Smart Sand - Q1 2024

Transcript

Operator (participant)

This call is being recorded on Tuesday, May 14, 2024. I would now like to turn the conference over to Christopher Green, Vice President of Accounting. Please go ahead.

Christopher Green (VP of Accounting)

Good morning, and thank you for joining us for Smart Sand's first quarter 2024 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 14, 2024. Additionally, we will refer to the non-GAAP financial measures of contribution margin, Adjusted EBITDA, and free cash flow during this call. These measures, when used in combination with our GAAP results, provide us and our investors with useful information to better understand our business. Please refer to our most recent press release or our public filings for our reconciliations of gross profit to contribution margin, net income to Adjusted EBITDA, and cash flow provided by operating activities to free cash flow. I would now like to turn the call over to our CEO, Chuck Young.

Chuck Young (Founder and CEO)

Thanks, Chris, and good morning. As we guided on our last earnings call in March, we had strong sales volumes in the first quarter. Sales volumes increased by approximately 31% to 1.3 million tons, a quarterly record for Smart Sand. With the increased sales volumes, contribution margin improved to $18.5 million, and Adjusted EBITDA increased to $9.3 million, both substantial improvements over fourth quarter 2023 results. The improved results in the first quarter demonstrate the long-term value of our strategic plan. Our long-term vision for Smart Sand has four main components. First, we are focused on expanding our Northern White Sand franchise. We believe Northern White Sand is the premier sand for both energy and industrial applications.

The research clearly demonstrates that using Northern White Sand instead of lower-quality regional sand results in greater economic value to oil and gas producers. Additionally, the unique properties of our sand make it ideal for many industrial sand applications. Second, we continue to look for opportunities to open new markets for our products and services. We have made investments in two new terminals in Northeast Ohio to expand our market presence in the Utica Shale Basin.

Oil drilling activity is increasing in this basin. These two new terminals provide us with great access to compete in this growing market for Northern White Sand. With our Blair facility being on the Canadian National rail line, we now have access to the growing demand for Northern White Sand in the Montney, Duvernay, and Horn River Shales of Northwest Alberta and Eastern British Columbia.

Combined with our access to the Cardium Basin from our Oakdale facility on the Canadian Pacific, we have unmatched access to Canada and expect it to be a growing market for our products going forward. Our Smart Systems well site storage and delivery solutions continue to deliver sand into the blender of pressure pumping equipment efficiently and at high rates. We made investments last year in our Utica, Illinois, facility to add cooling and blending capabilities to allow us to market our industrial product solutions to a broader base of customers.

We have 10 million tons of capacity of high-quality Northern White Sand available today to serve the market, and we will continue to look for new ways to take advantage of our unique position to expand our market presence. Third, we remain focused on organizational improvements to increase the efficiency and sustainability of our mining, processing, and logistics operations.

We are continually evaluating our operating and financial processes to enhance our business. This year, we are making changes to our wet and dry plants processing to improve the yields and reduce overall costs. We are working on a more coordinated approach between our three main operating plants to match our consolidated production with our overall sales needs to reduce inefficiencies and waste in our operation.

We are investing in an ERP system that will allow us to automate more of our data entry and financial reporting and provide information to management on a more timely basis to make operating decisions. Fourth, we continue to focus on our cost structure to help manage our business throughout the operating cycles. In the first quarter, we were able to reduce staffing at both the administrative and operational levels as a result of operating efficiency gains and strategic restructuring.

We continue to expand the use of hydraulic mining at our Oakdale facility to reduce mining costs. We are committed to being the premier provider of Northern White Sand in North America, and we are confident that the foundation for Northern White Sand demand is strong and will be durable over time. However, we recognize that the oil and gas demand for frac sand can and will continue to fluctuate based on current and expected prices for oil and natural gas. We recognize that the current lower natural gas prices may impact sales volume in the short term in the Marcellus market. However, we had strong demand in the Marcellus in the first quarter, and while we have seen some drop-off in demand in this basin, it has not been significant to date.

