Blueknight Energy Partners L.P.

Good morning. My name is Ariel and I will be the conference operator today. At this time, I would like to welcome everyone to the Blue Knight Earnings conference call for the second quarter of 2021. All lines have been placed on mute to prevent any background noise. If you should need assistance during the call, please press star then zero and an operator will assist you. I would now like to turn the call over to Matt Lewis, Blue Knights Chief Financial Officer. Please go ahead.

Thank you, and good morning. We're pleased to welcome you to Blue Knight's conference call, where we will discuss financial and operating results for the second quarter ended June 30th, 2021. After our prepared remarks today, we will open the lines to address any of your questions. As a reminder, the earnings release, which can be found on our website, includes financial disclosures and reconciliations for certain non-GAAP financial measures that should help you analyze results. Comments and answers to questions during the call today may include forward-looking statements that refer to management's expectations or future predictions. These statements are made as of the date of this call, and management is under no obligation to update these forward-looking statements in the future. They are subject to risks and uncertainties that could cause actual results to differ from management's expectations. With that, I will now turn it over to our Chief Executive Officer, Andy Woodward.

Thanks, Matt. Good morning to everyone who dialed in. On today's call, I will begin with second quarter highlights and our operational performance before Matt provides additional information on our financial results and key metrics. I will then finish with an update on our growth strategy before we open the lines for Q&A. For the second quarter 2021, I'm excited to report a solid performance for my business, especially relative to a strong performance last year. Matt will go into this in more detail, but I'm very pleased to see the progress we have made on achieving our cost-saving initiatives post our crude oil divestiture and the outperformance of our business compared to the prior year, with incremental improvements in adjusted EBITDA and more meaningful improvements in distributable cash flow, which was up 25% year over year. Furthermore, this performance translated into maintaining top-tier financial metrics with distribution coverage of approximately 1.2 times on all distributions, 2.0 times on common unit distributions, and total leverage of 2.2 times. Operationally, if you recall, during the first half of 2020, we saw a lot of construction demand pulled forward due to COVID lockdowns and fewer vehicles on the road. So volumes were uncharacteristically high. By comparison, first half, 2021 volumes were slightly below the prior year. However, we are encouraged by the fact that first half 2021 volumes are 5% higher than the previous three-year average. In addition, second quarter 2021 volumes are slightly ahead year over year, even despite a more seasonally wet and rainy spring. With this momentum and the favorable solid backlog of road construction projects, we have a more positive outlook for the remainder of the year, absent any unforeseen weather-related or other issues. As for our contract renewals, we've made considerable progress, executing over half of our renewals already that expired this year, as customers anticipate more favorable investment in infrastructure over the coming years. Although a final resolution hasn't been fully achieved at the federal level, we do see sizable increases in funding over the current FAST Act and remain optimistic that a deal gets done this year. At the state level, unexpected budget surpluses are being directed towards much-needed road work, and state lawmakers continue to pursue bills supportive of infrastructure. These positive developments at the federal and state level further support a constructive market backdrop. As we look to our guidance for the year, due to this more favorable outlook, coupled with six months of earnings in excess of last year at this time, we remain confident that we'll meet or exceed our 2021 financial guidance. With that, I'll turn it over to Matt to discuss our second quarter financial performance.

