currency? Just trying to get a handle on what may be the pivot points in the marketplace which obviously looks fairly mediocre for at least for the next several months.

James, the one point all our customers look at are cash flow and obviously with price of gas if we could forecast that through the summer and everybody is hedged fully at C$8 mcf for example we would have a great summer because we don't have everyone hedged and don't know what the summer will bring it's still an unknown but one thing Doug and Gene as well keep in mind that in '97 there are about 450 rigs in Canada at the end of 2007 there could be approaching 1,000. We possible have more rigs than we need in this country not to say that the drilling contracts of this world have gone a little bit amiss but there's not a lot of forward thought. And some people are still building on spec, those days are over, I think will you see somewhat of a shake out over 2007 and 2008. Some will make it, some won't, Jimmy, so it's a great chance for the strong to survive and lead the way and some people should just go on.

Yet you guys are spending close to C$300 million also continuing to add to that mounting number of rigs in the market. I mean, it's a little bit at odds. Obviously you are going to pay out contract but every contract you get for an incremental rig is potentially one of your own rigs that's not going to go to work.

Potentially but when you are in the service business and your customers tells you he want it he is going to pay for it we actual do what our customers tells us. We have no choice. We try to switch contracts and do other thing, we sat down and talked to all of our customers with rigs that aren't out at this time point in time. They are happy with the rigs they are going to get when they get them and they are very happy with what they have in house. But technology moves on as well and some of our newer rigged are more advanced than the older ones. It might seem like a unique situation but that's just life in the service business.

It seems like you took a rig or two out of service in the quarter. Is that likely that we will see additional retirement out of your fleet if the market remains over supplied?

I think we are just going to go to cold stack because we can do that in Canada better than, unlike the U.S. term.

And then going back to my original question, if you thought or your customers got more comfortable that we would be looking at a C$8 number, I guess Henry Hub number using that how long do you think it would take them to restart their engines and get going?

If we felt comfortable that we had C$8 -- I mean, let me try to phrase this succinctly, we have a lot of change in the industry this year as we are trying to see what kind of spending the trust companies are going to do, Jamie, we've also seen some of the oil companies below a lot of their money the first quarter. Obviously, I'm involved in all the gas which most people know of and a lot of companies have slowed down their budgets at this point in time because we feel that drilling costs will decrease this summer. Summer access is going to be key to what you do, land retention. We are already seeing the signs that the oil and gas assets that are sold on a weekly basis are declining on a net par acre per acre price. So everybody, this is one of those years where you are going to have to take stock and make sure that you cover the basics, maintain your staff, look at your people and proceed with -- you don't want to pile on the debt. You want to go off existing [inaudible] cash flow and those are all things that we will see. None of us really no it's a going to happen this summer.

Right, so, it sounds to me as if for all intents and purposes your customers probably don't come back in any big way until the next winter season come fourth quarter?

Why couldn't we just pretend that we are going to ignore 2007 like a lot of you guys have done in the past in different years and let's just talk about 2008? That would be much better.

Thanks, Hank, that's very helpful.

[OPERATOR INSTRUCTIONS] The following question is from Todd Garman, please go ahead.

Good afternoon. I was wondering if you can comment on how U.S. rates have changed I guess if they have changed in the last six months both on a spot and a contracted basis.

We can only go by hearsay. Obviously our rigs that we have down there haven't decreased at all. Rumor would have it and you can talk to your big gentlemen that will be chatting they've all said that the rates have started to decrease. There has been a shrinkage of the rates. We've heard somewhere in the neighborhood of $3,000, some more the older the rigs they are going to go into cold storage possibly for a long period of time. You till have a huge number of rigs arriving from different parts of the world in the United States rigs are available and the more availability of the rigs the less the pricing is going to be. It's a very simple supply and demand.

Second question regarding Canadian activity levels. If you look back over the past ten years does this year feel about 98, 99, or does it feel like '02?

That's a good point, we have more rigs in '02 and '01 but it was a short lived list when it came down, 97, 98, it probably is in that period, my gut feel today with the unknown in the amount of rigs out there, yes.

Thank you.

There are no further questions registered at this time. I would now like to turn the meeting back to Mr. Swartout.

Thank you very much, ladies and gentlemen. I'm proud what have this team at Precision is continuing to do to focus on people's safety and listen to our customers and going forward, 2006 will be a -- 2007 will be a challenging year but obviously this company is set to handle any challenges that are put in front of it. We have a tremendous team of ladies and gentlemen in this company that are focused on all the right things that make it very easy to be the best of the best ,and that's what we are. Thank you very much. We look forward to seeing you next quarter.

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