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US Silica Holdings, Inc. (NYSE:SLCA)

Q3 2012 Earnings Call

November 2, 2012 11:00 am ET

Executives

Donald A. Merril – Vice President of Finance

Bryan A. Shinn – President and Chief Executive Officer

William White – Chief Financial Officer

Analysts

Ben Swanley – Morgan Stanley Smith Barney

Doug Garber – Dahlman Rose & Co.

Douglas Becker – Bank of America Merrill Lynch

Bradley Handler – Jefferies & Co., Inc.

Travis Z. Bartlett - Simmons & Co. International

Thomas Dillon – William Blair & Company

Operator

Good morning, and welcome to U.S. Silicas 2012 Third Quarter Conference Call. Just a reminder, todays 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.

Donald A. Merril

Good morning and thank you for joining us for U.S. Silicas third quarter 2012 earnings conference call. Im 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 companys press release and our documents on filed 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 Exchange Commission later today.

At this time, Ill turn the call over to Bryan Shinn. Bryan?

Bryan A. Shinn

Thanks Don, and good morning, everyone. Ill 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.

Ill 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.

Im pleased to report that despite widespread weakness in a well services sector, our unique business model continued to deliver strong consistent results. 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, a $0.01 down over last quarter due to higher income tax expense, but still up 76% year-over-year. Based on these results in 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 todays 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 talents. Im especially proud of our team having achieved outstanding results during the first three quarters as a public company, and 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, lets 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 segments. 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. Were 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 encourage some one-time cost 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 the surging demand for a finest product rate adding incremental volume and increasing overall profitability, but at a lower margin.

Before moving on, lets 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 of high-quality Northern White sand appears to be increasing. We experienced robust demand for our oil and gas products during the quarter and were sold out of most grades. While were closely following the decline in rig count and industry discussions about a budget driven slowdown at the end of year, our orders remain very strong in October.

In terms of profits supply, were seeing several emerging dynamics that over time will constrain high-quality, low cost capacity additions. For example, service companies are increasingly reluctant to help funds start-up lines to take-or-pay contracts as they were willing to do over the last two years. Also after reviewing many potential Greenfield sites, its 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 entrance are facing increased community opposition. We believe that new entrance 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 sink with much of the North American service industry.

So Id like to discuss some of the factors that are driving U.S. Silicas success. First, despite low natural gas prices and a decline in gas directed rig count, weve continued to see our sales into the Marcellus increase. As weve mentioned on previous calls, we enjoyed significant trade advantage to this basin and we expect continued de-coupling of our revenue trajectory to get rig count in the Marcellus.

Second, the oil field 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 these contracts with smaller sand producers expire. And we continue to add new capacity. Third, we believe that proppants usage per rig continues to increase. Drilling rig and pressure pumping equipment are getting more efficient and while rig count and horsepower utilization may have declined.

We believe that proppants usage has continued to grow due to more wells drilled per rig and a longer average lateral length per well, either technology driven efficiency improvements and we expect proppants demand to continue to grow at rate higher than the rest of the industry.

And finally, Northern White raw sand is becoming the proppants of choice from a performance and economic standpoint. In terms of performance we believe that non-API proppants 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 proppants of choice.

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

We recognize that were 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 or resin-coated sand. Pricing is also declined to the sub $400 per ton level in many areas, given this it will likely take longer than originally plan for us to sell out our new resin-coated sand capacity.

However, as we 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 substrate, which is the single most important factor in the performance of resin-coated sand. We also had our choice of raw sand sizes to coat allowing for quick response to market needs.

Second, we choose to locate our coating facility in Rochelle, Illinois near a raw sand mine in Ottawa Illinois, which gives us a significant logistical cost advantage versus some competitors who either arent backward integrated or we ship sand 100s 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 were constructing in Sparta, Wisconsin. This project is on schedule for second quarter of 2013 start up. Initial production capacity as we stated previously, we will be between 750,000 to 850,000 tons of largely coarse sand, the majority of which we expect to ship into the Bakken. We anticipate that a limited amount of sand may be produced 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. Weve now shipped two unit trains from our Ottawa facility and equipping Sparta with the same capability. Unit trains are 70 plus rail cars trains that travel express between our plant and the target basin, this drive down cost 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 and partnership with the BNSF, which will be capable of receiving those unit train shipments.

Before I conclude my remarks, Id also like to discuss the announced succession of U.S. Silicas Chief Financial Officer. As you saw on our press release last month, Bill White is retiring at the end of the year and on behalf of our Board and all the employees of U.S. Silica, Id like to thank Bill for his 21 years of service and wish him the best in retirement. Bill, we cannot do without you.

