Blueknight Energy Partners L.P.

Good morning. My name is Claudia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Blue Knight Earnings Conference Call for the third quarter 2021. All lines have been placed on mute to prevent any background noise. If you should need assistance during the conference call, please press star then zero, and an operator will assist you. I would now like to turn the conference 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 Knights conference call during which we will discuss financial and operating results for the quarter ended September 30th, 2021. Please note that our 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 our results. Additionally, supplemental information will be available in our TEN-Q, which will be filed tomorrow with the SEC. I would like to remind you that comments and answers to questions during the call 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're subject to risks and uncertainties that could cause actual results to differ from management's expectations. Additionally, we should note that on October 8th, Blue Knight's Board of Directors of the General Partner received a non-binding cash offer from Ergon to acquire all of the outstanding publicly held preferred and common units. The offer was publicly filed with the SEC and is available on our website. Given that the General Partner is an indirect wholly owned subsidiary of Ergon, the Conflicts Committee, which is composed solely of Blue Knight's three independent directors, will evaluate the offer. Additionally, the Conflicts Committee retained independent financial and legal advisors to assist in their evaluation and potential negotiation of the offer. Given that the Conflicts Committee's review is ongoing, management is unable to comment about the process and will not discuss this matter any further. With that, after our prepared remarks today, we will open the lines for Q&A. I will now turn it over to Andy Woodward, our Chief Executive Officer.

Thanks, Matt. Good morning to everyone who dialed in. I plan to start today's call by highlighting our financial and operating performance during the third quarter and year to date, followed by an update on external factors influencing our business and the progress we are making with our growth strategy. Matt will then provide more details on our financial performance and key metrics before we open the lines for Q&A. Now, turning to our business highlights. I'm especially pleased with our performance over the third quarter, during which we achieved a handful of major milestones for the partnership. First, we successfully transitioned and achieved our synergy targets following the sale of our crude oil business. Second, all 2021 expiring contracts renewed to date have been extended at current or more favorable terms. Lastly, we have now reached our long-term target on coverage at 1.3 times on all distributions when looking over the last 12 months. The business is also tracking extremely well. We are having one of our best years in environmental health and safety performance and recorded one of our strongest quarters to date, which has contributed to adjusted EBITDA and DCF to be higher year-to-date by 12% and 19% compared to the prior year, respectively. With that said, we expect to exceed our 2021 financial guidance laid out earlier this year. Finally, our outlet continues to improve as we generate and advance growth projects consistent with our strategy and further supported by passage of the historic $1 trillion federal infrastructure bill that should lead to robust demand for asphalt over the next five plus years. For the third quarter 2021, adjusted EBITDA was 16.9 million, up 22% year over year, DCF was 13.9 million, up 21% year over year. Matt will go into this in more detail. The drivers of growth included 2.1 million in other income, higher volumes, continual improvement in corporate costs, and interest savings. This performance translated into maintaining our industry-leading financial metrics. The distribution coverage of approximately 1.73 times on all distributions 4.35 times on common unit distributions and total leverage of 1.87 times. Earlier this year, we communicated to the market our desire to achieve long-term financial targets of leverage of 3.5 times and coverage on all distributions of 1.3 times or greater on an LTM basis. I'm pleased to report today we have now achieved these targets on both measures. As we have communicated previously regarding our capital allocation policies, meeting these two targets were critical as we balance maximizing risk-adjusted returns, opportunistically repurchasing preferred units, and before we consider returning capital back to unit holders in the form of distribution increases. Looking forward, and as stated before, we may consider raising the distribution provided the increase corresponds with a sustainable increase and the underlying cash flow above the 1.3 times level. As we evaluate those decisions, we'll be considering both actual underlying growth, tailwinds and headwinds in the business over our long-term forecast. Nonetheless, we are very excited to have reached this point. Operationally, third quarter total throughput volumes were up 7% year over year, and year to date slightly ahead of the prior year and 3% above the trailing three-year average. In addition, of the 2021 contracts we've renewed so far this year, we have executed at current or more favorable terms. At a more macro level, Congress has recently passed a bill representing the largest investment in our nation's infrastructure in decades. As we've noted throughout the year, This bill leads to a sizable increase in funding over the next five plus years. This bill, along with increased spending levels at the state level, should provide a stable and rising demand environment for infrastructure and road construction work for years to come. Now, turning to our strategy. We've been hard at work generating new opportunities and advancing existing projects that were initiated earlier in the year when we began pursuing growth in earnest. These opportunities align with how we've described our strategic growth areas in the past and include projects that enhance the logistical or product capabilities of certain terminals, acquisitions of new terminals, and solutions for existing customers in complementary products beyond asphalt. If and when We have executed definitive agreements. We will announce these projects in more detail at the appropriate time. In summary, I'm encouraged by our performance this quarter, our long-term outlook for our business, and the steps we are taking to prove out and advance our strategy. I will now turn the call over to Matt to walk through our financial performance. Matt?

