Blueknight Energy Partners, L.P.
Q3 2018 Earnings Call Transcript

Published: 1 Nov 2018

[Operator:]

Good morning. My name is Chad and I will be your conference operator today. At this time I would like to welcome everyone to the Blueknight Energy Partners Earnings Conference Call for the Third Quarter ended September 30, 2018. All lines have been placed on mute to prevent any background noise. [Operator Instructions] I would now like to turn the call over to Mr. James Griffin, Blueknight's Chief Accounting Officer and Interim Chief Financial Officer. Please go ahead, sir.

[James Griffin:]

Thank you, and good afternoon. It is my pleasure to welcome you to today's conference call where we will discuss Blueknight's financial and operating results for the third quarter ended September 30, 2018. Mark Hurley, our CEO, will update you on our operational performance, projects and opportunities, as well as external factors influencing our business, after which I will provide a brief update on financial results for Blueknight. We will then take your questions after our prepared remarks. Before we begin, I would like to remind everyone that information on this call may contain certain forward-looking statements. Statements included in this call that are not historical facts, including without limitation, any statements about future financial and operating results, guidance, projected or forecasted financial results, objectives, project timing, expectations and intentions and other statements that are not historical facts are forward-looking statements. Such forward-looking statements are subject to various risks and uncertainties. These risks and uncertainties include, among other things, uncertainties related to the partnership's debt levels and restrictions in its credit facility, its exposure to the credit risk of the partnership's third-party customers, the partnership's future cash flows and operations, future market conditions, current and future governmental regulation, future taxation and other factors discussed in the partnership's filings with the Securities and Exchange Commission. If any of these risks or uncertainties materializes or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those expected. The partnership undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Blueknight Energy Partners is a publicly traded master limited partnership with operations in 27 states. We provide integrated terminaling, storage, gathering and transportation services for companies engaged in the production, distribution and marketing of crude oil, asphalt and other petroleum products. We manage our operations through four operating segments

[Mark Hurley:]

