U.S. Silica Holdings, Inc.
Q2 2015 Earnings Call Transcript

Published: 29 Jul 2015

[Operator:]

Greetings and welcome to the U.S. Silica Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Michael Lawson, Director of Investor Relations and Corporate Communications for U.S. Silica. Thank you. You may begin.

[Michael K. Lawson:]

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's second 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 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'll now 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 with a review of our second quarter financial performance, followed by commentary for both of our operating segments, and then our market outlook going forward. Don Merril will then provide some additional color around our quarterly results before we open up the call for your questions. For the total company, second quarter revenue of $147.5 million decreased 28% sequentially compared with the first quarter of 2015, adjusted EBITDA for the quarter of $23.4 million, declined 54% sequentially. The sequential declines in both revenue and profitability were primarily driven by lower volumes and pricing in Oil & Gas, as the rig count decline accelerated and we saw continued reduction in drilling and completion activity in all basins during the quarter. Volumes in Oil & Gas in the second quarter of 1.2 million tons fell 27% sequentially, driven by the significant reduction in land activity as the North American rig count fell 40% in the second quarter versus the first quarter of 2015. Sales volumes dropped early in the quarter as we employed a disciplined pricing approach to preserve margins in a challenging market environment. However, in response to an increasingly competitive landscape, we reduced pricing late in the quarter to capture additional volumes. At the same time, our teams are working very hard to minimize the impact of lower volumes on plant and distribution network utilization. As I noted earlier, pricing came under tremendous pressure during the quarter as market conditions continued to deteriorate. Lower pricing, lower volumes and decreased fixed cost leverage drove Oil & Gas contribution margin per ton, down 65% sequentially to $10.83 per ton. More than half of this sequential decline was driven by price and about one-third resulted from decreased fixed cost leverage. Customer and grade mix also negatively impacted Oil & Gas contribution margin per ton as well in the quarter. For example, we sold a greater percentage of fine grade material and almost half of the volumes sold in Oil & Gas during the quarter were to our two largest customers. We bought an (3

[Donald A. Merril:]

Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our two operating segments, Oil & Gas and Industrial & Specialty Products, and due to the relevance, my commentary will be mostly focused on comparing results to the latest sequential quarter. Revenue for the Oil & Gas segment for the second quarter of 2015 of $90.9 million declined 39% sequentially when compared with the first quarter of 2015, while revenue for the ISP segment of $56.7 million represented a 3% improvement sequentially. Contribution margin from Oil & Gas in the quarter was $13.3 million, down 75% on a sequential basis compared with the first quarter of 2015. On a per ton basis, contribution margin for Oil & Gas declined 65% sequentially to $10.83 compared with $30.91 for the first quarter of this year. Contribution margin for our Industrial & Specialty Products segment was $19.5 million, an increase of 26% sequentially over the first quarter of 2015 and up 11% compared with the same period of the prior year. On a per ton basis, contribution margin for the ISP business of $18.89 represented a 20% improvement over the first quarter of 2015. The sequential increase in ISP contribution margin per ton was driven by a combination of a mix of higher-margin business, including new value-added products, and lower operating costs during the quarter. Turning now to total company results. SG&A expenses for the second quarter decreased by $20.4 million to $6.6 million, compared with $27 million for the first quarter of 2015. The decrease was attributable to an $8.8 million decrease in compensation expense, and an $8.3 million decrease in business development expenses, and a decrease in bad debt expense of $1.6 million. As Bryan noted in his remarks, we are well on track to achieve our stated goal of reducing our budgeted SG&A spend by 20% this year. Depreciation, depletion, and amortization expense in the second quarter was $13.7 million compared with $13.2 million in first quarter of 2015. The increase in DD&A was driven by continued capital spending in support of our growth initiatives. We expect depreciation, depletion, and amortization expense to continue to grow due to anticipated capital spending in 2015. Continuing to move down the income statement and the other income and expense line, interest expense for the quarter was $6.2 million compared with $6.8 million in the first quarter of 2015. The decrease in interest expense was due to a decrease in the average interest rate on our debt, and a decrease in our debt principle and for deferred revenue. From a tax perspective, during the quarter we recognized an income tax benefit of $6.3 million. Considering the current market conditions, we adjusted our annual effective tax rate excluding discrete items to 0% during the quarter, which was driven by our estimated annual pre-tax income to be fully offset by the statutory percentage depletion deduction that we are afforded as a mining operation. Turning now to the balance sheet. Cash and cash equivalents and short-term investments at June 30, 2015 totaled $322.2 million compared with $342.4 million at December 31, 2014. As of June 30, 2015, our working capital was $390.3 million and we had $46.9 million available under our revolving credit facility. At June 30, 2015, total debt was $493.4 million. Net cash provided by operating activities during the quarter totaled $18.7 million, which exceeded our capital expenditures of $13.8 million in the second quarter of 2015. The bulk of our second quarter CapEx spend was largely associated with the company's investment in a new frac sand mine and plant located near Fairchild, Wisconsin, and various other growth, cost savings and maintenance capital projects. Based on current market conditions, we anticipate capital expenditures for 2015 will be in the range of $60 million to $70 million. From a capital allocation standpoint, we plan to use our strong balance sheet to pursue accretive acquisitions to enhance our speed, scale and strength as an enterprise. Consequently, in terms of uses of cash, our first priority will most likely be opportunistic M&A activity, as we strongly believe there will be consolidation opportunities in the fragmented sand space. We will also continue to spend cautiously on our Greenfield growth projects in order to maximize our flexibility once our markets recover and invest in various cost improvement projects to enhance our operational efficiency. Finally, as noted in the press release, we will continue to refrain from providing financial guidance until we can begin to see more clarity in our customer demand trends. We've been watching this very closely and will provide you with an update on our next earnings call. With that, I'll turn the call back over to Bryan.

