Emerge Energy Services LP (NYSE:EMES) Q2 2018 Earnings Conference Call August 1, 2018 4:00 PM ET
Deb Deibert - CFO
Ted Beneski - Chairman
Rick Shearer - CEO
Lucas Pipes - B. Riley
Selman Akyol - Stifel Nicolaus
Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Emerge Energy Services Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be at that time. [Operator Instructions]
I would now like to introduce to your host for today's conference Deb Deibert, Chief Financial Officer. Please go ahead.
Thank you, Operator, and welcome everyone, to the Emerge Energy Services LP second quarter 2018 conference call. 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. They 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, our actual results may vary materially from those expected. These risks are discussed in greater detail in our Annual Report on 10-K on file with the Securities and Exchange Commission.
Please also note that on this call we may use the terms adjusted EBITDA and distributable cash flow. These are non-GAAP financial measures and we have provided reconciliations to the most directly comparable GAAP measures in our earnings release published this morning for historical results. Please see our website for a reconciliation of our forecasted adjusted EBITDA to comparable GAAP measures.
Also, we have posted a new Investor Presentation under the Investor Relations portion of our website. We will be referring to this presentation throughout our call today.
And now, I would like to turn the call over to our Chairman, Ted Beneski.
Good afternoon, and thank you all for joining us to review the second quarter of 2018. We're pleased to say that since we last met in early May, we have continued our positive momentum with several notable accomplishments. First, we drove a strong improvement in adjusted EBITDA of 34% sequentially attributable to higher volume sold, higher sand prices and lower logistics costs.
Second, we signed several new take-or-pay customer contracts for our leading Eagle Ford in-basin operations at San Antonio plant. Third, our NSR permit process for the San Antonio plant expansion to 4 million tons per year has gone very smoothly. So, we're expecting to receive our new permit by late August which is ahead of the previous year and guidance.
And fourth, we announced a new in-basin operation in Kingfisher, Oklahoma for the scoop and STACK shale play. We're very excited about expanding our in-basin footprint to become an even more balanced producer of both in-basin and northern white sand. Turning to the second quarter overview, we grew our total volume sold by 6% sequentially to 1.6 million tons which is another company work and our frac volumes also increased by 6%.
Compared to the second quarter of 2017, our total volumes sold increased by 14%. The rail service for our Wisconsin operations improved moderately during the quarter. And our BNSF direct outlet continues to handle a heavier workload. Our Texas operations exhibited a growth in sales and production with both Kosse and San Antonio reaching higher production levels.
However, our San Antonio production volumes did not meet our internal expectations as we experience the two-month construction delay in finishing the new 2.4 million tons per year drive plant. We are now expecting a late August completion, which will drive a substantial San Antonio volume improvement in the third quarter. Receiving our NSR permit by late August, we'll further boost the plants performance for the second half of the year.
Adjusted EBITDA of $23.4 million in second quarter increased by $6 million sequentially and by $15.8 million year-over-year. The higher volumes especially from Kosse and San Antonio contributed to the higher overall profits and margins. Additionally, we implemented Northern White price increases in the second quarter of 2% compared to Q1. And the $4 million negative adjustment occurred in the first quarter for repayment of logistics related ramp which was deferred during the downturn did not repeat in the second quarter.
Our consolidated net income grew by $8 million sequentially to $9.4 million in the second quarter. Deb will have more of the details on the financial results in her section. Additionally, we are currently experiencing a minor market softness due to the Permian pipeline takeaway capacity constraints. Both we and our customers see this as a very temporary situation.
We're expecting the second half of the year to continue the high levels of activity witnessed in the first half of the year and our San Antonio plant should generate significantly higher profits during the second half of the year. As for the subject of a dividend, we are striving towards that goal as expeditiously as possible. Our main limitation is our Credit Agreement which prevents a dividend from taking place in 2018.
But we believe we are on track to deliver again beginning in early 2019. And now, I will turn it over to Rick.
