Smart Sand, Inc. (SND) Q4 2020 Earnings Call Transcript

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Smart Sand, Inc. (SND 8.49%)
Q4 2020 Earnings Call
Mar 3, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Smart Sand Fourth Quarter 2020 Earnings Call. [Operator Instructions]

I would now like to give today's conference call over to Mr. Josh Jayne, Director of Finance and Assistant Treasurer. You may begin.

Josh Jayne -- Director of Finance, Assistant Treasurer

Good morning. And thank you for joining us for Smart Sand's fourth quarter 2020 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 March 3, 2021.

Additionally, we will refer to the non-GAAP financial measures of adjusted EBITDA, contribution margin 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 adjusted EBITDA to net income, contribution margin to gross profit and free cash flow to cash flow provided by operating activities.

I would now like to turn the call over to our CEO, Chuck Young.

Charles E. Young -- Chief Executive Officer

Thanks, Josh, and good morning. As we're all aware, 2020 was a challenging year for the energy industry. However, thanks to several factors, including actions we took, we were able to stay well-positioned to achieve our long-term strategy. That strategy is this, to be the premium supplier of Northern White frac sand from the mines to the wellsite. The key success factors included, our low leverage, decisive actions to manage costs and our opportunistic acquisition of Eagle Materials proppant business.

As the frac sand market recovered in the fourth quarter, our sales volume increased by 98%. It went from 309,000 tons in the third quarter to 612,000 tons in the fourth. However, the most recent winter storms did impact activity in February, which may push some activity into the second quarter. We're encouraged by recent sales trends and customer inquiries, barring a dramatic drop in oil and gas prices, first quarter activity to be consistent with the fourth quarter, or perhaps, even a little better.

Last year, we generated free cash flow of $17 million, despite a challenging environment. We did it by controlling our operating costs and capex. Our focus for 2021 is to keep generating free cash flow by continuing to operate efficiently. Right now, we have $12 million in cash on our balance sheet and approximately $31 million in liquidity. We couldn't have managed through these difficult times without the efforts of our employees. I want to thank all of our employees once again for their continued commitment to Smart Sand.

As we've demonstrated, we're built to manage through the volatile operating cycles in the industry better than most of our peers. Our proven capital structure and operating philosophy provides Smart Sand the wherewithal to not only survive the industry's volatility, but to be stronger coming out of the downturn. As a result, Smart Sand is well-positioned to take advantage of improving market conditions, while also being able to pursue strategic opportunities that will allow us to capitalize on the recovery.

Our acquisition of Eagle Materials' frac sand business last September was a success. We added new sand capacity, plus an additional Class I railroad to our portfolio of assets. And we did it without taking on debt or significantly impacting our liquidity. Even though Eagle's Utica assets were idle at closing, we started mining operations and began selling sand from there in the fourth quarter. With start-up cost behind us, we look forward to this asset generating solid cash flow for years to come. This acquisition expands our footprint by allowing us to serve new markets and new customers.

We believe there will be more consolidation opportunities in the sands space and we want to play a part in that. But we will not risk our balance sheet. We will only consider consolidation with a purpose and we remain committed to our core principles of a strong balance sheet and low leverage. In regard to SmartSystems last mile product offering, we've completed testing on the SmartPath transloader. We now have four fleets equipped with it and ready for deployment. By the end of this year, we expect to have 12 fleets equipped with SmartPath. We continue to believe SmartPath transloader is unlike anything in the industry. It's a self-contained system designed to work with bottom dump trailers. It features a drive over conveyor, surge bin and dust collection system. So it's well suited to perform any frac job.

With market conditions improving and increased focus by E&Ps on the environmental impact of their fracking operations, we foresee increased industry interest in our SmartSystems product offering. A number of E&Ps have discussed a preference for silos with both built-in dust control and better dust control throughout the completion process. Smart Sand's suite of products is built to limit exposure to dust for all employees in and around the wellsite. We're excited to have more scale with our products in 2021.

As you know, the market is still operating at lower levels than at this time last year. But we've seen a nice uptick in volumes from the bottom we hit in the second quarter of 2020. Our policy of always staying in close contact with our customers ensures that we'll move forward together. We're going to continue the policies that have paid off for Smart Sand, maintaining our strong balance sheet, generating free cash flow, paying down debt and always having surplus liquidity.

We're excited about our future and for a number of reasons. We've seen a meaningful increase in sales volumes. Over the last 12 months, we've expanded both our customer base and operating basins we serve. With start-up costs for a new Illinois mining operation now in the rearview mirror, we can focus on execution. At our Oakdale mine, we continue to improve efficiencies and cost structure to make it one of the most efficient frac sand mines and processing plants in the industry. And we're ready to take market share with our last mile offering with the SmartPath transloaders. As always, we'll be keeping our eye on the future and our employee and shareholder interests will continue to be in mind in everything we do.

