Independence Contract Drilling, Inc. (ICD) CEO Anthony Gallegos on Q4 2021 Results - Earnings Call Transcript

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Independence Contract Drilling, Inc. (NYSE:ICD) Q4 2021 Results Conference Call March 7, 2022 12:00 PM ET

Company Participants

Anthony Gallegos - President, CEO

Philip Choyce - EVP, CFO

Conference Call Participants

Don Crist - Johnson Rice

Operator

Good day, and welcome to the Independence Contract Drilling, Inc. Fourth Quarter and Year End 2021 Financial Results Conference Call. [Operator Instructions]. Please note, this event is being recorded.

I would now like to turn the conference over to Philip Choyce, Executive Vice President and Chief Financial Officer. Please go ahead.

Philip Choyce

Good morning, everyone, and thank you for joining us today to discuss ICD's fourth quarter 2021 results. With me today is Anthony Gallegos, our President and Chief Executive 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.

In addition, we refer to non-GAAP measures during the call. Please refer to the earnings release and our public filings for our full reconciliation of net loss to adjusted net loss, EBITDA and adjusted EBITDA and for definitions of our non-GAAP measures.

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

Anthony Gallegos

Thanks, Philip. Hello, everyone. Philip will go through the details of our financial results for the fourth quarter of 2021 in a couple of minutes. And for the most part, we pre-released our fourth quarter financial results and an investor presentation filed with the SEC in January. So I won't focus much on that in my prepared remarks today, and we'll let Philip summarize those items for you. Today, I want to sum 3 things. I want to provide you an update on the market and our expectations for continued dayrate and margin expansion in 2022.

I want to provide you some context on our geographic and customer evolution during the fourth quarter. And I want to close with a summary of our 2022 strategic and financial goals. I'm proud to report that ICD achieved its 2 primary financial goals during 2021.

We achieved positive EBITDA as we exited the third quarter and improved on that in the fourth quarter. Most importantly, the company's operating fleet was generating positive cash flow entering 2022 with expected annualized EBITDA exceeding expected maintenance CapEx and cash interest payments.

As we exited 2021, our improved financial performance was a function of frequent repricing that came from our short-term contract posture and our increasing 300 Series utilization, both driving dayrate improvements on contract renewals and new contract placements.

Achieving these goals provided ICD the springboard we needed for 2022, which will allow us to meaningfully increase cash flow and continue to execute on our business plan. In the fourth quarter, we reported revenue per day of $19,042 and margin per day of $3,538.

As noted in our press release, margin per day was impacted by year-end incentive compensation accruals for field-level managers of approximately $343 per day. Excluding that accrual, margin per day was $3,881, representing a 12% sequential increase.

We ended the year with 17 rigs contracted. Philip will provide more details, but during the fourth quarter, we achieved a sequential increase in revenue per day of approximately 11%. More important, I want to reaffirm what we expect to see here in the first quarter of 2022.

We expect first quarter 2022 revenue per day to improve another 13% to 14% compared to fourth quarter levels, and most importantly, margin per day to improve between 45% and 50% compared to our adjusted fourth quarter level of $3,881.

First quarter margin expectations do reflect costs associated with reinstatement of field manager incentive comp. Obviously, first quarter dayrate increases more than offset labor inflation associated with pay adjustments implemented at the end of the fourth quarter.

As we sit here in March, we have good visibility toward the second quarter as well. For the second quarter, based on contracts we have in place right now, we would expect second quarter revenue per day to improve 20% to 23% compared to fourth quarter reported levels and margin per day to improve approximately 95% to 100% compared to reported fourth quarter levels.

This continued improvement is a function of having 17 rigs working, benefiting from pad-to-pad reprices and our ability to pass through some cost inflation related primarily to the label market.

These large sequential increases in dayrate and margin we are seeing are things we have forecasted on prior earnings calls and are not only indicative of the strong market we're in, but also our intentional strategy to focus on shorter-term contracts leading to rapid margin improvement.

