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Edited Transcript of EMES earnings conference call or presentation 3-May-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Emerge Energy Services LP Earnings Call

Southlake May 18, 2017 (Thomson StreetEvents) -- Edited Transcript of Emerge Energy Services LP earnings conference call or presentation Wednesday, May 3, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Deborah Deibert

Emerge Energy Services LP - CFO of Emerge Energy Services GP LLC

* Richard J. Shearer

Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC

* Theodore W. Beneski

Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC

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Conference Call Participants

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* Jason A. Wangler

Wunderlich Securities Inc., Research Division - SVP and Equity Analyst

* Marc Gregory Bianchi

Cowen and Company, LLC, Research Division - MD

* Selman Akyol

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Emerge Energy Services Q1 2017 Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to, Deb Deibert, CFO. Please go ahead.

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Deborah Deibert, Emerge Energy Services LP - CFO of Emerge Energy Services GP LLC [2]

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Thank you, operator, and welcome, everyone, to the Emerge Energy Services LP First Quarter 2017 Conference Call. Just a quick note before we start. Our discussion today may contain forward-looking statements. These statements may include, but not -- 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 I -- 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 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 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.

Finally, the internal estimate of Osburn Materials sand reserves is based on surveying, drill core analysis and other tests performed by Emerge Energy's geology and engineering staff. This estimate has not been reviewed by our independent reserve engineers and may be revised following our ownership of the property. By its nature, this estimate is more speculative than proven or probable reserves and subject to greater risk that such reserves will not be realized.

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

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [3]

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Thank you, Deb. Good morning, and thank you all for joining us to discuss our first quarter results, the current market outlook and an update on our business strategies. After speaking with you all about 2 weeks ago, regarding our exciting acquisition of Osburn Materials, based outside of San Antonio, Texas, we are now pleased to announce that Emerge Energy has reached a critical inflection point with our positive Q1 results. Volume and prices increased dramatically, reflecting the severe tightening of supply and demand in the frac sand industry, and we achieved breakeven adjusted EBITDA during the quarter for the first time since Q4 of 2015. All of our mines and plants are now running near full utilization, and we are seeing prices increase further in the second quarter. We are continuing to negotiate and finalize supply contracts with key customers, which indicates that the industry is valuing surety of supply, given limited availability of sand. Since we are reaching our production limits with our existing capacity, we are now turning our attention to expanding the San Antonio site into an eventual 3 million-plus tons per year operation.

For the first quarter 2017, Emerge Energy reported a consolidated net income loss of $11.4 million compared to a net loss of $20.8 million for the 3 months ended December 31, 2016. This was due to improvements in price and volume. We generated consolidated adjusted EBITDA of positive $68,000 versus negative $10.6 million in the fourth quarter of 2016, driven by a 52% sequential improvement in volumes sold to 1,251,000 tons, and a promising uptick in realized prices.

Despite the significant sequential improvement in Q1, and achieving our goal of breakeven adjusted EBITDA, we experienced meaningful one-time costs to quickly ramp up the utilization of our business. We incurred approximately $1.5 million in cost to pull over 800 railcars out of storage during the quarter. And the seasonal restart at all 5 Wisconsin mines required us to incur extraordinary site preparation costs of over $1 million.

The $10 to $15 per ton price increases that we outlined on our last earnings, were phased in during the quarter. So as of the start of Q2, we are getting the full benefit of those improvements in addition to further increases. With the roll off of the one-time costs, the run rating of higher pricing and another healthy increase in volumes, we're expecting a strong second quarter.

I mentioned on our call 2 weeks ago how we are successfully executing on our strategic plan. The closing of the Osburn Materials acquisition signified a key breakthrough for our company as we are now offering a full range of proppants to the oil and gas industry. Achieving breakeven adjusted EBITDA adds another accomplishment to start the year. And now our next goal is to return to a high level of profitability for 2017.

