U.S. Silica Holdings, Inc.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Greetings and welcome to the U.S. Silica Second 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.

[Michael Lawson:]

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's second 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 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 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 that all who wish to ask a question may do so. And with that, I would now like to turn the call over to our CEO, Mr. Bryan Shinn. Bryan?

[Bryan A. Shinn:]

Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing highlights from our very strong second quarter performance, followed by an update on the actions we're taking to grow our diversified company, maximize value for our customers, and further extend U.S. Silica's industry-leading positions in both our Oil and Gas and Industrial businesses. I'll conclude my prepared remarks with thoughts on the market outlook for our two operating segments. Don Merril will then provide additional color on our financial performance before we open the call for questions. Second quarter revenue of $290.5 million improved 19% sequentially. Adjusted EBITDA of $75.1 million for the quarter was the second highest in our company's history and increased 76% compared with the first quarter of 2017. Strong market demand drove record sales volumes and substantial price improvements in our Oil and Gas business. Volume of 2.7 million tons increased 8% sequentially and sand pricing was up almost 19% quarter-on-quarter. Logistical challenges related mostly to railcar availability and inconsistent demand for core sand limited sales early in the quarter, but by the end of the period we were producing and selling near our maximum oil and gas capacity of approximately 1 million tons per month. We also saw higher volumes, higher pricing and continued growth from Sandbox, our industry-leading last mile logistics solution. Sandbox loads grew 22% in the quarter on continued share gains, as we added several new customers. We currently have 45 active fleets and are scaling up the business rapidly to meet growing customer demand. Looking back, since we acquired Sandbox, in less than a year, we've doubled the number of customers, tripled the average loads and EBITDA per month, and quadrupled the number of active crews capitalizing on our first-mover advantage in the containerized delivery space. In total, across our entire Oil and Gas business, we saw an 83% sequential improvement in contribution margin to $71.2 million. The Industrial and Specialty Products business continues to enjoy tremendous success, as evidenced by yet another record performance from the segment during the quarter. ISP contribution margin of $23.3 million improved 8% on a year-over-year basis, led by strategic price increases and new product sales, the latter now making up 15% of ISP's total profitability. We continue to successfully mix enrich our sales by targeting higher margin business in new end markets. A perfect example of this strategy is our new cool roof business, where we've quickly increased the customer base and are experiencing very strong demand. Our teams are working hard to increase available supply of this specialty product. From an operational perspective, we not only produced record sand volumes in the quarter, but had our lowest cost per ton as well, as company-wide costs fell per ton 8% sequentially and declined 11% on a year-over-year basis, as we continue to drive cost down through the operational efficiency projects and logistics network savings. For example, we've been very successful in locking in dedicated unit train capable transload capacity at favorable rates with no minimum volume commitments or shortfall penalties. As noted in our press release, we're increasing capital spending as planned to support the continued growth of Sandbox and to complete the various brownfield and greenfield expansion projects currently underway to meet the surging demand for frac sand, across multiple basins. Regarding brownfield expansions, we're on track to bring online a 1 million ton annual expansion at our Pacific Missouri site by year-end. Nearly all of this new capacity has been fully contracted for five years and included a sizeable customer prepayment. Furthermore, we expect to begin to see additional volumes come online from our Tyler plant expansion in the fourth quarter and reach the full volume of 1.2 million expansion tons in the first quarter of 2018. Let me also provide an update on our greenfield plants. As previously announced, we've begun construction of our new state-of-the-art 4 million ton per year frac sand mine and plant in Crane County, Texas to serve the rapidly growing Permian Basin. We're on track for initial production by December of this year. While several other in-basin projects have been announced, we believe we've selected one of the most advantaged sites, given its high quality reserves, good water availability, easy logistics, and proximity to the Delaware and Midland basins. Interest in our mine capacity is strong, and we're in advanced discussions with numerous customers looking to secure contracts. Let me now turn to our outlook for the remainder of this year and beyond. Going forward, we believe that continuing improvement in North American well economics, partially driven by greater proppant usage will support long-term increases in proppant demand. Proppant intensity growth is expected to continue as lateral lengths and loadings increase. We also anticipate that a drawdown in DUC inventory will help maintain proppant demand for the remainder of this year, despite an expected reduction in the number of operating rigs. We forecast U.S. sand proppant demand at 70 million tons in 2017, and 90 million tons or greater in 2018. We expect to continue to see product mix move finer, and toward local and regional sand with Northern White sand demand potentially leveling off at some point. By 2018, we believe that 45% of U.S. proppant demand will come from the Permian, and that 85% of that demand will be for the finer grades 40/70 and 100 mesh, which is why our investments today are focused on in-basin mines and regional expansions that will position us to win going forward. It's also important to note that more than half of the 40/70 in the Permian will still need to come from outside the basin, supplied by companies like U.S. Silica that sit on the very low end of the cost curve. As the sand proppant market evolves in the coming quarters, we also believe that accretive opportunities may develop for industry consolidation, involving both existing and future capacity. Given our strong balance sheet and track record of finding and closing attractive acquisitions we do expect to be active in this area. For Sandbox, we believe the market will continue to favor containerized solutions for transportation to the wellhead. One leading industry analysts recently opined that market share for containerized last mile solutions is expected to grow 50% next year from less than 30% today. We believe Sandbox is well positioned to maintain its industry-leading role as the solution of choice for last mile logistics, and we remain on track to meet our 2017 profit expectations. Finally, most of ISP's major end markets are expected to remain healthy for the balance of the year. Housing starts, a key parameter for ISP's building products business are up 3.2% versus last year, coupled with strong job gains and income growth. Auto sales, another key economic indicator for the ISP business have reportedly plateaued after seven record-breaking years, but we continue to see strong demand from that important end market as well. We also expect to continue to look for highly accretive bolt-on acquisitions in ISP, as well as potentially larger M&A if we do find the right opportunity. And with that, I'll now turn the call over to Don. 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 second quarter of 2017 of $235 million, improved 22% sequentially compared with the first quarter of 2017, driven by a combination of higher volumes, higher pricing, and increased activity at Sandbox. Revenue for the ISP segment of $55.4 million, improved 7% on a sequential basis from the previous quarter, driven by a strategic price increases and a larger contribution from new higher margin products, including our most recent cool roof acquisition. Contribution margin on a per ton basis from our Oil and Gas segment was $25.94, compared with $15.34 for the first quarter of 2017. The improvement in Oil and Gas contribution margin per ton was primarily driven by the increase in volumes, higher pricing, increased fixed cost leverage and higher activity levels at Sandbox. On a per ton basis, contribution margin for the ISP business of $26.05 improved 10% with the same period of the prior year, driven by a combination of improved pricing and an increase in higher margin product sales. Turning now to total company results. Selling, general and administrative expenses in the second quarter of $26 million were up 16.4% compared with the first quarter of 2017. The sequential increase in SG&A is due largely to additional compensation related expenses and increased head count. Depreciation, depletion and amortization expense in the second quarter totaled $23.6 million compared with $21.6 million in the first quarter of 2017. The increase in DD&A was driven by incremental expense related to our capital spending and higher depletion cost associated with more tons sold. Continuing to move down the income statement; interest expense was $8.1 million in the second quarter versus $7.6 million in the first quarter of 2017. The effective tax rate for the three months ended June 30, 2017, was 19%. Now turning to the balance sheet. Cash and cash equivalents as of June 30, 2017, was $598.5 million compared with $711.2 million at the end of 2016. As of June 30, 2017, our working capital was $684.8 million, and we had $46 million available under our revolving credit facility. As of June 30, 2017, our total debt was $511.1 million compared with $513.2 million at December 31, 2016. During the second quarter, we incurred capital expenditures of $135.2 million, primarily for engineering, procurement and construction of the company's growth projects, and other maintenance and capital improvement projects. And as stated in the press release, the company has updated its full year 2017 capital expenditures guidance to a range of $325 million to $375 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 Michael Lamotte with Guggenheim. Please proceed.

