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Edited Transcript of SLCA earnings conference call or presentation 30-Jul-19 12:30pm GMT

Q2 2019 U.S. Silica Holdings Inc Earnings Call

Frederick, Aug 2, 2019 (Thomson StreetEvents) -- Edited Transcript of U.S. Silica Holdings Inc earnings conference call or presentation Tuesday, July 30, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan A. Shinn

U.S. Silica Holdings, Inc. - President, CEO & Director

* Donald A. Merril

U.S. Silica Holdings, Inc. - Executive VP & CFO

* Michael K. Lawson

U.S. Silica Holdings, Inc. - VP of IR and Corporate Communications

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Conference Call Participants

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* Chase Mulvehill

BofA Merrill Lynch, Research Division - Research Analyst

* Connor Joseph Lynagh

Morgan Stanley, Research Division - Equity Analyst

* George Michael O'Leary

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* John H. Watson

Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst

* Lucas Nathaniel Pipes

B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst

* Marc Gregory Bianchi

Cowen and Company, LLC, Research Division - MD

* Saurabh Pant

Jefferies LLC, Research Division - Equity Associate

* Scott Andrew Gruber

Citigroup Inc, Research Division - Director and Senior Analyst

* Stephen David Gengaro

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the U.S. Silica Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Michael Lawson, Vice President of Investor Relations and Corporate Communications for U.S. Silica. Thank you. You may begin.

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Michael K. Lawson, U.S. Silica Holdings, Inc. - VP of IR and Corporate Communications [2]

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Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's Second Quarter 2019 Earnings Conference Call. With me on the call today are Bryan Shinn, President and Chief Executive Officer; and Don Merril, Executive Vice President and Chief Financial Officer.

Before we begin, I would like to remind all participants that our comments today will include forward-looking statements, which are subject to certain risks and uncertainties. For 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 today's press release or our public filings for a full reconciliation of adjusted EBITDA to net income and the definition of segment contribution margin. (Operator Instructions)

And with that, I would now like to turn the call over to our CEO, Mr. Bryan Shinn. Bryan?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [3]

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Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing the highlights that drove our strong second quarter performance, and then I'll provide an update on changes we're making to our capital allocation plans and priorities as we start to generate an increasing amount of cash flow going forward. I'll conclude my prepared remarks with a market outlook for both our industrial and Oil and Gas segments and explain why we remain very excited about the opportunities to continue to grow and diversify our company, while at the same time, enhancing our sustainable business model.

For the total company, second quarter revenue of $394.9 million represented a sequential improvement of 4%. Solid execution from both operating segments generated better-than-expected adjusted EBITDA of $85.5 million. Our Industrial and Specialty Products business delivered a 21% year-over-year improvement in contribution margin in the second quarter to a record $50.1 million even though total tons sold declined 5% from 2Q '18 to 2Q '19. We believe this clearly illustrates that our strategy of repositioning to deliver more higher-value, higher-margin products is clearly working. This is why our volumes have remained relatively flat, while our contribution margin has been growing at double-digit rates over the last 5 years. We also had several exciting developments during the quarter in industrials, including signing of a long-term supply contract with a leading consumer products company to provide a high-value custom product for a new product launch; initial sales of ground silica to a large new customer under long-term contract; and we started up and began production at our new Millen, Georgia facility, where we will produce specialty heat-treated products like EVERWHITE for high-end quartz countertops and also our next generation of cool roof granules.

In our Oil and Gas segment, we sold a record 3.9 million tons, up 2% sequentially as we continue to ramp our new West Texas capacity exiting the quarter at a 7.2 million ton annual run rate. Volumes in oil and gas were negatively affected in the quarter due to the flooding in the Midwest, which took our Festus, Missouri plant offline for nearly 2 months. Oil and gas contribution margin of $71.5 million was better-than-expected due to strong performance from Sandbox, our leading -- industry-leading last mile logistics solution and a rebound in Northern White sand pricing. We continue to experience pricing pressure in West Texas during the quarter, which was more than offset by reduced operational costs, some of which may not repeat in the third quarter. We signed several new oil and gas contracts during the quarter, including 2 with energy companies for Northern White sand, illustrating the rebounding demand for high-quality Northern White sand through our industry-leading distribution network. Sandbox delivered another quarter of record performance, with loads up 14% sequentially and June exit low volumes hitting an all-time high. We continue to grow market share and estimate that we ended the quarter with approximately 27% market share of delivered sand. During the quarter, we also completed one of the highest volume jobs in Sandbox history for a major E&P in Texas, delivering over 8,000 loads while driving nearly 1.4 million miles with 0 safety incidents and 0 nonperformance time at the well site due to sand, quite an amazing accomplishment and a testament to the strength of the Sandbox value proposition.

