US Silica Holdings Inc (SLCA) 2012 Q3 法說會逐字稿

Good morning and welcome to U.S. Silica's 2012 third-quarter conference call. Just a reminder, today's call is being recorded and your participation implies consent to such recording.

At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. With that I will turn the call over to U.S. Silica.

Good morning and thank you for joining us for U.S. Silica's third-quarter 2012 earnings conference call. I am Don Merril, Vice President of Finance at U.S. Silica. With me today are Bryan Shinn, our President and CEO, and Bill White, our 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 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 the press release or our public filings for a full reconciliation of adjusted EBITDA to net income and definition of segment contribution margin. We issued a press release yesterday evening and expect to file a quarterly report on Form 10-Q with the Securities and Exchange Commission later today.

At this time I will turn the call over to Bryan Shinn. Bryan?

Thanks, Don, and good morning, everyone. I will begin today by sharing highlights of third-quarter performance followed by an update on our two business segments -- Industrial and Specialty Products, or ISP, and Oil and Gas Proppants. I will also discuss key market trends and provide a progress report on our two new plants which are under construction. Then Bill White will update you on our detailed financial results and guidance for the fourth quarter of 2012.

I am pleased to report that despite widespread weakness in the well services sector our unique business model continued to deliver strong, consistent results. For the third quarter of 2012 U.S. Silica achieved record performance in volume, revenue, and adjusted EBITDA, exceeding the high end of the guidance that we provided in our last earnings release.

Specifically, on a year-over-year basis volume increased by 19% and revenue by 58%. On a sequential basis volume rose 6% and revenue 11%. Adjusted EBITDA of $37.5 million increased 57% year-over-year and 2% sequentially. Third-quarter earnings per share were $0.36, $0.01 down over last quarter due to higher income tax expense, but still up 76% year over year.

Based on these results and a strong start to Q4, we expect full-year adjusted EBITDA to be higher than we indicated in our last call and Bill will share the details later in today's call.

Our continued outperformance is being driven by many factors including our highly differentiated logistics footprint, unique asset base, strong customer relationships, and deep organizational talent. I am especially proud of our team having achieved outstanding results during the first three quarters as a public company in what has been a markedly volatile environment for domestic energy services companies. Our financial performance during this time validates the power of our business model, which balances the upside growth potential in unconventional drilling with stable industrial markets.

Now let's turn to the details starting with our Industrial and Specialty Products segment. Today ISP accounts for approximately 45% of corporate revenue and 60% of our volume. The segment continues to provide consistent, reliable performance and excellent cash flow.

In Q3 contribution margin was up sequentially about 1% due to strong demand in the glass market and seasonality. Additionally, we continue to see increasing demand for our specialty products serving the renewable energy, foundry, and chemical markets. We also believe that our ISP business has further room for growth in the near term as the housing market continues to recover.

Additionally, we plan to shift our offering mix over time to more specialized products and solutions, which we expect will drive future revenue growth and margin expansion.

Next, I would like to spend a few minutes talking about our Oil and Gas business segment. Volumes, revenue, and contribution margin in Oil and Gas business were up 68%, 167%, and 120% year over year and 12%, 18%, and 3% sequentially. We are very pleased with these results, especially in comparison to our strong second quarter.

One item to note, our Oil and Gas segment contribution margin grew a bit slower than revenue and volume for the following three reasons. First, we encouraged some one-time costs associated with meeting stronger-than-anticipated customer demand during a planned maintenance outage on one of four dryers at our Ottawa plant. These costs will also impact the first half of the fourth quarter but will not recur after that.

Second, we experienced a mid-single-digit percentage spot price reduction during the quarter. And, third, we fulfilled a surge in demand for our finest product grade, adding incremental volume and increasing overall profitability but at a lower margin.

Before moving on, let's also talk for a few minutes about our view of overall oil and gas industry dynamics relative to our business. The North American frac sand market continues to be very strong and use a high-quality Northern white sand appears to be increasing. We experienced robust demand for our Oil and Gas products during the quarter and we are sold out of most grades.

While we are closely following the decline in rig count and industry discussions about a budget-driven slowdown at the end of the year, our orders remain very strong in October.

In terms of proppant supply, we are seeing several emerging dynamics that over time will constrain high-quality, low-cost capacity additions. For example, service companies are increasingly reluctant to help fund startup mines through take-or-pay contracts as they were willing to do over the last two years.

