Ladies and gentlemen, thank you for standing by, and welcome to the Smart Sand's Inc. Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference to speaker today, Josh Jayne, Finance Manager. Please go ahead, sir.

Good morning, and thank you for joining us for Smart Sand's Fourth 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, February 26, 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.

Thanks, Josh. In spite of challenging market conditions, Smart Sand delivered another solid quarter to finish out an impressive year. Lee will give you specifics on the fourth quarter financial results later in the call. But first, I want to touch on some of the important highlights that I think differentiates Smart Sand from our peers. A lot has happened since we went public in 2016. We've increased revenue every year. We've had positive net income every year. We've generated positive operating cash flows, adjusted EBITDA and contribution margin every year. And our EPS reached new heights at $0.79 a share for the year just ended. In every measurable way, Smart Sand has continued to deliver positive results through the ups and the downs in the industry cycle. We take a measured approach to our spending in the ups, focusing our capital on projects and assets that provide good long-term returns on investments, so we can manage through the downs. With this strategy, we're positioned to operate in any environment. Here are the key highlights of 2019. We generated a record adjusted EBITDA over $87 million for the year. That came on sales volume of approximately 2.5 million tons. Sales volume through our Van Hook terminal in the Bakken increased over the previous year by a solid 46%. We began rolling out our SmartSystems in the first quarter of the year, and we already have 9 fleets rented to customers. We see interest continuing to increase in our SmartSystems product offering, and we're ready to meet that demand. We reduced our net debt by $15 million even while investing capital to continue to build our SmartSystems fleets. We improved our capital structure. We did it by refinancing our credit facility and putting in place a 5-year $20 million secured revolver…

Thanks, Chuck. As Chuck mentioned, we were able to finish a challenging 2019 with many record-breaking metrics and a lot to be proud of. I will start with the fourth quarter results before highlighting a few key full year points. Starting with sales volume. We sold approximately 462,000 tons in the fourth quarter. The decline in volumes from the third quarter of 2019 was primarily due to a seasonal slowdown in completions activity in the fourth quarter. We anticipated this decline and responded with reductions in our operations to limit any negative financial impact. Total revenues for the fourth quarter of 2019 were $47.7 million, a 27% decrease compared to third quarter 2019 revenues of $65.7 million. Sand sales revenues, which includes reservation charges, decreased to $23 million from $29.7 million in the third quarter of 2019, primarily due to lower sales volumes sold in the quarter. The average sales price per ton in the fourth quarter was marginally higher at $49.70 per ton versus $48.53 per ton last quarter. In the fourth quarter, we recognized $11.6 million of shortfall revenue from customers who did not take their contractually-obligated minimum volumes. Concurrently, some of our contracted customers will likely not take their minimum volumes in the first quarter of 2020, and we expect to have shortfall revenues in that period as well. Logistics revenues, which includes freight for certain mine gate sales, railcar usage and our SmartSystems rentals, was approximately $13.1 million for the fourth quarter of 2019 compared to $20.4 million for the third quarter 2019. The decrease in logistics revenue was primarily due to a decrease in volumes quarter-over-quarter through our Van Hook terminal. Our cost of sales for the quarter was $29.8 million, a decrease of $8.8 million from the third quarter's $38.6 million. The decrease in…

[Operator Instructions]. Our first question comes from John Watson with Simmons Energy.

Guys, I wanted to start on the SmartSystems impressive sequential improvement in terms of systems deployed. I was hoping you could speak to the different dynamics surrounding the systems that have been deployed over the past quarter as well as your expectation for incremental deployments at the end of Q1 or into Q2?

Yes. So this is John here. So yes, we got some good uptake in our SmartSystems. With SmartSystems, one of the things that we were working on last year was getting a critical mass of equipment available that we could rent out and then actively going and selling it. And the customer base that's using it, clearly likes it. It's got a industry-leading dust controls. And as those OSHA requirements, the PEL limits from OSHA start to come more and more into effect, folks are concentrating more on that as to what the dust levels are on site. So we're seeing a bit of a transformation from some of the other technologies into silo technology. And with our silos, customers understand that it's very simple, has no moving parts, empties directly into the bin or into the blender. And so that helps. With regard to what our outlook is. So we've got 9 systems rented. We've got 12 available for rent. So obviously, we're going to be looking to get the remaining sets under lease, and then we're going to continue to build approximately 1 set front through the end of the year. As we are also loading out or building out our new smart pass system, which is a -- it's a unique, and we think market-changing technology that will allow for bottom dump and pneumatic operation for customers looking for that. So we're excited about that.