This focus and the outstanding efforts of our sales, operations and support teams continues to provide benefits as seen in our sequential improvements. We remain resolute in our belief that the industry is in the early stages of this up cycle and maintaining a short-term posture as it relates to contract terms in the near term will allow faster margin expansion and ultimately result in margins exceeding pre-pandemic levels.

During the fourth quarter, we repriced, contracted or recontracted 11 rigs, including 4 rigs placed with new customers. In every case, the dayrate increased significantly. We saw average increases of $4,100 per day or roughly 25% with some increases approaching 40%, which drives our confidence in the large margin expansion embedded in our first and second quarter guidance.

And more importantly, as the market continues to improve, driven by very tight rig supply, all of our rigs will have at least 1 more rate adjustment in the back half of 2022, which we believe will continue to drive positive momentum throughout this year.

I mentioned that I wanted to discuss customer and geographic evolution, which occurred for our fleet. The fourth quarter was transformational for ICD in this regard. In addition to reactivating and contracting our 17th rig, which is an ICD 300 Series rig working for a large public independent in West Texas. We also completed our geographic consolidation strategy by moving all our rigs into our West Texas and Haynesville operations. This involved mobilizing 2 active rigs from the Eagle Ford to West Texas and a third active rig from the Eagle Ford to the Haynesville.

While we remain positive on the Eagle Ford and the opportunities it presents to the industry, we elected to leverage our strong operational presence in our 2 core markets, that be in West Texas and Haynesville, which we believe will drive operational and cost efficiencies. After this consolidation, 65% of our rigs are working in West Texas, and 35% are working in our Haynesville market.

I believe this to be a very healthy, balanced exposure to both oil and natural gas-directed drilling activity with ICD laser-focused on serving North America's premier unconventional oil and natural gas plays.

While completing the 3 geographic relocations, we were able to increase the number of ICD rigs contracted to multi-rig customers in 2 cases and establish a contractual relationship with another first-time customer with whom we're already discussing adding a second rig later this year.

We also enhanced our customer mix over the past quarter. I think ICD's balanced exposure to both public and private E&Ps is somewhat misunderstood. So, I want to point this out today, of our 17 contracted rigs, almost half are working for public E&Ps, and of those working for private E&Ps today, 4 are currently working for one of the largest operators of any type in the Permian Basin.

Moving on to how we view the market for rig reactivations and the opportunity for ICD. I think it's important to emphasize how tight the rig market is today, which is driving our positive dayrate and margin expectations.

There is minimal excess supply of super-spec rigs. Today, an operator is lucky if they're able to find a hot rig available. Just to give you some context on this, about 2 weeks ago, we had a 300 Series rig come free due to one of our customer's inability to have a follow-up pad available. But we had a commitment on that rig within hours at significantly higher dayrates.

So as the industry adds drilling rigs, they're going to have to reactivate rigs that have been stacked for more than 2 years, which is quite costly for the drilling contractor. All-in rig reactivation costs are increasing for the industry, and we estimate total cost incurred to reactivate a rig has increased at ICD to approximately $3 million per rig for the next couple of reactivations.

We believe this will drive further increases in day rates and margins across our industry as we're focused on driving meaningful returns on capital for our shareholders. So what is the opportunity set for ICD to reactivate rigs? We have 7 idle rigs in our marketed fleet today. All of these rigs are 300 Series rigs.

Rigs meeting our 300 Series specification are in the shortest supply in the industry and they command the highest dayrates. The most recent contracts we have signed today for 300 Series rigs will generate margins greater than $10,000 per day on an all-in basis, and we would expect to do even better than that on a rig reactivation. Meaning, paybacks on these rig reactivation investments are well under 1 year for our next 3 rigs costing $3 million per reactivation and 1 year payback for our last 4 reactivations that will cost more in the $4.5 million range.

The point is demand exists for this class of rig, and it's extremely strong. Of course, there are labor and supply chain headwinds that have to be managed as well. But the market meets these rigs, and we would have reactivated all of these rigs already at the company had the financial liquidity and resources to make those investments.

That brings me to my final topic I want to discuss in my prepared remarks, which are ICD's goals and objectives for 2022. Obviously, providing the safest and most reliable operations is always our first priority. But right after that, for 2022, first and foremost, we need to address our term loan indebtedness and our financial liquidity, which is holding us back from aggressively executing on the opportunities in front of us.

Although the term loan doesn't mature until October 2023, a it will be classified as a current liability on our third quarter 2022 financials, absent an extension of refinancing. It will be challenging. It may be unlikely that we commence additional rig reactivations until we address our term loan maturity.

So given these factors and the overall improvements in the business climate, we believe now is the opportune time to address our term loan and liquidity, even if headwinds exist in the overall credit markets and the trailing 12-month financial performance of contract drilling industry in ICD.

As disclosed in our SEC filings and in our press release, we have been actively engaged in seeking opportunities to comprehensively address the term loan which will likely involve equity or equity-linked securities. And I can assure you that we've been working diligently on this, but we will not be at a point to comment publicly with any details on whether we will be successful in this regard until we have binding commitments from third parties.

Another overall objective is to position the company so that we exit 2022 and enter 2023 earning average margins per day across our entire fleet of $10,000 per day or more. This isn't the forecast but where we think we need to be and where we think we can take the company based on the market opportunities that we believe are going to be available to us.

From my prior remarks, you can see our margin progression is accelerating, and we're moving in the right direction. Assuming a successful term loan resolution that provides us additional financial liquidity, we believe making steady progress towards and ultimately achieving this objective will be the springboard to the reactivation of additional drilling rigs and untapping the value for our stakeholders that we believe is embedded in ICD.

So to close out my prepared remarks, I'm happy to say that I'm proud of where we are today. We're generating positive EBITDA again and delivering and expecting to continue to deliver very meaningful sequential improvements over the next several quarters. Given rig supply tightness, I believe there are existing opportunities for the company as the super-spec market continues to benefit from increased E&P demand for super-spec rigs.

We are expecting 2022 margins per day to be higher than what we were reporting pre-pandemic driven by improved 300 Series fleet mix and a more opportunistic contracting strategy and associated pricing. We believe we are in the very early innings of this up cycle, and we look forward to capitalizing on the opportunities in front of us.

With that, I'll turn the call back over to Philip, so he can walk us through the fourth quarter 2021 financial results for the company.

Philip Choyce

Thanks, Anthony. During the quarter, we reported an adjusted net loss of $13.2 million or $1.35 per share and adjusted EBITDA of $1.5 million. Reactivation cost expense during the quarter were negligible. We operated 15 average rigs during the quarter.

We expect utilization to increase sequentially by approximately 10% during the first quarter of '22 compared to our fourth quarter average which includes a few rigs transferring between customers. And as Anthony mentioned, we have reactivated our 17th rig and it began drilling mid-January.

Revenue per day came in at $19,042 per day, representing an 11% sequential increase. Cost per day of $15,504 was higher than guidance. Cost per day excludes approximately $400,000 of unabsorbed overhead costs.

Costs were impacted by higher labor costs, the field pay adjustments instituted during the back half of the quarter occurred, as well as a $343 per day Anthony mentioned, associated with the year-end incentive compensation accruals for our field-based managers.

Field pay now exceeds pre-COVID levels and we have reinstituted our field manager incentive structure for 2022. Obviously, wage inflation continues for ICD and our industry but as Anthony mentioned, we are able to more than fully offset these costs through our repricing and contractual provisions.

SG&A costs for the quarter were $3.9 million which included approximately $800,000 of stock-based and deferred compensation expense. During the quarter, cash payments for capital expenditures net of disposals were approximately $6.5 million.

There's approximately $4.5 million of CapEx accrued at quarter end, which we expect will flow through during the first quarter of 2022. Backlog of term contracts with original terms of at least 6 months at December 31, 2021, stood at $16.1 million, all of which expires in 2022.

In fact, 85% of it expires by the end of the second quarter. So we are well positioned to take advantage of dayrate momentum in an improving market. Obviously, our backlog is substantially below historical levels as most of our rigs are now operating on short term pad-to-pad contracts, which capitalizes on our view of a strong market.

Moving on to our balance sheet. At quarter end, we reported net debt, excluding finance leases and net of deferred financing costs of $136.3 million. This debt was comprised of our term loan and $6.3 million drawn on our revolver.

