U.S. Silica Holdings, Inc.
Q1 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Greetings and welcome to the U.S. Silica First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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 Lawson:]

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's first quarter 2017 earnings conference call. With me on the call today are Bryan Shinn, President and 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 risk 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 yesterday'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 all who wish to ask a question may do so. And with that, I would now like to turn the call to our CEO, Mr. Bryan Shinn. Bryan?

[Bryan A. Shinn:]

Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing our strong first quarter results, followed by an update on the investments we're making in our Oil and Gas business to keep pace with a surging demand for frac sand; as well as the actions we're taking in our Industrial business to diversify our product offerings, penetrate new markets and enhance our bottom-line results. I'll conclude my prepared remarks with a market outlook for both of our operating segments. Don Merril will then provide some additional color on our financial performance during the quarter before we open up the call for your questions. I'm extremely pleased to report that for the first quarter, total company revenue of $244.8 million improved 34% sequentially, while adjusted EBITDA of $42.7 million more than doubled compared with the fourth quarter of 2016. First quarter contribution margin in Oil and Gas was $38.8 million, up $20.4 million on sale volumes of 2.5 million tons, a 22% improvement sequentially and on par with the growth in well completions from 4Q 2016 to 1Q 2017. The sequential improvement in Oil and Gas contribution margin was driven by a combination of higher volumes, higher pricing and a significant increase in activity at Sandbox, our industry-leading last mile logistics solution. Our Industrial and Specialty Products unit had a very strong quarter as well with contribution margin of $20.2 million, improving 20% on a year-over-year basis and setting a new all-time record for first quarter. Successful global price increases and a stronger contribution from new higher-margin products lifted ISP profitability both sequentially and quarter-over-quarter. Turning to the business today on Oil and Gas side, continued industry recovery and powerful positive secular trends in the sand space are driving unprecedented demand for frac sand and last mile logistics. The U.S. rig count was up 27% during Q1 and proppant loadings and lateral lengths continue to grow. Our proprietary database that tracks U.S. completions activity indicates that approximately 300 frac crews are active today, up 9% from just a couple of months ago. On our fourth quarter call, we outlined the steps we're taking to meet this growing demand through a combination of greenfield sites and brownfield expansions with a likelihood of some M&A in the mix as well. Our comments last quarter and other industry capacity expansion announcements have created questions from some investors over the potential future supply and demand balance of sand proppants and the implications for pricing and other industry dynamics. Let me take a few minutes this morning to share some thoughts on how we see this unfolding and why we believe that the sand proppant market fundamentals should stay strong for the foreseeable future. We believe our industry will remain tight in the near future due to three main factors. First, our industry must add capacity to meet customers' needs. Our internal estimates and current sale-side reports estimate industry sand proppant demand to be about 75 million tons here in 2017, growing to over 100 million tons in 2018, with some estimates as high as 147 million tons. Our industry will be short capacity and we cannot let sand become the bottleneck for the completions industry. Second, all sands is not fungible within that 100 million-plus tons of projected 2018 demand. Unlike many industrial products, there's a lot of friction in the sand market for a variety of reasons, including logistics, quality differences and mesh sizes. Therefore, we on average should see 20% to 25% more total supply than demand before our markets come into balance. So, for example, if 2018 demand is 110 million tons, that implies its supply and demand balance around 135 million tons of effective capacity. Today, even after estimated reactivations of idle capacity, our industry would only have approximately 90 million tons of effective capacity, thus leaving a 45 million tons shortfall versus projected 2018 needs. And third, even all the likely capacity additions that are being talked about are not enough. We think there could be an additional 10 million to 15 million tons of brownfield capacity added in the next 12 to 18 months, including our own expansions; and perhaps, as much as 20 million to 25 million tons of greenfield capacity being added locally in the Permian, all of which will be needed if current demand estimates prove accurate. Even if our estimated 35 million tons of potential brownfield and greenfield additions come on line, the market will still be short. There's several implications of this on a national level. First, our markets are expected to stay very tight. Most of the major sand suppliers, including U.S. Silica, are running flat out today. Demand is expected to continue growing faster than supply for the foreseeable future, and as such, we expect to continue pricing recovery and improving margins in our sand sales. Second, customers are coming to us to lock in sand supply for the next three to five years. We're using these discussions to form deeper relationships with the companies that we expect to be the long-term winners. We're also working on the next generation of agreements that can better weather the cycle both for our customers and for U.S. Silica. And third, rapid growth in proppant demand represents a massive opportunity for Sandbox. Keep in mind that this new local sand phenomenon is not just an opportunity for U.S. Silica to substantially increase sand sales. All this new capacity has to get to the wellhead and we believe that Sandbox is the ideal delivery solution with an unmatched combination of flexibility, efficiency and scalability. Now, let's talk more about the Permian, specifically. It remains very hard to add capacity there. Despite all the hoopla, there are numerous challenges to bringing on new capacity locally in the Permian, including permitting, water, infrastructure, trucking and equipment availability, just to name a few. You not only need to find a good site, you need a lot of cash and the ability to sign long-term contracts with reliable customers, which leads me to my final point. When it comes to local sand, it's definitely not a field of dreams. We believe the market for local Permian sand will have limitations in that it will only be a subset of E&Ps who choose to use these products. And once those companies or their service companies sign long-term supply agreements, it's highly unlikely that additional capacity would be needed or built. Moreover, Permian local sands might not be right for some E&Ps because of their well designs and geology within their acreage. To sum it up, we believe that the winning sand proppant suppliers will be companies like U.S. Silica that have a strong balance sheet to fund expansions, the lowest operating costs, the ability to offer their customers numerous sand types and grades in all the major basins, along with industry-leading last mile logistics and the lowest delivered cost to the well. Turning to our expansions, we're making great progress on our work to increase capacity at selected existing facilities. We're in the process of completing design work and securing the various permits required. We've been able to secure the long lead-time equipment needed for these expansions with preferential delivery dates relative to others based on our longstanding relationships with key suppliers, and also on our industry-leading position. We also continue to evaluate opportunities for greenfield expansions in the Permian to take advantage of current market trends and increase product offerings for our customers. From an operations perspective, we set a record for lowest logistics cost per ton in the first quarter and shipped a record 90 unit trains, with 41% of our total Oil and Gas volumes now being shipped via unit trains. We took 304 railcars out of storage during the quarter and, as of today, have no railcars in storage. During the quarter, we also modified a contract with one of our major railcar supply partners, the terms of which are confidential, but favorable to both sides, providing the additional cars we will likely need in the future to meet growing demand. We also saw very strong growth in both volumes and profitability at Sandbox. In Q1, loads shipped were up 84%, sequentially. We now have almost 40 active crews across the major basins and are well on our way to doubling that number by the end of this year. Looking at the Industrial business, we've implemented price increases so far this year on over 90% of our products and have seen dramatic growth in some of our new offerings, which now comprise 10% of ISP's total segment contribution margin. Last month, we announced a niche acquisition in ISP that provides our company with a new capability in the growing market for energy-efficient industrial roofing. Cool Roof Granules could be a homerun, to use a baseball analogy, based on our offering and the potential size of the market. It's an excellent example of the kind of adjacencies to our core business that we're pursuing in ISP to support our customers' growth initiatives, penetrate new markets, diversify our product offerings and enhance our bottom-line results. Turning now to our outlook, as I noted earlier in my prepared remarks, we expect to continue to see strong demand for our Oil and Gas products and last mile logistics services in the quarter ahead, driven by an improved rig count, higher proppant loadings and market share gains on the part of Sandbox. Given that, we could see 15% to 20% higher sand volumes and pricing in Q2, and I also expect that Sandbox load volumes should increase more than 20% sequentially. Most of ISP's end-markets are expected to grow at just GDP rates this year. However, we expect that our Industrial business will grow at more than 5 times GDP from a combination of new product sales, price increases and share growth in base markets. The bottom line is that U.S. Silica is extremely well positioned for growth in both of our operating segments in 2017 and, based on current market outlooks, we expect to deliver strong top- and bottom-line results for the year. And with that, I would now like to turn the call over to Don Merril. Don?

