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U.S. SILICA HOLDINGS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read together with the Condensed Consolidated Financial Statements and the accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q as well as the Consolidated Financial Statements, the accompanying notes and the related Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Overview We are one of the largest domestic producers of commercial silica, a specialized mineral that is a critical input into a variety of attractive end markets. During our 114 year history, we have developed core competencies in mining, processing, logistics and materials science that enable us to produce and cost-effectively deliver over 250 products to customers across these markets. In our largest end market, Oil & Gas Proppants, our frac sand is used to stimulate and maintain the flow of hydrocarbons in oil and natural gas wells. This segment of our business is experiencing rapid growth due to recent technological advances in the hydraulic fracturing process, which have made the extraction of large volumes of oil and natural gas from U.S. shale formations economically feasible. Our silica is also used as an economically irreplaceable raw material in a wide range of industrial applications, including glassmaking and chemical manufacturing. Additionally, in recent years a number of attractive new end markets have developed for our high-margin, performance silica products, including high-performance glass, specialty coatings, polymer additives and geothermal energy systems. As of October 30, 2014, we operate 16 facilities across the United States and control 339 million tons of reserves. We own one of the largest frac sand processing plants in the United States and control approximately 186 million tons of reserves that can be processed to meet American Petroleum Institute (API) frac sand size specifications. Our operations are organized into two segments based on end markets served: (1) Oil & Gas Proppants and (2) Industrial & Specialty Products. Our segments are complementary because our ability to sell to a wide range of customers across end markets allows us to maximize recovery rates in our mining operations, optimize our asset utilization and reduce the cyclicality of our earnings. Recent Trends and Outlook U.S. demand for industrial silica has been growing steadily. According to The Freedonia Group, Inc. ("Freedonia"), demand for industrial silica sand grew at a 4% compound annual growth rate ("CAGR") from 2001 to 2011. This increase in demand was driven primarily by hydraulic fracturing, which grew at a 27% CAGR from 2001 to 2011, according to the most recent related Freedonia report dated October 2012. The recovery of the U.S. housing and automotive markets has also positively affected silica related to those markets such as glass, building materials, foundry and fillers and extenders. Trends driving the acceleration in demand include: • Increased demand in the oil and gas proppants end market. The increased demand for frac sand has been driven by the growth in the use of hydraulic fracturing as a means to extracthydrocarbons from shale formations. According to the 2013 Proppant Market Report, PropTester Inc., published February 2014, global frac sand demand grew at a 35.5% CAGR from 2008 to 2013. This included 29.3% growth in frac sand demand from 2012 to 2013. Domestic proppant producers are expected to experience annual increases in demand of 9% through 2018, according to the most recent related Freedonia report dated June 2014. We expect continued growth of horizontal drilling. The industry may experience temporary fluctuations in demand and price as the market adjusts to changing supply and demand due to energy pricing fluctuations. We significantly expanded our sales efforts to the frac sand market in 2008 and have since experienced rapid growth in our sales associated with our oil and gasactivities. • Rebound of demand in industrial end markets and continued growth in specialty end markets. The economic downturn resulting from the financial crisis negatively impacted demand for our products in industrial and specialty products end markets, most notablyin the glassmaking, building products, foundry and chemicals end markets. This drop coincided with a similar drop in key economic demand drivers, including housing starts, light vehicle sales, repair and remodel activity and industrial production. To the extent these demand drivers recover to historical levels, which isdifficult to predict given current economic uncertainty, we expect to see a corresponding increase in the demand for commercial silica. In addition, to the extent commercial silica products continue to be used in key alternative energy markets, we anticipatecontinued volume growth in specialty end markets, such as highperformance glass and geothermal energy systems as well as the increased use of commercial silica in new applications such as specialty coatings and polymer additives. 