Ladies and gentlemen, thank you for standing by, and welcome to the Smart Sand’s Third Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to your speaker today, Josh Jayne, Finance Manager. Thank you. Please go ahead, sir..

Good morning and thank you for joining us for Smart Sand’s Third Quarter 2019 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, November 6, 2019. Additionally, we may refer to the non-GAAP financial measures of adjusted EBITDA and contribution margin during this call.

These measures, when used in combination with GAAP results, provide us and our investors with useful information to better understand our business. Please refer to our most recent press release or our public filings for our reconciliations of adjusted EBITDA to net income and contribution margin to gross profit.

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

Thanks, Josh. I’m happy to report that the third quarter produced both some good financial results and continued progress on our long-term plans and objectives. Smart Sand remains on the move. Let’s start with some numbers.

In spite of a protected industry slowdown, we posted sales volumes of 611,000 tons, adjusted EBITDA of $28.8 million and net income of $10.8 million. In addition, we generated $22.9 million in cash flows from operations. Lee will take you through the rest of the key numbers in his report. Now, let’s look long-term.

I’d like to start off by reiterating what we’ve said time and time again. We’re in the business for the long haul, and we’re always looking for customers that want to partner with us to create sustainable, efficient, long-term frac sand supply chains.

We’re committed to working with our customers to find mutually beneficial sand supply, logistics and last-mile services or any combination thereof, that will ensure both their long-term success and ours. This quarter saw several positive developments. For one, we settled our lawsuit with Schlumberger.

We were able to find mutually beneficial terms, terms that allowed us to continue our long-term relationship. We pride ourselves on our ability to maintain long-term relationships with our customers. And we’ve shown this once again with the new long-term agreement with Schlumberger.

In this quarter, we also executed contracts with 2 new SmartDepot customers. That brings us to 4 fleets currently in the field. We continue to see growing interest from both new and existing customers for our last-mile solutions. We’re able to deploy our silos and have them operating the field as quickly as our customers need.

In addition, we’ve been busy developing new transloading technology for use on the wellsite. We’ll have more to share on this in the future. Another third quarter highlight was paying down our debt by approximately $16 million, another demonstration of our commitment to maintaining a strong balance sheet.

As a fully integrated frac sand supply-and-services company, we have all the infrastructure in place to provide sustainable logistics all the way to the wellsite, and ultimately, into the blender; and, importantly, at the rates our customers demand.

By partnering with the railroads, we can maintain costs at attractive levels while offering fast turnarounds with very little demerge and providing any size shipment desired, thanks to our dual-service railroad capabilities. And we believe that bulk commodities belong on rail for safety and sustainability reasons.

Our strategy continues to prove itself a winner, time and time again.

In that light, here are some key things we remain committed to; supporting our existing, long-term contracted customers; extending our spot-market business; being one of the lowest cost producers of high-quality Northern White sand; maintaining low debt-levels; and being one of the lowest leverage companies in the proppant industry; delivering efficient and sustainable supply chain logistics from the mine to the wellsite; and ramping up the utilization of our last-mile SmartSystems, including new technology to complement our SmartDepots.

Our commitments to quality and safety are two more pillars of our success. We know that the quality of our sand and the quality of our service are the key to our success. The high-quality sand that we’re able to consistently deliver is what keeps our customers coming back to us over and over again.

Our sand is among the safest in the industry through its intrinsic properties, which is absolutely critical with the new OSHA silica standards. With our sand, paired with our SmartSystems technology, we believe we offer the safest frac sand product available in the market today. In summary, it’s been a positive quarter for Smart Sand.

We recorded some solid financial numbers in the face of a slowing environment. We settled an important lawsuit and we’re already delivering sand under the resulting agreement. We began to gain traction in the last-mile market with our SmartSystems, and we’re demonstrating our ability to be a reliable last-mile partner for E&Ps and pressure pumpers.

We remained and remain excited about the potential of our new wellsite technology in 2020 and beyond. And by paying down $16 million in debt in the quarter, we demonstrated our continued commitment to low debt levels and to a strong balance sheet to support the company for the long-term.

I’ll close today by saying thank you to all the dedicated Smart Sand employees who continue to believe in our mission and work – who work so tirelessly to help us achieve all that we do. We couldn’t do this without you. And now, I’ll turn the call over to our CFO, Lee Beckelman..

Thanks, Chuck. Today, I’ll be going over the third quarter 2019 financial results, and my comments primarily will be focused on comparing them to the second quarter 2019 results. As Chuck highlighted, we had a very busy quarter. Starting with sales volume. We sold approximately 611,000 tons in the third quarter.

