U.S. Silica Holdings, Inc.
Q3 2015 Earnings Call Transcript

Published: 28 Oct 2015

[Operator:]

Greetings and welcome to the U.S. Silica Third 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, Mr. Lawson. You may begin.

[Michael Lawson:]

Good morning, everyone. Thank you for joining us for U.S. Silica's third 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 the 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. And with that, I'll now turn to 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 third quarter results, followed by business-specific commentary and then conclude my prepared remarks with market outlook perspectives. Don Merril will then provide additional color around our financial performance during the quarter before we open up the call for your questions. For the total company, third quarter revenue of $155.4 million increased 5% sequentially compared with the second quarter of 2015. Adjusted EBITDA for the quarter of $24 million was up 2% sequentially. The sequential improvement in both revenue and adjusted EBITDA was mostly driven by decisive actions that we took during the quarter to profitably sell higher volumes in our Oil and Gas business. These actions included offering highly competitive pricing, providing maximum flexibility to our customers, and utilizing our best-in-class logistics network to drive volumes and take share. Volumes in Oil and Gas of 1.6 million tons increased 32% sequentially even as we continue to see rig count and activity levels decline in response to reduced commodity prices. Contribution margin in Oil and Gas of $16.5 million was 25% higher sequentially, primarily as a result of share gains and improved asset utilization. Contribution margin per ton in Oil and Gas declined 5.6% sequentially. The decrease was mostly driven by a full quarter of the market-driven, more aggressive pricing that we put in place at the end of the second quarter, partially offset by the significant volume rebound, cost improvement initiatives and increased fixed cost leverage. Our Industrial business had an excellent quarter, delivering record contribution margin and contribution margin per ton of $20 million and $19.83 per ton respectively, on relatively flat volumes sequentially of approximately 1 million tons. New higher-margin products, favorable mix, and lower operating costs drove higher ISP contribution margin per ton higher by 5% sequentially. The ongoing investments we've made in ISP have fueled a revitalization in this important operating segment. Our ISP business is on track to deliver its best year in our 115-year history, which is a testament to the strength of our corporate business model. Our two complementary business units serve us well through a wide variety of economic cycles and market conditions. Next, I want to discuss key industry trends and how we are performing. In Oil and Gas, our sales volume in the third quarter were just 19% lower than the peak run rate that we saw in the fourth quarter of 2014. Since that time, U.S. rig count declined approximately 55%. I believe that the strength of our sales volume in Q3 demonstrates a few key points. First, our customers are continuing to pump more sand per well and per rig. A recent industry report estimated that sand consumption per horizontal well increased 26% from the third quarter of 2014 to the second quarter of 2015. Second, our sales growth rate this quarter clearly shows that U.S. Silica is taking significant market share and, third, we're seeing a flight to quality as customers are increasingly choosing U.S. Silica as one of their top suppliers. Those were all certainly positive trends for our company. However, the current reality is that the frac sand market remains oversupplied due to sharply lower demand and pricing continues to be pressured. In this challenging environment, we're working diligently to maximize margins by maintaining a relentless focus on cost and cash management. Let me give you some examples of what we're doing on the cost front. We have continued to reduce staffing and improve productivity. Year-to-date, we've reduced head count at existing facilities by approximately 10% and tons produced per labor hour are at an all-time high. We've also negotiated price concessions from many suppliers, optimized plant maintenance expenditures, and reduced railcar demurrage expenses. All-in, our various cost improvement initiatives yielded more than $1.50 per ton in savings during the quarter, the majority of which should be sustainable going forward. We're also on track to exceed our stated goal of a 20% SG&A reduction versus plan. Cash management is equally important in this environment and we're taking aggressive actions. For example, we will only spend about one-third of our original 2015 capital plan and are focusing on a limited number of high-return projects with more immediate paybacks. We're improving our planning processes to reduce inventory and storage costs as well. We've also added additional transloads to the network which are more freight cost-advantaged and can accommodate unit trains. The results have been dramatic as we shipped 47 unit trains in the third quarter, more than double the number we shipped in each of the first two quarters of 2015, including a 150 car unit train, the largest sand unit train ever shipped. Shipping more unit trains increases our inventory turns and helps our customers minimize their costs. However, more unit trains can also exacerbate the issue of having too many railcars given the current market environment. For example, during the third quarter, we added about 800 railcars to storage, bringing our total number of idle railcars to approximately 2,500. In our ISP business, a combination of increased residential construction and our growing new product portfolio targeting high-value applications within the home are both contributing to volume and margin expansions. In the third quarter, new products accounted for about 10% of ISP's contribution margin. Many of these value-added new products target applications that value aesthetics, energy conservation, and other performance characteristics, solving specific customer problems. Turning to other industrial sectors, we had multiple glass customers with facilities down for maintenance in the third quarter, negatively impacting volumes, but we expect sales to recover during the fourth quarter as those facilities come back online. Additionally, a new product that was recently qualified in the flat glass market will expand margins starting in the fourth quarter. We're also seeing some softness in the chemicals and foundry markets heading into year-end. Now, turning to our outlook for the fourth quarter, for Oil and Gas, we're preparing for a potential steep drop in product demand in December, based on a combination of factors, including the normal seasonal slowdown, concerns that some energy companies have already exhausted their 2015 capital budgets, and service companies talking about sending crews home starting as early as Thanksgiving. We anticipate that these factors will pressure volumes and pricing in our Oil and Gas business through the end of the year, and possibly into the first quarter of 2016. Lower volumes will not only decrease revenue, but reduce our fixed cost leverage as well, putting additional pressure on margins. ISP is expected to have a solid fourth quarter for many of the same reasons the segment was so successful in the third quarter, although volumes are expected to be lowered, given the seasonal nature of that business. And with that, I'll now turn the call over to Don Merril. Don?