[Michael Lamotte:]

Thanks. Good morning, guys.

[Bryan A. Shinn:]

Good morning, Michael.

[Michael Lamotte:]

If I could ask, first, on the question of volumes. On the first quarter call, you all talked about 15% – expectations of 15% to 20% growth Q1 to Q2, and we got 8%.

[Bryan A. Shinn:]

Right.

[Michael Lamotte:]

Bryan, can you talk about what the variance – what was behind the variance?

[Bryan A. Shinn:]

Sure. So, Michael, I would say, overall demand was very strong during the quarter. The reasons that the sales were not higher, really, pretty simple, we had – early in the quarter, we had lot of rail and logistics issues associated with getting everything ramp back up, but demand was just so strong that the railroads themselves had a lot of issues, and we had problems with railcars, getting returns from customers, et cetera. So, it was an issue that really occurred earlier in the quarter, and then sort of resolved itself pretty much as we went along. Probably the only other thing that contributed to it, maybe in a minor fashion was just some inconsistent demand for the coarse products. But if you look at – at the last couple of months, so the last two months of the quarter, May, June, and what we're looking at in July, we're averaging about 960,000 tons or 965,000 tons of sales per month, and that's against a capacity of 1 million. So, we're kind of right back in that range where we expected to be in Q2. So, really this was a kind of a transient problem early in the quarter that we think is pretty much fixed.

[Michael Lamotte:]

Okay, great. So, kind of 965,000 tons run rate through Q3 seems to be a reasonable number for the current quarter, 965,000 tons per month?

[Bryan A. Shinn:]

Yeah. I think that's a pretty good number, and our team is trying really hard to get up to that 1 million tons a month. It's just a bit of a challenge to get those last couple percentage points in there. And I would say the – to me, the only sort of uncertainty to get from 965,000 tons to 1 million tons is around the coarse demand, we still see some occasional weakness in 20/40 and 30/50. But with that said, I still think we're selling about 90% or more of our coarse capacity. So it's not like it's – it's a lot of the capacity is going unsold, but when you're trying to get all the way to max capacity, a few tons here and there on the coarse side in terms of softer demand gives you that gap between say 1 million tons and maybe 960,000 tons, 965,000 tons.

[Michael Lamotte:]

That makes a lot of sense. And then last one, just quick follow-up on that sizing grade question. You mentioned in your prepared comments that the market is moving increasingly finer and increasingly local. But I'm curious, is your view on the supply side, whether we're headed towards dislocations and imbalances, it seems to me that the market could be oversupplied on the 100 mesh side, relatively quickly, but that pricing for 40/70 could hold up given the dependence on Northern White for those sizes. Can you sort of share your thoughts on where you see the market going in terms of balance...

[Bryan A. Shinn:]

Sure.

[Michael Lamotte:]

...on the grade?

[Bryan A. Shinn:]

And I assume, when you talk about the supply of 100 mesh, you're referring to some of the local mines that...

[Michael Lamotte:]

Correct.

