U.S. Silica Holdings, Inc.
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Greetings and welcome to the U.S. Silica Third Quarter 2016 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 Communication 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 2016 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 our third quarter results followed by an update on the progress we've made integrating our two new acquisitions, Sandbox Logistics and NBR Sands. I'll conclude my prepared remarks with a market outlook for both our operating segments. Donald Merril will then provide additional color on our financial performance during the quarter before we open up the call for your questions. For the total company, third quarter revenue of $137.7 million improved 18% sequentially due in part to higher sales volumes in our Oil and Gas segment and a partial quarter of top line contributions from our new operations. Sales volumes in Oil and Gas for the quarter of 1.6 million tons increased 21% sequentially compared with a 14% improvement in the average U.S. rig count during the quarter. We sold more tons in basin during the quarter, as we began to see some of the mid and smaller sized customers who rely heavily on our logistics network coming back into the market. We sold 65% of our tons in basin during the quarter with our largest local sales occurring in the Permian, Mid-Con and the Northeast. Adjusted EBITDA for the quarter of $8.3 million increased 54% sequentially. Our Industrial and Specialty Products segment had another strong quarter with contribution margin of $21.6 million, an 8% improvement on a year-over-year basis. ISP once again established a record high on a contribution margin per ton basis of $24.64 per ton, up 25% compared to the third quarter of last year. While it doesn't get as much attention as our Oil and Gas segment, our Industrial business generates consistent cash flows that cover fixed cost in a downturn and provides a strong platform for growth going forward. The performance of our Oil & Gas business, excluding our recent acquisitions, largely mirrored the previous quarter. We continued to experience unfavorable mix issues and some pricing pressure throughout most of the quarter, which was partially offset by improvement in fixed cost leverage from higher volumes. Contribution margin in Oil and Gas was a negative $1.9 million, but better sequentially and aided in part by our acquisitions and higher pricing in the last month of the quarter as supply and demand tightened. I'm pleased to report that many of those price increases are holding into Q4. On the cost side, we continued to make substantial progress driving expenses out across the entire supply chain. We've delivered over $50 million in the cost savings on a year-over-year basis through head count reductions, plant debottlenecking, maintenance improvements and logistics savings. Our mines are doing a great job of staying nimble and remaining flexible to keep pace with market moves, while at the same time, driving per ton cost lower. As a result in September, we saw our lowest cost on a dollar per ton basis in the last four years. On the logistics front, we remain focused on adding transload capacity that is near drilling and completion activity, requires no volumes commitments or capital, and is unit train capable to help increase sales, decrease transload cost per ton and meet shipments as demand ramps up. We opened up two new unit train transloads during the quarter and currently 18 of our 49 transloads are unit train capable. We shipped a record 61 unit trains during the quarter, including the largest sand unit train ever, 156 car train shipped from Ottawa, Illinois to Halliburton transload in Texas. We've also renegotiated several contracts with third-party transload operators to eliminate minimum volume requirements and shortfall penalties and have made meaningful progress to date, as evidenced by the fact that across our network, we now have 30% more storage at 40% lower fixed cost. Now, let me provide you with an update on the integration of our two new acquisitions, both of which have been performing well in a short time that we owned them. I'll start with NBR, which we are calling our Tyler facility. We've successfully integrated Tyler into our operations and logistics network. We've ramped up volumes and are on a current run rate of about 1 million tons per year and expect to end the year at a run rate of about 1.6 million tons. Last week, we shipped our first product out of Tyler by rail to the Permian. Tyler with its low production costs and logistical advantages is one of the most competitive mines in our portfolio today and another reason why we're so excited about regional sands. We're also very excited about the prospects for Sandbox, which has seen a significant uptick in interest from customers since we acquired them. And as a result, we're working on several new proposals and customer trials. We've also been busy integrating Sandbox's proprietary solutions into our logistics network and merging their sales processes with our Oil and Gas business. Our strategy with Sandbox is to offer a low cost, highly efficient solution for last-mile sand delivery, which helps customers meet the demands of high sand intensity completions, while eliminating truck detention cost and supporting compliance with new OSHA regulations. We will also offer a ground-to-ground solution where we manage all aspects of sand logistics from the mine to the well head. And while we do plan to move a lot of U.S. Silica sand through Sandbox, we also expect to support our customers as they source sand from competitors. As discussed on our last earnings call, Sandbox today enjoys a market share of about 10% of the sand being pumped in the U.S. In the next few months, we plan to increase our capacity from 24 crews to 40 to 45 crews by investing about $25 million to build additional boxes, chassis and conveyors, as well as adding staff and leasing support equipment. Based on the current high level of customer interest, we expect to add several additional crews during the next 12 to 18 months. I'm very excited about both of these accretive and highly complementary acquisitions and the meaningful opportunities that they're expected to provide for growth and long-term value creation for our shareholders. We continue to seek other attractive M&A opportunities, and we have a very robust pipeline in both Oil and Gas and Industrial. Finally, I'd like to provide some commentary around our market outlook for both operating segments for the remainder of the year. As you know, our Industrial business is seasonal, and volumes and pricing for ISP typically decline from the third quarter to the fourth quarter due to weather and customers taking facilities offline for maintenance. Regardless, I think we'll continue to see year-over-year bottom line growth in ISP as higher margin products to make up an even larger portion of our total ISP contribution margin. In Oil and Gas, I believe that our market's likely bottomed in the third quarter and that we are in the very early stages of a recovery. We've seen some stability in WTI pricing driving subsequent growth in horizontal rig count. Completion activity is picking up, and our proprietary models indicate a 16% increase in working frac crews over the last 60 days. Our open order book is the highest it's been since February of 2015, and we're now hearing from numerous customers that their frac crews are booked to the end of the year. If the strong October start continues through the quarter, we expect an increased sales volume, and pricing will result in an improvement in our Q4 profitability. I firmly believe that U.S. Silica is uniquely positioned for the recovery in Oil and Gas. We have the best balance sheet in the space. We sit on the low end of the cost curve and have the widest raw sand product offering of anyone in our industry. We've built a high velocity logistics network with a wide footprint and tremendous flexibility to maximize our value to customers. And with the addition of Sandbox, we can now offer our customers a ground-to-ground logistics solution to solve their last-mile logistics challenges. With that, I'll now turn the call over to our CFO, Don Merril. Don?

