ProFrac - Q2 2023

Transcript

Operator (participant)

Greetings, welcome to the ProFrac Holding Corp's second quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

Rick Black (Executive VP)

Thank you, operator, 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 www.pfholdingscorp.com, as well as a telephonic recording available until August 17th, 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, and 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. Now, I would like to turn the call over to ProFrac's Executive Chairman, Matt Wilks. Matt?

Matt Wilks (Executive Chairman)

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. Lance will provide additional insight into our financial performance. Our second quarter results were challenged as a result of customer consolidation, coordination with customer CapEx schedules, and the impacts 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, 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 reductions. 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 2023. 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, 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've 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. 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 the Interior and 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're 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 supported for a stronger second half of the year. We're encouraged because we see multiple players, idle capacity, and remain steady on 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 are 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 2023, 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.

Ladd Wilks (CEO)

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. Being said, 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.

We see activities levels rebound, we will purposely 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. We fit the bill hands down, with some of the youngest and most advanced asset base in the industry. From a stimulation services standpoint, we continue to have a strong interest in our fuel-efficient fleets. We're seeing equipment type drive utilization, diesel appears to be the swing capacity. We've also slowed our CapEx spend, reduced e-fleet growth spend, lowered engine upgrade CapEx in response to activity levels. White space accelerated in Q2, 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 dislocations. 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 cost. 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 gaps and integrating more materials into our fleets. I'll now hand it over to Lance to provide more detail on our financial results.

Lance Turner (CFO)

Thank you, Ladd. As Matt mentioned, we generated $183 million in Adjusted EBITDA, $56 million in free cash flow. 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. This was partially offset by $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. 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 primarily driven 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, and 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 by 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 was $27 million.

We had a 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. With that, operator, please open the line for questions.

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press Star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we pull for questions. Thank you. Our first question comes from the line of Luke Lemoine with Piper Sandler. Please proceed with your question.

Luke Lemoine (Managing Director)

Hey, good morning, guys.

Lance Turner (CFO)

Good morning.

Luke Lemoine (Managing Director)

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?

Matt Wilks (Executive Chairman)

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

Luke Lemoine (Managing Director)

Great. Maybe try a different one here, Matt, to the upside. Any quantification guide where you think or how many fleet reactivations for ProFrac in, you know, 4Q or into 2024?

Matt Wilks (Executive Chairman)

We're, we're not gonna, we're not gonna guide to fleet count, but we're, we're paying very close attention to rig count. One thing I would point out, too, with these, with these operators is that the DUC inventory and the way that the industry has really looked at building DUC inventory has changed. It's completely changed. A high DUC count is a feature of low interest rates, and with rates coming up the way that they have, the cost of capital associated with, with a partial spend on an unproductive asset is not the best. It's not, it's not the most efficient use of capital, and we think that that's gonna keep DUC inventories, you know, subdued. And activity levels will, 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 the private guys deploy rigs and get back to work with where the cost of capital is. Really excited to see how quickly following those rigs you'll see frac fleet.

Luke Lemoine (Managing Director)

Okay. I'll try one more here. With the CapEx reduction, it sounded like the e-fleet deployments were pushed to the right a bit. Can you just update us on what the e-fleet deployment schedule looks like, probably over the next 12, 15 months?

Matt Wilks (Executive Chairman)

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

Luke Lemoine (Managing Director)

Okay, got it. Thanks so much, Matt.

Matt Wilks (Executive Chairman)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Stephen Gengaro with Stifel. Please proceed with your question.

Stephen Gengaro (Managing Director)

Hi, good morning, everyone. Thanks for taking my question.

Matt Wilks (Executive Chairman)

Thank you.

Stephen Gengaro (Managing Director)

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

Matt Wilks (Executive Chairman)

Certainly. In, in West Texas, there's a, you know, there, there is some spot pricing that is, that has come down from what has otherwise been a pretty narrow, tight range. Contracting rates are well above the spot market. These are isolated situations. The other thing to include is not all mines. This mine gate pricing and how you look at these basins, it's, it's more of a logistics business than it is anything else. If you look at the logistics differentials from mine to mine, to customer to customer, there's, there's huge gaps that it's easy to miss and when you model it out.

What we do is we go in and we focus really closely on where our logistics advantages are, and if there's spot pricing or if there's a competitor out there that has a disadvantage on logistics, we just don't compete with them and worry about them. We don't, we don't have to be the right solution for everyone, but 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.

Stephen Gengaro (Managing Director)

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

Matt Wilks (Executive Chairman)

I think it's horses for courses. I think that there are. I think it's less so about the basin and more so about the individual customer and their format. It's difficult to get full bundle with an operator that's got a full-blown procurement team. But, you know, we love all our customers, and we have a solution for each one, and we do our best to work out a solution that works for them.

Stephen Gengaro (Managing Director)

Understood. Great. Thanks for the color, and I'll turn it back.