[Bryan A. Shinn:]

...are forecasted to come up in the Permian. And as you said, the majority of that capacity is going to be 100 mesh, excuse me, so to the extent there is any stress, it will be on 100 mesh, 40/70, we think more than half of that pretty much is far out as we can see is still going to have to be supplied in the Permian, from outside the Permian. There is not enough capacity coming up, and we're nearing our capacity in the Permian to supply the 40/70. I think 100 mesh, we could see a scenario in the coming years, where the 100 mesh in the Permian is mostly supplied in the Permian. And so, if you think about the impact of that, it's going to be just like in 2015 and 2016, where there were sort of supply and demand issues, those who're in the low end of the cost curve like U.S. Silica, we'll still find good locations for our 100 mesh and all of our sand. And we've run a number of models on this, and I feel like we come out pretty well in almost any scenario that we can think of. I feel like the challenges will be for those who have higher cost mines, and particularly mines that we'd say shutdown in the downturn in 2015 and 2016, I feel like those are the tons that are kind of the marginal ones, as we see some additional 100 mesh coming into the Permian.

[Michael Lamotte:]

Great. I appreciate the color, Bryan. Thanks.

[Bryan A. Shinn:]

Thanks, Michael.

[Operator:]

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

[George O’Leary:]

Good morning, guys. Helpful color on the...

[Bryan A. Shinn:]

Hi, George.

[George O’Leary:]

...very helpful color on the logistics issues on the quarter and it sounds like pretty good line of sight on Q3 volumes. I was wondering if you could talk a little bit about pricing on the Oil and Gas side quarter-on-quarter for the third quarter?

[Bryan A. Shinn:]

Sure. So we've pushed price really hard in Q2, we're up almost 19%. Our team did a really good job there. We are seeing surprisingly strong pricing again in July. So I think that, I don't want to get too far in front of our skis here, but I would certainly expect, say 5% to 10% quarter-on-quarter of pricing from Q2 to Q3. But, I didn't please with the kind of prices that we've seen so far in July. And I think it's a testament to the strength of the demand out in the market.

[George O’Leary:]

Great. That's very helpful. And then, maybe just an update as you guys, I realize it's still early days, but work through the Permian project, how discussions with customers are going from a contracting standpoint there, and really at the Pacific Missouri plant, you guys got some prepayments, are those types of discussions ongoing with customers? And then, how do you think about pricing for Permian tons generally, are you trying to price it on delivered price basis, or is it still kind of a mine gate the initial negotiation, just more curious on the Permian contracting?

[Bryan A. Shinn:]

Sure. So it's really a good question, and we've taken a bit of a different approach on this. We're looking at this as an opportunity to continue to deepen our partnerships with key customers. And even though the, sort of, question at the moment is around the Permian capacity, when we talked to our customers, once again, they think about it a little bit differently as well. They look at our diverse footprint with having offerings regionally and nationally, and so in many cases, our discussions kind of expand out into a broader relationship between the companies. We do have some contracts signed. In many cases we have term sheets signed, where we're in the late stages of negotiation. And I was just going back and adding it up yesterday, we've got about 15 new contracts that are in some state of negotiation with leading oilfield customers. And it's hard to predict the exact outcome, but I would expect about half of those to get signed and to turn into solid contracts. And at the end of the day, it comes down to which of our customer partners who are willing to make credible commitments to get the contracts signed. I will say though that, we've put a lot of thought into these next-generation contracts and we're designing them in partnership with our customers to be agreements that we think can weather whatever cycles are ahead, certainly we all learned a lot in 2015 and 2016. And we want customer's contracts that work for both U.S. Silica and our customers, and I think we've made a lot of progress in doing that.

[George O’Leary:]

Great. That's very helpful. And maybe, if I could, just sneak one more in. You mentioned M&A, again, you guys are doing a lot on the brownfield side. Are bid-ask spreads compressing here, it seems like it's been tough to get larger transactions done for anyone in this space as of late. Just curious for a little more color on the M&A market, and how that's shaping up?

[Bryan A. Shinn:]

Yeah. So, it's really interesting. I think we have a lot of different opportunities. The deal flow is pretty strong, as far as – as looking at things. And so, we're active on both the Oil and Gas side of the business, as well as the ISP side.

[George O’Leary:]

Great. Thanks very much for the color.

[Bryan A. Shinn:]

Thanks, George.

[Operator:]

Thank you. Our next question comes from Brad Handler with Jefferies. Please proceed.

[Bradley Philip Handler:]

Thanks. Good morning guys.

[Bryan A. Shinn:]

Hey, good morning, Brad.

[Donald A. Merril:]

Good morning, Brad.

[Bradley Philip Handler:]

Good morning. Maybe I could ask you to come back to West Texas, certainly, a topic that's obviously getting a whole lot of attention for some obvious reasons. And, I guess, maybe given your response to George just now, maybe I could ask you to speak what the landscape looks like a little bit more broadly, obviously many announcements that have been made, and a lot of contracts that seem like they're sort of pending. And I don't, if I could ask you to reach into what you see and what you think you know, do you feel like the – do you feel like customers are starting to play off potential mines off of one another? Do you feel like there is enough aggregate demand to soak up all of what has been announced and it is obviously a considerable amount? Just what do you see from that contract process your own, but others as well, that talks to demand.

[Bryan A. Shinn:]

So, I think the overarching impression I get after having met with a number of customers myself is that, there is a strong desire to get contracts in place here, to make sure that they have enough supply to meet their needs, and the thing that I've heard over and over again is that many, I'll say, if not most customers are skeptical about signing long-term contracts, particularly if there is a prepayment involved, which all the contracts that we're talking about right now involves some form of prepayment. They don't want to sign prepayment type contracts with companies who've never been in the sand industry before. So, I feel like a company like U.S. Silica has a tremendous advantage as we are sitting at the table, we have a lot of credibility. And in many cases, these customers also want to sign contracts for Northern White sand. And I think, you read some of the opinion pieces out in the industry today and some of the pundits, who are saying Northern White is dead, that's certainly not what we're seeing out there, and that's not what customers are telling us. Actually, we've had a couple of customers tell us that they look at the local sand in the Permian, as kind of a plus one. And, if they can get good economics there on the delivered cost basis, it's going to allow them to dramatically increase the loading per well. So, a couple of them have told us directly that they're thinking about using those in-basin tons on top of the tons that they're already using, not instead of. So, I think that's going to be very interesting to see how things play out. But look – the other point of your question was are customers trying to play off suppliers, and certainly all customers want the best deal they can get and suppliers want the same thing. So, we'll see how it all plays out. But I would say, generally, the tone is we want more sand, we want to sign a contract with a company like U.S. Silica, and let's get this thing done is sort of the tone that I sense.

