Precision has reported net earnings of $82 million or $0.65 per diluted unit for the quarter ended September 30, 2008, an increase of $10 million or 13% compared to $73 million or $0.58 per diluted unit in the third quarter of 2007. The increase marked the first time since the fourth quarter of 2006 where net earnings were greater than the comparable quarter for the prior year.
Third quarter net earnings increased over prior year due to organic rig expansion in the United States and a rebound in Canadian rig activity that led to margin growth in Precision's contract drilling operations. During the quarter, the fleet was 29% more active than the prior year comparative quarter as deployments from Canada to active basins in the United States and higher activity in Canada generated an increase of 2,440 operating days.
"The noteworthy year over year safety, earnings and revenue improvement reflects the exceptional execution and performance by the people of Precision. Our U.S. expansion, pricing discipline in Canada and activity improvements across all business units contributed to this strong performance. Currently we are operating 28 rigs in the U.S., up from 12 at the beginning of the year, all under term contracts. Our Canadian drilling fleet is currently at 220 rigs with operating days up 14% from last year. We will be adding an additional 19 new builds to the Precision fleet, 17 of which are under term customer contracts. The recent acquisition of six well service rigs in Manitoba brings our well service fleet to 229 rigs," said Kevin Neveu, Precision's Chief Executive Officer.
"Of specific note during the third quarter was the increase in average drilling days per well and the exceptionally high level of directional and horizontal wells. Approximately 70% of our rigs in Canada and over 80% in the U.S. were drilling directional/horizontal wells. These drilling trends coupled with Precision's excellent safety record and strong margin performance clearly demonstrate the success and customer recognition of our high performance high value strategy.
"While we are cautious regarding the near term impact of the global banking crisis and ensuing economic uncertainty, we remain confident that organizational changes and cost reduction measures we introduced late last year position us well for this volatility.
"We are especially pleased to be a key provider of high performance high value services to the rapidly emerging North American shale gas story. We believe our intention to acquire Grey Wolf will accelerate this strategy over the long-term, bringing growth and diversification to Precision unitholders."
For the nine months ended September 30, 2008, net earnings were $210 million or $1.67 per diluted unit, a decrease of $46 million or 18% compared to $256 million or $2.04 in the equivalent period of 2007. The decrease in net earnings was due to lower first quarter industry demand and pricing for both operating segments in Canada partially mitigated by United States expansion, the emergence of international operations and stronger Canadian activity in the third quarter. During the first nine months, geographic diversification to United States natural gas resource plays accelerated with 16 rigs deployed from Canada expanding the fleet from 12 to 28. Precision's U.S. drilling rigs operated at near 100% utilization and fleet growth led to a three and a half fold operating day increase over the first nine months of 2007.
Precision's high performance high value customer service offering advanced since the second quarter of 2008 through North American and international developments that included the following:
On August 25, 2008 Precision announced that it had entered into a definitive merger agreement with Grey Wolf, Inc. ("Grey Wolf") pursuant to which, if approved by Grey Wolf shareholders, Precision will acquire Grey Wolf. Grey Wolf is the fourth largest onshore drilling contractor in the United States with a fleet of 122 drilling rigs and on a combined basis, Precision will be one of the largest land drillers in North America with a combined drilling rig fleet of 371 rigs. The combined Precision and Grey Wolf will have land drilling operations in most conventional and unconventional oil and gas basins in the lower 48 United States and in Canada with an emerging presence in Mexico. The transaction will enhance Precision's leadership position in the North American oil field services sector and represents an important milestone in Precision's long-term strategy for diversification beyond Canada. The transaction will position Precision as the lead shale gas driller in North America.
Under the terms of the agreement, Grey Wolf shareholders will receive US$5.00 in cash and 0.1883 Precision trust units ("Units") for each Grey Wolf common share, for aggregate consideration of about US$1.12 billion in cash and about 42 million Units. Grey Wolf shareholders will be able to elect to receive cash or Units subject to proration.
On August 24, 2008 Precision entered into an arrangement to fund the transaction and ongoing operating requirements through a US$1.6 billion debt structure as outlined in a commitment letter with four lenders, the Royal Bank, the Toronto Dominion Bank, Deutsche Bank and HSBC Bank.
The acquisition process for the transaction has progressed on schedule with successful completion of key steps that include early termination of the Hart-Scott-Rodino waiting period, determination by the Committee on Foreign Investment in the United States ("CFIUS") that there are no unresolved national security concerns and the receipt of prospective credit ratings from Moody's and Standard & Poor's.
