Earnings Call Transcript - SND Q1 2020

Josh Jayne, Finance Manager

Good morning, and thank you for joining us for Smart Sand's First 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 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 as of the live broadcast today, May 6, 2020. Additionally, we will refer to the non-GAAP financial measures of adjusted EBITDA and contribution margin 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 and contribution margin to gross profit. I would now like to turn the call over to our CEO, Chuck Young.

Chuck Young, CEO

Thanks, Josh. We're all aware that these are unprecedented times, times in which our industry faces great challenges. Recent developments have dealt a devastating blow to the industry, our country, and the global economy. Smart Sand has responded quickly, with strong steps to meet these sudden developments. I'll outline what we've done and where we stand in a moment. But first, let's look at our first quarter results. I'm pleased to say they were strong. Sales volume increased to 757,000 tons. That's up 64% over the fourth quarter 2019 results. Activity was brisk through our terminal in Van Hook. Clearly, the combination of our low-cost operations in Oakdale and our strong logistics footprint into that market is working. We saw greater utilization of our SmartSystems fleet, demonstrating growing interest in this product line and service. The drilling completions market in the U.S. is changing rapidly. There are 2 reasons: the impact of the COVID-19 pandemic on worldwide oil demand and the global oversupply of crude oil. These market dynamics will have an impact on our business during the downturn. But our first quarter results demonstrate the merits of our long-term strategy. That is the wisdom of being a low-cost producer that provides the efficient and sustainable mine-to-wellsite solutions the market needs. And when the market does return, we expect to be well positioned to take advantage of the revamp. With this in mind, I want to talk about some of the fundamentals behind Smart Sand. We're a purpose-built company, a company built to last, a company with strategic assets at the core of our business, assets that are made to weather the storms we're facing in the market today. From the beginning, we've managed our assets and our expansions in a meaningful way. We've built and acquired assets that are efficient and low-cost operations, and we did it with very little debt. We have a single site mine with access to 2 Class I railroads. That allows us to deliver sand anywhere in the United States or Canada. Having a single site means that we can better manage the mine, we can ramp production up or down quickly to respond to the rapidly changing market. Our Van Hook transload terminal has virtually no cost associated with it unless it's in use. So we can idle this facility in periods of low market demand, but quickly bring it back online as soon as our customers in the Bakken need it. Our SmartSystems manufacturing facility is able to scale back its manufacturing capabilities quickly. We've reduced our activity to focus on current needs, which is primarily perfecting our new transloader to SmartPath. Our SmartPath supplemental transloader technology will provide more efficient offloading of sand at the wellsite. It allows us to provide a broader range of products and services to meet our customers' last mile needs. Our goal in the next few months is to have the SmartPath available for deployment when market activity returns to more normal levels. With our new SmartPath technology, users can combine all the benefits of bottom dump trailers with safety. That means faster load and unload times, quick turnarounds and high capacity, but with low dust and a small footprint of silos on a wellsite. Our SmartPath patent-pending features include a fixed-in-place drive-over sand drop feeder, a complete dust control system, and the throughput capacity to keep ahead of the frac job. So in sum, SmartPath is a last-mile game changer because it bridges the current gap between using bottom dump trailers and silos. SmartPath uses a reliable and simple single chassis design, one built to safely keep up with any frac job. We'll have SmartPath units available for deployment in the second quarter. And since the demand for this new technology has been strong, we'll keep focusing our manufacturing on SmartPath. We're all in difficult times right now. Based on public announcements and discussions we've had with our customers, E&P activity for the remainder of 2020 could be down between 50% and 75% from first quarter levels. This drop in expected activity is unprecedented and is expected to impact the demand for our products and services. So we're responding to that. We're rightsizing our business, and we're aligning our costs with our sales. That way, we can weather this storm and ensure that we'll be left standing when the storm eventually passes. Here are some of the steps we've taken. We've significantly reduced our CapEx budget as much as 80% primarily by reducing SmartSystems manufacturing plants. The limited capital we'll be spending will mainly be for perfecting SmartPath. We now estimate CapEx will be in the $5 million to $10 million range for the year. This is a reduction of $15 million to $20 million from 2019 investment levels. We've also implemented several cost-cutting measures. Here are some of them. Salary reductions for all executive management from 35% to 40%; headcount reductions at our Oakdale facility to align our workforce with expected reductions in sales volume; salary reductions for other personnel of approximately 20%; and the suspension of all our variable cash compensation programs for all employees. These cost-cutting measures will reduce cash compensation expense for the company by approximately 50% or $10 million from 2019 levels. We're working with all our key vendors to manage our payments. We're trying to line up our cash payments with our cash receipts. Our goal during this downturn is to guide our operations within our current cash balances and our expected cash flows from operations. In March, we drew $6 million on our ABL Credit Facility to provide for immediate liquidity should the need arise. Our current borrowing base is $20 million, and we have $14 million in availability. We've made no additional draws on our ABL Credit Facility, and we now have $17 million in cash to fund our ongoing activity. We've made the tough decisions to reduce our workforce and cut costs everywhere we can. That's key to executing our long-term strategy so we can continue to operate the business that we build. Our principal operating philosophies haven't changed. Now more than ever, we'll strive to live within our cash flow so we can continue to operate in this difficult market environment while maintaining a strong balance sheet. We remain committed to offering the highest quality products and the highest quality service while maintaining low leverage. With this strategy at our core, we believe, as we always have, that we will ultimately prevail in any market. Now is a time of reflection and planning for the future. We continue to work with our customers and respond to their needs. We're listening not only to their needs for sand but also their requirements for storage, logistics and management. We're perfecting our offering to fully satisfy those needs when the demand returns. During this challenging time, we'll be strategic, cost-conscious, and prudent. Then when demand returns, we'll be ready to meet it. And with that, I'll turn the call over to our CFO, Lee Beckelman.

