U.S. Silica Holdings, Inc.
Q3 2017 Earnings Call Transcript

Published: 7 Nov 2017

[Operator:]

Greetings and welcome to the U.S. Silica Third 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 third quarter 2017 earnings conference call. With me on the call today are

[Bryan A. Shinn:]

Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing highlights from what I believe was an exceptionally strong performance in the third quarter, followed by an update on various strategic initiatives underway to create customer and shareholder value and generate dependable growth from a continued position of strength. I'll conclude my prepared remarks with a market outlook for the remainder of this year and our initial views on 2018. Don Merril will then provide additional color on our financial performance, before we open the call for your questions. Third quarter revenue of $345 million improved 19% sequentially. Adjusted EBITDA was a record $96.7 million and increased 29% sequentially. Very strong demand in our oil and gas sand business drove record sales volumes of 3.1 million tons, up 15% on a sequential basis, with capacity utilization running at almost 100% during the quarter. Pricing gains continued with mine gate pricing up over 5% sequentially. Sandbox also had a very strong quarter, continuing to rapidly build out and deploy new fleets to satisfy increasing customer demand and gain market share. Sandbox revenue grew 18%, primarily by adding new crews and equipment while increasing prices across the network. We exited the quarter fully utilized with 52 crews online, and subsequent to the quarter, we grew to 58 crews in October. We believe Sandbox is currently the number one non-pneumatic solution for last-mile logistics based on the recently announced competitor earnings. Our total Oil and Gas business saw a 35% improvement in contribution margin to $96.1 million driven by a combination of higher volumes and pricing, productivity improvement, and continued growth in Sandbox. During the quarter, we signed five new long-term supply agreements for both Northern White and Permian local frac sand. These contracts are two to three years in length on average and many were accompanied by a capacity reservation prepayment. To-date, customers have signed contracts with approximately $75 million in prepayments and we expect to exceed a total of $100 million in prepayments once we complete several other contracts that are in various stages of negotiation. Given the number of contracts that we're signing, I expect that our percent of contracted sales for frac sand over the next few years will be substantially above 50%. Also during the quarter, we completed the acquisition of Mississippi Sand, a regional sand producer with 1.2 million tons of low cost, mostly fine-grade capacity with a multimodal distribution network that has very low landed cost into the Haynesville, Northeast, and other key markets. The integration and projected synergies from the acquisition are tracking ahead of plan, and as expected, the new operation was accretive to our third quarter results. Turning now to our Industrial and Specialty Products segment, revenue in the quarter of $58.7 million improved 6% sequentially. Contribution margin for ISP reached a record $24 million, driven by a combination of strategic price increases and a mix of higher-margin products sold during the quarter including cool roof granules. Operationally, we continue to drive down our production and logistics cost through numerous improvement efforts. As you may recall, we used our best-in-class balance sheet during the downturn to invest in various projects to debottleneck plants, automate processes, improve load-out times and streamline our operations. As a result, our production and logistics cost per ton set new record lows during the quarter. Let me now turn to an update on our capital allocation plans and recent activities. Investing in high return growth projects continues to be a priority for us. As previously announced, we're on track to bring an additional 10 million tons of brownfield and greenfield capacity online in Oil and Gas by the middle of next year, increasing our total annual Oil and Gas production capacity to 23.5 million tons. Our expansion strategy in West Texas, centered around providing a critical competitive advantage in the Permian and that's having the shortest drive times from our mines to customer well sites. With Lamesa located in the northern part of the Permian and Crane County to the south, we expect to have substantially shorter delivery times to most wells in the Midland and Delaware Basins compared with competition. Also, as announced, subsequent to the end of the quarter, we were pleased to receive a certificate of inclusion into the Texas Conservation Plan, or TCP, for the dunes sagebrush lizard. Being part of the TCP helps preserve DSL habitat and is consistent with our decades-long company commitment to sustainability and environmental responsibility. Further, being part of this Plan helps assure future operations at our new Crane County facility, and it's important to many customers when selecting suppliers for in-basin Permian sand. We do not currently have plans for investment in new frac sand capacity beyond what we previously announced. We will, however, continue to invest substantially in Sandbox and select ISP growth projects given the attractive returns; and as always, we'll look for favorable opportunities to consolidate the frac sand space. As part of our capital allocation plan, we'll also continue to return cash to shareholders in the form of a quarterly dividend; and today, we're announcing a new larger $100 million share repurchase program which was recently authorized by our board. U.S. Silica is the only company in the sand space that has had the financial strength and flexibility to continually pay a dividend, fund substantial growth projects, complete accretive acquisitions, and do share repurchases, all while maintaining our industry-leading best balance sheet. Let's