Precision Drilling Corp (PDS) 2007 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Precision Drilling Trust first quarter 2007 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, Chara. Good afternoon, ladies and gentlemen. Doug, could you lead us into the first discussion, please?

Absolutely. Thank you, Hank. Ladies and Gentlemen, through a news release this morning, Precision reported that its financial results for the first quarter ended March 31, 2007. The news release included the unaudited consolidated financial statements of Precision Drilling Trust consisting of the consolidated statements of earnings and deficit, the consolidated balance sheet, the consolidated statements of cash flows as well as business segment information and Canadian drilling operating statistics. Please note that the financial figures are stated in Canadian dollars unless noted otherwise.

We remind our audience that today's comments may include forward-looking information and statements reflecting Precision's views about events and their potential impact on our operating and financial performance and legal entity capital structure, including weather trends, growth initiatives, demand trends, estimated capital expenditure levels and timing, projected equipment utilization, customer revenue rates, operating expense levels, earnings, cash flow, the cash distribution policy of Precision Drilling Trust and tax announcements of the Government of Canada. These expectations involve risks and uncertainties that the 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 disclosure in the news release and regulatory filings. The March 31, 2007, unaudited financial statements, complete with notes and management's discussion and analysis will be filed with regulators and made available at CDAR.Com within the next two weeks.

Precision Drilling Trust converted to an income trust on November 7, 2005, and is now generated a distribution history for 17 months and 5 complete quarters. During the five quarters ended March 31, 2007, Precision has declared cumulative cash distribution of 519 million or $4.13 per unit. 2006 marked Precision's first complete years in income trust , the 21st year as a publicly traded company, and the most profitable year for operations in Canada. As we embark on our second year as an income trust, Precision declared first quarter 2007 cash distributions of 72 million, or $0.57 per unit at the rate of 19 -- at the monthly rate of $0.19.

As many of our listeners know, Precision operates within a cyclical sector and with its concentration of services in Canada, it is subject to seasonal volatility for equipment utilization in addition to the underlying commodity price fundamentals. These business risks play an important role in Precision's past and future performance and we encourage our investors to examine the 2006 management discussion and analysis in our 2006 Annual Report on pages 30-66, and the MD&A in our Q1 2007 report to unit holders.

In summary the first quarter of 2007 was quite straightforward, in that it followed the trends established in the prior fourth quarter of 2006 for drilling, whereby Precision's comparatives to the prior year quarter resulted in Q4 '06 drilling activity being lower by 33% and for Q1 2007 it was 29% lower. What was different in Q1 2007 Precision was that instead of holding flat with prior year comparatives like in Q4 '06, our completion and production segment, led by our service rig division, was impacted by lower drilling levels as operating hours for the '07 quarter were 20% lower than Q1 '06. Completion work was off by approximately 30%.

The 2007 first quarter was quite traditional in that the winter drilling season did not really get going until the second week of January, and break up began, despite favorable weather late February, early March. This is in contrast to the urgency in high levels of customer demand over the past three years.

Financial highlights for the 2007 first quarter include, net earnings of 158 million and cash distributions declared of 72 million for an increase in unit holders equity of 86 million. On a per unit diluted basis Precision reported $1.26 in net earnings and cash distributions declared a $0.57, a decrease of 30% for each compared to the prior year quarter. Investing activities in the quarter led to 56 million in capital expenditures for additions to property, plant and equipment, and consisted of 18 million in maintenance capital and 38 million in expansion capital. Precision's organic growth program to expand the drilling rig fleet commissioned 5 new rigs in Canada during the quarter. During 2007, and the first half of 2008 the remaining 9 rigs for Canada and 5 for the United States are scheduled to be completed.

Fiscal 2007 follows record setting 2006 financial performance. The first quarter results were solid on the strength of customer pricing that held up well in January and February. With the significant year-over-year decline in customer demand for two successive quarters, and an industry rig fleet that is about 11% higher than a year ago, excess supply and lower demand has created a very competitive operating environment going into the seasonally inactive second quarter. Revenue rates are expected to decline and industry pricing discipline will be a key driver for Precision's results over the remainder of 2007.