[Donald A. Merril:]

Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our two operating segments, Oil and Gas and Industrial and Specialty Products. Revenue for the Oil and Gas segment for the third quarter of 2016 of $86.8 million improved 34% sequentially compared with the second quarter of 2016, while revenue for the ISP segment of $51 million declined 2% when compared with the previous quarter. Contribution margin from Oil and Gas in the quarter was a loss of $1.9 million compared with a loss of $6 million in the second quarter of 2016. On a per ton basis, contribution margin for Oil and Gas was negative $1.17 compared with a loss of $4.50 for the second quarter of 2016. As previously discussed, the impacts of our cost improvement projects, the positive impact of higher volumes and fixed cost leverage, and margins generated by the integration of NBR and Sandbox were largely responsible for the improvement in contribution margin per ton in the quarter. Contribution margin for our Industrial and Specialty Products segment was $21.6 million, virtually flat on a sequential basis when compared with the second quarter of 2016, but an 8% improvement on a year-over-year basis. Contribution margin per ton for the ISP business of $24.64 improved 4% sequentially from the second quarter of 2016 and 25% over the same period last year. As Bryan noted, the sequential increase in ISP contribution margin per ton was driven largely by a combination of increased higher margin product sales and lower operating costs. Turning now to total company results. Selling, general and administrative expenses for the third quarter of $18.5 million were up compared with the $14.6 million for the second quarter of 2016. The sequential increase in SG&A expense is largely due to acquisition-related cost incurred for NBR and Sandbox. Depreciation, depletion and amortization expense in the third quarter was $17.2 million compared with $15.2 million in the second quarter of 2016. The increase in DD&A was mainly driven by additional expenses related to the NBR and Sandbox acquired assets. Continuing to move down the income statement, interest expense for the quarter was $6.7 million, virtually flat when compared with interest expense for the second quarter of 2016. From a tax perspective, we recognized an income tax benefit of $12.2 million in Q3 of the current year. $2.1 million of this benefit is a discrete item, which relates to the early adoption of the recently issued accounting standards update, simplifying Employee Share-Based Payment Accounting. Excluding the aforementioned discrete tax benefit, the effective tax rate for the nine months ended September 30, 2016 was 44%. Turning now to the balance sheet, cash and cash equivalents as of September 30, 2016 totaled $264.1 million compared with $454.2 million at the end of the previous quarter. We used $176.4 million of this cash to complete the acquisitions of NBR and Sandbox. As of September 30, 2016, our working capital was $331.2 million, and we have $46 million available under our revolving credit facility. As of September 30, 2016, our total debt was $506.6 million compared with $490 million on June 30, 2016. The increase was due to additional debt assumed in connection with our acquisitions. During the third quarter, we incurred capital expenditures of $9.4 million, largely associated with the company's investments in various expansion, maintenance, and cost improvement projects. We are updating our guidance for capital spending for the remainder of the year and now anticipate that our capital expenditures for the full year 2016 will range between $42 million and $47 million, which includes approximately $14 million of spending associated with our two acquisitions. We remain steadfast in our efforts to reduce our cost structure, spending capital prudently and identifying the best uses of our cash to maximize financial returns. We've utilized our strong balance sheet to acquire powerful and profitable companies that will help us grow our business, improve our competitive stand to the marketplace and ultimately make our customers more successful. Our actions are centered on ensuring that we remain in the best position financially for the long-term success in a cyclical energy market. With that, I'll turn the call back over to Bryan.

