Independence Contract Drilling, Inc. (NYSE:ICD) Q2 2023 Earnings Call Transcript

Independence Contract Drilling, Inc. (NYSE:ICD) Q2 2023 Earnings Call Transcript August 6, 2023

Operator: Good day and welcome to the Independence Contract Drilling Second Quarter 2023 Financial Results Conference Call. [Operator Instructions] Please note today’s event is being recorded. I would now like to turn the conference over to Philip Choyce, EVP and CFO. Please go ahead.

Philip Choyce: Good morning, everyone and thank you for joining us today to discuss ICD’s second 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 our full reconciliation of net income and loss to adjusted net income and loss, EBITDA and adjusted EBITDA and for definitions of our non-GAAP measures.

And with that, I’ll turn it over to Anthony for opening remarks.

Anthony Gallegos: Hello, everyone. Thank you for joining us for our second quarter 2023 earnings conference call. During my prepared remarks today, I want to talk about the following. First, I want to highlight some significant steps we took during the second quarter toward important strategic initiatives. Second, I want to update you on the transition efforts around our Haynesville fleet, which is essentially complete. Third, I want to talk about the current market for super spec, pad-optimal rigs and how ICD is performing. Lastly, I want to close out talking about some things we’re doing to position ICD for the future. First, just a few comments on the quarter. Overall, ICD’s second quarter results came in ahead of expectations in terms of revenues, margin per day and adjusted EBITDA.

I’m particularly pleased with how reported margin per day held up in the face of market headwinds driven primarily with our Haynesville market, buoyed by a sequential improvement in reported cost per day. Overall adjusted EBITDA came in at $18.7 million. During the second quarter, we took the first step in the most important strategic initiative for our company, which is de-levering our balance sheet. I feel this way because in addition to delivering industry-leading service and professionalism to our customers, reducing the debt level of our company is the most impactful action we can undertake. During the quarter, we redeemed $5 million of convertible notes at par and also reduced revolver borrowings, while at the same time improving our net working capital position.

I’m pleased that we were in a position for our lenders to accept our offer to redeem $5 million of our convertible notes at par at the end of the second quarter. Also during the second quarter, we essentially completed our fleet geographic rebalancing process. As a reminder, ICD started 2023 with 10 rigs working in the Haynesville market and 10 rigs working in the Permian. We were more levered than any other drilling contractor to the Haynesville. And in light of the softening we saw earlier this year, we made the decision to relocate several rigs from the Haynesville to the Permian. The choppier Permian market we experienced in the second quarter impacted the pace at which we were able to recontract ICD rigs relocated from the Haynesville.

As of today, we have 4 rigs remaining in the Haynesville, and 3 of those are currently contracted. Although it is possible that we relocate additional rigs from the Haynesville, depending on how the markets develop over the next 12 months. For the time being, our rig transition program is complete. Overall transition costs, including trucking and crew transition costs, totaled approximately $2.8 million during the second quarter and $3.4 million in aggregate, below our initial estimates of $4 million total. Now turning to market conditions in our target markets. The overall U.S. land rig count is down 105 rigs year-to-date through the end of the second quarter. Although the Permian market has remained strong, consistent with our expectations at the beginning of this year, we have seen some softness resulting in an overall Permian rig count decline of about 11 rigs caused by weaker commodity prices early in the second quarter and the recent banking issues.

These factors resulted in some reshuffling of rigs by E&P operators and more rig-on-rig competition. In spite of all this, ICD increased its Permian contracted rig count by 20% year-to-date in the base of numerous competitive pressures. I think that speaks to the quality of our people and equipment and our strong brand. We remain optimistic about market momentum reaccelerating in the back part of this year, primarily in the Permian, based on recent moves in commodity prices, our customers having better access to credit, current customer inquiries and discussions we are having and our expectation that WTI will continue to strengthen in the back half of 2023, rolling into 2024. I also think the effects of recharged E&P capital budgets next year will provide additional boost to our Permian market.

While we expect some rigs to go back to work in Haynesville, we believe that gas-driven gas markets will remain a challenge for at least the rest of this year. We have, however, seen inquiries for work in the Haynesville pickup over the last couple of weeks. In addition, permitting activity for the Permian in June increased 25% month-to-month, and overall permits for U.S. land year to date compared to 2022 were up slightly in spite of the softer commodity price we saw early second quarter. Based on all this, we believe the U.S. land rig count is finding a bottom as we speak and will begin increasing in the coming months. On the day rate front, current leading edge super-spec day rates in the Permian are coalescing in the low- to mid-$30,000 range, including adders.

