U.S. Silica Holdings, Inc.
Q4 2016 Earnings Call Transcript

Published: 23 Feb 2017

[Operator:]

Greetings, and welcome to the U.S. Silica Fourth Quarter and Full-Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. 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 fourth quarter and full year 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 for 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 fourth quarter performance and highlighting a few of our key accomplishments in 2016. I'll then comment on the market outlook for both of our operating segments and discuss some of the actions we are taking to meet the growing demand that we see for both raw frac sand and last mile logistic solutions in our Oil and Gas business. I'm pleased to report that for the fourth quarter, total company revenue was $182.4 million and adjusted EBITDA was $20.7 million delivering sequential improvements of 32% and 150%, respectively. Fourth quarter contribution margin in Oil and Gas was $18.5 million, up $20.4 million sequentially on sales volumes of 2.1 million tons representing a 29% sequential increase in volume and outpacing U.S. rig count growth by about 6%. Improved quarterly results from the company and Oil and Gas were largely driven by higher oil field volume, increased fixed cost leverage, accretive margins from our new businesses, and some pricing recovery. Our Industrial and Specialty Products segment had a very strong quarter as well which resulted in the best year ever in its 116-year history. Quarterly contribution margin of $19 million improved 25% on a year-over-year basis and increased 45% on a per ton basis. New higher margin products, favorable customer and product mix, and lower operating costs contributed to ISP earnings growth in the fourth quarter and for the full year. Despite many challenges, we seized upon numerous opportunities in 2016 to make our company leaner, stronger, more flexible and ultimately easier for customers to do business with, all of which I believe will enable U.S. Silica to further extend its industry leading position as an innovative end-to-end frac sand company. In 2016, we also eliminated almost $60 million in annual costs. Some of these costs are cyclical in nature and are expected to come back as the business improves, but many of our cost improvement projects are structural and should support margin expansion going forward. We became a stronger company in 2016 by making the best balance sheet in the space even better through disciplined capital spending and by raising over $650 million by two successful public equity offerings. We used most of the proceeds from one of those offerings to extend our industry lead through two strategic highly accretive acquisitions, NBR Sands (sic) [Sand] (4

[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 fourth quarter of 2016 of $137 million improved 58% sequentially compared with the third quarter of 2016 driven by a combination of higher volumes including the impact of a full quarter of our two acquisitions and higher pricing. Revenue for the ISP segment of $45.4 million declined 11% on a sequential basis from the previous quarter following typical seasonal patterns in the business. Contribution margin from our Oil and Gas segment in the quarter of $18.5 million jumped into positive territory on a sequential basis compared with a loss of $1.9 million in the third quarter of 2016. On a per ton basis, contribution margin for Oil and Gas was a positive $8.88 versus a negative $1.17 for the third quarter of 2016. The return to operating profitability in our Oil and Gas business was driven by increased volumes and the associated favorable fixed cost leverage and accretive margins from our Sandbox and our new regional mine site in Tyler, Texas, and rising prices. Contribution margin for the ISP business for the quarter of $19 million improved 25% on a year-over-year basis, and contribution margin for the full year 2016 of $79 million increased 13% when compared with 2015. On a per ton basis, contribution margin for the ISP business of $24.03 improved 45% from the same period a year ago. The year-over-year improvement in ISP profitability was driven by improved pricing, increased new high margin product sales and lower production costs. Turning now to total company results. Selling, general and administrative expenses in the fourth quarter of $19.2 million were up 4% compared with the $18.5 million in the third quarter of 2016. The sequential increase in SG&A expense is largely due to additional compensation expense and having a full quarter of expense from the two newly acquired entities, partially offset by lower business development related expenses and the recovery of a previously reserved receivable. Depreciation, depletion and amortization expense for the fourth quarter was $21.2 million compared with $17.2 million in the third quarter of 2016. The increase in DD&A was mainly driven by incremental investments related to our acquisitions as well as other capital spending. Continuing to move down the income statement. Interest expense for the quarter was $8 million compared to $6.7 million for the third quarter of 2016. The increase was due to additional debt assumed in connection with our acquisitions. From a tax perspective, we recognized an income tax benefit of $6.6 million in the fourth quarter of 2016 compared to $12.2 million in the third quarter of 2016 due to a lower pre-tax loss. Now turning to the balance sheet. Cash and cash equivalents as of December 31, 2016, totaled $711.2 million compared with $277.1 million at the end of 2015. During the fourth quarter, cash provided by operating activities turned positive at $300,000 and in November, we executed another successful equity offering of 10,350,000 shares of common stock resulting in net cash proceeds of $467 million. As of December 31, 2016, our working capital was $783 million and we had $46 million available under our revolving credit facility. As of December 31, 2016, our total debt was $513.2 million compared with $491.7 million at December 31, 2015. The increase was due to additional debt assumed in connection with our acquisitions. During the fourth quarter, we incurred capital expenditures of $13.7 million largely associated with the company's investment in Sandbox and various other maintenance, expansion and cost improvement projects. For the full year 2017, we expect our capital expenditures will range between $125 million and $150 million and could be higher based on the pace of investments in our greenfield opportunities. Finally, while we are starting to see some signs of improved visibility in our Oil and Gas business, we will continue to refrain from providing any additional financial guidance until we begin to see more clarity and consistency in our customer demand trends. With that, I will turn the call back over to Bryan.

