Precision Drilling Corporation

Good day and thank you for standing by. Welcome to the Precision Drilling Corporation 2021 Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star and then the number one on your telephone. Please be advised that today's conference is being recorded. If you require assistance during the conference, please press star and then zero. I would now like to hand the conference over to Carey Ford, Senior Vice President, Chief Financial Officer. Please go ahead.

Thank you, Amanda, and good afternoon. Welcome to Precision Drilling's third quarter earnings conference call and webcast. Participating with me today is Kevin Nebu, President and Chief Executive Officer. Precision reported its third quarter results through a press release earlier this morning. Please note, these financial results are in Canadian dollars unless otherwise indicated. Also, please note some of our comments today will refer to non-IFRS financial measures and will include forward-looking statements regarding precision future results and prospects, which are subject to a number of risks and uncertainties. Please see our news release and other regulatory filings for more information on financial measures, forward-looking statements, and risk factors. Prior to Kevin providing an operational outlook and update, I will review our third quarter financial results. Precision third quarter results were characterized by increasing North American activity, improved spot market pricing, and largely temporary increases in U.S. operating costs ahead of a stronger Q4 and Q1 activity outlook. Our second quarter adjusted EBITDA of $45 million included a share-based compensation expense accrual of $14 million. Absent this accrual, adjusted EBITDA would have been $59 million. The share-based compensation accrual resulted from continued strong performance of precision chairs and our cash settled accounting treatment where each quarter we accrue an expense or benefit based on marking the plan to market and accounting for plan vesting in the quarter. As noted on our 2021 conference calls, the cash treatment and chair price volatility may present higher volatility in financial results. Please keep in mind that we have the ability to pay a portion of these awards in either cash or equity upon vesting. During the quarter, we received $6 million of Q's assistance payments, and we believe the Q's program is largely complete for precision with the 2021 impact of approximately $24 million. Moving to the US, drilling activity for precision averaged 41 rigs in Q3, an increase of two rigs from Q2, Daily operating margins in the quarter were $5,211, a decrease of $1,541 from Q2. Absent impacts from IBC and turnkey, daily operating margins would have been $1,295 lower than Q2. Although we were able to achieve pricing increases of close to $700, we experienced higher costs during the quarter resulting from higher repair and maintenance expense and rig mobilization costs that will be recouped in a rig contract. During the quarter, we prepared four rigs for activation and on average they had been idle for 20 months. Our U.S. operating costs for the quarter were higher than expected, but we believe the majority of the cost increase is temporary and the actions taken in Q3 are building a larger revenue base for the next two quarters. For Q4, we expect normalized margins to be 1,500 US dollars to 2,000 US dollars higher than Q3. Moving to Canada, drilling activity for precision averaged 51 rigs, an increase of 33 rigs from Q3 2020, and representing a nearly tripling of the rig count. Daily operating margins in the quarter were $6,238, a decrease of $2,268 from Q3 2020, primarily due to rig mixes, we had a much higher percentage of shallower rigs working this year. Absent the Q's impact, margins would have been $5,303 or $967 lower than Q3 last year and slightly higher than Q2 2021, which is consistent with the guidance provided last quarter. For Q4, we expect margins absent of Q's and one-time recoveries to be up $500 per day, higher compared to Q4 last year and $1,500 to $2,000 a day higher than Q3 this year. For reference, daily operating margins in Q4 2020 absent queues and one-time recoveries were $6,895. Moving on to international operations, drilling activity for precision in the current quarter averaged six rigs, International average day rates were $52,277 U.S. dollars, down $2,610 U.S. dollars from the prior year, primarily due to revenue generated during rig moves. In our C&P segment, adjusted EBITDA this quarter was $5.4 million, up approximately $1.5 million compared to the prior year quarter. Adjusted EBITDA was positively impacted by a 107% increase in well service hours. Well abandonment work represented approximately 15% of our operating hours in the quarter as customers appear to be focusing more on producing wells than plug-in abandoned work. Capital expenditures for the quarter were $20 million and our full year 2021 guidance has increased to $74 million. The increase in planned capital spending is largely due to advanced drill pipe orders