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U.S. Silica Holdings (NYSE:SLCA)
Q1 2020 Earnings Call
May 01, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to the U.S. Silica first quarter 2020 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr.

Arjun Sreekumar, manager of treasury and investor relations for U.S. Silica. Thank you. You may begin.

Arjun Sreekumar -- Manager of Treasury and Investor Relations

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's first quarter 2020 earnings conference call. With me on the call today are Bryan Shinn, chief executive officer; and Don Merril, executive vice president and chief financial officer.

Before we begin, I would like to remind all participants that our comments today will include forward-looking statements, which are subject to certain risks and uncertainties. For a complete discussion of these risks and uncertainties, we encourage you to read the company's press release and our documents on file with the SEC. Additionally, we may refer to the non-GAAP measures of adjusted EBITDA and segment contribution margin during this call. Please refer to today's press release or our public filings for a full reconciliation of adjusted EBITDA to net income and the definition of segment contribution margin.

[Operator instructions] And with that, I would now like to turn the call over to our CEO, Mr. Bryan Shinn. Bryan?

Bryan Shinn -- Chief Executive Officer

Thanks, Arjun, and good morning, everyone. I'll begin today's call with an update on our response to the COVID-19 pandemic, which was focused on ensuring the safety and health of our employees while minimizing disruptions to our operations and financial performance. I'll then discuss how we're responding to the current oil macro environment. Next, I'll review our solid first quarter performance in detail.

And finally, I'll conclude with market outlook thoughts for both of our operating segments and discuss the numerous cost reduction measures that we have instituted. I'll then turn the call over to Don Merrill, who will review key financial metrics before opening the call for questions. I'm pleased to report that we've experienced minimal operational disruptions thus far as a result of the COVID-19 pandemic. Following the guidance provided by the CDC and federal, state and local authorities, the majority of our corporate employees started to work remotely in late March, and we've promptly implemented numerous social distancing best practices throughout our entire operations network to protect the health and safety of our colleagues.

We also formed a COVID-19 action team that provides employees with regular communications, including industry-specific best practices, proper cleaning, disinfecting and hygiene practices and operational modifications to minimize exposure risk. I'd like to express my deep gratitude to all of our colleagues for their unbelievable dedication during these challenging times. We will continue to closely monitor the situation and make decisions based on guidelines from relevant authorities. Looking ahead, we expect that ISP segment sales volumes will generally follow GDP trends, a few end-use markets for industrial sand, such as building products and automotive will likely experience weaker customer demand, while demand for other ISP products, including diatomaceous earth and specialty clays used for the filtration of food and beverages and specialty sand used in container glass production is expected to remain robust.

In our energy segment, the oil demand declined resulting from the COVID-19, coupled with inadequate supply response and then exacerbated by the lack of global storage capacity has resulted in a sharp decline in crude oil prices. Accordingly, expectations are for at least a 50% decline in North American upstream spending this year and a similar decline in completions activity. We expect that volumes and loads in our Oil & Gas segment will directionally track completions activity. But as with the 2015 oilfield downturn, we expect to gain market share this year due to our attractive low-cost offerings.

In response to the expected sharp contraction in well completions, we've taken swift and aggressive actions to rightsize our cost and Oil & Gas supply chain footprint. Over the past few quarters, we've idled seven production facilities and reduced shifts at six other mines, thereby reducing our staffed annual Oil & Gas production capacity from 24 million tons to six million tons. We've also warm stacked some Sandbox equipment and moved other equipments to areas of higher demand. Drawing on our roots and continuous improvement and lean manufacturing, our operations teams are pursuing approximately $25 million in additional plant cost savings and supplier contract renegotiations.

In addition, we've taken significant actions to reduce the SG&A expenses. Over the last five months, we've eliminated approximately 250 positions across the company and reduced other costs, resulting in an expected 40% decrease in our SG&A run rate going forward. We're sad to lose so many of our valued colleagues, but took this difficult step for the overall health of the company. Now let's move on to our solid first quarter results.