[Bryan A. Shinn:]

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

[Operator:]

Thank you. Our first question is coming from Kurt Hallead of RBC Capital Markets. Please proceed with your question.

[Kurt Hallead:]

Hi. Good morning.

[Bryan A. Shinn:]

Hey. Good morning, Kurt.

[Donald A. Merril:]

Morning.

[Kurt Hallead:]

Hi. I think what I would like to focus on and try to get some additional color is on some of the fixed cost dynamics of the business and get a little better understanding on your ability to maybe reduce some of that fixed cost element, specifically as it relates to railcars. Can you help us out with that?

[Bryan A. Shinn:]

Yeah. Sure, Kurt. So, we're working really hard right now to take out all the cost that we can in the business. We're obviously looking at every aspect of our spending in this environment. So, we have a couple of different pieces. The first piece is around our general overhead spending and we targeted 20% reduction there and I am happy to say that we're right on track for that, so I think we'll continue to see positive benefits from that. We continue to optimize our plant costs as well, things like origin destination pairing to save as many shipping dollars as we can. So if I look over the whole system, we've got more than 200 different projects and programs that we're working on to take cost out. Specifically, you asked about the railcar side, right now we have a little over 1,400 railcars in storage and we're looking at a couple of things there to help us offset those costs. The first and best way to do it is to get more volume flowing through the system. So we're aggressively going after new business and my hope is that we'll able to get some cars out of storage just from getting more volume flowing through the network. And the second obviously is looking for ways to delay, defer, push those railcars off to others. And we've been pretty successful so far in finding people to sublease some of our cars. And there's a lot of other programs and projects around improving our rail costs so I think we'll definitely see that come down in the coming quarters.

[Kurt Hallead:]

Just as a follow up in that context, if I understand correctly the storage cost runs roughly, what, $400 to $500 per month per car? And then from a lease standpoint, can you give us an update on what the average lease term is that you're looking at for the 1,400 railcars that you have in storage?

[Donald A. Merril:]

Yeah, Kurt. This is Don. The lease expense that we have on a per car basis per month averages about $550 per month per car. So if you use some of the numbers Bryan just shared with you, we have 1,460 cars that are sitting in storage today at $550 per month, that's about $800,000 per month or $2.4 million in the quarter. Those are the types of inefficiencies that we're talking about when we talk about fixed cost leverage. So if you take that and divide it by the number of tons that we sold in Oil & Gas, that's about $2 a ton. So when you look at the overall reduction in contribution margin per ton in Oil & Gas, $2 of that was just associated with the fact that we've got underutilized railcars sitting in storage. So that $550 that we're paying out in a lease cost, when they're in use, people are paying us to use those. So you can see the pretty dramatic impact of that.

[Kurt Hallead:]

Okay. So, what are you targeting then in that context? Like what can you reasonably accomplish from getting more railcars out or getting more volume out? And can you give us some insights maybe on how to think about that progression in the second half of the year?

[Bryan A. Shinn:]

Sure. So Q2 was an interesting one for us. We started off the quarter with the aim to try and hold price out in the market to the extent that we could. And we worked that early in the quarter, but as it became obvious that that was going to be more and more difficult with the competitive environment out there, we pivoted to a motive of more volumes. So we're already seeing some of those additional volumes in June and July. And so, I think you'll see substantially higher volume run rates for us in Q3 and I believe that will necessitate us potentially taking some of these additional railcars out of storage. The issue on the other side of that, Kurt, is that we do have some railcars coming online this year. We're able to defer most of them out for several years, but there were a few that we couldn't. So we're working that balance. And also our customers have railcars that they have coming online as well. And in many cases they're asking us, reasonably so, to use the railcars that they have leased. So, we're trying to run all that balance, but our team is working real hard to get the volumes up so we can get the cars out of storage. And that's just one piece of this sort of fixed cost leverage that Don was talking about. There's a lot of other assets, mostly plant assets that are underutilized as well. So, volume cures a lot of things in terms of contribution margin per ton.

[Kurt Hallead:]

Okay, all right. Great. I appreciate that color. Thank you.

[Bryan A. Shinn:]

Thanks for the question, Kurt. Take care.

[Operator:]

Thank you. Our next question is coming from Ole Slorer of Morgan Stanley. Please proceed with your question.

[Ole H. Slorer:]

Yeah. Thanks. Thanks a lot. And thanks for all the details. And just, I realize it's very difficult to make any kind of medium term type forecast, but just a little bit more color on how the quarter trended pricing-wise. You gave us some volume indications here that it is picking up and some of the things you're doing on the cost side and maybe costs per ton should therefore be trending down. But on the pricing side, average selling price or revenue per ton, how did it end the quarter related to where it started? And how should we model that throughout this quarter, just trying to get the Oil & Gas division roughly in the right ballpark for the third quarter?

