A steady, monthly improvement in Patterson-UTI Energy Inc.'s (PTEN) U.S. onshore rig count has been evident since May, with the company's average in October expected to increase to 63 from 55 at the end of June, CEO Andy Hendricks said Thursday.

The Houston-based onshore drilling expert, which provides contract drilling and pressure pumping services across North America, also is seeing a continued transition to higher specification (spec) rigs, particularly in the Permian Basin, which means the market is tightening, executives said during a conference call to discuss third quarter performance.

"Our rig count in the United States has steadily improved on a monthly basis since May," Hendricks said. "For the third quarter, our average rig count improved to 60 rigs in the United States and two rigs in Canada, up from the second quarter average of 55 rigs in the United States and less than one rig in Canada."

The company’s U.S. rig count "has improved by a net 12 rigs, or 23% from the low in late April," Hendricks said. "This net 12 rig increase consists of 18 rigs reactivated while six rigs have been idled. "All the rigs reactivated are PTEN's trademark Apex rigs, which are alternating current-powered, including 17 that are 1,500 hp rigs.

"Of the 18 rigs reactivated, 15 had walking systems and 13 had 7,500 psi circulating systems," he said. "In total, 12 of the 18 rigs reactivated were 1,500 hp rigs with a 750,000 pound mass rating, a walking system, and 7,500 psi circulating system. Within our fleet, a total of 52 rigs have these capabilities, of which 48 are currently contracted for 92% utilization."

In the West Texas Permian Basin, which has been “the source of most of the incremental high-spec rig demand, all of our rigs with these capabilities are contracted. Across the industry, we believe there are a limited number of the most capable rigs. We estimate approximately 300 of these rigs across the U.S. that are 1,500 hp rigs with a 750,000 pound mass rating that are pad-capable, and have a 7,500 psi circulating system for longer laterals."

Initial increases in the onshore rig count were "driven by smaller operators that were drilling less service-intensive wells. However, we believe the market has transitioned with recent increases in the rig count being driven by higher-spec drilling rates, which is increasing the utilization and decreasing the availability for this class of rig, especially in the Permian Basin."

Where it's justified, PTEN plans to upgrade its fleet to meet demand for higher-spec rigs, he said.

"We have 40 1,500 hp Apex rigs that can be upgraded to these specifications by adding a 7,500 psi circulating system, which is approximately a $1 million upgrade. We have another 36 1,500 hp Apex rigs in our fleet that would require either a walking system, or both a walking system and a 7,500 psi circulating system for a total potential upgrading cost per rig of approximately $3 million. Given the increasing utilization of these higher spec rigs, and the capital required to upgrade rigs to these capabilities, we expect dayrates to increase as activity continues to grow."

PTEN is forecasting its average U.S. rig count in October to be 63, with two rigs running in Canada.

As has been the case since the downturn began two years ago, exploration and production customers still are terminating their rig contracts early. The early terminations bring in revenue, but they also move operating costs higher, Hendricks said.

"We recognized $1.1 million of revenues related to early contract terminations in our drilling business during the third quarter," he said. "These early termination revenues positively impacted our total average rig revenue per day of $21,870 by $200." However, excluding early termination revenue, total average rig revenue/day during 3Q2016 would have been $21,670, versus $21,980 in 2Q2016.

Total average rig operating costs/day increased sequentially to $13,180 from $12,770 because of "a decrease in the proportion of rigs on standby," he said. As well, the total average rig margin/day, excluding early termination revenue, fell sequentially to $8,490 from $9,210.

At the end of September PTEN had term contracts for drilling rigs worth $464 million of future dayrate drilling revenue.

"Based on contracts currently in place, we expect an average of 43 rigs operating under term contracts during the fourth quarter, and an average of 32 rigs operating under term contracts during 2017," Hendricks said.

A positive was seen in increased pressure pumping revenues, which rose 5.7% sequentially to $78.2 million because of increased product sales and higher activity levels.

"The increase in product sales was related primarily to a shift in our activity as we supplied the proppant for a higher proportion of our total activity," the CEO told analysts. Pressure pumping gross margin as a percentage of revenue fell to 1.2% from 6.0% in 2Q2016 -- primarily because of higher than expected costs associated with equipment maintenance.

PTEN did not slack off on the acquisition front during the latest period, completing its takeover of Warrior Rig Ltd., a Calgary operator known for developing innovative solutions in drilling rig technology (see Shale DailySept. 15). The plan is to expand Warrior's top drive service center in the United States to increase its capacity to service top drives manufactured by both Warrior and third parties.

"We believe our industry has begun the initial stages of the recovery process, which began with smaller operators picking up rigs to drill less service intensive wells," Chairman Mark S. Siegel said during the conference call. "We believe the market has transitioned in favor of higher-spec rigs, and we are encouraged by the recent increase in demand that is increasing utilization for this class of rig, especially in markets such as the Permian Basin. Overall, we believe the market for higher-spec rigs has appreciably tightened."

Siegel's comments mirror some by Nabors Industries Ltd. management team, which said customers are clamoring for top-of-the-line rig equipment (see Shale DailyOct. 26).

Net losses were $84.1 million (minus 58 cents/share) in 3Q2016, versus a year-ago loss of $226 million (minus $1.54). Revenue declined year/year to $206 million from $422 million. The company recorded pretax charges of $280 million for an impairment to the pressure pumping business, equipment write downs and an impairment of some oil and natural gas properties.