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Edited Transcript of SLCA earnings conference call or presentation 25-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 U.S. Silica Holdings Inc Earnings Call

Frederick, Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of U.S. Silica Holdings Inc earnings conference call or presentation Tuesday, April 25, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan A. Shinn

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

* Donald A. Merril

U.S. Silica Holdings, Inc. - CFO and EVP

* Michael K. Lawson

U.S. Silica Holdings, Inc. - Director of IR & Corporate Communications

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Conference Call Participants

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* Brandon Burke Dobell

William Blair & Company L.L.C., Research Division - Partner and Group Head of Global Services

* George Michael O'Leary

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

* James Knowlton Wicklund

Crédit Suisse AG, Research Division - MD

* John Matthew Daniel

Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service

* Kenneth Irvin Sill

SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst

* Kurt Hallead

RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst

* Marc Gregory Bianchi

Cowen and Company, LLC, Research Division - MD

* Michael K. LaMotte

Guggenheim Securities, LLC, Research Division - Analyst

* Ole Henry Slorer

Morgan Stanley, Research Division - Global Head of Energy Research, MD, and Oil Service and Shipping Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the U.S. Silica First Quarter 2017 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. - Director of IR & Corporate Communications [2]

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Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's First Quarter 2017 Earnings Conference Call. With me on the call today are Bryan Shinn, President and Chief Executive Officer; and Don Merril, Executive Vice President and Chief Financial Officer.

Before we begin, I would like to remind all participants that our comments today will include forward-looking statements, which are subject to certain risks and uncertainties. For a complete discussion of these risks and uncertainties, we encourage you to read the company's press release and our documents on file with the SEC.

Additionally, we may refer to the non-GAAP measures of adjusted EBITDA and segment contribution margin during this call. Please refer to yesterday's press release or our public filings for a full reconciliation of adjusted EBITDA to net income and the definition of segment contribution margin. (Operator Instructions) And with that, I would now like to turn the call to our CEO, Mr. Bryan Shinn. Bryan?

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

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Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing our strong first quarter results, followed by an update on the investments we're making in our Oil and Gas business, to keep pace with the surging demand for frac sand as well as the actions we're taking in our Industrial business to diversify our product offerings, penetrate new markets and enhance our bottom line results. I'll conclude my prepared remarks with a market outlook for both of our operating segments. Don Merril will then provide some additional color on our financial performance during the quarter, before we open up the call for your questions.

I'm extremely pleased to report that for the first quarter, total company revenue of $244.8 million improved 34% sequentially, while adjusted EBITDA of $42.7 million more than doubled compared with the fourth quarter of 2016. First quarter contribution margin in Oil and Gas was $38.8 million, up $20.4 million on sales volumes of 2.5 million tons, a 22% improvement sequentially and on par with the growth in well completions from 4Q '16 to 1Q '17.

The sequential improvement in Oil and Gas contribution margin was driven by a combination of higher volumes, higher pricing and a significant increase in activity at Sandbox, our industry-leading last mile logistics solution.

Our Industrial and Specialty Products unit had a very strong quarter as well with contribution margin of $20.2 million, improving 20% on a year-over-year basis and setting a new all-time record for a first quarter. Successful global price increases and a stronger contribution from new higher-margin products lifted ISP profitability, both sequentially and quarter-over-quarter.

Turning to the business today on the Oil and Gas side, continued industry recovery and powerful positive secular trends in the sand space are driving unprecedented demand for frac sand and last mile logistics. The U.S. rig count was up 27% during Q1 and proppant loadings and lateral lengths continue to grow. Our proprietary database that tracks U.S. completions activity indicates that approximately 300 frac crews are active today, up 9% from just a couple of months ago.

On our fourth quarter call, we outlined the steps we're taking to meet this growing demand through a combination of greenfield sites and brownfield expansions with a likelihood of some M&A in the mix as well.

Our comments last quarter and other industry capacity expansion announcements have created questions for some investors over the potential future supply and demand balance of sand proppants and the implications for pricing and other industry dynamics. Let me take a few minutes this morning to share some thoughts on how we see this unfolding and why we believe that the sand proppant market fundamentals should say strong for the foreseeable future.

We believe our industry will remain tight in the near future due to 3 main factors: First, our industry must add capacity to meet customers' needs. Our internal estimates and current sell side reports estimate industry sand proppant demand to be about 75 million tons here in 2017, growing to over 100 million tons in 2018, with some estimates as high as 147 million tons.

Our industry will be short capacity and we cannot let sand become the bottleneck for the completions industry. Second, oil sand is not fungible within that 100-million-plus tons of projected 2018 demand. Unlike many industrial products, there is a lot of friction in the sand market for a variety of reasons, including logistics, quality differences and mesh sizes. Therefore, we're on average to see 20% to 25% more total supply than demand before our markets come into balance. So for example, if 2018 demand is 110 million tons, that implies that supply and demand balance around 135 million tons of effective capacity. Today, even after estimated reactivations of idle capacity, our industry will only have approximately 90 million tons of effective capacity, thus leaving a 45-million-ton shortfall versus projected 2018 needs. And third, even all the likely capacity additions that are being talked about are not enough. We think there could be an additional 10 million to 15 million tons of brownfield capacity added in the next 12 to 18 months, including our own expansions and perhaps as much as 20 million to 25 million tons of greenfield capacity being added locally in the Permian. All of which will be needed, if current demand estimates prove accurate. Even if our estimated 35 million tons of potential brownfield and greenfield additions come online, the market will still be short.