Also, after reviewing many potential greenfield sites, it is our strong opinion that most of the best sites in Wisconsin have already been taken. Further, permitting is becoming much more complex and projects by new entrants are facing increased community opposition. We believe that new entrants will struggle in the coming years due to lengthening construction timelines, higher cost structures, limited logistics from single-mine operations, and increasingly demanding customers.

We recognize that our strong year-to-date and Q3 results appear out of sync with much of the North American service industry, so I would like to discuss some of the factors that are driving U.S. Silica's success. First, despite low natural gas prices and a decline in gas directed rig count, we have continued to see our sales into the Marcellus increase. As we mentioned on previous calls, we enjoy a significant freight advantage to this basin and we expect a continued decoupling of our revenue trajectory to gas rig count in the Marcellus.

Second, the oilfield service providers are in a position to streamline and limit their sand supply base to only the largest and most logistically capable providers, those with multi-rail, multi-basin, and multi-plant capabilities -- all of which advantages U.S. Silica. We expect to see this trend accelerate in the next three years, especially as contracts with smaller sand producers expire and we continue to add new capacity.

Third, we believe that proppant usage per rig continues to increase. Drilling rigs and pressure pumping equipment are getting more efficient, and while rig count and horsepower utilization may have declined, we believe that proppant usage has continued to grow due to more wells drilled per rig and a longer average lateral length per well. These are technology-driven efficiency programs and we expect proppant demand to continue to grow at rates higher than the rest of the industry.

Finally, Northern white raw sand is becoming the proppant of choice from a performance and economic standpoint. In terms of performance, we believe that non-API proppant producers will continue to struggle to find customers to buy their products. In terms of economics, we believe that raw sand will continue to gain market share and expand its dominant position as the proppant of choice.

Now let me give you an update on where we are with some of our previously announced initiatives. First, we continue to make good progress on the new resin coated sand facility that we are building in Rochelle, Illinois. We expect that the plant will come online as planned in the first quarter of 2013 and we have begun discussions with potential customers regarding initial purchases.

We recognize that we are entering a challenging market where demand for resin coated sand has softened, primarily due to the rapid decline in Haynesville activity and some substitution of raw sand for resin coated sand. Pricing has also declined to the sub $400 per ton level in many areas. Given this, it will likely take longer than originally planned for us to sell out our new resin coated sand capacity.

However, as we have stated on previous calls, we continue to believe that we can build a long-term profitable position in the market based on two factors. First, we produce the highest quality raw sand for our substrate, which is the single most important factor in the performance of resin coated sand. We also have our choice of raw sand sizes to coat, allowing for a quick response to market needs.

Second, we chose to locate our coating facility in Rochelle, Illinois, near our raw sand mine in Ottawa, Illinois, which gives us a significant logistical cost advantage versus some competitors who either aren't backward integrated or who ship sand hundreds of miles to their coating facilities. This backward integration enables us to have a low-cost position in the industry and, consequently, we believe that we can attain a high return on investment in the Rochelle capital project even in a lower, more competitive market price environment.

We also made significant progress with the greenfield raw sand plant that we are constructing in Sparta, Wisconsin. This project is on schedule for a second quarter 2013 startup. Initial production capacity, as we have stated previously, will be between 750,000 to 850,000 tons of largely course sand, the majority of which we expect to ship into the Bakken.

We anticipate that a limited amount of sand may be reduced during the first quarter of 2013, which should not have a material impact on our total volumes for the year.

Finally, we continue to expand our logistics capabilities. We have now shipped two unit trains from our Ottawa facility and are equipping Sparta with the same capability. Unit trains are 70-plus railcar trains that travel express between our plant and the target basin. This drives down costs and speeds delivery time to our customers.

As we announced previously, we are also building a 500,000 ton per year Eagle Ford transloading facility in San Antonio in partnership with the BNSF, which will be capable of receiving those unit train shipments.

Before I conclude my remarks, I would also like to discuss the announced succession of U.S. Silica's Chief Financial Officer. As you saw in our press release last month, Bill White is retiring at the end of the year. On behalf of our Board and all the employees of U.S. Silica, I would like to thank Bill for his 21 years of service and wish him the best in retirement. Bill, we couldn't have done it without you.

I would also like to welcome Don Merril to our team. You heard Don earlier in the call when he did the introduction. Don brings a wealth of public company experience, and I am pleased to introduce him as our next CFO. Don is with us today and certainly you will hear more from him on future earnings calls. Don, welcome.

Now I will turn the call over to our Chief Financial Officer, Bill White, to discuss our financial results in more detail and to update you on our guidance. Bill?

