Phil Cerniglia - IR Charles Young - CEO and Director Lee Beckelman - CFO William Young - EVP of Sales and Logistics.

George O'Leary - Tudor, Pickering, Holt & Co. Martin Malloy - Johnson Rice & Company Bradley Handler - Jefferies LLC John Watson - Simmons & Company Akil Marsh - Janney Montgomery Scott.

Good day, ladies and gentlemen, and welcome to Q2 2017 Smart Sand Inc. Earnings Conference Call. [Operator Instructions]. Also, as a reminder, this conference call is being recorded. I'll now like to turn the call over to your host to Phil Cerniglia, Investor Relations Manager. You may begin..

Good morning, and thank you for joining us for Smart Sand's Second Quarter 2017 Earnings Call. On the call today, we will 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 new information, future events or otherwise.

This conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 10, 2017. Additionally, we may refer to the non-GAAP financial measures of adjusted EBITDA and production costs during this call.

These measures when using 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 in production cost 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 the Smart Sand continued to provide positive financial results during the second quarter despite a slight sequential decrease in sales volume. Lee will give you more details on the results during his prepared remarks. But first, I want to touch on some of the highlights.

Compared to the first quarter, we posted higher revenues, net income and adjusted EBITDA. Our average selling price increased to approximately $32 a ton, while our production cost decreased to up $13. Both are improvements over first quarter results. We amended our Liberty contract during the second quarter to add contracted volumes.

Once we assign additional railcars to this contract, our current annual capacity will be 74% contracted, with long-term take-or-pay contracts that have a weighted average term of just under 3 years. However, our second quarter results were not where we wanted them to be.

We had some unplanned downtime at our Oakdale facility due to dust control and other operational issues, and we experienced some operational efficiencies related to railcar availability and the completion of the third rail loop at Oakdale.

The downtime, coupled with rail inefficiencies limited our ability to capture incremental sales volume during the quarter. The result was lower sequential sales volume. But let me be clear about one thing, the decrease in sales volume was not due to lower demand for Northern White frac sand.

To the contrary, we continue to see strong demand from our contracted customers, the increased interest its spot sales, and good dialogue with potential new customers about long-term take-or-pay contracts. We've also started to find increased interest in customers and basins outside the Permian, including the Bakken and the Marcellus.

Our respond to plant problems that led to the unplanned downtime has been swift. We believe we are implementing the necessary planned improvements to minimize future disruptions. Our third rail loop is essentially complete, and we now have the ability to store additional railcars at our Oakdale location.

That should give us greater flexibility to support spot sales and/or increase contracted customer demand going forward. We're also expanding our rail fleet, adding 750 new rail bars over the next 6 to 9 months. When all are delivered, our fleet will total 2,300 railcars.

These additional railcars will bring two great benefits, we'll be able to support incremental spot sales now; and we'll have more capacity to line up with new contracted volumes as we continue to pursue new long-term contracts.

Now I'd like to spend some time commenting on Northern White frac sand position in the marketplace and the influx of West Texas sand mines. First, we believe there's value and controlling and managing all stages of the supply chain to efficiently deliver frac sand all the way to the wellhead.

That's why we're actively looking to acquire or get committed access of logistical assets both in the Permian and other basins, such as the Marcellus and the Bakken. We anticipate making some investments in such logistical assets by the end of the year. As we said on our last call, we continue to evaluate mining opportunities in West Texas.

But this is not a defensive move. The investment in Texas mine will allow us to diversify our asset base by having a second operating facility, and we'll be able to offer different quality products through our customers, which some customers do prefer. Meanwhile, we still see strong interest for Northern White frac sand in all our operating basins.

The market continues to move to higher usage of finer mesh sands. Smart Sand currently has approximately 332 million tons of proven reserves at our Oakdale location, and this reserve base is 80% fine mesh grades. Many of our competitors didn't have these levels of finer mesh sand in their current reserve basis.

So they need it to add new fine mesh reserves. We believe this is one of the key drivers for many of them looking to add regional sand mine capacity.