During the first quarter of 2007, as compared to Q1 '06, Precision generated revenue of 411 million, a decrease of of 125 million or 23%. Operating earnings for the quarter was 178 million, a decrease of 68 million or 28%. The financial deterioration over 2006 is consistent with pricing trends and activities established in the prior fourth quarter. Activity declines for Precision in Canada are consistent with first quarter 2007 well licensing trends, where on a year-over-year basis, Q1 natural gas well licenses, excuse me, were 41% lower and for the month of March were approximately 66% lower than March of 2006. Near term, these statistics suggest that the second quarter of 2007 will carry forward and perhaps increase the pace of decline in year-over-year activity comparison.

During the '07 first quarter, pricing and overall average revenue rate increases over Q1 last year war 0 for the drilling division and 10% for the service rig division. In the first quarter 2007, the operating earnings margin as a percentage of revenue equates to 43%, a decline of 3 percentage points over the comparable first quarter of 2006. As we mentioned in the fourth quarter 2006 call, margin growth year-over-year for the drilling division had stalled. In the first quarter of 2007, drilling rates held flat but operating expenses on a per operating day basis were 6% higher. Forest service rigs operating expenses per operating hour were 10% higher while revenue increased by 20%.

The emergence of additional industry equipment supply and the fiscal reality for customer cash flows of 2006 natural gas price weakness continues to be the primary factor for the weakening environment in Canada. Operating cost as a percentage of revenue in the first quarter of 2007 were 47% an increase of 2 percentage points from Q1 '06. The percentage increase is due to cost increases which outweigh the slightly favorable impact of higher overall average revenue rates. Actual operating cost in Q1 2007 on a daily and hourly basis for the drilling and services rig divisions were higher by 6 and 10% respectively, or approximately $550 per drilling rig operating day and $40 per service rig operating hour. The increases were associated with labor, scheduled equipment maintenance and other direct operating costs.

During the first quarter of 2007, general and administrative expense is reported at 14.5 million, a 3.5% increase as a percentage of revenue. A decrease of 8 million due primarily to a reduction in employee incentive compensation accruals. Below the operating and earnings line for the quarter, interest expense in the amount of 2.5 million remains low and in line with the prior year. Operating statistics and average revenue rate information for Q1 2007 is compared to last year 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 Q1 2007 was 156 million, an increase of 115 million over Q1 2006, due to the early curtailment of winter activity in 2007 and the associated impact in the year-over-year change to non-cash working capital balance of 171 million. In other words, the typical surge of cash that occurs in the second quarter from the busy winter began early this year.

Turning to the Balance Sheet, as of March 31, 2007, Precision remains in strong financial position with working capital of 243 million -- 243 million, and long term debt of 148 million. We continue to carry financial strength and expect to add a conservative level of net debt as we proceed with our expansion plans. Precision continues to work well within its $700 million syndicated bank loan facility and $50 million operating line. Unit holders book equity increased during the quarter of 2007 by $0.69 a unit or $86 million, as net earnings in the amount of 158 million were higher than declared distributions to unit holders of 72 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 dependent on oil and natural gas commodity price fundamentals. Once again we recommend that listeners read Precision's regulatory filings.

To close, we acknowledge that the Government of Canada is proceeding with tax legislation as previously announced. Obviously, we continue to monitor the situation carefully in terms of the best overall value maximization for unit holders.

Hank that concludes our financial

Thank you very much, Doug. Next we will hear from Gene Stahl, Chief Operating Officer.

Thank you, Hank. I have just a few brief operational comments to make about the quarter. But before I do that I wanted to share with you a few of my thoughts about our people.

I'm proud of the performance of not only Precision's business segments, but most importantly of our people, and what is proving to be a far more challenging operating environment than we have seen in a number of years. Our people's ability to set goals, to prioritize, and to set timelines to deliver allow us to focus on what we can control as we look forward to the challenges in 2007.

Safety is our Number one focus. We started out the year strong with our safety stand down campaign, management and safety personnel visited more than 3,000 employees in the field to discuss issues, concerns, and best practices around work site and general safety. To that end, we continue tour target zero mission. Zero recordable injuries. We show continuous signs of improvement with a 17% decline in our recordable injury frequency in the first quarter. The injuries continue to be reduced.

