U.S. Silica Holdings, Inc.
Q1 2015 Earnings Call Transcript

Published: 29 Apr 2015

[Operator:]

Greetings and welcome to the U.S. Silica First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief 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, Director of Investor Relations and Corporate Communications for U.S. Silica. Thank you. You may begin.

[Michael K. Lawson:]

Thanks, operator. Good morning, everyone, and thank you for joining us for U.S. Silica's first quarter 2015 earnings conference call. With me on the call today are Bryan Shinn, President and Chief Executive Officer; and Don Merril, 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 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'll now turn the call over to our CEO, Mr. Bryan Shinn. Bryan?

[Bryan A. Shinn:]

Thanks, Mike, and good morning, everyone. I will begin today's call with a review of our first quarter financial performance, followed by market commentary for both of our operating segments and our outlook going forward. Don Merril will then provide additional color around our quarterly results before we open up the call for questions. For the total company, revenue in the first quarter of 2015 of $204 million was up 13% versus first quarter of 2014, but down 18% sequentially. Adjusted EBITDA for the quarter of $51.3 million represented a 22% increase from the first quarter of 2014, but a 23% decline sequentially. The sequential decline in profitability was driven primarily by lower volume and pricing in Oil and Gas, partially offset by favorable pricing and mix in ISP and lower overhead costs across the company. Volumes sold in Oil and Gas for the first quarter of 2015 declined 15% sequentially from the fourth quarter of 2014 as we began to experience greater impact from the steep decline in industry drilling and completion activity. As has been widely reported, the rig count has dropped approximately 50% from the peak in late November and has continued to decline into the second quarter. The pace and magnitude of activity reductions put substantial pressure on pricing, as our oil and gas customers sought concessions to stay competitive in their marketplace. Compounding this issue was the tremendous amount of dislocation occurring in the oil basins as customers were winning and losing work at a faster clip than ever, making us less efficient from a production and supply chain standpoint. As a result, contribution margin per ton in Oil and Gas declined 23% sequentially to $30.91, approximately the same level as Q1 2014. Approximately half of the sequential decline in Oil and Gas contribution margin per ton is attributable to lower pricing during the quarter. The remainder is due to unfavorable customer and product mix and higher transportation costs. Relating to mix, a higher percentage of our sales volumes during the quarter went to our largest customers and we also sold a finer product mix, both of which typically result in lower product prices. In terms of transportation, we also absorbed higher freight costs during the quarter and, due to the volatility in the market, shipped more tons on a sub-optimal basis. Moving to ISP, we sold 983,000 tons in the quarter, up 1% versus Q1 of 2014. New customers, new products and stronger pricing drove ISP contribution margin per ton 16% higher in the first quarter this year compared with the first quarter of 2014. ISP was successful during the quarter in penetrating new markets and taking share and continued to make good progress enhancing product mix profitability. Now, let me turn to our views on our markets, including the actions we are taking to control costs, grow our market position with key customers and maximize contribution margin dollars in the current business environment. I'll start first with the ISP. Our Industrial and Specialty Products segment is off to a strong start in 2015. Price increases and new higher-margin products, along with market-share gains and new business opportunities, are expected to drive top- and bottom-line growth in ISP this year. Given the sector weakness in Oil and Gas, it's a testament to the strength of our business model to have a complementary portfolio that not only produces stable and consistent earnings and cash flows, but has the opportunity to significantly grow earnings in 2015. The ISP business clearly differentiates U.S. Silica in a positive way from the vast majority of our competitors who are pure-play frac sand companies with no industrial sales. Turning to Oil and Gas, as I noted earlier, the rig count has declined approximately 50% from its peak late last year and some third parties now estimate that the peak-to-trough decline could approach 60% before bottoming out. In our view, that level of reduction would most likely equate to a 25% to 30% decrease in market demand for proppant in 2015, assuming the decline in completion activity would be partially offset by the continued use of more proppant per well. While currently a headwind, the growing number of drilled but uncompleted wells, which some parties estimate totaling upwards of 3,000, could provide a nice tailwind in the back half of 2015 or early 2016, depending on commodity prices, as operators work down their inventories of uncompleted wells. There are also purportedly thousands of wells that are potential candidates for re-fracturing, which could boost demand for our products as well. On the supply side, as we discussed on our fourth-quarter call, we and others in the industry are moving more cautiously with plans to bring on additional capacity this year, given the current market environment. We do expect to see some new capacity come on line in the market in 2015, but most likely a much lower increment than we had initially forecasted. However, even with less new supply coming on line, we believe that pricing and margins in the oil and gas sector will remain under pressure until drilling and completions activity fully rebound. Accordingly, we anticipate a sequential decline in our Oil and Gas contribution margin dollars and contribution margin per ton in the second quarter. We believe that the best companies in cyclical industries set themselves up for long-term success by effectively managing both up-cycle and down-cycle. Our team is focused on three areas currently to do that. The first is gaining share by selectively partnering with the right customers. We're making investments in those relationships today that will position us well for the future. Second, we're working to drive industry consolidation. And third, we are looking to acquire new capabilities. We're also carefully managing cash flow to allow us to take advantage of these potential opportunities. I expect that we will continue to work closely with our customers during this severe downturn to help them be more competitive. We've temporarily reduced prices and taken additional costs out of the supply chain in exchange for extending contract terms or increasing sales volumes. We also expect to continue to take share and to be positioned to emerge even stronger from the downturn. For example, recently working with a very large customer to help them reduce their input costs enabled us to capture substantial new volumes and earn the commitment from them to be one of their top suppliers going forward as they work to significantly consolidate their sand spend. We believe that if we work together with our customers to help them manage effectively through this extreme downturn, they will win; and so, in turn, will U.S. Silica. From an internal cost-containment standpoint, we continue to actively manage costs and resources by streamlining overheads and staying keenly focused on operational excellence. As we talked about last quarter, we're targeting a 20% reduction in our budgeted SG&A expenses. We have numerous cost-improvement projects underway across our entire supply chain. Our logistics team is actively working to renegotiate freight rates, railcar leases and transload fees as well as deferring railcar deliveries. At the plant level, we've shifted resources from growth projects to cost-saving programs to decrease our manufacturing costs and we've scaled back operations at some of our higher total delivered cost facilities. As we've said in the past, we will remain flexible in our capital spend so that we can quickly add capacity when opportunities arise. It's clear that we are operating in an uncertain environment right now. However, we believe that it's prudent to continue to plan for a significant long-term growth, as we expect that drilling and completions activity will ultimately rebound. We also believe that it's critical to maintain flexibility and create optionality as we closely monitor our customer needs and the market situation. We will also seek to use our strong balance sheet and cash position to make strategic investments in additional capacity and capabilities. While we are clearly focused on maximizing near-term business results, we're also continuing to move forward on our longer-term goals. Specifically, we plan to continue to take share in the oil and gas proppant market and grow and diversify our ISP business. With that, I'll now turn the call over to Don. Don?