Matt Wilks (Executive Chairman)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Don Crist with Johnson Rice. Please proceed with your question.

Don Crist (Senior Research Analyst)

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

Matt Wilks (Executive Chairman)

Yeah, certainly. The way we think about these plants is your, your costs are almost fixed. I mean, your labor costs are gonna be pretty consistent. Gas, electricity, everything's relatively consistent on these, on these businesses. The variable that moves your COGS is utilization and volume. We continue to see our utilization and the volumes that, that we're putting out climb. You know, at this point, all of our costs are essentially covered, and so we're in a really good spot to continue our growth in profitability. As we, as we continue to reach our nameplate capacity at each of these assets, you'll see a much stronger pull-through.

What we love so much about that business is, you know, one, our costs are relatively fixed, so everything we do from here on is, has a very high cash conversion rate, and the quality of the earnings on that business are, really stand out compared to a capital-intensive business like frac services.

Don Crist (Senior Research Analyst)

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

Lance Turner (CFO)

Yeah. I think, you know, I think one of the things I mentioned was inventory, which has been building over the past year. That's the biggest thing that we're focused on to provide that release. To the extent, you know, as we as the fleets remove, you'll also get that AR AP impact. I think that's, I think that's a fair assumption.

Don Crist (Senior Research Analyst)

Any kind of magnitude you'd like to give? Would that be $50+ million or so?

Lance Turner (CFO)

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

Don Crist (Senior Research Analyst)

Yeah, I appreciate the color, guys. Thank you.

Matt Wilks (Executive Chairman)

Thank you. I think that's, that's pretty bullish for, for Lance. He, he's a conservative, conservative type.

Operator (participant)

Thank you. Our next question comes from the line of Daniel Kutz with Morgan Stanley. Please proceed with your question.

Daniel Kutz (VP and Equity Analyst)

Hey, thanks. Good morning, guys.

Matt Wilks (Executive Chairman)

Good morning.

Daniel Kutz (VP and Equity Analyst)

Just looking at the press release, you guys had a comment in there that, and, and I think you guys touched on this in your prepared remarks, that as a result of, of kind of the actions you guys have taken to rightsize the cost structure and, and take out costs, that that should help maintain the per fleet profitability metrics. It's. I, I appreciate that there, you know, could be some activity downside, versus where you were in, in the second quarter, given the comment about, about some fleets coming off in, in August.

From a per fleet profitability perspective, should we interpret that comment as you guys feel pretty confident that looking at the second quarter, per fleet profitability should kind of be at that level in the third quarter or second half, or how would you guys think about that?

Matt Wilks (Executive Chairman)

Yeah. You know, we've, we've gone in and we've harvested a lot of the, the synergies from the acquisitions that we've made over the last year. We accelerated those, especially when you, when you have a, a fleet count reduction. What would normally be taken care of through turnover and, and natural attrition, has been something that we, we took a more direct approach and brought that forward in a much quicker fashion.

The other part is, is we took our entire calendar and said, "Look, we need to compress this as much as possible." Let's there's no reduction to our calendar or in how many hours we'll pump and how many services we'll provide, but we want to make sure that we optimize the assets that are working, so that we increase utilization and maximize those assets as much as possible. How do we cover the same work with fewer resources and then focus on them with, you know, everything that, that you need to maintain the highest level of pump hours per fleet, and then cut all the unassociated costs? By doing that, we, we return the business to a level of profitability on a per fleet basis that we're known for.

Daniel Kutz (VP and Equity Analyst)

Got it. That's helpful. Understood. I want to go back to the proppant production comment. I, I think, if I heard it correctly, that you'd said that if we look at the second quarter EBITDA, the, the potential for that business could be 2 to 3x that level. I was just wondering if you could, if you could kind of unpack what that might contemplate in terms of, you know, is it, is it higher pricing or higher margins or higher utilization? I, I mean, you, you, you kind of answered this question previously, saying that, that, that volume and utilization is the name of the game. Just wondering if you could, you could help us quantify what might be contemplated in, in, you know, 2 or 3x EBITDA for that segment. Thanks.

Matt Wilks (Executive Chairman)

Yeah, certainly the EBITDA that we produced with the at the utilization rate that we had in Q2, carried the full fixed cost and burden that we would have at a much higher utilization rate. When you start looking at a lower utilization and delivering results that, you know, exceed, well exceed that fixed cost, when you look at the increase of activity and higher utilization rate with the same fixed cost, it converts and gives you a nice levered, you know, result on your pull-through. It's...

I, I think that's a, a very attainable, goal, and our expectation is to be able to, to deliver that in a much quicker fashion than, mobilizing a, a, you know, mobilizing in a relative way on your frac services side.

Daniel Kutz (VP and Equity Analyst)

Got it. That's all helpful. Thanks a lot. I'll turn it back.

Matt Wilks (Executive Chairman)

Thank you.

Operator (participant)

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

Matt Wilks (Executive Chairman)

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.

Operator (participant)

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