move now to our outlook starting with the near term. We expect sand volumes to be up in Oil and Gas for Q4, but perhaps restrained by some frac crews that may extend their holiday time off, also plant downtime due to planned maintenance and brief outages for capacity expansion work at a few mines. We do expect to see continued pricing upside in Oil and Gas during the fourth quarter. Contract interest is at an all-time high, and we will continue to prioritize customers with capacity reservation fee contracts and long-term partners in this tight market. For Sandbox, we expect strong growth and plan to increase from the 58 crews online today to 70 active crews by year-end. In ISP, we expect volumes to be down due to the normal seasonal slowdown in that business, and we also expect price to decline slightly for ISP in Q4 due to unfavorable mix, as some higher-margin customers manage year-end inventories. Turning to our outlook for 2018, we're forecasting total industry demand for frac sand to be in the range of 90 million to 100 million tons, assuming a rig count that is essentially flat with today's levels and profit per well up 15% to 20% year-over-year. We believe that approximately 45% of that demand will come from the Permian or perhaps 25 million to 30 million tons could come online by 2018 year-end. However, that's far from certain given all the challenges, and we believe that new capacity will come online slower than expected resulting in a tighter 2018 market with higher pricing than many are modeling. Furthermore, we anticipate that trucking logistics will become a critical issue in the Permian, as new mines come online in disadvantage locations served by secondary and tertiary roads. Customers are increasingly concerned about this issue and are telling us that we're best positioned to serve them with our mine location and Sandbox delivery system. We're in the final stages of putting together our capital budget for 2018 and expect to invest substantially in Sandbox growth. We believe that Sandbox is positioned to support well over 100 frac crews by the end of 2018. More broadly, in Oil and Gas, we expect to remain mostly sold-out our frac sand across our network in 2018 at attractive pricing, given our strong contract portfolio and best-in-class combination of mines and logistics footprint. ISP, which has grown contribution margin at a 10% CAGR for the last five years, is expected to continue that trend in 2018 with increased market penetration of new higher-margin products like our cool roof granules and also through the introduction of additional attractive new products. From an end-market perspective, housing starts, which drive a significant part of the ISP business, are projected to be up nearly 5% according to the National Association of Home Builders. Finally, we're looking at some very interesting M&A opportunities in the Industrial space, some of which are significant in size and could potentially move the needle from a revenue and profitability standpoint. 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 third quarter of 2017 of $286.4 million improved 22% sequentially compared with the second quarter of 2017, driven by a combination of higher volumes, including our acquisition of Mississippi Sands, higher pricing, and the continued growth of Sandbox. Revenue for the ISP segment of $58.7million was up 6% on a sequential basis from the previous period, driven by volume increases and strong contributions from new higher-margin products. Contribution margin on a per-ton basis from our Oil and Gas segment was $30.54 compared with $25.94 for the second quarter of 2017. The improvement in Oil and Gas CM per ton was primarily driven by higher pricing, increased fixed cost leverage, and higher activity levels at Sandbox. On a per-ton basis, contribution margin for the ISP business of $25.84 improved 5% from the same period of the prior year, driven largely by higher pricing and a better mix of higher-margin products sold during the quarter. Turning now to total company results, selling, general, and administrative expenses in the third quarter of $29.6 million were up 14% sequentially compared with the second quarter of 2017. The sequential increase in SG&A is largely due to increased compensation expenses related to head count to staff the growth in the business. For the fourth quarter, we anticipate our SG&A will be in the $30 million range. Depreciation, depletion, and amortization expense in the third quarter totaled $24.7 million compared with $23.6 million in the second quarter of 2017. The increase in DD&A was driven by incremental expense related to our capital spending and higher depletion costs associated with more tons sold. DD&A for the fourth quarter of 2017 is expected to run about $25 million. Moving further down the income statement, interest expense for the quarter was $8.3 million. The effective tax rate for the three months ended September 30, 2017, was 26%. Our estimated full-year 2017 tax rate is approximately 23%. Now, turning to the balance sheet; cash and cash equivalents as of September 30, 2017 was $463.7 million, compared $711.2 million at the end of 2016. As of September 30, 2017, our working capital was $560.8 million and we have $45.2 million available under our revolving credit facility. As of September 30, 2017, our total debt was $511.3 million, compared with $513.2 million at December 31, 2016. During the third quarter, we incurred capital expenditures of $130.7 million, primarily associated with our previously announced Permian Basin growth projects and other maintenance and cost improvement capital projects. As stated in the press release, the company anticipates full-year 2017 capital expenditures to be at the high end of our second quarter guidance, or approximately $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. Ladies and gentlemen, we'll now be conducting a question-and-answer session. Our first question comes from the line of Ole Slorer with Morgan Stanley. Please proceed with your question.

