Fairmount Santrol's (FMSA) CEO Jenniffer Deckard on Q3 2017 Results - Earnings Call Transcript
Fairmount Santrol Holdings Inc. (NYSE:FMSA) Q3 2017 Earnings Conference Call November 2, 2017 10:00 AM ET
Executives
Indrani Egleston – Senior Director of IR
Jenniffer Deckard – President and Chief Executive Officer
Michael Biehl – Executive Vice President and Chief Financial Officer
Analysts
Marc Bianchi – Cowen and Company
Brad Handler – Jefferies
Jim Wicklund – Fairmount Santrol
George O'Leary – TPH and Company
Waqar Syed – Goldman Sachs
Ole Slorer – Morgan Stanley
William Thompson – Barclays Capital
Kurt Hallead – RBC Capital Markets
David Deckelbaum – KeyBanc Capital Markets
John Watson – Simmons & Company
Operator
Ladies and gentlemen, welcome to the Fairmount Santrol Third Quarter 2017 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, today's call is being recorded.
I would now like to turn the meeting over to your host for today's call, Indrani Egleston, Senior Director of Investor Relations and FP&A for Fairmount Santrol. Please go ahead, Indrani.
Indrani Egleston
Thank you, Dan. Good morning, and welcome to Fairmount Santrol's third quarter 2017 earnings conference call. With us today are Jenniffer Deckard, our CEO and President; and Michael Biehl, our Executive Vice President and Chief Financial Officer.
Before turning the call over to Jenniffer and Michael, we would like to remind all participants that certain statements during this call may constitute 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 press release and our documents on file with the SEC.
We would also like to remind you that during this call, we will comment on non-GAAP measures, including adjusted EBITDA. These financial measures are used by management to monitor and evaluate the ongoing performance of the company and to allocate resources. You can find a reconciliation of these non-GAAP measures to the nearest comparable GAAP results as an attachment to our third quarter earnings release, which we issued this morning.
Now to begin, here is our CEO and President, Jenniffer Deckard.
Jenniffer Deckard
Thanks, Indrani, and good morning everyone. Thank you for joining us today, and thank you for your continued interest in Fairmount Santrol. Before we begin, I would like to give congratulations to the city of Houston and their [indiscernible] for a great season. It was [indiscernible] to see something so positive for the city and its residents, especially following such a tough time period for the people of Houston. Well done.
I'll be starting the call with a high-level overview of our third quarter performance with some additional detail on our two business segments. Michael will then touch on the financials and our recent debt refinancing. We'll wrap up our prepared remarks with an update on our market and our expectations for the fourth quarter. Following our comments, we'll be happy to address your questions.
Beginning with our third quarter results, we were very pleased with our performance which was in line with, and in key areas, exceeded the guidance that we provided during our last earnings call. Total volumes in the third quarter was 3.4 million tons, an increase of 5% sequentially as we continue to maximize our constrained proppant capacity. Pricing increases, particularly on raw frac sand and a strong product mix in both segments, positively contributed to a third quarter revenue of $280 million, which represents a 20% growth over the second quarter. We delivered significant profitability expansion during the quarter, with net income of $34.9 million or $0.15 per diluted share. Adjusted EBITDA was $72.4 million, versus $47 million in the second quarter, as higher volumes and pricing combined with favorable sales mix and lower cost per ton continued to drive our substantial growth.
Moving to our segment performances and beginning with our I&R segment, volumes totaled 615,000 tons, which represented a decrease of 8% when compared to the third quarter of 2016. Despite lower volumes, we continue to see I&R profits grow, a trend Michael will discuss in a few minutes. I&R volumes were impacted relative to the prior year period by several factors. Some seasonal volumes were accelerated into the second quarter, and we were also impacted by some unanticipated customer downtime in the third quarter. Additionally, certain lower margin raw sand volumes were foregone in 2017 which impacted same-quarter volume comparison, but which had little impact on our profitability. Year-to-date I&R volumes through September are roughly flat against prior year levels, while maintaining our 2017 trend of meaningfully improving our profitability in this segment.
Turning to our Proppant Solutions segment, we once again had solid execution from our entire team, driving strong volume, revenue, and profitability growth as we continued to capitalize on improving core market conditions. We were particularly pleased to see strong performances across all product categories. Total Proppant Solutions volumes were 2.8 million tons, up 9% over the second quarter, and at the high end of the guidance we provided on our last call. Raw frac sand volumes totaled 2.6 million tons, representing a 9% increase over the second quarter. Volumes increased across both fine and coarse grades, but capacity constraints persisted, particularly on finer grades and limited this growth.
We benefited somewhat from higher capacity, with both Brewer and Maiden Rock facilities operational for the whole quarter, and with Shokapee beginning production at the end of the quarter. Pricing also improved during the quarter with raw frac sand prices increasing $7 per ton on a consistent mix basis, which was within our guidance. In the third quarter, our pricing was strongest on the finer grades of frac sand, as well as on sand sold in basins. Strength in our coated proppant sales continued in the third quarter, with volumes reaching 215,000 tons, an 11% increase over second quarter volume, which outpaced rig count growth. We are particularly encouraged that we saw good growth in both our curable resin-coated products used primarily for flowback control, as well as in our tempered resin-coated products used mainly for strength.
In the third quarter, Propel SSP volumes contained a higher mix of commercial sales as compared with the second quarter which had a higher proportion of trial volumes. The third quarter performance in our Proppant Solutions segment was bolstered by our strong logistics network, which continues to be an important value creator, both for us and for our customers in the marketplace. Our third quarter in-basin proppant volumes increased by over 15%, with more than 70% of our proppant volumes continuing to be solid in-basin. We also leveraged our 11 unit train-capable terminal delivering over 70% of our Northern White volumes by a unit train, hitting another record quarter for the company in that regard.
With that, I'll turn the call over to Michael to provide more color on our financial results.