[Bryan A. Shinn:]

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

[Operator:]

At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Michael Lamotte with Guggenheim. Please state your questions.

[Michael Lamotte:]

Thanks. Good morning, guys.

[Bryan A. Shinn:]

Good morning, Michael.

[Michael Lamotte:]

Bryan, if maybe I could start with the fourth quarter outlook, because there's so many moving pieces on the volume side. Can you perhaps put some more book ends around it in terms of what the market is doing on an apples-to-apples basis? I think I can do the math on the Tyler expansion, and perhaps the timing of fleet expansion in Sandbox. Are we going to see any impact of that in the fourth quarter?

[Bryan A. Shinn:]

Sure, Michael. So, as we think about Q4, obviously it starts with October. October is off to a very strong start. We're seeing volumes up significantly. And it looks like we are holding and in some cases expanding the price gains that we've got in Oil and Gas in the back half of Q3. Just some data points that we look at to help us sort out which way things are going in the Oil and Gas side. We've seen about a 16% increase in frac crews in the field in the last 60 days. I think most folks know that we have a proprietary model that we use to track that and it's been a pretty good predictor of demand in the past. We think that sand demand from an industry standpoint has now moved up to a run rate that exceeds 30 million tons a year and we would expect that in the coming quarters to continue to expand. But I guess probably the most direct indication of how Q4 looks is open orders. And the open order bank is the best that we've seen in 18 months. And I tend to look at a few things beyond that. One of the things that I was looking at is what sort of visibility are our customers giving us to orders. So, in the downturn, for example, sometimes we'd only have a week or two weeks' notice before we'd get an order from customers. We're actually back now to seeing, in many cases, a 60 to 90 day outlooks from our customers. And so, that does a couple of things. It certainly helps our planning, but it also gives me confidence that our customers have better visibility to demand. So, all in all, it feels like a pretty strong quarter ahead. I believe that Sandbox will also grow. To your kind of second part of your question, we have some additional crews that get deployed. There's strong pipeline of sales request there. So, all in all, it feels like Oil and Gas should be in for a pretty strong quarter in Q4. Obviously, on the other side of our business, ISP, we always have a decline in the fourth quarter. Many of our customers take seasonal outages for maintenance and other reasons. But I feel like with a full quarter of both Sandbox and NBR, a positive outlook for both volume and price in Oil and Gas, all that together should make for a pretty good fourth quarter.

[Michael Lamotte:]

That's helpful. Thank you. And if I could just drill down on a follow-up on the Tyler facility with the rail spur now up and running, what impact does that going to have on your idle car utilization? How much of an increase are we going to see in terms of that potential uplift between now and year end?

[Bryan A. Shinn:]

So, I think that when everything gets fully ramped up at Tyler, we could expect to use 300 to 400 cars out of the fleet. We've been doing a pretty good job of whittling down the cars in storage. If you look at kind of how that's moved over the last several months here, we've had about 400 cars out of storage in Q3. So as demand picked up in Q3, we got 400 out. Actually, the demand was strong enough on October that we've already taken another 270 cars out of storage. So, that should put us below 2,000 in storage as we pull all those out. Then, you put the Tyler usage on top of that. So, we should be down to about 1,600 cars or so in storage when all those things come to play. And if you look at how that compares to where we've been, just a couple of quarters ago, we had about 2,600 cars in storage. So, I think we have a line of sight to getting down to the 1,600 range and then obviously as demand picks up, hopefully, into 2017, we should be able to whittle that number lower.

[Michael Lamotte:]

That's great. Thanks, guys.

[Bryan A. Shinn:]

Thanks, Michael.

[Operator:]

Our next question comes from the line of Connor Lynagh with Morgan Stanley. Please state your question.

[Connor Lynagh:]

Thanks, guys. Good morning.

[Bryan A. Shinn:]

Hey. Good morning, Connor.

[Connor Lynagh:]

Could you just sort of help us understand the magnitude of price increases that we're talking about, both in terms of what's happened thus far and what we might expect over coming months here?

[Bryan A. Shinn:]

Sure. So, if you just sort of wind the clock back a bit, obviously the pricing has been pretty tough during the downturn and we had to make a lot of concessions to keep volume moving through the system. We really started to see the first sort of green shoots in early Q3, but in a much bigger way coming in September and then October. And so, what I expect is that the market's going to continue to tighten over the next few quarters. And what we're seeing is, as predicted, as things start to come back, the sort of local supply and demand imbalances. And you've heard us talk before that the pricing discussion at the end of the day is not really a national discussion. It's a very sort of local discussion. And so, I think that that tightening is definitely going to help us. If you look at the delivered cost curve into the basins, you can get a sense of pricing and how it's going to come back. I think initially, it's going to be relatively modest. What we're seeing is a $1 here and a $2 there, but it feels like the kind of thing that could – if demand continued on the strong track that it's on today, it could start to ramp up in a meaningful way.