[Bradley Philip Handler:]

Fair enough. Okay. For my follow-up, let me switch gears a little bit. You mentioned some of the logistics challenges. Can you speak to the risk of – and then, I guess, how you'd address the issues surrounding that over the next three or four quarters, as it relates to railcar access or the railroads being in place to deal with continued industry growth?

[Bryan A. Shinn:]

Yeah. So, it's a really good question. And I feel like, we've been through this a couple of times. I've been in the sand industry, selling into oil and gas for almost nine years now. And this is probably the third or fourth time that we've had a dramatic upturn in demand, and shockingly, the railroads seem to be caught unawares almost every time. We saw a lot of things early in the quarter that were of the flavor of why the railroads couldn't get their power out of storage fast enough, or they basically didn't have all the personnel hired that they needed to deal with the demand. And, I think, the good news is that basically that's been solved. So, I don't see a lot of issues there. I feel like the railroad industry is more prudent now, and obviously we spend a lot of time and I'm sure our competitors do as well talking to them about the kind of upturns that we think we're going to see in demand here. So, hopefully, we're not going to be in those issues in the future, but look at – I continue to be surprised by those type of things with the railroads. But I feel pretty good that we've got the logistics piece sorted out. So, I don't expect a lot of problems from that Brad.

[Bradley Philip Handler:]

Okay. It's helpful color. Thanks, I'll turn it back.

[Bryan A. Shinn:]

Thanks, Brad.

[Operator:]

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

[Marc Bianchi:]

Thank you. I guess, just to clarify a comment about pricing that you made earlier mentioning the 5% to 10%, is that on a mine gate or FOB basis?

[Bryan A. Shinn:]

So that's on a mine gate basis, Marc. You know, when we talk pricing, we always talk mine gate to kind of normalize out the transportation and logistics pass-through that's in the pricing that we sell downstream of our mines.

[Marc Bianchi:]

Sure, sure okay, so that makes sense. And if I think about the cost items that you mentioned you got some benefit in the third (sic) [second] quarter, presumably you would have some additional fixed cost leverage – sorry – benefit in the second quarter, presumably you'd have some fixed cost leverage in the third that helps. Also wondering, if there were any one-time cost impacts in the second quarter due to the logistical issues that you mentioned?

[Donald A. Merril:]

No. Marc, we really didn't see a whole lot of one-time type charges in Q2 due to logistics. It was more just not having the availability of those railcars to get our product to our customers. And we will see a little bit more of fixed cost leverage going into the quarter, so we should see our cost per ton go down, which I think we had a record in Q2 of our overall manufacturing cost per ton. So, we should see that number get better in Q3.

[Marc Bianchi:]

Okay. So, if I put all that together, you probably got a couple $3 of price, another $1 or so of the fixed cost benefit, and then whatever we assume for Sandbox, is it fair to say that you could be in the low $30 range for contribution margin across the sand business?

[Donald A. Merril:]

I think, it's fair to say we will be pushing to $30, yeah.

[Marc Bianchi:]

Okay, okay great. Then just one other I had related to the volumes, as you bring on the Pacific and Tyler expansions there. What are you thinking for how much that could really benefit fourth quarter? I understand you have the Permian coming on as well, but just separate from that looking at Pacific and Tyler first, how much does that really impact the fourth, and then obviously would you get all of that in the first quarter?

[Donald A. Merril:]

Yeah. So great question, as we're bringing up a lot of volume here moving into the fourth quarter. I would say, right now, we're estimating somewhere between the 100,000 tons and 200,000 tons of additional volume that we can squeeze out in the fourth quarter.

[Marc Bianchi:]

Okay. Okay. Great. Thanks guys. I'll turn it back for now.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Thank you. Our next question comes from Scott Gruber with Citi. Please proceed.

[Scott A. Gruber:]

Good morning.

[Bryan A. Shinn:]

Good morning, Scott.

[Scott A. Gruber:]

The 40/70 demand in the Permian is about 35% to 40% of the total, is that correct, so about 16 million tons to 18 million tons in a 45 million ton market?

[Bryan A. Shinn:]

Well, so I would say, it's probably maybe a little bit more than that in terms of total, I would say, that it's – the demand is almost equally split between 100 mesh and 40/70, maybe it's 60% 100 mesh, 40% 40/70 plus or minus, obviously, there is some 20/40 and 30/50 in there as well, but somewhere in that kind of range, say 40% maybe 40/70.

[Scott A. Gruber:]

Okay. And then, as we think about how the market is going to shift over time with the new local supply, which of your mines will continue to supply the 40/70 into the Permian, and given the potential for the 100 mesh to be almost solely locally sourced, how are you thinking about having to pivot some of the 100 mesh sales?

[Bryan A. Shinn:]

So, as we think about where our mines are positioned on the cost curve, we have a lot of really good options to get into the Permian for 40/70, as well as for the 20/40 and the 30/50. So we've got Pacific, we've got Tyler, Ottawa gets in at a pretty good price as well. So, we have a number of options there. And, as I think about 100 mesh, we currently ship 100 mesh from several mines as well into the Permian, and we have a lot of good destinations to move those as well. So if you look at Ottawa, for example, we never shut Ottawa down in the downturn even when things got really bad, and that's because the costs are so good there and the logistics. So, we have lots of options for 100 mesh to take it to different destinations. And then, excuse me – we also have lot of our industrial customers to take that product as well. So, we have many things we can do with this, Scott.