[Bryan A. Shinn:]

Yeah. So, June was a pretty good month for us, even though we increased volumes in June. So, I felt good about the way we exited the quarter, Ole. And if we sort of look at the drags on the margin and think about how that might change going forward, if you look at the difference between Q1 and Q2, our Oil & Gas margins went from roughly $31 to $11. So, it's kind of a $20 delta, but, $7, $8 of that was all around the sort of fixed costs absorption issue. So, that's a piece that we're working real hard to get as much of that out as we can in the coming quarters. The rest of it was a sort of pure price, or in some cases, customer mix. And, when I say customer mix, it's mix of customers or mix of products. So, one of the things that we've also experienced, as we've gone on throughout the year here is that our largest customers seem to be buying more and more product. And so, our top two customers accounted for more than 50% of our sales in Q2. And as you can imagine, those large customers tend to have lower prices. So, that's one factor in there. And also, we're seeing more fine grade products of 40/70 and 100 mesh as a percentage is growing a little bit. So, there's a lots of puts and takes. And it's kind of a flexible environment out there right now, but we're working real hard to try and maximize the contribution margin dollars that we can generate in this environment.

[Ole H. Slorer:]

And is it possible that the contribution margin could expand into the third quarter, or will it go down based on what you already see? Or is it just to find a balance to make a call? It sounds like it could go up slightly, but (22

[Bryan A. Shinn:]

So my expectation is that it's going to go up. And if you look all the work that we're doing around the cost take-out, for example, we have several million dollars worth of cost projects that have not hit the tape yet. So, I think those are going to benefit us. Obviously, as we can roll more volume through the system here, we'll get more fixed cost leverage. So, we're working real hard to be able to increase that margin. I don't think it's going to be a dramatic increase so that it all sort of comes back in one quarter. But I think we can get $1, $2 per quarter, if we can hit on these programs and if there's not another significant drop in pricing in the market, which is always a risk, given that WTI has now dropped down to about high $40s. It looked like it was going to settle out maybe in the high $50s, and now we're down a bit. And so, we're not really sure what the impact of that is going to be yet. It's too early to tell that, but we're certainly working hard to do everything we can do, control everything we can control to maximize our margins and our profitability.

[Ole H. Slorer:]

But based on what you are saying, it sounds like there is a ferocious consolidation of market shares within your customer base, where the larger guys are squeezing out the smaller guys, is that fair, or...?

[Bryan A. Shinn:]

I think that's a pretty fair characterization; we've definitely seen growing sales to the largest service companies out in the industry.

[Ole H. Slorer:]

Okay, thanks a lot. I'll hand it back.

[Bryan A. Shinn:]

Okay. Thanks, Ole.

[Operator:]

Thank you. Our next question is coming from Blake Hutchinson of Howard Weil. Please proceed with your question.

[Blake Hutchinson:]

Good morning.

[Bryan A. Shinn:]

Hi, good morning, Blake.

[Blake Hutchinson:]

Following on kind of that market share thought, Bryan, I want to make sure we're perfectly clear, when you talk about gaining share, is this – are you measuring it by kind of – because it's not always evident to us when we look at activity and adjust for intensity that we're doing more than kind of keeping pace with the market, are you taking share kind by your well-by-well model? Is it a feel you get from just your largest customer share or is there extreme evidence of Tier 1 providers taking share form Tier 3 providers that kind of gives you that insight to share gains?

[Bryan A. Shinn:]

So, we have a pretty detailed view on a basin-by-basin look, Blake, that really dives in and we know what the activity is in the basin, we know what our share was previously. And so, so we can track that pretty well and we are gaining share in this market. I think, it's related to the kind of national footprint that we have, the low-cost operations, the scale, the logistics, the customer relationships, all of the things we've talked about in the past, that's all coming back to pay us a lot of dividends in this challenging environment.

[Blake Hutchinson:]

Okay, but it's more to your kind of detailed model than just a kind of feel for the market?

[Bryan A. Shinn:]

Oh, no, it's definitely – we definitely have details behind that. And we always check it against the macros just to make sure that it all makes sense. And when you sort of do it in the macro, it makes sense and when you dive down, we look literally on a weekly basis basin-by-basin to look at our sales versus a variety of other metrics to get a triangulation on that.

[Blake Hutchinson:]

Okay. And then just to follow up on the pricing conversation. I guess as we look at your customer base becoming more and more concentrated, I guess it would – even though those are lower price customers, I guess it would give us a sense that you would actually have greater pricing visibility. But is the reality that even your large contract customers or all contract customers are kind of still working off spot all the time versus on contract, and is there visibility towards kind of getting back on contract? How is that unfolding right now?

[Bryan A. Shinn:]

Yeah, so, look, the reality is even though you've got maybe a little bit more consolidated customer base, things still move around quite frequently in this industry and it seems like there's always somebody who is short of some product somewhere and things kind of ebb and flow. So, it's just hard to pin that down to be quite honest. And we look at our sales at our plants and we look at the sales out at the transloads and one of the things we have seen is that we're seeing more kind of balance between those two in terms of volumes. So, in the past, we've been 60% or 70% out at transloads, now, we're more like sort of 50-50 and there have been months where we've actually dipped under 50% for sales at transload. So, it makes it very hard to sort of forecast what the pricing is going to be on an forward-looking basis.

[Blake Hutchinson:]

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

[Bryan A. Shinn:]

Okay, Blake. Thank you.

[Operator:]

Thank you. Our next question is coming from Michael LaMotte of Guggenheim. Please proceed with your question.

[Michael LaMotte:]

Thanks. Good morning, guys. If I could return quickly to the railcar question, specifically as it pertains to the deferral of deliveries. Can you give us a sense as to what the delivery schedule looks like through 2016? And whether or not the deferrals into 2017 end up creating more of a bullet delivery in that year? Or are you actually cancelling the contracts for railcars that have not started to be built yet?

[Bryan A. Shinn:]

So, we've cancelled some and then there is a large chunk that we actually deferred out into the back half of 2017 and the first half of 2018. So we have quite some time yet, it's plus or minus two years before the first of those cars will start to show up in 2017. And these were cars that we had ordered back in mid-2014, when the market obviously reflected it was going to be very short on railcars. We wanted to make sure we got into the queue. And, ultimately, I think we'll still need those railcars, but we don't need them right now.