Id also like to welcome Don Merril to our team. Youve 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?

William White

Thank you Bryan and 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 proppants 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 from 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 a 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 a 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 that 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 IPL 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 will spend on the construction of the Rochelle as part of plan. At this point, we are unsure of the effect that the recent East Coast two months will have on our Q4 performance as completion activity in the Marcellus maybe impacted.

Assuming minimal impact, we are providing fourth quarter guidance of $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, Ill turn the call back over to Bryan.

Bryan A. Shinn

Thanks, Bill. Id 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 liquids rich basins where activity in spite. 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, oil and gas industry experience an abrupt tightening of CapEx budgets due to a sudden drop in oil prices causing service provider to be cautious in their purchase of the sand. We responded by aggressively working with our customers to supply sand from our expanded in-basin distribution network, which enable 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 deliver the best earnings quarter in the history of our company. In Q4 and beyond, while we were undoubtedly experienced 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 thats 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 multirail, 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 U.S.

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 theyve 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 cut corners in their rupture market.

That concludes our prepared remark this morning. So lets open up the line for questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Ben Swanley with Morgan Stanley. Please proceed with your question.

Ben Swanley – Morgan Stanley Smith Barney

Hey, good morning and congratulations on a fantastic quarter.

Bryan A. Shinn

Thank you Ben, how are you doing?

Ben Swanley – Morgan Stanley Smith Barney

I think – I just wanted to follow-up on some of your guidance comments there, some quick math to just 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 give us a little bit more detail around that, I mean is this a timing issue of deliveries from 4Q actually hitting 3Q or what exactly is, how are you thinking about it?

Bryan A. Shinn

Ben, I think that were raising revenue guidance. I dont think we are actually lowering the 4Q guidance on adjusted EBITDA. Weve actually just kind of narrowed the range for the full-year. We are still looking at $33 million to $37 million in adjusted EBITDA for the quarter. Thats roughly in line with for all our other quarters have been, weve 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. Its not really a switch a move between quarters, its, we think we are still very consistent with where weve been all year in fact, again weve just narrowed the range a little bit taken up both the bottom and lowering the top.

Ben Swanley – Morgan Stanley Smith Barney

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

Bryan A. Shinn

Well, I dont know that we want to give you the exact quantifying too closely, but what we can do is well 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 two tend to sell at a lower ASP. So, its mixed and it was 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 our one of our four dryer for about a six-week period, three weeks in September and three weeks in October.

So we are going to see a similar impact related to that in 4Q as well. And then the least, but for one that will certainly did have an impact is we did continue to see a limited amount of spot price reduction against spot prices are only spot sales are only 22% to 25% of our overall oil and gas volumes thats the that market has continued to soften slightly, but not where it was in 2Q.

Ben Swanley – Morgan Stanley Smith Barney

Okay, so that the increased sales of 100 mesh, I mean thats still in a positive even though its dilutive maybe to the average number, its still some more dollars in the door. But then with Ottawa, with the dryer down in Ottawa, three weeks in 3Q, three weeks in 4Q, then in 1Q that should every thing should be back in line. So is that a little bit of a tailwind than in 1Q?

Bryan A. Shinn

Yeah, Ben this is Bryan. I think thats a good way to think about it. And to your point around 100 mesh, to the extent that that we can sell additional 100 mesh, I mean thats 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 their in Q3, we are really excited to be able to fulfill that.

Ben Swanley – Morgan Stanley Smith Barney

And I just sneak one more and if I can on the topic of spot pricing? Can you give us, 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?

Bryan A. Shinn

Sure, so maybe Ill 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 in context, as you know Ben, we have about 80% of our volume thats under contract for oil and gas, right so we are only talking about 20% of our oil and gas volume.

I would say in Q3, I was going to characterize the spot market, it was a lot like Q2 and that it was choppy, right. So it was kind of by basin, by grade, almost by day, what we saw changes there. We saw a couple of percent decline quarter-over-quarter, if you recall on last quarters earnings call, we said we saw that an 18% decline from Q1 to Q2, we didnt see anything like that in Q3, it wasnt much lower decline. But Ill say that as spot pricing still remain 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, that kind of steep industry cost curve that we have is going to continue to support strong margins for low-cost players like you U.S. Silica.

