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Edited Transcript of PD.TO earnings conference call or presentation 24-Apr-17 6:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Precision Drilling Corp Earnings Call

Calgary Apr 26, 2017 (Thomson StreetEvents) -- Edited Transcript of Precision Drilling Corp earnings conference call or presentation Monday, April 24, 2017 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carey Thomas Ford

Precision Drilling Corporation - CFO and SVP

* Kevin A. Neveu

Precision Drilling Corporation - CEO, President and Director

* Saber Rad

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Conference Call Participants

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* Benjamin E. Owens

RBC Capital Markets, LLC, Research Division - Associate

* Bradley Philip Handler

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Brandon Chase Mulvehill

Wolfe Research, LLC - Oil Services Analyst

* Connor Joseph Lynagh

Morgan Stanley, Research Division - Research Associate

* Ian Brooks Gillies

GMP Securities L.P., Research Division - Director, Institutional Research

* James Knowlton Wicklund

Crédit Suisse AG, Research Division - MD

* Jeff Fetterly

Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst

* John Matthew Daniel

Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service

* Jon Morrison

CIBC World Markets Inc., Research Division - Oilfield Services Analyst

* Michael James Sabella

Citigroup Inc, Research Division - Senior Associate

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Dan Healing

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Precision Drilling Corporation 2017 First Quarter Results Conference Call and Webcast. I would now like to turn the meeting over to Mr. Saber Rad, Manager, Investor Relations and Business Development. Mr. Rad, please go ahead, sir.

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Saber Rad, [2]

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Thank you, Shannon, and good afternoon, everyone. Welcome to Precision Drilling Corporation's First Quarter 2017 Earnings Conference Call and Webcast. Participating today on the call with me are Kevin Neveu, Chief Executive Officer; and Carey Ford, Senior Vice President and Chief Financial Officer.

Through our news release earlier today, Precision Drilling Corporation reported its first quarter 2017 results. Please note that these 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 news release for additional disclosure on these financial measures.

Our comments today will also include forward-looking statements regarding Precision's future results and prospects. 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 news release and other regulatory filings for more information on forward-looking statements and these risk factors. Carey will begin with a brief discussion of the first quarter operating results and a financial overview. Kevin will then provide a business operation update and outlook.

Carey, over to you.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [3]

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Thank you, Saber. In addition to reviewing the first quarter results, I will provide an update on our 2017 capital plan and our liquidity position. First quarter adjusted EBITDA was $84 million, which is 15% lower than the first quarter of 2016. The decline in adjusted EBITDA from last year is primarily the result of lower day rates in our North American drilling business, offset by higher North American activity levels and higher day rates internationally.

In Canada, drilling activity for Precision increased 71% from Q1 2016, while margins were $3,023 per day lower than the prior year. The margins for the quarter were negatively impacted by a decrease in average day rates, driven by rig mix with a higher percentage of shallower rigs working and legacy contracts rolling off and renewing at lower rates. The negative revenue impacts were slightly offset by daily operating costs that were approximately $1,000 per day lower than the prior year.

In the U.S., drilling activity for Precision increased 45% from Q1 2016, while margins were USD 9,884 per day lower. The decrease was primarily the result of lower idle-but-contracted payments and higher rig mobilization cost. Idle-but-contracted revenue was approximately USD 800 per day in the quarter compared to approximately USD 8,400 per day in Q1 2016. The impact from rig mobilization costs was approximately USD 1,400 per day in the quarter compared to approximately USD 100 per day in Q1 2016. Absent rig mobilization cost, daily operating costs were approximately USD 13,000 per day. We have 2 rigs receiving idle-but-contracted payments today, both of which will roll off in the current quarter.

Internationally, drilling activity for Precision decreased 6% from Q1 2016. The decrease in activity was primarily the result of no activity in Mexico, partially offset by the addition of 2 new rigs in Kuwait deployed in Q4 2016. International average day rates were USD 50,434, an increase of USD 8,825 from the prior year. The increase was largely a result of rig mix as the Kuwait rigs were added at higher day rates than the Mexico rigs that worked in Q1 2016 and did not work in Q1 2017. Today, we have 8 rigs active internationally.

In our C&P division, adjusted EBITDA this quarter was $4,587,000, up $6,794,000 from the prior year. The increase is a result of significantly higher activity and a lower operating cost structure, offset by lower pricing in most divisions.

Capital expenditures for the quarter were $22 million, and we now plan for capital expenditures of $119 million for the full year 2017. The 2017 capital plan is comprised of $13 million for expansion, $52 million for maintenance and infrastructure, and $54 million for upgrade. Consistent with the 2016 capital spend, upgrade capital is targeted for bolt-on upgrades to approximately 35 Super Triple rigs as customer demand dictates. To date, we have upgraded 11 rigs in our North American fleet this year. The increase in expansion capital of $9 million primarily relates to the completion of a new-build rig for the U.S., where we expect to use existing long-lead items and $7 million of additional capital spend.

We have continued to build our contract book, and as of April 21, 2017, we had an average of 60 contracts in hand for the second quarter and an average of 54 contracts for the full year 2017. Year-to-date, we have added 9 term contracts.

As of March 31, 2017, our long-term debt is $1.9 billion, and our net debt is approximately $1.8 billion. We had $121 million in cash on our balance sheet at the end of the quarter, and as of March 31, 2017, our total liquidity position was $836 million.

Two of our strategic priorities for the year are to demonstrate fixed-cost leverage in an increasing-activity environment and focusing on free cash flow and debt reduction. We have seen significant activity increases over the past 2 quarters, and salaried headcount has remained essentially flat.

In the quarter, we generated funds from operations of $86 million and increased our cash balance by approximately $5 million from Q4 2016. We continue to view reducing debt levels as a priority and intend to use free cash flow and cash on the balance sheet to delever.

I will now turn the call over to Kevin for further discussion of the business and outlook.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [4]

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Thank you, Carey, and good afternoon. As we mentioned in our press release, the rebound in North American customer demand carried through the first quarter and is continuing well into the second quarter. Today, we have 59 rigs running in the U.S. and 30 rigs in Canada as we experience the seasonal spring breakup period. Our combined North American activity is almost 3x higher than last year's record lows. There's no question that customer sentiment is substantially more constructive than in any point in the last 30 months, yet I believe the sentiment remains fragile and is sensitive to the seemingly daily volatility in commodity prices.

From an activity and demand perspective, we believe customers are carefully managing their spending by hedging production to lock in cash flows when commodity price permits. And this gives some confidence that the current customer demand and the activity we see today will be sustained through 2017 and into 2018.