[Donald A. Merril:]

Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our two operating segments, Oil and Gas, and Industrial and Specialty Products. Revenue for the Oil and Gas segment for the first quarter of 2017 of $193 million improved 41%, sequentially, compared with the fourth quarter of 2016, driven by a combination of higher volumes, higher pricing and increased activities at Sandbox. Revenue for the ISP segment of $51.8 million improved 14% on a sequential basis from the previous quarter, driven by a combination of higher volumes and global price increases. Contribution margin on a per ton basis from our Oil and Gas segment was $15.34 compared with $8.88 for the fourth quarter of 2016. The increase in profitability in our Oil and Gas business was driven by the increase in price, fixed cost leverage due to more tons produced than sold, and higher activity levels at Sandbox. On a per ton basis, contribution margin for the ISP business of $23.48 improved 20% compared with the same period of the prior year. The year-over-year improvement in ISP profitability was driven mostly by a combination of improved pricing and an increase in new high-margin product sales. Turning now to total company results, selling, general and administrative expenses in the first quarter of $22.3 million were up 17% compared with $19.2 million in the fourth quarter of 2016. The sequential increase of SG&A expense is due largely to increased compensation-related expenses. Depreciation, depletion and amortization expense in the first quarter was $21.6 million compared with $21.2 million in the fourth quarter of 2016. The increase in DD&A was mainly driven by incremental expense related to continued capital spending and higher depletion cost due to more tons sold. Continuing to move down the income statement, interest expense was $7.6 million for the first quarter and $8 million for the fourth quarter of 2016. Other expense was $4.9 million for the first quarter versus other income of $867,000 in the fourth quarter of 2016. The change was primarily due to the costs associated with restructuring a railcar contract that Bryan mentioned earlier. From a cash perspective, we recognized an income tax benefit of $1.7 million during the first quarter, all of which, $1.5 million, was related to excess tax benefits on equity compensation. Now, turning to the balance sheet, cash and cash equivalent as of March 31, 2017, totaled of $660.9 million compared with $711.2 million at the end of 2016. As of March 31, 2017, our working capital was $767.5 million and we had $46 million available under our revolving credit facility. As of March 31, 2017, our total debt was $512.5 million compared to the $513.2 million at December 31, 2016. During the first quarter, we incurred capital expenditures of $23.6 million, primarily for engineering, procurement and construction of our growth projects and other maintenance and cost improvement capital projects. As stated in the press release, the company expects full-year 2017 capital expenditures to be in the range of $125 million to $150 million. And with that, I'll turn the call back over to Bryan.

[Bryan A. Shinn:]

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

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Michael Lamotte with Guggenheim Securities. Please proceed with your question.

[Michael Lamotte:]

Thanks. Good morning, guys, and congrats on the quarter.

[Bryan A. Shinn:]

Thanks, Michael. Good morning.

[Michael Lamotte:]

Bryan, if I can start off, back at the Analyst Day, you did a good job delineating the market in terms of the general trend towards finer sands and local sands. I'm wondering if you could provide us an update on that, particularly with respect to the trend towards lower-quality sands, lower silica content sands and what we're seeing just in terms of meshing quality trends in general right now?

