SLCA (2019 - Q4)

Greetings, and welcome to the U.S. Silica Fourth Quarter and Full Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Michael Lawson, Vice President of Investor Relations and Corporate Communications for U.S. Silica. Thank you. You may begin. Michael

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica’s fourth quarter and full year 2019 earnings conference call. With me on the call today are Bryan Shinn, Chief Executive Officer; and Don Merril, Executive Vice President and Chief Financial Officer. Before we begin, I would like to remind all participants that our comments today will include forward-looking statements, which are subject to certain risks and uncertainties. For a complete discussion of these risks and uncertainties, we encourage you to read the Company’s press release and our documents on file with the SEC. Additionally, we may refer to the non-GAAP measures of adjusted EBITDA and segment contribution margin during this call. Please refer to today’s press release or our public filings for a full reconciliation of adjusted EBITDA to net income and the definition of segment contribution margin. Finally, during today’s question-and-answer session, we would ask that you limit your questions to one plus a follow-up to ensure that all who wish to ask a question may do so. With that, I would now like to turn the call over to our CEO, Mr. Bryan Shinn. Bryan?

Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing our fourth quarter performance and highlighting key accomplishments in 2019. I'll then provide updates on our three strategic priorities for 2020 and our commitment to sustainability and environmental stewardship. I'll conclude my prepared remarks today with the market outlook for our two operating segments; industrial and specialty products and oil and gas. Don Merril will then provide additional color on our financial performance before we open the call for your questions. Our Q4, total company revenue was $339.1 million, represented a sequential decline of 6%. Adjusted EBITDA for the fourth quarter was $73.6 million, which included a net $52.3 million of a customer shortfall penalty, compared with $58.4 million of adjusted EBITDA in the third quarter of 2019. In our industrial and specialty product segment, we experienced a normal seasonal decline plus overall weaker demand due to market conditions and the ongoing Asia trade dispute. Customers slowed purchases at the end of the year to manage inventories. This customer cash generation effort was more focused perhaps than in past years. As a result, contribution margin in this segment was down approximately 12% on a year-over-year basis. Sales and margins are rebounding in Q1 as expected. Oil and gas proppant volumes declined 14% sequentially in response to lower activity levels and normal seasonality related holidays and E&P budget exhaustion. Pricing continued under pressure throughout the quarter particularly in West Texas. We have however seen prices improved in the first two months of this year. Given that local sand continues to displace legacy capacity, we prudently idled additional sand proppant capacity in the quarter bringing our total capacity currently offline to approximately 8 million tons. We will continue to manage our capacity as the market evolves. I believe that the sand industry is behaving though in a disciplined manner as we have not seen additional capacity reactivated in response to stronger-than-expected demand to start 2020. I expect that U.S. Silica will continue to prioritize higher prices over additional sales volume in Q1. SandBox load volume declined 18% sequentially in line with lower completion activity in the market. As a result, we experienced modest downward pricing pressure in the quarter. We ended the year with approximately 24% market share of delivered oilfield sand and a robust pipeline of new business opportunities to pursue in 2020. From a broader perspective in 2019, we continue to build, invest and transform U.S. Silica for long-term success. We converted a former ceramic proppant plant in Millen, Georgia to manufacture new high-margin, high-performance ISP products to meet growing customer demand. We expanded milling capacity at our industrial facility in Columbia, South Carolina, which enable us to secure new business and a long-term contract with the major customer. In fact, we nearly doubled capacity to produce our finest ground specialty product last year with just $2.5 million of CapEx. A great example of how we can organically grow our ISP business with modest capital investment. We invested in next-generation's equipment for SandBox, expanding box payloads and offering customers a new gravity fed stand that is quieter, required less maintenance and is less expensive to make, and we signed several new long-term contracts with blue-chip customers in our energy segment which will provide a springboard for growth going forward. We also took significant steps towards rightsizing our oil and gas proppant business reducing the size of our logistics footprint, headcount and capacity to better align our business with the current market structure. I'm perhaps most proud of the fact that our team in 2019 recorded the safest year during my tenure U.S. Silica. We achieve the total recordable incident rate of 0.86, a 38% reduction from 2018, as well the lost time rate of 0.18, a 19% reduction from the previous year. I'd like to congratulate my 2,000 plus colleagues who completed our belief-based safety workshops across the enterprise and achieve this stellar accomplishment. Well done. Let me now turn to the progress we're making on our three strategic priorities for 2020 Generating free cash flow, repositioning our oil and gas business and growing our industrials business. Late last year, we announced a 10% reduction in headcount to improve efficiencies and better align operations and support staffing with the current challenges