[Connor Lynagh:]

That makes sense. And I know you guys do a good job tracking some of the smaller mines in the industry. So, could you talk about maybe what you're seeing in terms of mines coming back to work or further idlings since you last updated to that?

[Bryan A. Shinn:]

So, we haven't seen a lot come back on. Obviously, a couple of our public competitors have announced mine sites that they've brought back online. So, it feels like a few million tons that perhaps have come back. We still see substantial capacity offline today. And the interesting thing is that the capacity that's offline today, if that comes back, it's going to come back in a much higher delivered cost. So, I think, in addition to the local supply and demand imbalances that we're starting to see, if some of those sort of higher cost mine sites come back into the mix, that's going to be a tailwind for pricing as well.

[Connor Lynagh:]

Got it. Thanks a lot.

[Bryan A. Shinn:]

Thanks, Connor.

[Operator:]

Your next question comes from the line of Marc Bianchi with Cowen & Company. Please state your question.

[Marc Bianchi:]

Hey. Thank you. Just turning back to the railcars for a sec, can you remind us what the obligation is for railcars coming into the fleet over the next periods, next year, two years? And what kind flexibility you have to work that obligation down?

[Bryan A. Shinn:]

So, we have obligations for about 2,500 cars to come into the fleet over the next few years and we're working very closely, Marc, with our railcar leasing and construction companies. And I would say that we have a very constructive discussions with those entities and I feel like we're going to end up with a positive resolution to that in a way that we'll take cars when we need them and work with our partners in a way that benefits them as well. So, I think there's a good resolution here. But I also believe that if we continue to see the demand increase, if it follows the trend that we've seen in October here and some of the trends that we're hearing out in the industry, we'll whittle away the cars in storage pretty quickly. I was just doing some calculations the other day and sort of a good rule of thumb for folks to use is that it takes about 1,000 railcars to support 1.4 million tons a year shipped by rail. And so, said more directly, if our volume goes up, rail volumes go up 1.4 million tons, then we'll need another 1,000 railcars, right. And that assumes some things around how much of unit train, and manifest and all that, but I think that's a pretty good view for where we are anyway and probably others in the industry are similarly positioned. So you can see, as our volumes ramp up, the railcars to be used relatively quickly as well.

[Marc Bianchi:]

Great. Great. Thanks for that, Bryan. And maybe turning over to Sandbox, kind of a two-part question. First, can you say how much the business contributed during the third quarter? And how are you thinking about the competitive positioning there? We've heard from some of your peers that they've got their own last-mile solution. It looks very similar to Sandbox. How are you able to protect against that, and thoughts around the competitive positioning in light of what's been said?

[Bryan A. Shinn:]

So, Marc, as I think about Sandbox and how it performed in Q3, obviously we only owned it during the quarter for a few weeks, but I was really pleased with the results there. And quite honestly, the whole Sandbox integration and how it's going has exceeded my expectations. We don't have specifics for you today on the numbers for Sandbox, but relative to Sandbox versus other competitors out in the space, it's really a different animal, in my mind. I think Sandbox is unique for a couple of reasons. First is that we have a proven technology. And if you look at what this company has done, we currently move about 10% of the sand that's pumped down whole in the industry. We have 10 customer contracts associated with that. We've served more than 1,100 wells over the last few quarters. And we're a real business, not sort of an idea. We have more than 300 employees at Sandbox. We have six field locations to support our equipment. So, we're a proven technology and trusted by customers. I think that's one key thing about Sandbox. The second is that we have an extensive IP portfolio, and I think some of our would-be competitors look past that, but we have 73 patents that we filed, 24 of which have been issued and 49 are pending. And we have a extremely broad coverage here. It covers containers, actuators, literally the process itself of taking a container of sand to the well site and using it the way it's being used in this application is covered by a process patent, right. So, at the end of the day, anybody who wants to enter the space is going to have to work around our IP, and as a result, I think they'll be much less efficient and much higher costs than us. And quite honestly, as we've seen folks try to do that, we believe that many of them are violating our IP and we're going to defend that vigorously. So, that's the second key point about Sandbox. And then, third is that even if competition finds a way to come in and get around our IP, we're scaling quickly. We have a strong customer pipeline. This is now a part of U.S. Silica's best-in-class logistics network. We have the capital to expand, and we're doing that. And perhaps most importantly, we have the confidence of the industry and the confidence of customers. The fact that we're already pumping 10% of the sand or moving 10% of the sand that's being pumped, 1,000-plus wells served, I believe that Sandbox is going to end up as a clear choice for last-mile sand delivery. And we're going to substantially replace the other solutions that are out there today, including pneumatic trucks.

[Marc Bianchi:]

Very good. Thanks.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Our next question comes from the line of Scott Gruber with Citigroup. Please state your questions.

[Scott A. Gruber:]

Good morning.