Right now, there are minimal data points for spot day rates in the Haynesville, but I would expect they are just a little bit lower, maybe $1,000 to $2,000 a day, compared to the Permian. In terms of enhancing our fleet, we are planning some 200 to 300 series conversions in the back half of this year, one of which is in process in connection with a contract extension into mid-2024, which we just executed for a rig working in the Permian Basin at a mid $30,000 a day rate, including the adders. In this arena, we are seeing customer interest in high torque top drives, iron roughnecks and drill strings increase as a function of E&P’s increasing well lateral lengths and their unrelenting focus on drilling efficiencies. These are trends we expect will continue, and our investors should feel good knowing that the majority of our working rigs already have these capabilities embedded and the rest can be outfitted to have these capabilities with very modest amounts of CapEx. As I close out my prepared remarks, I want to mention our efforts regarding our technology rollout, which we call ICD Impact, which accelerated during the second quarter.

Our strategy in this arena has been to leverage ICD’s youngest rig fleet in the industry and the years of effort and investment made by our third-party partners by working with their professionals, collaborating with our customers and applying the knowledge, skills and insight of our employees. We have technology systems deployed on approximately 30% of our active rigs today with objectives to improve this percentage over time as customer demand warrants. We are excited about what ICD Impact means for our customers and other stakeholders going forward. I’ll make some additional concluding remarks before opening the call up for questions. But right now, I’d like to turn the call over to Philip to discuss our financial results and outlook in a little more detail.

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Philip Choyce: Thanks, Anthony. During the quarter, we reported an adjusted net loss of $1 million or $0.07 per share and adjusted EBITDA of $18.7 million. We operated 15 average rigs during the quarter. This excludes 2 average rigs earning revenue on an early termination basis during the quarter, and early termination of revenues during the quarter were $5.1 million. Moving on to our per day statistics. These statistics exclude both the early termination revenues and transition expenses. Although we had a number of rigs moving between customers and locations and our overall operating days fell by an average of 4.4 rigs compared to Q1, we are pleased we saw only minimal degradation in our revenue, cost and margin per day statistics.

Revenue per day during the quarter was $34,467, representing a slight decrease from the first quarter. Cost per day during the quarter was $19,005 representing sequential improvement. Overall margin per day was $15,462, representing only 1% sequential decline compared to the first quarter. SG&A cost were $5.2 million during the quarter, which included $1.3 million of stock-based and deferred compensation expense. These costs declined sequentially by 22% overall. Breaking out the components cash SG&A expenses decreased sequentially by 21% compared to Q1 due to lower incentive compensation accruals and cost-cutting efforts implemented during the quarter. Non-cash stock-based compensation expense also decreased sequentially in this case by 27% due to the effect of a lower quarter and stock price and variable accounting on performance-based stock awards.

Interest expense during the quarter aggregated $8.3 million. This included $1.2 million associated with non-cash amortization of debt discount and deferred issuance costs, which we excluded when presenting adjusted net income. Tax benefit for the quarter was de minimis. During the quarter, cash payments for capital expenditures net of disposals were approximately $11.5 million. This includes final payments of capital expenditures on our rig reactivation program, including our 21st rig that reactivated at the beginning of the quarter. There’s approximately $5.1 million of CapEx accrued in accounts payable at quarter end. Breaking out our $11.5 million cash payments on CapEx during the quarter, approximately 53% related to rig reactivations and 200 Series to 300 Series conversions, 35% related to maintenance CapEx and 12% related to investment in drill pipe capital inventory and spares.

For the remainder of the year, so when we move towards 18 or so working rigs by year-end, we expect capital expenditures during the back half of the year to aggregate approximately $9.5 million, which assumes 200 to 300 series conversions and approximately $1.5 million in tubular purchases. Moving on to our balance sheet. As Anthony mentioned, our strategic focus has shifted from rig reactivations to overall debt reduction. This also includes steady improvements in our working capital position as well. We made progress towards both of these goals during the quarter. We repaid $5 million of convertible notes at par and also reduced revolver borrowings by $5.3 million during the quarter. We were able to do this while slightly improving our net working capital position as well.

Adjusted net debt at quarter end was approximately $191.2 million, also a decrease from March. I want to point out our adjusted net debt statistics include accrued interest we have elected to pay in kind on September 30 of this year. Our financial liquidity at quarter end was $19.1 million, comprised of cash on hand of $5.6 million and $13.5 million of availability on our revolving line of credit. This is in addition to the net working capital improvement I just mentioned. Now moving on to third quarter guidance. We expect operating days to approximately 1,240 days to 1,250 days, representing approximately 13.5 average rigs earning revenue during the quarter. This excludes rigs earning revenue on an early termination basis, which will be minimal during the third quarter.