And with that, I'll turn the call over to our CFO, Lee Beckelman.

Lee E. Beckelman -- Chief Financial Officer

Thanks, Chuck.

2020 was a challenging year for the oilfield service industry. We witnessed a sharp sequential decline in our volumes from the first quarter to the second quarter and swiftly moved to cut capex and operating costs to manage through the downturn in the market. While these moves were painful at the time, they provided us flexibility to take advantage of opportunities as the market began to recover. Volumes continue to improve from the second quarter lows increasing by 98% in the fourth quarter from the third quarter.

We continue to be excited about the opportunities that come along with our acquisition of the Eagle Materials proppant business, which began operations at the Utica plant during the fourth quarter. We continue to believe there will be additional opportunities for consolidation in our industry and we are interested in playing a part in this consolidation. However, as we demonstrated with the Eagle acquisition, we are committed to low leverage levels, a prudent capital structure, generating positive free cash flow and maintaining adequate liquidity levels. We will not risk our balance sheet to pursue growth opportunities. Any acquisition we may consider will need to provide us with strategic long-term assets at a reasonable valuation that will not risk our strong balance sheet and liquidity.

Now, we will go through some of the highlights of the fourth quarter compared to our third quarter 2020 results. Starting with sales volumes. We sold approximately 612,000 tons in the fourth quarter, a 98% increase over third quarter volumes of 309,000 tons. We expanded our customer base during the fourth quarter and believe a more diverse customer base will strengthen our opportunities for growth in 2021. Total revenues for the fourth quarter 2020 were $25.3 million, compared to $23.4 million in the third quarter. Sand revenues were higher in the fourth quarter, primarily due to higher sand sales, which were offset by lower shortfall and logistics revenues.

Our cost of sales for the quarter were $33 million, compared to $18.2 million last quarter. The increase in cost of sales is primarily attributable to higher freight expense, negative impact from inventory adjustment as inventory was depleted from our winter stockpile and start-up cost at the Utica plant. Total operating expenses were $13.3 million, compared to $6.4 million last quarter. The increase in operating expenses was primarily due to a $5.1 million impairment charge on our Permian basin long-lived assets and a $1.3 million one-time sales tax audit settlement expense. Income tax benefit for the fourth quarter was $18.6 million.

During the quarter we evaluated our depletion deduction and determined we were eligible for a more advantageous deduction. This change will result in approximately $8.2 million of cash benefit from prior return amendments as well as a decreased effective rate on a go-forward basis. Due to IRS processing delays, as a result of COVID, we are unable to predict the timing as to when we will receive these funds. Without the impacts of the non-taxable gain on bargain purchase, depletion deduction and other NOL carry-back benefits allowed by the CARES Act, our 2020 effective tax rate would have been approximately 21%, which is on the higher end of our normal range. Going forward, we expect our annual effective tax rate to be in the mid to upper-teens.

In the fourth quarter, we had a loss of $2.9 million, which includes an impairment charge of $5.1 million on our Permian basin long-lived assets, a $1.3 million sales tax audit settlement charge and an income tax benefit of $18.6 million. For the fourth quarter 2020, contribution margin was a loss of $5.2 million and adjusted EBITDA was a loss of $7.7 million, compared to the third quarter contribution margin of $10.4 million and adjusted EBITDA of $6.1 million. The decrease sequentially was driven by lower shortfall revenues and higher freight expense, a negative impact from inventory adjustment as inventory was depleted from our winter stockpile and start-up costs at the Utica plant.

For the full year 2020, we sold approximately 1.9 million tons of sand compared to 2.5 million tons in 2019. Contribution margin in 2020 was $39.1 million and adjusted EBITDA was $20.5 million, compared to 2019 contribution margin of $106.5 million and adjusted EBITDA of $87.1 million. Net income in 2020 was $37.9 million, compared to $31.6 million in 2019. Contribution margin and adjusted EBITDA decreased year-over-year, due primarily to lower sales volume and lower shortfall revenues.

For the fourth quarter of 2020 we had $2.1 million in free cash flow, generating $3.3 million in operating cash flows or spending $1.2 million on capital investments. For the full year 2020, we generated $16.9 million in free cash flow, from $25.5 million in operating cash flows, less $8.6 million spent on capital investments. Capital investments in the quarter and for the full year 2020 have primarily been on new SmartSystems units.

