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Emerge Energy Services (NYSE:EMES)

Q2 2013 Earnings Conference Call

August 14, 2013 4:00 p.m. ET

Executives

Robert Lane – Chief Financial Officer

Ted W. Beneski – Chairman of the Board

Rick Shearer – Chief Executive Officer

Warren B. Bonham – VP & Director

Analysts

Douglas Becker – Merrill Lynch

Jeremy Tonet – JP Morgan

Dan Davis – Stifel

Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2013 Emerge Energy Services Earnings Conference Call. My name is Tihisha and I will be operator for today. At this time all participants all participants are in listen-only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host today Mr. Robert Lane, Chief Financial Officer of Emerge Energy Services, please proceed.

Robert Lane

Thank you, Tihisha. Just a quick note before we start. Our discussion today may contain forward-looking statements. These statements may include but are not limited to our estimates of future volumes, operating expenses and capital expenditures and they also include statement concerning anticipated cash flow, liquidity, business strategy and other plans and objectives for future operations. These statements are based on management believes and assumptions although we believe that the expectations reflected in such forward-looking statements are reasonable. We can provide no assurance that such expectations will prove to be correct.

These statements are subject to and uncertainties, if one or more of these risks materialize or should the underlying assumptions prove incorrect actual results may vary materially from those expected. These risks are discussed in greater in our prospectus on file with Securities and Exchange Commission. Please also note that on this call we may use the terms EBITDA, adjusted EBITDA and distributable cash flow. These are non-GAAP financial measures and we have provided reconciliations to the most direct comparable GAAP measures in our second quarter 2013 earnings release.

And now I would like to turn the call over to our Chairman, Ted Beneski.

Ted W. Beneski

Thank you, Rob and thank you to all of you who are joining us for our inaugural earnings call. We have been very pleased with our operational and financial in IPO this past May. Emerge had record results at both our sand and fuel divisions driven by strong volumes and focus on our customers and continuous operational improvements.

As we previously announced, we declared our initial distribution on July 16 of $0.37 per unit, were $0.70 per unit prorated for the quarter ended June 30, 2013. This compares to the projections contained in our IPO prospectus of $0.62 for the second quarter, where in other words we were 13% above our forecasted distribution.

As we move forward with our plan, we continue to believe that our full pay NOP model (ph) will give our investors the opportunity to see their distributions grow and believe that we will meet or possibly exceed the distribution laid out in our prospectus.

Just a few comments about the sand segment. Customers in the sand segment have reinforced our belief that our high quality core sand will continue to be a premium in demand for crude oil and liquid rich natural gas extraction industries. We continue to see growth there and demand driven by producers who are drilling more wells with their rigs, more stages per well and using more sand per stage. And we offer the same comments on the earnings calls of our customers and their customers over this most recent earnings cycle.

Our fuel segment has been able to take advantage of strong market dynamics and unique opportunities to continue to push our steady reliable EBITDA growth there as well. We were able to take advantage of the strong RIN environment for a good part of the quarter and our full pay NOP model allows us to pass that additional cash flow onto our investors.

I am happy to say that our board is considering a number of capital improvement projects. We’re moving ahead with the engineering work for a new wet plant for service to growth at Barron and we have also made additional capital improvements at our new Auburn and Barron facilities that enhance our rail loading and transloading capabilities. (Inaudible) to enhance their status to state of the art facility in the fact sand industry.

In our fuel segment we plan to build to additive systems at our two facilities which should add incremental EBITDA from both our terminal and purchasing customers. We are also looking at the next stage of our growth once the Barron facility is near capacity and we will share some of those plans with our investors at a future date.

With that I would like to turn the call over Rick Shearer, our CEO who will discuss the results of operations in our sand segment.

Rick Shearer

Thank you, Ted. This has been an extraordinary quarter for Emerge and our sand segment lead as Ted said by the strong ramp up in sales of our Northern White sand from our Barron County facility.

For the most recent quarter we sold 634,000 tons of sand including 309,000 tons from our new Auburn facility and 289,000 tons from our Barron plant. This run rate of over 2.5 million tons per year exceeds the 2 million tons we projected in our prospectus for the 12 months ending March 31, 2014 and we believe that we will exceed our annual projections for sand volume sold.