[Bryan A. Shinn:]

Sure, Michael. So, I would say what we're seeing right now is a continued trend towards the finer grades. If you look at the demand that we have out there today, there is more demand for 40/70 and 100 mesh, the two finer grades, say, than a 20/40, which is the coarse's grade. We've also seen some customers over time choose to use, as you said, sort of the lower quality or more local sand, particularly in the Permian. We think we'll see a continuation of that trend. But as I said in my prepared remarks, we're also running into a number of customers who are telling us that they tried those products and don't necessarily like the results that they're getting in their wells, or have just decided for a variety of reasons, because they don't think those are the right products, to use them. So, it'll be interesting to see how things play out over the next several quarters here. I believe that this trend is going to be just like some of the others in our industry that at the end of the day there'll be some kind of a balance that settles out between, say, Northern White and regional sands, and we know ours is not a homogeneous industry that seems like the frac industry like to do things differently and different engineers like to complete their wells differently. So, I think we'll continue to see a mix out there. And I believe that the strategy that we have in U.S. Silica is the right one, which is to be able to serve all the needs, whether customers want Northern White sand or whether they want regional sand, very local sand, want it delivered in the Sandbox. We've got all those bases covered and we're going to continue to expand our offerings to make sure that we can hold or grow our share in this growing market.

[Michael Lamotte:]

Okay. And then a quick follow-up for me. You mentioned that some customers looking for three- to five-year contracts. Now, I imagine with the pace of inflation in sand prices right now, there's a strong desire on their part to try to lock-in as much term as possible. How do you approach sort of balancing that benefit of the visibility with the desire to capture as much price as you can in the up-cycle?

[Bryan A. Shinn:]

It's a really good question, Michael. I mean, it's something that we debate a lot internally here. I said in my prepared remarks that we're working on what we have called sort of our next-generation contracts. And so, I think we have a really interesting opportunity here, given the demand and the short supply in the market. And I think most of our customers believe that that short supply is going to continue into the foreseeable future, as we do. So, it gives us a great opportunity to form those deeper partnerships with the key customers. As we think about those next-generation contracts, we really want agreements that can weather the cycle and work for both ourselves and our customers. It really doesn't do any good to sign a one-sided contract because you know how that turns out in this industry. So, we're trying to go for some longer terms, as you mentioned, three to five years. We also have some other interesting contract designs that I think can make them – the contracts a bit more sticky, if you will. So, we'll continue to look and work on those, and I think we'll either sign some contracts at pretty attractive fixed rates or have those that perhaps adjust up and down in terms of pricing with the market activity. But we're really looking to find contracts with the right customers and get those signed up. With that said, we're not in a tremendous hurry to sign contracts. I would say the only exception to that perhaps would be where we're looking at greenfield development. Given the capital and the risk involved in those, it certainly is better to have a really solid contract to backstop that investment.

[Michael Lamotte:]

Great. Thanks, Bryan.

[Bryan A. Shinn:]

Thanks, Michael.

[Operator:]

Thank you. Our next question comes from Ken Sill with SunTrust Robinson Humphrey. Please proceed with your question.

[Ken Sill:]

Thank you, and congratulations again.

[Bryan A. Shinn:]

Hey. Thanks. Good morning, Ken.

[Ken Sill:]

Yeah. I don't want to rain on the parade, but I do have a question on your average cost per ton in Oil and Gas that was up sequentially. And I'm trying to figure out this 8% increase sequentially, and trying to parse out how much of that might be related to extra cost incurred to kind of expand and how much is just costs are inflating across the spectrum and not just where the world is going?

[Donald A. Merril:]

Yeah, Ken. So, you have to remember that the cost associated with Sandbox is in our cost of goods sold number. So, most of that increase is due to having additional cost in there, but no additional tons coming from Sandbox. So, most of that increase comes from that. We also did see increased maintenance expenses in the quarter versus Q4. And to a minor extent, we also had an additional $0.50 or so a ton associated with carpools as we are getting our final cars out of storage.

[Ken Sill:]

So, that $0.50 per ton is going to go away this quarter, but the rest of it...

[Donald A. Merril:]

That's right. And I would...

[Ken Sill:]

Sandbox will continue to grow (23

[Donald A. Merril:]

No, I think we were a little high on maintenance as well. So, you'll see that – maybe that level out as well. But Sandbox is going to continue to add cost as we expand that business. But you have to remember the flipside of that is it adds to the contribution margin as well.

[Ken Sill:]

Yeah. So, it's showing up in the revenue side...

[Donald A. Merril:]

You got it. Exactly.

[Ken Sill:]

...in the revenue per ton. Okay. And then just wanted to see if you'd make a comment on perhaps the largest customer for sand in North America in their conference call yesterday said that they see plenty of capacity coming and they're not worried about pricing on sand going forward. I'm not sure how much that is, because they got cut short sand in the first quarter, if they'd gone out and signed a lot of contracts or if they've just adjusted their contracts to pass this through. But I guess you've kind of commented on the tug-of-war between capacity coming on and demand going up. But what do you guys see as the risks out there to too much capacity in the short run and the idea that people would find ways as the price of sand goes up to use less sand by being smarter about how they place it in the well (24

[Bryan A. Shinn:]

So, I think, Ken, in the short term here, let's call it between now and the end of 2017, the only real capacity additions that we see coming on line are the reactivations that are going on across the country. And our estimate is that there's about 10 million to 15 million tons of reactivations that could occur throughout the year here. The vast majority of those, in our experience, will be the higher-cost mines that were shut off in the downturn. And, look, at the end of the day, from a pricing standpoint, which I know is kind of where your question is headed, if those mines get reactivated with their much higher cost structure, they become the marginal producers out there in the short market. And so, I think that's a pretty positive sign for pricing, quite honestly. I don't see much new capacity coming on line in terms of brownfield or greenfield this year. I think we'll see some start to come on in maybe the very end of this year, like some of our brownfields are earlier in 2018. But after the next several quarters, I just don't see much there. And look, what we're seeing is the market tightening pretty substantially and we'd continue to see price increases, right through every month so far this year. So, we're pretty optimistic on where pricing is going to go in the foreseeable future here.