We will continue to keep a close eye on this market for the remainder of 2024, but we believe the long-term demand fundamentals for natural gas supply in the United States and Canada is strong. We expect this market to be a growing part of our business as we look out to 2025 and beyond. While pricing for natural gas is currently low, oil prices have remained at healthy levels. We serve the Bakken market in North Dakota, which is an oil basin, and demand remains consistent in this market. One of the reasons we invested in terminals in Ohio is this new activity in the Utica Basin is focused on oil opportunities. Having these new terminals allows us to balance out our sales activity between oil and gas applications. Gaining access to new markets has two additional benefits for Smart Sand.

First, it provides the opportunity to market to existing customers in a new basin. Many of our customers operate in multiple basins, and having logistics capabilities in the new basin allows us to expand our relationships and sales opportunities with existing long-term customers. Second, it opens up marketing opportunities to new customers now that we can provide efficient and cost-effective logistics options into the market where they operate.

We are committed to start returning value back to our shareholders in 2024. We are still formalizing the right approach for Smart Sand and plan to communicate our plans to start returning value to our shareholders later this year. That being said, we remain committed to a strong balance sheet, low leverage levels, and adequate liquidity levels to support our operating needs through any cycle. Our primary objective is to deliver positive free cash flow consistently.

In this first quarter, we had negative free cash flow. That was primarily due to the increased working capital investments required to support the ramp-up in sales. We expect our working capital needs to moderate over the remainder of 2024. We still expect to be free cash flow positive for the year. To be able to start returning value to shareholders, we have to be free cash flow positive, so delivering positive free cash flow consistently is a key objective for the company going forward. We believe Northern White Sand will continue to be a key product for both the energy and industrial sand markets. The first quarter was a strong start for the year for Smart Sand.

While there are some short-term headwinds in natural gas basins due to current low natural gas prices, the long-term fundamentals for Northern White Sand in general, and Smart Sand in particular, continue to be strong. We believe no other company is better positioned to take advantage of the market for Northern White Sand than Smart Sand. We couldn't have delivered these results without the hard work and dedication of our employees. I want to thank all our employees for their continued support and dedication to Smart Sand. As always, we'll keep our employee and shareholders' interest in mind in everything we do. With that, I'll turn the call over to our CFO, Lee Beckelman.

Lee Beckelman (CFO)

Thanks, Chuck. Now I'll go through some of the highlights of the first quarter 2024 results compared to our fourth quarter 2023 results. We sold 1.3 million tons in the first quarter, a 31% increase over fourth quarter sales volumes of 1 million tons. Total revenues for the first quarter were $83.1 million, compared to $61.9 million in the fourth quarter. Total revenues were higher in the first quarter, due primarily to higher sand sales volumes and improved Smart Systems revenues from increased utilization of our fleet. In the first quarter, we averaged four silo-only fleets and five complete Smart Systems fleets operating. Our cost of sales for the quarter were $71.2 million, compared to fourth quarter of $59.1 million.

The increase was primarily due to the higher sales volumes in the current quarter. Total operating expenses were $11 million in the first quarter, compared to $10.7 million in the fourth quarter. The increase sequentially was primarily due to higher incentive compensation and higher royalties from increased sales volumes. Contribution margin was $18.5 million, or $13.85 per ton in the first quarter. Fourth quarter contribution margin was $9.2 million, or $9.07 per ton. Adjusted EBITDA in the first quarter was $9.3 million, compared to $0.7 million in the fourth quarter. The sequential increase in contribution margin and Adjusted EBITDA was primarily due to increased sales volume and higher utilization of our Smart Systems fleet.

For the first quarter 2024, we used $3.9 million in cash in operating activities, leading to negative $5.5 million in free cash flow. After we spent $1.6 million on capital expenditures. The negative cash provided by operating activities was primarily due to increased working capital investment to support the growth in sales. We expect our working capital investment to moderate beginning in the second quarter, which should lead to improved operating cash flow beginning in the second quarter. We ended the first quarter with $14 million in borrowings on our credit facility. Today, our current outstandings in the credit facility are $9 million. We had approximately $4.6 million in cash and cash equivalents at the end of the first quarter.