18-------------------------------------------------------------------------------- Our Strategy The key drivers of our growth strategy include: • Expand our oil and gas proppants production capacity and product portfolio. We continue to execute on several initiatives to increase our frac sand production capacity and augment our proppant product portfolio. • In the first quarter of 2013, we purchased an existing silica sand processing facility from Quality Sand Products LLC ("QSP") in Peru, Illinois, which supports our Ottawa, Illinois facility. • In the first quarter of 2013, our new resin-coated sand facility in Rochelle, Illinois became fully operational with capacity to resin coat up to 400 million pounds of sand annually. • In the second quarter of 2013, our Sparta, Wisconsin facility became fully operational with an annual raw sand production capacity of 1,700,000 tons. • In 2013, we made an initial investment in a new Greenfield site near Utica, Illinois. This facility began its production in the third quarter of 2014. We expect this facility to have an annual capacity of approximately 1,500,000 tons of raw frac sand when fully operational by the end of the fourth quarter of 2014. • In 2014, we made an initial investment in a new Greenfield site near Fairchild, Wisconsin, which, depending on market conditions, could become operational as early as late 2015 and eventually add 3,000,000 tons of annual frac sand capacity. • On July 31, 2014, we completed our acquisition of Cadre Services, Inc. ("Cadre"), a leading regional sand mining company based in Voca, Texas. Cadre operates a single frac sand mine and plant, with an annual capacity of about 800,000 tons per year of Premium Hickory® sand and has more than 65 years of high-quality reserves. See accompanying Note D - Business Combination of our Financial Statements for more information regarding this acquisition. • We are also planning an 800,000 ton-per-year expansion at our Pacific, Missouri facility. This project includes adding a dryer as well as a new transload facility to support the additional volume and is expected to come online in the third quarter of 2015. • Increase our presence in industrial and specialty products end markets. We intend to increase our presence and market share in certain industrial and specialty products end markets that we believe are poised for growth. We will continue to work toward transforming our Industrial & Specialty Product segment from a commodity business to a more value-driven approach by developing capabilities and products that assist in enabling us to increase our presence in larger, more profitable markets. • Optimize product mix and further develop value-addedcapabilities to maximize margins. We continue to actively manage our product mix at each of our plants to ensure we maximize our profit margins. This requires us to use our proprietary expertise inbalancing key variables, such as mine geology, processing capacities, transportation availability, customer requirements and pricing. We expect to continue investing in ways to increase the value we provide to our customers by expanding our product offerings, increasing our transportation assets, improving our supply chain management, upgrading our information technology, and creating a world class customer service model. • Expand our supply chain network and leverage our logistics capabilities to meet our customers' needs in each strategic oil and gas basin. We continue to expand our transload network to ensure product is available to meet the growing in-basin needs of our customers. This approach allows us to provide strong customer service and puts us in a position to take advantage of opportunistic spot market sales. Our plant sites arestrategically located to provide access to all Class I railroads, which enables us to cost effectively send product to each of the strategic basins in North America. We can ship product by truck, barge and rail with an ability to connect to short-line railroads as necessary to meet our customers' evolving in-basin product needs. We believe that our supply chain network and logistics capabilities are a competitive advantage that enables us to provide superior service for our customers. For example, in 2013, we opened our San Antonio, Texas unit-train receiving transload facility, which was built in partnership with the BNSF railroad to support the Eagle Ford market. Additionally, we have entered into an agreement with the Union Pacific Railroad to build a transload facility in Odessa, Texas, which is expected to be fully operational near the end of 2014. We will continue to make strategic investments and develop partnerships with transload operators and transportation providers that will enhance our portfolio of supply chain services 19--------------------------------------------------------------------------------that we can provide to customers. We now have in-basin storage capacity at 30 transloads located near all of the major shale basins in the United States. • Evaluate both Greenfield and Brownfield expansion opportunities and other acquisitions. We will continue to leverage ourreputation, processing capabilities and infrastructure to increase production, as well as explore other opportunities to expand our reserve base. We may accomplish this by developing Greenfield projects, where we can capitalize on our technical knowledge of geology, mining and processing and our strong reputation within localcommunities. For instance, we are evaluating the potential development of a Greenfield project in Wisconsin, which could add 3,000,000 tons of annual frac sand capacity. Depending on market conditions, this facility could become operational as early as mid-2016. Our primary objective