[Bryan A. Shinn:]

Good morning, Scott.

[Donald A. Merril:]

Good morning.

[Scott A. Gruber:]

Bryan, in the past, you discussed in-basin pricing and moving simultaneously or possibly ahead of mine gate pricing. The price increases that you're realizing now, what is the trend across those two sales points?

[Bryan A. Shinn:]

Yeah. It's really an astute question, Scott. And I think you recognize as we do that the pricing really comes first locally in many ways, and the kind of battle, if you will, battling quotes on price is fought at a kind of a sub-regional level. And so, as you might expect, a lot of the initial price increases that we're seeing are in that kind of an area. And I'd also note, I said in my prepared remarks that we moved about 65% of our volumes in Q3 through our transload network. So, that's a big change from where we've been over the last couple of quarters. And the interesting thing is that we're seeing some of the small and medium sized service companies add crews back, and those are the folks that typically depend on our logistics network the most. But even the bigger service companies, as they're growing, as the market rebounds, even those folks don't have enough transloading capacity to deal with all the sands, so they're starting to use our network more as well. So, I think all that is a positive for pricing and ultimately for the margins that we realized.

[Scott A. Gruber:]

So, would you agree that incremental gains from here would be more weighted towards in-basin versus mine gate for at least the near term?

[Bryan A. Shinn:]

That is probably the way it plays out. It's difficult to predict, but that's what it's been in the past. And I don't see any reason why that wouldn't be true in this up cycle as well.

[Scott A. Gruber:]

And then just quickly, you may have mentioned this during your prepared remarks. So what was the timing around taking the Sandbox crew count to 40 or 45?

[Bryan A. Shinn:]

So, we're in the process now of building the equipment, and I would expect that over the next couple of quarters, we'll see those crews become available. So, the first crews will be available in the fourth quarter and then ramping up over the next couple of quarters.

[Scott A. Gruber:]

Great. Thank you.

[Bryan A. Shinn:]

Thanks, Scott.

[Operator:]

Your next question comes from the line of Blake Hutchinson with Howard Weil. Please state your question.

[Blake Allen Hutchinson:]

Good morning.

[Bryan A. Shinn:]

Morning, Blake.

[Blake Allen Hutchinson:]

Bryan, thanks for the reset on NBR and the volume growth there. I was hoping, as we kind of exit the year here, that maybe you could kind of reset for us. As we look at the system between the added Ottawa acreage and potential expansion there, underutilization of the system maybe at large and maybe pulling some mines not listed as API. What would you call your exit rate kind of practical oil and gas capacity as we look at it today?

[Bryan A. Shinn:]

So, I would expect that we'll be at about 12.5 million tons of usable Oil and Gas capacity. As you were sort of implying in your question, in the past, some things have gotten really hot. We've found a way to squeeze out a bit more from some of our industrial mines. But I think 12.5 million tons is probably the number to use.

[Blake Allen Hutchinson:]

Okay. And then, just referring to some of your commentary in your preamble, you talked about unfavorable mix. I guess when you look at that some – on the margin, some addition from NBR and your commentary around in-basin delivery, what specifically was working against you on the mix side?

[Donald A. Merril:]

Well, I think, on the mix side, there's really several different pieces of mix. There's customer mix, there's basin, et cetera. And what we were stung with a little bit in the quarter was more on the customer side. So, some of our customers – we didn't lose customers, but some of them moved some work around and timing of that hurt us in the quarter. So, things that got moved out of the third quarter into the fourth quarter was the biggest piece of that.

[Blake Allen Hutchinson:]

Okay. So, it's a volume commentary rather than necessarily something that showed up in ASP or something like that.

[Donald A. Merril:]

That's right. That's right.

[Blake Allen Hutchinson:]

Okay, great. That's all I had. I'll turn it back Thank you.

[Bryan A. Shinn:]

Thanks, Blake.

[Operator:]

Our next question comes from the line of Jim Wicklund with Credit Suisse. Please state your questions.

[Unknown Speaker:]

Morning. It's actually (34

[Bryan A. Shinn:]

Morning.

[Unknown Speaker:]

Hey. Just I wanted to dig a little bit more on the increase from 20 to 40 crews in Sandbox. What do you expect the market share impact could be? Can we expect market share to double the 20% with that increase in crews, or how should we be thinking about that?

[Bryan A. Shinn:]

Well, we've got to think about the kind of the crews themselves. And so a crew typically pumps a certain amount of sand, right? So, you do the math and you say – you pick a number and say, a typical crew might do 200,000 tons of sands, just to pick a number. Then, if we add 20 crews, do the math on how much that is, that's 4 million tons of sand that we additionally move. Now, it depends on where the demand goes in terms of the share, right. So, you have to do the calculation on that. And I tend to think about it more in terms of the amount of volume of sand that we can move through there. And that'll sort of equate to whatever share it equates to depending on how fast the market's moving. With that said, I expect that given the kind of pipeline of opportunities we have and the demand there that we may be back looking to add additional crews, assuming that we get the success that we expect with the next 20 or so that we're going to add.

