Independence Contract Drilling's (ICD) CEO Byron Dunn on Q1 2016 Results - Earnings Call Transcript

| About: Independence Contract (ICD)
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Independence Contract Drilling (NYSE:ICD) Q1 2016 Results Earnings Conference Call April 28, 2016 11:00 AM ET

Executives

Phil Choyce - SVP & CFO

Byron Dunn - CEO

Ed Jacob - President & COO

Analysts

Connor Lynagh - Morgan Stanley

Rob MacKenzie - IBERIA Capital

Tom Curran - FBR Capital Markets

Daniel Burke - Johnson Rice

Alex - Evercore ISI

Operator

Good morning, and welcome to Independence Contract Drilling's First Quarter 2016 Conference Call. Just a reminder, today's call is being recorded. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.

At this time, for opening remarks and introductions, I would like to turn the call over to Phil Choyce, Senior Vice President and Chief Financial Officer of Independence Contract Drilling

Phil Choyce

Good morning, everyone. Thank you for joining us today to discuss ICD's first quarter 2016 results. With me today is Byron Dunn, Chief Executive Officer, and Ed Jacob, President and Chief Operating Officer.

Before we begin, I would like to remind all participants that our comments today will include forward-looking statements which are subject to certain risks and uncertainties. A number of factors and uncertainties could cause actual results in future periods to differ materially from what we talk about today.

For a complete discussion of these risks, we encourage you to read the Company's earnings release and our documents on file with the SEC.

Additionally, we refer to non-GAAP financial measures during the call. Please refer to the earnings release and our public filings for our full reconciliation of EBITDA and adjusted EBITDA and for definition of our non-GAAP measures.

With that, I'll turn it over to Byron for opening remarks.

Byron Dunn

Thank you, Phil. Good morning, everyone, and thank you for joining us today.

In line with our standard format, I will review ICD's first-quarter operations and follow with thoughts on what we anticipate during the balance of 2016. Phil will provide details on our first quarter financials, and then we'll take questions from call participants.

During the first quarter, ICD generated free cash flow and had an 86% utilization rate of our available fleet of 200 Series rigs. By the end of the quarter, we completed the conversion of rig 103 to full 200 Series status, pad-optimal.

As discussed during our previous conference call, we implemented cost-saving initiatives that fully benefited operating costs during the first quarter. Phil will go through our cost metrics in detail later in the call. But these savings initiatives were the largest contributing factor to our first-quarter adjusted EBITDA of $7.4 million, coming in ahead of guidance.

Once again, our rigs recorded greater than 98% uptime across the fleet, and continued to set records vis-a-vis our customers' drilling curves. As our customers evolve from focusing on single well economics to a pad-centric well bore manufacturing model, they preferentially deploy rigs that eliminate non-productive time and provide value through elimination of full spread costs.

In that regard, we completed a full mapping of our conventional rig move process, and believe that we have reduced our average conventional rig move time, on average, by an entire day.

We did have one customer early term its contract for one of our rigs during the first quarter. This was the first early termination of a contract we've experienced during the downturn, apart from a farm-out arrangement discussed on last quarter's call.

Including this early termination, we currently have four rigs stacked. The rest of our marketed rigs are earning revenue on an operational or standby basis.

As was the case in prior quarters, there is no formal market for rigs within our target market area, and contract discussions are individually bespoke.

Going forward, an important driver for increasing demand for omni-directional walking pad-optimal rigs, is the accelerating adoption of pad drilling as the preferred development system in shale plays and the growth in the number of wells per pad.

We believe that the commodity price pressure we've been experiencing is accelerating this trend as producers implement long-term strategies driving permanent reductions in a development cost structure.

In that pad-centric environment, the only way operators can extract the maximum cost benefit is through the deployment of omni-directional walking pad-optimal rigs.

During the first quarter, we received inquiries for multi-well packages, as well as term contracts with tenors as long as one year.

Although I do not know and cannot predict if or when these inquiries will convert to actual drilling contracts, it's a strong signal that operators are beginning to test the waters as they consider the process the high-grading fleets and expanding drilling operations as early as later this year.

