Smart Sand Q2 2023 Earnings Call Transcript

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August 9, 2023

There are 10 speakers on the call.

Operator

Good morning, and welcome to the Smart Sand Second Quarter Investor Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity Please note this event is being recorded. I would now like to turn the conference over to Chris Green, Corporate Controller. Please go ahead.

Speaker 1

Good morning, and thank you for joining us for Smart Sand's Q2 2023 Earnings Call. On the call today, we have Chuck Young, Founder and Chief Executive Officer Lee Bekelman, 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 Sandisk claims any intention or obligation to update or revise any financial projections or forward looking statements, whether because of new information, future events or otherwise.

Speaker 1

This conference call contains time sensitive information and is accurate only as of the live broadcast today, August 9, 2023. 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 a reconciliation 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.

Speaker 2

Thanks, Chris, and good morning. Smart Sand delivered another quarter of strong operating and financial results. In the Q2, we sold approximately 1,100,000 tons. We generated $19,000,000 in contribution margin $11,400,000 in adjusted EBITDA in the quarter, both solid improvements over Q2 2022 results and Q1 2023 results. Additionally, in the first half of the year, we generated approximately $12,000,000 in free cash flow, including approximately $11,000,000 in the quarter.

Speaker 2

We expect to remain free cash flow positive for 2023. In the quarter, we paid down approximately $13,000,000 in debt. We are committed to maintaining a strong balance sheet to allow us to continue to successfully manage through the operating cycles in the oil and gas industry. Our focused business strategy of providing high quality Northern White sand in an efficient and sustainable fashion to our customers throughout North America Continues to deliver strong financial results and long term value for our shareholders. We could not have achieved these results without the dedication and hard work of our employees.

Speaker 2

I want to thank our employees for their efforts and continued commitment to Smart Sand. In the Q2, we saw continued strong demand for Northern White frac sand. Activity in the Bakken increased substantially from the Q1. We currently expect See strong demand in this basin through the end of Q3. Typically, the second and third quarters of the year are the strongest demand periods for sand in the Bakken, As most producers plan the majority of their completion activity in the summer months, we currently expect activity to moderate in the 4th quarter Due to normal seasonal slowdown in completion activity in this basin.

Speaker 2

With our Van Hook terminal in North Dakota, We believe we have the most efficient movement of Northern White frac sand into the Bakken, which allows us to continue to be a market leader in this key Northern White market. As we highlighted on our Q1 call, activity did moderate in the Marcellus in the 2nd quarter due to lower gas prices, But sales volume into this basin were still at healthy levels. Tons sold in the Marcellus were lower than the Q1 shipments, but slightly higher than the same period a year ago. Currently, we expect activity in the Marcellus to be lower in the Q3, where we're seeing signs that sales volumes at the Marcellus should pick up in the Q4. We believe long term natural gas fundamentals are strong and completion activity in the Marcellus will grow over time.

Speaker 2

We are currently our Waynesburg terminal in Southwestern Pennsylvania to allow us to take advantage of the expected increased activity in the Marcellus in the future And to increase our market share in this key Northern White market, this expansion is expected to be completed before year end. Our Blair facility in Wisconsin is operational and we made our first shipments into Canada this quarter. While still a small portion of our overall sales, We expect sales volumes to continue to grow in this market. With flare being directly on the CN Rail line, we are well positioned to compete in the Canadian frac sand market. We currently expect sales volumes into Canada to be 10% to 15% of tons sold in the second half of this year.

Speaker 2

Our focus on cost effective, efficient and sustainable delivery of frac sand from the mine to the well site has established Smart Sand as a market leader of frac sand in the Bakken Marcellus Markets. We believe the Blair facility now provides us an opportunity to become a market leader of Northern White sand in the Canadian market as well. We believe Northern White sand is undeniably a superior proppant to regional sand alternatives. While our primary focus will continue to be on growing our market share in primary Northern White markets, We believe Northern White sand leads to better long term well results and E and P companies in the Permian and the Eagle Ford And other markets that have regional sand can improve their long term well performance by using doors and white sand and their well completion designs. We commissioned a white paper that you can read on our website to build on a study done by Rystad Energy, a leading energy consulting firm that evaluated well results The Delaware and Midland Basins since 2018, comparing the performance of wells completed with Northern White Sand to wells completed with regional sand.

