ProFrac Holding Corp. Q2 FY2023 Earnings Call

Greetings, and welcome to the ProFrac Holding Corp. Second Quarter Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Rick Black, with Investor Relations. Thank you, Rick. You may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us for ProFrac Holding Corp.'s conference call and webcast to review our second quarter 2023 results. With me today are Matt Wilks, Executive Chairman; Ladd Wilks, Chief Executive Officer; and Lance Turner, Chief Financial Officer. Following my remarks, management will provide high-level commentary on the financial highlights of the second quarter of 2023 as well as provide the business outlook before opening the call up to your questions. There will be a replay of today's call available by webcast on the company's website at pfholdingscorp.com as well as a telephonic recording available until August 17, 2023. More information on how to access these replay features is included in the company's earnings release. Please note that information reported on this call speaks only as of today, August 10, 2023. Therefore, you are advised that any time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. Also, comments on this call may contain forward-looking statements within the meaning of the United States' federal securities laws, including management's expectations of future financial and business performance. The forward-looking statements reflect the current views of ProFrac's management and are not guarantees of future performance. Various risks and uncertainties and contingencies could cause actual results, performance, or achievements to differ materially from those expressed in management's forward-looking statements. The listener or reader is encouraged to read ProFrac's Form 10-Q and the other filings with the Securities and Exchange Commission, which can be found at sec.gov or on the company's Investor Relations website under the SEC Filings tab to understand those risks and uncertainties and contingencies. The comments made today also include certain non-GAAP financial measures as well as other adjusted figures to exclude the contributions of Flotek. Additional details and reconciliations to the most direct comparable, consolidated and GAAP financial measures are included in the quarterly earnings press release, which can be found on the company's website. And now I would like to turn the call over to ProFrac's Executive Chairman, Matt Wilks. Matt?

Thanks, Rick, and good morning, everyone. Thanks for taking the time to join us on the call today. After my prepared remarks, Ladd will take a deeper dive into the performance of our subsidiaries, and Lance will provide additional insight into our financial performance. Our second-quarter results were challenged due to customer consolidation, coordination with customer CapEx schedules, and the impact of the recent banking crisis on private operators. Despite these external challenges, we generated $182.5 million in adjusted EBITDA, reduced our debt by $86 million, and generated $56 million of free cash flow. We have adjusted our cost structure to rightsize our organization through the acceleration of acquisition synergies and headcount reduction. Most of these reductions will be reflected in our third-quarter results. As we move through the second half of our year, we expect to see our mining assets grow sales and expand customer footprint. We're pleased to see improving industry fundamentals and disciplined behavior from our peers, which support a constructive outlook in the second half of '23. I want to take a few minutes to discuss how we think about ProFrac Holdings and how we view the industry in relation to our subsidiaries. The first thing I want to emphasize is that we are a holding company, and we are the premier vertically integrated energy services holding company, offering a modern suite of complementary services and technologies to the industry. While we started out as a frac company, we have expanded and transformed into three major segments: Stimulation Services, Proppant Production, and Manufacturing. The fastest growing of these segments has been our Proppant segment, which is the largest in-basin proppant producer in the country. We believe this business is underappreciated, both in terms of potential and in terms of value it contributes to the ProFrac platform as well as ACDC stakeholders. We have been focused on diversifying the customer base and signing contracts for the Proppant Production division. In Q2, we were pleased that third-party sales reached 70% of revenue. We continue to pursue additional contracts that increase diversification and improve stability, and we expect to grow the customer base and total production at lower cost levels. Lastly, we believe the currently proposed regulation by the Department of Interior related to the DSL would have a minimal impact on our Proppant Production. This is because we believe that our West Texas assets are well outside of the high-risk habitat zones. Our goal is to provide more certainty and less volatility to our Proppant division, while boosting our utilization to a level that will optimize profitability. This segment has the potential to generate 2 to 3 times the EBITDA that we had in the second quarter. We highlight this segment to illustrate the incredibly high cash conversion of proppant sales and to demonstrate the stability that a lean multi-mine company can achieve. In terms of the overall market environment, we are optimistic and encouraged. We're optimistic because we are seeing pricing remain constructive. While lower asset utilization impacted second quarter earnings, we are confident that pricing remains at constructive levels, and market fundamentals continue to be supportive for a stronger second half of the year. We're encouraged because we see multiple players, idle capacity, and steady pricing. We see a number of smaller players that are aggressively bidding to spot work, but we view this as isolated and unsustainable. The number of fleets idled in the last six months is considerably higher than the number of staffed fleets that could go back to work in a responsive manner. In addition, natural gas pricing is constructive, which we believe will provide a built-in catalyst as we look forward to the remainder of 2023. As we approach the back half of '23, we believe we will see operators ramp activity as they prepare for their 2024 programs. I remain proud of what this team continues to accomplish and believe we are well positioned to capitalize on increasing industry activity. Our fundamental strategies haven't changed, and neither have our primary goals for ProFrac. We continue to execute on our goals. Our pumping efficiencies are best-in-class. We offer a portfolio of Tier 4 dual fuel and electric fleets capable of simultaneously delivering cost savings and emissions reductions for our customers, helping to further separate us from our peers. We are focused on maximizing utilization and profitability and continue to adapt our cost structure to further improve our cash flow. As always, industry discipline remains a welcome narrative. For ProFrac, we continue to believe that our disciplined approach will produce meaningful shareholder value. With that, I'll turn the call over to Ladd.