Our segment EBITDA was $14.1 million for the full quarter, a marked increase over the $8.9 million we generated for the same period last year and a 12% improvement over the first quarter of this year. We continue to execute on our fundamental strategy of broadening our customer base, working closely with customer to get them the products they need in a timely fashion and maintaining a cost profile that is one of the lowest in the business.

Our ability to load sand at our mines directly onto two class railroads allows to competitively reach most major sales plays in North America on a single line haul. We have expanded our logistics offerings both with Emerge owned sites and partner sites to give our customers the ability to take sand FOB or mine or FOB well head. We continue to believe that the coarseness of the sand from our Northern White reserves allows us to command premium pricing even as we expect new capacity to slowly come online from our competitors.

Considering that we just put the Barron facility into service at the very end of 2012 and that this plans 2.4 million ton for year capacity as one of the largest in the industry, we’re proud that our sales and operations teams have now have the plant operating over 50% of capacity and selling every ton we produce.

We believe it is more than likely that we will reach 80% capacity at Barron by this time next year. Each of our customers with whom we have contracts is ordering above their contract amendments and we continue to gain new customers on both the spot and contract basis.

We continue to see pricing dynamics and the market evolve, while we believe and our customers confirm that quality of product, service and deliverability still command the premium, there is still some price pressure by customers. We have recently had our price reviews with our two largest customers and have agreed to hold the prices steady for the coming year. We continue to enjoy strong pricing in some basins where we are ramping up sales and also continue to see a significant premium for our 1630 product. We expect these dynamics to stabilize our average selling price next quarter but overall do not expect to see dramatic movement in pricing in the near future.

From a logistic standpoint, our new Mingo Junction Ohio, Canton Ohio and Sax Smith Alberto transloading facilities allow us to serve customer needs in key basins at a moment’s notice. We remain committed to expanding our logistics network through efficient deployment of capital and mutually beneficial partnerships. As we look beyond Barron our team is exploring in number of opportunities including expansions, organic Greenfield projects and acquisitions to continue our growth trajectory.

Well, we’re not prepared to discuss these in detail at this time, our primary objective remains selling out our Barron facility and working closely with our customers to continue to deliver the high quality sand they expect from Emerge.

I would now like to turn the call over to Warren Bonham for a discussion of our fuel segment.

Warren B. Bonham

Thank you, Rick. Our fuel division continues to perform as expected generating dependable cash flow over the course of the quarter. For the quarter ended June 30, we sold a total of 55 million gallons of refined product and had an additional 102 million gallons of throughput by our terminal customers. This compares with 44 million gallons sold and 93 million gallons of throughput for the same period of 2012.

Transmit gallons produced with 19 million gallons for the most recent quarter and 6 million gallons for the same quarter in the prior year. The year-over-year results are not comparable since direct fuels was acquired for accounting purposes at the IPO and are not included in the predecessor results.

On a pro forma basis, our refined product sold for the quarter was 689 million, our terminal throughput for third party customers was a 116 gallons and our transmit volume was 29 million gallons. Were we to include direct fuels the sales in throughput numbers would be substantially the same in both the most recent quarter and the same period to prior year.

On adjusted segment EBITDA for the quarter was $4.6 million compared to $1.1 million for the same period in 2012. Well, some of this is also from the direct fuels acquisition, it was also a significant margin improvement because of changes we implemented following a thorough review of our marginally profitable contract late last year and the effect of favorable RIN pricing.

We have seen a significant increase in ethanol and RIN pricing over the course of the year driven primarily by the so called ethanol blend wall whereby the overall consumption of gasoline is not large enough to absorb the amount of ethanol that is mandated by the removable fuel standard.

Biodiesel RINS can be used to satisfy any shortfall in RINS from ethanol blending while we’re able to take advantage of RINS when they’re at elevated levels we do not know if this RIN pricing environment will continue on an ongoing basis and therefore we did not include it in the forecast laid out in our prospectus.

