US Silica Holdings Inc (SLCA) 2017 Q2 法說會逐字稿

Greetings, and welcome to the U.S. Silica Second 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.

Thanks. Good morning, everyone, and thank you for joining us for U.S. Silica's Second 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 over to our CEO, Mr. Bryan Shinn. Bryan?

Thanks, Mike, and good morning, everyone. I'll begin today's call by reviewing highlights from our very strong second quarter performance, followed by an update on the actions we're taking to grow our diversified company, maximize value for our customers and further extend U.S. Silica's industry-leading positions in both our Oil and Gas and Industrial businesses. I'll conclude my prepared remarks with thoughts on the market outlook for our 2 operating segments. Don Merril will then provide additional color on our financial performance, before we open the call for questions.

Second quarter revenue of $290.5 million, improved 19% sequentially. Adjusted EBITDA of $75.1 million for the quarter was the second highest in our company's history and increased 76% compared with the first quarter of 2017. Strong market demand drove record sales volumes and substantial price improvement in our Oil and Gas business. Volume of 2.7 million tons increased 8% sequentially and sand pricing was up almost 19% quarter-on-quarter. Logistical challenges related mostly to railcar availability and inconsistent demand for core sand limited sales early in the quarter, but by the end of the period, we were producing and selling near our maximum oil and gas capacity of approximately 1 million tons per month.

We also saw higher volumes, higher pricing and continued growth from SandBox, our industry-leading last mile logistics solution. SandBox loads grew 22% in the quarter on continued share gains as we added several new customers. We currently have 45 active fleets and are scaling up the business rapidly to meet growing customer demand.

Looking back, since we acquired SandBox, in less than a year, we've doubled the number of customers, tripled the average loads and EBITDA per month and quadrupled the number of active crews, capitalizing on our first-mover advantage in the containerized delivery space.

In total, across our entire Oil and Gas business, we saw an 83% sequential improvement in contribution margin to $71.2 million. The Industrial and Specialty Products business continues to enjoy tremendous success as evidenced by yet another record performance from this segment during the quarter.

ISP contribution margin of $23.3 million improved 8% on a year-over-year basis, led by strategic price increases and new product sales, the latter now making up 15% of ISPs total profitability.

We continue to successfully mix enrich our sales by targeting higher-margin business in new end markets. A perfect example of the strategy is our new cool roof business, where we quickly increased the customer base and are experiencing very strong demand. Our teams are working hard to increase available supply of this specialty product.

From an operational perspective, we not only produced records sand volumes in the quarter, but had our lowest cost per ton as well, as companywide costs fell per ton 8% sequentially and declined 11% on a year-over-year basis as we continue to drive cost down through the operational efficiency projects and logistics networks savings.

For example, we've been very successful in locking in dedicated unit train capable transload capacity at favorable rates with no minimum volume commitments or shortfall penalties. As noted in our press release, we're increasing capital spending as planned to support the continued growth of SandBox and to complete the various brownfield and greenfield expansion projects currently underway to meet the surging demand for frac sand across multiple basins.

Regarding brownfield expansions, we're on track to bring online 1 million ton annual expansion at our Pacific, Missouri site by year-end. Nearly all of this new capacity has been fully contracted for 5 years and included a sizable customer prepayment. Furthermore, we expect to begin to see additional volumes come online from our Tyler plant expansion in the fourth quarter and reach the full volume of 1.2 million expansion tons in the first quarter of 2018.

Let me also provide an update on our greenfield plants. As previously announced, we've begun construction of our new state-of-the-art 4 million ton per year frac sand mine and plant in Crane County, Texas, to serve the rapidly growing Permian Basin. We're on track for initial production by December of this year.

While several other in-basin projects have been announced, we believe we've selected one of the most advantaged sites given its high-quality reserves, good water availability, easy logistics and proximity to the Delaware and Midland basins. Interest in our mine capacity is strong and we are in advanced discussions with numerous customers looking to secure contracts.

Let me now turn to our outlook for the remainder of this year and beyond. Going forward, we believe that continuing improvement in North American well economics, partially driven by greater proppant usage will support long-term increases in proppant demand. Proppant intensity growth is expected to continue as lateral lengths and loadings increase.

We also anticipate that a drawdown in DUC inventory will help maintain proppant demand for the remainder of this year, despite an expected reduction in the number of operating rigs.

We forecast U.S. sand proppant demand at 70 million tons in 2017 and 90 million tons or greater in 2018. We expect to continue to see product mix move finer and towards local and regional sand with Northern White sand demand potentially leveling off at some point. By 2018, we believe that 45% of U.S. proppant demand will come from the Permian and that 85% of that demand will be for the finer grades, 40/70 and 100 mesh, which is why our investments today are focused on in-basin mines and regional expansions that will position us to win going forward. It's also important to note that more than half of the 40/70 in the Permian will still need to come from outside the basin, supplied by companies like U.S. Silica that sit on the very low end of the cost curve.