[Donald A. Merril:]

Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our two operating segments, Oil and Gas and Industrial and Specialty Products, and I will focus most of my comments on the sequential changes in our quarterly results. Revenue for the Oil and Gas segment for the first quarter of 2015 of $148.8 million declined 24% sequentially compared with the fourth quarter of 2014, while revenue for the ISP segment of $55.2 million represented a 3% improvement over the prior quarter. Contribution margin from Oil and Gas in the quarter was $52.2 million, down 35% on a sequential basis compared with the fourth quarter of 2014. On a per-ton basis, contribution margin for Oil and Gas declined 23% to $30.91 compared with $40.27 for the fourth quarter of the prior year. Contribution margin for our Industrial and Specialty Products segment was $15.5 million, an increase of 15% when compared to the fourth quarter of last year. On a per-ton basis, contribution margin for the ISP business of $15.72 represented a 20% improvement over the fourth quarter of 2014. The sequential increase in ISP contribution margin per ton was driven by a combination of better pricing, improved mix and the favorable impact of new products. Turning now to total company results; SG&A expenses for the first quarter decreased $8.7 million to $27 million compared with $35.7 million for the fourth quarter of 2014. The decrease is attributable to lower compensation and bad debt expenses in the quarter, partially offset by a large business development expense of $7.6 million related to an adverse unanticipated arbitration ruling and a $1.4 million restructuring charge designed to help bring the business more in line with current market conditions. Depreciation, depletion and amortization expense in the first quarter was $13.2 million, compared with $12.7 million in the fourth quarter of 2014. The increase in DD&A was driven by continued capital spending in support of our operating facilities and growth initiatives. Continuing to move down the income statement and the other income expense line, interest expense for the quarter was $6.8 million, compared with $5.4 million in the fourth quarter of 2014, which reflects the increase in our long-term debt. As you may recall, we upsized our term loan late in the fourth quarter of last year by $135 million to make our strong balance sheet even stronger. Our first-quarter effective tax rate of 19% was lower than expected due to a discrete tax benefit of $2.9 million booked in the quarter related to the aforementioned arbitration expense. Excluding the discrete tax item, our effective tax rate for the quarter was 25% and we now expect the full-year tax rate to be approximately 24%. Turning now to the balance sheet, cash, cash equivalents and short-term investments on March 31, 2015 totaled $327.8 million compared with $342.4 million at December 31, 2014. As of March 31, 2015, our working capital was $404.5 million and we had $46.9 million available under our revolving credit facility. Total long-term debt on March 31, 2015 was $494.2 million. We generated $19.8 million of net cash from operations and incurred capital expenditures of $13.4 million in the first quarter of 2015. The bulk of our first-quarter spend consisted of investments in various growth and maintenance initiatives. As stated in our earnings release, we now anticipate full-year capital spending to be in the range of $60 million to $80 million due to demand conditions in the oil and gas marketplace. As previously noted, we plan to use our strong balance sheet and financial resources available to capitalize on the unique opportunities that may be created by this low oil price environment in order to enhance the speed, scale and strength of the company. Finally, as noted in the press release, we will continue to refrain from providing financial guidance until such time as we can comfortably see more clarity in the oil and gas market. With that, I will turn the call back over to Bryan.

[Bryan A. Shinn:]

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

[Operator:]

Certainly. Ladies and gentlemen, we will now be conducting a question-and-answer session. Our first question comes from the line of Doug Becker with Bank of America. Please go ahead with your questions.

[Douglas L. Becker:]

Thanks. Bryan, maybe you could talk a little bit about where the contract renegotiations stand on the eight contracts that do account for a lot of your volume.