There are several implications of this on a national level. First, our markets are expected to stay very tight. Most of the major sand suppliers, including U.S. Silica, are running flat out today. Demand is expected to continue growing faster than supply for the foreseeable future and as such, we expect to continue pricing recovery and improving margins in our sand sales. Second, customers do come in to us to lock in sand supply for the next 3 to 5 years. We're using these discussions to form deeper relationships with the companies that we expect to be the long-term winners. We're also working on the next generation of agreements that can better weather the cycle, both for our customers and for U.S. Silica. And third, rapid growth in proppant demand represents a massive opportunity for Sandbox. Keep in mind that this new local sand phenomenon is not just an opportunity for U.S. Silica to substantially increase sand sales. All this new capacity has to get to the wellhead and we believe that Sandbox is the ideal delivery solution with an unmatched combination of flexibility, efficiency and scalability.

Now let's talk more about the Permian, specifically. It remains very hard to add capacity there. Despite all the hoopla, there are numerous challenges to bringing on new capacity locally in the Permian, including permitting, water, infrastructure, trucking and equipment availability, just to name a few.

You not only need to find a good site, you need a lot of cash and the ability to sign long-term contracts with reliable customers, which leads me to my final point. When it comes to local sand, it's definitely not a field of dreams. We believe the market for local Permian sand will have limitations and that it will only be a subset of E&Ps who choose to use these products. And once those companies or their service companies sign long-term supply agreements, it's highly unlikely that additional capacity would be needed or built. Moreover, Permian local sands might not be right for some E&Ps because of their well designs and geology within their acreage.

To sum it up, we believe that the winning sand proppant suppliers will be companies like U.S. Silica that have a strong balance sheet to fund expansions, the lowest operating cost, the ability to offer their customers numerous sand types and grades in all the major basins, along with industry-leading last mile logistics and the lowest delivery cost to the well.

Turning to our expansions. We're making great progress on our work to increase capacity at selective existing facilities. We're in the process of completing design work and securing the various permits required. We've been able to secure the long lead time equipment needed for these expansions with preferential delivery dates relative to others, based on our long-standing relationships with key suppliers and also on our industry-leading position. We also continue to evaluate opportunities for greenfield expansions in the Permian to take advantage of current market trends and increase product offerings for our customers.

From an operations perspective, we set a record for lowest logistics cost per ton in the first quarter and shipped a record 90 unit trains with 41% of our total oil and gas volumes now being shipped by unit trains. We took 304 railcars out of storage during the quarter and as of today, have no railcars in storage. During the quarter, we also modified a contract with one of our major railcar supply partners. The terms of which are confidential, but favorable to both sides, providing the additional CARR, who we'll likely need in the future to meet growing demand. We also saw very strong growth in both volumes and profitability at Sandbox. In Q1, loads shipped were up 84% sequentially. We now have almost 40 active crews across the major basins and are well on our way to doubling that number by the end of this year.

Looking at the Industrial business. We've implemented price increases so far this year on over 90% of our products and have seen dramatic growth in some of our new offerings, which now comprise 10% of ISP's total segment contribution margin. Last month, we announced a niche acquisition in ISP that provides our company with a new capability in the growing market for energy-efficient industrial roofing.

Cool roof granules could be a home run, to use a baseball analogy, based on our offering and the potential size of the market. It's an excellent example of the kind of adjacencies to our core business that we're pursuing in ISP to support our customers' growth initiatives, penetrate new markets, diversify our product offerings and enhance our bottom line results.

Turning now to our outlook. As I noted earlier in my prepared remarks, we expect to continue to see strong demand for our oil and gas products and last mile logistics services in the quarter ahead, driven by an improved rig count, higher proppant loadings and market share gains on the part of Sandbox. Given that, we could see 15% to 20% higher sand volumes and pricing in Q2, and I also expect that Sandbox load volumes should increase more than 20% sequentially.

Most of ISPs end markets are expected to grow at just GDP rates this year. However, we expect that our industrial business will grow at more than 5x GDP from a combination of new product sales, price increases and share growth in base markets. The bottom line is that U.S. Silica is extremely well-positioned for growth in both of our operating segments in 2017. And based on current market outlooks, we expect to deliver strong top and bottom line results for the year.

And with that, I would now like to turn the call over to Don Merril. Don?

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [4]

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Thanks, Bryan, and good morning, everyone. I'll begin by commenting on our 2 operating segments: Oil and Gas and Industrial Specialty Products.

Revenue for the Oil and Gas segment for the first quarter of 2017 of $193 million, improved 41% sequentially compared to the fourth quarter of 2016, driven by a combination of higher volumes, higher pricing and increased activity at Sandbox. Revenue for the ISP segment of $51.8 million, improved 14% on a sequential basis from the previous quarter, driven by a combination of higher volumes and global price increases. Contribution margin on a per ton basis from our Oil and Gas segment was $15.34 compared with $8.88 for the fourth quarter of 2016. The increase in profitability in our Oil and Gas business was driven by the increase in price, fixed cost leverage due to more tons produced and sold and higher activity levels at Sandbox. On a per ton basis, contribution margin for the ISP business of $23.48, improved 20% compared with the same period of the prior year. The year-over-year improvement in ISP profitability was driven mostly by a combination of improved pricing and an increase in new high-margin product sales.

Turning now to total company results. Selling, general and administrative expenses in the first quarter of $22.3 million were up 17% compared with $19.2 million in the fourth quarter of 2016. The sequential increase in SG&A expense is due largely to increased compensation-related expenses.