[Ole H. Slorer:]

Thanks a lot. And, yeah, congrats with a terrific performance around, I would say, Sandbox in particular. Could you talk a little bit though, Bryan, about kind of your total overview of the U.S. sand markets? I mean, you talked about signing contracts on pretty good terms both for Northern White and for regional sands in West Texas. I mean, you've taken a holistic approach by the looks of things and kind of gone after everything. So, could you tell us a little bit at the high level over the next 12 months how you sort of see the dynamics play out when you talk to your customers about what they want, particularly maybe West Texas customers, and then maybe also talk a little bit about customers elsewhere when it comes to the mix between all your different products and how you see them interact particularly on the Oil and Gas side, of course?

[Bryan A. Shinn:]

Sure, Ole, and thanks for the question and thanks for dialing in this morning. We see robust demand in 2018 across the frac sand sector. We believe that we'll be somewhere between 90 million to 100 million tons of total demand, and you can calculate that a number of different ways. One of my favorites, and it's probably the simplest, it's just a look at frac crews. And so, today, our frac crew tracker has about 396 crews active across the U.S. And we expect that number going to grow and many people are saying maybe 450 frac crews next year. So, frac crew typically consumes about 225,000 tons per crew or at least we think it will in 2018. So, now that kind of gets you towards the top end of the range of that 90 million to 100 million tons. There's a couple other ways to calculate it, but it looks like demand is going to be very robust in 2018. And as we talk to our customers, I think they're preparing for that. What we're seeing is heavy, heavy request for contracts, probably almost more than what I saw in 2018 quite honestly. We have more contracts now than we've ever had and more demand for contracts. And, I think, particularly to your question in West Texas, the kind of demand that we've seen there from our customers for our supply out of Crane and Lamesa has really been overwhelming. And I think it's because we have well-positioned those two sites so that we not only have great product and kind of bracket the Permian, but we've been very sensitive to logistics. As I mentioned in my prepared remarks, I think the tightening of logistics and logistics bottlenecks in the Permian is going to be one of the stories of 2018, perhaps maybe the story in the sand market. And I think it's going to have knock-on effects in the completions industry for sure. And as we talk to our customers, they are very keenly focused on last-mile logistics and how all the sand is going to move around the Permian. And I think it gives us a very strong competitive advantage there.

[Ole H. Slorer:]

Interesting. So clearly, I'm sure you noticed sort of the Wall Street panic over the past six months with respect to kind of this adding up all the nameplate capacity in West Texas and kind of concluding that the whole sand space will go in for a choppy ride in 2018. What do you think is the biggest difference in your view and this view based on your conversations with your customers?

[Bryan A. Shinn:]

So, we're on the ground looking at everything that's happening in West Texas and our customers are as well. And what we've seen is that a lot of the capacity expansion plans are slowing. I don't think the mindset is going to come up nearly as fast as people believe or as many folks have modeled today. Kind of my favorite quote was from one of our customers who went out a couple of months ago and did this tour themselves to sort it out, and they came back and told us that what they saw in most of these sites was a wooden shack at the end of a long dirt road, right? So, there just wasn't a lot going on. Now, we believe, as I think most do, that some capacity will come up. But the folks who are out there doing it right now and trying to get mines up are finding that it's much harder than they thought for a variety of reasons. So, I think the capacity is going to come up slower. It's going to be much harder to bring on, Ole.

[Ole H. Slorer:]

Very useful feedback. Thanks a lot, Bryan.

[Bryan A. Shinn:]

Thanks, Ole. Take care.

[Operator:]

Thank you. Our next question comes from the line of Marc Bianchi with Cowen. Please proceed with your question.

[Marc Bianchi:]

Thanks. Maybe just following up on the last question from Ole. As it relates to all this supply that could potentially come on, it sounds like if it's just deferred for, say, a quarter or two, that doesn't remove necessarily the overhang that may be on the stocks and on the industry. What are you looking for to really show that that new capacity may not come on at all or may not come on in a fashion to enable the prices to have a material impact? So, it's kind of a timing question, but just curious for your thoughts there.

[Bryan A. Shinn:]

It's a really good question, Marc, and I tend to think about it from a customer's perspective. So, what drives all of this is customer demand, and I feel like the jury is still out on the Permian sands and how many customers are going to accept that. And so, irrespective of all the expansion plans and things that might be out there from a variety of different companies, what really matters most is how the customers see this. And so, I was having a conversation with the very senior team at a customer a few weeks ago and they said, look, the jury is still out for us. We're still doing a lot of technical evaluations. We're not sure about the long-term well results, et cetera, et cetera. So, I think there's a chance that there's a bit of a bifurcation in the industry. So, there are some customers who really, really like and feel like their local sands work well and others that don't. I would say the other thing that could be a big restraining force here and we're going to see hit full force in 2018 is just that the logistics bottleneck and all the issues that are going to come up, particularly for the mines that are being built in and around the Winkler County area. We had an associate that was out there a couple of weeks ago, and he said he had to wait 45 minutes at one four-way stop because of all the truck traffic. That's just one example of the kind of bottlenecks and issues that are there. And to the extent that limits customers from getting product in a timely fashion or significantly increases the logistics cost to deliver the product to the wellhead, I think that also could restrain some of the enthusiasm for local sand.

[Marc Bianchi:]

Okay. Thanks for that, Bryan. It makes sense. I wanted to switch over to the reservation fees that you're talking about now and maybe this is a question for Don. Is the accounting for those reservation fees, is that matched with volumes, or how should we see that flowing through the income and cash flow statement?

[Donald A. Merril:]

Yeah. It's exactly matched with volumes. We account for it as deferred revenue. So, you'll see all of that show up on the balance sheet. And then, as people buy the volume, you'll see it go through the income statement.

[Marc Bianchi:]

Okay. So, fair to say not much realized in the third quarter?

[Donald A. Merril:]

That's fair. Yes.

[Marc Bianchi:]

Okay. Thanks. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Thank you. Our next question comes from the line of Jim Wicklund with Credit Suisse. Please proceed with your question. James Wicklund - Credit Suisse Securities (USA) LLC Good morning, guys.

[Bryan A. Shinn:]

Morning, Jim.

[Donald A. Merril:]

Hi, Jim. James Wicklund - Credit Suisse Securities (USA) LLC Bryan, you said you've hit your capacity additions that you had planned and you don't really have any capacity additions planned for 2018. Your buyback is only $100 million when you've got a chunk on the balance sheet. So, are we just being conservative? Is there consolidation in the industry a possibility? Can you talk to us about use of capital other than for expansion of Sandbox in 2018?

