Sprague Resources LP
Q2 2017 Earnings Call Transcript

Published: 9 Aug 2017

[Operator:]

Good day, ladies and gentlemen, and thank you for your patience. You've joined the Sprague Resources Q2 2017 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and our instructions will be given at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the conference over to your host, President and CEO of Sprague Resources, Mr. David Glendon. Sir, you may begin.

[David Glendon:]

Thank you, Lathif. Good afternoon, everyone, and welcome to Sprague Resources second quarter 2017 conference call. Joining me today are Gary Rinaldi, our Chief Operating Officer and Chief Financial Officer; John Moore, our Vice President and Chief Accounting Officer; and Paul Scoff, our Vice President and General Counsel. Some of today's call will include forward-looking statements. While Sprague believes these statements to be reasonable as of today's date, future results are subject to many risks and uncertainties that are difficult to predict and outside of management's control. Any forward-looking statements we make are qualified by the risk factors in our most recently filed SEC Form 10-K and future filings with the SEC. Sprague Resources LP undertakes no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. You can find a discussion of our use of non-GAAP measures as well as reconciliations between these measures and their most comparable GAAP figures in our earnings press release on Form 8-K with the SEC as well as additional disclosures and reconciliations in the Investor Relations section of our website. While demand for our products ebbed in the second quarter, our strategic growth efforts continued at a healthy click. During the first two quarters of 2017, we have closed four transactions that will propel meaningful growth in all three of our primary business segments and integration efforts are proceeding well. While these transactions position Sprague for growth, we're not content to slow the pace. Our pipeline remains healthy as we focus on opportunities to expand our geographic footprint and increase our ratable cash flow, further lessening the seasonal impact of weather on our performance. Moreover our strong balance sheet provides us with the financial flexibility to pursue attractive targets. Our results for the quarter appear muted in comparison to the prior-year Sprague's performance correlates well to the more normal second quarters of 2015 and 2014. While we expect our business to generate lower distribution coverage in the second and third quarters, these results have a minimal impact on our outlook, our growth strategy, and our long-term commitment to increase distributions to unit holders. Consistent with our previous guidance to increase distributions by $0.015 per unit per quarter until the end of 2019, our general partner recently declared a second quarter distribution of $0.6075 per unit or $2.43 on an annualized basis. This reflects an 11% increase over the distribution declared for the second quarter last year and reinforces the steady growth trajectory we expect to maintain. Before I turn the call over to Gary to review our results, there's a final point I'd like to make on a common misperception about Sprague, while change in commodity prices affect most energy sector participants, absolute price levels have only a limited impact on Sprague's financial results. We maintain a fully hedged and balance book and experience only modest working capital effects from change in price levels. I'll now turn the call over to Gary for a review of our quarterly results. Gary?

[Gary Rinaldi:]