Ben Swanley – Morgan Stanley Smith Barney

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

Bryan A. Shinn

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

Ben Swanley – Morgan Stanley Smith Barney

Okay, so, but I guess what Im trying to get out is, where we came out of the quarter, are we entering the fourth quarter below where we were entering this third quarter?

Bryan A. Shinn

Yes, so we cant really provide forward-looking guidance on prices for Q4, I believe we did say in our prepared remarks though that October looks like a pretty strong month for us and so we feel really good about the way Q4 has started and thats 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 last call where we directed people more towards the lower end of the range.

So that was – a great performance in Q3 and then the strong start to Q4 and Im just feeling pretty good about the rest of the year.

Ben Swanley – Morgan Stanley Smith Barney

Perfect, thank you so much and congrats again on a great quarter.

Bryan A. Shinn

Thanks Ben.

Operator

Our next question comes from the line of Doug Garber with Dahlman Rose. Please proceed with your question.

Doug Garber – Dahlman Rose & Co.

Good morning guys.

Bryan A. Shinn

Hi Doug.

William White

Hey, Doug.

Doug Garber – Dahlman Rose & Co.

Can you give us an update on your effort to sell more in the pace as apposed FOB mine just kind of throughout the year, how much you sold kind of FOB basin and where that is now beginning of the year and where do you expect it by the end of the year.

Bryan A. Shinn

Its a great question and certainly its been one of our strategic priorities in 2012 to enhance our, what we call sort of 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 matter i.e., through transloads. And I think year-to-date, if you look at how we finish the third quarter were quite closer to 50% Doug. And so I think we will continue to drive that number up, but we dont have a specific target for year-end, but in Q1 were going to open a large new unit train facility, transload facility down in San Antonio, so I think that will help us increase that number and certainly its one of the things thats helped us to be successful as we look at Q3 and I think its one of the differentiators between us and lot of other folks in the industry.

Doug Garber – Dahlman Rose & Co.

In terms of quantifying that, I mean of your I guess $146 million tick the midpoint of the adjusted EBITDA range. How much of that would you say is from adding this logistics portion if you will to go into that sort of detail.

Bryan A. Shinn

Its really a hard question because one way you could look at it is you could say, well how much additional margin do you make off of doing that right. The way I look at it though, I mean in addition to that, the real benefit is it allows us to forward stage material out in the basins where customers want it. And Ill give you an example, we had one of our contract customers call us up just a couple of days ago and theyve gotten a piece of work on short notice to go and do fracing and completing of several wells and they need something like 10,000 tons of sand to start shipping in two days right.

And so if we would have the inventory out in the basins, we wouldnt have been to get that work and were seeing that a lot of the service companies are getting work on much shorter notice then theyve done in the past. And so weve been very responsive to that, and weve adjust 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.

Doug Garber – Dahlman Rose & Co.

Thanks, thats a 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 one time thing?

Bryan A. Shinn

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 and once again it come backs to having the right product in the right place at the right time, and were seeing the fair amount of that in the East. So as we look into Marcellus obviously 100 mesh is growing pretty strong there. And I think our position there as a low cost supplier with excellent logistics is one have to differentially get more volume in the Marcellus.

A long-term obviously, it seems it can be driven by rig count. But I was pretty interested in some of the information thats come out on some of the E&P earnings call, so I was listening the premier call and they showed a couple of things there. One things they said is that, theyre seeing average drilling feet per day increased 28% over the past five quarters and thats the kind of thing obviously thats going to drive a lot of demand. And they maybe kind of the leading-edge of the industry, but other are probably seeing that.

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

Doug Garber – Dahlman Rose & Co.

And one more question, I guess on the Sparta facility, where are you going to look forward contracts for that capacity and if youre currently in the market for those contracts, where do they compared to the ones you signed last fourth quarter?

Bryan A. Shinn

So were probably six to eight months away from producing significant volumes as part of it. So were kind of in early paces of talking with customers. Obviously, there is a lot of factors to consider there, a part of it is waiting to see how that the 2013 drilling budgets come out from the E&Ps and try to get a sense of where thats going? Where does the supply demand balance for 2013? And so we want to see all that before we start locking into things. So I thinks its a little ways off yet, Doug, before we have some things to come back and talk about on that, but certainly on the coming couple of quarters, here as soon as we have something will be I talking to you all about.

Doug Garber – Dahlman Rose & Co.

And just want to clarify one of the comment you made, you said our resin-coated sand is a sub $400 a ton, is that FOB mine, or is that delivered, just trying to get a sense of what that at a point?

Bryan A. Shinn

So thats delivered.