[Ken Sill:]

Okay. That's great. And then just final question, could you give us any estimate, if possible, on the timeline for your investment or acquisition, or whatever on more in basin sand in the Permian, Delaware?

[Bryan A. Shinn:]

So, we're looking at a couple of different things as we talked about last quarter. So, we tend to think about three buckets. So, we've got brownfields, which are expansions of our existing site; the greenfield, which you just referred to; and honestly, M&A. I would say kind of starting with the brownfield perspective, we're probably talking plus or minus 4 million tons that we think we could bring online over the next several quarters. I would say that the first of that capacity wouldn't be online until probably late in 4Q and then in the first half of 2018, perhaps, the rest of that comes online. In terms of the greenfield specifically, I think we can have one or two greenfield sites in the Permian. There's lots of challenges to getting those built. And even with all of our sort of years of experience doing this, it's not like you just sort of show up and have shovel-ready projects. There's a lot of work to be done there. So, I would anticipate that the first of our greenfield capacity would probably be coming online no earlier than the middle of 2018 and could be as late as the third or fourth quarter, depending on the kind of delays and issues that we hit along the way.

[Ken Sill:]

Thank you.

[Bryan A. Shinn:]

Okay. Thanks, Ken.

[Operator:]

Thank you. Our next question comes from the line of Jim Wicklund with Credit Suisse Please proceed with your question. Mr. Wicklund, your line is now live. Please proceed with your question. James Wicklund - Credit Suisse Securities (USA) LLC Can you hear me now? Sorry about that.

[Bryan A. Shinn:]

Yeah. We can hear you, Jim. James Wicklund - Credit Suisse Securities (USA) LLC Sorry about that.

[Bryan A. Shinn:]

That's all right. James Wicklund - Credit Suisse Securities (USA) LLC Bryan, you mentioned 20 million to 25 million tons added locally in the Permian. Are you including the 10 million tons in Winkler County, and is that a high-level estimate of how much will be added over the next two years or are those discrete projects that you guys are tracking? I'm just curious to know, and this is everybody's question is how much Texas sand will come on in the next couple of years. And you did a great job of explaining the timing of it. I'm just curious whether your 20 million to 25 million tons added locally in the Permian includes the 10 million tons we already know about and then 15 million tons more that may happen or 15 million tons more that's booked? Can you give us a little granularity on that?

[Bryan A. Shinn:]

Sure, Jim. It's a great question and I know a lot of investors are interested in this. That's everything that we are aware of and, obviously, we're right in the middle of all of this. And those are all the, what I would call, the potential additions. We tend to be somewhat conservative. And so, I think what actually happens is less than that. You're already seeing a lot of things slow down, quite frankly. There are a lot of folks that made big announcements and a lot of splashes and talk out there about what they were going to do, but the realities on the ground are always harder. So, once again, when we do our estimates we sort of assume the, quote-unquote, worst case, which would be that 20 million to 25 million tons. I think what actually comes on is probably less than that, if I had to handicap it. James Wicklund - Credit Suisse Securities (USA) LLC Okay. That's very helpful. And you're right; that's the thing investors seem to be most focused on right now.

[Bryan A. Shinn:]

You bet. James Wicklund - Credit Suisse Securities (USA) LLC And my follow-up, if I could, you mentioned a 15% to 20% higher sand volumes and pricing. Is that 15% to 20% volume and 15% to 20% higher pricing or is that a combined number? And I'm curious whether that's at the mine gate, or are you just talking about a revenue per ton perspective on a reporting basis?

[Bryan A. Shinn:]

A really good question, Jim. I'm glad you brought it up, because I could see how that could cause some confusion. So, we're talking about a 15% to 20% increase in volume and a 15% to 20% increase in pricing. James Wicklund - Credit Suisse Securities (USA) LLC There you go.

[Bryan A. Shinn:]

So, it's both, right? And we look at, obviously, all the things that are on the board in terms of sales opportunities very carefully. I actually sit down with our sales team every Friday and we spend an hour or so going through all this. And just kind of give you the inside look to the type of things that we're seeing out there right now, from last Friday's review, we had a lot of sales in the pipeline that are in the sort of mid- to upper-$20s in terms of contribution margins per ton. Some in the $30s, and actually the highest prices we had on the board – or the highest margins we had on the board were over $50 a ton in terms of contribution margins. So, we're definitely seeing a pretty strong comeback in pricing and margins. So, it's pretty exciting to see where that's all headed right now. James Wicklund - Credit Suisse Securities (USA) LLC Okay. Excellent. And thank you, Bryan, for the – I mean, the market really needs this kind of granularity in detail. So, it's very much appreciated. Thank you.

[Bryan A. Shinn:]

Thanks, Jim.

[Operator:]

Thank you. Our next question comes from Marc Bianchi with Cowen & Company. Please proceed with your question.

[Marc Bianchi:]

Thank you. I was hoping you could help us a little bit with how much Sandbox contributed to the contribution margin in Oil and Gas in the first quarter?

