Independence Contract Drilling, Inc. (NYSE:ICD) Q1 2022 Earnings Conference Call May 5, 2022 12:00 PM ET
Philip Choyce – Executive Vice President and Chief Financial Officer
Anthony Gallegos – President and Chief Executive Officer
Conference Call Participants
Don Crist – Johnson Rice
Good day and welcome to the Independence Contract Drilling, Incorporated First Quarter 2022 Financial Results and Conference Call. [Operator Instructions]
I would now like to turn the call over to Mr. Philip Choyce, Executive Vice President and Chief Financial Officer. Please go ahead.
Good morning, everyone and thank you for joining us today to discuss ICD’s first quarter 2022 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 our definitions of our non-GAAP measures.
And with that, I’ll turn it over to Anthony for opening remarks.
Hello, everyone. Philip will go through the details of our financial results for the first quarter of 2022 in a couple of minutes. Before that, I want to briefly discuss the very strong demand for our pad-optimal super-spec fleet. I want to describe how ICD is positioning itself so that we may continue to participate in and benefit from this upcycle. And I want to close by sharing a couple of recent contract awards, which I think illustrate the very positive effects of the transformation which ICD is undergoing, which benefits all of our stakeholders, including our employees, our customers and our stockholders.
First, just a few comments on the quarter. We reported revenue per day of $21,823 and margin per day of $5,754. This represented a 15% sequential increase in our revenue per day and a 63% increase in our margin per day compared to the fourth quarter of 2021. Overall, we reported adjusted EBITDA of $3.6 million, representing 146% sequential increase from the prior quarter. This is the third straight quarter we have reported meaningful sequential margin and EBITDA improvements, which illustrates the significant operating leverage in our business as we continue to navigate the current upcycle.
What I think is most impressive about these first quarter sequential improvements that we were able to achieve them even though we absorbed sequential labor increases of approximately $900 per day and had approximately 31 idle non-operating days associated with rigs transferring between customers, more idle days than we expected, which was primarily driven by trucking delays and relocating rigs. Most importantly, market conditions and demand for our pad-optimal super-spec rigs continue to improve rapidly, so I’m quite optimistic about continued meaningful sequential improvements in upcoming quarters.
For the second quarter, we’re forecasting 30% to 35% sequential increases in margin per day and based on the contracts we have in place today and a significant number of rigs that will re-rate again throughout the third quarter, we expect meaningful sequential growth in margin per day and adjusted EBITDA continuing during the back half of the year and into 2023. When I look forward, I believe we are in the early innings of the most constructive market for pad-optimal super-spec rigs we have seen, and there are several factors driving this dynamic, which make us quite excited about ICD’s future.
First, we remain constructive on oil and natural gas prices, commodity prices continue to strengthen during the first quarter as a result of several factors and ICD will continue to benefit from our particular commodity exposure as a consequence of the geographic positioning of our rigs. We remain laser-focused on what we believe are the two most important oil and natural gas basins in North America. That’s the Permian and the Haynesville. Through this market position, roughly two thirds of our rigs are targeting oil and one-third are targeting natural gas. We believe this to be the optimum split for our fleet at this time, and our concentration in two basins allows us to benefit from greater economies of scale and contributes to better rig margin and more meaningful free cash flow as this cycle continues to unfold.
Second, the market for pad-optimal super-spec rigs such as our ShaleDriller fleet is as tight as I’ve ever seen. For the most part, there are virtually no hot super-spec pad-optimal rigs available today. If an E&P operator wants an incremental super-spec rig, it will likely have to come out of stack and reactivation costs today are very significant. Unlike past cycles, we’re not seeing a flood of spending to reactivate rigs even though demand from our customers may be there. Capital discipline on the part of our customers, our competitors in our industry is vastly different compared to prior cycles, driven by limited capital markets, investor requirements, focusing on returns over growth and balance sheets that will not support a type [ph] of growth.