Thank you, Bryan. Good morning, everyone. As Bryan indicated, the third quarter of 2012 was another solid quarter of earnings for U.S. Silica. There were 1.9 million tons sold in the third quarter compared to 1.6 million tons sold in the third quarter of 2011 and 1.8 million tons sold in the second quarter of 2012.

Our increase from the second quarter to the third quarter was driven by strong demand for all of our products, especially in the Marcellus, Eagle Ford, Permian, and Bakken Shale plays.

Revenues for the third quarter of 2012 were $115.9 million compared to $73.5 million for the same period in 2011 and $104.6 million for the second quarter of 2012. Nearly all of the revenue increase came from the Oil and Gas Proppant segment.

On a quarter-over-quarter basis, revenue for the Oil and Gas segment grew 18.4% to $64.5 million and revenue for the ISP segment grew 2.5% to $51.3 million during the third quarter. Adjusted EBITDA for the third quarter was $37.5 million, net income was $18.8 million, and earnings per share were $0.36 compared to adjusted EBITDA of $23.2 million, net income of $10.3 million, and earnings per share of $0.21 for the third quarter of 2011.

Volumes for the Oil and Gas segment for the third quarter of 2012 were 769,000 tons and the contribution margin for the Oil and Gas segment was $34.2 million, as compared to 459,000 tons and a contribution margin of $15.6 million for the third quarter of 2011. Volume for the ISP segment was 1.1 million tons and the contribution margin for the ISP segment was $14.2 million for the third quarter of 2012, as compared to 1.1 million tons and a contribution margin of $13.7 million for the third quarter of 2011.

SG&A expense was $10.1 million for the third quarter of 2012 as compared to $5.2 million for the same period in 2011. The increase in SG&A was driven primarily by continued additional staffing to support the growth in the Oil and Gas segment and to meet additional administrative requirements of a public company.

Interest expense was $3.3 million as compared to $3.8 million in the third quarter of 2011. The decline in interest expense year over year was due to the conversion to equity of a note due to our previous owner immediately prior to our IPO earlier this year.

Turning to cash flow and liquidity, cash and cash equivalents were $93 million as of September 30, 2012, as compared to $102.6 million as of June 30, 2012. The decrease was the result of our increased capital spending rate and there were no significant unusual items affecting cash flow during the quarter.

U.S. Silica incurred capital expenditures of $36 million in the third quarter of 2012 versus $24 million in the second quarter of 2012. The majority of the capital was spent on the construction of the Rochelle and Sparta plants.

At this point we are unsure of the effect that the recent East Coast storms will have on our Q4 performance as completion activity in the Marcellus may be impacted. Assuming minimal impact, we are providing fourth-quarter guidance of $100 million to $110 million in revenue with adjusted EBITDA of $33 million to $37 million.

Last quarter we guided you to the lower end of the range for 2012. We are now pleased to say that we expect to exceed that guidance and be in the range of $423 million to $433 million for revenues $144 million to $148 million for adjusted EBITDA, and $98 million to $108 million of capital expenditures.

Now I will turn the call back over to Bryan.

Thanks, Bill. I would like to close today with a summary of our 2012 performance as a public company.

The first quarter was characterized by sudden rig and fleet movements away from dry gas basins. This industry wide disruption caused severe spot sand shortages across many oil and liquid-rich basins where activity had spiked. We thrived in that environment and delivered above guidance Q1 earnings due to our outstanding supply chain network, scale, flexible production, and rapid response capabilities.

In the second quarter the oil and gas industry experienced an abrupt tightening of CapEx budgets due to a sudden drop in oil prices, causing service providers to be cautious in their purchases of sand. We responded by aggressively working with our customers to supply sand from our expanded in-basin distribution network, which enabled us to deliver high end of the range earnings versus guidance.

In Q3, while rig count continued to decline, we drove record demand for our products through service differentiation and delivered the best earnings quarter in the history of our company. In Q4 and being, while we will undoubtedly experience new challenges, we expect to continue to deliver outstanding financial results while exceeding our customers' expectations. Our confidence in this comes from a number of factors.

First, we have a strong, experienced management team that is focused on execution and delivering bottom-line results. We also have differentiated capabilities versus the majority of our competitors. It may sound simple, but our multi-rail, multi-plant network enables us to rapidly and cost-effectively deliver millions of tons of high-quality sand across all grades to almost every shale basin in the US.