Depreciation, depletion and amortization expense in the first quarter was $21.6 million compared with $21.2 million in the fourth quarter of 2016. The increase in DD&A was mainly driven by incremental expense related to continued capital spending and higher depletion cost due to more tons sold. Continuing to move down the income statement. Interest expense was $7.6 million for the first quarter and $8 million for the fourth quarter of 2016. Other expense was $4.9 million for the first quarter versus other income of $867,000 for the fourth quarter of 2016. The change was primarily due to the cost associated with restructuring a railcar contract that Bryan mentioned earlier. From a cash perspective, we recognized an income tax benefit of $1.7 million during the first quarter, of which $1.5 million was related to excess tax benefits on equity compensation.

Now turning to the balance sheet. Cash and cash equivalents as of March 31, 2017, totaled $660.9 million compared with $711.2 million at the end of 2016. As of March 31, 2017, our working capital was $767.5 million and we had $46 million available under our revolving credit facility. As of March 31, 2017, our total debt was $512.5 million compared to $513.2 million at December 31, 2016.

During the first quarter, we incurred capital expenditures of $23.6 million, primarily for engineering, procurement and construction of our growth projects and other maintenance and cost improvement capital projects. As stated in the press release, the company expects full year 2017 capital expenditures to be in the range of $125 million to $150 million.

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

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

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Thanks, Don. Operator, would you please open up the line 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 Michael LaMotte with Guggenheim Securities.

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Michael K. LaMotte, Guggenheim Securities, LLC, Research Division - Analyst [2]

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Bryan, if I can start off, back at the Analyst Day, you did a good job delineating the market in terms of the general trend towards finer sands and local sands. I'm wondering, if you could provide us an update on that, particularly with respect to the trend towards lower quality sands, lower silica content sands and what we're seeing just in terms of mesh and quality trends in general, right now?

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

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Sure, Michael. So I would say, what we're seeing right now is a continued trend towards the finer grades. If you look at the demand that we have out there today, there is more demand for 40/70 and 100 mesh, the two finer grades, say than 20/40, which is the coarse's grade. We've also seen some customers over time choose to use, as you said, sort of the lower quality or more local sands, particularly in the Permian. We think we'll see a continuation of that trend. But, as I said in my prepared remarks, we're also running into a number of customers who are telling us that they have tried those products and don't necessarily like the results that they're getting in their wells or have just decided for a variety of reasons, because they don't think those are the right products to use them. So it'll be interesting to see how things play out over the next several quarters here. I believe that this trend is going to be just like so many others in our industry that at the end of the day there'll be some kind of a balance that settles out between, say, Northern White and regional sands. And we know, ours is not a homogeneous industry, that, seems like the frac industry likes to do things differently and different engineers like to complete their wells different ways. So I think we'll continue to see a mix out there and I believe that the strategy that we have in U.S. Silica is the right one, which is to be able to serve all the needs, whether customers want Northern White sand or whether they want regional sand, very local sand, want it delivered in the Sandbox. We've got all those bases covered and we're going to continue to expand our offerings to make sure that we can hold or grow our share in this growing market.

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Michael K. LaMotte, Guggenheim Securities, LLC, Research Division - Analyst [4]

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Okay. And then a quick follow-up for me. On -- you mentioned some customers looking for 3- to 5-year contracts. Now I imagine with the pace of inflation in sand prices right now, there is a strong desire on their part to try to lock in as much term as possible. How do you approach or balancing that benefit of the visibility with desire to capture as much price as you can in the up cycle?

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

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It's a really good question, Michael, and it's something that we debate a lot, internally, here. I said in my prepared remarks that we're working on, what we call sort of our next-generation contracts. And so I think we have a really interesting opportunity here, given the demand and the short supply in the market. And I think most of our customers believe that, that short supply is going to continue into the foreseeable future as we do. So it gives us a great opportunity to form those deeper partnerships with the key customers. As we think about those next-generation contracts, we really want agreements that can weather the cycle and work for both, ourselves and our customers. It really doesn't do any good to sign a one-sided contract, because you know how that turns out in this industry. So we're trying to go for some longer terms. As you mentioned, 3 to 5 years. We also have some other interesting contract designs that, I think can make them -- the contracts a bit more sticky, if you will. So we'll continue to look and work on those, and I think we'll either sign some contracts at pretty attractive fixed rates or have those that perhaps adjust up and down in terms of pricing with market activity. But we're really looking to find contracts with the right customers and get those signed up. With that said, we're not in a tremendous hurry to sign contracts. I would say the only exception to that perhaps would be, what we're looking at greenfield development. Given the capital and the risk involved in those, it certainly is better to have a really solid contract to backstop that investment.

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Operator [6]

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Our next question comes from Ken Sill with SunTrust Robinson Humphrey.

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Kenneth Irvin Sill, SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst [7]

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Yes, don't want to rain on the parade, but I do have a question on your average cost per ton in oil and gas, that was up sequentially and I'm trying to figure out as 8% increased sequentially. And trying to parse out, how much of that might be related to extra costs incurred to kind of expand and how much is just cost for inflating it across the spectrum and not just where the world is going?

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

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Yes, Ken. So you have to remember that the cost associated with Sandbox is in our cost of goods sold number. So most of that increase is due to having additional cost in there, but no additional tons coming from Sandbox. So most of that increase comes from that. We also did see increased maintenance expenses in the quarter versus Q4. And to a minor extent, we also had an additional $0.50-or-so a ton associated with car pulls, as we're getting our final cars out of storage.