During the quarter, we didn't use our revolver and still have no outstanding borrowings other than $1.3 million in letters of credit. Our current unused availability on our revolver is $14 million. Additionally, we have $5 million in unused availability from the Acquisition Liquidity Support Facility we put in place with the Eagle proppants business acquisition. We ended the year with approximately $11.7 million in cash. Our current cash balance is approximately $12 million. Between cash and availability on our facilities, we currently have approximately $31 million in available liquidity. We do not expect to have any borrowings on our ABL revolver in the first quarter.

In terms of guidance for the first quarter, we expect sales volumes to be flat to up 10% from fourth quarter levels. We currently anticipate capital expenditures for 2021 to be in the $10 million to $15 million range and ccurrently expect free cash flow for the year to exceed $10 million.

This concludes our prepared comments and we will now open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] First question comes from John Daniel with Daniel Energy Partners.

John Daniel -- Analyst

Hey, guys. Good morning. Thank you for letting me ask a question.

Charles E. Young -- Chief Executive Officer

Good morning, John.

Lee E. Beckelman -- Chief Financial Officer

Good morning, John.

William John Young -- Chief Operating Officer

Good morning, John.

John Daniel -- Analyst

My question relates to -- you guys made a lot of comments about the need for acquisitions, consolidation, etc., and obviously, we all know you can't get specific. But can you just elaborate a little bit more about other party's interests and willingness to talk and just how active discussions might be on that front today versus 12 months to 24 months ago? And just what's -- and whether you don't -- whether you guys play in the process or not, just your thoughts about the likelihood of a broader consolidation unfolding this year in the sand business?

Charles E. Young -- Chief Executive Officer

So, I'll start with that and Lee you can chime in. But our main thing is whatever we do we have to keep our balance sheet similar to the way it is today. So, we're not going to [Indecipherable] to do it. So again, that makes the amount of people out there that we can consolidate with that makes it more difficult. Lee, I don't know if you need to touch base a little bit on what we're seeing.

Lee E. Beckelman -- Chief Financial Officer

Yeah. I think as we've highlighted, John, on this call and in previous calls, we're open to consolidation and we're not going to let -- risk our balance sheet and we're not going to consolidate just to consolidate, it has to have a purpose. And that purpose is really driven like Eagle. I think Eagle's a great example. You can look at it and the benefits that we believed we were going to receive from Eagle and we think -- we believe they're going to play out and be true and that is really getting the opportunity to expand ourselves through new customers and new operating basins, really improving our logistics capabilities and Eagle we had the -- it gives us access to additional new Class I railroad and also looking through consolidation to be able to potentially rationalize and improve our operational efficiencies and cost. And so, I think we're open to any and we're open to larger transactions, as well as bolt-ons like Eagle, but they have to fit those goals and they have to fit within the framework that we're not going to go out and risk our balance to do it.

So -- and in terms of your question about, I think, there is a general level of dialogue. But I think a lot of our peers have gone through restructurings and I think they're just coming out with their new managements and understanding their business. So, I think we need a little time for those businesses to kind of figure out where they want to be and who they believe makes sense to partner with. And for us to then have, I think, more fruitful dialogues. So I think over the next six months to 12 months, there's an opportunity to have these dialogues. But I think our objectives and from the people on the other side, I think, they have to be realistic about what they believe the value of their assets are.

Charles E. Young -- Chief Executive Officer

And John, one other thing I would add on that. We picked up assets last year in the pandemic and we have more assets than we ever had at the same time we paid down debt. So, that's kind of the way we're looking at this business. It's not a business you want to have a lot of debt in because the cycles are so fast.

John Daniel -- Analyst

No. No. I get all that and appreciate it. And by the way, the volumes in Q4 were great. I just was -- I'm trying to get a sense for -- are people willing to do the dance, if you will, or is everyone just kind of waiting to see. That's all. Just trying to get a sense for the -- how many interested parties are out there?

Charles E. Young -- Chief Executive Officer

[Speech Overlap] let me -- I think there's parties interested, but a lot of times they come with a lot of debt that's out there, especially in the private companies and the private equity that's involved and they want to bring the debt to the table instead of it being equity. So I think once they realize that no one's crazy about paying out cash and taking on debt and they got to build the business together with people. I think, then you'll see more activity.

John Daniel -- Analyst

Okay. Okay. I appreciate you giving me a chance to ask a question. Thank you.

Operator

Our next question comes from Lucas Pipes with B Riley Securities.