Let me now provide you with an update on U.S. Silica's capital allocation plans. Historically, we've taken a consistent and balanced approach to managing our capital. And I think we have a very good track record when it comes to our uses of cash. We've strategically invested in M&A with acquisitions such as SandBox Logistics and EP Minerals, and we've successfully invested back in the business by expanding our oil and gas capacity. We've also been very diligent in returning cash to our shareholders either through meaningful share repurchases or our quarterly cash dividend, which we've now paid out for 25 consecutive quarters. After successfully executing a significant growth and diversification strategy over the last 3 years, we're transitioning to a more targeted growth plan, which will take us from a net cash consumer to a net cash generator as a company. For example, you could begin to see the cash-generating power of this plan in Q2 as we generated $32.8 million of free cash flow after CapEx and dividend payments. Going forward, we're modeling substantially lower CapEx, minimal investments in oil and gas sand and stable dividend payments. Given that, we expect to have the ability to use some of our free cash flow to reduce debt over time. We're targeting a reduction of our gross debt to adjusted EBITDA leverage ratio to 3x or less by the end of 2021 through a combination of debt retirement and profitable growth. We intend to continue to invest in bolt-on type growth projects for our ISP business that have high returns and low risks, like our new Millen facility, and we'll also continue to invest in next-generation equipment for Sandbox like our bigger boxes and solar-powered stands to continue to grow share. We will, of course, continue to be opportunistic about share repurchases. But when it comes to choosing between the 2, we think that it's currently more prudent to delever the balance sheet, and we expect to start retiring debt in Q3.

Now let me conclude with market commentary, starting with industrials. Some analysts have warned recently of potential economic difficulties ahead. But we've yet to see any shifts in customer demand that would indicate a slowdown or imminent recession. We're experiencing strong demand for our Basic and Performance Materials products across a wide range of industries and continue to expand our capacity in both ground silica and functional coatings.

As I indicated on our last earnings call, we've installed new management at EP Minerals and plan to drive organic growth above historical rates through the introduction of new products and entry into new market segments. For example, we're currently pursuing several potential growth platforms in areas like high-purity filtration in the pharmaceutical, rubber and polymers industries. Our current outlook for industrials is for a strong Q3 with a normal seasonal slowdown in Q4.

Moving to market commentary for energy, the last mile logistics market continues to be competitive with the recent new entrants into the silo space. Our Sandbox unit is thriving by providing a differentiated full-service offering to operators and service companies alike. Moreover, Sandbox continues to make efficiency gains that drive substantial savings for our customers. Examples of this include bigger boxes, minimal NPT and technological improvements that boost operational efficiency and reduce labor cost. We also continue to explore other new oilfield segments and new industries for Sandbox expansion.

Finally, turning to the outlook for our Oil and Gas segment, third quarter oil and gas contribution margin dollars are expected to be relatively flat. We expect stronger overall sequential volume with some further pricing weakness in the Permian, although some of that pressure may be offset by the rebound in Northern White sand pricing. Our cost per ton continue to come down, especially in West Texas. U.S. Silica is at the very low end of the cost curve, and we'll continue to differentiate our frac sand business on logistics, partnering with Sandbox and targeting customers who continue to demand higher sand volumes driving a need for value-added logistics services. We do expect to see some softening in the fourth quarter as oilfield activity levels are anticipated to moderate as producers focus on living within their cash flows.

And with that, I'll now turn the call over to Don. Don?

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Donald A. Merril, U.S. Silica Holdings, Inc. - Executive VP & CFO [4]

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Thanks, Bryan, and good morning, everyone. First, I would like to reiterate Bryan's comments on delivering a very strong second quarter in which we generated $85.5 million of adjusted EBITDA, with improved operating performance across the company. As far as our segment results are concerned, second quarter revenue for the Industrial and Specialty segment was $121.8 million, up 3% from the first quarter of 2019 and an increase of 18% when compared to the same quarter last year. The Oil and Gas segment revenue was $273.1 million, up 5% from the first quarter of 2019 due mostly to continued growth in our Sandbox operation and an increase in proppant tons sold. On a per ton basis, contribution margin for the Industrial and Specialty segment set a record of $51.61 representing a 12% increase from the first quarter. Lower plant costs, price increases and a normal seasonal mix of higher-margin products sold during the quarter contributed to the increase in contribution margin per ton in this segment.

Looking ahead, third quarter contribution margin for the Industrial and Specialty segment should be very similar to the margins achieved in the second quarter, as historically, these are the 2 most profitable quarters of the year. The Oil and Gas segment contribution margin on a per ton basis was $18.17 compared with $15.16 for the first quarter of 2019, largely due to strong performance from our Sandbox business, a rebound in Northern White sand pricing and reduced operating costs, some of which may not repeat, partially offset by slightly weaker pricing in West Texas. As Bryan noted, we would expect the segment's contribution margin dollars to be relatively flat versus the second quarter of 2019.