Now looking at the demand in our particular markets. I'll start with a broad trend in unconventional liquids oil basins throughout North America where demand for our pad walking Super Triples remain strong and with many customers opting for high-pressure, high-volume mud systems, which enable long-reach drilling capabilities. And as we've commented in the past, these upgrades to our rigs are typically bolt-on or clip-on-style upgrades. And Carey did recap some of our upgrade capital spending earlier.

As we continue to see a tight market for these rigs, and we report leading-edge day rates in the low 20s, as we -- the market remains strong. And as we mentioned in our press release, our customers are generally willing to cover the repositioning cost, these upgrade economics and all of the above, provided we build all these costs into our day rates.

During last quarter, we also repositioned 6 U.S. rigs. And for the balance of the year, we expect possibly 2 or 3 more rigs may be repositioned. In addition in the first quarter, we relocated 2 international rigs to long-term storage sites, and I'll discuss this further later.

Now I'm going to run through our U.S. activity on a basin-by-basin basis. In the Permian Basin, we currently have 27 active Super Triple rigs, including 2 SCR-powered Super Triples. And we have an additional 2 AC-powered Super Single rigs for a total of 29 rigs currently running in the Permian Basin. And this is an increase of 9 rigs beginning of the year.

Moving to Eagle Ford. We currently have 8 Super Triple rigs operating, and 4 of these are Precision ST-1500s, including 2 SCR-powered Super Triples, and 4 are ST-1200 rigs. And since the beginning of the year, we've activated 5 rigs in the Eagle Ford basin.

Moving to Oklahoma. In the SCOOP/STACK, we have 7 Precision Super Triple rigs operating, and this includes 5 ST-1500s and 2 ST-1200s. And this is an increase of 3 rigs from the beginning of the year.

The Niobrara, which has proven to be a strong region for Precision, we have 6 Super Triples operating. 3 are ST-1500s and 3 are ST-1200s. And then finally, in the Marcellus, the Utica, Bakken, we currently have 4 Super Triple rigs operating, 3 of which are ST-1500s and 1 ST-1200. And then throughout Texas, Louisiana, we have a total of 5 other rigs running for a total of 59 rigs today. We also have a further 3 rigs which are contracted and should be starting up or mobilizing shortly. So we expect to be at 62 rigs running by the end of April.

Our remaining available fleet of U.S. rigs is 42, which includes 20 Super Triples. 10 of those are SCR-powered. We have a further 11 Super Singles, 7 of which are AC-powered; and then 11 remaining rigs that are configured for turnkey and gas storage well applications, totaling 42 available rigs in the U.S. All of these rigs are available for immediate deployment. And depending on the customer needs, some require -- some may require upgrades. And these upgrades should be considered to be in a range of a few hundred thousand dollars to possibly several million dollars. And this is currently envisioned in the $37 million we have remaining on our 2017 budget in anticipation of 24 more rig upgrades. We'd expect that we have customer contracts ensuring payback before we proceed to these projects.

In addition to the upgrades, most of these rigs have been -- not been active for 2 years or more, and they require some time-based recertifications. And since these recertifications are time based and the clock starts to run when the recertification is complete, we will not perform this work until a rig has a firm customer activation date scheduled. And you should think about these reactivations or these recertifications costing in the range of $300,000 to $500,000 of operating expense per rig.

But I want to point out that Precision's idle 42 rigs have not been cannibalized. All of these rigs are fully intact. And other than the time-based certifications, the rigs are ready to go back to work on a near-immediate basis.

I'll also remind you that Precision's activated over 100 rigs from 2016 trough levels, and including reactivated over 2,000 field personnel. I believe we've demonstrated our preparation and ability to rebound to meet customer needs in this rapidly rising market.

So to recap our term contract position. Currently, 31 of our U.S. rigs are on term contracts with fixed take-or-pay pricing. The balance of our U.S. activity is essentially on well-to-well contracts, and we would expect pricing to trend upwards over the coming quarters provided commodity prices remain in the current range. Eight of our U.S. rigs, contracted rigs, are still enjoying pre-downturn pricing, and we expect 3 of those will renew and reprice over the next 8 months. And we expect the renewal rates to be at or near leading-edge market pricing as most of these rigs are essentially leading-edge technology equipped.

Turning to Canada. As we mentioned on our mid-February conference call and in our press release, activity was substantially stronger than anticipated when customer pricing negotiations were conducted last fall. And hence, the day rates may have lagged the strong utilization levels. Also surprisingly, the industry rig mix included substantially more shallow rigs than expected, and price competition remains intense for the shallower rigs.

In the Canadian Deep Basin, and that's the Montney and Duvernay plays, our fleet of Super Triple rigs was essentially fully utilized this winter. And today, during mid-spring breakup, we still have 19 rigs running in the Deep Basin. And we expect a seasonal recovery this summer and should be back up over 30 rigs and then likely higher yet in the fall.

Our heavy oil region enjoyed a busy winter with as many 28 rigs running at the peak. Today, we have 10 rigs operating and expect to rebound back to mid-20s in the summer.

Now for the shallower Canadian plays, notably, the Cardium, the Viking, Bakken and the Shaunavon, we hit surprisingly high activity levels in Q1, peaking at over 30 rigs. But this remains a challenging and oversupplied segment in Canada with intense price competition and low margins. And while we do not aggressively pursue market share in this segment, our strategy is to remain competitive. Currently, we have 2 rigs operating in the shallower basins, and we expect this activity for Precision should rebound to the mid-20s later this summer. That should put us combined on these 3 regions somewhere into the mid-60s by midsummer and expect to have utilization further pick up in late fall.

With this activity and the profile we saw in Q1, we expect pricing to show signs of improvement particularly for the shallow basin where pricing was deeply depressed and truly not sustainable for the industry. For Canada, significant industry activity increases over 2016 remain in the cards with the only caveat being the risk of a sharp pullback in commodity prices.

Overall, our Q1 market share exceeded our 2014 and 2015 levels and was roughly in line with 2016 and was driven by strong customer acceptance of our high-performance strategy and particularly in the deep basin and heavy oil segments of our business. In Canada, we have 24 of our Canadian rigs under fixed-price contract terms. 19 of these are legacy contracts predating the downturn, and 14 of these will renew later this year. And these renewals are primarily Deep Basin rigs, and we expect also here to see leading-edge day rates for the renewals. Should demand play out as expected, we also anticipate pricing improvements on non-contracted well-to-well rigs. We're planning minimal upgrade capital needs for the Canadian fleet, and we expect our Canadian drilling business to be a continued source of strong cash flow for Precision.