Lee Beckelman, CFO

Thanks, Chuck. Though we started 2020 with a solid first quarter, we are faced with the reality that the dynamics of the market today are much different than in the first quarter. So I will go through the first quarter 2020 results, but as Chuck highlighted in his comments, currently, there is not a lot of clarity in the market about the next month, much less the second quarter or full year 2020. Starting with sales volumes. We sold approximately 757,000 tons in the first quarter, which was a 64% increase over fourth quarter 2019 volumes of 462,000. And a 17% increase over first quarter 2019 volumes of 648,000 tons. We saw a strong pickup in activity in the quarter from fourth quarter 2019 levels. Total revenues for the first quarter of 2020 were $47.5 million. Revenue was relatively consistent quarter-over-quarter as there were less shortfall revenues in the current period. Sand sales revenues increased to $30 million compared to $23 million, while logistics revenues also increased to $16.2 million from $13.1 million in the fourth quarter of 2019. The increases sequentially were primarily due to higher overall sales volumes. In terms of shortfall revenues for the second quarter of 2020, we expect to recognize at least $14 million related to a contract that is currently under litigation. We do not anticipate recognizing additional shortfall revenue from this contract after the second quarter 2020. Our cost of sales for the quarter were $41.1 million, an increase from the previous quarter of $29.8 million. The increase was due to higher volumes sold and more costs recognized as inventory was depleted from the winter stockpile. For the first quarter 2020, contribution margin was $11.5 million or $15.20 per ton. We had adjusted EBITDA of approximately $6.4 million in the current quarter compared to $19.6 million in the previous quarter. The lower adjusted EBITDA was primarily due to lower shortfall revenue and higher cost of goods sold in the current period. The first quarter is usually our weakest quarter as our costs are typically higher than in other quarters during the year as we recognize costs from depleting our wet sand inventory that were capitalized during the buildup of our winter stockpile in previous quarters. For the first quarter, we generated $12.1 million in operating cash flows, and we spent $4.2 million on capital expenditures, which was primarily on new SmartSystems units. As Chuck highlighted, we are reducing our build-out of SmartDepot silos and have shifted our focus to perfecting our new SmartPath transload technology, which we plan to have available for deployment in the market later this year. We have significantly cut our planned capital expenditures, and we currently expect to spend between $5 million to $10 million on capital expenditures during 2020. As of March 31, 2020, we had $11.5 million in cash and $14 million remaining availability on the ABL Credit Facility. We currently have $17 million in cash on hand and the same $14 million remaining availability on the ABL Credit Facility. As Chuck highlighted, we are proactively taking measures to reduce our cash expenses to allow us to manage through this downturn. With the capital and expense cuts we have implemented and our available liquidity, we believe we have sufficient liquidity to support our operations. Due to the current volatility of the market and lack of clarity on our customer activity, we are not giving specific guidance for the second quarter. This concludes our prepared comments, and we will now open the call for questions.

Lucas Pipes, Analyst

I wanted to ask first about the agreement with Liberty that was filed last night as an attachment to the Q. There is a mention of a credit to Liberty. Can you just expand a little bit? It seems to be tied to oil prices. But can you maybe expand on that? Is there a maximum that we could be looking at? Just trying to get a kind of range of potential outcomes there, given how low oil prices are currently.