Thanks James, and thanks to everyone who dialed in today. As we discussed in our recent earnings release, it was an active third quarter for both the partnership and in the markets in which we operate. Early in the third quarter, we completed the sale of three of our asphalt terminals to the general partner Ergon, which we covered in detail in our last call. Since then our asphalt business has continued to perform well. We've also been very active on the crude oil side of our business, where we have seen improved market conditions both for transportation and storage. Covering asphalt first. The performance of the segment was in line with our expectations after adjusting for the divested terminals. As is typical, the third quarter was the peak earnings period for the year. Volumes in general were in line with budget. We did have two markets in which we experienced lower volumes. The first was the East Coast market, our business has slowed throughout the year due to very wet weather conditions. This region was also obviously impacted by hurricanes Florence and Michael. We did experience some wind damage at two of our sites, Wilmington, North Carolina and Bainbridge, Georgia. Both terminals are now back in operation, however with repairs planned for the forth and first quarter. Total cost of repairs for the two terminals is estimated at approximately $700,000. The other area of low volumes was the Colorado market. This market was impacted by lower spending on state funded projects. The state however has announced an increase in funding for 2019, so we expect volumes to improve next year. Overall, any unusual weather situation we expect another good year in asphalt in 2019. Switching to crude oil, we are encouraged by the trends we see in this part of our business. As we have reported in previous calls, the storage market has been challenging for us this year and weak market resulted in a decrease in operating margin of approximately $7 million year-to-date. As we indicated in our previous guidance, the third quarter is expected to be the low revenue point in the cycle. The weakness in the market was due to declining crude inventories particularly in Cushing, in addition to a backward dated structure in the forward crude price curve for future prices are lower than prop prices. The backward dated structure lasted for approximately 10 months but is now flit back to a contango market, where future prices are higher than prop prices. In addition, inventories Cushing has started to build as was forecast by several industry analyst. Inventories have increased the last six weeks at an average rate of 1.6 million barrels per week and now stands at approximately 32 million barrels or 46% of the historical maximum inventory at Cushing of approximately 70 million barrels. This changing market dynamic has increased demand for storage and as a result, we have new customer agreements for approximately 2.6 million barrels of storage becoming effective over the next two months. We have secured contracts for 4.4 million barrels of storage as of January 1, 2019. And an agreement in principle with another counterparty for an additional 665,000 barrels of storage that we expect to execute this month. These contracts taken together represent approximately 90% of our total storage capacity available for contracting. We continue to see strong demand and we now anticipate being fully contracted in 2019. Moving over to our pipeline business. Our second Oklahoma crude pipeline resumed service in July as planed and volumes are increasing steadily. There was some expected expense and working capital associated with the restart that is included in our third quarter results. We initially provided the necessary line fill to restart the line, which appears on our balance sheet and consumes working capital. Now that the line is up and flowing, the line go requirement will be shared among all shippers reducing Blueknight share going forward. Returning the line to service has had a significant impact on our crude because. Our total November pipeline volumes are expected to be 38,000 barrels per day more than double our volumes at the end of the second quarter. Our crude oil pipeline services segment was cash flow positive in September for the first time in over a year. Total Oklahoma crude production is now approximately 540,000 barrels per day and is increased 23% over the last year. It is expected to continue to climb. With the robust drilling activity in Oklahoma, we're optimistic about this segment in the fourth quarter and throughout 2019. Further on pipelines. The previously announced Cimarron Express Pipeline project is progressing well, on time and on budget. This will be a 16 inch diameter, 68 mile pipeline that transport crude from the stack region in Oklahoma to our Cushing terminal. The fundamentals are favorable for this project as analyst report casting SCOOP and STACK takeaway capacity to become constrained in 2019 and early 2020. We are constructing the project on behalf of a joint venture half owned by our general partner Ergon. We expect the pipeline to start up mid-2019 flowing 40,000 to 50,000 barrels per day of crude oil on the back of a two county acreage dedication from Alta Mesa resources. Once it is generating cash flow, the partnership plans to acquire it from Ergon in late 2019 or early 2020. The high level of drilling activity in Oklahoma has also led to an increased demand for crude trucking services and volumes have increased steadily this year. We're confident the increased demand for trucking services will lead to improved margins in the fourth quarter and in 2019. In fact the rate increase went into effect on October 1, so we expect our crude trucking services segment to return to positive cash flow during this period as well. In summary, we're very encouraged by the trends in our crude business segments. We think these three segments, storage, pipeline and trucking could add approximately $10 million of EBITDA to our business in 2019. Together with another solid year expected in our asphalt segment, we're optimistic we can achieve our goals of increasing EBITDA to the mid $60 million range, improved distribution coverage to over 1.0 and reduce the leverage ratio to approximately 4.0 by the end of 2019. With the improved financial conditions, we'll then be well positioned to acquire the new pipeline from our general partner with no additional equity fund raise. I will now turn it back over to James Griffin, our Chief Accounting Officer and Interim CFO. James?

[James Griffin:]