Speaker 2

The results of these studies are striking. They clearly demonstrate the potential for producers to achieve improved well results using Northern White Sand as a proppant in their completion designs. By choosing Northern White sand versus regional sand, producers have the potential to significantly improve long term well results, which should lead to higher production, Higher free cash flow and ultimately lower capital spent over time as producers will have to drill less wells to deliver the same or higher production levels. Also, regional sands flying the Permian Basin is potentially facing a threat as the dune sagebrush lizard is now scheduled to be listed as Endangered species in the next 12 months to 18 months. This listing could impact sand mining, operations and supply that is based in the Permian It could lead to increased demand for Northern White sand in this basin.

Speaker 2

It is too early to tell how big of an impact the listing of the dune sageless lizard May have on regional sand mines in the Permian or potential increased demand for Northern White, but this is something we're keeping a close watch on. To be clear, Smart Sand does not have to sell sand into the operating basins of the Southwestern United States that are currently primarily supplied by regional sand to be successful. As demonstrated by our strong financial results, we will continue to deliver solid operating and financial performance by serving the current key Northern White markets. However, we believe we can deliver high quality Northern White sand sufficiently and sustainably into the Permian and Eagle Ford Basins, In particular, which can be a win win for Smart Sand and E and Ps, we can expand sales volume into these markets and E and Ps can benefit from better long term well results, which over time should lead them to be able to generate higher free cash flow as they generate more production from every well they drill. While our frac sand sales remain strong, we're continuing to look for to grow our other business lines.

Speaker 2

The performance of Smart Systems' last mile offering continues to We added our Smartbelt technology to our service offerings, which allows us to handle greater volumes of sand at the well site while reducing our ongoing maintenance requirements. We operated 2 smart system fleets with our smart belt system in the 2nd quarter and saw substantial improvement in our operating results due to lower maintenance costs. Additionally, with the new valve technology, our smart systems can support higher volumes directly into the blender of the pressure pumping equipment, Leading to more efficient last mile delivery for producers and pressure pumpers compared to other sand delivery options at the well site. We are investing in additional smart belts to add to our existing fleet to further extend these savings. We expect to have 9 fully functional smart systems With this new technology available to serve the market starting in 2024, we expect to see continued improvement in the operational Profitability of our last mile offering going forward.

Speaker 2

Our Industrial Product Solutions business also continues to grow. Industrial Product Solutions sales volume this quarter increased 70% over 1st quarter results and represented approximately 5% of our overall sales volume in the quarter. We are investing in cooling and blending capabilities at our Utica, Illinois facility, which should allow us to more aggressively market to the foundry markets and other industrial applications. This investment is expected to be completed by year end. We expect sales volumes to be in the 5% range or better for the remainder of 2024 We are taking the time to build this business for the long term success.

Speaker 2

As always, we will continue to keep our eye on the future. We are focused on generating higher returns from our existing quality asset base and logistics capabilities, while maintaining prudent leverage levels They'll allow us to successfully manage our business through the operating cycles in the oil and gas industry. Our goal is to consistently deliver free cash flow And to be a market leader of delivering high quality Northern White sand to frac and industrial sand markets. And we will always keep our employees and shareholders' interest And with that, I'll turn the call over to our CFO, Lee Beckelman.

Speaker 3

Thanks, Chuck. Now I'll go through some of the highlights of the Q2. We sold 1,100,000 tons in the Q2 2023, which is relatively consistent with Q1 sales volumes of 1,200,000 tons. Total revenues for the Q2 of 2003 $74,800,000 compared to $82,400,000 in the Q1 2023. Total revenues were slightly lower in the Q2 2023, primarily due to lower tons sold and contractual shortfall revenue recognized in the Q1 of 2023.

Speaker 3

Our cost of sales for the quarter were $62,100,000 compared to $70,700,000 last quarter. The decrease was primarily due to lower seasonal production costs. Production costs are typically lower in the 2nd 3rd quarters of the year as we build inventory over the warmer months to support sales demand later in the year as we enter the winter months. Additionally, We had lower freight expenses sequentially due to a shift in our in basin sales mix. Total operating expenses decreased at $9,600,000 in the second compared to $13,200,000 in the Q1 2023, due primarily to a $1,900,000 net loss on disposable Disposal of fixed assets included in the previous quarter as well as year end 2022 bonuses that were paid in the Q1 of 2023.