Chuck Young, CEO

All right. I'll let John touch on that.

John Young, COO

Yes, the agreement with Liberty involved making some pricing concessions to help them stay competitive in a highly competitive market. I don't specifically remember the credit you're mentioning, but I believe it wasn't significant for our business. It probably related to some earlier dollar amounts that were under consideration.

Lee Beckelman, CFO

Yes. Lucas, the credit really had to do with previous dollar amounts from volumes under the contract. And so we negotiated with Liberty to allow them to get a credit for those volumes going forward, depending on their volumes that they were taking. It didn't really affect or change their minimum volumes under the contract on a go-forward basis, but did give them some price break into the current year based on the volume activity that they're planning or under their contract for this year.

Lucas Pipes, Analyst

Got it. And from an accounting perspective, would those credits be captured in revenue? Or would this kind of flow differently through the financials?

Lee Beckelman, CFO

It ultimately affects revenue. We are seeing a lower realized price per ton for our Liberty sales moving forward.

Lucas Pipes, Analyst

Got it. That's very helpful, thank you. My second question concerns customer litigation and the associated accounts receivable. Naturally, both my hope and that of investors is for the collection of this money. Can you share what the current status is? What needs to transpire for resolution? And would it be reasonable to consider writing it off now and potentially collecting it later?

Chuck Young, CEO

Well, Lucas, as we've mentioned in previous calls, we cannot comment on our litigation since it is still ongoing. However, we continue to uphold our contract and navigate through the process. We remain confident that it will be resolved positively.

Lucas Pipes, Analyst

That's very helpful. And then maybe sneaking a last one. When I look at the equities of some of the Marcellus E&Ps, they've got quite a bit here over the last couple of weeks. Are you seeing increased activity from that region? Are you seeing that shift to gas, or is that maybe still a little bit too early given that we just kind of crossed into the $2 range on the Henry Hub here the last few days?

Chuck Young, CEO

John, I'll let you take that.

John Young, COO

Correct. Yes. So Lucas, the one thing that's interesting about the gas plays, right, is these gas companies have had a long time to get used to a relatively low commodity price. And so they've been bringing efficiency into their operation since that first collapse, say, in the 2012, 2013 time frame. So it's not surprising to us that those companies are continuing to aggressively pursue development of gas wells, particularly up in the Marcellus. We're seeing a fair amount of activity up there. What we're hearing anecdotally is that a lot of the pressure pumpers are redeploying crews into that area to try and chase the business that is available. It's understandable when you look at kind of negative commodity prices as recently as last week on the oil side that folks are more focused on natural gas. Our view has always been to try and do both, right? So while oil is depressed today, we think it's got a bright future, and natural gas is one of the things where we play well. We play well into the Marcellus. Our last-mile logistics work very well in the relatively rugged area up there, the mountainous area where wellsites can be small, and require a kind of small footprint of silos versus boxes. So we're really well prepared to compete effectively in the Northeast. We'll continue to do that as we have in the past. And when oil recovers, we'll be ready to compete in those markets also.

Stephen Gengaro, Analyst

Following up on previous questions, could you provide insight into the volume trends for the first quarter? It appears that many are still moving east and west rather than south. Additionally, it seems the gas markets are performing relatively well. Given the current market challenges, should we anticipate your volumes potentially outperforming the overall rig count and aligning more closely with developments in certain gas basins? How does this impact your business in relation to the pure oil rig count?

Chuck Young, CEO

It's difficult to predict activity levels at this time. The gas basins in the Marcellus, where we perform well, aren't declining as quickly and may not see as significant a drop in the next nine months compared to what we're anticipating in the oil basins. However, there are still uncertainties. We expect our current volumes to remain steady in the eastern markets, but we anticipate a pullback in the short term, particularly in our western markets like the Bakken and Colorado, which are more focused on oil.

Stephen Gengaro, Analyst

Okay. As we consider the balance between lower volumes and price, along with the impact of the winter inventory build on the first quarter cost of goods sold, should we expect a typical progression of contribution margin while factoring in overhead absorption and price changes? Should we still anticipate a sequential change, but perhaps more subdued due to market conditions? Or is it too soon to tell?

Chuck Young, CEO

I understand your question, Stephen. As margins decrease, there's a fixed portion to our business, meaning our cost per ton will increase slightly as volumes drop. However, I believe our contribution margin and pricing in the first quarter shouldn't differ significantly going forward. That said, with lower volumes, our cost per ton will rise because we're allocating fixed costs over fewer tons. Although we've effectively managed to cut costs, there will still be an impact on our contribution margin. Typically, in the second and third quarters, during times of strong activity, we increase our mining operations, which helps absorb many of our costs into inventory, resulting in a higher contribution margin during those periods. This year, however, since we're anticipating lower activity and are planning accordingly, we won't be as aggressive in mining initially until we assess how the market develops. Consequently, our cost of goods sold is likely to be higher than usual for the second and third quarters because we won't be building up our inventory as we typically do.