secured at the beginning of the quarter where we acted on an opportunity to purchase High Torque Drill Pipe from vendor inventory at a significant discount, mitigating steel price increases and ensuring availability in a rapidly tightening market. Our 2021 capital plan is comprised of $51 million for sustaining and infrastructure and $23 million for upgrade and expansion, which relates to anticipated investments supporting our alpha technologies as well as contracted customer upgrades. As of October 20th, we had an average of 35 contracts in hand for the third quarter and an average of 35 contracts for the full year 2021. As of September 30th, our long-term debt position net of cash was approximately $1.1 billion, and our total liquidity position was approximately $500 million, excluding letters of credit. Our net debt to trailing 12-month EBITDA ratio is approximately six times, and our average cost of debt is 6.3%. We remain in compliance with all our credit facility covenants in the second quarter and the third quarter with an EBITDA to interest coverage ratio of approximately two times. During the quarter, we reduced total debt by $8 million, and year-to-date debt reduction is $60 million. And we expect to make debt payments during the fourth quarter to achieve our debt reduction goal of $100 million to $125 million for the year. Our capital allocation program remains substantially weighted to debt reduction, and we remain on track to meet or exceed our long-term debt reduction target of $800 million between 2018 and 2022, where we have already reduced debt by $610 million since the beginning of 2018. We expect to continue generating free cash flow through operations in the fourth quarter and with higher activity, improved pricing, and only $3 million of cash interest due in the quarter, the business is well positioned to support further deleveraging. For 2021, our guidance for depreciation in G&A before share-based compensation remains $280 million and $55 million, respectively. Of note, our strict focus on cost control is represented by our consistent G&A expense guidance throughout the year, despite realized activity far exceeding our expectations at the beginning of 2021. Our run rate cash interest expense is less than $80 million and we expect it to move lower into next year as debt pay down continues. We expect cash taxes to remain low and our effective tax rate to be below 10%. One final note on operating leverage. Those who have followed the land drilling space through cycles understand the operating leverage and torque inherent in the business. As several years have passed, since we have experienced a market where both margins and activity were growing, I would like to highlight an illustration using today's activity and our lean and scalable fixed cost structure. With 112 rigs running globally today, a $1,000 per rig increase in daily operating margin across the fleet should result in approximately $40 million of increased EBITDA on an annualized basis. With activity expected to increase and continued pricing momentum, we look to demonstrate precision operational leverage through our financial results over the next several quarters. With that, I will now turn the call over to Kevin.

Thank you, Gary, and good afternoon. Well, this is the first time in over a decade where a strong and resilient commodity backdrop lines up with the annual E&P budgeting cycle. Unusual territory indeed. Virtually all, in fact, I believe all the key leading indicators we monitor are trending favorably as we develop Precision's outlook for 2022 and beyond. Following the significant drilling activity reduction during the pandemic, and now with energy demand firmly rebounding, we are very encouraged by the strong spot in future STRIP oil and gas commodity prices. Underlying these key industry fundamentals is the supply discipline demonstrated by OPEC Plus and the capital discipline of the publicly traded oil and gas producers. Looking at our core US and Canadian markets, the cash generating capabilities of the oil and gas producers will continue to be strong. much stronger than it was expected even just a few months ago. Much of the balance sheet repair work the industry needed and the investors sought has been completed or will shortly be complete. We believe the mantra of capital discipline and sustainable shareholder returns will continue to be the key strategic focus of our customers. And we expect this will lead to a healthier and more balanced result for our industry over the longer term. On the near term, the dwindling inventory of uncompleted wells in the US is a key indicator we watch closely. Undoubtedly, the operators will need to shift focus and direct spending back to the drill bit just to sustain current production levels, let alone provide for any increase in demand. Now, while many have written off the shales as a swing producer, when you look at the shale industry structure from a logistics, capability, infrastructure perspective, it's functionally structured to be one of the fastest responding sources of