Thanks Ted. To lead off, I'm proud of our team's outstanding achievements in the first half of the year. We are delivering solid results so far, but we have very critical work ahead of us in the second half of the year to make 2018 highly successful. Before we dive into the details on our operational update, I want to point out a return on asset study we conducted internally to compare ourselves to our public property - peers. Although we often hear compliments from customers and investors about how we are much more resourceful than other sand companies are internal study verified this hypothesis as our 2017 return on long term assets led the industry.
A few of our peers might be of larger size and bigger capital budgets but our company was founded on a culture of resourcefulness with discipline capital spending and yet we've still achieved a market leadership position as a top five producers. A great example of our capital discipline lies in the San Antonio operation. Once the plan is finished, our estimated total capital expenditures of $85 million including the sand reserves will be a fraction of our peer's in-basin plant of similar size.
We expect to continue this trend of outperformance on a return to metric for our newest in-basin plant the recently announced Kingfisher, Oklahoma plant. Now turning to an update on our San Antonio operations I'm pleased to report that we've signed several take-or-pay contracts with leading EMPs and pressure pumpers over the last few months. The demand for this product remained very strong and we're converting this appetite into contracted demand.
We now have nearly 50% of the ultimate 4 million plus tons per year of capacity signed under contract and will close to finalizing a number of other large contracts here. We expect to be over 80% contracted by the time the full capacity is available for sale which should be by the end of Q3. By design, we want to keep roughly 20% of our San Antonio capacity open for spot market sales.
As Ted mentioned in his remarks, we experienced a two-month construction delay on the new dry plant, but we have resumed construction and now expect this plant to be fully operational by late August. We're also very excited about the status of our NSR permit, we made it through the second public hearing period with no major comments, so we're expecting to obtain this permit in late August. Once the state officially grants us this permit, we will immediately increase output on the dryer and the current limitations on the amount of natural gas burned will be raised.
Also, we've ordered the required equipment to increase the wet and dry processing capacity to over 4 million tons per year, so construction on the upgrade will begin immediately. Our target to complete this upgrade for the wet and dry plant is the end of September. And we're still expecting to come in below the construction budget of $65 million for the entire project, excluding the initial reserves purchased.
We're highly compliment that San Antonio would drive a marked improvement in our financial performance for the second half of this year. Our other exciting new in-basin expansion is our Kingfisher, Oklahoma site which we announced in early June. We secured mining rights on over 600 acres at a very attractive location in the STACK portion of the Mid-Con basin. As illustrated on page 16 of our investor presentation, over half of the 137 drilling rigs in Oklahoma are located within a 75-mile radius of our plant.
Several competitors have announced sites further west of us but we are the only mine in Kingfisher county where drilling activity has been strong and should continue to grow according to several operators in the area. Despite the competition, we view the industry shifting towards a micro targeted strategy where 50 miles within a basin makes an important difference for purchasing decisions. We decided to put capital to work in the Mid-Con because we see this area as an attractive growth market for three reasons. First, operators are demanding local 100 mesh sand, they are using a well-designed and we're capitalizing on this demand by contracting with key customers.
Our goal is to have the plant over 80% contracted by the end of the year. Second, we're pushing a bundled package of Northern White sand namely 30-50 with some local 100 mesh product. Customers are requesting a combination of the two products and we have the capability to meet these needs. Third baseman has significant growth potential for sand consumption. Industry sources estimate the basin could consume 10 million tons of sand next year, but the proper intensity is much lower than the other leading shale basins if operators catch up to other regions on the sand per well, the demand could exceed industry forecasts.
Not only is the Mid-Con an attractive market, but our Kingfisher site also has attracted logistics as we are near a four-lane US highway and there is a rail service within three miles if we choose to develop a rail load-out option. For now, however, we expect to truck all the products to the well site. Additionally, we expect to spend $15 million of total capital on this site which is much much less than recent announcement made by our competitors.