[Bryan A. Shinn:]

Certainly, Jim. And I think the thing I love about our balance sheet is that it gives us flexibility. My belief is, as you said, that we're going to continue to invest substantially in Sandbox. There are some really interesting opportunities on the Industrial side of the business. We're still actively pursuing consolidation within the sand space. And so, I think that is a – it's a possibility but, of course, returning cash to shareholders is as well. And as we noted in our prepared remarks, we're the only company in the industry that's consistently paid a dividend, bought back stock, done accretive acquisitions, and been able to invest in growth. And so, we like having that sort of optionality, but to the extent that we can't do consolidation or some of the other things that we might like to do, we certainly have the capability to continue with increasing share buybacks. James Wicklund - Credit Suisse Securities (USA) LLC Perfect answer, and the market will be thrilled to death over your $100 million this morning. And my follow-up, if I could, there is concern – I know that a lot of people you don't think that all the West Texas capacity is going to come on. There are some thought that if the Permian is 45% of the $100 million then – and you look at just 100 mesh then it maybe that by the end of 2018, the Permian is either fully supplied locally or even possibly oversupplied. Do you agree with that as a possibility and would you rather – if somebody came and said, gosh, I got a sand mine for sale, would you be more interested if it was in West Texas or would you be interested more if it was someplace else?

[Bryan A. Shinn:]

So, I think there's definitely a possibility that the market could be self-supplied by the end of 2018, depending how fast some of that capacity comes online. The good news for us is, we play in all the basins and all the interesting facts we talked about all these contracts that we've signed and the others that are coming. A lot of the ones that have been signed and are in the pipeline are for Northern White sand, so I think the death bell on Northern White sand has been prematurely rung. Customers have a lot of desire for those products. Some of those contracts, believe it or not, are still in the Permian, but we have all the other basins as well. So, it's one of the advantages of U.S. Silica that we have this diversification. And then with Sandbox on top of that, we have the ability to really economically get product almost anywhere to any well site in the country, and it gives us great advantages. James Wicklund - Credit Suisse Securities (USA) LLC If I was an E&P company looking for surety of supply I would much rather sign a contract with somebody with multiple mines in multiple locations than just one. That's easy. Thanks, guys, very much. Look forward to next week.

[Bryan A. Shinn:]

Thank you, Jim.

[Operator:]

Thank you. Our next question comes from George O'Leary from TPH & Company. Please proceed with your question.

[George O’Leary:]

Good morning, guys.

[Bryan A. Shinn:]

Good morning, George.

[George O’Leary:]

Picking on the prepayment line of questioning and just given what you were talking about folks still having the desire to sign Northern White contracts, I was curious if you could provide a little color around the – of the $75 million in reservation fees or prepayments that you have, what the mix is of that between regional versus Northern White sands or if it's more grade-dependent? Just curious how that's set up, and then maybe any color on the mix of those contracts would be helpful.

[Bryan A. Shinn:]

Yeah. So, it's a little bit difficult to break it apart because some of the contracts that we signed include both regional and Northern White sand. So, it's kind of a mix, quite frankly. I would say that in terms of product mix that the industry is looking for right now, certainly, we've seen completions trend towards using more the finer products, so 40/70 and 100 mesh are typically in greater demand than our coarser products, the 20/40 and 30/50. The 20/40 is probably the product that's in least demand. But even with that said, we've been able to keep that product essentially sold-out as well. I think it speaks to the overall demand in the market today which is very strong, and I believe it's going to go up substantially in 2018.

[George O’Leary:]

Great. And then, just one more from me. As we look forward to Q4, you gave some kind of qualitative guidance, so I was just curious if you could provide any more color around the magnitude of the volume increase. And then, if not there, maybe the mine gate price increase you guys are expecting, and then how much Sandbox is going to contribute to contribution margin? So, just any more quantitative color you could provide on the Q4 outlook would be super helpful.

[Donald A. Merril:]

Yeah. Look, I think from a volume perspective, you're probably looking at a little bit up on the volumes side. We've got a lot going on in the fourth quarter. We've got some capacity coming online, but we also have all the things in the fourth quarter that we always tend to forget about like weather and holidays and things like that that will affect it as well. Pricing, we are seeing a little bit of a price uplift in – as we walk into the fourth quarter. I would say it's going to be in the low single-digits right now. It's probably what we'd see there. And Sandbox, of course, is continuing to grow as we go from 52 crews. I think, right now, we're sitting at about 58 crews on our way to 70. So, you're going to continue to see the uptick from Sandbox in the fourth quarter.

[George O’Leary:]

All right. Thanks for the color, guys.

[Bryan A. Shinn:]

Thanks, George.

[Operator:]

Thank you. Our next question comes from the line of Scott Gruber with Citigroup. Please proceed with your question.

[Scott A. Gruber:]

Yes. Good morning.

[Bryan A. Shinn:]

Good morning, Scott.

[Scott A. Gruber:]

The contracts you're signing today have more teeth than what we saw last cycle, but the sustainability of these contracts is still a concern for investors. Could you just provide some more color, Bryan, on the strength of these contracts? The prepayments are clearly great, but some more color on how these contracts differ from last cycle and why they should be stickier than what we saw last cycle?