For the most part, contract drillers are not reactivating drilling rigs unless the day rates and contractual terms to provide adequate returns on capital and rapid payback of the incremental investments. But the market needs more pad-optimal super-spec rigs, and we expect the U.S. land rig count, in particular, in our target basins will continue to increase. This demand, coupled by industry capital discipline is driving day rates and margins higher at a pace not seen before.
Today, leading-edge spot market day rates are above $30,000 for pad-optimal super-spec drilling rigs, but costs are higher. And even at these leading-edge day rates, we believe further day rate increases and longer tenor contracts will be necessary in order for contract drillers to make the necessary investments to reactivate additional rigs in the U.S. that the U.S. land market requires.
In terms of ICD’s marketing strategy, I expect our strategic decision to focus on short-term pad-to-pad contracts, which has been driving meaningful sequential margin improvements to really pay dividends over the remainder of 2022 and beyond. Right now, we do not have a single contract with a term extending past mid-October of this year. What that means is all of our rigs will be repriced during our customers’ normal annual budgeting season, and our entire fleet should rerate to at least current market day rates by the fourth quarter of this year.
And with our term loan refinancing now behind us, we have recommenced our rig reactivation program with our 18th rig scheduled to enter the market early to mid-July, with two additional rigs to follow later in 2022. All three of these rigs are 300 series rigs, which are in the shortest supply and command the highest day rates and demand for these types of rigs remains very strong. Reactivation costs for these three rigs should range between $3.5 million and $4.5 million, and we will achieve simple payback periods of less than one year on these investments.
Moving forward, with the day rate margin expansion we are anticipating, I expect, we will begin evaluating opportunities with our customers to begin adding term coverage to our contract portfolio as we navigate the second half of 2022 and beyond. All this sets up very nicely for ICD. With the market we see in front of us, we are expecting meaningful free cash flow generation that we can use to not only fund future rig reactivations with very attractive returns and paybacks, but also decrease our net debt position over time and substantially reduce and normalize our overall debt-to-EBITDA ratios.
Of course, while the market and demand for our contract drilling services continues to improve, there are headwinds that ICD and our industry must continue to address. The labor market is tight, as tight as we’ve ever seen it. Competition for people exist not only within our industry, but with other industries as well. This is particularly acute for the entry-level position. Also, supply chain challenges exist as the global economies continue to recover from the pandemic and its effects. Philip will go through more of the details, but we are making some investments to ensure the critical spares needed to support our business are available.
In spite of all these challenges, our operating teams and personnel are doing a fantastic job as we strive every day to provide the safest and most reliable contract drilling services in the U.S. contract drilling industry.
As I close out this portion of my prepared remarks, I want to highlight that it’s not just our day rate and margins that are improving, performance of our rigs remains strong, whether the metric is safety, downtime, rig move times or days versus depth, and that is reflected in our evolving customer mix.
Two highlights I’d like to share include a couple of recent contract awards. We have recently commenced a contract involving a 300 series rig with one of the Permian’s very largest, most active public independent operators, a very demanding and well-respected customer that we have not previously had the opportunity to work with. We also believe this customer will be an attractive candidate for additional 300 series rig additions. And on the ESG front, we’re very proud that we were selected by a current customer, one of the largest international E&Ps in the world to drill their pilot carbon capture well program here in the lower 48.
Selection of ICD for this high-profile project over our larger public competitors is further validation of the quality of our equipment, the professionalism of our drilling and support teams and reflects the confidence our customers have in ICD to do everything we can to exceed their expectations while providing the safest and most efficient contract drilling services possible.
I’ll make some additional concluding remarks, but right now, I’d like to turn the call over to Philip to discuss financial results and the outlook in a little bit more detail.
Thanks, Anthony. During the quarter, we reported an adjusted net loss of $11.2 million or $0.99 per share and adjusted EBITDA of $3.6 million. Reactivation cost expense during the quarter were negligible. We operated 16.30 average rigs during the quarter. We expect utilization to be relatively flat during the second quarter but gets to improve again as reactivated rig in our fleet beginning in the third quarter.
