Smart Sand, Inc. — FY 2018 Form 10-K
Reporting period: Year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter report. Smart Sand supplies Northern White frac sand and related logistics services to the oil and gas industry.
Key financial results
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Revenue | $212.5 million | $137.2 million | +55% |
| Gross profit | $67.6 million | $36.9 million | +83% |
| Operating income | $25.9 million | $18.7 million | +38% |
| Net income | $18.7 million | $21.5 million | -13% |
| Diluted earnings per share | $0.46 | $0.53 | Down |
| Adjusted EBITDA | $66.0 million | $30.6 million | +116% |
| Cash from operations | $50.9 million | $15.6 million | Increased |
| Cash used in investing | $126.0 million | $51.1 million | Increased |
Gross margin was approximately 31.8% of revenue, compared with 26.9% in 2017; operating margin was approximately 12.2%, versus 13.6%. Net margin was approximately 8.8%, versus 15.7%. Adjusted EBITDA and contribution margin are non-GAAP measures; the company cautions that they should not be viewed as substitutes for GAAP results.
Sand volumes sold rose 22% to approximately 3.0 million tons. Reported average revenue per ton, including transportation and other revenue, was $70.94 versus $56.03. Contribution margin was $83.9 million, or $28.00 per ton, compared with $44.2 million, or $18.05 per ton.
Business developments and comparison with prior period
- Oakdale’s annual nameplate processing capacity increased from 3.3 million to 5.5 million tons in 2018. The company reported 317 million tons of proven recoverable reserves at Oakdale and 100 million tons at its permitted but undeveloped Hixton site.
- Smart Sand paid approximately $15.5 million for assets and operating rights at the Van Hook, North Dakota transload terminal, which began operations in April 2018. It acquired Quickthree, a portable wellsite proppant storage systems business, for approximately $30.0 million cash plus potential earn-outs of up to $12.8 million.
- Higher sales volumes, increased in-basin deliveries and favorable first-half pricing drove revenue and gross-profit growth. Freight costs rose to $84.4 million from $59.7 million, and cost of goods sold per ton increased to $48.38 from $40.96.
- Net income declined despite stronger operating results, primarily because of a $17.8 million fourth-quarter impairment of Quickthree-related goodwill and an indefinite-lived trade name. The impairment followed a stock-price decline and the resulting relationship between market capitalization and book equity. The company also recorded a $1.9 million reduction in estimated acquisition earn-out consideration, offsetting operating expenses.
- Fourth-quarter revenue was $52.2 million and the company recorded a net loss of $4.4 million, including the impairment charge. By comparison, fourth-quarter 2017 revenue was $43.0 million and net income was $10.9 million.
Cash, debt, liquidity and capital plans
At December 31, 2018, cash was $1.5 million, working capital was $25.4 million, and total current assets and current liabilities were $50.1 million and $24.7 million, respectively. Cash declined from $34.7 million at year-end 2017. The company reported $44.3 million drawn on its revolving credit facility, $15.5 million of undrawn availability, and $48.7 million of total debt including notes and capital leases. It was in compliance with its credit covenants at year-end.
In February 2019, after the reporting date, the credit facility maturity was extended to June 30, 2020, while total capacity is to decrease to $50 million by December 31, 2019. The company estimated 2019 capital expenditures of $30 million to $40 million, excluding acquisitions, and said it expected available liquidity to cover cash needs for the next twelve months. It also had access to up to $14.2 million under equipment-financing arrangements for wellsite storage manufacturing.
Operating cash flow improved to $50.9 million, while investing cash outflow largely reflected Oakdale expansion spending and the Van Hook and Quickthree acquisitions. Financing cash flow was $41.3 million, primarily reflecting net credit-facility borrowings. The company repurchased 588,200 shares for approximately $2.0 million during 2018.
Outlook, commentary and principal risks
- Management described a weaker market in the second half of 2018: Northern White demand and spot sales softened amid Permian takeaway constraints, regional sand supply growth and lower oil prices. Some long-term contract prices were temporarily adjusted, generally in exchange for extensions. Contracted volumes fell in the fourth quarter, contributing to shortfall revenue.
- Approximately 58% of current annual nameplate capacity was under contract at December 31, 2018, with a volume-weighted average remaining term of about two years. Four customers represented 66.4% of 2018 revenue; Liberty and EQT alone represented 22.8% and 21.4%. Concentration creates counterparty and renewal risks.
- The company cited industry forecasts from Spears—not company guidance—of North American proppant demand rising from 98 million tons in 2018 to 101 million in 2019 and 120 million in 2020. Management noted that industry capacity exceeded demand in 2018, pressuring prices, and that regional sand could continue to displace Northern White in some basins.
- Two customer contract disputes were pending: suits against U.S. Well Services and Schlumberger Technology Corporation sought unspecified damages and declaratory relief; both defendants filed counterclaims. The company could not assess likely outcomes. $11.4 million of accounts and unbilled receivables related to customers with pending litigation. Recorded receivables do not represent the full amounts sought.
- Other material exposures include dependence on Oakdale for current sales, reliance on rail transportation, commodity-driven customer activity, price competition, customer credit, permitting and environmental requirements, silica health and safety rules, weather and seasonality, and the ability to fund expansion and service debt. The company reported $13.3 million of asset-retirement obligations and $8.6 million of outstanding performance bonds.
- The company adopted ASC 606 in 2018 with no opening retained-earnings adjustment. It expected adoption of the lease standard in 2019 to add approximately $36 million of right-of-use assets and related liabilities. Management concluded that no conditions raised substantial doubt about the company’s ability to continue as a going concern.
Important facts for investors to verify
- Track collections and legal developments in the U.S. Well Services and Schlumberger disputes, including recoverability of the related receivables and any counterclaims.
- Confirm performance of the eight take-or-pay contracts, customer concentration, contract extensions and pricing concessions, and the amount and timing of future shortfall payments.
- Assess 2019 utilization, realized pricing and margins against regional sand supply, transport constraints and the company’s stated $30–$40 million capital-spending estimate.
- Monitor liquidity and covenant headroom as facility capacity steps down, maturity approaches, and debt-funded expansion and equipment obligations continue.
- Evaluate whether Quickthree’s storage systems and Van Hook operations generate sufficient demand and returns, particularly after the impairment and changes in estimated earn-out value.
- Note that the financial statements received an unqualified independent audit opinion, but the auditor was not required to—and did not—express an opinion on internal control effectiveness. Management stated that disclosure controls and internal control over financial reporting were effective.