On July 31, 2008 Precision closed the acquisition of six service rigs from Rick's Well Servicing Ltd., a private company, for approximately $16 million. The assets are positioned in south-eastern Saskatchewan and south-western Manitoba and strengthen Precision's capabilities in these oil regions. Subsequent to closing, Precision moved an additional three service rigs into these regions.
August 31, 2008 marked the expiry of certain non-compete obligations from a 2005 business divestiture that restricted Precision's growth outside of North America and in certain business lines. Through its international subsidiary Peritus International Oilfield Services Ltd., Precision can now fully pursue global contract drilling opportunities.
Precision's organic growth in the United States accelerated with nine rig moves from Canada during the third quarter representing fleet expansion of 47%.
The 2008 Super Series drilling rig build program is comprised of ten Super Single rigs and nine Super Triple rigs, all are committed to customers. Seventeen of these rigs are under signed term customer contracts with letters of intent on the remaining two rigs. Twelve rigs are for deployment to the United States, six for Canada and one has been made available to a customer for international deployment.
Precision's revenue in the third quarter of 2008 was 25% higher than the prior year period at $286 million, increasing 33% in the Contract Drilling Services segment and 7% in the Completion and Production Services segment. Revenue in Precision's United States operation grew by one half over the previous quarter and by over two times the same quarter in the prior year. In Canada, Precision realized a 14% increase in operating activity in the Contract Drilling Services segment while service rig activity in the Completion and Production Services segment increased 4%.
Precision's operating earnings in the third quarter of 2008 were 34% higher than the prior year period at $99 million, increasing two percentage points to 35% of revenue. The improvement was primarily attributable to strong margins in the United States contract drilling division. Precision's operating segments in Canada performed well and returned to margins comparable to a year ago as internal manufacturing, maintenance and supply-chain management contained operating costs at levels relatively in line with prior year periods and customer pricing stabilized.
In the Western Canada Sedimentary Basin ("WCSB"), Precision experienced higher customer demand over the comparative year quarter due to the improvement in underlying cash flow fundamentals for the oil and gas industry. With significant improvement in natural gas pricing through the first nine months of 2008, producers began to accelerate drilling plans in the second quarter but the impact of spring break-up and wet weather delayed any significant uplift in activity until the third quarter which was up sharply over the prior year even though shallow gas drilling in Alberta remained at lower levels. Customer demand in Canada improved and Precision's operating days increased by 14% in the quarter compared to the third quarter of 2007. Industry rig supply fundamentals in Canada have also improved through a net reduction in capacity. Precision reduced its Canadian drilling rig fleet by a net 22 rigs or 9% as a result of deployments to the United States and fourth quarter 2007 retirements partially offset by additions to the fleet from the 2007 rig-build program.
For the third quarter of 2008, in both the Contract Drilling Services segment and the service rig division of Precision's Completion and Production Services segment, average daily or hourly rig rates were essentially flat with prior year. With strengthened fundamentals, higher demand in certain oil and natural gas markets, and a scarce labour supply spot market pricing has firmed. Precision continued to benefit from term contracts and strong customer relationships that place a premium on safe, high performance oilfield services.
Average customer pricing for Precision's operations in the United States held strong in the quarter as all drilling rigs are under term contracts. An increased active industry rig count and a trend toward directional and horizontal drilling programs continued to provide opportunities for Precision's versatile high performing drilling rigs.
Precision continued on schedule with its 2008 capital expenditure program estimated at $290 million with $75 million for upgrade capital and $215 million for expansionary initiatives. Most of the expansion capital spending is for the 2008 rig-build program and Precision estimates that an additional $130 million will be incurred during the first three quarters of 2009 to complete this program.
Precision continued to invest in its high performance high value strategy as energy commodity prices have reflected an underlying tight supply of natural gas and oil. The third quarter of 2008 continued to support this rationale, as AECO natural gas spot prices averaged $7.80 per MMBtu in the third quarter of 2008, an increase of 50% over the third quarter 2007 average of $5.20 per MMBtu. In the United States, Henry Hub natural gas spot prices averaged US$9.06 per MMBtu in the third quarter of 2008, an increase of 47% over the third quarter 2007 average of US$6.16 per MMBtu. West Texas Intermediate crude oil averaged US$118.68 per barrel during the quarter compared to US$75.31 per barrel in the same period in 2007. As always, significant economic and weather factors influence commodity prices and the one-year forward price for North American natural gas improved and traded within a wide range of about $7.50 to $13.00 on Canadian and U.S. exchanges in the third quarter of 2008, compared to a range of about $6.50 to $8.00 in the same quarter of 2007. On October 21, 2008 AECO spot natural gas closed at $7.17 per MMBtu and West Texas Intermediate spot closed at US$70.89 per barrel.
