Independence Contract Drilling, Inc. (NYSE:ICD) Q1 2023 Earnings Call Transcript May 12, 2023

Operator: Good day and welcome to the Independence Contract Drilling Inc. first quarter 2023 financial results conference call. [Operator Instructions]. 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 first quarter 2023 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 a full reconciliation of net income to adjusted net income, 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: Hello, everyone, and thank you for joining us for our first quarter 2023 earnings conference call. During my prepared remarks today, I want to talk about four items. First, I want to highlight our first quarter 2023 results; second, I want to talk about the current market for super spec pad-optimal rigs; third, I want to update you on the transition efforts around our Haynesville fleet; and I want to close out with how all of this is impacting ICD from a financial perspective and where our focus will be. But first, just a few comments on the quarter. Overall, ICD’s first quarter results came in ahead of expectations in terms of adjusted net income, revenues, margin per day, and adjusted EBITDA. Philip will go through the detail, but I want to point out that our reported revenue per day, margin per day, and quarterly adjusted EBITDA were again, all records for ICD.

This is the third quarter in a row we produced record results in one or more of these areas and provides another data point regarding ICD’s operating and financial transformation since exiting the pandemic. Overall, adjusted net income came in at $2.4 million, buoyed by sequential margin per day improvements of 8% that drove sequential improvements in adjusted EBITDA of 16%. In addition to being a record quarter financially, the end of the first quarter also marks an important pivotal milestone and transition for ICD when it comes to strategic focus and capital allocation priorities. Since August of 2020, our focus in capital allocation decisions were driven by the need to increase operating scale. As signaled in our last conference call, the delivery of our 21st rig will be the last rig we reactivate until market conditions improve, which means meaningfully reducing our overall net debt and related financial ratios will be our highest priority from a strategic and capital allocation perspective.

In fact, we improved our net working capital position by $11.7 million, and as of today, we have already repaid $3 million of revolver debt since the end of the first quarter. And we’ll look to steadily reduce net debt going forward. Philip will go through more details in his prepared remarks regarding our plans around this very important initiative for ICD and our stockholders. Now, turning to the market. In terms of the overall market and outlook for pad-optimal super spec rigs in our target markets of Texas and the contiguous states, demand for pad-optimal super spec rigs remains strong in the Permian Basin. While the overall Baker Hughes rig count for US land shows a rig reduction since the end of the fourth quarter 2022, most of that reduction occurred in unconventional oil basins outside of the Permian.

In fact, the Permian Basin added rigs since beginning of the year, while the Haynesville has seen a drop. But there will be more rig count reductions coming in the Haynesville, which I’ll address in a minute. We are witnessing some churn in the Permian rig market. And what we’re seeing is lower spec rigs, including some AC rigs being replaced with higher specification AC rigs being made available by some Permian and Eagle Ford E&Ps trimming the rig count or being displaced by higher specification rigs relocating into the basin from the Haynesville and other basins. As a consequence, we are seeing a little more rig-on-rig competition where rig additions are occurring or a rig replacement opportunity exists. As we indicated last quarter, we expected to see dayrate momentum slow, and that expectation is playing out.

While margin per day remains robust, we expect it will flatten for the next few quarters and could be choppy for us during the second and third quarters, in particular on the cost line as rigs transition from the Haynesville to the Permian. Still not a bad situation for ICD, given current levels and what those levels will allow us to do in terms of pursuing our corporate goals around deleveraging. We remain optimistic about market momentum accelerating again in the back part of the year, primarily in the Permian, based on our expectation that WTI will remain elevated in the back half of 2023 rolling into 2024. We believe the Haynesville rig market will remain challenging for at least the rest of this year. In spite of the choppiness in the Permian rig market, I mentioned earlier that we were successful in securing a contract for our 21st operating rig which went to work in the Permian Basin early in the second quarter.

This 21st rig was a reactivation project that we started back in October of last year and would be our last reactivation for a while. Like our other 300 Series rigs, this rig brings to bear the technical capabilities that our target customers prefer today, including being super spec, pad-optimal, three by four mud pump to generator configuration, and enhanced setback and racking capacity. The rig went to work for an existing customer, which happens to be one of the largest private E&P companies operating in the Permian Basin. Now, I’d like to provide a quick update regarding the transition efforts involving our Haynesville rig fleet. During our last earnings call, I described what we expected the impact of low natural gas prices would be in the Haynesville drilling rig market.

For reference, natural gas prices had declined significantly in the prior couple of quarters, and we were anticipating a significant decline in the number of working rigs in the Haynesville as E&P companies scaled back drilling activities, aligning to an oversupplied US natural gas market. You can see that reduction has commenced in earnest here in the second quarter as drilling contractors are finishing up the pads that they were on during the first quarter when those rig count trimming decisions were made by Haynesville E&P companies. ICD started 2023 with approximately 50% of our working fleet, 10 rigs deployed in the Haynesville market. And for us, the decision to relocate rigs from the Haynesville to the Permian was obvious. In response to the impending Haynesville rig count decline on our prior earnings call, we set forth our plans to relocate a portion of our Haynesville rig fleet to the Permian Basin with a goal to reach effective utilization of 21 operating rigs by the end of the year following this rebalancing.