For the total company, first quarter revenue of $269.6 million, decreased 20% sequentially. However, excluding a onetime customer shortfall penalty recognized in the fourth quarter, total company revenue declined approximately 5%, driven by lower loads and volumes in our Oil & Gas segment. Adjusted EBITDA for the first quarter of $48.2 million was down 34% sequentially. However, excluding that same customer shortfall penalty, adjusted EBITDA more than doubled sequentially driven by a substantial increase in our Oil & Gas segment contribution margin dollars.

Our Industrial & Specialty Products segment had a great quarter, with revenue up 9% sequentially and total segment contribution margin up 11%, driven by higher sales volumes and increased sales of higher-margin Specialty Products. Our EP Minerals product portfolio continues to perform well despite the challenging macro environment. Demand for filtration from food and beverage producers was strong in the first quarter and is expected to remain robust in the near term. In our Oil & Gas segment, we sold 3.2 million tons of sand in the first quarter, a 5% decline sequentially.

SandBox loads decreased by about 14% from Q4, but we still had almost 70 crudes generating revenue during the quarter. For the Oil & Gas segment, contribution margin dollars actually doubled sequentially when excluding the fourth quarter shortfall penalty, thanks to the aforementioned cost cutting efforts. Our negotiated settlement acquisition of Arrows Up also closed in the first quarter, and the integration has been seamless. We're very excited to have Arrows Up team join U.S.

Silica and to have another dynamic offering in our portfolio. Closing out my commentary on Q1. I'd like to say again how proud I am of the work that our team did and the results that we delivered in an unprecedented and challenging macro environment. I'd also like to take the opportunity today to remind everyone that while we're often painted with an oilfield services brush, our business is increasingly levered to industrial end-markets that are largely unaffected by the turbulence in the Energy space.

In fact, the recent volatility in crude oil prices illustrates precisely why we diversified our operations by investing in and growing our industrial businesses, which have higher barriers to entry, stickier customer relationships, higher margins and strong growth prospects. Even within our Industrial segment, our focus isn't exclusively on silica products anymore. We also produce diatomaceous earth, specialty clays and perlite, all higher-margin offerings with different end users and demand drivers compared to some of our silica products. In 2020, for example, we expect that more than 40% of our company contribution margin will come from non-sand products.

This diversification isn't by accident, it's by design. And in difficult times like these, when the U.S. shale market and our frac sand peers are retrenching, our investments in ISP are really paying off by providing less volatility and more reliable cash flow. In 2019, our industrial segment accounted for nearly 50% of our total contribution margin dollars when backing out the onetime customer shortfall penalty from 4Q 2019.

In 2020, we expect ISP to constitute about 70% of our company contribution margin dollars. And finally, today, let's discuss the market outlook for our operating segments. Our underlying assumption for the remainder of 2020 is that we will operate in an environment of high uncertainty driven by the COVID-19 virus and lower highly volatile oil prices. Given that, we will continue to focus on what we can control and ensure that our costs stay aligned with business affordability.

We expect that our ISP business will hold up well and that sales volumes will align U.S. GDP, given the nature of our end-use markets, diverse customer base and numerous specialty and niche products. In our Energy business, we believe that well completions and sand demand will decline in the coming quarters, and many customers may slow or pause activity in response to low WTI pricing. However, our costs in this segment are highly variable and will continue to rightsize operations accordingly.

Unfortunately, while we're not in a position today to provide specific EBITDA guidance given all the moving parts, I do believe that the current 2020 street consensus of less than $80 million of EBITDA is very conservative given our solid first quarter results and the stability of our industrial business. And finally, we're very focused on cash flow, as you might imagine, and our goal is to end 2020 with approximately the same amount of cash on our balance sheet as compared to the fourth quarter of 2019. Don will discuss cash flow in more detail in just a minute during his remarks. For me, the bottom line is that I believe we have the right plan and a committed team to maximize our business results in 2020, and to also be ready to capitalize the inevitable rebound occurs in the coming quarters.

And with that, I'll now turn the call over to Don. Don?