We paid down $5 million on our credit facility since the quarter end, and between cash and availability from our credit facility, we currently have available liquidity of approximately $15 million. As Chuck Young highlighted, sales volumes were strong in the first quarter as customers rebounded from lower activity in the fourth quarter last year due to budget exhaustion and seasonal weather issues, and hit the ground running in the first quarter of 2024 as they ramped up their budgeted activities for the year.

We do expect demand to moderate in the second quarter, as we are seeing some pullback in activity in the Marcellus due to lower natural gas prices. This, however, will be mitigated partially by increased activity in the Bakken and Canada. Currently, we expect second quarter sand sales volumes to be in the 1 million-1.2 million ton range. Contribution margin per ton improved to $13.85 per ton in the first quarter. We expect the second quarter contribution margin per ton to be in the $13-$16 per ton range.

We've made adjustments to our capital expenditures for the year and currently expect to be in the $15 million-$20 million range for 2024. While we had negative free cash flow in the first quarter due to the increased working capital investment to support the increased sales activity, we still expect to be free cash flow positive for the year. This concludes our prepared comments, and we will now open the call for questions.

Operator (participant)

Good morning, thank you, ladies and gentlemen. We will now begin the question and answer session. Should you have a question, please press star followed by the one on your touch-tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press the star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Josh Jayne with Daniel Energy Partners. Your line is now open.

Josh Jayne (Managing Director)

Thanks. Good morning.

Chuck Young (Founder and CEO)

Hey, Josh.

Lee Beckelman (CFO)

Hey, Josh.

Josh Jayne (Managing Director)

First question, Chuck, in his prepared remarks, talked about some capital improvements that you were doing to improve yield on your plants. Could you talk about those capital investments and ultimately the return that you expect to see on those?

John Young (COO)

Yeah. So, Josh, it's John here. I'll take, I'll take the first part of that, and then Lee can talk about the dollars and cents of it. So yeah, over the past few years, we've made significant investments into hydraulic mining. These are investments that reduce significantly the amount of yellow iron required in our process. What it effectively does is tie our mining operation to our processing plants without hauling. And, you know, part of that is that, you know, so you gain a tremendous amount of efficiency in that, you're not burning diesel fuel, you're not using up yellow iron equipment, haul trucks, excavators, and things like that.

And then once you get into the plant, you know, some of the things we've done is we've changed the way that we wash our sand to make sure that, where we can, we are cutting out the products, or the size of grains of sand that are not really in demand anymore. So if you think about it, you know, it used to be that frac sand was considered to be, you know, 16/30, 20/40 coarse grains of sand.

What we do is we tend to wash those out in the wet plant process, which is a lot more efficient than putting the energy in, drying that sand, and then screening those grades out. So, you know, making changes, incremental changes to our wash plants and the way we wash the sand out there, has allowed us to remove that sand before it gets into the more expensive process of drying. So that, that's what Chuck's referring to, both sides, the mining and the wet processing.

Josh Jayne (Managing Director)

And then, another one... Go ahead, Lee. Sorry.

Lee Beckelman (CFO)

Josh, I think, you know, a lot of it's driven by volumes and scale, but to the extent we think these changes in the hydro mining helps us reduce yellow iron and the management of our cost of that piece, and then the wet plant changes helps improve our yield, and we think this could lead to, you know, maybe $1-$2 per ton or more improved cost savings.

Josh Jayne (Managing Director)

Okay. Then, one other one, just when you think about the business, another thing that was alluded to in the prepared remarks was continuing to expand the business. And, as a Northern White player, you guys have been pretty acquisitive since 2020, adding both sand plants and terminals to your portfolio. Could you just talk about how you're thinking about the asset base today? Are there still opportunities to grow your asset base, or are the next few years sort about, you know, more executing on the asset base that you have? Just maybe you could talk through that a bit.

Chuck Young (Founder and CEO)

This is Josh. Currently, we have 10 million tons of Northern White capacity on a very diversified rail portfolio. So really around that, I think we'll just build, or get terminal access to enhance the ability of that sand to move into basins. I'll let John run through our asset base that we have currently and what we have in place and what we're looking for.