But we believe Texas mine opportunities won't come without its obstacles, including the following, access to wire, roads, electricity, trucking and labor and potential serious environmental issues and questions relating to the doomed Sagebrush Lizard and its habitat.

This is why we feel the capacity announcements and resulting investor sentiment has been overdone. We don't believe it's possible for all those capacity to come online at the levels nor in the timeframe currently being anticipated by the market. Our estimate is at 15 million to 20 million tons will come online over the next 12 to 18 months.

That would not meet the demand in the Permian basin as currently foreseen. As we evaluate these opportunities, we remain selective. We'll only move forward on things that we believe will benefit our customers, while providing both incremental margins and long-term shareholder value.

I'll now turn the call over to our CFO, Lee Beckelman, for a closer look at the company's second quarter results..

Thanks, Chuck. As Chuck highlighted, we had a solid second quarter financial results with revenues, net income and adjusted EBITDA all improving our first quarter results. My comments will be focused on comparing the second quarter 2017 results with the first quarter 2017 results. I'll start with sales volume.

Sales volumes are approximately 531,000 tons in the second quarter, a 5% decrease compared to first quarter 2017 volumes.

As Chuck -- as discussed by Chuck, our sales volume in the quarter were negatively impacted by unplanned downtime at Oakdale and operational inefficiencies specifically related to the availability of railcars and the completion of the third rail loop at Oakdale. These issues limited our ability to capture incremental sales volumes during the quarter.

Our sales mix in the second quarter was consistent with first quarter results with approximately 82% of our sales being with contracted customers and approximately 18% in spot sales. Due to the operational issues discussed previously, our average utilization in the second quarter was approximately 64%, which is lower than anticipated.

So the unplanned downtime projects continued into the third quarter so this will have some impact on our expected utilization going forward. We expect -- currently expect utilization to be in the 75% to 80% range in the third quarter.

In the second quarter 2017, approximately 82% of our sales volumes were shipped via unit train, compared to approximately 79% in the first quarter. In regards to revenue. Total revenue for the second quarter were -- was $29.8 million, a 19% increase over first quarter results.

While sales volumes declined in the quarter, sand sales revenue increased approximately $16.9 million from $16.7 million last quarter due primarily to a higher average sales price, which improved to approximately $31.74 per ton, a 6% increase over first quarter average selling price.

The average sales price per ton improvement sequentially was driven primarily by the sales mix in the quarter, with slightly higher 40/70 sales as a percentage of total volumes. Reservation revenue, which is also included as part of our sand sales revenue, was $7.5 million in the quarter, equal the first quarter results.

Transportation revenue, which includes freight and railcar rental, was $12.9 million in the quarter compared to $8.3 million last quarter due to higher shipments on the contract, in which we passed through freight expenses to our customers. For our cost of sales in the quarter, they were $24.1 million compared to $19.7 million last quarter.

The increase was primarily due to higher freight expense, railcar expense and maintenance related to the unplanned maintenance expenses during the quarter. These amounts -- these increases were offset by lower production expenses in the quarter.

While we had increased expenses as we ramped up mining operations and the quarter related to labor excavation and utilities, these increases were offset by lower inventory carrying cost. The lower production costs led to our production cost per ton for the quarter decreasing to $13.17 per ton compared to $15.84 per ton in the first quarter.

Gross profit was $8.4 million in the quarter, a 55% increase over first quarter gross profit. The increase in gross profit was primarily due to the lower production cost in the quarter.

Operating expense in the quarter were $4.6 million, an increase of approximately $731,000 from the first quarter, primarily due to increased wages and benefits due to some increased staffing, increased long-term compensation expense due to restrictive stock grants that were awarded in March and higher overall SG&A expenses primarily due to higher regulatory cost and some write-off of equipment.

For the quarter, we have income tax expense of $1.2 million. Our effective tax rate for the quarter was approximately 31%, and we anticipate our effective tax rate to be in the 35% to 40% range going forward. We had net income of approximately $2.6 million and adjusted EBITDA of $6.5 million in the second quarter.