Doug Garber – Dahlman Rose & Co.

Okay.

Bryan A. Shinn

Deliver to transload.

Doug Garber – Dahlman Rose & Co.

Okay. And just one quick, when your tax rate I think creeped up a little bit this quarter, maybe this ones for Bill, if there is a, for Q4, what are you expecting and why they creep up in Q3 a little bit?

William White

The creep up in Q3 was primarily the true up for the 2011 tax return. There might be a slight creep up in Q4, but its going to be fairly negligible as far as Q3 this year.

Doug Garber – Dahlman Rose & Co.

All right. Thanks, guys. Ill turn it back.

William White

Okay, thanks.

Operator

Our next question comes from the line of Doug Becker with Bank of America Merrill Lynch. Please proceed with your question.

Douglas Becker – Bank of America Merrill Lynch

Thanks. On the volume side, I want to just get a sense for what your view is typical seasonality going into the fourth quarter. It looks like historically theres generally been a bit of a decline, but what would you attribute to seasonality?

Bryan A. Shinn

You are talking about oil and gas, Doug or…

Douglas Becker – Bank of America Merrill Lynch

Oil and gas, yeah.

Unidentified Company Representative

Oil and gas, yes. So, oil and gas is, we initially as we got into the business, we saw a bit of seasonality and I think particularly in bases like the Marcellus where the fracking crews were still figuring out how to navigate mountains and working in cold weather. Over time, weve seen less and less of that as the infrastructure has come in.

I would say to the extent that we have seasonality now. Its really driven by drilling budgets and youve heard several of the service companies talk on their earnings call about potential end of the year slowdown as drilling budgets went out and maybe taking, extended holiday out of just put for their crews. And so thats what we are looking at right now work with our customers to understand where thats going to go.

But I have to say at this point, we dont see any slacking off in the demand in fourth quarter, were on a pretty strong. What we have seen in the past is that, it can also start out pretty quickly as well, but as of now the customers have given us really strong forecast through the end of the year.

Douglas Becker – Bank of America Merrill Lynch

Okay. And since you mentioned that just, how about an ISP does seem to be a seasonal hiccup there as well?

Bryan A. Shinn

Yeah, so fourth quarter is usually the slower quarter for ISP. In particular some of the industry like glass and the foundry industries have histories of taking extended holiday shutdowns in December and so we would – we typically see that. We also see end of Q2 or 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, they are probably two biggest things that we would see from the ISP standpoint.

Douglas Becker – Bank of America Merrill Lynch

Okay, and then on the Oil and Gas Proppants business, youve 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?

Bryan A. Shinn

Yeah, so its a good question and as I think about the margins, kind of puts and takes, on one side youve got, whatever pricing that will be on spot prices and for some more 100 mesh obviously, thats a negative in terms of percent makes our 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 and then also as we saw more through our internal distribution network, transloads, there is some additional margins associated with that, so its kind of plus and minus.

For 4Q, I wouldnt expect any kind of a major pick-up in margin. I think a lot will depend on what the supply and demand balance looks like in 2013 and weve a pretty good idea on the supply side, whats coming online, obviously the demand piece is going to be driven a lot by drilling budgets. So I think we have to see how that plays out.

Douglas Becker – Bank of America Merrill Lynch

Well I guess that leads into my next question on the supply side, I think from our side thats 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 highlight number of the difficulties in adding capacity but how do you think that translates?

Bryan A. Shinn

So if you look at 2012, clearly supply growth outpaced demand growth. Weve seen that with the turned down of rig counts and things. We still see a lot of variability by basin and by grade as far as supply. And what you see is that oil supply is not created equal rights and so weve a lot of efforts that go into rig characterize, everything is coming online and where those sites can be competitive and where they cant.

So we have tremendous visibility there. As I said in my prepared remarks, its definitely getting more difficult for capacity to come to market and a lot of factors associated with that service company, I think are not supporting pay-to-pay contracts for these new entrance like they used to and part of that is they are realizing the limitations of having a mine site on a single rail with limited access, permitting getting more difficult new entrants, so a lot of them have high cost structures, which are not sort of long term competitive right.

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

And I think about the growth side, we continue to see strong demand, the rig efficiency that weve talked about, but also this fracking efficiencies coming on, things like zipper fracs 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.

Douglas Becker – Bank of America Merrill Lynch

Would it be fair to summarize that; as we think about 2013 is what thing we had somewhat of a recurring in the rig count that supply and demand growth in 2013 would be balanced or is that youre optimistic?