[Bryan A. Shinn:]

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

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Marc Bianchi with Cowen. Please proceed with your question.

[Marc Bianchi:]

Thank you. Impressive plan that you'd laid out here with doubling the Sandbox fleet again and doubling capacity in Oil and Gas. I guess, maybe first on the Oil and Gas capacity plans. Can you talk to maybe how much of that growth you have from just expanding your existing facilities? And then how much you're expecting to come from greenfield and M&A?

[Bryan A. Shinn:]

Sure. Marc, and thanks for the question. As we said in our prepared remarks, we expect to add a fairly substantial new oil and gas capacity over the next 12 to 18 months. And maybe just give a little more color on the plan itself. There's three components to it. As you mentioned, there's expanding existing kind of low delivered cost mines and those fall into two categories in my mind. So, the first category of mine expansion is for those that are drilling – near the drilling activity, so that's like Mill Creek, Oklahoma, Tyler, Texas, Voca in Texas, mines like that. And then kind of second category of expansion is our low cost Northern White mines, so Ottawa, Pacific, Missouri, these type of mines. So in total, I would expect that we'll have expansions at the seven of our existing mine sites. And I would think that now, we would probably get 40% to 50% of the additional capacity increase that we're looking at from that part of the project. Then, of course, you have greenfield and M&A. From a greenfield perspective, we're going to focus on sites that are near the Delaware and Midland Basins. And we've got several opportunities in the pipeline there. And of course, we'll continue to pursue attractive M&A when we can find assets at reasonable pricing. So really excited about the strategy, and I believe that even though we've given guidance of $125 million to $150 million for CapEx this year, depending on how fast some of these projects proceed, the number could be even higher.

[Marc Bianchi:]

With that expansion, Bryan, how do you anticipate the mix of grades that you have to offer changing, if at all? And can you also remind us what that mix is right now?

[Bryan A. Shinn:]

Sure. So I would expect that the mix would get finer. If you look at the actions that we've taken recently, the last two mines that we bought with Voca, Texas, and Tyler. Both of those have been focused more on the fine side. Traditionally, our mix has been maybe 30% coarse and 70% fine, I would say it would move finer with these expansions, although as we expand Ottawa that has a much a broader mix.

[Marc Bianchi:]

Okay. Thank you. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Thank you. Our next question comes from the line of Ole Slorer with Morgan Stanley. Please proceed with your question.

[Ole H. Slorer:]

Yeah. Thank you very much. Exciting times in the sands, basically again, Mr. Shinn.

[Bryan A. Shinn:]

Yeah. Thanks, Ole. It certainly is.

[Ole H. Slorer:]

Hearing a lot of nice around price increases, I think, there are a lot of confusion around mine gate, but I'm also getting some increased sense that people are starting to get really worried about logistics, maybe not right now, but what they see just around the corner. So, can you give us your sense of what's happening at the mine gate. Is it just certain grades that are getting very tight and seeing kind of doubling of prices or is it also some of the previously residual products, and sort of what's going on in a nutshell?

[Bryan A. Shinn:]

Sure, Ole. So let me give you some of my thoughts and then I'll also ask Don Merril to comment on this. He has a lot of details on the pricing side. I would say generally, we're starting to see positive momentum in pricing. We saw that from Q3 to Q4 last year, and that trend is continuing in Q1 and I would say probably accelerating. So, I think we'll see some pretty substantial increases in price as we go through Q1 here. And I would expect based on everything that we're seeing that the market is going to continue to tighten in terms of supply and demand over the coming quarters. I guess, just one word of caution. I just want to be a bit careful about some of the numbers that we see thrown around. I've seen reports out there issued by various industry sources talking about $45 or $50 a ton mine gate pricing and certainly we're not seeing that, we've gotten some good price increases, but we're not at that level at this point. Don, do you want to comment on that, maybe add some more color.

[Donald A. Merril:]

Yeah. Thanks, Bryan. I would say, first of all, it's important to know when we talk about pricing, we always talk about mine gate pricing and we also take into account all of the impacts of customer mix of in basin sales, et cetera, right. So we pretty much scrub all of that out and what we're seeing – in Q3 to Q4 on average, we are seeing high-single digit price increases rolling into the end of the year. And what we've seen so far from the start of the year until today is probably in a low teens, right. So put it all together and we're seeing in that 15% to 20% price increase since October 1.

[Ole H. Slorer:]

Okay. Very helpful. When it comes to the tightening up of logistics, that market seems to be changing by the day right now. And can you give us your latest thoughts on the possession of Sandbox and you signed a big contract with Halliburton, has that deterred other operators from using it or has there been an endorsement that's' easiest to get more customers. So, what's going on at the moment there?

