Sprague Resources LP

Good afternoon, ladies and gentlemen, and welcome to the SPREG Resources LV Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If you should require further assistance, please press star zero on your touchtone phone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your speaker host today, Mr. David Glendon, President and CEO of Sprague.

Thank you, Ditamara. Good afternoon, everyone, and welcome to Sprague Resources' second quarter 2021 conference call. Joining me today is David Long, our Chief Financial Officer. I'd like to remind listeners that some of today's call will include forward-looking statements. These statements are based on our current expectations which we believe to be reasonable as of today's date, and SPRAG does not undertake any obligation to update any forward-looking statements to reflect new information or future events. Actual results may differ significantly because of risks and uncertainties that are difficult to predict. Please refer to our 10-K for a list of risk factors which could cause our actual results to differ from anticipated results, and review our 10-K, 10-Q, current reports, and other filings with the SEC. We also describe our business using certain non-GAAP financial measures. Reconciliations of these measures to comparable GAAP measures are available in our non-GAAP quarterly supplement and our earnings press release, both of which can be found in the investor relations section of our website. A lot has changed at Sprague since our last quarterly call, and I'd like to use this opportunity to offer some perspective on those changes and the implications for our investor base. As listeners know, Axel Johnson was Sprague's sole or controlling shareholder for 50 years. Throughout that time, we benefited from their support through a variety of market conditions and energy transitions and could always count on their patient, long-term approach and shared values of safe, responsible operations and customer primacy. We're grateful for the experience of working with and for the family and for their unwavering commitment to Sprague's success. An important element of that commitment to our long-term sustainability was the acknowledgement that others may be better suited to supporting Sprague in the next phase of its development. As the Axel Johnson portfolio evolved away from its historical, industrial, and natural resource-centric model, Sprague became more of an outlier, with internal growth projects subject to heightened scrutiny. As we've gotten to know the Hartree team, it's become apparent that while they share the same core values, They also possess a vision to reinvest and build on our strong foundation in adapting to new energy market dynamics. They believe in the opportunity to leverage our unique assets, logistical expertise, and customer franchise to exciting new energy products and services while capturing the value in the long tail of our traditional offerings. The timing of our transition to Hartree's majority ownership aligns well to the dynamic shifts occurring in the broader energy markets. Clearly, while fossil fuels will continue to play a critical role in driving economic prosperity and growth, we're also seeing widespread enthusiasm for reduced carbon intensity of energy sources. Whether it's liquid renewable fuels like biodiesel and renewable diesel, or increased reliance upon solar or wind sources, We believe that Sprague is very well positioned to capitalize on these trends, just as we have in every energy transition over the last 150 years. In heating oil markets, we've seen several northeastern states recently pass legislation mandating higher use of renewables, which Sprague's extensive infrastructure and experience is well suited to serve. We're adapting our terminal distribution system provide higher bio blends and other lower carbon fuels. In solar, we're looking to expand our first in the world solar tank experience to evolve from merely displacing our own energy use to constructing larger scale generation systems that can support customer energy transitions. In wind energy, our Searsport terminal is positioned to be a critical part of the infrastructure, serving the burgeoning offshore market. Additionally, we're exploring the prospect of utilizing some of our tankage at terminal locations for conversion to digesters for renewable natural gas production. All of these opportunities highlight the ongoing value of our infrastructure and our experience in presenting compelling investment prospects. And I'm excited to capitalize on the growth potential in the business with Hartree's support and additional expertise. Given these attractive investment prospects, our board continues to evaluate the distribution policy to more effectively balance current income and a sustainable growth trajectory for the business. While no specific levels have been determined for forward quarters, I do expect we'll make cuts to current distribution levels in order to fund compelling growth projects with cash from operations and maintain higher coverage levels. Additionally, given our current relatively low permanent leverage, We believe we have ample room in our credit facility to execute on attractive acquisition opportunities that may present. We also expect to execute additional sales of assets exhibiting limited growth prospects to provide further liquidity for growth projects. Please note that we recently announced Q2 distributions of 66.75 cents per unit equal the prior quarters, so any potential change would be effective with the third quarter's distribution in early November. Now I'd like to turn the call over to Dave Long for a detailed review of our second quarter results. Dave? Thank you, Dave, and good afternoon, everyone.