Bryan A. Shinn

You know I think it is possible, I mean as we look at it today, I would say that know certainly some of the coarser grades are still in short supply. So you look things like 2040 is pretty clear that in spite of what some folks might say our view is that 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 can have a balanced year in terms of supply and demand changes as we get into 13, but you know the demand piece is going to be key. We can calculate pretty clearly what supply is coming online, it is really where demand goes, it is going to be the wild card at this point.

William White

Dough one of the things that the Bryan highlighted in his prepared remarks also is, we are seeing a shift more to Northern White, and what weve 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, in a way from the non-API spec material.

Douglas Becker – Bank of America Merrill Lynch

Okay and then just one last quick one. In the past youve talked about some of the expansion projects adding about a $40 million run rate EBITDA with resin coating pricing coming down a little bit. Any update on what do you think the contribution from those projects will be?

Bryan A. Shinn

Yeah, so when we quoted that $40 million EBITDA rate, which weve 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 thats a good numbers and our teams are working real hard to work with our customers out there to get raw sand and a resin-coated volumes that placed out in the market.

Douglas Becker – Bank of America Merrill Lynch

It sounds good. Thank you very much.

Bryan A. Shinn

Youre welcome. Thank you.

Operator

Our next question comes from the line of Brad Handler with Jefferies. Please proceed with your question.

Bradley Handler – Jefferies & Co., Inc.

Thanks. Good morning.

William White

Hi.

Bryan A. Shinn

Good morning.

Bradley Handler – Jefferies & Co., Inc.

Could you maybe just one quick clarification, I just wasnt quite clear right. On the spot pricing move I thought we heard mid single-digits and then I think you also said something about 2% decline and I dont know if I heard that wrong or if there is a distinction there.

William White

Yeah, no its a mid single-digits is the right number. I think I said like a few percent or something like that.

Bradley Handler – Jefferies & Co., Inc.

Okay. Maybe…

William White

Single-digit, right.

Bradley Handler – Jefferies & Co., Inc.

Okay, thanks. I just wanted to make sure I got it. As it relates to your oil and gas contract relationships, my understanding is that few of those start to roll-off in 2013. I dont know how really in 2013. So I dont know how eminent some of this is, but had you had contract renegotiations renewal conversions already, and if so are the volumes changing potentially are they going up potentially as part of those renewals?

William White

Yes, its a great question, right. And so we had I think end of 2012 we have one of our nine take-or-pay contracts that comes off, but its a very small and its a smallest of all the contracts. And so were talking to that 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 did have kind of volume weighted average were contracted probably to the middle of 2014, so we still have long way to go on the average and we have some roll off in 2013, some in 2014 and some in 2015. So were in pretty good shape as far as the roll-off spread.

Bradley Handler – Jefferies & Co., Inc.

I see, okay. So probably too early for those conversation. So the additional volume the 60%, thats a growth that came from API grades, I gather that was still largely sold through those nine service contracts, is that right?

William White

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

Bradley Handler – Jefferies & Co., Inc.

Okay, okay. But I should understand to the degree that the volume fluctuates as a pricing, 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…

Bryan A. Shinn

The contracts are written with minimums, by grade by quarter that the customers have to purchase. And so we had a couple of situation where customers have needed to purchase additional volume. And then thats 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.

Bradley Handler – Jefferies & Co., Inc.

Understood, okay well I appreciate that color, one more from me. With the increase well, just asking more basically, of the API grades are we seeing you kind of bumping up against capacity constraints for now. I mean in the fourth quarter get better from an API sales standpoint, is there more capacity that you can squeeze out if required?

William White

So we have been relatively speaking sold out. There may be a little bit of 4070 in the system depending on the weaker for the month. But we just have been sold out all year in our API spec grades.

Bryan A. Shinn

The other comment around that we obviously have a inventory that s coming out and in our transload locations right, so theoretically you can drill down innovatory to increase sales. But we would like to maintain minimum inventories out there to make sure that we get consistent business through there. So everything about the capacity and then the small amount of inventory we hold it, its not a lot, so to the extent those can fluctuate back and fourth you could see volumes go up a little bit. But we are basically sold out.

Bradley Handler – Jefferies & Co., Inc.

But the number is higher in the third quarter than it was in the first or the second by a good margin. So Im just trying to, just sort of rounding error if you will or is it.

William White

Its a couple of things its again 40% of that growth was 100 match, which were not so above the one. There was a smaller amount of that it was also 40, 70 increase. And then the other part we did drill down the inventory a little bit in the third quarter. So the extent the rest of it came from drawing inventory sales.