Sales volumes in the quarter were negatively impacted by weather related shipping delays in the Bakken and a slowdown in spot sales due to a drop in the overall well completions activity in the third quarter. In regards to revenues, total revenues were $65.7 million in the third quarter. Just below our second quarter revenues of $67.9 million.

Sand sales revenue, including reservation charges was $29.7 million in the third quarter, down modestly from $31.4 million in the second quarter.

Logistics revenue, which includes freight for certain mine gate sand sales, railcar usage and logistics services, including our SmartSystem rentals, was approximately $20.4 million, which was consistent with the second quarter logistics revenue of $20.3 million.

In the third quarter, we recognized $15.6 million in shortfall revenue compared to $16.3 million of shortfall revenue in the second quarter.

As we have mentioned before our take-or-pay contracts with minimum quarterly and annual required volumes and payments provide Smart Sand with a stable source of revenue to help the company manage through the industry operating cycles.

$14 million and $10.8 million of the shortfall revenue in the third and second quarter, respectively, were related to a contract currently in litigation. Our cost of sales for the quarter was $38.6 million compared to $43.1 million in the previous quarter.

The decrease in cost of sales is primarily due to lower overall volumes, disciplined cost management at our Oakdale facility and seasonal production efficiencies we experienced as we begin the buildup of our winter stockpile. For the third quarter 2019, our contribution margin per ton was $55.13 compared to $41.80 per ton last quarter.

The increase was primarily as a result of the high shortfall revenue, coupled with lower total volumes sequentially, and the seasonal cost efficiencies I’ve just highlighted. Gross profit was $27.1 million in the third quarter compared to $24.9 million in the second quarter.

The increase was also primarily due to the cost savings experienced in the winter stockpile buildup. Our operating expenses for this quarter included a non-cash expense of $7.6 million related to intangible assets for our existing transload system that was acquired as part of the Quickthree acquisition in June 2019.

As Chuck stated, we are developing a new transload technology. And since we have decided not to manufacture our existing transload technology, we are required to impair the intangible assets that had been allocated to that technology.

All of our other operating expenses, including salaries, depreciation and SG&A expenses, were relatively consistent quarter-over-quarter. For the quarter, we had income tax expense of $2.6 million compared to $4 million in the second quarter. We expect our effective rate to continue to be in the low 20% range.

We had net income of approximately $10.9 million and adjusted EBITDA of $28.8 million in the third quarter.

The strong results are primarily attributed to contractual shortfall revenue from customers that did not take their required volumes of sand under our take-or-pay contracts, coupled with the seasonal cost savings from the buildup of our winter inventory. In the third quarter, we generated $22.9 million of cash flow from operations.

We used this cash flow to pay down our existing debt, which was reduced by $15.9 million during the third quarter and to pay for capital expenditures. Our year-to-date cash flow from operations was $40.3 million. In the third quarter, we spent $5.6 million on capital expenditures. Year-to-date, our capital expenditures had been $19.5 million.

These expenditures are primarily been for the manufacturing of our SmartDepot silos and efficiency upgrades at our Oakdale facility and our Van Hook transload terminal.

We currently anticipate total capital expenditures to be in the $25 million to $30 million range for the full year 2019 as we wrap up maintenance and efficiency projects at Oakdale and Van Hook and for the continued build-up of additional SmartSystems equipment.

As of September 30, 2019, we had approximately $2.1 million of cash in our balance sheet and $30 million in total undrawn availability under our credit facility. Consistent with our long-term goals, we currently expect that our cash flow from operations will exceed our anticipated capital expenditures for the full year 2019 and for 2020.

With our expected cash flows from operation, current availability under our credit facility and other available sources of borrowings, we believe we have sufficient liquidity to support all of our ongoing activities. Our Board of Directors initiated a stock purchase program in the fourth quarter of 2018.

They authorized the repurchase of 2 million shares for a period of 1 year. Under this authority, we repurchased approximately 600,000 shares. The Board recently voted to extend the share repurchase program for a period of 1 year, and we currently have 1.4 million shares remaining under this authority.

There were no share repurchases in the third quarter. In line with the overall North American oilfield service sector, we do currently expect to see a slowdown in activity in the fourth quarter. It is difficult, with the volatility in the current market, to give specific sales volume guidance.

But currently, we expect sales volumes to potentially be down 20% to 25% from third quarter levels. However, we do currently expect activity to pick back up in the first quarter of next year, as E&Ps ramp up activity in the first part of the year based on their 2020 budgets.

We currently expect adjusted EBITDA to be in the $10 million to $20 million range in the fourth quarter of 2019. This adjusted EBITDA range includes shortfall and contract termination payments we expect to recognize in the fourth quarter. This concludes our prepared comments, and we will now open the call for questions..