Thanks, Andy. Looking at Blue Knight's third quarter financial highlights, income from continuing operations was $12.6 million compared to $9.4 million in the prior year. In the quarter, we recognized other income of approximately $2.1 million that was related to certain insurance claim reimbursements in our asphalt business. Adjusted EBITDA from continuing operations was $16.9 million during the quarter, up 22% compared to the prior year. And three quarters into 2021, adjusted EBITDA was $40.3 million, up 12% compared to the prior year. Third quarter distributable cash flow from continuing operations was $13.9 million, up 21% compared to the prior year. I'd highlight that our cash interest expense improved both sequentially and year-over-year, and our coverage ratio, which is typically strongest during the third quarter of each year, was 1.73 times on all distributions and 4.35 times on common unit distributions. To frame this up over the trailing 12-month period, our distributable cash flow was approximately 43.8 million, and our calculated coverage ratio was 1.36 times on all distributions and 2.67 times on common unit distributions. Looking at segment performance, third quarter 2021 represented our strongest third quarter since 2017. Asphalt terminaling operating margin, excluding depreciation and amortization, was 17.4 million. up 6% compared to the prior year, primarily due to higher variable throughput revenue, contract renewals, and other annual escalators. Total fixed fee take-or-pay revenue was $24.4 million. Variable throughput revenue, which can fluctuate from third to fourth quarter each year based on when customers achieve minimum annual thresholds, was $2.8 million, up 6% compared to prior year. And on a full year basis, we expect variable throughput revenue to be in line with historical averages or around 5% to 6% of total revenue after excluding recoverable costs. General and administrative expense was $3 million during the quarter, down 8% compared to the prior year. As Andy highlighted, we have successfully reduced our cost profile post-investiture of the crude oil business. We expect to capture approximately $1.5 million in synergies during 2021. Give you an update on our investing activities. Third quarter 2021 maintenance capital of $2.4 million was a bit higher compared to prior year, but year to date, it is essentially flat to 2020 amounts. And to reiterate, we expect full year maintenance capital to be within the upper end of the guidance range of $6.5 million. Finally, I'd highlight that our debt and liquidity position continued to improve relative to prior periods. This time last year, we reported total debt of $261 million and a total leverage ratio of 4.06 times. As of September 30th, 2021, our total debt outstanding was $101 million and our total leverage ratio was 1.87 times. We believe we are well positioned to utilize our balance sheet to support future growth initiatives. Operator, please go ahead and open the lines for Q&A.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two.

We will pause for a moment as callers join the queue. Our first question is from Steve with Sebbis Garden Capital.

Please go ahead.