Michael Biehl
Thanks, Jenniffer, and good morning. For the financial update I plan to cover the highlights of the quarter and not cover all the detail addressed at our earnings release unless you need more color on a particular item, which we can take care of in the Q&A at the end of the call. If you haven't already done so, I encourage you to read our press release filed with the SEC this morning to obtain more context around our third quarter results.
Company posted strong financial results for the third quarter, with total volumes increasing 5%, and revenues up 20% sequentially. Consolidated gross profit was $99 million or 36% of sales, up from $70 million in the second quarter, which represented 30% of sales. Net income in the third quarter was $34.9 million, or $0.15 per diluted share compared with net income of $10.5 million or $0.5 per diluted share in the second quarter. Adjusted EBITDA was $72.4 million, which excludes non-cash stock compensation expense of $2.4 million. On a trailing 12-month basis, our adjusted EBITDA is now over $150 million. The continued sequential improvement in profitability is due to our team's hard work in opening plants to meet rising demand for supply and working with our customers to leverage our assets and terminal network to deliver our products where they're most needed.
Now for an update on our segments, in our I&R business revenues were $30.3 million for the third quarter, a decrease of 4% from the third quarter of 2016, which is the most comparable period due to the seasonality of this business. The year-over-year revenue decline for I&R is largely due to lower volumes, as Jenniffer previously mentioned, which were partially offset by higher pricing as a whole and product mix shift towards higher priced products. Year-to-date I&R revenues are up 5% versus the prior year. So despite the modest revenue decline in the third quarter, I&R is showing solid growth for the year. I&R's gross profit for the third quarter was $14.4 million or 47% of sales, which represents a 6% increase from 2016 third quarter gross profit levels.
The improved profitability came as a result of higher pricing, and a mix shift towards higher margin products, as noted earlier, and as well as better fixed cost leverage on our facilities, which reduced cost per ton for both I&R and proppant products. During the quarter and throughout the year, I&R team has done an excellent job containing costs, and focusing on higher margin products as gross profit for both the quarter and year-to-date period is up substantially over the prior year levels.
Turning to Proppant Solutions, revenues were $250 million, up 25% sequentially, largely driven by improved pricing on raw frac sand of over $7 per ton on a consistent mix basis. The increased volumes and higher mix of in-basin sales also contributed to the revenue growth. Gross profit for proppants was $85 million in the third quarter, or over $30 per ton, compared with $54 million in the second quarter or $21 per ton. Improved pricing, favorable sales mix, and lower cost per ton all contributed to the significant growth in profitability.
The reduction in cost per ton was driven by reduced excess rail car costs, which fell to less than $400,000 in the third quarter offset by modestly higher sand production costs as we had more volumes from our higher cost facilities. Direct costs for our Shakopee operation was modest as we utilized resources from our existing mines to ramp up production. SG&A for the quarter was $31.1 million, which included $2.4 million in non-cash stock compensation expense.
SG&A for the second quarter was $26 million and included $2.8 million in non-cash stock compensation expense. The increase in expense over the prior quarter and our guidance range is primarily due to higher variable compensation and related payload taxes. We expect SG&A for the fourth quarter to approximately $27 million, including non-cash stock compensation expense of approximately $3 million, but excluding approximately $3 million in legal and rated agency fees related to our recent financing.
Tax expense was $2.8 million in the third quarter, representing an annual effective tax rate of 6%, versus 5% last quarter. The change in the annual effective tax rate is due to the establishment of evaluation allowance reducing the value of certain deferred tax assets for our Mexico business. This quarter's strong results along with results from the first half of the year generated over $100 million in cash in the operating activities, a significant improvement over prior year levels. We put this cash generated from operations to good use in investment in our new Kermit facility by paying down our debt.
Capital expenditures for the first nine months of the year was $36.5 million with $22.2 million spend occurring in the third quarter. Shipping cost in the third quarter were approximately $4 million, and close to $10 million through the first nine months of the year. Third quarter capital expenditures related to construction of our new Kermit facility was approximately $8.5 million.
Full-year 2017 ongoing capital expenditures, excluding our Kermit facility are now expected to be approximately $40 million. This is a modest decrease. This is our power game as we continue to be selective with now obtaining capital for specific projects.
Total CapEx for Kermit in 2017 is now expected to be around $25 million paid, with the remainder pushing into 2018. We had previously communicated that we expected to $40 million to $45 million from Kermit-related CapEx in 2017, but some of the spend has shifted to next year due to timing of equipment, and extended payment terms. The exchanges in our CapEx payment do not alter our previously communicated Kermit timeline, and we still expect to begin production during the second quarter next year. Including Kermit, our ongoing capital expenditures levels, we now expect our total CapEx in 2017 to be approximately $65 million.
We sold interest payments for the Kermit property at $40 million, with $20 million already paid in the third quarter, $10 million already paid in the fourth quarter and the remaining $10 will be paid in 2018 when Kermit begins to file soon. The $40 million capitalized resold interest in Kermit will begin to be amortized once the Plan B operations, with this expense recorded as amortization expense.
Now I would like to provide some color on our continued efforts to improve our capital structure with our recently announced refinancing. When we analyze different options for addressing our debt maturity, we ultimately decided that the combination of term loan and asset-based revolver will provide us the greatest flexibility as we continue to reuse our total debt level, and also refinance some file we give in the future, while resolving in the higher but acceptable interest rates in the current money environment and more specifically within our industry.
We run into a new $700 million term loan B that matures in the fourth quarter of 2022, and carries an interest rate of LIBOR plus 600 basis points. Additionally, the new ADL credit revolver, which also expires in 2022, has a $125 million limit and a current rate of LIBOR plus the 175 basis points. We immediately grew $60 million on this revolver to facilitate in the pay down of our existing term loan and use cash on hand for the remaining pay down. We estimate the combination of new term loan and the revolver will increase our annual interest expense in approximately $10 million.
