Precision Drilling Corp (PDS) 2014 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Precision Drilling Corporation 2014 second quarter results conference call and webcast. I would now like to turn the meeting over to Mr. Carey Ford, Vice President, Finance and Investor Relations.

Mr. Ford, please go ahead, sir.

Thank you, Melanie. Good afternoon, everyone. I'd also like to welcome you to Precision Drilling Corporation's second quarter 2014 Earnings Conference Call and webcast.

Participating today on the call with me are Kevin Neveu, our Chief Executive Officer; and Robert McNally our Executive Vice President and Chief Financial Officer. Also present are Gene Stahl, President of North American drilling operations; and Doug Strong, our President of completion and production services.

Per a news release earlier today, Precision Drilling Corporation reported on the second quarter 2014 results. Please note that the financial figures are in Canadian dollars unless otherwise indicated.

Some of our comments today will refer to non-IFRS financial measures, such as EBITDA and operating earnings. Please see our press release for additional disclosure on these financial measures.

Our comments today will also include statements reflecting Precision's views about future events and the potential impact on the Corporation's business operations structure, rig fleet, balance sheet, and financial results, which are forward-looking statements. We caution you that these forward-looking statements are subject to a number of known and unknown Risks and Uncertainties that could cause actual results to differ materially from our expectations. Please see our press release and other regulatory filings for more information on forward-looking statements and these risk factors.

Rob McNally will begin the call with a brief discussion of the second quarter operating results and a financial overview. Kevin Neveu will then provide a business operations update and our outlook.

Rob, over to you.

Thank you, Carey.

Earlier today we reported a strong quarter, with record second quarter revenues and EBITDA of CAD475 million and CAD135 million, respectively. We also announced a quarterly dividend of CAD0.06 per share, bringing the total dividends paid since December of 2012 to approximately CAD125 million. Revenues were up 25% versus the same quarter in 2013, primarily due to higher US and International drilling activity and pricing, and significantly higher Canadian drilling activity.

Second quarter 2014 EBITDA was CAD130 million which is 47% higher than the second quarter a year ago. The higher Q2 results primarily reflect increases in US, Canadian, and International drilling activity and increased margins versus the second quarter 2013.

EBITDA margins were 27% this quarter versus 23% in the second quarter of 2013. The higher EBITDA margins were driven by increased activity in all of our drilling markets, increased pricing in the US and International markets, and lower operating expenses in the US and Canadian drilling businesses. The increased EBITDA was partially offset by stock-based compensation accruals of CAD14 million in the quarter, which resulted from our strong share price performance during the quarter.

Margins for both US and Canadian drilling were up significantly in the quarter, primarily driven by the cost controls that we have been implementing over the past few years. Getting our Tech Center utilization up in Houston and gaining economies of scale with higher year-over-year rig counts have both been drivers of the margin gains. In the US during the second quarter, margins were up about CAD1900 a day over the second quarter of 2013, which is primarily due to the cost controls that I previously mentioned and a little bit less than CAD500 per day in pricing gains.

Drilling activity in the US improved by 16% year over year, with an average of 93 rigs running during the quarter versus 80 in the second quarter of 2013. Today, we have 96 rigs either drilling or moving in the United States.

In Canada, drilling margins improved by over CAD1700 a day year over year. Again, driven by cost controls and economies of scale. Drilling activity increased by about 33% over the second quarter a year ago, which was the highest level of second quarter Canadian drilling activity that we've seen since 2006. Today, we have 95 rigs either drilling or moving in Canada.

In our International drilling group, revenues were a little over CAD46 million for the quarter, which was an increase of CAD17 million over the second quarter of 2013. We do expect International revenues to continue growing with the addition of previously announced rigs and contracts.

Our completion and production segment revenues were CAD67 million in the quarter, up 20% over the second quarter of 2013. EBITDA in the second quarter of 2014 was CAD5 million, which is 124% above the second quarter a year ago. While demand is still relatively weak for most C&P services, we do believe that we have seen the bottom and expect modest increases in demand in the second half of the year. Our relatively new coiled tubing business continues to gain traction both in the United States and Canada.

As detailed in our press release this morning, our planned capital expenditures for 2014 are now expected to be CAD934 million, including CAD561 million for expansion capital, CAD199 million for sustaining infrastructure capital, CAD174 million to upgrade existing rigs. We expect that the CAD934 million will be split CAD894 million in the drilling segment and CAD40 million in completion and production segment.

The primary driver of the increase in CapEx is continued strong demand for new build super series rigs and additional rig upgrades. The expansion capital of CAD561 million includes the cost to build 18 newbuild drilling rigs, 7 for the Canadian market, 8 for United States, 2 Kuwait and 1 for the Kingdom of Saudi Arabia. The majority of the remaining expansion capital is allocated to long lead items, which we anticipate using for new build rigs that we expect to deliver later this year and into 2015 for the US, Canadian, and International markets.

Our sustaining and infrastructure capital is based on currently anticipated activity levels for 2014, and includes a technical and operations support center in Nisku, Alberta along with other regional support centers and corporate systems. We also plan to upgrade approximately 20 rigs in 2014 at a cost of about CAD174 million.