Matt? Thanks, Andy. Before we get started, Please note that additional information regarding the partnership's results of operations will be provided in our quarterly report on Form 10-Q, which we expect to be filed later this afternoon with the SEC and available on our website. Now turning to Blueknife's financial results. Second quarter 2021 income from continuing operations was $7.1 million, compared to $5.4 million in the prior year. Adjusted EBITDA from continuing operations was $12 million, up 6% year over year. I'd also note the prior year period excluded $537,000 in one-time employee separation costs and transaction-related fees. Distributable cash flow from continuing operations was $9.7 million, up 25% compared to the prior year. And as Andy highlighted, our coverage ratio was 1.21 times on all distributions, and 1.97 times on common unit distributions. Over the trailing 12-month period, our coverage ratio increased to 1.29 times on all distributions and 2.32 times on common unit distributions. Looking at segment performance, our asphalt terminaling operating margin, excluding depreciation and amortization, was 14.6 million, up 3% compared to the prior year. Total fixed fee take or pay revenue was $24.4 million, or approximately 99% of our total revenue after excluding variable cost reimbursements. As a reminder, when comparing to the prior year period, certain asphalt terminaling contracts were renewed and amended from a lease arrangement to an operating arrangement, which resulted in an increase or gross up of certain revenue and expense items. Aside from this change in presentation, Year-over-year improvements in revenue were primarily due to favorable contract renewals and annual CPI adjustments included in each of our contracts. General and administrative expense was $3 million during second quarter 2021 compared to $3.9 million during the prior year. After excluding non-cash equity-based compensation expense and one-time adjustments, cash G&A of $2.8 million improved 12% compared to the prior year. This is primarily related to the capture of certain cost-saving initiatives identified as part of the crude oil divestitures, such as our recent consolidation of corporate office space by more than 50%. As discussed during our last earnings call, we expect to achieve the lower end of our synergy target range during calendar 2021, or approximately 1.5 million. I'll now move on to a summary of our second quarter investing activities and highlights related to our debt and liquidity position. Second quarter 2021 total net capital expenditures from continuing operations was 1.5 million. This included net maintenance capital of 1.2 million. Looking at the second half of 2021, we anticipate higher maintenance capital spend due to increased estimates at certain non-operated sites and an unplanned tank repair identified during the quarter. However, on a full year basis, we currently expect to remain within the upper end of the 2021 annual guidance range of $6 to $6.5 million in total net maintenance capital. Turning to our debt and liquidity, I would also like to highlight that we closed a new four-year $300 million senior secured revolving credit facility during the quarter. The agreement, which includes a provision to increase total commitments up to $450 million, was extended through May 2025 and will provide critical low-cost capital and liquidity to support our future growth efforts. The other terms of the arrangement are largely unchanged relative to our prior agreement, which we believe is a favorable outcome in this market, credited towards our improved leverage and earnings profile post-exiting the crude oil business. As of June 30th, 2021, total debt outstanding was $111 million. Our total leverage ratio was 2.17 times, and liquidity available under the credit facility was approximately $188 million. Subsequent to quarter end, We paid down an additional $7 million, and as of July 29th, our total debt balance was $104 million. We are well positioned for growth and focused on a disciplined capital allocation strategy that prioritizes both organic and strategic investments. We're evaluating opportunities with varying ranges of required capital, and as Andy mentioned, many of which are in the early stages. But we believe if we can remain patient in redeploying capital and emphasize maximizing risk-adjusted returns, we will be successful in creating long-term value for our unit holders. I'll now turn it back over to Andy to provide an update on our strategy and business development activities.

Thanks, Matt. As we continue our journey to become a leading specialty terminaling business focused on infrastructure and transportation and markets, We have made considerable progress over the quarter on improving our strategic process and evaluation framework and generating ideas and opportunities that both protect and enhance our current platform. These efforts are underpinned by four strategic aims that we believe are critical in achieving our vision. Our first and foremost aim is to be customer focused and attract high quality long-term customers through superior service and solutions. Our second aim is to target quality assets that are well positioned over the long term and strengthen and complement our existing and leading specialty terminal network. Our third aim is stewardship and developing and designing a mission-driven organization and culture to maximize value to all stakeholders. And lastly, our fourth aim which becomes a product of executing on the first three is returns driven. Maintaining discipline and allocating capital to maximize risk-adjusted return. We believe these four strategic aims, along with leveraging our core competencies and competitive advantages within Asphalt, will create the most value for our stakeholders over the long term and lead to new market opportunities as we stay focused on the customer identify their evolving needs, and ultimately position ourselves to best serve those needs over time. As we have communicated before, growth in our business will take time, especially the right type of growth that both protects and enhances our current business. It requires discipline and patience, often requiring us to thoughtfully pass on opportunities that we feel do not fit our long-term strategy and vision for Blue Knight. With that said, We are making considerable progress, and I feel the types of opportunities we're seriously evaluating and advancing fit this framework and exceed my own expectations of where we would be by this time. We look forward to sharing more details at the appropriate time. In summary, I'm very proud of our performance this quarter, the steps we are taking on our strategy, and the progress we are making to prioritize and advance potential new opportunities. We will open the line for Q&A. Operator?