Don Merril -- Executive Vice President and Chief Financial Officer

Thanks, Bryan, and good morning, everyone. First, I would like to reiterate Bryan's comments on the company delivering a strong first quarter and generating $48.2 million of adjusted EBITDA despite the obvious and well-known macro challenges. Moving on to the results of our two operating segments. First, quarter revenue for the Industrial & Specialty Products segment was $113.9 million, up 9% from the fourth quarter of 2019.

The Oil & Gas segment revenue was $155.7 million, down 34% from fourth quarter of 2019, due primarily to the recognition of a customer shortfall penalty in the fourth quarter as well as a 5% sequential decrease in tons sold. On a per ton basis, contribution margin for the ISP segment of $45.20 represents an approximate 3% decrease from the fourth quarter. The decrease was due primarily to a change in mix, as sales of whole grain silica increased at a faster pace than our higher-margin specialty products. As Bryan stated, we anticipate that our ISP business will prove resilient and follow the GDP curve as our customers navigate the coming quarters.

The Oil & Gas segment contribution margin on a per ton basis was $10.27 compared to $20.22 for the fourth quarter of 2019, largely due to the aforementioned customer shortfall penalty recognized in the fourth quarter. However, it is important to mention the cost focus of the company, resulting in a decline of cost of goods sold driven by the idling of facilities, continued efficiencies at our West Texas operations and a decline in our logistics costs and a result of the optimization of our transload network. Unfortunately, we expect the Oil & Gas segment volumes to decline in the second quarter, in line with expectations for a severe reduction in completions activity. We will continue to challenge our team to deliver the lowest cost possible while providing the best service in the industry.

Let's now look at total company results. Selling, general and administrative expenses in the first quarter totaled $30.1 million, representing a decrease of 19% from the fourth quarter of 2019. The substantial decrease was driven largely by reduced employee costs and associated spendings with the previously announced and unfortunate reductions in force. We now expect SG&A expense in 2020 to decrease to a run rate of approximately $85 million by the end of the year.

Depreciation, depletion and amortization expense in the first quarter totaled $38.4 million, a reduction of 10% compared with fourth quarter of 2019. The reduction was driven by a decrease in total depreciable assets due to the idled plants and the subsequent asset impairment. Our effective tax rate for the quarter ended March 31, 2020, was a benefit of 33%. Moving on to the balance sheet.

Cash and cash equivalents, as of March 31, 2020, was $144.7 million. And liquidity, including the revolving credit facility, was $213.2 million. During the first quarter, we drew $25 million on our revolving credit facility as a precautionary measure in response to the economic uncertainties caused by COVID-19. The reduction in cash was expected and was largely driven by front-end loading capital expenditures and working capital needs.

Capital expenditures during the quarter totaled $16.1 million and were primarily related to the payment of capex accrued in 2019, and improvements in expansions at our high-margin industrial facilities in Millen, Georgia and Columbia, South Carolina. We are now anticipating our 2020 capital expenditures to be approximately $30 million at the low end of our previous guidance of $30 million to $40 million and down approximately 75% last year. Of that $30 million, approximately $15 million is earmarked for maintenance spend, while the remaining $15 million will be allocated toward growth projects in our Industrial business. I'd now like to focus on our cash and liquidity position.

As a reminder, we have no near-term obligations come in due as our term loan doesn't mature until 2025 and our revolving credit facility expires in 2023. Further, we expect our term loan interest and swap payments to decline significantly in 2020 due to the recent reduction in LIBOR rates and the termination of our interest swap agreement. Additionally, we have identified refunds of $16 million of alternative minimum tax credits and $39 million related to net operating loss carrybacks attributable to the CARES Act provision that we expect to recover in 2020. This $55 million of cash will certainly help support our cash flow goals for 2020.

And with that, I'll turn the call back over to Bryan.

Bryan Shinn -- Chief Executive Officer

Thanks, Don. Operator, would you please open the lines for questions?

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from the line Stephen Gengaro with Stifel. Please proceed with your question.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thanks. Good morning, gentlemen. So I guess two things. One, I'd start with on the Oil & Gas contribution market side, so we can get a sense looking ahead.