Philip will provide more detail, but I want to touch on our liquidity and where we see capital spend headed in 2016. Recently, we amended our credit facility to relax covenants, including those related to utilization and availability.

Last week, as you all know, ICD raised over $43 million in an overnight equity offering, strategically positioning us both defensively and offensively. Defensively, by removing any uncertainty the market may have had regarding our balance sheet, as well as any possibility of a liquidity problem as rig appraisals come down. And offensively, by positioning ICD to make rig build decisions and grow the Company as market conditions dictate, without having to raise capital first.

We have already made investments in many of the long lead time items for two new ShaleDriller rigs in Galayda, as well as our last remaining 100 Series conversion. This equipment can be built out in short order in response to tightening market conditions for pad-optimal rigs.

Pro forma for the equity offering at the end of the first quarter, we would have had only $12 million of net debt, a net debt to adjusted EBITDA ratio well below one times.

We budget capital expenditures of $10 million in 2016, and intend to continue to generate free cash flow during the remainder of 2016.

Post-equity placement, ICD is optimally positioned to quickly take advantage of increased demand for omni-directional walking pad-optimal rigs. As we have discussed numerous times on prior conference calls and at investor conferences, as pads become ubiquitous in the economic development of U.S. shale plays, efficiency and cycle time reduction becomes far more important than just day rate.

For example, the hard economics of employing an omni-directional walking pad-optimal ShaleDriller for a large independent client resulted in the elimination of 70 days in cycle time on a 12 well pad program, saving not only drilling days and day rate, but an all-in cost reduction of $5.25 million in spread cost versus our clients AFE.

This reduction in overall spread development cost may be a permanent fixture for our client, assuming the continued use of pads and deployment of omni-directional walking pad-optimal rigs.

This spread cost reduction totally overwhelms the impact of a few thousand dollars per day in day rate hypothetically saved by utilizing a legacy non-pad-optimal rig with no ability to cut cycle time and challenged in its ability to manufacture a high-quality long lateral.

We believe that this economic reality will drive both day rate and utilization for the U.S. pad-optimal fleet as pad development proliferates.

From a rig supply standpoint, sell-side research reports have estimated that only 150 or so 1,500 horsepower AC-Drive truly pad-optimal rigs are in the total North American land fleet.

I'll now hand the call over to Phil to discuss our first-quarter financial results in detail.

Phil Choyce

Thank you, Byron. During the first quarter, we reported a net loss of $414,000 or $0.02 per share. There were no non-operational items affecting the quarter.

The fleet generated 943 revenue days, representing a slight sequential decrease from the prior quarter. This included 162 days earned on a standby-without-crew basis, but excludes 10 days for which the Company recognized early termination revenues.

Our marketed rigs achieved 86% utilization during the quarter.

Overall, we recognized revenue of $22.5 million, including $220,000 associated with the early termination of a contract at the end of the first quarter that was not included in our quarterly guidance, and approximately $750,000 associated with pass-through revenues.

Total operating costs in the first quarter were $12.6 million. Included in operating costs were approximately $469,000 or $0.02 per share net of tax associated with Galayda Yard rig build operations that previously had been capitalized.

As discussed on our prior-quarter's conference call, this construction activity has become intermittent or cease. All or a portion of these costs previously capitalized in connection with rig builds and upgrades will be expensed by us for accounting purposes.

On a per-day basis, fully burdened operating costs, which exclude Galayda Yard expenses and pass-through costs, were $11,589 per day. Approximately $350 per day of these costs were associated with preservation activities associated with idle rigs.

Overall, our cost realization was favorable compared to our guidance for the quarter, as our rigs performed exceptionally well during the quarter and we began to fully realize the benefits of our efficiency initiatives implemented in 2015.

Approximately $300,000 of preservation costs were deferred until the second quarter of 2016.

SG&A expenses were $3.6 million. Included in SG&A expense was $1.2 million related to non-cash stock-based compensation.