Thank you. We will now begin the question and answer session. To join the question queue, you may press star, then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. Once again, to join the question queue, please press star, then one now. We will pause for a moment as callers join the queue. Our first question comes from Jeff Bailey of Beach Capital. Please go ahead.

Hey, Matt and Andy, another great quarter. Can you hear me okay?

We can hear you loud and clear, Jeff.

Wonderful. My first question, Matt, would you explain the interest expense on the income statement for the quarter? Annualized, it's like 6.5%, so I assume there's some one-timers in there?

Sure, Jeff. You know, we'll have some additional details in the 10-Q, which will be filed this afternoon, but to explain it, there was about $600,000 in expenses that were written off related to the old credit facility that were, you know, previously there. So, if you think about the actual cash interest expense on a go-forward basis, I think you can look at that as being around $800,000 per quarter is probably how you should think of it going forward. So, there are just some non-cash items related to the old facility in that number.

Got it. Got it. And then previously, Blue Knight had some swaps to fix the interest rate on the credit facility. And of course, investors noticed that you decided to do a revolving facility instead of any fixed rate debt below a revolver. Can you explain, Matt, your calculus on keeping the interest rate variable for the next, well, at least for the next several quarters, because you didn't talk about fixing anything.

Sure. Yeah. You know, at this point, we do have the revolving credit facility that we're at the bottom of the tier. So, it's LIBOR plus 2% until we get above three times levered. And looking at the yield curve, you know, the one-month LIBOR is, I think, right around 10 basis points. And so, exchanging floating for fixed at that point, sure, is something I think we would evaluate if it makes sense. But At the same time, you know, we are benefiting from, you know, really low rates when we think about that LIBOR component.

Okay, so for now, you're going to leave it floating, no plans to get any swaps or anything?

No immediate plans, but certainly something that we would evaluate if it makes sense to do it for a portion of the debt outstanding.

And Jeff, this is Andy. You know, that's something that I mean, just for your awareness and others, we've been evaluating, I would say, over the last two years. And thankfully, we've opted not to exchange that floating rate for fixed rate. But as Matt mentioned, where rates are currently, looking at the forward curve, again, it's something we constantly are evaluating on a long-term basis for what we would consider permanent debt.

Yeah, leaving an open variable has worked out wonderfully for the union holders the last two years. It's just interesting because there's a lot of mixed signals. There's so much talk about inflation and so many bankers are worried about inflation, but yet interest rates are so low and the yield curve is so flat. But I guess you'll evaluate it going forward, so I get what you're saying. Yeah. And Andy, so regarding the preferred, we can assume no preferred was repurchased in the quarter also?

That's correct. The only preferred we purchased was announced last quarter. It's, again, similar to interest rate swaps, you know, something we're constantly evaluating.

Okay. And then Andy, you've talked a bit for a few quarters about organic growth opportunities and perhaps expanding some of the services that some of the existing sites offer and different modes of transportation into sites that you already own. But we haven't heard any announcements yet. So are we to assume that maybe those organic projects aren't penciling out the way you hoped and that mostly growth might be inorganic, or is there another reason why you've been quiet on that so far?

Yeah, no, it's a fair question, and it's a good question. I would say what we've been focused on post the crude oil sale, which, again, was earlier this year, when we close that transaction is on growth. And the areas that we've primarily been focusing on is our process and strategic framework to drive growth in the business on a long-term basis going forward. And I can't say enough how much progress we've made both strategically around that process and also the types of projects that we are advancing And we look at it on a stage basis in advancing certain projects to get them to a place where we're hopeful that we'll be in a position to announce those types of projects here soon. It's just these things take time, and a good example is our own crude oil transaction that that we announced late last year and just closed here recently. That was a project that had been in the works for seven to probably even seven months to even longer than that. So it's just to say these things take time. And I think a lot of our remarks today is to leave the investor with the sense that this is something we are hyper-focused on and we are making considerable progress on as well.