[Scott A. Gruber:]

Does the 100 mesh out of Ottawa, does that – is this the next primary basin to sell it into. Is that Appalachia, is that how you think of pivoting those volumes?

[Bryan A. Shinn:]

So, we certainly sell a lot into the Northeast already, but there are lots of other destinations for that as well. Ottawa has access to four Class-1 railroads, and we can barge out of there, so basically any place in the country you think about selling the product, we have a pretty good low cost solution to get there.

[Scott A. Gruber:]

Got it. And what's the great split at Voca?

[Bryan A. Shinn:]

I would say, today we're probably running about 15% to 20% coarse products, and then we've got 40/70 and the 100 mesh making up the rest of that.

[Scott A. Gruber:]

And that, how do you think about shifting the Voca volumes, does those primarily go into the Permian today, is that correct?

[Bryan A. Shinn:]

They do. Yeah, they're primarily going to the Midland. So, I think that there is parts of the Midland that we'll still be able to reach effectively with 100 mesh, particularly as we copy that or couple that rather with Sandbox. And then, of course, 40/70, I think we can still move into the Permian. We know there's going to be demand for that there, and 20/40, 30/50, I think that's going to still be viable out of Voca as well, given that they've done that locally in the Permian.

[Scott A. Gruber:]

Got it. Appreciate the color.

[Bryan A. Shinn:]

Okay. Thanks, Scott.

[Operator:]

Thank you. Our next question comes from Connor Lynagh with Morgan Stanley. Please proceed.

[Connor Lynagh:]

Yeah, thanks guys.

[Bryan A. Shinn:]

Hi.

[Connor Lynagh:]

Similar questions. Given that we're on – heavily focused on the Permian expansions here. So, can you give us a sense of how much, so you did $70 million of contribution margin in Oil and Gas in the second quarter, how much of that is from selling 100 mesh sand into the Permian?

[Bryan A. Shinn:]

Yeah. No, we never break it out down to level, Connor.

[Connor Lynagh:]

Well so your comments would suggest that it's probably 20% of market demand. I guess what I'm wondering is, how much if you had to shift that to other basins, how much degradation would you see in your margins? I mean is it 10%, is it 50%? I think there is some pretty dire scenarios out there. So, just trying to get a feel for how big an impact it would be.

[Bryan A. Shinn:]

Yeah look, it's a little early to tell, given no one knows for sure how this is all going to play out. But I feel like we have really good options as I said moving the products to other basins and our modeling that we've done to date, albeit on sort of incomplete information, it doesn't show a significant degradation. You've got a lot of folks, who are up in Wisconsin and at some sort of Tier-3 cost locations, who I think are going to be the ones who get pushed out of the market. And so, I just – I don't see a lot of degradation there, quite frankly. But, I think we'll have to see how things play out in the market, which basins do the products actually move to, and how does it all play. So a little bit earlier to tell that, but I think these kind of thoughts that somehow, same pricing is going to collapse across the country or we're going to see to your point 30%, 40% or 50% degradation in margins, certainly a way over blown. I could see maybe a 5% or 10% change in margin or something like that, but not 30%, 40% or 50%, that just doesn't make sense, when you model it out.

[Connor Lynagh:]

Right. And so you're obviously putting your money where your mouth is on that – to investing in Pacific and Tyler. So where do you expect those volumes to be placed? Are those getting contracted into the Permian or are those going in other regional markets?

[Bryan A. Shinn:]

So Pacific is a great example, we had a customer who wanted to sign up for almost all that expansion volumes. So certainly, they've done the math on the cost from Pacific versus their other alternatives, and they like the combination of logistics and quality coming out of Pacific. So at the end of the day, we'll ship that product, wherever the customer wants it. It's kind of up to them where it's going to go. And my guess is that their work will move around over time. But if you're a customer, and you're going to sign a contract with a company like U.S. Silica, and it's going to be focused on say a particular mine site, you want to pick a site that's versatile, right. So that's one of the advantages for U.S. Silica, almost all of our sites that serve oil and gas go to multiple destinations, and we have a lot of kind of low cost solutions, you put Sandbox in there. I think it's very attractive for us. And one of the things that I think the people miss is, they try to do this analysis, what happens in the future as Permian sand comes on, is – who are the folks in the market that have the most options and the most flexibility to move product around and maximize the value from that product, and I think U.S. Silica is right at the top of the list there.

[Connor Lynagh:]

Right. Thanks a lot.

[Bryan A. Shinn:]

Thanks, Connor.

[Operator:]

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

[Ken Sill:]

Yeah. Good morning, gentlemen.

[Bryan A. Shinn:]

Good morning, Ken.

[Ken Sill:]

Yeah. Obviously, a lot of discussion, lot of fear about West Texas expansion, and there has been a lot of announcements since last conference call. What is your take on how much expansion has been announced, and how much you think might actually get done?

[Bryan A. Shinn:]

Yeah. It's a good question. As you could imagine, we spend a bit of time analyzing that and thinking about it, Ken. And our projection right now is that we could see around 25 million tons of new potential greenfield capacity up in the next 12 to 18 months. The vast majority of that, as we've talked about already is probably going to be 100 mesh, call it 80% 100 mesh, maybe 20% 40/70. And there is no doubt that it's going to shift the cost curve for both of those products to the right, in the Permian, i.e. this cost on a delivered basis – this capacity on a delivered basis is going to come in on the left end of the cost curve. And, so if you think about what the implications are of that, I would say, that by the end of 2018, we'd probably see 50% or more of the 100 mesh that's consumed in the Permian being supplied by those in-basin mines. Certainly, 40/70 as we said, the majority of that is still going to come from outside the basin, and of course, the coarse grades are going to be supplied outside of the basin for sure. So, I think that's generally, our view of how it plays out. As I've said a couple of times on the call here the good news for us is that, I mean, we're extremely well positioned both in terms of benefiting from those volumes that are now going to be supplied in basin with the capacity that we're installing there, but also with all of the other grades that we're selling to the basin and a flexibility that we can bring. So, net-net, I feel like we're going to be one of the real winners out of this, and we're going to add tremendous value to the company when it's all set and done.