Before we review the financial results, we're happy to report that Sprague successfully sold its Oswego New York terminal to an asphalt marketing customer in the second quarter. The transaction prices completed an attractive multiple with the proceeds used to pay down the company's acquisition debt balance. And now a discussion of our financial results. SPREG's quarterly adjusted gross margin decreased by 40%, or $26.4 million, to $38.8 million as compared to the second quarter of 2020. This decreases attributable losses in our refined products, natural gas, and materials handling businesses, and I'll provide more detail of the underlying results of each business shortly. SPREG's second quarter adjusted EBITDA of $3 million decreased by $25 million, or 89%, as compared to the prior year. Operating expenses increased by 4%, or $0.7 million in the second quarter, primarily due to increase in stockpiling expenses and employee overtime. SG&A expenses decreased by $2.3 million, or 12%, primarily as a result of a decrease in incentive compensation and to a lesser degree audit and legal costs. Below the EBITDA line, second quarter cash interest of $6.7 million decreased by $1.7 million, or 20% below the prior year, which was primarily due to lower borrowing rates. SPREG recorded $0.7 million for cash taxes in the second quarter, which was down by $1 million, or 58% year over year. Quarterly maintenance capex was higher by $2.2 million to $3.5 million, Maintenance CapEx was higher principally due to incremental investments in dock and tank repairs at several Sprague terminals. Given the decrease in adjusted EBITDA and increase in Maintenance CapEx, Sprague's distributable cash flow for the second quarter decreased by $24.9 million year-over-year to a negative $7.7 million, generating a quarterly distribution coverage ratio of negative 0.4 times. At the end of the second quarter, SPREG's permanent leverage was 3.7 times, while our borrowing capacity under our working capital and acquisition lines was $101 million at quarter end. In terms of forward guidance, SPREG's fully-adjusted EBITDA target remains unchanged at $105 billion to $120 million. And now a discussion of our business segments. In refined products, sales volumes increased by 10% for the quarter. adjusted gross margin decreased by $25.7 million, or 49% to $27.2 million, which was primarily due to weaker year-over-year market structure to purchase, store, and hedge inventory. We'd like to remind listeners that there was a strong contango market structure in 2020, which affords very considerable value in carrying higher inventory levels in Q2 of last year. In natural gas, sales volumes for the quarter increased by 5% year-over-year, while adjusted gross margin decreased by $0.5 million, or 21%, to negative $2.7 million compared to the same period a year ago. The increased volume was primarily attributable to improved economic conditions given the return to normal post-pandemic conditions, while gross margin was lower given warmer temperatures and lower price volatility, leading to fewer supply optimization opportunities. Materials handling the second quarter adjusted gross margin was $12.7 million, 2% or $0.2 million lower than the same period a year ago. The decrease was principally due to lower tank rent demand for third parties at Sprague's Canadian operation. At this point, I'd like to open the call for questions.

Thank you. To ask a question, please press star one on your touchtone telephone. If your question has been answered and you wish to remove yourself from the queue, please press the pound key. Again, that's star one to ask a question. The first response is from Bob Effies. Please go ahead.

Hi, Bob Epps from Investor in Richmond, Virginia. Can you tell me if any executive officers or management sold any of the stock of the partnership after July 15th?

We'd have to check the Form 4s, which are publicly available Speaking personally, I do have a 10B51 program in place, which has very limited selling on a monthly basis, which has just expired with this month. So specifically under that program, there would have been 3,000 units sold. But I'm not aware of any other executive team sales. I certainly didn't have any sales as CFO, so...

Okay. Given the overall nature of your earnings release, and I apologize for my raspy voice, but given the overall nature of your earnings release, why did you not pre-announce? I'm sorry, why did we not pre-announce? Yes, why did you not pre-announce? Because, you know, you would – you certainly would have had a sense of what the situation was as far as the earnings for the quarter prior to the end of the quarter.

Yeah, well, what I'd say, Bob, is these earnings are entirely consistent with what we'd expect in a normal trajectory in the business. So I think certainly comparative to last year where we had the contango that manifested itself in the middle part of the year, That was an outlier year in terms of the trajectory of earnings over the course of the year. If you look back at the history of this business, first quarter and fourth quarter generate the vast majority of the earnings, and second and third quarters are usually weaker, in many cases negative. So I think there's no reason to preannounce, given that it was entirely consistent with expectations for the trajectory of the business.