Both net income and adjusted EBITDA increased sequentially due primarily to lower production cost in the quarter. Year-to-date through June 30, 2017, we have spent approximately $7.7 million in capital expenditures, primarily related to our expansion projects for 2017, along with some operational efficiency and replacement projects.

We continue to move forward on our expansion project in Wisconsin, our currently off schedule to bring online in late 2017, early 2018 a second wet plant and 2 dry plants to increase our nameplate processing capacity to 5.5 million tons per year.

We have essentially completed the third rail loop at Oakdale in July, and we have broken ground on the expansion of our Byron logistics facility. Due to heavy rain in Wisconsin in June and July, construction at Byron has been slower than anticipated and it will like -- likely not come online until late third quarter or early fourth quarter.

Our capital expenditure budget for 2017 is still approximately $85 million. As of June 30, we had approximately $64 million of cash in the balance sheet.

Our credit facility, $45 million was fully available and undrawn and available as needed as the source of liquidity, and we continue to maintain a clean balance sheet with essentially no outstanding debt and ample liquidity to support operations and planning growth initiatives. This concludes our prepared remarks.

And operator, we're now ready to open up the line for questions..

[Operator Instructions]. Our first question comes from George O'Leary of TPH & Company..

First question was really just -- you guys mentioning that you'd be at 75% to 80% utilization in the third quarter.

As thinking about that kind of average nameplate capacity for the third quarter with the puts and takes, both the mine expansion, the Byron rail loop coming online, what would you guys anticipate average nameplate capacity is for the third quarter?.

Our nameplate capacity is still 3.3 million tons on an annual basis, so I think that calculates into 825,000 tons per quarter.

And so that's still kind of -- until we bring the fourth and fifth drier online, which won't come on until -- the earliest will be December, more likely in January, early February of '18, that's when we would expand up to 5.5 million.

But it is the small rail loop and Byron coming on allows us to be able to get -- to push our utilization up to get closer to getting higher utilization related to that 3.3 million..

Great, that's super helpful color. Just trying to make sure I wasn't using the wrong numerator there when doing calculation to going forward. And then, I think I had some issues on the quarter. And you guys addressed a number of those in terms of getting more railcars.

I guess, is there any residual impact from those issues that flowed through into the beginning of the third quarter? Or would you guys say right now, you're already backup at that 3.3 million tons of capacity that you could actually ship this quarter?.

So we -- over the last 2, 3 months, we've really done a lot of improvements on the plant -- plants and we're still continuing to do those. And then additionally, we've added this third rail loop in Oakdale, which is helping us to move the flow of sand better. So we anticipate that you'll see some recovery this quarter in volumes..

And then, maybe if I could, just a little bit of color from you given that the 2 products you sell are 100 mesh and 40/70 are the 2 primary products anyway.

Just color on the pricing delta as it sits today for spot volumes? And what you see for the third quarter on pricing of both of those products?.

Yes. So it's John here, I'll take that question. So right now, we still continue to see a relatively strong pricing for 40/70 or well into the 40s on 40/70. The order grade to sand 100 mesh is still in the 30s, along with the 30/50. Not a huge amount of sand for 20/40. For us, we don't make a lot of 20/40 anyways.

So basically, 30s and into 40s for -- in the mid-40s for 40/70..

Our next question comes from Martin Malloy of Johnson Rice..

Could you talk maybe a little bit more about the cadence for how you expect those production cost to trend over the next couple of quarters here as you ramp up to 5.5 million capacity?.

Yes. I think as we've talked about before, our goal is to -- we believe we should be able to get our production cost down to the $12 per ton level or better. If we get to our utilization above 75% consistently. And so I would expect that our utilization and our sales volumes continue and improve over the next couple of quarters.

And as we ramp up with the new capacity that you'll start seeing us kind of get to that $12 per ton essentially about the fourth quarter or in the first quarter of next year..

Okay. And then, just in terms of thinking about the basins and where you're sending the sand to, I think previously, it was kind of 40% to 45% Marcellus, something similar for the Permian, and then other basins making up the remainder.