Due to rapidly shifting basin activity, this is becoming an increasingly important strategic supplier selection criteria for North American well service providers. In addition, our reputation for quality and service are critical differentiators which enable our customers to focus on maximizing equipment and workforce utilization without worrying about whether the specific proppants that they have ordered will arrive on time.

Lastly, we have a low production cost structure which we believe is at the bottom of the industry curve. This cost advantage is especially pronounced when compared to a number of new entrants into our industry who have cut corners in their rush to market.

That concludes our prepared remarks this morning, so let's open up the lines for questions.

(Operator Instructions) Ben Swomley, Morgan Stanley.

Good morning and congratulations on a fantastic quarter.

Thanks, Ben.

I just wanted to follow up on some of your guidance comments there. Some quick math suggests that you are raising fourth-quarter revenue but maybe lowering fourth-quarter EBITDA guidance just a little bit compared to where we were three months ago.

Can you just give us a little bit more detail around that? Is this a timing issue of deliveries from 4Q actually hitting 3Q, or what exactly is -- how are you thinking about it?

Ben, I think that we are raising revenue guidance. I don't think we are actually lowering the 4Q guidance on adjusted EBITDA. We have actually just kind of narrowed the range for the full year.

We are still looking at $33 million, $37 million in adjusted EBITDA for the quarter. That is roughly in line with where all our other quarters have been. We have been right at $37 million and there is a little bit of uncertainty into the fourth quarter.

So we are still very comfortable with where we are going. There is not really a move between quarters; we think we are still very consistent with where we have been all year. In fact, again, we have just narrowed the range a little bit, taken up both the bottom and lowering the top.

Okay, that makes sense. And I think you mentioned about three reasons why the frac sand contribution margin came down a little bit in the quarter sequentially. Can you just quantify for us about how much of the decline comes from each of the different items?

I know that we want to give you an exact quantifying too closely, but what we can do is we will tell you that the largest impact was due to product mix. About 40% of the increased volume came from 100 mesh and we did see a shift towards the finer grades overall in the third quarter. And those do tend to sell at a lower ASP.

So it is mix and it was an especially surprisingly strong quarter for us on 100 mesh. That would have been the largest. The second largest item would have been the cost increase. We had a dryer down at Ottawa, one of our four dryers, for about a six-week period; three weeks in September and three weeks in October. So you are going to see a similar impact related to that in 4Q as well.

Then the least, but one that certainly did have an impact, is we did continue to see a limited amount of spot price reduction. Again spot prices are only -- spot sales are only 20% to 25% of our overall Oil and Gas volume. But that market has continued to soften slightly, but not where it was in 2Q.

Okay, so the increased sales of 100 mesh, that is still a positive. Even though it is dilutive maybe to the average number, it's still more dollars in the door. But then with Ottawa, with the dryer down at Ottawa three weeks in 3Q, three weeks in 4Q, then in 1Q everything should be back in line. So is that a little bit of a tailwind then in 1Q?

Yes, Ben, this is Bryan. I think that is a good way to think about it.

And to your point around 100 mesh, to the extent that we can sell additional 100 mesh that is just kind of money in the bank for us, even though it does lower our percentage margins. But it is still a net positive drop in EBITDA to the bottom line. So as we saw the strong demand there in Q3 we were really excited to be able to fulfill that.

Just to sneak one more in if I can. On the topic of spot pricing, can you quantify for us a little bit, I think you did it last quarter, the average spot pricing this quarter versus last quarter and maybe the direction through the quarter?

Sure. So maybe I will start off and talk just a little bit more broadly around spot pricing, I know it is something that a lot of folks are interested in.

Just to put it in context, as you know, Ben, we have about 80% of our volume that is under contract for Oil and Gas, so we are only talking about 20% of our oil and gas volume. I would say in Q3 if I was going to characterize the spot market it was a lot like Q2 in that it was choppy. So it was kind of by basin, by grade, almost by day we saw changes there.

We saw a couple percent decline quarter over quarter. If you recall, on last quarter's earnings call we said we saw about an 18% decline from Q1 to Q2. We didn't see anything like that in Q3; it was a much lower decline. But I will say that our spot pricing still remained substantially above our average contract price.

So we feel pretty good about the balance between spot and contract pricing, and we believe that over the long term the kind of steep industry cost curve that we have is going to continue to support strong margins for low-cost players like U.S. Silica.

Okay. So it sounds like maybe a little bit lower but not really moving directionally through the quarter, just kind of choppy?

