Form 10-Q: Independence Contract Drilling, Inc. Quarterly Report (Unaudited)

Drilling Contractor Navigates Challenging Market Conditions

Overview ICD Energy is a land-based contract drilling company that provides services to oil and gas producers in the United States. The company owns and operates a fleet of 26 modern, technologically advanced drilling rigs, with a focus on unconventional resource plays in the Permian Basin and Haynesville Shale regions.

ICD’s business is heavily dependent on the level of exploration and production activity by its oil and gas company customers. The industry is cyclical, with drilling activity closely tied to commodity prices and market expectations. Volatility in oil and natural gas prices, as well as industry consolidation and operational efficiencies, have created a challenging environment for ICD in recent quarters.

Financial Performance For the six months ended June 30, 2024, ICD reported revenues of $90.0 million, a 25.1% decrease compared to the same period in 2023. This decline was primarily attributable to lower contractual dayrates and a reduction in operating days. Revenue per day fell 14.6% to $29,622, while operating days decreased from 3,113 to 2,691.

Operating costs for the first half of 2024 were $62.4 million, down 12.5% year-over-year. This decrease was driven by cost-cutting initiatives and the lower activity levels, partially offset by a 1.4% increase in cost per operating day to $18,846. Selling, general and administrative expenses also declined 32.5% to $8.1 million.

Despite these cost reductions, ICD reported an operating loss of $7.0 million for the six-month period, compared to operating income of $12.6 million in the prior year. The company recorded a net loss of $25.7 million, compared to a $4.1 million net loss in the first half of 2023. The increased losses were primarily due to the drop in revenue, as well as a $4.3 million asset impairment charge related to the company’s exit from its Houston rig yard.

Table 1: ICD Energy Financial Highlights

Operational Trends The decline in ICD’s financial performance reflects the challenging market conditions facing the contract drilling industry. Commodity price volatility, customer consolidation, and improved drilling efficiencies have all contributed to reduced demand for land-based rigs.

After reaching highs in early 2022, oil and natural gas prices have fallen significantly. West Texas Intermediate (WTI) crude oil prices peaked at $123.64 per barrel in March 2022 but have since declined to $77.27 per barrel as of July 2024. Natural gas prices at the Henry Hub spiked to $9.85 per million British thermal units (MMBtu) in August 2022 but have since plummeted to just $1.81 per MMBtu as of July 2024.

These price declines, along with takeaway capacity issues, have weakened market conditions in the Haynesville Shale region, leading to a reduction in the number of drilling rigs operating there. ICD has responded by relocating some of its rigs from the Haynesville to the more active Permian Basin, where 13 of its 15 contracted rigs were operating as of June 30, 2024.

However, the company continues to face headwinds in its core markets. Increased industry consolidation among its customer base, as well as improved drilling efficiencies, have allowed E&P companies to complete their budgeted drilling programs more quickly. This has resulted in an increased pace of rig releases and the need for ICD to actively recontract its fleet, often at lower dayrates.

During the second quarter of 2024, ICD received release notices for three rigs, effective in the third quarter. The company is now marketing these rigs across its customer base for fourth-quarter 2024 and 2025 opportunities, but expects some idle time before they are recontracted. ICD anticipates that its average operating rig count will decline in the third and fourth quarters of 2024 compared to the first half of the year.

Table 2: ICD Energy Operational Metrics

Liquidity and Capital Resources As of June 30, 2024, ICD had $21.0 million in liquidity, consisting of $5.5 million in cash and $15.5 million in available borrowing capacity under its $40.0 million revolving credit facility. The company used its revolver to fund $7.0 million in mandatory redemptions of its convertible notes during the first half of 2024.

ICD’s primary sources of capital and liquidity are expected to be cash flow from operations, borrowings under its revolving credit facility, and the ability to pay interest in-kind on its convertible notes. The company has elected to pay interest in-kind on the convertible notes, which will result in the principal balance increasing through the March 2026 maturity date.

While ICD’s net working capital was $10.0 million as of June 30, 2024, this excludes the current portion of its revolver borrowings and future mandatory note redemptions. Beginning in September 2024, these obligations will be reclassified as current liabilities, reducing the company’s net working capital position.

ICD believes its current liquidity, along with cash flows and financing options, will be sufficient to fund its operating expenses, maintenance capital expenditures, mandatory note redemptions, and other corporate needs over the next 12 months. However, the company’s ability to maintain adequate liquidity will depend on its success in recontracting rigs at acceptable dayrates and managing its cost structure in the face of the challenging market environment.

Strengths and Weaknesses ICD’s key strengths include its modern, technologically advanced rig fleet, strong safety record, and operational expertise in its core Permian Basin and Haynesville Shale markets. The company’s focus on unconventional resource plays has allowed it to establish a solid customer base among leading E&P operators.

However, ICD’s financial performance is highly dependent on the cyclical nature of the oil and gas industry. The company’s revenues and profitability are directly tied to drilling activity levels, which are heavily influenced by volatile commodity prices. ICD’s ability to maintain utilization and dayrates in the face of industry consolidation and improved drilling efficiencies remains a significant challenge.

Additionally, ICD’s capital structure, with a substantial convertible note obligation and reliance on its revolving credit facility, exposes the company to refinancing risk as these instruments mature. The mandatory redemption requirements on the convertible notes also create ongoing liquidity demands that ICD must manage carefully.

Outlook and Conclusion The outlook for ICD Energy remains uncertain, as the company navigates the volatile and competitive contract drilling market. While the company has taken steps to reduce costs and redeploy assets to its most active region, the Permian Basin, the pace of rig releases and need for recontracting creates significant uncertainty around future utilization and dayrates.

ICD’s management has initiated a strategic review process to evaluate refinancing options for its convertible notes and other potential transactions. The success of this process will be critical in determining the company’s long-term financial flexibility and ability to weather the current industry downturn.

In the near term, ICD expects its average operating rig count and revenue per day to decline in the second half of 2024 compared to the first half, as it works to recontract released rigs. Maintaining adequate liquidity through this transition period will be a key focus for the company.

Overall, ICD Energy faces significant challenges in the current market environment, but its modern rig fleet, operational expertise, and strategic review process provide some avenues for the company to navigate these headwinds. Investors will closely monitor ICD’s ability to recontract rigs, manage its capital structure, and position the business for improved financial performance when industry conditions eventually recover.