Although not to the magnitude of the sand division, we have a number of small capital improvements we’re working on in our fuel segment as we believe can become material contributors to EBITDA overtime. The segment we’re planning to put in additive systems at both of our facilities and continue to look at ways to debottleneck our biodiesel operations.

In all we believe that the fuel segment can continue to deliver steady predictable results as we look to grow that EBITDA as well.

I will now turn the call over to Ron Lane, our Chief Financial Officer.

Robert Lane

Thank you, Warren. Emerge reported a net loss of $7.3 million or $0.32 per unit for the period beginning May 14, 2013, the date Emerge closed its initial public offering through June 30, 2013. This included a charge of $10.9 million of expenses associated with our IPO that were paid from proceeds of the IPO, but for accounting purposes output through the income statement for the period after our IPO.

Over this same period, Emerge reported distributable cash flow of $8.9 million of $0.37 per unit. Our full quarter adjusted EBITDA was $17.1 million compared to $10.1 million for the same quarter last year. This difference is primarily because of the significant year-over-year increase in sand sales and the effects of the acquisition of direct fuels.

Our total SG&A increased to $4.8 million from $2.8 million because of additional expenses we now incur as a public company and because of the incremental SG&A from direct fuels. Our interest expense for the quarter was $3.5 million compared to $2.8 million for the prior year period. This increase was because of the additional debt incurred from the construction of our Barron County facility as well as the assumption of the debt of direct fuels offset by our lower interest rate following the close of our current credit facility.

Excluding the acquisition of direct fuels our capital expenditures for the quarter was $3 million, this includes $265,000 of maintenance CapEx approximately $258,000 which was spent following the close of our IPO. We ended the quarter with $118.9 million of debt outstanding including our capital leases and $15 million of cash on the balance sheet.

At the end of the quarter we had $36 million of availability on our credit facility. As mentioned earlier, we declared our cash distribution of $0.37 per quarter on July 16, which was paid to-date orders of record on August 6.

I would now like to turn the call back over to Ted.

Ted W. Beneski

Thanks Rob and operator I think, we’re now ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Doug Becker from Merrill Lynch, please proceed.

Douglas Becker – Merrill Lynch

Thanks. Congratulations on a quick start of the blocks. Maybe a little bit of color on the volumes, I know there were some talk in the queue about the addition screen at the New Auburn facility, how quickly does that come on and if new Barron volumes are ramping up very quickly what do you need to see think about that second wet plant that you alluded to at the Barron facility?

Ted W. Beneski

Rick.

Rick Shearer

I’ll be happy to take that thank you. First part of your question around New Auburn we have seen such strong demand out of the new Auburn plant that we have made the decision to move ahead and put a new Rotec screen and additional Rotec screen in the New Auburn facility, the screen actually arrived at the plant today and that installation should be completed and increased production should begin in early September that should increase our capacity about 200,000 tons or little more on a annual basis here at New Auburn.

On the Barron plant as far as the new wet plant and the new mine what we call Sue Creek that mine and that wet plant is moving forward, we expect to have that mine open in the wet plant operational by mid-to-late summer of next year that will give us 40 million tons of additional high quality reserves, actually giving the company over a hundred million tons of high quality reserves here in Wisconsin.

Douglas Becker – Merrill Lynch

Okay and we have been hearing more about slick well fracs which use more of the finer grain of sand, the 100-mesh sand do you see that as a source of upside for the Kosse volumes?

Rick Shearer

Potentially it could be, one of the advantageous for the facilities that we have not only in Kosse which is the finer grade 100-mesh frac sand, but even here in Wisconsin is when you have a Kosse product mix as we do even here we can adjust accordingly to demand because the Kosse products are a higher price, have higher average selling price we don’t necessarily want to drive our business on that basis, but we have that flexibility but certainly it could mean additional opportunity and additional growth for our Kosse Texas mine, yes.

Douglas Becker – Merrill Lynch

Okay. Thank you very much.

Rick Shearer

Thank you.

Operator

Your next question comes from the line of (inaudible) from Wells Fargo Securities, please proceed.

Unidentified Analyst

Hey guys also my congratulations on the ramp up, really great operational performance. I wanted to ask the follow-up on the comment you made where you think you can stabilize prices next quarter, I just wanted to make sure I understand exactly what that that means, do you think we can keep prices in the third quarter in this $49 a ton range?