in our energy businesses, delivering annualized SG&A savings of approximately $20 million. We've minimized our planned capital expenditures for 2020 to a range of $30 million to $40 million. We've increased asset efficiency and are driving to the lowest cost on basic products to increase automation and we rightsizing plants, while continuing to ship the mix of our industrial business to higher-margin products. From a cash management perspective, we have an intense focus on optimizing working capital including accelerating collections, negotiating better terms with key vendors and improving inventory management as well as monetizing non-core assets wherever possible. We've also make good progress on our second strategic priority, which is to reposition our oil and gas business. As I stated earlier, we've executed steps to rightsize production. We'll continue to optimize our network by eliminating suboptimal shipments and exiting high-cost transload sites while renegotiating transload fees and rail rates. We also staggered railcar leases with 1100 cars rolling off this year and 900 more rolling off lease next year. Moreover, we're developing new low-cost rail routings and are maximizing barging to keep us on the very low end of the cost curve. In terms of our third priority growing our industrial business, I'm very pleased with the work that our ISP team had done to lay a path for growth. Once again, we've implement a price increases for most of our non-contracted silica sand, aggregate diatomaceous earth and clay products. We continue to shift our ISP business towards higher margin products and are pursuing several growth platforms. For example, we're using new milling technology that delivers expanding capabilities. We're also targeting new high-value, not-in-kind markets where customers are looking for an effective alternative through existing offerings. We have several new products in various stages of customer trials. In many cases, the sale cycles for these new products are long, but we're gaining traction and making very good headway. Our plan is to increase the base business through price and share gain, focus on launching our new higher-margin products and grow opportunistically through small tuck-in adjacent acquisitions. Let me now provide you with an update on our major ESG initiatives. Being a leader in sustainability and environmental stewardship is core U.S. Silica and a value that matters deeply to our employees, our stakeholders and to me personally. This commitment to sustainability includes stewardship of water, one of our most precious resources. We continue to advance our water conservation and recycling efforts. For example, we invested over $5 million last year in our Jackson and Mississippi facility and reduce our water consumption by 37 million gallons annually. We're also committed to reducing energy consumption. For example, in LoveLock, Nevada, we shifted to energy efficient lighting technology and variable frequency drives for key equipment. These changes substantially lowered our energy costs and will save approximately one million kilowatt hours of electricity annually, enough to power about 100 households for a year. We have a terrific team at U.S. Silica and their well-being continues to be a primary focus also. In 2019 we partnered with NIOSH, the National Institute of Occupational, Safety and Health to identify unexpected dust sources and reduce exposure for our employees. Finally, we continue to develop low environmental impact products for our customers. For example, our organic pesticide, DEsect has helped us branch out into the commercial agricultural business showing significant success over the past two years. Because its made up of minerals rather than chemicals, DEsect is not harmful to the environment and doubled as a soil amendment to improve organic plant growth. Let me conclude my prepared remarks today with a market outlook for both of our operating segments starting with industrials. Based on recent reports from the Federal Reserve and others, we believe that downside risks to the U.S. economy have receded. The U.S. job market and consumer spending remains strong and we're relatively optimistic that the overall strength of the U.S. economy in 2020. Further, a strong job market continued U.S. population growth are constructive for home building and remodeling, both important positive indicators for industrial business. On the flip side, light vehicle sales and the U.S. beer and wine markets are forecasted to contract in 2020 creating headwinds for some of our silica sand and diatomaceous earth product offerings. Further, we're carefully watching for potential impact from emerging global health and trade issues. All-in, we believe that our industrial business can grow profitably at a rate of two to three times GDP in 2020 driven by combination of higher volumes, continued price increases and new product introductions. Oil and gas, we're off to a good start in Q1. We expect to continue to prioritize pricing and profit per ton over incremental sales volumes for oilfield sand and do not plan to return idled capacity to the market. Accordingly, I think we'll sell between 13 million and 14 million tons of frac sand in 2020. For SandBox, we anticipate that load volumes will be flat to slightly down year-over-year and that pricing pressure will persist but not worsen. I also expect our energy business in total to mirror the last two years in terms of the seasonality of profitability as customers continue to stay disciplined and spend within their cash flows throughout the year. After taking all these factors into account, I expect that the current street consensus, adjusted EBITDA outlook of $165 million to $170 million is a reasonable, but conservative estimate for total company profitability in 2020. We expect to update our 2020 outlook as the year progresses. And with that, I'll now turn the call over to Don. Don?