Speaker 3

For the Q2 of 2023, contribution margin was $19,000,000 and adjusted EBITDA was $11,400,000 Compared to the Q1 contribution margin of $17,800,000 and adjusted EBITDA of $8,400,000 The increase in contribution margin was due primarily to lower production cost and improved margins for our smart system fleets. Adjusted EBITDA was higher sequentially due to the higher contribution margin and lower operating expenses. For the Q2 of 2023, contribution margin per ton was 17 point $0.57 per ton compared to $14.89 per ton in the Q1 of 2023. For the Q2 of 2023, we generated $16,100,000 in net cash provided by operating activities, leading to $10,800,000 in free cash flow after we spent $5,200,000 on capital expenditures. Year to date through the end of June, have generated $11,900,000 in free cash flow.

Speaker 3

We ended the 2nd quarter with no outstanding borrowings on our credit facility. We had approximately $5,500,000 in cash and cash equivalents at the end of the second quarter. Between cash and availability from our credit facility, We currently have available liquidity in excess of $24,000,000 Currently, we expect sales volumes to be in the $1,000,000 to $1,200,000 range in the 3rd We believe 3rd quarter contribution margin per ton will remain in the mid double digit range of $14 to $17 per ton, consistent with the last three quarters. Shortfall revenue in the 3rd quarter will be similar to the Q1 shortfall revenue. The majority of the reported shortfall revenue being recorded In the 2023 is related to one contract that recognizes shortfall revenue in the 1st Q3 of each year.

Speaker 3

This contract expires in the Q3 of this year. We still expect capital expenditures for the year to be in the 20 $1,000,000 to $25,000,000 range, which includes the capital expenditures related to the start up of the Blair facility, which is now operational, As well as the expansion of the Waynesburg terminal and investment in the cooling and blending capabilities at Utica that Chuck mentioned in his comments. We still expect free cash flow to be positive for the year. This concludes our prepared comments and we will now open the call up for questions.

Operator

And our first question comes from Patrick Ouellet of Stifel. Please go ahead.

Speaker 4

Hey, this is Pat on for Steven Jaggarit today. Thanks for taking the time to answer the questions.

Speaker 5

Sure. How are you doing? So Could you give us

Speaker 4

an update on industry supply and demand for frac sand and what it looks like specifically for Northern White? And maybe how you expect demand to play out in the second half of the year and into 2024?

Speaker 6

Yes. So as Chuck had

Speaker 7

kind of said in his comments, we expect some moderation in demand In the Q4, it's hard to say what that's going to be. The Q4 is always kind of a little bit of a shot in the dark at this time of the year. But certainly the fundamentals look good on Northern White right now. The market has been relatively in supply and demand balance. And so we think that it's promising for the rest of this year from a volume perspective.

Speaker 7

And we also think that Canada it's going to be a nice bright spot for us kind of going into the 3rd Q4 this year.

Speaker 4

Great. Okay. Thanks. And then just building off talking about Canada. Regarding gross profit, you noted Improvements sequentially based on sales mix of the basins you were delivering to.

Speaker 4

So is any of that margin improvement coming From the deliveries to Canada?

Speaker 6

Well, again, as we highlighted in our press release and comments, part of the margin improvement was Lower production cost in the Q2, because we capitalize inventory costs and typically we have lower production costs in the second and third quarter Then we'll see a little higher in the 4th and the first quarter as we draw down inventory. So that was basically a driver of that. Pricing was relatively flat in the Q2 versus the Q1. In Canada, we do expect that to help overall sales, But most of our sales in Canada right now are on a FOB mine basis. So that actually will lead our pricing to be a little lower on an average sales price even though We'll have less freight expense associated with that.

Speaker 6

So the margins in Canada right now seem to be fairly similar to what we're seeing in the U. S.

Speaker 4

Okay, great. That's very helpful. I'll turn it back.

Operator

The next question comes from Jim Barrett of Barrett Investments. Please go ahead.

Speaker 8

Good morning, everyone.

Speaker 6

Good morning, Blair.

Speaker 8

Lee, this may be a question for you. Your current level of capital spending for this year, Is that the new normal given the additional glare and growth plans for smart systems? Or do you expect spending to Subside in 2024 and 2025?

Speaker 6

Well, this year we're expected to spend about $20,000,000 to $25,000,000 which included Growth initiatives at Blair, the expansion at Waynesburg as we highlighted as well as the IPS expansion. So every year we evaluate, but I can say generally that our maintenance type and efficiency capital is probably going to be typically in the $10,000,000 to $15,000,000 a year. And then depending on growth initiatives, we might see another $5,000,000 to $10,000,000 So, well, I think we'll continue to range under our current operating structure with our 3 mines and probably a $15,000,000 to $25,000,000 CapEx per year depending on growth initiatives each year.