[Operator Instructions] Our first question comes from John Watson with Simmons Energy. Your line is now open..

Thank you. Good morning..

Good morning, John..

Good morning..

Lee, you mentioned 2020 operating cash flow exceeding CapEx. I was wondering if you could provide some updated color on where 2020 CapEx could fall..

Well, John, we’re not going to give specific guidance on CapEx for 2020. And then I think as we’ve demonstrated in 2019 year-to-date and through our comments that we have flexibility in how we can manage our capital expenditures.

So, depending on how activities going and our cash flow is growing, we have the ability to be able to contract or expand our capital to kind of match up to that. And we’re committed to making sure that our CapEx will be spent below what our cash flow is..

Okay. Understood. And I appreciate if you can’t specific this either. But you received a cash payment from a lawsuit and you also have a recent contract termination that will provide a cash payment.

Could you provide any color on the cadence of these payments in Q4? And if they dip into 2020, what that might look like?.

Well, I can’t give specifics on the actual number, amount of the payments. But in terms of the payments that were recognized in Q4, they likely will actually be generate cash in early first quarter 2020..

Okay, okay, understood. And then, lastly for me, you gave the guidance for Q4, which is helpful, and I think fits well with what we’re hearing from other completions players. I was wondering if there’s any weakness in Northern White pricing baked into that guidance.

Has it held up as you expected or have we started to see pricing deteriorate, given where activity is headed?.

Yeah, so, John, this is John Young here. Pricing is still – in Northern White, still appears to have some strength. We’ve seen a little bit of deterioration. But in the spot business, we’re kind of in the low- to mid-20s right now, which doesn’t represent a huge deterioration from where we were in the last quarter..

Okay, understood..

And demand continues to remain strong for kind of the finer grades of sand, the 40/70 and 100-mesh..

Okay. Thanks, John. Congrats on the strong cash flow. I’ll turn it back..

Thanks, John..

Thank you..

Thank you. Our next question comes from George O’Leary with Tudor, Pickering, Holt. Your lien is now open..

Good morning, guys..

Good morning..

Good morning..

Maybe piggybacking on John’s initial question, but just asking it slightly differently. Can you remind us what you view as maintenance CapEx for the business? And then, I realize you can throttle up or throttle down depending on how activity is.

But as we think about where – what buckets you might spend growth CapEx on, can you just kind of frame the opportunities that’s been the most intriguing to you for deployment of growth CapEx at this point?.

Well, in terms of maintenance CapEx, again, it’s kind of dependent on projects, including efficiency projects. But order of magnitude, our maintenance CapEx is probably in the $5 million to no more than $10 million a-year range, and it will probably be at the lower end of that on pure maintenance.

In terms of growth prospects and capital, primarily, most of our growth capital today continues to be in supporting – building up our last-mile storage system, the SmartSystems, and deploying those into the market.

And so the vast majority right now of growth capital that we would plan in 2020 would be continuing the build-out of those fleets, with the intention of seeing a greater utilization and an implication in the marketplace..

Great. That’s helpful.

And then on that plan on the SmartDepot front, if you think about just – you just framed it from a customer dialogue standpoint I realize the outlook for 2022 is probably fairly murky, but over the next 3, 6 months what’s the appetite from customers to either test out new systems or display systems that they’re not happy with? How’s that customer dialogue going?.

Yeah. So John here again. So what I would comment on there is with the customers that we’ve deployed our silos to, in general, they seem to be very happy with the low-depth levels that are inherent in the design. All our silos already exceed the OSHA standards that are due to come in, I think, in 2021.

We’re – our focus is, obviously, on reducing the number of trucks, reducing the number of loads. And so as we continue to deploy new technology in this space, it’ll be focused on increasing the use of bottom-dump trailers, which increase throughput. So Chuck had kind of alluded to a new technology we’re working on. That is along those lines.

So we’re excited about – I think your question was on the next 36 months. We’re really excited about the next 36 months. And quite frankly, we’re excited about the next 12 months in this space..

And the other thing I would add is with this new OSHA standards, we think there’s a lot of solutions out there that won’t work with that, and we think we’re in a perfect position to pick up that market share..

Great. Thanks for the color, guys. I’ll turn it back over..

Thanks..

Our next question comes from Stephen Gengaro with Stifel. Your line is now open..

Thank you, and good morning, gentlemen..

Good morning..

Good morning..

Can you help us – I’m trying to parse this out a little bit, and I was curious if you’d be willing to give a little bit of color around this.

