Sprague Resources LP
Q1 2016 Earnings Call Transcript

Published: 6 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Sprague Resources' First Quarter 2016 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] As a reminder, this conference call may be recorded. I would now like to turn the conference call over to David Glendon, President and CEO. Please go ahead, sir.

[David C. Glendon:]

Thank you, Abigail. Good afternoon, everyone, and welcome to Sprague Resources' first quarter 2016 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. Following my introductory remarks, Gary will review our financial results. We'll then open the call to questions. But first, as a reminder, 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. I would also remind listeners that we adjust our GAAP results to the unrealized portion of our derivative hedges and report adjusted EBITDA and adjusted gross margin. You can find a discussion of our use of these non-GAAP measures as well as reconciliations between these non-GAAP measures and their most comparable GAAP figures in our press release in the Investor Relations section of Sprague's Web-site. Last year I started this call by admitting I had feared 2014's first quarter performance set an unrealistically high bar, yet was pleased to report that the first quarter of 2015 actually exceeded it. I suppose that three years in a row was a bit too much to hope for. Just as markets tend to revert to a mean value over time, it can't always be colder than normal in the Northeast. We received just such a reversal of fortunes in this past winter with the record warm temperatures. While most residents of the Northeast were likely pleased by this development, marketers of heating fuels and ski resort operators felt the pain. Though the lack of degree days certainly impacted our results for the quarter, weather variability is and has been an ongoing factor in our business to be managed, and I remain confident that we are well-positioned to both deliver on the guidance we have previously issued and to execute on strategic growth opportunities against this backdrop. The winter's absence affected our business in predictable ways. We saw reduced sales volumes to customers who use our fuels for heating purposes, lower demand from interruptible Northeast power generators and dual-fuel accounts, and reduced throughput of salt volumes in our Materials Handling business. The weak demand and ease of waterborne resupply logistics meant the multiple suppliers were competing for the limited discretionary gallons in every harbor where we operate terminals and supply customers. Warm weather also virtually eliminated our customers' need for incremental gas supplies above their contracted levels and reduced the opportunity for both Refined Products and Natural Gas supply teams to utilize their logistics expertise in optimizing our assets. Recall that temperatures in our operating footprint during the first quarter of 2015 as measured by heating degree days were roughly 19% colder than normal, and Sprague produced outstanding results during those critical demand periods. This year we saw the opposite. First quarter Northeast temperatures were approximately 25% warmer than last year and 12% warmer than the 30-year average. In our first two winter seasons as a public company, we benefited from colder than normal weather and the favorable supply/demand conditions that come with them. This winter has now provided a benchmark for business performance in some of the least supportive weather conditions possible. The difference between the two quarters is at $18 million in adjusted EBITDA. While it's tempting to try and derive a direct translation from degree days to adjusted EBITDA, I'd caution listeners from relying exclusively on this math, given the role of other drivers in our operating results. Still, recent winters do serve to establish some boundaries for good versus bad winters. I'd remind listeners that weather calculations are inherently backward looking and do not necessarily imply headwinds in future quarters. Over the 146 years we've been in business, all kinds of weather conditions have come and gone. We are prepared for both cold and warm outcomes and our business is sized and structured to manage these conditions when they occur, as you'll see when Gary discusses our Q1 costs. Today, we are reconfirming our 2016 full-year adjusted EBITDA guidance range between $105 million and $120 million, as we took into account the January and February weather when we provided guidance on our March call. As you know, we maintain a higher than average target coverage ratio to reflect this inherent variability. As you'll hear from Gary later, Sprague's coverage remains high, our leverage low, and we're able to tap into ample acquisition facility liquidity to capitalize on compelling growth opportunities without the need to access currently pricey equity and debt markets. Turning to specific growth prospects, in Natural Gas, our teams are integrating the assets of Santa Buckley Energy's natural gas business which we purchased in February of this year. This acquisition strengthened our market position in the Connecticut and Massachusetts gas markets and brought with it an opportunity to further enhance our product offerings across the entire footprint. We expect to complete the integration of this purchase by the end of the second quarter and have already realized a lower effective multiple for the transaction by displacing Santa's previous dependence on outsource supply and logistics. I'd also note that we discussed on previous calls our belief that many of the projects to bring additional natural gas capacity to constrain Northeast markets were likely to be delayed or canceled. We've seen recent announcements on several of these projects confirm that view, ensuring that Sprague's expertise in serving capacity-constrained markets will continue to demonstrate considerable value. In Refined Products, strong progress is also being made at the Kildair terminal as our team works towards an expected second quarter completion of the distillate tank conversion project. And on the Materials Handling front, we continue to make progress on a dock upgrade at River Road and look forward to offering our customers improved services there. In addition, our teams have seen increased interest by multiple counterparties to use our terminals for staging and export services out of Maine as well as nascent indications that the passage of a multiyear federal highway bill last year may be volume positive for several of our asphalt customers. Finally, we continue to pursue compelling growth opportunities in each of our business segments at a time when many are reducing capital spending and do not have the balance sheet flexibility to pursue acquisitions. While each of our acquisitions take time to mature and their completion schedule is often driven by the seller's own timetable, we still believe Sprague will average one or two meaningful and accretive transactions a year. In closing, I remain optimistic for Sprague's continued expansion. We have generated above-average distribution growth, a cushion of high coverage, a strong balance sheet with declining leverage from already modest levels, and completed strategic acquisitions without the need to access public capital markets. I am confident we have the cultural values, employees and commitment to customer success necessary to continue that performance in the years ahead. There has always been value in Sprague's ability to fuel the growth of commercial and industrial businesses across our footprint, and it will continue. Gary?