Thank you, Mark. Yesterday, we reported financial results for the third quarter ended September 30, 2018, net income of $2.4 million on total revenues of $133.2 million for the three months ended September 30, 2018, as compared to net income of $9.8 million on total revenues of $47.5 million for the same period in 2017. Operating income was $6.7 million for the three months ended September 30, 2018, as compared to operating income of $12.2 for the same period in 2017. Adjusted EBITDA $14.5 million for the three months and September 30, 2018 as compared to $21.6 for the same period in 2017. Distributable cash flow of $9 million for the three months ended September 30, 2018, as compared to $16.6 for the same period in 2017. We have provided a reconciliation of our non-GAPP measures in the non-GAAP financial measure section of earnings release. Keep in mind that net income, adjusted EBITDA and distributable cash flow for the three months ended September 30, 2018 were adversely impacted by the previously disclosed sale of three asphalt terminals to Ergon in July 2018. The distribution coverage ratio for the 3 months ended September 30, 2018 was 0.92 times. Additional information regarding partnerships results of operations will be provided in the partnership's quarterly report Form 10-Q for the three and nine month period ended September 30, 2018 to be filed later today with the Securities and Exchange Commission. I'll now go through the highlights for each segment. Starting with our asphalt terminaling services, operating margin excluding appreciation and amortization decrease by $2.9 million or 14% percent for the quarter ended September 30, 2018 as compared to the quarter ended September 30, 2017 and remain consistent for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. These results are positively impacted by the acquisition of two asphalt facilities in December 2017 and March 2018 respectively and were partially offset by the sale of three asphalt facilities to Ergon in July of 2018. Furthermore, the adoption of the revenue accounting standard ASC 606 resulted in a decrease of $1.6 million in throughput revenues during the quarter ended September 30, 2018 as compared to the quarter ended September 30, 2017 as certain contractually guaranteed minimum throughput revenue that in the prior year under the previous accounting standard had been recognized in the third quarter of the year as minimum throughput levels are exceeded and is now being recognized throughout the year on a straight line basis. Moving on to our crude oil terminaling services, our operating margin excluding depreciation and amortization decrease by $2.9 million for the quarter ended September 30, 2018 as compared to the quarter ended September 30, 2017 due primarily to the expiration of the 2.2 million barrel storage contract on April 30, 2018 and the expiration of the 0.7 million barrel contract on October 31, 2017. The expired contracts were not replaced during the third quarter of 2008. As of October 25, 2018, we had approximately 4.4 million barrels of crude oil storage under service contracts including a recently executed contract for 2 million barrels that commences November 1, 2018. As Mark stated, we have agreed in principle the terms for an additional 0.6 million barrels of storage that expect to execute soon with an expectation that the contract will commence in January of 2019. In our crude oil pipeline services segment, our operating margin excluding depreciation and amortization expense decreased by $0.1 million for the quarter ended September 30, 2018 as compared to the quarter ended September 30, 2017. Keep in mind that the third quarter of 2017 included a gain of 1.1 million from the sale of our interest in advantage pipeline. During the quarter ended September 30, 2018, we continued to increase the utilization of our Oklahoma pipeline system for our crude oil marketing services operations for the three and nine months ended September 30, 2018 approximately 56% and 34% respectively of the total volume transported on our Oklahoma pipeline system was comprised of barrels that we purchased from producers in the field and transported to our Cushing terminal to support our crude oil marketing operations. And as a percentage of barrels transported for our crude oil marketing operations increased, we increased our balance of the total line fill requirements of the pipeline system which resulted in the total volume of crude oil we purchase exceeding the volume of crude oil we sold during the quarter ended September 30, 2018. We reached our line fill requirements during the three months ended September 30, 2018 and we expect our operating margin in this segment to increase in the future period as a result In our crude oil trucking services segments, our operating margin excluding depreciation and amortization increased by $0.1 million when compared to the quarter ended September 30, 2018 versus the quarter ended September 30, 2017 as volumes increased approximately 45% due to the growth of our crude oil marketing operations. We continue to see volumes increase as we proceed further into the year and we expect results to continue to improve in this segment. Regarding liquidity and capital investments as of September 30, 2018, our consolidated total leverage ratio was 5.39

[Operator:]

Thank you. We'll now begin the question-and-answer session. [Operator Instructions] The first question will be from Josh Golden with JP Morgan. Please go ahead.

[Josh Golden:]

Hi. Good morning. Thanks for the call. Just couple quick questions. Can you give me current debt on the balance sheet, I don't think there was one or lease of the press release?

[Mark Hurley:]

Go ahead, James.

[James Griffin:]

Sure, Josh. So as a September 30th, our debt balance was building hedge $271.6 million.

[Josh Golden:]

And that's obviously, reflective of the proceeds from the terminal transaction?

[James Griffin:]

It is Josh. I will tell you that as we mentioned as we were growing the percentage of the total volume shift on our pipeline systems for our marketing efforts, we were building line fill during that timeframe and so there was an increase in working capital draw, as a result of that and as Mark indicated as we begin to have a larger percentage of third parties on the system we would expect that that lines will carry to decrease on our books.