Yes, it was choppy through the quarter and it's a few percent lower, but nothing like the move that we saw coming off the really high prices. If you remember, Q1 had really high spot prices and we saw the steep decline into Q2.

Okay. But I guess what I'm trying to get at is where we came out of the quarter are we entering the fourth quarter below where we were entering the third quarter?

So we can't really provide forward-looking guidance on prices for Q4. I believe we did say in our prepared remarks though that October looked like a pretty strong month for us, and so we feel really good about the way Q4 has started.

And that is part of what drove us to start talking about middle of the guidance range and kind of moving things up versus what we said on the glass ball where we directed people more towards the lower end of the range. So the great performance in Q3 and then the strong start to Q4 has us feeling pretty good about the rest of the year.

Perfect. Thanks a bunch and congrats again on a great quarter.

Doug Garber, Dahlman Rose.

Good morning, guys. Can you give us an update on your effort to sell more in the basin as opposed to FOB mines? Just throughout the year how much you sold FOB basin and where that is now, beginning of the year, and where you expect it by the end of the year.

It's a great question and certainly has been one of our strategic priorities in 2012 to enhance our what we call internal distribution network, if you will. So the basin sales. We started out the year we were less than 10% of sales that were sold in that manner, i.e., through transloads. I think year-to-date, if you look at how we finished the third quarter, we are probably closer to 50%, Doug. And so I think we will continue to drive that number up.

We don't have a specific target for year-end, but in Q1 we are going to open our large, new unit train facility, transload facility down in San Antonio so I think that will help us increase that number. Certainly it is one of the things that has helped us be successful as we look at Q3, and I think it is one of the differentiators between us and a lot of other folks in the industry.

In terms of quantifying that I mean of your, I guess, [146], take the midpoint of the adjusted EBITDA range, how much of it would you say is from adding this logistics portion, if you are willing to go into that sort of detail?

It is really a hard question because one way you could look at is you could say, well, how much additional margin do you make off of doing that? The way I look at it though, in addition to that, the real benefit is it allows us to forward staged material out in the basin where customers want it.

And I will give you an example. We had one of our contract customers call us up just a couple of days ago. They had gotten a piece of work on short notice to go in and do fracking and completing of several wells, and they needed something like 10,000 tons of sand to start shipping in two days. And so if we didn't have the inventory out in the basins we wouldn't have been able to get that work.

We are seeing that a lot of the service companies are getting work on much shorter notice than they have done in the past, and so we have been very responsive to that. We have adjusted our supply chain priorities so that we have the product out in the basins where they need it, and I think that helps us get a lot of additional sales.

Thanks, that is helpful color. Another question, I guess the biggest surprise this quarter was in terms of the Oil and Gas volume. And I guess that was from 100 mesh sand. Do you expect that sort of run rate of about 3 million tons kind of quarterly to continue, or do you think this 100 mesh strength is just kind of a one-time thing?

So if you look at our Oil and Gas volume we were up 12% sequentially and about 60% of that was from non-100 mesh, so we had really good strength in the API spec grades as well. We are seeing a pickup in 100 mesh in the market. Once again, it comes back to having the right product in the right place at the right time.

We are seeing a fair amount of that in the East, so as we look in the Marcellus obviously 100 mesh is going pretty strong there. I think our position there as low-cost supplier with excellent logistics is allowing us to differentially get more volume in the Marcellus.

Long-term obviously things are going to be driven by rig count, but I was pretty interested in some of the information that has come out on some of the E&P earnings calls. I was listening to the Pioneer call and they said a couple of things there.

One of the things they said is they are seeing average drilling feet per day increase 28% over the past five quarters. And that is the kind of thing, obviously, that is going to drive a lot of demand. They may be kind of at the leading edge of the industry, but others are probably seeing that.

We are also seeing expanded use of white sand. Pioneer mentioned that it had 74 wells through Q3 year-to-date where they have replaced ceramics with high-quality Northern white sand and they are getting excellent results out of that. So to me those are the kind of things out there that are really going to drive demand, and we are extremely well-positioned to be able to respond to that.

One more question, I guess, on the Sparta facility. When are you going to look for contracts for that capacity? And if you are currently in the market for those contracts, where do they compare to the ones you signed last fourth quarter?

So we are probably six to eight months away from producing significant volumes at Sparta, so we are kind of in the early phases of talking with customers. Obviously there is a lot of factors to consider there. Part of it is waiting to see how the 2013 drilling budgets come out from the E&Ps and trying to get a sense of where that is going, where is the supply demand balance for 2013. And so we want to see all that before we start locking into things.