[Bryan A. Shinn:]

Sure, Doug. Thanks for the question. We are in the process of talking, obviously, with all of our contract customers, working diligently with them to try and help them be more competitive in this down-cycle. And the way we've played it with almost all the customers is that we've temporarily reduced prices, typically, in exchange for some other value, as we talked about in the past, things like more share or different product mix or a different destination mix or something like that. I mean, typically, as we are talking to the customers in this environment, we start out with a conversation around how to support their business goals. And customers really are – you'd be surprised how different customers are approaching this, and these are service companies, as you know. Some are focused on taking share. Others are moving to new basins. Still others are looking to have faster response time from suppliers, things like that. So, we're working with different customers in different ways. But for sure, they're all looking for pricing flexibility. Obviously, what we're looking for is value in return. So, we're currently talking with all eight of these customers and that process, I think, will just be sort of ongoing throughout this downturn.

[Douglas L. Becker:]

So, as we think about margin per ton in Oil and Gas, there still will be some impact in the second quarter from these renegotiations, I assume. And then, maybe if you just talk about some of the other trends that you're seeing as it affects margin per ton, whether it's in basin sales, the unit trains, and it sounds like we're still seeing the mix shift a little bit to finer grains. Really, just summarizing that question, some of the moving parts on margin per ton as we think about second quarter.

[Bryan A. Shinn:]

Sure. Sure. And, look, I think it's an astute observation on margins. There are just a lot of moving parts and, quite honestly, that's the kind of piece of the equation that makes it difficult for us to give firm guidance as we look forward here. Generally, I believe, as you stated, that we're going to see margins move lower in the second quarter and then, hopefully, kind of bottom out as we get to the end of the second quarter. And as we look at the factors that drive this, there's several of them. So, the first is product mix. And as you said, Doug, we're seeing a finer mix out there, more 40/70 mesh and 100 mesh. Typically, that's a negative for our pricing and margins because those products typically command less price in the marketplace. We're also seeing a trend in customer mix. Our bigger customers are getting bigger in this downturn. And as you would expect, bigger customers tend to have lower prices. And so, that's another kind of negative that weighs on pricing. We're also seeing movement in destination. This one is kind of overall probably a neutral. It moves up and down. Obviously, some destinations for us are more profitable than others. Transportation costs are certainly an issue in this environment. Railroads have given back some of the increases that they've given us, but not all. So, we're still working with our railroad and transportation partners. And certainly, as we think about the impact of the drilled, but uncompleted wells, that tends to weigh a bit on volumes in the industry. So, a lot of different things that we're looking at there. What we're trying to focus on is what's in our control. So, the first thing is reducing our costs, and I'm sure we'll talk more about that on the call here. We are trying to optimize every shipment that we can, create the optimal sort of origin and destination. We're also taking rational pricing actions. I think that's important. And we're certainly focusing our sales efforts on our most-profitable destinations. So, there are things that we can control and we're working really hard to do all those to maximize our margins in this downturn.

[Douglas L. Becker:]

Thanks, Bryan.

[Bryan A. Shinn:]

Thanks, Doug.

[Operator:]

Thank you. Our next question comes from the line of Connor Lynagh with Morgan Stanley. Please go ahead with your questions.

[Connor Lynagh:]

Yeah. Thanks and good morning.

[Bryan A. Shinn:]

Morning, Connor.

[Connor Lynagh:]

I was wondering if you guys could talk about how your volumes have trended maybe March and April versus January and February, and just sort of how we should think about your exit rate out of the quarter and how it's looking right now.

[Bryan A. Shinn:]

So, as we went through the first quarter, I would say that demand stayed pretty strong through most of it. It was just kind of right at the end of the quarter that we really saw demand drop off, I mean, literally, as we got into the last week of March and into the first week of April, when we saw some significant reductions. And I think there's still a lot of uncertainty around that demand number and where it goes. One of the issues for us is that our customers, i.e., the service companies, and their customers, the energy companies, are not providing a lot of forward-looking guidance. Certainly, we have supply chain planning, but even that's relatively short term in this environment as we talk to our customers. I think we can get kind of a feel for where demand is going as we look at rig count, Connor. So, the way we're calculating it right now, we're expecting something greater than 50% in terms of peak-to-trough decline. So, you do some math on that and it gets you to probably a 40% to 45% average rig count decline year-on-year. That's what we're planning for. In terms of how that impacts frac sand demand, we're still seeing good trends in terms of more sand per well, 15% to 20% on the average. There's a few folks who are using less, but it's pretty insignificant. So, overall, the increased demand of sand per well is still intact. We get some tailwind from rig efficiencies and the fact that more vertical wells have been laid down than horizontals. I mentioned earlier about the DUCs, the drilled but uncompleted wells, that's a bit of a negative for us. So, you do all that math and our current outlook is that we could see total industry demand for frac sand down 25% to 30% in 2015 versus 2014. And that's up probably 5% to 10% – or, sorry; down 5% to 10% from where we thought it was going to be when we talked on the last quarterly call. And most of that is driven by the additional declines in rig count. So, you kind of put all that down and say, what does it mean for U.S. Silica? Well, if the industry could be down 25% to 30%, we are taking share, we expect to take more share. So, we should be down less than that. My hope is that we can offset that with somewhere in maybe 5% share gains. So, if the industry is going to be down 25%, maybe we're down 20% or something like that. But I think those are the numbers that people should be thinking about. Certainly, that's how we're looking at it in terms of volume as we go forward. And I guess just one last comment

[Connor Lynagh:]

Okay. That's fair. Maybe switching gears a little here, you guys have been talking about industry consolidation and you guys as the potential consolidator. So how are conversations like that going? Are you seeing any opportunities and how are you thinking about that right now?

