Hi-Crush Partners' CEO Discusses Q3 2013 Results - Earnings Call Transcript

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 |  About: Hi-Crush Partners LP (HCLP)
by: SA Transcripts

Operator

Good morning and welcome to Hi-Crush’s 2013 Third Quarter Conference Call. As a reminder, today’s call is being recorded. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

At this time, for opening remarks and introductions, I would like to turn the call over to Bob Rasmus, Co-Chief Executive Officer of Hi-Crush. Mr. Rasmus, you may begin.

Bob Rasmus - Co-Chief Executive Officer

Thank you, Melissa and good morning everyone. Thank you for joining us today to discuss Hi-Crush’s third quarter 2013 results. With me today are Jim Whipkey, Co-Chief Executive Officer of Hi-Crush and Laura Fulton, our Chief Financial Officer.

Before we begin, I’d like to remind all participants that our comments today will include forward-looking statements which are subject to certain risks and uncertainties. A number of factors and uncertainties could cause actual results in future periods to differ materially from what we talk about today. For a complete discussion of these risks, we encourage you to read the partnership’s earnings release and our documents on file with the SEC. Additionally, we will talk about the non-GAAP measures of EBITDA, distributable cash flow and production costs during the call. Please refer to the earnings release or our public filings for definitions of our non-GAAP measures and the full reconciliation of EBITDA and distributable cash flow to net income and production costs, the cost of goods sold.

I am going to start today with current trends in the industry and then Laura will run through the quarter and Jim will talk about our commercial activities, operations and our growth prospects. Also a reminder that we are looking forward to welcoming you to our first Analyst Day in a little under two weeks on November 19, where we will expand on some of the trends we talk about today.

Now, let me start with volumes for the quarter. We did see an increase in volumes sold at Wyeville and through our distribution network. However, our volumes could have been even higher in the quarter. Late in the third quarter, we experienced a delay in volumes taken due to events specific to our customers. For example, as you have heard in some of the E&P calls this quarter, there were some disruptions affecting completion activities in the Rockies. This resulted in an estimated EBITDA impact of about $1.5 million for the quarter. A reminder that our contracts typically call for volumes to be spread over a contract year, which generally starts in the summer months and which allows for flexibility for just such situations. Volumes rebounded in October. The trends during the quarter and the outlook for the upcoming quarters are positive for Hi-Crush. Both the oil service companies and the E&Ps are developing new completion technologies that use more sand. It is becoming clear that operators in many basins are benefiting now and will continue to benefit from using more sand. We heard this quarter and we continue to hear examples of the better returns seen by the E&Ps when using more sand and not just any sand, but Northern White sand in particular.

We are also seeing an ongoing trend of oil service companies gravitating towards using only a handful of reliable suppliers. Service companies need certainty in volume, quality and timing of supply while preserving their flexibility to change as their needs dictate. This has become even more important as operators move to pad drilling. We believe the proppant industry of the future will consolidate around a small handful of suppliers that have both the scale of supply and a solid distribution network. Customers will increasingly demand companies with Hi-Crush’s reach to meet their proppant needs. And then there is the continuing trend towards a full-service model. Our acquisition of D&I has already opened numerous new doors. We are looking forward to talking more about that at our Analyst Day on the 19 of this month.

One of the key benefits of the expanded, more diversified Hi-Crush is we now have additional distribution outlets for our customers. A year ago, we had three customers. Today, we have over 25 and growing. More customers means greater diversification of revenues, which can only be a positive for our unit holders. Distribution flexibility is a hallmark of our service model. During the quarter, we completed the expansion of our Dennison, Ohio facility, one of our Utica transload sites, which has allowed us to handle significantly more railcars. In fact, we have doubled deliveries of sand to our customers at this site. This is an important example of our continued expansion in the Utica and Marcellus, where the production trends continue to improve. Also during the quarter, we sold our first 100-mesh sand from Wyeville. This helped lower our production cost per ton even further. In summary, we are pleased with our performance, the trends and how we are positioned.

With that, I will hand the call over to Laura to run through an update of our financials and our results for the quarter. Laura?