[Bryan A. Shinn:]

Yeah. Thanks for the question, Ole, it's pretty exciting times in Sandbox. The customer demand quite frankly is just sort of off the charts for Sandbox. We certainly see the last-mile logistics continuing to tighten and that's been driven by the increasing sand per well. So, if you look at the amount sand that a frac crew has to transport out to the well to get it down-hole these days, it's gone up easily 10%, 15%, in some cases 20%, compared to the last few quarters. So, we're seeing that the sand go up pretty substantially in terms of volumes. And one of the neat things about Sandbox is the more the intensity goes up, the better advantage we have versus conventional trucking. And so we decided to substantially expand Sandbox in light of those market dynamics. And just to kind of level set and take everybody back, when we bought the company, bought Sandbox back last year, they had 23 crews, about 18 of those were active. So that's kind of the baseline. We've previously announced a $25 million CapEx expansion to essentially double the business going from 23 to 46 crews. That's going so well and we expect that to be essentially all sold out in the near future here, we've decided to double again which will take us up to about 90 Sandbox fleets. And I would expect that we'll spend somewhere in the neighborhood of $35 million or $40 million this year to bring those additional fleets online. And our expectation is, as I've said in my prepared remarks that we'd be up to 80 fleets or more in terms of equipment deployed by the end of 2017. And if you do some quick math, looking at the number of frac crews out there and some reasonable growth projections, that would put us at about a 25% share position. You may recall in one of the previous earnings calls, we talked about having a target of getting to 40% share in terms of sand that's moving through our system. So that would be 40% of all the frac sand moving through Sandboxes. We expect to be somewhere around 25% of that already by the end of 2017. So we're making great, great progress there. So very exciting times at Sandbox, and looks like that's going to be a fantastic performer for U.S. Silica.

[Ole H. Slorer:]

It sounds like even from a financial standpoint, does it still – I mean, it was generating $10 a ton, I think, or something in that neighborhood of EBITDA. Have you backed off that a little bit or is it tightening or how do you see the kind of profitability on the market share? Are you willing to talk about that?

[Bryan A. Shinn:]

So, I feel like we continue to make attractive margins. Certainly, margins to support our reinvestment economics and then some. So, we feel really good about that and I've been involved in a lot of industries in my career and in an industry where demand for your product is going up exponentially, prices really go down a lot, right? So, we're holding the line on that.

[Ole H. Slorer:]

Okay. Thank you. I won't push any more on that, but thank you very much.

[Bryan A. Shinn:]

Okay. Thanks, Ole.

[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:]

Good morning, Chase.

[Chase Mulvehill:]

Good morning. So, I guess, can we just talk about 1Q outlook a little bit. You talked about having 10 million tons of capacity. Is that a 1Q number or was that year-end 2016 number, and what does 1Q capacity look like and do you think that we can ship all that capacity out?

[Bryan A. Shinn:]

So, what we said in the past is that, if everything is turned on and we're also selling a bit from our traditionally industrial mines, that our capacity is somewhere between 12 million and 12.5 million tons of oil and gas product. We're not running at that rate today. We're having to ramp up obviously, so we don't have everything turned on, but I would expect in the next 60 days plus or minus, we'll have everything turned on. So, we won't see that full run rate in Q1, but certainly we have the intention to get as much capacity into the market from our existing assets as we can.

[Chase Mulvehill:]

Okay. So, looking at 2Q assuming that oil prices remain here, 12 million to 12.5 million tons is probably a good number as we go into 2Q, correct?

[Bryan A. Shinn:]

So, look – I mean, that's certainly our goal. Unfortunately, sometimes life intervenes, but that's how much we could make if we literally make every single ton, and all the grades match up. I would say that probably one caveat you just have to be careful of there is that we're still seeing lower demand for 20-40, our coarser grade as compared to the others. We are starting to move some of that product now as the supply and demand tightens, but that's probably 5% to 10% hit to our overall capacity if we can't move all of that. So, there's some puts and takes in there but, certainly, as I talked to our operations, supply chain and sales team, my challenge to them is to get us close to that 12 million ton run rate number in terms of production and sales as we possibly can.

[Chase Mulvehill:]

Okay. And could you help us with the Sandbox and maybe talk about pro forma revenue growth or something like that to help us dial that in?

[Donald A. Merril:]

Yeah. What we've said in the past is that, look Sandbox is becoming a very integral part of our Oil and Gas business, so look, we're going to continue, as Bryan said, going to continue to expand that business upwards of 90 crews by the end of the year. But we really haven't gotten into a lot of the detail of what that would extrapolate into.

[Chase Mulvehill:]

Maybe you'd be able to help us with kind of legacy frac sand contribution margin per ton, what that look like in 4Q? And then as you see this progressing through 2017 and 2018, do you think you can get back well above that $20 per ton?

[Donald A. Merril:]

Let me answer that question, just as it pertains to Q3, to Q4. And clearly we went from a negative contribution margin to a positive margin in the legacy business, there's no doubt about it, right, as we saw price increases, as we saw the volume increase and then the impact of our fixed cost absorption against that. So, clearly, we're moving in the right direction. And of course, it was helped by the Sandbox contribution margin as well.