incremental oil and gas production. Every aspect of the domestic shale industry has been structured around the rapid return of capital. The industry features include fast and efficient decision-making, short-cycle drilling and completion techniques, industrialized scale to lower costs, and now digital analytics optimization. We believe that by following a disciplined approach to capital deployment and coupling a capital-efficient, well-managed, grilled profile, the shales may still play an important role as a swing producer. Thank you very much. virtually every producer and most service firms are addressing emissions reductions and lower environmental impacts, expanding community engagement, while continuing to drive efficiency, safety, and financial performance. At Precision, we highlighted our ESG positioning by setting it as a strategic priority at beginning of the year. This led to the creation of two business teams, which we internally branded as the E-Team, focused on environmental initiatives, and the S-Team, focused on employee and stakeholder engagement. An early result of this initiative was the third quarter launch of the Precision Evergreen brand of environmental solutions designed to enhance the performance of our drilling operations while reducing the environmental and emissions impact for our customers. Two of our Evergreen service offerings are off to a quick start as our customers seek out ways to reduce GHG emissions. We deployed our first Evergreen hybrid rigged power system during the third quarter. This system will reduce emissions by dynamically substituting natural gas for diesel and utilizing a battery energy storage system. This system requires fewer internal combustion engines than a traditional system. It will lower emissions and fuel costs for our customer while reducing maintenance costs for precision. We have customer orders and interest for several more of these Evergreen hybrid power systems planned for deployment in 2022. Also during the third quarter, we introduced the Precision Evergreen Combustion Fuel Monitoring System. This system provides high-frequency and accurate real-time combustion fuel monitoring and utilizes alpha analytics to determine precise emissions information. With these accurate emission profiles monitored during all aspects of the drilling operation and then utilizing alpha automation, we can optimize the power demands in engine loading and make other recommendations to reduce rig emissions. The introduction of this system has been a huge success with customer demand widely outstripping supply even before our first field deployment. Currently, we have five of these systems in our backlog with three to be deployed before the end of this year. We see the potential to install these systems on every rig in our fleet as our customers strive to measure, manage, report, and reduce their GHG emissions. It's very exciting to see our customers acting on the GHG emission file and I'm thrilled the precision is a key part of their strategy. Alpha Digital Technologies continue to penetrate the market with sequential utilization growth, with revenue and the associated margins continuing to grow. We now have 46 rigs equipped with Alpha Automation in the field, and 60% of our North American drilling days on those rigs include Alpha Automation. 16 apps are fully commercial, and we've increased app activity by 38% sequentially. Also, we continue to add new Alpha customers during the quarter, supporting our thesis that Alpha digital technologies are a key driver of Precision's market share growth opportunity. So, it's important to discern that we are not describing a digital aspiration or a future promise. This is today. We're generating significant customer savings with our Alpha digital services. We're capturing a fair and reasonable portion of that value. I point you to our Alpha webpages. where we post case studies and we demonstrate that our a la carte pricing model for Alpha Technologies retains 40 plus percent of the total well cost savings we create for our customers. We view this as a sustainable and enduring value proposition for both our customers and Precision Drilling. Turning now to the domestic U.S. market, our activity trend has slightly lagged our prior guidance and there are a couple factors that have constrained rigged ads over the past few weeks. You'll know that from mid-July to late August, The Delta variant surge and the resulting economic risk drove WTI down below $60 for a few days. This volatility and uncertainty delayed customer decisions, delayed planned rig deployments, and accounted for a couple of rig activations postponed until later this year. But the second factor, which is probably more important, is related to our strong focus on price discipline and day rate increases, which we demonstrated during the third quarter by walking away from several rig opportunities where pricing pressure driven by the E&P procurement teams is below our desired thresholds. We know that in the short term, this will cost us some market share, but we believe that as