I'd like to repeat a couple comments that I made last quarter regarding the effectiveness of our upgrade program. Which I don't believe that we've helped the investment community understand quite well enough.

From 2010 through the end of 2013, we upgraded a total of 43 rigs for the North American market. During the first quarter of 2014, those rigs had 93% utilization, and generated EBITDA of over CAD11,000 per day. We're extremely pleased with the effectiveness of our ongoing rig upgrade program.

We described a change in accounting estimates last quarter, which I will reiterate. As a result of our annual review of estimated useful lives and method of depreciation of our PP&E, effective January 1, 2014 we're calculating depreciation on our drilling rigs and service rigs on a straight-line basis. The move to straight-line reflects the demand for technologically advanced assets, which are expected to depreciate over time rather than on a per unit basis. The use of straight-line depreciation will result in idle assets being more aggressively depreciated.

The second quarter of 2014, depreciation expense calculated using the straight-line method was CAD106 million. Had we continued to depreciate assets using units of production, depreciation would have been CAD86 million. The estimated additional depreciation expense for 2014 from this change is approximately CAD45 million for the year. Expect the greatest difference from employing the straight-line method to be seen in second quarter because we will continue to depreciate assets that are idle during spring break up in Canada.

Turning to the balance sheet, during the second quarter, we issued US $400 million of 5.25% senior notes that are due in 2024 in a private offering. We were very pleased with the pricing we achieved in this financing. We plan to use of proceeds for general corporate purposes, including building and upgrading rigs.

Our balance sheet remains strong and flexible. As of June 30, 2014, total debt was approximately CAD1.7 billion, and net debt was approximately CAD1.1 billion. Our blended interest rate is just over 6.2%, and our earliest debt maturity is in 2019. We believe that our balance sheet is in excellent shape, positions us well to address the high return growth opportunities that may be in front of us.

As we detailed in our press release, we are positioned to be able to deliver new rigs at a pace of three per month later in 2014 and four per month in early 2015. But I would note that we will only deliver the rigs if there are suitable customer contracts that we can obtain. Our current belief is the industry demand will support a solid build program for Precision Drilling over the next couple of years.

We currently have 110 rigs committed under term contract for the third quarter of 2014. For the balance of 2014, based on current contracts in hand, we have contracts for 114 rigs, which is comprised of 52 in Canada, 51 in the United States, and 11 internationally. We do expect to see the number of rigs under contract rise as we move through the year and begin delivering the new build rigs.

Including today's announced new builds we will have 237 tier one rigs, up from just 93 five years ago. Which puts us in a great position to generate strong returns for our shareholders now and to the future.

That concludes my comments, so I'll turn it over to Kevin for further discussion of the business.

Good afternoon and thank you, Rob.

Precision's record second quarter revenue and EBITDA is a result of strong performance across all of our drilling businesses, while our completion and production services segment continues to see weak customer demand, although our US expansion of coil operations has led to some improved year-over-year results for the group.

I'll spend a few minutes now and discuss some of the trends and indicators we see emerging during the second quarter of 2014. Most importantly from a leading indicator perspective, our impressive Canadian second quarter drilling activity, particularly our strong margin performance, sets the stage for a robust finish to 2014 and further points to a strong winter in 2015, and I'll speak to this a little more later.

The substantially improved Canadian second quarter margins demonstrates operational leverage we should expect in our Canadian businesses, with increased pad drilling operations, and should also help map the potential long-term strategic impact of the year-round pad drilling associated with the LNG opportunity facing precision.

During the second quarter, we received firm customer commitments for one new build and three major upgrades for Canadian customers. All four of these rigs will be tier one rigs designed specifically for year-round pad drilling, and three of the four rigs are intended for deep basin gas. Current Canadian activity, as Rob mentioned, is 95 rigs and should cross the 100 mark in the next few days. And, keep in mind that we have five rigs temporarily down in Manitoba and Southeast Saskatchewan due to the recent flooding. These rigs should also go back to work in early August, further lifting our Canadian activity.

Broadly, Canadian day rates are stable despite some second quarter price jostling. For Precision, our second quarter average day rates were pulled down by mix, with more smaller rigs working through spring than last year, drawing down the day rates. Now you should read this as a bullish call on future activity by our customers, as they see business picking up though third and fourth quarters.

For us, as summer activity ramps up and our mix normalizes, we expect to be back on a year-over-year pricing trajectory to be demonstrated in 2013 in the first quarter of this year. The Western Canada skilled employment market remains tight, and we do expect to see labor cost increases. If this happens, we intend to pass these increases through to our customers, with price increases which will sustain or improve our margins. And with the increased customer demand continuing to progress throughout the year we believe the environment for pricing remains constructive.

At Precision, we remain bullish and poised for the growth opportunities created as Canadian LNG export projects proceed. But like most, we recognize that several hurdles remain.