So I think it is a little ways off yet, Doug, before we have some things to come back and talk about on that. But certainly in the coming couple of quarters here as soon as we have something we will be out talking to you all about it.

Just wanted to clarify one other comment you made. You said resin coated sand is sub $400 a ton. Is that FOB mine or is that delivered? Just trying to get a sense of that data point.

So that is delivered, delivered to a transload.

Okay. And just one quick one. Your tax rate I think creeped up a little bit this quarter. Maybe this one is for Bill; for Q4 what are you expecting and why the creep up in Q3 a little bit?

The creep up in Q3 was primarily the true-up for the 2011 tax return. There may be a slight creep up in Q4, but it is going to be fairly negligible. It is more a Q3 issue.

All right. Thanks, guys. I will turn it back.

Doug Becker, Bank of America Merrill Lynch.

Thanks. On the volume side, one, just to get a sense for what you view as typical seasonality going into the fourth quarter, it looks like historically there has generally been a bit of a decline but what would you attribute the seasonality?

On which side?

You are talking about Oil and Gas, Doug, or --?

Oil and gas, yes.

Oil and Gas. So Oil and Gas is interesting; we -- initially as we got into this business we saw a bit of seasonality and I think particularly in basins like the Marcellus where the fracking crews were still figuring out how to navigate mountains and work in cold weather. Over time we have seen less and less of that as the infrastructure has come in.

I would say to the extent that we have seasonality now it is really driven by drilling budgets. You have heard several of the service companies talk on their earnings calls about potential end of the year slowdowns as drilling budgets run out and maybe taking extended holiday outages for their crews. And so that is what we are looking at right now; working with our customers to understand where that is going to go.

But I have to say, at this point we haven't seen any slacking off in the demand in fourth quarter. It is running pretty strong. What we have seen in the past is that it can also slow down pretty quickly as well, but as of now customers are giving us really strong forecasts through the end of the year.

And since you mentioned it, just how about on ISP? It does seem to be a seasonal hiccup there as well.

So fourth quarter is usually the slower quarter for ISP. In particular, some of the industries like the glass and the foundry issues have histories of taking extended holiday shutdowns in December and so we would typically see that.

We also see end of Q2, early Q3 being a strong quarter typically. A lot of our construction-related business starts to pick up around that time, so things are tied to the housing industry. So those are probably the two biggest things that we would see from the ISP standpoint.

Okay. Then on the Oil and Gas Proppants business you have highlighted a number of moving parts from one-time costs. At the same time, you have these ongoing efficiency gains, more in-basin sales and unit cars. Could we see margins actually up in the fourth quarter versus the third quarter or is that probably more likely in the first quarter?

Yes, so it is a good question. As I think about the margins, kind of the puts and takes, on one side you have got whatever pricing that they will be on spot prices. If we sell more 100 mesh obviously that is a negative in terms of percent mix or contribution margin per ton.

Then on the positive side, our team is doing an amazing job on production cost improvements and productivity. We have a lot of things there. Then also as we sell more through our internal distribution network, i.e., our transloads, there is some additional margins associated with that. So it is kind of a plus and minus.

For 4Q I wouldn't expect any kind of a major pickup in margin. I think a lot will depend on what the supply and demand balance looks like in 2013. We have a pretty good idea on the supply side what is coming on line. Obviously the demand piece is going to be driven a lot by drilling budgets so I think we will see how that plays out.

I guess that leads into my next question on the supply side. I think from our side that is definitely one of the more difficult variables to get our arms around. What color can you add on the supply side for 2013? I know you highlighted a number of the difficulties in adding capacity, but how do you think that translates?

So if you look at 2012, clearly supply growth outpaced demand growth. We have seen that with the turn down in rig counts and things. We still see a lot of variability by basin and by grade as far as supply.

What you see is that all supply is not created equal, and so we have a lot of efforts that are going to really characterize everything that is coming on line and where those sites can be competitive and where they can't. So we have tremendous visibility to that.

As I said in my prepared remarks, it's definitely getting more difficult for capacity to come to market and there are a lot of factors associated with that. Service companies, I think, are not supporting take-or-pay contracts for these new entrants like they used to, and part of that is that they are realizing the limitations of having a mine site on a single rail with limited access. Permitting is getting more difficult, the new entrants, so a lot of them have high cost structures which are not sort of long-term competitive.