[Josh Golden:]

Okay. Thank you. James also real quick you mentioned $5.4 million CapEx, nine months to to-date and expectation to 2018. Can you give us - you discuss during the prospect of mid sixty's EBITDA for 2019. Can you give me just a rough estimate of what you think maintenance CapEx maybe for 2019?

[James Griffin:]

Josh I'm not really looking at anything out of our usual run rate for 2019, so I suspected it's going to be consistent with what we experienced over the past couple of years at this point time.

[Josh Golden:]

Okay. Thanks, James. That's perfect. Next question is I just want to refresh Cimarron. What kind of multiple are you targeting on that, just even case volumes and pricing is good, look at the multiple either what's called between 20 timeframe?

[Mark Hurley:]

Yeah Josh. It is - it's got a payback period of about somewhere between 5 and 6 years.

[Josh Golden:]

Okay. What kind of multiple you had, I can figure that out. Okay. Thank you. And then my last question is sort of one of the partnership the structure. I think the assets are great assets, we're pretty happy, but Mark from the standpoint of Ergon, just quite - you know I think there's a concern in the marketplace given the corporate governance issues that come to along with the MLP sector. Is that the limited partners could end up losing ownership or the partnership, looks like everything is moving in the right direction linearity talked about the storage with the crude and the project is certainly excellent on project for the partnership. But perhaps you could give us a little bit of color on the commitment by Ergon to partners?

[Mark Hurley:]

Yeah, absolutely. It's been a very positive thing for us moving from the previous ownership to this ownership Ergon been very supportive in terms of obviously being our biggest customer one of two biggest customers. They have really stepped up and helped with growth with the Cimarron Express by plant project. So I see nothing but positives there and so Ergon I think I see investment being very long term, it's a big part of their portfolio. In terms of losing ownership, I don't understand, I guess I should say I think it's not a concern that the common units owners should have. It's not something that we have talked about Ergon sees it as a long term investment among these projects in these market - markets to be successful. They want the unit price to grow, they want to distributions to grow. And I think all those things should be very well aligned with the owners of both the common units and the preferred units. So I think that - I think the concern that they would lose ownership, this is on right now.

[Josh Golden:]

Mark I think thanks. I think it's excellent color and I think that will help a lot people who use and look forward to a bring future. Thank you.

[Mark Hurley:]

Well thank you, Josh. I appreciate your questions.

[Josh Golden:]

Thanks.

[Operator:]

Next question will be from Jeff Bailey with Beach Capital. Please go ahead.

[Jeff Bailey:]

Good morning, gentlemen. Thanks for answering the questions. And little bit of what the previous question just asked, I find it interesting that Blueknight management owns the considerable number of the common units as well as a few of the overall members of the board of directors, so it seems to me like their interest would be aligned and maintaining a partnership as healthy as possible, as just a comment, I would throw out.

[Mark Hurley:]

[Indiscernible].

[Jeff Bailey:]

Thank you. My questions mostly relate to the Cushing story, I know just a couple days ago, CBR the refiner announced that they were going to reverse the Red River pipeline and thereby curtail their purchases from Cushing. But they didn't announce how many barrels they were going to be stranded there Cushing by that reversal. Do you have any idea, how many barrels reinstate back in Cushing?

[Mark Hurley:]

I do not - I do not, is not one of the major pipelines leaving Cushing but I do not have not privy to that kind of data.

[Jeff Bailey:]

And then in previous call, you mentioned how you were going to change marketing strategy a little bit to target more of operators that Cushing as opposed to traders. Can you talk about what your go to market strategy is to attract that different clientele for Cushing storage?