Hi, thanks. Hey guys, thanks for taking my questions. You know, I have a question on guidance, but I'd first like to discuss a strategic topic. And, you know, I can understand you can't comment on the bid made by Ergon last month to acquire Blue Knight. you know, at $332 per unit at the common and $846 per preferred unit. And I'm not going to put you in a position of comment on that. I would like to make sure I've got the facts right, though. And I want to say up front that I'm not unhappy as a unit holder that the offer's been made because it gets us to talk about it. It was also obviously the catalyst for the DG capital letter, that raised objections to the offer dated October 12th. But I would say, simply put, that the offer as it stands today is insulting and it's offensive. It's offensive to the management of Blue Knight. It's insulting to the common unitholders and it's deficient for the preferred unitholders. And it undervalues Blue Knight. But like I said, I want to make sure I got the facts right. And by way of background... You know, Ergon invested – first invested in Blue Knight in 2016 and became general partner then. And they actually, you may know, had a relatively bullish conference call with former Blue Knight management back then. Leslie Lampton of Ergon and Mark Curley, who was a former CEO of Blue Knight, were on that call, and they showed a strategic alignment. And thereafter, and for the ensuing three years – Blue Knight deployed capital towards low-returning crude oil businesses, and trends deteriorated. And Blue Knight was forced to cut the dividend, the common dividend, twice, once significantly in 2018 and then significantly again in 2019. And then, of course, after that, Ergon put in a bid to acquire Blue Knight, not unlike today but at lower levels, two years ago. The stock, since they first made that investment, became general partner. is down 40%. Despite the run it's had year-to-date now, it's still down 40% from their initial investment. The distribution on common is down over 70% since they became general partner. I'm going to say that again because I think it's pretty important. The distribution per common unit when Ergon first became general partner at Blue Knight was $0.58 per unit. It's $0.16 per unit today. So there's obviously been a bit of value destruction since they've been general partner. But the good news is that they've actually made some good decisions along the way as well. Namely, Andy, they appointed you CFO in April 2019, a blue knight, and then CEO in June of 2020 when they made the overdue management change. And as you may or may not know, the stock, the common units, are up 180% since you joined the company. And under your leadership, Blue Knights successfully divested the crude oil, the lower-returning crude oil business earlier this year. And right now, at 1.8 times leverage, you've got the cleanest balance sheet in the history of the company. And the company is in the best financial position it's ever been in. And now, of course, you've got the infrastructure bill on the come, as CG Capital pointed out in the letter. And Ergon's takeout offer, as it stands now, doesn't account for any of this. Following the divestiture of crude oil, you have an under-levered balance sheet at 1.8 times. Your target leverage ratio, as you say, is 3.5 times. When you pencil out the sources and uses of this offer with a 3.5 times leverage, it isn't a takeout. It's a take-under. Ergon could and would use Blue Knight's balance sheet to lower its cash outlay with this bid. In other words, the implied... Cash cost to Ergon is really the equivalent of what the bid was two years ago to acquire this company, which, by the way, was withdrawn within five weeks. And that's when the company was on the ropes. It doesn't reflect any of the improvements you've made to date as evidenced by this quarter, and it doesn't reflect the growth outlook that you have going for you ahead of time, looking forward. It's insulting, and it's gross. And as for the preferred unit holders, the bid would be highly taxable for the sellers, not for Ergon. But importantly, it also sidesteps the likely better alternative of a recapitalization of sorts or a negotiated conversion of the preferred to common at an exchange ratio that would benefit all shareholders – common unit holders, preferred unit holders, and Ergon – Ergon has 60% of the preferred units. They could execute this easily. The reason why the common units are depressed is because this company's capital structure is massively inefficient. Two-thirds of your fully diluted equity value is in a preferred security that's illiquid and has a high cost of capital. It looks like you have a $130 million market cap, and yet you have a $400 million fully diluted value. I'm sorry, I'll get there, Andy. My point, though, is that a conversion would clean up the capital structure, result in a higher valuation for the company, and raise the daily trading value for the stock. And it would benefit all shareholders, including preferreds, and probably be a lot more tax efficient. And so the offer in its current state, it benefits only one party as far as I can see it, and that's Ergon. Now, I do have a question. I just wanted to get that out of the way. My question is surrounding not about the bid, but we've been on the impression that you've been working internally on, as you said, strategic growth plans and stuff to present to the general partner and the board. And then as for timing, we were hoping to hear something more meaningful come the fourth quarter call, say by March at least. With this bid that was made a month ago, my question is, does it change that process internally of how you're presenting stuff to the general partner and the board, and does it change the timing of when we might hear something more meaningful?