[Donald A. Merril:]

Yeah. Marc, we really haven't given that type of detail on Sandbox. And quite frankly, it's not that easy to do because of just how the businesses are really coming together and coalescing.

[Marc Bianchi:]

Okay. Well, perhaps, can you say, is it as much as a third of the contribution margin in the segment?

[Bryan A. Shinn:]

So, Marc, I guess the way I look at it, if you think about the Sandbox progression, we talked about investing $23 million in CapEx to roughly double our capacity in Sandbox from 23 to 46 crews, and we said that we'd have roughly 40 crews deployed as we kind of got into the second quarter. And we're right on track for that. And we've also previously said that, plus or minus, a Sandbox crew typically generates around $1 million of EBITDA per year. So, I think it kind of gives you a sense of where it is. As Don said, it's becoming harder and harder to sort of disentangle this, because we have sand delivered to the wellheads at kind of a one price and there's lots of different sort of internal things that make it difficult to unbundle it. But hopefully, that gives you a sense of the kind of contribution that we're getting from Sandbox. That said, we saw, obviously, strong increases in sand volume throughout the quarter, and both pricing and margins increased every month through Q1, and we're seeing the same – I'm talking for sand now, every month through Q1 and we're seeing that again in April.

[Marc Bianchi:]

Okay. Well, thanks for that, Bryan. I guess, sort of following up to Jim's question on the margins and your comments on the margins, you threw out a bunch of numbers there in terms of where the market is. But based on if Sandbox was $10 million or something in the first quarter, that would imply a legacy contribution margin of something like $11. So, what's the trajectory for that sand legacy contribution margin realization in the second quarter here, given what your earlier comments were on where the market is?

[Bryan A. Shinn:]

So, I think we'll see another nice improvement in that margin in Q2. And you can imagine, as we're starting to get opportunities in mid-$20s, few in the $30s and some in the $50s in terms of contribution margin per ton, that averages up pretty quickly. We've also gone back and are working with some of our customers who have lower-price contracts. And I think we'll be renegotiating those contracts. I think customers realize that prices have moved. And so, all of those things feel like positive tailwinds to pricing as we go throughout the year here.

[Marc Bianchi:]

Is it unreasonable to get $20 a ton on average in the second quarter for the sand business excluding Sandbox?

[Bryan A. Shinn:]

I don't know. I'll pitch that question to Don. He's more in touch with those kind of detailed numbers than I am.

[Donald A. Merril:]

Yeah. Look, I mean, you could be pushing that number, I think, all in. So, if you were just to take a look at all the contribution margin for our Oil and Gas segment, you're probably in the mid-20s.

[Marc Bianchi:]

Okay. Maybe just one more on the volume progression, you mentioned the volumes for the second quarter, but that would kind of put you in nearly the 12.5 million tons capacity that you've got here for the company. What's the limitation on volume growth for the third quarter based on the brownfield expansions that you've got? Are you capped or do you think that you'll be able to kind of grow solidly double digits if the market is there for you?

[Bryan A. Shinn:]

So, we're working very hard, as you can imagine, to get more tons in play given the dynamics in the market today. The teams are just working night and day to try and get more brownfield sooner given the customer demand. It's going to be a challenge to get it in 3Q. I think what you'll see is that, as you said, we'll be sort of capped out at 12 million or 12.5 million tons for a little while anyway. But we're trying like heck to get more of that brownfield expansion that we now have slated coming online in Q3 to try and get some of that in – Q4 it's coming online, try and get some of that into Q3 if we can, Marc. But there's no guarantees of that given that there's permits to be had and equipment on order. And it's amazing, as we went out and started the project work to do some of this capacity expansion, one of the things we quickly found was that all the equipment manufacturers were pretty busy. And so, there are definitely some bottlenecks on things like dryers and screens. And I think that's going to be another limitation to the industry's ability, including our ability, to add capacity quickly.

[Marc Bianchi:]

Sure. Thanks for the comments. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Thank you. Our next question comes from the line of George O'Leary with Tudor, Pickering, Holt & Company. Please proceed with your question.

[George O’Leary:]

Good morning, guys.

[Bryan A. Shinn:]

Good morning, George.

[George O’Leary:]

I heard a little bit from some of your peers in the industry that customers who are seeing kind of scarcity of the grades or the types of sand that they'd like to purchase are actually offering to help finance new-build mines, possibly brownfield expansions. And just curious if you're seeing any of that and what kind of form that maybe is taking thus far or might take going forward?

[Bryan A. Shinn:]

Yeah. So, it's a really interesting question, George. And I think that's one of the things that we're definitely seeing out there. We've had a number of conversations with customers who are amenable to those type of arrangements. And when I spoke earlier about the next-generation contracts, that's definitely one of the options that's in there. And if you can get a customer to prepay or to offer some cash up front, certainly it makes the whole contract stickier once they've made that payment.

[George O’Leary:]

Great. That's really helpful. And then, just a follow-up around pricing, as you provided some good color. But just curious if you could speak to the delta in pricing or the pricing dynamics across different grades of sand, whether it'd be the finer mesh sands and tighter supply moving up more meaningfully. Has 20/40 started to move at all? And then, maybe if you guys are just selling anymore 20/40 or 30/50 today than you were a quarter or two ago?

[Bryan A. Shinn:]

Well, I think you nailed it, as you talk about the finer grades being more in demand. So, certainly, 100 mesh and 40/70 have higher prices today than, say, 20/40. 30/50 seems to be gaining some additional traction out there. But I would say, 20/40 is the one that is in the least demand right now. Although we have seen some customers, particularly in the Midland Basin think about using more 20/40. And particularly, some of the regional 20/40 we have, like the 20/40 out of Boca (39

[George O’Leary:]

Great. And then, maybe just one more from me if I could. We continue to hear and you alluded to it as well in your comments that completions are lagging in drilling. Would you say that is more a function of – and you mentioned versus a few months ago completion crew count up 9%, I think, earlier in your comments. Would you say it's more an issue of frac crews in the field? And so, is there kind of some stealth demand out there as frac crews catch up to the drill-bit in terms of well completions activity?