Thanks, Matt. As always, I'd like to thank our team for their hard work and dedication as they continue serving our customers. We firmly believe that great customer service distinguishes our company in the market and is a direct result of the strong culture within our teams to continually serve our customers. Turning to the quarter. As many of you who closely follow our industry have seen, there were meaningful shifts in activity during the second quarter that resulted in white space and subsequent fleet reductions. However, Matt did a great job detailing how pricing remains constructive, and industry discipline continues to support a positive outlook. ProFrac's differentiated and vertically integrated service offering is the cream of the crop in our industry. As we see activity levels rebound, we will purposefully deploy our fleets only where they can earn attractive returns and generate cash for us to return to our stakeholders. We don't want to get caught up in short-term dislocations in a healthy industry. Customers want service providers with assets and technologies that can reliably deliver efficiency and cost savings, and we fit the bill hands down with some of the youngest and most advanced asset bases in the industry. From a stimulation services standpoint, we continue to have strong interest in our fuel-efficient fleet. We're seeing equipment type drive utilization, and diesel appears to be the swing capacity. We've also slowed our CapEx spend, reduced e-fleet gross spend, and lowered engine upgrade CapEx in response to activity levels. White space accelerated in Q2 but appears to have bottomed out in May. After the past year of acquisition, we're adjusting our commercial strategy to target a more diverse customer base with committed contracting approaches across the fleet. Our goal is to capture longer-term dedicated work, reducing volatility in the business during short-term market dislocation. Turning to our Proppant Production segment. As we guided to last quarter, the second quarter represented the first full quarter contribution from all of our eight mines. Sand volumes were up as a result, yet constrained from what we believe is their full potential due to lower industry-wide utilization. The Proppant segment continues to show signs of improvement. Our efforts to diversify the customer base reached an all-time high for third-party sales, and we continue to pursue additional contracts that increase diversification and improve stability. We expect further growth in this segment as the customer base expands, production increases, and costs are lowered. As we've discussed before, our vertical integration strategy significantly benefits both our customers and ProFrac throughout the cycles. Our ability to bundle fleets with internally produced sand, logistics, and chemicals saves our customers significant costs. Looking to the back half of the year, we're positioning ourselves to reactivate fleets in Q4 and Q1 as customers solidify their 2024 budgets. The general trend suggests improved activity as we progress into next year. When pursuing commercial opportunities, ProFrac will always prioritize generating returns over winning market share. We are working diligently with our customers as they build out their calendars with the goal of minimizing gas and integrating more materials into our fleet.