I'll take that question, Steve, and, you know, maybe I'll just start by saying to all investors to, you know, if there's comments, if there's concerns, to, you know, I think the appropriate medium for that is to send those comments and concerns deal letter through our investor relations department. I certainly don't want to use this call as that opportunity. Happy to take questions like this one, Steve, and I'll answer it. But I do want to encourage investors to do that, and I think that's the appropriate medium. But with that said, in answering your questions, I still stand behind my comments last quarter that I think you're referencing that You know, I remain hopeful that, you know, opportunistically or we can announce something by year end, but at least by our year end call. And as it relates to growth projects and strategic projects, we are absolutely, nothing's holding us back sharing those types of opportunities. with our board. I think we, me personally, and I think management as a whole takes a lot of pride in how we have dialogues with our board, along with how we have dialogues on these calls with all of our investors. And I think we've been pretty clear since we've completed that crude oil transaction. And as you know, with the liquidity we have on hand that, you know, our number one priority right now is growth. So, as you can imagine, with our board and with just time passing since then, we're likely showing potentially more opportunities now than at any other point in time. So, this offer itself from Ergon has not slowed any of that down. I would say the board's been very supportive of what management's board meetings and along with our recommendations in those board meetings. And again, we're hopeful that by year-end we'll have something to announce, but at least by our year-end call with all investors.

Okay.

I guess that helps there. And then now, just for the numbers a little bit, you know, on your a good quarter and the trends are obviously very good. You mentioned just in relative EBITDA for, let's say, 2021, you're obviously exceeding your guidance. But your guidance was, as I remember, kind of flat with 2020 X synergies in EBITDA. And you're kind of trending well ahead of that right now. So I don't know. I don't want to pinpoint you to a number or range for what you think 2021 is going to look like. But Can you at least tell us, you know, in the fourth quarter, you know, with comparisons and trends and so forth, do you expect the fourth quarter to be up year over year in terms – and I'm talking in terms of total EBITDA?

Hey, Steve, this is Matt. I'll take that one. And rather than going specifically to the fourth quarter, I mean, I might just share that, you know, within our release, within our prepared remarks, I mean, we did note that we expected to exceed – those full-year guidance targets that we laid out. And so I think you can take that comment and obviously our performance year-to-date to kind of maybe back into your fourth quarter. But specifically around maybe, you know, one of the biggest drivers, kind of 3Q to 4Q, is that variable throughput revenue. And so I think just calling out that on a full-year basis, we expect that to be between 5% and 6% of total revenue. So you can take those pieces, I think, to kind of get to your fourth quarter number. But, you know, we are really pleased with the performance to date, and we are seeing benefits in the synergies and seeing kind of that G&A run rate.

And so, you know, that's probably how I would just speak to that question.

Okay. That is helpful. And then I know you're not – we don't expect to hear anything about next year's guidance until probably next, you know, the fourth quarter report. But is there anything you can say about next year at this point? You know, maybe, you know, how many contracts, the percentage of contracts may be up for renewal? You know, and then secondly, with this infrastructure bill, I know it's kind of early now, but as you pencil that out, I mean, is that something that you would expect to be able to contribute next year to the second half?

You know, Steve, this is Andy.

You're right. We plan to give more of an update on guidance for 2022 on our year end call when we have more visibility in the business that year. I think as it relates to contracts for 2022, we haven't provided this publicly, but I would just assume that it's in line with what we've had at the start of this year. And then as it relates to the infrastructure bill, I think you're right. We've gotten that passed finally, You know, how that shows up is a bit unknown to us. I think we've provided some guidance on the past call of the amount that that could contribute to our baseline business. But as you said, it's early on in that bill, and we'd likely see something contribute to it next year, but more than likely you'd see the full impact after next year as states start to plan around it and have time to plan around it.

Okay. All right. That's helpful. Thanks, guys. Thanks, Steve. Thanks, Steve.

Once again, if you have a question, please press star then 1 on your telephone. Our next question is from Jeff Bailey with Beach Capital. Please go ahead.