Did Arrows Up contribute much in the first quarter? You mentioned it was accretive. I was just curious if you could quantify that at all.

Bryan Shinn -- Chief Executive Officer

Yes. It was accretive. I would say it was minimal dollars here in Q1, but it was accretive, for sure.

Don Merril -- Executive Vice President and Chief Financial Officer

We closed that pretty late in the quarter. So it really didn't have much runway to contribute, Stephen.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Great. And then as you think about the Oil & Gas contribution margin per ton as we look ahead, given the cost-cutting that has been in place thus far, do you think that contribution margin in Oil & Gas stays slightly positive over the next quarter or two? Or do you think it could go negative given how sharply we're seeing volumes contract? It's hard to gauge kind of a year ago, you removed costs relative to that.

Bryan Shinn -- Chief Executive Officer

Yes. I'll maybe give you the start of an answer. And I think Don probably can articulate some more details. One of the things that I think is misunderstood a bit about our Oil & Gas sand business is that the costs are highly variable.

So we've been able to take out quite a lot of costs, particularly as it relates to the local mines, those that don't need rail. So we do have a bit of an overhang from railcars associated with our Northern White business. But I wouldn't say the local sand is 100% variable in terms of costs, but its pretty close. Don, I don't know, what would you add to that?

Don Merril -- Executive Vice President and Chief Financial Officer

Well, I would agree. Look, we've proven that we're able to take out costs as volumes and demand drop on our side, and that's why we saw such a good quarter. We've been able to save on the cost side. We've been able to save significantly on the freight side as we've been rightsizing our transload network.

And look, we're going to continue to do that. We're going to continue to challenge our folks to keep contribution margin positive the rest of the year.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thank you. Just one final, on the balance sheet, receivables jumped in the quarter. I just wanted to get a handle on the drivers of that. And should we think about that as being a source of cash as we go through 2020 from here?

Don Merril -- Executive Vice President and Chief Financial Officer

Yes. Look, the big jump in receivables is not only trade receivables, its other receivables as well. And in my remarks, we talked about tax refunds, and there's $44 million worth of tax refunds that are sitting in that number. So yes, I anticipate that to be a big source of cash by the end of the year.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Great. Thank you.

Operator

Our next question comes from the line of Kurt Hallead with RBC Capital Markets. Please proceed with your question.

Kurt Hallead -- RBC Capital Markets -- Analyst

Hey. Good morning. I hope everybody in your family is healthy.

Bryan Shinn -- Chief Executive Officer

Well, same to you. Thank you.

Kurt Hallead -- RBC Capital Markets -- Analyst

Thanks. And absolutely phenomenal job here for their contribution margins in the Oil & Gas segment in the first quarter. So kudos to the efforts you guys got going on there.

Bryan Shinn -- Chief Executive Officer

Thank you.

Kurt Hallead -- RBC Capital Markets -- Analyst

So yes, sure. So I think the first question I have then would be on the industrial side of the business, right? And Bryan indicated that, that would track GDP pretty closely. You got a couple of your businesses that are holding up really, really well. But when we look at some of the GDP data come in to the four here for the second quarter, especially and potentially kind of spilling over into the third quarter, there's some data points out there that suggest GDP could be dropping 10%, 15%, 20% on a year-on-year annualized run rate.

So should we use that as our marker when we kind of think about the volume dynamics on ISP or there enough offsets with the diatomaceous earth and the clay products that maybe kind of dampen that dynamic?

Bryan Shinn -- Chief Executive Officer

Sure, Kurt. So a very good question. And I think, as I mentioned in my prepared remarks, the industrial business is perhaps a bit under appreciated. And I think it's exactly in times like these where the industrial business will certainly shine.

Our expectation in general, as you said a moment ago, is that we'll see further weakness across the economy in Q2 and Q3 for sure. And probably for us specifically, where we'll see that weakness is in customers and the building products and glass manufacturing sector. So for example, glass for automobiles, there's not much of that happening right now. And some of the building products have definitely gone soft.