[Chase Mulvehill:]

Okay. That's all I have. I'll turn it back over. Thanks.

[Bryan A. Shinn:]

Thanks, Chase.

[Operator:]

Thank you. Our next question comes from the line of Blake Hutchinson with Howard Weil. Please proceed with your question.

[Blake Allen Hutchinson:]

Good morning.

[Bryan A. Shinn:]

Hey, good morning, Blake.

[Blake Allen Hutchinson:]

Just I want to make sure – I hate to revisit again, but I want to make sure we've got the thoughts on capacity correct because you lay out the cross bars of expanding over 12 to 18 months, but at the front end of it, you outlined a lot of things that were kind of already in the works and would suggest very quick turn time. So, as we think about you hitting or ramping the full capacity by 2Q, when would you expect, kind of, your early brownfield initiatives to start to be more additive or meaningfully additive? And I don't know if you – however, you want to couch this, maybe there's a good exit rate or mid-2018 or something like that to help us make sure we're dialing that in properly?

[Bryan A. Shinn:]

Sure, Blake. So, I would expect that we would start to see impact from the, kind of, brownfield expansions, if the will, by Q4 of this year. And so the target that our operations and project teams to hit, is to try and get us to a 1 million to 2-million-ton incremental run rate in Q4. And so it's dependent on a lot of different things, there's still some permitting that has to be done, there's equipment that has to be ordered, a lot of things as you can imagine here, but I would certainly expect that we'll start to see some meaningful impact by Q4 from those projects.

[Blake Allen Hutchinson:]

Okay. That's great. Thank you very much. And then I just want to kind of step back and you guys have done a great job in this down cycle of not only acquiring, but kind of being ahead of the market in terms of trend. Are you hearing a bit more chatter about more complex and dense completion programs moving to even finer grades than 100-mesh? And looking back to your Analyst Day, you spent a lot of time talking about how 100-mesh isn't really even necessarily a grade. I just wanted to get your thoughts on whether that's a realistic market going forward going to even finer grades and how you may be considering addressing that or is it just in your mind a micro market at this point?

[Bryan A. Shinn:]

Yeah. It's a great question Blake, and I'd say what we've seen so far is that the trend has been focused pretty much on the Permian and we see it a little bit in some of the other basins in the south; but it's been a Permian trend. And it's a real one, if you talk to the energy companies who are some of the biggest supporters of the finer proppant completion technology, they're seeing good results and are very pleased with the well performance there. So, I think it's a real trend. I think it's a market that's here to stay. But with that said, I also think that there are other energy companies that have different views and want different kinds of proppants, coarser grades or Northern White versus a regional. And then you've got all the other basins that aren't the Permian where these other grades are being used. So, it feels to me like it's just a question of where the overall share settles out for these 100-mesh completions versus some of the other coarser types of completions. And I would say that certainly we've seen more of the finer completions taking hold in the industry, and it's one of the reasons that as we think about our expansions, for example, we're focused on mines that are near where the drilling is going, which tend to be more 100-mesh mines like Mill Creek, Oklahoma or Tyler, Texas.

[Blake Allen Hutchinson:]

Great. Thanks for that. I'll turn it back.

[Bryan A. Shinn:]

Okay. Thanks, Blake.

[Operator:]

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

[Brandon B. Dobell:]

Thanks. Maybe, Bryan, maybe kind of a crystal ball question, but if you were sitting in a seat of a smaller producer, what kinds of things are you looking at or kind of planning or thinking about that would give you the confidence to restart or, I guess, a greenfield developed capacity? And I guess the factors I'm thinking about would be price, customer mix, maybe location, et cetera. But I guess what I'm trying to get at is the guy that have mines that are 500,000 tons, 1 million tons, that maybe aren't logistically advantaged. What are they looking for to get more confident that they should be back in the market?

[Bryan A. Shinn:]

Yeah. It's a great question, and what we've seen is that the vast majority of the mines that have been sidelined were mostly higher cost Northern White mines. And, as I said, in my response to Blake, what the market seems to want to more right now is fine product and regionally produced product, which has a lower delivery cost. So, I think that's a bit of challenge. Also, when you think about restarting a mine site, there's a big capital infusion that you have to make, and most of the mine sites that have been idled, particularly those in Wisconsin, don't have any stockpile of in-process mined inventory. So the first thing you have to do is restart your mining process. And typically, that means waiting until the weather warms up. And then you have to build this big stockpile, a lot of working capital, all kind of issues associated with starting up a new mine. And so if I owned one of those mines and I was thinking about starting it up, those are the kind of things that would be weighing on my mind.

[Brandon B. Dobell:]

Okay. And then you commented I think in the opening remarks about railcars. As you take a little bit of a longer-term view in the context of you guys doubling potential capacity, how do you think about railcar utilization or efficiency relative to what you guys saw back in 2013 and 2014? I guess, I'm trying to get a feel for do you need more railcars after you bring the remaining ones out of storage? Do you think you can get to a $20 million kind of throughput number with kind of what you have under lease right now?

