Smart Sand Inc (SND) 2020 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Smart Sand's Fourth Quarter 2020 Earnings Call. (Operator Instructions) I would now like to introduce your host for today's conference call Mr. Josh Jayne, Director of Finance and Assistant Treasurer. You may begin.

Good morning, and thank you for joining us for Smart Sand's Fourth Quarter 2020 Earnings Call. On the call today, we have Chuck Young, Founder and Chief Executive Officer; Lee Beckelman, Chief Financial Officer; and John Young, Chief Operating Officer. 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 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, March 3, 2021. Additionally, we will refer to the non-GAAP financial measures of adjusted EBITDA, contribution margin and free cash flow during this call. These measures, when used in combination with our 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 our reconciliations of adjusted EBITDA to net income, contribution margin to gross profit and free cash flow to cash flow provided by operating activities.

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

Thanks, Josh, and good morning. As you're all aware, 2020 was a challenging year for the energy industry. However, thanks to several factors, including actions we took, we were able to stay well positioned to achieve our long-term strategy. That strategy is this, to be the premium supplier of Northern White frac sand from the mine to the wellsite. The key success factors included our low leverage decisive actions to manage costs and our opportunistic acquisition of Eagle Materials proppant business. As the frac sand market recovered in the fourth quarter, our sales volume increased by 98%. It went from 309,000 tons in the third quarter to 612,000 tons in the fourth. However, the most recent winter storms did impact activity in February, which may push some activity into the second quarter. We're encouraged by recent sales trends and customer inquiries, barring a dramatic drop in oil and gas prices, first quarter activity should be consistent with the fourth quarter or perhaps, even a little better.

Last year, we generated free cash flow of $17 million, despite a challenging environment. We did it by controlling our operating costs and CapEx. Our focus for 2021 is to keep generating free cash flow by continuing to operate efficiently. Right now, we have $12 million in cash on our balance sheet and approximately $31 million in liquidity. We couldn't have managed through these difficult times without the efforts of our employees. I want to thank all of our employees once again for their continued commitment to Smart Sand. As we've demonstrated, we'll be able to manage through the volatile operating cycles in the industry better than most of our peers. Our prudent capital structure and operating philosophy provides Smart Sand to wherewithal to not only survive the industry's volatility, but to be stronger coming out of the downturns. As a result, Smart Sand is well positioned to take advantage of improving market conditions, while also being able to pursue strategic opportunities that will allow us to capitalize on the recovery. Our acquisition of Eagle Materials frac sand business last September was a success. We added new sand capacity plus an additional Class I railroad to our portfolio of assets, and we did it without taking on debt or significantly impacting our liquidity. Even though Eagle's Utica assets were idle at closing, we started mining operations and began selling sand from there in the fourth quarter. With start-up costs behind us, we look forward to this asset generating solid cash flow for years to come. This acquisition expands our footprint by allowing us to serve new markets and new customers. We believe there will be more consolidation opportunities in the sand space, and we want to play a part in them, but we will not risk our balance sheet. We will only consider consolidation with a purpose, and we remain committed to our core principles of a strong balance sheet and low leverage.

In regard to SmartSystems last mile product offering, we've completed testing on the SmartPath transload. We now have 4 fleets equipped with it and ready for deployment. By the end of this year, we expect to have 12 fleets equipped with SmartPath. We continue to believe SmartPath transloader is unlike anything in the industry. It's a self-contained system designed to work with bottom dump trailers that features a drive-over conveyor, surge bin [and dust collection] system. So it's well suited to perform any frac job. With market conditions improving and increased focus by E&Ps on the environmental impact of their fracing operations, we foresee increased industry interest in our SmartSystems product offering.