The new term loan and revolver replace our previous term loans, which is scheduled to mature in September 2019, and our revolver which is to expire on September 2018. At the end of the third quarter, and the previous capital structure still in place, we had total debt of $794.5 million. Following the refinancing, our pro forma debt balance will be $752.9 million. This debt refinancing in addition to our prepayments throughout the year demonstrates our continued commitment to reduce our total debt level and provide us more flexibility to continue to improve our long-term capital structure.
We estimate that we will incur approximately 8 million cash expenses associated with the refinancing, of which 5 million will be capitalized and amortized over the five-year terms of these new loans. The remaining original issue discount of 1.3 million at September 30, relating to the previous term loans will be written off as a non-cash charge in the fourth quarter. All the remaining 7 million at September 30, and deferred financing fees on previous term loans will also be written off in the fourth quarter as a non-cash charge.
We are pleased that Moody has upgraded our corporate family ratings of B AA3 stable from C AA1 positive, and that S&P and Fitch maintain comparable. We believe this is a positive development that acknowledges the significant steps we have taken to strengthen our capital structure and improve our operational results, and more likely benefited as more as we address our capital structure in the future. While we made significant progress in our balance sheet, including this refinancing, we will remain a priority to further strengthen the balance sheet by continuing to reduce total debt levels and transpose our capital structure as our business generates stronger free cash flows.
With that, I will turn it back to Jenniffer, who will comment on what we expect to see for the markets in Fairmount Santrol.
Jenniffer Deckard
Thank you, Michael. Market dynamics have continued to progress in line with our comments during our last call. And so, we continue to believe that 2018 proppant demand will approximate 100 million tons. This depends on a series of factors, the base of which is an industry expectation for U.S. rig counts to remain stead at approximately 850 land rigs on average for next year.
More importantly, we expect a few tailwinds to proppant demand, including an estimated 10% increase in overall proppant intensity and an expectation that the availability of completions resources will better match drilling resources, facilitating a 2018 drawdown of duck inventory versus a comparative build over 2017.
As we look more specifically at the Permian Basin, we continue to estimate that demand will comprise approximately 45 million tons or 45% of overall estimated proppant demand in 2018. Furthermore in the Permian, we expect that roughly 40% of this demand will be for 100 mesh sand, 40% will be for 40/70 mesh sand, and 20% of this demand will be for coarser grade. So, roughly, 18 million tons of Permian demand will be for 100 mesh sand with the remaining 27 million tons of anticipated demand comprising non 100 mesh sand.
Turning to supply, it's important to be clear on the different descriptions that are used for capacity, name plate and effective. Name plate includes all plans, both active and idle, and as soon as they produce at their permitted levels and can sell all that they produce. Effective capacity represents what can actually be produced and sold. The two can differ significantly for a variety of reasons, including operational factors, logistics, timing of demand, and importantly a balance between demand and production capability by grade. This is just as true in the Permian Basin as it across the entire proppant industry. We believe that approximately 30 million to 40 million tons of name plate capacity will likely be online in 2018. For this capacity, we estimate that around 20% of the reserves are 40/70 grades, with the remainder 100 mesh.
It's important to note that the 40/70 produced in the Permian is not the same product as Northern White 40/70, with a great distribution that is generally fueled as the finer side of the product specification. This introduces further uncertainty as to the ultimate adoption level of Permian 40/70 sand, and its ultimate use to satisfy a very strong 40/70 demand within the Permian. However, applying a conservative land, if we were to assume that there is 100% adoption of all Permian sand and gradation and that the Permian production is able to yield 20% 40/70 product, then 6 million to 7 million tons of the expected 18 million tons of 40/70 demand in the Permian could be surprised by inversing production. This would mean that approximately 20 million tons of non-100 mesh demand in the Permian would still need to be met with supply that is produced outside of the Permian Basin. If any of these more conservative assumptions do not hold true, this figure will be even higher and demonstrates the large role that non-Permian supply will continue to play in meeting Permian demand.
With so much focus on the Permian, demand in other basins is often overlooked, but we expect demand outside of the Permian regions to have meaningful growth in 2018 as well. We estimate non-Permian demand will be in the area of 55 million tons in 2018, and will be more evenly distributed across all grades. Adding this demand to the 20 million ton estimate of Permian demand that would be supplied from outside the Basin, the total demand for sand produced outside of the Permian Basin would reach roughly 75 million tons in 2018. This amount is in the range of the total expected proppant demand for 2017. We estimate the breakdown by grades for these 75 million tons of 2018 non-Permian supply/demand to approximate 35% course, 40% 40/70, and 25% 100 mesh. This aligns very well with the grade mix from our own non-Permian product footprint.
As we stated previously, our ability to flex our production grade mix mesh demand is very essential to our success, and it's attributed to several factors, including the inherent complementary geology between our various facilities, as well as within our extensive weather and footprint itself, and also to be operational modifications we have implemented to optimize our product mix. This operational flexibility allows us to have higher effective capacity utilization and to better serve the needs of our customers through both optionality as well as scale.
Coming back to the Permian, I'd like to provide an update on our Kermit facility. Instruction remains on schedule and we continue to expect production to commence in the second quarter of 2018. We have signed multiple contracts for future production at the facility, and we are in advance negotiations with others. In line with our previously stated targets, 70% to 80% of our total effected capacity is under contract, and we will continue to be in this range when Kermit comes online. Based on our plans mining design, we will have the flexibility to produce either a mix of 40/70 and 100 mesh sand, or all 100 mesh sand depending on market demand.
One topic that continues to serve in discussions about Kermit is the local [indiscernible] for DSL. As part of our sustainable development culture, we take very seriously the topic of protecting native species in the areas where we operate. We have a very long history of demonstrating this commitment, including the support of the substantial native bat habitat in our Maiden Rock facility. In our extensive lease, which covers over 3,200 acres, there are areas of high likelihood of DSL occurring and low likelihood of occurring. As far our lease agreement and in consultation with leading experts on the DSL, our mining plans are designed to specifically focus on areas characterized as low likelihood of DSL occurring.