Revenue per day came in at $21,823, representing a 14.6% sequential increase. Cost per day of $16,069 was a little higher than guidance. Sequential increases were expected based upon field pay increases instituted at the end of 2021. However, cost per day metrics were impacted by fewer operating days associated with longer transition time for a couple of rigs moving between customers, which was primarily the result of trucking delays.
SG&A costs for the quarter were $5.2 million, which included approximately $1 million of stock-based and deferred compensation expense, sequential increases in cash SG&A related to the reinstitution of pre-COVID pay as well as further compensation adjustments to address the tightening labor market as well as elevated recruiting and onboarding costs.
During the quarter, cash payments for capital expenditures net of disposals were approximately $5.7 million. This included $4.5 million relating to prior year deliveries. Breaking this CapEx out, approximately $3 million related to rig reactivations, $2.4 million related to maintenance CapEx and $300,000 related to investments in capital inventory and spares. There’s approximately $3.8 million of CapEx accrued at quarter end, which we expect will flow through during the second quarter of 2022.
We plan to reactivate three additional rigs by the end of 2022 at an aggregate cost of between $12.5 million and $13.5 million. We are increasing our 2022 annual CapEx budget from $10 million to $24 million to account for these rig reactivations as well as investments in capital spares we plan to bring forward into 2022 to mitigate supply retain risks and meet customer requirements.
Our backlog of term contracts are the original terms of at least six months at March 31 stood at $13.1 million, all of which expires in 2022. In fact, virtually all of it expires by the end of the third quarter of 2022. So, we are well positioned to take advantage of day rate momentum in an improving market and rerate our entire fleet by the beginning of the fourth quarter. 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, we completed the refinancing of our term loan in March, issuing $157.5 million of convertible notes. A small portion of this convertible debt balance is classified as a derivative liability for GAAP purposes. At quarter end, we reported net debt of $140.1 million net of deferred financing costs. This debt was comprised of the convertible notes and $7.8 million drawn on our revolver, but excluded finance leases. Finance leases reflected on our balance sheet at quarter end were approximately $5.2 million.
During the quarter, we raised approximately $3.6 million under our ATM program. Our financial liquidity at quarter end was $21.3 million, comprised of $9.3 million of cash on hand and $12 million available under our revolving credit facility. We also improved our working capital position as a result of the term loan financing with being approximately $6 million at quarter end, representing a $12 million sequential increase from the end of 2021.
Looking forward, we intend to further normalize working capital over the remainder of 2023 – 2022 through cash additions to the balance sheet. Q4, the cash flows and funding of our planned capital and rig reactivation program, Anthony discussed our forward outlook for meaningful expansion of day rates and margins and operating cash flows, which we anticipate, along with current liquidity will be sufficient to fund these investments.
Our convertible notes provides the flexibility to pick interest at our option. And while we are executing upon our rig reactivation program, we do expect to utilize this option unless additional more desirable capital sources come available to us.
Now, moving on to the second quarter guidance. We expect operating days to approximate 1,531 days, representing 16.8 average rigs working during the quarter. We expect margin per day to come in between $7,500 and $7,750 per day, representing an approximate 32.5% sequential increase at the endpoint of this range. We expect revenue per day to come in between $24,400, $24,500 per day with many of the day rate increases on contract rolls, only partially benefiting the second quarter. Cost per day is expected to increase $500 to $700 per day, sequentially higher as we incur investments associated with staffing and other costs for future rig reactivations in a very tight labor market.
Unabsorbed overhead expenses will be up $600,000 and are not included in our cost per day guidance. We expect second quarter cash SG&A expense to be approximately $4.1 million, stock-based compensation expense is expected to be approximately $1.1 million. We expect interest expense to be approximately $6.4 million and depreciation expense to be flat with the first quarter. Approximately $400,000 of anticipated interest expense will be cash based with the remainder related to amortization and deferred financing costs are related to interest on the convertible notes we expect to pay in time.
Under the terms of our convertible notes indenture, following expected approval of matters at our 2022 annual meeting in June, our PIK interest rate under the notes reduces substantially effects September 30 of this year. That would reduce our quarterly interest expense by approximately $1.8 million in the quarter compared to the second quarter guidance due to a lower interest rate becoming applicable.