Laura Fulton - Chief Financial Officer

Thank you, Bob. I am sure you have read our 10-Q and earnings release filings with the SEC this morning. Today, I will give some color on our third quarter results. Today’s results show reported net income of $15 million or $0.52 per limited partner unit. This includes $0.13 per common and subordinated units related to the $3.75 million distribution earned for the second quarter 2013 under the preferred interest from Augusta that was paid in August. There are really three items that negatively impacted the quarter, about $850,000 in non-cash expense from the step-up in value of inventory associated with the D&I acquisition, another $300,000 in litigation cost as well as the EBITDA impact, Bob mentioned of $1.5 million. It’s important to note that all of the inventory turned in the third quarter so there will be no step-up expense in the fourth quarter. Litigation cost will also drop off due to the settlement with Baker Hughes.

Revenues for the quarter were nearly $44 million. This included sales of 533,000 tons of frac sand produced and delivered at our Wyeville facility or purchased under long-term supply agreements as well as revenues generated from transload and terminaling services. At current levels, Wyeville is contracted at over 90% of its nameplate capacity. Our average sales price on frac sand sold was $73 per ton reflecting the mix of tons sold under our contracts with FOB plant pricing and through our distribution network with destination pricing. Since we acquired D&I and then have now moved to a blend of FOB pricing and in-basin pricing, we will be reporting our average sales price per ton this way going forward.

And with the new Baker Hughes agreement, our weighted average contract life has now increased over 50%. Gross profit for the quarter was $17.6 million. Production costs at our Wyeville facility were $13.10 per ton for the third quarter compared to $13.28 per ton for the second quarter and $17.62 per ton in the first quarter of 2013. As Bob mentioned, we sold our first 100-mesh sand during the quarter, which helped us bring our production cost per ton down even further. In fact, we believe Hi-Crush is the lowest cost producer in the industry. Our distribution costs were also in line with our expectations. We are looking forward to sharing more information with you on our proprietary production model at the upcoming Analyst Day.

G&A expense was higher at about $5 million compared to $3.8 million in the second quarter. These are not easily comparable numbers. So let me go through some detail. First, third quarter G&A includes amortization of intangibles of $1.4 million and the non-recurring litigation cost of $300,000. Again, as we have reached the settlement with Baker Hughes, we do not expect to incur similar cost in the fourth quarter.

Second quarter G&A included $1.7 million in one-time acquisition costs related to the D&I acquisition as well as a similar $300,000 in the non-recurring litigation costs. If you exclude all of those items, our recurring cash spending on G&A was $3.3 million in the third quarter compared to $1.8 million in the second quarter. Remember that, we only owned D&I for 20 days in the second quarter. So G&A from the distribution expense was higher about $1.2 million comparing the 20 days to the full third quarter.

And previously we have given guidance that the acquisition of D&I would add $2 million to $2.5 million annually or $500,000 to $625,000 each quarter as we expand it above the combined historical G&A spending levels. Taking into consideration the full quarter impact of D&I our third quarter G&A is actually under those projections. Net income totaled $15 million, while EBITDA was $19.2 million for the quarter. EBITDA includes the income from the preferred interest in Augusta. And excluding the $850,000 in non-cash expense from the step-up in inventory associated with the D&I acquisition, EBITDA would have been $20.1 million.

We had distributable cash flow of about $17.6 million. And our distributable cash flow coverage reached 1.24 times, in line with our objectives. Excluding the non-recurring $850,000 in non-cash expense and the $300,000 in litigation costs, distributable cash flow would have been $18.7 million with coverage at about 1.32 times. And as we have said before, we plan on providing low-double digit increases in our distributions during 2014 to our unit holders. On October 17, we declared our third quarter cash distribution totaling $14.1 million or $0.49 per common and subordinated unit. This distribution represented our first increase for the partnership and was 3% higher than the previous quarter’s distribution. On an annualized basis, this equates to $1.96 per unit.

With that, I will turn the call over to Jim for some further comments on commercial activities and operations, as well as our future outlook.

Jim Whipkey - Co-Chief Executive Officer

Thanks Laura. I would like to elaborate a bit on our commercial activities and operations and reiterate some of our growth objectives going forward. Before I begin, I know that some of you may be interested to hear more about our recent litigation settlement with Baker Hughes, which included the signing of a new six year sand supply contract. Because of the nature of our settlement, we can’t discuss details beyond what we disclosed in our 8-K filing and press release. But needless to say, we are pleased this issue has been amicably resolved and look forward to a mutually beneficial relationship with one of the major players in this business.