For now, we are monitoring the Providence of British Columbia's promise to establish our constructive royalty structure later this year. If they follow through, we believe one of these projects may achieve final investment decision in late 2014, with possibly one or two more to follow in 2015. Previously, we have suggested a potential of between 5 and 15 newbuild rig contracts could be awarded during 2014.

During the second quarter, 4 of those were awarded. Precision was successful, winning two; with one being a newbuild and the other a major upgrade, virtually a new build. We remain pleased -- both of these are pad capable rigs designed for full-year operations. And we remain pleased with our strong market position as a driller of choice with deep basin gas and liquids projects in Canada.

Now turning to United States, Precision is responding to the increase in customer demand in virtually every region we operate. The Permian Basin remains a hot spot. However, our announced new builds are spread over the Bakken, Eagle Ford, Utica, Marcellus, Niobrara, [Woodford], and of course the Permian. These new build are well distributed, with multiple rigs, but spread amongst six different customers, including one new customer.

Following a relatively flat activity period in the first half of the year, we're experiencing a third quarter ramp up similar to last year. Today we're running 96 rigs and have two more currently moving to location and expect to be over 100 by early August, with further increases as new builds are delivered later this year and through 2015.

Pricing is firm in both spot markets and more importantly particularly strong on term contract pricing. During the second quarter, we averaged a CAD1000 per day increase on term contract renewals. We expect most or all of this increased income will flow through to our bottom line. This, coupled with Precision's continued and sustainable improvements in cost, we think we see a potential for further margin expansion as the year evolves. I'm very proud of the work done by our people to optimize operating costs, while sustaining and maintaining our high quality, high performance field operations.

Precision's new build fraction in the US has been impressive to the point that we've already increased our planned build program from two rigs to three rigs monthly, and have accelerated the program forward to Q4 2014. And based on customer visibility, demand may pull Precision's newbuild production rate up to four rigs per month in early 2015. I think it's important to remind our investors that while we've ramped up our capacity this is not a spec build program. We will only build and deliver rigs if we have firm customer commitments. We believe this capital discipline is a core building block of Precision's strategy.

Precision's ability to increase the build program and meet the rising demand, is a result of our scale, our operational leverage, the commitment and focus of our people, not to mention the strength of our balance sheet. We believe this ability to rapidly scale our operating model and respond to market conditions is a key competitive advantage for Precision.

Our current contracted build program will grow Precision's US tier one fleet from 87 rigs in the beginning of 2014 to 113 by mid-2015, a 30% increase in our tier one fleet in the US. And we have further potential to deliver up to 30 additional rigs during the course of 2015 if demand warrants. And a line of sight customer visibility right now is very encouraging.

Speaking to the importance of scale, in constructing rigs is one element of scale. But staffing these rigs, firing them up, getting them to start up and running, managing a 30% growth rate is another critical element to the benefits of scale, and Precision's ability to adjust to that scale. Precision's integrated directional drilling capability took a huge step forward with the recently announced Schlumberger technology service agreement and marketing alliance. This alliance enables Precision to provide the full spectrum of leading downhole technology and compete on all types of directional drilling and steering, particularly the high-end Rotary steerable drilling applications, which enables significant efficiency gains for our customers.

Industrial logic, and operational value Precision's integrated service capability delivers is not going unnoticed by our customers. Today, we have over 20 different integrated customers, and more seriously considering our integrated offering. And as of today, we have completed two jobs using Schlumberger's Rotary steer-able tools and have six other jobs we have completed using other tool packages from Schlumberger. So far, this confirms the expected value the relationship unlocks for Schlumberger, for Precision, and for our customers.

Regarding our International activity, we're happy to have completed the construction and delivery of the two ST 3000 new big builds for Kuwait. Both of these rigs were delivered on budget, and on schedule. And those rigs are now delivering full run rate revenue and EBITDA and contributing significantly to our Middle East critical mass. And of course, the recently announced new builds, one each for the kingdom of Saudi Arabia, and Kuwait, demonstrate good progress towards building out our International scale.

[Dedding] activity throughout Middle East remains a very high level and we expect further opportunities following the conclusion of the eve festival later this month. Our operations in Kurdistan have been unaffected by the ISIS uprisings in Iraq, and while we keep a watchful eye on the security of our employees, we have no reason to expect any of it's issues. We remain confident that Kurdistan is an excellent growth opportunity for Precision. But we also believe our customers are holding pattern, as Kurdistan oil export issues are resolved in Iraq, and rest stabilizes.

During the second quarter, our Mexico operations remained in a state of flux, as the super bid award process has finally been sorted out. Precision will have four rigs working on sustained long-term contracts with favorable financial terms. Two other rigs will receive early termination payments that are currently mobilizing back to the US for immediate activation.

The final two rigs will remain in Mexico, and we'll continue to market those rigs for drilling support inside IPM projects with the major service integrators. It is clear that International activity and customer demand continues to grow. We're highly engaged with most opportunities, but will continue to carefully select and conservatively expand our activities, looking for the highest margin, best value opportunities for Precision. You should still think about our International growth at the rate of three to four rigs per year.