Lucas Pipes -- B. Riley Securities -- Analyst

Hey. Good morning, everyone. I will start [Phonetic] on the M&A landscape out there and specifically kind of what -- if you have a preference in regards to geography? Is it -- you want to kind of stay close to your current operating platform or would you be willing to try out a little bit further? Thank you.

William John Young -- Chief Operating Officer

So, Lucas, you broke up a little bit. I think your question was about M&A activity and whether we want to stay close to kind of our focus on Northern White. Was that the question?

Lucas Pipes -- B. Riley Securities -- Analyst

That's correct. Yes.

William John Young -- Chief Operating Officer

Yeah. Okay. So, yeah, our view on this is pretty simple. I mean, I think, everybody, who's followed Smart Sand for any length of time knows that we are biased toward Northern White. We're long-term believers in Northern White. So as we kind of continue that focus, we want to bolt-on potentially assets that are complimentary to what we have. However having said that, it doesn't mean that if there's other opportunities that are -- would be acquisition or merger opportunities that come with regional sand plays or different types of quote unquote Northern White plays, that we wouldn't be open to those.

What we're interested in is companies that would fit with our overall goal, which is to grow without acquiring -- incurring lots of new debt and things that are complimentary to what we have. In addition, some of those opportunities may involve assets that would be idled to produce if there is ever any oversupply, things like that. So, if we look at a number of things, but ultimately, we are focused on keeping our balance sheet clean and when we think about deals, that's kind of the overarching principle that we look at these things for.

Charles E. Young -- Chief Executive Officer

And not only in sand, but logistics as well.

Lucas Pipes -- B. Riley Securities -- Analyst

Very helpful. Very helpful. And on the balance sheet, I want to confirm. I think you said in your prepared remarks that you wouldn't have any borrowings outstanding against your ABL at the end of Q1, could you confirm that? And then as it relates to ABL and that liquidity, would you be able to remind us kind of what sort of fixed charge coverage ratios that might be EBITDA covenants and whether you expect to be in compliance with all of those at the end of Q1, Q2? Thank you.

Charles E. Young -- Chief Executive Officer

We'll direct that to Lee.

Lee E. Beckelman -- Chief Financial Officer

Yeah. Currently we expect no borrowings. We do have some LCEs under the facility about $1.3 million and there might be some additional fees, but there will be no borrowings out of the facility in the first quarter or we don't expect to have any. In terms of our covenants, currently we're an ABL. So we're governed by our borrowing base against receivables and inventory. And as long as we keep our borrowing levels below a certain level, which is around 85% of the stated borrowing base in a given period, we don't have any covenants that we have to basically comply to on a quarterly basis.

But if we were to move into a borrowing level, which we don't expect to anytime soon at that 85% level, the only covenant we would have would be a fixed charge coverage and it's at a one-to-one coverage and it'd be something that we'd be able to very easily manage. So, we don't have any concerns or issues in terms of adequate liquidity, access to the borrowing base. Again, we expect to have no borrowings in the first quarter and we don't have any covenants that any way causes any issues.

Lucas Pipes -- B. Riley Securities -- Analyst

That's very helpful. And I believe you said you wouldn't consider using debt for acquisition. Would that include the ABL as well or would you consider borrowing on the ABL for an acquisition, for example?

Lee E. Beckelman -- Chief Financial Officer

No. What we said is we want to keep low leverage levels. So I will never say absolutely that we will never take on some debt. But we want to keep those levels very low and manageable. And if we were to use an ABL, it would only be for a temporary basis, if at all. But our goal would be not to have any debt or very little debt. And our goal would be to maintain the ABL to maximize liquidity to support the ongoing operations.

I think you can look at our Eagle acquisition as a good example. As part of that negotiation, we negotiated a separate $5 million facility to provide liquidity for the Eagle acquisition to make sure we protected our ABL and kept that liquidity fully available for the existing operation. So any acquisition we do, we want to make sure that we don't risk the long-term strength of the balance sheet, but also that we ensure that we have more than adequate liquidity to support the existing business, as well as any acquisition and new assets we take on.

Lucas Pipes -- B. Riley Securities -- Analyst

Very helpful. I appreciate all the color and best of luck.

Lee E. Beckelman -- Chief Financial Officer

Thank you.

Operator

[Operator Instructions] Our next question comes from Stephen Gengaro with Stifel.

Stephen Gengaro -- Stifel -- Analyst

Thanks. Good morning, everybody.

Charles E. Young -- Chief Executive Officer

Good morning, Steve.

Stephen Gengaro -- Stifel -- Analyst

A couple of things if you don't mind and where I would like to start with -- on the fourth quarter and sort of the cost of sales and contribution margin itself. I understand the moving pieces. Can you give us a little more color on, A, sort of a seasonality of the costs and just sort of refresh our memory of the key drivers of that. And then second, is there any way to break down the different pieces, the start-up cost to freight and inventory adjustments as far as the impact in the quarter?