We believe that we are on track for a highly positive year, based on the results of our hard work throughout the downturn, coupled with strong market demand. We are now issuing guidance for the next 2 years. Our 2017 guidance for adjusted EBITDA is $40 million. And our 2018 guidance for adjusted EBITDA is a range from $140 million to $160 million. This guidance assumes that the demand for frac sand stays strong, with an oil price environment of at least $45 to $50 per barrel. It also assumes that the Phase 2 expansion of our San Antonio plant is completed during Q4 of this year and our Phase 3 expansion for the 3 million tons per year added capacity is completed and operational by early Q3 2018. We expect to be quickly sold out on that new capacity. With that, I'll now turn it over to Rich Shearer, our CEO, who will cover the sand operations in more detail.

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [4]

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Thank you, Ted, and good morning, everyone. First of all, I'm very proud of our team's effort to get back to this important point of breakeven adjusted EBITDA. It's especially pleasing that we accomplished this goal 1 quarter ahead of our forecast. While we took a brief moment to celebrate, we are now moving quickly to hit our new goal of generating a healthy profit for 2017.

Our second quarter results should prove to be a positive step in that direction, because as Ted just mentioned, we have further volume and pricing actions that will help boost our bottom line. Once again, we drove a meaningful increase in volumes sold during the quarter, with a 52% sequential increase in Q1 to 1,251,000 tons, which represents an all-time record quarter for us. And this followed the 68% surge in volume sales in Q4 2016.

We believe that these sizable moves represent a major gain in market share, approaching our target of 10%. Our growth rate vastly outpaced the public data and we expect to continue our share gains as smaller, poorly capitalized sand producers who have recently lost share struggle to regain trust from leading service and E&P companies. We are proving that the major pressure pumpers and E&Ps prefer to buy sand from the Tier 1 producers, rather than depend on less reliable, smaller rivals who cannot offer the same wide range of products and logistic services.

Now turning to developments in the frac sand industry. We want to address the supply and demand dynamics. We echoed the comments of our peers that the industry is still experiencing a tight level of supply, despite the recent capacity expansions announcements made by us and some of our competitors. We remain sold out of the fine mesh products, and we are starting to see better movement of our coarser grade products, especially 30/50 and even a good portion of our 20/40 product. One of our peers has articulated why the industry supply number must be adjusted to reflect real operating conditions or effective capacity rather than relying upon the nameplate figures. This is a very important point, especially in an environment where the fine mesh sands are in higher demand than the coarser products. As such, you should haircut the nameplate figures by at least 10% to 20% to account for the grade imbalance, and also factor in another 10% for more plant downtime and maintenance to arrive at a plant's realistic output.

Ultimately, we expect the demand for 20/40 and 30/50 will return to a higher level of -- as completion designs continue to evolve. In fact, we've heard from a few of our customers that they are starting to shift away from pure 100 mesh designs due to long-term well performance concerns and are reintroducing some of the coarser grades into their more recent designs. This bodes well for us, with our coarser deposits in Wisconsin. But we also now are better positioned to meet fine mesh demand with the recent acquisition of Osburn Materials. We pointed out in our update 2 weeks ago that this 80-million-ton Eagle Ford based deposit, according to our internal estimates, is mostly 40/70 and 100 mesh. Upon completion of Phase 3 of the San Antonio plant, we will have 1/3 of our production capacity in local sands at our 2 Texas sites.

Speaking of our recent San Antonio announcement, we want to reiterate how we think this attractive deal will be difficult for competitors to replicate at scale. Permitting remains a significant obstacle for all greenfield sites, even in the most oil and gas friendly state of Texas. It is good to note that our new San Antonio plant with its 80-plus year history as a mining operation has built up a great rapport with the county and the community. New entrants are facing considerable backlash with local residents for greenfield developments, and a competitor must also match up high-quality sand on a large contiguous property with a desirable logistics package. Our new San Antonio site checks all of those boxes, and we have the first mover advantage as the closest frac sand operation of scale in the Eagle Ford basin.