Yes, our whole goal around this product is not having sand limit the amount of stages you can do on a well per day. And I think we're actually getting pretty close to where we're seeing that we're making a big impact.

Great. Secondly, the volume guidance for Q1 is an impressive increase. I was hoping you could speak to the pricing environment for Northern White and how that impacts Q1 results? And also looking into Q2 as well?

Yes. So Northern White continues to be a challenged pricing environment. However, it is in -- depending on the grade, it's basically in the mid-20s FOB, the mine. But there is still significant demand for Northern White, particularly Northern White that's delivered with efficient logistics, which is obviously a big focus of our customer base out there. So right now, 1Q is looking pretty good. The rest of the year is -- certainly, Q2 is probably looking okay, too. And then we kind of lose visibility into 3 and 4. So we're excited. The volume increase in general was expected. Budget exhaustion hit pretty hard towards the end of last year. So we're -- people have gotten off the mark, and they got off the mark quickly in 1Q at the beginning of January.

Perfect. Last one for me. The Q1 guidance provided is helpful. I was wondering if you could comment on your free cash flow expectations for the quarter? I would think your EBITDA to free cash flow conversion in Q1 improves from Q4 levels. Am I thinking through that correctly?

Yes, that's correct. We expect to generate positive cash flow in the first quarter.

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

This is actually Dan on for Lucas. I just had a modeling question here. Good to see that you've settled this lawsuit with Slumber J. From a working capital perspective, you've had this big accounts receivable build in 2019 from -- as far as like cash flow collection. What can we expect from that in the coming quarters?

Well, the bill has primarily been from the 1 contract we have a dispute. And so until that gets resolved, that will continue to be part of the accounts receivable. In terms of cash flow generation now, we expect, as we highlighted in our comments, we expect to be cash flow positive for the year. And so we expect to generate positive cash flow over our capital spending for fall of 2020.

Got it. I just -- I guess, specifically, it was like you guys had a big working capital draw in 2019 and is the expectation that, that will reverse in 2020?

It should basically -- it might not necessarily reverse because again, part of that receivable is related to the speed litigation. So until that gets resolved, that receivable will stay on our balance sheet, but it should basically not build this year. So we should have a relatively -- our working capital should be relatively balanced, and we won't have the same build we had in 2019 because we're not going to have as much incremental shortfall revenues related to that disputed contract. That make -- is that helpful?

Yes. Yes, that's helpful. Thanks. And then just one from a higher level perspective. We heard yesterday from a competitor that demand out of the Marcellus has been pretty strong thus far despite kind of lower prices, natural gas and some of the financial challenges that those guys are facing there. Just wondering if you guys are seeing the same thing so far in 2020?

Yes. So I would say we're seeing across the board relatively strong demand, particularly from the traditional markets that we serve, which includes the Marcellus.

Our next question comes from George O'Leary with Tudor, Pickering, Holt & Co.

I noticed that the language in the 10-K just around contracting is that more E&Ps are buying on a spot basis and buying on shorter duration contracts. I wonder if you could speak to that a little bit more, just kind of what duration are most E&Ps contemplating, is anyone still contemplating long-term contracts to try to lock in these lower prices? Just kind of what you guys are seeing on that contracting environment, how that's evolved over the last year?

Yes. So I think it's a combination. I mean, certainly, E&Ps and pressure pumpers, for that matter, understand that they're -- even in certain circumstances, there is some oversupply in the sand market. So they're taking advantage right now. But the ones that are really focused on thinking about this business not in the next 3 to 6 months, but thinking about it for the next 6 to 10 years are interested in having that long-term sustainability discussion with us. And that includes everything from the mine gate, all the way to the well head and making sure that you're operating that supply chain in a sustainable fashion. And those folks are engaged in conversations with us on to the long term. I don't know that we'll ever see the days of the 5 and 6 year deals that you could typically get way back when. But long term sustainable logistics will yield long-term sticky sales for us, and it'll be the mechanism of the contracting on that maybe a little bit different than it was before.

I would add to that. I think what we're doing into the Bakken with our 150 car unit trains kind of differentiates the way that sand moves. And I think to every basin, I think that's what people are going to have to look at the long-term logistics and what people are doing to make it more efficient.