Thanks Bryan and good morning everyone. The adjusted EBITDA for the fourth quarter was $73.6 million. And as Bryan stated, this figure includes a net $52.3 million customer shortfall penalty that was recorded in the quarter. The amount recorded is an estimate based on current negotiations and could increase or decrease. We cannot comment further on this, but we will keep you informed as changes occur. During the fourth quarter of 2019, like the fourth quarter of 2018, we experienced a sharp decline in customer demand for Northern White frac sand and for regional non-in-basin frac sand as more tons were produced and sold in-basin. Unfortunately, this contributed to a significant decrease in frac sand pricing. Given the changes in demand and customer preferences for in-basin sand, we also experienced the decline in the utilization of the sand railcar fleet in our transload network and the overcapacity industry-wide of this type of railcar grew even more. As a result of the triggering events described above, we impaired $363.8 million of assets in the fourth quarter consisting of $243.1 million related to property, plant and equipment, $115.4 million related operating lease right-of-use assets and $5.3 million related inventories and intangible assets. The bulk of the property, plant and equipment impairment charges were related to facilities that have been idled or are operating at reduced capacity including Tyler, Texas, Spartan, Wisconsin and Utica, Illinois. The operating lease right-of-use asset impairments are entirely related to railcar leases. As of December 31, 2019, we maintained a fleet of 6,979 leased railcars of which 2,271 were in storage. In 2020, we expect approximately 1100 railcars the roll off lease. Moving onto the results of our two operating segments. Fourth quarter revenue for the industrial and specialty product segment was $104.8 million, down 12% from the third quarter 2019 due largely to the typical seasonality we see in that segment. As mentioned earlier, the ISP segment is off to a good start in 2020 and the first quarter should look like quarter three of 2019. Oil and gas segment revenue was $234.3 million down 3% from the third quarter of 2019 due largely to a 14% decline in frac sand volumes, a pricing reduction of 20% offset by the previously mentioned shortfall penalty. On a per ton basis, contribution margin for the ISP segment was $46.45 was essentially flat versus the third quarter despite the 12% reduction in volume. The oil and gas segment contribution margin on a part-time basis was $20.22 compared with $12.98 for the third quarter of 2019. The increase is due to the customer shortfall penalty offsetting the impact of lower volumes and pricing. Let's now look at total company results. Selling general and administrative expenses in the fourth quarter of $37.3 million represented a decrease of 7% from the third quarter of 2019. This decrease was largely the result of lower employee costs due to headcount reductions partially offset by higher non-cash equity-based compensation expense. We believe that SG&A expense will total approximately $125 million for the full year 2020 due to the headcount reductions announced in 2019 and our other cost-cutting initiatives. Depreciation, depletion and amortization expense in the fourth quarter totaled $42.8 million, down 9% from the third quarter 2019. The decrease in DD&A was mostly due to the reduced depletion expense driven idled plants. We estimate that DD&A to be roughly $185 million for the full year 2020. Our effective tax rate for the quarter and year ended December 31, 2019 were 24% and 23% respectively. At this point in the year, we anticipated tax benefit of about 23% in 2020. Moving on to the balance sheet. As of December 31, 2019 the company had $185.7 million in cash and cash equivalents and $93.5 million available under its revolving credit facility, resulting in total liquidity of $279.2 million. Our net debt at year-end was $1.05 billion, and our term loans has a maturity date of 2025. Capital expenditures in the fourth quarter totaled $20.5 million and were mainly related to growth projects in our ISP segment, as well as spending on equipment to expand our SandBox operation and other maintenance and cost improvement projects. We expect to keep capital expenditures in the range of $30 million to $40 million in 2020 and be funded from our cash flow from operations. Lastly, I'd like to comment on our capital allocation policy. As you know, we recently elected to reduce the quarterly dividend of $0.02 per share. We did this to better align with our strategic priorities and felt that this action was appropriate as it will free up additional cash that could be use to reduce our leverage and grow our higher-margin industrial and logistics businesses. And with that, I'll turn the call back over to Bryan.

Thanks Don. Operator, would you please open the lines for questions.

Thank you. We will now be conducing a question and answer session. In the interest of time, we ask that you please limit yourself to one question and one follow-up. [Operator Instructions]. Our first question comes from the line of Stephen Gengaro wth Stifel. Please proceed with your questions.

