Independence Contract Drilling, Inc.

Independence Contract Drilling, Inc.

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Independence Contract Drilling, Inc. (ICD) Q3 2017 Earnings Call Transcript

Published at 2017-10-31 17:00:00
Operator
Good day and welcome to the Independence Contract Drilling Incorporated Third Quarter 2017 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 of Independence Contract Drilling Incorporated. Please go ahead.
Philip Choyce
Good morning, everyone and thank you for joining us today to discuss ICD's third quarter 2017 results. With me today is Byron Dunn, 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 and 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 this 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 the definitions of our non-GAAP measures. And with that, I'll turn it over to Byron for opening remarks.
Byron Dunn
Thank you, Phil. Good morning, everyone and thank you for joining us today. This morning, I will review ICD’s third quarter 2017 operations and update our outlook for the remainder of the year. Phil will provide details on our third quarter financials and then we'll take questions from call participants. In the third quarter, ICD generated record operating and revenue days. We completed our final ShaleDriller conversion and our fleet reached 100% utilization with every available rig contracted. We signed early renewal of four term contracts with term extensions between 6 and 12 months and with day rate increases in excess of $2,000 per day. We began our first contract with an international major operating in the Delaware Basin. In today's environment, delivering high producing, cost effective wellbores is absolutely critical. Working with our customers, we continue to help them exceed their own operational and economic expectations, while collectively leading the industry in creating value for clients. For example, last quarter, we drilled the second longest well in the Austin Chalk. We set new field records for both lateral length and drilling rate in the Delaware Basin, which is undoubtedly the most challenging in the Permian and we implemented technologies that will reduce our environmental footprint and lower fuel consumption, including the use of highline power, which will materially decrease operating costs for those rigs. As we predicted on our last conference call, the overall rig count has begun to fall. However with ICD’s pad optimal fleet of full utilization, we continue to see robust demand for our pad optimal ShaleDrillers and currently have the highest volume of forward rig availability inquiry that we've enjoyed in years. Substantial demand for pad optimal equipment combined with little availability drove the early renewal of the four existing contracts I previously highlighted which added three full rig years of backlog. Although day rate momentum has slowed recently, base day rates for pad optimal rigs have reached a new level in the high teen to low $20,000 per day range. With regard to the four contract extensions I mentioned, let me note that we will see some day rate benefit from these new contracts in the fourth quarter with most of the incremental revenue per day manifesting itself in the first quarter of 2018 and beyond. Although we set new operating records during the quarter, revenue days came in on the low side of our guidance due to hurricane Harvey dislocations. Operating costs per day were higher than in the second quarter due to Harvey and weather related issues as well as safety field incentive bonuses, hiring and training entry level employees and unscheduled repair and maintenance during the quarter. On a forward run rate basis, as our rigs operate at full effective utilization and as entry level recruiting in staffing stabilizes, fully burdened OpEx at the rig level should be in the $12500 to $13000 range with rig level cash costs settling in the $10,700 to $11,000 per year range. As we discussed on last quarter's conference call, we expected a declining gross rig count during the back half of 2017 and that decline continues to occur. We expect the gross rig count to continue a shallow decline in to 2018 as technologically and economically obsolete rigs drop at the margin. We believe that E&P operators have promised growth and profitability at commodity price thresholds that can only be provided through complex pad drilling programs, utilizing the fastest and most efficient pad optimal rigs such as ICD ShaleDrillers. Large E&P players are shifting to development drilling using larger pads, batch drilling and much more efficient pad optimal drilling equipment. As these operators continue the process of high grading the rig fleet into 2018, dropping sub optimal rigs that are technologically obsolete. In that environment, pad optimal equipment will be well positioned to realize day rate and margin expansion based on the high economic value add these pad optimal rigs provide. With our fleet fully committed, ICD remains well positioned to capture improving day rates in 2018. We have strategically implemented a staggered term contract expiration matrix throughout 2018 supporting a process that allows ICD to capture day rate improvement as contracts roll and re-rate. At third quarter end, backlog stood at $75 million with all revenue days contracted through the first quarter of 2018 and 84% in the second quarter of 2018. ICD’s balance sheet is in great shape. Until we elect to complete our next two new build rigs, our capital stand will be associated only with maintenance capital expenditures and a few discrete purchases to build out our inventory of critical spares. As a result, we plan to begin steadily paying down debt until such time as we elect to restart our rig build program. Our operations are easily supported by our ABL against a commitment of $85 million in the borrowing base of almost 108 million. At September 30, we had net debt of $44.3 million. As I mentioned previously, we have already invested approximately half of the construction cost to build two new ShaleDrillers. I noted the strong demand for our rigs with active inquiries and discussions from mobilizations well into 2018 and I am hopeful that improving market conditions will drive day rates and tenures, which meet the financial benchmarks we require to complete those rigs and continue to grow our fleet. Concluding, I am quite pleased with ICD’s current position. Our rigs have reached full effective utilization and are contracted with customers with long term drilling programs requiring pad optimal equipment for their proper execution. Our recent term contracts have provided additional forward-looking visibility and our ABL availability and borrowing base remains strong. This provides ICD with the liquidity to strategically complete the two half build 200 series rigs as market conditions improve. We continue to see sustained steady demand growth for pad optimal class rigs by operators with industry leading cost structures, the type of operator represented in ICD’s client list. And with that, I'll turn the call over to Phil.