[Bryan A. Shinn:]

Yeah. I think that's a big contributing factor to it. It seems like there's just not enough frac crew horsepower and other services out there right now. And so, I think that it's a great opportunity for our service company customers as things start to catch up a bit here. As we've seen these DUCs go up, there could be a surge coming. And I think that's the good news. The bad news is it's going to stress everybody's supply chains again. And I think that could lead us into another round of a substantial pricing increases as well. So, we'll see how that plays out.

[George O’Leary:]

Great. Thanks very much for the color, Bryan.

[Bryan A. Shinn:]

Thank you, George.

[Operator:]

Our next question comes from Ole Slorer with Morgan Stanley. Please proceed with your question.

[Ole H. Slorer:]

Yeah. Thank you. Hi, Bryan. I'm sorry I was...

[Bryan A. Shinn:]

Good morning, Ole.

[Ole H. Slorer:]

...stuck on another earnings call. I was stuck on another earnings call this morning, which I can tell you wasn't nearly as exciting as your earnings call. So, I think (40

[Bryan A. Shinn:]

Ole, I'm disappointed. You didn't turn into our call first? I can't believe it.

[Ole H. Slorer:]

I regret it sincerely, I have to tell you. Yours is clearly where the action is. But I'm sorry to – I heard Wicklund talk about it, but I'm sorry about going back to something you probably already have addressed. But it's sort of all the questions I get is about all of these traditional high-cost operators compared to you claiming that they're buying low-cost sand, which in itself seems like an oxymoron. I mean, you've raised a bunch of capital. You have not been able to put it all to work. So, could you give us your sense again? I'm sorry you already done it, but why you turn some of these things down? And what do you think that the true full cost is on some of those things that are being touted as less low cost?

[Bryan A. Shinn:]

It's really good question, Ole, and as you can imagine, we spend a lot of time looking at all sorts of alternatives and working with our customers to make sure we understand their needs. And so, that's where we're starting all of these. We work closely with our customers and we see others out there buying things that sort of looks perhaps like desperation in some cases, but we tend to focus on what the customers want and work our way back. And so, I think we are focused on the most attractive, best-positioned M&A and greenfield opportunities in the space. And our team has a pretty good rubric to sort that out, to make sure that we make the best decisions. And I think you can see from some of the things we've done, whether it's the capacity expansion we've announced or the M&A that we've done that we've been really discipline in what we've focused on. So, I think we'll continue to do that. Some opportunities, as you've said, that look great on the surface, but when you dig in, you find lots of different issues. And once again, it goes back to the customers. As we're considering opportunity, we'll go to talk to some of our larger customer partners and ask them what they think about it. And depending on the feedback we get there, that tends to inform our decision pretty substantially.

[Ole H. Slorer:]

Yeah. I would imagine that having been effectively the only buyer with a strong balance sheet back when everybody else was a seller and you didn't bite. So, I mean, is it fair to say that you've screened a lot of these opportunities?

[Bryan A. Shinn:]

I think we've screened everything. Some of them, we've screened them two or three times. And one of the other questions we ask ourselves is not just what looks good today, but where things go in the future. And so, we tend to look at kind of who the winners and losers are going to be in terms of locations and products. And we're looking to go kind of where the market's moving in the future and not perhaps where it's been in the past.

[Ole H. Slorer:]

Okay. Thanks for that. And by the way, I would encourage you never to tell anybody how much money you're making on Sandbox, particularly (44

[Bryan A. Shinn:]

Thanks, Ole. Thanks for that.

[Operator:]

Thank you. Our next question comes from Kurt Hallead with RBC Capital Markets. Please proceed with your question.

[Kurt Hallead:]

Hey. Good morning.

[Bryan A. Shinn:]

Good morning, Kurt.

[Donald A. Merril:]

Good morning, Kurt.

[Kurt Hallead:]

Yeah. Thanks. Hey, that's a great color so far, this morning. And if my math is correct, the way you've kind of spelled out your volumes and your pricing progression, it looks like your revenues are going to be well north of $300 million in the second quarter; whereas, the Street's probably sitting at $290 million. So, I think that's a point of consideration that everybody in this call needs to think about as we going forward. Now, did I hear correctly, you talked about your contribution margin per ton in Oil and Gas potentially being in the mid-$20 range for the second quarter? Is that what your answer to Marc's question was?

[Donald A. Merril:]

That's right.

[Bryan A. Shinn:]

Yeah. That's for the combined Oil and Gas, everything we do there, the whole segment.

[Kurt Hallead:]

Okay. Great. Awesome. Now, in terms of – you mentioned a very interesting dynamic about the bottlenecks and bringing some additional capacity into the marketplace. I clearly don't think that's been a focus on the investor mind. I think that basically you put a shovel in the ground, bring it to the well site, put a downhole and all this Permian muck brown sand is going to replace all the high-quality stuff. So, can you talk a little bit more about the bottlenecks and how long it might actually take for some of the supply to hit the marketplace?