Finance leases reflected on our balance sheet at quarter end were approximately $5.8 million. During the quarter, we raised approximately $7.6 million under our ATM and equity line of credit programs at an average price of $3.39 per share. Our financial liquidity at quarter end was $27.3 million, comprised of $4.1 million of cash on hand, $11.3 million available under our revolving credit facility and $11.9 million under our term loan accordion.

We terminated our equity line of credit agreement prior to year-end. We did enter into a credit facility amendment that prevented us to pay our January 1 interest payment of approximately $3.2 million in kind through a reduction in drawdown in our available accordion balance.

Also subsequent to year-end, we raised another $3.6 million in proceeds through ATM offerings at an average price of $3.36 per share. I also want to comment on the noncash charge of approximately $18 million we reported as income tax expense during the quarter.

We reported in a corresponding deferred tax liability of approximately $18 million on our balance sheet as well. This charge relates to our 382 ownership change driven by a new large shareholder reporting early in the fourth quarter. The 382 limitation resulted in a loss of approximately $85 million of net operating loss carryforwards.

After giving effect to these losses, our NOL carryforwards at year-end stood at approximately $432 million, subject to annual use limitations. As a result of this change, we will now begin realizing tax benefits when we generate book losses. We expect tax expense will continue to be limited to state franchise tax items in 2022.

Now moving on to 2022 year-end and first quarter guidance. The fiscal year 2022 matters. Our capital budget for 2022 is $10 million. This is based upon operating a 17-rig fleet. Approximately $8 million relates to maintenance CapEx, around $1,200 per operating day, and the remaining $2 million relates to carryover costs relating to activation of our 17 rigs and discrete capital spare items.

As mentioned in our press release, there's approximately $4.5 million of 2021 CapEx accrued at year-end that will also flow through our cash flow statement during 2022. As Anthony highlighted, we likely won't begin to reactivate our 18th rig until we are able to successfully comprehensively address our existing term plan of debt, which we are actively working on.

Cash SG&A for the year is estimated to be approximately $15.5 million and then noncash SG&A expense will be approximately $3.5 million, with the caveat that most of noncash SG&A subject to variable accounting based upon the closing price for our common stock at the end of the applicable reporting period.

The increase in cash SG&A expense from 2021 primarily relates to return to pre-COVID pay, normalized incentive compensation accruals, which had lower during COVID and some salary adjustments due to a tightening labor market.

Depreciation expense for 2022 will be approximately $40 million. Now moving on to first quarter guidance. We expect operating days to approximate 1,485 days, representing a 16.5 average rigs working during the quarter.

This represents a 10% sequential increase in average rigs compared to the prior quarter. We have a couple of rigs moving between customers during the quarter. We expect margin per day to come in between $5,800 and $5,900 per day, representing an approximate 51% sequential increase at the midpoint of this range.

We expect revenue per day to come in between $21,600 and $21,700 per day with many of the dayrate increases on contract roles only partially benefiting the first quarter.

Cost per day is expected to range between $15,700 and $15,900 per day, sequentially higher as we absorb increases associated with pay increases instituted at the end of the fourth quarter. Anthony mentioned that significant margin and dayrate expansion is expected to continue into the second quarter.

Unabsorbed overhead expenses will be about $800,000 during the quarter and also are not included in our cost per day guidance. This includes approximately $200,000 of onetime costs associated with exiting a stacked yard that is no longer needed.

We expect first quarter cash SG&A expense to be approximately $4.3 million, with a sequential increase associated with return to pre-COVID pay and incentive comp levels, pay adjustments associated with the tightening labor market and seasonal increases in audit and other professional fees.

Stock-based compensation expense is expected to be approximately $1 million with the sequential increase being driven by variable accounting based on our closing stock price at the end of the reporting period.

We expect interest expense to be approximately $4 million and depreciation expense to be approximately $10 million. We expect tax expense to be a benefit of approximately $0.5 million. Capital expenditures, we expect approximately $7 million net of dispositions to flow through our cash flow statement during the first quarter. And this includes the $4.5 million of expenditures made in 2021 for which payment will occur this year.

