Suburban Propane Partners, L.P.

Good morning and welcome to the Suburban Propane Partners second quarter earnings conference call. All participants will be in a listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. If you ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Davin D'Ambrosio, VP and Treasurer. Please go ahead.

Thanks, Chad. Good morning, everyone. Thank you for joining us this morning for our fiscal 2023 second quarter earnings conference call. With me this morning are Mike Stavala, our President and Chief Executive Officer, Mike Coogland, Chief Financial Officer and Chief Accounting Officer, and Steve Boyd, our Chief Operating Officer. This morning, we will review our second quarter financial results, along with our current outlook for the business. Once we've concluded our prepared remarks, we will open the session to questions. Our conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended relating to the partnership's future business expectations and predictions and financial condition and results of operations. These forward-looking statements involve certain risks and uncertainties. We've listed some of the important factors that could cause actual results to differ materially from those discussed in such forward-looking statements, which are referred to as cautionary statements in our earnings press release, which can be viewed on our website at suburbanpropane.com. While subsequent written and oral forward-looking statements attributable to the partnership or persons acting on its behalf are expressly qualified in their entirety by such cautionary statements. Our annual report on Form 10-K for the fiscal year ended September 24, 2022, and Form 10-Q for the period ended March 25, 2023, which will be filed by the end of business today, contain additional disclosure regarding forward-looking statements and risk factors. Copies may be obtained by contacting the partnership or the SEC. Certain non-GAAP measures will be discussed on this call. We have provided a description of those measures, as well as a discussion of why we believe this information to be useful in our Form 8K, which was furnished to the SEC this morning. The Form 8K will be available through a link in the investor relations section of our website. At this point, I will turn the call over to Mike Stavala for some opening comments. Mike?

Thanks, Devin. Good morning. Thank you all for joining us today. The fiscal 2023 second quarter was dominated by near record warm temperatures throughout much of the quarter, particularly in the eastern half of the United States, which limited customer demand for heating purposes. In fact, during January and February, the most critical months for heat-related demand, average temperatures were 16% warmer than normal, and that two-month stretch was reported as one of the warmest on record. Our West Coast operations experienced colder-than-normal temperatures, coupled with historic levels of snowfall and precipitation in certain areas. Customer demand in those territories responded well, which helped offset some of the volume shortfall in our eastern operating territories. The second quarter ended with a late burst of cooler temperatures at the end of March, which has created some momentum for customer demand into the early part of the fiscal third quarter. Therefore, when you look at the 2022-2023 heating season in its entirety, Aside from colder than normal temperatures in the latter half of December 2022 and cooler temperatures at the end of March, the majority of the heating season was unseasonably warm and in many areas of our footprint near record warm. However, our operating personnel have managed through these warmer weather scenarios before and do an excellent job managing the things they can control, providing outstanding service, managing selling prices, and controlling expenses. And with the success of our customer-based growth and retention initiatives over the past several years, we have stabilized our customer base, which helps support our overall volume performance. As a result of overall softness in demand, volumes in the quarter were 9.4% below the prior year second quarter, and adjusted EBITDA was down 13.6%. Despite the challenging second quarter as a result of the weather, The strength of our first quarter performance, which was up $3.5 million compared to the prior year, coupled with cooler than normal temperatures to start the third quarter, will help mitigate some of the earnings shortfall experienced in the second quarter. On the strategic front, as mentioned in detail during our first quarter earnings announcement, at the beginning of the second quarter, we expanded our renewable energy platform with the acquisition of renewable natural gas, or RNG, producing assets in Stanfield, Arizona and Columbus, Ohio for $190 million. These assets, when combined with the previously announced RNG facility to be constructed at Adirondack Farms in upstate New York, creates a platform that is expected to produce a run rate capacity of approximately 850,000 MMBTUs per year once expansion and upgrade plans are completed over the next 18 months or so. Since closing the acquisition at the end of December, We've been focused on integrating certain functions into the suburban platform, including back office activities such as cash management, accounting and financial reporting, and certain operational management functions. Equilibrium Capital, the seller, has agreed to provide ongoing operational management and transitional support to suburban under a management services agreement that extends through December 2025. This allows suburban to continue to benefit from the deep knowledge and expertise of the equilibrium management team in operating these assets during the transition. At the Stanfield facility, we have substantially completed the capital expansion efforts that were ongoing at the time of the acquisition. And since the beginning of March, have exceeded our expectations for daily pipeline injection. Stanfield facility generates revenues from a combination of RNG sales, LCFS credits in California, D3 and D5 RINs, tipping fees, and fertilizer sales. The Columbus facility is one of the main sources for receiving and processing municipal waste as well as food waste from several large food and beverage providers in the Columbus area. The facility earns tipping fees for accepting and processing approximately 100,000 tons of waste into biogas and fertilizer. We will be deploying additional capital to install gas upgrade equipment at the facility in order to upgrade the biogas into pipeline quality RNG. At which time, we will be able to earn additional revenue from sales of RNG, D5 RINs, LCFS credits, and fertilizer sales. We expect to reach run rate earnings capacity for the Columbus facility around the third quarter of fiscal 2024. Therefore, while there will be an immediate contribution to EBITDA in our fiscal 2023, The acquired facilities are expected to achieve run rate EBITDA once gas upgrade equipment is installed at the Columbus facility, with potential upside as earnings from both facilities benefit from efficiency gains, incremental production capacity, potential increases in LCFS and RIN credit values, as well as additional incentives from the Inflation Reduction Act. In addition to the acquired facilities, Suburban Renewable Energy and Equilibrium have formed a partnership to serve as a long-term growth platform for the identification, development, and operation of additional RNG projects. Under the joint venture agreement, the parties have agreed to invest up to $155 million over the next three years or so, of which Suburban will fund $120 million and Equilibrium will fund $35 million. Suburban Renewables will own approximately 70% of the joint venture once capital has been fully committed and deployed. We have a number of additional RNG projects and opportunities in varying stages of analysis under this joint venture partnership. In a moment, I'll come back for some closing remarks and provide additional color on our strategic initiatives. However, at this point, I'll turn it over to Mike Coughlin to discuss the second quarter in more detail. Mike?

Thanks, Mike, and good morning, everyone. To be consistent with previous reporting, as I discuss our second quarter results, I'm excluding the impact of unrealized mark-to-market adjustments on our commodity hedges, which resulted in an unrealized loss of $4.5 million for the second quarter compared to an unrealized gain of $33 million in the prior year. Excluding these items, as well as the non-cash equity and earnings of our unconsolidated subsidiaries accounted for under the equity method and acquisition-related transaction costs, net income for the second quarter was $112.8 million, or $1.76 per common unit, compared to net income of $142.8 million, or $2.26 per common unit, in the prior year. Adjusted EBITDA for the second quarter was $149 million, compared to $172.5 million in the prior year. As Mike mentioned, our earnings for the quarter were impacted by lower heat-related demand resulting from extremely warm weather during the most critical months of the quarter, as well as the continued impact of inflationary pressures on our expenses. Although those headwinds presented operating challenges, our earnings for the quarter benefited from organic growth in our customer base, continued solid margin management, and contribution from the R&G facilities acquired at the beginning of the quarter. Retail propane gallons sold in the second quarter were 144.1 million gallons, which was 9.4% lower than a prior year, primarily due to warmer weather, partially upset by favorable customer base trends. With respect to the weather, average temperatures as measured in heating degree days were 12% warmer than normal and 5% warmer than the prior year's second quarter. Although we experienced an overall decrease in heating degree days compared to the prior year, our operations were most negatively impacted by extremely warm temperatures during the critical months of January and February and were most pronounced in our east and midwest operating territories, while our operations in the west generally experienced normal to cooler than normal temperatures. For the months of January and February, average temperatures were 16% warmer than normal and 11% warmer than the same period last year and were on par for the warmest on record for that two-month period. From a commodity perspective, propane inventory levels in the U.S. remained elevated during the second quarter and contributed to declines in wholesale prices compared to the prior year's second quarter. According to the Energy Information Administration, U.S. propane inventories at the end of March 2023 were at 56 million barrels, which was 67% higher than March 2022 levels and 20% higher than historical averages for that time of the year. As a result of the increase in inventories and other factors, average wholesale prices for the second quarter of 82 cents per gallon at Spaces-Montbellevue decreased 37% compared to the prior year's second quarter. Excluding the impact of the mark-to-market adjustments on our commodity hedges that I mentioned earlier, total gross margin of $299.4 million for this second quarter decreased $16.7 million, or 5.3%, compared to the prior year, primarily due to lower volume sold, offset to an extent by higher propane unit margins and margin contribution from the RNG assets. Excluding the impact of the unrealized mark-to-market adjustments, Propane unit margins for the second quarter increased 4 cents, or 2.3%, per gallon compared to their prior year, primarily due to effect the selling price management during a period of declining commodity prices that helped offset the impact of inflationary pressures on our delivery costs and other expenses. With respect to our expenses, combined operating and G&A expenses of $153.1 million for the second quarter increased $10.1 million, or 7.1%, compared to their prior year, primarily due to continued inflationary pressures across most areas of the business, included higher payroll and benefit-related expenses, and higher vehicle lease and fuel costs. The comparison of our expenses to the prior year were also impacted by the costs associated with the acquisition and operations of the RNG assets. Included within GNA expenses for the second quarter, or acquisition-related costs of $3.4 million, which were excluded from adjusted EBITDA. Although inflationary pressures persist, they have been gradually moderating over the last few months. Nevertheless, we will remain focused on leveraging our investments in technology and our flexible operating model to drive efficiencies while continuing to provide superior customer service. Net interest expense of $19.9 million for the second quarter was $4.6 million were 30.3% higher than their prior year due to a higher level of average outstanding borrowings under a revolving credit facility resulting from the financing for the RNG acquisition coupled with higher benchmark interest rates for borrowings under the revolver, as well as the impact of the $80.6 million in green bonds assumed in the RNG acquisition. The green bonds are long-dated and carry an attractive fixed interest rate of 5.5%. Total capital spending for the quarter of $13.2 million was $1.6 million higher than their prior year, primarily due to growth capital associated with the expansion and upgrade of the RNG production facility in Stanfield, Arizona. Although construction at the Stanfield facility is substantially complete, we expect our growth capital spending in the near term to be higher than historical levels as we install the RNG upgrade equipment at the Columbus facility and construct the RNG facility at Adirondack Farms, which is expected to take about 18 months to complete. Turning to our balance sheet, during the second quarter, we'll utilize cash flows from operating activities and borrowings under the revolver to purchase the RNG production assets and to make additional investments in overall fuels, all in support of our long-term strategic goal of building out a renewable energy platform. As a result of the increase in total debt resulting from the RNG acquisition, which included the assumption of the green bonds, along with the impact of warmer weather on earnings during the second quarter, our consolidated leverage ratio for the trailing 12-month period ended March 2023 increased 4.43 times. Although the leverage metric is elevated relative to our historical levels and our target level of 3.5 times, we remain well within our debt covenant requirement of 5.75 times. We have now moved through our historically high period of seasonal working capital needs and into the fiscal quarters, we expect to generate excess cash flows. We will continue to remain focused on utilizing the excess cash flows to strengthen the balance sheet and as opportunities arise to fund strategic growth, including the growth capital for our RNG platform. We have more than ample borrowing capacity under our revolver to support our capital expansion plans and ongoing strategic growth initiatives. While the recent debt-funded acquisition will temporarily add to our leverage profile, We expect our leverage metrics will improve over time as the earnings from the acquired assets reach the run rate potential. As I stated last quarter, we have a long and proven track record of being great stewards of our balance sheet. We have long believed that conservative balance sheet management provides added protection for the potential short-term earnings impact of weather-driven demand softness, but also provides a dry powder for opportunistic investments in the execution of our long-term strategic initiatives. Over the course of the last three fiscal years, we've reduced our total debt by nearly $150 million, all while continuing to invest in the growth of the business. As we continue to focus on the execution of our long-term strategic goals, we will also stay focused on maintaining a strong balance sheet. Back to you, Mike.