Depreciation expense was $5.8 million during the quarter, and first-quarter tax expense was de minimis. Interest expense was $977,000, and came in, in line with our prior guidance.

At March 31st, we had net debt of $55.3 million, excluding $800,000 associated with vehicle capital leases, which were structured as operating leases in prior periods.

Our borrowing base under our credit facility pro forma for our amendments and related matters, was approximately $86 million at the end of the quarter. And pro forma for the recent equity raise, our net debt, excluding the capital leases, was approximately $12.3 million at the end of the quarter.

We believe it is significant that ICD generated free cash flows during the first quarter of 2016, and we did it while substantially completing our rig conversion in process during the quarter and substantially reducing payables and other accrued liabilities in the process as well.

During the quarter, cash outlays for capital expenditures were approximately $5.7 million, of which approximately $2.6 million was associated with prior-year equipment deliveries.

We continue to estimate that our capital expenditures during 2016 will approximate $10 million, and we intend to differ all non-mandatory equipment deliveries under outstanding purchase orders until market conditions stabilize and improve.

Looking forward at the second quarter, we expect that we will have between 737 and 747 revenue days, of which we estimate approximately one half will be earned on a standby basis. This guidance includes approximately 100 uncontracted revenue days associated with three rigs we forecast operating in the spot market during the quarter.

Compared to the first quarter, we expect that our absolute reported revenue will decrease during the second quarter as a result of an increase in the number of revenue days earned on a standby basis.

But I want to point out that our expected margins per day are not adversely impacted due to a corresponding drop in operating expenses associated with these rigs.

We estimate our margin per revenue day to range between $10,600 and $11,000 per day during the second quarter. This is a fully burdened margin per day, includes early termination revenues we expect to realize during the quarter, and it reflects rig perseveration costs deferred from the first quarter, as well as transitional payroll costs we expect to incur during the quarter related to the redeployment of skill position personnel from idle and standby rigs and to our operating crews.

The only other operating costs we expect to incur not within this guidance are either pass-through or costs associated with our Galayda Yard. We expect the Galayda Yard expense to range between $650,000 and $700,000, as we anticipate minimal construction activities during the second quarter.

We expect SG&A expenses for the second quarter to approximate $3.6 million, of which approximately $1.4 million will be non-cash stock-based compensation.

Depreciation of tax expenses should approximate first-quarter levels, and interest expense will range between $650,000 and $700,000 during the quarter.

In addition, we expect to recognize a one-time non-cash interest expense charge of approximately $0.5 million associated with the reduction in deferred financing costs due to the reduction in the commitment under our revolving credit facility from $125 million to $85 million.

For purposes of calculating earnings or loss per share during the second quarter, taking into account our recent offering, we estimate that our outstanding share count during the quarter will be approximately 33.6 million shares. We expect the share count to be utilized in calculating earnings or loss per share thereafter to be approximately 37.3 million shares in forward quarters.

And with that, I'll turn the call back over to Byron.

Byron Dunn

Thanks, Phil. I'd like to make just a closing remark with regard to our prepared comments before we open up for questions.

The management team at ICD remains focused on our cost structure liquidity base and on positioning the Company with our clients such that ICD is an early beneficiary of increased demand for pad-optimal rigs.

We're well-positioned from both a balance sheet and liquidity standpoint and strategically, both defensively and offensively, to resume the introduction of new pad-optimal ShaleDriller rigs into our fleet as market conditions dictate.

We've worked diligently and maintain a keen focus on the preservation of intellectual capital and skilled employees. And in that regard, I'd like to thank all of our employees for their loyalty and commitment to ICD's safety culture and our exemplary execution and performance for all of our clients. Our people, as well as our equipment drive the ICD difference.

And with that, Operator, let's open the lines for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Connor Lynagh with Morgan Stanley. Please go ahead.

Connor Lynagh

Hi. Good morning, guys.

Ed Jacob

Hey Connor.

