Smart Sand, Inc. (SND) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Smart Sand Fourth Quarter and Full Year 2017 Earnings Conference Call. [Operator Instructions]. As a reminder this conference is being recorded. I would now like to hand the floor over to Phil Cerniglia, Investor Relations Manager. Please go ahead, sir.

Good morning, and thank you for joining us for Smart Sand's Fourth Quarter and Full Year 2017 Earnings Call. On the call today, we have Chuck Young, Founder and Chief Executive Officer; Lee Beckelman, Chief Financial Officer; and John Young, Executive Vice President of Sales and Logistics. 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 the information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, March 15, 2018. Additionally, we may refer to the non-GAAP financial measures of adjusted EBITDA and production costs during this call. These measures, when used in combination with 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 full reconciliation of adjusted EBITDA to net income and production costs to cost of goods sold [Operator Instructions]. I would now like to turn the call over to our CEO, Chuck Young.

Thanks, Phil. Good morning. I'm pleased to report that Smart Sand has posted another good quarter and good year. Here are some highlights. We had the highest utilization levels in our history, up nearly 200% year-over-year. Revenues and net income were higher for both the quarter and the year, and market demand was and continues to be very positive. Demand for frac sand remains strong. In fact, we believe we could top 120 million tons this year. We also continue to see positive momentum in frac sand pricing. Lee will give you more details on our financial results during his prepared remarks, but first, I'd like to give you a progress report. Let's start with our Oakdale expansion. We announced last year that we'll be boosting Oakdale capacity to 5.5 million tons. Things are moving along nicely. We completed the construction of our third rail loop last June and our second wet plant in October. We also finished the multiunit train build-out of the Byron transload facility on the Union Pacific railroad in December. Our 2 new dry plants should be completed and operational during the second quarter. The new capacity should ramp up over the second quarter and be fully operational by the third quarter. Starting in the second quarter, our annual production capacity of 5.5 million tons will be 55% contracted. These contracts have a weighted average life of just over 2 years. Our strategy remains centered around our team's ability to adapt quickly to the constantly changing industry landscape while operating safely and efficiently to maximize profitability through all industry cycles. Operating at this record level would not have been possible without the hard work and dedication of our talented employees. We believe several key advantages will enable Smart Sand to continue to take advantage of the current positive market trends. They include our dedicated workforce, our long-term take-or-pay contracts, our low-cost operating structure, our strategic investments and logistics infrastructure at our Oakdale facility, and our strong balance sheet that provides us flexibility to support our long-term growth initiatives. Now I'd like to talk about Smart Sand's initiative to expand its geographic and product delivery footprint. As I've said on past calls, we're looking to grow our business model to have more direct exposure and sales opportunities in the operating basins. We're pursuing investments primarily in three growth areas, transloads in the operating basins, last mile solutions for sand storage at the well site, and development of mine locations outside of Oakdale. In regard to transloads, we're in active discussions to acquire and/or develop transloads in such basins as the Bakken and the Marcellus. We're also in discussions with potential anchor customers for these facilities. We believe investing in transloads in the operating basins provides 3 major long-term benefits for Smart Sand. First is the opportunity to attract new contracted customers. Many customers in today's market want surety of supply at a specific location in the basin in which they operate. By having our own terminals, we can market directly to these customers. Second is increased opportunity for on-demand, in-basin spot sales. We can forward load sand to have available in the basins, allowing us to capture potential additional spot business. And finally, we'll have the opportunity to capture incremental margin on the sale of our sand farther down the supply chain. While having our own invasive terminal capacity, we'll have the opportunity to directly manage the costs of rail and terminal operations. That will increase the potential margin we capture as we sell our sand at an in-basin price. We believe long term that many customers want a sand service company that can not only provide high-quality sand but also offer efficient and cost-effective solutions for delivering that sand all the way through the wellhead. With that in mind, we continue to actively evaluate opportunities for last mile solutions. We think there's a lot of product innovation in this area, so we continue to evaluate our options to invest or partner in last mile solution. Stay tuned on this as we are very close to finalizing how we plan to compete in this segment of the sand logistics supply chain. Hopefully, we'll be able to provide greater detail on this on our next earnings call, if not sooner. Finally, we signed long-term leases on 2 locations in the Permian Basin of West Texas. These leases give us access to acreage in basin under 20-year leases at a very low cost upfront and low minimum royalties. We incurred less than $5 million in upfront payments to acquire these leases. We estimate that these locations collectively have several hundred million tons or more of frac sand reserves. These locations are available to us for future development to provide frac sand directly to the customers in the Permian. We're currently in the process of permitting and initial design of a potential facility at one of these locations. And due to our low cost of entry, time is on our side. We have the option of waiting until we're more certain of the market demand for this new regional sand supply before we commit fully to invest in developing a mine at one of these locations. Looking ahead, we see a number of positive signs including these, increasing demand for frac sand, positive momentum in pricing, and continued progress in our expansion programs. I'll now turn the call over to our CFO, Lee Beckelman, for a closer look at the company's fourth quarter and full year 2017 results.