Thank you, David, and good afternoon, everyone. I'm pleased to report Sprague financial and operational results for the second quarter of 2017. We continue to deliver on our previously issued guidance while maintaining strong 12-month coverage and increasing distributions at a double-digit annual rate. Sprague's adjusted gross margin in the second quarter was $40.7 million, a decrease of $8 million or 16% compared to last year. Natural Gas was the primary driver of the decline while the rest of our business segments combined were marginally down for the quarter. Sprague's adjusted EBITDA of $4.3 million declined $9.6 million versus last year are driven primarily by the decrease in adjusted gross margin. Incorporating the results of the second quarter, we expect full-year adjusted EBITDA to be at the lower end of the previously issued guidance of $115 million to $130 million. Sprague's operating expenses of $16.9 million increased $400,000 compared to the prior year. Expenses of $800,000 related to our recent acquisitions were partially offset by reductions in repairs and maintenance and Materials Handling related stockpile expenses. OpEx for 2017 is projected to be between $69 million and $74 million, in line with our previous issued guidance. SG&A expenses for the quarter increased $1.4 million to $19.6 million as expenses related to the Global acquisition, higher M&A activity related professional fees were partially offset by lower employee-related costs including incentive comp. We expect SG&A expenses for the year to be in the range of $90 million to $95 million. Cash interest of $5.7 million increased by $500,000 compared to the second quarter 2016 reflecting increases in acquisition debt and interest rates. Cash interest for the year is expected to range between $25 million and $29 million. Maintenance CapEx for the second quarter totaling $2.7 million increased by $600,000 compared to the prior year, the increase related to activity from the recently acquired terminals as well as planned IT upgrades supporting Sprague's scalable back office infrastructure. For 2017, maintenance CapEx is expected to be at the low end of our previously issued guidance of $14 million to $17 million and depending on the timing of certain projects may come in below this range. Distributable cash flow for the second quarter was negative $3 million, down $10.6 million from last year. The decrease was primarily driven by lower EBITDA as well as higher cash interest, cash taxes and maintenance CapEx. By targeting and maintaining a solid distribution coverage currently 1.3 times in a trailing 12-month basis, Sprague is able to absorb quarterly fluctuations in cash flow while continuing to increase distributions at a double-digit pace. Now let's focus on the business segment results in more detail. Our Refined Products business was flat quarter-over-quarter. Sales volumes for the quarter increased by 3%, which was offset by a 2% decline in adjusted unit margins, degree days were down for the quarter with April, the last month of any appreciable heating demand nearly 23% lower than the prior year. Despite a lower heat load, our total distillate sales increased by 5% supported by the recent acquisitions. Residual fuel sales increased by 9% as Kildair leveraged recent capital investments and improved supply economics to increase market share of marine fuel oil sales. Partially offsetting this was a 13% decline in gasoline volumes, driven by intense competition from refiners at high run rates led to an oversupplied market. In our Natural Gas business, volumes for the quarter were down 5% to 13.5 billion cubic feet, with three large volume low-margin customers accounting for the majority of the decline. As David and I have previously mentioned, this is a direct result of the continued execution on our long-term strategy of moving down market in natural gas. Over time, this shift has given substantial improvements in adjusted gross margin by transforming our customer mix from lower unit margin, higher volume accounts often with concentrated credit risk to a more diversified portfolio of smaller sized customers. Natural Gas adjusted gross margin for the second quarter was $2.6 million or $7.3 million lower than the prior year, extended maintenance on the Algonquin pipeline, increase supply cost to our customers and lower market volatility reduced supply optimization opportunities relative to last year. In addition, timing differences related to basis gains and losses and changes in the fair value discount of the forward book were magnified as we recorded positive changes in the second quarter last year versus negative adjustments in the current quarter this year. Please note that because of the reduced activity levels in the second quarter, the impact of these various drivers is more pronounced. As a reminder, our Natural Gas business should be viewed on a full-year basis to eliminate the quarter-to-quarter distortion that can occur during lower consumption periods. On a year-to-date basis, Natural Gas adjusted gross margin is slightly ahead of the prior year. In our Materials Handling business, adjusted gross margin of $12.8 million was $300,000 below the prior year, reduced windmill activity at Searsport and lower heavy fuel storage revenues at Kildair were the primary drivers of the decrease. These were largely offset by increased liquid bulk activity from asphalt supported by the expansion capital project at our River Road terminal completed in May as well as higher pet coke and salt activity during the quarter. Sprague continues to generate attractive multiples through the aggressive pursuit of organic growth initiatives. As I just mentioned at our River Road terminal, an asphalt storage project supported by a long-term contract came online in early May and began generating handling revenues. A similar project to convert distillate and heavy fuel oil storage to asphalt service at our Providence terminal will be completed later this month. And our recently acquired East Providence terminal, the conversion of excess distillate storage, the gasoline throughput used is expected to go live in October. These initiatives are examples of our asset optimization strategy, which captures incremental returns and more readable cash flow from existing assets , all backed by multi-year contracts. In 2017, we expect expansion CapEx to be at the upper end of our previously issued guidance of $19 million to $22 million. Sprague's prospect for the future and continued ability to outperform relevant indices are apparent and proven. With an active acquisition pipeline and committed expansion capital projects not to mention nearly $250 million of liquidity in our acquisition line, we're well positioned to deliver on our growth strategy. I'll now turn the call back to David to wrap up.

[David Glendon:]

Thanks, Gary. Before taking questions I'd like to share the results of our recent survey conducted among the Refined Products customer base. The feedback we received clearly demonstrates Sprague' ability to deliver an exceptional customer experience and capture unparalleled customer loyalty, over 70% of Sprague's customers rated our account managers in Sprague's real time online sales platform as superior to our competition. The number of brand promoters, who are most likely to recommend Sprague to others was an impressive 60%, well above the benchmark average of 37%. As part of our commitment to develop innovative products and services, we're rolling out an app to allow Sprague real time access for mobile devices. During periods of market volatility, the timing of order execution can have a dramatic impact on the final sales price. The added flexibility, the SRT mobile tool will allow our customers to quickly capitalize on market opportunities and better manage their business. I'd like to thank all members of the Sprague team for achieving these accomplishments through their ongoing commitment to exceed customer expectations during every interaction. This concludes our comments. At this point, I'd like to open the call for questions.