So when I look at kind of year-over-year and I understand kind of the seasonal cost of goods sold benefit, is there any color or guidance you can – you could help us with around gross margins on sand sales versus, I think, starting to strip out shortfall revenue? I’m just trying to get a kind of a picture of how I should think about the current margin levels as we look into 2020.

And maybe I’m not sure you can – if there is any color on sort of contracted volumes, maybe just – if you’d be willing to add some color on the contracted volume status as we look into 2020..

Well, again, we don’t give specific guidance on contribution margins or gross profit, but what I think you can take from where we’re at year-to-date and kind of look at that right now, we think that will be consistent with what we would see in 2020.

So in terms of how you’re looking at it with or without shortfall revenues, I think you can look at that and say right now, we feel this could be relatively consistent in terms of margin capabilities. In terms of contracts, right now, we’ve got about 55%, I believe, of our capacity under contract for 2020.

And we continue to work on new contracts and new opportunities, but we continue to see those contracts playing out throughout 2020 as they have in 2019..

I think a big part of the picture right now is that most of our competitors pay more in interest than we have in total debt, and we think that, that will become a big part of the future of frac sand this coming year.

So either people need to start paying back their debt, free cash flow on a little bit or there’s going to some severe problems for many of our competitors, and we think we’re in the best position..

Okay. That’s helpful. As I – as a point of….

It’s kind of a showstopper, right?.

Yeah. No, I mean, the cash flow is positive, and things seem to be going well. So that’s – it’s – there’s clearly differentiation. I would agree with you.

When you look at the first 9 months of 2019, just so I can sort of benchmark it a little bit, the shortfall revenue basically, is it largely just drop straight to the [oping point, maybe that which I] [ph] think about it when I sort of….

Stephen, as you’ve asked this question before in the past, we don’t give specific and we don’t talk specifically about the shortfall revenues and how they drop through to the – throughout the financials. And we don’t talk specifically about anything that’s under litigation. So there’s really nothing else we’re going to say about that..

Okay. Got you. Thank you..

Thank you. Our next question comes from Lucas Pipes with B. Riley FBR. Your line is now open..

Hey, good morning, everybody..

Good morning..

I wanted to also follow-up on the contract position. My sense is that pricing adjusts with WTI.

And I wondered, are current prices – are the prices you get under your contracts comparable to current spot-prices that we could see in, for Northern White or is there may be a discrepancy?.

Well, it depends. Specifically, it’s contract by contract. But generally there – where we’re at relative to the WTI and how our contract structure works, we’re relatively in line with spot prices..

Got it. That’s very helpful. I appreciate that.

And then, can you remind us of the tenure of your contract?.

Currently, our contract life on a weighted average basis is just about around 15 months..

I appreciate that. That’s helpful. Thank you. And then, bigger picture question on the demand side, in your prepared remarks you referenced the potential for higher demand again in 2020 as budgets kind of get reset to higher levels.

What’s your degree of confidence in demand coming back early next year? Would appreciate your color and subjective thoughts on this. Thank you..

Yeah, sure. So, obviously, we got a good amount of experience now in kind of fourth quarter, what I’ll call seasonality and you can’t ignore some of the things that happened in the past years. It seems like seasonality takes over, as we get into kind of Thanksgiving, be on vacations and budget exhaustion.

But the conversations we’ve been having with our customers indicate that we’re going to be having a relatively strong first half of next year.

The real question that remains in our mind is to how quickly that picks up once we hit January, right, do we have any kind of hangover from kind of the Christmas period or do we get started on January 1? And we’ve seen varying degrees of that over the years, so it’s hard to predict.

With regard to kind of overall volume demand, I think it’s very much tied to commodity price on the oil side. And, if oil continues to kind of – on its trajectory, a kind of a march up into the $60s and $70s, I think we’ll continue to see robust demand for Northern White sand..

Got it. Okay, well, I appreciate it and best of luck..

Thanks, Lucas..

Thank you..

Thank you. [Operator Instructions] The next question comes from [George Umass with Roth Capital, LLC] [ph]. Your line is now open..

Good morning, guys..

Good morning..

Good morning, George..

Pardon me, if you answered this earlier. But last quarter, you mentioned that 30% of your volumes year-to-date were into the Bakken.

Can you refresh that number for us?.

Yeah, well, we’ve actually been talking about different regions. And year-to-date, our volumes into the Western United States, which includes the Bakken, Colorado and other markets; it’s about 55%..

Okay, thank you..

Thank you. I’m not showing any further questions at this time. I would now like to turn the call over to Chuck Young for any further remarks..

Thank you for joining us for Smart Sand’s third quarter 2019 earnings call. We look forward to reporting to you again in the New Year..

Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect..