Independence Contract Drilling Inc (ICD) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Independence Contract Drilling, Inc. Fourth Quarter and Year End 2017 Financial Results Conference Call. (Operator Instructions) And please note that today's event is being recorded.

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

Good morning, everyone, and thank you for joining us today to discuss ICD's fourth quarter and year-end 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 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 loss to adjusted net loss, EBITDA and adjusted EBITDA and for definitions of our non-GAAP measures.

And with that, I'll turn it over to Byron for opening remarks.

Thanks, Phil. Good morning, everyone, and thank you for joining us today. As usual, I'll first review ICD's fourth quarter 2017 operations and update our outlook for 2018. Philip will provide details on our fourth quarter financials and then we'll take questions from call participants.

In the fourth quarter, ICD generated record revenue and operating days as our fleet reached and maintained 100% utilization. Higher day rates came into effect later in the quarter on 4 contract extensions we discussed on our previous conference call, which will benefit future quarters.

Substantial market momentum has continued into the first quarter of 2018 with ICD signing 4 additional contract extensions at materially higher day rates over expiring terms.

We believe demand in day rates will continue to grow throughout 2018 for pad-optimal rigs as the impact of several years of underinvestment and decline curve acceleration manifests.

Because we strategically stagger contract explorations during 2017, we are poised to capture additional day rate improvement during 2018. We have 3 contracts that will rerate during the second quarter, 5 in the third quarter and 3 in the fourth quarter of 2018.

At year end, backlog stood at $75 million, with all available revenue days contracted through the first quarter of 2018 and approximately 80% through the second quarter. Demand for pad-optimal land drilling rigs is greater than the U.S. fleet can deliver and continues to grow as our clients, the top-tier players in the shales, expand wellbore manufacturing principles and design successively more complex pad drilling programs, programs that only pad optimal rigs can economically execute.

As 2018 unfolds, it's become more common for ShaleDrillers to be drilling 22,000-foot wells, to have 4 or more wells on a pad and much more common to have complex pad drilling programs, which require rigs to walk at an angle rather than merely XY.

ICD currently has 4 rigs employed on complex pads that are walking 2 directions or diagonally consistently. These complex well patterns are no issue for pad-optimal ShaleDriller rigs, but are not feasible to economically execute by skidding or other upgraded XY and legacy equipment.

So as I mentioned, we believe the U.S. fleet of pad-optimal rigs is fully utilized. As a result, we're seeing a couple of things in the industry. One is that operators are trying to increase contract tenures on pad-optimal rigs and we also see a lot of lower spec equipment coming back into the market as higher quality rigs are unavailable. Obsolete rigs are being upgraded and put back to work and they'll work at least in the near term. This is creating a new market tiering with true pad-optimal equipment at the top of the pyramid and the base occupied by upgraded AC skidding rigs, with upgraded equipment packages and improved limited moving systems.

This lower tier was previously held by DC and AC skidding rigs during the last cycle.

Given the robust and improving market for pad optimal equipment, ICD's Board of Directors approved the construction of our next newbuild rig. We expect that rig to be completed and mobilized for operations early- to mid-third quarter 2018.

The incremental cash cost to construct this rig as a fully pad-optimal 200 series with a VFD that can accommodate 4 gen sets and 3 pumps running simultaneously, is approximately $10 million and Phil will get into some more detail on that in his remarks and comments.

The newbuild will be financed by our existing ABL. With a commitment of $85 million and a borrowing base of approximately $107 million, at December 31, 2017, we had net debt of $46 million. So there's plenty of room in the ABL to complete and seal this rig.

So wrapping up, our rigs have reached full effective utilization, day rates are improving and we are returning to growth mode with newbuild approval by our Board of Directors.

ICD continues to build a strategically staggered backlog and higher day rates with customers having long-term, complex wellbore manufacturing programs requiring pad-optimal equipment. Our recent term contracts have provided additional forward-looking visibility and our ABL availability and borrowing base remains strong.