[Gary A. Rinaldi:]

Thank you, David, and good afternoon everyone. Sprague's first quarter financial results were lower compared to last year, primarily due to the absence of normal winter temperatures during the quarter. According to NOAA's Climate Prediction Center, heating degree days in the Northeast during the first quarter of 2016 were 12% warmer than their historical norm. As David mentioned, the first quarter 2015 saw temperatures 19% colder than normal, creating a year-over-year difference that explains the significant amount of the decline in our relative financial performance this quarter. Sprague's total adjusted gross margin for the first quarter was $86.5 million, a decline of $27.8 million from last year's record, as weaker Refined Products and Natural Gas performance outweighed stronger Material Handling results. First quarter adjusted EBITDA declined $18.1 million to $45.4 million as material reductions and operating expenses and SG&A costs offset a portion of the adjusted gross margin decline. Sprague's core strength that we outlined in March continues to be true today despite the first quarter weather-driven decline. Our distributions are increasing by double-digit percentages annually, coverage remains well below our long-term target, our balance sheet is strong and growing stronger as we naturally delever with excess operating cash flows, and we continue to show an ability to find meaningful acquisitions outside of the public auction process. Sprague's operating expenses decreased $2.1 million to $16.8 million during the first quarter. Lower employee related costs associated with benefits and overtime in addition to lower boiler fuel expenses were responsible for the majority of the decrease. We expect our full-year 2016 operating expenses to total between $65 million and $70 million, assuming no new terminal acquisitions are made. Sprague's SG&A cost decreased $8.3 million in the first quarter compared to a year ago as the quarter's lower earnings resulted in decreased incentive compensation expenses which are tied to our business performance each quarter and included in our reported SG&A expense line. In addition, changes to Sprague's incentive compensation plan, lower M&A related expenses, and professional fees associated with our three 2014 fourth quarter acquisitions also contributed to the quarter-over-quarter decline. We are forecasting total 2016 SG&A expenses to be between $85 million and $90 million, partially driven by personnel and M&A expense synergies from our recent acquisitions. Sprague generated $37.8 million of distributable cash flow in the first quarter compared to $58.6 million in the first quarter of 2015. Our coverage remained strong at 3.3x despite the impact of the warm winter. Assuming Board approval of our distribution growth guidance, acknowledging that seasonality is expected to result in coverage ratios lower than 1x in the second and third quarters, Sprague's first quarter distributable cash flow by itself represents almost 80% coverage for the full year. On a trailing 12-month basis, distribution coverage is 1.6x. Sprague's cash interest expense declined 10% compared to a year ago, driven by the additional paydown of our acquisition debt with excess cash flow and lower working capital requirements as a result of lower commodity prices and volumes. These benefits were partially offset by slightly higher interest rates, impacting both the working capital and acquisition facilities. Maintenance CapEx also declined marginally versus the first quarter of 2015. Turning to our balance sheet, Sprague's financial position remained strong and my comments from March are worth repeating. We are not dependent on the capital markets to achieve meaningful distributable cash flow growth. We have demonstrated our ability to fund organic growth projects many times over and our permanent leverage is at the fore of our long-term target range of 2.5x to 3.5x. While components of our business certainly are weather sensitive, as we saw in the first quarter, Sprague has nonetheless delivered two consecutive years of double-digit distribution growth while maintaining high coverage. Far from sacrificing distribution growth for balance sheet health, Sprague is actually delivering both to its unitholders. Sprague's available working capital liquidity was $119 million as of March 31, and our acquisition facility had $286 million of liquidity at the end of the first quarter, yielding a permanent leverage ratio of 2.5x adjusted EBITDA on a trailing 12-month basis. You'll recall that Sprague paid down $56.8 million of acquisition debt between December 2014 and the end of 2015, and paid down an additional $36.5 million in February of this year. An incremental $150 million of acquisition debt capacity was made available through our acquisition facility upsizing in March. In addition, subject to certain conditions, Sprague has access to $400 million in accordions, $200 million each for the working capital facility and acquisition line, if needed, to provide even more liquidity for growth opportunities. Also, I want to remind