is to acquire assets complementary to our Oil & Gas Proppants segment, with a focus on mining, processing and logistics to further enhance our market presence. Some of these assets have differing levels of frac sand quality. We prioritizeacquisitions which provide opportunities to realize synergies (and, in some cases, the acquisition will only be accretive assuming synergies), including entering new geographic and frac sand product markets, acquiring attractive customer contracts, and improving operations. For instance, we completed the Cadre acquisition on July 31, 2014, which generated synergies and positively impacted our results of operations. See accompanying Note D - Business Combination of our Financial Statements for pro forma results of operationsrelated to the Cadre acquisition. • Maintain financial strength and flexibility. We intend to maintain financial strength and flexibility to enable us to pursue acquisitions and new growth opportunities as they arise. As of September 30, 2014, we had $121.7 million of cash on hand, $75.2 million in short-term investments and $47.0 million ofavailability under the Revolver. How We Generate Our Sales We derive our sales by mining and processing minerals that our customers purchase for various uses. Our sales are primarily a function of the price per ton realized and the volumes sold. We invoice the majority of our clients on a per shipment basis, although for some larger customers, we consolidate invoices weekly or monthly. The total amount invoiced reflects product, transportation and additional services as applicable, such as storage and transloading the product from railcars to trucks for delivery to the customer site. Our five largest customers accounted for approximately 38% of total sales during the nine months ended September 30, 2014. We primarily sell our products under short-term price agreements or at prevailing market rates. For a number of customers, we sell under long-term, competitively-bid contracts. As of October 30, 2014, we have eleven take-or-pay supply agreements in the Oil & Gas Proppants segment with initial terms expiring between 2014 and 2019. These agreements define, among other commitments, the volume of product that our customers must purchase, the volume of product that we must provide and the price that we will charge and that our customers will pay for each product. As discussed in Part I, Item 1A, of our 2013 Annual Report, "Risk Factors-A large portion of our sales is generated by our top customers, and the loss of, or significant reduction in, purchases by our largest customers could adversely affect our operations," these customers may not continue to purchase the same levels of product in the future due to a variety of reasons, contract requirements notwithstanding. Prices under these agreements are generally fixed and subject to upward adjustment in response to certain cost increases. As a result, our realized prices may not grow at rates consistent with broader industry pricing. For example, during periods of rapid price growth, our realized prices may grow more slowly than those of competitors, and during periods of price decline, our realized prices may outperform industry averages. Additionally, at the time the take-or-pay supply agreements were signed, some customers provided advance payments for future shipments. A percentage of these advance payments was recognized as revenue with each ton of applicable product shipped to the customer. Collectively, sales to customers with take-or-pay supply agreements accounted for 45% and 31% of our total company revenue during the nine months ended September 30, 2014 and 2013, respectively. Although sales under take-or-pay supply agreements, as opposed to short-term price agreements or at prevailing spot market rates, result in us realizing lower margins than we otherwise might during periods of high market prices, we believe such lower margins are offset by the benefits derived from the product mix and sales volume stability afforded by such supply agreements, which helps us lower market risk arising from adverse changes in spot prices and market conditions. Additionally, selling more tons under supply contracts also enables us to be more efficient from a production, supply chain and logistics standpoint. The Costs of Conducting Our Business The principal expenses involved in conducting our business are labor costs, electricity and drying fuel costs, maintenance and repair costs for our mining and processing equipment and facilities and transportation costs. Transportation and related costs include freight charges, fuel surcharges, transloading fees, switching fees, railcar lease costs, demurrage costs and storage fees. We believe the majority of our operating costs are relatively stable in price, but can vary significantly based 20 -------------------------------------------------------------------------------- on the volume of product produced. We benefit from owning the majority of the mineral deposits that we mine and having long-term mineral rights leases or supply agreements for our other primary sources of raw material, which limit royalty payments. Additionally, we incur expenses related to our corporate operations, including costs for sales and marketing; research and development; and finance, legal, environmental, health and safety functions of our organization. These