Ladies and gentlemen, thank you for standing by, and welcome to the Smart Sand, Inc. First Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference to your speaker today, Josh Jayne, Finance Manager. Please go ahead, sir..

Good morning, and thank you for joining us for Smart Sand's First 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 as of the live broadcast today, May 6, 2020. Additionally, we will refer to the non-GAAP financial measures of adjusted EBITDA and contribution margin 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 and contribution margin to gross profit.

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

the impact of COVID-19 pandemic on worldwide oil demand and the global oversupply of crude oil. These market dynamics will have an impact on our business during the downturn. But our first quarter results demonstrate the merits of our long-term strategy.

That is the wisdom of being a low-cost producer that provides the efficient and sustainable mine to wellsite solutions the market needs. And when the market does return, we expect to be well positioned to take advantage of the revamp. With this in mind, I want to talk about some of the fundamentals behind Smart Sand.

We're a purpose-built company, a company built to last, a company with strategic assets at the core of our business, assets that are made to weather the storms we're facing in the market today. From the beginning, we've managed our assets and our expansions in a meaningful way.

We've built and acquired assets that are efficient and low-cost operations, and we did it with very little debt. We have a single site mine with access to 2 Class I railroads. That allows us to deliver sand anywhere in the United States or Canada.

Having a single site means that we can better manage the mine, we can ramp production up or down quickly to respond to the rapidly changing market. Our Van Hook transload terminal has virtually no cost associated with it, unless it's in use.

So we can idle this facility in periods of low market demand, but quickly bring it back online as soon as our customers in the Bakken need it. Our SmartSystems manufacturing facility is able to scale back its manufacturing capabilities quickly.

We've reduced our activity to focus on current needs, which is primarily perfecting our new transloader to SmartPath. Our SmartPath supplemental transloader technology will provide more efficient offloading of sand at the wellsite. It allows us to provide a broader range of products and services to meet our customers' last mile needs.

Our goal in the next few months is to have the SmartPath available for deployment when the market activity returns to more normal levels. With our new SmartPath technology, users can combine all the benefits of bottom dump trailers with safety.

That means faster load and unload times, quick turnarounds and high capacity, but with low dust and a small footprint of silos on a wellsite. Our SmartPath patent-pending features include a fixed-in-place drive-over sand drop earlier, a complete dust control system and the throughput capacity to keep ahead of the frac job.

So in sum, SmartPath is a last-mile game changer because it bridges the current gap between using bottom dump trailers and silos. SmartPath uses a reliable and simple single chassis design, one built to safely keep up with any frac job. We'll have SmartPath units available for deployment in the second quarter.

And since the demand for this new technology has been strong, we'll keep focusing our manufacturing on SmartPath. We're all in difficult times right now. Based on public announcements and discussions we've had with our customers, E&P activity for the remainder of 2020 could be down between 50% and 75% from first quarter levels.

This drop in expected activity is unprecedented. And is expected to impact the demand for our products and services. So we're responding to that. We're rightsizing our business, and we're aligning our costs with our sales. That way, we can weather this storm and ensure that we'll be left standing when the storm eventually passes.

Here are some of the steps we've taken. We've significantly reduced our CapEx budget as much as 80% primarily by reducing SmartSystems manufacturing plants. The limited capital we'll be spending will mainly be for perfecting SmartPath. We now estimate CapEx will be in the $5 million to $10 million range for the year.

This is a reduction of $15 million to $20 million from 2019 investment levels. We've also put in place several cost-cutting measures. Here are some of them.

Salary reductions for all executive management from 35% to 40%, headcount reductions at our Oakdale facility to align our workforce with the expected reductions in sales volume, salary reductions for other personnel of approximately 20% and the suspension of all our variable cash compensation programs for all employees.

These cost-cutting measures will reduce cash compensation expense for the company by approximately 50% or $10 million from 2019 levels. We're working with all our key vendors to manage our payments. We're trying to line up our cash payments with our cash receipts.

Our goal during this downturn is to guide our operations within our current cash balances and our expected cash flows from operations. In March, we drew $6 million on our ABL Credit Facility. We did that to provide for immediate liquidity should the need arise. Our current borrowing base is $20 million, we have $14 million in availability.

We've made no additional draws on our ABL Credit Facility. We now have $17 million in cash to fund our ongoing activity. We've made the tough decisions to reduce our workforce and cut costs everywhere we can. That's key to executing our long-term strategy so we can continue to operate the business that we build.

Our principal operating philosophies haven't changed. Now more than ever, we'll strive to live within our cash flow so we can continue to operate in this difficult market environment, while maintaining a strong balance sheet. We remain committed to offering the highest quality products and the highest quality service while maintaining low leverage.