listeners that we manage the business with a focus on Sprague's permanent leverage ratio due to the fact that our working capital needs fluctuate with our seasonal inventory. Sprague's credit facility is also governed by leverage metrics based on permanent debt, recognizing that our working capital borrowings are backed by physical inventory and accounts receivable with a typically short cash conversion cycle. While this permanent debt only approach may not be shared by all those evaluating Sprague's financial position, I would encourage those calculating our leverage and EV-to-EBITDA ratios to consider the impact our seasonal inventory patterns may have on the calculated ratios depending on the time of the year. Now turning to our business segments, in our Refined business, first quarter sales volumes declined 34% to 477 million gallons compared to the first quarter of 2015. Adjusted gross margin declined $24.7 million to $41.6 million for the quarter. Warmer than normal temperatures this year in contrast to colder than normal temperatures last year were responsible for the large variance quarter-over-quarter, particularly in distillate and heavy fuel oil where majority of the fuel is delivered to meet heating demand. Sales to regional power suppliers were also lower given the lack of need for their generating capacity and significantly fewer natural gas interruptions kept many of our dual-fuel customers out of the distillate market this year compared to last. Ample supplies of inventory and the relative ease of resupply due to the absence of winter storms created a more competitive price environment and lowered adjusted unit margins. Gasoline volumes and margins were also lower quarter over quarter as strong gasoline refining margins incentivized refiners to push higher volumes through wholesale supply channel. A more favorable market structure for carrying inventory did provide a partial offset to lower volumes and margins. Finally, I'm pleased to report that Sprague's project to bring two additional tanks into distillate service at Kildair is proceeding on schedule and we expect completion late in the second quarter. In Natural Gas, adjusted gross margin for the first quarter decreased $3.7 million to $31.1 million as the lack of heating degree days eliminated the need to provide our customers with incremental swing volume above their contracted volumes and did not present an opportunity for us to utilize our supply and logistics capabilities. This incremental volume absence and its associated margin was the primary driver for the quarter over quarter decline. Natural Gas volume and adjusted gross margin declines were partially offset by two months of earnings generated by our acquisition of Santa Buckley's natural gas contracts in February. As David mentioned, we are now focused on integrating new customers from this winter's Santa acquisition into our back office systems and utility pools, enabling Sprague to capture savings from our own supply and logistics capabilities and lowering the effective multiple paid for those contracts. Finally, Materials Handling adjusted gross margin increased $1.2 million or 12% to $11.4 million in the first quarter. In addition to revenues attributable to our new scrap metal handling service in Searsport, higher windmill handling activities in our heavy lift segment drove the majority of the increase. Several other segment categories were incremental positive or negative variances compared to a year ago, which offset one another. Combining the first quarter results we presented today with our expectations for the remainder of the year, we are reconfirming full-year 2016 adjusted EBITDA guidance between $105 million and $120 million. We still plan to manage total 2016 maintenance CapEx to between $8 million and $11 million. And if energy commodity prices remain near current levels, we believe our full year cash interest expense will range between $22 million and $26 million. Please note that this guidance is based on assumptions of normal weather and market structure conditions for the remainder of the year and does not include any contribution from possible acquisitions. We also continue to discuss the pace of distribution growth over time with our Board and they remain supportive of our near-term guidance of $0.015 per unit quarterly increases as well as our longer-term guidance that Sprague will deliver unitholders double-digit percentage annual distribution growth over time. Finally, I am pleased to announce that our fleet was recently recognized as the safest in their class for 2015 by the New York State Motor Truck Association. We additionally were recognized with a silver award for their fifth consecutive year, which is a testament to the sustained safety culture inherent in our driver's daily responsibilities. Our teams also had great success in reducing risk by improving our health and safety environment management systems this past year and we remain focused on the continuous improvement necessary to achieve long-term success. This concludes my remarks. I'll let David wrap up before we take questions.