A number of E&Ps have discussed a preference for silos with both built-in dust control and better dust control throughout the completion process. Smart Sand suite of products is built to limit exposure to dust for all employees in and around the well site. We're excited to have more scale with our products in 2021. As you know, the market is still operating at lower levels than at this time last year, but we've seen a nice uptick in volumes from the bottom we hit in the second quarter of 2020. Our policy of always staying in close contact with our customers ensures that we'll move forward together. We're going to continue the policies that have paid off for Smart Sand, maintaining our strong balance sheet, generating free cash flow, paying down debt and always having surplus liquidity. We're excited about our future and for a number of reasons. We've seen a meaningful increase in sales volumes. Over the last 12 months, we've expanded both our customer base and operating basins we serve with start-up costs for our new Illinois mining operation now in the rearview mirror, we can focus on execution. At our Oakdale mine, we continue to improve efficiencies and cost structure to make it one of the most efficient frac sand mines and processing plants in the industry. And we're ready to take market share with our last mile offering with the SmartPath transload. As always, we'll be keeping our eye on the future and our employee and shareholder interest will continue to be in mind in everything we do.

And with that, I'll turn the call over to our CFO, Lee Beckelman.

Thanks, Chuck. 2020 was a challenging year for the oilfield service industry. We witnessed a sharp sequential decline in our volumes from the first quarter to the second quarter and swiftly moved to cut CapEx and operating costs to manage through the downturn in the market. While these moves were painful at the time, they provided us flexibility to take advantage of opportunities as the market began to recover. Volumes continued to improve from the second quarter lows, increasing by 98% in the fourth quarter from the third quarter. We continue to be excited about the opportunities that come along with our acquisition of the Eagle Materials proppant business, which began operations at the Utica plant during the fourth quarter. We continue to believe there will be additional opportunities for consolidation in our industry, and we are interested in playing a part in this consolidation. However, as we demonstrated with the Eagle acquisition, we are committed to low leverage levels, a prudent capital structure, generating positive free cash flow and maintaining adequate liquidity levels. We will not risk our balance sheet to pursue growth opportunities. Any acquisition we may consider will need to provide us with strategic long-term assets at a reasonable valuation that will not risk our strong balance sheet and liquidity.

Now we'll go through some of the highlights of the fourth quarter compared to our third quarter 2020 results. Starting with sales volumes. We sold approximately 612,000 tons in the fourth quarter, a 98% increase over third quarter volumes of 309,000. We expanded our customer base during the fourth quarter and believe a more diverse customer base will strengthen our opportunities for growth in 2021. Total revenues for the fourth quarter 2020 were $25.3 million compared to $23.4 million in the third quarter. Sand revenues were higher in the fourth quarter, primarily due to higher sand sales, which were offset by lower shortfall in logistics revenues. Our cost of sales for the quarter were $33 million compared to $18.2 million last quarter. The increase in cost of sales was primarily attributable to higher freight expense, negative impact from inventory adjustment, as inventory was depleted from our winter stockpile and start-up costs at the Utica plant. Total operating expenses were $13.3 million compared to $6.4 million last quarter. The increase in operating expenses was primarily due to a $5.1 million impairment charge on our Permian Basin long live assets and a $1.3 million onetime sales tax audit settlement expense. Income tax benefit for the fourth quarter was $18.6 million. During the quarter, we evaluated our depletion deduction and determined we were eligible for a more advantageous deduction. This change will result in approximately $8.2 million of cash benefit from prior return amendments, as well as a decreased effective rate on a go-forward basis. Due to IRS processing delays as a result of COVID, we are unable to predict the timing as to when we will receive these funds. Without the impacts of the nontaxable gain on bargain purchase, depletion deduction and other NOL carryback benefits allowed by the CARES Act, our 2020 effective tax rate would have been approximately 21%, which is on the higher end of our normal range. Going forward, we expect our annual effective tax rate to be in the mid to upper teens.