We have also been in close dialog with the Texas Control's office to both share our mining plans and to specifically explore how we best work with them to further protect the habitat of the species. We are in discussions with the leading experts on the DSL at multiple Texas universities to develop comprehensive research proposal with the goal of increasing DSL occupancy across the range of potential habitat in both West Texas and New Mexico. Based on our extensive experience with the intact of true industry collaboration, we started the dialog to establish a consortium of sand suppliers to work together among other common regional interest to support the preservation and the advancement of DSL habitat.
Now turning to our total company capacities in the third quarter, even with Brewer and Maiden Rock full active during the quarter, we still remain capacity-constrained operating at nearly 95% utilization of our active raw frac capacity. Our Shakopee, Minnesota mine is now fully operational and is working on building a stockpile for the winter, while also adding modest fourth quarter sales volumes. With the addition of Shakopee, our name plate frac name capacity is 12.6 million tons annually. Still as we enter the winter months, we tend to see somewhat lower overall production at many of our mines. This seasonal impact may modestly impact our effective capacity and we are therefore estimating fourth quarter effective capacity to be similar to third quarter levels.
I will now turn the call back over to Michael for more detailed update on our expected fourth quarter results and commentary into 2018.
Michael Biehl
Thanks, Jenniffer. We expect total proppant volumes in the fourth quarter will be roughly flat in comparison with the third quarter as we remain capacity-constrained for the reasons Jenniffer highlighted.
Additionally, we only stand for the normal seasonal slowdown in proppant demand as customer budgets run out at the end of the year. Through October, proppant volumes are in line with third quarter average levels. So we expect seasonal factors to impact our production, there are quoted proppant demand in the back-half of the quarter.
We've implemented strong high speed improvements throughout the first three quarters of 2017, which put our pricing a little ahead of market pricing at the beginning of the fourth quarter. Given the anticipated seasonality impacts on demand in the fourth quarter, we anticipate that our proppant and pricing levels will likely remain flat on a consistent mix basis for both raw sand and quoted proppants.
Looking to the beginning of 2018, we expect strong market demand as capital budgets are renewed and completions increase. In line with this expected demand increase, inline with some expected annual cost increases in our operations, we plan to increase raw sand prices again in the first quarter. At this point, it's too early to determine the magnitude of what will be implemented at the start of the year, and we will provide further guidance during our next earnings call.
Proppant cost is expected to be roughly flat to slightly up in the fourth quarter. Cost for turnover mining plants is generally higher in the fourth quarter due to seasonal reasons and as our higher cost plants are more fully utilized, we expect our mining cost to increase slightly.
Based on timing of customer commitments and seasonality in our customers businesses, we expect INR volumes to be flat to slightly up in the fourth quarter against the comparable fourth quarter of 2016 levels. We expect to see continued improvements in profitability versus the prior year period, similar to what we have seen throughout the year.
This concludes our prepared remarks, and now Dan, would you please open the lines for Q&A.
Question-and-Answer Session
Operator
Certainly [Operator Instructions] Thank you. Your first question comes from the line of Marc Bianchi with Cowen. Please go ahead.
Marc Bianchi
Thank you. Jenniffer, thanks for all the commentary on the outlook for the Permian. I'm curious if you had any conversations with customers in terms of you know, their sensitivity is changes in prices, so talking about 40% 100 mesh, 40% 40/70 today, if prices change quite a bit, do you think that mix would change?
Jenniffer Deckard
Good morning, Marc. It's a great question, and as we've seen in the industry the shift towards finer grade sand, at first, there was some availability, there is some play to that in cost. And certainly there is a play as to how can we -- proppant be effectively placed throughout the [indiscernible]. We believe that at this point the design and the type of proppant that will be used will be more impacted by the design itself rather than cost, and that perhaps as costs change it might have a greater impact on the amount of proppant to be used rather than the grade that would be used.
Marc Bianchi
I see. And for your own contracting strategies, 70%-80% of capacity is under contract; can you talk about the pricing dynamics there, maybe as you started talking to people about contracting some of that, how that's evolved and you know, maybe what the relative spread versus you know, what something from one of your Northern White facilities might be costing the customer?
Jenniffer Deckard
Yes, that's also a good question, Marc. So, our pricing strategy, we'd do continue to maintain our historical approach, which is a market-based pricing. So, as this Permian market evolves and when we are really in the -- I would say still the first inning of how the supply/demand dynamic is going to work in the Permian, I think that we will continue to see maybe a shift in Fairmount's approach where we might have some fixed cost contracts that would be associated also with some prepayments by taking this, but we maintain our position that in the long run marked-based contracts are the best for Fairmount and also the best for our customers. So, we believe that dynamic will probably continue.
Marc Bianchi
Okay, great. And then just one -- yes, go ahead Michael. Sorry.
Michael Biehl
Marc, I would say that it's really -- we still expect 70%-80% as we said of our contract, you know, we have contracts in place for our tonnage. And some of that uncontracted tonnage goes into -- as a supply to our resin facility. So it's not like we have 30% or 20% that's uncontracted some of that in resin side. So it's a pretty low level that's uncontracted.
Marc Bianchi
Okay, great. And then just if I could one more as it relates to start-up, you mentioned that everything is on track despite some shifting around in the capital for the facility but as we look at all these facilities coming on you referred some anecdotes about power being a hurdle everybody is obviously concerned about what's going to happen with all the trucking capacity, could you talk through some of the hurdles that may exist and what gives you confidence that's not going to a bottleneck for you guys?
Michael Biehl
While we in terms of getting the property up and running, we drilled the water wells on the property and expect to provide sufficient water sourcing, power infrastructure is quite where we need to be and similar to other mines there, so we're going to be running off gas for a while probably it could be up to a year until they get the power grid upgraded. This really should be minimal cost impact to our plant operations, our permits for air transport, gas and electrical have all been accepted with no issues. So I think we continue to be in target.
Marc Bianchi
Okay, great. Thanks Michael, I'll turn it back.
Operator
And your next question comes from the line of Brad Handler with Jefferies. Please go ahead.