Speaker 8

And on a separate note, could you tell us how much of your Volumes currently are under long term contracts?

Speaker 6

Well, roughly today about 50% of our volumes are under some term portion of contracts. That goes our contract structure today go anywhere from kind of 6 to 18 months for maybe half of those volumes and we do have a few long term contracts that go out multi year. I see. Go out multiyear.

Speaker 8

I see. And Chuck, could you the Canadian market, Can you tell us who are your sand competitors to service those customers and just give us sort of A sense of what the competitive framework is in that up there?

Speaker 2

Yes. So basically the Canadian market for the most part, we see it's Canadian national origination. Soares, Badger, companies like that are existing companies, but we see that market and the activity that's Going on with the E and Ps there, it looks to be very, very strong. The pipeline infrastructure is being put in place and we're feeling really good about that market.

Speaker 8

Okay, good. And my last question is that the white paper that was on your website, that highlighted The superior economics of using Northern White sand in markets like the Permian and Eagle Ford, any Reception from the customers in Texas as to the Is that generating any additional interest? Are you still in the very early innings of Educating customers as to the relative merits of the different types of sands?

Speaker 2

Yes. I think in general right now, You've seen a lot of the E and Ps really looking at their production and their wells in the Permian and looking for Ways to impact that, so we definitely think it's on the radar. Additionally, This dune sagebrush lizard thing has a way of not only impacting sand mining down in the Permian Basin, but also could Potential impact on people in their acreage holdings on drilling down there. So I think in general, there's kind of a concern On what's going on down there, again, we're not spending capital on this right now down there, but we are Very much watching this.

Speaker 8

Okay. Well, thank you both very much.

Speaker 5

Thank you.

Operator

The next question comes from Jonathan Catlin of Catlin Capital Management. Please go ahead.

Speaker 9

Hi, good morning gentlemen. Congratulations on a terrific quarter. I just had two questions. You say that, you're going to be cash flow positive For the year, you're already, I think, substantially cash flow positive for the year. Does that mean the second half we're going to have to see negative cash flow?

Speaker 9

And number 2 is just more of a general question. This quarter was kind of the performance seems a bit surprising. Analyst estimates were Estimated loss, you did a you had a substantial gain. It looks like your business is evolving and there it looks like you are Moving into more profitable areas of the market, can you just kind of give some color on where those areas Eiry, which markets are you seeing better profitability in and how sustainable they are?

Speaker 6

Well, I'll answer the first question. We did have strong free cash flow in the first half of the year. We will see potentially a little higher CapEx in the second half of the year. We spent about $9,200,000 in the first half. We've guided $20,000,000 to $25,000,000 as we complete these projects that Chuck highlighted in his comments.

Speaker 6

So we could see a little higher CapEx in the second half of the year. And typically, we'll have a little bigger build of working capital for inventory in the Q3 that should moderate some in the Q4. So I would expect us To not be as positive free cash flow in the second half of the year, but I do expect to generate some positive free cash flow in the second half of the year And we have strong overall free cash flow for the full year. And then in terms of markets, John and Chuck can join in. But I think, again, we believe because of our logistics advantages and what we've invested in the Van Hook terminal and the Waynesburg in particular, continue to lead us to be market leaders in the Bakken and the Marcellus in particular, and we continue to expect to still be Strong leaders in those markets and we believe going forward that we can do the same thing in Canada.

Speaker 6

So The real upside potential for us is continue to grow our market shares in the Marcellus and the Bakken based on our low cost production as well as our really efficient movement, Assuming the railroads continue to be good partners with us and look to expand that and build that same model into Canada. And so we don't necessarily talk about our individual profitability by basin, but those three basins continue to be. We still see good long term prospects in those in all three of those basins in terms of being primary Northern White. And then Additionally, while it's still a small part of our business, our smart systems continue to get traction as we improve their operational efficiencies. And So we expect it to continue to be additive to overall contribution margin going forward.

Speaker 6

And we are starting to make inroads into Industrial Products Solutions. As we said, it's percent of our sales this quarter, substantial improvement quarter over quarter. So we see those 2 as being additive on top of the frac And business, this should help us potentially positive as well as we go forward. Yes.

Speaker 7

And the only thing I'd add to that is that over the years we've made some investments in operational efficiency at our mine sites, and those are starting to pay some dividends. So that's certainly something that's providing A little bit of tailwind on operating results here. So hopefully that continues. We think that these investments that have been made were Something that we've been looking at doing and we're seeing some advantage for them.