John Young, COO

Yes. When looking at other frac sand competitors, we have always highlighted that our site has a single mine with a significant capacity of 5.5 million tons. This allows us to efficiently increase capacity during good times and also scale down effectively during tougher market conditions. We manage one safety plan, one environmental plan, and one team overseeing the entire facility, which simplifies operations compared to having multiple plants scattered across regions. This setup prevents the challenges of permanently closing sites or furloughing workers. We can adjust our business operations whether we are selling 5 million tons a year or just 1 million tons, maintaining efficient workforce management and remaining competitive at what should be the lowest cost in the industry. However, our costs may not be as low as we would prefer due to fixed costs that we have to manage. We believe we are well positioned to navigate what we expect to be a significant downturn, while also feeling optimistic about a future recovery for which we will be ready to ramp back up.

Stephen Gengaro, Analyst

Great insights. If I could add one more point, considering the market, your balance sheet is in strong condition, and you clearly have endurance based on what I've observed. How do you perceive the market in 2021 or 2022 as things normalize, specifically in 2022? Do you believe you'll ultimately find yourself in a stronger competitive position because some of your peers, particularly some local companies, might not survive? How do you view the competitive landscape in the long term?

Chuck Young, CEO

We certainly believe that it will be challenging for some companies to survive. There will likely be consolidation because we don’t see the balance sheets of many of our competitors being sustainable, but I’ll let Lee share his thoughts on that.

Lee Beckelman, CFO

No. John can also provide his input. We agree that if this downturn lasts 6 to 9 months or longer, it will be extremely challenging for some of our competitors given their leverage levels. We believe not all of them will survive this situation and there may be some consolidation. However, consolidation or closures will likely lead to reduced sand capacity in the industry. Additionally, we expect a significant drop in production in the Lower 48 U.S. over the next 6 months to a year. When the market improves and prices rise, we anticipate a strong increase in activity from producers trying to regain lost production, but there will be less supply available to support that surge. This scenario should put us in a good position to benefit when the market rebounds.

Dylan Glosser, Analyst

Just in regards to shortfall revenue, you guys obviously saw a material decrease in Q1 from Q4. And just with where the market has headed over the past few months, what is your expectation for shortfall revenues over the next coming quarters? And do you expect that this might pick up again?

Lee Beckelman, CFO

Well, again, we're not giving specific guidance other than the guidance we gave in our prepared comments is that we do expect around $14 million of shortfall revenue in the second quarter, and that's related to our contract that's currently under litigation. As it relates to our other contracts, I think we're just going to have to wait and see how it plays out in terms of volumes, et cetera, on a quarter-by-quarter basis.

Dylan Glosser, Analyst

Okay. Yes. Sorry, I think I missed that. I was a little late getting to the call. I might have missed this as well, but how many SmartSystems were active in Q1? And where do you expect this lever might be moving through the next few quarters?

John Young, COO

In the first quarter, we had nine SmartSystems silo systems active, but that number has decreased to the low single digits in the second quarter. As Chuck mentioned in his prepared remarks, we are concentrating on perfecting our SmartPath technology deployment. Once the market rebounds, we will have a SmartPath system that integrates well with our silo deployment. We anticipate that demand for this should be strong, as it offers an efficient solution for using bottom dump trailers with silo systems. We'll continue to pursue opportunistic business with our last-mile systems, with twelve systems ready to deploy today. We will also be developing SmartPaths in the coming months. However, we don't plan on manufacturing any additional silos for the foreseeable future, as our focus will be on producing SmartPath systems.

Lee Beckelman, CFO

And Dylan, I'll just add to that. In the fourth quarter, we had about four fleets rented, and we ramped up to 9. So it was really demonstrating that the market was starting to really accept our product and making good progress there. So with this pullback, you're seeing the drop back, but I think that gives us good confidence when the market comes back that our product has been accepted by the market, and we have a good chance to ramp that activity up pretty quickly.

Josh Jayne, Finance Manager

I am not showing any further questions at this time. I would now like to turn the call back over to Chuck Young for closing remarks.

Chuck Young, CEO

Thank you for joining us for Smart Sand's First Quarter 2020 Earnings Call. Stay safe. We'll talk soon.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.