Thanks, Chuck. As Chuck highlighted, we had a strong fourth quarter for sales volume and a very successful 2017 in terms of overall sales and financial results. My comments primarily will be focused on comparing the fourth quarter 2017 results with the third quarter 2017 results. I'll also touch on the calendar year 2017 results as well. Starting with sales volumes. We sold approximately 706,000 tons in the fourth quarter, an 8% increase compared to third quarter 2017. Our spot sales activity increased in the fourth quarter compared to the third quarter, while spot sales increasing to approximately 26% of our total sales volumes versus approximately 20% in the third quarter. In the fourth quarter 2017, approximately 68% of our sales were shipped via unit train compared to approximately 77% in the third quarter. This reduction in unit train shipments was somewhat related to the increased spot sales activity during the quarter. Total revenues for the fourth quarter were $43 million, a 9% increase over third quarter results. Sand sales revenues increased to $24.4 million in the fourth quarter from $22.2 million last quarter due primarily to higher sales volumes. The average sales price per ton in the fourth quarter was basically flat with the third quarter 2017 results at $34.49 per ton versus $34 per ton last quarter. Pricing in the quarter actually improved at the mine gate in the 5% to 10% range. However, we had less spot in-basin sales during the fourth quarter, which led to overall lower average spot sales pricing in the quarter relative to the third quarter. Reservation revenue, which is included as part of sand sales revenue, was $7.5 million in the quarter, equal to the third quarter 2017. During the quarter we had no shortfall revenue. In the third quarter 2017, we recognized $1.2 million of shortfall revenue related to an annual contractual shortfall payment from one of our customers. Transportation revenue, which includes freight and railcar rental, was $18.7 million in the quarter compared to $15.9 million last quarter due to higher shipments under contracts, in which we passed through freight expenses to our customers. Our cost of sales for the quarter was $32.9 million compared to $26.3 million last quarter. The increase in cost of sales was primarily due to a number of seasonal maintenance and onetime factors, including less capitalization of costs during the winter. As we have highlighted on our third quarter earnings call, typically we have higher recorded expenses in the fourth quarter and first quarter of each year as we typically shut down our wet plant operations during the winter months. This leads to less costs being absorbed and capitalized into inventory during these time periods and as such, leads to higher overall reported expenses during these quarters relative to the second and third quarters, when we are operating the wet plant at full capacity. Secondly, we had higher labor costs in the quarter. We had approximately $1.3 million in higher labor costs in the fourth quarter due to discretionary bonuses being paid in the quarter and due to increased headcount as we began building up and training our staff to be ready for the plant expansion expected to be operational in the second quarter of 2018. We are continuing to ramp up our workforce, so we'll continue to have higher wages relative to our production levels in the first quarter as well. We expect this ramp-up of labor expense to moderate beginning in the second quarter as we approach full staffing to support our expanding capacity of 5.5 million tons per year. We also had increased utility expense of approximately $718,000 in the quarter. We experienced extremely cold weather in the fourth quarter in Wisconsin, which led to increased fuel usage expense to run our operating plants. Increased maintenance and equipment expense of approximately $3.6 million. Due to the weather conditions in the fourth quarter, we had increased downtime that led to increased maintenance and equipment expense. Additionally, we did extend our mining and wet plant activities further into the fourth quarter than we had done previously, which led to additional mining and wet plant expenses during the quarter. Our production cost per ton for the quarter increased to $14.79 per ton compared to $10.79 per ton in the third quarter. For the year, our production costs were approximately $13.61 per ton, 11% improvement over 2016 levels of $15.22 per ton. As I highlighted previously, we normally have higher reported production costs during the winter months. Additionally, we had higher expenses that I highlighted, which negatively impacted our production costs during the quarter. Our goal over time on operating consistently at higher utilization levels is to get our production costs down to $12 per ton range. In the first quarter 2018, we will continue to have higher production costs due to seasonal aspects we have highlighted, some additional maintenance weather-related expense that continued into January and the continued ramp-up of our workforce to be ready to support our higher production levels beginning in the second quarter of this year. We currently expect our production costs in the first quarter to be in the $18 to $20 per ton range. However, we do expect our cost per ton to