Once again, we're minimizing the capital spend yet still aggressively expanding our business to keep up with the industry's high growth rate. Our resourcefulness in terms of structuring the mineral rights, deploying spare equipment on hand and purchasing used equipment will allow us to stay within our original 2018 total company capital budget of $90 million and still generate attractive returns. We've already submitted our permits to the state and expect to receive an approval by mid-August hitting this milestone will keep us on track for shipping sand out of Oklahoma by the end of the year.
Our third in-basin operation is our legacy plant located in Kosse, Texas. The performance of this facility has improved significantly this year, as we produced over 200,000 tons of frac sand year-to-date representing almost double the activity compared to the first half of last year. We're seeing strong demand from customers in the Eagle [ph] area where our plant has a distinct advantage to the rigs operating in the sub-basin and the production costs here have also decreased nicely. We expect demand for this plants product to stay strong allowing us to invest small amounts of capital to further improve efficiencies and throughput expect the Kosse bottom-line contribution to continue to improve.
Let's now review our current assessment of the frac-sand market. We acknowledge that the industry is in a state of transition with customers demanding in-basin product in the Permian, Eagle Ford and Mid-Con basins and the announced in-basin plans are ramping up utilization. However, customer interest in northern white sand remains resilient and we're continuing to move significant amounts of Northern White product into all the major basins. We expect to whether any disruption in Northern White given our strong logistics capabilities into multiple basins across North America.
If you turn to page 11 of our investor presentation, the graphic on the right side of the page illustrate our diversification of volumes sold by end market. Whereas the Permian basin accounts for nearly 40% of the total market demand, we sold only 24% of our last 12 months of volume in the West Texas.
Outside of Texas and Oklahoma, we have leading positions in the Balkan, the Rockies and Western Canada each currently accounting for up to 15% of our total volume. These three key markets need Northern White quality and consume a large amount of coursed fine grades. On top of this, we continue to see frequent requests for Northern White 30-50 and 40-70 even in the markets where in-basin sand consumption has become more prevalent. Nonetheless there are signs that 100 mesh is becoming over supplied in West Texas freeing up the Northern product to move to these other basins.
As such, we're seeing some 100-mesh price pressure which could impact their overall Northern White ASP in the second half of the year. For the third quarter, we are forecasting our total Northern White pricing to be flat compared to the second quarter. We do not yet have a clear view on Q4 Northern pricing, but we do not foresee the free-fall that some market participants are projecting.
Although, we've already partially covered the topic of logistics, we do want to highlight our logistical strengths that are aiding us in this challenging marketplace. In July, we announced the new terminal contract located in British Columbia which is set to open later this month. This terminal in view, it allows us to more aggressively pursue the growing market in the Montney basin. Additionally, we've now finalized a new terminal contract in Wellington, Utah located in the Uintah basin. Our Wellington transload site should position us to be a major frac sand supplier in Utah within the shared track space for unit training capabilities.
This emerging sale plays beginning to accelerate in drilling activity as customers are becoming increasingly bullish on the horizontal development opportunities there. We're now working on supplying one of our key Texas customers for their Utah needs and other operators are interested in contracting with us from Northern White product in this emerging basin as well. These two new terminals represent prime examples of how we are adapting to the current market dynamics and capitalizing on our ability to ship product directly on four different class one rail lines.
As we've stated before, the Northern White competitors with single rail line access will suffer first if the Northern White capacity does exceed demand. The leading sand producers including us with multiple rail line service and a complete set of terminals and customer contracts will be much better positioned to handle any disruption. The other important logistic subject is last mile. We're increasing our focus on handling this last link in the supply chain because customers are more commonly requesting a fully bundled package of sand and the related handling.
This does not mean we are looking to purchase one of the many available technologies or companies. In fact, this place is becoming increasingly competitive. Rather we will take a similar tactic that we utilize with our terminal strategy partnering with third party logistics experts who own and operate the infrastructure. We've proven this model to be effective with the terminals and we're confident this will translate into success for the last mile.
