Ladies and gentlemen, thank you for standing by. And welcome to the Smart Sand Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question- and-answer session. [Operator Instructions] I would now like to give today’s conference call over to Mr.

Josh Jayne, Director of Finance at Assistant Treasurer. You may begin..

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 and 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..

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 proppants 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 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 recover. 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 Eagles’ Utica assets were idle at closing, we started mining operations and began selling sand from there in the fourth quarter.

With startup 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 as 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 transloaders. 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 in 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 increase 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 basis we served, with startup 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..

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 meetings were painful at the time, they provided us flexibility to take advantage of opportunities as the market began to recover. Volumes continued 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 proppants 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 I 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 be -- 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 startup 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 determine 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 with 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 startup 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. We currently 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..

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

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

Good morning, John..

Good morning, John..

Good morning, John..

My question relates to, you guys made a lot of comments about the need for acquisitions, consolidation, et cetera, 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?.

Yeah. 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….

Right..

… we’re not going to hesitate that to do it. So, again, that makes the amount of people out there that we can consolidate with it makes more difficult..

Right..

Lee, I don’t know if you need to touch base a little bit what we’re seeing..

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 to 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….

Right..

… like Eagle. I think Eagle is a great example.

You can look at it and the benefits that we believed we were going to receive from Eagle and we think that 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 bases -- 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….

Right..

… 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, they were not going to go out and risk our balance to do it. So….

Sure..

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 management’s 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 dialogue. 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….

Yeah..

… people on the other side, I think, they have to be realistic about what they believe the value of their assets are..

No That’s all right..

And John, one other thing I would add on that. We picked up assets last year in the pandemic and we have more assets….

Right..

… than we ever had at the same time we pay down debt. So that’s kind of the way we’re looking at this business….

Right..

It’s not a business you want to have a lot of debt in, because the cycles are so fast..

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 essentially how many interested parties are out there?.

Yeah. Yeah. Let me give -- let me give point. I think there’s parties interested. But a lot of times they come with a lot of debt that’s out there, especially….

Right..

…in the private companies in the private equity that’s involved and they want to bring the data 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..

Yeah..

And that they got to build a business together with people I think then you’ll see more activity..

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

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

Hey. Good morning, everyone. I will start with 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..

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.

I -- was that the question?.

That’s correct. Yes..

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 towards 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, you 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..

And not only in sand but logistics as well..

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..

We’ll direct that to Lee..

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. 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 any 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 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..

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 which is -- would you consider borrowing on the ABL for an acquisition, for example?.

No. What we said is we want to keep low leverage levels. So I will -- we 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, 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..

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

Thank you..

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

Thanks. Good morning, everybody..

Good morning, Stephen..

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 the key drivers of that, and then, second, is there any way to break down the different pieces of startup cost to freight and inventory adjustments as far as the impact in the quarter?.

Yeah. This is Lee. I’ll take that question Stephen. And I don’t think I can give you as probably as many specifics as you’d like.

But I think there was a lot of -- going back, first of all, the 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 mined 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..

Right..

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?.

Yeah. No. That helps a lot..

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 startup 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..

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?.

Well, it’s really too early to tell on that, Stephen….

Okay..

… 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 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..

Thank you. And then just a final question, you mentioned, I think, in the 10-K, about the -- just kind of the about expectations for 2021. And I think he 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?.

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..

Okay. Great. Thank you, gentlemen..

Yeah..

And I’m not sure any further questions at this time. I’d like to turn the call back over to our hosts for any closing remarks..

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

Ladies and gentlemen, that’s conclude today’s presentation. You may now disconnect and have a wonderful day..