Any update there in terms of how you're seeing that trend?.

Yes, year-to-date, overall, we're actually -- we're in the low 40% of our volumes are going into the Marcellus. And then high 30% is going into the Permian today, and then the rest, the delta, 10% to 15% is being split fairly evenly between the Bakken, and the Eagle Ford in the Mid-Con..

Okay, and then if I could just sneak in another question here. Just on the rail rates.

As you see the original sands come online, will that give you any -- the leverage with the rail roads to attract some good rates?.

Well, we definitely are hoping that the railroads react to some of the expansion down into certain basins. There are risks of losing their volumes on that. And we can point to other industries, where the movements bulk materials like this are lower cost per ton.

And we're hoping that the railroads partner up with the Northern Sand Mines to react to that..

Our next question comes from John Watson of Simmons & Co..

I appreciate the update on your contracted volumes.

And I was wondering if we could also get an update on negotiations for volumes at the expansion of Oakdale? Are any of those volumes for next year contracted as of today?.

There are no -- we don't have any volumes contracted as of today, but as we've mentioned on previous calls, we have pretty good line of sight from newly--- from new potential customer and existing contracted customers with that expansion to above 75% utilization. And we would look to have that kind of early mid-2018..

Okay, great.

And I apologize if I missed this, but could you give us the percentage of volumes that were contracted during Q2 of your volumes sold?.

Q2, our volumes is around 82% contracted volumes, 18%-spot..

Perfect. And then, maybe one more if I could.

Following up on Marty's question, could you talk us through may be some of the barriers to entry for your competitors that currently saw the other basins to start competing with you in the Marcellus, is that's such an important basin for you guys?.

Yes. So I think there's a number of barriers or entries that are the same as what they were before primarily as you see the shift to finer gradation sands throughout the either the oil tax or the gassy place.

And really what it comes down to is that, traditionally, the Marcellus has been served out of kind of the Wisconsin-Illinois and Minnesota mines and a lot of those mines tend to be grow through the course in nature.

And -- so that hasn't changed, but the primary product of interest in the Marcellus tends to be the finer sand limits, 40/70 or 100 mesh. So you don't have the reserve base to satisfy that requirement. You may have a bit of an issue competing there.

But then there's also some logistical challenges into the Marcellus, the wells there getting bigger as everywhere else is. And should begin on manifest in the small manifest yards becomes difficult.

Most of our volume into the Marcellus today is shipped by a unit train and there's a little bit of a crunch on the infrastructure out there with regard to being able to bring in those volumes sufficiently. So I'd say that, that's probably a pretty good dayrate in there also..

[Operator Instructions]. Our next question comes from Brad Handler of Jefferies..

A couple of different questions for me.

Did you satisfy all of your demand from your contract customers in Q2?.

Yes. Very much the [indiscernible]..

Okay. So they're shorter. You know why I'm -- I'm sorry, I'm cutting you off. Go ahead..

Yes, sorry. The answer to that is yes. We met all our contractual requirements in Q2..

Okay. All right, very good. And then, can you give us a little bit more color on your pursuit in West Texas. Let me think you've secured an option for land.

Maybe a little bit of a -- what happens now? What's your timeframe? Or if there's more than 1 location you're still looking at in West Texas?.

Okay. So like our peers, we're evaluating the Permian mine opportunities. We have 2 options in place. We're working on a few more.

In developing the mine site, we are forming boxes that needs to be checked, right? One's the geology, which is includes sand and water, the reserve base size, the logistics and utilities, and then this 1 box that we're having is difficult to tell -- difficulty and they're working in a little bit may be more readily than some of our competitors in the environmental and regulatory piece because of where this sand actually exists.

And to us, there's no skipping steps on that..

Okay, I appreciate that.

So -- and you have -- I guess the options have a window of time, but you have exclusive rights to secure that land while you figure this out, right?.

Sure. Sure, and we have a renewable period in those options as well, so that we can make sure that we get all the boxes checked..