Connor Lynagh

Maybe if you guys could talk about, I know that there's really no spot market to speak of right now. But maybe you could sort of frame for us the rigs that you rolled over that were working on spot in the first quarter and now continuing to work. And the rig that you extended the term contract on, what kind of rates are we talking about on those?

Maybe you can benchmark in terms of where we are today versus where rates were at the peak, if you don't want to talk specifics, but some sort of color on what people are willing to pay these days.

Ed Jacob

Connor, this is Ed. I think we've heard a lot of comments from our competitors' calls and for the last few -- at least last quarter, I think speculation was that the market was between 15 and 17. I said 18 then. I think that in what we have seen, that's pretty much true. We're in that 15 to 17 window of revenue opportunity today.

In the peak, we were up to 27, and some geographical areas were north of that, but they also had a higher cost basis. But I think that 15 to 17 is, from what we've seen, is where the market is.

But I do want to, again, state that it really is dependent on the geographical area, and the length of the contract is going to have a lot of impact on that.

Connor Lynagh

Okay. So maybe following up on that last point, I think in the past you guys have said one-year contracts is what you're looking for in order to start building again. And you mentioned that you're seeing some maybe soft inquiries, but including one-year contracts.

Are these rates where you would consider building on a one-year contract, or are you waiting for higher, despite the term that's being offered?

Byron Dunn

Connor, this is Byron. From that standpoint, everything we've said in the past continues to hold. When the market becomes a one-year-contract market, we will build. And we're not building because of whatever the spot or term contracts are at that point in time.

We'd be building because we'd be in anticipation of a full effective utilization and demand for pad-optimal rigs, and that will be the first signal that we're headed there.

Connor Lynagh

Understood. Thanks a lot.

Byron Dunn

Thank you, Connor.

Operator

The next question comes from Rob MacKenzie with IBERIA Capital. Please go ahead.

Rob MacKenzie

Thanks. Good morning, guys.

Byron Dunn

Good morning, Rob.

Rob MacKenzie

Question for you, Byron, I guess. I'm trying to reconcile your prepared remarks here. I think you mentioned that you had four stacked rigs and the rest were earning revenue.

Byron Dunn

Yes.

Rob MacKenzie

Which, if I count the 101 that's still yet to be upgraded at a stack, that leaves 10 potentially earning revenue. But your revenue day guidance of 737 to 747 implies effectively eight full rigs earning revenue.

Is there a partial utilization of a couple rigs within that assumption? Help me bridge the gap, if you will.

Byron Dunn

No. Yes, no, there's no partial utilization. Let me turn it over to Phil, and Phil can you walk you through that.

Phil Choyce

Yes. I think when we think about the rig that has not been upgraded, rig 101, that wasn't included in that. We've got four rigs that are stacked. One of them actually earning revenue on an early termination basis. And then we've got another nine rigs that are earning revenue during the quarter at the end of the quarter.

Byron Dunn

So 101 is now 217. Rob, that wasn't completed until the end of the first quarter.

Phil Choyce

103.

Rob MacKenzie

Okay. So 101..

Phil Choyce

103. Sorry.

Byron Dunn

I'm sorry. 103. 103 is 217, and that rig was not -- the conversion was not completed until right at the end of the first quarter. So we didn't begin marketing that really strongly until about halfway through the quarter.

Rob MacKenzie

Okay. All right. Good. And then you mentioned, I think you said you had 100 uncontracted days for rigs that are on the spot market. Does that represent days that are yet to be filled in the second quarter for those rigs that are currently working?

Phil Choyce

Yes, we've got one rig rolling off a term contract during the quarter that we expect to operate in the spot market. We have two rigs that are contracted in the spot market now, and we expect to renew those later in the quarter. But if you add up the days and our assumptions that are not fully contracted, it's about 100 days.

Rob MacKenzie

Okay. So just so I understand you, your 737 to 747 guidance assumes or doesn't assume those rigs re-up?

Phil Choyce

That's assumes they re-up.

Rob MacKenzie

Okay.

Byron Dunn

And we're pretty confident about that right now.