You know, Q1 started off to be a real great quarter for Precision and then it just ended really way too early. Many of our customers completed their Q1 capital budgets earlier than normal and activity fell off significantly in March. In fact, this year, I would say that we could actually say that we experienced a customer driven breakup rather than a weather related breakup. We do not have full visibility of the impact on pricing in the spot market in the current quarter. We are anticipating an extended breakup. Many of you are aware of the number of scenarios that translate into upside in 2007. Our experience tells us that we can see just as many challenges as we look forward. In many places, temperatures have remained below seasonal levels, road bans will likely be in effect for quite some time, and coming out of breakup we expect to see that the market will continue to be competitive as we bid for work across all product lines.

Fortunately, in Canada, in our operating environment, Precision is fortunate to have solid relationships with our customers. With the right products in the right places, we can deliver to the diversity of our customers needs. This foundation is supported by a team which focuses on that which they can control.

An update on our capital spending, despite the slowdown that we're anticipating, Precision is committed to its capital expenditure program. We continue to build the rigs and service rigs, snubbing units, wastewater treatment units into the North American market. We have stayed committed to this decision for two basic reasons. First, I firmly believe that the service company of choice in the future is one that can do something better, and the type of technology we're including in this equipment positions us for the future. And secondly, the quality of the customer commitments that we have makes great business sense for Precision to carry forward with this organic growth initiative.

In turn, we're also taking advantage of moving some existing equipment and rigs from the Canadian fleet into the U.S. market, where we continue to see opportunities with existing customers. We have sent 4 existing rigs to the U.S. on long term commitments, bringing our current rig count into the U.S. to 5. In addition, we anticipate the first of five generation 12 super singles to cross the border in July of this year. Our success to date in the U.S. has been defined by providing specialized rigs on specialized products and we continue to build rigs and other equipment to a number of unique projects in the U.S.

And again, to tie in lastly, and most importantly, I know that everyone of our managers would agree that the welfare of our people remains critical. With lower activity levels this year, we already have seen a 25% decrease in our labor hours. In this environment we will focus on some of our unique core training initiatives. Our safety and observation communications class, our rig managers support classes to support over 500 of our rig managers, our designated driller programs that keep key employees working in times of slow activity. All of these will expose our thousands of employees to unique chance to refresh and update their skill sets as we prepare for not only the challenges but the opportunities that lay ahead. And Precision's success will but defined by our ability to focus on what we can control.

That's all I have, Hank. Thank you.

Thank you very much, Gene. Precision is very proud of our safety record and it's one of the main stages we go forward, as well as being the very careful how we spend our money and we're very focused on our costs going forward. We cannot control the suppliers, obviously, but we're aware that as we go forward and there's less utilization we will not inventory as much as we have in the past, and we've done this for the last 20 years and we've been through it and we'll go through it and handle it very well.

I think we'll open it to question and answers now, please.

Thank you. (OPERATOR INSTRUCTIONS) There will be a brief pause while participants register. Thank you for your patience. The first question is from John Tasdemir of Tristone Capital. Please go ahead.

Yes, afternoon, guys. First, a pretty respectable quarter given the underlying back drop of the industry, so congrats on doing that and margins were a lot better than I thought they would be. First a couple of clean up questions. Doug, maybe you can help me on kind of go forward SG&A and tax rates?

Yes, John. The effective tax rate for the first quarter was 10%, and I think you'll see that that compares to the quarter last year of 8%, and I think you'll find that that tax rate as we annualize out our earnings, if earnings progress and hold up reasonably well, you'll find that I think that effective tax rate will gradually decline. It's already pretty low rate at 10 but it will decline moderately as we get into the year.

Okay. SG&A?

SG&A, obviously you saw the impact of incentive base the compensation this year in terms of year-over-year comparatives. The SG&A is 3.5% of revenue for the quarter and that compares to 4.3% last year. We were on record of saying that kind of a normalized level within around the 5% range and I'd suggest that that's still the case.