[Bryan A. Shinn:]

I think there are a lot of opportunities out there. One of the difficulties is that given that first quarter was still relatively good in terms of volumes and margins, you can see U.S. Silica's results and what we delivered. I think others around the industry are probably going to have experienced at least some of that. And so, I'm not sure that the full impact of the downturn has set in yet in people's minds. So, it feels like the bid/ask spread is still a bit wide in terms of acquisitions, but there are a number of things that we have on the radar screen right now. And certainly, we're working very diligently to see if we can help be a consolidator in this industry.

[Connor Lynagh:]

All right. Thanks a lot. I'll turn it back.

[Bryan A. Shinn:]

Yeah. Thanks, Connor. Take care.

[Operator:]

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

[Blake Hutchinson:]

Good morning.

[Bryan A. Shinn:]

Good morning, Blake.

[Blake Hutchinson:]

Just, Bryan, first, I wanted to get some of your thoughts around the half of the kind of contribution margin decline that you would attribute kind of to more pure pricing, rather than some of the mix changes. As we look at that, I guess, historically, given your spot versus contract exposure, we might be able to assume that actually a great deal of that was due to significant declines in the spot market. Would that be the right way to characterize that? And I guess, what does that mean for kind of pure pricing declines going forward? Do you actually expect them to, I guess, abate given that you take a large spot market hit in the first quarter and then maybe some of your volumes move more towards contract? How does that relationship work on the pure pricing front?

[Bryan A. Shinn:]

So, there's certainly a lot of moving parts in all that, Blake. And if you look at Q1, we still saw significant volumes going to our contract customers, obviously, as you might expect in this environment. But with that said, because of the dislocations and disruptions, spot pricing was still fairly robust. For most of our grades in most locations, we still saw that $10 a ton, plus or minus, kind of uplift in terms of spot pricing. I think that that will probably get tamped down a bit going forward. As some of our larger customers continue to take share, more of the sales will come under the contracts themselves. So, that's probably a bit of a drag as we go forward on pricing.

[Blake Hutchinson:]

Okay. And I guess, how quickly – when we have this conversation about kind of the trade-offs between pricing and volumes, how quickly or do we – did we see it in 1Q or do we see it in 2Q, or is it back half of the year where you start to see the benefits from kind of the give and take in some of these contracts from a volume perspective?

[Bryan A. Shinn:]

Yeah. It's a great question. And so, we've already taken a few points of market share just in Q1. I think we'll continue to take share throughout the year. The question is what's the size of the pie that you're taking the share on, right? So, as the pie shrinks, even though you're taking share, overall volumes may still go down. But we can't really do anything about the size of the pie. All we can do is to try and take share where it makes sense, but be rational and logical in terms of how we do our pricing and continue to look towards the future and realize that the people who are successful are those who know how to manage the down-cycle as well as the up-cycle, and we certainly expect to be one of those companies.

[Blake Hutchinson:]

Great. Thanks for the time, guys. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Blake.

[Operator:]

Our next question comes from the line of Rob Shoemaker with KeyBanc. Please proceed with your questions.

[Robin E. Shoemaker:]

Thank you. Good morning.

[Bryan A. Shinn:]

Good morning, Robin.

[Robin E. Shoemaker:]

I wanted to ask – go back to your market-share gains for a minute, and you've got a slide in one of your presentations that shows 10 large producers of frac sand that have about 65% of the market, and over 40 smaller ones that have 35%. So, could you describe where your market-share gains are coming from within that competitive matrix?

[Bryan A. Shinn:]

I think that the early gains, Robin, have come from some of the smaller, less-capable players who are struggling in this environment. We've already seen some competitors that have shut down. We've seen others who have drastically pared back their asset portfolio and others that are in the process of doing that. And I think it's really at the expense of those folks that we made the initial gains and I think we'll continue to gain from that pool, just because it's a fairly large group. When you look at the kind of moderate and high-cost competitors that we have, they're somewhere between 30% to 40% of the industry. So, there is a pretty large pool of supply out there that I think will just be increasingly challenged to compete, given the demands of our customers.

[Robin E. Shoemaker:]

Okay. Good. Thank you. So, on your customers as they try to reduce the delivered price of sand, you've got the rail piece and you've got the trucking piece of the equation. What do you think is – I know it's not your business. But on the truck delivery of sand, how much of the decline in sand pricing, the delivered sand pricing, is coming from rail versus trucking, if you have a sense of that?

[Bryan A. Shinn:]

So, I think as you've observed there are four or five buckets kind of across that supply chain, specifically around the trucking side. We've heard stories of many trucking companies having their margins squeezed, some of them shutting their doors as well. So, I think there is definitely a squeeze there. I think there is a squeeze on the transloading side itself. Obviously, there's costs associated with that. The rail part is difficult, because the railroads tend to be somewhat more immune to pricing pressure, but what we've seen so far is that with the kind of relationships that we have with the railroads, we're actually getting some movement there and some support from our railroad partners. So, it's kind of – all along the chain, it feels like margins are coming out, quite honestly.