Hey, good morning, Matt and Andy. Another impressive quarter. And I'd like to affirm too, hey, just like to affirm too, thank you for the open lines of communication with the investment community. It's greatly appreciated. My first question, two questions really are for Matt. Matt, sometimes Blue Knight has provided the up-to-date information debt balance, do you have that available for shareholders, the 11-11 debt balance?

Yeah, we released within the press release, it was 96 million. I think that was as of the 4th of November, Jeff.

Okay, thanks. And then, Matt, how are you penciling out interest expense for 2022? given the forward curve and, but also the lower debt balance to offset.

Sure. Yeah. You know, we, I was going to say this, this quarter, the cash interest expense was a little below 700,000. And I think that as we've talked on calls previously, I think that's a pretty fair quarterly number on a go forward basis. I mean, obviously the curve is upward sloping and you know, that's something that I think we've talked about on prior calls and is, an item that we're evaluating internally and with our senior lenders on what makes the most sense from a timing standpoint. But I think that's a pretty fair quarterly assumption going forward. And then taking into account, you know, continued debt reductions would just reduce that balance.

Yeah. And then just to reaffirm, a couple hundred thousand each quarter is non-cash, right? It's debt cost amortization, but it shows up just in the interest expense line. Okay.

That's exactly right. So the difference between your cash paid on the DCF and what you would see on the income statement is that amortization of that issuance cost.

That additional detail is available in our queue that will be filed tomorrow.

Okay, great. So the cash interest cost is more representative. There's not going to be a catch-up at the end of the year or anything like that. It's all non-cash. There's a couple hundred thousand of non-cash in there for the interest expense. Right. Right. Got it. Okay. And then I'm not sure if this is for Andy or for Matt, but ever since you guys came on, you've pretty much grown operating leverage every quarter, year over year, and this quarter is no exception. You talked about the Cushing synergies and how those are completed. Is there still more operating leverage that you can realize for your investment? going forward. And I'm kind of looking at it measured by discounted or distributable cash flow for every dollar of revenue.

Thanks, Jeff. This is Andy.

I think from our standpoint, it's something we're always looking at. How can we continuously drive improvements in our baseline business, drive efficiencies in our business? Now, We've done that, as you noted, with a lot of urgency and earnest over the last couple of years and have identified quite a bit, including in sizable pieces related to the crude oil transaction. That's not to say we won't find more, but it is to say that it's just part of how we run the business, how we challenge one another, and we're constantly looking at ways to not only run the business more efficiently, but find improvements along the way.

Yeah.

Yeah, because the synergy started to show up before the crude oil disposition. And so, I'm just wondering if there's still more left, even despite that you've already realized the targets related to the crude oil disposition.

Yeah, there's certain things. I mean, just maybe to give kind of a couple examples, Jeff. I mean, we consolidated some office space here in Tulsa, Oklahoma, and took our footprint down by half. And the benefit of those from a new contract that we executed are effective really, I think, October forward. And so, you know, those are examples of things that we'll continue to see benefit from Cal 2021 to 2022. But certainly, to the extent we have more synergies, I mean, that's something that we're

spending a lot of time on to try to make sure we capture those fully.

And then, Andy, we've talked about this before, but it's a trend that's continued. About a million barrels of daily refining capacity has come out of the domestic industry. Are you still not seeing that as a problem for asphalt procurement going forward?

Yeah, no, I think our views of that are similar to views of the past. You know, we think on the asphalt side that unrelated to what you've seen on refined products is there's strong to growing demand for asphalt. And refiners can tweak that. their product slate to sometimes produce more asphalt than other refined products. And I think we're certainly even seeing that in this marketplace. So, you know, I think that demand gets filled regardless. As you know, there are certain refiners converting to renewable diesel, even some potentially even shutting down. But we don't think we still think that supply, plenty of supplies out there to fulfill the demand and the growing demand that we see over the next five plus years.

Okay.