Okay. Yes, it was, that definitely stood out. All right, from a bigger picture perspective, I know this is kind of difficult to answer on a conference call, but what is your strategy when it comes to pricing versus utilization? What can we expect I guess over the next six months?

Well, John, we're going to find out in the next few months how bad the pricing will be and the challenges that we'll have. Obviously, we are large enough that we do not lead the pricing, we follow, and we're only as good as our competitors. So I have to keep in mind as we go into the summer of 2007 that there are a lot of rigs with contracts, and some gentlemen have a lot of rigs under contract and they will use those rigs and there won't be a spot market for some other people, and there will be people getting rigs that are under long term contract farmed out to other gentlemen. So we're going to have a little bit of chaos as we go through the next couple months and we're not anticipating any great numbers as we go forward. We're organized to take what comes at us. We're very focused.

Obviously we think the numbers are going to be challenging in Canada. When you look at the numbers that the intermediates and the juniors are for [FMD] we see them way over where they would like to be, and obviously the lack of cash will drive the prices down. So the challenges are that the number of wells have dropped at this point in time and hopefully they will pick up, but the increased number of rigs will make it a little bit more competitive. And if we had to forecast today where we would be when we look at '98 and 2002 for example, traditionally, those years are the two years where we did not make, in the last nine months of the year, as much as we did in the first three months of the year, and hopefully we can make what we made in the first quarter in the next nine months of this year and hopefully more.

But those are the challenges, and we can't really see that right now, and it's hard even for our trustees to define what they would like to do going forward. But I think we all know there we're going to be challenged this summer and the prices will deteriorate obviously from where we set the prices in October of 2006. So we're all prepared for that, and we're prepared on personnel to make sure we keep as many personnel as we physically can. We would like to keep more, obviously, and our costs, we're going to be very careful of our costs going forward, and obviously as we decrease our profitability, the bonus potential for the staff, the way we're set up, has decreased and they are aware of that as well. So we are all pulling together as a team and we're prepared for it, fully prepared.

Well, thanks. Appreciate those comments. That's all I had.

Thank you.

Thank you. The next question is from Alan Laws of Merrill Lynch. Please go ahead.

Good afternoon. I have a few questions. First I'd like to say I appreciate your candor, you're always being honest on what the environment is like. My first question is, how much do you think that the gas prices is affecting your competitive back drop versus capacity growth in the Canadian market? Or a better way to ask the question is, if gas prices get better how long do you think it would take to absorb the fleet capacity and rest pricing declines?

Well, Alan, tha's a very good question but how good is gas going to get and how much better? It's all relative to that number. Obviously if we had $10 gas, we would see most of the rigs at work. $8 gas is questionable. We have to see the numbers from our customers get in line as well, because they get return on capital and we go forward, you've seen their numbers, they're nothing to jump at, a few of them are very good. Some of them are average and some of them aren't very good. And obviously, the smaller gentlemen are going to have trouble getting funding as they go forward because they haven't performed to the extent that you had given them.

This is a time when we have to be very careful of what we do and what we say. We're certainly not forecasting any great records going forward this year. We're very confident that we do a tremendous job and Precision is a first class service provider in all fronts and we will get a small premium for that, but we still have to deal with what our competitors come up with for pricing and they will drive us to where we'll be, we don't decide, but we do follow.

All right well, you're adding rigs to this back drop, some of your competitors are adding rigs still. Is this a carry over more from '06 or are you going to continue on this path given the current backdrop?

We add rigs and we have customers that guarantee us a full contract for that rig, and anybody that's in business would accept that we have customers -- we have competitors that build rigs on spec, those are the gentlemen that will be a little bit down. Obviously, oil and gas companies are going to challenge some of the contracts they have with late deliveries, et cetera. We certainly have a whole fleet and some of the ones that we haven't started yet, we've gone back to the oil company and we've said here is our whole fleet, would you like one of these or would you like the new state-of-the-art, with all of the bells and toys and whistles on it, and they've decided to continue for the new rig. And these are very good business people and they've made the decision, but we've discussed it internally with ourselves and externally with them, and we're very confident that our capital expenditures are 95% guaranteed by our customers and we would be foolish not to work with our customers.