[Unknown Speaker:]

Okay. Thank you. That's very helpful. And then, just one more follow-up there. What do you expect the incremental CapEx to be to take it from 20 to 40 crews?

[Bryan A. Shinn:]

So, we said that we're going to invest about $24 million, $25 million. That's a pretty good estimate for that.

[Unknown Speaker:]

Okay. Thank you.

[Bryan A. Shinn:]

Thank you.

[Operator:]

Our next question comes from the line of Robin Shoemaker with KeyBanc Capital Markets. Please state your question.

[Robin E. Shoemaker:]

Wanted to clarify one point you've talked about. Are you anticipating, in terms of your railcars on order, a kind of a settlement such as others have announced here or are you just kind of work with them and to manage the number of cars you need coming out as your current leases expire and so forth?

[Bryan A. Shinn:]

So, what we've seen, Robin, is that our railcar partners have been very interested in continuing to work with U.S. Silica. And so, I think we'll find out a business arrangement that works for everyone. We are currently continuing to discuss that. And obviously, as the market changes here, particularly if it turns out that – looks like we may need actually cars sooner rather than later depending on how fast things ramp up, that obviously makes it an easier discussion as well.

[Robin E. Shoemaker:]

Right. Okay. And then on the Sandbox volumes, are those volumes reflected in your total sales volumes as it – which would ultimately include a significant amount of third-party sand? How's that being reported with regard to what we see quarterly as your sand sales volume?

[Bryan A. Shinn:]

Yeah. It's a really good question, Robin. I'm glad you asked it because I think there's been some confusion around this whole notion of our sand versus someone else's sand, what gets moved in Sandbox. And let me just start and say, to begin with, certainly we expect to move a lot of our own sand with the Sandbox's, but we'll move other people's sand as well. And so, when I think about what's included in there, for example, in Q3, there's no third-party sand included there in the volumes. Certainly, it's in the revenue. So the revenue we get from providing the work of a Sandbox crew is in there, but we don't count the sand that, say, we moved that was not ours.

[Robin E. Shoemaker:]

Okay. Good. And then on the selling price of sand, which presumably the last milestone price would be higher, is that – well, I guess that's reflected in your revenue, so it would influence your average selling price per ton.

[Bryan A. Shinn:]

That's correct.

[Robin E. Shoemaker:]

Okay. Okay, understood. Thank you.

[Bryan A. Shinn:]

Thanks, Robin.

[Operator:]

Our next question comes from the line of Kurt Hallead from RBC Capital Markets. Please state your question.

[Kurt Hallead:]

Hey. Good morning.

[Bryan A. Shinn:]

Good morning, Kurt.

[Donald A. Merril:]

Good morning, Kurt.

[Kurt Hallead:]

So, again, a number of questions again from investors about there being a potential oversupply of sand in the marketplace. And if I recall correctly, when we had you on the road not too long ago, you guys indicated there's different shredder sand supply at different cost levels. And I was wondering if you might kind of help run – if you might want to kind of run through that real quick and just give us an idea of what kind of capacity is out there and then maybe what varying price points that may come back in?

[Bryan A. Shinn:]

Sure. It's a great question, Kurt. I guess I tend to look at it in terms of two kinds of capacities. So, there's a sort of max capacity that you could ever find out there if you swept everything out of the corners and rated industrial mines that maybe don't have the right kind of quality and things like that. Those numbers are probably around the 100 million ton mark. You'll see estimates out there anywhere from sort of 90 million to 120 million tons. We believe it's somewhere around 100 million and 105 million tons. Then, you kind of come back to and say, so what's the practical capacity that has any sort of reasonable cost and any sort of reasonable quality. And I would look at that more as a sort of 70 million ton number. And if you think about today kind of what's offline, we think there's 20 million to 25 million tons offline. So, it kind of brings it back to something like 45 million or 50 million tons, in my opinion. That is a sort of realistic capacity out there today. And that is most of what I would call sort of the low to kind of the beginning, the medium cost capacity. The low cost capacity is probably 35 million, 40 million tons, something like that, maybe a little bit less depending on how you want to define low. So, it feels like one of these things that – it's bit of an inexact science because at the end of the day, all these numbers I'm talking about are on low costs. Those are at the mine gate. And as you and I both know, the real battle is fought out in the basins. And so, the better question to ask is what does that cost curve look like on a delivered basis and that is substantially more complicated. We have a pretty detailed model on that. And I guess what I can say is that the curve ramps up much more quickly in terms of cost on a delivered basis, so said more plainly that there's far fewer amount of tons in that low-cost bucket. And the good news for U.S. Silica is that almost all of our cost – or all of our production is in that kind of low cost side of the curve.