[Bryan A. Shinn:]

Sure. Sure, Kurt. As we said in our prepared remarks and as I talked about on a few of the questions already this morning, these projects are not the shovel-ready. It's easy to sort of ride through a Winkler County and you see dunes of sands that looks like you could just go out there with a shovel and start putting it into the market and nothing could be further from the truth. We face, in our own work here, a number of challenges, like water permitting, just the infrastructure out there is not great, the roads are not set up to handle thousands and thousands of trucks, which we're talking all trucking here for the most part, just the availability of trucks, availability of equipment. These things are getting very expensive too. It seems like the prices are going up for land in some cases. Everything is getting more expensive. And I think the one that everybody seems to have just overlooked completely is the fact that you need contracts for these sites. We called it sort of field of dreams in our prepared remarks. But I don't see a lot of energy out there in the part of smart investors to just build something in the hopes they can sell these products there. They're specialized products. Certainly, there are some customers that want these products, some of the energy companies, but some don't. We have a number of energy companies that we've talked to that are telling us they don't want to use those sands and don't plan to use them. So, you have to be smart. You can't just go out there and put up a site and hope that someone will come. And I think one of the real bottlenecks, as I said, that's been overlooked is that once the companies that want to purchase these tons or their service companies have contracted up all their needs, there's no need for additional mines. And so, I think that's going to be a bit of a – kind of a self-governing mechanism as well to oversupply.

[Kurt Hallead:]

Now, I think in the past, you guys have kind of laid out some supply cost curve. Have you guys given that some additional thought and can you give us an update on how much can be supplied at $20 a ton? How much can be supplied at $40 a ton? Do you have any updates on that, some perspectives on that for us?

[Bryan A. Shinn:]

Sure. So, one of the questions we get from investors is, with this new low-cost capacity coming on line in the Permian, how does that change the cost curve? Does it flatten it? What are the impacts? And so, if we look at kind of the high side of what could come on line in the next 12 to 18 months, and that's that 20 million to 25 million tons of Permian greenfield capacity that we mentioned earlier, it's going to shift the cost curve in the Permian to the right a bit, that's for sure. But if you look at our projections, and I think anybody who looks at this seriously will see the same thing, the market's still going to be short given the demand that we see out there today and the projections for growth. So, the incremental tons into that market are likely to still be high cost or relatively high cost Northern White tons. So, I think, sort of the question behind the question is always what does it do to pricing. And as long as those incremental tons are still in the market, I think the pricing holds up pretty substantially. The good news for us is, in any scenario, we're going to be on the far-left side of that cost curve, at the very bottom of it. And so, we're going to enjoy, I think, fantastic margins and volumes in almost any scenario you could imagine. And we also get the question, well, as these tons come in, sort of which tons get pushed out? I think it's probably some of the uber-high-cost tons that are being reactivated in the Permian today. I think those are the ones that perhaps suffer as some of this new capacity comes online more locally in the Permian.

[Kurt Hallead:]

Yeah. And then, there was some discussion from another mid-sized service company about non-API 200 or 300 mesh. I mean, what's your sense in the marketplace for that type of sand?

[Bryan A. Shinn:]

Yeah. It's a really interesting question. And I've seen some of the technical work that's going on there, and it looks like there's potentially very interesting well improvement dynamics associated with the 200 and 400 mesh-type products. The good news about these products is that they go all the way out to the tips of the fracture. And so, these are sort of plus-one products. The way they're used is they're pumped in first, and then the normal proppant load is pumped in behind that. And these small-sized proppants get all the way out to the tips of the fracture. And this product is a manufactured product. We know that because we've been doing it for several decades here at U.S. Silica for our Industrial businesses. So, we're very interested in this and following it closely. As far as I'm aware, we're one of only two companies in the U.S. that has the capability to manufacture these type of products. And I believe we have, by far, the largest manufacturing capacity base. So, to the extent these products take off, it'll be good news for U.S. Silica.

[Kurt Hallead:]

Great. Thanks for the additional color. Appreciate it.

[Bryan A. Shinn:]

Thanks, Kurt.

[Operator:]

Thank you. Our next question comes from Brandon Dobell with William Blair. Please proceed with your question.

[Brandon B. Dobell:]

Thanks. Morning, guys.

[Bryan A. Shinn:]

Good morning, Brandon.

[Donald A. Merril:]

Good morning.

[Brandon B. Dobell:]

Bryan, as you talk about some of these, I guess, next-generation contract negotiations, maybe put in context whether Sandbox is a push, a pull, if you're making that a real strong pillar of how these contracts get structured or what kind of contracts you're actually even looking at going after? Just trying to get a sense of how tightly you're trying to make these two things together with this new contract as opposed to just taking whatever comes down the pipe?

[Bryan A. Shinn:]

So, it's a really interesting question. And I would say that every customer we talk to, whether there's a contract on the table or whether it's just a normal sort of customer-supplier discussion, we get into Sandbox, and usually at the request of the customer. So, certainly, Sandbox will be an important part of many of these contracts. We'll see contracts, I think, that perhaps have delivered to the wellhead pricing. Also, the next-generation contracts that are associated with either brownfield or greenfield capacity, we have the opportunity to customize the load-outs at those facilities to take advantage of all the things that Sandbox has to offer. I was talking with our Sandbox team the other day, and I heard a fascinating statistic from them. They said that they estimate, depending on how the work is set up, that we need 25% to 50% fewer drivers and trucks per ton of sand that gets delivered with Sandbox versus pneumatics. And in an era where trucking is short, truckers are short, that's like gold. Right? And so, I think it explains, perhaps more clearly than anything, why there's this thirst for Sandbox out there. There's all kinds of other benefits to Sandbox, but I think customers recognize that; and, the fact that you don't need as many drivers or trucks, I think, is a big advantage in this market.