improve over the course of 2018 as we ramp up production and sales, and we currently project that our production cost per ton for the full year 2018 should be in the $12 to $14 per ton range. Gross profit was $10.1 million in the quarter, a 20% decrease from third quarter gross profit. The decrease in gross profit was primarily due to higher expenses that we incurred during the fourth quarter. Our operating expenses in the quarter were $5.5 million, a $1.3 million increase over third quarter results, primarily due to discretionary bonuses paid during the quarter and approximately $600,000 of development expenses that were written off in the quarter related to projects that we ultimately didn't pursue. For the quarter, we had income tax benefit of $6.2 million due primarily to an $8.5 million benefit recognized in the quarter due to the U.S. tax law changes that went into effect in December 2017. This benefit was related primarily to the reduction in the U.S. federal corporate tax rate to 21% from 35% previously, which led to a remeasurement of our deferred tax assets and liabilities. We anticipate our effective tax rate to be in the low 20% range going forward, currently. We had net income of approximately $10.9 million and adjusted EBITDA of $8.9 million in the fourth quarter. Net income increased slightly relative to the third quarter, while adjusted EBITDA decreased sequentially due primarily to the higher production cost we had in the quarter. As highlighted earlier, in the third quarter, net income and adjusted EBITDA were positively impacted by an annual contractual shortfall payment from one customer of $1.2 million. In the fourth quarter 2017, we spent approximately $23.6 million in capital expenditures, and we spent a total of $51.2 million for the full year 2017, primarily related to our expansion projects for 2017, along with some operational efficiency and replacement projects. We continue to move forward on our expansion projects in Wisconsin and are currently on schedule to bring online in the second quarter of 2018, two dry plants to increase our nameplate processing capacity to 5.5 million tons per year. Our capital budget for 2018 is currently expected to be in the $85 million to $95 million range. Included in this total is approximately $46 million in capital associated with the completion of the expansion of our Oakdale facility, most of which will be spent in the first quarter this year. Additionally, we have budgeted approximately $19 million in capital projects to increase the efficiency and production of our wet plant operations and additional office and warehouse space for Oakdale, and approximately $6 million in routine replacement-related capital expenditures. The remainder of our planned capital budget for 2018 is targeted to be spent on growth initiatives, primarily related to logistic investment opportunities. As Chuck and I have highlighted, our capacity expansion is nearing completion and should become operational beginning in the second quarter this year. During the first quarter, we are operating within our current 3.3 million tons of annual capacity, so we continue to be capacity constrained. For the first quarter, we expect sales volume to be in the 700,000 to 750,000 range. As highlighted earlier, we expect to have higher production costs in the first quarter due to our normal seasonality and the ramp-up in our labor to be ready to support our higher production levels later in the year. Therefore, we currently anticipate adjusted EBITDA to be in the $4 million to $8 million range in the first quarter of 2018. However, market demand continues to be strong. And based on current market conditions, we expect to be able to take advantage of our increased capacity beginning in the second quarter this year to increase our sales, and we expect our production cost per ton to moderate as we ramp up production beginning in the second quarter. So we believe, again assuming market conditions stay consistent with current activity throughout 2018, that we should have sales volumes for 2018 in the 3.5 million to 4 million ton range and adjusted EBITDA for the year in the $70 million to $80 million range. As of December 31, 2017, we had approximately $35 million of cash in our balance sheet. We expect most of this cash will be utilized in the first quarter of 2018 to complete the Oakdale expansion. Our $45 million revolver is currently available for us to draw on as needed as an additional source of liquidity. We do expect to draw on this facility most likely later this month or early in the second quarter due to the timing differences in our capital spending relative to our cash flow from operations as we begin to ramp up production in the second quarter. For the full year 2017, we sold over 2.4 million tons, 196% increase over 2016 sales volumes. Revenue for 2017 was $137.2 million, a 132% increase over 2016, due primarily to the higher sales volume and higher freight revenues, resulting from an increase in shipments to customers when we bill freight. Net income for 2017 was $21.5 million compared to net income of $10.4 million in 2016, and adjusted EBITDA for the full year 2017 was $30.6 million compared to $37.8 million last year. This concludes our prepared comments, and we will now open the call for questions.

