Smart Sand Inc (SND) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Smart Sand Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd like to introduce your host for today's conference, Mr. Phil Cerniglia, Investor Relations Manager. Sir?

Good morning, and thank you for joining us for Smart Sand's Third Quarter 2017 Earnings Call. On the call today, we will have Chuck Young, Founder and Chief Executive Officer; Lee Beckelman, Chief Financial Officer; and John Young, Executive Vice President of Sales and Logistics.

Before we begin, I would like to remind all participants that our comments made today will include forward-looking statements, which are subject to certain risks and uncertainties that could cause actual results or events to materially differ from those anticipated. For a complete discussion of such risks and uncertainties, please refer to the company's press release and our documents on file with the SEC.

Smart Sand disclaims any intention or obligation to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 9, 2017.

Additionally, we may refer to the non-GAAP financial measures of adjusted EBITDA and production costs during this call. These measures, when used in combination with GAAP results, provide us and our investors with useful information to better understand our business. Please refer to our most recent press release or our public filings for a full reconciliation of adjusted EBITDA to net income and production costs to cost of goods sold. (Operator Instructions)

I would now like to turn the call over to our CEO, Chuck Young.

Thanks, Phil. Good morning, I'm pleased to report that Smart Sand had the best quarter since its founding 6 years ago. Sales volumes were up dramatically, both year-to-date and year-over-year. This would not have been possible without the hard work and dedication of our employees. Their focus on maximizing production and effectively managing railcar movements, while operating in a safe and efficient manner, led to our record sales volume for the quarter.

There were also other positives in the quarter. Our expansion program continues to move along, also, product demand and pricing remain highly favorable. Lee will give you more details on our financial results during his prepared remarks, but first I'd like to touch on some of the highlights.

In the third quarter, we sold approximately 653,000 tons of frac sand and we generated adjusted EBITDA of $11.6 million or $17.80 a ton. This represents a 23% increase over second quarter volumes and a 184% increase over third quarter 2016. Those record sales volumes resulted from strong demand for our high quality, Northern White frac sand, along with operational improvements at our facility.

Based on current activity and dialogues with our customer base, we expect this trend to continue into the fourth quarter of 2017 and into 2018. Lee will provide you more details on projected fourth quarter sales volume during his remarks.

Let's now look at our expansion plans and the future of Smart Sand. I'll start with the previously announced expansion plans. At Oakdale, we're on track to bring online another 2.2 million tons of annual processing capacity by the end of the first quarter of 2018. This will increase our nameplate capacity of our Oakdale facility to 5.5 million tons per year.

Also at Oakdale, we expect the completion by year-end of our Union Pacific unit train capable rail yard. This gives us the ability to ship via unit train on both the Canadian Pacific and the Union Pacific railroads out of Oakdale, and it ensures that every ton of sand produced in Oakdale can move via the lowest cost and most efficient originating rail carrier.

Now to current product demand and pricing. We continue to see strong demand for 40/70 and 100 mesh. And there is improving demand for coarser grades of sand, in particular 30/50. With 40/70 continuing to be the tightest product in terms of supply and demand balance, we've actually seen some of our customers start to experiment more with 30/50 in their frac designs.

There is also improving demand in basins outside the Permian. Year-to-date, the majority of our sand has been sold and delivered to basins other than the Permian. Spot pricing overall and in particular for 40/70 continues to improve. Currently about 20% of our sales volumes are spot.

For the quarter, our average sales price per ton increased by approximately 7% over second quarter results. For Q4, we foresee opportunities for improvement in spot pricing of 5% to 10% at the mine gate and we expect ongoing strong demand for spot sales. We continue to strategically pursue long-term contracts we believe will add new contracted volumes for Oakdale capacity over the next several months.

As I've said before, Smart Sand wants to expand its geographic and product delivery footprint. We're looking to grow our business model to have more direct exposure and sales opportunities in the operating basins.