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Kenneth Irvin Sill, SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst [9]

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So that $0.50 per ton is going to go away this quarter, but the rest of it (inaudible)?

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [10]

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That's right. And I would -- I think we were a little high on maintenance as well, so you'll see that -- maybe that level out as well. But Sandbox is going to continue to add cost as we expand that business. But you have to remember, the flip side of that is it adds to the contribution margin as well.

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Kenneth Irvin Sill, SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst [11]

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Yes, so it's showing up on the revenue side?

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [12]

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You got it. Exactly.

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Kenneth Irvin Sill, SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst [13]

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So it's in the revenue per ton. Okay. And then just wanted to see if you'd make a comment, one of perhaps the largest customer for sand in North America on their conference call, yesterday, said that they see plenty of capacity coming and they are not worried about pricing on sand going forward. I'm not sure how much of that is -- because they got cut short sand in the first quarter, if they've gone out and signed a lot of contracts or if they've just adjusted their contracts to pass this through. But I guess, you kind of commented on the tug-of-war between capacity coming on and demand going up. But what do you guys see at the risks out there to too much capacity in the short run and the idea that people would find ways as the pricing goes up to use less sand by being smart about how they're placed in the wellbore?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [14]

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So I think, Ken, in the short term here, let's call it between now and the end of 2017, the only real capacity additions that we see coming online are the reactivations that are going on across the country and our estimate is that there's 10 million to 15 million tons of reactivations that could occur throughout the year here. The vast majority of those in our experience will be the higher cost mines that were shutoff in the downturn. And look, at the end of the day from a pricing standpoint, which I know is kind of where your question is headed, if those mines get reactivated with their much higher cost structure they become the marginal producers out there in a short market. And so I think that's a pretty positive sign for pricing, quite honestly. I don't see much new capacity coming online in terms of brownfield or greenfield this year. I think we'll see some start to come on in maybe at the very end of this year, like some of our brownfields are earlier in '18. But out for the next several quarters, I just don't see much there. And look, what we're seeing is the market tightening pretty substantially. And we continue to see price increases right through every month so far this year, so we're pretty optimistic on where pricing is going to go in the foreseeable future here.

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Kenneth Irvin Sill, SunTrust Robinson Humphrey, Inc., Research Division - MD and Senior Oilfield Services Analyst [15]

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Okay. Well, that's great. And then just final question. Could you give us any estimate, if possible, on the time line for your investment or acquisition or whatever on the -- more in basin sand in the Permian, Delaware?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [16]

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So we're looking at a couple of different things as we talked about last quarter. So we tend to think about 3 buckets: so we've got brownfields, which expanses our existing site, the greenfield, which you just referred to and then obviously, M&A. I would say kind of starting with the brownfield perspective, we're probably talking plus or minus 4 million tons that we think we could bring online over the next several quarters. I would say, that the first of that capacity wouldn't be online till probably late in 4Q. And then in the first half of 2018, perhaps the rest of that comes online. In terms of the greenfield specifically, I think we can have one or two greenfield sites in the Permian. There are lots of challenges to getting those built and even with all of our 30 years of experience doing this, it's not like you just sort of show up and have shovel-ready projects. There is a lot of work to be done there. So I would anticipate that the first of our greenfield capacity would probably be coming online no earlier than the middle of 2018 and could be as late as the third or fourth quarter, depending on the kind of delays and issues that we hit along the way.

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Operator [17]

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Our next question comes from the line of Jim Wicklund with Crédit Suisse.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [18]

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Bryan, you mentioned 20 million to 25 million tons added locally in the Permian. Are you including the 10 million tons in Winkler County? And is that high-level estimate of how much will be added over the next 2 years? Are those discrete projects that you guys are tracking? I'm just curious to know and this is everybody's question is, how much Texas sand will come on in the next couple of years? And you did a great job of explaining the timing of it. I'm just curious, whether your 20 million to 25 million tons added locally in the Permian includes the 10 million tons we already know about? And then 15 million tons more that may happen or 15 million tons more that's booked? Can you give us a little granularity on that?

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

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Sure, sure, Jim. It's a great question. I know a lot of investors are interested in this. That's everything that we are aware of. And obviously, we're right in the middle of all this. And those are all the, what I would call the potential additions. We tend to be somewhat conservative. And so I think what actually happens is less than that. You're already seeing a lot of things slow down, quite frankly. There are a lot of folks who made big announcements and a lot of splashes and talk out there about what they were going to do. But the realities on the ground are always harder. So once again, when we do our estimates, we sort of assume the "worst case", which would be that 20 million to 25 million tons. I think what actually comes on is probably less than that, if I had to handicap it.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [20]

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Okay. That's very helpful. And you're right, that's the thing investors seem to be most focused on right now. And my follow-up, if I could. You mentioned a 15% to 20% higher sand volumes and pricing. Is that 15% to 20% volume and 15% to 20% higher pricing or is that a combined number? And I'm curious whether that's at the mine gate or you're just talking about a revenue per ton perspective on a recording basis.