Thanks. Good morning, gentlemen.

Good morning, Steven.

I guess two things. When I start with is, we're hearing a lot of about in-basin capacity right now. And I know you mentioned in the press release that the two mines down there are among the highest utilized in Texas. Can you talk about what you're seeing from a in-basin capacity perspective? And also sort of how that's impacting the pricing situation down there?

Sure, Stephen. So if I think about the Permian which is where we usually speak to when we're thinking about in-basin capacity given that's where most of it is. I sort of think of it this way. I think the -- for a total supply that got installed is something like maybe 75 million tons. What I would call the kind of capable supply that sort of realistic supply that could be out there is more like 60 million tons. And what we've seeing today is that what's active is probably closer to 50 million tons. And so if you look at that opposite the demand, I think as we exited Q4 and entered Q1 demand was probably in the 40 to 45 million ton range. So we're starting to get pretty tight relative to the active supply that's out there in the Permian today.

Okay. Thank you. And then as you think about the ISP business and the contribution margin per ton numbers as we kind of roll forward here. Should that number advance a bit at some of these new product lines are introduced? And is that more of a 2021 event or is that going to impact 2020 much?

So, I think what we'll see is that we'll continue to launch a series of new products, all of which have very high contribution margins. At the same time, there is some legacy demand that's rebounding a bit and that legacy business tends to be at a bit lower margins than average that we see today. So, I think we'll see kind of a balancing act going forward. And it really depends on how fast the new products get launched and how much extra demand we get from some of our legacy customers. We've had a couple of big contracts on the legacy side that we've signed recently. And so, that would be obviously very accretive to overall contribution margin, but somewhat dilutive to the total. So, I think, it'll be sort of plus or minus. So, as I model it, I would say it's pretty flat going forward for the next several quarters as we kind of play out this balance between new products and some legacy products.

Great. Thank you.

Yes. Thanks, Stephen.

Thank you. Our next question comes from the line of Tommy Moll with Stephens Inc. Please proceed with your questions.

Hey, good morning. This is actually Cameron [ph] on for Tommy.

Hi, Cameron. How you're doing this morning?

Doing well. Thank you. I want to start with ISP and some of the growth opportunities you guys are going to be investing in going forward. Its look that right now ISP is about a third of revenue. How do we see that growing going forward into 2020 and 2021? Any color you can give there that would be helpful?

Sure. So, I think over the next two years we'll see a number of new products get launched. And that's really what's going to drive a big chunk of our revenue growth in the industrial business. If you look at the pipeline that we have today for new products it's about $200 million in annualized contribution margin per ton. So these are all things that are kind of working their way through. In the last 12 months we've launched products which we think have the potential to generate about 20 million tons of annualized contribution over the coming years as they scale up. And then we've got another about $18 million of annual contribution margin generation in what we would call scale up. They're close to being launch, but not officially launch yet. And I was actually looking back at the products that have been launched. I know, we get a lot of questions from investors on what's actually come out. And just to give some examples, we've got a consumer product that looks really interesting. It's actually causing us to add some new production equipment at one of our facilities, but we have a long term contract there with a leading consumer product company. And I think that's going to be a very interesting product. We've launched a high-end filtration product, a new one, a new specialty filler on the DE side. And when we say fillers, we're talking about products that go into the compounding market. So resins, polymers, paints, coatings those type of things. Could still light for quartz countertops. We've talked about that quite a bit and we'll see that ramp up over the next couple of years. And then we have a couple of really cool high-end specialty products, one for high-end ceramic manufacturer and one for the aerospace industry. So, I think we'll start to see more of an impact from these products in the second half of this year and then it should ramp up as we go through 2021. So, I'm very excited about the product that we have -- products that we have here, Cameron, and we'll definitely start to see the effects in the coming quarters.

That's great. Awesome. Thank you. And then flipping to oil and gas proppant demand, looks like it will be about 5% year-over-year in 2020. But if you can maybe talk about some of the things that have given you confidence in that? And then, do we think that could be a creative to contribution margin per ton into 2020?