Brad Handler
Thanks, good morning.
Jenniffer Deckard
Good morning, Brad.
Brad Handler
I guess I will ask a couple of cash related questions please maybe come back quickly come back to something in the market but could you maybe Michael could you please frame out and give us some of the moving pieces on your expected CapEx for next year?
Michael Biehl
Well for next year we're still in the process of putting together our forecast, some of the carryover from Kermit will go into next year as we mentioned in the call, we would generally expect CapEx to be in similar ranges as we historically have for everything else though.
Brad Handler
Sorry and that push all the work on you as opposed to me doing that. But how much is left for Kermit then, if you spent $25 million in '17?
Michael Biehl
We would have at least while we spent $40 million to $45 million in total and I'm sorry that would be for 2018, that would be carryover.
Brad Handler
I'm sorry, so $40 million carries over for '18?
Michael Biehl
I'm sorry.
Brad Handler
Forgive me I think that's feeling confused about it. So how much is left in Kermit?
Michael Biehl
$40 million to $45 million, that was carryover into 2018, that's out of the total 60 to 70 in total, we would have another $10 million in leasehold interest payments that we would make in 2018 once the plant starts and then if you look at our historical guidance or historical CapEx levels that typically between $40 million and $50 million on the average barring any new projects or stripping that doesn't include stripping which typically runs $10 million to $12 million per year.
Brad Handler
Okay, great. Thank you. That's perfect and then I guess just maybe a follow up from me, can you update us on your I guess on the earn-out related to SSP, good news it sounds if I heard you correctly it sounds like the majority of the jobs being run in this quarter were on a commercial basis, that's clearly great progress but the I know there was an earn-out payment due and perhaps there is a little bit of rethinking around the relationship in total maybe not but if you could update us on that SSP earn-out and the relationship please?
Jenniffer Deckard
Sure. I guess I'll start with the relationship, there's certainly no changes there, so very strong partner with us and continuing to develop and trying to commercialize, Propel SSP which is going in the positive direction, we've had no changes in the terms of our earn-out arrangements for Propel SSP, we rightly would have a payment due based on the year-to-date to Q3 performance of SSP and we'll be paying that here in the next month or so as bill.
Brad Handler
Okay, got it. Okay, thanks. I'll turn it back.
Operator
Your next question comes from the line of Jim Wicklund with Fairmount Santrol. Please go ahead.
Jim Wicklund
Good morning guys, excellent job on pushing the price, so Jenniffer, you're going to start producing in Kermit in Q2 you note your capacity constraints, so the question is what's next? How much capacity do you think you need to add in '18 and '19 you gave us $100 million in '18 which ties with our number and while '19 isn't known this is always a growth business it seems. Can you talk about what and where your next batch of sand is going to come from?
Jenniffer Deckard
Hi, good morning Jim. Good question. I think for us we're going to be focusing 2018 to both complete and then bring online our Kermit facility. As always we continue to evaluate opportunities as they present themselves, we also continue to explore all sand opportunities. So we wouldn't discount additional sand in the future but honestly our focus is going to be on the plant that we have, it's going to continue to be investing in value added solutions in both Proppant Solutions and our I&R segment, we think that there is a great deal of opportunity to continue to get margins from value added products as well as our logistics network.
So we're going to continue to leverage the networks that we have and increase margins on the investments that we've already made and future expansions with sand to be continued to be evaluated but no specific plans that we could point to at the moment.
Jim Wicklund
One of the concerns we have and you kind of noted it that the first several additions in of Texas regional sand had somewhat negative impact on Wisconsin and otherwise and now they're starting to have a negative impact on the same competition in Texas, would you do you think that we need to develop as an industry more sand in Texas or more sand elsewhere, where do you think that the industry will really go to next in terms of developing additional sand resources?
Jenniffer Deckard
It would be our view that we're yet to see an impact from in-basin sand, so I believe we have not yet seen that, try to outline other I believe actually as the industry continues to grow and as the in-basin sand evolves, we believe that there is still going to be a very strong need for the Northern White sand into all basin including the Permian. So I think that will continue to see both in-basin and continue to see a good place for Northern White as the industry developed.
Michael Biehl
We still have about million and half tons, I don't enclose capacity in Michigan and re-fill plant in Wisconsin and our Hager Bay plant in Wisconsin but at this time had made a decision for them but those are also available facilities where we have to supply.
Jim Wicklund
Thank you, Michael. That's very helpful and on logistics you note your unit train capabilities Transload got really hot for a while and nobody has talked about it much, you note that you're looking at value added and returns, can you give us your thoughts on what Transload, the Transload segment of the industry is going to look like over the next two years and how that's going to develop not just for you, the industry?
Jenniffer Deckard
I think Jim one of the interesting things that I think people maybe don't think about with all of this in-basin capacity and we think about the size of Texas, we actually believe that not only we will our in-basin network including and let's talk about specifically the Permian will continue to be based for Northern White Sand, we actually think that it will also help us in the distribution of our Kermit facility and will enable us to keep that plant at full capacity and we'll continue to bolster our focus on reducing the last mile for our customers and having product closer to the wealth side as possible even within the basin.
Jim Wicklund
Okay, thank you very much, appreciate it. Good quarter.
Jenniffer Deckard
Thanks Jim.
Operator
Your next question comes from the line of George O'Leary with TPH and Company. Please go ahead.
George O'Leary
Good morning, guys.
Jenniffer Deckard
Good morning, George.
George O'Leary
Just a quick one from me, just curious what you guys are seeing on the contracting front more broadly and I think the main focus of investors has been on who is contracting with which Permian player at what price but as you guys are reactivating [indiscernible] and signing incremental contracts across your mining platform, are you seeing interest in prepayments and incremental contracts on the Northern White front as well and does that cover all grades or as rest lock up prepayments and lock contract clearly on the plan side?