Our current collaboration with Solaris provides a nice starting point, but is by no means an only option. We are in advanced discussions with other leading last mile providers including a major trucking company to bundle our sand and capture new business opportunities. In closing for my section, we are proud of our accomplishments in the first half of the year and we're very optimistic about the second half of the year.
We have the right business plan in place for this dynamic market and we're committed to executing that plan. The more we see how the market evolves off late, the more convinced we are that our model brings competitive advantages to emerge energy for continued success ahead.
With that, I'll turn it over to Deb to review the financials.
Thank you, Rick. Emerge Energy reported consolidated net income of $9.4 million or $0.30 per diluted unit throughout the second quarter of 2018. This represents an improvement of $7.9 million compared to $1.5 million in the first quarter of 2018 or $0.05 per diluted unit. The sequential increase in our net income was driven by the improvement in volumes sold, higher sand prices and lower logistics related costs.
Additionally, we incur several one-time charges during the first quarter that we detailed in our last quarter's call a $3.9 million write-off, a differed financing cost, $1.1 million of debt modification expenses and $1.7 million write-off of prepaid royalties and intangible assets.
None of these occurred in the second quarter. In the other expenses and income line item, we recognize a 200,000 mark-to-market loss on the fair value of warrants outstanding compared to 700,000 mark-to-market gains in the first quarter. Revenue declined by $5 million sequentially to $101.8 million in the second quarter as higher volumes and prices were offset by a lower percentage of our volumes sold to in-basin terminal this percentage declines to 39% in the first quarter to 26 percent in the second quarter. Our adjusted EBITDA increased by $6 million to $23.4 million in the second quarter compared to $17.4 million in the first quarter.
The same factors behind our net income increase, higher volumes sold, higher Northern White sand prices up 2% and lower logistics related costs, these all contributed to the EBITDA improvement. We also incurred a $4 million reversal deferred rent expense in the first quarter that did not repeat in the second quarter. We generated $17.3 million of distributable cash flow during the second quarter compared to $8.7 million in Q1.
But as the board of directors of our general partner elected not to make a distribution for the quarter. Also, as previously disclosed, we are restricted into our current credit agreements from paying distributions in 2018. Our capital expenditures for the second quarter totaled $25.7 million substantially all of which was growth. Most of our growth CapEx for the quarter was directed towards the new San Antonio plant and a portion of the plant at Oklahoma for equipment and construction downpayment.
Now that we have spent over $55 million for capital expenditures for the first six months of the year including $1 million for capitalized interest. Our updated full year 2018 capital expenditures range is $80 million to $90 million.
Turning to the balance sheet, we had $3 million drawn at second quarter unit on our $75 million revolving credit facility and our second lien note had principal outstanding of $215 million. We had $1 million of cash and $61 million of availability under our revolver. Our total leverage ratio continues to improve and a calculation with 2.96 times like in 12 months adjusted EBITDA on June 30. We are currently in compliance with our financial comment including our minimum revolver availability, maximum total leverage and minimum fixed charge coverage ratio as we expect to remain in compliance in the future.
Our operating cash flows were positive $25 million in the second quarter. Our total net working capital decreased by $13 million primarily driven by decreased in our accounts receivable balance offset by a higher inventory balance due to the exemption of the stockpiling Northern White sand for the winter. Turning to the third quarter, we expect volumes to continue to improve with our new San Antonio dry plant finishing construction in late August and we have the potential for higher production once we obtain the new permit.
Northern White volume is expected to fall slightly given a slow July although orders are starting to rebound. For total volumes, we are anticipating flat to 5% growth compared to the second quarter. As Rick mentioned earlier on Northern White pricing we are seeing some 100-mesh pricing pressure and are anticipating flat overall Northern prices while most of our in-basin sand pricing is fixed for the rest of the year. Total revenues could be flat to slightly down due to a further decline in the percentage of total sales to our in-basin terminal.