[Robin E. Shoemaker:]

Great. All right. Thanks a lot.

[Bryan A. Shinn:]

Thanks, Robin.

[Operator:]

Our next question comes from the line of Trey Grooms with Stephens. Please proceed with your question.

[Drew Lipke:]

Yeah. Good morning, Bryan. This is actually Drew Lipke on for Trey.

[Bryan A. Shinn:]

Hi. Good morning.

[Drew Lipke:]

First question, sort of a follow-up on the last one. You've been looking at M&A and looking at peers and you've talked about two-thirds industry capacity at the mine is low cost and the other third is higher cost. And you talked about these higher-cost players closing their doors. What does the current cost curve of the industry look like now, in your opinion? And as these guys struggle, how rational are they being in the market?

[Bryan A. Shinn:]

So, I think that, obviously, the higher end of the cost curve is starting to come off first, as you might expect. It's a little bit early to know exactly what the shape of that curve looks like. But I would expect that, as you might think, the high-cost guys come off first. And then, sorry, what was your second question?

[Drew Lipke:]

Just as these guys struggle, how rational are they being in the market?

[Bryan A. Shinn:]

Okay. So, look, we see some irrational behavior out there. I think the part about being a disciplined pricing company in this environment is not to chase rumors and speculation. There may be low volumes of product out there available at very discounted prices and we sometimes get those numbers played back to us by our customers or by others in the industry. An interesting thing is we've had several examples where we didn't sort of go down to that level to match a price, and the customers would come back to us a week later and decide to buy from U.S. Silica because these kind of low prices were either a phantom or was from a company who didn't have the capability to consistently deliver. So, I think, we just kind of stick to our guns. We'd be rational, reasonable, work with customers and continue to take share out in the market.

[Drew Lipke:]

Okay. And then, just second question around Fairchild. I think your maintenance CapEx annually is around $20 million. You've still got that flexible $60 million to $80 million CapEx guidance out there now. As you look at Fairchild and the return profile that you're seeing or the payback period you're seeing now, I think in the fall of 2014 that was around one-and-a-half year to two-year timeframe. With current prices, what does this payback period look like and what's your thought process on bringing this capacity into the market?

[Bryan A. Shinn:]

So, I would say that in this environment with pricing and margins down, the payback period is probably something more like two years or two-and-a-half years instead of maybe one-and-a-half years to two years. And I would expect, at least the way that we're thinking right now, is that sometime in the first half of 2016, we would be ready to bring a Fairchild on. We are maintaining a sort of a flexible construction approach there that we can turn up or turn down, Drew. But it's really going to be driven, in my mind, by our customers and what they tell us in terms of demand and how fast we see things pick up. And to that, if I was sort of prognosticating, as things turn up, let's say, in 2016, I would expect that volumes would come back first and then price would come back later. So, given that we know there will be some capacity sitting on the sideline where people are running partial shifts and things like that on their existing facilities as well as if facilities are in some state of construction, as the industry rebounds, like I said, we'll probably get volume first and then pricing. So, if I was kind of modeling the business in the out years, say, in 2016 and maybe early 2017, I'd have volumes coming out, but not necessarily margins a lot, to begin with.

[Drew Lipke:]

Okay, that's helpful. Thank you.

[Bryan A. Shinn:]

Okay. Thanks, Drew.

[Operator:]

Our next question comes from the line of Marc Bianchi with Cowen. Please go ahead with question.

[Marc G. Bianchi:]

Hey, good morning.

[Bryan A. Shinn:]

Good morning, Marc.

[Donald A. Merril:]

Good morning, Marc.

[Marc G. Bianchi:]

I'd like to go back to the margin discussion a little bit. I appreciate that second quarter is likely lower as we roll through negotiating through contracts. But can you talk a little bit more specifically about the exit rate on the per-ton margin, $30 in Oil and Gas during the first quarter? Where did that exit and maybe where does that stand right now, trying to dialing second quarter a little bit better?

[Bryan A. Shinn:]

Sure. Sure. So, as I think about the exit rate for the quarter, we were probably a couple dollars a ton lower than the average for the quarter. And as I sort of generally think about Q2 and where we go, my sort of range of outcomes is something that's in and around that number down to something that could be as we exit Q2 a similar kind of price decline that we saw from Q4 to Q1. And it's just kind of all moving all over the place right now, Marc, and it's hard to nail down. Still sort of early days here in the quarter, so it's hard to know for sure. The one thing that I am confident in is that pricing and margins are going to be lower in Q2 than they were in Q1, for sure.

[Marc G. Bianchi:]

Sure. That makes sense. I think you previously mentioned on today's call that you're expecting a bottoming, perhaps, by the end of the second quarter in profitability for per ton. What gives you confidence that it could be bottoming by the end of the second quarter?

[Bryan A. Shinn:]

I think we look at the rig count trajectory and where that goes. We look at conversations with our service company partners and others in the chain. And whether it's exactly the end of Q2 or sometime in Q3, it feels like there is kind of a firming up there. But once again, this is just to kind of give folks some guidance, if you will, in terms of how we see it. It's difficult to project how it plays out right now.