Jenniffer Deckard
I should think so for us first of all almost every contract and I would maybe even say every contract for us has a grade distribution that matches our capabilities, so that's very key for us and we have a great partners that have broad needs for our products. So I would say that our contracts aren't don't tend to be grade specific or for single grades. We are seeing continued interest and I would say at a decode level for both Northern White and in-basin and the mix is probably pretty similar as to so I would say prepayment are not necessarily a function of in-basin but rather I think an evolving way that the industry is trying to look at the next generation of managing contracts in general.
George O'Leary
Thank you. Then one more if I could on the - on the logistics front maybe following onto Jim's question but looking more at the real side, you have all your railcars at a storage, you're running effectively close to capacity today but you are opening an incremental margins, is there a need to add railcars to the fleet or given the logistics network you guys have can you guys just give a little bit more efficient on the supply point of incremental volumes come into play, it sounds like first quarter.
Jenniffer Deckard
That's a great question and something we pay significant amount of attention to and so we currently have with the benefit of all of our cars now actively out of storage and placed in service and within solid service from our rail partners, we're hitting our full cycle times right on target and we think that we're adequately positioned for today probably with the little bit of room and as we bring on more capacity we think that we are adequately positioned on railcars and I think we have as we try to build into our fleet over the last several years.
We have some flexibility as cars come on and off the lease to either reduce cars or keep them in the system. Our Kermit facility will of course be not require railcars, so as we think about those three million tons we take those out of the equation as far as our rail fleet is concerned. So although same taking into consideration, we're very comfortable with our positioning over the next few years on railcars.
Michael Biehl
Hey George, we really haven't experienced on the significant [indiscernible] in the third quarter or so far in the fourth quarter some of our peers.
George O'Leary
That's very helpful color. Thanks Jenniffer, and Michael.
Jenniffer Deckard
Thank you. Have a great day.
Operator
Your next question comes from the line of Waqar Syed with Goldman Sachs. Please go ahead.
Waqar Syed
Thank you. Jenniffer, in the third quarter, what level of price increases did you see for any in the resin side coated products?
Jenniffer Deckard
Similar to what, with regard to similar to what we've stated in the past our resin pricing, our pricing on resin coated Proppants on a like to like basis has been relatively flat throughout the year and we not really given any guidance for upward mobility on that in the near term.
Waqar Syed
And then as we look into the fourth quarter you said resin maybe you may sell a little bit less volumes and cost maybe up a little bit, do you see margins come off than in the fourth quarter and if so could you give us kind of ballpark number of how much compression could there be?
Jenniffer Deckard
Well, I would say a couple of things so we expect flat pricing and if volumes are down and costs are up relative to fixed cost absorption and we probably see some margin reduction. Today to October our products volumes and held strongly for both frac sand and our value added prop and so what we would expect is some seasonal decline in volume in perhaps November and December.
And to this point if you historically look we see last year actually increase but there were different dynamics. So not in a position to predict or give any kind of estimates on that reduction could be because it today is equal to third quarter run rate.
Waqar Syed
Okay, thank you for the color.
Operator
And your next question comes from the line of Ole Slorer of Morgan Stanley. Please go ahead.
Ole Slorer
Thank you very much and then again thanks for all that data that you gave I think you'll have to go back and read the transcript because the stimulus lot of it but one thing I wonder if it was kind of my right away was the 20 million tones that you saw as imports into the Permian next year, how does that compare with what shipment into the Permian this year.
Jenniffer Deckard
Our estimate on the Permian in total was about $30 million to $35 million so that would be about $10 million to $15 million below. And I think that will then be made up by local supply which will then they offset by growth outside of the Permian.
Ole Slorer
So the call on Permian or all permit imports into Permian of Northern wide would you expect next year relative to this year.
Jenniffer Deckard
So that would be $18 million so this is first based on all of the assumptions that we lined up so moved ones of those something the moves the whole thing but based on the assumption that we outlined there that will be about 20 million tones of demand coming into the Permian that would be supplied from outside of the Permian so that would be the 40/70 demand that cannot be supplied by invasion supply as well as all of the course material because the Permian sands don't comply course material now the 20 million.
Ole Slorer
Okay and how does that compare with the Permian demand this year in 2017.
Jenniffer Deckard
2017 we believe the total demand was $30 million to $35 million with the comparison along that.
Ole Slorer
Okay so down a little bit I get it. My second question just a little bit on the G&A again you gave some breakdown Michael but Still failing to fully appreciate why the number is almost twice what it was year ago.
Michael Biehl
Well, it's a combination of things its merit increases that we put in at the beginning of the year that would have been there last year it's also driven by a higher short term incentive based upon our ramping up our performance so as we go through the year of performance increases.
We have to adjust our accrual for the short term incentive comp and with the significant ramp up over the first, second and third quarters that primarily drove that. There's also was a catch up in the third quarter payroll taxes related to the incentive that totals about 2 million.
And then so with the fourth quarter so the level you have we would expect that sort of say type of ramp up what we have to stretch out from prior quarters on both the incentive accrual and the any kind of payroll taxes related to it.
Ole Slorer
And looking into 2018 so it expects sort of similar run rate to the second half of this year or how can you help us think about that.
Jenniffer Deckard
Well our variable plans that we're accruing for right now would go back to reset targeted level so and if we factor in some headcount increases as we continue to grow but it would be more comparable to what we're forecasting for fourth quarter so in this type of levels.
Ole Slorer
Yes, thanks for that. Yes. As asking about pricing but in your base case do you see as scenario or at some point next year you reopen and your closed mines.
Michael Biehl
Yes, it's certainly possible holding with depending upon where demand from other basins, we have the ability to do that and depending upon what the demand is for the type of sand they'll be different grades of sand at each of these locations based tend to be course sand. But we would have the ability to open those up actually pretty quickly.
Jenniffer Deckard
Also is unit has unit has training capability which also helps us liability.
Ole Slorer
Yes, they're not absolutely but yes but that presume they are slightly higher costs I mean in other words you do expect the pricing environment that there's a lot of that but that was kind of like.