A key industry question is this: who will be the winners in the long run in the sand mining and logistics business? In our view, it will be the companies that can provide high-quality frac sand, efficiently and cost-effectively, all the way to the wellhead.

With that goal in mind, we're evaluating opportunities in 3 areas. First, we've signed options to lease mineable acreage in the Permian Basin. These lease options have been structured to minimize both upfront payments and royalties as well as environmental and related risks, while preserving our ability for future expansion. I expect to move forward on one of these options by the year-end. These locations appear to have distinct advantages compared to many of the other existing and announced projects in the region. However, before committing capital to construction, our goal will be to design an anchor contract for that new facility.

Second, we're exploring opportunities outside of the Permian. We're in active discussions to acquire and/or develop transloads in basins such as the Bakken and the Marcellus. We believe investing in transloads in these basins will allow the opportunity to attract new contracted customers, customers that want surety of supply at a specific location. That will provide more access for on-demand spot sales. We can have sand available in the basins, and thus the opportunity to capture incremental margin on the sale of our sand farther down the supply chain. We're currently in discussions with potential anchor customers for these facilities.

Finally, we continue to evaluate opportunities to invest or partner in a last mile solution. Our goal is to be able to provide our customers with the option to buy sand from Smart Sand directly at the wellhead. We believe, long term, that many customers want a sand service company that cannot only provide high-quality sand, but also offer efficient and cost-effective solutions for delivering sand all the way to the wellhead. We think there's a lot of product innovation in this area, so we're evaluating multiple solutions that appear to be technically superior to the alternatives being more commonly used today in the marketplace.

As we analyze and evaluate these opportunities, we will remain selective. We'll only move forward on the opportunities that we believe will benefit our customers, while providing both incremental margins and long-term shareholder value. We believe we've identified ways to develop these opportunities more cost-effectively and efficiently than our competitors.

I'll now turn the call over to our CFO, Lee Beckelman, for a closer look at the company's third quarter results.

Thanks, Chuck. As Chuck highlighted, we had our best quarter-to-date, substantially increasing our financial results both quarter-over-quarter and year-over-year. My comments will be focused on comparing the third quarter 2017 results with the second quarter 2017 results.

I'll start with sales volume. Sales volumes were approximately 653,000 tons in the third quarter, a 23% increase compared to second quarter 2017 volumes. As discussed by Chuck, this was a result of our focus on maximizing production and effectively managing railcar movements, while operating in a safe and efficient manner.

Our sales mix in the third quarter was consistent with second quarter results, with approximately 80% of our sales being contracted customers and approximately 20% being in spot sales. We currently expect sales volume to be in the 700,000 to 750,000 tons range in the fourth quarter. In the third quarter of 2017, approximately 77% of our sales volumes were shipped via unit train compared to approximately 82% in the second quarter.

In regards to revenues, total revenues for the third quarter were $39.3 million, a 32% increase over second quarter results. Sand sales revenues increased to $22.2 million in the third quarter from $16.9 million last quarter, due primarily to higher sales volume and a higher average sales price, which improved to approximately $34 per ton, a 7% increase over the second quarter results.

The average sales price per ton improvement sequentially was driven primarily by an increase in spot sale volumes and higher spot sale pricing. Reservation revenue, which is included as part of our sand sales revenue, was $7.5 million in the quarter, equal to second quarter 2017 levels.

During the quarter we recognized $1.2 million in shortfall revenue related to annual contractual shortfall payments from one customer. This customer's contract is based on a contract year that matures in the third quarter. The majority of the shortfall payment relates to volumes not taken during 2016, as this customer's activity has picked up in 2017, consistent with the overall improvement in the frac sand market.

Transportation revenue, which includes freight and railcar rental, was $15.9 million in the quarter compared to $12.9 million last quarter due to higher shipments in our contracts in which we passed through freight expenses to our customers.