[Operator Instructions]. And our first question comes from the line of George O'Leary from Tudor, Pickering and Holt.

Very helpful color on the guidance front. I was just curious if you could provide just a little more insight, given all the moving pieces, whether logistics, the mine coming online, the hiring, et cetera, and maybe the cadence as we progress through the year, both volumes and top line. I realized the plants coming on in the second quarter, I mean, it's probably biased, volume growth and revenue growth towards the back half of the year, but just curious how you would frame that for folks.

Yes, George, right now we expect to bring the dryer four on five early in the second quarter, we'll be ramping that up, decommissioning, kind of in April, then ramping up production over May and June. And so I think second quarter will improve from first quarter results. We'll have some increased volumes that will be ramping up. And then as we get to the second half of the year, again, assuming market conditions can stay consistent where they are today and activity remains strong, that we'd start being more fully utilizing that capacity in the second half of the year. And normally, as we've said in the past, we'd like to -- we believe, when we're operating well and there's strong demand, that we should be in the 85% to 90%-plus range of utilization of our nameplate capacity. So that's our goal as we get into the second half of the year.

Yes, one other thing, we brought the people in already and trained them to run those plants. So we've been carrying that even though those plants aren't up and running yet. So when the plants are commissioned that we have skilled labor already in place to make sure that our nameplate capacity, we actually can run at that.

Yes, that's part of our cost increase in the first quarter is that we brought in most of those employees, we were training them, so we should be fully staffed or close to fully staffed as we get operational beginning kind of in early April.

Very good. That's very helpful. And then just from an underlying pricing perspective in the sand market, what are you guys seeing? Or what are you guys seeing so far, first quarter? It sounds like most other producers or foreign enterprises actually increasing first quarter, and then as some more of these Permian sand mines have come on, how would you describe that competitive nature of selling volumes down into the Permian Basin? Has there been any change there? Any pushback on the mine pricing? Just curious on what you're already seeing.

So what we've been seeing is a lot of people that thought they had this Permian sand supply locked up and could potentially be contracted that some of these Permian mines are falling flat on their ability to produce sand. So we have a lot of people all coming at once, and we're probably one of the few people that actually have built Northern White capacity over the last year. It's coming up. And we're really happy with where our contract talks are on that Northern White capacity. So we think the Permian sand is running into a little bit of a problem in being able to produce. I'll let John comment on a little bit on price.

Yes, and so the pricing continues to improve sequentially quarter-over-quarter. We probably saw about a 5% to 10% increase on the spot pricing from the last quarter. All indications is that we're going to continue to see very strong demand on both 100 mesh and 40/70. Interestingly 30/50 is becoming -- there's more demand on 30/50 cropping up now. So we anticipate that the pricing is still going to continue to be strong. Certainly, there's no lack of buyers for our sand, and we anticipate that to continue, provided oil price and all the adjunct things stay the same.

Great. I'll slip in one more if I could. You guys mentioned looking at last mile solutions, just I realized you don't want to tip your hand. But just looking at the various solutions that are out there today and maybe just in big buckets, boxes versus silos versus other, what are some of the pluses and minuses as you guys see it to the various different offerings that are out there?

So we think that silos system is the better system. We are very, very close to making a decision in the direction we're going in that area. And then we also think that the trucking part of it is a huge -- how fast you can turn trucks is a huge part of this. And basically, any decision we make will also involve making sure that the trucks that we work with are turning quickly.

And our next question comes from the line of James Wicklund with Crédit Suisse.

If I look at your guidance for Q1, and I understand that the startup costs and higher operating costs and all, and then some improvement in Q2. Based on your guidance, you could be at a $30 million to $40 million EBITDA quarter run rate by Q4. Am I doing the math, right?

I think your number in Q4 may be a little high. I think we'll be -- kind of what we're seeing is we'll ramp up fairly well into the second quarter and then have a pick up in the third and fourth. So I'd say, $40 million in the fourth quarter is a little high, so moderating down more to a lower level, but being more consistent kind of second quarter and then ramping up in the third and fourth quarter.

Okay. We'll work on the math. I appreciate it. And in terms of adding people, how many people have you added to Oakdale? What's the percentage increase and the absolute number increase of people you've added in Oakdale? Just give us an idea of scale.

I think order of magnitude, we've gone from roughly -- I think, in September, we probably had around 80 folks or so at Oakdale, and we're ramping up to be around 150. And that'll be -- and so you've got to remember we've added -- we've gone from three wet dry plants and a wet plant to two dry plants and an additional wet plant. So we're at seven, actually, operating plants at the facility versus 4 previously. But again, we're going to be ramping up to around, give or take, 150 people on operations.