As the sand proppant market evolves in the coming quarters, we also believe that accretive opportunities may develop for industry consolidation involving both existing and future capacity. Given our strong balance sheet and track record of finding and closing attractive acquisitions, we do expect to be active in this area.

For SandBox, we believe the market will continue to favor containerized solutions for transportation to the wellhead. One leading industry analyst recently opined that market share for containerized last mile solutions is expected to grow 50% next year from less than 30% today. We believe SandBox is well-positioned to maintain its industry-leading role as the solution of choice for last mile logistics and we remain on track to meet our 2017 profit expectations.

Finally, most of ISPs major end markets are expected to remain healthy for the balance of the year. Housing starts, a key barometer for ISPs Building Products business are up 3.2% versus last year, coupled with strong job gains and income growth. Auto sales, another key economic indicator for the ISP business have reportedly plateaued after 7 record-breaking years, but we continue to see strong demand from that important end market as well. We also expect to continue to look for highly accretive bolt-on acquisitions in ISP as well as potentially larger M&A, if we do find the right opportunity.

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

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

Revenue for the Oil and Gas segment for the second quarter of 2017 of $235 million, improved 22% sequentially compared with the first quarter of 2017, driven by a combination of higher volumes, higher pricing and increased activity at SandBox.

Revenue for the ISP segment of $55.4 million (technical difficulty) improved 7% on a sequential basis from the previous quarter, driven by strategic price increases and a larger contribution from new higher-margin products, including our most recent cool roof acquisition.

Contribution margin on a per ton basis from our Oil and Gas segment was $25.94 compared with $15.34 for the first quarter of 2017. The improvement in Oil and Gas contribution margin per ton was primarily driven by the increase in volumes, higher pricing, increased fixed cost leverage and higher activity levels at SandBox. On a per ton basis, contribution margin for the ISP business of $26.05, improved 10% with the same period of the prior year, driven by a combination of improved pricing and an increase in higher-margin product sales.

Turning now to total company results. Selling, general and administrative expenses in the second quarter of $26 million, were up 16.4% compared with the first quarter of 2017. The sequential increase in SG&A is due largely to additional compensation-related expenses and increased headcount.

Depreciation, depletion and amortization expense in the second quarter totaled $23.6 million compared with $21.6 million in the first quarter of 2017. The increase in DD&A was driven by incremental expense related to our capital spending and higher depletion costs associated with more tons sold.

Continuing to move down the income statement. Interest expense was $8.1 million in the second quarter versus $7.6 million in the first quarter of 2017. The effective tax rate for the 3 months ended June 30, 2017 was 19%.

Now turning to the balance sheet. Cash and cash equivalents as of June 30, 2017 was $598.5 million compared with $711.2 million at the end of 2016.

As of June 30, 2017, our working capital was $684.8 million and we have $46 million available under our revolving credit facility. As of June 30, 2017, our total debt was $511.1 million compared with $513.2 million at December 31, 2016.

During the second quarter, we incurred capital expenditures of $135.2 million, primarily for engineering, procurement and construction of the company's growth projects and other maintenance and capital improvement projects. As stated in the press release, the company has updated its full year 2017 capital expenditures guidance to a range of $325 million to $375 million.

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

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

(Operator Instructions) Our first question comes from Michael LaMotte with Guggenheim.

If I can ask first on a question of volumes. On the first quarter call, you all talked about 15 -- expectations of 15% to 20% growth Q1 to Q2, and we got 8%. Bryan, can you talk about what the variance -- what was behind the variance?

Sure. So Michael, I would say, overall demand was very strong during the quarter. The reasons that the sales were not higher were pretty simple. We had -- early in the quarter, we had a lot of rail and logistics issues associated with getting everything ramped back up, but demand loads were just so strong that the railroads themselves had a lot of issues and we had problems with railcars, getting returns from customers, et cetera. So it was an issue that really occurred earlier in a quarter and then sort of resolved itself pretty much as we went along. Probably the only other thing that contributed to it maybe in a minor fashion were just some inconsistent demand for the coarse product. But if you look at the last couple of months, so that the last 2 months of the quarter, May, June and what we're looking at in July, we're averaging about 960,000 tons or 965,000 tons of sales per month and that's against a capacity of 1 million. So we're kind of right back in that range where we expected to be in Q2. So really this was kind of a transient problem earlier in the quarter that we think is pretty much fixed.

Okay, great. So kind of 965,000 tons run rate through Q3 seems to be a reasonable number for the current quarter?

Yes, I think that's a pretty good number. And our team is trying really hard to get up to that 1 million tons a month. It's just a bit of challenge to get to those last couple of percentage points in there. And I would say the -- to me the only sort of uncertainty to get from 965,000 tons to 1 million tons is on the coarse demand. We still see some occasional weakness in 2040 and in 3050. But with that said, I still think we're selling about 90% or more of our coarse capacity, so it's not like it's -- it's a lot of the capacity that's going unsold, but when you're trying to get all the way to max capacity, a few tons here and there on the coarse side in terms of softer demand give you that gap between say 1 million tons and may be 960,000, tons, 965,000 tons.