The proppant market is really interesting. And as you kind of step back in and look at it, I think there's several positives starting to emerge. We've certainly seen West Texas capacity, a lot of it get idled. That we've seen other capacity come out of the market over the last couple of quarters. U.S. Silica, for example, is idled about 8 million tons of capacity and a lot of our competitors have done the same thing. And so, I think that will help drive some rationalization in the market. And certainly from our perspective, we're prioritizing higher sales prices over incremental sales volumes here in Q1. And just generally across the industry, I see a lot of discipline in the sand space right now, which I think is good. But to your point, we're seeing demand pick up pretty strongly here in Q1. We think completions and stages are headed higher. We've seen some estimates that suggest the 10% increase plus or minus in Q1 versus Q4 in terms of completions and stages. So that's all positive for proppant demand. I think we'll see our volumes up a few percent sequentially here as we go from Q4 to Q1. Again, really trying to focus on pricing as opposed to getting that last incremental sales ton. I guess the other comment I have on 2020 is that we'd expect to see the same kind of seasonality of E&P spend as we've seen in 2018 and 2019 so. So just to be specific, I would expect that spend in Q1 will be okay. Q2 and Q3 will be much higher. And then as we get into the fourth quarter, things will fall off. We've always [ph] seen that trend for a couple of years now and my guess is that persists here in 2020.

Great. All right. Thank you so much. And I'll turn it back.

Okay. Thanks Cameron.

Thank you. Our next question comes from the line of Kurt Hallead with RBC Capital. Please proceed with your questions.

Hey. Good morning.

Hi, Kurt. Good morning.

Appreciate. Great summary there. Hey, Bryan, question for you just on the competitive dynamics within the oil and gas business especially as you look at SandBox, I understand that there are a few different dynamics out there that are altering the way that sand is being distributed on in-basin dynamic. You have I guess some conveyor belt system that's supposedly out there. And then you have this mobile processing unit that's out there. Just wanted to kind of gauge -- get your get your feel on how that's impacting SandBox and what you may be doing to combat that?

You know, it's a really good question Kurt. I think as we step back and look at SandBox what we've gained share a very quickly in the market. We think we're at about 24% today market share. And so, just step back and think about that. That means, about one out of every four tons that's being consumed in the oilfield today is being run through a SandBox system. So we've grown pretty rapidly. The loads that we delivered in 2019 were up about 30% versus 2018. So kind of massive increase year-on-year. 2020, feels like it may be more of a flattish year as we work to hold onto that share. And also all the competitive dynamics that you mentioned, I still feel really optimistic about SandBox. I think when you look at the benefits that it brings, they're just enormous. And I saw a recent survey that was done by leading bank. And for the first time ever the respondents in this survey and these were all energy company and service company customers of ours and out of the market. But the first time ever those customers expressed more of a preference for box systems versus silos. So survey said that 48% of these respondents like boxes and only 44% liked silos. So -- and particularly in some of the basins where the pad sizes are the smallest like in the Marcellus or the terrain is tough, so Marcellus, Rockies, Mid-Con and some other areas that there's an overwhelming preference for box solutions and we're the leader in that sector. So I think that benefit is going to accrue to us. And there's numerous advantages over the silo system. So, I feel really good about SandBox and our prospects. And I think we'll have a good year in 2020. I just don't expect to take a whole lot more share this year. We're certainly working on that. But just given the share we took to come into 2020, feels more like there kind of a flattish year to me.

Got you. Thanks. And then just follow-up on the commentary about the pricing again staying within the oil and gas proppant side. Appreciate the fact that you're going to look to maximize that dynamic. At the same token in the prepared commentary you mentioned that. So let me phrase it differently. So in the context I was wondering if you give us some relative magnitude of what kind of pricing improvement you could expect given the discipline that you've already indicated that was under way in the market?

When we look at what's already occurred here in Q1, we're seeing spot pricing up significantly, particularly in West Texas. I would say that what we've seen so far sort of quarter to-date, we're up about $2 to $3 a ton in overall pricing versus our Q4 exit pricing rate. And if you look at spot pricing in West Texas where it was some cases $10 or $12 a ton or something like that at the very end of last year, it's now back up in the low to mid 20s. And I think over time as more capacity comes off line and things rationalize, I think we could end up with a pricing in the mid to upper 20s, quite honestly. It may take a several quarters to get there, but again with the industry looking like its going to be pretty disciplined here. I think there's a chance that we settle out in a pretty good spot.

That's great. Awesome. Appreciate that color. Thank you.

Thank you, Kurt.

Thank you. Our next question comes from the line of George O’Leary with Tudor Pickering Holt. Please proceed with your questions.

Good morning, Bryan. Good morning guys.

Hi. Good morning, George.