[James Griffin:]

Absolutely. What we want to do for our justice is to get more diversity in the types of customers that we have Cushing and in as much diversity as possible in the in the contract duration. So that now is actually a good time to go execute that strategy when demand for storage is higher right, so it's something that we're paying a lot of attention to. And I would say in general, we want to attract customers who have more of an operational need for storage and so cost because we generate revenue in two ways of storage one is just by leasing space, leasing tanks. And the other is by generating service revenue and that's both throughput revenue and planning services that's what of it. Right now or over the last couple years, we have been light on services revenue. You seeing that, not as size will want to see it. And so as we're talking to customers for this remaining amount of storage that we have is not a whole lot of this point honestly. Those are the kind of customers that we want to attract. The other thing we want to do is keep our pipelines full because those pipelines flow into Cushing and every pipeline that flows in. I'm sorry every barrel the flows in, flows out and that generates revenue. And a great example of that is the STACK pipelines, that when that pipeline starts expected to flow about 40,000 barrels to 50,000 barrels a day. And that that volume is going to flow through our terminal regardless of whether it's a back or data market or can tank a market. And so we want to try to insulate ourselves, a little more from what's happening in the in the market going forward and so that's why that project is so attractive to us because not only on its own merits, a good cash generator at a reasonable cost but it brings more throughput revenue to Cushing and it opens the door for new customers there will be customers or potential customers flowing barrels on that pipe, that we don't do business with today. And so it allows us to expand the customer base. And so projects like that, we have to go after aggressively, and we have a couple of others that are more in the conceptual phase, so I can't talk about it right now. But it's those kinds of projects that we want to go after trying to diversify that cash flow. So Jeff, I hope answer your question if not I could have expand on it.

[Jeff Bailey:]

But just along those lines, do you operate did the operators did they pay us slightly dip lower rate for their storage as opposed to trade the marketers because the operators obviously more of a constant client?

[James Griffin:]

I mean not. Not markedly so. I mean the storage rates yet generally tend to be about the same and obviously you will do - will go negotiate different rates for different lengths of time. And in looking at the type of customer, we may take into consideration the amount of throughput revenue would be like customer site, it has some impact. But I wouldn't say it drastically changes the storage rates that we get.

[Jeff Bailey:]

Okay. Do you see the Colorado proposition $112 affecting Cushing at all, if it were to pass?

[Mark Hurley:]

I don't see any direct connection now. Not for us.

[Jeff Bailey:]

But on a lot of barrels coming from Colorado in the Cushing and that would have passed I've read that over 50% of drilling could potentially 50% of production could eventually go away within a year or 2?

[Mark Hurley:]

Well I mean the barrels are come in the Cushing come from West Texas, we get a lot of barrels from Canada, we get a lot of barrels from North Colorado, Wyoming. So Colorado makes up a portion of that but if you were to break down the percentage that's coming in from Colorado. I don't think it would be significant enough to drastically change the dynamics in Cushing. It's my view.

[Jeff Bailey:]

Okay. And then how wide the can contango to get your opinion before there is really more a rush for storage? We know it is crushed from backwardation but how wide it has to get a cover story in interest cost where the traders really get active?

[Mark Hurley:]

Well, we're already seeing a pickup in demand. And so we've had - we're dealing now with 6 or 7 potential customers, and so the pickup in demand has already been there because I think they're looking at the same forecast that we are. In fact, the contracts that we have already executed that as James mentioned, we executed before the markets went back to contango, so I think they're looking at. They're getting pretty bullish on storage, right now. And so it's just a good opportunity for us to be able to take this time to be able to diversify our customer mix but we see the demand being there. And no doubt, if today the spread is $0.10 to $0.15 a month, no doubt that if it goes to $0.50 a month you'll see that demand strength has been, the question about that.

[Jeff Bailey:]

Okay. Wonderful. And then do you have any models as far as basin. How the basin line how fast that ramp up and how many barrels projected to bring into Cushing?

[Mark Hurley:]

I do not - I do not. I would refer to the study done by Barclays. If you dig into the model there that's probably the best number that you can get.

[Jeff Bailey:]

Okay. Thanks for answering my question, Mark.

[Mark Hurley:]

Okay. Thanks, Jeff.

[Operator:]

The next question will be from Mike Gyure with Janney. Please go ahead.

