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Edited Transcript of SRLP earnings conference call or presentation 8-May-19 5:00pm GMT

Q1 2019 Sprague Resources LP Earnings Call

Portsmouth Jun 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Sprague Resources LP earnings conference call or presentation Wednesday, May 8, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David C. Glendon

Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC

* David C. Long

Sprague Resources LP - CFO of Sprague Resources GP LLC

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Conference Call Participants

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* Charles W. Barber

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Sprague Resources First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to introduce your host for today's conference, David Glendon, President and Chief Executive Officer. Sir, please begin.

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [2]

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Thank you, Norma. Good afternoon, everyone, and welcome to Sprague Resources First Quarter 2019 Conference Call. Joining me today are David Long, our Chief Financial Officer; Kory Arthur, our Vice President and Chief Accounting Officer; and Paul Scoff, our Vice President and General Counsel.

I'd like to remind listeners that some of today's call will include forward-looking statements. These statements are based on our current expectations, which we believe to be reasonable as of today's date, and Sprague does not undertake any obligation to update any forward-looking statements to reflect new information or future events. Actual results may differ significantly because of risks and uncertainties that are difficult to predict.

Please refer to our 10-K for a list of risk factors, which could cause our actual results to differ from anticipated results and review our 10-Q, current reports and other filings with the SEC. We also describe our business using certain non-GAAP financial measures. Reconciliations of these measures to comparable GAAP measures are available in our non-GAAP quarterly supplement and our earnings press release, both of which can be found in the Investor Relations section of our website.

In the first quarter of 2019, Sprague generated total adjusted gross margin of $95 million and adjusted EBITDA of $51 million. Materials Handling results were strong, particularly benefiting from the Kildair asphalt conversion and tank leases, while Refined Products and Natural Gas continued to contend with some of the challenges described on our previous earnings call. Specifically, a weak market structure in distillates and limited blending opportunities tempered our Refined Products results, while lower volatility in the Natural Gas markets created fewer optimization opportunities.

Looking forward, I'm encouraged that market conditions are showing signs of improvement in 2019. Notably, the distillate forward curve is now in contango for the back half of 2019, which is in marked contrast to the structure at this time last year. As listeners know, a contango or carry structure makes storage assets like Sprague's system more valuable. We're also seeing apparent bipartisan support for the reinstatement of the biodiesel blenders tax credit in 2019, which would provide significant opportunities for additional blending economics in our distillate business.

In the Natural Gas business, we expect lower pipeline maintenance programs in 2019, enabling our logistics activities to generate more optimization benefits if price volatility returns. Finally, while the convergence of sulfur specifications in Northeast heating oil markets limited our blending activities in 2018, we noted that this development would also facilitate the repurposing of tanks to alternative services and lower our working capital costs by eliminating the requirement to store multiple grades.

I'm pleased to report that we've already converted 2 of our major terminal facilities to a fungible distillate inventory position with heating oil only differentiated by the rack injection of dye. These developments provide confidence in maintaining our 2019 guidance figures and support our current distribution pace. In April 2019, the Board of our general partner declared a distribution of $0.6675 per unit for the first quarter of 2019, reflecting a 2% increase over the Q1 2018 distribution.

Now I'd like to turn the call over to Dave Long for a detailed review of our first quarter results. Dave?

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David C. Long, Sprague Resources LP - CFO of Sprague Resources GP LLC [3]

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Thank you, Dave. With regard to our quarterly results, Sprague's adjusted gross margin of $95 million for the quarter declined by $14 million or 13% compared to the first quarter of 2018, Refined Products and Natural Gas being the primary sources of the decrease as Materials Handling generated substantial gains relative to the first quarter of 2018. Refined Products' adjusted gross margin in the first quarter of 2018 included a $4 million biotax credit related to 2017 activity, which was offset below the adjusted gross margin line as a reduction to adjusted EBITDA.

Sprague's first quarter adjusted EBITDA of $50.9 million declined by $4.2 million or 8% as compared to the prior year. Operating expenses rose 2% or $580,000 in the first quarter relative to the same quarter a year ago, primarily due to increased insurance and utility expenses as well as higher boiler fuel costs in support of our asphalt handling activities.

SG&A expenses decreased by $7 million or 25%, primarily due to declines in incentive compensation accruals, sales commissions and acquisition-related expenses which were partially offset by $600,000 increase in severance expenses associated with the ongoing cost-reduction initiatives.

Net cash interest expense at $10.5 million in the first quarter increased by $2 million or 24% over the same period last year. This increase was largely the result of higher borrowing costs, which were partially offset by hedges on our floating rate debt.

Sprague recorded a benefit of $611,000 for cash taxes in the first quarter, reflecting a year-on-year quarterly reduction of $3 million, while maintenance CapEx in the quarter, which included various tank and pump upgrades and IT projects decreased by $796,000 or 35% to $1.5 million relative to the first quarter a year ago.

Given the decrease in adjusted EBITDA and the increase in interest expense, distributable cash flow for the first quarter declined year-on-year by 9% to $39 million, generating a distribution coverage ratio of 2.3x for the first quarter of 2019. At the end of the first quarter, Sprague's permanent leverage was 3.5x, down slightly from 3.6x at December 31, while our combined borrowing capacity under our working capital and acquisition lines was $278 million at quarter end. With regard to 2019 guidance, we continue to target full year adjusted EBITDA of $105 million to $125 million and intend to maintain distributions at current levels.

And now a discussion of our business segments. In Refined Products, sales volumes declined by 5% for the quarter relative to a year ago, while adjusted gross margin declined by $11.6 million or 21% to $44.7 million. These declines were primarily driven by the impacts of a well-supplied market, limited blending opportunities, fewer natural gas interruptions with Sprague's residual fuel customers and reduced marine bunker sales, partially offset by modest year-on-year quarterly increase in adjusted gross margin at our Coen business.

In Natural Gas, sales volumes for the quarter were down by 2% year-over-year, while adjusted gross margin declined by $5.6 million or 15% to $32.3 million. These results were impacted by lower adjusted unit gross margins, which were down by 13% due to increased competitive intensity and fewer logistics optimization opportunities given lower absolute prices and less market volatility.

In Materials Handling, the second quarter adjusted gross margin grew by $3.3 million or 25% to $16.5 million. Revenue growth at Kildair was the primary driver of the year-on-year quarterly growth led by increases in tank rental income from 2 customers as well as a full quarter of activity of an asphalt materials handling service agreement that began in March of 2018. The U.S.-based Materials Handling business experienced modest growth in the quarter, primarily due to higher liquid bulk activity.

At this point, I'd like 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 comes from Jeremy Tonet of JPMorgan.

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Charles W. Barber, JP Morgan Chase & Co, Research Division - Analyst [2]

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This is Charlie on for Jeremy. The first question, just wanted to touch back on -- I think we talked about it last call, but you were looking at maybe some potential asset sales. Just curious, any progression there, any kind of latest communication on that front.

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [3]

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Charlie, it's Dave Glendon. Yes, we continue to explore a couple of smaller asset sales, and those dialogues are ongoing. No agreements reached yet to report on, but the discussions continue with counterparties. And again, these would be converting current facilities to nonpetroleum usage -- alternative use of the real estate.

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Charles W. Barber, JP Morgan Chase & Co, Research Division - Analyst [4]

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Okay. Great. And then just on Refined Products, you talked about additional blending opportunities. When would we kind of be able to see that come to fruition? And can you give us a little more color on the distillate market? You're kind of seeing contango now. I mean how much that's really changed and kind of the expectations for the -- I guess, the latter part of the year. If you think that can sustain that structure?

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [5]

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Sure. So specifically, and I'll answer them in reverse order. On the distillate forward curve, when we were here last year at this time, so April, May last year of this time, the forward curve from June to Dec was flat to slightly backwardated. Right now, you've got a carry structure of -- ranging between $0.04 and $0.05 for that period, which is far more compelling than it was last year. Candidly, it's not at the level that would encourage you to start filling your tanks in anticipation of winter demand, but it would mean that your hedge roll activities would be far less painful than they were over the course of the back half of last year.

On blending opportunities, we've talked about the sulfur blending opportunities are largely gone with the convergence of sulfur specifications and Northeast heating oil marketplaces. And what I'd refer to as opportunity will really come in the form of biofuels which are highly dependent on the return of the blenders' tax credit, which, again, I think, all pundits have been calling for a return for quite some time now, but it seems that Congress is having a difficult time finding a bill to attach it to. But everything I see suggests a high degree of confidence in the ultimate return to that tax credit.

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Charles W. Barber, JP Morgan Chase & Co, Research Division - Analyst [6]

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You mentioned $0.04 to $0.05. Can you give us some context there maybe historically what you've seen in a normal healthy market?

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [7]

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Yes. I would say that's not -- that's a relatively normal structure, a carry of $0.01 a month or so, which again at least covers the working capital cost associated with that storage. When we've seen really attractive contango opportunities in past years, it's been more on the order of $0.02 per gallon per month, which would really stimulate a storage play or an investment grade of storage opportunities.

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Charles W. Barber, JP Morgan Chase & Co, Research Division - Analyst [8]

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Okay. Great. And then just one more on Natural Gas. So the pipeline maintenance has continued to be a headwind here. Was this -- can you give us more color on that maintenance? Was that unplanned from the third parties? And when is the -- when will this kind of finally subside?

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [9]

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So it was really a 2018 phenomena with the extensive pipeline maintenance. 2019 Q1 wasn't so much of pipeline maintenance issue as it was a lack of volatility in the natural gas market. So again, we've got a stable book to margin in our Natural Gas business. And then we often see optimization opportunities around that. They did not materialize in 2018, again, as a function of the long-haul pipeline restrictions. Those extensive pipeline maintenance programs are largely complete. So we do anticipate more normal set of opportunities as we go through the course of 2019.

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Operator [10]

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(Operator Instructions) And at this time, we have no other questions. I'd like to turn the call back over to Mr. David Glendon for closing remarks.

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [11]

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Thank you, Norma. Thanks, everyone, for joining us today. And we look forward to seeing many of you at the MEIC conference next week. Have a great day.

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Operator [12]

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Ladies and gentlemen, thank you for your participation in today's conference. You may disconnect. Everyone have a wonderful day.