That makes a lot sense. And then last one, just quick follow-up on that sizing grade question. You mentioned in your prepared comments that the market is moving increasingly finer and increasingly local. But I'm curious as your view on the supply side, whether we're headed towards dislocations and imbalances. It seems to me that the market could be oversupplied on 100 mesh side relatively quickly, but the pricing for 40/70 could hold up given the dependence on Northern White for those sizes. Can you sort of share your thoughts on where you see the market going in terms of balance on the grade?

Sure. And I assume when you talk about the supply of 100 mesh, you're referring to some of the local mines that are forecasted to come up in the Permian. And as you said, the majority of that capacity is going to be 100 mesh. So to the extent there is any stress, that will be on 100 mesh. 40/70, we think more than half of that pretty much are stored out that we can see, it's still going to have to be supplied in the Permian from outside the Permian. There is not enough capacity coming up anywhere near that capacity in the Permian to supply the 40/70. I think 100 mesh, we could see a scenario in coming years where the 100 mesh in the Permian is mostly supplied in the Permian. And so if you think about the impact of that, it's going to be just like in '15 and '16, where there were sort of supply and demand issues. Those go in the low end of the cost curve like U.S. Silica. We'll still find good locations for our 100 mesh and all of our sand. And we run a number of models on this and I feel like we come out pretty well in almost any scenario that we can think of. I feel like the challenges will be for those who have higher cost mines and particularly mines that were say shutdown in the downturn in '15 or '16, I think like think those are the tons that are kind of the marginal ones as we see some additional 100 mesh coming into the Permian.

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

A helpful color on the -- a variable color on the logistics issues on the quarter and it sounds like pretty good line of sight on Q3 volumes. I was wondering, if you could talk a little bit about pricing on the oil and gas side quarter-on-quarter for the third quarter?

Sure. So we pushed price really hard in Q2. We're up almost 19%. And our team, they did a really good job there. We are seeing surprisingly strong pricing, again in July. So I think that -- I don't want to get too far out in front of our skis here, but I certainly expect say 5% to 10% quarter-on-quarter up-pricing from Q2 to Q3. But I've been pleased with the kind of prices that we've seen so far in July. And I think it's a testament to the strength of the demand out in the market.

Great. That's very helpful. And then maybe just an update, as you guys, I realize still early days, but work through the Permian project, how discussions with customers are going from a contracting standpoint there and as well as the Pacific, Missouri plant you guys got some prepayments or those type of discussions ongoing with customers? And then how do you think about pricing for Permian tons generally? Are you trying to price it on delivered basis? Or is it still kind of a mine may be in initial negotiation? Just more curious on the Permian contracting.

Sure. So it's really a good question. And we've taken a bit of a different approach on this. We're looking at this as an opportunity to continue to deepen our partnerships with key customers. And even though the sort of question at the moment is around Permian capacity, when we talk to our customers, once again, they think about it a little bit differently as well. But they look at our diverse footprint with having offerings regionally and nationally. And so in many cases, our discussions kind of expand out into a broader relationship between the companies. We do have some contracts signed, in many cases, we have term sheet signed, where we are in the late stages of negotiation. And just going back and adding up yesterday, we have got about 15 new contracts that are in some state of negotiation with leading oilfield customers. And it's hard to predict the exact outcome, but I would expect about half of those to get signed and to turn into solid contracts. And well, at the end of the day, it comes down to, which of our customer partners were willing to make credible commitments to get to the contracts signed. I will say though that we put a lot of thought into these next-generation contracts and we're designing them in partnership with our customers to the agreements that we think can weather whatever cycles are ahead. Certainly, we all learned a lot in '15 and '16. And we want customers -- contracts that work for both U.S. Silica and our customers, and I think we've made a lot of progress in doing that.

Great, that's very helpful. Maybe if I can just sneak one more in. You mentioned M&A, again, you guys are doing a lot on the brownfield side. Are bid-ask spreads compressing here? It seems like it's been tough to get larger transactions done for anyone in the space as of late. Just curious for a little more color on the M&A market, how that's shaping up?

Yes. So it's really interesting. I think we have a lot of different opportunities. The deal flow is pretty strong as far as -- as looking at things. So we're active on both Oil and Gas side of the business as well as the ISP side.

Our next question comes from Brad Handler with Jefferies.

Maybe if I can ask you to come back to West Texas, certainly a topic that's obviously getting a whole lot of attention for some obvious reasons. And I guess, maybe given your response to George just now, maybe I could ask you to speak what the landscape looks like a little bit more broadly? Obviously, many announcements that have been made and a lot of contracts that seem like they're sort of pending. And I don't -- if I could ask you to reach into what you see and what you think you know, do you feel the -- do you feel like customers are starting to play off potential mines off of one another? Do you feel like there is enough aggregate demand to soak up all of what has been announced, and it is obviously a considerable amount. Just what do you see from that contract process, your own, but others as well, that talks to demand?