[Ken Sill:]

Yeah. I guess your 25 million ton estimate, I've seen estimates of size kind of 40 million tons to 50 million tons. Is your 25 million tons based on just what you think is actually going to get done? Or there's some double counting going on today and the rest of the current year (40

[Bryan A. Shinn:]

So, obviously, generally, it's our view on what actually gets done. I think there's a lot of things that get announced and even some permits that get filed up. If you take a ride around in there, who is actually starting to do construction and move dirt around if you will, quote-unquote. I think you get a feel for what might actually get done. And as we talk with customers, as customers tell us, look, we've never signed a contract with a company who doesn't have a lot of experience mining – they give us more information around what they're willing or likely to do. I think there is kind of a restraining force here that the market perhaps misses, which is, at the end of the day, once all the good contracts are gone, it's going to be pretty difficult to justify building the next mine and certainly the one beyond that. So, I think there's a lot of restraining forces there. You've heard all the discussions around all the issues that are there. Things like labor. Labor is a big issue. I think that's one that's probably overlooked. I also think that logistics is one that people talk about and they say that's going to be difficult and challenges, but they haven't really done the math. So, one of the advantages that we're going to have with our Crane County mine for example is that we believe we'll have substantially shorter haul times to many of the locations in both the Midland and the Delaware versus say all the mines that are coming up in the Winkler County, and so we have one customer particular who – when they looked at our mine site, they said, okay, that's the one that we want to sign up tons for because we can already see with your location that it's going to be much easier logistics, and we're not talking about 10 minutes or 15 minutes difference in haul time here. I mean, it could be hour, hour and a half, two hours on a load-by-load basis when you drive the roads around Winkler County. So, I think there's going to be a differentiation there. I think customers are starting to get a bit more savvy, in terms of analyzing the different sites and kind of rank ordering the attractiveness. And once again, I think we come out far ahead in that, but some of the other sites that are a bit more speculative right now that don't have some of the attributes, those are the ones that perhaps don't get built or if they do, it's sometime much further off in the future.

[Ken Sill:]

Yeah. That was leading into my second question, which was trying to figure out why you think your site is going to be cost advantaged? And obviously, we're not as familiar with it as you are, but you kind of Google Earth it, and looking at West Texas, it's kind of hard to see what the transportation differential is really going to be, so a little more discussion on that would be interesting. And also, is there a difference between the quality of your sand across some of these different mines, the crush strength or the mix of sand across the basin?

[Bryan A. Shinn:]

So, on the quality side, I think we're kind of right at the top end of the local sand quality, when you look at our crush strength, in particular. So I would say, it's an advantage, we're in the sort of advantaged category, there's probably others out there that are similarly positioned, but certainly not all. I feel like the biggest advantage that we have, there are really two things; one is we've been doing this for 117 years, so I feel like that's probably worth something in terms of our ultimate cost to make the product. So, there is a probably $1 or $2 there per ton. We don't have hardly anything in terms of royalties. We just have sort of a de minimis royalty. We've seen others take the approach of having really high royalties, they could be multiple dollars per ton. So, when you add that up on top of our I think advantage in terms of just knowhow in doing this, there's probably a few dollars a ton advantage there, just in getting the products into a truck. And then, once it's in the truck, if you drive around the roads in say Winkler County, small two-lane roads, stop signs everywhere, there's going to be literally thousands of trucks a day, trying to drive those roads. We've done some driving studies and some tabletop studies that suggest that as I said earlier, there could be substantial differences in time, delivery times, and imagine if we can load a truck up and deliver it. And then, one of our competitors takes an extra hour, hour-and-a-half to deliver that same load, it's a lot of extra cost for them, they have to – the truck is leased for that so many hours, they have to pay the driver, all those things. You get fewer loads per day. So, I think when you rack it all up, there are going to be some substantial differences in delivered costs per ton and that's where the question that you need to ask, it's not about necessarily the mine gate cost even though I think there will be some differentiators there as well. But start doing some work, just look at the map, right. I mean if you have to go 50 miles, 50 miles on an interstate, is a lot different than 50 miles on a two-lane country road with stop signs, right, with all these trucks floating around. So, I think, it just makes a logical sense that if you're positioned a mile or so from the interstate like we are, you're going to be much better off than if you have to run all those miles on country roads.

[Ken Sill:]

All right. Thank you very much.

[Bryan A. Shinn:]

Thanks Ken.

[Operator:]

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

[Kurt Hallead:]

Hey, good morning.

[Bryan A. Shinn:]

Good morning, Kurt.

[Kurt Hallead:]

So, yeah, very interesting times in the frac sand space for sure. So, I was curious whether or not you can give us some perspective on the cost differentials for transportation within the Permian, and then from a regional standpoint and then from a Northern White standpoint. And just the basis of that question beyond the obvious is that at the end of the day, if the customer's benefit of buying Permian sand using the Permian is predominantly transportation cost. Just wondering, why anybody in this industry would even have to think about cutting the mine gate price of sand, when it's all about the transportation cost differential? So, I really want to get a handle on that transportation cost differential.