Rick Shearer

Yes, at least yes. Our feeling is that for a number of reasons when we look at ASP we had a major segment that is growing rapidly for us actually in Western Canada which is a very solid pricing center for us that business was slower than expected actually in the last quarter as a result of flooding and the break-up period as they call it in Canada. So, as we improve our customer mix and the two major customers that we have even though their business is growing with us their percentage of total customer base is being reduced that gives us a chance to bring in a customer mix at a higher average selling price. So basically, for that reason we fully expect that our average selling price will stabilize if not uptick slightly.

Unidentified Analyst

Okay. So those two major customers do they have the right to buy as much sand as they want it, the preferred pricing or do they have a limit as to how much volume they could purchase at those prices?

Rick Shearer

We certainly will fulfill our contract requirements and as capacity will allow, we will continue to sell to them to meet their needs.

Unidentified Analyst

And continue to sell above the contracted minimums at the preferred price.

Rick Shearer

Yes. As capacity, our capacity will allow that’s correct.

Unidentified Analyst

Okay and then a question on the cost side, how much sand are you currently purchasing from third parties and the wet sand that is, and how much more expensive is that and your internally mine sand?

Rick Shearer

We have had a situation where with the very strong demand in Wisconsin and the very wet spring, the fact that we had hardly any feed remaining by the end of the winter because the product was all converted and sold, the wet sprint impacted as well we had a situation where yes we did need to buy and we did successfully buy sand from a third party that will be on a limited basis as you probably know and that will expire by the end of this summer as far as the additional fee that we would get from a third party that has increased our cost slightly. But that cost will go away certainly as I say starting this fall into the winter and we will be fully self-sufficient with the capacity and the new mines that we bought online and the Sue Creek mine to come on next summer.

Unidentified Analyst

Okay. So even with the higher throughput, you are able to stock pile some, I guess inventory for the winter months?

Rick Shearer

Oh yes. We’ll have in excess of 1.3 million ton stock piled to take care of our customer needs for the winter that’s correct.

Unidentified Analyst

Terrific. Thank you very much guys.

Ted W. Beneski

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of (inaudible).

Unidentified Analyst

Good afternoon guys and thank you for taking my call. This is Brian on for Salmon. Just have a couple of quick follow-up questions first of, what was the makeup of the spot sales relative to total ton sold?

Rick Shearer

On a percentage basis I would actually have to look at that to give you a precise answer so rather than guess we would have to get back to you on that.

Unidentified Analyst

Okay. And then, in light of the additional screener project, how should we think about the volumes ramping up at new opportunities is the volume already contracted or?

Rick Shearer

Yes. Essentially, we have customer demand in place I don’t want to say that you’ll see the impact of that in September, but certainly in the two to three months period in essence we will take up that, that additional capacity, that’s the expectation.

Unidentified Analyst

Okay. And could we get any color on we’re seeing a strongest demand geographically?

Rick Shearer

Well, lot of that demand is really as much in the marketplace as it is our ability to serve from a logistic standpoint for Emerge Energy, we’re seeing very strong growth in Western Canada and Eureka and the Marcela Shale place as well as continuing strong demand in Texas.

Unidentified Analyst

Great. And then, just lastly with a quarter half over how should we be thinking about volumes and pricing?

Rick Shearer

Well, I think very confidently. I think as we move ahead on both fronts, we’re confident that things look very good from our perspective and we are working very hard to ensure that indeed we continue to produce and we continue to ramp up this business.

Robert Lane

I think I have made the comment earlier that we certainly expect to meet what we have laid out in the prospectus in terms of a forecast for the next quarter that I would say that we are tracking ahead of that at this point in time.

Unidentified Analyst

Great, that’s all. Thank you guys.

Rick Shearer

Thank you.

Operator

Your next question comes from the line of (inaudible) please proceed.

Jeremy Tonet – JP Morgan

High this is Jeremy Tonet JP Morgan. Congratulations on the strong quarter.

Ted W. Beneski

Thank you.

Rick Shearer

Thank you.