Thank you, Ladd. As Matt mentioned, we generated $183 million in adjusted EBITDA, $56 million in free cash flow, and we reduced our debt by approximately $86 million during the quarter. On a consolidated basis, revenue for the second quarter totaled $709 million, a decrease driven primarily by lower activity levels as outlined by Matt and Ladd. Selling, general and administrative costs were $70 million in the second quarter, down slightly from the first quarter. Second quarter SG&A included a number of one-time items such as $9 million in acquisition and litigation-related costs, partially offset by a $7 million reduction in SG&A in our other business activities segment relating to Flotek. SG&A also included non-cash stock-based compensation of approximately $9.8 million. We believe our baseline SG&A was down approximately $1 million from the prior quarter when excluding Flotek and these various items. Additional reductions are expected in the third quarter as a result of our cost reduction efforts. Turning to our business segments. The Stimulation Services segment generated revenues of $608 million in the second quarter, down from the first quarter primarily due to lower fleet count and more white space on active fleets. Adjusted EBITDA for the segment was $123 million compared to $206 million in the previous quarter. In response to the white space that we outlined, we reduced our fleet count at the end of the second quarter and reduced fleet count again in the first half of August. We believe this calendar optimization will allow us to capture significant cost savings in the third quarter and beyond. The Proppant Production segment generated revenues of $110 million in the second quarter, up approximately 34% sequentially. Adjusted EBITDA for the Proppant Production segment totaled $58 million, up approximately 40% from the first quarter. The revenue uplift was driven primarily by the full impact of all eight mines during the quarter compared to approximately 5.5 active mines in the first quarter. While we saw an uptick in total production, we are focused on getting total output higher. As we improve efficiencies at our plants, we expect to see a lower cost per ton. The Manufacturing segment generated revenues of $31 million in the second quarter, down approximately 54% from the previous quarter. Approximately 73% of this was intercompany revenue for products and services provided to the Stimulation Services segment. Adjusted EBITDA for the Manufacturing segment was $3.1 million, down from the first quarter. This segment was impacted by lower orders from our Stimulation Services segment as they reduced equipment-related expenditures and focused on utilizing inventory on hand. Cash capital expenditures totaled $98 million in the second quarter. As we focus on reducing our CapEx for the remainder of the year, we expect our total CapEx to be approximately $300 million, which reflects the deferral of our fleet upgrade program, including Tier 4 upgrades and electric fleet deployment. We will remain disciplined with our capital allocation plans and continue to look for areas to further reduce growth CapEx spend. Operating cash flow was $154 million during the second quarter. We continue to manage our receivables and payables to manage liquidity. In addition, we are focused on consuming the inventory that we have built over the last year, which we expect to start providing a working capital benefit to ProFrac in the back half of the year. Total cash and cash equivalents at the end of the quarter were $27 million. We had total liquidity of $164 million, consisting of a combination of cash and $137 million of availability under our asset-based credit facility. At the end of the second quarter, we had approximately $1.2 billion of debt outstanding. As Matt mentioned, our focus for the remainder of 2023 is generating free cash flow for debt repayment. We illustrated this priority in the second quarter as we produced free cash flow of roughly $56 million, which we used in combination with cash on the balance sheet to pay down approximately $86 million of outstanding debt.

Our first question comes from the line of Luke Lemoine with Piper Sandler.

I believe you should have had about 35 active fleets in 2Q. Can you provide some commentary on the magnitude of the fleets that you guys put on the sidelines in June and then in August?

Yes. We're not going to provide any commentary on it. What we've focused on is maximizing the utilization of every asset that we have and focusing on rightsizing the cost structure associated with that. What we've seen across the industry is a pullback in overall available active fleet. We're really encouraged by seeing similar approaches to reducing costs associated with inactive fleets. We believe that provides some sensitivity for activity levels picking up and what that means for pricing longer term. The sensitivity is truly there on the upside. We're already seeing some green shoots and believe the second half of the year will be much more robust than people expect.

Great. Could you provide some insight, Matt, on how many fleet reactivations you anticipate for ProFrac in the fourth quarter or into 2024?

We're not going to guide to fleet count, but we're paying very close attention to rig count. One thing I would point out, with these operators, is that the DUC inventory and the way that the industry looks at building DUC inventory has completely changed. A high DUC count is a feature of low interest rates, and with rates increasing, the cost of capital associated with a partial spend on an unproductive asset is not the most efficient use of capital, and we think this will keep DUC inventories subdued. Activity levels will more likely be closely related with rig count. When we look at rig count and the structure, instead of just looking at it at a high level, we're seeing a lot of private companies deploy rigs and get back to work; where the cost of capital is really exciting to see how quickly following those rigs, you'll see frac fleets.

Could you provide an update on the e-fleet deployment schedule over the next 12 to 15 months, especially in light of the CapEx reduction which seemed to push the deployments back a bit?

So we had some under construction that we've pushed into 2024 delivery. We're focusing on generating cash, reducing CapEx, and paring down our overall leverage.

Our next question comes from the line of Alec Scheibelhoffer with Stifel.

So just to kick us off here, we've seen some data points that spot pricing has been weaker in the Permian for Proppant. I'm just curious, have you guys been seeing that as well? And can you talk about maybe what prices are doing in the Haynesville, and I guess, by that effect also the Eagle Ford? And I guess also how ProFrac plays in that market?

Certainly. In West Texas, there is some spot pricing that has come down from what has otherwise been a pretty narrow range. Contracting rates are well above the spot market, and these are isolated situations. Another consideration is that not all mines. This mine gate pricing and how you look at these basins is more of a logistics business than anything else. If you look at the logistics differentials from mine to mine and customer to customer, huge gaps are easy to miss and when modeled out. We focus closely on where our logistics advantages are, and if there's spot pricing or a competitor out there with a disadvantage on logistics, we simply don't compete with them. We don't have to be the right solution for everyone; but for the customers that we work with, we're the right solution for them, and we can earn a higher price per ton and still save them money.

