Sprague Resources LP
Q4 2017 Earnings Call Transcript

Published: 14 Mar 2018

[Operator:]

Good day, ladies and gentlemen and welcome to the Sprague Resources LP fourth quarter 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 instructions will follow at that time. [Operator Instructions]. I would now like to introduce your host for today's conference, Mr. David Glendon, President and CEO. Sir, you may begin.

[David Glendon:]

Thank you Amanda. Good afternoon everyone and welcome to Sprague Resources fourth 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. Before providing our prepared remarks, I would like to remind listeners that 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. As detailed in our fourth quarter non-GAAP financial measures supplement, which is posted to our website, adjusted EBITDA now excludes merger and acquisition related expenses. Before I turn the call over to Gary for a detailed review of our results, I would like to briefly comment on some key highlights of 2017, including our strong finish to the year. 2017 was notable for the success of our acquisition program with five closed transactions providing a solid platform for growth in 2018 and beyond. To recap last year's activity, the addition of L.E. Belcher expands our refined products presence in Western Massachusetts while the Global natural gas acquisition strengthens our position in New York City, New Jersey and other key markets. The Capital and Carbo acquisitions generate ratable throughput fees while expanding our prospects for transportation fuels marketing. And Coen expands our footprint into Western Pennsylvania, Ohio and West Virginia and adds energy field services to our business model while also contributing more ratable cash flow. Collectively, these transactions serve to further diversify our business model, expand our geographic footprint and reduce our weather sensitivity. As we have noted on previous calls, most of 2017 was challenged by warmer than normal weather and associated compressed margins. These dynamics shifted with the arrival of cold weather late in December and our businesses responded to produce an increase in adjusted EBITDA of 37% for the fourth quarter, which also benefited from the contribution of the 2017 acquisitions. Full-year adjusted EBITDA of $109 million was within the guidance range we signaled in November. The sustained cold that gripped the northeast during late December and early January represented the first test of our logistics prowess in three years and I am extremely proud of how our team responded. In refined products, we kept our customer supplied in all markets while many of our competitors struggled to replenish inventories. The frigid Arctic conditions following on the wake of the bomb cyclone also stressed the region's power grid, which turned to oil fire generation to meet nearly 30% of their total requirements during this period. Sprague's ability to meet this challenge by maintaining reliable uninterrupted supply at all terminals allowed us to capture a significant portion of this excess demand. Our dispatch and delivery teams worked around the clock to ensure that customer premises stayed warm and our performance was rewarded with new account growth. In natural gas, our supply and logistics teams navigated pipeline constraints and cash market volatility to meet customer needs while capturing upside opportunity inherent in those contracts. It's times like these that demonstrate the option value embedded in our business model and I couldn't be prouder of our team's ability to execute under these demanding conditions. I will now turn the call over to Gary for a more detailed review of our results. Gary?

[Gary Rinaldi:]