[Bryan A. Shinn:]

Sure, Scott. It's a good question, as you can imagine, and we thought a lot about this. I think this is probably our Gen 4 contract, if you will. And the thing I love about the capacity reservation fee and the way those contracts are structured is that we get to take those prepays to earnings on a quarterly basis, whether any tons get consumed or not. So, if a customer buys tons, the prepay gets credited against that. If they don't, then we get to take that to earnings anyway. So, I think that gives customers a real incentive to purchase the tons. So, I think that's been a big learning for us. I think also that the contracts that we're signing that are not capacity reservation contracts, we kind of have our choice of dance partners, if you will, given the demand for contracts right now. And so, you can imagine that we're picking the kind of bluest of the blue chip customers to sign with. So, I feel really good that a higher percentage of our customer base will continue to be pumping, for example on the on the service company side, even if the market turned down. So, I personally, as I look across our contract portfolio, feel much more confident around how we react in a downturn in terms of profitability and our ability to sustain these contracts as compared to probably almost any other time in the last seven or eight years as we've really gotten into all of this.

[Scott A. Gruber:]

Got it. And, Bryan, when you listed your priorities for cash deployment, you didn't mention any other greenfield projects in Oil and Gas. So, just to be clear, is it fair to say that you're de-emphasizing additional greenfield projects, prioritize brownfield and potentially some M&A?

[Bryan A. Shinn:]

So at this point, we don't have any other greenfield projects contemplated as we look at 2018. I feel like we will be able to satisfy the needs of our customers and kind of industry demand with what we have on the board right now. And we're focused at this point much more on investing aggressively in Sandbox to continue to take share there, focused on the ISP business, and making sure we have enough cash on the balance sheet to continue to do the kind of attractive M&A that we've done over the last couple of years.

[Scott A. Gruber:]

Got it. Sounds good. I'll turn it back.

[Bryan A. Shinn:]

Okay. Thanks, Scott.

[Operator:]

Thank you. Our next question comes from the line of Michael Lamotte with Guggenheim. Please proceed with your question.

[Michael Lamotte:]

Thanks. Good morning, guys.

[Bryan A. Shinn:]

Good morning, Michael.

[Michael Lamotte:]

Bryan, a couple of times you mentioned being sold-out for 2018, effectively 100% capacity utilization. I assume that includes Cadre as well?

[Bryan A. Shinn:]

Yeah. So, that's basically across our network. And when I think about being sort of essentially sold-out, what that means in my mind is for the grade that's probably in least demand, which is 20/40, we think we can be sold-out of that, but there may be an occasional day or week where there's not a lot of demand for that. But we also have the option in most of our mines to move products to the Industrial business as well and to kind of absorb just the ups and downs of the market. But I'd expect that we'd be about as close to sold-out as you could possibly get.

[Michael Lamotte:]

Okay. Great. And then the pricing around Sandbox. It's two quarters in a row now that you've talked about pricing moving up. I'm curious about sort of contracted versus spot exposure in Sandbox, and if there have been any changes in the contracting model there that could lead to a change in the rate of change of price improvement in Sandbox over 2018?

[Bryan A. Shinn:]

So, we have signed several new contracts at Sandbox, and there's more on the way. I think given that over the last, say, 12 to 18 months, Sandbox has been kind of a new solution out in the industry; customers wanted to really take a look at it and make sure that it made sense for them. And I think what we found is, almost universally, once a customer tries Sandbox that they never go back. And some of our larger customers, or larger customers who have tried Sandbox, are now asking for several new fleets. So, I think there will be more growth there; there will more contracts coming, and I feel very good about the portfolio that we have of customers. And if you really step back and think about it, over the next couple of years, pneumatic trucks, as a way of transporting sand in the last mile are just going to go away for a variety of reasons, not the least of which is regulatory-driven. So, all that share of the market out there that pneumatics has is kind of up for grabs. And I think that Sandbox will get more than our fair share of that as we go forward here.

[Michael Lamotte:]

Maybe another way of asking a pricing-related question is, are you benefiting from the inflation that we're seeing in pneumatics? Is that giving you some pricing power in Sandbox?

[Bryan A. Shinn:]

It definitely is. And as trucking becomes more expensive, the delta between Sandbox and pneumatics goes up dramatically. So, if you think about the amount of truck time that it takes to deliver a load of sand with the Sandbox system versus pneumatics, in many cases, it takes an extra 30% to 40% of the time for the truck to do what it needs to do if it's a pneumatic truck. So, every time the rates go up in trucking, that's just, on an absolute dollar basis, like dollar per load of sand, that gap widens. And so, all that's an opportunity for us to capture price, but also share some of that saved cost with customers. And I think customers look at it that way too. And as we go in and talk to the customer, we don't expect to get all that value, we want to share it with them. And I think that's what makes the model so powerful, is that we typically go in and say, well, look, we can provide you much better service, better on-time delivery, meet upcoming EPA and OSHA regulations, and save you money at the same time. It's a pretty, pretty compelling value proposition.

[Michael Lamotte:]

That's great. Thanks, Bryan.

[Bryan A. Shinn:]

Thanks, Michael.

[Operator:]

Thank you. Our next question comes from the line of 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:]

Morning, Kurt.

[Kurt Hallead:]

Hey, guys. Just wanted to just follow up on your commentary on the market demand dynamics going into 2018. You talked about frac crews and sand per crew and how you can kind of get to that calculation, that's very helpful and useful. And you guys mentioned that you guys are going to be effectively sold-out of all of your capacity in 2018. So, would that get – I guess that would get us to around 20 million tons of Oil and Gas volumes for Silica in 2018, if we kind of looked it that way, am I thinking about that correctly?

[Bryan A. Shinn:]

Yeah. I think that's about right.