Understood. And also as a follow-up, can you also talk to customer preferences for bundling frac sand? And have you seen any changes with the pricing dynamic across the basins for sand?

I believe it varies by customer. It’s not just about the basin; it's really about the specific needs of each customer and their preferences. It's challenging to secure a complete package with an operator that has a full procurement team. Nevertheless, we appreciate all our customers and have tailored solutions for each, striving to find an approach that meets their needs.

Our next question comes from the line of Don Crist with Johnson Rice.

I wanted to continue on the sand discussion. I mean, it sounds like since you closed performance, the team has really gotten to work and optimize all eight of the mines. Can you talk about how costs have come down? Because it looks like your profitability kind of ticked up a couple of hundred basis points in the quarter.

Yes, certainly. We think about these plants; your costs are almost fixed. Labor costs will be consistent, gas, electricity—everything is relatively consistent in these businesses. The variable that moves your COGS is utilization and volume. We continue to see our utilization and the volumes that we're putting out climb. At this point, all our costs are essentially covered. So we're in a strong position to continue our growth in profitability. As we reach our nameplate capacity at each of these assets, you're going to see a much stronger pull through. What we love so much about that business is, one, our costs are relatively fixed. So everything we do from here on has a very high cash conversion rate. The quality of the earnings in that business really stands out compared to a capital-intensive business like frac services.

I appreciate that color. And Lance, maybe one for you. As the business has slowed a bit in the second quarter, how should we think about working capital? Should it release into the third quarter and possibly into the fourth quarter and generate some free cash flow?

Yes. One of the things I mentioned was inventory, which has been building over the past year. That's the biggest focus to provide that release. As the fleets reduce, you'll also see an impact on AR AEP. Overall, I think it's a fair assumption.

Any kind of magnitude you'd like to give, would that be $50-plus million or so?

I think that's feasible. We're targeting the majority of that on the inventory side. But all in, I think it's feasible.

I think that's pretty bullish for Lance. He is conservative in his outlook.

Our next question comes from the line of Dan Kutz with Morgan Stanley.

Looking at the press release, you mentioned that the actions taken to adjust the cost structure and reduce expenses should help maintain profitability metrics per fleet. I understand there may be some decline in activity compared to the second quarter, especially with some fleets coming offline in August. From the perspective of per fleet profitability, should we take that to mean you are confident that it will stay at the same level in the third quarter or second half? What are your thoughts on that?

Yes. So, we've harvested a lot of the synergies from the acquisitions made over the last year, accelerating those, especially when you have a fleet count reduction. What would normally be managed through turnover and natural attrition has been taken care of much quicker. The other part is we took our entire calendar and said, 'Look, we need to compress this as much as possible.' There’s no reduction to our calendar or how many hours we'll pump. We want to ensure that we optimize the working assets, increasing utilization and maximizing them to the fullest. In doing so, we maintained the highest level of pump hours per fleet and cut all unassociated costs. This has allowed us to return the business to a level of profitability on a per fleet basis that we're known for.

Got it. That’s helpful. Understood. Let’s go back to the Proppant Production comment. I think if I heard it correctly, you said the potential for that business could be 2x to 3x the second quarter EBITDA. I was wondering if you could unpack what that might contemplate in terms of higher pricing, higher margins, or higher utilization? You mentioned previously that volume utilization is the name of the game, but just wondering if you could help quantify what might be contemplated for that 2x or 3x EBITDA for that segment?

Yes. Certainly, the EBITDA that we produced at the utilization rate in Q2 covered the full fixed cost burden we would have at a much higher utilization rate. When looking at lower utilization and delivering results that exceed our fixed costs, higher activity and utilization with the same fixed cost will convert to a nice, levered result on your pull-through. I find this to be a very attainable goal, and we expect to be able to deliver that much quicker than mobilizing in a relative manner on the frac services side.

Thank you. This concludes our question-and-answer session. I would like to turn the floor back over to management for closing comments.

Thank you, operator. ProFrac has purposely built a dynamic platform capable of delivering strong results through market cycles. Although the second quarter posed some challenges, we've already begun to see these headwinds subside, and we believe that we are incredibly well positioned to deliver meaningful shareholder value in the near term. Thank you for joining us today. We look forward to speaking with you again next quarter.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.