[Brandon B. Dobell:]

Okay. And as we think about your capital needs through the balance of the year, I mean, it sounds like there's a lot of upward pressure on at least the opportunity for more crews. What's the likelihood or how do we frame out the context here that you come back in a quarter or two and say, look, the trajectory on demand for crews heading into 2018 is just a lot stronger because like the contract types were signed and that we've got to push faster for more crews? Or you say, you know what, we're comfortable with that because we want to maintain control of the process and those kind of things?

[Bryan A. Shinn:]

So, I think we'll be very disciplined on that, Brandon. And to the extent we have demand indications and customers willing to sign contracts, I think we won't hesitate to invest additional capital. I feel like we just take out a market leading position here and we're far and away the largest in the containerized sand sector. And we want to add to that lead. And once we get customers locked in and sort of converted over to our system, it feels like we'll hold a lot more of that share longer the faster we get it now. So, we're not averse to investing further. I think our board has been very excited about the potential of Sandbox as are we all. So, we'll make the appropriate investments depending on the signals that we get from the market.

[Brandon B. Dobell:]

Okay. Thanks a lot.

[Bryan A. Shinn:]

Thanks, Brandon.

[Operator:]

Thank you. And our final question comes from the line of John Daniel with Simmons & Company. Please proceed with your question.

[John Daniel:]

Hey, guys. Thanks for getting me in.

[Bryan A. Shinn:]

Hey. Good morning, John.

[Donald A. Merril:]

Good morning, John.

[John Daniel:]

I apologize. I'm driving now, so I don't have the luxury of typing in Excel. But just want to come back to the contribution margin guidance. It seems like the revenue per ton, when you refer to pricing at 15% to 20%, are you specifically referring to that revenue per ton?

[Donald A. Merril:]

We're specifically talking about mine gate pricing going from 15% to 20%.

[John Daniel:]

Mine gate.

[Donald A. Merril:]

Absolutely, yeah.

[John Daniel:]

Okay. Just wanted to clarify that. Okay.

[Donald A. Merril:]

Yes.

[John Daniel:]

Fine. All right. Then (55

[Bryan A. Shinn:]

It's mostly third party.

[John Daniel:]

Third party. Obviously, you guys have been pretty active in looking at stuff. What is the probability of something happening with you this year within the Oil and Gas segment?

[Bryan A. Shinn:]

So, we continue to have a robust pipeline across both Industrials and Oil and Gas. And it's hard to assign probabilities to these things, John, because they're obviously binary, right. They either happen or they don't. But look, I think that over the next several quarters, I'll be surprised if there's not an acquisition into the Oil and Gas space and there could be another small one in ISP as well. If we find another one like the Cool Roof that we just completed, that's going to be a homerun for us. So, we're looking for those great deals that we can really grow quickly.

[John Daniel:]

Okay. Has the recent contraction in equity prices for sand names, I mean, has that – maybe someone who isn't thinking about selling to pause, given the run-up in the stock prices is now coming back to you saying, hey, let's talk again? Has there been any change in attitude among sellers?

[Bryan A. Shinn:]

We've seen some of that. It's tricky you want to find the sweet spot. If price has dropped too much, people feel like they're selling too cheaply. If price go up too much, obviously, we're not happy with the price we have to pay. So, we're always looking for that sweet spot I think in Sandbox and NBR, we're able just to kind of find those right times where it made sense for everybody. But as we know, time is the enemy of any deal. We've had a number of things on the board that we're fairly far advanced, and for one reason or another, typically market or price movements like you're describing, one side or the other didn't like the deal anymore and we just couldn't get it done.

[John Daniel:]

Okay. Fair enough. And then, just the final one, if I could get you to opine on Q3. And by the way, thank you for the guidance this quarter. It was very helpful. But just looking at the nature and the timing of the pricing improvements that you're seeing now, would you feel comfortable saying that at least Q3 could see another double-digit revenue per ton increase?

[Bryan A. Shinn:]

Look, I think it's possible. Obviously, this market changes pretty quickly. But given the dynamics that are out there, the number of DUCs that we're starting to see, assuming that we get a positive read-through on oil pricing, coming out of the OPEC Meeting, all these other factors, I think it's possible that we'll see continued tailwinds there. And I kind of use it as my leading indicator my weekly meeting that I have with our sales team, as I mentioned earlier, and (58

[John Daniel:]

Okay. And then I'm going to squeeze one final one. And you referenced some sales, I think, at $50-type contribution margins per ton.

[Bryan A. Shinn:]

Yes.

[John Daniel:]

Could you say is that coming out of Texas? Is that coming out of Illinois? Just geographically where you're getting that?

[Bryan A. Shinn:]

So, those particular sales were not coming out of mines in the region.

[John Daniel:]

Okay. Got it. Thank you very much.

[Bryan A. Shinn:]

Thanks, John.

[Operator:]

Thank you. We have come to the end of our question-and-answer session. I would now like to turn the call back over to Mr. Bryan Shinn for any closing remarks.

[Bryan A. Shinn:]

Thank you very much. I'd like to close the call today with a few key thoughts. Oil and gas market has continued to strengthen and we expect substantially higher sand demand in the second quarter and for the rest of 2017, resulting in higher prices and margins as we've talked about on the call today. The rapid increase in sand consumption across the industry should also continue to drive very strong results in Sandbox. With demand rising rapidly, I feel we need to add capacity and our plans are on track to do so. We believe that the market will continue to remain tight for the foreseeable future. We also have several very interesting opportunities in our Industrial businesses, which we didn't talk about today. But I think those are going to result in further rapid growth and substantial profit and cash generation in that sector of the company. In short, it's a great time to be the market leader in the sand business today. So, thanks everyone for dialing in and have a great day.

[Operator:]

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