Philip Choyce
Thank you, Byron. In the third quarter, ICD reported a net loss of $6 million or $0.16 per share. Excluding non-cash charges summarized in the press release, our adjusted net loss was $5.1 million or $0.13 per share. Based on 1235 revenue days in the third quarter and 11% sequential increase in the second quarter, total revenue was 23.4 million, including pass-through revenue of 1.2 million. Average revenue per day of $1834 came in line with our guidance. Approximately 5% of third quarter revenue days were in under our higher day rate legacy contracts that expired during the quarter. This contract re-rated to the current day rate environment during the quarter. Hurricane Harvey impacts during the quarter included a slight reduction in revenue days compared to our original guidance as well as modest increases in operating costs per day. In addition, our corporate office buildings experienced water related damage that is the subject of an insurance claim. Cost per day of $13513 came in higher than our guidance. Some was due to Hurricane Harvey and related weather events, but we also experienced higher unscheduled repair and maintenance expenses as well as increased costs associated with new hire retention initiatives and increased performance based safety compensation at the rig level. Gross margin per operating day, excluding rig construction expenses, was below our guidance as a result of the cost items discussed. SG&A expenses were $2.9 million, including $900,000 of non-cash compensation expense. Cash SG&A expenses of $2 million declined 9% sequentially as a result of lower professional fees and incentive compensation expense. Non-cash compensation expense declined 25% sequentially due to the completed vesting of equity awards originally granted at the time of the company's initial public offering. Depreciation expense, interest expense and tax expense, all came in line with our prior guidance. At September 30, we had net debt excluding capitalized leases of $44.3 million. Our borrowing base under our credit facility was $107.5 million, exceeding the $85 million of commitments under the facility. Cash outlays for capital expenditures in the quarter, net of disposals, were $9.6 million, of which 4.7 million related to deliveries occurring during the second quarter of 2017. Moving forward, until we begin completion of our next two rigs, where we have already made significant investments, our capital program will be comprised only of maintenance CapEx as well as a few discrete capital items to complete our capital spare inventory. For the fourth quarter, we expect cash outlays for CapEx of approximately $1 million plus an additional $2.5 million that will flow through our cash flow statement relating to prior period purchases that are accrued as accounts payable at quarter end. We have $5.7 million of assets held for sale that will offset capital expenditures as proceeds from sale are realized. At September 30, 2017, our contract backlog was approximately $75 million, representing 10.8 rig years of activity. Of this backlog, 32% is expected to be realized during 2017, 63% in 2018 and 5% in 2019. Byron mentioned that we recently signed extensions on four term contracts that added three rig years of backlog and rerated the current market rates. These increased day rates began when the multi-well pads at these rigs are currently drilling or completed. We expect two of these contracts to switch to new rates later this quarter with the other two switching at year end or early Q1, 2018. With that backdrop, our average day rate and backlog for the remainder of 2017 is approximately $18,500 per day and increases to approximately $19,100 per day in Q1, 2018 and $19,600 per day for the remainder of 2018 as our remaining lower day rate contracts were all during the first half of 2018. As a result, we expect to realize some sequential top line revenue per day improvement beginning in the fourth quarter with our fleet at 100% utilization and more meaningful sequential revenue per day and margin improvement beginning in Q1 and Q2 of 2018 and lower day rate contracts continue to rerate higher. Fourth quarter guidance. In the fourth quarter, we expect our rigs will generate between 1278 and 1288 revenue days, with revenue per day increasing slightly and ranging between $18,000 and $18,400 per day as we begin to realize some benefits from our new contract extensions. We expect fully burdened operating costs per day to fall to a range of $12,800 and $13,000 as repair and maintenance expenses move back to normalized levels compared to cost experienced during the third quarter. These per day expectations exclude pass through revenues and expenses and our cost per day also exclude rig construction expenses. We expect fully burdened margin per day to be up sequentially with a range between $5,000 and $5,500 per day. Rig construction expenses are expected to be approximately $450,000 during the fourth quarter. SG&A should approximate $3.1 million, of which $600,000 will be non-cash. Depreciation expense should approximate $6.7 million. Interest expense should approximate $840,000 and tax expense should be flat with the third quarter. And with that, I’ll turn the call back over to Byron.