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

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Really good question, Jim, I'm glad you brought it up because I could see how that could cause some confusion. So we're talking about 15% to 20% increase in volume and a 15% to 20% increase in pricing. Both, right? And we look at our sales, the things that are on the board in terms of sales opportunities, very carefully. I actually sit down with our sales team every Friday and we spend an hour or so going through all this. And just to kind of give you the inside look to the type of things that we're seeing out there right now, from last Friday's review, we had a lot of sales in the pipeline that are in the sort of mid-to upper 20s in terms of contribution margins per ton, some in the 30s and actually highest prices we had on the board or the highest margins we had on the board were over $50 a ton in terms of contribution margin. So we're definitely seeing a pretty strong comeback in pricing and margins. So it's pretty exciting to see where that's all headed right now.

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Operator [22]

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Our next question comes from Marc Bianchi with Cowen and Company.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [23]

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I was hoping you could help us a little bit with how much Sandbox contributed to the contribution margin in Oil and Gas in the first quarter?

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [24]

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Yes, Marc, we really haven't given that type of detail on Sandbox. And quite frankly, it's not that easy to do because of the -- just how the businesses are really coming together in coalesce.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [25]

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Okay. Well, perhaps can you say that as much as 1/3 of the contribution margin in the segment?

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

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So Marc, I guess the way I look at it, if you think about the Sandbox progression, we've talked about investing $23 million in CapEx to roughly double our capacity in Sandbox from 23 to 46 crews. And we said that we'd have roughly 40 crews deployed, as we kind of got into the second quarter. And we're right on track for that. And we've also previously said that plus or minus a Sandbox crew typically generates around $1 million of EBITDA per year. So I think it gives you -- it kind of gives you a sense of where it is. As Don said, it's become harder and harder to sort of disentangle this, because we have sand delivered to the wellheads and it's kind of a one price and there's lots of different sort of internal things that make it difficult to unbundle it. But hopefully, that gives you a sense of the kind of contribution that we're getting from Sandbox. That said, we saw, obviously, strong increases in sand volume throughout the quarter and both pricing and margin increased every month through Q1, and we're seeing the same, I'm talking for sand now, every month through Q1 and we're seeing that again in April.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [27]

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Okay. I guess, sort of following up to Jim's question on the margins and your comments on the margins. I mean, you threw out a bunch of numbers there in terms of where the market is, but based on, if Sandbox was $10 million or something in the first quarter, that would imply a legacy contribution margin of something like $11. So what's the trajectory for that sand legacy contribution margin realization in the second quarter here, given what your earlier comments were on where the market is?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [28]

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So I think we'll see another nice improvement in that margin in Q2. And you can imagine, as we're starting to get opportunities in the mid-20s, few in the 30s and some in the 50s in terms of contribution margin per ton, that averages up pretty quickly. We've also gone back and are working with some of our customers who have lower priced contracts. And I think, we'll be renegotiating those contracts. I think customers realize that prices have moved. And so all of those things feel like positive tailwinds to pricing as we go throughout the year here.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [29]

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Is it unreasonable to get $20 a ton on average in the second quarter for the sand business, excluding Sandbox?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [30]

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I don't know exactly. I'll allude it to Don, he is more in touch with those kinds of detailed numbers than I am.

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [31]

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Yes, look, I think you could be pushing that number. I think all-in, so if you were just to take a look at the -- at all the contribution margin for our Oil and Gas segment, you're probably in the mid-20s.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [32]

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Okay. Maybe just one more on the volume progression. You mentioned the volumes for the second quarter, but that would kind of put you in nearly the 12.5 capacity that you've got here for the company. What's the limitation on volume growth for the third quarter based on the brownfield expansions that you've got. Are you capped or do you think you'll be able to kind of grow solidly double digits, if the market is there for you?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [33]

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So we're working very hard, as you can imagine, to get more tons in play, given the dynamics in the market today. The teams are just working night and day to try and get more brownfield sooner, given that the customer demand. It's going to be a challenge to get it in 3Q. I think what you'll see is that, as you said, we'll be sort of capped out at 12 million or 12.5 million tons for a little while, anyway. But we're trying like heck to get more of that brownfield expansion that we now have slated coming online in Q3 to try and get some of that in -- sorry, Q4 it's coming online, trying to get some of that into Q3, if we can, Marc. But there's no guarantee to that, given that there's permits to be had and equipment on order. And it's amazing, as we went out and started the project work to do some of this capacity expansion, one of the things we quickly found was that all the equipment manufacturers were pretty busy. And so there are definitely some bottlenecks on things like dryers and screens and I think that's going to be another limitation to the industry's ability, including our ability to add capacity quickly.

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Operator [34]

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

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

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I heard a little bit from some of your peers in the industry that customers who are seeing kind of scarcity of the grades, or the types of sand that they'd like to purchase are actually offering to help finance new-build mines, possibly brownfield expansions. And just curious, if you're seeing any of that and what kind of form that may be is taking thus far, might take going forward?

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

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Yes, so it's a really interesting question, George. And I think that is -- that's one of the things that we're definitely seeing out there. We've had a number of conversations with customers who are amiable to those types of arrangements. And when I spoke earlier about the next-generation contracts, that's definitely one of the options that's in there. And if you can get a customer to prepay or offer some cash up front, certainly it makes the whole contract stickier once they've made that payment.

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

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Great, that's really helpful. And then, just a follow-up around pricing, and you provided some good color. But just curious, if you could speak to the delta in pricing or the pricing dynamics across different grades of sand, whether it be the finer mesh sands and tighter supply moving up more meaningfully, has 20/40 started to move it all? And then maybe if you guys are just selling anymore 20/40 or 30/50 today than you were a quarter or 2 ago?