Rob MacKenzie

And that would be based, Byron, on the conversations you're having with similar or other customers?

Byron Dunn

Yes.

Rob MacKenzie

Great. Thanks. And then, coming back to the new building decision, can you give us a feel for, obviously, given the significant amount you've spent on some of the rigs so far, A, what it would cost to upgrade rig 101 when you decide to do so, refresh us on where that cost may be, as well as what your first two or three or four incremental new builds would cost to build with some costs already excluded.

Byron Dunn

Sure. So we don't really upgrade them. We convert them. I don't think it's possible to take a non-walking rig and upgrade it in a way that's efficient or effective. So what we do is we do a full conversion.

We replace the entire substructure on the 100 Series rig to a 200 Series sub, and then we repopulate it with the drilling equipment from the 100 Series rig. And Phil can give you the numbers on that. And what was the other half of your question?

Rob MacKenzie

Oh, and then what would it cost for the first, second, third, fourth, fifth new builds, given you've already spent a fair amount of money on component parts for those?

Byron Dunn

Okay. So there are two rigs worth of long lead time items that we've paid for. So the incremental cost for those two rigs would be about $10 million each, rather than $20 million. And the timing days, Dave, that'd be? Get those out.

Ed Jacob

Three months.

Byron Dunn

Three months. So we could get a couple out in three months and we've basically got a half of the cost sunk.

Rob MacKenzie

Great.

Byron Dunn

So conversion…

Phil Choyce

The conversion's probably about $6 million, $7 million. It's about $30 million or so to do the conversion and the next two rigs, incremental CapEx.

Rob MacKenzie

Okay. Great. Thanks, guys. I'll turn it back.

Phil Choyce

Okay.

Operator

The next question comes from Tom Curran with FBR Capital Markets. Please go ahead.

Tom Curran

Good morning, guys. Curious, in the secondary market, have you seen either an auction of or an attempted entire company sale involving rigs that would be comparable to the ShareDriller Series 1 in terms of specs?

Byron Dunn

Well, that'd be -- it's not perfect, but you're talking about like Flex 3s. That's not the best comparison, but it would be regular non-skidding, non-walking AC rigs. So that would be what you're asking?

Ed Jacob

Tom, this is Ed. I haven't seen any AC competitive equipment that has been offered for sale in the last few years, so. I've seen some equipment, some SCRs, or I've seen a legacy-type rig that was converted to AC power, but it still didn't incorporate all the pad-optimal qualities.

But I haven't seen any of the rigs that we're talking about up for sale.

Tom Curran

Okay. And I'm not surprised by that. I just wanted to check in and confirm. Any idea of where one of the leading appraisal firms would value that generation of rigs at this point?

Phil Choyce

You mean our type of rig, Tom?

Tom Curran

Yes, like a ShaleDriller one.

Phil Choyce

Okay. Well, we get…

Byron Dunn

Oh, no. 100 Series he's talking about.

Phil Choyce

Are you talking about

Tom Curran

Right.

Phil Choyce

…100 Series or a 200 series?

Tom Curran

Yes.

Byron Dunn

100 Series.

Tom Curran

100 Series.

Phil Choyce

100 Series, I think it would be fair market value today $6 million or $7 million, maybe, $8 million. I don't have the precise, it would be…

Byron Dunn

They're not worth very much to us in the 100 Series format. They aren't going to go back to work. They will go back to work as a 200 Series multidirectional, walking pad-optimal rig.

But I guess the message there is, there's not a lot of value associated with slow-moving legacy rigs.

Tom Curran

Fair enough. Last question I have on this line, turning to the ShaleDriller Series 200, the 200 Series, fully outfitted with everything a customer might possibly want now, including 7,500 psi capability, three mud pumps, what would a third-party vendor be charging right now for that? Given, I'm assuming, there's been some decline in pricing, what could you get that for from NOV at the moment?

Byron Dunn

You couldn't. So the type of equipment that we assemble and have designed is not available anywhere else. Any third-party rig will cost you more because they've got to build in their margin and it will be less functional. So it's just not available.