With that, I'll turn the call over to Phil.

Thanks, Byron. In the fourth quarter, ICD reported a net loss of $5.7 million or $0.15 per share. Excluding noncash charges summarized in our press release, our adjusted net loss was $4.6 million or $0.12 per share.

Based on 1,289 revenue days in the fourth quarter, a 4% sequential increase from the third quarter, total revenue was $25 million, including pass-through revenue of $1.4 million.

Average revenue per day of $18,338 came in line with our guidance. Approximately 5% of third quarter revenue days were earned on a higher day rate legacy contract that did not extend into the fourth quarter of 2017.

Cost per day of $13,094 came in slightly higher than our guidance, primarily related to higher repair and maintenance expense.

Overall gross margin per operating day came in on the lower range of our guidance as a result of these items.

SG&A expenses were $3.0 million (sic) [$3.1 million] during the quarter, including $500,000 of noncash compensation expense. Cash SG&A expenses of $2.6 million increased 30% sequentially as a result of higher incentive compensation expense compared to the prior quarter.

Noncash compensation expense declined 44% sequentially due to the completed vesting of equity awards originally granted at the time of the company's initial public offering. Depreciation expense and interest expense came in line with our prior guidance. Tax expense was slightly higher. This related to a noncash deferred Louisiana state income tax accrual.

At year end, we had net debt, excluding capitalized leases, of $46 million. Our borrowing base under our credit facility was $107 million, exceeding the $85 million of commitments under the facility.

Cash outlays for capital expenditures in the quarter net of disposals were $4.2 million, of which $2.5 million are related to deliveries occurring during the third quarter of 2017.

Accounts payable at year end included approximately $5.0 million related to fourth quarter deliveries.

At December 31, 2017, pro forma for 4 recent contract extensions, our contract backlog was approximately $75 million. Of this backlog, 88% is expected to be realized during 2018 and the remainder in 2019. As lower day rate contracts rerate to the current day rate environment, we expect to see continual revenue per day improvement throughout 2018. For example, our average day rate in backlog during the first quarter of 2018 is approximately $19,000 per day compared to $19,700 per day during the second quarter of 2018.

Byron provided an overview of our contract renewal schedule, which will provide additional opportunities for revenue per day improvement in addition to what we already have in our backlog as we move forward into 2018.

2018 annual and quarterly guidance. Before I move on to specific first quarter guidance, some items related to our full fiscal year 2018 expectations. We expect corporate SG&A to be approximately $13.3 million, of which $3.0 million will be noncash stock-based compensation expense. We expect the annual depreciation expense to be approximately $24.5 million, but will increase by approximately $500,000 per quarter above this level when our planned newbuild deploys.

Galayda Yard construction expenses will be approximately $1.4 million, but will be fully absorbed in quarters when our new rig build is being constructed. And we expect tax expense to remain flat with overall 2017 levels.

Our 2018 capital budget is $21 million composed of the following: $10 million to complete the announced newbuild rig and $10 million in maintenance of potential additional equipment purchases as required.

CapEx on the newbuild could increase by up to $2 million depending on the required equipment specification of the customer. Most of this CapEx will be weighted toward the back half of the year. And we also expect several million dollars to flow-through our cash flow statement relating to fourth quarter equipment deliveries that we had not yet paid for at year end. Moving on to first quarter guidance.

We expect our rigs will be 100% utilized with revenue per day ranging between $18,800 and $19,000 per day as we begin to realize some benefits from improving day rates under contract extensions. We do not expect day rate improvements for our 4 recently signed extensions to kick in until the second quarter of 2018. We expect fully burdened operating costs per day to range between $13,300 and $13,500 to date with a sequential increase above targeted levels, primarily relating to cyclical first quarter matters.

These per day expectations exclude pass-through revenues and expenses and our cost per day also exclude rig construction expenses. Rig construction expenses are expected to be approximately $450,000 during the first quarter.