And then you don't see any related price increases. We've talked before, you said that, you know, the price of asphalt, the demand for asphalt is relatively inelastic given the lead times for a lot of these projects. But I mean, 5% of, of, refining industry capacity is a pretty big number in a commodity market, and that's just for today. So you don't see any subsequent increase in asphalt price as affecting demand too much in the near future?

No, I personally don't see that large of an impact, and namely, I speak to refiners perhaps increasing the amount of asphalt that they produce, you know, as their other products are either flat or slightly declining.

Okay.

And then my last question relates to inflation. We've talked on previous calls, and then the SEC documents are pretty clear that Blue Knight has escalators and other protections from cost increases and general price increases. But we don't really know as investors, you know, what indices those are pegged to. As we get a headline number yesterday of 6% and change, as we build our models for 2022, can we start plugging in 6% cost escalation, or I should say price escalation in those numbers for blue night? I mean, that's just taking the CPI. But I'm just looking for a little more clarity on how we can incorporate inflation into our models.

Yeah, and Jeff, this is Matt. I mean, what I would do, rather than taking that one data point, I'd look, there's probably a lag effect in just the way that a lot of our contracts read. And so if you look at a period that would be, call it from November to October and take that monthly average and then compare that to the year over year, that's effectively kind of, you know, maybe a better way to look at kind of what would be an annual escalator. And so, you know, there is a lag. And so, if that would stay flat at call it 6% for another 12-month period, then that would, you know, kind of roll further down to kind of 2023 plus. So, I would just kind of take, you know, like I said, a trailing average whenever you're trying to come up with those actual adjustments, call it, you know, January of 2022.

Okay.

And then, but if we move forward even from there, can we expect on a lag basis Blue Knights results to roughly mirror CPI? Or is there a chance that it over-indexes or under-indexes? Because like I said, we're not privy, you know, to what indices are being used to renegotiate or to escalate as, you know, inflation progresses.

You know, Jeff, this is Andy.

I would look to, you know, what's been historical year-over-year increases to the business rather than these, you know, hopefully one-time inflation increases that we're seeing currently. I mean, we're sensitive to it as well as our customers are sensitive to it. And so, we certainly when it comes to negotiations and renewals, want to take that into consideration with them and not somehow use it to our advantage because we truly look at these customers on a long-term basis, and we value them not only for that business but for future business as well. So we take all those things into consideration when it comes to renewals. So hopefully that gives you enough guidance. That's probably all we can say at the moment related to it.

Okay, that's all I got. Another great quarter. Thanks, guys.

Thanks, Jeff.

Our next question is from John Ledecker with Birch Partners. Please go ahead.

Good morning, Andy and Matt. Congratulations on another great quarter.

Thanks, John.

A couple more granular questions for you, if I may. In the third quarter or in October, were you able to buy any more preferred stock?

What we actually did is in the early third quarter, we had an opportunity in August to transact in a block trade with an institutional investor that approached us. So we did acquire approximately 30,000 units at roughly $8.11 per unit. That was it.

Okay, great. And my second question is more legal in orientation. And that is, hypothetically, if the company and Ergon agreed on a deal, without specifying that any further, would public shareholders have appraisal rights under Delaware law?

Can you elaborate, John, on that question further?

Well, typically, I'm not a lawyer, but I'll give you my understanding of this. Under Delaware law, if a takeover offer is made, and if shareholders believe that price is inadequate, they can appeal to the Delaware courts to have their interests appraised. And there have been quite a number of cases over the years where courts have said, yes, the offer undervalues the property, and we think it's worth a higher number. And the company that's performing the takeover offer is required to pay that.

Okay. Yeah. Well, quick answer for me is I don't know.

And again, we just can't comment on the process.

Well, I understand what you're saying. I respect that. But this is a question of fact, not a question of process as to whether shareholders have that right. So, you know, if possible, you might bounce that off your in-house counsel or the outside counsel that's advising the conflicts committee and see what they have to say. It's something to be aware of, appraisal rights under Delaware law.

Yeah, we'll pass those comments along. Okay, great. Thanks.

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. Again, we appreciate your support. Look forward to speaking with many of you soon. Again, thanks for dialing in and have a good rest of your week. Operator?

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