[Marc G. Bianchi:]

Sure. Okay. If I could just ask one more, on the industry capacity expansions being delayed or cancelled. How do you see industry capacity growth this year, given the marketplace that we are in, in terms of could you put any (37

[Bryan A. Shinn:]

I believe that most of the capacity and most of the companies that are bringing that capacity on will be approaching things very cautiously, right? I would expect that we're probably low- to mid-single digits in terms of percent increase of capacity that actually comes online; or, said another way, I think, most of the things that were planned, including our expansions, will be delayed out into 2016 or perhaps beyond.

[Marc G. Bianchi:]

Great. Thanks, Bryan. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

Thank you. Our next question comes from the line of Richard Verdi with Ladenburg. Please go ahead with your questions.

[Rich A. Verdi:]

Hi. Good morning and thank you for taking my call and great quarter, given the environment. You handled it deep (38

[Bryan A. Shinn:]

It's a great question, Rich, and we've seen a couple of technologies come on the market like HiWAY. Of course, HiWAY has been around for a while now. And I'd say that most of them from our experience have been kind of niche, very focused technologies that wouldn't have a significant impact on U.S. Silica's frac sand business.

[Rich A. Verdi:]

Okay. That's helpful. Thank you. And you had spoke a lot about rigs being laid down, and I apologize if I missed the following, but what about super-frac? Is Silica seeing this theme play out?

[Bryan A. Shinn:]

So, we're still seeing substantial increases in sand per well. We had – originally, when we made our projections for 2015 back many, many months ago, we were expecting to see a 15% to 20% increase in sand usage per well, and actually that has held up pretty well. We believe we're still in that kind of range. And as we survey our customers and talk to the energy companies, there are a few of them that in this environment for their own reasons, mainly cash flow in some cases, are deciding to actually minimize the cost in terms of proppant and everything else. But that's a very, very small percentage. I would say, by and large, we're seeing the large-scale – large sand usage fracs that we predicted.

[Rich A. Verdi:]

Okay. That's helpful. Thank you again and good quarter.

[Bryan A. Shinn:]

Thanks, Rich.

[Operator:]

Our next question comes from the line of Tom Dillon with William Blair. Please go ahead with your questions.

[Tom R. Dillon:]

Hi. Just to piggyback off that Fairfield question, have you changed your plans for the Cadre mine in Texas at all?

[Bryan A. Shinn:]

We have not. Cadre is actually doing very well in this downturn. There's sort of limited suppliers of that type of product in the Brady, Texas, area. And we've seen good demand from Cadre. I would say that one of the things we'd always talked about was potentially expanding that site. And depending on how demand plays out in that kind of Permian Basin area, which is where the vast majority of it gets consumed, I think that's always a potential in the future as well, Tom. So, we're very happy with the way Cadre is performing.

[Tom R. Dillon:]

Okay. Great. And then, can you just provide a little more detail around the arbitration charge and what that means for the other contracts?

[Bryan A. Shinn:]

Sure. Sure. So, this was a $7.6 million arbitration ruling that actually relates to a dispute that we had with a contract manufacturer, which dates back to 2012. So, this is not a dispute with an oil and gas customer. This isn't an oil and gas contract dispute. This is a contract manufacturing for a product that we were developing. It was a dispute around that. And so, this has absolutely nothing to do with ongoing operations. We don't agree with the ruling. We're appealing it. And of course, as you might expect, we can't really talk about a lot, given that it's a pending litigation matter at this point.

[Tom R. Dillon:]

Understood. Thanks, guys.

[Bryan A. Shinn:]

Okay. Thanks, Tom.

[Operator:]

Our next question comes from the line of Chase Mulvehill with Suntrust. Please go ahead with your questions.

[B. Chase Mulvehill:]

Hey. Good morning. Thanks for squeezing me in.

[Bryan A. Shinn:]

Good morning, Chase.

[B. Chase Mulvehill:]

Just so I can make sure that I'm hearing everything right. So, here is what I'm hearing so far. I hear that – from you guys, I'm hearing that 2015 Oil and Gas volumes could be down 20% for you guys and 2Q contribution margin per ton is probably in the mid- to high-20%s, bottoming by the end of 2Q. Is that what I'm hearing so far?

[Bryan A. Shinn:]

Yeah. So, I think that – the margin is still uncertain, so I think there is kind of wider error bars around that. The volume feels, in my mind, anyway, just because we can link that back to rig count and these are hard published numbers that you can do easy math off of, think that one's easier. The contribution margin per ton, I think, still has to play out. My intent was just to give folks kind of a directional view as to where contribution margins might be going. And we'd said generally that it's going to be lower in Q2. But I'm still concerned that we haven't really seen the bottom yet of our contribution margin. So, we have to see how things play out over the next couple of months here.

[B. Chase Mulvehill:]

Okay. All right. And then, so how much is pricing down at the mine and how much more pricing do you think that you have to give at the mine?

[Bryan A. Shinn:]

So, it's really pretty consistent. There is not that much difference in the mine gate pricing, per se, as opposed to the transload pricing, even though some of the transload pricing is spot, right, but some is actually delivered under contract. I would say that the biggest difference between the mine gate pricing and the transload pricing is that our larger customers who have their own railcars and transloads tend to be the ones to disproportionately take the mine gate products, right? So, if you follow through with that, they tend to be the ones with the lowest prices. So, it skews the plant pricing a bit just because of the customer mix. Does that make sense?

