Emerge Energy's (EMES) CEO Rick Shearer on Q1 2014 Results - Earnings Call Transcript

May. 5.14 | About: Emerge Energy (EMES)

Emerge Energy Services LP (NYSE:EMES)

Q1 2014 Results Conference Call

May 05, 2014 / 4:00 A.M. E.T.

Executives

Robert Lane – CFO

Ted Beneski – Chairman of the Board

Rick Shearer – CEO

Warren Bonham – VP, Director

Analysts

Brandon Dobell – William Blair & Co.

Ethan Bellamy – Robert W. Baird & Co. Inc.

Selman Akyol – Stifel Nicolaus

Matt Conlan – Wells Fargo Securities LLC

Mark Meyer – LPL Financial

Operator

Good day ladies and gentlemen, and welcome to the Q1 2014 Emerge Energy Services earnings conference call. My name is Whitley and I'll be your operator for today. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

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

Robert Lane

Thank you, Whitley. 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 may also include statements concerning anticipated cash flow, liquidity, business strategy, distributions and other plans and objectives for future capital expenditures and operations. These statements are based on management's beliefs 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 certain risks and uncertainties. If one or more of these risks materialize or should the underlying assumptions prove incorrect. u actual results may vary materially from those expected. These risks are discussed in greater detail in our 10-K filing on file with the 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 earnings release published this morning.

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

Ted Beneski

Thanks, Rob. Good afternoon and welcome, everyone, to another Emerge Energy Services conference call. Once again, Emerge Energy turned in a record quarter -- record Sand volume sold, record adjusted EBITDA, record distributable cash flow and a record distribution.

Net income for the three months ended March 31, 2014 was $18.5 million, or $0.77 per unit, compared to $9.9 million for the same period in 2013. We reported adjusted EBITDA of $28 million for the first quarter of this year compared to $17.3 million a year ago, an increase of 62%. Our distributable cash flow for the quarter was $25 million, and we were pleased to declare a distribution of $1.13 per unit.

While this quarter was a tough one according to many of our customers and competitors, our team was able to effectively respond to adverse weather and a lack of rail car availability. In fact, as Rick will discuss in more detail later, we turned in our strongest quarterly Sand sales volumes to date. While there certainly has been a healthy increase in overall market demand for high-quality, Northern White silica sand, it was our team's ability to fulfill that demand in the first quarter that really helped set Emerge Energy apart.

Meanwhile, our Fuel division continues to perform better than we had expected in part because of strong margins in our wholesale business, primarily in Birmingham, and also because of transmix volumes being much stronger in both our Euless, Texas facility and our Birmingham facility.

We also want to update our announced capital projects. We are pleased to announce that our LP mine and wet plant are currently up and running and we expect our Thompson Hills mine and wet plant facility to also be fully operational later this year. And of the two announced major new drive plant facilities, we continue to make strong progress with permitting and other necessary preconstruction work and expect both to be operational later this year.

I'd now like to turn the call over to Rick Shearer, our CEO, who will discuss the results of operations in our Sand segment.

Rick Shearer

Thank you, Ted. Once again, we are pleased to announce yet another record-setting quarter for Emerge Energy. The Sand segment's adjusted EBITDA was $22.2 million for the three months ended March 31, 2014 compared to $12.7 million for the same period in 2013, an increase of 76%.

For the three months ended March 31, we sold 882,000 tons of sand, including 353,000 tons from our New Auburn facility, roughly the same as last quarter, and a whopping 490,000 tons from our Barron plant. New Auburn is selling out at its full permitted capacity of 1.4 million tons while Barron is at over 80% capacity.

For those who remember our call back in August of last year, we projected then that we would be at 80% or greater capacity utilization for Barron by mid-August of this year. What was most impressive was that we achieved this goal at our Barron plant in spite of the poor rail service during the quarter. Obviously, our sales and production teams took our 80% goal to heart, and it is gratifying to see them bring in such great numbers ahead of schedule.