Thank you David. Good afternoon everyone. I am pleased to report Sprague's financial and operational results for 2017. As David mentioned, the fourth quarter highlighted the full potential of our expanded platform and we remain optimistic regarding Sprague's future performance and growth prospects. Integration efforts related to the acquisitions are on plan as we continue to leverage our existing infrastructure to realize additional efficiencies. Sprague's adjusted gross margin for the fourth quarter increased by $12.7 million, or 18% versus the prior year to $82.1 million. All three business segments outperformed for the quarter recording double-digit increases over last year. Full-year Sprague's adjusted gross margin of $262 million increased by 1%. Reflecting the increase in adjusted gross margin and the impact of the retroactive reinstatement of the biodiesel tax credit, adjusted EBITDA improved by $11.2 million for the quarter or 37% to $41.9 million. For the full-year, adjusted EBITDA declined by 1% to $109 million as higher operating expenses and SG&A cost related to the acquisitions offset the 1% increase in adjusted gross margin. This result was within the range we signaled during our third quarter earnings call. And for 2018, we expect adjusted EBITDA to be between $120 million and $140 million. Operating expenses in the fourth quarter increased by $4.9 million to $21.7 million driven by the 2017 acquisitions. For the year, OpEx of $72.3 million reflects an increase of 10% as reductions in stockpile expenses and materials handling were offset by operating cost of the recently acquired terminals. For 2018, OpEx is expected to be in the range of $86 million to $91 million. SG&A expenses for the quarter increased by 9% to $24.1 million. For the year, SG&A expenses of $87.6 million reflects a 4% increase as reductions in incentive comp were offset by expenses related to the five acquisitions, including M&A costs as well as increases in software licensing fees. For 2018, we expect SG&A expenses to total between $92 million and $97 million. Cash interest of $7.3 million for the quarter was $900,000 above the prior year while Cash interest for the year increased $1.3 million to $24.4 million. The increases are mainly attributable to the additional debt levels related to financing the acquisitions and associated expansion CapEx as well as higher interest rates on our floating-rate debt. This was partially offset by lower pricing on our acquisition facility. Cash interest for 2018 is expected to be in the range $28 million to $33 million. Maintenance CapEx increased by $1.6 million to $3.9 million for the quarter, while increasing $3 million to $12.4 million for the full year. Dredging and upgrades to docks, storage tanks and IT applications were the primary drivers of the increase. For 2018, maintenance CapEx is expected to be between $13 million to $16 million with a full year of activity related to the recent acquisitions. Expansion CapEx for the year was just below the high end of our guidance of $25 million to $27 million. During 2017, we executed on a number of accretive growth projects. At our River Road terminal, excess distillate and heavy oil storage was converted to support fee base asphalt handling. Similarly, at the newly acquired East Providence terminal, we converted distillate stores to support gasoline throughput. And we recently signed a long-term agreement to convert our asphalt marketing business at Kildair to a fee based throughput handling business reducing volatility and market risk. For 2018, we expect expansion CapEx to be between $8 million and $13 million as we return to more historic run rates. Driven by strong adjusted gross margin performance in all three of our primary business segments, distributable cash flow for the quarter increased 38% to $31.2 million and for the year,, distributable cash flow declined by 8% to $72.7 million. As mentioned on prior calls, full-year results were impacted primarily during the first two quarters by warm weather and compressed margins in an oversupplied market. Despite this, strong distributable cash flow in the fourth quarter generated coverage of two times improving our full-year distribution coverage to 1.2 times. For 2018, we expect distribution coverage to be in the range of 1.1 to 1.3 times. Now for a discussion of our business segments. In refined product, sales volumes were relatively flat with both fourth quarter and full year results reflecting an overall increase of 1%. The 2017 acquisitions drove the majority of the volume growth with distillates posting increases of 8% for the quarter and 4% for the year as cold embraced the Northeast at the end of the year. At Kildair, distillate volumes materially increased as strong gains continued from last year's conversion of excess heavy fuel oil capacity to distillate storage in support of our growing marine diesel business. Asphalt volumes and margins also improved at Kildair driven by higher levels of infrastructure spending in Quebec. These increases were partially offset by declines in gasoline and heavy fuel oil volumes in the U.S. The refined products adjusted gross margin for the fourth quarter improved by $8.6 million or 22% to $47.2 million. The Coen Energy, L.E. Belcher and Carbo acquisitions were the primary contributors to the increase in adjusted gross margin. In natural gas, sales volumes improved 2% for the quarter and were flat for the year as volumes related to the Global acquisition were partially offset by the loss of a few large volume low-margin accounts. Natural gas adjusted gross margin in the fourth quarter improved by $2 million or 11% to $20.7 million as the volume growth combined with a 9% increase in unit margins. For the year, natural gas adjusted gross margin rose by $2.6 million or 4% to $65.1 million. The Global acquisition was the primary driver of the adjusted gross margin improvements over the prior year. In materials handling, adjusted gross margin for the fourth quarter grew by $2.5 million or 25% to $12.4 million. Asphalt handling drove most of the improvement as the expansion CapEx projects at our River Road and Providence terminals generated solid returns. Additional salt and VGO activity also added to the fourth quarter increase. For the year, materials handling adjusted gross margin of $46.5 million improved by $800,000 or 2% as increased asphalt and salt handling was partially offset by reduced windmill activity. Sprague continues to yield benefits derived from maintaining a strong balance sheet and ample liquidity. Permanent leverage of 3.2 times remains near the midpoint of our long-term target of 2.5 to 3.5 times despite the five acquisitions and large expansion capital projects completed during 2017. As of year-end, Sprague had liquidity of nearly $380 million combined in the working capital and acquisition lines as well as access to an additional $470 million available through accordions in our credit facility providing the capacity and flexibility to finance near to medium term growth without the need for issuing equity. Now I will turn the call back to David. David?