[Bryan A. Shinn:]

It's a great question, and I would say that as we look at the cars that we have in storage today, assuming the market continues to grow as expected here, we'll probably have all of our cars out of storage by the end of 2017. We continue to work closely with a number of railcar providers, but given the industry surplus of the small cube covered hopper cars, which is what the sand industry uses, I certainly wouldn't expect that the car manufacturers will be looking to build any new ones anytime in the near future. Certainly, that puts a lot of pressure on lease rates in the industry, which would be fine with me, but if you're a manufacturer or a leasing company, you probably wouldn't like that. So it'd be interesting to see how the industry dynamics play out. Certainly, there's more unit trains that are being used today, which means fewer cars than what we've had in the past would manifest shipping. So a lot of puts and takes. We'll watch it closely and see. But if we need additional railcars, there's certainly a lot of them out there to get.

[Brandon B. Dobell:]

Okay. Thanks.

[Bryan A. Shinn:]

Thanks, Brandon.

[Operator:]

Thank you. Our next question comes from the line of John Daniel with Simmons & Company. Please proceed with your question.

[John Daniel:]

Hi, guys. Just I have a few for you this morning. I don't know if you're willing to do this, but I'd love for you to try to just speak to the pricing arrangements with Halliburton on the Sandbox relative to what the arrangements are with other customers?

[Bryan A. Shinn:]

John, we can't really talk about specific terms of contract, whether it's with Halliburton or anybody else. But as we announced in our press release, Halliburton has selected us to be their preferred provider of containerized sand for their last-mile delivery. As always, we're very excited to work closely with Halliburton and help them achieve their business goals.

[John Daniel:]

Okay. The doubling of the Sandbox boxes systems out there, can you say how much of that is directed towards Halliburton?

[Bryan A. Shinn:]

We can't say specifically, but the reality is, we see growth from a number of different customers. Halliburton contract is a piece of it, but there are a lot of other customers out there that want the technology as well.

[John Daniel:]

Okay. I understand the desire to not give specific financial guidance, but I'm going to try to pin you down and follow on Chase's questions, but I mean, we're at the end of February now, you've got your January volumes in the book, can you just give us a sense for where – it sounds like basically anything you can sell, you're selling today, just a reasonable range for where you expect Q1 volumes to be?

[Bryan A. Shinn:]

Yeah, Q1 volumes are going to be up from Q4. And right now based on what I'm seeing, I would say that's somewhere in the range of upwards of 10% to 15%.

[John Daniel:]

Okay. Thank you. And then sort of a – last one from me. I'll turn it back over and not to be a jerk with this question, but just given generous valuation levels that are out there and what seems to be a relatively easy process to add new capacity and to expand existing capacity. Why focus on acquisitions right now?

[Bryan A. Shinn:]

Well, it's a great question John. And I believe that M&A is part of our overall strategy. When I think about bringing new capacity into the company, I like the fact that we have the optionality to expand existing mines, do greenfields or do M&A. And as we've done with Sandbox and as we did with Tyler, I think we'll try and cherry pick the very best opportunities and where we find attractive assets at reasonable pricing, we won't hesitate to pull the trigger on that.

[John Daniel:]

Okay, fair enough. Thanks guys.

[Bryan A. Shinn:]

Thanks, John.

[Operator:]

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

[William Thompson:]

Hey. Good morning, Bryan.

[Bryan A. Shinn:]

Good morning, Will.

[William Thompson:]

Being sold out at the bottom of the cycle is kind of a unique situation, I want to hash on this again. But what is the limiting factor to do brownfield expansion?

[Bryan A. Shinn:]

Well, when you look at the existing sites some of which like Ottawa are over 100 years old, right. There's certainly limitations there. So, if there's rail involved you've got to look at the practicality of how many cars you can take away, certainly there's a mining aspect to it as well, how much can you mine from the deposits. There's a footprint of the processing facilities and what's reasonable there. So there's lot of different things that we look at. I would say that if you had asked me a year or two ago, how easy it would be or how many sort of, quote unquote, brownfield expansions would we have, I would have said not a lot, but actually the genesis of this most recent capacity expansion program was kind of born out of our cost-out and simplification work that we did in 2015 and 2016, and you can imagine as we try to get our cost down, we had engineers and other folks crawling all over our operations thinking about how we could take cost out and along the way, they found some really interesting kind of clever creative opportunities to increase capacity. And so, we filed all those away, and now that we've got the kind of tremendous demand signals that we have in the market, we think it's time to move forward with those, but it's not like we just sort of woke up one morning and said, great, let's go expand these seven facilities. It's a lot of time and thinking and it can be challenging to get it done.

[William Thompson:]

And then greenfield development, would be financed through royalties or how should we think about that?

[Bryan A. Shinn:]

I'm sorry, ask that question again, Will?

[William Thompson:]

Greenfield development, is that financed through acquisitions or will you be doing royalties again?