Our Kosse, Texas facility has been another great story as of late, turning in 39,000 tons for the quarter, well more than half of which was in the month of March. We expect that our Kosse plant sales will increase significantly next quarter as well and continue to contribute meaningfully to our Sand segment EBITDA for the near future.

We often talk about the advantages of being on two Class I railroads and of our fully enclosed dry plant facilities. Well, this winter, the coldest one in two decades, proved just how valuable those two advantages were. Despite the extreme cold temperatures, we did not have a single down production day at either our New Auburn or Barron dry plants. And with our ability to transload between the two facilities, we were able to move sand into whichever facility had excess rail cars on any given day. With all apologies to George Peppard, we love it when a plan comes together.

Obviously, with Barron nearing capacity and new Auburn completely sold out, we are eager to get our two new proposed facilities up and running. We received the construction permit on the first of the two new drive plants that we had announced, and we expect to break ground next week while permitting on the second complex continues. Our plan is still to bring this additional 5 million tons of new capacity online by early 2015, although we are working hard to have it all online by year-end.

We are experiencing intense demand for our sand products and continue to develop our strong customer relationships. Since our last update, we have signed for new contracts, a two-year 200,000 tons per year efforts-based contract, another two-year 125,000 ton per year efforts-based contract, a three-year 90,000 ton per year fixed volume contract, as well as yet another three-year, 350,000 ton per year take or pay contract. We are in talks with a number of other customers to secure additional contracts while sales to existing customers remain very strong and over contracted levels.

On the cost side, we have worked through all of the high cost wet feed we had to purchase to meet increased demand going into the winter. Most of that purchase wet feed sand should be replaced with our own lower-cost sand, including wet feed from the new facilities we are constructing. Our LP operation has already begun mining and washing sand and we are now already trucking feed from this new mine to our Barron facility for drying and shipping to our customers.

We are finalizing our permit adding at our Thompson Hills mine in wet plant and hope to begin mining and washing sand there by the middle of the year.

Our logistics footprint continues to evolve. We currently have 11 transload facilities into which we deliver. In an effort to better serve our Canadian customers, we are now building out a new network of transload locations with new partners, allowing us to offer exclusive use of several strategically located terminal sites in the Western Canadian sedimentary basin. Frankly, if we're going to be changing and expanding Canadian transload sites, Canada's spring thaw or breakup season is the best time to do so.

We also are working to establish more transload beachheads in the Lower 48 and are well along with those discussions. Meanwhile, our rail car fleet continues to grow as expected, which should provide us with sufficient cars for not only our current production but our proposed facilities as well. We have grown our rail car fleet by more than 1500 cars just since the last quarter. We expect to add a similar new number of cars to our fleet by mid summer.

In short, market demand for coarse, high-quality, Northern Light silica frac sand continues to grow and Emerge Energy is well-positioned to continue capitalizing on this opportunity.

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

Warren Bonham

Thank you, Rick. Our Fuel division started the year on a very solid note contributing $7.6 million of segment adjusted EBITDA for the three months ended March 31, 2014 compared to $4.6 million for the same quarter last year, an increase of 65%.

For the quarter ended March 31, we sold a total of 68 million gallons of refined product and had an additional 53 million gallons of throughput by our terminal customers. This compares to 36 million gallons sold and 37 million gallons of throughput for the same period in 2013. We refined 35 million gallons and transmits in the most recent quarter and 6 million gallons for the same quarter the prior year.

As a quick reminder, our Fuel segment year-over-year results are not comparable because we acquired Direct Fuels at the IPO on May 14, 2013 and Direct Fuels pre-IPO results are not included in the predecessor results. Were we to include Direct Fuels, the sales and transmix volumes would be higher in the most recent quarter compared to the same period in the prior year but throughput volumes would still be lower.

We have had somewhat higher than normal margins over the past two months in part because refined products are in relatively short supply in the Birmingham area. This has allowed us to take advantage of attractive local market pricing. Additionally, our ability to nominate shipments on Colonial has allowed us to capture additional margin on certain pipeline batches.

RIN pricing remains at levels that are modestly higher than historical levels. Again, we treat RINs as a cost of goods sold, so any benefit we receive as a net producer of RINs allows us to reduce our per-gallon cost and thereby increase our margin. We expect to have a very strong April based on current pricing and anticipate that next quarter will be relatively strong. As we continue to fill up our third-party tanks and our transmix tower at Birmingham, we believe that we will continue to see solid performance from our Fuel segment.

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

Robert Lane

Thank you, Warren. Emerge Energy reported net income of $18.5 million, or $0.77 per diluted common unit, for the first three months ended March 31, 2014. This compares to net income of $9.9 million for the three months ended March 31, 2013.

For the same period, Emerge Energy reported adjusted EBITDA of $28 million compared to $17.3 million for the same quarter last year. The improvement is primarily because of the significant year-over-year increases in sand sales, the contribution of our sands logistics efforts, and the acquisition of Direct Fuels, as well as improved wholesale margins in the Fuel segment.

For the first three months ended March 31, 2014, Emerge Energy generated $25.1 million in distributable cash flow. Our Board of Directors released approximately $1.2 million of the remaining $2.3 million reserve established for capital expenditures in the third quarter of 2013. After adding back this part of that reserve, our cash available for distribution was $26.2 million.

Our total SG&A increased to $8.5 million from $3.3 million because of additional expenses we now incur as a public company, incremental cash and non-cash bonus accrual, and the SG&A associated with our Barron facility and Direct Fuels.

Our interest expense for the quarter was $1.6 million compared to $4.2 million for the prior-year period. The decrease is primarily due to the more favorable interest rates we are now paying under our current facility, which are at the lowest applicable level under that credit agreement.

We ended the quarter with $111.1 million of outstanding debt, including our capital leases, and $5.2 million of cash on the balance sheet. At the end of the quarter, we had $76.9 million of availability on our credit facility.

Our capital expenditures for the quarter were $6.3 million, which includes $900,000 of maintenance capital expenditures.

We declared our fourth-quarter distribution of $1.13 on April 23, which will be paid on may 14 to investors who are holders of record on May 6. The distribution will include $0.05 per unit of previously reserved cash flow from the third quarter of 2013 and does exceed our current 2014 distribution guidance of $3.40 to $4.00 per unit.

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

Ted Beneski

Thank you, Rob. Like Rick said, our fully enclosed facilities and rail flexibility in the Sand segment prove to be key to Emerge Energy's success in an environment that caught some, frankly, a little bit flat-footed. We continue to believe in the value of our investment and believe that both of our segments are poised to continue their success throughout this year.

We thank each of you for your continued interest in Emerge Energy. And operator, I think we're now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from the line of Brandon Dobell with William Blair. Please proceed.

Brandon Dobell – William Blair & Co.

Thanks. Good afternoon, guys.

Ted Beneski

Good afternoon.

Brandon Dobell – William Blair & Co.

A couple of things to focus on the Sand segment. You mentioned the different types of contracts that you are signing. I guess I'm curious. I guess put some background on the why certain types of customers are choosing certain types of contacts. And maybe as part of that discussion, your existing contract customers, how much are they buying over their volumes? And is there any ongoing discussions with them to change their contract terms given the demand environment right now?

Rick Shearer

Brandon, I can take a shot at that. This is Rick. I'll say, first of all, there is a growing interest on our customer base and looking at getting contracts and getting things put in a more formal way as far as commitments to supply and commitments to buy, all of this of course driven by the spiked demand now for frac sand.

I think really the contracts that are being put in place are really based on our customers' perception of maybe the long-term need for sand, the growing need, and the commitments they are willing to make to ensure that they have sand for their particular needs.

Frankly, a year ago, I wouldn't have expected the take or pay contract, so it would be in the offing. But as you heard us say, we now are having discussions and we are closing take or pay contracts. So, I think there's something to be said for that as far as what's happened in the marketplace and last 12 months and this increased spike in high-quality frac sand demand.