Understood. Can you talk a little bit about what you and Matt are seeing out there? As you look at it, it seems like in a way the build-it-yourself projects would be expensive because of inflation, whether it's labor or materials, and those may be hard to make work. And then obviously there's a ton of capital in the energy space, both strategic and private, floating around looking for things to buy. Are you finding it difficult at all to get projects to pencil out just because of the environment, both inorganic and organic?

We're actually seeing the opposite of that, Jeff, right now. Namely, from a strategic perspective, what's core to our strategy is the customer, and and staying in front of the customer and best serving those customer needs currently and over time. And I think that strategy is playing out really well for us where we're getting in front of them and looking for ways to solve some of the issues that they're running into. And like you said, I think we're in a very energy transition type environment right now, which for us, we think brings on additional opportunities, not only in asphalt, but outside of asphalt too. And so I think we're well positioned both from a strategic standpoint and our core business, and also from a liquidity standpoint to be able to help our customers solve their needs over time. So we're seeing more activity, I would say, in that area than we were expecting. And then on top of that, more on the inorganic or strategic side, And we're also seeing a lot of activity out there that's similar to our own portfolio optimization that we went through last year. We're starting to see a lot of other companies get out there and do the same. And on that note, we've been a part of a handful of processes ourselves. But again, it goes back to some of our comments from earlier in that what we're focused on is patience and discipline and making sure we're finding the right opportunities that both enhance our current platform and business, but also protect it going forward.

Wonderful, wonderful. Well, investors will be well-served. Thank you very much. Another great quarter, guys. Have a great day. Thanks, Jeff.

Our next question comes from Steve Chick of Sebbies Garden Capital. Please go ahead.

Hi. Thanks for taking the question. So I guess first off, you know, you're heading into, you know, seasonally your most profitable quarter here, typically in the third quarter. And I'm wondering, you know, with variable throughput volume and variable throughput revenue is obviously a big part in the second half year. And there were some shifts a year ago. So you actually have some pretty favorable tailwinds or comparisons. And obviously you've got some momentum coming off the first half. And is it too early? I mean, you've got a month in the quarter behind you. Does this variable throughput, these thresholds, are they something that gets attained later in the quarter? How much visibility do you have into that threshold specifically and kind of the general momentum of your business? If you could kind of comment on that, that'd be very helpful.

Sure. Yeah. No, thanks, Steve. It varies by customer in terms of when we hit that threshold. And so it really depends on their activity. you know, first half of the year and then really getting into the third quarter is where we do see that uplift. And depending on the construction activity and the weather, similar to what we saw last year, I think we saw in certain regions like the Rockies, we had great weather even going into the fourth quarter that we saw some benefit beyond even, you know, September, October. And so, what I would say is if you look at the first half of the year, I think you can total it up and it's about on average, maybe 46% of that total operating margin before depreciation and amortization. So, you know, I would say that it probably will follow historical trends when you think about the third quarter, maybe being around 27 or 28% of that operating margin for the year. And so, I think that's a fair number to use. And again, as we get further throughout the third quarter, we'll have, you know, more visibility once we get to November.

Okay. That's helpful. And then, um, you know, I guess relative to capital allocation and, you know, kind of on, on these strong results and, you know, your current EBITDA run rate, um, and, and distributable cashflow, it, it, it really kind of, and as you said, I think in your comments, what your LTM, um, coverage ratio is, is what 1.29 times, I believe you said. And so you're even at this point, pretty, uh, in a pretty good position, From a distribution standpoint, I'm just wondering about kind of the prospects of raising the distribution rate on the common. It seems like on my math, you know, you could easily raise it by, say, 25 percent or, you know, like a penny per unit per quarter and still be well within your own targets, which actually looks like you're exceeding. So what are your thoughts on that and the distribution rate?

Yeah, you know, we did. The guidance target for 2021 was to have coverage above 1.2 times on all distributions, and we also expanded that long-term target to 1.3 times or greater on all distributions. So, on a trailing metric, we are closer to that longer-term target. You know, our capital allocation is unchanged. I mean, we do think about that in growth projects first, and then After that, you're returning capital to unit holders, whether that's in the form of buybacks on the preferreds or, you know, distribution increases. That's something that we're evaluating when it makes sense. But we're not there at this point.