[Bryan A. Shinn:]

So, I think, it could be a number of different ways. We could just purchase the land outright and just develop the mine sites and typically we don't pay royalties, but we wouldn't say no to that if the opportunity was really good. In some cases, we've also used third parties to develop the sites for us and then we'll pay them a small premium for doing that, so we can kind of leverage our resources and there's lots of different ways we can do it and all those things are in play for us right now.

[William Thompson:]

All right. Just one last one, the 75% mix in basin delivery, can you tell us what's driving that, is that a function of smaller service companies coming back in the market or direct sourcing from E&Ps?

[Bryan A. Shinn:]

So, I think there's two things. One is that we're seeing smaller service companies, kind of small and medium-sized guys who depend heavily on our logistics network, we're seeing them come back in the market and you're seeing a kind of a surge of new companies, some of which are thinking about doing IPOs and kind of being capitalized through private equity and other sources. And then the other thing is that we would camp Tyler in that equation now. So, between Tyler and the small and medium-sized service companies, that accounts for the bulk of that change, Will.

[William Thompson:]

That's helpful. Thank you.

[Bryan A. Shinn:]

Thanks.

[Operator:]

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

[George O’Leary:]

Good morning, guys.

[Bryan A. Shinn:]

Good morning, George.

[Donald A. Merril:]

Good morning.

[George O’Leary:]

Just curious to hear, you mentioned some greenfield projects potentially over near the Permian Basin, and specifically mentioned the Delaware. Curious as to kind of what does reserves look like, kind of how you came about finding that opportunity? It's my understanding that to-date there's not much there, so that would be a pretty unique asset for somebody to have.

[Bryan A. Shinn:]

So we have a few opportunities that we like in that area. And we're doing a lot of work to evaluate the deposits and the quality of the deposit. I would say, in those areas, it's primarily 100-mesh deposits, you don't see much of the coarser products but, of course, that's what the demand is in that area. So it feels like if you could find one or two things there, that would be a great fit with the completions technologies that are being practiced in the Delaware right now specifically.

[George O’Leary:]

That's helpful. I thought the color you gave on fine sand demand versus coarse was interesting as well. Just curious more broadly, given your attractive footprint both regionally and from a Northern White perspective, how you've seen that mix evolve as a percentage of your overall sales volume or overall revenues over the last two quarters or so. As the market tightens, there's more Northern White coming to the mix just given some of those mines are having to be reactivated to meet this incremental demand or on the other end of the spectrum, has regional just still continued to take share as we run up pretty quickly here from a rig count perspective?

[Bryan A. Shinn:]

Yeah. It's a really good question, George. And I think it's – the answer is maybe just a little more complicated than regional versus Northern White. I think, a lot of it depends on the transportation and logistics set up at your mine. And so, for example, throughout the downturn, in 2015 and 2016, we saw our Ottawa facility, which is Northern White on the BNSF stay completely sold out because we had all kinds of great options and places to sell it. On the other hand, our Sparta mine in Wisconsin, which is on the CP was a bit more challenged to get down to the Permian, just because of the kind of logistics set up there. So, I think what we'll see, as things turn up here is that, all of our assets will be in strong demand. And as we've added regional assets like Tyler for example, that's going to increase the percentage of regional sand sold versus the sort of, quote unquote, Northern Light, but a lot of that's due to the M&A that we've done over the last couple of years. We've added two big regional mines. And so just taking the math into account, it's going to skew the percentages in that direction.

[George O’Leary:]

All right. Great, guys. Thanks for the color.

[Bryan A. Shinn:]

Okay. Thanks, George.

[Operator:]

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

[Ken Sill:]

Yeah. Good morning.

[Bryan A. Shinn:]

Good morning, Ken.

[Ken Sill:]

Much more fun calls than we've had in the last couple of years. I was wondering if you could take a minute to walk us through the benefits of Sandbox versus brand X or other containerized sand systems. The concept of focusing on getting the last-mile, we think, is obviously going to help margins and help deliverability over the course of the cycle. But what about the competing options that are out there, it seems to be like money is flowing into them too?

[Bryan A. Shinn:]

Yeah. Sure it's a really good question and we feel like when you do all that math that Sandbox is the best option out there today and a lot of it is tied up in the trucking. Our trucking is much more efficient. We don't have to use specialized trucks like we use for pneumatics and we have built-for-purpose equipment which optimizes the total cost. I think, we've also sized our boxes appropriately so that it minimizes the amount of handling that is required on the well site and customers tell us that they really like that. I also think that, we've seen some of our customers move away from their silo-based systems because typically they run into all kinds of issues with footprint and also with reversed logistics. So if you stop a job in the middle of it and you have a silo full of sand, what do you with it. So, there's a number of different benefits and I think our customers take all that into account and given that we're on a pace for a pretty rapid market penetration, I would say that customers are voting with their wallets and more often than not they're choosing Sandbox.

[Ken Sill:]

Yeah. And I guess, I was more interested in the other containerized sand solutions. I've seen one where they just used flatbed trailers and load their boxes on the flatbed. So, whereas yours are specialized containers. So, what's the plusses and minuses of having a dedicated trailer system versus what these other guys are using?