At that time, we estimated relocation costs could range between $3 million to $4 million. Today, I’m pleased to report that we remain on schedule to achieve these goals with the caveat that we are still in the early stages of the process right now. And we have seen some recent choppiness in oil prices, which, if this trend continues, could slow the pace of ICD reaching 21 operating rigs by the end of the . Two rigs have already been relocated and are drilling in the Permian with minimal transitional idle time and I’m pleased that our out-of-pocket transition costs for both of these rigs were primarily absorbed by our customers. Three additional rigs have been physically relocated. Out-of-pocket trucking costs for these relocations also were not material and below our budgeted estimates.

One of these three rigs is earning early term revenue and we would not expect it to recommence operations until the third quarter, while we are marketing the other two rigs into opportunities with customers who currently plan for late May and mid-June start dates. Overall, we believe market demand and strength in the Permian for pad-optimal super-spec rigs as well as our customer base will be strong enough to absorb rig additions to the basin. That leaves us with five rigs remaining in the Haynesville at this time. For those rigs, as of today, we have successfully re-contracted or signed extensions for two rigs which had contract expirations occurring during the first quarter or early second quarter. For the other three rigs, which we have contract terms extending in the third and fourth quarters, we expect those rigs to continue operating or earning standby revenue during their terms depending on customer requirements.

Depending on market conditions in the Haynesville later this year, any of these rigs also could be candidates to move west depending on the interplay between the two rig markets. The big picture, we’re on track with our rig relocation plans and overall transition costs are coming in better than expected at this time. Again, we are still in the early process, but we feel confident in our outlook so long as oil prices remain constructive. I am pleased that today all of our strategic and financial goals around generating significant free cash flow and reducing overall leverage remain intact. We expect 2023 to be a record year for ICD from a revenue per day, margin per day, EBITDA, and free cash flow perspective. I’m excited that in the near term, our free cash flow and net debt reduction plans have commenced and will accelerate as we improve our working capital position by paying down debt and putting cash on the balance sheet as we slow our capital investments and additional rig reactivations.

Strategically, we remain laser focused on creating a pathway toward generating free cash flow and steadily decreasing our net debt position as we move towards the refinancing window for our convertible notes. In fact, here in the second quarter, we must offer to repurchase $5 million worth of our convertible notes at par. The offer is at the lender’s option, so if they don’t accept that offer, the cash will remain on our balance sheet. Overall, we must make offers over the next seven quarters, which, if accepted by our lenders, will total $15 million over the balance of 2023 and $14 million in 2024. In addition, depending upon market conditions, we may also be in a position to stop picking interest sooner than we’ve previously indicated, which also is likely dependent upon the elections of our lenders relating to the mandatory offers I just outlined.

As we have discussed, one of our long-term goals is to reduce our net debt to adjusted EBITDA ratio meaningfully towards a range of less than 1 to 1.5 times during the refinancing window involving our convertible notes which begins in early 2025. For reference, we are currently 2.27 times levered on an annualized basis using our first quarter results, which, even with the completion of rig reactivation CapEx and seasonal first quarter working capital investments, represented an improvement over the same metric of 2.5 times at year end. As I mentioned earlier, we’ve already begun the process of paying down debt. Everything’s in place for ICD to achieve its short and long-term financial and strategic goals. Before I hand the call over to Philip, as I’m sure everyone is aware Danny McNease retired from our Board a few weeks ago, I wanted to thank Danny for his many years of service to ICD’s board.

I’ll make some additional concluding remarks, but right now, I want to turn the call over to Philip to discuss our financial results and outlook in a little more detail.

Philip Choyce: Thanks, Anthony. During the quarter, we reported an adjusted net income of $2.4 million or $0.14 per fully diluted share and adjusted EBITDA of $21.4 million. We operated 19.4 average rigs during the quarter. Our 21st rig commenced operations early April and did not benefit the quarter. Revenue per day during the quarter was $34,870 and margin per day was $15,665, all sequential improvements. Cost per day of $19,205 increased sequentially, primarily due to higher R&M expense. First quarter costs also include seasonal increases for payroll taxes. In the quarter, we incurred $600,000 of unreimbursed costs related to our Haynesville to Permian relocation program, which are excluded from our cost per day metrics. Selling, general and administrative costs were $6.7 million during the quarter, which included approximately $1.8 million of stock-based and deferred compensation expense, sequential decreases in cash SG&A over the fourth quarter primarily relate to lower incentive compensation accruals compared to the prior quarter.