Byron Dunn
Well, thank you, Phil. I guess in closing, I'd like to as always express my regard and support for the fine work that ICD’s employees do. They truly make the company. And with that, operator, let's open the line for questions.
Operator
[Operator Instructions] The first question will come from James West of Evercore ISI.
James West
Byron, so you've got the two new builds that are half -- you have paid for about half of those. You talk about [indiscernible] business improving before you go forward with the finalization of those rigs. Can you remind us again, I know it's been a conversation about rate plus term, but it seems like we're getting there on almost both those. I mean, could we see you guys go forward with those new builds in the next quarter or two?
Byron Dunn
I think so. I think day rates are where they need to be in. If we get a 2-year term relative to the ABL, we're good to go. And we've got two year terms in the past, in the last couple of quarters. So I don't think that's out of the -- I think that's part of the conversation right now. We just have to link that up with the delivery date and we'd like to get those out as fast as we can.
James West
And what’s the timeline from when you sign a contract to when those rigs would be in the field?
Byron Dunn
From when I approve the ASC, it’s about four months for those.
James West
Four months. Okay. Great. And then we've talked previously about additional new builds on top of that, but those would be more -- you talked some -- there could be a possibility of a partnership with a likeminded say E&P, are those conversations still ongoing?
Byron Dunn
They are. The type of rig we're talking about is substantially different than 200 Series. So we are talking about a million pound mass, 2000 horsepower rigs, extended walking capabilities, vastly expanded mud handling capabilities. These are associated with mega pad drilling in the very lowest levels of the Wolfcamp and that's probably a $28 million to $30 million proposition. So that type of rig is in demand. There's nothing like it available right now. There's a handful of heavy rigs that are out there doing some of that work, but they are suboptimal. So those conversations we're having surround the demand for this equipment, its unavailability and around financial terms that would make sense for everybody involved to begin construction of that type of equipment.
Operator
The next question will come from Kurt Hallead with RBC. Please go ahead.
Kurt Hallead
Byron, just maybe for a little clarification, you referenced that there are some opportunities to get to your term and then you kind of referenced relative to ABL. Can you just clarify what that means exactly?
Byron Dunn
Phil why don’t you take that, because we’re balancing our ABL draw against our contract backlog in order to mitigate market risk.
Philip Choyce
So when we think about our forward-looking cash flows and what our lenders want to see. Obviously we have plenty of borrowing base they’d want to see if we need to tweak any covenants or something like that. If we were to build both of those rigs today then we'd have to go back and tweak our cash flow covenants for a quarter or two. If they are associated with two-year contracts that’s a very easy conversation for us to have with our lenders and it's really just us looking at forward looking cash flows and getting them comfortable with any kind of incremental debt we've got to put on the company.
Kurt Hallead
Now in the context of these two year deals, what kind of pricing would be associated with the two-year contract?
Byron Dunn
The conversations we're having range from the high teens to the low 20s. So there's multiple conversations and there's multiple price points. There's also adders for oil-based mud, there's a lot of bits and pieces in there, but it's right in line with the guidance we've given. I think the market is there and what we're doing is pushing there.
Operator
Our next question will be from Daniel Burke with Johnson Rice. Please go ahead.
Daniel Burke
Hey Byron, could you elaborate on what you guys are doing with regard to electrified power or using grid power, it sounded like? Maybe I misunderstood your earlier.
Byron Dunn
What we're doing is we're setting up rigs so they can run on high line power. And the issue there is high line power is typically dirty, there's harmonics. So we have to rectify it. Take it back to AC. And when you do that you don't run your genset. So it's good for the operator and it's good for us on an operating cost basis because we're not running the gensets.