Our cost of sales for the quarter was $26.3 million compared to $21.4 million last quarter. The increase was primarily due to higher freight expense of $4.7 million, due primarily to higher shipments in the quarter and also higher railcar expense and higher maintenance expense in the quarter due primarily to some unplanned maintenance.

Most of the freight expense in the quarters relate to shipments for contracted customers and is a pass-through cost in which customers reimburse us. But it also includes some in-basin spot sales, in which Smart Sand pays for the freight directly. The revenue associated with these in-basin sales is accounted for in sand sale revenue.

Our production cost per ton for the quarter decreased to $10.79 per ton compared to $13.17 per ton in the second quarter. As stated on previous earning calls, over the course of the year, with consistent utilization levels of 75% or higher, we believe our production cost per ton should average in the $12 per ton range.

Historically, we experienced higher production costs in the fourth quarter and first quarter of each calendar year as we shut down our wet plant operations during the winter months and draw wet sand from inventory to dry during these periods. In the second and third quarters of the calendar year, we historically overproduce wet sand relative to our current figured sales volumes and capitalize these costs into inventory to be expensed when the material is used in drying sand to be sold during the winter months of the fourth and first quarters.

Gross profit was $13 million in the quarter, a 56% increase over second quarter gross profit. The increase in gross profit was primarily due to higher revenues, the shortfall payment and the lower production cost in the quarter. Our operating expenses for the quarter were $4.3 million, a slight decrease from the second quarter due primarily to an adjustment to our bonus accrual for the year.

For the quarter, we had income tax expense of $1.7 million. We anticipate our effective tax rate to be in the 30% to 33% range going forward currently. During the quarter, we had some onetime discrete items that impacted our tax provision for 2017, including adjustments to our depletion deduction and related amendments to prior year returns.

We had net income of approximately $7.1 million, earnings per share of approximately $0.17 per share and adjusted EBITDA of $11.6 million in the third quarter. Both net income and adjusted EBITDA increased sequentially due primarily to higher sales volume and increase in average selling price and lower production cost.

As highlighted earlier in the third quarter, net income and adjusted EBITDA were positively impacted by an annual contractual shortfall payment from one customer of $1.2 million. Year-to-date through September 30, 2017, we have spent approximately $27.6 million in capital expenditures, primarily related to our expansion projects for 2017 and some operational efficiency and replacement projects.

We continue to move forward on our expansion projects in Wisconsin, and are currently on schedule to bring online in late 2017, early 2018, 2 dry plants to increase our nameplate capacity to 5.5 million tons per year and to bring into service our unit train cable rail facility at Byron. Our second wet plant began operations in mid-October. Our original capital budget for 2017 was $85 million.

In the fourth quarter 2017, we currently expect to spend in the $20 million range and we currently expect total capital expenditures in the year to be in the $50 million range. Our facility expansion project at Oakdale is still in line with its budget and is still scheduled to be operational by the end of the first quarter of 2018. The remaining capital of the original $85 million in the fourth quarter of this year, should be spent by the end of the first quarter next year.

As of September 30, we had approximately $52 million of cash on our balance sheet and we currently have approximately $47 million in cash. Our $45 million revolver is fully available to us to draw down, as needed, as additional sources of liquidity. We continue to maintain a clean balance sheet with essentially no outstanding debt and ample liquidity to support operation and planning growth initiatives.

This concludes our prepared remarks. Operator, you may now open the line for questions.

(Operator Instructions) Our first question is from Martin Malloy of Johnson Rice.

Congratulations on getting the volumes up and production cost down during the quarter. My first question is around the contracting that you have in place. I believe that there's some escalators in some of your contracts regarding the price of WTI being above $55. Could you talk about the mechanics of how that works? How long WTI has to be above $55? And what percent of your contracts this applies to?

Well, the WTI escalator applies to all of our contracts, and currently we're around 74% contracted of our current capacity. The way that mechanism works is that it's a look back at the previous contract quarter. And if WTI were to average at $55 or higher -- most of the contracts have a breakpoint of $55, if WTI was to average $55 or higher, then we would get an increase in our contracted pricing. Every contact is a little different, but on average it would be about $5 per ton.