Net margin per day to come in between $14,250 and $14,750 with the sequential decline relating to lower day rates on contract renewals. We also expect some sequential cost inefficiencies during the quarter associated with the lower operating days and reduced operating days. From a contract mix standpoint, the vast majority of our rigs are now operating on short-term pad-to-pad contracts and reflect the current day rate environment. For example, during the third quarter, we expect only 25% to 30% of our revenue days to be earned on contracts that were entered into prior to March 31 of this year. Unabsorbed overhead expenses will be about $600,000 and also are not included in our cost per day guidance. And as Anthony mentioned, our Haynesville to Permian transition program is complete.

We do not expect to incur any transition expenses during the third quarter. We expect third quarter cash SG&A expense to be approximately $4.3 million, with a small sequential increase primarily tied to expected increases in recruiting and onboarding costs as we begin staffing up for expected reactivations in late third quarter and early fourth quarter. Stock-based compensation expense is expected to be approximately $1.9 million, assuming no material changes to our stock price as of today that would further impact variable awards. We expect interest expense to be approximately $9.5 million. And of this amount, approximately $2.4 million were related to non-cash amortization of debt discount and deferred financing costs. Depreciation expense for the third quarter is expected to be flat with the second quarter.

We expect tax benefit to be flat with the second quarter. With that, I will turn the call back over to Anthony.

Anthony Gallegos: Thanks, Philip. Before opening the call up for questions, I want to briefly summarize where we are as we enter the second half of 2023. While this may not be the year that we thought it would be, 2023 is proving to be a very important year for ICD. Initiating our efforts to de-lever our balance sheet, repositioning our rigs to a more appropriate geographic positioning and balance and executing on our technology pathway are all very strategic initiatives, which are happening. And these initiatives will provide value to the stockholders, customers and employees of ICD in the coming years. I would like to thank our many operations, support and corporate team members who work hard every day to deliver high levels of safety performance, customer service and professionalism, which our customers expect from ICD in which we expect of ourselves. With that, operator, let’s go ahead and open up the line for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Don Crist with Johnson Rice. Please go ahead.

Don Crist: Good morning, gentleman. How are you all today?

Anthony Gallegos: Doing good.

Don Crist: I wanted to explore the topic of adding rigs back in late third quarter, fourth quarter and possibly into ‘24. We have heard several anecdotes from other companies and just wanted to get your take on what gives you confidence. Are there significant tenders that are out there today or are they just conversations today?

Anthony Gallegos: Certainly, Don, the nature of the discussions with customers has changed over the last couple of months. I think, obviously, strengthening commodity prices helped the macro picture in the U.S. And what’s happening there, I think it helped. I think those things along with some others have given some customers some confidence that they can step back in and add. Just to give you a little transparency, we are not – not doing a lot of work today for the super majors. We do work for the independents and we do a lot of work for privates as well. And it’s in that last bucket where we have probably seen the most change over the last couple of months with the private E&Ps. Remember also they were the first ones about a year ago to start laying down rigs. They kind of sat on the sidelines in the last few quarters. And I think as we look out over the third and fourth quarter for us at least, that’s where we see opportunities to bring rigs up.

Don Crist: And just to take that a step further in the Haynesville, are you getting into conversations now given that the ‘24 strip is over $3 to actually add some rigs back in the Haynesville? I know that’s not going to be a priority since you moved a lot of rigs out of the area. But is that market starting to see some tightening versus loosening over the past several quarters?

Philip Choyce: Yes. Certainly, over the last couple of weeks, Don, again, those discussions have also picked up as well. We bottomed out at 2 of the 4 rigs that we had earning revenue there. We are at 3 today, pretty optimistic. The fourth one will go back to work before we talk to you guys again. And the rig count over there has bottomed out at around 44 rigs. That’s down from mid-70s, so quite a drop. Strip has moved. I was looking at it earlier this week, and you look out past October this year, it’s above $3. And in January, it’s over $3.70. And that – what we hear from customers is $3.25, $3.5, they are thinking about growing. And we are pretty optimistic about being able to put that fourth rig to work probably in the third quarter.

Don Crist: I appreciate that color. And just one final one for me. On the conversions, are those customer-driven conversions from 200 Series to 300 Series and how many more of those do you think you could do over the next several quarters?

Anthony Gallegos: Yes. It’s been great. I am really proud that we were able to sign the second one up. In both of the instances, they were customers that were using our 200 Series rigs, doing a great job for them. Obviously, they were very happy. Our customers would like maximum flexibility as they look out over the coming quarters and coming years to be able to take a rig and work across the spectrum of projects which they have. So in both cases, the operators, customers were very supportive of the conversion to 300 Series capability. And I would point out, in both cases, we were able to – we are going to earn a premium day rate relative to what that rig would have earned had we not converted it. So, this will be the second one, that’s in motion as we speak.