With this strategy at our core, we believe, as we always have, that we will ultimately prevail in any market. Now is a time of reflection and planning for the future. We continue to work with our customers and respond to their needs. We're listening not only to their needs for sand, but also their requirements for storage, logistics and management.

We're perfecting our offering to fully satisfy those needs when the demand returns. During this challenging time, we'll be strategic, cost-conscious and prudent. Then when demand returns, we'll be ready to meet it. And with that, I'll turn the call over to our CFO, Lee Beckelman..

Thanks, Chuck. Though we started 2020 with a solid first quarter, we are faced with the reality that the dynamics of the market today are much different than the first quarter.

So I will go through the first quarter 2020 results, but as Chuck highlighted in his comments, currently, there is not a lot of clarity in the market about the next month, much less the second quarter or full year 2020. Starting with sales volumes.

We sold approximately 757,000 tons in the first quarter, which was a 64% increase over fourth quarter 2019 volumes of 462,000. And a 17% increase over first quarter 2019 volumes of 648,000 tons. We saw a strong pickup in activity in the quarter from fourth quarter 2019 levels. Total revenues for the first quarter of 2020 were $47.5 million.

Revenue was relatively consistent quarter-over-quarter as there was less shortfall revenues in the current period. Sand sales revenues increased to $30 million compared to $23 million, while logistics revenues also increased to $16.2 million from $13.1 million in the fourth quarter of 2019.

The increases sequentially were primarily due to higher overall sales volumes. In terms of shortfall revenues for the second quarter of 2020, we expect to recognize as revenue at least $14 million related to a contract, which is currently under litigation.

We do not anticipate recognizing additional shortfall revenue from this contract after the second quarter 2020. Our cost of sales for the quarter were $41.1 million, an increase from the previous quarter of $29.8 million. The increase was due to higher volumes sold and more costs recognized as inventory was depleted from the winter stockpile.

For the first quarter 2020, contribution margin was $11.5 million or $15.20 per ton. We had adjusted EBITDA of approximately $6.4 million in the current quarter compared to $19.6 million in the previous quarter. The lower adjusted EBITDA was primarily due to lower shortfall revenue and higher cost of goods sold in the current period.

The first quarter is usually our weakest quarter as our costs are typically higher than other quarters during the year as we recognize costs from depleting our wet sand inventory that were capitalized during the buildup of our winter stockpile in previous quarters.

For the first quarter, we generated $12.1 million in operating cash flows, and we spent $4.2 million on capital expenditures, which was primarily on new SmartSystems units.

As Chuck highlighted, we are reducing our build-out of SmartDepot silos and have shifted our focus to perfecting our new SmartPath transload technology, which we plan to have available for deployment in the market later this year.

We have significantly cut our planned capital expenditures, and we currently expect to spend between $5 million to $10 million on capital expenditures during 2020. As of March 31, 2020, we had $11.5 million in cash and $14 million remaining availability on the ABL Credit Facility.

We currently have $17 million in cash on hand and the same $14 million remaining availability on the ABL Credit Facility. As Chuck highlighted, we are proactively taking measures to reduce our cash expenses to allow us to manage through this downturn.

With the capital and expense cuts we have implemented and our available liquidity, we believe we have sufficient liquidity to support our operations. Due to the current volatility of the market and lack of clarity on our customer activity, we are not giving specific guidance for the second quarter.

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

[Operator Instructions]. Our first question comes from Lucas Pipes with B. Riley FBR. .

I wanted to ask first about the agreement with Liberty that was filed last night is an attachment to the Q. There is a mentioning of a credit to Liberty. Can you just expand a little bit -- it seems to be tied to oil prices.

But can you maybe expand on that? Is there a maximum that we could be looking at? Just trying to get a kind of range of potential outcomes there, given how low oil prices are currently..

All right. I'll let John touch on that..

Yes. So Lucas, yes, the agreement with Liberty was basically one where we gave them some concessions on pricing as to maintain their competitiveness in what was a pretty substantial competitive market. I don't, at the current time, recall exactly what the credit you're referring to was on that.

But my recollection of the filing of that is that it wasn't -- I don't know that it was a material credit to our business. It probably had something to do with some previous dollar amounts that were in question..

Yes. Lucas, the credit really had to do with previous dollar amounts from volumes under the contract. And so we negotiated with Liberty to allow them to get a credit for those volumes going forward, depending on their volumes that they were taking.

Didn't really affect or change their minimum volumes under the contract on a go-forward basis, but did give them some price break into the current year based on the volume activity that they're planning or under their contract for this year..

Got it.

And from an accounting perspective, would those credits will be captured in revenue? Or would this kind of flow differently through the financials?.