Thanks, Mike. As announced on April 20th, our Board of Supervisors declared our quarterly distribution of 32.5 cents per common unit in respect of our second quarter of fiscal 2023. That equates to an annualized rate of $1.30 per common unit. Our quarterly distribution will be paid on May 9th to our unit holders of record as of May 2nd. Our distribution coverage continues to remain healthy at 2.26 times for the trailing 12-month period, despite lower earnings in the quarter and higher capital expenditures and interest associated with our RNG platform. So just a few more thoughts on our strategic initiatives and the build out of our renewable energy platform under suburban renewable energy. In addition to the expansion of our RNG platform during the quarter, we continue to advance our efforts to commercialize the new low carbon alternative called propane plus RDME. Through our 38% ownership stake in Oberon Fuels, the producer of renewable DME, Suburban propane is the only distributor in the United States to offer this new blended product that combines the low carbon benefits of traditional propane with renewable DME to further reduce the carbon intensity of propane in order to meet aggressive carbon reduction standards in California and beyond. We began our pilot program in April of 2022, and given the favorable results to date, we have begun to offer the blended product to all of our forklift customers in certain markets in Southern California, with expansion plans for other parts of California and ultimately other parts of the country. We have also started third-party testing of the blended product at higher blend levels in order to evaluate engine performance and emissions profiles. Once testing results have been analyzed, we expect to be able to increase the blend level from current ratios, which will have an even greater impact on carbon reduction. As for 25% investment in independence, hydrogen, the team and independence hydrogen have been working hard to commission their first clean hydrogen production facility in Virginia, which is expected to come online this month. Under their business model, independence hydrogen produces clean hydrogen locally and distributes in gaseous form to local markets initially for materials handling equipment. Since making our investment in March 2022, suburban propane has worked closely with the team at Independence Hydrogen to provide support across a number of functional areas, particularly given the similarity of their business model relative to our distribution model. In conclusion, we have long been known for our best-in-class operating model within a highly competitive and mature propane industry. Our operating personnel have done an excellent job managing our core propane operations, even in the face of many challenges in the economy over the past several years. We will continue to foster the growth of our core propane business while focusing on the execution of our long-term strategic growth plan for the continued build-out of our renewable energy platform under our newly created subsidiary, Suburban Renewable Energy. As society transitions to renewable energy solutions and low-carbon alternatives across many sectors of the economy, We are making strategic investments, leveraging our 95-year legacy as trusted local distributors of energy to position Suburban Propane for long-term growth and sustainability, creating long-term value for you, our valued unit holders. And finally, I want to take this opportunity to thank the more than 3,200 employees at Suburban Propane for their hard work and unwavering focus on the safety and comfort of our customers and the communities we've served during the last quarter. I'm extremely proud of all of their efforts. As always, we appreciate your support and attention and would now like to open the call up for questions. And Chad, if you wouldn't mind helping us with that. Certainly.