So I think there is a lot of sort of negative factors impacting the ability to get more supply online. If you look at what is in the pipeline today, certainly some of that will get built, but you have to go through and do a much more detailed analysis and look site by site. And that is what our team does to get a feel for what is coming online.

And so while I can't give you a specific here, I think that over the next couple of years there is going to be a lot of pressure, negative pressure on new supply. When I think about the growth side we are continuing to see strong demand. The rig efficiencies that we talked about, but also there is a fracking efficiencies coming on. Things like zipper fracks and some of the longer laterals and those things that are happening out there are going to drive additional demand.

So as we look forward over the next couple of years we feel pretty positive about the supply and demand balance as it is going to impact our business.

Would it be fair to summarize that -- as we think about 2013, let's say we have somewhat of a recovery in the rig count, that supply and demand growth in 2013 would be balanced? Or is that too optimistic?

I think it is possible. I mean as we look at it today I would say that certainly some of the coarser grades are still in short supply. So when you look at things like 2040 it's pretty clear that, in spite of what some folks might say, our view is that that is still in short supply. And in some cases [30/50].

100 mesh is obviously long. I think everybody realizes that, but I think there is a chance that you could have a balanced year in terms of supply and demand changes as we get into 2013. But the demand piece is going to be the key. We can calculate pretty clearly what the supply is coming online. It's really where demand goes that is going to be the wild card at this point.

Doug, one of the things that Bryan highlighted in his prepared remarks also is we are seeing a shift more to Northern white. What we have said previously is the gap between supply and demand has been filled by more non-API spec material. And what we think we are seeing is increased movement back into Northern white and away from the non-API spec material.

Okay. Then just one last quick one. In the past, you have talked about some of the expansion projects adding about a $40 million run rate EBITDA. With resin coated pricing coming down a little bit any update on what you think the contribution from those projects will be?

So when we quoted that $40 million EBITDA rate we had taken into account the decline in resin coated sand pricing. So I think when we look at our exit rate from 2013 we still think that that is a good number. Our teams are working real hard to work with our customers out there to get our raw sand and our resin coated volumes placed out in the market, Doug.

Sounds good. Thank you very much.

Brad Handler, Jefferies.

Thanks, good morning. Could you -- maybe just one quick clarification. I just wasn't quite clear on the spot pricing move. I thought we heard mid-single digits and then I think you also said something about 2% decline. I don't know if I heard that wrong or if there is a distinction there.

No, mid-single digits is the right number. I said like a few percent or something like that.

Okay, maybe that is --

Mid-single digits, Brad.

Okay, thanks. I just wanted to make sure I get it. As it relates to your Oil and Gas contract relationships, my understanding is a few of those start to roll off in 2013. I don't know how early in 2013, so I don't know how imminent some of this is.

But have you had contract renegotiations renewal conversations already? And if so, are the volumes changing potentially? Are they going up potentially as part of those renewals?

Yes, it is a great question. So we had -- at the end of 2012 we had one of our nine take-or-pay contracts that comes off, but it is a very small one. It's the smallest of all the contracts and so we are talking to that customer right now about kind of rolling things over.

If you look at the rest of them where the majority of the volumes are, if you do kind of a volume-weighted average we are contracted probably through the middle of 2014. So we still have a long way to go on the average and we have some roll off in 2013, some in 2014, and some in 2015. So we are in pretty good shape as far as the roll offs, Brad.

I see. Okay, so probably too early for those conversations. So the additional volume, the 60% of the growth that came from API grades, I gather that was still largely sold through those nine service contracts. Is that right?

Some of it was there, but there was a lot of spot volume as well in that 60%.

Okay, okay. But I should understand, to the degree that the volume fluctuates -- there is a pricing framework for a wide range of volume, I assume, in those service contracts. So are you pricing to those customers on a spot -- is there sort of an opportunistic spot for overage volumes or is it --?

So the way the contracts are written with minimums by grade, by quarter that the customers have to purchase. And so we have a couple of situations where customers have needed to purchase additional volume and then that is kind of a one-off negotiation based on what they need it for, what our supply/demand situation is, and a variety of other factors. I would say generally the additional volumes have been sold at higher than contract prices, but it can vary depending on the situation.

Understood, okay. Well, I appreciate that color. One more for me.

With the increase -- let me just ask it more basically. Of the API grades are we seeing you kind of bumping up against capacity constraints for now? I mean can the fourth quarter get better from an API sales standpoint? Is there more capacity that you can squeeze out if required?

So we have been, relatively speaking, sold out. There may be a little bit of 40/70 in the system depending on the week or the month, but we have essentially been sold out all year in our API spec grades.