Let's now look at total company results. Selling, general and administrative expenses in the second quarter of $38.7 million represent an increase of 12% from the first quarter of 2019. The actual results were higher than the guidance given last quarter, due mostly to increased compensation expense and expenses related to our Frederick office facility closure. We expect SG&A expenses to be similar in the third quarter when compared to the second quarter of 2019. Depreciation, depletion and amortization expense in the second quarter totaled $44.9 million, an increase of 1% from the first quarter of 2019, driven by our plant capacity expansions and our acquisition of EP Minerals. We expect DD&A to be flat to slightly up in the third quarter when compared to the second quarter. Our effective tax rate for the quarter ended June 30, 2019, was a benefit of 28%, including discrete items. The company believes our full year effective tax rate will be a benefit of about 36%.

Moving on to the balance sheet. As of June 30, 2019, the company had $189.4 million in cash and cash equivalents and $95.2 million available under its credit facilities for a total liquidity amount of $284.6 million. The company increased the cash balance by $27.8 million during the quarter due to strong cash flow from operations of $71.6 million and reduced capital spending versus the first quarter of this year. Additionally, the company's net debt was under $1.1 billion at the end of the quarter. Capital expenditures in the second quarter totaled $34.1 million and were mainly for engineering, procurement and construction of our growth projects primarily at our Lamesa, Texas mine as we near completion of that project, the equipment to expand Sandbox operations, several growth projects in our Industrial and Specialty segment and other maintenance and cost improvement capital projects. At this point, we expect capital expenditures of approximately $125 million for the full year 2019. As I have said in the past, these expenditures will be within our operating cash flow and the remaining quarters of the year are expected to be free cash flow positive. As we evolve into a more industrial focused cash generation company, we should have the flexibility to delever our balance sheet and make it even stronger, with a target leverage ratio of 3x or lower by the end of 2021.

And with that, I'll turn the call back over to Bryan.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Marc Bianchi with Cowen.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [2]

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I wanted to start by discussing the CapEx plan and kind of your overall cash reduction plan. I'm looking at the $125 million for this year. And I think in the past, we've discussed a maintenance level closer to $50 million overall for the company. Could you help bridge from the $125 million to that maintenance, maybe what to think about for 2020? If I'm doing the math right, it looks like you're kind of in the $20 million to $25 million per quarter here in the back half of the year. But just kind of curious how you guys are thinking about that progression.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [3]

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And thanks for the question. As we look at maintenance CapEx, we're typically more in the $25 million range. So I think that kind of forms the base, if you will, of our CapEx. And as I look forward to 2020, I would say that we'll probably be somewhere in the $60 million to $80 million range. We've got a few things that we'll continue to invest in on the industrial side of the business, building out some facilities that we need to satisfy new contracts and new products that we're currently developing. And obviously, we'll still continue to invest a bit in Sandbox as well, but I think $60 million to $80 million in that type of range is probably the right number for 2020.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [4]

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And then, I guess maybe looking more specifically to third quarter here. If I have the guidance kind of right in my calculation here, you're looking for essentially flat EBITDA about $85 million on an adjusted basis. Interest expense is $25 million. So we could have cash from ops approximately $60 million. Curious if there's any other things we should be considering. And then, again, the CapEx piece being in the low 20s, yielding something in the maybe $35 million to $40 million of free cash for third quarter. Am I thinking about all those components right? Or is there anything else we should be considering as we do the bridge to third quarter?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [5]

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I think as usual, Marc, you're right on it. That is probably our base case. Obviously, with the oil and gas markets being what they are, you don't know how the third quarter is going to end up, so I would say, to the extent there's any risk, it's in deterioration in oil and gas, volumes on the sand side and maybe to a lesser extent, on the Sandbox side as we get into the back half of the quarter. We haven't really seen much of that. So far, the quarter started off pretty well. But as you know, things can change pretty quickly in that part of our business. So we're keeping a close eye on that. But I think the way you described it is pretty accurate from my perspective.

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Operator [6]

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Our next question comes from the line of Scott Gruber with Citigroup.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [7]

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Staying on the third quarter, Bryan, you mentioned that the contribution margin dollars for oil and gas would be flattish, but volumes are supposed to be up about 10%. Can you just talk about the different moving pieces in there? Is -- Sandbox volumes expect to be down on sort of completion activity, pricing, how that's moving for oil and gas and Sandboxes. Some of the components around that Q3 guide, especially with volumes expected to be up.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [8]

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Sure. So as you said, we'll expect to see volumes up in oil and gas. I think low volumes in Sandbox should be up just a little bit. We're baking in the fact that there will probably be some pricing deterioration. As we talked about just a minute ago with Marc, we're sort of assuming the worst that perhaps things get a little bit dicier as we get to the back part of the quarter here. As I said, we haven't seen that yet, but it seems like there's a lot of talk on the street around some deterioration in Q3. So we'll see how that plays out. So generally, that's how we're thinking about it, but the business looks pretty strong on the oil and gas side, quite frankly. Sandbox is going extremely well. Sand volumes are up. Northern White sand seems to be rebounding. Volumes and pricing are actually up there. So I think there's a lot to be optimistic about as well.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [9]