We will now begin our question and answer session. To ask a question, you may press star then one on your touchstone button. If you're using a speakerphone, please pick up your handset before pressing the keys. Withdraw your question. Please press star, then two.

At this time, we will pause momentarily to assemble our roster. First question will be from Gabe Maureen from Mizuho.

Please go ahead.

Morning, guys. Hey, Gabe. Welcome back. Thanks so much. Good to be back. Multi-part question on the RNG opportunity set. Just wondering now with the Arizona facility up and running, what the approach, I guess, is going to be to hedging or not hedging some of the different revenue streams kind of coming out of that facility. And then also wanted to know about the reference to CapEx being higher going forward. Just kind of wondered if you could give us a good sense for kind of the trajectory around the Ohio facility, how much of the spend might be this year, how much might be next, and then kind of relative amounts?

Sure. So as your first question on hedging, at this point, we're not. We have a long-term offtake agreement with one large customer that is taking all the gas that we're injecting into the pipeline and and we get the value of LCFS and RIN credits through that contract. As I said on our last call, when we were evaluating this acquisition opportunity, we had the benefit of seeing a decline in the LCFS markets and RIN values as well, which helped us to really evaluate the potential for the earnings of this business in what we consider to be sort of a more normal environmental attribute market with some potential downside risk, certainly, but also with the potential for upside as more states contemplate LCFS programs around the country. So, at this point, we're not evaluating the need to hedge, we're actually, on a trajectory to deliver the kind of results that we had expected, particularly from the Stanfield facility. And in fact, one of the things that we're starting to see is now that we've gotten the capital fully deployed and we're starting to see daily pipeline injection, we're actually, as I said in my opening remarks, starting to see daily injections exceed some of our expectations. So that's a good sign. for us to see, and we're also exploring additional opportunities to sell additional fertilizer that's coming off of the production process. So, you know, I think we're already finding ways to be more efficient as well as identify new opportunities for sales. And in the current credit environment, we're sort of happy where values are today, and we do believe there's upside. As to the capital question, you know, the Columbus facility is going to take about $12 million of capital to put in the upgrade equipment. Most of that is likely going to happen in fiscal 2024. There might be a little bit of capital this year, but I think most of it at this point is going to go into 2024. And then we still have the construction of the R&G assets up in upstate New York. There's probably another 12 to 15 million of capital in 2024. And maybe another 15 million or so this year in 2023. So that's kind of the trajectory we're on relative to growth capex for those two major projects. And hopefully that helps you with understanding where we're at.