Looking ahead to the fourth quarter of 2008 and into 2009 the unfolding global financial crisis has created a high degree of uncertainty. While mindful of recent commodity price volatility and its impact on industry spending, Precision's North American oilfield service businesses carry positive momentum established during the first half of 2008 through higher energy prices and an increasing activity trend. The benefits of these factors were demonstrated in third quarter performance and persist early into the fourth quarter.
Rig bookings by customers for the 2008/2009 winter drilling season in Canada remain ahead of year ago levels and Precision has increased its personnel recruitment efforts and training for the expected seasonal increase in drilling during the first quarter of 2009. In alignment with current customer demand and the impact of last year's freeze on field labour rates, substantial hourly wage rate increases were made to rig crews by the industry to start the fourth quarter in Canada. These increases were made to ensure competitiveness and to address an industry-wide labour shortage. Precision expects to recoup these costs through customer pricing adjustments effective October 1, 2008.
Precision's 2008 rig-build program is on schedule to deliver 19 drillings rigs pursuant to term customer contracts over the next nine months with up to four in the fourth quarter, six in the first quarter of 2009, eight in the second and one rig in the third quarter. These Super Series rigs will further expand Precision's operations in the United States land drilling market and reinforce high performance high value assets in Canada.
Supply from producing U.S. land wells has been bolstered by recent successful shale and tight gas drilling. Year-over-year production response from shale gas plays such as the Barnett, Deep Bossier and emerging plays such as the Marcellus and Canadian shales, Montney and Horn River, give promise that continental natural gas will continue to be part of the long-term energy solution for North America.
The significant rise in production from these wells has been a product of long section horizontal drilling combined with multi-stage large fracturing processes. These wells are service intensive and as a result expensive to drill, but strong initial production rates facilitate early payouts for producers. From a drillers perspective these wells also have a steep rate of production decline in the first year of 50-80%, necessitating additional drilling to replace rapidly depleting wells. The complexity of these wells dictate the use of high performance rigs with large capacity mud pumps, advanced drilling control systems and high mobility capabilities. These rigs are often referred to as "fit for purpose" as a significant percentage of the existing industry rig fleet does not adequately address the need. Precision's Super Series rigs and a large number of its "traditional" rigs have been upgraded to these high performance requirements.
Looking ahead to 2009, industry fundamentals for Canada are supported by the recent strengthening of the U.S. dollar versus the Canadian dollar, a reduced industry drilling rig count and natural gas pricing in October 2008 that is up to 10% higher than a year ago. Precision will continue to risk manage its business growth through strong margin term contracts and existing operations with a highly variable operating cost structure to match equipment utilization.
The current state of the global banking system is an overriding concern as access to capital through the debt and equity markets is challenging. The liquidity and capital contraction is expected to cause many producers of oil and natural gas to demonstrate renewed focus on balance sheet discipline and to work within their existing financing and cash flow means. Subject to the coming winter heating season and demand levels for natural gas in North America, the current economic slowdown could moderate energy consumption growth and may result in lower producer spending for marginal oil and natural gas programs.
For Precision, existing debt facilities provide access to about $500 million of undrawn debt capacity and the tenure on the facility was renewed for a new three year term in the second quarter of 2008. In conjunction with the proposed acquisition of Grey Wolf, Precision is planning to replace existing facilities with a new debt structure of US$1.6 billion pursuant to firm funding arrangements with four reputable lenders.
Precision's resolve to acquire Grey Wolf remains rooted in strategy and will position the combined entity as one of the largest North American drillers with an asset base that is exceptionally well positioned in most of North America's promising resource plays, especially shale gas. The acquisition will bring significant benefit to Precision through immediate access to customers, employees and a very well maintained fleet of deep drilling rigs that round out Precision's predominantly shallow to medium depth rated fleet. Combined, the companies will have opportunity to leverage available rig capacity for international deployment, to access a large and loyal list of North American customers and to gain operational benefits by embracing optimal internal safety, supply chain, rig manufacturing and upgrade, new rig technology and human resource systems.
Precision's strategic focus is on global contract drilling through United States expansion, international diversification opportunities and complementary product line expansion. Precision's strategy is centered on value-based high performance services where customers recognize and reward superior performance. This presents Precision with significant opportunity to displace low performing rigs, especially in technically demanding unconventional drilling applications. A greater proportion of wells drilled in North America are seeking unconventional oil and natural gas reserves and due to the complexity of these programs, high performance drilling rigs and services are required. The differentiation between underperforming rigs and high performing, highly mobile, well-designed rigs with exceptional crews continues to emerge.
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