The good news is we have the offsets and the things that you mentioned, food and beverage and other specialty products. So when you look at all that in total, I think we'll do better than the GDP numbers. And the current base forecast that we have for the year would have us down only about 10% to 15% in contribution margin in the industrial business for the year versus the kind of GDP numbers that you were talking about of being down 30% or 40%. So I think our team's done a really good job of constructing that business.

And we're doing a lot of work with customers right now to try and figure out what they're seeing out there. And we do have a number of customers that are telling us that they're anticipating somewhere around mid-third quarter to be able to restart a couple of their closed plants that are big customers and consumers of our products. So we're somewhat hopeful that as we get a few months out here, we might start to see some rebound there. But overall, our current forecast is down about 10% to 15% in contribution margin dollars for 2020 in the industrial business.

Kurt Hallead -- RBC Capital Markets -- Analyst

OK. That's great color. I appreciate that. And then just my follow-up to come back around to the the Oil & Gas side of the business, when you think about the potential decline in volumes that are going to be coming here, especially in the second quarter.

You talked about a high variable cost component. So I tend to think about these dynamics, trying to think about the decremental margin on the dollar. Would that decremental margin going to be like 20% to 25% or could the decremental margin be like 40% to 50%? I'm just trying to gauge kind of relative magnitudes. Any help on that would be great.

Bryan Shinn -- Chief Executive Officer

Sure.

Don Merril -- Executive Vice President and Chief Financial Officer

Yes. Look, I think it's the latter part of that. I think your decrementals are probably in the 40% to 50% range, as we go through the second quarter. We've done a lot of heavy lifting going into this quarter.

And as Bryan mentioned, look, April was a good month, right? So we've got a little bit more work to do here as we rightsize the organization through May and June. But look, it's going to be in that range. But like we said earlier, at the end of the day, from an Oil & Gas perspective, I do believe contribution margin is going to remain positive.

Kurt Hallead -- RBC Capital Markets -- Analyst

That's awesome. Thanks for that color, guys. Appreciate it.

Operator

Thank you. Our next question comes from the line of Cameron Lochridge with Stephens Inc. Please proceed with your question.

Cameron Lochridge -- Stephens Inc. -- Analyst

Hey. Good morning. Thanks for taking my question. I just had one quick one on the Oil & Gas segment.

I was hoping just kind of qualitatively, could you maybe talk about your strategy going to the downturn and talked about taking market share, where maybe you think you're best positioned to gain some share? And then to the extent that you have any visibility into it, as we come out of the downturn, do you think contribution margin per ton could get back to that mid- to high teens level and as we come out of this or still drill and tell? Thank you.

Bryan Shinn -- Chief Executive Officer

Thanks for the questions, Cameron, and very important items that you brought out. So in terms of the share, first, I guess maybe to start with the things we're not going to do to gain share, and that's reduced pricing. So this isn't about taking pricing down to get share. I think our share is going to come because of our active position on a cost curve of favorable logistics that we have and the reputation that we have in the market.

What we're seeing, and we already start to see this, in Q1, and we're seeing it more as we get into Q2 here, the customers who are still working out there and they're still completing wells are looking for high-quality partners to work with, people who're going to be around long-term. And we've seen some of our customers actually consolidate all their demand to U.S. Silica. So I think that speaks to how we're positioned in the market, not just in terms of our cost, but also the reputation and the quality and the service that we provide.

So I feel like that's one way that we're going to gain share. The other way is just the financial strength that we have. I feel really good about our liquidity. We're not worried like others are about restructuring at this point and having to take some of those actions and creating a lot of doubt in our customer's mind.

So I feel like we'll be one of the ones out there standing throughout this. And I think that certainly helps us. In terms of how things recover here, I would go back and look at some of the previous downturns, 2008, 2009, '15, '16. What we typically see coming out of that is that there's a few folks like us who can turn up capacity very quickly.

We've been running the whole time and we're going to be the initial beneficiaries of that upturn. And I would expect that margins would surge as they have in previous recoveries. So exactly what number it gets to, I'm not sure. But I can remember some of the past recoveries, the margins doubled, tripled, it went up a lot, at least initially.