the super spec market continues to tighten and activity ramps up into 2022, we'll be well positioned to take more favorable prices. So I reiterate what we stated on our second quarter call, that our goal is to march our rates back to positive EPS territory, and we remain committed to that strategy. Despite those headwinds, we are achieving pricing traction. We can see it in our renewal book where active and hot rigs are recontracting now in the low $20,000 range and moving upwards. We can see this on rig activations where the pricing is now moving into the $20,000 range. And you can see it in our reported day rates now up $700 sequentially. Now while our evergreen solutions and Elva digital technologies with the Elacart price premiums may be a tougher sell to an E&P procurement executive who's typically focused on the headline all-in rig rate, We are highly successful selling these solutions to most of our customers who have a strategic view on emissions reduction and total wellbore AFE cost. Now Carey mentioned certain items dragging our costs related to reactivating rigs and mobilizing rigs. We view these costs as transitory and expect at the bottom for both day rates and margins as well in the rearview mirror. Today we are operating 45 rigs, but more interestingly is our bid book, which is at a multi-year high with over 200 active bids that we're tracking. Now, that does not mean that we expect 200 industry rig ads, but it's a strong leading indicator of heightened customer interest. There is no question that US rig counts are going up into 2022. Turning to Canada, currently we're operating 61 rigs and our Q3 average was surprisingly 21% higher than Q1, which is typically our busiest time in Canada. Our Canadian outlook is further strengthening with the key commodities, ACO gas, WCS oil, and the NGL condensate prices all during the critical budget season for our customers. We expect Q1 activity for the industry could exceed 2018 levels, suggesting peak industry demand in the 200 to 250 to 300 rig range. I would not be surprised to see even higher demand of operators front load 2021 spending during the winter season. With our strong positions in the Montanean heavy oil, along with broad industry demand and the consolidated Canadian drilling market, we are bullish on the near-term and mid-term outlook for both utilization and day rates. The pricing discipline I mentioned in our U.S. business is also our focus in Canada. We will continue driving our day rates to achieve positive EPS. We believe the market structure will support this strategy. Now turning to our international business, activity remains steady. We are in the process of renewing two of our three Saudi Arabian rig contracts for an additional two to three years and expect these rigs will remain stable for the next several years. Aramco is in the process of reactivating idle but contracted rigs and we expect new tenders to be developed once those rigs have been reactivated in early 2022. In Kuwait, we've also extended contracts for two of our operating rigs and this indicates that our customer is now beginning to forward plan. The pending multi-rig tender we've been talking about is expected to be released later this month. As we understand it, our customers delayed the tender, waiting on the government to reopen the work visa process. Now remember that virtually all field crews in Kuwait are foreign expatriate workers, and the work visas are not in the control of the national oil company. Earlier this week, the visa process was reopened, and this should clear the way for the big tender to proceed. Outside the NOCs in Kuwait and Saudi Arabia, we're currently addressing customer inquiries at the highest level in several years. Clearly, we see activity trending upwards internationally. Our well servicing group remains very busy, with 40 rigs running today in Canada and five in North Dakota. Crewing service rigs is an acute industry challenge that our team has managed exceedingly well, and we continue to meet our customers' needs. We believe crewing will remain an important competitive advantage for precision well servicing. It will also drive further upward pricing tension in the well service sector. Our focus on driving our rates back to positive EPS is also a key objective of this business. Regarding our strategic priority for cash flow leverage and debt reduction, I believe Carey covered those topics well, and as he explained, we remain on track. I'll reinforce that when we make these multi-year commitments focused on creating shareholder value, we support those commitments by building the internal systems and aligning our people to deliver on those commitments. On that note, I want to conclude by thanking the employees of Precision. all of you out in the field operating our rigs, all of you in our support facilities, and our corporate team for all doing their parts to deliver our strategic priorities and making precision successful through what's been an intensely challenging period. Thank you. I'll now turn the call back to the operator for questions.