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

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Well, I think you nailed it. As you've talked about the finer grades being more in demand, so certainly 100 mesh and 40/70 have higher prices today than, say, 20/40. 30/50 seems to be gaining some additional traction out there. But I would say 20/40 is the one that is in the least demand right now. Although, we have seen some customers, particularly in the Midland Basin that think about using more 20/40 and particularly, some of the regional 20/40 we have, like the 20/40 out of Voca, for example. So it's bit of a mixed bag, but generally, the finer grades are in higher demand and we're seeing stronger prices there than we are on the coarse products.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - Director, Oil Service Research [39]

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Great. And then maybe just one more for me, if I could. We continue to hear and you alluded to it as well in your comments that completions are lagging drilling. Would you say that is more a function of -- and you mentioned versus a few months ago, completion crew count up 9%, I think earlier in your comments. Would you say, it's more an issue of frac crews in the field and so, is there kind of some stealth demand out there as frac crews catch up to the drill bit in terms of well completions activity?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [40]

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Yes, I think that's a big contributing factor to it. It seems like there are just not enough frac crew horsepower and other services out there right now. And so I think that it's a great opportunity for our service company customers as things starts to catch up a bit here, where we've -- as we've seen the ducts go up, there could be a surge coming. And I think that's the good news. The bad news is it's going to stress everybody's supply chains again, and I think that could lead us into another round of substantial pricing increase as well. So we'll see how that plays out.

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Operator [41]

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Our next question comes from Ole Slorer with Morgan Stanley.

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Ole Henry Slorer, Morgan Stanley, Research Division - Global Head of Energy Research, MD, and Oil Service and Shipping Analyst [42]

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I'm sorry, I was stuck on another earnings call this morning, which I can tell you, wasn't nearly as exciting as your earnings call, so I think I've hit a home run. But...

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

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Well, I'm disappointed. You didn't tune in to our call first? I can't believe it.

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Ole Henry Slorer, Morgan Stanley, Research Division - Global Head of Energy Research, MD, and Oil Service and Shipping Analyst [44]

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I regret it, sincerely, I have to tell you, since yours is clearly where the action is. But I'm sorry to -- I heard Wicklund talk about it, but I'm sorry about getting back to something you probably already have addressed. But it's sort of all the questions we get is about all this traditional high cost operators compared to you claiming that they're buying low-cost sand, which in itself seems like an oxymoron. You must, I mean, you raised a bunch of capital. You have not been able to bring it all to work. So could you give us your sense, again, I'm sorry you've already done it, but of why you turned some of these things down? And what you think that the truthful cost is on some of the things that are being accounted as low cost?

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

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Yes, it's a really good question, Ole, and as you can imagine, we spend a lot of time looking at all sorts of alternatives and working with our customers to make sure we understand their needs. And so that's why we're starting all this. We work closely with our customers and we see others out there buying things that sort of looks perhaps like desperation in some cases. But we tend to focus on what the customers want and work our way back. And so I think we are focused on the most attractive, best positioned M&A and greenfield opportunities in the space. And our team has a pretty good rubric to sort that out to make sure that we make the best decisions. And I think you can see from some of the things we've done, whether it's the capacity expansion we've announced or the M&A that we've done that we've been fairly disciplined in what we've -- what we focused on. So I think we'll continue to do that. Some opportunities, as you said, that look great on the surface, but when you dig in you find lots of different issues. And once again, it goes back to the customers. As we're considering opportunity, we'll go talk to some of our larger customer partners and ask them what they think about it and depending on the feedback we get there that tends to inform our decision pretty substantially.

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Ole Henry Slorer, Morgan Stanley, Research Division - Global Head of Energy Research, MD, and Oil Service and Shipping Analyst [46]

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Yes, I would imagine that having being effectively the only buyer with a strong balance sheet back when everybody else was a seller and you didn't bite. So I mean, is it fair to say that you've screened all of these opportunities?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [47]

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I think we've screened everything. Some of them we've screened them 2 or 3 times. And one of the other questions we ask ourselves is, not just what was good today, but where are things going in the future. So we tend to look at kind of who the winners and losers are going to be in terms of locations and products. And we're looking to go kind of where the market's moving in the future, not perhaps where it's been in the past.

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Ole Henry Slorer, Morgan Stanley, Research Division - Global Head of Energy Research, MD, and Oil Service and Shipping Analyst [48]

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Okay. And by the way, I would encourage you, never to tell anybody how much money you're making on Sandbox, it's particularly not an attractive market, it's tight.

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Operator [49]

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Our next question comes from Kurt Hallead with RBC Capital Markets.

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Kurt Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [50]

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That was great color so far this morning and if my math is correct, the way you kind of spelled out your volumes and your pricing progression, it looks like your revenues are going to be well north of $300 million in the second quarter. Whereas, The Street's probably sitting at $290 million. So I think that's a point of consideration that everybody on this call needs to think about as we go forward. Now on a -- did I hear you correctly, you talk about contribution margin per ton in Oil and Gas potentially being in the mid-$20 range for the second quarter. Is that what your answer to Marc's question was?

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Donald A. Merril, U.S. Silica Holdings, Inc. - CFO and EVP [51]

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That's right.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [52]

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Yes. That's for the combined Oil and Gas, everything we do there, the whole segment.