In the fourth quarter, we had a loss of $2.9 million, which includes an impairment charge of $5.1 million on our Permian Basin long-lived assets, a $1.3 million sales tax audit settlement charge and an income tax benefit of $18.6 million. For the fourth quarter 2020, contribution margin was a loss of $5.2 million and adjusted EBITDA was a loss of $7.7 million compared to the third quarter contribution margin of $10.4 million and adjusted EBITDA of $6.1 million. The decrease sequentially was driven by lower shortfall revenues and higher freight expense, a negative impact from inventory adjustment, as inventory was depleted from our winter stockpile and start-up costs at the Utica plant. For the full year 2020, we sold approximately 1.9 million tons of sand compared to 2.5 million tons in 2019. Contribution margin in 2020 was $39.1 million and adjusted EBITDA was $20.5 million compared to 2019 contribution margin of $106.5 million and adjusted EBITDA of $87.1 million. Net income in 2020 was $37.9 million compared to $31.6 million in 2019. Contribution margin and adjusted EBITDA decreased year-over-year, due primarily to lower sales volume and lower shortfall revenues. For the fourth quarter of 2020, we had $2.1 million in free cash flow, generating $3.3 million in operating cash flows, while spending $1.2 million on capital investments. For the full year 2020, we generated $16.9 million in free cash flow from $25.5 million in operating cash flows, less $8.6 million spent on capital investments. Capital investments in the quarter and for the full year 2020 have primarily been on new SmartSystems units. During the quarter, we didn't use our revolver and still have no outstanding borrowings other than $1.3 million in letters of credit. Our current unused availability on our revolver is $14 million. Additionally, we have $5 million in unused availability from the acquisition liquidity support facility we put in place with the Eagle proppants business acquisition. We ended the year with approximately $11.7 million in cash. Our current cash balance is approximately $12 million. Between cash and availability on our facilities, we currently have approximately $31 million in available liquidity. We do not expect to have any borrowings on our ABL revolver in the first quarter.

In terms of guidance for the first quarter, we expect sales volumes to be flat to up 10% from fourth quarter levels. We currently anticipate capital expenditures for 2021 to be in the $10 million to $15 million range and currently expect free cash flow for the year to exceed $10 million.

This concludes our prepared comments, and we will now open the call for questions.

(Operator Instructions) Our first question comes from John Danny of Daniel Energy Partners.

My question relates to -- you guys made a lot of comments about the need for acquisitions, consolidation, et cetera. And obviously, we all know you can't get specific, but can you just elaborate a little bit more about other parties' interest and willingness to talk? And just how active discussions might be on that front today versus 12 to 24 months ago? And just what -- and whether you don't -- whether you guys play in the process or not, just your thoughts about the likelihood of a broader consolidation unfolding this year in the sand business.

So I'll start with that, and Lee, you can chime in. But our main thing is, whatever we do, we have to keep our balance sheet similar to the way it is today. So we're not going to take on debt to do it. So again, that makes the amount of people out there that we can consolidate wit, it makes it more difficult. Lee, I don't know if you could touch base a little bit on what we're seeing.

Yes. I think as we've highlighted, John, on this call and in previous calls, we're open to consolidation. And -- but we're not going to let risk our balance sheet, and we're not going to consolidate just to consolidate it. It has to have a purpose, and that purpose is really driven like Eagle. I think Eagle is a great example. You can look at it, and the benefits that we believed we were going to receive from Eagle, and we think that we believe they're going to play out and be true, and this is really getting the opportunity to expand our sales through new customers and new operating basins, really improving our logistics capabilities. And Eagle, we had the -- it gives us the access to additional new Class I railroad. And also looking through consolidation to be able to potentially rationalize and improve our operational efficiencies and cost.

And so I think we're open to any -- we're open to larger transactions as well as bolt-ons like Eagle, but they have to fit those goals, and they have to fit within the framework that we're not going to go out and risk our balance sheet to do it.

So -- and in terms of your question about -- I think there is a general level of dialogue, but I think a lot of our peers have gone through restructurings, and I think they're just coming out with their new management and understanding their business. So I think we need a little time for those businesses to kind of figure out where they want to be and who they believe makes sense to partner with. And for us to then have, I think, more fruitful dialogue. So I think over the next 6 to 12 months, there is an opportunity to have these dialogues. But I think you know our objectives and from the people on [other] side, I think they have to be realistic about what they believe the value of their assets are.

John, one other thing I would add on that, we picked up assets last year in the pandemic, and we have more assets than we ever had. At the same time, we paid down debt. So that's kind of the way we're looking at this. It's not a business you want to have a lot of debt in because the cycles are so [fast.]