Okay. Last one, if I can sneak in, everybody's talking about the disruptions in rail in Q1. You guys don't seem to be particularly affected. But I would think that spot sales, the price of spot sand would have gone nuts in Q1 with all the shutting capacity on the sand. How are you all seeing this play out in Q1? And can you talk about the impact of spot pricing?

Well, so spot pricing is continuing to improve, Jim. From a logistics perspective, we think we've managed through the bottlenecks pretty well. And the -- what helped with that, obviously, was having 2 railroads effectively serving Oakdale, so we're able to kind of balance the load between them and continue to move our product effectively. Also, we shipped a lot of unit trains. We've been a prime mover on unit trains, and that's certainly helped with our movement. But yes, that railroads had a little bit of struggle during the first quarter. It's yielded a bit of improvement on our spot pricing. And I think it will tell you that demand has been very, very, very strong, and we don't see any slowdown from that.

Yes. One thing I'd add to that, Jim, is primarily the -- because of the 3/3, we're primarily filling our contracted volumes. So we don't have a lot of room for spot in the quarter. I mean, we're still about the 20%, 25% spot and 75% of contracted volumes and that's going to mute how much benefit we can get from spot pricing in the first quarter.

We're pretty excited about this new capacity coming online because it'll be outside of some of the existing contracted pricing. And that looks very positive where that pricing is at.

Okay. Do we have our rail issues behind us now?

So I would say, because we have two rails, that the rail issues were less for us. We've heard, we've read the releases from people that they'd had problems with certain rail lines in Wisconsin. But it really -- for our business, it really is not impacted like it has some of the other sand mines. And we also think part of that issue is gradation issue, where the sand that where we're at, we have 81%, 40/70, 100 mesh, and some of these other mines are basically were built for the 20/40 market. And when you go into winter and you have a winter pile and you start racing through some of the mesh sizes you don't have, that could cause some issues in what you're able to make for the marketplace.

[Operator Instructions]. Our next question comes from the line of John Watson with Simmons & Company.

Looking through the 10-K, it looks like you all contracted an additional 560,000 tons or so from the Q3 call to now. Can you talk to us about these contracts, how they compare to some of your legacy agreements and perhaps provide an update on any additional contracting discussions that are underway?

Well, currently, of the 5.5 million tons that'll be up and running at April we're about 55% contracted. And so our contract discussions continue to -- so that gets -- calculates to be about around 3 million tons on contracted capacity of the 5.5 million tons. And we continue to have really good dialogue and good opportunity for additional contracted volumes at Oakdale. So that all continues to be positive. I guess, John, can add a little bit more comments on the contracting side.

Yes. So we added some contracts in the fourth quarter. And we hope to have some additional things that we'll report on additional contracts shortly here. But the market for contracting is definitely strong right now, and given that we're one of the few that has additional Northern White capacity, I think that's been helpful for those discussions.

And our next contracts that you'll see, you'll see us move away from some of the FOB Oakdale to FOB the basins through terminals. So we're really -- that's a focus of our business. We want to capture more of that margin because we think we're pretty good at managing the logistics of that. And you'll see us get into that as you also see us start to put our foot into the last mile.

Okay. That's helpful. And for the contracts that you've signed recently, safe to assume that those are a similar structure to your agreements that you signed in past years?

Yes, our contracts have similar structure. Typically, we'll have WTI escalators. We'll have either reservation charges or quarterly true-ups built into our contracts currently. So our -- and our discussions are all typically in that similar fashion.

Perfect. And then on contracted pricing, I think we talked about a $5 move in Q1 and then potentially another move in Q2 based on where WTI is trading. Can you give us an update on those expectations and where you think contracted pricing will settle in Q1 and maybe expectations for Q2?

I think the benefit in Q1 is more around $2 to $3 a ton, because again, it lags, so you look at the last calendar quarter. So I think in the fourth quarter, we had WTI average of about $55 and that led to a benefit in Q1 around $2 to $3 on a weighted average basis. If all stays consistently above $60, between $60 and $65 for WTI, we're looking at probably getting an incremental benefit of $4 to $6 per ton that would flow through under those contracts.

Great. One last one for me. The strategic opportunity, you all mentioned in the press release in the Bakken, that's a transload not an in-basin mine, correct?

Correct. The strategic opportunities are in the Bakken and the Marcellus as well as other areas. Right now those are transload opportunities that we'd be looking to either commit to build a structure in a location or buy an existing asset or group of assets.

And that concludes our question-and-answer session for today. I'd like to turn the floor back over to Chuck Young for any closing comments.

Thank you again to everyone for joining our earnings call today. We look forward to taking advantage of the positive market trends in 2018.

Ladies and gentleman, thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone, have a great day.