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And so the pricing concern, that's primarily on oil and gas volumes primarily in the Permian? Or is there any concern around logistic pricing at this point?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [10]

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Not really logistics, it's more just sand pricing volatility, what spot pricing will do in the Permian. Obviously, we have a lot of our business locked down under contracts on the oil and gas side. So that provides a good chunk of stability there. But spot prices can move pretty dramatically. It is interesting, though, I feel like we're starting to see some stability in pricing, particularly in the Permian. If you look at some of the competitors that we have out there today, some of them have reduced shifts at their mines. We're hearing that there might be some mines that actually shut down in the Permian in Q3 and I think, perhaps, into Q4, particularly if things deteriorate in Q4 as they typically tend to do in oil and gas. That's really going to put a lot of pressure on some of the folks out there who might be just sort of teetering on the ability to operate and generate any kind of earnings or cash. So we'll see how that kind of plays out. But based on what we're hearing, I would expect us to see some mine closures and some consolidations out in the Permian mine landscape, which I feel like will be constructive to pricing and margins as we go forward here.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [11]

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Just stepping back, I mean the pieces sound better than flat margin dollars is just kind of lack of visibility that leads you to that forecast?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [12]

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I think that's a piece of it and just caution, quite honestly, we haven't seen much deterioration yet. But just -- the talk on The Street is that things are going to get worse in the back half of Q3. We've listened in to other earnings calls that have gone before us here in the quarter, and most people are talking about things getting worse in the back half here. So I feel like we're better positioned than most, but want to be a bit conservative in our forecast.

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Operator [13]

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Our next question comes from the line of Stephen Gengaro with Stifel.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [14]

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I guess 2 things that are really follow-ups on what has been asked, but you mentioned, I believe, 2 Northern White contract extensions or new contracts during the quarter. And can you speak to kind of what that pricing looks like versus where the spot market is?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [15]

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Sure, sure. Happy to do that, Steve. We have some pretty exciting developments on contracts this quarter for oil and gas. Two contracts we signed were extensions of large contracts that we already had. And then, 2 were brand-new. The 2 that were brand-new were Northern White sand direct contracts with energy companies. And so feel really good about that. There's been a lot of debate around how fast or if Northern White is going to make a comeback. And I think we're definitely starting to see the early innings of that. And I particularly like that the Northern White sand contracts we signed were with energy companies. My experience is that energy companies have a much better visibility as to what they're going to use in terms of proppant as opposed to the service companies who, obviously, move around a lot and work for different energy companies. So it was important to me that, as an indicator, that these 2 contracts got signed in terms of pricing. We're very happy with the pricing in these contracts. Obviously, we can't talk specifics for competitive reasons. But I think that Northern White is definitely starting to make a bit of a comeback here.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [16]

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Can you say if they're going East and West versus South?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [17]

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In terms of basins you mean or price or -- what do you mean?

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [18]

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Yes. Exactly. In terms of basins, yes. In terms of basins.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [19]

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So it's not a lot in the South at this point. It's more sort of East and West in terms of these contracts. I think one of the other items that's been widely discussed is Northern White sand in the Eagle Ford. So if you get into South Texas, we're starting to see some early signs of Northern White demand there. It's interesting, a lot of the completions that are being done there are in parts of the shale where the closure stresses are pretty darn high. And several energy companies are not having success would be the local sand there. The quality is not very good. So I think we'll see kind of the next leg up in Northern White demand be driven by that trend in the Eagle Ford.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [20]

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Great. And then just as a follow-up, when you think about Sandbox, I mean we increasingly hear about kind of more integration of transportation with well-site solutions. Could you just remind us kind of Sandbox's positioning as it pertains to that sort of kind of larger opportunity on the well-site logistics side?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [21]

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Sure. So if you look at Sandbox and how we're positioned, we have a wide range of offerings to customers. But the one that's most popular is our full-service offering, which basically means we provide essentially everything for the customer. So we have our people, it's our sand. It's our folks on the well site, it's our drivers, it's -- in many cases, our trucks as well. And we also have the logistics solution, kind of the backbone that we've built to go with that. And we work hand in glove with the energy company or the service company. And literally, I think we're the only company out there who's doing this that has their own full-time employees on the well sites integrated in with the crews. And that gives us tremendous visibility and also helps us drive better efficiency, which means lower cost for our customers.