So I think the overarching impression, I guess, after having met with a number of customers myself is that there is a strong desire to get contracts in place here to make sure that they have enough supply to meet their needs. And the thing that I've heard over and over again is that many, and I'll say if not most customers are skeptical about signing long-term contracts, particularly if there is a prepayment involved, which all the contracts that we're talking about right now involve some form of prepayment. They don't want to sign prepayment-type contracts with companies who have never been in the sand industry before. So I feel like company like U.S. Silica has a tremendous advantage, as we're sitting at the table, we have a lot of credibility. And in many cases, these customers also want to sign contracts for Northern White sand. And I think, you read some of the opinion pieces out in the industry today and some of the pundits, who are saying Northern White is dead. That's certainly not what we're seeing out there and that's not what customers are telling us. Actually, we've had a couple of customers tell us that they look at the local sand of the Permian as kind of a plus 1, and if they can get good economics there on the delivery cost basis, it's going to allow them to dramatically increase the loading per well. So a couple of them have told us directly that they're thinking about using those in-basin tons on top of the tons that they are already using not instead of. So I think that's going to be very interesting to see how things play out. But look, the other point of your question was, are customers trying to play off suppliers? And certainly, all customers want the best deal they can get and the suppliers want the same thing. So we'll see how it all plays out, but I would say generally, the tone is, we want more sand, we want to sign a contract with a company like U.S. Silica and let's get this thing done as sort of the tone that I sense.

Fair enough. For my follow-up, let's switch gears a little bit, you mentioned some of the logistics challenges. Can you speak to the risk of, and then how you would address the issues surrounding that over the next 3 or 4 quarters as it relates to railcar access or the railroads meeting in place to deal with continued industry growth?

Yes, so it's a really good question. I feel like, we've been through this a couple of times. And I have been in the sand industry selling into oil and gas for almost 9 years now, and this is probably the third or fourth time that we've had a dramatic upturn in demand. And shockingly, the railroads seem to be unaware as almost every time. We saw a lot of things early in the quarter that were of the flavor of, while the railroads couldn't power out of storage fast enough or they basically didn't have all the personnel hired that they needed to deal with the demand. And I think the good news is that basically that's been solved, so I don't see a lot of issues there. I feel like the industry -- railroad industry is more prudent now, and that's why we spend a lot of time and I'm sure our competitors do as well talking to them about the kind of upturns that we think we're going to see in demand here. So hopefully, we're not going to be in those issues in the future, but I continue to be surprised by those type of things with the railroad. I feel pretty good that we've got the logistics piece sorted out, so I don't expect a lot of problems from that, Brad.

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

I guess, just to clarify a comment about pricing that you made earlier. You mentioned the 5% to 10%. Is that on a mine gate or FOB basis?

So that's on a mine gate basis, Marc. When we talk pricing, we always talk mine gate to kind of normalize out the transportation and logistics pass-through that's in the pricing that we sell downstream of our mines.

Sure, sure. Okay, so that makes sense. And if I think about the cost items that you mentioned. You've got some benefit in the third quarter, presumably you would have some additional fixed cost leverage -- benefit in the second quarter, presumably you'll have some fixed cost leverage in the third that helps. Also wondering, if there were any onetime cost impacts in the second quarter due to the logistical issues that you mentioned?

No, Marc. We really didn't see a whole lot of onetime charges in Q2 due to logistics. It was more just not having the availability of those railcars to get our product to our customers. And we will see a little bit more of fixed cost leverage going into the quarter. So we should see our cost per ton go down, which I think we had a record in Q2 of our overall manufacturing cost per ton. So we should see that number get better in Q3.

Okay. So if I put all that together, you've probably got a couple or $3 of price, another $1 or so of the fixed cost benefit and then whatever we assume for SandBox. Is it fair to say that you could be in a low-$30 range for contribution margin across the sand business?

I think it's fair to say we'll be pushing $30, yes.

Okay, great. Then just one other I had related to the volumes as we -- as you bring on the Pacific and Tyler expansions there. What are you thinking for how much that could really benefit fourth quarter? I understand you have the Permian coming out as well. But just separate from that looking at Pacific and Tyler first, how much does that really impact the fourth? And then obviously would we get all of that in the first quarter?

Yes. So a great question. As we're bringing up a lot of volume here, moving into the fourth quarter, I would say, right now, we're estimating somewhere between 100,000 tons and 200,000 tons of additional volume that we can squeeze out in the fourth quarter.

Our next question comes from Scott Gruber with Citi.

The 40/70 demand in the Permian is about 35% to 45% of total, is that correct? So about 16 million to 18 million tons in a 45-million-ton market?

Well, so I would say, it's probably -- maybe a little bit more than that in terms of total. I would say that it's -- that the demand is almost equally split between 100 mesh and 40/70, maybe it's 60% 100 mesh, 40% 40/70 plus or minus. Obviously, there is some 2040 and 3050 in there as well. But somewhere in that kind of range say 40% range for 40/70.

Okay. And then, as we think about how the market is going to shift over time with the new local supply. Which of your mines will continue to supply the 40/70 into the Permian? And given the potential for the 100 mesh to be almost solely locally sourced, how you're thinking about having to pivot some of the 100 mesh sales?