Sure. I understand that. If when you look at this from a return point of view, are you seeing more of these opportunities in the U.S. market or in Canada or maybe both?

Well, we're seeing some very unique opportunity in the U.S. Because there's some very unique drilling scenarios coming up, where they want a long horizontal and a shallow, and obviously the super single that we have is a very dynamic piece of equipment that is breaking records where it's gone. Obviously we only have the two super singles in the United States at this point in time, and we have some other rigs that are doing exceptionally well. Fortunately, we've got some very well trained people and we are starting to integrate some of our U.S. operations with U.S. operational people, but it's a challenge for people in the U.S. as well, and obviously, the U.S. is getting a better return in some areas. We're seeing some of the major cut back on their Canadian budgets and spending most of the money in the United States, at least for the second and third quarter.

Now, where the challenge will be as we go into the latter part of 2007, is that, if we don't have people to put these rigs to work in October and then all of a sudden, the price of gas changes and it goes to 9 or $10 in January, we will all be challenged to try to put the rigs to work in the first part of 2008 because we won't have the people in place. Unfortunately, with the dynamics of Alberta and the other industries that are taking the labor workforce from us and challenging us for pricing, those are things we look at. But obviously I don't think that we're going to have a large increase in our labor cost in the fall of 2007 with the dynamics that we see today.

All right. Well the last question then is, given what you're seeing out there, the chaos or whatever you laid out for the next couple quarters, are the numbers out of Canada going to be challenging enough to impact your ability to pay your distribution at current levels given you have this locked in CapEx program?

We have the trustees that set it. I guess if you look at what we have going forward and what we alluded to earlier, is that if you take our first quarter, and we dividend out about half the money, let's suppose that's the case, and we have the expenditures which you can see coming forward, I think probably there will be a change in distribution at some point during 2007. I'm not the one that's going to make the decision. The trustees will make it. And to the severity of that will be as to what happens over the next 60, 90 days will be much more cognizant of what the reality is and their decisions will be made with that information.

Okay, I'll turn it back. I appreciate the candor. Thank you very much.

Thank you. (OPERATOR INSTRUCTIONS) The next question is from Brian Purdy from National Bank Financial. Please go ahead.

Good afternoon. I'm just wondering if you could give us any color on what the day rates look like in the U.S.? Obviously you've been moving a few rigs down there and the exchange rate has moved up $0.89 or $0.90 here. Are you seeing better day rates in that market? And just given where the exchange rate goes, potential to move more rigs down there?

I will say that the day work rates are better in the United States on the rigs we have moved down to date. But keep in mind that these are very unique rigs and very unique product development scenarios for them and they are outperforming all the other equipment that's there. Everything we take into the U.S. has been very high-tech equipment that is certainly out producing the competitors in the areas that we're in. So, obviously, we have been very fortuitous to get decent contracts, but the U.S. has not had the seasonality or demise in day [work] prices as Canada. They are still running at close to 90% utilization, I believe, of existing equipment. And when you look at Canada today, with what we have this spring and especially March was our worst March we've had in ten years, we've had too much equipment for the demand and once you have too much equipment for the demand prices are going to come down and they're going to come down hard.

Okay, great. And in terms of rig capabilities of your competitors down there, can you make any comment or in the U.S? Is it a little easier comparison wise than in Canada?

No. We're not going to rate our competitors in the United States. They have their pluses and minuses. We have our pluses and minuses. We know that when we go to work we watch our customers, as we do in Canada, to make sure that we have the leading edge, if we're not the leading edge, why we are we not the leading edge in the areas we're in, and we're very comfortable that Precision is a first class producer of drilling products.

Okay. Great. And just wanted to ask if of you'd have any early indications for next winter, just from any of your customers making plans that far out?

No, we haven't. Everybody is still waiting to see what's going to happen with gas this summer. Obviously, people are starting to get a little more comfortable with the gas price will come up, and if you look at the [Ford] strip that it's holding slightly at this point in time. Again, it comes back to, it doesn't matter what gas is, but these gentlemen that are our customers can't get a return on capital, we have a problem. We all have to work together to find the solution. They have to be profitable for us to be profitable and we cannot be profitable when they are not profitable. It's very simple.