Obviously, that will settle down a bit over time, but I think there are some potentially very large gains that we can have as things turn around here.

Cameron Lochridge -- Stephens Inc. -- Analyst

Great. Appreciate the color. I'll turn it back.

Operator

Thank you. [Operator instructions] Our next question comes from the line of Taylor Zurcher with Tudor, Pickering, Holt. Please proceed with your question.

Taylor Zurcher -- Tudor, Pickering, Holt & Co. -- Analyst

Thank you and good morning. Bryan, generally, clearly, your completions activity in Q2 is getting pretty ugly. And as you said, customers are slowing, if not, outright pausing some of their planned completion programs. And so I'm curious, for customers you have that have contracted volumes during this period, let's say, through 2020, what kind of conversations are you having with them today? Or are any of them come to you looking to blend and extend some of their volumes further out to the right? Or how are those kind of conversations going today?

Bryan Shinn -- Chief Executive Officer

So we have a number of contracts, over 20 contracts out in the oilfield area right now, and I think customer conversations are all over the map. The good news is that a lot of those contracts are our next-gen contract, where customers basically paid us fees up front for capacity reservation, and we had to earn those fees on a pro rata basis on a quarterly over the life of the contract. So we have the rights within the contract to do that, and we already have that cash on our balance sheet. So that gives us a pretty good negotiating position.

With that said, we want to be a supplier long-term to our customers. And we recognize that this is an unusual situation, and it's not like the customers are choosing to go to buy from someone else instead of U.S. Silica. For example, they just don't need the sand at this 10 seconds, given that many of them, as you said, are turning down completions activities for a while.

So we'll be smart and sensible about how we do that. But I like the fact that we're in a much better position despite that the nature of the contracts than we've been in previous downturns.

Taylor Zurcher -- Tudor, Pickering, Holt & Co. -- Analyst

OK. Understood. And again, I realize this is a fluid environment. But from a pricing perspective, could you maybe frame where pricing in Oil & Gas peaked in Q1? And on a leading-edge basis, are we already back below the lows that we saw in Q4 of last year or maybe somewhere around that?

Bryan Shinn -- Chief Executive Officer

So I would say that the pricing in Q1, how the peak was in the mid-20s in terms of dollars per ton, April has held up OK. It's probably closer to $20 a ton, I would say. But I would expect that things will fall off here in May and June as activity goes down. I don't have a specific number for you for May and June, because its still, as you said, a pretty fluid situation.

But I think it's been pretty widely reported that upstream spending is going to be down 50% or more as we get into Q2 here. And we're also hearing from some customers that they're making choices as to whether they drill and complete, whether they just drill or whether they stop everything altogether. So we're waiting to see how some of those things play out. That said, we do expect pretty dramatic decreases in May and June in terms of completions activity.

Taylor Zurcher -- Tudor, Pickering, Holt & Co. -- Analyst

Well, thanks for the answers, guys. Appreciate it.

Operator

This concludes our question-and-answer session. I'll turn the floor back to Mr. Shinn for any final comments.

Bryan Shinn -- Chief Executive Officer

OK. Thank you very much, operator. I'd like to close today's call by reemphasizing that we have a diversified business portfolio with numerous industrial markets outside of Energy that are holding up well in the current economic conditions. And also, we continue our strong focus on controlling costs and maximizing profitability and free cash flow.

The bottom line for me is that I believe we have the right plan and a committed team to maximize our business results here in 2020, and we're also ready to capitalize when the inevitable rebound occurs in the coming quarters. Thanks for dialing into our call, and have a great day, everyone.

Operator

[Operator signoff]

Duration: 33 minutes

Call participants:

Arjun Sreekumar -- Manager of Treasury and Investor Relations

Bryan Shinn -- Chief Executive Officer

Don Merril -- Executive Vice President and Chief Financial Officer

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Kurt Hallead -- RBC Capital Markets -- Analyst

Cameron Lochridge -- Stephens Inc. -- Analyst

Taylor Zurcher -- Tudor, Pickering, Holt & Co. -- Analyst

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