[Bryan A. Shinn:]

So, I think, if you kind of start at the highest level and look at how much it cost to transport say by rail on Northern White down into the Permian, it's probably somewhere in the neighborhood of $40 a ton to $50 a ton. So, if you assume that – that let's just say mine gate costs are the same for regional versus Northern White, and you sort of take that piece out of it to make it simple, there is really a $40 or $50 umbrella there in terms of rail versus truck. And so, I would say, once again it depends on the distance, right, the further you get away from the mine site, the longer you have to truck, the less the advantage becomes. So at some point, there is an equilibrium, and we've typically seen that in the past, be in the maybe 200 mile range, maybe 250 mile range, depending on the cost of trucking. I think that's another thing that's underappreciated right now. We've seen trucking costs go up a lot, certainly we understand that well given that we have a lot of our own truckers and we hire trucks for Sandbox. So, let's keep an eye on the, kind of the arbitrage between truck and rail, and at the end of the day, that in my mind really controls, whether people buy some of this local sand versus Northern White, set the quality aside again, let's assume that the local sand is good enough, it really comes down to arbitrage between rail and truck. And so, we're going to keep our eye on that. Right now, it looks like for most of the Permian, we're probably talking at least a $20 savings for the local mines versus Northern White, in some cases it could be more, depending on the proximity to the mine. So, kind of at high level that's how we think about it, Kurt.

[Kurt Hallead:]

Okay. And then, how much of this incremental capacity that you have coming on has been prepaid or let's just say if your negotiations go as your historical experience with these customers would tend to go when it's all said and done, how much of your incremental capacity will be prepaid?

[Bryan A. Shinn:]

So, I'm going to make sure I understand your question. So you are saying if we sign the contracts that we want to sign, how much of these – how much of those contracts or what percentage or something will have a prepayment associated with them?

[Kurt Hallead:]

Yeah. What percent of that volume will have a prepayment to it, yeah?

[Bryan A. Shinn:]

So, at this point, all the contracts that we're looking at have prepayments associated with them for either the brownfields or for the local sands.

[Kurt Hallead:]

Okay. So, is it – does it strike you in that context I would ask if there was truly a potential for excess supply and pricing coming down. Why would an E&P company ever entertain a prepayment agreement, when they can get more for less in two months or three months from now, right? And what am I missing on that?

[Bryan A. Shinn:]

Yes. So look, I think it goes back to the conversation we were having earlier here around not all suppliers are created equal, right. I'm not saying that every supplier can get that kind of a contract. But you have energy companies and service companies, who have needs across multiple basins; who want Northern White sand, who want other sort of regional-ish sand from places like say Pacific, Missouri or something, want Sandbox services. So, I think we have a different level of offering, and when customers look at that and think about who they want to sign up with, I think we come out on top in that equation. I think that's one key point. The other key point though is, I know there's been a lot of debate and discussion around where is sand intensity going, where is overall profit volume going. So, ask your question another way. Why would we feel confident? Why do customers tell us that they're willing to sign these kind of contracts if sand intensity is going down, or profit volumes are going down? To me, it's one of the strongest endorsements that I've seen, and I've been around the industry for a while, like you, I tend to vote with my wallet, and if customers are voting with their wallet, that tells me that they believe that intensity is going up and demand is going up. And there is a fairly short list of high quality national suppliers that you might sign a contract with, and I think we're right at the top of that list. So to me, that's why customers are working with us and willing to potentially sign these type of contracts.

[Kurt Hallead:]

And then lastly, so you are at effectively 12 million tons of annual volume capacity right now, you can take that up by a couple – 200,000 tons to 400,000 tons maybe by the fourth quarter. So what's the exit rate of 2018 with all the brownfield and Greenfield, what's the annual volume you could potentially sell?

[Bryan A. Shinn:]

So, I mean, we've said before that we felt like we're on track on a sort of exit run rate to add 1 million tons to 2 million tons of capacity by the end of 2017. And then we expect that we would ramp up through the first several months of 2018.

[Kurt Hallead:]

Okay. So what – so if you look at the exit rate of 2018, where are you in terms of annualized capacity?

[Donald A. Merril:]

Yeah. So by the end of 2018, we expect to have our 8 million tons to 10 million tons that we talked about, the majority of that up and running by the end of 2018.

[Bryan A. Shinn:]

Right.

[Kurt Hallead:]

Right. So, you'll be about around 20 million tons per quarter, right.

[Bryan A. Shinn:]

Yeah.

[Kurt Hallead:]

Okay. Right. Thank you. Appreciate it.

[Bryan A. Shinn:]

Thanks, Kurt.

[Operator:]

Thank you. Our next question comes from Blake Hutchinson with Howard Weil. Please proceed.

[Blake Hutchinson:]

Good morning.

[Bryan A. Shinn:]

Good morning, Blake.

[Donald A. Merril:]

Good morning.

[Blake Hutchinson:]

Just one of the things, maybe you can help us look forward to here with regard to shift perhaps towards some of the volumes being in the Permian sand, is what that effect – the effect would be on the Sandbox franchise itself, I mean, do we just need to look at this kind of a net push, doesn't matter, whether you're delivering from transload or in -nearby in-basin mine or there are some advantages, does the intensity pick up there, potentially for you and the industry. Again, just thinking about the kind of growth trajectory for last mile delivery logistics?