Bradley Handler – Jefferies & Co., Inc.

Understood, okay very good. Thanks guys.

William White

Okay, thank you.

Operator

Our next question comes from the line of Travis Bartlett with Simmons & Co. Please proceed with your question.

Travis Z. Bartlett - Simmons & Co. International

Hey guys good morning.

William White

Hey, Travis.

Bryan A. Shinn

Hey, Travis.

Travis Z. Bartlett - Simmons & Co. International

First of all average selling prices within the proppants segments were pretty strong during the quarter up about 5% despite would sounds like more finite grades as the percentage of the total. Can you talk a little bit about what drove an increase during the quarter and what your expectations are going forward?

Bryan A. Shinn

That ASP was all driven by transportation revenue relative to where we move more volume into the transloads.

Travis Bartlett – Simmons & Company

Okay. And then you guys have said this in the past, but what percentage of your sales volumes were profits during the quarter for contracting customers?

Bryan A. Shinn

About 80%.

Travis Bartlett – Simmons & Company

80%?

Bryan A. Shinn

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

Travis Bartlett – Simmons & Company

Okay. And then one last quick modeling one here, any expectations for depreciation and SG&A during Q4?

Bryan A. Shinn

The depreciation will pick-up 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 and Rochelle parts of that online, were going to try to do that, for example Sparta theres a wet process based where were building a stock balance. Its not salable product, but its the first part of the process. We will start depreciation on that in 4Q. Its not going to be a substantial large number, but you might see probably 5% to 10% increase in depreciation costs in 4Q.

Travis Bartlett – Simmons & Company

Okay. Very good, thanks. Thats all I got, Ill turn it back.

Bryan A. Shinn

Okay, thanks Travis.

Operator

Thank you. Ladies and gentlemen due to time constraints, our last question will come from the line of Tom Dillon with William Blair. Please proceed with your question.

Thomas Dillon – William Blair & Company

Hi, most of my questions have been answered. But are your expectations for the timing on unit trains both same, late December, early January?

Bryan A. Shinn

Yes, so we have actually shipped the first two unit trains, Tom, we did 170 car unit train and 100 card unit train, out of our auto facility. And so when you think about doing unit trains, it kind of takes both ends right. You have to be able to do build it and run the process smoothly at the plant, and then you also have to have the facility at the other end to receive it.

So we want to make sure that were prepared for our San Antonio facility opening up in the first quarter. And so I dont 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 routinely ship unit trains down into the Eagle Ford. But in the meantime, like weve done with our first two unit trains out of Ottawa, we have customers and facilities that we can shift to that will hold those volumes of car, we will certainly do that.

Thomas Dillon – William Blair & Company

Okay. And then how transportation costs moved directionally over the past six months? I imagine even with less activity in North America, and then I guess, how do you think these costs will look over the next three to six months in the context of your logistical changes?

Bryan A. Shinn

Theyve probably been slightly lower, but its really not been that material for us. And again for the most part, a lot of this has passthrough with a small market for us. In some instances for us, if directionally where its going, its a bit cheaper for us to shift to the Marcellus and to some of the other basins for example. So its slightly lower overall, but its not really been significant yet.

Thomas Dillon – William Blair & Company

Okay. And then looking out maybe three, six months?

Bryan A. Shinn

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

William White

Our transportation costs are typically pretty stable Tom, so I wouldnt expect a lot of change there if youre putting together model or something I just kind of leave it where it is.

Bryan A. Shinn

Right.

Thomas Dillon – William Blair & Company

I guess, and then it sounds like everything is going pretty well with the new transloads. So I guess Im just curious whats been the most challenging part on the growth with the new transloads?

Bryan A. Shinn

I think just adapting all our processes to be able to manage that, you have to kind of keep in mind the kind of volumes that we are sending out right, its millions and millions of tons of sand. And so to go from less than 10% of that being shipped one way to 15% in the matter of a few months. A lot of systems work and our IT guys and our operations supply chain focused on a great job managing all of that in conjunction with our finance team. So now that plus also finding the right locations, its not so easy to find a good transload right where the customers wanted in the heart of several of these plays. So its all come together really well for us.

Thomas Dillon – William Blair & Company

Okay, thanks.

Bryan A. Shinn

Thanks Tom.

Operator

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.

Bryan A. Shinn

Well, thanks everyone for dialing in today and we look forward to talking to you all again next quarter. Everybody take care.

Operator

Ladies and gentlemen, this does conclude todays teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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