So, we are engaged in a number of contracts. We want to continue to sign more contracts and build long-term relationships with our customer base. This is a great way to do that.

As far as the customers that are already contracted, I guess it's hard to say but on average, I would say those customers are buying anywhere from 30% to 50% more than their contracted amounts. Of course, as contracted customers, we are doing everything we can to of course meet their needs. And in many cases, we are now talking to those customers about adjusting the contracts and revising the formalized tons that they will need and that they'll agree to take based on our commitment to supply them.

Brandon Dobell – William Blair & Co.

Okay. And then I want to follow on from that. Assuming you guys get the 5 million tons of new capacity let's call in early 2015 up and running, any sense of how much of that you've been able to -- I don't know if presell is the right word, but do you have conversations about commitments for those incremental tons that are coming down the pipe, or are your contract conversations just about the remaining capacity you have at Barron right now?

Rick Shearer

No, actually, we really have our capacity committed for what exists today. And these contracts are all focused on selling out the additional 5 million tons of capacity that we are planning to have with these two new facilities. And as a result of that, this is for somebody who, like me, who has a sales background, and for those of us in our sales team, this is a very difficult time for us because, in my mind, unselling can be much more difficult than selling product. And right now, there is so much demand in the marketplace that we literally can't keep up. And our goal right now is to keep our contracted customers happy and keep others very much on board with us so that, when we have this added capacity, we will be able to supply their needs more fully. So, we're working very hard on that.

The majority of the contracts that we have moving forward right now are geared toward the fourth quarter and toward the gear up of these two additional dry plants.

To get specific about the expectations, I think, when the plants start up, there will be a certain ramp up period for sure. But ultimately, we will have demand to probably fulfill I'll say 75% or better of the new capacity coming on.

Brandon Dobell – William Blair & Co.

Okay, great. Thanks a lot, appreciate it.

Rick Shearer

Sure.

Operator

Your next question comes from the line of Ethan Bellamy with Baird. Please proceed.

Ethan Bellamy – Robert W. Baird & Co. Inc.

Hey, guys. Congrats on another good quarter. With respect to pro forma weighted average contract life, what is that now? And then just so I understand the game plan here, are you saying that you want to contract out everything, pro forma the new construction, so you'll be at 100% contracted when you get those plants built? Is that the goal?

Rick Shearer

Ethan, this is Rick. I'll take a shot at that. I think the weighted average for the existing contracts, the remaining term from today forward is 3.7 years. And our intent is we would like to keep a certain amount of headspace with the new capacity coming on ideally in the range of 15% or so, 15% to 20% I'll say, for spot business and additional needs.

Ethan Bellamy – Robert W. Baird & Co. Inc.

Okay, so if your pro forma for the new construction, you are 85% contracted let's say, is that going to be significantly more number of customers or existing customers taking new capacity? How will your book of business look at that point?

Rick Shearer

Well, we have a very solid book right now of about 25 regularly buying customers. We will be adding a couple other significant customers to our customer list when this new capacity comes on. Beyond that though, most of that tonnage will be increased tonnage to meet the demand of existing customers.

Ethan Bellamy – Robert W. Baird & Co. Inc.

Okay, helpful. One last one, just wanted to reiterate and make sure I had these numbers right. You said 1500 new rail cars in the quarter and another 1500 by the summer, and so that puts you up 3000 for the year?

Rick Shearer

Yes, actually I'll go into a little more on that, Ethan. Let me give you a couple of numbers. At the end of the fourth quarter, we had 2800 rail cars in our network. At the end of the first quarter, we have 4200. At the end of the second quarter, we'll have 5300. Sometime about a year from now, we expect to have over 8000. And currently about 60% of those cars are leased by Superior Silica Sands, the balance owned or leased by our customers.

Ethan Bellamy – Robert W. Baird & Co. Inc.

Great, thank you very much. I appreciate that clarity.

Operator

Your next question comes from the line of Selman Akyol with Stifel. Please proceed.

Selman Akyol – Stifel Nicolaus

Thank you. Good afternoon. So, just to go back to the new contracts that you announced, the four new contracts, are those new customers or are those just new contracts with existing customers?

Rick Shearer

Those are new customers.

Selman Akyol – Stifel Nicolaus

Okay. And then if you just look at your entire contract portfolio, how much of that would you currently say is under take or pay contracts?

Robert Lane

We hadn't actually disclosed those numbers. I think that it's safe to say that more than half of our contracted volume at this point is probably efforts-based.

Selman Akyol – Stifel Nicolaus

Okay. And then on the transloading sites, I was thinking there was 19. It sounded like you were down to 11?

Rick Shearer

Yes, as I tried to say earlier, Selman, what we are wanting to do is position ourselves better in Canada to make sure that we have better control and more flexibility to better service our customers in Canada. As a result of that, we've made some changes that have temporarily lessened the number of transload sites available in Canada. We are working to replace those numbers as a result of what I just mentioned, the fact that we want to better serve our customers. And we felt like with one of the contractors there that had a number of terminals, that we weren't given the priority or getting the service that was in our best interest. So we've made a change.

This really isn't and never has been a numbers game to us. It's getting the right service and the right strategically placed terminals. We ideally want those terminals wherever we go to be exclusive use terminals, and we are certainly headed in that direction with our new Canadian footprint that we're putting in place.

So even as we speak, we've got a number of new terminals being put under contract, and you'll hear more as we go forward about our efforts to build out a better network of transload terminals on it. But we are working hard on that and I feel very good about the progress not just in Canada but elsewhere in the United States as well.

Selman Akyol – Stifel Nicolaus

I got you. And so I guess I presume the Permian still remains a top priority for you guys this year as well?

Rick Shearer

Yes, the Permian, with the new rail service being on four Class I railroads, including the BNSF, we are all about getting into the Bakken and to the Permian in a bigger way. We're certainly a player there, but this will allow us to expand our service capability into those two major shale plays in particular.

Selman Akyol – Stifel Nicolaus

All right. Then just to make sure I heard everything correctly, you talked about being 85% sold out on the new capacity as you go to 2015. I know there's a ramp, I know there's a ramp.

Rick Shearer

Let me correct you, though. I believe I said 75%.

Selman Akyol – Stifel Nicolaus

75%? Okay.

Rick Shearer

And that is my estimate at this time.

Selman Akyol – Stifel Nicolaus

All right, thank you.

Rick Shearer

Sure. Thanks, Selman.

Operator

(Operator Instructions). Your next question comes from the line of Matt Conlan with Wells Fargo. Please proceed.

Matt Conlan – Wells Fargo Securities LLC

Hey, guys. Nice quarter. Costs seemed to be up a little bit in the quarter. Your per ton margin was down a little sequentially, not a lot but a little. And just wanted to see. Did you have any weather issues in there, something else that resulted in the per ton margin going down a little bit?

Robert Lane

Matt, This is Rob. It's a great observation but I think that the primary reason here was that it's sort of a -- the flip side of the demand being so great as it was, that we didn't have as much wet plant and wet feed capacity as we had wanted. So we had to purchase some third-party sand. We were trying to be very selective to make sure it was done at the same sort of quality levels that we were accustomed to with our sand, and sometimes that means trucking it a little bit further and maybe paying a couple of bucks more than we have to do if we did so internally. So really that's where a lot of that came from.

Obviously, the LP mine, the Thompson Hills mine, that's our attempt to try to address that and get out in front of the fact that the demand is so high -- is to make sure that we can provide as much wet feed as we possibly can. We're still going to have some of that noise continue into the second quarter. We may have a little bit into the third, but we're hoping, once we get into the fourth quarter, that we should have most, if not all, of the purchased sand is what we call it internally, the purchased damp feed replaced by internally processed and washed damp feed.

Matt Conlan – Wells Fargo Securities LLC

That's great. Thanks for anticipating my follow-up question there as well.