Now turning to our completion and production business in Canada. The rebound of this business segment mirrors the swing we experienced in our drilling business. The increased scale provided by the recently acquired 48 well service rigs and the increased customer demand, coupled with the aggressive cost-cutting and the reorganization executed by our team, has put this business back on its feet. Our C&P unit generated EBITDA levels and cash flow exceeding any period in the last 7 quarters. We're very proud of this performance. We expect this momentum to continue through 2017 as this sector rebounds from the record lows of 2016.

Our international business continues to perform well, although we were require to move 2 idle rigs from temporary rack sites to long-term storage locations. And this has drove up our cost during the first quarter. We expect our 8 operating rigs to remain stable through the year with no renewals or repricing expected, and the financial performance should be relatively stable for the full year depending only on the timing of the lower-revenue rig moves we experience throughout the year.

Our longer-term international outlook remains encouraging with several active bids under way. However, we continue to see delays in awards, and we see some planned tenders also being delayed. We believe that these delays are tied to commodity price volatility, and we would expect to see some of these tenders move forward to contract awards should commodity prices improve even modestly.

Now I'll come back -- I'll wrap up now by reminding you that on May 15, Precision will be hosting our Investor Day at our Houston Technology Center. And Carey mentioned a new-build rig that we completed during the first quarter. This is Precision's Super Triple ST-1500 rig 609, and this rig is equipped with 3 mud pumps and high-pressure mud system and pad walking equipment, like the majority of our Super Triple fleet. But rig 609 will also be equipped with -- and we'll demonstrate in -- with live demonstrations, rig process control automation, high-speed downhole data transmission via the drill pipe, directional drilling advisory software, and will also demonstrate pad walking capability. All of these technologies are in the field of [ automation ] and can be uploaded or bolted on to Precision's full fleet of Super Triple rigs. We'll also provide our road map to the full commercialization of these exciting value-accretive technologies. This should be a comprehensive hands-on day for the attendees.

So I'll wrap up by thanking the employees of Precision for their hard work and very strong operational performance in a strong rebound quarter for the company. I'll now turn the call back to the operator for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Sean Meakim with JPMorgan

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [2]

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I was hoping just to touch base, maybe start with -- on Canada. As you come out of spring breakup heading into the second half, just how would you characterize your expectations around conversations with customers around pricing and contracting as you -- given what you experienced during winter drilling season?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [3]

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I've held a number of conversations with customers myself over the past few weeks, and I know our sales team has been highly engaged with customers about rebound pricing. I think our customers have an appreciation that the service sector, frankly, last year, went through a very unhealthy period. And they understand the need for price increases kind of across the space, not just drilling, but in all sectors of oil services. I'd describe the discussions as constructive. We recognize the cost pressures our customers face. I think they recognize that we need to be slightly higher on day rates to have a healthy business. So I think it's going well. I'd also comment that, right now, as I speak, I know our sales guys are up meeting with customers and so are our competition. So it's hard to be very specific. But I would tell you that I think that the healthier regions, like the Deep Basin and heavy oil particularly, are areas where our customers may have a little more room to work with us. And in the shallower areas, they're always budget challenged, and so may be tighter. But I am expecting that across the space, that we'll have some room to work with customers to increase pricing and lead to a healthier segment.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [4]

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Got it. So that seems fair. And then just thinking about that customer discussion, there's been some back and forth as we think about how much of their budgets were expended during that stronger-than-expected winter drilling season. Do we expect, from your perspective, budgets to move higher in the second half? I'm just thinking about the interplay between kind of what's baked in and what's already -- what's been spent versus what's left for the second half.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [5]

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I think we tried to give some sense of what we expect the rig counts in the second half. So we see ourselves rising back to 60-plus rigs as the ground dries out. There's always a fair amount of volatility in summer activity based on localized rain showers and things like that. But 60 to Q3 and probably higher in Q4. But Q4 activity will depend, I think, on decisions our customers will make later in Q2. So there's some timing issues. We're expecting an OPEC meeting in May, and I think a lot of people believe that OPEC will extend the price cuts. We'll have to wait and see for sure what happens. But if they extend price cuts, if prices show a little more firmness, if we get day rates trending closer to $55, not $50, you could see increased spending in the fourth quarter for Canada. But I think the activity levels that we've discussed are covered by customer hedges. So I feel comfortable with what we discussed. I think there's room for upside, providing some of these chips fall in the right place for us. I hope that's helpful.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [6]

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No, that's very helpful. And just one thing I want to highlight is, obviously, a lot of details are going to come out in the Analyst Day. But if I could, you noted that the beta-style field trial's under way for the automation of directional drilling, closed-loop automation. Is there any kind of a taste you can give us of what you guys have been seeing out in the field with this new technology?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [7]

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I think, Sean, suffice to safe to say that we're comfortable rolling this out to the investors now because we've seen the results in the field. I've used the term highly encouraging. Some of these technologies, like I'll mention the directional drilling advisory software, we've got several years of very good experience behind us. So the beta term there might be a little bit late, but on automation technology and sort of the data transmission technology, we're still in the beta phase. But we're really encouraged by what we see, and we believe there's meaningful value for our customers, meaningful competitive advantage to be gained here. And we're anxious to tell you more about it.

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Operator [8]

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Our next question comes from Brad Handler with Jefferies.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [9]

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I guess I'll start with Canada as well and there's bit of meandering in my questions, so I'm almost apologizing a little bit beforehand. But if maybe you can help us just think about a few things. So in the second quarter, how predominant would you expect the Super Triples to be of your total rig count? It's pretty high percentage of it, right?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [10]

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Well, the guidance I've given you so far is about half the activity in the second half of the year.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [11]

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Well, I think if we're thinking about right now, we're running 19 Super Triples, as Kevin said. And we gave us some guidance in the last quarter. We thought that we would average right around the low 30s, kind of trough just below 30. So if we're going to keep similar activity, it'd probably half to 2/3 of our activity will be Super Triples in the second quarter.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [12]

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On the second quarter.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [13]

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(inaudible) second quarter.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [14]

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Second quarter, right.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [15]

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Yes, yes. Sorry. No, I was starting very near terms. The -- and I guess -- does that suggest, by the way, that since you've got 24 fixed-price contracts, you've got some idle-but-contracted revenue streams or no? Because of the nature of the contract and it only gets trued-up later in the contract or something.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [16]

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Correct. Most of the Canadian contracts are designed where our customers can choose to not operate the rigs during the second quarter.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [17]

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Right. Okay. Now you talk about 19 legacy contracts of the 24, and 14 renewing. Can we assume that market pricing is still below current -- current market pricing still below that legacy contract level? Or are we truing down as you...