[Bryan A. Shinn:]

It's a great question. And I would say that, generally, I believe it's a positive for Sandbox, probably our most profitable – our most profitable lanes that we serve, the most profitable customers or those that are in a maybe a 30 mile to 50 mile radius from a trucking standpoint. And this kind of works out to the way that the trucking, pricing bands work, and drivers, how many turns they can get a day and all that. So, I think this is going to be a positive for us, when we have to go 150 miles or 200 miles one way to pick up a load, the profitability is still good, but it's not as strong as if we can sort of turn the equipment much faster. So, I think it's going to be a positive for us. I think also this is going to allow us to get to the vision that we had when we originally bought Sandbox. So, creating a number of pop-up transloads around the basin. So, I mean, we can literally change the notion of what a transload is, it doesn't have to be on a rail siding. And so our team is working on that, and I think you'll see some other innovations coming out of this as well, as we design our new mine sites in the basin, we're going to have Sandbox only lanes kind of express lanes for Sandboxes, we can have Sandboxes stage there already filled, so customers can come in and pick them up quickly. Lot of new things that, that we're going to bring into the offering here. I think we'll just further enhance the Sandbox, a differentiation versus the competition.

[Blake Hutchinson:]

Great. And then just a quick one because we are coming up on the hour. Your commentary regarding your pricing thoughts, Bryan, I guess as we thought about the 19% sequential change from 1Q to 2Q, the price book tends to roll somewhat slowly, so it suggests you're at a higher rate – exit rate. Was the 5% to 10% commentary kind of a weighted average or a continuum?

[Donald A. Merril:]

Yeah, it was a weighted average. We tend to talk in averages on a quarter-over-quarter basis, so we should see that type of price increase on average in the third quarter.

[Blake Hutchinson:]

Great. Just want to make sure, I was clear. I'll turn it back, guys. Thank you for the time. Thank you.

[Bryan A. Shinn:]

Thank you.

[Donald A. Merril:]

Thanks, Blake.

[Operator:]

Thank you. Our next question comes from Samantha Hoh with Evercore ISI. Please proceed.

[Samantha Kay Hoh:]

Hey, guys. Thanks for squeezing me in. Just to go back on the Sandbox, I was quite surprised that the fleet count didn't increase more over the last quarter, given all the fleet reactivation, the pressure pumping fleet reactivation that we've heard about. Can you kind of talk about how those get rolled out and maybe what the growth profile look like for the second half?

[Bryan A. Shinn:]

Yeah. It's a very good question. So we continue to grow Sandbox literally as fast as we can. We're scaling up the manufacturing and all the internal systems to support the avenues and hiring team members to help drive all of it. I would say, at the end of the day that one of the other things that we're seeing is because of the increase in intensity in the sand per well, we've having to add additional sandboxes to our fleet and that's a positive thing. So, we tend to get paid on loads of sand that we deliver as opposed to just get paid for a fleet in many cases. So, essentially what's happening is who are working for frac fleet X, instead of consuming, let's say, 20,000 tons a year now they need to consume 250,000 or 300,000. And so we're adding equipment to some of those fleets as well. So when we acquired the business, we had typically about 40 sandboxes per fleet. Now, we're adding sometimes 50, 55 or 60 new boxes. So that – it sort of makes the fleet number look like it's not growing as fast, but we're adding lot of boxes and it's going to add a lot of revenue as well. So, we'll think more about that in the future and try to find some way to kind of bridge that for folks, so you can follow that. But at the end of the day, it's a really positive thing. It's a kind of a low capital intensity way to add revenue because we only have to add boxes and a few chassis, we don't have to add conveyors and all the other equipment. It's just a matter of moving more sand out to the wellhead, and so moving a fleet that used to have 40 boxes to say, have 50, 55, or 60, it's really positive capital investment for us. So we're doing that as well.

[Samantha Kay Hoh:]

And then just one last one. How much do you think of your – like your Crane capacity, do you think will be served by like Sandbox, in terms of like market share just coming out of that facility?

[Bryan A. Shinn:]

I would expect that...

[Samantha Kay Hoh:]

(58

[Bryan A. Shinn:]

...so you're saying, if – for our Crane County, how much, what percentage of the volume that leave that site would be in Sandboxes, is that your question?

[Samantha Kay Hoh:]

Yeah. Yeah.

[Bryan A. Shinn:]

I would think it'd be a relatively high percentage. Certainly, some of the customers that we're talking to for contracts there, want the Sandbox service as well. So I hate to put a number on it, but we're starting out with probably 30% of our load-out lanes dedicated to Sandboxes. But we have the other ones made and designed, so that we can convert those to Sandbox lanes if we want. So, we'll see how that plays out, but I would say at least 20% to 30%, but perhaps it was upside to that.

[Samantha Kay Hoh:]

Great. Thank you so much.

[Operator:]

I would like to turn the floor back over to Mr. Shinn, for closing comments.

[Bryan A. Shinn:]

Okay. Thanks, operator. I'd like to close the call today with a few key thoughts. First, the oil and gas market has continued to strengthen and as we said on the call, we expect higher sand demand in the third quarter and for the rest of 2017, and we expect that to result in higher prices we talked about a 5% to 10% increase in Q3, and certainly as Don said, we'd expect that to roll through to Oil and Gas margins that on a contribution margin per ton basis should approach $30 here in Q3. I guess, my second thought is that, the rapid increase in frac sand consumption across the industry and the move towards containerized sand delivery, as I said in my prepared remarks should also continue to be a really nice tailwind for Sandbox. We're adding boxes, we're adding people, we're growing literally as fast as we reasonably can there. Third, I would say that U.S. Silica is very well positioned to take advantage of consolidation opportunities that might arise in Oil and Gas, as well as attractive M&A in the ISP business. And lastly, I want to thank all my colleagues at U.S. Silica for their outstanding efforts so far in 2017 in meeting the tremendous opportunities that are available to us. Certainly, it's been a pretty exciting year so far with the market starting to pick up here in Q2 and continuing into Q3. Also, I want to thank our investors for their interest and support, and I look forward to meeting and speaking with all of you in the near future. Thanks for dialing in everyone, and have a great day.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.