Great. Thanks very much.

Thank you.

Thank you. There are no further questions registered at this time, gentlemen. We do have a question, Kevin Lo of First Energy Capital. Please go ahead.

Hi, guys. One quick thing. You were talking about contracted status. How much of your fleet rate now is contracted versus non?

Gene, I'll let you answer that, please.

Yes, of the 240 plus rigs, 40 would be under contract terms.

That's great. Thank you.

Thank you. The next question is from Todd Garman from Peters & Company. Please go ahead.

Just a quick question, Doug, regarding taxes here. What would you estimate the split to be between your current and deferred tax rates going forward for the year?

Yes, Todd, I think what you saw in the first quarter, given the comments that have been given already, is indicative of how the year will come out. Most of the tax expenses, future tax, not cash taxes, and it's related to, obviously differential between tax depreciation and book depreciation, so I would expect that trend to continue throughout the year.

Thank you.

Thank you. The next question is from Mike [Mizzar] of BMO Capital Markets. Please go ahead.

Hi, guys. Just a quick question here. You'd mentioned, obviously pricing, I know you don't have a lot of visibility, but just generally in terms of pricing impact by depth market, can you speak to that a little bit?

Well, our comment is that the shallow of course is [loss] of rig unless it's a very unique shallow rig. But the super singles are going to hold quite steady this summer and deeper rigs are not as (Inaudible) at this point in time, so, it varies depending on your depth and size of rig and age of rig as well, so they are all coming down from what they were this winter, but that's the only thing we're comfortable with. The one that we'll say is the closest to the winter rates will be the super singles which are in, still, far more demand than we have availability.

Sure. Okay. Fair enough. Thanks very much.

Thank you. The next question is from James Leung of Mackenzie Financial Please go ahead.

Good afternoon. Just one question. Just a follow-up to that question regarding the split between current and future taxes. Just, if you roll forward to 2011, what -- would that split be materially different and what will be the absolute rate at that point?

Yes, that will be entirely dependent on the level of profitability, and I think last year demonstrates that, when you take a look at the fact that we were cash taxable last year, we're a trust over LP over Corporation. So we do have future income taxes on our balance sheet, and we are potentially cash taxable within a corporation, where we outstrip the shelter within the trust. So, I'd suggest that's purely a function of profitability. And looking forward to 2011 in tax pools, we're a mature organization and we are spending on our expansionary capital initiatives, so we are replenishing our CCA pools but at the same time we're drawing them down each year at a pretty good rate. So, I think, take a look at the combination of last year and this year, I think you see a nice dichotomy based on where our profitability is.

Okay, thanks.

Thank you. Think are no further questions registered at this time, gentlemen.

Thank you. Ladies and gentlemen, we've tried to be as honest with our forecast as we can. I think you can go over the conference calls you've had with us over the last six or seven years since we've been doing them. We have been very forthright that we were going to have record quarters and record years, we were the first to say it, and when there were going to be challenges we were the first to say it. This will be a challenging year. There is no question. We are prepared to handle it with first class operational characteristics and our people will be looked after. This Company will go on and do very well. There will be a resurgence at some point in time. These rigs will go back to work. But when you have a supply base and you keep increasing your number of rigs, you are challenged to keep the price of the rigs up on a per day basis. And even though we have dropped in number of wells, obviously with the increase in number of rigs it will be more challenging in the future to keep the prices up.

That's just reality and that's something we're prepared to deal with in the U.S. and we will forego our Weatherford challenges, as far as working internationally within a year and a few months, and at that point in time we will look at international operations, as we are, we have the ability to work in the United States. We will look at some potential acquisitions, and as we go forward this year, and we're looking forward to a very unique year going forward, and working hard to make sure that we can deliver the earnings and the profitability that we deserve on a service basis with the competitors that we have.

I'd like to thank everybody very much and look forward to talking to you when we have our second quarter numbers. Thank you.

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