[Bryan A. Shinn:]

Yes. So, I think there's a couple of things. What we've seen is that some of the systems use much smaller boxes. So, if we talk to our customers, what they tell us is they have to handle things twice as often. So, if you have a box that's half the size, you have to handle it twice as much, right? And our customers hate handling things on the well site. We've also heard that by having the customized trailer that we do with a single box on there versus multiple boxes, you basically, when you go to load it, you just pull it up to the loading spout and you load it once at the transload and it's off. If you have multiple boxes on the site, you have to move the truck and load multiple boxes. There's also been some issues with how boxes on flatbeds are anchored. I know they're anchored securely. Once again, we have fit kind of made for purpose system to do that. So, I think, we've got a lot of advantages and quite frankly a lot of intellectual property around that as well.

[Ken Sill:]

Yeah. That's my last question on that. I don't really understand how broad your IP is, so I don't know whether you want to talk about that at this stage, whether the Halliburton settlement was interesting and obviously good for you. Are there any more press releases like that out there that we should expect?

[Bryan A. Shinn:]

So, we have a pretty extensive intellectual property portfolio. We have more than 70 patents that we filed and more than 24 that have issued. So, there's a lot that are still in process and we have a lot of additional IP that's going to be coming out and so what we're seeing is that those that come after us and had to work around our IP and make compromises in their designs and so, I think that gives us a pretty good advantage. Certainly, you can imagine in this industry there's a lot of copycatters and a lot of imitators and so we're vigorously defending our intellectual property. But I think the real win for us in Sandbox is just it scale quickly and have the best solution out there and have customers vote with their wallets. And if we can get to 25% share by the end of 2017, with our eyes on 40% share in the market, that's an ultimate win. All of these other things, IP, and talking about advantages and disadvantages of this system and that system, what really matters is who's taking share and who's winning in the market. And I think we're clearly doing that.

[Ken Sill:]

All right. Thank you.

[Bryan A. Shinn:]

Okay. Thanks, Ken.

[Operator:]

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

[Scott A. Gruber:]

Good morning.

[Bryan A. Shinn:]

Good morning, Scott.

[Scott A. Gruber:]

Bryan, I just want to circle back on Sandbox. In an earlier comment you made, I think you mentioned that you're holding the line on pricing for Sandbox. Can you just put that comment in the context of the environment here where last-mile trucking costs are starting to rise? I would just think that holding pricing on Sandbox should be somewhat easy given the asset churn as I said and given the rising rates with the competing system. Is that fair or are the competing containerized systems' pricing aggressively for market penetration?

[Bryan A. Shinn:]

Well, if you think even holding the line on pricing is easy these days, you haven't met our customers. Everyone wants a discount for everything, Scott. But look, we're working very hard with our customers to have a fair pricing arrangement. I think that it's a challenge to significantly penetrate a market if you're also increasing prices substantially. I feel like there's a lot of benefits here that customers see, and leaving some of the benefits for the customers while taking share and getting good contracts set up feels like a pretty good trade-off for us. With that said, we are out there raising prices in some locations, given the rise in trucking costs, and some of that is having to raise price just to stay even. So, if we really kept true pricing flat, as trucking costs rise, our margins would decline, right. So, we have to have some increase just to stay even. But certainly, we're aggressively trying to get price there where we can, but our focus is on overall margins and trying to penetrate this market for sure.

[Scott A. Gruber:]

So if you put the Halliburton agreement to the side, are margins then generally stable in Sandbox?

[Donald A. Merril:]

Yeah. I would say that they are stable. And like Bryan said, we're taking every opportunity we can to raise prices where it makes sense, where trucking is becoming very tight. Right now, again to reiterate, this is a share game for us and we're going to be steadfast in that.

[Scott A. Gruber:]

Got it. And how are your variable and fixed costs splitting today given that volumes are starting to rise rapidly? And are you starting to see inflation on the variable side, particularly labor?

[Donald A. Merril:]

Yeah. We are. So, normally, I would answer that question 50/50, right, but I think we are starting to trend more to the variable side. I don't think we're quite to 40/60 yet, but clearly going that direction.

[Scott A. Gruber:]

Okay. Appreciate it. Thank you.

[Donald A. Merril:]

Yeah.

[Bryan A. Shinn:]

Okay. Thanks, Scott.

[Operator:]

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

[Kurt Hallead:]

Hey. Good morning.

[Donald A. Merril:]

Hi. Good morning.

[Bryan A. Shinn:]

Good morning, Kurt.

[Kurt Hallead:]

So just as a quick reference point. Your stock is down 4% on the day despite all the good news that you happen to be bringing on the call. So, just figured you guys might want to be aware of that. So, the dynamics that are at play here, right, everything that I've heard so far suggests that demand for frac sand continues to accelerate off the fourth quarter run rate, and you guys would generally agree with that. Is that correct?

[Donald A. Merril:]

Yes. That's right, Kurt.

[Kurt Hallead:]

Right. So then your volumes were up 30% sequentially in the fourth quarter and if demand is accelerating then by definition shouldn't we be looking at a potentially higher or a similar kind of growth rate that you had maybe in the third and fourth quarter where you were at 20% to 30% growth. And I know you guys kind of indicated may be 10% to 15% growth in frac sand volumes. So, if things are accelerating, I just want to try to connect the dots on the growth rates.