Tom Curran

All right. Thanks, guys.

Operator

The next question comes from Daniel Burke with Johnson Rice. Please go ahead.

Daniel Burke

Hey. Good morning, guys.

Phil Choyce

Hey Daniel.

Daniel Burke

Sorry. Just to start off with a specific one, can you go back to the 100 uncontracted days, I thought I heard that assumes the two term rigs rolling this quarter will remain active in the spot market. I wanted to clarify, one, if that was the case, and, two, if there's also a hold in that 100 days for the two rigs that are presently operating or have been operating so far this year in spot.

Phil Choyce

The 100 days, we had two rigs rolling off term contracts during the quarter. One of them is idle right now. And we're not assuming that one goes back to work this quarter in our guidance.

We have another rig rolling off term contract later in the quarter, and the guidance assumes that one continues working in the spot market.

And then we have two rigs in the spot market now that are contracted through mid-June, and we're expecting that those continue operating in the spot market.

Daniel Burke

Okay. That's helpful. And then, Byron, you talked about receiving some level of inbound inquiries. With regard to your rigs that are on standby right now, any signal that those might return? Or what's the process by which the operator would inform you that they were considering such a shift?

Byron Dunn

I think we had one, but it would be they'd call Ed and let him know that they wanted to reactivate the rig and where they wanted it to go to. So it's pretty simple.

Daniel Burke

Okay. And that has occurred in one instance?

Phil Choyce

We've had discussions about reactivating one.

Daniel Burke

Okay, discussions.

Phil Choyce

But we haven't reactivated it yet.

Daniel Burke

Okay. And then -- that's helpful and good to know. And then maybe just a last one, other than the just-converted 100 series, are any of the other rigs idle? Do they currently have the third mud pump 7,500 psi configuration?

Ed Jacob

This is Ed. Daniel, we have a couple rigs that are on standby that have the 7,500 psi configuration. We also have plans in place to add a third pump on half of our fleet. So if the customer requires it and the economics justify it, at that point we could execute the plan and have essentially all of our fleet up to 7,500 psi capability and half of them with a third pump.

Byron Dunn

To answer your question further, Daniel, none of our idle rigs are equipped with 7,500 psi systems. We have rigs on standby that are equipped with 7,500 psi systems.

Daniel Burke

Got it. Okay. Well, thank you, guys, for the comments.

Ed Jacob

You bet. Thank you, Daniel.

Operator

[Operator Instructions] The next question comes from James West with Evercore ISI. Please go ahead.

Alex

Hey guys. This is Alex. How are you?

Byron Dunn

Hey Alex.

Alex

I was curious of the $43 million in proceeds, how much went to paying back the revolver.

Phil Choyce

All of it.

Alex

All of it, all right. Cool. And then second question, just want to make sure I have my math here correct. So basically, for second quarter, a little more than two rigs on term, four rigs on standby, and the remainder in the spot market?

Phil Choyce

That would be correct.

Alex

Okay. And you guys said 15 to 17 still for the spot, right? Correct?

Phil Choyce

Yes.

Alex

All right. Awesome. Thank you very much, guys.

Phil Choyce

You bet, Alex.

Operator

The next question is a follow-up that comes from Rob MacKenzie with IBERIA Capital. Please go ahead.

Rob MacKenzie

Yes, just a housekeeping question. Byron, I wrote down you had upgraded the 103 to rig 217. It seems like there's a four-rig gap between your rig 212 and 217.

Byron Dunn

Yes, there is.

Rob MacKenzie

Okay. Is that for rigs you already ordered the spare parts for, in essence, or a lot of items for, just try and keep them in order?

Byron Dunn

That's correct.

Phil Choyce

That is correct. There's no difference between -- there's no significance between rig 217 and 212 from a functionality perspective.

Rob MacKenzie

Okay. Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Byron Dunn for any closing remarks.

Byron Dunn

In closing, I'd like to say thank you for participating and your interest in our Company. And we look forward to speaking with you all again next quarter.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you.

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