Since the announcement was made 2 weeks ago, we have started to market the product and we are receiving strong interest from current and potential new customers. We are close to achieving the Phase 1 expansion of 24/7 operations, and remain on target for Phase 2 completion by Q4 of this year. Phase 1 and Phase 2 expansions will allow us to sell more than 60,000 tons per month of frac sand. The Phase 3 expansion will add another 3 million tons per year in San Antonio by mid-2018.

Our other imminent expansion plan is at our Kosse, Texas site. We are evaluating our options to debottleneck the plant and increase the capacity above 600,000 tons per year. Our ability to finance this project will be an important factor, either internally or through an external source such as a customer. This Kosse expansion will add another 35,000 tons to 40,000 tons per month of capacity.

Ted briefly mentioned the pricing and contract topics in his remarks, but I want to expand upon this subject. With the continued positive momentum in our industry, we are realizing higher prices, essentially every month. And we do not see that slowing down in the near future. We figure that the more expensive marginal sand producers, who were idled for most of 2016, will need to reactivate to meet what many industry sources say will be at least a 70-million-ton market demand for 2017. These higher cost players should drive average selling prices higher during the year. And several major E&Ps have back-end loaded capital budgets to add further rigs in the second half of this year.

We are currently experiencing an increase in average selling prices by approximately $5 to $7 a ton versus averages in Q1. And we are quickly approaching discussions with customers for Q3 pricing, which we expect to show further price increases. We have made considerable progress during the quarter with our customer contracts, and the priority from the customer base is still one of locking in volumes. We are close to executing our last remaining major contracts that would place over 60% of our total expected volume for the year, under take-or-pay contracts. As a reminder, these contracts are multi-year deals with fixed volumes, but the pricing fluctuates quarterly based on market prices.

Looking at our Q1 performance in more detail. Our adjusted EBITDA from continuing operations improved sequentially by $10.7 million to a positive $68,000. We are once again extremely pleased by our sales volume growth, and the pricing gains started to fall to the bottom line during the quarter. Although we achieved our goal of breakeven adjusted EBITDA, we are expecting much better results the rest of this year as the major price increases outlined on last quarter's call did not fully take effect on January 1. As such, we will see another strong quarter of price gains in Q2, and we're anticipating further price increases over the balance of the year.

Because the business accelerated faster in Q1 than we had initially planned, we incurred 2 one-time expenses to meet the higher demand for product. First, our mines in Wisconsin required spring site preparation work that totaled over $1 million. And this abnormal expense will not reoccur the rest of the year. Secondly, we pulled over 800 railcars out of storage during the quarter, ending with 842 railcars in storage on March 31. And we incurred over $1.5 million of costs to place these railcars back into service.

The higher sales volumes and stronger utilization of our logistics assets are now driving much better utilization, thereby improving our overall fixed cost absorption. With another increase in volumes expected in Q2, we should pull out additional railcars from storage, and we could be in a position to have all railcars out of storage later this year.

We continue to evaluate our terminal network and are nearing the completion of our Big Lake Texas facility for early Q3. The Big Lake terminal will allow us to more efficiently meet the growing demand in the Permian basin. The flexibility retained by having third parties build and operate these facilities is critical in today's market, where the activity can migrate between and within basins.

Staying on the topic of logistics, we continued to assess our position on a last mile solution. As a reminder, we are providing this through third parties rather than through our own equipment or brand, but there could be an opportunity to expand further into this segment. We will keep studying the different concepts out in the market and will look to consider partnerships that benefit both parties. Last mile services are very much in our business strategy going forward.