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [18]

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Right. Yes, no question, market pricing is below the legacy price levels, but that gap is narrowing. And I'd say that our numerical guidance for the U.S., kind of low 20s, would be similar for Canada for similar a Super Triple rig.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [19]

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Okay. Appreciate that. And then maybe just in terms of -- and this becomes a little bit more of a general question. But in terms of the pricing outside of, perhaps, of a specific contract, but just in terms of periods of time where the process of pushing pricing higher -- again, I understand there's some sort of seasonal dynamics here, and there's drilling programs that get set. So when might that process start? Or how long does it take? Or when do you kind of get a sense? And when do you conclude negotiations as to sort of what the next round of pricing -- next levels of pricing will be across the rig types?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [20]

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So Brad, just traditionally, the winter drilling season usually gets priced in, in early part of the fourth quarter the prior year. So typically, for this winter, we were priced in early October. And then that pricing is usually fairly sticky throughout the year unless something changes. And this year, something changed. Activity was higher than expected. So I would tell you that we began pricing up into this activity late December last year, early January through Q1, but that was really on a handful of rigs. As we move into Q3 and Q4 on all the uncontracted rigs, we'll be working hard to move pricing up, whether it's shallow or deep or in place, where we're dealing with uncontracted rigs, moving pricing up and guiding our sales team to try and get us back to what I call sustainable levels. So it's anywhere from a few hundred to maybe a few thousand dollars per day across the fleet.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [21]

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Okay. And it's potentially more fluid and more real time than maybe even I realized. So...

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [22]

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Well, I know today, we have our sales team out in customer offices. I'm sure some customers are listening to our comments on this call right now, so I'm being really conscious. But that said, I'll go back and say that our customers recognize that the industry in 2016 was unhealthy and likely getting put into distress in many cases. For us, we made it through okay. But clearly, higher day rates are needed across this space to ensure health, and I think those conversations are moving forward in a very constructive manner. So just to finish off the answer. This year, we expect to see spot market rates increase throughout the year. If Q4 budgets improve and then we see stronger budgets into 2018, that would come on the back of an improved commodity outlook. I think you'd see further price traction in the fourth quarter and into the first quarter of next year, predicated on stronger commodity prices. Price is getting closer to USD 55 rather than kind of circling up on USD 50, like we've seen the last few weeks.

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Operator [23]

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Our next question comes from Connor Lynagh with Morgan Stanley.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Research Associate [24]

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Maybe a higher level one for me here. Can you talk about some of the technologies -- and I assume this will be somewhat of an Analyst Day preview, but some of the technologies that you're deploying in addition to the automation features and how you view yourself differentiating in both the U.S. and the Canadian market?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [25]

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Connor, it's a fairly complicated question. I'll try to move through it in pieces here. Think about this like blocks of technology that we're proving kind of independently, then bringing it together to create a unique package. So the blocks that we're proving separately would be directional drilling advisory software, rig automation software, high-speed data communication from downhole to surface, so those are the 3 core blocks. Underpinning those 3 core blocks is a standard rig software package on all the rigs. And so I can tell you that all of our AC rigs use one standard platform for the software and for hardware, as a matter fact. It's all provided by one vendor. In fact, our partner in that package is National Oilwell Varco, and they control the software. They design the software, but it's one package for all the rigs. Each of these technology blocks essentially operates like an app where it can operate onto that system. So we're using -- the base system is NOV’s AMPHION system. Their automation software they brand as NOVOS, and that allows us to then plug in things like our automation software, the high-speed data connection from the drill pipe and bring all of this together. Ultimately, our endgame here is to automate and make consistent, repeatable all of the manual processes on the rig. That's one piece. It's to utilize advisory software to improve the overall directional drilling performance, and then eventually move to full closed-loop drilling process control. And we think all of these building blocks can be put together uniquely on the Precision platform across the entire fleet. And they're rely really just plug-in technologies. So nothing I've described here obsoletes or reduces any of the value in the current Super Triple fleet. It all plugs in or plugs onto the existing rigs. So I hope that gives you a bit of a sense of the preview. We'll have to go into more detail on May 15.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Research Associate [26]

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Right. Understood. Understood. Maybe just a quick one. So you mentioned that you use National Oilwell for a lot of this. How do you think about the risk-and-return profile of building it yourself or paying somebody else a margin to use their technology?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [27]

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Well, there's a couple of things here. First of all, we believe that Precision is excellent at configuring drilling rigs, operating drilling rigs, staffing drilling rigs and keeping customers happy as a high-performance, high-value operator of drilling rigs. We don't think our core competency is writing software. We'd rather leave software applications to software experts, who really have the discipline, the process, and the capability to do it and to do it on a large scale, not just the Precision fleet, but that of the entire fleet. You mentioned National Oilwell Varco, and I did, but we also have partnerships with Pason, with Schlumberger and with others that we're combining in this technology envelope, and I should've mentioned that. But again, we're putting the expertise where it lies. So for example, data gathering, Pason is excellence at data gathering. They're involved in that piece. Directional drilling technology and downhole equipment is Schlumberger's expertise, and we have our alliance with Schlumberger to provide the downhole tools. And then with that is the cable software that Pason provides. And then finally, again, the NOV platform. So again, I think it's keeping the expertise where it best lies in the industry and letting Precision focus on combining these technologies on a unique platform and then executing very well in the field.

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Operator [28]

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Our next question comes from Chase Mulvehill with Wolfe Research.

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Brandon Chase Mulvehill, Wolfe Research, LLC - Oil Services Analyst [29]

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So I guess I'm going to follow on Canada a little bit. You talked about having 60 -- or potentially 60 rigs active in the third quarter. Could you help us, either from a day rate perspective or a gross margin perspective, about expectations on those 60 rigs?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [30]

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It's always a little tricky to give day rate and margin expectations that far out. But if we're going to guide the market here to 60 rigs kind of at the end of summer, assume that 30 of those will be Super Triple rigs, which will be of a higher day rate, a little bit higher cost; and 30 of those would be the shallower rigs, likely Super Single, which would be kind of a little bit lower day rate and slightly lower cost.

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Brandon Chase Mulvehill, Wolfe Research, LLC - Oil Services Analyst [31]

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Okay. All right. And from an OpEx perspective, if we think about it in the third quarter, should we think about it kind of flat year-over-year? Or we should think about it more as what your OpEx per day in the first quarter of '17?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [32]

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I think the OpEx will be a little bit lower than where we were in Q3 of last year just because we'll have higher activity. So we'll have a better fixed cost coverage.