[Michael LaMotte:]

So, does that mean there is really nothing coming in the next 12 months to 18 months in terms of delivery?

[Bryan A. Shinn:]

There is some cars coming for the remainder of this year. There is not much coming in 2016. And then it will resume again in 2017 and 2018. And one of the other things as well that we've looked at, if you look at existing cars that we have, we have a certain percentage of our leases that roll off every year, right? So, we're going to have the ability to either renew those leases and sort of increase our cars by the time we get to 2017 and 2018 or let those roll off, and that will give us the flexibility to sort of choose how many railcars we end up with in 2017 and 2018, and I believe, the last look at the numbers is that we could essentially be even in terms of railcars by the time we got to 2018 even with where we are today if we let leases that are about to expire, expire through the end of 2015, 2016 and the first half of 2017.

[Michael LaMotte:]

Okay. That's great. That's very helpful. If I could follow-up on some of the non-operating costs, too, then. The guidance on SG&A obviously second quarter very good, compensation expense being a big chunk of that reduction. It seems like in the second quarter, there were a bit of a one-time adjustments on 2015 as it pertains to things like bonus accruals and even on the tax line as well. Second half of this year, how do those normalize, if I could sort of run Q3 SG&A or Q2 SG&A rates out, it looks like a 50% year-on-year reduction versus 2014. So SG&A is actually going to go back up again in absolute dollars in the second half of this year?

[Donald A. Merril:]

Yeah. I think that's fair to say. I would be modeling somewhere between $15 million and $15.5 million per quarter for Q3 and Q4 for SG&A.

[Michael LaMotte:]

Okay. And then on the tax line, can we assume a zero income tax year. You've been – the depletion allowance has been about 10 percentage points to your effective tax rate the last three years. Can we use that as a proxy for what you expect profit before tax to be this year?

[Donald A. Merril:]

Well, what we've done is taken a look at the overall forecast and basically like I said in my commentary that the statutory depletion deduction is going to offset our book pre-tax income. So, that's what we're anticipating. So, that 0% effective tax rate, excluding discrete items, is where we anticipate to be for the full year.

[Michael LaMotte:]

Okay. Thanks, guys.

[Bryan A. Shinn:]

Thanks, Mike.

[Operator:]

Thank you. Our next question is coming from Robin Shoemaker of KeyBanc. Please proceed with your question.

[Robin E. Shoemaker:]

Yes. Thank you. So, I wanted to ask you – you indicated in your press release, 62% of tons sold in basin and you're talking here on the call about kind of a 50% delivered in basin. Now – so, should we expect this number to be around more like 50% in the second half of the year?

[Bryan A. Shinn:]

Yeah. So it moves around a lot, Robin. And so I would say a 50/50 is probably is a good way to look at it, 50% in basin, 50% from an FOB plant standpoint.

[Robin E. Shoemaker:]

Okay. And just in terms of the margin at plant and in basin, I mean, clearly there's a difference there. How would you characterize that?

[Bryan A. Shinn:]

So I would say that typically our margins in the basins are a few dollars a ton higher, maybe $3, $4 a ton higher, something like that. It obviously depends a lot on the specific location. But historically we've always gotten a small premium for that. And given the extra work and effort that has to go into it, it makes a lot of sense and I think customers understand that.

[Robin E. Shoemaker:]

Okay. Just one other thing. In terms of this big picture growth in proppant intensity per well that we've seen for several years now and I think continues through this year, what's your comment around that? Is the rate of growth in proppant intensity per well from your perspective, is that slowing, is it still continuing at the pace that it was? How would you describe that?

[Bryan A. Shinn:]

It's a great question, Robin, and it's one that I was watching with a lot of interest. You never know when the market goes through a big correction what changes. And so we were watching that pretty closely. I'm pleased to say, though, that we really have seen no let up in that trend. We had originally modeled 15% to 20% proppant per well increase for 2015. And our own data indicated that we're on track for that. And also a major service company on their earnings call last week said that they're seeing proppant per well up about 19% so far this year. And we've actually recently gotten a lot of feedback from a variety of customers who are talking about increasing their proppant per well. So I think that's a positive for the industry and certainly it seems like that's a long-term trend that we see no sign of abating.

[Robin E. Shoemaker:]

Okay. Great. Thank you.

[Bryan A. Shinn:]

Thanks, Robin.

[Operator:]

Thank you. Our next question is coming from Trey Grooms of Stephens. Please proceed with your question.

[Trey H. Grooms:]

Hey. Good morning.

[Bryan A. Shinn:]

Good morning, Trey.

[Trey H. Grooms:]

Couple of quick questions. Most of the questions have been asked. But you pointed to capacity utilization being low and a drag on the quarter, which I guess should be expected given what's going on with sales and demand. But, Don, when you look at the inventory levels, it's down just slightly sequentially versus a much steeper decline in sales. How should we be thinking about your approach to pulling those inventory levels down as we progress through the back half of the year? Should we expect that? And then what impact could that have on capacity utilization as we look in the back half? Do you think that that could still be a drag or less or more of a drag as we go through the back half?

[Donald A. Merril:]

Yeah, so good question. I think the inventory levels that you're seeing at the end of June reflect the fact of what Bryan said earlier, that June was a pretty good month. We started to see our sales ramp back up so we wanted to make sure that we had the inventory in place in order to capture those sales. So the inventory that you're seeing, a lot of that is in-basin, which obviously comes at a higher cost because it includes the freight to get it there. So that's what you're seeing there. And I would anticipate that inventory level staying relatively flat throughout the rest of the year, again, as we try to capture more than our fair share of the growth in the marketplace.