[Kurt Hallead:]

All right. That's very helpful. And just maybe connect the dots here. You referenced that in that low cost tonnage is maybe 30 million to 35 million tons and obviously get into the delivered cost base, it's – maybe it's even lower than that. Tie that back to the comment you made that you think the current run rate for the industry right now is in excess of 30 million tons on an annualized basis. So, are we at a point here where we potentially see a more meaningful move in pricing?

[Bryan A. Shinn:]

It feels to me like we're getting close to that tipping point and it's obviously different by basins. And I think it's one of the things we're going to talk about in a bit more detail on our Investor Day coming up in December here in Houston, but this notion of what does that delivered cost curve look like and what are the increments as you start to move up that curve, I do feel like we're getting to – once you get beyond 30 million tons, you're starting to get to a steeper part of the curve than we've been on. And that should lead to some more meaningful price increases over the next couple of quarters. Certainly, that's what we're looking for.

[Kurt Hallead:]

And then, I just had one follow-up on the Sandbox market share. I'm not quite sure how to think about the market share dynamic in terms of Sandbox. My understanding is that it's effectively an open-source process. So, it's not just your sand, it could be anybody's sand. So, can you help us understand more kind of the market dynamics or market share dynamic or the competitive framework?

[Bryan A. Shinn:]

Yes. So, I like your terms sort of open source. At the end of the day, our customers are the service companies today. And so, if we're talking to a service company X, we want to help them be more efficient and help them grow their share. And at the end of the day, they'll buy sand from whoever they have contracts with and whoever they want to buy it from. Obviously, some of those contracts and purchases will be us, but even today where we think we've got 20% or 21% of the market, that means there's 80% of the share out there that's not U.S. Silica. So, I'd expect that we'll move through these boxes. Sometimes it's our sand, sometimes it's competitors' sand, and it really doesn't matter to us. I like the market share number just because it helps me, quite frankly, keep track of the progress that we're making. And when we first started looking at this acquisition many months ago, I wasn't sure how big it really was. And quite honestly, I was shocked when I learned that they were actually handling – already handling 10% of the sand moving through the industry. So, it gave me kind of a warm and comforting feeling that these folks knew what they were doing, and it was a kind of company that was going to be a great fit with U.S. Silica.

[Kurt Hallead:]

So, when you say share, it's 10% of the total industry volume that is going through a Sandbox system.

[Bryan A. Shinn:]

Correct. So, just to put numbers on it. If you say today, the total industry volume is 30 million tons, if we have 10% share, that means we're flowing through the Sandbox system 3 million tons a year. That's how to think about the 10%.

[Kurt Hallead:]

All right. That's great. Thanks so much, Bryan. Appreciate it.

[Bryan A. Shinn:]

Thanks, Kurt.

[Operator:]

Our next question comes from the line of Brandon Dobell with William Blair. Please state your question.

[Brandon B. Dobell:]

Thanks, guys. Maybe sticking with Sandbox for a second. Given the location differences, maybe the Tyler and the Voca mines, is there a strategy there to use the Sandbox offering to try and, I don't know, control the origin destination strategy a little bit more, maybe use that as a lever to try and direct volumes to where you think you've got the best fixed cost absorption or where you think you've got the best opportunity for share growth at some point?

[Bryan A. Shinn:]

No. it's a really interesting question. And I think the way we look at it is the Sandbox solution is a great fit with regional sand mines. It's almost sort of a match made in heaven, if you will. And just to your question around the Tyler mine site, what I found interesting is I was digging back through our proprietary frac crew model, and I looked at where the crew growth had come from in the last 60 days, the number two area was East Texas and Louisiana, right, so kind of the Haynesville area. And that sets us up extremely well, I think, for both the growth out of Tyler as well as using Sandbox in those areas. And one of the other things that's interesting, we have this as a potential synergy, and it looks like it's probably going to be better than we thought, there's potential for us to use these containers internally as well in a number of ways. And we think there's some pretty big cost savings there also. So, that's kind of a plus one that we hadn't really talked much about. But in addition to growing the sort of traditional Sandbox business, we're creatively looking for other uses for the containers that can bring even more value to us.

[Brandon B. Dobell:]

Doe this push for Sandbox, does it change how you think about the, I don't know, economics or the asset turns or maybe where to deploy capital in terms of the rest of the logistics network? Maybe it means you've got to have fewer railcars because these were a substitute or fewer terminals in the basin because these were a substitute or am I stretching it too far?

[Bryan A. Shinn:]

No. Look, I mean, you're already two steps ahead. You've graduated to the PhD class in this already, I can see. And look -

[Brandon B. Dobell:]

I've been shooting still hard for that. I appreciate that, Bryan.