Yes, the options give us all the right in the certain period of time to evaluate the property, to an evaluation of reserve base, and then to -- gives us also the time to check points to really look into these other key attributes that we want to make sure we're comfortable with before we make the financial commitment on a particular property..

And more particular than this, I think for us right now, a lot of it relates to this Sagebrush lizard that kind of brought the petroleum industry into a top place with efficient wildlife a number of years back.

And a lot of the stuff around preserving the habitat involved these [indiscernible], right? And we want to make sure that wherever we're in, it's not been mapped by the state, is a higher probability habitat area for the lizard. And I don't think that, that's what's been occurring in the industry, and I think it's a major issue.

And I think a lot of the petroleum producers are really starting to get a little nervous about the some of the activities that are occurring down there..

Understand. Yes, we also have a -- had that center that's ultimately that's what's going to drive the pressure coming from the producers themselves who would be worried about backlash so it makes sense, sure. Okay. All right, one more unrelated one if I may. And probably for Lee.

Lee, are there a couple of crosscurrents in the production cost outlook for even the third quarter or the second half of the year? In other words, you cited lower inventory carry costs as being a tailwind in 2Q.

Do you run out of that as you normalize, but then better utilization helps pull you down net, that's what's happening?.

Actually, lower carrying cost are some of the benefit in 2Q. As you -- we were pulling more. Right now we mine, overproduce our inventory in the nonwinter months. And then, we pull from inventory in the fourth and first quarter.

So depending on how that -- so you're capitalizing cost as it relates to inventory in the summer months, and then you're pulling out of inventory in the winter months and depending on the average cost you're using, that affects your quarterly average production cost.

So it's not a simple one-point answer, Brad, but those are the kind of the factors that play into it. So I would say, we'll get our utilization up. It should lead to us being able to spread that cost over more time and we can get our utilization to be consistent. That should allow that cost over time to be more consistent and in a tighter band.

And should go down over time..

Our next question comes from Akil Marsh of Janney..

In regards to CapEx in 2017, I think previously guided to $85 million in CapEx.

Is that still hold for your full year CapEx number?.

Yes, right now, that's we're -- now we spent about $7.7 million year-to-date but we're really ramping up a lot of our expenditures that relates to primarily to putting into second wet plan and the fourth and fifth drier so that was always heavily weighted to the second half of the year.

So you should see our CapEx number start to ramp up in the third and fourth quarter..

Okay. And in regards to free cash flow, obviously, with the expansion coming online early in 2018, it looks as if you'll be generating a fair amount of free cash flow in 2018.

So I was just hoping you can provide some thoughts on your ranking of priorities in terms of how to deploy that free cash flow in 2018?.

Well, free cash flow, we're going to love to see where we have opportunities to grow the business and how we can deploy that capital to grow the business, and I think that will be driven by opportunities to expand.

I think you'll have started to alluded to our logistical footprint in terms of terminal and potentially allow small opportunities to capture incremental margin on the selling of sand.

And then, as we look -- as we talked about, we do have options for land in the Permian that we would look to potentially move forward if we see the demand lining up at that.

And we still have the potential to increase at Oakdale and/or we have a site to fixed in, which is north in west of Oakdale that's primarily we believe a -- an opportunity to take advantage of the Canadian market at some point.

So I think we're looking at our free cash flow and evaluate where we think the best growth opportunities are and deploy in that direction..

Okay. And one final for me. The potential of Rice, EQT deal, obviously, Rice is a decent sized customer to you guys.

Do you have any thoughts, in general about that deal, and how, if at all, that would impact you?.

We don't expect that the impact at all -- the anticipation would be that the contract travels over to whatever the new entity is. And we continue to display, you could see but we're -- Rice certainly hasn't given off any indication nor EQT and that there's any issue there..

I show no further questions in the queue at this time. I would now like to turn the call over back to Chuck Young, CEO, for closing remarks..

Thank you, again to everyone for joining our earnings call today. We look forward for -- to the remainder of 2017..

Thank you. Ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day..