Thanks, Mike. Yeah, I know that was very helpful. And then I wanted to, I guess, gauge kind of comfort with the balance sheet currently now that everything's closed. The winter's behind you. I think last quarter's call, you made some comment about potentially accelerating deleveraging. Maybe this quarter, it sounds like you're comfortable letting it occur naturally. So I'm just kind of, or over time, I'm just wondering kind of, you know, if there's been a change in stance there and what your latest thinking is there.

Yeah, I think we're comfortable where we are, Gabe. When these assets reach full run rate capacity in 2024, that'll naturally bring down the leverage. The other interesting thing, we obviously have a fair amount of excess free cash flow that has given us the opportunity over the last few years to delever as well as invest. And one of the things, if you look at our actual total debt at the end of March relative to the end of September, let's say, which was a bit of a low point. You know, we're only up about $170 million of debt, and that's after investing about $200 million in the RNG assets alone. So, you know, so I think The strength of our balance sheet, the excess cash flow generating capacity of the propane business has really afforded us an opportunity to deploy capital in, you know, higher growth opportunity investments such as the RNG platform and, you know, the other investments we've made in hydrogen and BME.

Gotcha. Thanks, Mike. Appreciate the time. Great. Thanks, Gabe.

And again, if you have a question, please press star then 1. The next question will be from Ned Berimov from Wells Fargo. Please go ahead.

Hey, good morning. Thanks for taking the question. Mike, in your remarks, you indicated, hi. So in your remarks, you indicated a number of other RNG opportunities under evaluation. Could you maybe provide more details on your funnel? Are you looking at new builds or operating facilities, the approximate size of these investments? And maybe if you can also give us a sense of how competitive is the RNG space today and who do you typically run into?

Yeah, it's all over the board, Ned. I think, first of all, just framing the potential. I think if you look at what we talked about with the joint venture, with equilibrium, which says that, you know, combined we're looking to deploy about $155 million of capital over the next three years or so, of which Suburban's piece of that is $120 million. You know, that sort of frames the potential. You know, we have a handful right now of opportunities that range from mostly, active facilities that maybe need a little bit more capital to get to a certain capacity or maybe upgrade to RNG like we're doing in the Columbus facility to, you know, small investments in bigger platforms that need a little bit of extra capital that maybe we don't want to take 100% ownership of to, you know, straight up, building opportunities similar to what we're doing at Adirondack Farms in upstate New York. And, you know, the good thing is that we, with all the activity that we have with Equilibrium and the team that we have a relationship with there, plus the firms that we're working with up in New York, we have a really good network of engineering, construction, maintenance, and procurement firms that we're very close to now that are providing excellent support on our projects, but also helping us identify additional opportunities. So, you know, there's nothing that I would say is imminent, but the funnel is pretty robust, and we're going to take a very patient and disciplined approach identifying the best opportunities that, uh, warrant us deploying capital.

Got it. Thanks for that. And then how do you think about propane acquisitions while the RNG assets are ramping up? Is this on hold or would you still look at kind of smaller tucking transactions if they make sense for you?

We, we we're, we're going to continue to feed the propane business. The propane business is our, is, is still our bread and butter. It is the source of cash flow that allows us to invest in higher growth opportunities such as renewable energy. And so, we're going to continue to look for ways to enhance that platform. We do have also a funnel of opportunities that are in active analysis right now. There's a couple. that are very promising, you know, relatively small tuck in, but, you know, fitting into our strategic view of, you know, highly attractive markets where we either have a very strong presence or we have identified population growth where the market can benefit from a suburban presence is not big enough today. So those are the kind of opportunities that we're seeing. And this is, as you know, the time of year where more and more of the smaller companies contemplate putting their business up for sale once the heating season is behind us. So, you know, the funnel in the propane M&A market is also starting to build nicely.

Very thorough. Thanks for all the detail. And one housekeeping item, if I may. Going forward, will you break out the contributions from your suburban renewable energy subsidiary as a separate segment?

As the earnings of the newly acquired RNG platform get to run rate, I would expect sometime, you know, probably at the tail end of 2024,

is when I would expect to see us do that, Ned. Thanks, Mike. Great. Thank you.

And again, if you have a question, please press star then 1. Ladies and gentlemen, this concludes our question and answer session.

I would like to turn the conference back over to Mike Stavala for any closing remarks.

Great. Thanks, Chad. Thank you all again for your attention today and your support. We hope that you enjoy the coming summer season, and we look forward to talking to you again after the end of our fiscal third quarter. Thank you.

And thank you, sir. The conference has now concluded. Thank you for attending today's presentation.