[Donald A. Merril:]

In the right zip code.

[Kurt Hallead:]

Okay. So, that would be about 20% of the market. Looks like this year, you've been running maybe, order of magnitude, 13%, 14%, 15% of the market. So, that's the kind of market share uptick, and is that all coming on the heels of Sandbox you think, or is that – what else could be driving that market share other than Sandbox?

[Bryan A. Shinn:]

So, I would say, right now, we're at sort of that maybe a 15% to 16% share. And I think your number of somewhere around 20% feels about right for 2018. I think it's a couple of things, Kurt. As I talk to customers, I consistently hear that customers like our mines, they like our footprint, they like doing business with the company, and then when you throw Sandbox into the mix, it just makes it so easy for them to make the choice. And we're starting to offer customers a choice as well of basically all-in delivered pricing right to the wellhead. So, we now provide a mine-to-wellhead solution. It's kind of a new offering that we've been rolling out. And I think customers really like that, especially in a tight sand market. Imagine, we come in and say, well, we're going to handle your last-mile delivery and, oh, by the way, we have one of the largest sand networks in the industry, so you never have to worry about going to get sand or where you're going to get your sand. And it's been fascinating to me to watch as things have tightened up in the industry, customers typically have to go to six, seven, eight different transloads that might be sourced from maybe three or four suppliers to get enough sand to do one well. And when U.S. Silica comes in and say, we'll just do it all for you and we'll give you an all-in price per ton right into the blender, it's looks pretty darn attractive, I think.

[Kurt Hallead:]

Okay. Excellent. Thanks for that color. And then, as a follow-up on Sandbox, I think in the past you guys have indicated that each Sandbox crew generates about $1 million in EBITDA on an annualized basis. Is that still the case?

[Bryan A. Shinn:]

Yeah. So, the good news is that that number is going up. We've increased, in many cases, the number of boxes that we have per crew, and we tend to get paid per load of sand that we deliver. And as the sand intensity per well is going up, I mean, more sand, more loads delivered, and so I think we probably now maybe more like in the $1.2 million to $1.3 million EBITDA per crew. And I think there's a chance that that continues to trend up based on what we're seeing out there.

[Kurt Hallead:]

Okay. So, you exit 2018 at 100 million – crews, that means over $100 million of EBITDA just from Sandbox alone.

[Bryan A. Shinn:]

Yeah.

[Kurt Hallead:]

Pretty impressive. All right. And then, lastly, just on share repo, any general sense on the cadence of that and do you think that $100 million is something that you'll run through throughout the course of 2018 or something that extends out in 2019? Any thoughts on that would be appreciated.

[Bryan A. Shinn:]

Sure, Kurt. I think we'll look carefully at that. And I would say it depends on a number of factors and circumstances, but we continue to believe that our equity, perhaps doesn't reflect all the upside that's in the stock and I think we'll definitely be out there in the market purchasing shares.

[Kurt Hallead:]

Yeah. Thanks, Bryan.

[Bryan A. Shinn:]

Thanks, Kurt.

[Operator:]

Thank you. Our next question comes from the line of William Thompson with Barclays. Please proceed with your question.

[William Thompson:]

Thanks. Bryan, just a follow-up on that last question. So, you guided us kind of on EBITDA per Sandbox fleet. You gave us a math around the pressure pumping crews and sand per crew. I mean, should we think about – the way to think about the business is if you're doing $1.2 million EBITDA per fleet and frac crews are doing 225,000 tons per crew, like, you're capturing about $5 of EBITDA per ton. How should we think about the ability to capture some of the value proposition that Sandbox provides?

[Bryan A. Shinn:]

Yeah. I think you're in and around that math. And as you said, it kind of just becomes straight math at some point when you think about what's being generated there. And the exciting thing for me is that it looks like we have the opportunity to continue to capture more value particularly as we transition to some of these all-in to the wellhead models. I think the value is just going to go up and we're really providing tremendous convenience for the customers, and so far, they're willing to pay for that.

[William Thompson:]

Okay. And then in terms of the 90 million to 100 million tons of 2018 frac sand demand, that 15% to 20% year-over-year, I think, sand tons per well growth. In terms of where we are today, I mean, how much growth do we factor in from today's levels to maybe year-end 2018?

[Bryan A. Shinn:]

In terms of...

[William Thompson:]

So, obviously, we've seen a pretty good growth year-to-date.

[Bryan A. Shinn:]

In terms of sand per well or...

[William Thompson:]

Yes. Correct. I'm just trying to figure out – reconcile where we are today versus that forecast in 2018.

[Bryan A. Shinn:]

Yeah. So, I think it's probably, if you look at that given all the intensity increases already, it's probably a little bit less on a year-end to year-end basis but not much. I mean, I think you're in that kind of range. Maybe I'd use 12% to 15% given that we've already seen some increases. But it's – we had a pretty good view for what's happening given the amount of frac crews that we serve today. And that's why I just find it ironic that we've seen some reports out there that sand intensity per well is decreasing; we live this every day on the Sandbox side and we know exactly what the intensities are, and they continue to go up pretty dramatically.

[William Thompson:]

And then since no one's asked about ISP, obviously, you got it to 10% CAGR growth in terms of contribution margin. Can you talk about the moving parts to continue to drive – obviously, you've kind of talked about that business as a GD++ growth and you're kind of moving on to higher-value products. Maybe just a little more color there?