And with that, I will turn the call back over to Anthony.

Anthony Gallegos

Thanks, Philip. Before I open up the call for questions, I'd like to quickly summarize the 3 key takeaways from our prepared remarks. One, the super-spec rig market is extremely tight. Two, because of our super-spec rig fleet, our target markets and our reputation, ICD is benefiting from this market tightness. And three, our outlook and goals for 2022 are reasonable and when attained, will allow ICD to achieve meaningful financial and operational improvements during 2022.

Operator, let's go ahead and open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Don Crist with Johnson Rice.

Don Crist

You talked a lot about the contracts and how many you're going to reprice this year. Can you just give us a sense of what your kind of contract duration is? Or if you want to talk about it in a different way? How many contracts will roll this year and how that could translate into higher pricing going forward?

Anthony Gallegos

Yes, Don, I appreciate the question. we've been intentional about our contracting strategy. As you know, rates went down quite a bit as a result of COVID.

We needed to get them back to somewhere more appropriate. It's tempting, as rates move up, especially in the range where we are now, to begin to maybe term up some rigs. But again, we've been very intentional about wanting to keep contract duration short so that, that gives us an opportunity to reprice more frequently.

And you're beginning to see the results of that flow through our financials, which is very important, first quarter. Our fourth quarter was progress. You're going to see even more here in the first and especially second quarter. But the average contract duration today for us is kind of pad to pad.

We've got a couple that are 6 months in duration, but you're just talking a very small number of the 17 contracts which we have. So to answer the question, it's pretty much pad to pad. We're expecting repricings here in the first half of the year.

We've done some of those here already through early March. We'll be repricing here in the second quarter, and then we expect at least 1 more repricing between now and the end of the year across the fleet.

Don Crist

I appreciate the color there. And can you give us just a sense as to what leading edge pricing is today? Isn't in that upper 20s yet?

Anthony Gallegos

Yes. We have 2 classes of rig that we market at ICD. All of our rigs are super spec. The 200 Series and the 300 Series rigs are our rigs. The 300 Series rigs certainly are being priced in the range that you're talking about.

We're seeing dayrates approaching 30, which I think you've heard some people talk about is with the adders, whether it be drill pipe, technology, things like that. For our 200 Series rigs, obviously, they're priced at a little bit less, 23.5 to 24 is a good baseline number for those rigs. But even for that class of rig, we see very high demand for it as well, especially one that's high. So that's pretty much the rate structure today, Don.

Don Crist

Okay. And on the labor side, obviously, labor has tightened all forms of industry, not just in the energy industry today. What is the ability or how are you passing that through? Is it just on the day rate side? Or do you have contractual arrangements to where you can pass through any kind of uplift that may be seen in the back half of the year on the labor side?

Anthony Gallegos

Yes. So our contracts have a wage escalation provision in them. Sometimes there's a minimum threshold that you have to exceed in order to put that to the contract -- put that to your customer.

But it's been my experience in my career, and it's certainly playing out in this current up cycle as well, that customers generally don't push back on that because just the human capital in the part -- in the role that it plays in what we do is so important, everybody recognizes the benefits of retention. And we just use the cost escalation provision in the contract. Where a contract is short in duration, then we would recover that in the repricing. And obviously, we want to have the increase in dayrate more than exceed the increase in cost because we're very focused here at ICD on increasing margin. So -- but that's the way it's addressed, Don.

Don Crist

Okay. And 1 final one for me. I mean, obviously, there’s been some movement on the ATM here. Can you give me a sense as to what share count, I should be using for the first quarter?

Anthony Gallegos

About 11, 11/3.

Operator

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

Anthony Gallegos

Thank you so much. We want to say thank you to everybody for dialing in today. As we’ve discussed, there are a lot of really good things happening at ICD. We worked hard over the last 18 months to get here, and we’re looking forward to the rest of this year and even the period beyond. None of this would be possible if not for our talented motivated employees. I want to thank them for their hard work and dedication.

So with that, we’ll sign off from Houston. Thank you, everyone.

Operator

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

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