[Operator:]

Thank you, sir. [Operator Instructions] Our first question comes from Justin Jenkins of Raymond James, your question please.

[Justin Jenkins:]

Okay. Great. Good afternoon, Gary, David. Maybe just starting on the Refined Products segment decline in unit margins we saw here in 2Q. Gary, I think you covered it in your prepared remarks as to the reasons but maybe if we can get your views on trends to start 3Q here and your expectations going forward it seems like the recent inventory changes might be helpful? But I'd appreciate your perspective.

[David Glendon:]

Yeah, I think, Justin, you've heard others I think in recent calls talk to the oversupplied market I think that's the way that's been characterized in the Northeast and we've certainly seen that dynamic over the second quarter and maintaining into the third quarter. What you've got is a market curve that has a very modest contango effect which means that everybody is holding inventory but everybody is also pursuing every different discretionary sales opportunity that's available to them because the carriers and so compelling us to just hold inventory. So we have seen pressure at the margin line across the Refined Products business. And candidly, we do expect to see that continue through Q3. Again the forward curve is changing a little bit, but it's still in that kind of flat-to-modest carrier environment that encourages people to be pretty aggressive at the rack.

[Justin Jenkins:]

Right. That's helpful. Thank you, David. And then I maybe on the strategic sense here you mentioned a full pipeline of M&A opportunities, is that concentrated in any one of the segments or is it pretty broad based here or any color on the M&A outlook will be helpful.

[David Glendon:]

Yes, it's pretty broad based, Justin, and again we see compelling opportunities across all the business segments to be honest with you. While we're very pleased with the ones we've executed on already in 2017, we're not taking our foot off the gas pedal because we continue to see good opportunities again across all of the business areas. You are seeing competition for those depending on how well publicized they are and where they reside, but yet still to be brief we are seeing opportunities across all three segments.

[Justin Jenkins:]

Perfect.

[Gary Rinaldi:]

I'm sorry, Justin, we have plenty of liquidity as you know on our acquisition facility and our leverage is at the low end of the range still.

[Justin Jenkins:]

Perfect. I'll leave it there. Thanks.

[David Glendon:]

Thanks, Justin.

[Operator:]

Thank you. [Operator Instructions] The next question comes from the line of Lin Shen of HITE. Your line is open.

[Lin Shen:]

Hi. Good afternoon. Thanks for taking my question.

[David Glendon:]

Hi, Lin.

[Lin Shen:]

Hi. Also want to ask about the Refined Products, you mentioned that you see there competition on to gasoline or margin, do you think this could be any structure change so that the margin history we had it before probably going to change or you think it's going to short term?

[David Glendon:]

So let me just make sure I understand the questions. It's a follow on to Justin's question about margin structure.

[Lin Shen:]

Yeah.

[David Glendon:]

Yeah, again, I think what you'll see Lin is for to change you'd have to see one of two things to manifest themselves. So again we've characterized it as an oversupplied market. If you saw a change in the forward curve structure then the incentives for holding inventory in pursuing discretionary changes, our sales would shift slightly. So either you went into a higher carry or a backward dated market you will see the behavior of inventory holders change. But again in today's environment, we see that flat market. The other thing that would cause change obviously which would influence us is the demand pattern shift. We don't expect to see that in transportation fuels, but obviously if you've got cold weather you will see a demand uptick for heating fuels in particular, but until we see that I would say you're going to continue to see pressure at the rack on margins.

[Lin Shen:]

Great. And also - you also mentioned that you see the margin for your Natural Gas business also lower due to a less volatility. Can you also comment about that, is it also because of the curve?

[David Glendon:]

No. So that's that I would characterize much more as a temporary phenomenon. So what you see in this two things as Gary referenced, one was there was a maintenance on the Algonquin pipeline that just presented some short-term constraints on the system and just precluded the realization of certain opportunities, but the other is more I'll call it noise in the second quarter adjustments for the forward book which were exacerbated if you compare it relative to last year's second quarter. But again we strongly encourage everybody to look at the Natural Gas business on an annualized basis and we see the trend that you've observed over the last several years continuing to hold up there with solid and growing average margin realization across the entire book.

[Lin Shen:]

Great. Thank you very much. Appreciate it.

[David Glendon:]

You're welcome.

[Operator:]

Thank you. [Operator Instructions] And as I show no further questions, ladies and gentlemen this concludes today's conference. Thank you for your participation and have a wonderful day.