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Brandon Chase Mulvehill, Wolfe Research, LLC - Oil Services Analyst [33]

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Okay. Right. And then quick -- on the U.S. OpEx per day, how should we be thinking about that in the second quarter of this year?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [34]

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I think Kevin gave some guidance on what we expect to expense based on the number of rigs that we reactivate. So there's some recertification cost and time-based maintenance that will be required for rigs that, if we go from, let's say, 60 to 70 rigs, I think that the numbers that Kevin quoted of $300,000 to $500,000 per day are...

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [35]

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Per rig.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [36]

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Per rig to reactivate will be have an impact on the cost per day. The other variable is turnkey activity. You noticed that we had $1 million in turnkey revenue in Q1, which is the lowest we've had in a long time. If we have more turnkey activity, that'll drive operating costs up a bit. So I think we mentioned that absent move cost and with very little turnkey activity, our operating costs are about $1,300 per day. That would be a good baseline. I would add to that some extra cost if we end up activating more rigs throughout the quarter, and we'll just see where the turnkey costs shake out.

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Brandon Chase Mulvehill, Wolfe Research, LLC - Oil Services Analyst [37]

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Okay. All right. And last one, and then I'll jump back in. If we think about the balance sheet and just kind of think about net debt and potentially delevering the balance sheet, is there anything that we're not thinking about creatively that you can do, whether it's assets sales, is there a JV, or anything that we might not be thinking about that you could do to kind of delever the balance sheet, or accelerate delevering the balance sheet?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [38]

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Chase, there's probably several things we're thinking about that we really don't want to talk about publicly right now. I would tell you that it's 1 of our top 3 primary focuses for 2017. And would tell you that discipline around delevering over the next several years will remain a top priority for us, whether the market's going up or down going forward.

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Brandon Chase Mulvehill, Wolfe Research, LLC - Oil Services Analyst [39]

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All right. Great to hear. I think that's a -- still a little bit of overhang on the stock, so it'd be nice to get some clarity there.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [40]

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Appreciate -- it is. And I'll just comment the discipline using cash from operations and generating cash to the business is how we see deleveraging occurring over the few years.

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Operator [41]

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Our next question comes from Jim Wicklund with Crédit Suisse.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [42]

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That gives us a really good idea of costs. We don't have really as good an idea of day rates, and day rates were a little bit of a surprise this quarter. Can you tell us where sequentially, where second quarter -- where the June quarter day rates for U.S. and Canada are expected to be?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [43]

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So I think by surprise, you're probably referring to the Canadian rates being pulled down a little bit. Is that what you're hinting at, Jim?

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [44]

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Yes.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [45]

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Yes. So the Canadian day rates were pulled down primarily by shallow rig activity during the first quarter. We talked about having 30 more rigs drilling shallow in the first quarter. Second quarter, we're down to just 2 shallow rigs. So that sort of solves the Q2 day rate gap that you're concerned about. Carey, go ahead.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [46]

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Yes, just adding to Kevin's comment. In Q1 '16, we had 45% of our activity days were Super Triple rigs. In Q1 '17, that number went down to 34%. So we just had a -- it's actually from a cash flow standpoint and utilization standpoint, it's a good story, reactivating more rigs. But the rigs that we're reactivating would be lower day rate rigs, which drag down the average rate.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [47]

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So we should expect to see day rates move up $1,000 in Canada in Q2?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [48]

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They typically do. Typically, Q2 is one of our higher day rate quarters because of the rig mix, where you have deeper rigs -- higher percentage of deeper rigs working.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [49]

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Okay. And in the U.S., I mean, if the rig count didn't go up anymore this year, would be up 50% year-over-year. And I'm not sure what most people's expectations are for E&P cash flow growth, but you're somewhere in there. And everybody, I think, realizes that the rig count probably isn't going to go the same rate it's done as the last 11 months. How much visibility do you have with your customers on additional rigs coming into the market from here?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [50]

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Jim, so we did comment that we have, I think, 3 more rigs to activate that are contracted right now. We have ongoing conversations or negotiations with a couple of handfuls of customers out there for 1 or 2 rig opportunities. I don't expect all of those to become rig activations. And I think there is -- thinking -- I think there's 2 things going on. I think that our customers hedge cash flows, and the activity we see now could probably bump up a little further. Whether it's 62 or 65, I don't think it's a big needle mover in activity. But I think the next leg up is going to be kind of waiting on a bit of an improvement in commodity prices. I think there's a lot of people waiting to see -- in the commodity markets, waiting to see what OPEC does in May. I think the expectation is that OPEC will extend productions, that we'll see fundamentals continue to improve throughout the year, commodity prices firm up a little bit. But until that materializes, we could be running to the end of the rig count ramp-up at least during the second quarter, I think.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [51]

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Okay. And last one, if I could. I know people has continued to be an issue. You've hired back 2,000 people, and a lot of those were ex-Precision employees, which is excellent. Have you lost any revenue due to not being able to find people? And can you kind of discuss where you go from here in terms of people?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [52]

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Yes. Jim, kind of off the top, we haven't lost any revenue due to inability to staff rigs, not a single rig. And we brought back about 2,000 people by the peak of the winter season in Canada. About 85% by design are recall, and 15% by design are new hires, so we can keep a new stream of people flowing in. So we're pretty pleased with our performance so far. We don't expect to see any missed opportunities due to staffing challenges. It's a heavy lift. I can tell you that our organization, from the CEO down -- actually, from the board, down to the CEO, down to our drillers are focused on recruiting, training, developing people. And it's easily the biggest single workload we have in our company.

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Operator [53]

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Our next question comes from Ben Owens with RBC Capital.

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Benjamin E. Owens, RBC Capital Markets, LLC, Research Division - Associate [54]

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So I appreciate you guys giving the information on the legacy contracts and how many are rolling in 2017. I was curious if any of the ones that aren't repricing in 2017, do they extend into 2019? Or do they all expire in 2018?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [55]

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On the North American contracts, actually most will expire in '18. Maybe one goes into -- no, will actually go into '19. On the international contracts, we haven't given a full split on those, but several of those contracts is going to the 2020s.

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Benjamin E. Owens, RBC Capital Markets, LLC, Research Division - Associate [56]

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Okay, great. And then on the U.S. piece, just curious about, do you think given the mix of legacy contracts and new contracts done at the market rate, do you think that day rates could be sequentially up in the second quarter from first quarter?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [57]

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Probably not in the second quarter but we are expecting to see margins, our EBITDA margins at the rig level, company-wide, trend up in the second half of the year. And I'm just not sure if that's going to be Q3 or Q4, but I'm confident second half of the year -- as confident as I could be in a volatile commodity world that we'll see commodity -- that we'll see our rig rates and margins trending up in the back half of the year.