Finally, I want to spend some time with an update on our self-suspending sand, brand-named SandMaxx. We continue to build on the success we achieved in an extremely difficult market that was 2016, when we trialed the product in numerous wells. While we currently have 1 customer buying railcars of SandMaxx monthly, our goal for 2017 remains broader market acceptance by year-end. And additional trials lined up for the next few months should mark further progress for this innovative product. The evidence that SandMaxx pumped wells greatly outperformed wells completed with conventional sand keeps mounting as proven by recent data obtained from our customers. Additionally, the ancillary cost savings in the form of less water, more stages pumped per day, reduced labor, lower maintenance and less chemicals are real and material. We now believe that the early field success of SandMaxx has answered the question of whether this technology works. The field data shows that SandMaxx works and works well. We are steadfastly committed to gaining broad market acceptance of this technology, because targeted downhole proppant placement could be one of the next notable efficiency gains in the shale revolution. And now, I'll turn it over to Deb to review the financials. Deb?

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Deborah Deibert, Emerge Energy Services LP - CFO of Emerge Energy Services GP LLC [5]

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Thank you, Rick. Emerge Energy reported a consolidated net loss of $11.4 million or negative $0.38 per diluted share unit for the 3 months ended March 31, 2017. This compared to a net loss of $20.8 million or negative $0.77 per diluted unit for the 3 months ended December 31, 2016. We reported consolidated adjusted EBITDA in accordance with our credit agreement, of positive $68,000 for the first quarter of 2017 compared to negative $10.6 million for the fourth quarter of 2016. As we mentioned earlier, pricing and volume gains drove our bottom line improvement, although, we still incurred over $2.5 million for returning railcars from storage and mining preparation costs. SG&A increased by $900,000 sequentially to $5.9 million as we've increased our staffing given the business improvement and we incurred over $200,000 in costs associated with the Osburn acquisition, which are added back to adjusted EBITDA. Interest expense declined by $250,000 to $3.2 million due to a lower average balance on our ABL following the equity offerings in November and December. In other expense, we also recorded a $696,000 mark-to-market loss on the fair value of warrants outstanding. We generated a distributable cash flow deficit of $4.3 million for the 3 months ended March 31, 2017, and the Board of Directors of our general partner elected not to make a distribution for the quarter. We are also restricted under our credit agreement from paying distributions at this time. Our capital expenditures for the quarter were $1.4 million, which includes $900,000 of maintenance capital. As we previously reported, we continue to operate on a significant reduced capital expenditure budget and are including only those projects in 2017 that are necessary for our current operations and/or for which we are contractually obligated. We previously reported that our total capital expenditures for 2017 would be around $5 million. But the addition of the San Antonio plant Phase 2 expansion adds almost $3 million to our full year target, which is in accordance with our current covenants. If the market continues to improve, we will seek permission from our lenders to increase the limits.

Turning to the balance sheet. The principal balance on our ABL facility increased from $141 million outstanding at December 31, 2016, to $159 million at March 31, 2017, given a large build in working capital associated with a higher receivables balance. As noted in our Osburn update call 2 weeks ago, we issued a new $40 million second lien term loan to help finance the acquisition and lower the outstanding balance on our ABL facility. Also in conjunction with the transaction, we entered into an amendment with our senior ABL lenders that approved the acquisition and permitted the second lien debt raise. We agreed to certain commitment reductions, and we increased the capital expenditures covenant to allow for the San Antonio Plant Phase 2 expansion. This transaction freed up some additional liquidity, and we are now also in a position to generate positive cash flow, and we expect the ABL balance to decline over the course of the year. In our covenants, we have a minimum adjusted EBITDA covenant resuming in the second quarter that we expect to clear with a strong cushion. And our total $32 million ABL availability easily exceeded the minimum availability covenant of $15 million. This question was further improved in April when the Osburn transaction and financing led to an additional ABL paydown. We were in compliance with all other debt covenants and filing requirements in the first quarter, and we expect to remain in compliance in the future.

As Ted mentioned earlier, we are now issuing guidance for adjusted EBITDA for full year 2017 and 2018. We are guiding to $40 million of adjusted EBITDA in 2017, and a range of $140 million to $160 million in 2018. You may find a reconciliation of net income to adjusted EBITDA on our website. Once again, this guidance assumes that the market demand remains robust for frac sand and our San Antonio expansion plans are hit. Operator, we are now ready to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Marc Bianchi with Cowen.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [2]

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Thanks for the guidance here. Not too far off, I guess, what we're thinking in terms of the progression for the company. But just curious, what might be underlying those assumptions for you, mainly in terms of volume? Thanks for the Osburn, but just wondering about the Wisconsin facilities?

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [3]

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I think probably the most important volume number that we are focused on in terms of what we believe we can achieve in 2018 is 8 million plus tons sold.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [4]

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Okay. So that would be including Osburn and then just assuming some sort of ramp from here to that number.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [5]

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Yes, it's important to note that we're including completing Phase 3 of the Osburn expansion and having that additional volume included in that 8 million total for the back half of 2018.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [6]

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Okay. With this additional EBITDA, Ted, you will probably be ramping up pretty quickly on distributable cash flow. Recognize that there's some restrictions on distributions and you probably also want to be investing in growth as well. How do we think about how much TCF could be coming back to shareholders out of that -- I guess it's $140 million to $160 million of EBITDA?

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [7]

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You know, it's a great question. The truth is we have not even begun to think about distributions yet. By the end of the next quarter or 2, we will have a more formal idea what we plan to do there. But clearly, as we've stated, we don't have the ability to make distributions now. We have to get permission from the bank group to begin making distributions, which we don't expect to be a problem. And as soon as we have the available cash, we expect to begin distributing it. So we are not a conventional MLP. We're a full-pay, variable-rate MLP. So the mantra in the past and it will continue in the future is whatever available cash we have to distribute, we will distribute it.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [8]

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Right. Okay. Maybe just a little more near-term if I could. In terms of the pricing commentary, Rick, you mentioned that it's improving. There was a -- perhaps a customer, but a pumping company this morning had their earnings call, and had discussed that the tightness had moderated and pricing increases have stopped. So that sounds a little bit different from what you guys were saying here today. Curious if you could provide a little bit more color on kind of the pace of price progression as we exited the quarter and really on the ground today.

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [9]

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Yes, Marc, we're not seeing that at our end. I mean, we are continuing to see opportunities for continued product demand. The only issue on the soft side at all of demand and pricing would be the coarser grades right now. But even that's improving. So we think that's going to continue to move forward, both around well performance and around the -- just shortage of 100 mesh and 40/70. So for that reason as well as even with continued demand and through our contracts and so forth, we are seeing clearly as we sit here now, a weekly increase in our average selling price. And we see that moving forward certainly through Q2, and from the discussions we've had with customers with more rigs coming in, with the budgets as they're set right now and the increased demand going forward, assuming everything stays in place with oil pricing at least where it is today around $50 a barrel, we have every expectation that our average selling price will continue to increase even into the second half of this year.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [10]

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Okay. And that $5 to $7 that you mentioned that -- is that at the mine gate or does that include some terminal loading and transportation as well?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [11]

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No. That's at the mine gate, Marc.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [12]

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And then on the cost side for second quarter, you'll have all these facilities running at much higher utilizations. How much of a cost benefit do you get from that? I know you outlined kind of the restart costs, but just thinking about the fixed cost utilization benefit that you'll get, how many dollars a ton should we be thinking about that?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [13]

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You know, it's hard to quantify that, Marc. So I guess, I won't try to guess at this point. But we are seeing our costs come down, as you noted, with the higher utilization. We've got all 5 of our Wisconsin plants -- or mines I should say, and our 3 dry plants operating full scale. So between that and between the efforts that we made with our operations team to continue to take cost out of our business model, getting the full effect of hydraulic mining et cetera, things we've talked about in the past, there's no question we will continue to see our COGS come down as we move further into Q2 and Q3. But at this point, I guess, I won't guess at what that number is. But we're working very hard to continue to take costs out of the model, rest assured.

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Operator [14]

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Our next question is from [Ari Cole] with Cole Capital.

(Operator Instructions)

Our next question comes from Selman Akyol with Stifel.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [15]

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Just a couple of quick questions. So first of all, just so I can make sure I fully have it, you're running the one-time cost through the cost of goods sold line? Is that where that's being reflected at?

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Deborah Deibert, Emerge Energy Services LP - CFO of Emerge Energy Services GP LLC [16]

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Yes, that's correct.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [17]

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Okay. And then, as you think -- sort of, if I heard you correctly, so that's roughly $2. And then you said pricing's improved another $5 to $7. So sequentially we should be looking for an uplift in prices of $7 to $9 a ton going into the second quarter?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [18]

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Yes.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [19]

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Okay. And then, also, just in terms of the volumes. You had sort of approaching 50% uplift from Q4. In terms of just thinking about the second quarter, is there anything in terms of trajectory rate you can give us there? In terms of volume growth?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [20]

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We're going to continue and we're certainly on pace to move ahead with our volumes, Selman. And so you will see Q2 volume growth. It will level out some just because of the capacity that we use. Even in Q1 as we ramped up, we did some pretty creative things to get the plants going early and to get additional feed in place. So as we move ahead, and we look at 2017, I mean as we're tracking overall, we're going to be in a range of probably 5.7 million tons to 5.8 million tons is our expectation.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [21]

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I got you. And then if I heard you correctly, if you are successful in achieving your 2018 guidance there would be nothing -- I mean you have some covenants but you think you can work with your banks, you can get back to distributions? Did I hear that correctly as well?

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [22]

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Our relationship with the banks has been very positive as we demonstrated through the end of last year and the beginning of this year. And we expect that positive relationship to continue. And they've been willing to work with us on sensible asks. So there will be some more asks going forward including our ability to make additional CapEx investments for Phase 3 of the Osburn acquisition as well as an ask for distributions.

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Operator [23]

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And we have a follow-up question from Marc Bianchi with Cowen and Company.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [24]

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On the contracts. Is there any sort of floor pricing in there? And what does the term look like?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [25]

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Generally Marc, these are 3-year contracts. It's interesting to note that the customers have actually approached us. And they did that late last year, early this year, wanting secure source of supply. And I think that's very telling of what's happening in the market and the need for reliable source as things continue to tighten up going forward. There is no discussion, certainly nothing in writing as far as a pricing floor. But there certainly is a commitment as we said earlier on volume. We did hedge with one major, major customer who agreed to significantly higher prices than what we had in our plan. This was a way of hedging for the entire year of 2017. Everything else we've put in place has really been market driven, with the idea that our expectation is that with the demand in the market pricing will continue to move up during the year. And we want to take full advantage of that.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [26]

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Sure. Okay. And shifting over to Osburn. How much volume should we expect in the second and third quarter here just from -- I understand the end market's a little bit different currently, but maybe walk us through some of the near-term expectations there if you could?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [27]

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Well, there's some -- a number of advantages in the Osburn acquisition but one of them is market diversity. The Tooke family has done a wonderful job developing the industrial sands market there, in select foundry products, in construction products, in sport sands. They sell over 400,000 tons a year, some of that being damp sand. We want to grow those markets and build on that diversity. That will serve us well in the cyclical nature of the oil and gas market. And we're going to actually take a lot of the market entrants and the information that we're learning from the Osburn acquisition and transfer that to our Kosse plant, which has the capability to move into those markets as well. So that's a good thing. If you look at the frac sand then, it's a matter of what we can do by adding some staffing and going 24/7. We expect to do that within the next 2 to 3 weeks. And that will allow us to add about another 30,000 tons a month of frac sand. That's not a lot, but it does get us into a market at a very rich margin. And it begins to build a position that we can capitalize on as we add more tonnage capability at this site. And of course, we'll be focusing on the Eagle Ford, initially, with the capacity that we do have for the frac sand market, we'll be trucking directly to the wellhead and taking full advantage of those economics.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [28]

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Does the inclusion of Osburn initially have a negative impact to margins until you're able to really ramp up the frac sand sales or is that not necessarily the case just because everything else is still sort of at a low level?

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Deborah Deibert, Emerge Energy Services LP - CFO of Emerge Energy Services GP LLC [29]

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No. This was just a wonderful acquisition for us. It's been accretive on day 1. So even though there's a ramp up to future profits, it's already showing some addition to the bottom line.

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Operator [30]

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Our next question is from [Ari Cole] with Cole Capital.

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Unidentified Analyst, [31]

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Regarding your guidance for 2018, just trying to get some clarification. Do you have any contribution in volume or EBITDA from a SandMaxx effort going live in 2018? Or is that left out of the numbers for now?

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [32]

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Yes, SandMaxx is included in the forecast for 2018, but it's relatively small. We've looked at 2016 and 2017 as mostly trial years for the product. We have strong belief that it is going to be an important part of the next revolution in sand utilization at the wells. But we believe it will marginally contribute to the forecast in 2018, relatively small.

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [33]

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Let me just add to Ted's comments. We took a very conservative approach I think, certainly around SandMaxx. But I want to emphasize that doesn't mean that we're any less enthused about the technology or its potential. We are absolutely convinced this is game-changing technology. The technology does work and it works well. The question we don't know is what the adoption curve is going to look like. Just how quickly the industry and a number of our key customers who have looked at this product will continue now to embrace this technology and build their business around it. I think that will happen, but we just don't know when and we're hopeful it will happen sooner rather than later. But for our guidance purposes and our budgeting purposes, we took the more conservative approach.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [34]

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And just to kind of quantify what approximately the contribution will be in 2018, it will be in the 7% to 8% range, in terms of the guidance we offered.

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Unidentified Analyst, [35]

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Right 7% to 8% of the EBITDA number.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [36]

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Exactly.

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Unidentified Analyst, [37]

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All right. And then clarifying on Osburn. I just want to make sure we avoid double counting here, because I'm trying to clarify if once you move towards the 3 million capacity expansion per year, will you be selling exclusively frac sand or will you continue doing some of the industrial shipments? And what I'm just trying to understand is, if it's a mix of the 2 in the second half of 2018, what sort of volume would you expect for frac sand and what amount of volume you would expect for the sports sands?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [38]

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Ari, we will continue to sell now into both markets. So we will not be exclusively frac sand once the 3-million-ton plant is built. We want to continue to build on the industrial markets that the Osburn plant has done such a good job of developing. They have a wonderful reputation, they are a leader in the industry and these other diversified markets. We want to build on that. And we're going to focus resources and efforts to do that. But to answer your question further. Once the 3-million-ton plant is built by the middle of 2018, which is our expectation, we'll have that 3-million-ton plant sold out, of course that means 1.5 million tons in the second half of 2018. And then with Phases 1 and 2 as we described earlier, the short-term capacity enhancements, there should be around 700,000 tons further, of frac sand capability. So all in, you'll be selling on an annualized basis approximately 3.7 million tons of frac sand and there's 400,000 tons of non-frac market business right now. We can only estimate what we could do, but I would certainly expect during 2018 we can move that up to -- we're hoping 500,000 tons to 600,000 tons of the industrial markets, I'll call it.

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Unidentified Analyst, [39]

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All right. I apologize for being confused here, maybe math wasn't my best class in the school. But the run rate at the end of 2018 for the entire facility to Osburn, I think I'm understanding, is you'd be hoping to be shipping or have the capacity to ship 3.7 million tons all told, of which 3.1 million tons would be frac sand and 0.6 would be industrial or sport sand?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [40]

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Ari, that was on an annualized basis. So if you're trying to project 2018, you would take 50% of that number.