Daniel Burke
Can you talk about the magnitude of opportunity across the fleet?
Byron Dunn
Two right now. So early stages, but two and we'll see where they take us.
Daniel Burke
And then maybe just a couple on the CapEx side. First, can you maybe just update us on where you are in terms of that sort of maintenance level CapEx if we think about that as a base run rate in 2018 before attempting or thinking about the potential overlay of the rig completion projects. And then the second one practically looking at CapEx this year, are you guys experiencing a little bit of creep or am I just getting a little crossed over with the accrued CapEx versus the current quarter CapEx figures.
Philip Choyce
We brought in the third quarter a couple pieces of equipment that probably - we're probably about a million and a half higher than what our guidance was for the year on CapEx. Moving forward we do need - we took some deliveries in the third quarter that will pay for in the fourth quarter, incremental CapEx in the fourth quarter above that will be about a million. Maintenance CapEx next year with a 14 rig fleet would be between $3 million and $4 million. We've got a couple pieces of equipment we need to buy, there's a top drive, cattage, and there may be a pump or two that we would add onto next year from a CapEx perspective.
Daniel Burke
I mean not to put words in your mouth, so comfortably sub-10 million before contemplating the conversions then, is that still the right…
Byron Dunn
Yes, yes. Our fleet is relatively new. You can use a $100,000 per rig per year for kind of maintenance CapEx. And then on top of that we've got some facility costs et cetera, et cetera. So our cash requirements in a non-build environment are quite low.
Operator
The next question will be from Robert MacKenzie of Iberia Capital. Please go ahead.
Robert MacKenzie
Byron, I wanted to dig a little further into the prospects and how you feel about the likelihood of signing up something here for a reported 300 Series rig. Do you think you’ve gotten closer in terms of the conversations over the past month, two month, three month?
Byron Dunn
So I have to be careful because I thought at one point we had a done deal. And then some things occurred we didn't. So we've been extraordinarily close I think, but I have nothing to report, multiple conversations. And we're not the ones that are slowing it down, not that anyone is purposely slowing anything down, but we continue to push as hard as we can. And to a great degree the market is coming to us because this equipment doesn't exist and it's going to be required. So at some point the dam breaks, I’m little uncomfortable trying to predict it because if I'd done that in the past I would have been wrong.
Robert MacKenzie
Can you talk to us about data analytics and how bigger role that may play both on the new rig design and also on your current fleet.
Byron Dunn
So there's two things to think about there, one is data capture and we already do that. So we have an enormous amount of data that we capture through the computer systems on the rigs that’s available to clients and that's used, not used, it’s very client specific. But I think we're gravitating toward an environment where the capture of that data and the integration of it into historical drilling curves and cost structures will become more and more prevalent. The second answer is that there are systems that go onto the rig particularly because we have [indiscernible] systems that eliminate directional drillers and they do a lot of things in terms of speeding up drilling, risk reduction and cost reduction. And we're in active conversation with two providers of that type of equipment. And we'll make a decision in the next quarter or so about which way we're going to go. That’s a cost adder, so that wouldn't be included in the base day rate, if a client wanted us to switch a system like that and there would be an additional per day cost associated with it.
Operator
[Operator Instructions] The next question will be from Thomas Curran with FBR Capital Markets. Please go ahead.
Thomas Curran
Bryon, when it comes to the next two new build conversations you’re having. On your side strategically could you rank order for us in descending order which basins ideally you would deploy each or both of those two new builds into. And then also on the customer side, do you have a preference for favoring a new customer over an existing one or are you just agnostic on that.
Byron Dunn
We have no particular favoring of new customers, existing customers. I can tell you that the demand for additional equipment that we're seeing is concentrated in the hands on the Permian. Every once in a while we get inquiries for the Eagle Ford. We've operated in the MidCon and we get inquiries there. But the vast majority is going to be Permian and Haynesville. And to the extent one of these new builds are build, I would expect that they would be - based on everything I know right now I expect that those would be the basins that this new equipment would show up in.
Thomas Curran
And then across all the new technologies we've been discussing using the power lines for power, big data analytics, the directional drilling add-on, for any of that is there a certain critical mass level in a given basin, where if and once you hit a certain number of rigs running there, it will make an aspect of one or more of these technologies easier technically or more affordable, is there any kind of critical mass considerations by basin for you.