costs are principally driven by personnel expenses. How We Evaluate Our Business Our management team evaluates our business using a variety of financial and operational metrics. Our business is organized into two segments, Oil & Gas Proppants and Industrial & Specialty Products. We evaluate the performance of these segments based on their tons sold, average selling price and contribution margin earned. Additionally, we consider a number of factors in evaluating the performance of the business as a whole, including total tons sold, average selling price, segment contribution margin, and Adjusted EBITDA. We view these metrics as important factors in evaluating our profitability and review these measurements frequently to analyze trends and make decisions. Segment Contribution Margin Segment contribution margin, a non-GAAP measure, is a key metric that management uses to evaluate our operating performance and to determine resource allocation between segments. Segment contribution margin excludes certain corporate costs not associated with the operations of the segment. These unallocated costs include costs that are related to corporate functional areas such as operations management, corporate purchasing, accounting, treasury, information technology, legal and human resources. Segment contribution margin is not a measure of our financial performance under GAAP and should not be considered an alternative to measures derived in accordance with GAAP. For more details on the reconciliation of segment contribution margin to its most directly comparable GAAP financial measure, income (loss) before income taxes, see Note Q - Segment Reporting to our Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Adjusted EBITDA Adjusted EBITDA, a non-GAAP measure, is included in this report because it is a key metric used by management to assess our operating performance and by our lenders to evaluate our covenant compliance. Our target performance goals under our incentive compensation plan are tied, in part, to our Adjusted EBITDA. In addition, our Revolver contains a consolidated total net leverage ratio that we must meet as of the last day of any fiscal quarter whenever usage of the Revolver (other than certain undrawn letters of credit) exceeds 25% of the Revolver commitment, which is calculated based on our Adjusted EBITDA. Noncompliance with the financial ratio covenant contained in the Revolver could result in the acceleration of our obligations to repay all amounts outstanding under the Revolver and the Term Loan. Moreover, the Revolver and the Term Loan contain covenants that restricted, subject to certain exceptions, our ability to make permitted acquisitions, incur additional indebtedness, make restricted payments (including dividends) and retain excess cash flow based, in some cases, on our ability to meet leverage ratios calculated based on our Adjusted EBITDA. Adjusted EBITDA is not a measure of our financial performance or liquidity under GAAP and should not be considered as an alternative to net income as a measure of operating performance, cash flows from operating activities as a measure of liquidity or any other performance measure derived in accordance with GAAP. Additionally, Adjusted EBITDA is not intended to be a measure of free cash flow for management's discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and debt service requirements. Adjusted EBITDA contains certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized, and excludes certain non-recurring charges. Management compensates for these limitations by relying primarily on our GAAP results and by using Adjusted EBITDA only supplementally. Our measure of Adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the methods of calculation. 21 --------------------------------------------------------------------------------The following table sets forth a reconciliation of net income, the most directly comparable GAAP financial measure, to Adjusted EBITDA. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Net income $ 41,277 $ 21,334 $ 88,302 $ 58,803 Total interest expense, net of interest income 4,859 4,127 12,543 11,201 Provision for taxes 14,427 5,739 31,907 19,103 Total depreciation, depletion and amortization expenses 12,425 9,152 32,355 26,320 EBITDA 72,988 40,352 165,107 115,427 Loss on early extinguishment of debt (1) - 480 - 480 Non-cash incentive compensation (2) 1,424 854 4,807 2,236 Post-employment expenses (excluding service costs) (3) 380 382 1,143 1,554 Other adjustments allowable under our existing credit agreement (4) 2,695 2,956 8,143 5,099 Adjusted EBITDA $ 77,487 $ 45,024 $ 179,200 $ 124,796 (1) Includes write-offs of debt issuance costs, legal fees and a prepayment penalty related to the early extinguishment of debt. (2) Includes vesting of incentive equity compensation issued to our employees. (3) Includes net pension cost and net post-retirement cost relating to pension and other post-retirement benefit obligations during the applicable period, but in each case excluding the service cost relating to benefits earned during such period. See Note O- Pension and Post-retirement Benefits to our Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. (4) Reflects miscellaneous adjustments permitted under our existing credit agreement, including such items as expenses related to offerings of our common stock by our former controlling