Okay. So it's possible that, that would apply during the first quarter of '18?

Potentially. If oil prices stay where they are today and are consistent above $55, we could see -- start to see some benefit of that beginning in the first quarter of '18, yes.

Okay. And then the option that you have for the properties down the Permian Basin, any commentary that you could give us in terms of the discussions that you've had with customers down there and the reception that you're getting?

Yes. So well -- so there's definitely demand down there for -- from existing customer base and additional customers for us to have a Permian option. With regard to the mines that we've looked at, the same mechanisms that we looked at when we built Oakdale are the same. We looked at reserve size, making sure that we've got scalable -- good scalability up to the plant. We're looking for logistics that are going to work out at that site. But yes, there is demand out there, again, from both the -- would be new contracted customers for us and some of our existing customer base. And as Chuck had mentioned, if we're looking for an anchor, we'd be looking for an anchor tenant there to start that project.

Yes. I think it's important to mention that our entry point is best-in-class of anybody out there that's been down adding this kind of capacity on. So we feel really good about what we've done there. We're also looking to see how the logistics problems, as far as the trucking, is going to work from those invasive mines. And we're also looking to see what the railroads -- we think the railroads are going to protect their market share down there. So we're looking to see how that all plays out and we're ready to pivot.

Our next question is from John Watson of Simmons & Company.

A quick one on 30/50. Could you give any more color on that? Is that due to a change in well design or is it because of a shortage of 40/70? Now are there multiple of customers who are now looking for 30/50 instead of 40/70?

So yes. So John, it's certainly the heaviest demand is on the finer mesh, 100 mesh and 40/70. 40/70 is still the product that is in very heavy demand. As far as -- I think we're kind of in a little bit of a mechanism where our customers are -- they may have trouble getting 30/50, so their pivot point either to 100 mesh or 30/50. If they can't get 100 mesh, then they may pivot to 30/50. I think, probably, it's just an overall kind of shortage of ability to get sand, though, and they don't want to hold up on pumping these wells. So I don't know if it's a long-term benefit. From our perspective the 30/50 is a -- we make a lot more 40/70 than we do 30/50, which is kind of an interesting point, but all of our 30/50 is now being taken.

Yes. I'd add to that if you're playing the spot market right now in this business, you're probably being rationed sand. So when you're rationed sand, you'll change your designs. The pressure pumpers need the sand. If they're not -- if they don't have sand, they're not working. So I think that there's a lot of people that are running into that. And quite honestly, all the development talk has been about Permian mines, and they haven't all come on as of yet. And a lot of the sand is up in the north; no one's really developed additional capacity. And really, the Permian stuff is a 100 mesh story, right? So there's a lot of people pumping different stuff and playing with different mixes and doing what they have to do to get their wells completed.

Got it. That's super helpful. And on the spot pricing front, expectations for pricing was higher by 5% to 10% in Q4. Is part of that due to pricing for grades like 30/50 moving higher and maybe the gap between 30/50 and 40/70 shrinking? Or is that just a general expectation for pricing for all grades to move higher by a couple of percentage points?

Yes. John, so it's general. We're seeing price improvement across the board in spot. And right now, the pricing, depending on the product, ranges from into the 40s and in some cases up into the 50s now. And we've seen -- we kind of have seen continued appetite to absorb price changes in the market there. So again, it's really a case of we're making -- we're selling as much sand as we're making right now. And there doesn't seem to be any indication of that slowing down anytime soon.

We have many more orders than we have sand, right? So -- and a lot of requests for sand and it's just -- it's -- we can't get this new capacity on soon enough.

(Operator Instructions) I see no other questions in queue. I'll turn it to management for closing remarks.

Thank you for joining us for the call. That concludes our third quarter earnings call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your program. You may now disconnect. Everyone have a great day.