[David C. Glendon:]

Thank you, Gary. I want to thank every Sprague employee for their hard work in the first quarter and the progress we've made integrating new assets, responsibilities and people into our organization. We're now happy to answer any questions on the call.

[Operator:]

[Operator Instructions] Our first question comes from Justin Jenkins with Raymond James. Your line is open.

[Justin Jenkins:]

Good afternoon and appreciate all the color today. So I guess I'll start on the commodity side. Clearly last couple of quarters were tough on the weather-front, but just looking at the distillate market and certainly a bit of inventory out there, I guess I'm just curious what you guys are seeing lately from a demand standpoint?

[David C. Glendon:]

Demand obviously for the winter was down pretty significantly, as you've seen from us and I'm sure you've seen from other reporters who are exposed to Northeast weather as well. I will report that April was a little colder than normal, Justin, but degree days as we know in April don't mean nearly as much as degree days in January or February. And I think what you're reporting or what you're pointing to is, storage levels are relatively full right now, both here in PADD 1 and more broadly across the globe, which at least in theory should lead to pretty healthy contango environments. We had seen a little bit of a narrowing of those spreads in the outer months, but I think, again it's our belief that that contango will persist through 2016 and avail us of some additional storage opportunities.

[Justin Jenkins:]

Okay, that's helpful. And then I guess on the M&A front, any change there recently? I'm guessing the focus is still on privately negotiated deals, but any color on activity levels?

[David C. Glendon:]

Absolutely, the focus remains on private deals, and as I referenced, those tend to operate on a seller's timeframe. But we're comfortable with the guidance that we've provided that we anticipate couple of transactions on average over the course of the year.

[Justin Jenkins:]

Perfect. And then last one for me, I appreciate the color you gave on the Santa Buckley deal and its integration, but can you give us a sense maybe on how we should expect the benefits in financial uplift to unfold over time?

[David C. Glendon:]

I mean there will be modest, I mean we characterize I think as a 5x multiple at the outset and I think we see ways to modestly improve upon that over time, Justin. So I guess I'll leave it at that.

[Operator:]

Our next question comes from Jeremy Tonet with JPMorgan. Your line is open.

[Andrew Burd:]

It's Andy Burd for Jeremy. Couple of quick questions. The reiterated full-year guidance implies some pretty solid year-over-year growth in the final three quarters. Is that just a full-year run rate of some of the acquisitions and the lower SG&A that you mentioned or is there something else that I didn't mentioned, that we're missing?