shareholder, business development activities related to our growth and expansion initiatives, purchase accounting adjustment, one-time litigation fees, expenses related to debt refinancing and employment agency fees. Results of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 Sales Three Months Ended Nine Months Ended September 30, Percent Change September 30, Percent Change 2014 2013 '14 vs. '13 2014 2013 '14 vs. '13 Sales: Oil & Gas Proppants $ 186,812 $ 94,174 98 % $ 466,727 $ 245,428 90 % Industrial & Specialty Products 54,444 50,198 8 % 160,425 151,083 6 % Total Sales $ 241,256 $ 144,372 67 % $ 627,152 $ 396,511 58 % Tons: Oil & Gas Proppants 1,895 1,052 80 % 4,738 2,961 60 % Industrial & Specialty Products 1,098 1,059 4 % 3,168 3,084 3 % Total Tons 2,993 2,111 42 % 7,906 6,045 31 % Total sales increased 67% and 58% for the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013. The increases were driven by a 42% and 31% increase in tons sold and an 18% and 21% increase in average selling price for the three and nine months ended September 30, 2014, respectively. For the three and nine months ended September 30, 2014, tons sold in-basin through transloads represented 39% of total company tons sold, compared to 26% and 22% for the same periods in 2013. The increases were due to increased customer demand for our proppants at transload locations close to oil and gas customer drilling sites. The increases in total sales were mainly driven by Oil & Gas Proppants sales, which increased 98% and 90% for the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013. Oil & Gas Proppants tons sold increased 80% and 60% for the three and nine months ended September 30, 2014, respectively, due to year over year growth in the demand for our frac sands. The average selling price for Oil & Gas Proppants increased 10% and 19% 22 -------------------------------------------------------------------------------- for the three and nine months ended September 30, 2014, respectively, due to increased tons sold through transloads as a percentage of total tons sold and due to higher price driven by year over year demand. Industrial & Specialty Products sales increased 8% and 6% for the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013. Tons sold grew 4% and 3% for the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013, and average selling price increased 5% and 3%, respectively, when compared to the same periods in 2013. The increases were primarily driven by year over year growth in demand. Cost of Goods Sold Cost of goods sold increased by $58.7 million, or 65%, to $149.7 million and by $163.2 million, or 66%, to $408.9 million for the three and nine months ended September 30, 2014, respectively, when compared to $91.0 million and $245.7 million for the same periods in 2013. These increases resulted from more tons sold and from higher transportation and related costs, as well as $0.7 million related to a Cadre inventory valuation purchase accounting adjustment. As a percentage of sales, costs of goods sold represented 62% and 65% for the three and nine months ended September 30, 2014, respectively, and 63% and 62% for the same periods in 2013. These changes result from the main components of cost of goods sold as discussed below. We incurred $80.9 million and $231.6 million of transportation and related costs for the three and nine months ended September 30, 2014, respectively, compared to $46.4 million and $114.9 million for the same periods in 2013. The increases in transportation and related costs incurred were due to increased tons sold through transloads. As a percentage of sales, transportation and related costs increased to 34% and 37% for the three and nine months ended September 30, 2014, respectively, when compared to 32% and 29% for the same periods in 2013 due to an increase in tons sold through transloads as a percentage of total tons sold. We incurred $20.1 million and $52.7 million of operating labor costs for the three and nine months ended September 30, 2014, respectively, compared to $15.5 million and $45.4 million for the same periods in 2013. The increases in labor costs incurred were due to producing and selling more tons. As a percentage of sales, operating labor costs decreased to 8% for the three and nine months ended September 30, 2014, when compared to 11% for the same periods in 2013, mainly due to an increase in average selling price. We incurred $8.0 million and $24.4 million of electricity and drying fuel (principally natural gas) costs for the three and nine months ended September 30, 2014, respectively, compared to $6.3 million and $19.1 million for the same periods in 2013. The increases in electricity and drying fuel costs incurred were due to higher production volume. As a percentage of sales, electricity and drying fuel costs decreased to 3% and 4% for the three and nine months ended September 30, 2014, when compared to 4% and 5% for the same periods in 2013. We incurred $10.9 million and $24.5 million of maintenance and repair costs for the three and nine months ended September 30, 2014, respectively, compared to $5.7 million and $16.3 million for the same periods in 2013. The increases in maintenance and repair costs incurred were due to higher production volume. As a percentage of sales, maintenance and repair costs represented 5% and 4% for the three and nine months ended September 