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Operator [58]

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Our next question comes from Ian Gillies with GMP.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director, Institutional Research [59]

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I just wanted to touch on the new rig build that you mentioned earlier in the conference call. Are you able to provide any color around where the hurdle rates and payback terms may be relative to the new builds you were doing in 2013, 2014? And whether they've changed or stayed the same?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [60]

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Okay. So you're the first guy that's asked this question, and I thank you for asking the question. This rig was assembled and put together really for the purposes of the Investor Day. And we do not have a customer lined up as yet. And we'd expect to put it out into the market at a return rate in line with our previously guided return rate, so high teens, low 20s. So I will tell you that this rig is a very good-looking, brand-new ST-1500. I expect it'll be contracted sometime during 2017, maybe sooner than later. We'll see. But we assembled and put it together as a tactical step, kind of away from our long-term strategy to never build new rigs on spec. But we really wanted to have a rig in the yard that we could not just show this technology on an aspirational mode but on full production mode. Carey?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [61]

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Yes, and we have enough indications from customers that we can contract this rig this year, that it made sense to build it. And we're -- following our Investor Day, the following day, we're having a customer day where we're going to invite several customers to our facility to view the rig.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director, Institutional Research [62]

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That's helpful. And perhaps just a follow-on question just to ask explicitly. This isn't the start of a new rig build program for Precision?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [63]

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No, it's not. I appreciate the question. It's not a start of a new build program. We don't see a horizon out there that has new builds on it, probably not this year.

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Operator [64]

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Our next question comes from John Daniel with Simmons & Company.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [65]

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Kevin, you mentioned low 20s for the rates on some of your best rigs, U.S. rigs. Is that low 20s the actual day rate? Or is that a revenue-per-day concept? And if the latter, what else is built into the low-20s calculation?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [66]

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We would term it a day rate the way we have always historically.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [67]

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Yes. And John just so -- I think you know this, but just so we're clear. The directional drilling revenue that we would have associated with the integrated directional drilling contract is excluded from the day rate. That would show up in the directional drilling revenue that we report.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [68]

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Okay. That’s what I thought. I just wanted to confirm. Okay. Can you update us on your thoughts as it relates to M&A opportunities? You mentioned free cash flow would be used towards debt reduction. Does that then limit consolidation efforts by you?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [69]

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I guess the complicated answer, simple answer is, I don't know that we're going to find any M&A targets that will meet our bid. And so we would be -- if we could find a rig that was exactly a PD spec, that we could buy at a below-book value, we'd be interested in buying it probably. But the fact is, I don't think there are any PD spec rigs for sale, or any PD rigs -- spec rigs up in the market. And by PD spec, I mean every key piece of equipment has to match our spec. The software has to match our spec, and the rig layout should match our spec. And that's a pretty complicated list.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [70]

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I was actually thinking more along the lines -- I apologize on -- within the C&P segment, as you guys have been pretty clear on not wanting to buy other drilling rigs.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [71]

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Yes. John, on the C&P segment of it, where we see kind of the most value to be created is consolidation within the well service industry. And we're really hesitant to use our capital to effect consolidation. But if there are situations where we can find creative ways to do a cashless transaction, similar to the one we did with Essential, we would interested in looking at that. But again, it's pretty small dollars compared to our drilling business.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [72]

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Okay. Last one for me, not trying to be too anal here. But following up on Wicklund's question, you guys haven't missed any opportunities due to staffing challenges, and that seems to be sort of the common refrain from your peer group. Should we assume that the labor's tightness situation is somewhat overhyped?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [73]

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No, you can't. But I'd say 2 things, John. First of all, I think in this whole oil services space, the land drillers are among the best at restaffing generally, where -- of any oil service space. Because you're giving -- you're typically giving several months of work to the worker. A lot of the other services are kind of, call it, services that the work might be real short service, whether it's -- I don't want to get specific -- well, pressure pumping, well servicing. But in drilling, we can almost always guarantee months of work, so that attracts people quicker. But I'll tell you that it's hard work. It's heavy lifting. It's, in some cases, it can cost more. But I think the drillers have done a very good job meeting that challenge, but it's still one of the toughest thing we do. Carey?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [74]

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Yes, adding on to what Kevin said. We've seen more challenges in the well service business attracting new crews than we have in the drilling business. So we think that for the oil services industry in general, the labor situation is probably not overhyped. But land drillers have, I think, comparatively done better than some of the other service providers in attracting people.

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Operator [75]

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Our next question comes from Jon Morrison with CIBC Capital Markets.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [76]

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Kevin, if I interpret your comments correctly on Canada, you're basically saying that you believe you'll get upwards of 60 rigs by mid-ish Q3. And it's fair to assume that whether you get there early or late will largely just be a function of weather.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [77]

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I would say that we have line of sight to that level of activity right now. And Jon, unless something disrupts commodity prices, I think that's a pretty good mark for mid-Q3. You know as well as I do that weather in early July can be pretty spotty in Western Canada. And you combine that with some commodity price volatility and there's lots of excuses for customers to delay reactivations, but we'll see how it plays out.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [78]

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It's fair to assume that line of sight that you referenced is based on fairly firm customer conversations and not a guesstimation for the market that's going now.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [79]

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Yes, I agree with those comments. And as firm as they can be with the volatility we've seen in prices.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [80]

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Okay. And can you give me more color on the U.S. mobe cost incurred in the quarter. I guess, 2 parts: One, were the mobe costs supported by customer contracts at this point? And secondly, a lot of things get included in mobe costs by various different companies. So rig transportation, reactivation, R&M, perhaps equipment tweaks for different climates. How much of that was physically moving the rigs versus other things, getting them ready to work?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [81]

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I'll give part of the answer and let Carey jump in here if he wants to add anything to it. So we -- I wouldn't say mobe. We actually repositioned 6 rigs, primarily in the U.S. and the 2 rigs are international. And in our accounting, the rig positioning cost is just the cost of loading the rigs up, moving them somewhere else, and spotting them on typically a straight-on location. We also talked about -- I commented any rigs that we activated during the first quarter that had -- that were longer than 4 years from prior certification probably required some recertification. So we had some of those during the first quarter. And that's going to the mast, the substructure, the top drive, all the load-bearing components. And I'll comment that the recertification period is based on calendar 4 years or calendar 5 years or calendar 2 years depending on the component. It's not based on hours of use or days of use. So if it ran out a year ago when the rig was idle, we wouldn't recertify it because we'd lose calendar days until it gets put back to work. So we've held off recertifications until we have a firm date for the rig. If we have a firm date, we do the recert as close to that start-up date as we can so that we can get the full benefit of the maximum time of the certification. So long story short, in the first quarter, we had some higher than probably modeled recertification costs, and we had the mobe costs. I'd say it was probably 2/3 or more mobe, 1/3 recertification. Carey, is that fair?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [82]