So as we think about where our mines are positioned on the cost curve, we have a lot of really good options to get into the Permian for 40/70 as well as for the 2040 and the 3050. So we've got Pacific, we've got Tyler, Ottawa gets in at a pretty good price as well. So we have a number of options there. And as I think about 100 mesh, we currently ship 100 mesh from several mines as well into the Permian and we have a lot of good destinations to move those as well. So if you look at Ottawa for example, we never shut Ottawa down in the downturn, even when things got really bad, that's because the costs are so good there and the logistics. So we have lots of options for 100 mesh to take it to different destinations. And then we also have a lot of our Industrial customers to take that product as well. So we have many things we can do with it, Scott.

Does the -- the 100 mesh out of Ottawa, does that -- is that the next primary basin to sell it into? Is that Appalachia, is that how you think about pivoting those volumes?

So we certainly sell a lot into the Northeast already. But there's lots of other definitions for that as well. Ottawa has access to full Class I railroads and we can barge out of there. So basically the only place in the country you think about selling a product, we have a pretty good low-cost solution to get there.

Got it. And what's the grade split of Voca?

I would say today, we're probably running about 15% to 20% coarse products. And then we've got 40/70 and the 100 mesh making up the rest of that.

Okay. How do you think about shipping of the Voca volumes? Does this primarily go into Permian today. Is that correct?

We do. It's primarily going to the Midland. So I think that the products of the Midland we will still be able to reach effectively with 100 mesh, particularly if we copy that -- or couple that rather with SandBox. And then of course, our 40/70, I think we can still move into the Permian. We know there is going to be demand for that there. And for 2040, 3050, I think that that's going to still be viable out of Voca as well given that there is none of that locally in the Permian.

Our next question comes from Connor Lynagh with Morgan Stanley.

Similar questions. Given that we're on heavily focused on Permian expansions here. So can you give us a sense of how much -- so you did $70 million of contribution margin in Oil and Gas in the second quarter. How much of that is from selling 100 mesh sand into the Permian?

Yes. No. We never break it out down to that level, Connor.

Well, so your comments would suggest that it's probably 20% of market demand. I guess, what I'm wondering is, how much -- if you had to shift that to other basins, how much degradation would you see in your margins? I mean, is it 10%? Is it 50%? I think there are some pretty dire scenarios out there, so just trying to get a feel for how big an impact it would be?

Yes. Look, it's still early to tell, given no one knows for sure how this all is going to play out. But I feel like we have really good options, as I said, moving the products to other basins and our modeling that we've done to date, albeit sort of incomplete information, doesn't show a significant degradation. You've got a lot of folks who are up in Wisconsin and at some sort of Tier-3 cost locations, who think they're going to be the ones who gets pushed out of the market. And so I just -- I don't see a lot of degradation there, quite frankly. But I think we'll have to see how things play out in the market, which basins did the products actually move to, how does it all play? So a little bit early to tell that, but I think these kind of thoughts that somehow sand pricing is going to collapse across the country or we're going to see to your point, 30%, 40% or 50% degradation in margin certainly are way overblown. I could say that may be a 5% or 10% change in margin or something like that. But not 30%, 40% or 50%. That just doesn't make sense when we model out.

Right. And so you're obviously putting your money where your mouth is. And that's you're investing in Pacific and Tyler. So where do you expect those volumes to be placed somewhere? Are those getting contracted into the Permian or are those going in other regional markets?

So Pacific is a great example. And we had a customer who want to sign up for almost all that expansion volume, so certainly based on the math on the cost from Pacific versus the other alternatives and they're like the combination of logistics and quality coming out of Pacific. So at the end of the day, we'll ship that product where customer wants it, kind of demand where this might to go, my guess is, that work will move around over time. But if you're a customer, you're going to sign a contract with a company like U.S. Silica and it's going to be focused on say a particular mine site, you want to pick a site that's versatile, right? So that's one of the advantages of U.S. Silica, almost all of our sites that serve oil and gas, drill in multiple destinations and we have a lot of kind of low-cost solutions, you put SandBox in there, I think it's very attractive for us. And one of the things that I think people miss as they try to do this analysis what happens in the future as Permian sand comes on is, who are the folks in the market that have the most options and most flexibility to move product around and maximize the value for that product. And I think U.S. Silica is really at the top of the list there.

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

Obviously, a lot of discussion, a lot of fear about West Texas expansion. And there has been a lot of announcement since last conference call. What is your alls' take on how much expansion has been annexed? And how much you think might actually get done?