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Kurt Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [53]

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Okay, great. Awesome. Now in terms of -- you mentioned a very interesting dynamic about the bottlenecks in bringing some additional capacity into the marketplace. I clearly don't think that's been a focus on the investor mind. I think it's basically, put a shovel in the ground, bring it to the well site, put it down whole. And all this Permian muck brown sand is going to replace all the high-quality stuff. So can you talk a little bit more about the bottleneck? And how long it might actually take for some of the supply to hit the marketplace?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [54]

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Sure, Kurt. As we said in our prepared remarks and as I talked about on a few of the questions already this morning, these projects are not shovel-ready. It's easy to sort of ride through a Winkler County and you see dunes of sand and it looks like you could just go out there with a shovel and start putting it into the market and nothing could be further from the truth. We face, in our own work here, a number of challenges like water, permitting, just the infrastructure out there is not great. The roads are not set up to handle thousands and thousands of trucks, which we're talking all trucking here for the most part. Just the availability of trucks, availability of equipment. These things are getting very expensive too. It seems like the prices are going up for land in some cases. Everything is getting more expensive. And I think the one that everybody seems to have just overlooked completely is the fact that, you need contracts for these sites. We called it sort of field of dreams in our prepared remarks, but I don't see a lot of energy out there in the part of smart investors to just build something in the hopes they can sell these products. They're specialized products, certainly there are some customers that want these products, some of the energy companies, but some don't. We have a number of energy companies that we talked to that are telling us they don't want to use those sands and don't plan to use them. So you have to be smart. You can't just go out there and put up a site and hope that someone will come. And I think that one of the real bottlenecks, as I said, that's been overlooked is that, once the company that want to purchase these tons or their service companies have contracted up all their needs, there is no need for additional mines. And so I think that's going to be a bit of kind of a self-governing mechanism as well to oversupply.

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Kurt Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [55]

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Yes. Now I think in the past, you guys have kind of laid out some supply cost curve. Have you guys given that some additional thought and can you give us an update on was it -- how much can be supplied at $20 a ton and how much could be supplied at $40 a ton? You got any updates on that, some perspectives on that for us?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [56]

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Sure. So one of the questions we get from investors is with this new low-cost capacity coming online in the Permian, how does that change the cost curve? Does it flatten it? And what are the impacts? And so if we look at kind of the high side of what could come online in the next 12 to 18 months, and that's 20 million to 25 million tons of Permian greenfield capacity that we mentioned earlier. It's going to shift the cost curve in the Permian to the right a bit, that's for sure. But if you look at our projections and I think anybody who looks at this seriously will see the same thing. That the market's still going to be short, given the demand that we see out there today and the projections for growth. So the incremental tons into that market are likely to still be high cost, a relatively high cost Northern White tons. So I think the -- so the question behind the question is always what does it do to pricing? And as long as those incremental tons are still in the market, I think the pricing holds up pretty substantially. The good news for us is, in any scenario, we're going to be on the far-left side of that cost curve at the very bottom of it. And so we're going to enjoy, I think fantastic margins and volumes in almost any scenario you could imagine. And we also get the question, well, as these tons come in sort of which tons gets pushed out. I think it's probably some of the uber-high cost tons that are being reactivated in the Permian today. I think those are the ones that perhaps suffer as some of this new capacity comes online more locally in the Permian.

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Kurt Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [57]

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Yes. And then there is some discussion from another midsize service company about non-API 200, 300 mesh. I mean, what's your sense on the marketplace for that type of sand?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [58]

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Yes, it's a really interesting question. And I've seen some of the technical work that's going on there. And it looks like there is potentially very interesting well improvement dynamics associated with the 200 and 400 mesh-type products. The good news about these products is that they go all the way out to the tips of the fracture and so these are sort of plus one products. The way they're used is that they're pumped in first and then the normal proppant load is pumped in behind that and these small side proppants get all the way out to the tips of the fracture. And this product is a -- it's a manufactured product. We know that because we've been doing it for several decades here at U.S. Silica for our industrial businesses. So we're very interested in this and following it closely. As far as I'm aware, we're one of only 2 companies in the U.S. that has the capability to manufacture these type of products, and I believe we have by far the largest manufacturing capacity base. So to the extent these products take off, it'll be good news for U.S. Silica.

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Operator [59]

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Our next question comes from Brandon Dobell with William Blair.

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Brandon Burke Dobell, William Blair & Company L.L.C., Research Division - Partner and Group Head of Global Services [60]

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Bryan, as you've talked about some of these, I guess next-generation contract negotiations, let me put in context whether a Sandbox is a push, a pull, if you're making that a real strong pillar of how these contracts get structured, or what kind of contracts you're actually even looking at going after? Just trying to get a sense of how tightly you're trying to make this -- these two things together with these new contracts as opposed to just taking whatever comes down the pipe?

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

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So it's a really interesting question. And I would say that every customer we talk to, whether there is a contract on the table or whether it's just a normal sort of customer-supplier discussion, we get into Sandbox and usually, at the request of the customer. So certainly, Sandbox will be an important part of many of these contracts. We'll see contract, I think that perhaps have delivered to the wellhead pricing. Also the next-generation contracts that are associated with either brownfield or greenfield capacity, we have the opportunity to customize the load outs at those facilities to take advantage of all the things that Sandbox has to offer. I was talking with our Sandbox team the other day and I heard a fascinating statistic from them. They said that that they estimate, depending on how the work is set up, that we need 25% to 50% fewer drivers and trucks per ton of sand that gets delivered with Sandbox versus pneumatics. And in an era where trucking is short, truckers are short, that's like gold, right? And so I think it explains, perhaps more clearly than anything, why there's this a thirst for Sandbox out there. There's all kinds of other benefits to Sandbox, but I think customers recognize that. And the fact that you don't need as many drivers or trucks is a big advantage in this market.