It ultimately goes through revenue. Basically -- we basically have a lower realized price per ton for our Liberty cells going forward..

Got it. That's very, very helpful. I appreciate that. And then second question is in regards to some of the customer litigation and the accounts receivable associated with that. Obviously, my hope and investors' hope is that, that money will be collected.

But can you maybe share some perspective as to where this stands today? Kind of what -- how the pieces have to fall in place? And is it -- maybe it could make sense to just write it off and then expect to collect at a later time..

Well, Lucas, we don't -- as we've stated in previous calls, since this litigation matter is still in process, we don't make any specific comments on our litigation. Other than that, we continue to defend our contract and to work through the process. And we're still confident that it will work out..

That's very helpful. And then maybe sneaking a last one. When I look at the equities of some of the Marcellus E&Ps, they've got quite a bit here over the last couple of weeks.

Are you seeing increased increase from that region? Are you seeing that shift to gas or is that maybe still a little bit too early given that we just kind of crossed into the $2 range on the Henry Hub here the last few days?.

John, I'll let you take that..

Correct. Yes, so I'll answer that. Yes. So Lucas, the one thing that's interesting about the gas plays, right, is these gas guys have had a long time to get used to a relatively low commodity price. And so they've been bringing efficiency into their operation since that first collapse, say, in the 2012, 2013 time frame.

So it's not surprising to us that those guys are continuing to aggressively pursue development of gas wells, particularly up in the Marcellus. We're seeing a fair amount of activity up there. What we're hearing anecdotally is that a lot of the pressure pumpers are redeploying crews into that area to try and chase the business that is available.

And it's understandable when you look at kind of negative commodity prices as recently as last week on the oil side that folks are more focused on nat gas. Our view has always been to try and do both, right? So while oil is depressed today, we think it's got a bright future. And nat gas is one of the things where we play well.

We play well into the Marcellus. Our last-mile logistics work very well in the relatively rugged area up there, the mountainous area where wellsites can be small, small footprint and require kind of small footprint of silos versus boxes. So we're really well prepared to compete effectively into the Northeast.

We'll continue to do that as we have in the past. And when oil recovers, we'll be ready to compete in those markets also..

Our next question comes from Stephen Gengaro with Stifel..

So following up a little bit on the prior questions. When you think about your volumes in the first quarter, can you give us a sense for directionally -- I mean, I think a lot of them are still going east and west versus south. And along those lines, it seems like the gas markets are holding up better.

So without -- I know you -- the market is extremely difficult to look at right now.

But should we think about your volumes maybe outperforming the overall rig count and being more in line with what we're seeing going on in some of the gas basins? Or how do you think that aids your business relative to kind of what's going on with the pure oil rig count?.

Well, Stephen, as we stated, it's very hard to predict right now in terms of activity levels. We are seeing that gas basins in the Marcellus, which is a market that we do compete well in, isn't dropping as rapidly and may not have as a dramatic drop over the next 9 months that we're expecting on the oil basins. But there's still nothing to tell us.

So -- I think that when we say that we expect our current volumes to be consistent into the east and -- but we'll see a pullback at least in the short term is probably more in our western markets, which are going to the Bakken and Colorado, which are more oil-driven..

Okay. And then as we think about the sort of the balance between lower volumes price and obviously, the first quarter cost of goods sold get impacted by the winter inventory build.

Should we think about the normal progression of contribution margin, but build in sort of the overhead absorption and price changes? Like -- so should we still see that sequential change, but just a lot more muted because of the market? Or is it just too early?.

I understand your question, Stephen, but I would say that again, as margins goes down, just -- there's a certain fixed portion to our business, so our cost per tons are going to go up a little bit as volumes go down.

But overall, I think our contribution margin and pricing in the first quarter should not be materially different than going forward other than at lower volumes, you're going to have a higher cost per ton because you're spreading that fixed cost over lower volumes.

Even though we've done a good job of pulling back on cost, we're still going to have an impact to our contribution margin from that.

And I also will say that right now, typically, in the second and third quarter, and when we have strong activity, we ramp up our mining activity pretty strongly, and that leads to actually an absorption of a lot of our costs into inventory, which allows us to have a higher contribution margin in the second, third quarter of most years.

Well, this year, because we're expecting lower activity and we're planning for that, we're not going to be as aggressive in mining, at least initially, until we see how the market plays out.

And so that's probably going to lead to our cost of goods sold being higher than you normally see in the second and third quarters because we're not going to be building up our inventory as we do normally..

That's very helpful color and....

And John, you might want to add to that, talk a little bit about our single mine site and the advantages of that..