Now, turning to our completion and production services segment we're pleased to see better margin performance in Q2 last year than the combined 20% revenue growth in this business unit. As Rob mentioned, the year-over-year growth is a result of our US expansion and our coil operations. Generally, the market continues to be depressed. Particularly in Canada, where customers are focusing a disproportionate amount of capital on drilling programs.

As the largest Canadian driller, we're not bothered by this customer focus on drilling, that we're comforted that we can write off the low demand of oil servicing. However, we also know that a huge inventory of newly drilled oil wells is growing, and we'll soon need some form of remediation or service to sustain lower production width. At Precision, we could afford to wait it out.

Today we have approximately 75 service rigs running in Canada, which is on par with activity this time last year. Our mix has improved, with more rigs being positioned in 24 hour operations, particularly the SAGD operations near Fort McMurray. In the US, we have eight (inaudible) rigs operating in the Bakken, and eight (inaudible) units primarily in the Marcellus.

I think the takeaways for the quarter for Precision are the following. The strong Canadian demand has us looking for a strong finish to the year, and momentum into 2015. Our sustainable cost management or drilling operations both in Canada in the US will continue to support stronger sequential margins. Number three, Precision sees extremely strong customer demand for new build super series rigs in the US. And, with a 30% growth rate in our tier one fleet by mid-next year, and good visibility beyond with up to 30 more production slots available for 2015, we are very excited about the US business today.

Our continued steady but conservative International expansion is approaching the level we need to achieve critical mass. And finally, we are very encouraged by the opportunities created in the early successes with our Schlumberger integrated drilling alliance and we expect to provide more details over the coming quarters.

On that note, I'll turn the call back to the operator for questions. Thank you.

(Operator Instructions)

Jeff Spittel, Clarkson Capital Markets.

If we could talk a little bit about, Kevin, I think you mentioned the basin distribution seems to be pretty broad with new build demand. How is the mix in terms of the customer concentration been evolving over the last few quarters? Is there any discernible change you've noted over the last 6 to 12 months?

Really, I think if you look to who the most active E&P companies are in the US right now, our client mix is tracking that pretty well. Certainly, we're active with eight or nine of the top 10 E&P's in the US, but our spread goes up and down the customer base with nice diversity.

Okay. Just to follow on that, I think that it's still true that we don't have any customers that are more than mid-single digit percent of revenue.

Okay. Great. I appreciate it, and then maybe a big picture philosophical question. Obviously, the market is pretty hot right now. And I know you like to stick to a discipline in terms of having contracts before you deliver a new build. How do you weigh up that discipline with what you're seeing from some of the other competitors starting to up their cadence of construction and at what point do you start to look out and say -- hey at least we get a little bit worried about the rate of construction in the industry as a whole?

Jeff, we run a pretty careful model on the current rig fleet, on the rig deployments, on the capital build plans of our peers. We're watching this carefully. Certainly, well before we announced any kind of increase in our program. We have pretty good sense of where this is going midterm. So, I don't think that we sense and overbuild happening right now.

I do know that our peers that building most of the rigs comes down to just four companies in the US, ourselves included, have actually exercised pretty good discipline both on the contracting and pricing side. And we're all large-cap public drillers that have to report back to shareholders every quarter.

The discipline's been good. I expect it to remain good, and I think we're all watching the same indicators. At this point, little reason to be concerned about overbuild.

We'll keep an eye on this and report back every quarter.

Sure. That's a great answer. Appreciate it. Nice quarter.

Thank you.

Scott Treadwell, TD Securities.

Just to follow-up on the newbuilds, any build slots left for late 2014 delivery or Q1 2015, or are you now pushing out new deliveries into Q2 Q3 next year?

If I ask my guys to try to squeeze another rig into Q4 2014, they might run me out of here. But as things get into 2015, I think we start having a little more flexibility, and I think we're looking really more firmly at Q2, Q3, Q4, with a bit of flexibility at the front end, but nothing in 2014. I think we've done a pretty good job getting ourselves up to three rigs per month in Q4, when we were originally forecasting that to be more of a Q1 event.

Okay. And on the newbuilds you announced, you said there's one new client. I'm just wondering can you generalize, of those newbuilds are any of those targeted to replace existing Precision contracts, whether or not that rig goes on to another contract or are those all additional rigs for customers' programs?

Scott, you should view these as all being additional rigs.

Okay. Perfect.

You talked about incremental activity in Canada, looks like you think there's a bit more yet to come. Does the book of work look pretty solid through the fall and into the freeze up? You probably don't have visibility right into December, but certainly through the quarter and into Q4?

It's a bit of a foggy period to get really good clear customer guidance right now, but there's no question that they kept activity strong through the second quarter in anticipation of a tight market in the third quarter.

Lots of activity ongoing right now. Lots of things moving around. Our sense is, as I said, from an indicator perspective this looks like a robust finish to 2013 -- 2014 and pretty good ramp into 2015.

Okay. And then --

Scott, I'll tell you, that my call based on what I see right now. We don't have customers coming out laying up Q1 drilling plans with us quite yet.

Exactly. Okay. And then on the -- with the recent debt issue, you know the messaging has certainly been if the rig builds cycle wasn't there, you had the optionality to pay down some of the early debt issues that you have on the balance sheet today. With this rig build announcement, is it now almost certain that this addition of funds is likely to fund growth rather than pay down the debt that's on the balance sheet from the last issue?

Like you say we have the flexibility to pay down debt if we have excess capital. I suspect that given the demand for new build rigs that that's not likely going to be the scenario. I think we'll likely to use the capital to build rigs.

Okay. And maybe a bit of a clarification on the Schlumberger alliance, obviously it's early days, but I'm assuming that Precision doesn't have to outlay capital, i.e. not buying tools. It's pure joint marketing, and in the worst case you might rent the tool from Schlumberger and then put it on the rig if it's a directional system. But it would sort of be a bit of a pass-through, and you'd have a finders fee in the Rotary steerable case. Is that sort of the way to think about it?

Actually I think it's a little more than that. So, certainly the capital will stay on Schlumberger's balance sheet. And we will share in the revenue in the EBITDA for the jobs in a structured manner.

And for us, there is both revenue and EBITDA gains, no capital investment, extremely good technology support from Schlumberger with training and operational support on-the-job if we need it. It really does feel like a win-win-win for us right now, and our customers win because they do get that consolidated efficiency.

Okay. And I guess maybe the wrinkle there, I know when you started the directional business, you were pretty definitive in saying if a Precision directional tool caused lost time that you guys would put on the big boy points and step up and wear that. Now you're dealing with another company. Has that been addressed? Is there anything you can give us there on the color there?

I'd say that we've done a real good job properly assessing the risks and sharing the risks.

Okay. No. I understand you obviously can't be too detailed on that. So --

Let me be a little clearer here. We tracked the performance of every directional driller in our rigs for a long, long, long time. And it's clear that companies the quality of Schlumberger with their tool maintenance, tool application, tool performance, have a very low frequency of unexplained failures.

Okay. And that was obviously part of your decision process of aligning with them?

No question.

Perfect. That's all I've got. Thanks for the color.

Kevin Lo, FirstEnergy.

Great job on the cost side. Just wondering whether there was any seasonal impact, or should we continue to see a relatively low-cost structure in both Canada and US going forward?

So Kevin, I'd expect most of the cost savings that we've achieved to stick. There's a few one-time things in there, but it's primarily sustainable cost savings that I'd expect that we'll maintain going forward.

And can you allude to why it was so dramatic between Q1 and Q2 in terms of reduction? It seems like everything happened all at once. Was it a new facility that came on stream or something?

It was a combination of things. It was getting critical mass in the tech center in Houston, it was having more rigs running, so we had just more scale, and that was especially true in the Canadian market versus last year's Q2.

Just things started to click. Then, as I said, there were a couple of one-time items that had to do with insurance. But it just all kind of started to come together here this last quarter.

Okay. Great. And just the last thing is can you kind of update us on the number of rigs that you may decommission as you roll out some of these new rigs?

Kevin's remarks were that we should kind of think about all these rigs as newbuilds, but is there any thought that there might be some rigs that might be decommissioned between now and the end of 2015?

Kevin, nothing material. Unless we had a rig that somehow had a failure of some sort. But no decommissioning plans.

Kevin, we decommissioned the vast majority of our tier three rigs a couple years ago. And the rigs that we have now are good, well-maintained rigs, and I don't expect to see any decommissioning is in this year or next year.

Okay. Great. That's all for me. Thank you.

Dana Benner, AltaCorp Capital.

I wanted to turn to your -- to the various newbuilds that you've added this quarter. And I wonder if you can enlighten us as to whether the economic terms has changed materially. I'm sure they are still well within your normal range, et cetera. But are there other things going on in that market that are more attractive, less attractive? Any additional color would be helpful.

Sure. I'd say that the economic terms haven't moved a lot. They've gotten marginally better, but for the newbuilds that we've signed over the past few years, they've always been pretty good. Right? Kind of full-year cash on cash return kind of economics.

I'd say that the biggest change that we've seen in this last quarter is our customers' willingness to commit to three-year contracts in US versus wanting shorter contracts even just six months ago, where they are really looking at two years, shorter contracts. So there's been much more willingness to sign on to longer-term contracts. So I'd say that's the biggest change.

Right. Secondly, the rigs that are rolling over right now, on what type of terms are we seeing the -- for example, here's one data point. Nabors yesterday said I think -- and this is just one, I think the average term for them for their renewals was something like seven months. And, so maybe a third being renewed at that and then two-thirds on spot. How would you characterize the renewals that you're seeing right now, and maybe your strategy around doing those?

Dana, there's two types of renewals that we're seeing right now. There's a group of renewals are going back into term where they're going to six-month, one-year terms. We still have a few renewals where the rig comes off long-term contract, stays with the same customer, stays at the original full market dayrate and goes into day work. Net net contract position's staying strong, and the dayrates are right up that newbuild dayrate now.

But, during the quarter, I think I commented in my comments here that average -- on the term rollovers, average day rates increased by about CAD1000 a day. A combination of six-month and one-year contracts.

I don't have the average.

That's fine. Thirdly, looking at the newbuild, announcements virtually all for the US next year, how would you characterize the Canadian market right now and the willingness to commit to newbuilds? If we look at the rate this year, it's pretty evenly balanced between Canada and the US, and all of a sudden it's been skewed heavily toward the US. So what should we read into that?

A couple of things. We've actually been -- we haven't given a lot of clarity on upgrades. We've had a pretty good run of some really major upgrades on rigs here, where we take a tier two rig and really convert it to a full spec pad type rig. I commented on one of those -- one of the LNG potential plays. We've had a handful of those this quarter.

For us, they're excellent. We get a two-year contract, we get a high spec rig at the backend, we're earning returns that exceed a brand-new build type returns, so we're happy with that. But generally speaking, I think the next catalyst for new build rigs in Canada is going to have to be likely LNG.

And so presumably, we're a few months away from getting more clarity, so folks are holding off?

Yes. I think we really need to see a project hit first investment approval -- final investment approval. That has to happen.

All right. Helpful.

One final question. Just looking at the way the world is evolving here, as part of the -- we've got Schlumberger out there saying that they think we see more integrated services in North America, which would be a big change, and that's the basis for doing this type of a deal. And then we've got Nabors doing a deal with CMJ and wanting -- thinking about that more as a way to compete on maybe some IPM projects internationally. So we're seeing at least the beginnings of what could be a meaningful change in the architecture of our business globally. So, it's a big question, but I'd love to hear your thoughts on both of those sub areas.

It's a little harder for me to comment on combining drilling and pressure pumping, but let me talk more about the sea change that's happening right now with unconventional drilling. So, we moved away from what I'd call wildcat drilling. Most of what we're doing -- in fact all of our rigs right now across North America are engaged in resource drilling. Almost nothing on reservoir drilling. And I don't know the numbers right now, but roughly 190 rigs running about 185 of those are resource rigs.

This is an industrialized process, Dana, where you've got a rig on a pad or a rig in the field drilling the same well a number of times, and that same well could be a couple hundred times in a given area. We've drilled the same well, so we get an optimize that -- people are calling this manufacturing, they're calling it mass production, I think a better term is industrializing it. Where you take it, you make everything consistent, printable, repeatable. You optimize every element, and squeeze down the drilling days. We talked to a customer last week that we are working for in the Eagle Ford, and I think we were at 35 drilling days early on, in Eagle Ford we're down to less than nine days for most of their wells. We've optimized every piece.

And I think that's the platform where, when you combine the drilling with the directional drilling, I think that is just a natural fit, because the same guys run the rig all the time, the tools are part of the rig, they're part of doing the same job, so I think there's a real natural fit to integrate directional drilling with the rig. In fact, I think the next extension's going to be integrating realtime near bit measurements with drilling controls, and we're well-suited to do that now with the connection that we have on the technology for the tools and our tier one rigs.

So I think this is a natural fit. I don't know that it means that it goes beyond that and we start seeing companies fully take over field Management. Our customers here are very good at managing their fields. They do that excellently, but I think we can combine directional drilling with our drilling and consolidate the risk for our customers and absolutely reduce the cost. Certainly, optimize the efficiency.

Okay. Very interesting. I'll turn it back. Thank you.

Thanks, Dana.

Dan MacDonald, RBC Capital Markets.

It sounds a bit from your comments that the main customer push to add the higher-end tools via the Schlumberger JV was from your US clients. Is that fair?

I would tell you that this is our strategy, it's not a client push.

I would add to that its North American wide. This is not just in the US or just in Canada. I think we're going to see activity in both areas.

There is wider spread use of Rotary steerable in the US than there is in Canada, but I think we have the opportunity to help that technology move forward in both markets.

Do you want to share which basin the couple jobs you've done already have been done in?

No. I don't want to give specifics.

Okay. And then if we look at the upgrade opportunity here, you announced or you said you had three upgrades that you signed up for here in the Canadian market in Q2. How many of the 20 that you've targeted are spoken for or are already in progress and then how many do you think might come out of what is left of the idle fleet at this point?

It's Gene here again. You commented 20 upgrades? I don't think we threw out the number of 20 upgrades.

Yes we have. For the year.

For the entire year?

Yes.

Upgrades are all spoken for. We don't start upgrades until we've got commitment and we know what they're doing where they're going, because to do the upgrade we need to know the program outline first off.

And if you're thinking about the pace of those upgrades, think about it just ratably throughout the year.

And then can you give us a sense of the balance of what might be upgrades for the existing fleet versus coming out of the remaining idle capacity you might have?

No. Don't have that information with us. And we usually don't provide it.

Dan, these are typically tier two rigs. That will have they may have some utilization or may be fairly limited and we're at the point now where these are relatively big upgrades. They might be somewhere between CAD10 million and CAD15 million for some of these but what we end up with is really what looks like a brand-new tier one rig.

And some of the upgrades are tier one rigs that have pad moving systems tacked on. We upgrade the rig customer contracts (inaudible) pace of that upgrade, so we've always stated that we believe if we increase the capability of the rig for our customer, we'll collect our portion of the rent.

Okay. Great. That's all I have. Thanks.

Brad Handler, Jefferies.

Hoping you can clarify a couple points, so I'll come back to a couple topics that have been hit already. In the last go round, Kevin, you mentioned you thought that Canadian revenues in the second half of the year could be up 10% to 15% over year on year. Or maybe it was drilling activity, but I think it was revenues. You didn't reiterate that. I'm not quite clear if you think that is the same? Are you comfortable giving the same guidance, or are you not comfortable giving guidance? What do you think?

I would tell you that I haven't given any guidance around that range. From what we see and feel at this point, certainly it's at 15% year-over-year. Maybe some room for improvement on that.

Okay. Still on the 15%? Okay. Thanks.

The high end of the range, and then maybe further room for improvement. It's pretty sketchy to be calling out much more than that as we look at the back half of the year. Q2 was very, very good. And Q3's starting out very nice.

We have also seen a few years where things tapered off early in December. And that can make a big difference in numbers. It doesn't mean it's a ramp down for 2015, but it doesn't mean it's a bit of a break before heavy winter drilling season, so I'll stop short of going beyond 15% at this point.

Okay. All right.

I was trying to calibrate where I thought you commented a quarter ago. But that's fine. Maybe a question for Rob then. Rob. If I were to model CAD11,800 a day of cash margin in the US business in 3Q, does that give you heartburn? Are you comfortable with that? Again, sort of getting at the sustainability of the cost improvements.

I'm not going to give you a number, Brad, but I would say that earlier comments on the costs is we will maintain most of those cost savings that we achieved in this last quarter. A few pieces of it are one-time items but mostly we'll maintain the cost and I don't expect revenues to go down. So you can draw from that your conclusions.

Okay. Will do. All right. Thanks, guys. Appreciate it.

Klayton Kovac, Tudor, Pickering, Holt.

So, regarding pricing increases in the US, are you seeing this across both your tier one and tier two asset classes?

The average I gave you included both tier one and tier two rigs that we're renewing after their terms. Recognize, most of our operations of US right now are tier one rigs.

Rob, you quoted out 90%?

Yes. It's the vast majority.

So if there's any rollovers it's likely an even blend 90% tier one, 10% tier two. That increase is across the boards on average.

Okay. And then --

That was Q2 so, no reason to believe that falls back in Q3, if there's any renewals in Q3.

Okay. And then as a follow-up for what type of rigs will be most in demand for LNG related drilling in Canada?

It will be a combination of our northern climate winterized super triple 1500s and super triple 1200s. Those two rigs. The 1200 is an extremely mobile rig that can get around the fields here almost any time. The 1500s are going to be for the deeper plays when you get down below 4500 meters of vertical depth. But a combination of those two types of rigs.

Okay. Thank you. I'll turn it back over.

Thank you.

Mike Mazar, BMO Capital Markets.

Just on the ramp up to the four rig per month cadence I got a few questions around that. One is, is there a significant investment required in the manufacturing capacity itself to accommodate of that? Secondly, or are you changing anything associated with the manufacturing process itself? Whether it be perhaps outsourcing certain components more than you did before, or is the percentage sort of built in-house still staying the same? And third, are you seeing any meaningful cost inflation on the actual build side itself?

You're really cutting deep with those questions. Good questions.

First of all, no capital required by Precision to extend our capacity to four, and possibly to five even later next year if that were necessary, so that's the first comment. Second comment is that we've been very strategic in our procurement with our vendors. And going back six, seven years now we've had long-term deals in place with a number of vendors ranging from drill pipe to electric motors and top drives.

I would tell you that while we are not making any public statements, we've increased our relationships on strategic purchasing or high-volume long-term purchasing whereby we get very favorable pricing and very favorable delivery terms, and it's helping us ramp up our production with really no impact inside Precision.

And your last question on capital costs, I'd say that's there's a bias going down. Because of the steady build program we're going to drive some costs out of the build process as opposed to seeing cost increases.

And the strategic purchasing alliances that we have.

That makes sense. So, ultimately to put another way there was excess capacity in the manufacturing operation?

Well, in Precision, we ramp it up and ramp it down depending on demand, and we ramped it down to kind of as low as less than a rig a month for a while from four rigs a month back in early 2013. And now we are back up to four rigs again in 2015. So I think rather than thinking about excess capacity we like to have variability in Precision for ramping things up and ramping things down.

Sure. Thanks, guys.

(Operator Instructions)

Jon Morrison, CIBC World Markets.

Can you give any idea of how quickly the order intake it has accelerated or customer conversations have improved relative to April for the magnitude of the long lead time order increase? It's fairly material in terms of step change from what you messaged last quarter.