Jenniffer Deckard
Yes, it's always it's interesting as we took plants down and we brought them for you might expect that they were in order of cost per ton but not necessarily so in the first order is do they match the demand from our particular customers and so that's the key driver as we bring plants online and then they are total delivered cost into basin after that. So I wouldn't necessarily just assume that Hager City is one of is our high cost mines is it not necessarily the case.
Michael Biehl
Right. To expand on that further away. Shakopee is really our highest cost mines so these other plants coming on line would be actually at lower cost than when the overall cost returns down.
Ole Slorer
Okay.
Michael Biehl
Into that we keep in mind is that the Permian supply is mostly under mess. There is about 20% we think of 40/70 but its five year 40/70 it's more like 60-70. So it'll be interesting to see whether that 40/70 is acceptable in the Permian compared to another light 40/70 and again with most of the supply really the course grades and will continue to be supplied into the Permian.
Ole Slorer
Yes, just one final one may be on the Permian reduction I mean to some of the customers I've been back for example have been very clear in saying that they want to go to all local family if they can others on the other hand. Significant players rather significant technology approach have stated that they did not expect to follow that trend so when you been talking to the various players out there and in marketing at hermit's and also marketing or other products what's your take on the differences in and the customer behavior amongst; talking amongst of relatively at most sophisticated customers. In terms of what kind of profit mix they'll settle for.
Jenniffer Deckard
And the great point I let and I think that you hit the nail on my head and our actual experience in talking not only with our direct also field service customers but also with the EMPs is that there will be some players that will move on price only and there are some players that will move at some degree of price and give up there, what they might otherwise have a conviction in the design of their wealth. And there are some that are very set in what they believe they're well need for both the short term and long term recovery of the reserve and I think that we'll see a little bit of all of that which is I think why you see Fairmount entering into the in Basin because we want to be able to provide the full product breath and that's required by all of our customers.
So I believe that will be a hybrid not only in 2018 but going forward and I think a really great example of that is not necessarily between local and northern white but rather this continuous experimentation and refinement of the design as to product grade so there was a very big move to finer materials as I mentioned mainly for cost and for placement but as we started to see recovery rate. We have started to see EMP shift from 100% 100 mesh usage to maybe hundred mesh and tailing in with 40/70 Closer to well bore which actually makes sense if you think about A wall conductivity so I think that's continue to ultimately recoveries will drive the decision making over the long term.
Ole Slorer
Okay, I agree could be interesting to say place I don't think that but I think ripple plenty of surprises as we discover how that, that's going to settle bit thank you very much. I'll hand it back.
Jenniffer Deckard
Thanks a lot.
Operator
And your next question comes from the line of William Thompson with Barclays. Please go ahead.
William Thompson
Thanks for taking me on. So Jenniffer, I may missed did you reiterate your expectation for $30 million to $40 million Permian capacity by under 18 is that the number you quoted.
Jenniffer Deckard
Right. So that's our expectation based on going to all of the permits, all of the announcement and applying some factors of likelihood and all sorts of factors. We believe that on average the capacity will be $30 million to $40 million in 2018.
William Thompson
Okay and so if 80% of that production is 100 mesh I mean and that implies close to $30 million or say $28 million to $30 million of 100 mesh capacity so how do we think about what's kind of pricing if you think that Permian demand $45 million and only 40% of that's going to be for 100 mesh. It seems like on that kind of scenario those 100 mesh market would be quite oversupply pretty quickly.
Jenniffer Deckard
It's an interesting point because I think there's been a lot of focus placed on pricing for Northern white 100 hundred mesh. But we think that across the entire industry demand is going to remain very tight for 40/70 and even 100 mesh within the Permian you're looking at the correct metrics there if you think about Permian 100 mesh demand and even if a 100% of that moved to local if we have 30 million to 40 million tones of total need capacity added you would see a gap between demand and supply for 100 mesh in the Permian. So for that particular 18 million ton is of Permian demand is 45 million and 18 million to 20 million of that is hundred mesh. And it's all once Permian supply there will be more supply than demand for that product.
William Thompson
What do you think pricing would need to go to incentivize other players from adding there's numbers out there as high as mid 60 million tons of potential capacity. I mean where do you think pricing needs to go to kind of discenterlize some of the capacity come online or use you don't think those plants already built.
Jenniffer Deckard
I think it's too early to tell but I actually believe that it's going to be more a matter of how much comes online than price it will be a price point. At which maybe people wouldn't add capacity but I think rather it will be what is the estimated total demand in the Permian versus the expected addition of capacity as to whether someone will come on line or not.
William Thompson
And then quick one ask one from me just the 70%, 80% contracted volumes can you just help us understand how much I understand it's mostly market based pricing but how should we think about six volume versus percentage of how we should think about that breakdown of those contracts.
Jenniffer Deckard
The large majority of that contract is fixed volume at market pricing so it's we have a few share of wallets predominantly its fixed volume.
William Thompson
Okay, thank you.
Operator
[Operator Instructions] Your next question comes from the line of Kurt Hallead with RBC. Please go ahead.
Kurt Hallead
Hey, good morning.
Jenniffer Deckard
Good morning, Kurt.
Kurt Hallead
Lot of ground already covered this morning, so I would say, maybe Jenniffer, from your standpoint going to have given very specific and great color on the demand dynamics in basin out of basin for the Permian, when you went through your process, could you give us some insights on or maybe how you kind of risk assessed that capacity that expected to come into the Permian and kind of give us some sense on how much it's not come one because of the Sagebrush Lizard versus effective capacity. Can you just give us some color on how you risk assess that dynamics?
Jenniffer Deckard
Yes, our assessment was really more around tiny and likelihood of the builder. And unlikely the builder is the owner, so not really around the specific dynamics of a certain mind other than how far long are they truly in a process, is it a permit, has ground then broken, trying to think about lead times on equipment, those were more of the factors that we considered and trying to come up with a rating. Certainly I'm sure is not going to be exactly the size but was pretty methodically acquired and also I think the strength of customer relationship and being able to contract. So that was another factor we took into consideration.