So, we talked a lot about some of the volumes on the new contracts, but I don't think we have discussed the pricing. How is the pricing on these new contracts relative to what you currently have under contract?

Rick Shearer

Matt, the pricing is definitely going up. You're going to see, coming off of Rob's comments, a trend where our costs are going down and our average selling price will be going up. We think that's very reflective of where the market is right now and it's recognized certainly by our customers. So, I don't think there's any question. We'll see where these ultimately, all the other contracts, take us, but all the discussions we're having now are significantly above our average selling price today.

Matt Conlan – Wells Fargo Securities LLC

Can you quantify, 5%, 10% above where they are, something like that?

Rick Shearer

I would say we're probably looking at a range of the new contracts of somewhere in a range of between 5% and 10% increase.

Ted Beneski

One of the things that I think is important for everybody to understand is there is -- and we've mentioned this in previous calls -- there is this shift going on providing product FOB our processing plants to providing sand all the way to the customer location, the drilling wellhead. And so prices will go up dramatically because of that, because it includes all the logistics associated with that extra step.

But in addition, I think what Rick is referring to is if you were to normalize for that and just try to make a guesstimate, if everything had remained FOB our plant, it would be going up about the 5% level.

Matt Conlan – Wells Fargo Securities LLC

Okay, so that 5%, or 5% to 10% range is based on the base of an FOB price, not the in-basin price?

Ted Beneski

Right.

Matt Conlan – Wells Fargo Securities LLC

Great, very helpful. And did I miss guidance on where you expect distributions to be for second quarter?

Robert Lane

We did not revise our distribution guidance.

Matt Conlan – Wells Fargo Securities LLC

Okay, great. That helps me. Thank you very much.

Rick Shearer

Thanks, Matt.

Matt Conlan – Wells Fargo Securities LLC

Thank you.

Operator

Your next question comes from the line of Mark Meyer with LPL Financial. Please proceed.

Mark Meyer – LPL Financial

Hello. Hey, great quarter and thanks for taking my call. Based on your existing reserves and current production rates, about how many years could you continue this run rate?

Rick Shearer

We are between 25 and 30 years, and we are adding, as of course we are looking to add the two new dry plants that we discussed by the end of this year. Of course, we are adding additional reserves to make sure that we continue 25 years or more reserves for those two facilities as well. But we've got well over 100 million tons of high-quality reserves in place for the two plants that currently exist.

Mark Meyer – LPL Financial

Okay, thank you so much.

Rick Shearer

Thanks, Mark.

Operator

Your next question is a follow-up from Matt Conlan with Wells Fargo. Please proceed.

Matt Conlan – Wells Fargo Securities LLC

Like a bad penny, I'm back again. Real quickly just on housekeeping, the DD&A looked like it went down quarter to quarter. Is there anything we should read into that?

Robert Lane

We just had a few marginal asset retirements.

Matt Conlan – Wells Fargo Securities LLC

Okay, but nothing significant? Should we build going forward on the $5.8 million or on the $6.5 million that you had at the end of last year?

Robert Lane

I would do it with the $5.8 million. Also to my memory, we were asked to extend the life of some of our assets by the accountants. So there's nothing really to be read into it.

Matt Conlan – Wells Fargo Securities LLC

Okay, terrific. Thanks.

Robert Lane

Sorry, Matt, one other quick note on that is that because we were using more third-party sand and less of our own sand, or at least the sand that we end up having sort of in mind that we have to depreciate our leasehold of that is that that's going to slightly -- that may slightly affect those numbers as well, but it's mostly the former regions.

Operator

There are no further questions in queue.

Ted Beneski

Okay, well, thank you very much for joining our call today. We are very excited about the results we were able to deliver in the first quarter, and we do expect this to be a big year for Emerge. So thank you again for all your great questions and we look forward to more conversations in the months to come. Thank you all.

Operator

Ladies and gentlemen, that concludes today's conference. You may now disconnect. Have a great day.

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