[Gary A. Rinaldi:]

This is Gary. Good question. It's basically, number one, the fourth quarter, we're forecasting obviously normal winter, okay. So year-over-year with last November-December being very warm, there's a fairly material uplift there. Secondly, we're already into May and we're forecasting a stronger second quarter versus last year. Last year's second quarter was relatively weak. We're forecasting higher earnings at Kildair for the year versus last year. And then as you mentioned, the OpEx and SG&A run rates are expected to be well below last year, is the guidance we provided. So, a combination of those factors. We're comfortable assuming the guidance we've given so far.

[Andrew Burd:]

That makes perfect sense and very helpful. Thank you. And then following up on the costs, SG&A declined year-over-year. Is it possible for you to quantify the difference between the transaction related expenses that you saw last year in the first quarter versus the higher compensation in the first quarter, just so that we can kind of get a sense as to what a normal compensation number would look like in a normal winter?

[Gary A. Rinaldi:]

Yes, we've provided a guidance on the full SG&A cost, but the majority of the decrease was related to incentive compensation, but we did have fairly significant reductions in the M&A related costs because the fourth quarter transactions of 2014, a number of professional fees related to it, impacted the first quarter of 2015, which is creating a year-over-year reduction in the cost related to the transactions.

[Andrew Burd:]

Yes, that makes perfect sense. I guess I'm just trying to get a sense of the breakdown between the transaction related expenses versus the compensation related expenses change year-over-year. Maybe we can take that offline.

[Gary A. Rinaldi:]

Yes. I can say it's 75%-25% incentive compensation related costs versus M&A related reductions as well as other SG&A related reductions, smaller reductions.

[Andrew Burd:]

That's perfect, that answers the question. And then last question on the integration of Castle. I know that there was a lot of opportunity there to improve the business and bring it up to kind of the Sprague standard. How many efficiencies remain there and are there any incremental new opportunities going forward that you're looking at that you might not have shared in the past?

[David C. Glendon:]

So we did complete or largely complete on an extensive rack automation upgrade system which automated the rack but also allowed for blending of much broader product slate. A little bit difficult to tell with the winter we had, or didn't have, as to how much that will impact on a run rate basis, but that project is largely complete. The other thing that we're working extensively on is what we call 'delivery integrity program', which is being rolled out over the course of this year, really investing in ensuring that the customer premises are in good condition and building that customer franchise through that investment. So we do see, Andrew, some continued opportunity to enhance the operations of the Castle business that we inherited.

[Operator:]

Our next question comes from Nathan Judge with Janney. Your line is open.

[Nathan Judge:]

Just wanted to kind of ask how you're seeing acquisition markets in particular, anything we should be thinking about as far as versus I guess the natural gas marketing side, and in particular, any cancellations of these big pipes, has that presented new opportunities for margin enhancement or how is that going to play out for you?

[David C. Glendon:]

I'll answer that one first because I think candidly we answered the first question, I've largely given, which is we remain active, we're seeing opportunities but they are on a seller's timetable. So we're still optimistic we'll get, based on the guidance we provided, one additional transaction done this year. In terms of the pipe cancellations, that's really a longer-term dynamic that I'd indicate. So I think we – clearly our business, given the way our business is structured, our contracts are structured, benefit from a constrained environment in the Northeast. And I think a concern that I've heard expressed about the business over the longer term is, gee, with all this capacity coming onstream, is that going to erode margins over the longer-term in your natural gas business? And I think we've consistently said, to the extent that the Northeast market becomes like the Southeast or the Texas market, that's a fair point to make that you would see the competitive intensity increase and the margins generally compete it away. But our beliefs there was that the Northeast market would remain constrained and that many of these pipelines that were on paper were not going to get built or certainly were going to be delayed, and I think evidence over the last couple of months has supported that view that it's exceptionally difficult to site permit and get approvals to construct significant pipeline capacity into the Northeast. So our business model has much greater I think from that perspective long-term certainty and long-term value than we've been given credit for in the past. Is that responsive, Nathan?

[Operator:]

It looks like Nathan's line actually dropped.

[David C. Glendon:]

Perfect.

[Operator:]

I'm showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.