Jeremy Tonet – JP Morgan

Just want to touch base on the fuel segment would you guys be able to share pro forma number for segment EBITDA if direct fuels were acquired for the whole quarter is that something that you could provide?

Robert Lane

Yeah. I think we can give you a little more color on that as direct fuels was acquired roughly halfway through the quarter, just slightly over half of the quarter is included and if it had been purchased at the start of the quarter probably would have added another $1.3 million of EBITDA.

Jeremy Tonet – JP Morgan

Okay great and then as far as the RINS impact is that something that you guys can quantify what type of benefit that was to the quarter?

Robert Lane

Yeah. I think it was roughly a million dollars of benefit in the second quarter.

Jeremy Tonet – JP Morgan

Okay, great. And then, it seems like results are going quite nicely in that segment, I’m just wondering how repeatable some of the increased margins are versus some of the one-time stuff like RINS which may disappear in the future if you can provide any color on that that’ll be helpful.

Robert Lane

I think apart from the RIN upside it -- you pointed out is somewhat unpredictable. I think the other value improvement initiatives are all gaining a lot of traction we talked about the contract rationalization project which is last year and that’s certainly is taking whole there are some discussions underway with some additional through quarters, biodiesel is a new initiative for us which was not present last year to new this year. So there are a variety of things that are new this year that are very much sustainable.

Jeremy Tonet – JP Morgan

That’s very helpful. That’s it from me, thank you.

Operator

Your next question comes from the line of Dan Davis from Stifel please proceed.

Dan Davis – Stifel

In regard to the frac sand you mentioned that you were one of the lowest cost producers, could you give me an idea of what your cost are per ton and what when you go to 80% capacity, what effect that’ll have?

Rick Shearer

I think, it’s generally recognized that anybody who is somewhere around the $20 to $21 ton price is probably one of the lower price performers in the market as far as cost. I think the obvious issue in ramping up the Barron plant we would fully expect that the cost for us at the Barron plant on a per ton basis would of course go down as we continue to ramp up that plant up to the 2.4 million ton level.

Dan Davis – Stifel

All right. Thank you.

Rick Shearer

We’re factoring the cost only to get better.

Dan Davis – Stifel

Thank you.

Rick Shearer

Thank you.

Operator

Your next question comes from the line of (inaudible), please proceed.

Unidentified Analyst

Hi gentlemen congratulations on a great quarter, this is Denise Ward, (inaudible) and my question is for Rick and Rick how do you see the some of the consolidation that started to take place in the industry with some of our competitors we’re seeing so far this year, how do you see that impacting the situation for Emerge as you go forward?

Rick Shearer

Dennis we are starting to see that happen I think everyone is aware of consolidation taking place most recently one of the newer companies Fairmount Minerals one of the newer companies to make an acquisition I should say has begun that process. It’s been going on now far a little while we somewhat expected that maybe this would happen because so many people rushed into the space without the expertise and without the knowledge of the industrial sand industry and the frac business, but we suspected that there might be some people who would struggle once they got into this space. We do see that happening, I think consolidation will no doubt continue, I think it’ll be a good thing for Emerge because what basically seems to be happening as the customers are realizing that they’re the haves and they have nots in the frac sand production arena and they are beginning to realize that they need to stay with your people who can perform and the people can offer consistent quality and consistent reliability in delivery.

So, I think this is going to work both on the pricing side and on the volume side as consolidation continues Dennis, and there will be people whom the industry Emerge Energy that will no doubt benefit from the consolidation that is going on.

Unidentified Analyst

Thank you very much that’s what I was hoping you would say, have a good day.

Rick Shearer

Thank you.

Operator

Ladies and gentlemen we have no more questions in the queue, I’ll now turn the conference back over to Ted Beneski for any closing remarks, please proceed.

Ted W. Beneski

Thank you operator and I just want to thank everybody for joining us today obviously we are very, very pleased with our results out of the blocks and we expect to track ahead of our forecast over the next couple of quarters and excited about the opportunity to get in front of you again in about one quarter’s time. So, thank you for joining today and we appreciate the support.

Operator

Ladies and gentlemen that concludes today’s conference, thank you for your participation. You may now disconnect, have a great day.

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