First quarter SG&A should approximate $3.3 million, of which $700,000 will be noncash. Depreciation expense should approximate $6.7 million, interest expense should approximate $950,000 and tax expense should be around $50,000.

And with that, I'll turn the call back over to Byron.

Thanks, Phil. At this time, operator, if you'd open the line for questions and answers.

(Operator Instructions) And our first questioner today will be Kurt Hallead with RBC Capital Markets.

So, Byron, we'll get -- finally get some momentum enough in the marketplace to add another rig to the fleet kind of long-awaited process. I was wondering if you might be able to give us some insight as to the kind of contract terms that you're now seeing that are giving you this conviction to move forward with this newbuild.

It depends on how we can figure it, Kurt. But in general, we're talking to over 5 people right now that are looking at anything from a regular 200 series to a 200 series with some additional equipment. And the day rates going to range depending on what we do out-of-the-box from low 20s to mid-20s.

And what kind of term are they willing to commit to?

I personally would prefer a year. We'll see where they can back. But I'd like to keep it long enough that we have visibility in our ABL, but I wouldn't want to go out 2 or 3 years necessarily because I think we're in a very robust day rate environment.

Okay. Now if I'm not mistaken -- if I am, please correct me, which I know you will, but I do think you had some parts or other things laying around for a second rig that you could potentially get out into the system as well. What do you think that -- if true, what do you think the prospects are for getting a second rig out to the marketplace this year?

Really high. And the issue is this, it's -- as we go and build this second rig, the nature of the very top tier of the market is changing. And it's -- I don't think that the requirements have coalesced. So we're in conversations again with multiple large players about what they're looking for, for mega pad development and it's not consistent. And I don't want to underbuild, but I also don't want to overbuild. And in general, what you're seeing is a general desire for additional racking capacity. You're looking at a general desire for a heftier mast and sub because fast moves are becoming -- are less relevant in that application and a couple of other things. So it hasn't coalesced. We're in conversations. And again, I want to make sure that when we do pull the trigger on this, we're pulling the trigger on a piece of equipment that's going to be broadly applicable. So that's where we are on the second one right now. I don't think at this point, it will be a regular 200 series ShaleDriller.

And our next questioner today will be Daniel Burke with Johnson Rice.

Byron, just more broadly, can we -- when you talked about your day rate expectation for the rig you'll bring out mid -- to just pass mid this year. Can we use that same day rate range as a discussion point for what you're seeing throughout the rest of your fleet? Or any distinctions you draw?

Only distinction I'd draw would be the equipment package and there will be some spread between the day rates based on a number of pumps and number of pumps that can operate simultaneously. But otherwise, it's broadly similar.

Got it. And then, when we think about this year's CapEx, Philip, you're pretty clear on the $10 million for the rig and $10 million for kind of other and you mentioned additional purchases. But to be clear then, that $20 million-and-some doesn't include a partial plug for the next partially completed rig.

It does not include that. No.

Okay. And then, I'll move pretty quick here. But any -- there's been wage pressures out there and the like so -- and granted that's a pass-through, but any change looking past the payroll impacts that you all see in Q1 in terms of where you think your fully burdened operating costs are going to end up?

From a wage perspective, no. I think we're a preferred place to work. I think that we've got upward mobility of possibilities for the people that work for us. So we've really haven't had a lot of trouble holding skilled labor. As I mentioned in the past, entry-level folk are -- you can get them, but there's some additional training requirements that we didn't see in the last cycle. So there's an additional cost that Phil can quantify surrounding bringing them in, training them, mentoring them, the Yellow Hat program because the folk we're getting in right now don't have the base electrical, hydraulic mechanical skill sets that we saw previously. So if there is any pressure, it's not necessarily total compensation, it's costs associated with bringing those folk on. Now we do have initiatives in place to bring our overall operating cost per day down by several hundred dollars, but that's a broader initiative that has to do with efficiencies and structure efficiencies and rental utilization. We expect contract terms to change to a degree as we go through this process and collectively, all of that will bring our cost down somewhat. But right now, wages aren't an issue.