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Operator [22]

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

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [23]

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Wondering if we could talk a little more about the outlook on pricing for Permian sand in particular. So when you're talking about pricing being lower in the third quarter versus the second quarter, how much of that is pricing that you already gave up in the second quarter, like run rate effect versus just some conservatism or expectations of further pricing declines?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [24]

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So I think it's more conservatism on things to come, quite honestly. You can sort of see our run rate in Q2 already cooked into the numbers. I feel like it's more on things to come as opposed to things that have already been solidified, Connor.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [25]

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Okay. That's fair. And I know you guys do a fair bit of tracking of supply. So are we at a point where supply is flat to down in the Permian? I mean you're pointing out potential for mine closures. But if they're more supply sort of ramping as we move through the year, just generally from you and your competition?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [26]

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That's certainly not what we've seen. I think it's going in the other direction. I believe that we're going to see supply come offline. As I said earlier, I think we'll actually see some mine sites close. I heard rumors of a couple of those and particularly, if things get a little bit tougher here in the back half for some period of time, it's going to make it a difficult decision for current competitors who are actually losing cash on every ton they produce. So that's when it becomes tough when you have to attach a $20 bill to every ton that you ship out. My experience is that people don't continue to operate very long in that kind of an environment.

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Operator [27]

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Our next question comes from the line of Chase Mulvehill with Bank of America.

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Chase Mulvehill, BofA Merrill Lynch, Research Division - Research Analyst [28]

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I guess I wanted to come back and talk about the balance sheet a little bit. You put some nice leverage ratio targets out there, 3x at the end of 2021. Could you maybe help us kind of understand what's the implied gross debt target in that 3x leverage ratio?

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Donald A. Merril, U.S. Silica Holdings, Inc. - Executive VP & CFO [29]

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Yes. Chase, it's Don. Look, let me give you a little bit more detail around the thought process there. Our assumption is that we're going to require somewhere between $200 million and $250 million of cash available to buy down our debt. And the high end of that range assumes that we're not going to see any growth from Q2, right? So we think that's relatively conservative. And if we look at historical growth rates in the growth side of our business ISP and the Sandbox business, that's what drives that lower number closer to $200 million. So at the end of the day, that's what we're looking at as far as our gross debt.

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Chase Mulvehill, BofA Merrill Lynch, Research Division - Research Analyst [30]

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Okay. All right. That's helpful. I appreciate the color. The follow-up, you've got a few charges that showed up in the quarter. One with merger and acquisition-related charges of about $6.1 billion (sic) [$6.1 million]. So maybe if you can kind of highlight and kind of talk to kind of what that actually was. And then on the facility closure cost, do those go away in 3Q? And then the start-up and expansion cost to $3.7 million, when did those go away?

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Donald A. Merril, U.S. Silica Holdings, Inc. - Executive VP & CFO [31]

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Sure. So on the M&A charges of $6.1 million, $4.5 million of that approximately is a charge that runs through the P&L associated with the step-up value of the inventory when we purchased EP Minerals. So it's a noncash charge that artificially reduces your overall margins. So we add that back to show the real earnings power of that business. The other roughly $1.5 million, as Bryan stated earlier, we did do some management changes at EP Minerals, and there were some severance charges that we put in that line as well. So that goes away in Q3. But that $4.5 million of EP Minerals, the step-up value of inventory probably sticks around until maybe halfway through the first quarter.

So I would anticipate $4.5 million in Q3, maybe a little bit lower in Q4 and then in the $2 million range in Q1. And then that line as far as those charges go would go to 0. You also asked about plant capacity, the plant capacity charge of $3.7 million really was made up of 2 different things. We still have some start-up charges out in our Lamesa, Texas facility. That was about $2.5 million, and that's just the inefficiencies of getting that up. We are in the last stages or phases of that. So I could see that being roughly cut in half in Q3 and gone in Q4. And then we also had some start-up costs associated with the Millen facility, which I'm very happy to say came up ahead of schedule and under budget. So there's only a few of those in my career I can talk about, but that was very, very well done by the team on the industrial side.

And I believe the other question you asked was about facility closure. The majority of that was related to our Frederick office facility. We have -- let's just say about half of that was Frederick, and the other half of it had to do with our Voca facility closure. The Voca facility should experience very little charge in Q3, but we should have roughly the same amount of the facility closure for Frederick in Q3, and that's mostly related to the stay bonuses that we offered. All those great, great people up in Frederick who chose not to relocate here to Katy. So -- and when we move into Q4, that line should be, again, approaching 0.

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Operator [32]

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Our next question comes from the line of George O'Leary with Tudor, Pickering, Holt.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [33]

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Good quarter. I was just curious, the oil and gas volume guidance for the third quarter stands out as pretty impressive in a frac market where it feels like activity may had the wrong direction. So I was just curious what drives -- the primary drivers and the confidence there? Is that mostly Sandbox market share capture? Is that some of the weather issues that you guys experienced in the second quarter abating? Or did you guys just have a good volume level in June that you can kind of extrapolate out to get to the 10% growth quarter-over-quarter? Just curious the drivers because that is an impressive volume growth number that you're guiding to in the...

