Smart Sand, Inc. Q1 FY2022 Earnings Call

Good morning, and thank you for joining us for Smart Sand's First Quarter 2022 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 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, May 12, 2022. Additionally, we may refer to the non-GAAP financial measures of contribution margin, EBITDA, adjusted EBITDA and free cash flow during this call. We believe that 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 and our public filings for our reconciliations of contribution margin to gross profit, EBITDA and adjusted EBITDA to net income 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. We enjoyed another good quarter for volume out of both Utica and Oakdale. First quarter volumes of 852,000 tonnes are up 12% from first quarter 2021 levels and trending up in March. But overall, we were essentially flat with last quarter due to logistics and weather issues in January and February. However, sales were strong in March, and March volumes represented 43% of our tonnes sold during the first quarter, setting up what we believe will be a strong run rate for the second quarter and the balance of 2022. Commodity prices have remained strong, and we expect to achieve record volumes in 2022. Additionally, we completed the purchase of a sand mining and processing facility in Blair, Wisconsin, with a nameplate processing capacity of 2.9 million tonnes of frac sand per year. The plant remains idle, and we are currently evaluating whether the equipment from that facility will have its best economic use at the Blair site or another of our locations. We expect to have more to report on this subject in later 2022. Pricing continues to improve as a result of strong market demand. As mentioned on our last call, first quarter results generally reflected pricing that was put into place in the fourth quarter of 2021. So far, our second quarter pricing is showing substantial improvement. Similar to others, we are experiencing increased costs due to inflation, logistical constraints, and labor shortages. However, we are prepared to meet these challenges and expect to see improved operating and financial results starting in the second quarter. With less than 15% of our capacity signed up under long-term contracts, we have the opportunity to take advantage of the improved market fundamentals, which should lead to higher prices and higher volumes sold. We are very pleased with the initial results we have seen at our newly constructed unit train-capable transloading terminal in Waynesburg, Pennsylvania. More than half of the tonnes shipped through this terminal in the first quarter were shipped in March. We expect a larger percentage of our volumes will be shipped through this terminal going forward, which will drive our margins higher. The new terminal is exciting for us, not only because it expands our presence in the Appalachian Basin but also because it provides ESG benefits to customers in the region by reducing trucking mileage and associated carbon emissions related to sand delivery. As we have said many times in the past, we believe that bulk commodities belong on rail and that sustainable logistics must include terminals close to our customers' drilling activity. Our mine to well site, rail, and terminal approach yields a safer, cost-efficient, and more reliable supply chain. We are pleased with the traction we are seeing in our Industrial Product Solutions division. Our product list, number of customers, and geographical reach are all expanding quickly. We are working towards penetrating the glass, building products, foundry, filtration, recreation, and other markets throughout North America. Further, we plan to broaden our service capabilities with blending, packaging, as well as finer-grade products in the second half of 2022. We have seen an uptick in interest in our SmartSystems. We currently have 8 SmartDepot silo fleets operating in the field, 2 of which are equipped with our SmartPath transloading system. We continue to expect positive contribution margin from this business in 2022. By using our SmartSystems equipped with the SmartPath, our customers can reduce the number of trucks needed to deliver sand to the well site by more than 30% versus our competitors' offerings, providing our customers with substantial delivered cost savings to the wellhead. Additionally, by taking trucks off the road, we benefit our communities by reducing accidents, carbon emissions, noise, and dust. ESG goals are important to Smart Sand and its customers, and SmartSystems helps achieve these goals by improving efficiencies and reducing impact. Our balance sheet remains strong. Today, we have $5 million in cash on our balance sheet and approximately $24 million in liquidity. We will continue to remain disciplined with capital spending while pursuing projects that will generate long-term value. We are excited about our future for a number of reasons. Our balance sheet remains in great shape, and we have the assets in place to generate free cash flow during an up cycle. With mines situated on 4 Class I railroads, we now have the logistics in place to more efficiently deliver sand to our customers wherever they are operating. The market for sand has tightened significantly, which should allow us to generate improved operating and financial results beginning in the second quarter. Having operated with SmartPath successfully for more than a year, we look forward to expanding our last-mile market share. Industrial Product Solutions is growing quickly and diversifying our business at margins that exceed oil and gas margins, providing more stability to our earnings profile. As always, we will continue to keep our eye on the future and the interests of our employees and shareholders in mind in everything we do. And with that, I'll turn the call over to our CFO, Lee Beckelman.