John Young (COO)

Yeah, Josh. So, you know, in addition to what Chuck says, I mean, we're you know, we've spent, you know, our tenure here at Smart Sand, building that diversified rail portfolio. We originate currently on four Class I railroads. We believe we have best-in-class logistics. You know, our current markets where we're very strong in are the Marcellus, the Utica, the Bakken, and Canada would be the primary markets we're targeting.

And our assets include mines in Illinois and Wisconsin. You know, three operating mines there, Oakdale, Blair, and Utica, Illinois, as opposed to Utica, the basin in Ohio. The railroads serving us are the CPKC, the Canadian National, the Burlington Northern, BNSF, and the Union Pacific, UP. And we have owned terminal assets in the Marcellus. We have two in the Utica Basin. We have an asset in the Bakken, a gigantic transload there. And then in Canada, we're in the process of duplicating an asset that looks similar to those assets that we've made in the Lower 48.

So we are, we're pretty excited about our ability to not only deliver the sand that we're delivering today, but also, as Chuck had mentioned, get more of that 10 million tons of capacity out into the market and down the hole for our customers. And a big part of that is, you know, our last mile, and the ability for our last-mile solutions to unload and deliver sand at the highest rates demanded by our most efficient operators.

So you know, we are, we are putting that sand down the hole at rates that the best guys out there are demanding, which are super high. So we're, we're pretty excited about kind of the asset base we have, and I think Chuck will talk a little bit more about being opportunistic about additional opportunities out there. So far, we're pretty pleased with where our asset base sits today.

Chuck Young (Founder and CEO)

Yeah, as that utilization, again, goes up, so does our cost of production goes down. So it's, as we develop that, it's a great scenario for us long term.

Josh Jayne (Managing Director)

Maybe just one last question before I turn it back. Could you just talk about the differences that you see, moving forward with the Canadian market versus the U.S. market? I know some softness a little bit here with what we've seen on the natural gas side domestically. Could you just talk about those two markets and the differences you potentially see?

Chuck Young (Founder and CEO)

So, in Canada, you know, we see LNG terminals that are coming online, pipelines that have been put in place. So, you know, as the activity starts there, it's going to continue to feed those plants. So we feel really, really good about that. John, I don't know if you have some additional.

John Young (COO)

Yeah, I think, you know, from a standpoint of when we look at the nat gas fundamentals out there, you know, the majority of our gas customers, you know, are focused on the long-term fundamentals of nat gas, which all look pretty positive. And what's interesting about that is, we're seeing a consistent message, whether it's the Marcellus or, in Canada, kind of the two primary nat gas market as we have.

You know, there's no question, as Chuck had mentioned, there's a tailwind provided by the Canadian takeaway capacity improvements, right? Those assets are there today, and they're in really good shape for having a place for that gas to go. And the Marcellus is improving every day on that. You know, the key message from our, you know, larger customers is that they believe long term in the fundamentals of nat gas.

Chuck Young (Founder and CEO)

Yeah.

John Young (COO)

We're excited about it. We're excited about that we also get to diversify our Northeast operations with the Utica, which is more of an oil play, right?

Chuck Young (Founder and CEO)

Yeah.

John Young (COO)

And so, you know, that provides kind of a balanced market position up in the Northeast that, you know, before this, bringing on of what looks like it's gonna be pretty attractive in Utica-

Chuck Young (Founder and CEO)

Yeah

John Young (COO)

... we didn't have that.

Chuck Young (Founder and CEO)

At the same time, let us be clear, the Marcellus, we're extremely, you know, positive about that market long term. We think that's gonna be a great place, and we've got some great customers up there that are doing great things. So we're excited about, about that.

Josh Jayne (Managing Director)

Thanks. I'll turn it back.

Operator (participant)

Your next question comes from Stephen Gengaro with Stifel. Your line is now open.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Thanks. Good morning, everybody.

Chuck Young (Founder and CEO)

Hey, Steven.

John Young (COO)

Good morning, Stephen.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

A couple of things, but just one quick clarification. Oh, on the income statement, the Smart Systems revenue you break out, is that purely just the well site sand storage, or are there other pieces that go into that number?

John Young (COO)

No, today, that is just purely the well site storage business going forward. That breakout will be just for that business line item.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Okay, great. Thank you. Can you talk a little bit about the dynamics of just the supply-demand in the U.S. sand market and how you see that kind of impacting the pricing dynamic over the next couple of quarters?