Yes. I think that particularly when you look out there at the other frac sand competitors selling sand, our site -- we've always kind of trumpeted the fact that we have a single mine site with massive capacity, right, 5.5 million tons of capacity. And we have a real ability when times are good to ramp up capacity efficiently.

And then when we get into these more challenging market conditions, we can ramp down efficiently.

We have one safety plan we have to manage, we have one environmental plan we have to manage, and we have one group of managers managing that entire facility rather than having multiple plants across regions and across the nation where it becomes very difficult to effectively ramp down without either shuttering those sites permanently, furloughing all these workers and whatnot.

We have the ability to continue to rightsize the business whether or not we're selling 5 million tons a year or if we're selling 1 million tons a year. We have that ability to efficiently manage that workforce and compete at still what will be the lowest cost in the business.

They just may not be as low as we'd like them to be with regard to some of the fixed costs that we have to absorb rather than our variable cost. So that's -- we think we're well positioned. We're tucking in our horns to get through what we think is going to be a significant downturn.

But at the same time, we're also optimistic for the future that we're going to see a sharp turnaround on this, and we'll be prepared for that, too, to ramp back up..

Great. Great color. And then if I could just add one more. Do you -- as you think about the market, you're obviously -- your balance sheet is in very good shape, you have -- clearly have a staying power from what I could tell.

How do you think the market looks in 2021 or 2022 as things normalize, let's say, 2022? Do you think you're ultimately in a better competitive position because some of the peers out there, especially some of the in-basin guys who just may not be around? I mean how do you think about that competitively longer term?.

We absolutely think that there's going to be difficult for people -- difficult time for people to survive. There's going to be some consolidation just because we don't think these balance sheets of a lot of the other -- our competitors are sustainable, but I'll let Lee put his two cents in there..

No. And then John can chime in as well. But I think we agree that if we're in a period of 6 to 9 months or longer of this kind of dramatic turndown, it's going to be very difficult for some of our peers at their leverage levels. And we don't think all of them survive this. And potentially, there's going to be consolidation.

But at the end of the day, consolidation, I think, and/or closures leads to reduced capacity overall for sand in the industry. And then if you couple that with what we're seeing is an expected could be a fairly significant reduction in production in the Lower 48 in the U.S. over the next 6 months to the year.

When the market does turn and pricings does improve, you could see -- we kind of anticipate that there could be a pretty good ramp-up in activity for producers trying to recapture production loss, and there'll be less supply to support that activity that should position us well to take advantage of that when the market comes back..

Our next question comes from Dylan Glosser with Simmons Energy..

Just in regards to shortfall revenue, you guys obviously saw a material decrease in Q1 from Q4.

And just with where the market has headed over the past few months, do you -- what is your expectation for shortfall revenues over the next coming quarters? And do you expect that this might pick up again?.

Well, again, we're not giving specific guidance other than the guidance we gave in our prepared comments is that we do expect around $14 million of shortfall revenue in the second quarter, and that's related to our contract that's currently under litigation.

As it relates to our other contracts, I think we're just going to have to wait and see how it plays out in terms of volumes, et cetera, on a quarter-by-quarter basis..

Okay. Yes. Sorry, I think I missed that. I was a little late getting to the call.

I might have missed this as well, but how many SmartSystems were active in Q1? And where do you expect this lever might be moving through the next few quarters?.

John, why don't you take that?.

Yes. So we had -- in the first quarter, we had 9 SmartSystems, silo systems active. That number has come down into the low single digits in the second quarter. As Chuck had kind of mentioned in his prepared remarks, we are focused on perfecting and getting the deployment of our smart -- our new SmartPath technology nail down.

So once this market comes back, we've got a SmartPath system that works well with our silo deployment. And our understanding is the demand on that should be relatively robust given that it gives a true way to use bottom dump trailers with silo systems in an efficient and quick manner.

So we're going to continue to chase opportunistic business with our last mile systems, and we're prepared with the 12 systems ready to go today. And we'll be building SmartPaths over the next little while. We probably won't be building any additional silos for the foreseeable future, but we will be focused on manufacturing on SmartPath..

And Dylan, I'll just add to that. In the fourth quarter, we had about four fleets rented, and we ramped up to 9. So it was really demonstrating that the market was starting to really accept our product and making good progress there.

So with this pullback, you're seeing the drop back, but I think that gives us good confidence when the market comes back that our product has been accepted by the market, and we have a good chance to ramp back that up -- that activity up pretty quickly..

I am not showing any further questions at this time. I would now like to turn the call back over to Chuck Young for closing remarks..

Thank you for joining us for Smart Sand's First Quarter 2020 Earnings Call. Stay safe. We'll talk soon..

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