Lee E. Beckelman -- Chief Financial Officer

Yeah. This is Lee. I'll take that question, Stephen. And I don't think I am going to give you as probably as many specifics as you'd like. But I think there was a lot of -- going back, first of all to seasonality, if you go back, and historically, you can see this consistently in our numbers. The fourth quarter and the first quarter is always our lowest or typically our lowest contribution margin and EBITDA because we do consistently have larger inventory costs that we bring in into our reported costs in those quarters as we pull down inventory during the winter months to support our sales activity.

And so, that can have a pretty big swing in terms of our reported contribution margin and EBITDA numbers quarter-to-quarter. I think you consistently see that in the fourth quarter and the first quarter where we are substantially below what we can report in the second quarter and third quarter when we're running our operations and either consistently using our -- the mining tons that we mine and/or actually capitalizing costs as we build up our inventory for the winter stockpile for the next year and that swing on a $1 per ton basis can affect our contribution margin from anywhere to $3 to $5 a ton. And so, to give you some context, that can be kind of a swing quarter-to-quarter just from that inventory adjustment affecting our numbers as we pull inventory down during the winter months and we either add inventory or just kind of run with the mining that we have during the summer months. So, does that help in that regard?

Stephen Gengaro -- Stifel -- Analyst

Yeah. No. That helps a lot.

Lee E. Beckelman -- Chief Financial Officer

And then freight expense. I think, freight expense did pick up, but that was primarily driven by the volume. So, I think we did have a pickup in freight expense in the fourth quarter. And so, we had a pretty low freight expense in the third quarter. But I think what you'll see is that, if we stayed these consistent levels, that's going to be relatively consistent going into the -- in 2021. So I wouldn't expect a big variation from there going forward, because that's much more volume driven.

And then in terms of Utica, basically, we bought Utica in mid-September and really September and October was start up. And then we really didn't start really getting sales from that and generating some cash flow to really mid-to-late November. And order magnitude, we probably had about $1 million of incremental cost from Utica start-up and ramping up in the fourth quarter that I think going into the first quarter, we'll be able to absorb that cost as we start getting consistent sales out of that mine.

Stephen Gengaro -- Stifel -- Analyst

Great. No. That's great detail. Thank you. Just two other quick ones. One, a follow-up and that is, does the Utica facility dilute the seasonality impact at all?

Lee E. Beckelman -- Chief Financial Officer

Well, it's really too early to tell on that, Stephen, but I think it ultimately. I think one of the challenges for us versus some of our other peers in the past is they had a lot more mines and they also had industrial sand. And so, the impact of the seasonality I think gets more muted and we've always just had mainly the one Oakdale facility. So it kind of fully flows through. And you see it more prominently in our numbers and maybe some of our peers in the past.

I think Utica will help with that, because they have -- their operations are indoors like part of our facilities and so there's less a building of a winter stockpile. So I think, over time, if we ramped the Utica up to levels that we hope to, that may help impact that overall number. But I think it's a little too early to see how that's going to play out until we get through a really a full -- we need a full year of operating cycle to see how that plays out into these reported numbers.

Stephen Gengaro -- Stifel -- Analyst

Thank you. And then just a final question, you mentioned, I think, in the 10-K, about the -- just kind of about expectations for 2021. And I think you basically said volumes flat up a bit year-over-year. What are you seeing, if anything, right now on the pricing side and sort of the impact to some of the competition going by the way side or going into bankruptcy? Has there been any changes you have on the pricing side and do you expect anything as we move forward here in '21?

William John Young -- Chief Operating Officer

Yeah. So, Stephen, I mean, the volumes obviously are improving. We expect price to follow. But as of now, there's no material increase just yet on it. Yeah, although, that we do believe that as activity continues to increase pricing increases will likely come.

Stephen Gengaro -- Stifel -- Analyst

Okay. Great. Thank you, gentlemen.

Operator

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host for any closing remarks.

Charles E. Young -- Chief Executive Officer

Thanks, everyone, for joining us on our quarterly call. We'll see you for the first quarter call soon.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Josh Jayne -- Director of Finance, Assistant Treasurer

Charles E. Young -- Chief Executive Officer

Lee E. Beckelman -- Chief Financial Officer

John Daniel -- Analyst

William John Young -- Chief Operating Officer

Lucas Pipes -- B. Riley Securities -- Analyst

Stephen Gengaro -- Stifel -- Analyst

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