John Young (COO)

Yeah, I can talk a little bit about that. So, you know, as I've said in the past on some of these calls, the Northern White market is in relative supply and demand balance. You know, certainly, we certainly have additional capacity to be responsive to increases in demand, that may come about as, you know, as we see some of these new, you know, opportunities. You know, I mentioned the Utica before. You know, we don't, we don't really focus too much on the regional sand stuff down in the Permian, for example. We're not really a player there, such that we send sand into the Permian.

It's for folks that, you know, are kind of looking at their well results and, you know, trying to test a little bit with some Northern White. So we see a little bit of uptake there, but that market doesn't impact us. But the Northern White market has, you know, been through its, consolidation with regard to, supply. You know, I think that there's some different numbers out there on what the actual supply is, you know, available. But so far, our view on it is that it remains in, you know, kind of relative, supply-demand balance, you know, which yields relative stable pricing, that we've seen now for a little while.

I think there's, you know, potentially some tailwind, you know, to pricing, you know, being able to get some price moving forward as some of these, you know, markets like Canada for us and, you know, potentially some of these new markets in, Ohio, come to fruition. So, you know, I think it's generally a positive, scenario, but I think the supply and demand are still in relative balance.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Great-

Lee Beckelman (CFO)

Yeah, even to the extent that Northern White does pick up, and we see with the Utica growing in oil and Canada demand growing, and we still believe Northern White is a more superior product to regional sand, and think some folks in the Permian and others may start looking at that harder. To the extent there is an uptick or an increase in Northern White, we're probably the best-positioned company to take advantage of that because of the available capacity we have and our logistics footprint.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Yeah, Lee, I was actually gonna ask as a follow-up. Have you heard any incremental interest from E&Ps as far as, and we talk about, you know, Tier 1 to Tier 2 acreage and longer laterals, et cetera, and how they're kind of dealing with decline curves? I'm just curious if there's been any kind of increase in kind of inquiries and/or Northern White demand for—from Texas.

John Young (COO)

So there's definitely been an increase, Stephen, you know, and it seems to be picking up. I mean, we, we sponsored a conference earlier, or we sponsored a presentation earlier this year at the SPE conference in The Woodlands, which did get a lot of attention on the basic economics of Northern White versus regional, right? And so, you know, I think that's gonna take some time in the market to sort itself out. You know, as I mentioned before, you know, we see a little bit of uptake on Northern White, but, you know, we're not blind to the fact that, you know, that Northern White market down there is probably 5, maybe 10% of the overall take-up in the Western Permian.

But I think there are major E&Ps out there searching for answers on decline curves. And, you know, in the past, we've said it. We think in the past, everyone's been focused on everything but sand. But, you know, there is a pretty strong correlation between when these changes were made to regional sand from Northern White, that you know, that was kind of the start of these, you know, kind of unexplained decline curves. So we think there's a potential tailwind there, but again, our business is very focused on what we do today, and, you know, such that any sand comes back in the Permian, that'll be a tremendous benefit for us.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Thank you. And then just one final question on the industrial piece of the business, can you give us a rough idea of what percentage of the business it currently is, and, you know, kind of how you see that evolving over the next year or two?

Lee Beckelman (CFO)

Yeah, right now, the business is kind of in the 5% range or so in terms of our total volumes. And I think we're still trying to establish ourselves, and we have a lot of potential contracts coming up in 2025 and 2026 that we're looking to try to line up for. And we could hopefully see this business to be, you know, grow to at least 10% or more than that over the next two or three years. Our goal is to get industrial to at least 10% or better and have it consistent at those levels on a go-forward basis.

Stephen Gengaro (Managing Director and Senior Equity Research Analyst)

Great. Thank you for the color, gentlemen.

Lee Beckelman (CFO)

Thanks, Steve.

John Young (COO)

Thank you.

Operator (participant)

There are no further questions at this time. I will now turn the call over to Chuck Young for closing remarks.

Chuck Young (Founder and CEO)

Thanks for joining us for our earnings call. Look forward to speaking with you again in August. Thank you.

Operator (participant)

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect.