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Edited Transcript of SRLP earnings conference call or presentation 7-Nov-19 6:00pm GMT

Q3 2019 Sprague Resources LP Earnings Call

Portsmouth Nov 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Sprague Resources LP earnings conference call or presentation Thursday, November 7, 2019 at 6:00:00pm 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 & Principal Accounting Officer of Sprague Resources GP LLC

* Paul A. Scoff

Sprague Resources LP - VP, General Counsel, Chief Compliance Officer & Secretary 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

* Justin Scott Jenkins

Raymond James & Associates, Inc., Research Division - Senior Research Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Sprague Resources LP Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, David Glendon, President and CEO. Please go ahead, sir.

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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, Sonya. Good afternoon, everyone, and welcome to Sprague Resources Third Quarter 2019 Conference Call. Joining me today are David Long, our Chief Financial 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-K, 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 third quarter of 2019, Sprague generated total adjusted gross margin of $52 million, representing a 12% increase over the last year's $46 million. Adjusted EBITDA of almost $14 million was 60% greater than 2019's comparable figure and strong cost discipline resulted in a nearly 1:1 ratio of gross margin to EBITDA increases.

Although the seasonal nature of our business generates lower results in the second and third quarters, we're encouraged by the trend of improving operating results versus 2018. In particular, we've seen our new customer acquisition efforts bear fruit in each of our 3 business segments. In Refined Products, we're gaining new delivered accounts by collaborating with our wholesale customers on transportation requirements, leveraging their existing assets to reap efficiency gains. In Natural Gas, our investment in technology is enabling greater productivity in our customer coding process. The additional speed and creativity in responding to customer requirements for pricing solutions has been accompanied by both account and volume growth. Our Materials Handling business has also seen new long-term contracts at our Bronx and Portland facilities, with capital investments in tankage conversions. Looking forward, we're seeing the effects of IMO 2020 and expected uptick in distillate demand reflected in a much tighter forward curve. As I've noted in the past, Sprague can benefit from either healthy contango structure where our storage generates incremental value or real backwardation when our logistics expertise proves invaluable in high-demand periods. We also continue to follow congressional action regarding the reinstatement of the biodiesel blenders tax credit. In Natural Gas, continued challenges in permitting new infrastructure are expected to maintain volatility in northeast gas markets, even as commodity prices stay low.

Finally, the Board of our general partner declared a distribution of $0.6675 per unit for the third quarter of 2019, which is flat to the previous quarter. Notably, the owner of Sprague's general partner agreed to waive its incentive distribution rights for the quarter as we continue to build higher coverage on the common units.

I'd hope this dispels any concerns about potential description cuts and reinforces our sponsor's support for the business' long-term health. While we acknowledge the broader governance concerns in the MLP space, we believe we have a compelling story on the alignment of the GP, LP and management interests that distinguishes Sprague in the market.

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

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

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Thank you, Dave, and good afternoon, everyone. Sprague's quarterly adjusted gross margin increased by 12% or $5.7 million to $551.7 million as compared to the third quarter of 2018. The increase in our quarterly result was attributable to strength in our Refined Products and Natural Gas businesses, which were partially offset by a decrease in our Materials Handling business.

Sprague's third quarter adjusted EBITDA of $13.9 million increased by $5.3 million or 62% as compared to the prior year. Operating expenses decreased by 3% or $586,000 in the third quarter, primarily due to lower stockpiling and boiler fuel expenses associated with our Materials Handling.

SG&A expenses increased by $647,000 or 4%, primarily due to modest increases in projected forward year incentive compensation accruals, which were partially offset by realized cost reduction initiatives that were completed in early 2019.

Below the EBITDA line, third quarter cash interest of $8.5 million increased by $879,000 or 12% over the prior year, which was primarily due to higher borrowing rates. Sprague recorded $2.3 million for cash taxes in the third quarter, reflecting a year-on-year quarterly increase of $1.4 million, while quarterly maintenance CapEx increased by $957,000 or 37% to $3.5 million.

Maintenance CapEx was higher principally due to the timing of several IT and terminal-related projects. Given the increase in adjusted EBITDA, Sprague's distributable cash flow for the third quarter improved by $2.8 million year-on-year to negative $340,000, generating a quarterly distribution coverage ratio of 0x. At the end of the third quarter, Sprague's permanent leverage was 3.3x, down from 3.6x at December 31. While our borrowing capacity under our working capital and acquisition lines was $270 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 to limited partners at current levels. As Dave mentioned, the general partner has agreed to waive its incentive distribution rights for the quarter.

And now for a discussion of our business segments. In Refined Products, sales volume increased by 6% for the quarter, primarily in distillates, while adjusted gross margin increased by $6.8 million or 25% to $33.4 million, primarily due to higher margins at Kildair given strong blending economics.

In Natural Gas, sales volumes for the quarter increased by 14% year-over-year while adjusted gross margin increased by $674,000 or 22% to $3.7 million. The volume increases were primarily result of new customers, while unit margins improved due to stronger valuation of forward positions given more favorable natural gas market conditions.

In Materials Handling, the third quarter adjusted gross margin was $13.1 million, $1.6 million lower than the same period a year ago. More than half of this decrease occurred in our U.S.-based operations resulted from lower bulk deliveries due to timing differences as well as tariff-driven reductions in pulp and paper handling activities. The Materials Handling adjusted gross margin at Kildair also declined primarily due to the expiration of a crude handling contract at the end of May, which was partially offset by incremental gains from 2 throughput customers.

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. I first wanted to ask on Refined Products. Nice quarter here. Can you talk about the quarter specifically on the higher marine fuel margins? And -- but then secondly, the outlook you have here, just looking at kind of where distillates inventory sits for Pad 1 seems pretty low here. Just trying to think about what opportunities that could present for you especially should we see winter actually show up the next couple of quarters?

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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. Thanks for the questions. In terms of Q3, and as we noted at Kildair, they saw some nice blending opportunities given our participation in both heavy fuel oil and marine gas oil. The IMO 2020 dynamics are starting to cause some real kind of dislocations, not too dramatic yet, but there have been some dislocations, which we've been able to capitalize on. And turning to the forward outlook, you're absolutely right, Pad 1 distillate stocks are at an all-time low as we enter the winter demand period and you couple that with the increased call on distillates that's emerging from IMO 2020, and we do expect to see tight conditions on distillate stocks in the fourth quarter and beyond. So that tends to present some opportunities for us as we think our logistics experience really has value under those conditions. So we look forward to capitalizing on those.

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

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Okay, great. And then on Natural Gas. How much of the year-over-year performance was the customer account growth versus improved market conditions? I'm assuming that they weren't kind of 50-50. And can you give a little bit more color on the market conditions, and how you benefited from them?

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

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Yes. So I don't have this -- I can't give you the exact breakdown whether it's 50-50 or something other than that. We did see a little bit more volatility in the cash markets in the quarter, not dramatic, but we didn't see some. But one thing I would note is, as I noted on the call or in my prepared remarks, we've invested significantly in technology and particularly our new pricing tool in our Natural Gas business that took -- that we invested in over the last couple years. We went live with it in the second quarter of this year, and we're just seeing a real uptick in our ability to quote multiple different terms, products, et cetera, to a wider swath of customers. And so we have seen a pretty healthy pickup in new account growth, which, to your point, won't -- materializes over the next year to 2 years. It's not an immediate pickup as customers are typically contacting for period that starts a couple of months from when we sign them up. So we're pretty excited about the prospect of continuing to see organic growth in our Natural Gas marketing business.

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

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Great. And then just last one for me on the recent IDR waiver. I believe it was a quarter-to-quarter. Just given the seasonality of the business, when it probably makes sense to have that at least through, I guess, next quarter, first quarter of '20? And then also the excess cash that frees up. Is that being directed towards that reduction?

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

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So I'm pleased, Charlie, for the first time to turn the call over to Paul Scoff, our General Counsel, to answer that question.

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Paul A. Scoff, Sprague Resources LP - VP, General Counsel, Chief Compliance Officer & Secretary of Sprague Resources GP LLC [8]

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Thanks, Charlie. The determination on the IDR waiver is going to be on a quarterly basis. I think our sponsor wants to take the opportunity to see how things are progressing and make that determination each quarter as we move forward. And it's available for them to do so.

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Charles W Barber, JP Morgan Chase & Co, Research Division - Analyst [9]

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Okay.

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [10]

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And I'd just add to that, Charlie. I mean generally, obviously, you know this that the coverage ratio is more challenged in the second and third quarters. But again, we believe we have a very supportive sponsor, who's going to look at it on a quarterly basis and make that determination. I think you've seen the 8-K, I'm sure, which specifies the conditions under which those could ultimately be repaid.

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Operator [11]

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And our next question comes from Justin Jenkins with Raymond James. And, Justin, if your phone is on mute, please unmute.

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Justin Scott Jenkins, Raymond James & Associates, Inc., Research Division - Senior Research Associate [12]

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Sorry about that, everyone. I guess maybe just following up on the last question there on the IDR waivers. Any thought process in terms of looking to make that a permanent situation? And then maybe a little more color on the process of how the GP can recover the waived IDRs from this quarter?

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [13]

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Yes. So, Justin, I think -- look, we certainly understand the message that the industry has heard on IDR eliminations and expect that at some -- at an appropriate time, we engage in a transaction along those lines. But candidly, the math given the yields right now on our common units is hard to make it work at the current time. So I think you won't see us doing anything in the immediate term there unless we saw better dynamics in the LP units that would permit that. So again, I think we've always said, we'd address it when it became an issue and do so in constructive terms. I don't know if that answered your second question on -- was there a specific question, Justin, about the potential to repay them?

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Justin Scott Jenkins, Raymond James & Associates, Inc., Research Division - Senior Research Associate [14]

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No, I guess more specifically on the waiver from the 3Q distribution here. Does the general partner have the ability or chance to recover that payment that's been waived? Or is that a permanent waiver there for 3Q?

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David C. Glendon, Sprague Resources LP - President, CEO & Director of Sprague Resources GP LLC [15]

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Okay. So they do have the opportunity to recover under conditions under which on a look back basis, giving effect for the repayment that our coverage -- our distribution coverage would be north of 1.1x.

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Justin Scott Jenkins, Raymond James & Associates, Inc., Research Division - Senior Research Associate [16]

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Got it. Okay. That's helpful. And then second question for me is on the EBITDA guidance. I know that the seasonality and weather play a huge role here in final outcome, but any thoughts in terms of trying to narrow up the range of outcomes here. We've got a $20 million spread in the guidance...

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David C. Long, Sprague Resources LP - CFO & Principal Accounting Officer of Sprague Resources GP LLC [17]

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No. Fair question, Justin. I think it's 2 factors. One is the fourth quarter and first quarter are, obviously, the far bigger drivers of our performance, and we did see some wide ranges historically in what can be achieved in those quarters. But secondly, the very practical reality of the uncertainty on the biodiesel tax credit means that the guidance band has to be understandably wide at this point time.

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Operator [18]

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Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. Thank you for participating. This concludes today's conference call, and you may now disconnect.