U.S. Silica Hits on Revenue and Volume

U.S. Silica reported revenues well above our estimate and consensus, but profit performance was again negatively affected by lower contribution margins; we believe the culprits are probably 100 mesh demand, costs from Utica ahead of the upcoming ramp-up, transportation buildout expenses, and perhaps other mix issues. While we do not believe 100 mesh is cannibalizing demand for coarser grades, the volumes for U.S. Silica are growing so fast that contribution per ton is likely to suffer for quite some time (unless 100 mesh pricing improves, something we do not expect even though management said it is sold out of every grade).

Guidance: The company narrowed its 2014 guidance for adjusted EBITDA of $180 million to $200 million to the high end of the range, versus our previous adjusted estimate of $199 million. The company guided capital expenditures of $75 million to $85 million last quarter. The company announced it will be bringing its new Utica, Illinois, mine online late in the second quarter. We had not modeled any tonnage contribution from Utica in the second quarter, but now we will model a tad. We expect this new mine to help not only from a capacity-addition perspective, but also from a contribution margin per ton perspective, as it should provide certain logistical advantages. Pricing commentary in the release was positive and should help investors get more comfortable with forward estimates.

Results: Oil-and-gas volumes were higher than we modeled (but were not surprising given recent industry commentary), up 41% year-over-year, to 1.30 million tons, and up 18.2% sequentially, while ISP volumes were a tad below our expectation, up 1.1% yearover- year, to 0.98 million tons, but down 2.5% sequentially. Contribution margin dollars were $54.8 million versus our previous $53 million estimate, with oil and gas above our estimate ($41.6 million versus our $40.8 million) and ISP below ($13.2 million versus our $14.1 million). Contribution margin per ton in oil and gas was not great ($32.0 million, down 19% versus last year and coming off a down 35% recorded in the fourth quarter), driven by, we believe, poor fixed-cost absorption, certain basin activity levels that presented logistical challenges, and a mix headwind from 100 mesh (and maybe 40/70 versus coarser grades).

In our view, the oil-and-gas contribution per ton result will be the key issue for the call as we continue to believe investors are grasping for evidence of price (up or down), transportation efficiencies (or lack thereof), and production cost efficiencies; therefore, contribution per ton is the only data point to focus on. Reported EPS included $0.03 in M&A and business development expenses that management called out; we expect most investors will not add back the expense, but regardless of how the issue is treated, upwardly revised guidance commentary accounts for it.