[Trey H. Grooms:]

Okay. Thanks for the color there. And then I guess just on the M&A that you pointed to, Bryan, we've heard you talk about that several times as the primary use of cash as we look forward. A couple of things. One, I think the smaller players are definitely struggling, as you mentioned, a lot of the big guys are moving away from those guys – from the smaller players. Are you still seeing those smaller guys go away, leave the market? Are you still seeing some of that or do you think we've hit a bottom in that? And how does that look towards M&A, how do you take that into consideration when you look at M&A looking for targets? And also if you could comment just as a follow on to that, your comfort level around leverage. I know you guys just upsized some of your debt late last year, but looking at M&A, your comfort level around that?

[Bryan A. Shinn:]

Sure. So M&A is I think getting more interesting in Oil & Gas. It feels like the bid/ask is tightening up a little bit here and it's what we predicted as things progressed on and we got further into the trough here. So I think that could be very constructive for M&A. As far as the small players, we have seen several of them leave the market. Certainly, some are for sale. Unfortunately, the reason those folks weren't competitive in the market typically goes back to things that you can't correct. So maybe they are on the wrong rail line or they have a high cost structure that you can't fix. And so those probably aren't the type of targets that we would be interested in. So I think we would look more at folks who have low cost capacity. And I think having low cost has proven to be a key differentiator here in this downturn. And so I really wouldn't want to bring anything into our portfolio that didn't meet that criteria. As far as the leverage, maybe I'll ask Don to give his thoughts on that.

[Donald A. Merril:]

Yeah, so even if you look at the company today, we're still pretty comfortably levered. If you look at a TTM basis, on a net leverage basis we're about 1.2 times to 1.3 times levered. On a go forward basis, if we were to look at adding additional leverage to the company for a solid acquisition to help consolidate the industry, a 3.5 times leverage is something that I've consistently said I'm comfortable with. When it starts to get over that, you can bet we have a plan to pay down the debt pretty quickly based on the cash that can be delivered from this type of a business.

[Trey H. Grooms:]

Great. Thanks a lot for the color.

[Bryan A. Shinn:]

Thank you, Trey.

[Operator:]

Thank you. Our next question is coming from Marc Bianchi of Cowen. Please proceed with your question.

[Marc G. Bianchi:]

Hi, guys. I'm interested in the comment on the strength in June. Curious if you can quantify how much that was up relative to the second quarter average?

[Bryan A. Shinn:]

Yeah, so we saw good volumes come back in June and pricing was maybe a little bit better as well. We still haven't seen all the cost improvements roll through yet, so those will come I think in the next couple of quarters. But what I would say that if I extrapolated the June run rate, it would probably put us more on a 6 million ton annualized rate or something like that. And so, ironically, if you look at where we were last year, we did about 6.8 million tons in Oil & Gas for the year. And I think depending on how much volume improves in the back half, I don't think we can get all the way there, but we can still have a pretty good year in terms of volumes, if things continue like they are in June and now in July. We're seeing strength in July as well, Marc.

[Marc G. Bianchi:]

Great. You mentioned market share gains being part of the driver there, but how much of the benefit would you say is market share with either existing or new customers versus underlying activity improvements, as maybe some of the companies work through their drill down completeds or just start to increase activity, how would you sort of separate that, in terms of the benefit increase?

[Bryan A. Shinn:]

Yeah. So, I think it's a couple of things obviously. If I look at the difference between the share and the market improvement, it felt like in June, and early July, the market was definitely picking up. And, we obviously last week, saw 19 rigs come back, there was a lot of sort of positive commentary from our customers. So, I would say it's maybe 60-40 towards share, if I had to posit a split. My concern going forward though is, what's the reaction to oil back down in the $40s, right? So, if WTI hangs under $50, does that put a weight on these sort of activity coming back. And I think that's one we'll just have to wait and see how it plays out.

[Marc G. Bianchi:]

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

[Bryan A. Shinn:]

Thank you, Marc.

[Operator:]

Thank you. Our next question is coming from Agata Bielicki of Simmons & Company. Please proceed with your question.

[Agata Bielicki:]

Good morning, all.

[Bryan A. Shinn:]

Good morning, Agata.

[Agata Bielicki:]

So, I was wondering if you could compare and contrast the utilization in your Texas sand mine versus your other mines?

[Bryan A. Shinn:]

So, our Cadre mine is actually holding up quite well, demand for that product is strong. And to the point where we're looking at potentially doing some capacity expansions there. So, that feels like it's been a – it's a great acquisition for us, those products do very well in the Permian and customers love them. So, utilization there, I would say is higher than the rest of our network, if you look at it in total.

[Agata Bielicki:]

Okay. And so, then, I guess like as you mentioned that capacity expansion makes a bit more sense than maybe some of the acquisitions that you touched on earlier?

[Bryan A. Shinn:]

Yeah, no – for sure. And I know that one of the concerns out there is around CapEx and how we might be spending that. And, are we really going to spend say $60 million or $70 million in this environment? And I think we're looking very carefully at that and shifting around instead of spending on a large new plant in Wisconsin, we're shifting our priority in terms of how we spend the CapEx. So we have a number of cost improvement projects, so we're focused on those. We have some ability to do some more in the transload area to help us grow volumes, so we'll do that. And then on the capacity side, we're really focused in sort of incremental expansion where there are high demand. So Boca is one and the other one is Mill Creek. So Mill Creek is a 100 mesh plant and the demand there is very high for both oil and gas and industrials, so much so that we're almost on allocation right now between the two sets of customers. So there are some incremental things we can do there. And then the last piece which is one that folks might not have thought about, but over the last few years, demand has been so strong that we kept pushing out some maintenance projects that needed to be done. So once again, we want to continue to invest for the future and not short-change our facility. So we will continue to spend CapEx, but do it wisely and not just sort of blindly pursue a mega plant in Wisconsin. We have a lots of other opportunities as well.

[Agata Bielicki:]

Okay. That makes sense. Thanks. And I guess then switching gears a little bit, outside of those two larger customers, what proportion of your oil and gas volumes go to the lower tier frac players and do you have any kind of concern that exposure to them is a risk if the large cap players continue to take market share?

[Donald A. Merril:]

No. We watch that very closely. So we feel pretty good right now with where the balance sheet is as far as the accounts receivable and the allowance thereof. So we feel pretty good about it. Most of our sales right now are going to the large and mid-size players. We're being very, very careful and cautious on who we sell to.

[Agata Bielicki:]

Okay, great. Thanks. I'll turn it back.

[Bryan A. Shinn:]

Okay, thanks, Agata.

[Operator:]

Thank you. Our next question is coming from Adam Thalhimer of BB&T Capital Markets. Please proceed with your question.

[Adam Robert Thalhimer:]

Hi, good morning, guys.

[Bryan A. Shinn:]

Good morning, Adam.

[Adam Robert Thalhimer:]

On the ISP side, Bryan, you mentioned some positive demand trends there. We haven't seen a lot of growth on the volume side within that business. What would be your expectations for an acceleration there?

[Bryan A. Shinn:]

Yeah. So, it's really an interesting question, Adam. And in some cases, that was our choice. So, we've rationalized our customer base. We had a lot of industrial customers that really did not generate tremendous profit. So, we were able to take those tons and shift them over to more profitable customers and segments. And in some cases, they were also fungible with Oil & Gas. So, we're always trying to find the highest end-use or highest margin spot, if you will, for our volumes. But I'm really excited about the industrials business. It's something that we've been talking more and more about over the last few quarters. They have a great pipeline of new products and some of them are just sort of knock-your-socks-off things. And I believe that we have tens of millions of dollars (46

[Adam Robert Thalhimer:]

Okay. But some of the customer calling will flow through in the back half of this year as well?

[Bryan A. Shinn:]

I'm sorry, say it again?

[Adam Robert Thalhimer:]

You're saying you chose to move away from some customers in that business, which is why the volumes were down in the quarter. But some of that will flow through in the back half of the year as well, or do we get to some kind of inflection point where you lap that?

[Bryan A. Shinn:]

Yes, so we've been moving to more specialty and performance products. So, in some cases, we'll direct the whole grain sand into some other processed product. So, at the end of the day, the volumes are less but the profitability and the pricing and the margins as you see can go up substantially. So, we're up more than 20% I think quarter-over-quarter in margin so that's an example of what we're trying to achieve there. So, we want to emphasize more the specialty and performance products, which tend to be lower volume, higher return products.

[Adam Robert Thalhimer:]

Got it. Okay. And then lastly I mean, I'm just listening to you on this call and it feels like with the results that you saw in June, the business is pretty sensitive to WTI prices. I mean is that – I mean that's obvious, it's blatantly obvious, but I'm trying to figure out because you're saying, well, volumes went up in June, because we got more aggressive on price, but then you said in June, volume and price were up so I'm still trying to figure that out.

[Bryan A. Shinn:]

Yeah. So, look, I think that – and there is obviously sensitivity to WTI. I think sort of internally the way we're looking at it is, there is a lot of sensitivity to our fixed cost leverage. And if we can't keep our assets fully utilized, you start to drag on earnings pretty quickly, right? So, like Don talked about the railcar example or if you look at just our plant sites in general, it gets pretty expensive to run the site at 50% of capacity on a per ton basis. And of course the problem is that the demand is not smooth in Oil & Gas, right? So, it's kind of up one week maybe down a little bit the next and back and forth. And so, it's a challenge to optimize your operations for that.

[Adam Robert Thalhimer:]

Okay. Thank you.

[Bryan A. Shinn:]

Thank you, Adam.

[Operator:]

Thank you. Our next question is coming from Brad Handler of Jefferies. Please proceed with your question.

[Bradley P. Handler:]

Thanks. Good morning guys.

[Bryan A. Shinn:]

Hey. Good morning, Brad.

[Bradley P. Handler:]

Good morning. Couple of questions, just to help me understand things a little better and then they maybe to calibrate the potential, the risk/ reward a little bit. So first keying off of a couple of your comments in the prior question. So is it possible that in terms of a pricing dynamic, as you regain share at the end of the quarter and into July, was it perhaps related to favorable mix? I mean if Cadre was running really well and you regained volumes, did you see mix shift favorably towards the end of the quarter and into the third quarter?

[Bryan A. Shinn:]

Yeah, there could have been a little bit of that.

[Bradley P. Handler:]

Is it – okay. Is it – or is that plus what you're saying is also apples-to-apples for 100 mesh or for 20/40 mesh you actually had some pricing – some better pricing than you had earlier in the quarter?

[Bryan A. Shinn:]

So, Cadre has been holding up pretty well. I think that we've also got resin-coated sand in there also, so it all sort of lumps together and if you think about what we can do with the sand grains, we continue to work to maximize the pricing that we can get and the returns from it.

[Bradley P. Handler:]

Okay. All right. Thanks. Second, unrelated, but still in the same sort of vein. So relative to comments that maybe more of the mix is 50/50 in basin versus FOB, and perhaps also aligning the idea that you're probably with the new transload is going to do that much more unit train shipments, which presumably is helpful. So what's the impact on – if I go back to the railcars, what's the impact on perhaps unused railcars? Is there a risk that we – you end year with 2,000 or 2,500 railcars that are idle, for example?

[Bryan A. Shinn:]

Yeah. I don't think so, Brad. We are actually pretty reasonably well sized for the kind of demand that we exited out in June and we're seeing in July. So I think that – it'll just depend on how many additional customer cars come online and how much the customers want to sort of push their cars versus our cars. We don't have a great visibility on that, as we look out to like the fourth quarter or something like that, is kind of a quarter-by-quarter discussion with the customer. So we continue to work on that, my hope is that we will actually be taking cars out of storage, not putting cars into storage.

[Bradley P. Handler:]

Right, with the higher volumes perhaps, you'll be pulling them out of storage.

[Bryan A. Shinn:]

Correct.

[Bradley P. Handler:]

Got it. Interesting. Okay. Thanks, I'll turn it back.

[Bryan A. Shinn:]

Thanks, Brad.

[Operator:]

Thank you. Our next question is coming from Chase Mulvehill of SunTrust. Please proceed with your question.

[B. Chase Mulvehill:]

Hey, good morning, fellows.

[Donald A. Merril:]

Good morning.

[Bryan A. Shinn:]

Good morning.

[B. Chase Mulvehill:]

Yeah. I guess first I just kind of want to touch on the fixed cost, I think a lot of guys have talked about it. But can you just kind of break down what percent of Oil & Gas cost of goods sold was related to fixed cost?

[Donald A. Merril:]

Yeah. I think right now, we're probably running pretty close to 60%.

[B. Chase Mulvehill:]

Okay. And does that include DD&A or is that cash cost?

[Donald A. Merril:]

Yeah. Yeah, yeah. No, it would include DD&A.

[B. Chase Mulvehill:]

Okay. All right. And then as we kind of move into third quarter, if we can kind of just walk through some of the moving parts. So if we can kind of just talk about volume expectations. June and July seemed to be pretty good, but it sounds like you expect those to be up. And just how much do you think those would be up? And if we can walk through mix. You talked about transload potentially being 50% and then pricing and then also maybe on the cost side?

[Bryan A. Shinn:]

Yeah, so I think in terms of volumes when I look at June and July, if I was thinking about annualized run rate basis, it would be over 6 million tons. And as I was saying earlier on the call, we actually sold 6.8 million tons in all of last year. So it's not that far off last year's run rate. I feel like if we can get back to a pretty reasonable volume level, the challenge really is on the margin side those two big components. One is kind of pricing itself, which also includes customer and destination mix. And then the second is the fixed cost absorption or lack thereof. And so we're trying to work real hard on the things that we can control to get the margins up. But it feels like, and once again, there's always a caveat of nobody knows where WTI is going. But if we can stay in this level where we are now, it feels like volumes have somewhat stabilized, which is good news.

[B. Chase Mulvehill:]

Okay. And 6.8 million tons for Oil & Gas, right?

[Bryan A. Shinn:]

That's correct.

[B. Chase Mulvehill:]

I mean, that's some pretty stiff increases in the second half, right?

[Bryan A. Shinn:]

Sorry. No, that was last year. So I'm just comparing that. So if you said – let's say we exited the quarter at a 6 million ton run rate on an annualized basis. I was just saying just for reference that last year we were at 6.8 million tons to kind of put it in context, if you will, that it's not 25% off of last year's total. It is 25% off of peak in 4Q. So we were running at about 8 million tons plus or minus in 4Q of last year on a run rate basis. So just to give you some context, we exited the quarter probably 20% or 25% off of last year's peak run rate. But given where rig count is right now and how far things are down on a run rate basis, that's where you can see that we're taking share out there.

[B. Chase Mulvehill:]

Okay. All right. So if you get to, I think you said 6 million tons this year, that's greater than double-digit percentage increase in each quarter of the second half. Do you think that's more a third quarter weighted or fourth quarter weighted?

[Bryan A. Shinn:]

So, look, our business usually slows down a little bit in 4Q for a variety of reasons. Usually Oil & Gas slows down a bit just because budgets expire and some places, like the Marcellus, it's tougher to do work in the winter. The industrials business always slows down in the fourth quarter. A lot of different factories like glass factories and things take annual shutdowns and people go on holiday vacations and all that kind of stuff. So 4Q is usually our slowest quarter across the company.

[B. Chase Mulvehill:]

Okay. All right. I think you said about 50% of your volumes will be sold at the transload. So do you think that your transload volumes will be up, flat or down in the third quarter?

[Bryan A. Shinn:]

Look, I don't know. I would say it's probably flattish. It moves around so much, Chase, it's hard to forecast. I mean literally, trying to know what our transload volumes are going to be two weeks or three weeks from now is a challenge, let alone what it's exactly going to be like in the quarter. But I would say it's relatively flattish. But if I was putting a model together, I would assume it's kind of 50/50 and you won't be too far off.

[B. Chase Mulvehill:]

Okay. All right. So significant increases of volumes at the mine gate. That's kind of the takeaway, right?

[Bryan A. Shinn:]

I think that makes sense.

[B. Chase Mulvehill:]

Okay.

[Donald A. Merril:]

A lot of that is driven by customer mix because our bigger customers have their own supply chain networks and they would rather pick it up at the mine gate as opposed to in-basin.