[B. Chase Mulvehill:]

Yeah, yeah. And then, also in the past, you guys have mentioned that about $5 per ton of contribution margin was attributed to logistics. So, could we get an updated number on what the logistics accounted for, for contribution margin in 1Q?

[Donald A. Merril:]

I think in the past we've said it's been roughly $3 to $5, right, and I think we're still...

[B. Chase Mulvehill:]

Yeah.

[Donald A. Merril:]

We still see a premium when we do sell in basin, clearly.

[B. Chase Mulvehill:]

Okay. Okay. So, that's not zero in 1Q?

[Donald A. Merril:]

I wouldn't say it's zero, no.

[B. Chase Mulvehill:]

Okay.

[Bryan A. Shinn:]

No. And it's one of the reasons, Chase, that our spot pricing has held up higher than contract pricing generally, is that we kind of extract that premium, right?

[B. Chase Mulvehill:]

Absolutely. Okay. That's all I have. Thank you, fellas.

[Bryan A. Shinn:]

Thank you, Chase.

[Operator:]

Our next question comes from the line of Agata Bielicki with Simmons & Company. Please go ahead with your question.

[Agata Bielicki:]

Good morning, gentlemen. Thanks for squeezing me in.

[Bryan A. Shinn:]

Hi, Agata. Good morning.

[Agata Bielicki:]

How many unit trains were shipped in Q1?

[Bryan A. Shinn:]

I think it was 23 unit trains.

[Agata Bielicki:]

Okay.

[Bryan A. Shinn:]

Maybe 23, 25, something like that. I don't have the exact number in front of me, but it was several.

[Agata Bielicki:]

And with your current build-out plans at the transload, how many could you expect to ship, let's say, for the remainder of the year?

[Bryan A. Shinn:]

Yeah. So, look, it depends a lot on volume, obviously, right?

[Agata Bielicki:]

Right.

[Bryan A. Shinn:]

But I think, we originally were thinking that we could be well over 100 unit trains this year, perhaps more, depending on how demand played out.

[Agata Bielicki:]

Okay. And then, circling back to Blake's question, what percentage of your volumes were sold in contract Q1 (46

[Bryan A. Shinn:]

We were probably 60% to 70% of our volumes in Q1 sold to contract customers.

[Agata Bielicki:]

Okay. All righty. And then, I guess, going back to the super-frac question, I'd be curious to know if you are aware from any of your service customers if they are pumping, let's say, 10,000 tons or maybe even more of sand per well, if you've heard any of those anecdotes.

[Bryan A. Shinn:]

Yes, we have. There's still very large fracs being done, just as there were at the end of 2014.

[Donald A. Merril:]

Even more than 10,000 tons.

[Bryan A. Shinn:]

Yeah, we've seen, I think 15,000 tons...

[Donald A. Merril:]

Yeah.

[Bryan A. Shinn:]

...is the largest one that we've heard of so far.

[Agata Bielicki:]

Okay. Great, that's good color. And I guess, one more for me, just going back to ISP. I know you guys talk about the new products and the products in the pipeline and the mix being more favorable there. But wondering if you could speak to maybe what some of those products are and/or maybe some of the ones that are in the pipeline and kind of when you expect those to come to market.

[Bryan A. Shinn:]

Yeah. It's a great question, Agata. I'm glad you mentioned ISP. It tends to get kind of short shrift here with all the Oil and Gas interest that we have. We have a very robust new product pipeline in ISP. We have actually 40 products right now, a few more than that, in the pipeline. We launched 10 products in 2014. We launched five in Q1 of this year and we expect that we'll probably have a total of 10 that we launch in 2015. Current expectation is in 2015 that we generate somewhere between $7 million to $10 million of contribution margin from those products. And we'd expect, just with the pipeline that we have, that it's probably worth $25 million to $35 million on an annualized rate of contribution margin out within the next couple of years as those products grow. We have a number of different products that we've launched. Many of them are coated products. So, we have a coated solutions platform that we are developing. And one of the products, just to give you an example, is a sand that's coated with an antimicrobial coating. It has a lot of different applications. We started in the water treatment industry. But I really think we've got kind of a hidden gem here in our industrial business. And there's acquisition opportunities here, too. We don't talk about that a lot, but I think there's some pretty neat things that will come out of ISP. And my guess is, as I've talked to a number of investors over the last few years, almost nobody has any kind of upside in ISP in terms of their modeling. So, if you invest in our stock, you kind of get that for free, in some ways.

[Agata Bielicki:]

Okay. Great. Thanks, guys. I'll turn it back.

[Bryan A. Shinn:]

Okay. Thanks, Agata.

[Operator:]

Our next question comes from the line of James Schumm with Oppenheimer. Please go ahead with your question.

[James Schumm:]

Hey. Good morning.

[Bryan A. Shinn:]

Good morning, James.

[James Schumm:]

So, I think you said your in-basin sales were 63% in the first quarter. Is this – do you expect that to fall more or do you think that's a good run rate for 2015?