[Bryan A. Shinn:]

Sure. So, we have several products in the pipeline, some of which are going to launch, I believe, in 2018. We also have a couple of what I'll call sort of larger, chunkier opportunities, which are very specific growth that I'm pretty excited about. And, of course, what's not included in that 10% CAGR guidance is M&A, obviously. And we've got several things on the board right now. We probably have a more robust pipeline in ISP than we've had in the past and other things there that have $25 million, $50 million, $75 million of annualized EBITDA, and then growth on top of that. So, I feel like there's some real potential here to step change the ISP business, and we're going to work real hard on that in 2018.

[William Thompson:]

Excellent. Thank you.

[Bryan A. Shinn:]

Thanks, Will.

[Operator:]

Thank you. Our next question comes from the line of David Deckelbaum with KeyBanc Capital Markets. Please proceed with your question.

[David A. Deckelbaum:]

Good morning and thanks for taking my questions. Nice job on the quarter.

[Bryan A. Shinn:]

Thanks, David.

[David A. Deckelbaum:]

Just curious with the Sandbox expansion, one, should we – is it fair to assume that most of the expansion is going to be Permian or effectively all of it; and, two, how many of new contracts for supply are being bundled right now with Sandbox?

[Bryan A. Shinn:]

So, I would say, over time, what we're going to see is that the Sandbox distribution amongst basins essentially resembles the rig count and where the frac crews are. We're already in several basins, in fact, in most basins already. So, I think that will sort of normalize out over time. And, sorry, what was your second question, David?

[David A. Deckelbaum:]

It was just, how many of the new contracts on the supply side include Sandbox agreements or is it not included right now as a bundled offering on the long-term contracts?

[Bryan A. Shinn:]

So, the long-term contracts typically are not bundled all into the wellhead pricing, although I think we've got a couple of those. So, typically, what we would see is that there's a sand contract, but then as we're discussing the sand contract, we talk about last mile of delivery and, in many cases, it ends up being two separate contracts, as you can imagine. Customers will – they understand the frac sand piece and what they want to buy, but Sandbox, we have to run a demo, and they want to kind of see it in action. And so, in many of these cases, these are our new customers who have never used Sandbox before. So, it's a bit of a longer cycle time of sale cycle there. You have to convince them that it all makes sense and things are as advertised. So, we don't hold up the sand contracts kind of waiting for Sandbox demos. So, we tend to decouple that in many of the cases.

[David A. Deckelbaum:]

I appreciate that. If I could just ask one more quickly. Just you talked about Permian supply now coming on perhaps as quickly as people think and, at the same time, you announced a new mine in Lamesa over the last quarter. Can you talk about the opportunity that you see in Lamesa for the industry? Do you think that there's a more limited scope in terms of leases that are available out there for sand development? Because I do think it's at least a geography that caught people off guard.

[Bryan A. Shinn:]

So, we spend a lot of time looking for the right sites, and I believe that we have the two premier sites in the industry today. Obviously, there's always other locations out there that people are looking at. But all the ones we looked at, quite frankly, had some level of compromise; either there was a logistics issues or there was a water issue or there wasn't natural gas on the site or any one of a number of factors. So, you can't say that there's not other land out there because there is, but I feel like over time, what's going to happen is the best sites are going to get picked up and then the ones that are left have some sort of defects or deficiency. And quite honestly, it's a lot like Wisconsin or Minnesota, right, when there was a kind of a gold rush mentality up there. People came in, found the best sites and got those, and then the people who came in later had to make compromises. So, I feel really good about what we have. I think we've got the premier mine sites in the Permian, and I think we're going to do real well with both of them.

[David A. Deckelbaum:]

Thank you, guys.

[Bryan A. Shinn:]

Thanks, David.

[Operator:]

Thank you. Our next question comes from the line of Chase Mulvehill with Wolfe Research. Please proceed with your question.

[Chase Mulvehill:]

Hey, good morning.

[Bryan A. Shinn:]

Morning, Chase.

[Chase Mulvehill:]

Morning, Bryan. So I guess I will come back to the 2018 comment that you're effectively sold-out, and so that's about 20 million tons of kind of volumes in 2018. How much of that is actually contracted and how much of that contracted is actually contracted at fixed price?

[Bryan A. Shinn:]

So, historically, we've said we wanted to be between, say, 50% and 75% of our Oil and Gas volume under contract. I would say that given the high demand that we're seeing, it is toward the higher end and there may be a quarter or two where we actually go over the 75%, is where the contracts stack up. And most of the pricing in these contracts is fixed. There are some contracts that adjust with the rig count, but I would say that the majority of these are fixed-price contracts.

[Chase Mulvehill:]

Okay. All right. And then, you got some 4 million tons of brownfield capacity in the two Permian mines coming online. Can you talk about the timing of when you expect that capacity to come online?

[Bryan A. Shinn:]

So, in the Permian, we've said that the Crane County site will be online by the end of this year. And so, I think it's probably last half of December. So, we're not going to see much of that in 4Q, but we'll certainly see it ramp in 2018. And then, Lamesa, I think we're in the sort of March-April timeframe for ramp-up there. And then for the other brownfield sites, I think we will see some capacity come online in 4Q, but most of that will be ramping up again in 2018. So, you add it all up and there's a few tons that come online in 4Q here, but most of it really starts to ramp in 2018.