[Bryan A. Shinn:]

At the end of the day, right, I think Sandbox is going to fundamentally change the way we and any industry move sand. It's going to change the notion of transloading. I mean, I think about our Sandboxes as mini transloads on wheels, right. We can do a lot of things with those. And it's why it's so important that this is kind of integrated into our Oil and Gas business. We don't think of this as sort of a bolt-on that sits out there by itself. It's a critical part of our Oil and Gas business. It's been integrated into our sales processes and just kind of the way we think about Oil and Gas. And you're right on track, Brandon.

[Brandon B. Dobell:]

Okay. Thanks a lot.

[Bryan A. Shinn:]

Thank you.

[Operator:]

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

[B. Chase Mulvehill:]

Hey. Good morning.

[Bryan A. Shinn:]

Good morning, Chase.

[B. Chase Mulvehill:]

Good morning. So, I'm going to stick on Sandbox for just a minute. So, now that you guys own Sandbox, do you have more E&Ps asking to buy sand directly from you?

[Bryan A. Shinn:]

I don't know we'd have more. I mean, we've had a those kind of inquiries in the past. I think we've been pretty clear that our customer base is service companies and that's who we view as kind of the primary consumers of this. What we have seen is that we've seen E&Ps specify the Sandbox system and pull that back through the service company. So – but certainly, our sales teams are out there talking to energy companies, but the tone of the conversation is, hey, you should pull this through your service company because they – we think those are the best partners for us to work with in general.

[B. Chase Mulvehill:]

Okay. And is Sandbox tied to more a large or a smaller service company?

[Bryan A. Shinn:]

It's a mix. It's all the way up and down the line. What I believe is that we've probably had – if you were doing some kind of an average, it's probably more the smaller to medium sized service companies. I think what we're seeing now is, as U.S. Silica has gotten involved, more interest with some of the larger sand companies, because I feel like they have more confidence in the sustainability of the business, being able to plug in the U.S. Silica sand network. And you just sort of imagine the kind of powerful value proposition of being able to go to the customers in what looks like potentially a quickly rising market and, say, we cannot only supply you the Sandbox, but we can supply you the sand. And you don't have to look too far back into the past to think about the days where sand was in a short supply, and being able to kind of package that together and make that offering, I think, is a really powerful one to say, look, that we can deliver the sand all the way to the wellhead. And since we do everything, and you, Mr. Service Company don't have to touch it.

[B. Chase Mulvehill:]

Okay. Last one and I'll get back in. Could you – and I'm sorry if somebody already asked this. But could you give us kind of the underlying contribution margin per ton and the price per ton for the Oil and Gas frac sand business, kind of excluding Sandbox?

[Donald A. Merril:]

Yeah. I would say the base business – and look, these lines are getting a little blurry as we integrate these new two acquisitions, but I would say the base business was about the same as it was in Q2.

[B. Chase Mulvehill:]

That's both on pricing and contribution margin per ton?

[Donald A. Merril:]

Well, no, I would say that we faced some headwinds on pricing throughout the quarter. And as Bryan stated, we saw that trend turnaround late in the third quarter. So, net-net, price was down a little bit. And we had some headwinds as we discussed earlier as well around mix that was mostly offset by operational, by fixed cost leverage and operational savings.

[B. Chase Mulvehill:]

Okay. So, pricing per ton kind of down 5 percentage and contribution margin per ton flattish, is that a good kind of modeling assumption?

[Donald A. Merril:]

No, I don't know that price was down that far, but I would say...

[B. Chase Mulvehill:]

Okay.

[Donald A. Merril:]

... the contribution margin per ton is flattish. Yes.

[B. Chase Mulvehill:]

Okay.

[Donald A. Merril:]

(52

[B. Chase Mulvehill:]

Awesome. That's helpful. Yes.

[Donald A. Merril:]

Yes.

[B. Chase Mulvehill:]

Thank you.

[Donald A. Merril:]

Thanks, Chase.

[Bryan A. Shinn:]

Thanks, Chase.

[Operator:]

That does conclude our question-and-answer session. At this time, I will turn it back over to Mr. Bryan Shinn for closing remarks.

[Bryan A. Shinn:]

Thank you. So, I'd like to close the call with a few key thoughts. First, I want to reiterate that I'm really pleased with the progress on our two recent acquisitions. As we heard, a lot of the questions today were around Tyler and Sandbox and I just couldn't be more pleased on how both of those are going. I'm confident that they're both going to add substantial value for both our investors and our customers over time. The second point is that we remain keenly focused on three key areas and it really hasn't changed much as we've gone through 2016. And these are the things that I think provide a really clear path to success for our company. So, those are cash, customers and consolidation. We didn't talk about M&A today, but certainly we have a robust M&A pipeline and I think we have more opportunities there. Lastly, I want to thank all my colleagues at U.S. Silica for their outstanding efforts in meeting the tremendous challenges and opportunities that our company has faced so far in 2016. And I also want to thank our investors for their interest and support. And I look forward to meeting and speaking with many of our investors at our upcoming Investor Day, which will be held December 1 in Houston. So, thanks, everyone, for dialing in and have a great day.

[Operator:]

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