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Yes, it's fair.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [83]

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And the majority of the mobe costs, we're seeking to recapture those through day rate. The recertification costs are just normal operating maintenance expense. We wouldn't typically have a handful of mobe -- of recertifications in 1 quarter, because typically they happen kind of evenly spread over the course of the year.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [84]

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Yes, I think this is actually in Q1, we activated a higher percentage increase in rigs than we ever have in the history of our company.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [85]

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I appreciate the color you guys gave around where your U.S. fleet is working today. Is it fair to assume that the bulk of your incremental conversations at this point are still focused on the Permian and Oklahoma? Or are you starting to see more potential reactivation shift back to Niobrara and Eagle Ford at this point?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [86]

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I'd say that at least half or more will be Permian Basin, but the balance will be kind of evenly spread, as we've seen with Oklahoma and Niobrara and Eagle Ford.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [87]

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Carey, can you give us some color on what underpinned the decision to bump the CapEx at this point? And is it all fairly earmarked that it will get spent in '17? Or are there still decent variability to where the number shakes out at the end of the year?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [88]

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There's always variability on maintenance, and that just depends on activity level. The upgraded CapEx is dependent on customer demand. So if we think about demand from our customers and current drilling programs that our customers are looking to pursue in a kind of USD 50 to USD 55 oil world, then 35 rigs upgrading throughout the year sounds about right. If we have a drop in commodity prices, that number will go down. And if we're fortunate enough to have an increase in commodity prices throughout the year, that number could go up.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [89]

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In the international segment, can you share how many rig tenders you're actually involved in today, specifically in the Middle East?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [90]

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The total number of rigs probably is the range of 40 or 50 rigs that we're involved in tendering for. We'd only target probably between 5 and 10 of those to be successful. So we structure our tenders to kind of favor getting to our sweet spot, which will be 5 to 10 rigs, and maybe tendering in 5 different countries right now. Is that helpful?

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [91]

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Yes. How are those 40 to 50 rigs that you're potentially bidding into, how many of those would be satisfied with some form of a root -- move from a different country or ultimately a new build? And how many new builds are you comfortable contemplating at this point, tying everything back to your comments around cash flow and living within your means?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [92]

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Yes, a really complicated question. If we don't see commodity prices improve, probably there's no new builds, and they're probably just reactivations. So that the first comment. So if we're bidding on some of these bids and they end up turning into a success and commodity prices still a bit soft, it's probably just relocating any one of the 6 rigs we have in Mexico and the Middle East. If the commodity prices improve and firm up, then I suggest they firm up into the high 50s, then there could be some new builds, anywhere from 2 to 4 new builds. But then probably, the business we have in other markets is looking a lot better, too. I would not expect us in a constrained commodity price world or a constrained activity world, to be drawing down our cash position or impacting our ability to pay down debt to satisfy new builds.

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Jon Morrison, CIBC World Markets Inc., Research Division - Oilfield Services Analyst [93]

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Okay. Last one for me. Would a temporary exit of Mexico be on the table at this point, given where PEMEX's development plans are in the onshore market?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [94]

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Probably not because the rigs are down there, they're stored safely. They're secure. There's no cost to keep them there, no meaningful cost. Those rigs probably don't have a home unless something really turned up quickly in the Middle East. But then we'd be adding a mobe cost, you could call it a million-dollar mobe cost in the Middle East on top of whatever upgrades rigs would need. But if the Middle East -- I kind of think that whatever it takes to get the Middle East going probably means that the IPM work in Mexico probably picks up. So much is predicated on commodity price that it's really hard to see. We're certainly not going to spend money moving rigs in advance of a need.

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Operator [95]

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Our next question comes from Jeff Fetterly with Peters & Co.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [96]

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Just clarification questions on the rig upgrade side. So you said there's 42 available rigs in the U.S. for deployment. Did I hear that correctly?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [97]

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That's right.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [98]

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Okay. And should we take the 35 rigs being upgraded this year and subtract it from that 42 number? Or is there...

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [99]

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No. No I think we're almost 10 rigs into the upgrade program, so that could probably leave room for 24 more upgrades. But we could see a case where a rig that's running right now that has 2 mud pumps gets a third mud pump at a higher day rate. So one assumption might be that of the 42 rigs left, we could upgrade 24 of them, or maybe some of the money in the upgrade budget goes to upgrading rigs that are currently running that aren't totally leading-edge spec.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [100]

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Yes. And although the majority of the upgrades will be for the U.S. market, there could be some upgrades for the Canadian market, too.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [101]

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Do you have a ballpark estimate of what your inventory of rigs that would be available for upgrade will look like at the end of the year, assuming you stay with the 35 number that you talked about?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [102]

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Well, again, it's a mix of rigs that are idle right now, and Kevin gave an overview of the idle rigs that could be upgraded. But then there are some rigs in the field that might have some features but may be missing a walking system or a third mud pump that we might look to upgrade in the field.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [103]

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Yes. Out of our U.S. fleet of 104 rigs, think about 94 of those or 92 of those being either upgraded or upgrade candidates; and that about 10 or 12 are probably not upgrade candidates. The rigs that'll be specified for turnkey work and for storage well drilling are typically bigger, deeper rigs that we've had good business over the years with, that likely are not candidates for upgrades at any point in time.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [104]

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Okay, great. That's a helpful number. Just to clarify the earlier question on mobilization. So Carey, you said in your prepared remarks that rig mobilization was USD 1,400 per day?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [105]

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That's correct.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [106]

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So the comment about 2/3 being rig move, 1/3 being recertification, is that $1,400 applicable to those 2 pieces or just to the mobilization cost of the rig?

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [107]

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So it's just in the mobilization cost of the rig. I think Kevin's comments about the time-based certifications were more of kind of an impact of the overall higher cost for the quarter.