No, no, I get all that and appreciate it. And by the way, the volumes in Q4 were great. I just -- I'm just trying to get a sense of, are people willing to do the dance, if you will, or as everyone is kind of waiting to see. That's all, I was just trying to get a sense for the -- how many interested parties are out there...

I think there are parties interested, but a lot of times, they come with a lot of debt that's out there, especially in private companies. And the private equity that's involved in them, they want to bring the debt to the table instead of it being equity. So I think once they realize that no one's crazy about paying out cash and taking on debt, and they've got to build the business together with people. I think then you'll see more activity.

Our next question comes from Lucas Pipes with B. Riley Securities.

(inaudible) on the M&A landscape out there and specifically kind of what -- if you have a preference in regards to geography, is it -- you want to kind of stay close to your current operating platform? Or would you be willing to enter out a little bit further?

So Lucas, you broke up a little bit. I think your question was about M&A activity, and whether we want to stay close to, kind of our focus on Northern White. Was that the question?

That's correct, yes.

Yes. Okay. So yes, our view on this is pretty simple. I mean, I think everybody who's followed Smart Sand for any length of time knows that we are biased towards Northern White. We're long-term believers in Northern White. So as we kind of continue that focus, we want to bolt-on potentially assets that are complementary to what we have. However, having said that, it doesn't mean that if there is other opportunities that are -- would be acquisition or merger opportunities that come with regional sand plays or different types of "Northern White" plays that we wouldn't be open to those. What we're interested in is companies that would fit with our overall goal, which is to grow without acquiring -- incurring lots of new debt and things that are complementary to what we have. In addition, some of those opportunities may involve assets that would be idled to reduce if there is any older supply, things like that. So we look at a number of things, but ultimately, we are focused on keeping our balance sheet clean. And when we think about deals, that's kind of the overarching principle that we look at these things for. And not only in sand, but logistics as well.

Very helpful. Very helpful. And on the balance sheet, I want to confirm, I think you said in your prepared remarks that you wouldn't have any borrowings outstanding against your ABL at the end of Q1. Could you confirm that? And then as it relates to ABL and that liquidity, would you be able to remind us kind of what sort of fixed charge coverage ratios there might be EBITDA covenants? And whether you'd expect to be in compliance with all of those at the end of Q1, Q2?

Will direct that to Lee.

Yes. Currently, we expect no borrowings. We do have some LCs under the facility, about $1.3 million. And there might be some additional LCs, but there will be no borrowings out of the facility in the first quarter. We don't expect to have any. In terms of our covenants, currently, we're in ABL. So we're governed by our borrowing base against receivables and inventory. And as long as we keep our borrowing levels below a certain level, which is around 85% of the stated borrowing base in a given period, we don't have any covenants that we have to basically comply to on a quarterly basis. But if we were to move into a borrowing level, which we don't expect to anytime soon at that 85% level, the only covenant we would have would be a fixed charge coverage. And it's at a 1:1 coverage, and it will be something that we'd be able to very easily manage. So we don't have any concerns or issues in terms of adequate liquidity, access to the borrowing base. Again, we expect to have no borrowings in the first quarter, and we don't have any covenants that any way causes any issues.

That's very helpful. And I believe you said, you wouldn't consider using debt for acquisition. Would that include the ABL as well? Or would you consider borrowing on the ABL for an acquisition, for example?

Well, what we said is we want to keep low leverage levels. So I will never say absolutely, they will never take on some debt, but we want to keep those levels very low and manageable. And if we were to use an ABL, it would only be for a temporary basis, if at all, but our goal would be not to have any debt or very little debt, and our goal would be to maintain the ABL to maximize liquidity to support the ongoing operations.

I think -- you can look at our Eagle's acquisition, it's a good example. As part of that negotiation, we negotiated a separate $5 million facility to provide liquidity for the Eagle acquisition to make sure we protected our ABL and kept that liquidity fully available for the existing operations. So any acquisition we do, we want to make sure that we don't risk the long-term strength of the balance sheet, but also that we ensure that we have more than adequate liquidity to support the existing business as well as any acquisition and new assets we take on.