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Brandon Burke Dobell, William Blair & Company L.L.C., Research Division - Partner and Group Head of Global Services [62]

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Okay. And as we think about your capital needs through the balance of the year, it sounds like there's lot of upper pressure on, at least, the opportunity for more crews. What's the likelihood or how do we frame out the context here that you come back in a quarter or 2 and say, "Look, the trajectory on demand for crews heading into '18 is just a lot stronger, because like the contract types were signed and then we've to push faster for more crews?" Or you say, "Look, we're comfortable with that because we want to maintain control of the process and those kinds of things?"

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [63]

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So I think we'll be very disciplined on that, Brandon. And to the extent we have demand indications that customer is willing to sign contracts, I think we won't hesitate to invest additional capital. I feel like we stake out a market leading position here. We're far and away the largest in the containerized sand sector and we want to add to that lead. And once we get customers locked in and sort of converted over to our system, it feels like we'll hold a lot more of that share longer the faster we get it now. So we're not averse to investing further, I think our board has been very excited about the potential of Sandbox, as are we all. So we'll make the appropriate investments depending on the signals that we get from the market.

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Operator [64]

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And our final question comes from the line of John Daniel with Simmons & Company.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [65]

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I apologize, I'm driving now so I don't have the luxury of typing in Excel. But just want to come back to the contribution margin guidance. It seems like is the revenue per ton -- when you refer to pricing at 15% to 20%, are you specifically referring to that revenue per ton?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [66]

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We're specifically talking about mine gate pricing going from 15% to 20%.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [67]

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Mine gate. Okay. All right, then I'll prefer that you then answer my question on that. The business development expenses that you guys have, how much of that -- is that mostly third-party-type folks assisting you or is that internal costs and then...?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [68]

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It's mostly third party.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [69]

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Third party. Obviously, you guys have been pretty active in looking at stuff, what is the probability of something happening with you this year within the Oil and Gas segment?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [70]

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So we continue to have a robust pipeline across both Industrials and Oil and Gas. And it's hard to assign probabilities to these things, John, because they're obviously binary, right? They either happen or they don't. But, I think that over the next several quarters I'll be surprised if there's is not an acquisition into the Oil and Gas space and it could be another small one in ISP as well. If we find another one like the cool roof that we just completed, that's going to be a home run for us. So we're looking for those great deals that we can really grow quickly.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [71]

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Okay. But has the reaching contraction at great prices for sand names, I mean has that -- may be someone who isn't thinking about selling at cost given the run up in the stock prices is now coming back to you saying, "Hey, let's talk again." Has there been any change in attitude amongst sellers?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [72]

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We've seen some of that. It's tricky. You want to find a sweet spot and if prices drop too much, people feel like they're selling too cheaply. If prices go up too much, obviously, we're not happy with the price we have to pay. So we're always looking for that sweet spot I think in Sandbox and NBR, where we're able to just to kind of find those right times where it made sense for everybody. But as we know, time is the enemy of any deal. We've had a number of things on the board that were fairly far advanced and for one reason or another, typically market or price movements like you're describing, one side of the other didn't like the deal anymore. And we just couldn't get it done.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [73]

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Okay. Fair enough. And then just a final one, if I could get you to pile on Q3, and by the way thank you for the guidance this quarter. It was very helpful. But just looking at the nature and the timing of the pricing improvements that you're seeing now, would you feel comfortable saying that at least Q3 could see another double-digit revenue per ton increase?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [74]

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Look, I think it's possible. Obviously, this -- the market changes pretty quickly. But given the dynamics that are out there, the number of ducts that we're starting to see, assuming that we get a positive read through on oil pricing, coming out of the OPEC meeting, all of those factors. Well, I think it's possible that we'll see continued tailwinds there. And I kind of use as my leading indicator, my -- we've been meeting there with our sales team, as I mentioned earlier, and one of the things on the board with relatively high margins that makes me optimistic that those are going to read through. So I would say, cautiously optimistic that we could achieve what you described.

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John Matthew Daniel, Simmons & Company International, Research Division - MD and Senior Research Analyst, Oil Service [75]

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Okay. And then I'm going to squeeze one final one. And did you reference a -- some sales, I think it's $50-type contribution margins per ton. Can you say is that coming out of Texas, is that coming out of Illinois? Just in regards from where you're getting that?

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [76]

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So those particular sales were not coming out of mines in the region.

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Operator [77]

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We have come to the end of our question-and-answer session. I would now like to turn the call back over to Mr. Bryan Shinn for any closing remarks.

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Bryan A. Shinn, U.S. Silica Holdings, Inc. - CEO, President and Director [78]

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Thank you very much. I'd like to close the call today with a few key thoughts. The Oil and Gas market has continued to strengthen and we expect substantially higher sand demand in the second quarter and for the rest of '17, resulting in higher prices and margins as we've talked about on the call today. The rapid increase in sand consumption across the industry should also continue to drive very strong results in Sandbox. With demand rising rapidly, I feel we need to add capacity and our plans are on track to do so. We believe that the market will continue to remain tight for the foreseeable future. We also have several very interesting opportunities in our Industrial businesses, which we didn't talk about today. But I think those are going to result in further rapid growth and substantial profit and cash generation in that sector of the company. In short, it's a great time to be the market leader in the sand business today. So thanks, everyone, for dialing in, and have a great day.

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Operator [79]

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