Byron Dunn
I don't think so. I think it's a rig by rig decision. And we can switch it on or off. And so it's up to the clients, what they want to use. And again we already provide data capture and once we decide on a particular vendor for some additional software associated with the variable frequency drive and the drilling program. That's again something that’s rig specifically that can be turned on or off. So I don't think there's any critical mass aspect to that decision.
Thomas Curran
And then last one from me, Philip, Assuming you don't move forward with either of the new builds and you steadily pay down all of your debt. Can you give us an idea of what that sequence would like on a quarterly basis in terms of the amount of debt you'd expect to be paying down until taking it to zero?
Philip Choyce
Oh taking it zero, when you think about our free cash flow next year, our CapEx is going to be low, our cash flows, operating income is all increasing. We're not a tax payer. So pretty steady next year drawdown in debt, I don't have a specific number for you where we go to zero. I don't think it would be next year. It has to be sometime later 2019. But if we're getting improving day rats above what we've got now, then that's going to accelerate. So I don’t have a specific timeline, but we're going to pay down a substantial amount of debt next year assuming that we don't build those next two rigs.
Byron Dunn
I think that’s accurate. And that sometime in 2019 if we didn’t build the rigs, we would extinguish our debt.
Philip Choyce
We’d pay down to zero by the end of 2019.
Thomas Curran
And that's what I was trying to get, even if it's just hypothetical scenario and when would you expect to get there based on the pace of pay downs. Thanks for the answers guys.
Operator
[Operator Instructions] The next question will be from Taylor Zurcher with Tudor, Pickering & Holt. Please go ahead.
Taylor Zurcher
Just a housekeeping one from me. So pro forma for these four contract renewals, could you just share what the contract rollover schedule looks like let's say over the next six months, couple of quarters.
Philip Choyce
We're pretty much booked up through the first quarter. I think we have 13.5 rigs in backlog in the first quarter, 8.2 in the second quarter next year and then 3.4 in the third quarter of next year.
Taylor Zurcher
And then I appreciate the color on day rates. I'm just curious because it seems like the average spot rate or at least the breath from high teens to low 20s at least on the margin seems to be getting wider. And so I guess my question is, is that more of a geographic issue, a customer issue, a term issue or is that sort of a mix of all three, probably a bit of an unfair question, but just curious the different puts and takes as to how maybe a rig rolls off this quarter and you sign one at 18,000 [ph] day versus something more in the low 20s.
Byron Dunn
So the market is reestablished itself. During the downturn, there really wasn't a market. There were ad hoc conversations and I think we discussed that over the last six, seven quarters or so. So what's happened in the last two and a half quarters is a pretty efficient market has reestablished itself. And there are people out there who prefer to use us. And we'll get a negotiated structure with them. There are people that bid these things out. But everybody is aware of what the current market is for this type of rig. What's working in our favor right now is and what people are finding who are talking to us is they'll go out and they'll look to get a quote on a rig that that has pad optimal capabilities for some time next year. And there aren't necessarily any. There are contracted rigs and of course you go back to your existing client and work with them as we go through this process. But there isn't a lot of availability. And that dynamic is typically what sets up an improving day rate market. So I think the market is pretty efficient. I think it's reformed. And I think the momentum has slowed a little bit, but I'd expect that in a pre-budget time period. And I think once budgets are done and people go out and look for equipment; it's going to be very positive for the four day rate environment in 2018.
Taylor Zurcher
Last one from me if I can, you noted that the four renewals were sort of early renewals. Are we to assume those earlier than typically the case i.e. the customer might be afraid that the rig would go elsewhere unless they renew it today or was that sort of in due course?
Byron Dunn
So a couple things, one is that particular client is very pleased with us. We work in partnership with them to get a lot of things done, so we have a very good relationship. The market is tight. And they came to us before contract expiration for renewals and we worked with them and put a package together. So a number of things came together that produced that situation, but I think you're correct in that people are going on testing the market and not finding the type of equipment they want to use readily available.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Byron Dunn for any closing remarks.
Byron Dunn
I want to thank you all for being on the call taking the time to hear our story this morning. Looking forward to visiting with you - some of you personally over the next couple of weeks and speaking with you again in February and talking about our fourth quarter and how we see 2018 laying out. Thank you very much.
Operator
The conference is not concluded. Thank you for attending today's presentation. You may now disconnect.