Yes, it's a good question. As you could imagine, we spent a bit of time analyzing that and thinking about it, Ken. And our projection right now is that we could see around 25 million tons of new potential greenfield capacity up in the next 12 to 18 months. The vast majority of that, as we talked about already is probably going to be 100 mesh, let's call it 80% 100 mesh and maybe 20%, 40/70. There is no doubt that it's going to shift the cost curve for both of those products to the right in the Permian high units this costs on a delivered basis. This capacity on a delivered basis is going to come in on the left-hand of the cost curve. And so if you think about what the implications are of that, I would say that by the end of 2018, we probably will see 50% or more of the 100 mesh that's consumed in the Permian being supplied by those in-basin mines. Certainly, 40/70, as we said, a majority of that are still to come from outside the basin and coarse grades are going to be supplied outside the basin for sure. So I think that's generally our view of how it plays out. As I've said a couple of times on the call here the good news for us is that I mean we're extremely well-positioned both in terms of benefiting from those volumes that are now going to be supplied in-basin with the capacity that we're installing there, but also with all of the other grades that we selling in the basin and the flexibility that we can bring. So net-net, I feel like we're going to be one of the -- we're winners out of this. And we're going to add tremendous value to the company when it's all said and done.

Yes. I guess, your 25 million ton estimate, I've seen estimates of size of kind of 40 million to 50 million tons. Is your 25 million tons based on just where do you think is actually going to get done? Or there is some double counting going out on that for rest of this year?

So generally, it's our view on what actually gets done. I think there's a lot of things that get announced, even some permits to get filed. If you take a ride around in there and you see who is actually starting to do construction and move dirt around, "if you will, " I think you'll get a feel for what might actually get done. And as we talk with customers, as customers tell us, look, you know, we'd never sign a contract with a company who doesn't have a lot of experience mining or the company -- they give us more information on what they are willing or likely to do, I think there is kind of a restraining force here that the market perhaps misses, which is, till today when probably good contracts are gone, it's going to be pretty difficult to justify building next mine and certainly the one beyond that. So I think there is a lot of restraining forces there. You've heard all the discussions around all the issues that are there, things like labor. Labor is a big issue. I think that's one that's just probably overlooked. I also think that logistics is one that people talk about. And they say that it's going to be difficult and challenging, but haven't really done the math. So one of the advantages that we're going to have with our Crane County mine for example, is that we believe we'll have substantially shorter haul times to many of the locations, in both the Midland and the Delaware versus say all the mines that are coming out of Winkler County. And so we have 1 customer in particular, who when they look at our mine site, they say, okay, that's the one that we want to sign up tons for, because we can already see with your location that it's going to be much easier, the logistics. And we're not talking about to say 10 or 15 minutes difference in haul time here. I mean, it could be hour, 1.5 hour, 2 hours on a load-by-load basis, when you drive with load around Winkler County. So I think there is going to be a differentiation there. I think customers are starting to get a bit more savvy in terms of analyzing the different sites and kind of rank ordering the attractiveness. And once again, I think we come out far ahead in that. But some of the other sites that are a bit more speculative right now, if they don't have attributes, those are the ones that perhaps don't get build, or if they do, it's sometime much further off in the future.

Yes. That was leading into my second question, which was, trying to figure out why you think your sites going to be cost advantaged? And obviously, we're not as familiar with it as you are, but you kind of Google Earth it and looking at West Texas, it's kind of hard to see what did transportation differential is really going to be. So a little more discussion of that would be interesting. And also, is there a difference between the quality of your sand across some of these different mines, like the crush strength or the mix of sand across the basin?

So on the quality side, I think we're kind of right at the top end of the local sand quality. When you look at our crush strength, in particular. So I would say, it's an advantage, we're in the sort of advantaged category. There is probably others out there that are similarly positioned, but certainly not all. I feel like the biggest advantage that we have are really 2 things. One is, we've been doing this for 117 years. So I feel like that's probably work something in terms of our ultimate cost to make the product. So that's probably a $1 or $2 there per ton. We don't have probably anything in terms of royalty. We decided sort of a de minimis royalty. We've seen others take the approach of having really high royalties -- it could be multiple dollars per ton. So we had that up on top of our -- I think advantage in terms of just know-how in doing this. There is probably a few dollars a ton advantage there just getting the products into a truck. But then what's in the trucks, you could drive around the roads in say Winkler County, small 2 lane roads, stop signs everywhere. There is going to be literally thousands of trucks a day trying to drive those roads. We've done some driving studies and some tabletop studies to suggest that, as I said earlier, there could be substantial differences in time, delivery times. And imagine, if we can load a truck up and deliver it and then one of our competitors takes an extra hour, 1.5 hour to deliver that same load, it's a lot of extra cost for them. They have to have the truck leased for that so many hours, and pay the driver, all those things, get fewer loads per day. So I think when you wrap it all up, there are going to be some substantial differences in delivered cost per ton, and that's where the question that you need to ask, it's not about necessarily the mine gate costing, and I think there'll be some differentiators there as well. But start doing some work. Just look at the math, right? You know if you have to go 50 miles, 50 miles on an Interstate is a lot different than the 50 miles on a 2-lane country road with stop signs, right, with all these trucks floating around. So I think it just makes logical sense that if you're positioned a mile or so from the Interstate like we are, you're going to be much better off and you have to run on all those miles on country roads.