The other comment around that, though, is we obviously have inventory that is blown out in our transload location. So theoretically you could drawn down inventory to increase sales, but we like to maintain minimum inventories out there to make sure that we get consistent business through there. So you have to think about the capacity.

Then the small amount of inventory we hold; it is not a lot. So to the extent those kind of fluctuate back and forth you can see volumes go up a little bit but we are basically sold out.

But the number is higher in the third quarter than it was in the first or the second by a good margin. So I am just trying to -- I don't if it's just sort of a rounding error, if you will, or --?

It is a couple of things. Again, 40% of that growth was 100 mesh, which we are not sold out on. There was a small amount of that that was also 40/70 increase and then the other part we did draw down inventories a little bit in the third quarter. So the extent -- the rest of it came from drawing inventories down.

Understood. Okay, very good. Thanks, guys.

Okay, thank you.

Travis Bartlett, Simmons & Co.

Good morning. First of all, average selling prices within the proppant segments were pretty strong during the quarter, up about 5% despite what sounds like more finer grades as a percentage of the total. Can you talk a little bit about what drove that increase during the quarter and then what your expectations are going forward?

That ASP was all driven by transportation revenues, Travis. It is where we moved more of the volume into the transloads.

Okay. Then you guys have said this in the past, but what percentage of your sales volumes for proppants during the quarter were for contracted customers?

About 80%.

80%?

We have typically run between 70% to 80% for each of the quarters this year.

Okay. Then one last quick modeling one here. Any expectation for depreciation and SG&A during Q4?

The depreciation will pick up. The SG&A is going to be pretty consistent probably with Q3. The depreciation will pick up; to the extent that we can bring some of the Sparta or Rochelle parts of that online, we are going to try to do that.

For example, Sparta there is a wet process piece where we are building a stockpile. It is not saleable product, but it is the first part of the process. We will start depreciation on that in 4Q.

It is not going to be a substantially large number, but you may see probably 5% to 10% increase in depreciation cost in 4Q.

Okay, perfect. Thanks, that is all I have got. I'll turn it back.

Tom Dillon, William Blair.

Most of my questions have been answered, but are your expectations for the timing on unit trains still the same, late December, early January?

So we have actually shipped the first to unit trains, Tom. We did one 70-car unit train and one 100-car unit train out of our Ottawa facility. And so when you think about doing unit trains it kind of takes both ends. You have to be able to build it and run the process smoothly at the plant end. Then you also have to have the facility at the other end to receive it.

So we wanted to make sure that we were prepared for our San Antonio facility opening up in the first quarter. I don't have a specific date for San Antonio yet, but I would say it will probably be late first quarter by the time that opens up. And so at that point we should start to routinely ship unit trains down into the Eagle Ford.

But in the meantime, like we have done with our first to unit trains out of Ottawa, if we have customers and facilities that we can ship to that will hold those volumes of cars, we would certainly do that.

Okay. Then how have transportation costs moved directionally over the past six months? I imagine they have been slightly lower with less activity in North America. Then I guess how do you think these costs look over the next three to six months in the context of your logistical changes?

They have probably been slightly lower but it has really not been that material for us. Again, for the most part a lot of this is passed through with a small markup for us. In some instances, for us directionally where it is going it's a bit cheaper for us to ship to the Marcellus than to some of the other basins for example. So it is slightly lower overall, but it has not really been significant yet.

Okay and then looking out maybe three, six months?

I would expect something pretty close to where we are right now. We are not forecasting any a significant drop.

Our transportation costs are typically pretty stable, Tom, so I wouldn't expect a lot of change there. If you are putting together a model or something, I would just kind of leave it where it is.

Then it sounds like everything is going pretty well with your new transloads, so I guess I'm just curious what has been the most challenging part with the new transloads?

I think just adapting all our processes to be able to manage that. You have to keep in mind the kind of volumes that we are sending out; it is millions and millions of tons of sand. And so to go from less than 10% of that being shipped one way to 50% in a matter of a few months, a lot of systems work.

Our IT guys and our operations and supply chain folks have done a great job managing all that in conjunction with our finance team. So that, plus also finding the right locations; it is not so easy to find a good transload right where the customers want it in the heart of several of these plays. So it has all come together really well for us.

Okay, thanks.

We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Thanks, everyone, for dialing in today. We will look forward to talking to you all again next quarter. Everybody take care.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time.

Thank you for your participation and have a wonderful day.