For the second quarter, we expect tax expense to be a benefit of approximately $150,000, for capital expenditures we expect approximately $4.5 million net of dispositions before through our cash flow statements during the second quarter.
And with that, I will turn the call back over to Anthony.
Thanks, Philip. Before opening up the call for questions, I want to say that we’re pleased with ICDs strategic positioning in the current market environment. We have a strong win in our sales with very strong demand for our Pad-Optimal Super-Spec rigs. Our recent contract awards provide tangible evidence and increased confidence that the investments we’re making in our 300 series rigs, combined with our consolidated footprint and very good operational performance will generate strong returns on investment and cash flows. With our recent refinancing complete, we continue to position the company so that all of our stakeholders can continue to participate in this upcycle as we increase our margins, EBITDA and free cash flow. We expect all of this will enable us to reduce our net debt position and significantly improve leverage ratios as we move forward during the sub-cycle and untap the value embedded in ICD’s rig fleet and operations.
With that, let’s go ahead and open up the line for questions.
[Operator Instructions] First question comes from Don Crist of Johnson Rice. Please go ahead.
Good morning gentlemen. How are you all today?
We’re doing good. How are you Don?
I’m hanging in there, to best to know how. Obviously, the rig market is super tight right now, and you have short duration on your contracts. Can you talk about the delicate dance that all are doing with the E&Ps right now on term contracts? I’m sure that they want to term up rigs for next year and have that assured supply of a rig? Can you talk about where you all are thinking about that could shake out and when you could start adding some term contracts in the mix?
Sure. Don, at least for us, over the last couple of quarters, we’ve not had a lot of customers wanting to term up rigs. And of course, you know we’ve been very vocal in our position, given our outlook that we didn’t want to turn up rigs either. So I think it’s a little bit early. I think as we move through the calendar year and discussions in earnest began around 2023 programs. I think that’s where you’re going to see more customers. And frankly ourselves be more willing to talk about term.
We just believe with the market for our class of rigs being as tight as it is that there would be plenty of opportunity to continue to show day rate progression over this year. And I’m pleased to say at least through the first three months of the year, that’s the way that it’s played out. And of course, it’s our expectation that’s going to continue. So we’re not in a great big hurry. But day rates now, as you’ve heard in the remarks are starting – leading-edge rates are starting to start with the three. If you think about what that does in terms of security and things like that, I believe, as we move into the back half of this year, you’ll see ICD begin to put a little bit more backlog on the books and be willing to entertain those term types of discussions.
Okay. And obviously, CapEx is going up a touch here. Can you – can we dig into what spares you’re adding? Is that strings of pipe or kind of other large components that have a long lead time today that you’re trying to firm up to where you don’t have any potential issues in the future?
Yes. So part of it is drill pipe, as you mentioned. But also remember, supply chains across industries are stretched. I mean, whether it’s the person that provides us parts for our engines, our traction motors or things like that, Don, just given the way things are playing out there, we need to make sure that we have access to equipment that we need to keep our rigs running, keep downtime low, keep our customers happy. Philip did you...
Yes. The biggest part of it is drill pipe. There’s a lot of components of items that will inventory a little bit more than we had before. But it’s not necessarily new engines or something like that. It might be us overhauling an engine and spare and things like that. But the biggest thing as far as bringing new equipment forward is drill bite.
And what is the lead time for that today? Is it still in that nine month range? Or is it...
That’s probably – depends on what you’re ordering, but probably six to nine months.
Okay. And on one of your competitors, well, not really a competitor, Cactus, this morning talked about some lower-spec rigs expected to hit the market in the next six to nine months or so. Do you see the E&Ps kind of perpetuating here because of the limited availability of low specs or sorry, high-spec rigs and looking towards older rigs just to get things done. That was the first that I had heard this morning on that. Any insight on the market to E&P is going to lower spec rigs going forward?