Thanks, Chuck. Now we'll go through some of the highlights of the first quarter compared to our fourth quarter 2021 results. Starting with sales volumes. We sold 852,000 tonnes in the first quarter 2022, a 2% decrease from the fourth quarter 2021 volumes of 872,000 tonnes. Chuck discussed how weather and logistical issues impacted shipments in January and February. The sales volumes were strong in March, and we expect that trend to continue. Total revenues for the first quarter 2022 were $41.6 million, compared to $35.1 million in the fourth quarter of 2021. Sand revenues were $38.3 million, up 12% sequentially, due primarily to higher pricing and $1.9 million in shortfall revenue recognized in the quarter. Cost of sales for the quarter were $43.6 million compared to $39.4 million last quarter. Production costs were higher sequentially due to higher utility costs driven by increased natural gas prices, increased equipment and maintenance expenses, and higher freight expense due to higher in-basin sales in the quarter. Total operating expenses were $7.9 million compared to $8.5 million last quarter. The decrease was mainly a result of bonuses that were paid in the fourth quarter of 2021. For the first quarter of 2022, the company had a net loss of $5.9 million or $0.14 per basic share and diluted share compared to a net loss of $12.2 million or $0.29 per basic and diluted share for the fourth quarter of 2021. For the first quarter 2022, contribution margin was $4.3 million, and we had a negative adjusted EBITDA of $1.9 million, compared to the fourth quarter contribution margin of $1.9 million and a negative adjusted EBITDA of $4.5 million. For the first quarter 2022, we had negative $19 million in free cash flow due to a negative $8.7 million in operating cash flows, $3.8 million on capital expenditures, and $6.5 million spent to acquire the Blair assets during the quarter. The $3.8 million in capital expenditures in the quarter was primarily related to the completion of our Waynesburg, Pennsylvania transloading terminal. Operating cash flow was negatively impacted by an increase in working capital late in the quarter due to the increased sales activity in March, which we expect to be a benefit in the second half of the year. During the quarter, we didn't use our revolver, and we still have no outstanding borrowings other than $1 million in letters of credit. Our unused availability under the revolver is currently approximately $19 million. We paid down $1.8 million against our notes payable and equipment financing in the first quarter. Our current cash balance is approximately $5 million. Between cash and our availability on our facilities, we currently have approximately $24 million available liquidity. In terms of guidance for the second quarter, we currently expect sales volumes to increase by more than 25% from first quarter levels. March volumes represented 43% of our total volumes in the first quarter. We have seen March activity levels continue into April and have strong visibility for the balance of the second quarter. Pricing continues to improve, which combined with higher sales volumes, should lead to higher contribution margins in the second quarter. We spent $10.3 million in capital expenditures in the first quarter, including $6.5 million related to the acquisition of the Blair facility. We continue to expect capital expenditures for the year to be in the $25 million to $30 million range with the additional capital over the remainder of 2022 currently planned to be spent on efficiency projects at Oakdale and Utica as well as investments to support our growing IPS business. This concludes our prepared comments, and we will now open the call for questions.

I guess my first question is really just tied to sort of where the current pricing trends you're seeing there and then willingness on your part or the customer's part to start locking up some of those volumes and what could be the duration of that?

In the early first quarter, we observed our FOB equivalent to mine gate pricing in the low to mid-20s. Now, as we move into the second quarter, we're seeing prices well into the 30s. We are currently able to raise our prices regularly due to a tight market for sand. Looking ahead for the rest of the year, assuming strong commodity prices for oil and natural gas along with relatively low contracted volume—most of our volume is spot pricing—we should be able to continue increasing prices.

Okay. I know you don't want to put an exact price on this, Chuck. But directionally, when would you want to start contracting?

We are always open to contracting when it benefits both us and the customer. Given the current prices, we are starting to consider long-term contracts. Our approach is to maintain a long-term perspective in this business, as we perform best with reliable volumes over time. Our aim is to have about 60% to 70% of our volumes contracted, although we still have some progress to make to reach that target.

And John, this is actually Chuck. That was John, just to clarify. But we're also seeing customers; it's one part making the sand, it's another part moving it. To handle the kind of volumes that are in the marketplace now, people actually need to have a plan in place with the rails. So we actually think there's more appetite for contracts now because of that.

Got it. And then just a final one for me is I think you noted 8 SmartPath systems. If everything went perfectly throughout the balance of this year, where do you think you could exit '22?

Yes. I think on the smart systems, and we're currently at 8, I think we could probably increase our utilization 10% to 20% in terms of additional units starting kind of in the third or fourth quarter of this year.

So two things for me. First, when I consider the quarter in relation to your profitability or contribution margin per tonne, it appears that it increased slightly on a sequential basis. However, given the pricing, I would have expected it to increase more. Could you provide some insight into how it changed over the quarter? Additionally, how should we anticipate the levels of contribution margin per ton that could be achieved in the upcoming quarters?