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Unidentified Analyst, [41]

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Right. But the annualized number for the facility steady-state once fully expanded is 3.1% and 0.6% for industrial?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [42]

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The run rate for frac sand would be starting the second half of 2018 at 3.7 million tons, this is annualized run rate for frac. And 500,000 tons of non-frac. Over and above the 3.7 million tons.

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Unidentified Analyst, [43]

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Got it. No, thank you. The (inaudible) was confusing. And just finally, in terms of financing expansion you alluded to the fact that you might have 1 or more customers may prepay or help out in some way on the Kosse expansion. What are your thoughts in terms of the most likely way you might be able to do the -- pay for the expansion here at Osburn as things progress?

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [44]

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Ari, it's funny when we first began our expansion in the early days into Wisconsin, we used a technique that we thought was a pretty interesting and fruitful one, which was we talked to our customers about their need for sand and we essentially financed that initial expansion based on prepaid sand from customer cash. And we have that opportunity once again with the Kosse expansion, to expand earlier than might be comfortable for our banks, using that same approach. So I would say that is probably the most likely way we would expand Kosse currently. But as the senior debt markets open up and the debt markets open up in general as we progress through 2017, we may shift to a straight bank financing of the expansion.

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Unidentified Analyst, [45]

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Okay. And I applaud these efforts, and just kind of a commentary. There are numerous other industries, such as semiconductors and elsewhere, where it's quite common for customers to prepay to help the manufacturer open up new facilities, it's a win-win for both. And I'd just point out in these other industries that the customers are willing to prepay, basically no interest anything charged and no special pricing or revenue on the product they end up receiving. They're paying full prices for the product once it's delivered, it's just the surety of supply and the more rapid increase in capacity, they're the benefits to getting with a prepayment. And they're happy with that.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [46]

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You're exactly right. And that's exactly the method we used in our early days of our expansion into Wisconsin. So we are very familiar with that territory and we're executing on it once again.

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Operator [47]

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Our next question is from Jason Wangler with Wunderlich.

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Jason A. Wangler, Wunderlich Securities Inc., Research Division - SVP and Equity Analyst [48]

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This maybe was discussed before. But just as we look at the pricing of the industrial sand versus the frac sand. How should we think about that as you kind of start modeling that being a decent portion of your business?

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Richard J. Shearer, Emerge Energy Services LP - CEO of Emerge Energy Services GP LLC, President of Emerge Energy Services GP LLC and Director of Emerge Energy Services GP LLC [49]

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Those markets do vary. As I mentioned earlier, Jason, we're looking at the foundry market, we're looking at sports sands, we're looking at construction sands. A lot of that is damp product, that needs to be emphasized because the costs are significantly less, $5, $6 less at least on the COGS side for the damp product. So it's very difficult to say exactly how that pricing measures out. But I can give you a snapshot. Deb, as you just said, this acquisition was immediately accretive and the numbers from the average selling price for the mix that we've seen initially show an overall -- this is for all the industrial products being sold in San Antonio. The average selling price is just under $20 a ton. That's just a short snapshot of what we've seen since we took over the business, subject to change of course based on product mix and so forth going forward.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [50]

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And just maybe to quantify how much we expect in terms of our 2018 guidance to come from these industrial sands. It's in the 2% to 3% range or less.

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Operator [51]

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And I'm showing no further questions. I would now like to turn the call back over to Ted Beneski for any further remarks.

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Theodore W. Beneski, Emerge Energy Services LP - Chairman of Emerge Energy Services GP LLC [52]

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Great. Thank you, operator. I just want to thank you all for participating on the call today. And in closing, I just wanted to say that we continue to be encouraged by the strong progress we have made at Superior Silica Sands and Emerge Energy. After coming out of the difficult downturn that lasted nearly 2 years, we are very optimistic about the positive direction in which Emerge is headed. Thank you all.

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Operator [53]

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Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone, have a great day.