[Bryan A. Shinn:]

I think it could fall a little bit. And what we're seeing is that some of our larger customers that have their own logistics infrastructure want to use that fully. And by the logistics infrastructure, I mean railcars and transloads. And they did that for sure in 2014 as well. But as demand falls just kind of on a percentage basis, the percentage of those sales that customers are picking up on their own at our plants will increase a bit, right? So, it's a math issue. It's not that, in my experience so far, that customers are actually moving more tons so much with their own equipment. It's just kind of a percentage, just kind of looking at the equation. Does that make sense?

[James Schumm:]

Yeah, yeah. That makes sense. And then, also, I think you mentioned some sub-optimal transportation this quarter. I mean, could you quantify that? I mean I'm just looking at cost per ton in your Oil and Gas segment and I was just wondering if you could sort of quantify that. And then...

[Bryan A. Shinn:]

So, if I'd to put a number on it, I would say it's probably somewhere between $2 to $3 a ton of sub-optimal shipments. And just for color, for those on the phone who might not know exactly what we're talking about, typically, every destination and origin pairing that we have in our system has a different level of profitability. And when products are moving and the network is full, it gives us a lot of opportunities to kind of move things around. We typically have had good lead time in terms of orders from our customers. That's the way things have been over the past many quarters. As we've gotten into the downturn, we have customers putting in orders at the last minute, canceling orders at the last minute. And all that can play a bit of havoc with our supply chain as we have unit trains moving around and lots of railcars, thousands of railcars that we're trying to manage. So, that's what happens when we get into this kind of environment. Certainly, our team is working extremely hard to take those costs down as low as possible. But we find ourselves frequently in the position of getting a last-minute order from a customer. And so, our option is to either not serve that customer and don't incur the sub-optimal shipment, but also don't get the profit from the sale, or be willing to take a lower net margin just because we know it will incur – we will incur some additional charges because of that.

[James Schumm:]

Yeah. So, thanks, that's helpful. And I mean, do you expect this to continue into maybe Q2 and Q3, just given the shifting landscape or do you think that was more of a one-off for Q1?

[Bryan A. Shinn:]

So, I wouldn't necessarily expect it to get worse. But I'm not sure it's necessarily going to get any better either for the next couple of quarters as the industry is still kind of settling and moving around. And really, it's these kind of short-term orders and short-term cancellations that give us those extra costs.

[James Schumm:]

Okay. And then, just finally, are there any other opportunities to reduce your costs? I mean I know increasing unit shipments, but are there other opportunities to reduce cost per ton going forward?

[Bryan A. Shinn:]

There are a number of things that we're working on. And we've committed to a 20% reduction in our overhead costs based on our – based off our original forecast. In the whole logistics chain, there are lots of opportunities. And the way we manage our railcars, the type of contractual relationships we have with a variety of people in that chain, we're going back to all of our suppliers and asking for pricing concessions, how we handle things at our plant sites, there's a number of things, James, that we are working on. And I expect that we'll be able to take out some significant costs in the coming quarters here.

[James Schumm:]

Okay. Great. Thanks for the time, guys.

[Bryan A. Shinn:]

Thank you.

[Operator:]

Our next question comes from the line of Richard Verdi with Ladenburg. Please go ahead with question.

[Rich A. Verdi:]

Hi, guys. Thanks for fitting me back in again. I had one follow-up question. I guess I'm having a hard time connecting the dots with something. And you had mentioned earlier in your prepared remarks that expect maybe 25% weakness. You have some market share gains at 20% weakness. But here's the thing. Our channel checks with the rail guys are saying that Silica is moving volumes that are quite substantial to what they're seeing with other customers. And so, I guess I'm having a hard time connecting the dots here with, are you really having a hard time moving volumes or is it more of a pricing aspect? Could you just give me a little color there?

[Bryan A. Shinn:]

So, look, we're obviously trying to make every sale that we can in this environment, Rich, and certainly – boy, if – maybe we've a black hole somewhere that's swallowing our sand, I don't know. But look, I mean, we're pushing very hard to get every sale that we can. At the same time, as I said before, we also want to be sort of logical and rational in the marketplace and realize that we're in this game for the long term. And could we ramp up volumes and make $1 a ton margin or something? Probably, but that's not going to be in our best interest in the short term or the long term. So, I'm not really sure where the information is coming from, but certainly we're selling everything that we can in this environment at reasonable pricing.

[Rich A. Verdi:]

Perfect. All right. That's good. Thank you very much, guys. I appreciate it.

[Operator:]

Thank you. This concludes today's question-and-answer session. I'd like to turn the floor back to Bryan Shinn for closing remarks.

[Bryan A. Shinn:]

Thank you. In closing, let me say that in spite of the short-term challenges that our industry faces in the oil and gas market, I continue to be optimistic about U.S. Silica's future growth prospects. I believe we're extremely well positioned to take advantage of an expected energy market rebound when that occurs. And I look at our industry-leading sand reserves, our mining facilities, transportation and logistics infrastructure, very strong balance sheet and the outstanding team that we have, and I'm extremely encouraged about our prospects for the future. I want to thank our investors and our analyst community. We certainly appreciate your interest and your support. And I look forward to meeting and speaking with all of you at the many conferences and events that we plan to attend in the coming months. So, thank you all for dialing in, and have a great day, everyone.

[Operator:]

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