Kurt Hallead
Okay. I appreciate that and then you want just for Michael, I know you went through some element to line item guidance for fourth quarter. I don't know if I picked up on it, so on your expected interest expense, I know you said they are being increased in interest expense but I didn't know if I picked up on the fourth quarter that point for interest expense and the same would go for tax, if you could just the effort…
Michael Biehl
It'd be roughly about $10 million on annual basis of we divide that by far it would be roughly $2.5 million just from the…
Kurt Hallead
So interest expense in the fourth quarter would be $2.5 million higher than third?
Michael Biehl
Well, actually kind of stupid because they are going to touch until November 1.
Kurt Hallead
Okay. And then, on tax, I didn't catch that?
Michael Biehl
On the tax side, it's -- I mean, we would [indiscernible] profitability and utilization of our NOL but would expect this to be of a 6% effective run rate that's certainly adjusted in the third quarter. So if there is anything change in that, we would adjust the team really in the fourth quarter but right now we just had a 6% you know, run rate for our effective tax rate.
Kurt Hallead
Excellent. Thank you. I appreciate it.
Michael Biehl
Okay.
Operator
The next question comes from the line of David Deckelbaum from KeyBanc. Please go ahead.
David Deckelbaum
Good morning, Jennifer and Michael. Thanks for taking my questions.
Jenniffer Deckard
Good morning, David.
David Deckelbaum
I wanted to ask a little bit more granularity on the third quarter, you saw a pretty descent increase in price per ton in double-digits. I guess so far you kind of highlighted market impacts going into next year, would you say that in third quarter sort of pricing for all grades moved in similar directions, are you seeing the greatest tightness and increase right now on the 40/70 side and have you already seen the impact of the 100 mesh pending supply in the Permian impacting your overall 100 mesh pricing?
Michael Biehl
So we've not yet seen any impact from the in-basin there is really very little yet hitting the market. Our pricing trends in Q3 were stronger for the final rate 40/70 and 10 mesh and we are also stronger in-basin. So I think those are the items we highlighted as kind of meeting the total increase and flat for value-added products other than the mix.
David Deckelbaum
Got it. And I know just kind of touching on Kurt's question there. Certainly you didn't necessarily risk the Permian supply for the June sales versus -- I guess for the $3 million annual tons of capacity that you all discuss a permit, has that already risk for DSL or I guess should we just think about it as you would end up risking some of the reserves of the location that you would potentially not develop to the sensitive habitats?
Jenniffer Deckard
Yes, actually that if we were to place any kind of risk, I would say that would be the risk that we would place although even with in our view the largest risk factor their we have significant amount of reserves that are very sufficient to cover this whole operation for many dozens of years as well as we also have a great relationship there with our landowner and as we need more volumes in the future that's probably something that we can benefit together for.
David Deckelbaum
So it sounds like there would probably be characteristic for the industry as well which is why you are risking around I guess likelihood of owner and timelines, it's probably more applicable.
Jenniffer Deckard
That's our view David.
David Deckelbaum
I guess the last question I have I guess is just on the cost side of the equation, are you seeing any tightness right now particularly on the logistic side. We are pretty anecdotally just increases and costs around trucks and labor, how are you seeing that right now and how are you thinking about that going into next year?
Michael Biehl
Really, haven't seen it experience that yet. I mean, that we haven't seen any bottlenecks in terms of from our side and logistics that it's certainly something that could come as the Permian minds come online but we haven't experience that yet.
Jenniffer Deckard
Yes, I would also say on the logistics that I think our customer base provides the last mile logistics and we don't provide that and I think that we have a customer base that has a pretty solid network and ability to manage that.
David Deckelbaum
Thanks for the color guys.
Jenniffer Deckard
David, congratulations to you.
David Deckelbaum
Thank you.
Operator
Your next question comes from John Watson from Simmons & Company. Please go ahead.
John Watson
Thanks for squeezing me in. I'll be brief, it looks like mine hours at Hager City might have gone up slightly in Q3, is there anything for us to really into there in the near-term?
Jenniffer Deckard
I'm so sorry. Could you repeat the question?
John Watson
Sure, it looks like the mine hours worked at Hager City might have picked up during the third quarter, is there anything for us to read into there in the near term, in terms of potential reactivation?
Michael Biehl
When you say mine hours, do you mean. I mean, because we don't Hager City is an open, you mean Maiden Rock?
John Watson
No, no. I mean, Hager City from [indiscernible] hours they disclosed, if the answer is no that's fine, that's something I know.
Michael Biehl
Oh, yes. Okay.
Jenniffer Deckard
That Hager City and Maiden Rock actually shared in trend capabilities. So those hours would actually have been just related to transloading and working through Maiden Rock volumes.
John Watson
Okay, perfect. And then, as a follow-up to Jim, have you looked at any indecent facilities not in Texas or Kermit and maybe you are not moving forward on anything for next year, is that something you considered or might be possible?
Jenniffer Deckard
I think over the last two years we've looked at 100s of locations and several 100 sand samples and so I think that we've covered the damage and we continue that profit, but that actually isn't something very new. We always continue to look at where that fits in the next sand opportunity might be.
John Watson
Got it. Thanks. I'll turn it back.
Jenniffer Deckard
Thanks, John.
Operator
There are no further questions at this time. I'll turn the call back over to the presenter.
Jenniffer Deckard
Nice. Thank you, Dan. And thank you to all of you for listening and participating today and a special thank you to our Fairmount Santrol family for their dedicated hard work that enabled us to achieve such a positive quarter. We are well positioned to deliver our solid fourth quarter and with the positive momentum created by our refinancing, we are now focused on getting our Kermit facility online to capture what we expect to be increasing opportunities in 2018 and to continue delivering value to our customers, our shareholders and our Fairmount family members. As always, we appreciate your continued interest in Fairmount Santrol. Have a great day.
Operator
This concludes today's conference call. And you may now disconnect.
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