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

So yes, very interesting times in the frac sand space for sure. Bryan, I was curious whether or not you can give us some perspective on the cost differentials for transportation within the Permian? And then from a regional standpoint, and then from a Northern White standpoint? And the basis for that question beyond the obvious is that at the end of the day, if the customers benefit of buying Permian sand, and using the Permian is predominantly transportation costs. Just wondering why anybody in this industry would even have to think about cutting the mine gate price of sand, when it's all about the transportation cost differential. So I really want to get a handle on the transportation cost differential?

So I think if you kind of start at the highest level and look at how much it cost to transport, say by rail, Northern White down into the Permian, that's probably somewhere in the neighborhood of $40 to $50 a ton. So if you assume that let's just say mine gate costs are the same for regional versus Northern White, and you start to take that piece out of it to make simple, there is really a $40 or $50 umbrella there in terms of rail versus truck. And so, I would say, and once again, it depends on the distance, right? The further you get away from the mine site, the longer you have to truck, the less advantage it becomes. So at some point, there is an equilibrium and we've typically seen that in the past, being the maybe 200-mile range, maybe 250-mile range, depending on the cost of trucking. I think that's another think that's underappreciated right now. We've seen trucking costs go up a lot. Certainly, we understand that well, given that we have a lot of our own truckers and we hire trucks for SandBox. So let's keep an eye on the kind of arbitrage between truck and rail, and at the end of the day, that in my mind really controls whether people buy some of this local sand versus Northern White, set the quality aside again, let's assume that the local sand is good enough, it really comes down to arbitrage between rail and truck. And so we'll keep eye on that. Right now, it looks like for most of the Permian, we're probably talking at least a $20 savings for the local mines versus a Northern White, in some cases it could be more, depending on the proximity to the mine. So kind of high level that's how we think about it, Kurt.

Okay. And then how much of this incremental capacity that you have coming on has been prepaid or let's just say, if your negotiations go with your historical experience with the customers would tend to go when it's all said and done, how much of your incremental capacity will be prepaid?

So, let me make sure I understand your question. So if you're saying, If we signed a contract that we want to sign, how much of those contracts or what percentage or something will have a prepayment associated with them?

Yes, what percent of that volume will have a prepayment to it, yes?

So at this point, all the contracts that we're looking at have prepayments associated with them for the either the brownfields or for the local sands.

Okay. So is it -- does it strike you in that context, that if, if there was truly a potential for excess supply and pricing coming down, why would an E&P company ever entertain a prepayment agreement when they can get more -- and get more for less in 2 or 3 months from now, right? What am I missing on that?

Yes, so look, I think it goes back to the conversation we were having earlier here around not all suppliers are created equal, right? I'm not saying that every supplier is going to get that kind of a contract. But you have energy companies, the service companies, who have needs across multiple basins, who want Northern White sand, want other sort of regional-ish sand for places like say, Pacific, Missouri or something want SandBox services. I think we have a different level of offering. And when customers look back and think about who they want to sign up with, I think we come out on top of in that equation. I think that's one key point. The other key point though is, I know there's been a lot of debate and discussion around where the sand intensity going, where's overall profit volume going? So to ask you question in another way. Why would we feel confident? Why do customers tell us that they're willing to sign these contracts, if the sand intensity is going down or profit volumes are going down? To me, it's one of the strongest endorsements that I have seen and I've been around in the industry for a while like you. I tend to vote with my wallet, and if customers are running with their wallet, that tells me that they believe that intensity is going up and demand is going up. And there's a fairly short list of high-quality national suppliers that you might sign a contract with, and I think we're right at the top of that list. So to me, that's why customers are working with us and willing to potentially sign these type of contracts.

And then lastly. So you are at effectively 12 million tons of annual volume capacity right now. You can take that up by a couple, 200,000 tons, 400,000 tons may be by the fourth quarter. So what's the exit rate of 2018? With all the brownfield and greenfield, what's the annual volume you could potentially sell?

Something we've said before that we felt like we're on track on a sort of exit run-rate to add 1 million to 2 million tons of capacity by the end of '17. And then we expect that we would ramp up through the first several months of 2018.

Okay. So if you look at the exit rate for 2018, where are you in terms of annualized capacity?

Yes, so by the end of 2018, we expect to have our 8 million to 10 million tons that we talked about, the majority of that up and running by the end of 2018.

Right. So you'll be about 20 -- around 20 million tons, right?

Yes.

Our next question comes from Blake Hutchinson with Howard Weil.

Just one of the things maybe you can help us look forward to here with regard to shift perhaps towards some of the volumes being in the Permian sand. Is what that effect -- the effect would be on SandBox franchise itself? I mean, do we just need to look at this as kind of a net push? It doesn't matter whether you're delivering from transload or in nearby in-basin mine? Or there is some advantages of this intensity pickup there potentially for you and the industry? Just thinking about the kind of growth trajectory for the last mile delivery logistics?