Yes. Regarding the quarter, as we noted, January and February were negatively affected by weather and some operational issues, and pricing didn't begin to improve until later in March. Consequently, we experienced higher operating expenses early in the quarter, but we started to see better performance with higher volumes and improved pricing in March. Additionally, the first quarter generally incurs the highest expenses as we draw down inventory, which is recorded as an expense. This leads to elevated operating costs during the first quarter as we utilize our wet pile inventory to meet sales volumes. These factors contributed to increased expenses this quarter, contrasting with our expectations for the remainder of the year. However, with the improved pricing we are already observing, we anticipate our margins will enhance in the second quarter and continue to improve from there. Assuming we can achieve or exceed our volume targets and sustain those levels for the rest of the year, we believe our contribution margin could approach $10 per tonne in the second half of this year.

That's helpful. When we consider your volume potential in light of the acquisitions and the existing constraints on the rail system, your volume guidance for the second quarter appears quite robust. You had an excellent March, and in this market, it seems like you'll reach approximately 4 million tonnes this year. However, what do you see as the sustainable volume levels you can achieve based on market conditions regarding rail and demand?

So I would just say that with what we're doing right now, and we've actually had to really gear up the plant with both employees and additionally, with logistics, we feel like there's more demand right now than we have supply as we scale up the plants. But we see there's a pretty good runway ahead. I don't know, Lee, if you have something else to add to that.

Yes. I think what you're asking is where we could go if the market stays consistent or improves, and what run rate we could achieve. Currently, we are guiding for a 25% increase from the second quarter to the first quarter, which would mean over 1 million tonnes per quarter. Is it possible to do better in the second half of the year? Yes, but that will depend on three factors: selling the right product mix at our mine while managing our production mix; addressing labor constraints and fully staffing Oakdale; and, as Chuck often mentions, efficiently moving large unit trains as part of our bulk commodity business. This requires having the right railcars and sand mix, along with the railroads being able to deliver efficiently.

And the right landing spot. Actually, we're having conversations with our main railroad out of Oakdale right now about lengthening trains from like the standard 100 cars to trying to get up to as large as 200 cars. And now we actually have the bookends both in the Marcellus and in the Bakken to do that. So I think you're seeing the railroads there having staffing issues, too. But if we make these trains longer, we can ship the same amount of sand with the same amount of people from them.

Yes. And so if you look at our current effective capacity between Oakdale and Utica, we have about 7.1 million tonnes of annual capacity. And so if these things continue to line up and this market stays where it is or is consistent or better, we should be able to get up to 70% to 80% utilization of that as we start getting into the second half of this year.

Great. That's very helpful. I have two more quick questions. One is regarding the balance sheet. Many of our service companies experienced a drain in working capital during the first quarter, particularly with receivables. How should we approach understanding the various components of working capital as the year progresses?

Currently, we experienced a significant increase in receivables in March. We anticipate continued sales growth in the second quarter, which means our receivable balance will increase, but not at the same pace. This should lead to some cash conversion. Typically, during the second and third quarters, we build up inventory, particularly our wet pile inventory for the summer months. Therefore, we will see an accumulation of inventory and working capital over the next two quarters, which is expected to shift starting in the fourth quarter and into the first quarter. You can expect an increase in working capital due to sales activity and the usual summer inventory buildup in the upcoming two quarters. However, you will likely see a positive impact from working capital in the fourth quarter.

Great. And then just one final. I know this is probably a little further out. When we think about some of the efforts you're making on the industrial side, when would that sort of start to really impact kind of volumes and contribution margins per tonne, etc.? Is that sort of a '23-plus event? Or could it be before that?

Yes. I think right now, what we've seen is the industrial sand cycle has pretty much a long sale cycle. So you've got to really build in and kind of build up the relationships. And then from that, you can really start driving those volumes and revenues. We did actually have a positive impact industrial sales in the first quarter, but it's a pretty small number. But I would, based on our current kind of activity, we can start really penetrating that market more significantly over the next couple of quarters so that industrial sales could start delivering a more meaningful number kind of in the fourth quarter or early 2023.

Rick and his team have done an excellent job on that. We have reached a variety of customers, and they are becoming familiar with our capabilities. We believe this will lead to significant growth over the next year or two.

But it will probably be a relatively small portion for this year.

And I am showing no further questions at this time. I would now like to turn the call back over to Mr. Chuck Young for any closing remarks.

Thank you for joining us for our first quarter conference call. We look forward to speaking with you in August.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.