Just following on to that prior question on the frac sand pricing front. I wondered if you could maybe bifurcate between Northern White pricing and in-basin pricing? And how those are both trending on a quarter-over-quarter basis and kind of relative to each other? And then, is there any differentiation in the pricing between grade, 100-Mesh 20/40, we even heard 30/50 is getting a little bit above at this point. But just wondered if you walk through any pricing deltas across those various buckets?

So George, I would say what we've seen so far is that the West Texas pricing is up the most and that's really just because it got depressed the most at the end of last year. Northern White sand has been a bit more steady certainly fallen out of favor a bit as we went through 2019 and it's come back some, but not as much as the West Texas pricing. So I think that's where we're seeing the most increase right now. And to your point there are certain grades like 30/50 which seems like its the grade that goes in and out of favor the most. There's times where it's really hard to sell 30/50 in times where we just don't have enough of it for demand. So a lot of it's relative to specific energy company customers and what they like to pump. Some customers love 30/50. So it's sort of all over the map as usual. But I would say most of the pricing rebound right now is in West Texas.

Okay. That's super helpful. And then on the cost reduction side, you guys are clearly making good headway in reducing costs across the board and the $20 million in SG&A reduction was nice to see. From just the logistics and our COGS side of the equation, given the incremental mines that you've idled. Is there any way to frame how much you've taken out of the system and how much you will take out as these ongoing cost reduction efforts continue from a dollars perspective any way to frame that for us?

Yes. Look, we've taken out a lot of cost. To your point, I think we're going to see the cost really start to hit the bottom line, is more on the logistic side. There's really not a good way to frame that. We're really not talking about contribution margin per ton. As you know for a full year impact I think Bryan hit it best saying that as we go forward, we're going to see incremental impacts, the favorable impacts to cost of our CM per ton as we go forward.

I'll sneak in one more if I could. And I appreciate that prior response as well. On that -- so pricing has started to move to beginning of the year. But will we see more of the realization of that pricing move materialize in the second quarter from a results perspective? Or are there some spot pricing? Did it rise early enough and quick enough in the year that Q1 will see some benefit over Q4 on the oil and gas side of the business?

I think we'll definitely see some benefit in Q1 over Q4. And if we stay disciplined as a company and if the market continues to be disciplined, I think we could certainly see that hanging over into Q2.

Thank you guys very much.

Okay. Thanks George.

Thank you. Our next question comes from the line of Connor Lynagh with Morgan Stanley. Please proceed with your questions.

Thanks. Morning guys.

Good morning. Connor.

So, I was wondering if we could just tie all these different moving pieces together, it seems like you'll have a bit of a pricing tailwind in the first quarter, you probably have some lower costs in the oil and gas business after you've finished idling some of these mines. So would you be willing to hazard a guess as to how much contribution margin per ton or contribution margin dollars how you prefer to frame it. Could be up relative to the fourth quarter?

Look, you said a very good in the very beginning of your question, there's a lot of moving parts right now. And look, we've got some as Bryan talked. We talked, we've got some really nice tailwinds. We've got some costs that are coming out. Right now volumes look good. But look in a relatively schizophrenic market. It's really hard to tell and give any guidance on that. Maybe as we move into the following quarter, we'll have a little bit more insight to that. But right now it's difficult to do that just because we really don't know on the volume side where this is headed.

Okay. That's fair. I mean maybe if we could just talk about the things you do know, how big of a cost tailwind do you have? It seems like there was a lot of idling actions and things like that in the fourth quarter and you're still starting to roll off some railcars. So, on that side of things, how much of a benefit would you expect?

I think from the idling of railcars, the railcars coming off lease is where we're going to start to see the cost come out. I think we are going to have a benefit I would say. If you look at the overall benefit of the cost, let's say, contribution margin per ton you're probably looking at somewhere between $2 to $2.50 a ton.

And that's a full year benefit or the first quarter?

That's full year. Well, it will start hitting in Q1. Yes. You're going to start to see that benefit in Q1. So you've got $2-ish a ton that you're going to see from an overall CM per ton impact for these cost take outs in Q1 and then it'll follow every quarter after that.

Got it. Okay. One last one here just on the higher level supply/demand picture here. How do you think about what the incentive prices to bring back some of the capacity that you've pulled out or more broadly in the industry. I mean how much higher does pricing lease move before you think. Is that makes sense to bring back?