And this is Andy.

You know, I think part of reading into that, too, is and also I think it gets back to a lot of our comments from earlier. We're really pleased what we're seeing right now on the growth side of things and potentially deploying sizable chunks of capital towards growth. And I think what Matt and I are trying to do here over the long term, and management included, is when we start to unlock that growth potential is to start then looking at the underlying cash flows in a – and making sure that we feel very comfortable in the sustainability of those underlying cash flows and then looking at distributions after the fact. And so that is something we're very focused on. And as Matt said, it's not a, you know, it ends up being a blended approach of all the different ways for us to deploy capital. So it's not one over the other. It's looking at all three or four things combined.

Okay, that's helpful. And then just to, I'm wondering if you can elaborate a little bit, you know, without tipping your hand, but in some of the projects you're evaluating, and I guess you commented on this a little bit earlier, but between growth, I'm talking more on the growth side, between organic versus M&A, are you kind of more or less excited about either route? I mean, are you seeing, you know, more on the organic side versus M&A? And what's the likelihood we may be able to hear something more meaningful, you know, say, by year end?

No, Steve, those are good questions. I think from our standpoint, you know, it always comes back to returns and where we feel we can get the highest returns over the long term. And we often use the word risk assessment. adjusted returns, so things we look for is counterparty risk, high-quality customers, long-term contracts. And for the most part, that's going to, in our minds, weight towards more organic. And I think that's playing out as well in the types of opportunities that we're looking at that get us really excited and we start to prioritize are more that organic bucket that we're evaluating and then strategically you know oftentimes you know we could be receiving bank packages for somebody looking to sell assets and and you know I think those just come with a little bit more skepticism over one why are they selling and then to what can we do that really unlocks further value in that business and our own through that type of acquisition. And I think that's just going to take a little bit more time for us to be able to see enough of those types of opportunities for us to execute on. And so I certainly think coming out of the gate here on growth, it's probably going to weigh more towards organic. I'd be thrilled, to your point, if we could be in a position to announce something by end of the year or at least by our year-end call with investors. But, again, I really go back to what we're focused on is what we can control, and that's the process, generating ideas, staying in front of our customers, and having enough ideas and good projects where, from a probability standpoint, some of these are going to hit over that time frame.

All right, that's really helpful. All right, thanks, guys.

Thanks, Steve.

Our next question comes from Chris Cook of Zezov Associates LLC. Please go ahead.

Hi, thanks. Nice quarter, guys. Just a real quick one. Is it a typo in the Q2 earnings release with respect to the distributions declared on the preferred being $6,250,000? Yeah, $6,255,000. Shouldn't that be $6,155,000 because of the buyback in the first quarter?

We'll have to look at that. You're right, Chris. I mean, let me take a look at that number because you're right. When we purchased the preferred units in the first quarter, we did get the benefit of not having to pay the distributions on those 688,000 units. in the first quarter, so it should be kind of this 6-1. Oh, in the first quarter as well?

Correct. Okay. Yeah, I wasn't sure when you bought them back in the first quarter, but I, okay. So it may be wrong for the first and second quarter in the income, in the press release.

Oh, I think you're looking at, so sorry, I was looking at actually the distribution, so I'm looking at the non-GAAP table. which is 6.255 million, which that's the cash component of quarterly distributions. You're looking at more of just the allocation on the different- No, no, no, no.

That's my question. If you bought back 688,000 preferred, I can't come up with that math. But anyway, it's a $100,000 item. So it's not that big a deal.

Yeah, the difference you're seeing there is just, Chris, the difference you're seeing there is just the general partner's share of the preferred units. That's the $100 variance on those quarters. Oh, because they get some sort of KIS? Yeah, they get a percentage of all distributions based on their ownership percentage. Gotcha. Sorry about that.

Yep. Sorry about that. Thank you.

Our next question comes from Tom Forbes, a private investor. Please go ahead.

Yes, I'd appreciate if you could provide a little insight on what impact in volume the pending infrastructure bill would have on your investment. operations for over the next, I guess, what is it, a five-year deal?