Interest expense during the quarter aggregated $8.7 million. This included $2.4 million associated with non-cash amortization of deferred issuance and debt discount, which we’ve excluded when presenting adjusted net income. We paid accrued interest on our convertible notes in-kind at the end of the quarter. Tax benefit for the quarter was de minimis. During the quarter, cash payments for capital expenditures net of disposals was approximately $18.1 million, approximately $16.2 million related to payment of prior year CapEx accrued at year end. Breaking these cash payments out, approximately 75% related to rig reactivations and 200 to 300 Series conversions, which included payments associated with our 20th rig, which has commenced operations in late December; as well as our 21st rig, which we completed during the quarter; 20% related to maintenance CapEx; and 5% related to investments in drill pipe, capital inventory, and spares.

As Anthony mentioned, we have paused our rig reactivation program. So for the time being, going forward, CapEx will principally relate to maintenance CapEx and tubular purchases. Overall, we have not adjusted our CapEx budget for 2023, which was front-end weighted. As Anthony mentioned, we currently remain on schedule with our rig relocation program and currently do not expect any major adjustment to our rig operating assumptions for the year that would impact our maintenance CapEx assumptions. Moving onto our balance sheet, from a working capital perspective in addition to payments on prior year CapEx deliveries, our first quarter balance sheet reflects the normal seasonal impacts from the payments of year-end incentive compensation, ad valorem taxes, and related payments.

Those payments aggregated $5.5 million during the quarter. And overall, as a result of these payments and the payments on the CapEx, net working capital increased approximately $11.7 million during the quarter. Adjusted net debt at quarter end was $194 million. This amount represents the face amount of our convertible notes and borrowings under our ABL net of cash and ignores impacts from debt discounts, deferred financing costs, and finance leases. As Anthony mentioned, following reactivation of our 21st rig, our capital allocation focus has now pivoted away from reactivations towards debt reduction. And since quarter end, we have already paid down $3 million of debt. Financial liquidity at quarter end was $22.1 million, comprised of cash on hand and $15.4 million of availability on our revolving credit facility.

And this is in addition to the working capital improvement I just mentioned. Now, moving on to second quarter guidance. The operating days were approximate 1,632 days, representing 17.9 average rigs earning revenue during the quarter, which assumes several of our recently idle rigs commence operations late May to mid-June on contracted opportunities we are currently pursuing. Those projects slid to the right or did not materialize. Exposure to the quarter was approximately 60 operating days. We expect margin per day to come in generally flat with the first quarter but with some cost inefficiencies associated with higher contractual churn, given the number of rigs moving between basins. And overall, we estimate margins come in between $15,000 and $15,500 per day.

Unabsorbed overhead expenses will be about $600,000 during the quarter and also not included in our cost per day guidance. And then unreimbursed costs associated with our Haynesville to Permian relocation program are expected to be approximately $2 million during the quarter and are not included in our cost per day guidance. We expect second-quarter cash SG&A expense to be approximately $5 million and stock-based compensation expense to be approximately $1.9 million. We expect interest expense to be approximately $9.8 million; of this amount, approximately $2.6 million relate to non-cash amortization of deferred financing costs and debt discounts. And depreciation expense for the second quarter is expected to be relatively flat with the first quarter.

And finally, we expect tax expense to be de minimis for the second quarter. And with that, I will turn the call back over to Anthony.

Anthony Gallegos: Thanks, Philip. Before opening up the call for questions, I want to briefly summarize ICD’s strategic positioning and what it all means for ICD’s stockholders. Here are a couple of points for you to consider. First, our utilization and margin growth since August of 2020 has been best-in-class. This speaks to the quality of our people, our assets, and our performance. Also, today, our daily rig margins are the best in ICD’s history and on par with, and exceeding, some of our larger company peers as we continue to earn recognition from our customers for industry-leading customer service and professionalism. The company has never performed better, and I believe all of this will be on display over the remainder of 2023 as we navigate transitioning a large part of our rig fleet from the Haynesville to the Permian.

Second, we have the youngest and we believe best-in-class rig fleet. The market for pad-optimal super-spec rigs remains strong outside of the gas driven basis. We continue to demonstrate our fiscal discipline by deferring further investments and additional reactivations beyond the 21st rig, which came out early second quarter. And finally, we have substantially improved our liquidity and balance sheet and expect continued progress as we move through 2023 and beyond. Although softness in gas drilling markets will impact the pace of rig reactivations and is requiring us to reposition some rigs, ICD has never been in a better position to navigate these types of short-term challenges. Our operational strength and reputation with our customers has never been stronger, our fleet, which has been transformed by the market penetration of our 300 Series rigs, has never been more valuable.

I’d like to thank our many operations, support, and corporate team members, which work hard every day to deliver high levels of safety, performance, customer service, and professionalism, which our customers expect from ICD. With that, operator, let’s go ahead and open up the line for questions.

Q&A Session

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

Operator: Our next question comes from Steve Ferazani with Sidoti.

Operator: Our next question comes from Dave Storms with Stonegate Capital Markets.

Operator: Our next question comes from David Marsh with Singular.

Operator: Our next question comes from Dick Ryan with Oak Ridge Financial.

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: We just want to say thank you to everybody for making time to hear our first quarter 2023 earnings call. I do wish you all safety and prosperity and look forward to talking to you again soon. Thank you.

Operator: The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.