The way we look at it, I think there's two components to it, Connor. There's how much higher and for how long. Right? So let me start with the second one. For me personally, I would need to see several months of sustained profitability, of sustained higher prices before I'd be at all excited about bringing capacity back on line, because there's a definite cost to do that. And if you look across the industry, there's two kinds of capacity takeout. There's takeout where sites have been completely shut. And there's a big hurdle there to reactivate. And then there's places where maybe you've taken out a shift or two and you would just need to go out and hire people. So in the second case the barriers little bit lower. In the first case, it's much higher. And a lot of we've seen so far is pretty hard to take out across the system. So if you look in our case for example, we've shut our local mine. We shut our Tyler mine. And to restart those mines would take a lot in terms of what we'd have to see in the market. And I believe just based on the actions that we've seen here in the first quarter would no one sort of rushing to reactivate capacity that the industry in general is kind of coming around at the start of let's just not rush out and get more tons online when we see a spike for a week in pricing. So I think it's going to take much more sustained pricing over a longer period of time to entice most of the rational people in the industry to restart capacity.

All right. Thanks very much.

Thanks Connor.

Thank you. Our next question comes from the line of Jon Hunter with Cowen and Company. Please proceed with your questions.

Hey, good morning and thanks for taking my questions.

Good morning, Jon.

So first one I had is on the overall EBITDA outlook for the year, 165 to 170. If I take your 13 of 14 million tons of oil and gas volume expectation for 2020 and assuming some growth within ISP, you have to assume kind of high single digit contribution margin per ton within the oil and gas business to be able to achieve that kind of level of EBITDA for the year. And I know you mentioned some of these cost-out opportunities and some pricing. But I guess I'm wondering what are the exact moving pieces and kind of a cadence to getting to that level of profitability in 2020 as you see it today?

So I think obviously there are a lot of moving pieces here. And there's a lot of ways that this can play out. I think what we trying to do is to give an indication when we sort of knit that all together recognizing that some pieces are going to move up and down. We felt like this 175 or 165 to 170 number for the year was appropriate, but perhaps conservative. I think there's some upside to that particularly given the early sort of pricing positives that we're seeing.

Got it. And then as it relates to kind of free cash flow for the year, I'm curious how much of the $52 million shortfall revenue was a cash benefit or is expected to be a cash benefit? And kind of what are your expectations for working cap in 2020?

Yes. So the shortfall penalty about a little less than half of that is going to be cash. But that's not baked in right now into our expectation of being free cash flow positive next year. Our goal is to continue to push on our every button we can from cost savings to working capital. I'm glad you brought that up. Working capital was a big source of our cash in 2019. And I think we've got more to squeeze out of that in 2020. So we're goiong to continue to focus on that.

Got it. Thank you.

Thanks Jon.

Thank you. Our next question comes from the line of John Watson with Simmons Energy. Please proceed with your questions.

Thank you. Good morning.

Good morning, John.

Good morning, Bryan. I wanted to start on ISP. It's obviously a fluid situation. But could you talk us through how the coronavirus could potentially impact that segment? How you're thinking about it today understanding that it's subject to change?

Sure, John. A very good question. I would say, as of this point we haven't seen any impact from the coronavirus. I think there's sort of two sides to that coin for us. On one hand, we have some of our customers across the industrial sector who have parts of their supply chain in China. So those are customers ultimately could be impacted to some degree depending on how this plays out. So it's on the negative side. On the other side of the coin, we have an emerging competitor in China who is relatively small, but aggressive competitor out there in the market. And so, I would expect that they may face some challenges as well. So I look at all that sort of on balance and it's hard to see a real positive or real negative for us just sort of back way up from it. And if there's a massive sort of disruption to global business as a result of this we'll certainly we'll be pulled into that. Our industrial business sells to more than 10,000 customers across all kinds of value chains. So I would say we would be impacted probably at an average of a variety of industries. We're not overly concentrated in any sort of specific area at this point in terms of an industry or geography and we still have probably 85% of our sales and profitability coming domestically. So I think we're not tremendously rely on sales outside the U.S. But as I said before some of our customers definitely have global supply chains.

Sure. Okay. That's helpful. Secondly, I wanted to follow up on John's question with respect to the shortfall. And I appreciated the pricing and demand dynamics you outlined. What would have to change in terms of the pricing demand environment for you to realize more shortfalls this year? Is that something you're anticipating and that you're baking into the adjusted EBITDA commentary that you made earlier?