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Jeff Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [108]

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Okay. And then from an overall standpoint, just trying to understand when your incremental margins -- you expect your incremental margins to turn positive. If we look at Q1 in terms of the drilling segment EBITDA margins, ignoring Q2 for a second, but when you blend the rigs coming off of contract, the new builds coming in, the lower cost structure with sort of the better incrementals off of that, do you expect that your Q3 margins could be better than your Q1 margins? Or do you think it'll take longer than that?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [109]

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Well, Jeff, I think we've really guided it to the second half of the year. It depends just -- it really depends on how Q3 and Canada seasonally ramps up, so it's a little hard to say. I mean, clearly, I think that means that Q3 is kind of a tipping point at worst.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [110]

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Yes. And Jeff, I think you said something about new builds coming in. I -- we hadn't announced any new builds coming into the market.

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Operator [111]

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Our next question comes from Dan Healing with Canadian Press.

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Dan Healing, [112]

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I'm just looking at the part of the press release where it talks about bringing in 2,000 employees. Some of those are new guys. In view of that, how do you regard the Canadian government's decision to go ahead with legalization of recreational marijuana?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [113]

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We've been thinking about this for a long time. We deal with it in the U.S. in several different districts. I think we deal with it quite well. Dan, we're not happy to see those kind of regulations loosened up for all the reasons we have to deal with on a rig. We wanted people to be fully capable of operating at maximum efficiency. So not pleased with it. Nonetheless, it's a reality. We need to manage it and deal with it. We're managing it and dealing with in the U.S. I comment that we are 0 tolerance. We have a number of techniques to check the capability of our people, not just, I'll call it drugs, but whether they're tired or distracted or sleepy. All of those things kind of lead into risky behavior on the rigs. So I think we're focused on safety. We remain focused on safety, and this -- the federal government change, while not something we're thrilled about, I think we'll manage our way through it just fine.

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Dan Healing, [114]

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Okay. And just one follow-up, if I can. They're leaving a lot of the rule-making up to the provinces. As a company whose rigs are employed in several jurisdictions, how do you feel about that?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [115]

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I think we're comfortable with provinces managing the testing and the regulations. We're 0 tolerance, so our regulation kind of overrides the provinces. If we believe an employee is impaired by distraction, by drugs, by alcohol, or by lack of sleep, he's not permitted to work. And we have ways of testing for all of those problems.

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Operator [116]

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Our next question comes from Michael Sabella with Citigroup.

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Michael James Sabella, Citigroup Inc, Research Division - Senior Associate [117]

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I was wondering if we could talk for a minute about what you guys are seeing on the international side on day rate, bearing in mind that everything you had working in 1Q was contracted, but -- that you'd be involved in several tenders. Where would we expect those tenders to come in relative to the current segment day rates? And how are customers approaching the rate discussion?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [118]

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The information we get back right now is actually very vague. So one tender we submitted earlier this quarter hasn't been reported back to the companies, ourselves included. So we don't know what the results of the first tender are. We have several more that were kind of in process. Just -- there's so little moving to the award phase right now. It's really hard to get a sense for tender day rates. I -- there isn't really a spot market in places we're active, so we don't really see spot market rates in the places we're active. I know there are in many other international locations. But I think the answer is that we're going to be very disciplined. If we need to add capital to the rigs, we're going to seek a return. And if that causes us to lose a tender, we'll take that. We'll wear that risk. So I don't have a good answer. I have no clarity other than we'll be tendering these projects. Some will require upgrade capital, some may require no capital, some will require maybe a new build. Our expectations of return haven't wavered, and if we lose because we're too expensive, so be it.

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Michael James Sabella, Citigroup Inc, Research Division - Senior Associate [119]

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And then I was wondering if you could just talk for 1 more quick minute on what you see as the long-term cost structure in the U.S. And I know Carey's comments around kind of $13,000 per day, excluding maybe the mobilization cost and some other things. When do we think we can ultimately get down to that level? And then are we looking -- thinking long term, there's some normal costs per day for the business below $13,000? And then one more follow-up quickly in the U.S., if you could. Just a question around any additional long-lead-time items in storage that could help change the return profile for any more new-build rigs going forward.

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Carey Thomas Ford, Precision Drilling Corporation - CFO and SVP [120]

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Okay, Michael, I'll start with the operating costs. We mentioned the $13,000 a day as being kind of a baseline. I wouldn't encourage anybody to model that into their models for the next few quarters because there are always things that come up. But that's where, if things are really clicking, running 60 rigs, where our costs would likely be. From, call it, going from 60 to 100 rigs, there may be a slight increase in or improved fixed-cost absorption. But it isn't a step change. So we could see operating costs go a little bit lower. But I would never expect them to get significantly lower.

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Michael James Sabella, Citigroup Inc, Research Division - Senior Associate [121]

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And then just follow up on the long-lead-time items in storage and the one new build you had. Are there any more rigs that you could deploy, some capital that's already been spent previously to change the return profile? Or is this like a special onetime deal?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [122]

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Well, it doesn't change the return profile. It does change the amount of cash we need to expend. So we do have an inventory of long-lead-time components that we had at the end of the last up cycle, some things like top drives, engines, BOPs, things like that. It would reduce the amount cash we need to spend out to complete rigs, but we would still seek to get returns on the entire value of the rig, notwithstanding any minor or less expensive cash outlays. Is that helpful?

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Michael James Sabella, Citigroup Inc, Research Division - Senior Associate [123]

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Yes.

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Operator [124]

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Our next question is a follow-up from Brad Handler with Jefferies.

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Bradley Philip Handler, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [125]

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I guess maybe I noted the additional contracts you secured in the quarter. I guess I'm -- this is sort of a half confirmation kind of a question. But it seemed that they were pretty much all tied to recovering some form of upgrade or another. And so is that exactly where that your mentality is around contracts at this point in North America?

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [126]

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I would say that what we're looking for is -- I think, we -- I think all of us have a pretty good sense where the spot market rigs are for the rigs as they sit. If we happen to invest in a rig or invest to move the rig or invest to upgrade the rig, we want to recover that cost inside the original contract where we'd be thrilled to have a full high-spec rig at the end of a 6-month or 1-year contract. And the prior quarter's comments about the trajectory of day rates, nothing we've said today changes that view.

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Operator [127]

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I'm showing no further questions at this time. I'd like to turn the call back over to Kevin Neveu for closing remarks.

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Kevin A. Neveu, Precision Drilling Corporation - CEO, President and Director [128]

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All right. Well, again, thank you for joining our call today. We look forward to hosting some of you at our May 15 Investor Day in Houston. We remind you to join us in July for our Q2 earnings release and conference call. Thank you.

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Operator [129]

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Ladies and gentlemen, this concludes today's conference. Thanks for your participation, and have a wonderful day.