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [34]

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So it's a number of things, George. Particularly on the sand volume side, we continue to ramp up at Lamesa. Crane is basically running at full rate or pretty close to it. Unlike almost all of our competitors out in West Texas, we stayed pretty much fully sold out. And if we can make a ton out in West Texas, we can sell it, and I think it's a testament to the location of our sites and the very quick turn times that we have. We have some of the fastest turn times for trucks in the industry. So that's one. Second is, as you mentioned, the weather last year impacted us somewhat. Our Festus, Missouri site, which is just outside of St. Louis, for example, was actually shut down for 2 out of the 3 months in Q2. And that was because of either water flooding at the site or the level of the Mississippi River, which was too high to ship out barges, which is our primary outlet there. So that alone add back in a pretty substantial amount of volume. Those tons are in high demand. That's really good Northern White quality sand. So those 2 things taken together give us a lot of confidence, plus all the contracts that we have. So the new contracts that we just signed, those are all kicking in, so we feel pretty good about our volume level. As I said earlier, pricing is outside of the contract. There's always a bit of uncertainty. And so we'll watch that closely as we get through the quarter here.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [35]

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Okay. That's super helpful. Thank you, Bryan. And then my second question actually follows on the end of your response. Just on the Northern White front, clearly, a really strong first 6 months of the year versus what we saw in the fourth quarter of last year. What would you say you've seen so far in the third quarter on a leading-edge basis around Northern White frac sand pricing? Our understanding is maybe starting to trend down as frac activity trends down, but given you guys have boots on the ground, curious for your thoughts there.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [36]

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Yes. That's not really what we've seen. We were up in Q2, 3.5%, 4% in Northern White sand pricing and I feel like pricing looks pretty strong in Q3 here. Again, I think it depends on how you're situated from a logistics standpoint. We happen to be particularly advantaged so we can get to more places than most of the competitors that we have. And also, we're starting to sign more and more Northern White sand contracts. And so it gives us, I think, better visibility into the pricing there. So I'm feeling pretty good about both the volume and the pricing for Northern White sand as we head into Q3 here.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [37]

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That's great. I'll sneak in one more, if I could. It seems like the contracting commentary you gave is certainly promising. Do you have any instances you can point to? I'm not looking for specific customers, instances you can point to where customers are actively shifting away from certain grades of in basin sand, and maybe they walked away from Northern White once upon a time and now they're walking back to it? Are you guys seeing that at all in any basins that stand out, in particular, where that's playing out?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [38]

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Well, I think the one where it's just starting is in the Eagle Ford. As I mentioned earlier, that's the one where, if you look at the volumes, the Northern White sand volumes actually declined a little bit for us in the Eagle Ford in Q2. And I think that's in response to all the start-ups of the new mines that happened in the Eagle Ford recently. And as customers have tried that product and seeing the results from their wells, it feels like they're starting to come back to Northern White sand. And we've had conversations with a couple of energy companies. Big players in the Eagle Ford, in particular, are now saying that they only want Northern White sand for their wells. So I feel like Northern White will definitely make a pretty nice rebound in South Texas.

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Operator [39]

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Our next question comes from the line of John Watson with Simmons Energy.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [40]

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Bryan, I thought the new initiatives you called out on Sandbox in the release were interesting. And I was wondering if you could elaborate on the bigger boxes you mentioned. How many tons did those hold? And can you also just speak to what opportunity increasing the size of your box presents?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [41]

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So the boxes will typically hold 10% to 12% more volume than some of our older boxes. And the benefits there are a couple. Obviously, your trucking expense is relatively fixed. So you pay the driver the same amount. You have to pay the same amount for the taxi and to rent the cab and all that. So to the extent you can increase your sand for that sort of fixed cost, if you will, that goes around transporting the sand, it improves efficiencies dramatically. And we work closely with our customers to also cut down delivery times as much as possible. So when you put all that together, it just makes us that much more efficient for our customers. And we're all about preventing nonproductive time, and giving the lowest possible cost to our customers. And so I think having that as another arsenal, another sort of gun in our arsenal, if you will, really makes it easy for us to go out and continue to penetrate the market, and it gives us even a bigger advantage versus a lot of the competitive offerings out there.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [42]

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Right. Makes sense. And am I correct to assume that it's a low percentage of loads today that are in the bigger boxes that you expect to grow over time?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [43]

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Yes, that's correct. We don't have a lot of the new boxes deployed yet. So we have the boxes, and we also have a set with our sand that stands. And so essentially, instead of having the boxes sit on top of a conveyor that has a lot of moving parts, the boxes sit on a stand, which has very few moving parts. Lower cost to build the boxes and lower potential for failure. So we're deploying that second-generation box and the stands right now.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [44]

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Okay. Great. Switching gears to ISP, I apologize if I missed this. I think I heard Don say that you're expecting a strong third quarter. But I don't know if I heard a volume number. What should we be expecting for volumes in the third quarter? And specifically, what type of contribution should we be expecting from the Millen site?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [45]

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So I think the -- when you look at the volumes in the third quarter, they're going to be up just slightly. And I think you'll see the contribution margin per ton perhaps be down just a little bit. We had some one time benefits maybe per dollar, per ton or something like that for some energy surcharges that we pass through to customers in Q2, which won't repeat in Q3. So when you do the math on that, sort of net-net, it's neutral. So I think we'll see flat contribution margin dollars in industrials in Q3. In terms of Millen, we've just started that facility up. We started to produce some of the initial tons there. So I don't think you'll see a whole lot of additional contribution margin in Q3. But going forward, as we get into Q4 and Q1, I think you'll start to see some benefit from Millen in there.