No. We don't have a lot actually baked into that at all. Look, my expectation and my hope is that, we continue with a strong oil and gas environment and all of our customers are sort of byproduct to their contract levels. I think what I would say though is that our expectation at the same time is that customers do live up to their contractual commitments no matter what. And I think this discussion around the shortfall penalty is a good example of us holding customers accountable for the contracts that they signed up for.

Right. Okay. Thanks for that Bryan. I'll turn it back.

Thanks, John.

Thank you. Our next question comes from the line of J.B. Lowe with Citi. Please proceed with your question.

Hey, good morning guys.

Good morning, J.B.

Just to wrap up that last line of questioning. On the 13 to 14 million tons you guys are expecting in 2020, how many of those are actually under contract?

We have about 80% of our sales this year under contract for oil and gas.

And so, is there a potential that we do see further shortfall payments as we move throughout the year based on what you've been -- the discussions you've been having with your customers?

I mean, that's not our expectation. But certainly it's a great backstop for us. It should something change. The market looks pretty robust in the oilfield right now. So that's not anywhere in our base case. But as I said, is always the backstop in case things don't go well in the market this year.

Okay, great. And then just my other question was on SandBox. You saying that you don't think pricing is going to get too much worse. Is that a function of the competitors in the market just being a little bit more disciplined. Because I know that there's pushes into both types of systems from some of your competitors. Just wondering what their kind of pricing behavior has been in recent weeks and months?

So I think what we're starting to see is somewhat of a settling out of the market. And you kind of get a sense of which customers like boxes, which customers like silos. And it feels like the market share is starting to kind of level out. And so I think some of the aggressiveness that we've seen out there from some competitors perhaps moderates a bit this year just as look, if you continue to try to take share from certain customers or in certain regions or something and you don't have success at some point you probably give up and you become happy with the share that you have. And so I think perhaps some of the aggressive actions and pricing that we've seen from our competitors which frankly is unsustainable in some cases may that moderates a bit in 2020. And it's hard to tell for sure. But it is a relatively small competitive said. It's not like there's 20 players like in a sand industry or SandBox has a much more kind of narrow set of competitors. And quite frankly there's only and maybe three or four out there including ourselves that really matter in terms of share.

All right. Great. Thanks so much.

You're welcome.

Thank you. Our final question comes from the line of Lucas Pipes with B Riley FBR. Please proceed with your questions.

Hey, good morning guys. This is actually Dan on for Lucas. I just had a quick question on the oil and gas contribution margin. If I'm remembering correctly back in November you had guided that pretty significantly lower sequentially. And looking at the number I think it actually came in like 35% higher. So, if you could just get some color on maybe what happened there, if it was just like pricing on uncontracted volumes came in a lot better. If there were some costs you're able to take out from the idled mines that would be great? Thanks.

Look, I think we're starting to see some of the impact of idled mines and lower cost, but you have to take into consideration the shortfall penalty that's in there as well and that's what's impacting -- that's the most dramatic upside of the contribution margin per ton in the oil and gas segment.

Got it. And then just one follow-up on a higher level. Maybe if you could break out the demand outlook by basin. Especially curious about maybe what's going on in the more natural gas heavy plays like the Marcellus where pricings are really fallen off and some of those players are having a bit harder time financially? Thanks.

Yes. I don't have a specific breakout in front of by basin. But I can comment on the Marcellus. We've seen pretty strong demand up there quite honestly. We're extremely well-positioned there. We can deliver by barge or by rail. And I think we're the lowest landed cost supplier into the Marcellus. So, we've had pretty good luck there in terms of sales over the last few quarters. Now look I do take your point. We know that natural gas pricing has come down substantially and we'll perhaps be under further pressure. So we'll watch that closely. But the Marcellus has been pretty strong for us. Mid-Con has been strong. And we actually do really well out west. So we're in all the basins. And so whether you want local sand or Northern White. I feel like we can be one of the most effective total supplier across the country.

Great. Thank you.

Thanks, Dan.

Thank you. There are no further questions at this time. I'd like to turn the call back over to Mr. Shinn for any closing remarks.

Thanks operator. I'd like to close today's call by reemphasizing that we continue to focus on a few key priorities, namely, accelerating organic growth in our industrial business, effectively deploying our oil and gas assets to maximize profitability and then of course generating free cash flow. I'm confident that we have the right strategy, the right plan and the right resources for success. And I'm very optimistic that 2020 will be a strong year for U.S. Silica. So with that, thanks for dialing into our call and have a great day everyone.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.