And our next questioner will be James West with Evercore ISI.

This is Alex on for James. I was curious if operators have begun to make a distinction with respect to day rates between the upgraded skidding rigs and the pad-optimal ShaleDrillers and rigs of that category or if it's, at this point, they're being still pretty price sensitive.

It depends on the application. So if you take a look at a retrofitted skidding rig that walks, there's a market for that. And the market for that in the Permian at least and some other areas is going to be small pads or pads with straight wellbores, inline wellbores. And what you've done is, you've taken a skidding rig and improved its movement capability. But let me step back for a second, because I think there's a lot of conversation that's swirling around upgrades and spec. And so, I would suggest you look at it as 2 general buckets of capabilities. The first bucket of capability would be the equipment on the rig and that's 7,500 psi systems and top drives, hydraulic catwalks, 3 pumps and so on. And the second bucket of capability is going to be focused on the delivery of that equipment to the wellbore and that's the substructure and mass moving capabilities. So you can take a rig that's got sub spec equipment and you can pretty easily upgrade that. You can add pumps, you can -- with money, you can do a lot of stuff and you can get it up to snuff from the standpoint of pumps, catwalks, so on and so forth. The more difficult issue is the moving issue because now you're taking a piece of equipment that was designed to do a very specific task very well and you're asking it to do something different. And in that case, there's trade-offs. And the trade-offs around center of gravity; lake spacing; flowline; grasshoppers, which is the mechanism that moves pumps -- cables and hoses around and there's some limitations there. And you also -- when you take nonwalking equipment and make it walk, you've got 4 plates or 4 beams so you have to bury everything on the pad. So you have something that I think is supplanting the old skidding system with something different and there's a market for that and there's a day rate for that market. There's a lot of that around. So the day rate for that market is quite a bit different than the day rate for the pad-optimal market. So I'd say, it's not necessarily the rig, Alex, it's the application. And I'd encourage you to think about it in terms of kit and in terms of the delivery mechanism.

Got it. So I guess, at this point, would you say the market for the pad-optimal applications are large enough or demand is high enough to kind of drive a significant disparity between 2 applications?

Okay. So I don't participate in that other market. And so I hear things are anecdotal. I can tell you that the day rate market for pad-optimal equipment is very robust and moving up.

And our next questioner today will be Marc Bianchi with Cowen.

I guess, first on the newbuild here and the 5 customers you're talking to, is this a replacement for that? Or is it an incremental rig add to your knowledge?

Both. It depends on the customer. There is probably a little bit more weighted to incremental, but there is some replacements as well. So we're either displacing equipment or customers are expanding their drilling. I think they're expanding their drilling programs in any case, but some is incremental and some is replacement.

Okay. And I guess, if you -- so you've got a newbuild opportunity here. There are some others that are out in the market. It seems like the high-end pad-optimal market is pretty much you fully utilized. Maybe there is a few more upgrades here and there. But what do you think it really takes from a demand perspective and day rate perspective to see a lot of newbuilds here in the market? And let's say, we fast forward 6 months and there is a certain amount of rig count increase that you think needs to occur and a certain amount of day rate. What does that look like in your mind for the market environment?

Yes. Well, I think actually the day rate -- the rig count could decrease and we could still see an increase in wells drilled and footage drilled, as equipment becomes more effective. So I wouldn't necessarily look over the longer-term for rig count increases. But I think, to answer your question, you're going to need day rates in the mid- to high 20s with 2- to 3-year contracts before you're going to do something from scratch.

Right. Okay. And then just one that's a little bit different. On drill pipe, can you guys remind us, do you own your drill pipe or is it usually the customer in your case?

We typically provide a string of drill pipes. And if they need something different than the spec, we provide and they'll rent that or they'll provide that pipe, but each one of our rigs comes with a full string of drill pipe.

Can you talk to what you're seeing there in terms of changes in customer preference, maybe how -- what your requirements are now for investing or replacing any of that and what the lead times might look like?