[Chase Mulvehill:]

Okay. And in 2018, is there any optionality for further brownfield around Lamesa or Crane County or Mississippi Sand?

[Bryan A. Shinn:]

So, I mean, there's always some tweaks you can do here and there, but I tend to look at what we're permitted for, and so, the capacity that we have – or capacity we have permitted right now. And so that's what I'm counting on for 2018. So, I'm not looking for any dramatic expansions there at this point.

[Chase Mulvehill:]

Okay. All right. I'll squeeze one more in and kind of talk about the railroads. What are you seeing from a pricing standpoint from the railroads, and what's their general view about potential risk to rail volumes?

[Bryan A. Shinn:]

So, we have really good relationships with our primary rail carriers, and I would say that the behavior we're seeing from them is relatively standard. They're giving incentive to some locations, raising prices in others; it's all sort of dependent on the ebb and flow of the materials. I would say that they recognize that there's perhaps some volume that they're going to lose as the Permian gets some of its own capacity. But at the end of the day, the sand volume by rail is still a relatively small part of the overall network for carriers like the UP and BNSF. So, I certainly don't see them do anything sort of unusual or out of character as a result of what's going on down in the Permian.

[Chase Mulvehill:]

Okay. That's helpful. Thanks, Bryan.

[Bryan A. Shinn:]

Thanks, Chase.

[Operator:]

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

[Ken Sill:]

Thank you. Congratulations.

[Bryan A. Shinn:]

Thanks, Ken. Good morning.

[Ken Sill:]

Good morning. I've got a question on Sandbox. So, the crews are getting bigger, the fleets are getting bigger, is that proportional with you guys' expectation for increased EBITDA contribution or has the capital cost gone up a little bit less quickly than the EBITDA contribution?

[Bryan A. Shinn:]

So, I think what we're seeing is that the EBITDA contribution is going up fairly substantially. Certainly, there's a bit more capital cost here, but it's not like we have to replicate the whole crew to get those extra tons that are coming through now. So, really all we have to do is build some more boxes and then the chassis that carry the boxes gets hooked up to the truck. So, the rest of it is fairly the same. So, I think it's kind of a plus one, quite honestly. And I love it when we get more boxes in the fleet, it's just more profit that comes out of that.

[Ken Sill:]

That's a good formula. And then on the fixed-price contracts. Do you guys have escalators in there, because I'm assuming at least from a paying for labor, drivers for driving the Sandbox fleets, you've got the same cost pressures everybody else does.

[Bryan A. Shinn:]

Yeah. So, on Sandbox side, we definitely have the ability to pass on – in all the contracts, the ability to pass on increases in trucking costs. I mean, obviously, I think everybody recognizes, including our customers, that those costs go up and down over time. So, there's no problem getting those kind of contracts signed.

[Ken Sill:]

And then kind of a detailed question on the contracts where you got the deposits. As you bring those deposits into income as the volume is sold, does that increase the margins on those contracts or the margin is pretty much in line with everything else, you just add the deposit, which offsets the purchases?

[Bryan A. Shinn:]

Yeah. So, the margins stay the same. The customer just sees a lower price on their invoice, right. So, the margin that we book is the same as whatever the kind of the "nameplate" margin is in the contract. But since the customer's already paid for that ton or part of that ton, they'll get a credit of X dollars per ton.

[Donald A. Merril:]

Right. They'll earn a certain amount of that capacity reservation fee back per ton that they buy.

[Ken Sill:]

And I'll just squeeze one more in here. Just looking forward, right, so the markets kind of almost myopically focused right now on the Permian where you're laying out basically your volumes are sold, you're going to be fine. If you're looking out past 2018, oil prices are up higher, what regions do you see outside of the Permian as being most likely to see growth, and what is the threat of additional in-basin capacity in some of these other regions where we really haven't seen a lot of in-basin capacity added?

[Bryan A. Shinn:]

So, I think we'll see the Bakken come back, DJ basin. Obviously, the MidCon is going pretty well. So, I think there are some mines in other basins and, for example, we have a mine in Oklahoma that serves the MidCon, right? And so, that's where a lot of the sand that's already serving that basin comes from. So, I think you'll see those. But Permian seems like it's kind of its own thing. There's such a critical mass there of drilling and completions that making an investment in a big mine site there makes more sense than doing that in, perhaps, some of the other basins. So, might we see the occasional mine pop here or there? Perhaps, but we're not expecting that to be kind of – some kind of megatrend, if you will, that happens around the industry.

[Ken Sill:]

Got it. Thank you.

[Bryan A. Shinn:]

Thanks, Ken.

[Operator:]

Thank you. Ladies and gentlemen, that's all the time we have for questions today. I'd like to turn the floor back to Bryan Shinn for closing comments.

[Bryan A. Shinn:]

Thank you very much. I'd like to close the call today with a few key thoughts. First, I believe that we are extremely well-positioned to capitalize on all the important market trends that we talked about today, and I really appreciate all the questions to help us clarify that a bit more. I think we'll have a strong finish to 2017 and substantial growth in 2018. Second, I want to thank our customers, especially those who've recently signed frac sand contracts with us and I want thank them for choosing to work with U.S. Silica and putting their trust in us. We look forward to exceeding your expectations with our best-in-class assets and team. And, third, I want thank our investors for their interest and support and I look forward to meeting and speaking with many of you in the near future. Thanks, everyone, for dialing in and have a great day.

[Operator:]

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.