Now on to operations, we continue to be fully contracted at levels above 90% of our nameplate processing capacity for the remainder of 2013, and at least through midyear 2014. As Bob mentioned, there was a delay in some of our volumes taken by contract customers towards the end of the third quarter, but we are already starting to see those volumes being made up in the fourth quarter and would expect this to continue through subsequent quarters. So without giving away our Analyst Day highlights, let me elaborate a bit on our plans for future growth. First of all, it remains our goal to secure long-term contracts for 2014 and beyond to keep Wyeville fully contracted. The new contract with Baker Hughes begins January 1 and goes until the end of the decade, and that will support this goal. The effects obviously will be seen in the first quarter.

As we discussed in our last call and talking about extensions of existing contracts, as well as new customer contracts, we see the scope of these contracts evolving to include other mechanisms such as deliberate pricing in multiple basins, as well as transload and storage arrangements. Hi-Crush’s addition now of a first class distribution network is going to be a key determinant in our minds in shaping these contracts and in winning these new contracts. On a macro level, based on conversations we have been having with new and existing customers, we see long-term demand increasing for Hi-Crush sand and services. For us, this growth could take the form of additional production capacity, new transload locations, new storage capacity, other value added services. As Bob said, the acquisition of D&I has opened a lot of doors for us and many of these customers are looking for several of these services.

We, of course, have the potential for future drop downs from Augusta, as well as other sponsor level projects. Augusta, as you recall, is a premier state-of-the-art facility with more than 48 million tons of proven reserves of Northern White frac sand. Like us, here at Hi-Crush, our sponsor remains very bullish on future growth in the proppants business. If you have been following the press in Wisconsin in the past week or two, you may know that our sponsor has been involved in the permitting process for a third facility on a second Class 1 railroad, a new Class 1 railroad for Hi-Crush which will further increase our logistics capabilities, giving us even more opportunities to serve our customers. We will hopefully be able to share more on the progress of this exciting project in a couple of weeks with you.

We continue to evaluate new opportunities to build on our dominant distribution footprint in the Marcellus and the Utica. And as we said in last quarter’s conference call, we are also in the process of expanding our distribution capabilities into additional basins. Again we will have more on that at Analyst Day. We are definitely not stopping at the Marcellus and the Utica. And M&A, it’s an ever present option. There are still many private sand suppliers that we think don’t fit today’s integrated services model. That said, if there is an asset that’s accretive and is the right fit, we will look at it. So to wrap up, we are obviously excited about the opportunities in front of us and look forward to showing you a deeper look on the 19th. As Laura mentioned, we increased our distribution a quarter earlier than we had guided. The D&I transaction has been highly accretive. And we believe we are on track to achieve double-digit distribution growth for our unit holders in 2014 and the foreseeable future.

Thank you all, again, for your interest in Hi-Crush and for your time today. Operator, you may now open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Praveen Narra with Raymond James. Please proceed with your question.

Praveen Narra - Raymond James

Hi, good morning, everyone.

Bob Rasmus

Good morning.

Praveen Narra - Raymond James

You mentioned the 100-mesh sand production, if I remember correctly, that was being produced along with the other sand just in conjunction. So could you give us some color as to the amount of 100-mesh that the Wyeville mine produces on an annual basis? And then...

Jim Whipkey

Yes, sure. We used to throw that stuff away and use it to reclaim the land, but it’s an extremely high quality 100-mesh. It’s the best stuff available, especially into the Marcellus where it’s being used very widely. This is a 12k, 13k, 14k crush 100-mesh. So we spend a little bit of money on silos and on ROTEX screeners. And we are now taking what used to be a waste product and selling it actively into the Marcellus and the Utica. It has the effect of lowering our operating cost, since we don’t have to get rid of it anymore. And you can see by the fact that we are down to $13.10 per ton. We believe from Wyeville alone we can produce 200,000 tons to 250,000 tons a year of 100-mesh when we get fully geared up.

Praveen Narra - Raymond James

Alright, that’s great. And then if you don’t mind, could you give us an idea of where pricing falls on a general basis relative to your average contract price?

Jim Whipkey

100-mesh is a completely different animal. It typically fetches less than half of what 40-70 and 30-50 does. Beyond that it depends where it’s going and how it’s shipped, but it’s definitely economic for us to gear up and sell it.

Bob Rasmus

And when we talk about production capacity, we are talking about 70-mesh and closer, when we talk about nameplate capacity and contractor capacity that doesn’t include any 100-mesh production.

Praveen Narra - Raymond James

Right and then just more out of curiosity, is it – are all of your sales of the 100-mesh going to the Utica and Marcellus?

Jim Whipkey

No, no I mean there is some headed – it’s been used in the Eagle Ford and the Midcontinent also. It’s amazing how these E&P frac engineers change their frac designs. And we have certainly seen a rebound in 40-70 demand and 100-mesh demand, as these designers are steering towards some of the finer grades, at least in the past couple of quarters.

Praveen Narra - Raymond James

Interesting and then could you just give us a little bit more color as to where the company stands as far as building new mines and pursuing potential M&A. I mean should we take the independent project as a sign of Hi-Crush aggressively pursuing new mines ahead of M&A or is it just a timing and an opportunity that popped up?

Bob Rasmus

It’s we are always evaluating opportunities that provide the best return and provide the opportunity to create the best returns for our unit holders. As we have said in previous calls and Jim mentioned in his remarks today, we continue to see a wide variety of M&A opportunities both on the production side and the distribution side. But as it relates to the production side, we have a great deposit a course deposit in our proposed third facility. So we are moving ahead with permitting that. And the reason we are doing that is that we are fundamentally bullish on the industry trends for the outlook for the sand use.

Praveen Narra - Raymond James

Yes, I would agree. Thank you guys very much.

Jim Whipkey

Alright, thank you.

Operator

Thank you. Our next question comes from the line of Jeff Birnbaum with UBS. Please proceed with your question.

Jeff Birnbaum - UBS

Good morning everyone.

Jim Whipkey

Hi, Jeff.

Jeff Birnbaum - UBS

Sorry, having a bit of a difficulty there with the headset. So I know Laura mentioned this and it’s something that that’s been discussed a bit previously, but I mean just given the increasing importance of D&I to the business, can you talk a bit about what you are seeing in additional opportunities for FOB destination versus plant and how you see that potentially impacting average sales prices and margins going forward?

Bob Rasmus

Sure. I mean, what we sold in the past was we really sold sand FOB plant. Now, we will be able to provide various options to our customers and a whole suite of services that we can sell sand FOB plant, we can sell sand FOB destination we can provide transload, terminaling and other storage facilities, so that we can provide greater activity and greater service to the customers.

Jim Whipkey

Jeff, we are really excited about where we can take this distribution model. We see it as nothing, but pure growth potential for us. I think we talked last call about how the E&P companies are becoming more demanding and they are asking the service companies to be flexible as to where the sand is delivered, as to which grades are delivered. They hold beauty contests, where service companies are competing on one week deadlines. And we think this is here to stay. So yes, our FOB contracts are in place. They are a solid foundation, but moving forward, as I have said in my comments, we think that destination pricing is going to take significant role in future long-term contracts and we are prepared to meet that challenge.

Jeff Birnbaum - UBS

Yes. And Jim, just following up on that, I don’t want to steal too much the thunder from your Analyst Day, but between doing that and kind of the new technologies that have been discussed quite a bit in recent weeks on fracking, are you guys seeing much change beyond just the Marcellus and Utica in the last few months in where your deliveries are going? And I guess to the extent you want to get into how negotiations for future changes and how they are going that would be certainly welcomed?

Jim Whipkey

Yes. I mean, we are absolutely making progress in establishing transloads in other basins, Jeff. And you talk about that technology, a lot of our sand goes to the Eagle Ford and to the Permian and to the Mid-Continent right now. It’s really only since the acquisition of D&I that we have become a real force in the Marcellus and the Utica, but looking at the Eagle Ford, for example, look at what EOG is doing. Common wisdom has always been drilled two-mile long lateral lengths to maximize recoveries, but now they are having tremendous success in places like Gonzales County with shorter and wider fracs that use a lot more sand. So we listen to them and companies like EOG and others and Whiting and Marathon and we see where they are going. We talk to the service companies. That helps us target where we would like to setup new sand distribution sites.