Typically -- we'll typically buy a 5-inch drill pipe for our rigs. If they want something different, sometimes they might want a smaller string 4.5, depending on what they want to do, they'll provide that. I don't think we've seen materially different lead times as far as drill pipe as of right now.

Okay. And there isn't a major component of your CapEx this year that's allocated towards drill pipe that's unusual?

We'll bring a string in. We'll bring a string in. The CapEx, the $10 million aside, about half of that maintenance-related items. The other half is really earmarked for -- and Byron mentioned about engines and pumps and things like that. If we put those on rigs and our customers are going to increase their day rates, then we'll spend that CapEx, so that's what the other kind of half is for.

And our next questioner today will be Ryan Pfingst with B. Riley FBR.

I'm in for Tom Curran this morning. On the second rig, I know you said there is a high chance it gets out in the marketplace this year. Is there kind of a floor that you want to see in terms of day rate or length to get that out in 2018?

Again, it depends on the design. So the designs we're looking at vary anywhere from $10 million incremental to $17 million or $18 million incremental. So it depends. There is a day rate requirement for any of those cost points. But more importantly, I want to get it right. And again, if you think back to when we started Independence Contract Drilling, before we even raised our first capital, we went out to the majors and the large independents and asked them, given the change in the market and the change in your drilling campaigns and what we believe to be a wide usage of pads and the shortcomings of the existing U.S. fleet, what do you want? And the things that we got back from them were very consistent and they formed the underpinning of the 200 series design. And we're trying to do something similar as we go forward, but we're getting -- we're not getting a consistent message. So I think, more important, once we get the message clear, the cost will fall out and the day rate will fall out. And given the demand for the equipment, I'm not worried about those dominoes falling. I can't tell you when they will fall, but that's the process we are going through.

Got you. And do you still think the highest demand right now for these rigs will be either the Haynesville or the Permian?

Yes.

Okay. Great. And then, just generally, do you have -- and could you share an update on some of your other technology initiatives?

Well, because we have AC computer-controlled equipment, we capture all the data our clients wants. So to one degree or another, we're working with people who want to get at that data, capture it and use it. So that's -- I wouldn't say it's homogeneous, but that process is ongoing. And we're working with a major technology company right now about integrated software systems for -- implement on our rigs, something broadly similar to what you see with other drilling contractors in the market. And I believe we'll have a pilot program up and running next quarter and depending on how that works out, we'll have more to say and more to do with the rigs. But -- so broadly, it's data capture and automation and better control the directional drilling process.

And our next questioner today will be [Chip Ruby] with [Ruby] Asset Management.

So the 2 rigs that you had half completed were for about $22 million, and then you are upgrading 1 for about $10 million. Were they both equally completed? And I guess the question is, is the build -- total build cost for the rig that you're spending the CapEx on this year about $21 million just by doing the math you've given us?

Yes. Okay. So when I say half completed, there was a little bit of a shorthand. What it basically meant was the long lead time items, which are a major component of the rig cost had been procured. And these have been procured sometime in the past. And as we went through the downturn, we didn't build those rigs. So we found ourselves in a vastly improved market with the long lead time items for 2 rigs. And the first one we are building as a traditional 200 series, has an incremental cost of $10 million. So Phil, the total cost if you...

It's probably consistent with what we've done in the past, $21 million or so plus or minus.

So the sunk plus the incremental?

Yes.

Okay. That was my assumption. So I'm a little newer to the company, but if you just look at your 14 rigs that you have out there that have maybe 2.8 year or 3 year life right now times $21 million, you're about $300 million asset value, a substantial discount to the enterprise value. And I guess, my question is, the market is implying that you're just not going to get a return on this capital, which heeds back to the day rate question. So at 21,000, 22,000, 23,000 day rate question on this new cap, what sort of return on assets, return on capital are we looking for to justify this build? And how far is that off of your corporate goals over a 3-year period?