Speaker 9

Thank you very much. That's very helpful.

Speaker 5

Thank you.

Operator

Next question comes from Stephen Gengaro of Stifel. Please go ahead.

Speaker 5

Thanks. Good morning, gentlemen.

Speaker 9

Good morning, Steve.

Speaker 5

I was wondering, so We hear a lot or a lot. We definitely heard about stock pricing softness in Texas. And I was curious Given the different supply demand drivers for Northern White and the destinations for your product, what are you seeing In sort of the spot market and how does that kind of impact any existing contracts?

Speaker 7

Yes. So obviously, we keep an eye on what's happening down in Texas and there has been some moderation on the pricing there. I'm not entirely sure what's driving that. I there's a lot of supply down there and any hiccups in demand can impact that market pretty dramatically. In Northern White, In certain cases, we see pricing moderating depending on grade of size of sand grain and those types of things.

Speaker 7

But It's hard to pin down exactly an individual market and it's something softening. We keep a close eye on it. We work closely with our customers. We work closely with the railroads to make sure that we're continuing to offer a competitive product in there. But given that Northern White's been in relative supply and demand balance over You'll recall since the downturn of COVID, and some of the mines are no longer in existence, We've seen that supply demand to remain in balance.

Speaker 7

And so I don't know, Stephen, if that continues. I don't I haven't heard of any additional Supply coming on board, coming online in Northern White to any great degree. So any kind of demand upset either on the upside or the downside has potential to affect that. But mostly what we see when prices are moderating is more seasonality or rigs moving and things like that. But Right now, it seems like the market is in relative balance.

Speaker 5

Great. Thank you. And then one other for me. Have you seen much change and you might have mentioned this and I got cut off, but have you seen much change on the cost side as far as I know you've done A lot of work and done a good job managing the cost side. But on the basically based on the COGS line, has there been any Positive movements we should be thinking about as we go forward from here?

Speaker 6

Well, I think as we highlighted and John talked about earlier, we have made investments to improve our efficiency, particularly Around mining at our Oakdale facility and we're actually just kind of starting those processes. So we would expect that to really start helping Margins and costs as we go into 2024. And again, that's also driven by higher volumes. To the extent We get higher volumes and increase our utilization. We do have kind of high fixed operating leverage.

Speaker 6

So as we can sell more volumes and spread our fixed costs, That helps drive our costs per ton out as well down as well. So assuming we can maintain or increase our volumes And keep improving our mining efficiencies in particular on these new initiatives, I would expect to help on Cost per ton basis bring down our cost down going into 2024.

Speaker 5

Thank you. And if I can just slip one more in, when we think about The kind of evolution of frac sand demand or usage per stage, now that's obviously improved over the years. Where does that Stand now. Is it stabilizing? Do you still see modest growth?

Speaker 5

How should we think about that?

Speaker 7

Well, I think in a word that we are seeing growth, right? The stages are the laterals continue to get longer. Folks want to pump More sand per stage. They want to do the stages faster. And really, when we think about this Growth and the amount of sand that we are forcing down the well in any given basin that we're operating in, it really comes back to kind of logistics puzzle we talk about often on these calls, which is making sure that you've got the ability to deliver the quantities of sand reliably sustainably and get them down the hole.

Speaker 7

So you have to be thinking about from the mine to the well site. Chuck had mentioned, we've launched this new smart belt technology for our well site solutions And that was driven primarily by the requirement for forcing huge amounts of sand down the well in a short amount of time. And We think that we've got a good mousetrap on that and the ability to support these longer laterals. We certainly have the reserve base. We have over 500,000,000 tons of sand.

Speaker 7

We certainly have the production capacity. We have about 10,000,000 tons of annual capacity available and we have the right mix that comports with what these guys are looking to do, the fine grain sand. So we feel like we're and we have the logistics infrastructure with rail to make that sand delivery into the market.

Speaker 2

We put our system, our last mile system up against anybody's system on how much sand could be pumped down a whole a day. I think that people are starting to really recognize that.

Speaker 5

Okay, great. Thank you for all the details, gentlemen. Thanks, Stephen.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Chuck Young for any closing remarks.

Speaker 2

Thanks for joining us on our Q2 call. Look forward to speaking to you again in November.

Operator

Conference has now concluded. Thank you for attending today's presentation and you may now disconnect.

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