Now in some cases, we're already selling these products, but we were having them toll manufactured. So what you'll see is not necessarily volumes go up, but you'll see our costs come down dramatically. In many cases, we're having these products toll manufactured in Europe. So you can imagine the added cost to have to ship raw material there, ship finished product back and deal with all that. So I think you'll see some good cost takeout on the industrial side of our company.

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Operator [46]

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Our next question comes from the line of Lucas Pipes with B. Riley FBR.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [47]

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I wanted to follow up a little bit on the potential closures in the Permian. Bryan, could you kind of share your thoughts as to what distinguishes the has from the has not? Is it transportation? Is it mesh size, location? What do you think makes the difference between a mine that is going to stay open and one that is going to be closing? I assume the cost curve is pretty flat there. So I would appreciate your thoughts.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [48]

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Sure. It's a great question, Lucas. I think there's a couple of things. The first and probably most important is location. So that's one of the things that you can't change, and you can't really improve. And so if you pick the wrong location in terms of proximity to the well activity, it's hard to fix that. And it's not just proximity, but you have to think in terms of driving distance. And so if you have to drive an extra hour or 2 hours on a round-trip basis, it adds substantial cost to your offering, ultimately, as the customers perceive it. I think also, the ability to turn trucks and get them through your site very quickly.

Customers are looking at that closely right now. Because at the end of the day, if a truck has to sit for an extra 0.5 hour or 1 hour at a mine site waiting to be loaded, the customer ends up paying for that in the terms of [the merch]. I think we've also seen some pretty inconsistent operation from a number of the sites. On some cases, the quality has not been good. Properties like turbidity, which kind of measures that, if you will, the dustiness of the sand has not been good and some of the cost structures that our competitors have just aren't very competitive. They haven't been able to figure out how to get their mining cost down. Maybe they lease the land instead of bought it, so maybe they have a $4 or $5 per ton lease payments that have to add on, things like that. So there's a lot of things that differentiate, as you said, the haves from the have nots.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [49]

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Very helpful. Thank you for that. And then in Northern White, you mentioned that the region is experiencing somewhat of a comeback. And in your opinion, is it a specific mesh size that is seeing a resurgence in demand? Or do you think it is also related to maybe some other factors? I would appreciate your thoughts. And then lastly, you've seen a lot of production cuts in Northern White. Do you expect any of that production to come back?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [50]

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Sure. So I wouldn't say it's a particular mesh size. It tends to be different by basin. So if you look at, let's say, the Northeast, 100 mesh and 40/70 are very popular there. If you get out into the Bakken or the DJ Basin, maybe it's 30/50 or 20/40. So it kind of varies by basins. And in terms of capacity cut there, we've already seen about 30 million tons of Northern White sand capacity be idled. I think depending on how this resurgence goes, these are -- things kind of stay where they are. Perhaps there's another 5 million to 10 million tons that come out. And those are still the noncompetitive tons.

And I think one of the things to emphasize here is we have multiple mines, so we can take advantage of that and be competitive to all these different basins. If you just have one mine site, like a lot of these kind of lingering competitors do, it's very hard for them to be broadly competitive. We can move things around. And in particular, some of our Northern White sites also have industrial businesses that we've cultivated over the years. So that gives us ability to flex things up and down in oil and gas in a way that if you're a single mind, oil and gas focused, you just can't do.

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Operator [51]

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Our next question comes from the line of Saurabh Pant with Jefferies.

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Saurabh Pant, Jefferies LLC, Research Division - Equity Associate [52]

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I wanted to talk a little about Sandbox. So you guys talked about increasing competitive pressures, the potential of some pricing raise in the back half of the year, right? With that as a backdrop, right, just strategically, how do you think about your own strategy? What do you think if pricing is down, whatever, 5%, 10% kind of a number, right? Just theoretically speaking, would you like to chase that pricing down and maintain market share? Or would you rather be willing to set out and lose a little bit of market share? Because I would assume part of that loss would be temporary.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [53]

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Yes. So it's a really interesting question. The competitive pressure that we're seeing ironically is not in the containerized area, standardized sand delivery. It's more on the silo side. So we've seen a couple of new entrants into that space. And I would say that, in general, is sort of pressuring prices. But what we found is that most customers who like containers will sort of maybe threaten that they're going to switch to silos, but at the end of the day, really won't do it. So we've seen some pricing pressure. Look, customers always want a lower price, but I think we have value to offer to our customers on the containerized side in a way that the silos can't really match. And so that's why more and more customers are converting to silos.