[Donald A. Merril:]

Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our two operating segments, Oil and Gas and Industrial and Specialty Products. Revenue for the Oil and Gas business for the third quarter of 2015 of $102 million increased 12% sequentially compared with the second quarter of 2015, while revenue for the ISP segment of $53.4 million represented a 6% decline sequentially. Contribution margin from Oil and Gas in the quarter was $16.5 million, up 25% on a sequential basis compared with the second quarter of 2015. On a per ton basis, contribution margin for Oil and Gas declined 6% sequentially to $10.22, compared with $10.83 for the second quarter of this year. Contribution margin for Industrial and Specialty Products segment was $20 million, an increase of 2% sequentially over the second quarter of 2015, and up 19% compared with the same period of the prior year. On a per ton basis, contribution margin for the ISP business of $19.83 represented a 5% improvement over the second quarter of 2015. The sequential increase in ISP contribution margin per ton was driven by a combination of a mix of higher margin business, new value-added products and lower operating costs during the quarter. The Industrial business clearly differentiates U.S. Silica from most of its frac sand competitors. With ISP, we are not dependent on one cyclical industry, but diversified into many industries and end markets. It provides consistent cash flows to the business, enables us to sell more of what we take out of the ground, and basically provides enough contribution margin today to more than cover our total company SG&A spend. Turning now to total company results, SG&A expenses for the third quarter increased by $7 million, to $13.6 million, compared with $6.6 million for the second quarter of 2015, which was artificially low due to a re-evaluation of compensation expenses of $5.5 million. The remaining increase is mostly due to adjustments to our bad debt reserve. Depreciation, depletion and amortization expense in the third quarter was $15.2 million, compared with $13.7 million in the second quarter of 2015. The sequential increase in DD&A was driven by our year-to-date capital spending and higher depletion expense, due to more tons sold during the quarter. Continuing to move down the income statement, interest expense for the quarter was $6.7 million, which is related to our debt and deferred revenue. From a tax perspective, during the quarter we recognized an income tax benefit of $4.7 million. Considering the current market conditions, we updated our annual effective tax rate, excluding discrete tax items, to a negative 16%. Our estimated annual effective tax rate is negative as a result of our statutory percentage depletion benefit, which we are afforded as a mining operation, being greater than the computed income tax expense on our estimated annual income before taxes. Turning now to the balance sheet, cash and cash equivalents and short-term investments at September 30, 2015 totaled $299.8 million, compared with $342.4 million at December 31, 2014. As of September 30, 2015, we had $46.9 million available under our revolving credit facility, and our total term loan debt was $492.5 million. We incurred capital expenditures of $11 million in the third quarter of 2015. The bulk of our third quarter spend was associated with the company's investments in various maintenance, expansion, and cost improvement projects. Based on current market conditions, we now anticipate capital expenditures for 2015 will be in the range of $50 million to $55 million. We continue to proactively manage our business to preserve our financial strength in what could be a prolonged downturn in the oil and gas market. We have what I believe to be one of the strongest balance sheets in the business, which will allow us to navigate the current market uncertainty and respond quickly to opportunities, to make a strong company even stronger. From a capital allocation standpoint, our first priorities are M&A, as we believe the frac sand space desperately needs to consolidate. As we've said in the past, it's all about speed, scale, and strength. And we believe U.S. Silica, with its best-in-class balance sheet, is the obvious consolidator in the space. Finally, as noted in the press release, we will continue to refrain from providing financial guidance until such time as we can begin to see with more clarity our business customer demands. We have 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:]

Our first question comes from Connor Lynagh with Morgan Stanley. Please proceed with your question.

[Connor Lynagh:]

Hi. Good morning, guys.

[Bryan A. Shinn:]

Morning, Connor.

[Connor Lynagh:]

On the topic of M&A, if we could start there, obviously a lot of pressure in the space right now. Would you say you guys are having more productive conversations than you were at the beginning of the year? Do you feel that you're any closer to being that consolidator than you were before?

[Bryan A. Shinn:]

Yes, so, it's a great question, Connor. It's obviously something that we spend a fair amount of time on. I think not a lot has changed in terms of the market rationale for that. We still have a very fragmented supply base today for frac sand. And we continue to believe that consolidation is inevitable. And so, I think the opportunities that we saw to leverage our scale and resources to service customers better are certainly all there. And so, we're working hard to drive that across the industry. And I feel like as we get into more challenging environments here, it's likely to help close the bid ask.

[Connor Lynagh:]

Yes. Makes sense. Makes sense. Obviously pretty noteworthy cost savings on the quarter here. Just wondering if you could provide a little more color as to sort of what the moving parts were there. I think you said $1.50 per ton was sort of your direct savings. So, I'm assuming that the rest is more fixed cost absorption. So, should we expect that to sort of reverse as we sort of slow down activity later in the year here?

[Donald A. Merril:]

I would say the fixed cost absorption clearly helping us in the quarter versus Q2 and the CIP savings of greater than $1.50 per ton is really driven by a lot of hard work across the organization, specifically in our operations group. I think those types of savings are annuities that we would see on a go-forward basis. And look, we're going to continue to get the absorption if we maintain these types of volumes.

[Connor Lynagh:]

Okay, great. Thanks a lot.

[Operator:]

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

[John Matthew Daniel:]

Hi, guys. Good job on the margins this quarter.

[Bryan A. Shinn:]

Thank you.

[John Matthew Daniel:]

Bryan, I'm not sure if you're able to share this, but I'm just curious if you could tell us where you envision your frac sand inventory level at year-end 2015, Q1 2016 versus where we were at year-end 2014 – just given dialing back of production, et cetera?

[Bryan A. Shinn:]

So obviously, we're playing close attention to that, John. And I think a lot will depend on how Q4 plays out here. It's kind of an interesting – as we look at Q4, I think all of us expected that Q4 was going to be a bit lower perhaps than we've seen out of Q3. It's not exactly unfolding that way. So actually, we're seeing volumes up a lot in October versus where we've been in the past. And actually right now, October looks like it could be a stronger month in terms of Oil and Gas volumes than we saw in the months in Q3, right, where we took 32% – had a 32% volume increase. So, Q3 was really strong. It looks like October is maintaining a lot of strength in terms of volume as well. And so we're watching that closely. My guess is that we may be sort of flattish year-on-year in terms of inventory. But if, for some reason, the volumes persist, then perhaps inventories might even be down a little bit, so we'll have to see how that plays out.

[John Matthew Daniel:]

Okay. Just two quick ones for me and then I'll let others jump in. You probably heard this yesterday, but one of your peers said that 12 players have effectively idled or dialed back production in 15 plants. But they didn't put that in the context of volumes being taken offline. I'm assuming you're tracking a similar number of instances. But can you provide any color or quantify just what that might be in terms of nameplate capacity, which could be – which may have been taken offline?

[Bryan A. Shinn:]

Sure, John. As you know, we track all that data very closely. And we estimate as well that up to 15 sites, perhaps, have closed their doors. Our view of that capacity that's come offline is 12 million to 13 million tons, somewhere in that range. I think, at the same time, we have a number of sites that are running at reduced capacity. So, that adds further to the mix. So there's a fair amount of capacity that is offline right now. And I think when you add all that up, the numbers are probably somewhere between 20% to 30% of the industry capacity is completely offline right now.

[John Matthew Daniel:]

Okay. Great. And then the last one for me is just you noted in the prepared remarks the highly competitive pricing. How much of that do you think is a function of some of your peers just trying to move inventory and generate cash – perhaps some of your more poorly capitalized peers? And that's it for me.

[Bryan A. Shinn:]

I think we saw some of that earlier in the year. There's probably less of that now. To the extent there is irrational pricing in the market today, I think there is – one explanation could be for – as you call them, some of our less well-capitalized peers who have built stockpiles and already put the cash into kind of building that work-in-process inventory now that they may be viewing that as a sunk cost. But those piles will come down in the next quarter or two, and I think that volume disappears from the market going forward.

[John Matthew Daniel:]

Okay. Thanks. I'll turn it over.

[Bryan A. Shinn:]

Thanks, John.

[Operator:]

Thank you. Our next question comes from Michael LaMotte with Guggenheim. Please proceed with your question.

[Michael Kirk LaMotte:]

Thanks. Good morning, guys. And I just want to echo those comments and congratulations with ASP down 15% and margins down 6% per ton and good job on the cost side.

[Bryan A. Shinn:]

Thanks, Mike.

[Michael Kirk LaMotte:]

Bryan, maybe, you can sort of follow up on the question of pricing. Again, Hi-Crush pointed out yesterday that they expected 10% to 15% pricing declines in fourth quarter versus third quarter. And you've been experiencing that for the last three quarters in a row. Can you maybe give us a sense as to where your third quarter average selling price was relative to a spot rate if there is such a thing right now?

[Bryan A. Shinn:]

Sure. So, as we look at pricing in the market – look at our 3Q numbers specifically, if you look at kind of the headline, you'll see pricing looks like it's down about 15% quarter-on-quarter. The reality is, though, about 5% of that 15% is really wrapped up in mix. So when you lift the lid on that and really do a like-for-like comparison on pricing, we saw more like a 10% decline from Q2 to Q3. As we've started off here in Q4, I would say the pricing is relatively flattish in October versus where we exited the third quarter. And the reality is that most prices have kind of gone to a spot type of behavior right now. Even places where we have contracts, we're in continual discussions on a day-by-day, week-by-week basis with those customers. So, I think that the sort of contract versus spot distinction has, perhaps, lost a bit in this challenging market environment.

[Michael Kirk LaMotte:]

Okay. Thank you. And just on the mix then, are you seeing more secular or structural trends shifting to, say, Brown Sand versus the Northern White? And, if so, what kind of impact does that have actually on the contribution margin as well as ASP?

[Bryan A. Shinn:]

Yeah. So, it's a great question, right. And when it comes to the sort of regional sands, if you will, our Voca plant, for example, in Texas, volumes are holding up very well there. We've seen some customers willing to make the trade-offs between lower performance and price that you get with the regional sands. We really haven't seen much cannibalization of Northern White volumes at this point. And interestingly, most of the regional sands that get sold today are the finer grade, it's mostly 100 mesh and maybe a little bit of 40/70. So we haven't seen a lot of interplay between the regional sands and Northern White as of yet. I think one other factor to keep an eye on here is that with trucking rates being so low, most of the regional sands are trucked out to the wellheads. So, that's kind of helping enable some additional volumes from regional sands that I think as trucking rates come back up and normalize over time; that may make it a bit more challenging for the regional sands as well.

[Michael Kirk LaMotte:]

Okay, interesting. And then maybe last one if I can for Don, the 2,500 stack cars today, where do you think that number is if – let's just say, volumes are flat four quarters from now – third quarter of 2016? Where does that idle car number go over the next 12 months?

[Donald A. Merril:]

Yeah, I would say the conservative view on that would be about the same, right. We will have some cars coming off lease and things like that happening next year, which would drive that number down. But from an overall production standpoint, I would say that that number conservatively would be the same. But let's keep in mind that we're working very, very hard to reduce that number through all sorts of cost savings programs and other programs such as subleasing and so on. So, I would say that number gets better, but a conservative approach would keep it flat.

[Michael Kirk LaMotte:]

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

[Bryan A. Shinn:]

Thanks Michael.

[Operator:]

Thanks. Our next question comes from Marc Bianchi with Cowen. Please proceed with your question.

[Marc G. Bianchi:]

Hey. Thanks, guys. Don, just a housekeeping item. Could you offer some forward commentary on G&A for the fourth quarter, just given the moving parts that we've seen?

[Donald A. Merril:]

Yes. So, I would say that G&A for the fourth quarter is going to look a lot like it did in the third quarter. I estimate, right now, I would say $13 million to $13.5 million would be a good number to use for Q4.

[Marc G. Bianchi:]

Okay, great. Thank you for that. I guess maybe if we could switch over to the Industrial side quickly, this is definitely a bright spot for you. Part of the concern that some of the conversations we've had with investors is that this business was helped by a strong Oil and Gas business during the last, call it, year and a half, two years – helped pull the margins up in this business because of the opportunity cost of selling volumes into Oil and Gas versus ISP. How much of a risk should we view that going forward to the $20 margins that you're getting right now in ISP?

[Bryan A. Shinn:]

Yes. So, it's a great question, and it's something that we've looked at pretty hard internally as well. And when you look at our Industrial business, the vast majority of the profits come from sectors in the economy that really didn't – our products didn't cross over that much with Oil and Gas. Most of the crossover between Industrial and Oil and Gas is in the glass market. And while that tends to be a higher volume end use for us, it tends to be lower profitability. And in those cases, there are large customers where we have long-term contracts, multiyear contracts, and we've operated that way with them for, some cases, 70, 80 years, so there's a lot of stability there. So I don't see much risk there. And we're really not seeing much in the way of margin compression at all. Actually, it's quite the contrary. All the new products we're introducing, and the new end uses that we're getting into, tend to be much higher margin end uses, so I'm pretty bullish on where the Industrial business can go. And you can see the power of the business model of having that complementary Industrial business, especially in this secular downturn in Oil and Gas.

[Marc G. Bianchi:]

Sure. Okay. Bryan, thanks for that. Maybe just one more on the railcars, how should we think about the margin headwind there in the fourth quarter, if we see some volume declines? Just maybe on a per ton basis, if you could talk to that.

[Bryan A. Shinn:]

Yes. So, maybe I'll address that, and I'll let Don jump in and help me out when I get wrong here somewhere. But I think you can think about the excess railcars that we have in storage right now as generally costing us about $4 million a quarter, something like that. And so, I'd expect similar kind of numbers in Q4. One of the things I wanted to point out though, because a lot is being made about the excess railcars, and certainly, we wish we didn't have them. But our team has done an excellent job in pushing out deliveries of railcars, and I think that this is a piece that people don't maybe understand so well. We have no railcars being delivered in 2016 or the first half of 2017. So, literally, we won't see our additional railcar deliveries for almost seven quarters. So we have a long time to absorb existing cars, have cars that we have go off-lease. And so I think we can manage our problem there pretty effectively. And I think that was sort of, to Don's point earlier, where we don't really expect it to get a lot worse now. If there's another major leg down in the market or something for a quarter or two, it may cause us to put more cars in storage. But fundamentally, I think we have done a really good job of pushing out future deliveries, Marc.

[Marc G. Bianchi:]

Okay. Thanks. I'll turn it back.

[Bryan A. Shinn:]

Thanks, Marc.

[Operator:]

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

[Blake Allen Hutchinson:]

Good morning, guys.

[Bryan A. Shinn:]

Good morning, Blake. How are you doing?

[Blake Allen Hutchinson:]

Very well. Just another kind of mix-based question. I guess one of the benefits of the franchise, and that you have – you're pushing so much product out in the basin, and even really over the first half of the year, is that you've been able to take, historically, advantage of the in-basin spot market and fend off some of the pricing pressure because of that. As you align more of your volumes directly with customers and move towards a heavier unit train model, does that take away a little bit of that in-basin advantage? I guess I'm trying to get an idea of where that spot sale/in-basin mix is, versus just the point A to point B known delivery?

[Bryan A. Shinn:]

Right. So, it's a really interesting question. And if you look at where we are right now, we're probably about 50/50 in terms of ex-plant sales to transload sales. And I still think our transloads are helping us out a lot. We put a tremendous amount of energy in the last few months into increasing our transload footprint. We actually, in the last couple of months, have added 11 new transloads. And we have another eight in the pipeline that we're evaluating. So we're continuing to add there, and our guys are doing a great job of finding low-cost ways to do that, so these are essentially, sort of, zero capital – in most cases, zero commitment locations that we can move product into. And it's one of the reasons that we're continuing to be successful in the marketplace. And many of the unit trains that we sent out last quarter were not just directly to customers, but we're using those to restock our transload network as well. And when we do that, that certainly gives us a good cost advantage out into the marketplace. So, I love our transload footprint. I think we definitely have opportunities to make additional margins on spot sales, and our team is doing that. So, I think we're very well positioned with how we set up our mine-site mix and our destination-transload mix.

[Blake Allen Hutchinson:]

Okay. That's helpful. And then just – obviously, you gave some thought for where we were – or where we are in October, and still pretty strong. I guess, even as things maybe get a little bit tougher as the quarter goes on, I take it you don't envision this market going back to where we were in mid-2Q, where it just became extremely chaotic and a sale wasn't a sale until the sand was in the well, I guess. And do you think at least most of the kind of movement amongst vendors and basins has run its course? Is that the assumption, that even if things get tougher, it's mainly a volume hit rather than introducing that, again, element of chaos into the business?

[Bryan A. Shinn:]

So, I think that things have smoothed out a bit. It's not quite, as you said, the chaos that it was a couple of quarters ago. And part of that is, as some of our less capable competitors have come offline, we don't have that sort of irrationality out in the marketplace. So, it feels smoother than it did a few quarters ago. It doesn't feel as smooth as it did back in 2014, for sure. So I think there's a ways to go there. And around 4Q, I just want to make sure that I've been clear, October is off to a great start, right. But I think all of us hear the anecdotes out there, and we're getting direct feedback from both operators, and from service companies, around things like, the budgets are almost exhausted, we're going to be sending our crews home for a long vacation between Thanksgiving and Christmas – all those types of things. So, one of the challenges for us, in managing in this environment, to your question around chaos, is that what we see in front of us right now is, we're having to run our assets flat out just to keep up with customer demand. And then, at the same time, it looks like there's some challenges coming once we hit Thanksgiving, right. So, the trick is to manage all that and be able to fill as many orders as we can, at the same time, keeping one eye on, how do we take cost out very quickly as the market perhaps slows down in the second half of the quarter? So, I think that's the – sort of, to use your words, sort of, the chaos that we're managing now is to try and work our way through all of that and get the best results for the company and for our shareholders.

[Blake Allen Hutchinson:]

Great. Thanks. I'll turn it back. Good run down, guys.

[Bryan A. Shinn:]

Okay. Thanks, Blake.

[Operator:]

Thank you. Our next question comes from Chase Mulvehill with SunTrust. Please proceed with your question.

[B. Chase Mulvehill:]

Hey, good morning, fellas.

[Bryan A. Shinn:]

Good morning, Chase.

[B. Chase Mulvehill:]

So I think you mentioned that pricing was down on a like-for-like basis about 10% in the third quarter. Could you kind of walk through where you started the quarter and where you ended the quarter on pricing?

[Bryan A. Shinn:]

Yes. I think as we looked at how things went down in the quarter, it was relatively flattish through kind of the midpoint of the quarter and then we started to see pressure as we came through the quarter. So, I would say there was more pricing pressure in the back half than in the front half of the quarter.

[B. Chase Mulvehill:]

Okay. And then if we think about kind of where leading-edge spot pricing is for 20/40 at the mine gate, are we kind of in the low to mid-20s?

[Bryan A. Shinn:]

Yes. So look, we haven't given any specific guidance on pricing by grade, right. I would say that generally what we see out there are the same trends that we've seen all along is that pricing is generally closely linked to the availability of the products in the deposits, right. So, if you look at almost all the deposits around the country, the high-quality, say, 20/40 product tends to be in a lesser proportion than, say, 100 mesh, right. So we still see higher prices on 20/40. And there's a spread between that down the 100 mesh, which tends to be the lowest price.

[B. Chase Mulvehill:]

Okay. All right. And I'm going to try to pin you guys down on fourth quarter a little bit – I apologize for this – but how should we be thinking about volumes and pricing and contribution margin in the fourth quarter? It sounds like the volumes and pricing are holding up in October. It sounds like you're really not – you're not anticipating any real declines until we kind of hit Thanksgiving or December. So how should we – I mean, one of your peers talked about, I think, volumes being down at least 15% and pricing down 10% to 15%. Does that seem too aggressive as we think about the model for 4Q for you?

[Bryan A. Shinn:]

So, look, I get where you're going, Chase, and the reality is that it's just very tough in this environment to prognosticate out what's going to happen six, eight, 10, 12 weeks from now. When we talk to our customers, what they're telling us is they don't have visibility out beyond a couple of weeks, right. So it's very hard for us on the oil and gas side to be able to predict. Directionally, based on everything we're hearing and – nothing we're seeing yet, but everything we're hearing, I expect volumes to be substantially down as we get, say, into December. But exactly what that looks like, it's hard to say, right. Some of our customers are claiming that they're going to find ways to still pump frac jobs through that. And so, part of it depends on how successful they are and which energy company they're hooked up with and a lot of things that we just don't control. So, look, I wish I could give you a more specific answer, but it's just hard to characterize right now.

[B. Chase Mulvehill:]

Okay. Got it. Last one and I'll turn it back over. A lots of talk about consolidation here. What are the things that you are looking for when evaluating an acquisition?

[Bryan A. Shinn:]

So I think I look at what's made us successful, what's made us a leader in the industry. And so, you start out with a quality of the assets that that company would have. So, for example, we don't want assets that aren't low-cost. I think it's been shown pretty clearly in the downturn that it's not a good idea to have a lot of moderate or higher cost assets in your portfolio. We also look carefully at logistics and what logistic solutions they could bring as well. Is it sort of a neutral or an additive to what we have? I think we also look at how well-run the company has been and then it sort of drops off into a variety of second-tier things. But mostly, it's about the assets and how they could integrate in with our enterprise.

[B. Chase Mulvehill:]

Great. Thanks. I'll turn it back over.

[Bryan A. Shinn:]

Okay. Thanks, Chase.

[Operator:]

Thank you. Our next question comes from Jim Schumm with Oppenheimer. Please proceed with your question.

[James Schumm:]

Hey, good morning, guys.

[Bryan A. Shinn:]

Good morning, Jim.

[James Schumm:]

So, I just wanted to – I thought I recalled from the last quarter that you guys said that your mix between in-basin and at the mine gate was more like 50/50. It looks like you came in at 61% in-basin. I didn't know – is that due to a customer mix shift? Do you think you're gaining share with some of the smaller pressure pumpers? Did your business with maybe Schlumberger, Halliburton decline a little on a relative basis? So I'm just trying to understand that. And then I think you guys said again this quarter now you're sort of seeing 50/50 in-basin and at the mine. So I'm just trying to understand what's going on there?

[Bryan A. Shinn:]

Yes. So, I think if you look where we were last year, for example, we were trending towards maybe 65

[James Schumm:]

So, I get that, I guess. But I guess that you guys said, I think in July, that you were 50/50. You said today you were at 50/50. Are you just talking in broad terms? Because when you reported Q3, you were saying 61% in-basin, not 50/50. Do you know what I'm saying? So, you said 50/50 in July, you said 50/50 now, but you sort of reported 61% in-basin. And so I'm just wondering where we went there.

[Bryan A. Shinn:]

Yes. So look, I'm not sure, I mean, there could have been some confusion around how our Cadre site was being reported – whether that was counted in-basin or not. We'll go back and look at that. But if you look at the volumes I've got (0

[James Schumm:]

Okay. So no real meaningful shift in your customer mix from quarter-to-quarter?

[Bryan A. Shinn:]

No, there's been nothing there that's different, Jim.

[James Schumm:]

Okay, all right. And then on the transloads, I guess I was a little surprised to hear you say you added 11 transloads. I was going to ask if there was an opportunity to reduce costs by maybe eliminating some transloads. And if you could just talk a little bit about that, like the fixed costs versus variable costs there, and like I said, is there any opportunity to sort of reduce cost or optimize there?

[Bryan A. Shinn:]

Yeah. So it's interesting. Right. We've been on a journey over the last few years trying to figure out how we optimize our logistics network. And what we found, generally speaking, is that every time we add a node at either the origin or the destination, we managed to drop the overall cost of going through the network just because it gives our supply chain planning teams more optionality. Right. I think the challenge comes in as to what's the cost to add those additional nodes? And in this environment, we found a lot of opportunities where we can get into unused or underutilized facilities for essentially no upfront investment and minimal or no long-term commitment. So, those are the things that have helped us a lot, quite honestly. And when you look around the different basins, you'll find kind of subsectors of certain basins where there really wasn't a transload nearby, and our customers had worked there. So by us being able to put these transloads to work and ones that in many cases have unit train capabilities, we're able to gain share. And there's some pretty profitable sales as well.

[Donald A. Merril:]

Guys, this is Don. I'd also point out that we actually closed four transloads in the quarter. So, on a net basis, it was seven. But it just goes to Bryan's point that we're looking for the best locations for the product.

[James Schumm:]

Okay. And so if I hear you guys correctly, so basically very little fixed cost on the transloads you're adding right now. So it would just be pretty much all variable costs, as you run volumes through there.

[Bryan A. Shinn:]

Yeah. That's correct. There's essentially zero fixed costs associated with that. It's a great question, though, Jim, a really good one.

[James Schumm:]

Okay. Great. Thanks, guys. Appreciate it.

[Bryan A. Shinn:]

Thank you.

[Operator:]

Our next question is coming from Brandon Dobell with William Blair. Please proceed with your question.

[Brandon B. Dobell:]

Thanks. Morning, guys.

[Bryan A. Shinn:]

Good morning, Brandon.

[Donald A. Merril:]

Morning, Brandon.

[Brandon B. Dobell:]

As we think about the capacity and the different mine sites you guys have, should we expect any further idling, trying to move volumes between plants to get the best utilization at the lowest cost operation, or do you think you've got kind of volumes at the various plants squared away relative to how the business should trend?

[Bryan A. Shinn:]

So, I think, we've made a good first step at that. We're watching the volume trends very closely. And I think that, if things really slow down in the back half of the quarter and if that carries over into 2016, which is one of the scenarios that you hear people talking about, we may have to take some additional actions in terms of taking some capacity offline. But as I said before in response to another question, part of what we're having to manage through right now is that demand is really strong. And so, if we prematurely close facilities, we wouldn't be able to keep up with all the orders that we have today. So we're trying to manage that and really build flexibility into our system.

[Brandon B. Dobell:]

And to that point, Bryan, obviously, you guys are taking share. I think, the large companies generally are. And it feels like it's sustainable, but at the same time, maybe, it's just the transportation advantage or maybe it's just because the larger service companies have railcars, and you have mines that have enough space or transload (45

[Bryan A. Shinn:]

Yeah. I think there's a couple of things, right? The first is that some of the smaller guys are shutting down; and in this environment, I wouldn't expect them to be starting back up. The second is that all of our larger customers have told us explicitly that they are in the process of reducing suppliers, right. So, I think that helps benefit us. And then third, as you pointed out, I think we've got the best combination of low cost operations, logistics, and processes to be very flexible with customers. I'll give you an example of the kind of things that we're doing that I don't think others are. We mentioned that we had 47 unit trains shipped in the quarter. One of those unit trains was actually on the way to one of our transloads to restock some inventory, and we got a call from one of our larger customers with an urgent need for a unit train of sand. So, we literally called the train up en-route and diverted it over to the customer's location. I don't see any of our competitors doing those kind of things, right? So, I think we're providing the right kind of service. We have deep relationships with these customers, and I feel like we're going to continue to gain share in this market.

[Brandon B. Dobell:]

To that point, with your large customers and the mix they are now of volumes, do you feel you've got further risk of average selling price pressure because of larger customers, or the large service companies, continuing to be a bigger part of your volumes? Just kind of, I guess, a call it, (47

[Bryan A. Shinn:]

Yeah. So, it's an interesting thought. I guess the way I look at it is that, in this environment, the customers I most want to do business with are the bigger customers out there, right. For a variety of reasons, not the least of which is, we don't worry about getting paid from those folks, right. I think over time, though, as the market rebounds, one way or another, because it's always happened this way, we'll see some smaller service companies either start up or come back in business. And so, those tend to be customers that, for a variety of reasons, need our logistics network even more, and we tend to get higher prices there, right? So, I feel like over time, there will be some sort of self-correction in the pricing and the customer mix between large and small, but right now, I like working with the market leaders – those who are going to be the clear winners in this secular downturn.

[Brandon B. Dobell:]

Okay. And then final one from me. Is the unused or stored railcar issue a big enough one for you guys that it has, I guess, changed the economics or the calculations around M&A or strategic investments, those kinds of things? Is it a big enough number, a big enough headache, or I guess a big enough opportunity cost, that it's changed the kind of things you're looking at from an M&A point of view?

[Bryan A. Shinn:]

No, it really hasn't up until this point. I think that, when we look at opportunities in M&A and oil and gas, and we have done it in the industrial business as well, but when we tend to look at lower cost operations, those tend to be folks who are somewhat similarly situated to us.

[Brandon B. Dobell:]

Yeah.

[Bryan A. Shinn:]

And there may be opportunities, if some of those folks have too few railcars, to actually leverage some of those off. So, it could actually be a positive there, with some of the different M&A transactions that we're considering.

[Brandon B. Dobell:]

Okay. Perfect. Thanks, guys.

[Bryan A. Shinn:]

Thanks, Brandon.

[Operator:]

Thank you. Our next question comes from Robin Shoemaker with KeyBanc Capital Markets. Please proceed with your question.

[Robin E. Shoemaker:]

Thank you. So, Bryan, I'm just struck by the efficiency of unit trains and the way that they are kind of permanently reducing the number of railcars you need in your stable to handle even higher volumes. So even if you got back to that 2 million per ton quarterly run rate that you were at at the peak, or maybe even higher. So, thinking in terms of this 2,500 I believe that you have on order coming in, say, starting mid-2017. How many of the railcars you have today can you turn back ,or get rid of, in order – prior to taking those 2,500? And just correct me if I'm wrong, but it just doesn't look like you need any additional railcars to the number you have currently, to handle significantly higher volumes of sand than you are selling now?

[Bryan A. Shinn:]

Yes, so, Robin, in answer to how many railcars we can turn back, I believe between now and 2018, we have the ability to turn back in excess of 1,500 railcars, so that's what's expiring off of lease. And I think, in terms of the railcar needs, it depends on your aspiration, right. I have an aspiration to be 30% or 40% market share in this industry, and so – for our company. And so, when you do that math, it's not outrageous to think about the kind of railcars that we might need, and it also depends on what you think in terms of a rebound, right. If we get back anywhere close to the kind of numbers that we've seen in the past for this industry, and you throw on top of that the increasing sand usage per well, you can get to some pretty large volumes of sand that need to be moved and quite honestly, the only way we could do that as an industry is to do more unit trains.

[Robin E. Shoemaker:]

Yeah. So, you said that $4 million is the current cost per quarter. I think it was – $2.5 million was the number you gave for the second. So, can – so you're saying that that's kind of – the $4 million is the run rate for the next couple of quarters on that?

[Bryan A. Shinn:]

That's what we would expect. Absent some significant downturn in the market which, look, obviously, this market has been pretty volatile, right? So it's hard to predict. But if things stay relatively constant, it feels like that's where we'll be.

[Robin E. Shoemaker:]

Okay. Since you indicated 30%, 40%, where do you think roughly your market share is, or was, in the third quarter? Obviously you gained market share, but do you have a...?

[Bryan A. Shinn:]

So I would estimate that we're between 15% and 20% market share right now, probably somewhere in the middle of that range.

[Robin E. Shoemaker:]

Excellent. Thank you very much.

[Bryan A. Shinn:]

Okay. Thanks, Robin.

[Operator:]

Thank you. Our next question comes from Trey Grooms with Stephens Incorporated. Please proceed with your question.

[Drew Lipke:]

Yeah. Hey. Good morning, Bryan. It's Drew Lipke on for Trey.

[Bryan A. Shinn:]

Hey, good morning.

[Donald A. Merril:]

Good morning.

[Drew Lipke:]

One quick question, I want to follow-up on the M&A criteria, you talked about, – you must be a low cost, must be quality assets, you look carefully at the logistics. Can you kind of give us your thoughts on, we're running – industry is running below capacity utilization right now. So when you look at actual mine acquisitions, first, the potential for enhancing your logistics infrastructure versus, sounds like you guys are doing a great job in terms of just building it out organically. So can you help us sort of think through that process?

[Bryan A. Shinn:]

Yeah. So, I think, you know, its – it's not like you can build this network with sort of two or three monster location. It's kind of like the old analogy, we don't want three aircraft carriers; we want a fleet of PT boats. And we need to be very flexible, and what we've seen is that opportunities come and go sometimes as quickly as a quarter or two quarters, you may have an opportunity in a certain location and having a low cost way to put large volumes of product quickly into a basin in a specific area of the basin is really important and it goes back to our model of trying to be very flexible and help our customers and one of the other questions asked why we think we are taking share and is it sustainable? I think it's another piece of the model. Our customers like to work with us. They tell us that all the time. We frequently hear that that we are the most flexible easiest to work with company in the industry. And you know, imagine your service company today obviously you are struggling, you are trying to win business and you want partners that can serve you the way you want to be served. And I think also it's a testament to the fact that our oil and gas team are all oil and gas industry veterans. We took a different approach as we built our oil and gas team. We didn't put sand mining people in there, and trying to teach them the oil and gas industry. We went out and recruited top talent from oil and gas, and then they are learning the mining industry and I think that served us extremely well, Drew.

[Drew Lipke:]

Okay. And then on ISP side, can you talk – and this is kind of a broader question, but can you remind us a little bit more in the breakdown between end markets and kind of the outlook for some of these end markets and then also with the higher margin products that you've introduced and you mentioned the building products on the ISP side there, how should we think about what (55

[Bryan A. Shinn:]

So to your first question, kind of at the macro level, if you look at our industrial markets, we're about 50% into housing and automotive, and then it breaks off into a lot of different markets there. Specifically, our largest market, if you kind of aggregate the glass market together, so our container glass, flat glass and fiber glass are large areas for us. In terms of housing, we're in all kinds of places around your house. As a matter of fact, whatever room you're sitting in today, if you look around you can probably find 10 examples of products that U.S. Silica is in. And so we're in roofing, we're in insulation, we're in floor tiles, all kinds of things like that. Foundry industry is our third or fourth largest market. We're in paints and coatings, and then it sort of tails off into chemicals and recreational markets and things like that. But, by and large, glass is the biggest market for us when you aggregate it together and think 50% housing and automotive in terms of end-used market. In terms of our new products, they're a much more diverse mix. They go into a lot of different end-use markets. Yes, what inning we're in, I think we're maybe still on the on-deck circle. I'm not even sure we've gotten up to bat yet. And this is World Series time, so we can use a baseball analogy, but very early innings there. Literally, some of these products have only been in the market 6 months to 9 months, but already, as I said in my prepared remarks, we're seeing 10% of our contribution margins in Q3 from oil and gas generated from these new products. So our team has done a great job there. I think, it's a big success story for the company. And you'll hear more about this in the future as we continue to be successful in ISP.

[Drew Lipke:]

All right. Thanks, guys.

[Bryan A. Shinn:]

Okay. Thanks, Drew.

[Operator:]

Thank you. At this time, I would like to turn the call back over to Mr. Shinn for closing comments.

[Bryan A. Shinn:]

Thanks, operator. In closing, I want to leave you with a few thoughts on why U.S. Silica is positioned well for long-term success. We got a couple of questions around this on the call, and I just want to reiterate these points. So, it's clear to everyone at least what our thinking is. Now, first, we continue to believe in the long-term viability of shale energy in North America and the need for increasing volumes of sand based on the growth in proppant per well. Second, I believe that we have a best-in-class combination of our corporate business model, having industrial and oil and gas, low cost operations, logistics infrastructure and scalable processes that are executed by what I think is the most talented team in our space. And then the third point is that, I believe our industry is poised for consolidation. We talked a bit about that today and with our strong balance sheet I think we're the most obvious consolidator in this space. With that, I want to thank my colleagues for all their hard work and tireless efforts through these challenging times and also want to thank our investors for their interest and support, and I look forward to meeting everyone and speaking with you all in the future. 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 have a great day.