[Mike Gyure:]

Yeah I appreciate the color, Mark on the asphalt side of the business. Can you maybe talk about or I guess the markets maybe did see strength? As opposed to the weakness and then I guess with the ones that you did see weakness do you think that, is really sort of moving stuff from the third quarter to the fourth quarter is that really like you said just pushing out till next year?

[Mark Hurley:]

I think - two various ways, we saw weakness as I mentioned, one was on the East Coast and one was on Colorado. And so I think there will be different situations as far as how those markets catch up. Construction on the East Coast construction did get behind this year and those of you who live on the East Coast now just very wet year and so we have several terminals right along the coast, where we've seen lower volumes and we expected. And I think if, the weather permitting, we could see some of that catch up or being done here very quickly. I think the situation in Colorado is just different because it was really a state funding issue, and so we are expecting and we've been told by people who are close to that market that we will see an uptick. But that uptick is probably going to be more in the calendar year 2019 and anytime sooner than that. And then inventory I'm sorry, demand and volume across the rest of our network has been pretty strong. And our network covers a lot of geography and so infrastructure spending in general has improved. We think if they do something at the federal level, it's just going to make the situation better and so we're pretty optimistic about 2019 across the entire network.

[Mike Gyure:]

Okay. Great. And then on the crude storage that you talked about being near 90% capacity or you're going to be 90% capacity by the beginning of the year? Can you talk about yes how long those contracts last and maybe what the pricing if it's better or worse than it was sort of this year?

[Mark Hurley:]

As far as a contractor ration I mentioned that we're trying to get more diversification in contract term life. And so as of January 1, with everything we have contracted and the one contractor expect to sign here imminently. We have a small contract that expires at the end of June of next year. And we feel with the market conditions we expect to see we feel confident we'll be able to 3 knew that one and again it's pretty small contract and then the rest of the contracts expire at different intervals all the way out to the end of 2021. And so we've got, we have diversification there, in the contract direction. We do not talk rates, Mike so I apologies for that because we're always constant negotiation. I will say that, if I look at the contracts that we get done and are in the midst of doing now. Typical kinds of rates if I look back over the last 5 years, so we're within kind of the normal band, we're coming out of a soft market. So we're not they're not going to be at the high end of the band but they are in kind of the historical norms that we see for this type of business.

[Mike Gyure:]

Okay. Great. And then maybe one last one on the Cimarron Express Pipeline project, you talked about being on time and on budget maybe just talk about I guess what's going on at this point in the project and kind of sort of what the next I would say benchmark is that you're looking for?

[Mark Hurley:]

Yeah. Absolutely. In the right in the midst of the right away acquisition and that's gone fairly well for us. I think we cross almost 200 different land and so it's quite a process to go through the right or right away acquisition with the various owners involved. But we are in the midst of that and I would say that will probably come to a close here at the end of the year. And then we have put out bids for construction and so we expect to get those bids back here in early November. And then we expect to go to construction I believe it's February with startup planned for the June, July kind of timeframe. We own the pipe we hold the pipe has been secured and we really will move into construction here in the next couple of months, and that's really kind of a last phase.

[Mike Gyure:]

Great. Thanks very much, Mark.

[Mark Hurley:]

Yeah. Thanks, Mike.

[Operator:]

[Operator Instructions] The next question will be from [indiscernible]. Please go ahead.

[Unidentified Analyst:]

Yeah, thanks my question's been asked and answered.

[Operator:]

[Operator Instructions] At this time, I'm showing no further questions. So this concludes our question-and-answer session. I'd like to turn it back to Mr. Hurley for any closing remarks.

[Mark Hurley:]

Well once again, thank you, operator, for dialing and I know the third quarter for us has been a lot of moving parts and I appreciate, you following the story and appreciate your attention to the company. I think that as we pointed out several weeks back and we're doing the things that we need to do, to get on the right path to increasing cash flow, reducing debt. And ultimately down the road increasing our distribution. And so we appreciate your time as always if you have any questions following this call, you're welcome to call. Thank you very much.

[Operator:]

Thank you, sir. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.