Jeff Birnbaum - UBS

Okay, thanks. And just one final one from me, I mean just what’s the current thinking I suppose on dropdowns of interests on Augusta 2014 and beyond? Well, why don’t I just leave it at that? Thanks.

Bob Rasmus

I think we are looking at dropdowns of Augusta sooner rather than later.

Jeff Birnbaum - UBS

Great. Thanks so much everyone.

Jim Whipkey

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of TJ Schultz with RBC Capital Markets. Please proceed with your question.

TJ Schultz - RBC Capital Markets

Hey, everyone. Good morning. Just staying on that last topic on Augusta, can you just discuss the contracted status of Augusta into 2014 and 2015 and how that plays against your comment that you would expect drops sooner than later?

Bob Rasmus

Augusta, as a private company, we have never discussed publicly the profile that, but Augusta is significantly contracted and that’s all we are willing to say.

TJ Schultz - RBC Capital Markets

Okay. And Wyeville you have some contracts expiring in ‘14 and ‘15 and you have discussed here kind of terms evolving on new contracts. Would you expect existing customers to be rolled over just with different terms or if you could just discuss if these conversations with customers have already started?

Jim Whipkey

Yes, absolutely. These conversations are ongoing, TJ. And we have done nothing but improve our service capabilities and our relationships with all of our currently contracted customers and have no reason to think that these relationships won’t continue far into the future. Will there be changes? Well, yes and I think as I discussed, we see an opportunity to include additional services into these contract extensions. In our minds, the service companies don’t really like to have to handle storage and distribution, they do it reluctantly, but we are in conversations with some of our customers to take a more active role in taking on some of those tasks and we think those could work their way into contract extensions and new contracts.

TJ Schultz - RBC Capital Markets

Okay. And then I guess lastly on the Baker Hughes contract, I understand there are some limitations there, but is there any indication you can give us on terms, whether they are similar to kind of the original contract or is this – what gives you some perspective that terms are evolving away from a simple take or pay model?

Jim Whipkey

We really can’t talk about it, TJ. It was obviously something we are real happy with to have the third largest oilfield service company in the world with a big six-year contract with us. Beyond that, we can’t give you any of the details other than to say we are happy to be back doing business with them.

Operator

Thank you. Our next question comes from the line of Tom Dillon with William Blair. Please proceed with your question.

Tom Dillon - William Blair

Hi, really more of a modeling question. Just trying to disaggregate the two distinct volume levels, how much of your sand was sold through D&I this quarter?

Laura Fulton

We haven’t disclosed the amount of actual tons that were distributed through the D&I model. I think in our 10-Q we do give some information about kind of the percentage of revenues that were coming from the sand sold FOB plant versus destination pricing, but the business model really is just to sell the sand, whether it’s FOB plant or in-basin pricing, whatever our customers need.

Tom Dillon - William Blair

Okay. And were there any spot sales that were made during the quarter? And if so where those made to third-party customers or just upside sales to some of your existing base?

Bob Rasmus

Yes, they were spot sales in the quarter and they were sold to both existing and the combination of new customers. As we mentioned, we have expanded our customer base significantly from three in the prior quarter – at the beginning of the prior quarter to over 25 now.

Tom Dillon - William Blair

Okay. And then can you provide your thoughts around the sustainability of current production costs, just trying to get a sense of what it looks like maybe looking out into 2014?

Bob Rasmus

We believe we are the low cost producer in the industry. And if you look back at our production costs and our historical records, I think that shows through. And as we continue to both increase production and as we have sold some 100-mesh that will continue to drive our production costs down into the levels that you have seen now.

Tom Dillon - William Blair

Okay. And then can you provide some further color around the spot pricing and demand dynamics by grade and basin? Thanks.

Bob Rasmus

No. And I think you hit the key there when you talk about dynamics by grade and basin. As I say, it’s difficult to say what spot pricing is. And we have typically chosen not to comment on spot pricing, because it is a reflection of grade and basin and timing and need and whether it’s FOB plant, FOB delivered, but overall that we have seen that prices have stabilized.

Tom Dillon - William Blair

Okay.

Operator

Thank you. Mr. Rasmus, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Bob Rasmus - Co-Chief Executive Officer

Thank you, everyone, for your time today. We look forward to seeing those of you who can attend our Analyst Day on the 19th and we look forward to further discussions.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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