We picked up another 2 points of share this quarter. So I'm not really interested in chasing price down. With that said, we have looked at doing business with and have started to do business with some very large energy companies. And the kind of volumes that they bring and the overall value of those accounts would potentially command a lower price. And so there is a relationship between the amount of business you do with a customer and the type of price they expect. So I think that's more of the type of pricing that we're interested in looking at as opposed to just chasing competitive pressure from silos or something like that. They come in and make a low ball offer, I don't think we're going to chase that down. We're going to maintain our margins on the Sandbox side.

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Saurabh Pant, Jefferies LLC, Research Division - Equity Associate [54]

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Right. Okay. No, that's helpful. And then I know you haven't given a lot of color on the contracting side, right? But you've press released some of the large contracts that you won. Again, on the Sandbox side, the Halliburton contract started early last year, the Chesapeake contracts started early this year, right? But again, we don't have a lot of color as to the terms and conditions of those, right? So I'm sensitive to that you cannot disclose everything, right? But how should we think about the potential risk of some of these contracts? And some of the other contracts that you have signed potentially rolling over, coming up for renewal back half of the year, early next year, right? And some associated pricing risk along with that, right? How should we think about that?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [55]

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So our contracts have held up remarkably well given the ups and downs in the oilfield over the last year or 2. I think that we either have capacity reservation fees that most of these customers have paid to us, and we already have their money in the bank, if you will. And the way they get it back is by buying sand from us so that's the most secure. But then we also have a number of contracts with a pretty firm take-or-pay penalties. And what we're seeing so far is that the structure in both of those contracts has kept us and the customers are very well aligned. And that's really the purpose of the contract. Occasionally, we do collect a take-or-pay penalty here or someone has to forfeit a CRF. But I feel like we serve both [laws] if we have to do that. So we're always looking for ways to stay aligned and work together. But I think the contract structure that we have is the best that we've had in the 10 years that I've been hearing at U.S. Silica. So I feel pretty good about it.

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Saurabh Pant, Jefferies LLC, Research Division - Equity Associate [56]

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Great. Bryan, just to be clear, I was thinking more on the Sandbox side, right? I'm assuming all of that more or less applies to the Sandbox contracts as well.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [57]

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It's similar, right? I think on Sandbox, the other thing is that we have an offering that is somewhat more unique. I believe on the sand side, it's harder to differentiate in some ways. We have better service, and we have the right network and all those things. But at the end of the day, the sand sort of relatively -- is the sand. And our sand in some cases is not that much differentiated from our competitors. Sandboxes is a very different animal. So for example, the big job that we called out in South Texas in the press release -- sorry, in the earnings call, our prepared comments, it was a massive job, one of the biggest ones that's ever been done in the industry.

And the energy company told us, look, we could not have done this job without you. You're the only last mile provider because of the way your company is structured and the value that you bring, you're the only one that could have done this. So those are the kind of relationships that we want. And I think continuing to delight the customers and on the sandbox side and do things that no one else can do is probably our best assurance of continued business as opposed to contracts. And we have contracts in that but what I really like about Sandboxes, we have a much better ability to differentiate our service and our offering as compared to just the sand side of the business.

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Saurabh Pant, Jefferies LLC, Research Division - Equity Associate [58]

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Right, right. That makes a lot of sense. One last one for me quickly. On the West Texas side, right, you pointed to pricing continuing to come down. If I remember correctly, I think 80% or more than 80% of your West Texas volume is under contract. So I'm assuming the pricing that you are getting on your volumes is significantly higher than -- the spot pricing appears to have fallen at least for 100 mesh in that low to mid-teen range. I'm just trying to think how much more are you getting versus spot? And what's the risk that over the next couple of quarters, your pricing comes down to, at least, closer to where spot pricing is, right? Just trying to assess that risk.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [59]

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So I would say the contract pricing is generally a bit above spot. But the spot moves around quite a bit. And again, I think it comes down to the value as long as we continue to be the -- kind of a low-cost provider there. And as long as we continue to have the fastest truck turn times, we'll command a premium in the market. Also, our teams are working very diligently to continue to reduce our cost in West Texas. I think we have more to go on that. And so my hope is that even if there is some downward pricing pressure over time, we'll be able to continue to take out costs so that our margins stay relatively flat.

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Operator [60]

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Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Shinn for any final comments.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - President, CEO & Director [61]

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Thanks, operator. I'd like to close today's call by reemphasizing our confidence in the strength of our business and our ability to generate free cash flow in the coming quarters. We remain very excited about the prospects for our company and are committed to reducing our leverage as discussed today, and I look forward to discussing our plans with our investors and analysts at the many conferences that we'll be attending in the coming weeks. Thanks for dialing in, and have a great day, everyone.

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Operator [62]

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