30, 2014, compared to 4% for the same periods in 2013, respectively. Segment Contribution Margin Oil & Gas Proppants contribution margin increased by $36.9 million, or 92%, to $77.0 million and by $64.0 million, or 57%, to $175.7 million for the three and nine months ended September 30, 2014, respectively, when compared to $40.1 million and $111.8 million for the same periods in 2013. Increases were driven by the following specific factors: increased sales due to an increase in tons of product sold driven by continued year over year growth in demand for our frac sands, as well as an increase in average selling price due to increased tons sold through transloads and due to higher prices driven by year over year demand, partially offset by increased cost of goods sold per ton mainly due to additional transportation and handling costs driven by increased tons sold through transloads. Industrial & Specialty Products contribution margin increased by $2.3 million, or 16%, to $16.8 million and by $4.5 million, or 10%, to $47.6 million for the three and nine months ended September 30, 2014, respectively, when compared to $14.5 million and $43.2 million for the same periods in 2013, due to increased sales volume and average selling price driven by growth in demand, partially offset by increased cost of goods sold. Selling, General and Administrative Expenses 23 -------------------------------------------------------------------------------- Selling, general and administrative expenses increased by $5.8 million, or 45%, to $18.6 million and by $18.0 million, or 51%, to $53.3 million for the three and nine months ended September 30, 2014, respectively, when compared to $12.8 million and $35.3 million for the same periods in 2013. The increases were mainly driven by an increase in compensation expense of $4.9 million and $13.3 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Additionally, business development expense increased by $1.3 million and $3.7 million to $1.3 million and $5.0 million, respectively, for the three and nine months ended September 30, 2014, compared to $0 and $1.3 million for the same periods in 2013. In total, our selling, general and administrative costs represented approximately 8% and 9% of our sales for the three and nine months ended September 30, 2014, compared to 9% for the same periods in 2013, respectively. Depreciation, Depletion and Amortization Depreciation, depletion and amortization expense increased by $3.3 million, or 36%, to $12.4 million and by $6.0 million, or 23%, to $32.4 million for the three and nine months ended September 30, 2014, respectively, when compared to $9.2 million and $26.3 million for the same periods in 2013. Year over year increases were driven by continued capital spending associated with our growth and capacity expansion initiatives combined with increased depletion due to additional volume of mined silica sands. We expect depreciation, depletion and amortization expense to continue to grow due to anticipated capital spending in 2014. Depreciation, depletion and amortization costs represented approximately 5% of our sales for the three and nine months ended September 30, 2014, compared to 6% and 7% for the same periods in 2013. Operating Income Operating income increased by $29.1 million, or 93%, to $60.5 million and $43.4 million, or 49%, to $132.6 million for the three and nine months ended September 30, 2014, respectively, compared to $31.4 million and $89.2 million for the same periods in 2013. The increases were primarily due to a 67% and 58% increase in sales, partially offset by a 65% and 66% increase in cost of goods sold and a 41% and 39% increase in operating expenses for the three and nine months ended September 30, 2014, respectively. Interest Expense Interest expense increased by $0.8 million, or 19%, to $5.0 million and 1.5 million, or 13%, to $12.8 million for the three and nine months ended September 30, 2014, respectively, when compared to $4.1 million and $11.3 million for the same periods in 2013, mainly due to interest expense related to the deferred revenue for the three months ended September 30, 2014. Provision for Income Taxes The provision for income taxes increased by $8.7 million, or 151%, to $14.4 million and $12.8 million, or 67%, to $31.9 million for the three and nine months ended September 30, 2014, respectively, when compared to $5.7 million and $19.1 million for the same periods in 2013. The increases were driven by higher effective tax rate and increased pretax book income. The effective tax rate was 26% and 27% for the three and nine months ended September 30, 2014, compared to 21% and 25% for the sames periods in 2013. Historically, our actual effective tax rates have been lower than the statutory effective rate primarily due to the benefit received from statutory percentage depletion allowances. The deduction for statutory percentage depletion does not necessarily change proportionately to changes in income before income taxes. Net Income/Loss Net income was $41.3 million and $88.3 million for the three and nine months ended September 30, 2014, respectively, and $21.3 million and $58.8 million for the same periods in 2013, respectively. The year over year increases were due to the factors noted above. 