No, I think – Don, I think – and we’re focused on U.S. unconventional, as you know. We don’t have a lot of exposure or opportunities to see into the particular markets that may be driving that type of commentary. If I had to guess, that’s probably a reflection of where oil and gas prices are, maybe there’s some conventional activity in basins outside of our two core markets that may be stimulating that sort of demand, that would be my guess, because we certainly – when we think about our target customers, the programs that our engineer, our rigs are engineered to prosecute, they require pad optimal rigs, rigs that can walk. They require super-spec capability, AC-driven equipment, 3/4 configuration in terms of mud pumps and generators and things. So we certainly have not had that put in front of us as another opportunity for our customers, but I think it’s probably a reflection of the markets where we compete.
Right. Okay. Good quarter. I appreciate the color. I look forward to catching up in about a month or so.
Thank you, Don. Thank you.
Thank you. Next question comes from John Daniels, Simmons [ph]. Please go ahead.
Good morning. John, how are you?
I’m surviving. I want to follow up to Don’s question just a little bit. But given just how tight the market is, I would have assumed that more E&P companies would be coming to you asking for term. I’m just curious why that might not be the case, your thoughts?
Yes. The market has moved really fast, John. I mean you know as well as I do, you just dial back three, four months ago what the outlook was, when you talk to people a lot of times the commentary around where the market was going, where it would be in a year from now was, but look at the strip, the 12-month strip for example. And as this year has played out, no one saw the geopolitical situation that erupted in February and the impact that’s had.
I think it’s a function of the market moving very fast. I think it’s the short-term focus on the part of customers. I think maybe there’s some surprise at how fast rates have moved and certainly where they are right now. I think those are reasons why neither party has been that interested in terming up rigs up to this point.
Did you have...
I think it’s also a function of how our customers – their capital discipline. They haven’t set their budgets for next year. So signing a term contract into that type of commitment. Maybe in the past, they were more willing to do that. I think they’re waiting more for their budgetary season. So I think there’s going to be more opportunities when that happens.
Okay. And this is sort of a confrontational question, so forgive me in advance, but just trying to get your thought. But if this is sometimes a tough business where customers beat on you when things get soft and vice versa. So I’m just – I really want to hear your thoughts on this, but it would seem to be an existing customer would want to keep a high-performing hot rig, which you have, right? And assuming that’s the case, which I’m sure it is, I mean, why not take a more aggressive approach with respect to contract renewals? And I understand the need, there’ll be a customer service business. I have my own. I’m just – I want to hear your thoughts. That’s all.
Yes. So John, I think we have, not just ICD, but the industry has taken a much more aggressive approach. I assume you’re referring to pricing.
Well, I mean, clearly, yes, I mean, we’ve definitely seen it on price. And the industry has done a great job. But now that you’re getting the price and margins are expanding nicely, just why not sit down, just making this up I’m not trying – again, not trying to be a jerk but like why don’t you say the customer, hey, if you want to keep this rig that’s going to mature in October, you need to sign up right now for another 12 months today. So that when you have now a firm backlog of much more duration. Just your thoughts. I don’t need to...
Yes. No. Because up until now, John, we’ve not wanted a 12-month term contract, day rates, right? We think there’s further headroom and where rates are going to go. I think we’re breaching the $30,000 a day mark now on a spot market, leading-edge day rate basis. And I think that’s going to look and feel a lot like when we went through 2020. There’s a psychological kind of barrier that’s there. It’s taken a little time, I think, for people to get their head around that. But I don’t think it stops there either. So I would just submit that we’ve not wanted term contracts up until now.
Fair enough. Thank you for indulging me and it’s remarkable to see the change in performance. So, congrats.
No problem John. Thanks for your question.
Thank you. This concludes our question-and-answer session. I’d now like to turn the call back over to Mr. Anthony Gallegos for closing remarks.
Okay. Well, thank you very much. Guys, we’d like to say thank you to everybody for participating in today’s call. I certainly want to wish everyone a safe and productive day. And with that, we’ll sign off from Houston. Thank you.
Conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.