Yes. So I think we are talking about a deep cyclical enterprise, deep cyclical part of the market. So I'm not sure that -- I'm not sure I agree with your market assessment. Generally, what we look at is how do we capture breakeven. So how long is our capital exposed before we recapture all of it. And we -- and the other thing, because this is a deep cyclical industry, you have to build into the market when the market is beginning to improve because of the long time it takes to put equipment into the market. So definitionally, when you're adding new equipment, you're at a part of the market that has a day rate environment, which isn't going to get you to your breakeven goals. But the expectation is, we're moving into a much more robust and prolonged part of the market where those goals will be met. So I think -- I'd be happy to talk with you about this off-line. I think it's a longer conversation, but in general, we look for a 5-year cost recovery.

So -- and again, I didn't mean to imply that you're not going to get it. I completely agree with what you said and I'll take this off-line, but it's astounding how undervalued your company is in a rising environment, fully utilized, putting new assets out there, best-in-class assets and trading under net asset value at the bottom of the cycle. So I just wanted to ask kind of what the normalized return on capital might be over a cycle? I understand we're not going to earn it today.

Yes. Okay. Give me a ring off-line. I can walk through -- again, this is a longer conversation. We can go through it in some detail how we can get it, what we get, but we fully intend to capture our cost of capital and more.

(Operator Instructions) And our next questioner today will be Connor Lynagh with Morgan Stanley.

I just wanted to follow up on a comment you were making, in that you're getting inconsistent feedback from your customer base as to what they want to see in a new rig. So I was wondering, if you could just expand on that a little bit and say like, where do you see agreement? Where do you see the biggest points of divergence in terms of what companies are looking for? And does it vary depending on whether operating or just generally where you're seeing this divergence?

Yes. It's not in the kit, Connor. So everybody is pretty clear on what they want in terms of mud pumps. And so all that -- that bucket of kit that I talked about earlier where you're going to find some divergence is what kind of a master they want, what does the design look like, what's it capable of. And there is some software system nuances here as well. And then what kind of a substructure. And you want it to move faster does -- is it going to be on location for 2 or 3 years and moving fast doesn't matter. And then that gets back to their pad design. And so what's their well spacing. To the extent that they're using concrete coffins, what do those look like. So I think what we have are differences in pad design, driving differences in preference for mast and sub with broad agreement on kit is where I think we are.

I mean, I guess, I would say the general thesis for your initial design was that the pad size was going to continue moving higher and you're going to do a lot more drilling on dense pads. So if that trend continues, I guess, the first question is, do you see it continuing? And then, if you do see that, do you think that you're more likely to build the more expensive version of the rig that you were highlighting earlier? Or is it more likely you're going to push out another 200 before you start moving onto the 300 design?

Well, I think, there is a broad and growing demand for ICD ShaleDriller. So that market is probably going to be the largest component of the market going forward. We're looking at the next level of the market, which again is going to be a little bit heavier. Look, if you're going to drill 4-mile laterals in the Wolfcamp D, you're not going to do that with a ShaleDriller or really with much of anything that's available right now. So to the extent laterals become much, much, much longer and you're doing it -- or you're doing cube development. I think Encana just put a press release out recently about cube development of the shales. If you're going to do things like that, then you need to maintain the flexibility to walk diagonally or at some kind of an angle. And at the same time, you need heavier equipment. And it's -- again, I just -- I don't want to underbuild, I don't want to overbuild and I'm not comfortable that we've coalesced on what the industry is really going to need going forward. So we're going to nail that down before we start spending money. And then, of course, unless we get the day rate we need for that particular design, we won't -- we'll wait for that to happen as well, which I think is inevitable given the development plans that we're hearing. So I think it's coming to us.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Byron Dunn for any closing remarks.

Well, once again, thank you all for joining us. We appreciate the questions, the support, the interest in our company. And we look forward to continue -- we look forward to moving back to a growth phase for Independence and talking to you next quarter. Thanks very much.

And the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.