24 -------------------------------------------------------------------------------- Liquidity and Capital Resources Overview Our principal liquidity requirements have historically been to service our debt, to meet our working capital, capital expenditure and mine development expenditure needs, to return cash to our stockholders, and to finance acquisitions. We have historically met our liquidity and capital investment needs with funds generated through operations. We have historically funded our acquisitions through cash on hand or borrowings under our credit facilities and equity investments. Our working capital is the amount by which current assets exceed current liabilities and is a measure of our ability to pay our liabilities as they become due. As of September 30, 2014, our working capital was $296.2 million and we had $47.0 million of availability under the Revolver. We believe that cash generated through operations and our financing arrangements will be sufficient to meet working capital requirements, anticipated capital expenditures, scheduled debt payments for at least the next 12 months and any dividends declared. Management and our Board remain committed to evaluating additional ways of creating shareholder value. Any determination to pay dividends and other distributions in cash, stock, or property in the future will be at the discretion of our Board and will be dependent on then-existing conditions, including our business conditions, our financial condition, results of operations, liquidity, capital requirements, contractual restrictions including restrictive covenants contained in debt agreements, and other factors. Additionally, because we are a holding company, our ability to pay dividends on our common stock may be limited by restrictions on the ability of our subsidiaries to pay dividends or make distributions to us, including restrictions under the terms of the agreements governing our indebtedness. Cash Flow Analysis A summary of operating, investing and financing activities is shown in the following table: Nine Months Ended Percent September 30, Change 2014 2013 '14 vs. '13 Net cash provided by (used in): Operating activities $ 106,987 $ 28,527 275 % Investing activities (149,880 ) (71,668 ) 109 % Financing activities 86,345 110,806 (22 )% Net Cash Provided by Operating Activities Operating activities consist primarily of net income adjusted for certain non-cash and working capital items. Adjustments to net income for non-cash items include depreciation, depletion and amortization, deferred revenue, deferred income taxes, equity-based compensation and allowance for doubtful accounts. In addition, operating cash flows include the effect of changes in operating assets and liabilities, principally accounts receivable, inventories, prepaid expenses and other current assets, income taxes payable and receivable, accounts payable and accrued expenses. Net cash provided by operating activities was $107.0 million for the nine months ended September 30, 2014 compared to net cash provided by operating activities of $28.5 million for the nine months ended September 30, 2013. This $78.5 million increase in cash provided by operations was primarily the result of the following factors: a $29.5 million increase in net income; a $21.4 million decrease in inventory changes mainly due to more inventory sold than produced; a $27.7 million change in accounts payable and accrued liabilities due to increased expenses; a change in income tax payable of $22.3 million, mainly due to a federal tax extension payment of $19.6 million for the 2012 tax year paid in March 2013; an $8.6 million increase in depreciation, depletion and amortization and equity-based compensation; partially offset by a change in accounts receivable of $34.6 million due to an increase in revenue. Net Cash Used in Investing Activities Investing activities consist primarily of capital expenditures for growth and maintenance. Net cash used in investing activities was $149.9 million and $71.7 million for the nine months ended September 30, 2014 and 2013, respectively. We used cash to purchase Cadre, which totaled $98.3 million, and capital expenditures, which totaled $51.6 million as of September 30, 2014 for the engineering, procurement and construction of our Greenfield raw sand plants near Utica, Illinois, and Fairchild, Wisconsin, our new transload facility in Odessa, Texas, our expansion project at Pacific, Missouri facility and other maintenance capital projects. Capital expenditures for the nine months ended September 30, 25 -------------------------------------------------------------------------------- 2013, which totaled $46.8 million, were primarily for the continuing engineering, procurement and construction of our Greenfield raw sand plant in Sparta, Wisconsin, and the construction of our transloads in San Antonio, Texas, Fairmont, West Virginia and East Liverpool, Ohio. Management anticipates that our total capital expenditures in 2014 will be approximately $100 million, which is primarily associated with growth and maintenance capital including the construction of the mine and processing facility near Utica, Illinois, and Fairchild, Wisconsin, the construction of the transload facility in Odessa, Texas, as well as an expansion of our Pacific, Missouri facility. Net Cash Provided by Financing Activities Financing activities consist primarily of equity issuances, capital contributions, dividend payments, borrowings and repayments related to the Revolver and