[B. Chase Mulvehill:]

Okay. And then just real quick, if you can walk us through the cost per ton as we flow through into the second half?

[Donald A. Merril:]

I think, yeah...

[B. Chase Mulvehill:]

...for the Oil & Gas.

[Donald A. Merril:]

Yeah, yeah. So in Oil & Gas. I think the opportunity for us is to decrease the cost per ton. As Bryan was saying earlier, there is millions of dollars out there in cost savings. So I think to decrease the cost per ton or, said another way, increase contribution margin per ton of about $1 a quarter is pretty reasonable to look at out there based on some of the cost savings programs we have in place.

[B. Chase Mulvehill:]

Okay. Awesome. That's all I have. Thank you.

[Donald A. Merril:]

Thanks.

[Bryan A. Shinn:]

All right. Thanks, Chase.

[Operator:]

Thank you. Our next question is coming from Tom Dillon of William Blair. Please proceed with your question.

[Tom R. Dillon:]

Hey, guys. I'll just get one quick one in here. Can you talk about the frequency of the small guys selling at fire sale prices second quarter versus first quarter? And then any indication where they're at and what they're doing now?

[Bryan A. Shinn:]

Yeah, so it's interesting, we've seen some of the small guys start to exit the market. And I would say that it's basically input from our sales team that the fire sale prices are not as much now as we saw earlier in the year. It just feels like things like have stabilized a bit. And I also think it became pretty clear to some of our large customers that even though there might be some fire sale prices out there, the ability to deliver product consistently and with consistent quality just didn't seem like it was there. So we have a pretty good feel for who's still in the industry and who's not and who is trying to sell their assets. And so from all that, it just feels like the fire sale-ing has gone down a bit.

[Tom R. Dillon:]

Sounds good. Thank you.

[Bryan A. Shinn:]

Thank you, Tom.

[Operator:]

Thank you. Our next question is coming from Richard Verdi of Ladenburg Thalmann. Please proceed with your question.

[Rich A. Verdi:]

Hi. Good morning, guys. And thanks for squeezing me in here. Speaking high level on the acquisition front for what you're looking at today, what's the size of the EBITDA contribution we can maybe expect as well as the timing?

[Bryan A. Shinn:]

In terms of EBITDA contribution from an acquisition specifically?

[Rich A. Verdi:]

Correct. From what you're seeing, high level.

[Bryan A. Shinn:]

So it depends. I think that when you look at who are the low cost players in our space and you look at those folks, you can get a sense of what that might look like. And generally people who are low cost tend to be larger, like U.S. Silica. So it's probably larger rather than smaller, but that doesn't mean that there's not a good incremental small acquisition that pops up as well. It's just sort of a tough one to handicap right now, Rich.

[Rich A. Verdi:]

Okay. And on a timing perspective, could we maybe think about 12 months, 24 months? Or is that a little bit too difficult right now to answer and put your arms around?

[Bryan A. Shinn:]

In terms of when something might happen, you mean?

[Rich A. Verdi:]

Yeah.

[Bryan A. Shinn:]

Well, look, I mean, obviously we're out there pushing everyday to help drive consolidation in the industry. So, it's really hard to handicap an exact time, but it does feel like the bid/ask spreads might be closing just a little bit here, as everybody kind of sees where the market has landed here.

[Rich A. Verdi:]

Okay. And then just one last question too, I've asked this before – can you just give us an update on your adjusted EBITDA thesis? We had spoken in the past about taking that mark from about the $250 million level to about $900 million to $1 billion in 2020 or 2021. Can you just maybe tell us a little bit about how you think about that, that idea, that notion now?

[Bryan A. Shinn:]

Yes, so we put two goals out there. One was to roughly double the size of the company to about $450 million to $500 million in EBITDA by 2017 and then as you said double it again by 2020. As I think about that interim 2017 goal, I really think that – that could still be possible, but it certainly won't be through the path we had originally intended, which was heavy Greenfield acquisitions. The reality is it's going to be through M&A, as opposed to building new sites. But I really do believe that the market is going to recover sometime in the next 18 months to 24 months and when it does, I think we will be extremely well positioned to be on the way to our aspiration of getting somewhere close to $1 billion in EBITDA. That seems like a bit of a stretch right now, given where the market is, but when things come back, I think they can come back fast and come back hard and if we're positioned with a lot of capacity and a lot of other assets and attributes that we've put together through a couple of acquisitions, it feels like we could be a really strong player in the space.

[Rich A. Verdi:]

Excellent. Okay. Great. Thank you, guys.

[Bryan A. Shinn:]

Okay, Rich. Thanks.

[Operator:]

Thank you. This concludes today's question-and-answer session. I would like to turn the floor back to Mr. Shinn for any additional or closing comments.

[Bryan A. Shinn:]

Thank you very much. In closing, let me say that we're unquestionably in a very difficult oil and gas market today, but I believe that U.S. Silica will not only excel in this market, but emerge stronger once the recovery happens and my beliefs are based on our operational excellence, wide distribution footprint, low cost model, best in class balance sheet and not the least of which are our exceptionally talented team, and speaking of that, I want to thank all my colleagues at U.S. Silica for their tireless efforts and staying focused on working through these tough times, while at the same time, positioning our organization for future growth as the oil and gas market recovers. I also want to thank our investors and our analyst community. We appreciate your interest and support. And I look forward to meeting and speaking with you all at the many conferences and events we plan to attend throughout the rest of the year. Thank you all for dialing in, and have a great day, everyone.

[Operator:]

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day.