(Operator Instructions) Our next question comes from Stephen Gengaro with Stifel.

A couple of things, if you don't mind. And what I'd like to start with -- on the fourth quarter and the sort of the cost of sales and contribution margin itself, I understand the moving pieces. Can you give us a little more color on, a, sort of the seasonality of the costs and just sort of refresh our memory, the key drivers of that? And then second, is there any way to break down the different pieces, the start-up cost of freight and the inventory adjustments as far as the impact in the quarter?

Yes. This is Lee. I'll take that question, Stephen. And I don't think I give you probably as many specifics as you'd like, but I think there was a lot of -- going back, first of all, the seasonality, as you go back and historically, you can see this consistently in our numbers. The fourth quarter and the first quarter is always our lowest, typically our lowest contribution margin and EBITDA because we do consistently have larger inventory costs that we bring in into our reported costs in those quarters as we pull down inventory during the winter months to support our sales activity. And so that can have a pretty big swing in terms of our reported contribution margin and EBITDA numbers quarter-to-quarter. And I think you consistently see that in the fourth quarter and first quarter, we're substantially below what we can report in the second and third quarter when we're running our operations and either consistently using our -- the mining tons that we mine and are actually capitalizing costs as we build up our inventory for the winter stockpile for the next year. That swing on a dollar per ton basis can affect our contribution margin from anywhere to $3 to $5 a ton. And so to give you some context, that can be kind of a swing quarter-to-quarter just from that inventory adjustment, affecting our numbers as we pull inventory down during the winter months, and we either add inventory or just kind of run with the mining that we have during the summer months. So does that help in that regard?

Yes. No, that does help. That helps a lot.

And then freight expense, I think (inaudible) pick up, but that was primarily driven by the volume. So I think we did have a pickup in freight expense in the fourth quarter. And so we had a pretty low freight expense in the third quarter. But I think what you'll see is that if we stay at these consistent levels, that's going to be relatively consistent going into the -- in 2021. So I wouldn't expect a big variation from there going forward because that's much more volume driven. And then in terms of Utica, basically, we bought Utica in mid-September, and really, September and October were start up, and then we really didn't start really getting sales from that and generating some cash flow. It's really mid to late November. And order of magnitude, we probably had about $1 million of incremental cost from Utica, start-up and ramping up in the fourth quarter that I think going into the first quarter, we'll be able to absorb that cost as we start getting consistent sales out of that mine.

Great. No, that's great detail. Just 2 other quick ones. One, a follow-up on that is, does the Utica facility dilute the seasonality impact at all?

Well, it's really too early to tell on that, Stephen. But I think it ultimately -- I think one of the challenges for us versus some of our other peers in the past is, they had a lot more mines and they also had industrial sands. And so the impact of the seasonality, I think, gets more muted, and we've always just had mainly the one Oakdale facility. So it kind of fully flows through, and you see it more prominently in our numbers than maybe some of our peers in the past. I think Utica will help with that because they have -- their operations are in doors like part of our facilities. And so there is less building of a winter stockpile. So I think over time, if we ramp Utica up to levels that we hope to, that may help impact that overall number. But I think it's a little too early to see how that's going to play out until we get through really a full -- we need a full year of operating cycle to see how that plays out into these reported numbers.

And then just a final question. You mentioned, I think in the 10-K about the -- just kind of the expectations for 2021. And I think you basically said volumes flat to up a bit year-over-year. What are you seeing, if anything, right now on the pricing side and sort of the impact of some of the competition going by the wayside or going to bankruptcies? Has there been any changes you have on the pricing side? And do you expect anything as we move forward here in '21?

Yes. So Stephen, I mean, the volumes obviously are improving. We expect price to follow. But as of now, there is no material increase just yet on it. Although that we do believe that as activity continues to increase, pricing increases will likely come.

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host for any closing remarks.

Thanks, everyone, for joining us on our quarterly call. We'll see you for the first quarter call soon.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.