Term Loan, as well as fees and expenses paid in connection with our credit facilities, advance payments from our customers, and outstanding checks to our vendors. Net cash provided by financing activities was $86.3 million for the nine months ended September 30, 2014, driven by $100.0 million advance deposit from a customer and $9.1 million in proceeds from options exercised and excess tax benefit from equity-based compensation partially offset by $20.1 million in dividend payments. Net cash provided by financing activities was $110.8 million for the nine months ended September 30, 2013. During the period, we had an increase in borrowings under our refinanced Term Loan of $373.8 million and $6.5 million of proceeds from options exercised, which was offset by a $257.0 million repayment of our existing long-term debt, $6.6 million in dividends paid, $4.1 million in financing fees, and a $1.7 million change in our book overdraft. For more details about our senior credit facility, please see accompanying Note H-Debt to our Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are likely to have a current or future material effect on our financial condition, changes in financial condition, sales, expenses, results of operations, liquidity, capital expenditures or capital resources. Contractual Obligations There have been no significant changes outside the ordinary course of business to our "Contractual Obligations" table in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our 2013 Annual Report, except that we entered into additional new leases for railroad cars. For more details on future minimum annual commitments under such operating leases, please see accompanying Note M-Leases to our Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Environmental Matters We are subject to various federal, state and local laws and regulations governing, among other things, hazardous materials, air and water emissions, environmental contamination and reclamation and the protection of the environment and natural resources. We have made, and expect to make in the future, expenditures to comply with such laws and regulations, but cannot predict the full amount of such future expenditures. As of September 30, 2014, we had $10.8 million accrued for future reclamation costs, as compared to $9.4 million as of December 31, 2013. We discuss certain environmental matters relating to our various production and other facilities, certain regulatory requirements relating to human exposure to crystalline silica and our mining activity and how such matters may affect our business in the future under Item 1, "Business," Item 1A, "Risk Factors" Item 3, "Legal Proceedings", and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Environmental Matters" in our 2013 Annual Report. Critical Accounting Estimates Our unaudited condensed consolidated financial statements have been prepared in conformity with GAAP, which requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. While we do not believe that the reported amounts would be materially different, application of these policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. We 26 -------------------------------------------------------------------------------- evaluate our estimates and judgments on an ongoing basis. We base our estimates on experience and on various other assumptions that are believed to be reasonable under the circumstances. All of our significant accounting policies, including certain critical accounting policies, are disclosed in our 2013 Annual Report. Recent Accounting Pronouncements New accounting guidance that we have recently adopted, as well as accounting guidance that has been recently issued but not yet adopted by us, are included in Note A-Summary of Significant Accounting Policies to our Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Availability of Reports; Website Access; Other Information Our internet address is http://www.ussilica.com. Through "Investor Relations"-"SEC Filings" on our home page, we make available free of charge our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our proxy statements, our Current Reports on Form 8-K, SEC Forms 3, 4 and 5 and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our reports filed with the SEC are also made available to read and copy at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the Public Reference Room by contacting the SEC at 1-800-SEC-0330. Reports filed with the SEC are also made available on its website at www.sec.gov. Copies of our Corporate Governance Guidelines, our Audit Committee, Compensation Committee and Nominating and Governance Committee charters, the Code of Conduct for our Board of Directors and Code of Conduct and Ethics for U.S. Silica employees (including the chief executive officer, chief financial officer and corporate controller) can also be found on our website. Any amendments or waivers to the Code of Conduct and Ethics applicable to the chief executive officer, chief financial officer and corporate controller can also be found in the "Investor Relations" section of the U.S. Silica website. Stockholders may also request a free copy of these documents from: U.S. Silica Holdings, Inc., attn.: Investor Relations, 8490 Progress Drive, Suite 300, Frederick, Maryland 21701or [email protected]. 27-------------------------------------------------------------------------------- |