[David Glendon:]

Thanks Gary. We look forward to building on our strong track record in 2018 as the recent acquisitions and more normal weather provide a solid platform for growth with the midpoint of our 2018 adjusted EBITDA guidance reflecting an increase of nearly 20% over last year's results. I believe that our unique combination of current yield, consistent strong growth and healthy coverage represents a compelling opportunity that will eventually be rewarded and I appreciate the continued support of our investor base. At this point, I would like to turn the call back to Amanda to open it up for questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Andrew Burd of JPMorgan. Your line is open.

[Andrew Burd:]

Hi. Good afternoon. A few questions. I guess first one will be more housekeeping related. First question is on the biofuel credit. Where exactly did that hit the P&L?

[Gary Rinaldi:]

Yes. Hi Andrew, it's Gary. The biofuel tax credit was recorded in December for the fourth quarter and it was adjustment to EBITDA below the line though it's obviously entirely related to refined products. You can make a case that you should add that back to the refined products gross margin. But it a below the line adjustment to EBITDA.

[Andrew Burd:]

No. It's perfect. It answers the question. And then for G&A, I appreciate you said, some new businesses and some software licenses expense are driving year-over-year increase. But it seems the last couple of years when you add back M&A related expenses, it was around the $85 million-ish number versus $86 million to $91 million in 2018. So just thinking about the step-up year-over-year and what's driving that after a couple of flattish years?

[Gary Rinaldi:]

Yes. Sure. So the midpoint of the SG&A range for 2018 is about on the high six, $6.9 million or $7 million. It's primarily driven by a full year of the five acquisitions which is impacting both selling and G&A costs. And in addition, there is an uplift related to incentive comp which is tied to a material increase in distributable cash flow for the year. It's primarily those two items.

[Andrew Burd:]

Okay. No. That's helpful and appreciate that you are more conservative than most and add back the share-based comp to DCF and not EBITDA. So understood there. And then final question, it's more king of big picture. I guess, first is, are you reiterating today the distribution growth guidance you talked about in the past through 4Q 2019? I guess that's the first question. I have a follow-up.

[Gary Rinaldi:]

Yes. We have been very consistent for a long time regarding guidance on our distribution growth. We have reiterated we intend to increase our distributions $0.015 per unit per quarter out through the end of 2019, which does not include any additional acquisitions. And so we are just reiterating what we have been saying for quite some time at this point. And it's driven by strong distribution coverage, okay.

[Andrew Burd:]

Yes. Understood. I didn't see it in the press release. I just wanted to make sure that that was as usual very consistent. And just a follow-up question on that point and appreciate that you are getting dragged down in the gutter with other MLPs and it has nothing to do with you, but there have been quite a few changes in MLPs more probably when it comes to IDRs and capital allocation with a lot of management teams choosing to retain more cash and simplify structures. Clearly, Sprague's strong execution doesn't necessitate that changing course. But what might cause you to maybe revisit that consistent distribution growth outlook through 4Q 2019? Or even the IDR structure? Is there anything that would change that course at this point?