Thanks, Tom. You know, I think that's a good question. I think from our standpoint, we look at what's being considered at the federal level as, you know, if you think on an annual basis from federal dollars allocated to states, you $45 billion spent on road construction, highway work. And we think what's being considered there could be an increase to that annual number on an incremental basis of close to 30%. And so the benefits to us, we see in probably three different areas. The first is in the form of excess throughput or volumes in a given year. And for us, I think from an EBITDA standpoint, it's a little bit tough to predict. You know, there's a lot of variables that go into this, the states that we're in, our customers' ability to get rewarded contracts. So a lot of variables. And then on top of that is weather or other potential issues. But, you know, we think – from a volume standpoint and from an EBITDA standpoint, it could translate into anything from 5% or 8% higher EBITDA or operating margin for our asphalt business. And so that's the first category. The second category is we think it also helps us with our contract renewals. And our renewals on an annual basis, typically have anywhere between 20 percent of our capacity up for renewal to 30 percent. And so, we think that this supports more favorable renewal environments. And then the third category is new projects. And we feel that with this type of incremental spending at the federal level, it could translate into new organic growth projects for us with customers. That's all to say we do think it's going to be a positive outcome for our business. It'll be positive for our customers. But I do want to remind you and others that this is highly, highly fixed fee type business. So how it shows up in our business will be much more muted than other places in the industry.

Okay, and a follow-up question. Assuming it materializes, can you serve this added volume without significant capital investment to expand your facilities?

Tom, that's a great question, and you're probably not going to love my response. It's really going to depend customer to customer. You know, I think there's There's excess opportunities at existing sites for certain customers to be able to handle additional volumes to other customers that sometimes have multiple tank turns already in the facilities we operate or that they operate. And so that would likely require some new capacity. So it really, really depends.

Okay.

Thank you. Thanks, Tom.

Once again, if you have a question, please press star, then 1. This concludes our next question. It comes from Glenn Gardipi of Northern Systems. Please go ahead.

You mentioned that you were going from lease arrangements to operating arrangements. Could you please explain that more and what the effect is on the company?

Sure. That was where, again, if you compare the year-over-year in some of our fixed fee revenues, we've got a services arrangement in place, and so we grossed up certain revenue and expense accounts where, you know, you really want to look at the net effect of that within our operating margin to get the benefit on a year-over-year basis. But what you'll find is what was previously just kind of leased revenue, we have now a little bit higher service revenue component that The expenses are now netted from it under this new agreement.

Does that mean that you're operating the facilities with your own personnel versus the leasee's personnel?

Yep, that's right.

So if the infrastructure package was passed, the fact that you're using your own personnel, that would – mean that your expenses would increase from that standpoint?

Potentially. You know, again, I think it really depends. And I think from a personnel standpoint at our sites and the potential increases in volume, even with additional growth capital needed to build additional capabilities at the sites, we can handle that with the existing personnel that we have in place.

Okay. And just one other question. Have you been looking at the purchase of any full blacktop plants from other sellers?

When you refer to blacktop plants, I mean, we're looking at plants very similar to our own.

Yes, that's what I mean.

Yes, yes. Then, you know, those are those are the types of that opportunities that I would call down the fairway point that we're, we're highly, highly focused on, you know, and we've been, we've been calling those types of opportunities, tier one opportunities here internally. And then, and if we were successful there, with existing customers, we think by leveraging what we can do on the asphalt side, on the Tier 1 opportunities, that they'll start to lead into Tier 2 opportunities, which we – which to provide a little bit of background on that category, that's where we start to get into other complementary products beyond asphalt. So, again, we're trying to leverage our strengths from a core competency standpoint. Then we'll lead into other new markets and opportunities with our customers over time.

Okay. Thank you very much.

Thanks, Glenn.

This concludes the question and answer session. I would like to turn the conference back over to Andy Woodward for any closing remarks.

I want to thank everyone for dialing in. We appreciate your continued interest, patience, and support and look forward to speaking with many of you soon. Thank you, and have a good rest of your week. Operator, I'll turn it back over to you.

Thank you. This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.