Our production costs should decline with the higher utilization at San Antonio and a gradual phase out at the start of related costs in San Antonio. However, our logistics discount that we received during the downturn will be fully expired in the third quarter with all of these pieces, we expect adjusted EBITDA margins on a per 10 basis in the third quarter to be similar to the second quarter.
Finally, we are updating our full year 2018 guidance to $110 million of adjusted EBITDA and $50 million and net income. We had planned all along for 2018 to be back end loaded given San Antonio ramp up schedule, but the two months construction delay has pushed down our timeline. We still expect San Antonio to drive a substantial improvement for the second half of the year and margin should expand materially in the fourth quarter with San Antonio achieving full utilization post NSR permit upgrade.
Operator, we're now ready to open the call for questions.
[Operator Instructions] Our first question is from the line of Lucas Pipes with B. Riley FBR. Your line is open.
Hi good afternoon everybody. I wanted to follow-up a little bit on the comments about the last mile and first could you share with us kind of what percentage of your volumes have currently sold with the last mile service attached to it?
And then where do you think you could take that business and how advanced are those negotiations that you were or conversations that you were referencing earlier?
Sure. The last mile is certainly getting more and more in demand and more and more exposure in the marketplace particularly with the EMP's. You can imagine that the they are certainly looking for this service capability. So, we're ramping up our last mile capability. The estimated amount of last mile service that we do right now is probably something between 50% and 60% I would estimate at this point.
There is continued growth and interest in last mile and that's driving us to be even more definitive in our last mile capability. I really can't get into further discussions going forward, but we are talking to a number of last mile providers. There's a lot of interest and a lot of opportunity as far as putting an attractive partnership together and we're working hard to put something in place there.
More to come on that once we get some things finalized.
That's good to hear. Thank you for that detail. And then may be to follow up on San Antonio and the production delays. It doesn't appear to be a major delay, but I wondered if you could maybe elaborate on what happened for this to be little bit slower than anticipated? Thank you.
Sure. I mean the issue really is related to our construction contractor. He has been overwhelmed in a word had crew strung out and had a lot of work heavily in Texas and elsewhere that allowed some of the backup between that and some of the issues of getting some matters resolved with the county officials to continue the work forward and it ended up relating to the delay that we've seen. The good news is those issues are now largely behind us and we're starting to track very well with the program as we had anticipated.
So even as we sit here now the numbers and the tons per day are ramping up. We'll see significant improvement in August and as you heard us talk, we'll get the second dryer in place by September and ultimately with the NSR we'll be running at full capacity in the fourth quarter.
Got it. Helpful. Thank you. And maybe I can sneak one last one here just on the market. You mentioned two dynamics. One, we have the price pressure on the 100 mesh, I was curious as to kind of your longer-term outlook how that will play out over say the next 12 months and then you mentioned the temporary at demand issues and I think you attributed to the takeaway capacity in the Permian which we viewed as more temporary.
So, on the first one, the 100 mesh what's your outlook longer-term and then on the temporary issues how quickly do you see those resolve based on your conversations with your customers? Thank you.
Sure. On the 100 mesh, with that product in particular being so problem with the added capacity coming on you would expect there would be some competitive pressure on the pricing there and we're not really surprised to see that. That's driving a couple things, one is we're starting to look to display some of the product in other basins now that is to move the sand that 100 mesh that we had in West Texas in particular and other basins and we didn't discuss this in the prepared comments but our sales management team has done an outstanding job of upgrading our sales team, our sales force and adding more sales people for a broader coverage in all the basins that and an improvement and added staffing in our internal selling side all of that as a way to set the table to start moving more aggressively putting more times in some of the other attractive markets where we have strong shipping lines from Wisconsin.
And I think we mentioned this earlier, but that that really means focus now on the Rockies, Utah, and Wyoming, Western Canada for sure, the Bakken and the Marcellus as well. And we're starting to already see that happen as we begin to move some of this volume more into these other basins that's being well received and that certainly should help us keep the pricing firm as best we can anyway on the 100 mesh we'll see how this all plays out.