It's a great question. And I would say that, generally, I believe it's a positive for SandBox. Probably our most profitable lanes that we serve, the most profitable customers are those that are in a maybe 30 to 50-mile radius from a trucking standpoint. And it just kind of works out to the way that the trucking pricing dance works and drivers, how many turns they get, depending on that. So I think this is going to be a positive for us. When we have to go 100, 150 or 200 miles 1-way to pick up a load, the profitability's still good, but it's not as strong as we can sort of turn the equipment much faster. So I think it's going to be a positive for us. I think also this is going to allow us to get to the vision that we had when we originally bought SandBox, so creating a number of pop-up transloads around the basin. So I think we can literally change the notion of what a transload is, it doesn't have to be on the rail siding. And so our team is working on that. And I think you will see some other innovations coming out of this as well, as we design our new mine sites in the basin, we're going to have SandBox-only lanes, kind of express lanes for SandBoxes. We can have SandBoxes staged there already filled so customers can come and pick them up quickly. A lot of new things that we're going to bring in to the offering here that I think will just further enhance the SandBox differentiation versus the competition.

Great. And then just a quick one, because we're coming up on the hour. Your commentary regarding your pricing thoughts, Bryan, I guess, as we talk about the 19% sequential change from 1Q to 2Q, the price book tends to roll somewhat slowly. So it suggests you are at a higher rate -- exit rate. Was the 5% to 10% commentary kind of weighted average or a continual?

Yes, it was a weighted average. We tend to talking averages on a quarter-to-quarter basis. So we should see that type of price increase on average in the third quarter.

Our next question comes from Samantha Hoh with Evercore ISI.

Just to go back on the SandBox, I was not surprised that the fleet count didn't increased more over the last quarter given all the fleet reactivation, the pressure from the fleet reactivation that we heard about. Can you kind of talk about how those get rolled out and maybe what the growth profile looks like for the second half?

Yes, it's a very good question. And so we are continuing to grow SandBox literally about as fast as we can. We're scaling up the manufacturing and all the internal systems to support that, and hiring team members to help drive all of it. I would say at the end of the day, though, one of the other things that we're seeing is because of the increase in intensity in the sand per well, we're going to add additional sandboxes to our fleet. And that's a positive thing. So we tend to get paid on loads of sand that we deliver as opposed to just get paid for a fleet in many cases. So essentially what's happening is, if we're working for frac fleet X, instead of consuming, let's say, 200,000 tons a year that now they need to consume 250,000 tons and 300,000 tons. And so we're adding equipment to some of those fleets as well. So when we acquired the business, we had typically about 40 sandboxes per fleet. Now we're adding sometimes 50, 55 or 60 new boxes. So that -- it sort of makes the fleet number look like it's not growing as fast, but we're adding a lot of boxes and it's going to add a lot of revenue as well. So we'll say more about that in the future and try to find some way to kind of bridge that for folks so you can follow that. But at the end of the day, it's a really positive thing. It's kind of a low capital intensity way to add revenue because we're going to only have to add boxes and a few chassis, we don't to have to add conveyors and all the other equipment. It's just a matter of moving more sand out to the wellhead. And so moving of fleet that just have 40 boxes to say have 50, 55 or 60, it's a really positive capital investment for us. So we're doing that as well.

And just 1 last one. How much do you think of your -- like your Crane capacity do you think will be served by like SandBox in terms of like market share just coming out of that facility?

I would expect that -- yes, so you're saying, for our Crane County, how much -- what percentage of the volume that leaves that site would been in sandboxes, is that your question?

Yes.

I would think it will be a relatively high percentage. Certainly, some of the customers that we're talking to for contracts there want the SandBox service as well. So I would hate to put a number on it, but we're starting out with probably 30% of our load out lanes dedicated to the Sandboxes, but we have the other ones made and designed so that we can convert those to SandBox lanes if we want. So we'll see how that plays out, but I would say at least 20% to 30%, but perhaps it's upside to that.

I would like to turn the floor back over to Mr. Shinn for closing comments.

Okay. Thanks, operator. I'd like to close the call today with a few key thoughts. First, the oil and gas market has continued to strengthen and as we said on the call, we expect higher sand demand in the third quarter and for the rest of 2017. And we expect that to result in the higher prices we talked about a 5% to 10% increase in Q3, and certainly, as Don said, we'd expect that to roll through to Oil and Gas margins that on a contribution margin per ton basis should approach $30 here in Q3.

I guess, my second thought is that the rapid increase in frac sand consumption across the industry and the move towards containerized sand delivery, as I said in the prepared remarks, should also continue to be a really nice tailwind for SandBox, we're adding boxes, we're adding people, we're growing literally as fast as we reasonably can there.

Third, I would say that U.S. Silica is very well-positioned to take advantage of consolidation opportunities that might arise in Oil and Gas as well as attractive M&A in the ISP business.

And lastly, I want to thank all my colleagues at U.S. Silica for their outstanding efforts so far in 2017 in meeting the tremendous opportunities that are available to us. Certainly, it's been a pretty exciting year so far with the market starting to pick up here in Q2 and continuing into Q3.

I also want to thank our investors for their interest and support. And I look forward to meeting and speaking with all of you in the near future. Thanks for dialing in everyone. And have a great day.

This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.