[Donald A. Merril:]

Yeah. Look, Kurt, you know us well enough that typically we're going to be conservative when we give you numbers. We are seeing increases in demand here into the first quarter. So, my 10% to 15%, look, I think that's a number we can beat.

[Kurt Hallead:]

Yeah. Okay. And then I was looking at in the context, like you're not capacity constrained in that context. So your growth rate is 10% to 15%, you wouldn't be, kind of, maxed out on your ability to deliver product to the market, right? So, you can grow faster than that given your current capacity levels. Is that fair?

[Bryan A. Shinn:]

That's right, Kurt. And I think the other reality though is that we're turning up a couple of the facilities, turning them back on, if you will, adding back crews and getting more staffing in places where we had de-staffed a bit during the downturn. So, there's a little bit of that, but we haven't bumped up against the capacity limit yet of what's staffed, that's for sure.

[Kurt Hallead:]

Got it. Okay. Okay. Great. Now, on a pricing dynamic, you guys did a very fair job to try to, kind of, clarify some of the discussion that's been out in the marketplace about mine gate pricing and so on. When you look at the pricing mix, you got $65 per ton pricing in the fourth quarter, how would you kind of split that between mine gate and logistics?

[Donald A. Merril:]

It's a good question, right. I think, clearly, having our transload – or sorry, our in-basin sales go up in the fourth quarter versus the third quarter, certainly impacts that ASP number. But I would say that about half of that increase would be due to the things that – the pricing and so on. And the other half probably is related to the sales that we're doing in-basin.

[Kurt Hallead:]

Got it. Okay. All right. Now, the context on the increase in your capacity, right? It's big number, doubling capacity, half of that coming from existing sites, So, once you go down that path and once you start the process, like, if the market demand dynamics – if the demand curve doesn't accelerate to the extent that your supply curve would, how quick can you adjust and slow down that process if needed?

[Bryan A. Shinn:]

Yeah. It's one of the advantages of doing this kind of work, is that we can modulate that. Kurt, depending on the demand for sure. And the only other thing I really like about the plan that we laid out here with these components of expansion, greenfield, and M&A is that, anchoring it with expansions, they tend to be the highest probability of success. We know the mine sites, we know the equipment there, we know the transportation arrangements and so we typically would feel really good about those. I also like the fact, by doing expansion and greenfield and M&A, we're going to lower the overall cost of adding capacity, and I think that was part of John Daniel's question that he asked earlier. I also like the fact that we're spreading our risk amongst several sites and basins and customers. We haven't talked about that on the call here, but there's an element of risk here which you brought in that what if the market turns down, right? So, if you look at what we're talking about here, expanding seven sites, you throw in a couple of greenfields, maybe an M&A, I mean, we could be investing in 10 or more locations, which could be serving multiple basins. So, I really like spreading the risk around. I'm not a fan of sort of putting our chips all on one big bet, given the unpredictability and volatility of this market, once again, as you pointed out, Kurt. So, I feel this will puts us in a really good position to respond and react, and as basins get either more demand or less demand, we'll have a larger network of sites that we can turn up or turn down to respond to that.

[Kurt Hallead:]

Okay. And then I just maybe a follow up on this, in the context of the – I think, the market was spooked by your commentary about doubling capacity. The investor base tends to freak out on oil service companies when they start talking about increasing whatever kind of rig count or frac count or whatever. Now, are you getting signals from your customer base that kind of prompted you to make this move or are you kind of doing this on, lack of a better term, more of a speculative basis?

[Bryan A. Shinn:]

So, we're definitely getting signals from our customer base. We've got a lot of ongoing discussions, as you might imagine, with customers, and they're sort of begging us to get this online faster given the pace of demand increase right now. So, I'm not worried about that part at all for sort of the technical aspects of getting all this done. And certainly, greenfields are less certain than the expansions and M&A is less certain than the greenfields and the expansions. So, back to my earlier comments, but certainly we see strong interest in the market for these tons and for this strategy.

[Kurt Hallead:]

Okay. All right. Thanks for clarifying all those points. Appreciate it.

[Donald A. Merril:]

Thanks, Kurt.

[Bryan A. Shinn:]

Thanks, Kurt.

[Operator:]

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

[Bryan A. Shinn:]

So, I'd like to close the call with a few key thoughts. First, the market has clearly turned upward as we talked about many times during the call today, and we certainly expect substantially higher sand demand in 2017. Second, I want to reiterate that I'm very excited about the opportunity that we have over the next few quarters to support our customers as we invest in capacity expansion and greenfield sites, as well as potential M&A. And lastly, I want to thank all my colleagues at U.S. Silica for their outstanding efforts so far in 2017 in meeting the tremendous opportunities that are available to us. I also want to thanks our investors for their interest and support, and I look forward to meeting and speaking with all of you in the near future. Thanks, everyone, for dialing in, and have a great day.

[Operator:]

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