Yes. Last quarter I think we were talking about eight or nine rigs we've added to our backlog and we were ramping up based on that. But we also indicated we had pretty good visibility to suggest a two rig per month run rate in 2015, and now we're saying we got good visibility to push that even further. All of that has happened, really, from our conference call in April, pretty much through today.

And so that's just a three-month period. But what I will comment on, John, is our customers aren't looking out too much past mid-Q2 2015 right now. As we get later in the year, we could see people looking out into later 2015 and that launch may continue.

And as I commented earlier, we do a pretty careful job monitoring the deployment of tier one rigs across the industry, what the basins are doing, where that's going. I think I feel pretty good about the potential providing the macro stays in place, to fully build out the exterior at the kind of pace we're talking about on good solid contracts. But, like always, this remains a cyclic business.

We're in a -- good fundamentals today with still good gas prices, they've come off a little bit, but I don't think gas prices are going to go away. But consistent, strong oil prices and consistent excellent results of the drill bit.

So, it's fair to say that customer conversations have been what's moved the needle since the last call relative to a broad feel of the market, or are you guys seeing increases in the program?

Yes.

Are you guys comfortable delivering 48 rigs next year? Either from a financial or execution point of view?

I alluded to that in my prepared comments. I think our scale supports that, but just go back a year ago in the US, we're running over 20 rigs more than we were a year ago in the US without a single hiccup in operations. In Canada, we ramp up and ramped down for the seasonality, here without any hiccups.

That's one of our benchmarks is the ability to crew these rigs up with hands, but more importantly to put experienced trained and well-experienced leadership on the rigs. So I think our scale gives us that power. And even thinking forward about a potential 48 rigs next year, that's still less than our typical winter ramp up in Canada is.

And the four rigs a month, just to clarify, is that your North American newbuild capacity or would that include anything you're going to do building something outside of North America?

I think outside North America might be one or two rigs over the course of the year, so yes it includes everything, including outside North America, but John, that number's one or two rigs during the course of the year.

It's not going to be 10 rigs.

Sort of come back to come back to this, because I know we've talked about it a couple different ways but on the operating costs in the US, they declined by $1300 quarter-over-quarter and you reference in the release labor efficiencies and labor related costs being the biggest drivers. And given that I would assume that you're not paying a Precision employee less today than you were in Q1, and activity levels were relatively flat on a quarter-over-quarter basis, how do you drive that magnitude of change?

There's some of it that's scale, running more rigs than what we were running the previous quarter, spreading overhead costs. There's some insurance component to it. There is excess bodies that aren't there now that we've pushed out of the system that weren't necessary.

It's the tech center operating, there's a number of items that go into that. Not all of that is sustainable. Some of it was one time, but the majority of it is sustainable costs that we think we'll keep out of the system.

Okay. On the two rigs coming back into the US from Mexico, are the mold costs covered by your customer?

Yes.

Is the payout meaningful, that we should be thinking about modeling or it's irrelevant?

Irrelevant. It doesn't matter.

On the --

John, those rigs will receive an early termination premium that captures remote costs, captures lost margins, it's a pretty good deal.

And once they're brought back to the US, there's no concerns that those take a while back to work in anyway?

No. They're actually already committed to jobs, and they're on their way to location now.

Okay.

In fact, I can tell you our International team really competed hard to try to keep those rigs available for marketing in Mexico and we said we got jobs for them. We're going to work.

Perfect. On the Schlumberger side, just a point of clarification. Do you guys actually set the price on what you're going to be charging for a job that you're doing with the Schlumberger tool, or is that dictated by kind of the framework of understanding that you have with Schlumberger? I.e. can you underprice Schlumberger for the same work, or are you competing on execution with the customer?

That's about five different questions all rolled into one. I think the answer is we're calling this a marketing alliance and an alliance we're going to work together on making sure we create the right customer value, so I'd say on the pricing with customers we are going to be highly collaborative with how we integrate that service to how we price it through our platform.

Okay.

Schlumberger runs a directional drilling business to run these tools directly. I think that business will stand and run on its own.

I think our job is to prove that when you combine it with Precision, there's a special value created and we've seen it already. I know this unlocks value, we are proving it, and fair to say Schlumberger's happy with the progress.

Last one for me, just on the International side. In your preamble, you talked about not being far off of getting International profitability to North American levels. Can you give any sense how many more rigs you need to added to existing geographies to bring gross margin or EBITDA margin in both markets to be the same? Is it five more rigs in the same geographies where you work or is it more meaningful than that?

Think about it a couple of ways. So first of all, the operations in Mexico run pretty much remote control from Houston, so there's really no fixed overhead tied to Mexico. So whether it's one it's one rig or four rigs we're happy. But the Middle East, 12 to 15 feels like a pretty good range for us. So we're getting there.

Assuming that they're going to the countries where we already have infrastructure. We're a lot better off if we're putting additional rigs into Kuwait or Saudi or Kurdistan than if we were to open a shop in a new country.

For sure. Okay. I appreciate the color.

Thanks, John.

There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Ford.

That concludes our second quarter 2014 conference call. Thanks for joining us today.

Thank you. The conference has now ended.

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