[Gary Rinaldi:]

Yes. A fair question, Andrew. I think we believe in doing what we said we are going to do and being consistent along those lines. So while I am sure there are some things that could cause us to question that, there is nothing that I foresee that would cause us to rethink the guidance through 2019. And as for the IDR question, I know it is getting a lot of attention. Candidly, that's a Board level conversation at the appropriate time. We don't believe that we are at the point where it's a constraint on our ability to grow, which obviously has driven a lot of others to take steps there. But over time, it clearly becomes a significant portion of your total distribution and that's the appropriate time to consider changes to that structure.

[Andrew Burd:]

Great. Thanks very much for taking the questions.

[Gary Rinaldi:]

Sure thing, Andrew.

[Operator:]

[Operator Instructions]. Our next question is from the line of Mike Gyure of Janney. Your line is open.

[Mike Gyure:]

Yes. Could you guys talk maybe a little bit about what you are seeing as far as margins? And maybe refined products and natural gas here as we are moving through the first quarter obviously, weather is probably helping there. But maybe can you talk about, I know last year certainly margins were impacted by the oversupply. Maybe what's going on or your view of the oversupply or supply in the market today?

[David Glendon:]

Sure. So I would say a couple of things. One is a natural gas, we always encourage people look at it on an annual basis. So you do see some volatility quarter-to-quarter, which varies considerably. But we have said consistently, view it on an annual basis and you have seen a steady trend as we move down market to smaller customers, average unit margins trending upwards. And we don't see any fundamental reason to change that perspective. On refined products, boy, it differs all the time in every market, Mike, candidly. So yes, last year was oversupply conditions, lots of competition at the rack for the discretionary gallons and high inventory levels. That can change pretty quickly. So that persisted through almost all of 2017 as those of you in the Northeast recall, it got quite cold at the very last week or so and lasted a couple of weeks into January. And we did see some nice opportunities for margin expansion during that short period of time. So it's really a function of how much stress is in the system and how adept are we at managing our inventory levels in response to very changing demand profiles but it does vary pretty considerably. And candidly, February got very warm again. So everybody had inventory. So as fast as it comes, it can go as well.

[Mike Gyure:]

And then maybe on the acquisitions. Obviously a lot of the EBITDA growth year-over-year is from a full year of the acquisitions being added in. Can you talk about, I guess, where you are far as the integration maybe with Coen? I think it was the last one. And how that's shifting as we move into 2018 here?

[David Glendon:]

Yes. I would say, it's on track and you are correct that a lot of the growth in 2018 is from a full year of the acquisition effect. Although I would remind listeners that at least one of the acquisitions we made, the Capital Terminal, in particular, the full year EBITDA contribution was expected to be a couple of years out, just given the transition there. But Coen, in particular, is on track. We are on pace with our acquisition efforts. I think we have integrated a lot of the activities already. We have had a couple of people move out to Coen and we have rounded out the management team there and we are very pleased with the early-stage results from that acquisition.

[Mike Gyure:]

Okay. And then maybe lastly, the expansion capital guidance that you laid out, the $8 million to $13 million range. I guess, how does that spread across the different segments? Or is that just a little bit everywhere?

[Gary Rinaldi:]

Yes. Michael, the expansion CapEx is primarily related to the new acquisition, really East Providence, Coen and Carbo. So it's all refined products related and we are going to try to actually increase the growth projects, expansion projects during next year. So that's why there is a bit of a wide range on the guidance.

[Mike Gyure:]

Great. Thanks very much guys.

[David Glendon:]

Thank you Mike.

[Gary Rinaldi:]

You are welcome.

[Operator:]

Thank you. And at this time, there are no further questions. So ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now all disconnect. Everybody have a great day.

[David Glendon:]

Thank you.