Historically the short-term softness in the market. Yes, we have all saw a catalyst here with some of the backlog of moving product out of West Texas creating a surge of inventory that spilled over into some of the other basins the entire industry saw this certainly not just Emerge Energy.
But we did see a surprising softness over the last 30 days or so. The feedback we're getting right now says that the inventories are improving and the business is starting to ramp up as we head into August. So we think and from everything we know, it was just a very temporary blip on the screen perhaps the 45 days or so is the expectation, but there are signs even this month that things are improving from what we saw last month.
Very helpful. Thank you and best of luck.
Thank you. Our next question is from Selman Akyol of Stifel. Your line is open.
Thank you. A couple questions I guess. So, thinking about the dividend you restarted that in 2019 what changes. Is that just you plan to refinance or is that just something that was just a 1-year moratorium I guess it's in that credit range that you have?
So, there was a one-year moratorium and beginning of 2019 we can pay distributions if we meet certain criteria based on the total coverage ratio, the fixed charge ratio and availability. And based on our current forecast, we do believe that we will be able to meet the criteria next year.
Now there are limitations on how much we can distribute each year, but those are listed in the agreement. That's in the second lien term note agreement that has the limitation.
Okay. And then going back to San Antonio facility, previously how is staffing going there. As you look to continue to ramp up I.e. can you ramp up with the current number of employees or you guys still need additional people in order to move volumes higher out of there?
No, Selman we're going to add more people as we ramp up the construction. As you know, we don't have the wet plan up and running right now but we're bringing feed in through the old wet plants and other sources. So, we'll need to continue to build that staffing. Ultimately will be about 100 employees when we're fully staffed and up and running full speed by October at least. The other piece of good news is that it's gone through a lot of work and a lot of effort by our HR team and our operations management group, but we are seeing better quality people coming on board now and with all the training we're doing and so forth we're feeling better and better about the quality of team, the quality of people that are coming on board there.
So, all of this is really a timing thing. I mean we touched on it during the entire call today that we're very optimistic about San Antonio but it's really a timing thing of getting this thing ramped up and getting to the full potential of this operation and it's all pointed toward making that happen in the fourth quarter.
Got it. And then how many people do you have there working today.
I think the actual headcount today is probably about 65 people. That's my best estimate.
Just going back to the temporary slowdown and I know in the press release I guess you talked about, you referred to sort of constraint takeaways and I can understand why that would lead to a slowdown, less well completions et cetera I guess. Why do we don't see those constraints lifting I guess until next year, middle of the year to third quarter or so?
So why do you think things get resolved before then?
Well, I think part of it was just the inventory management. I can't speak for our competitors, but I can tell you we had an absolute record breaking month in May and a lot of sand was bought in the marketplace and inventory was build up and in addition to the comment we made about West Texas, I think it did push the inventory levels expecting continued growth, continued demand at a very high level and when that fell back even in the least people had more than enough sand on hand.
So, we've had to catch our breath to get an inventory adjustment industry-wide really because it spilled out into some of the other basins as we said. So, now we're seeing that correction start to fix itself so to speak, so that we could begin to see improved demand industry-wide again in this month and beyond for sure.
Okay. Thank you very much.
Thank you. [Operator Instructions] And I'm showing no questions at this time, I would like to turn the call back over to Mr. Ted Beneski for any further remarks.
Thank you, operator. In closing we just want to thank you for participating on the call today. We're pleased with the progress we've made in the first six months of the year and we're confident that the second half of the year will be even more successful especially with our new NSR permit materializing by late August.
We're excited about the opportunity in front of us and we look forward to speaking to you next quarter. Thank you all.
Ladies and gentlemen thank you for participating in today's conference. This does conclude today's program. And you may all disconnect. Everyone have a great day.