Okay. That's very helpful color. And then just -- could you provide a little more color, one, on the geographic split in volumes that you guys have contracted for 2020? And then from a SmartSystems perspective, where they sit today, again, from a geographic perspective? And then what -- are you targeting any basins, in particular, or not targeting certain basins for various strategic reasons? Just those two questions would be very helpful.

I'll take the SmartSystems. As far as SmartSystems, that works very well in every basin. So we don't have 1 basin targeted. We will go to wherever we find business and it makes sense.

Yes, in terms of our current geographic mix, for 2019, roughly 70% of our volumes went to the Bakken and Marcellus, and roughly 30% went to other markets. Every quarter that really changes depending on kind of supply and demand and different factors in the strength of our logistics. So from our Oakdale facility, we can deliver to any basin in the country efficiently. So while 70% is where we are today, that doesn't mean we're not trying to continue to sell volumes in every basin. And back to Chuck's point, in terms of our long-term logistics focus and our focus on really driving the rail cost down through having very efficient operations and large unit trains, we think we can continue to grow in other basins as well. But right now, we're about 70% in those two basins, Marcellus and the Bakken. In terms of contracted mix, the route is, as John alluded to, the contracts are changing. And so we're not going to really get into a discussion of how much we have contracted or not contracted because our volumes are being sold on a spot basis. Some are taking their contracted volumes. Some of our customers are taking in excess of the contracted volume. So it really depends on activity levels and working with our customers, and we're very flexible in terms of how we're working with. I think one thing to focus on is we have the lowest cost structure in the industry when you factor in not only our cost of production, but our debt cost as well. So we have the flexibility to be very competitive on both a contracted basis and a spot basis.

And the other thing that gives us some stickiness is when we're supplying sand through our last-mile equipment, here, we really get it to a place where we've got a steady pool on a sand, which is very good for our business long term.

Our next question comes from Stephen Gengaro with Stifel.

You mentioned in the prepared remarks about the SmartSystems. And I think you mentioned sort of taking share from containers. Are your -- are you seeing -- are most of your system is displacing containers? Or are you displacing other silo systems? And I think along with that, when you talk about your sand volumes, are your SmartSystems only handling your sand or not necessarily?

Our SmartSystems handle anybody's sand, but they prefer Northern White. As far as taking market share, we do see a big pushback on box systems just because of the work that has to be done on the wellhead and like lifting the boxes over the top of people's heads. And just in that factor. And as far as ESG goals and things like that, we think that our system kind of has a better way there. And then in addition, our ability to unload trucks with some of our other technology, which involves gravity dump trailers, differentiates over the traditional pneumatic silo. So we do see people -- anyone that's looking to pump a lot of sand in a day, pneumatic trucks make it more difficult. But if you can gravity dump and you can unload the trucks quickly, I think you've got like a leg up on everyone. So again, people are talking about that market slowing down. We've never seen more interest in what we're doing. And we've got some new stuff that's coming up, and hopefully, we get that working very, very shortly. And we feel like we're going to have a lot of business coming our way.

Okay. And then two other ones. One quick one. On the tax -- on the impairment charge, is there a tax benefit to the impairment charge we should be thinking about for kind of adjusted EPS purposes?

No.

Okay. So there's no tax impact from the charge. Okay. And then just finally, when we think about the logistics revenue numbers, and I think you mentioned that the sequential drop was just largely volume related. But that -- as we think about modeling that number going forward, that's driven off of the SmartSystems and transload facility, right? Those are the two primary drivers?

Well, yes, the SmartSystems is going to be a growing component of that. And then as we sell sand in basin, which primarily that goes through our transload facility in Van hook, a share of those revenues, depending on how the contract is structured, would go through that as well. But we also -- part of our logistics revenue is that some of that is pass-through that basically we help to line up the logistics for our customer. And the revenue and the cost kind of passed through consistently. So it's a mix of three different drivers to that number, Steve.

Okay. And based on your strong volume guidance for the first quarter, I'd imagine that now would move at least directionally?

Yes. Yes, directionally, it should be fairly consistent. So as our volumes go up, that's going to kind of move consistently with the increased volumes.

I'm 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 fourth Quarter 2019 Earnings Call. We're excited about how 2020 has kicked off, and we look forward to reporting our progress again in May.

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