Thank you. Your next response is from David Rothschild. Please go ahead. Thank you.

I'm also a shareholder, been so since 2014. Your earnings announcement said you're going to provide more information on the anticipated change of the distribution, and I haven't heard any guidance on that. Do you have just a ballpark range? Well, it'll be at least a buck a share or or $1.20 a share, do you have any minimum level of what you think it will go down to? Or is it going to get sliced down to a dime or 20 cents? I mean, I'd like to get some guidance whether to hang on or dump the thing.

I can appreciate the desire to have more granularity on that. We're certainly not going to provide specific guidance at this point in time because, as you know, it is a board discussion that's held quarterly. But I hope I provided some perspective on it, which was really the – Potential magnitude of any distribution cut will be tied to growth capital investments that are exciting opportunities for the business. So if you look at the last several years, you can see that we haven't invested substantial amounts of growth capital in the business. And we do see opportunities along the lines of what I talked about. And those will be the driver. Again, the board conversations will continue up to and through the third quarter announcements.

Well, it sounds like the new general partner is not willing to support you as much as the old one was. That's what I'm hearing from you.

Yeah. Boy, if you heard it that way, then I've misspoken because I think it's exactly the opposite of that. I think the new general partner is very supportive of reinvesting in the business as opposed to, you know, maximizing their own cash take out of the business. So, well, look, we had a great sponsor and owner before who was very supportive of the business, but I'm equally excited, if not more so, about the prospects under the new majority owner who sees exciting opportunities to reinvest and grow the company.

It would still be nice to have some minimum level what you guys are thinking, just some rough guidance.

Yeah, I'm sorry. Again, that's going to continue to be a board discussion. So, you know, again, I don't see us in the camp of others who have, you know, made – Huge cuts to distributions, but again, we're going to continue those discussions and provide that guidance once those decisions are made.

Okay. Well, obviously, the market doesn't like the news today on your stock. Thank you. Thank you.

Again, to ask a question, please press star 1 on your telephone keypad. Your next response is from Eric George. Please go ahead.

Hey, gentlemen. Your new partner, I believe, paid about $16.50 for their position on a per share basis. Is that right? Yes.

For the LP units, that is correct. So they purchased the Axel Johnson holdings, which included the GP position, and they attributed some of the value to the GP.

And that was about what, three or four months ago?

End of May is when that transaction closed.

Okay. So that's, to an informed buyer and seller, that's what it's worth. I never understood what the hell it was doing at 28, so... And I'm not long the stock, so I'm trying to get an idea of where maybe to do that. And I like the 16.5 number. I may be hoping for, I may be being greedy here, but I would think at that level, barring a disastrous cut, the yield would still be competitive.

Yeah, that'll be, you know, up to your determination to make as to what you find compelling.

How is the materials handling doing? Is that still lagging a bit, or did you see it going forward? With all the windmill stuff going on, I thought that would be in better shape.

Yeah, well, you've seen the materials handling is down a touch. Some of that is, candidly, just timing-related issues, depending on when cargos land. Just to respond specifically to the windmills, there's a lot of enthusiasm and potential projects on the drawing board for windmills off of the East Coast, but there's very little physical activity right now associated with that enthusiasm. I think that will be a longer developing opportunity. I think it's potentially a very exciting opportunity for us, but I don't think you're going to see offshore wind components handled for a little bit of time. We have continued to handle some onshore components, but really that activity hasn't grown as much as an enthusiasm for offshore. The other two things that have... happened in materials handling, which would have caused a slight downdraft. David referenced the sale of the Oswego terminal, which was a materials handling asphalt terminal. So with that sale, there'll be a slight downdraft in the asphalt activity system-wide, although it was a very attractive sale for us. And also with the Contango coming out of the markets, some of our incremental tank leases at Kildare have not been replaced. But again, overall, that's a very rateable business, and you'll continue to see that over the course of the full year.

Thank you.

You're welcome.

Your next response is from Louis Goverman. Please go ahead.

Thank you. Thank you. I was just wondering if the board has had any conversations that you can share with us about whether a going private element is in the works or might be in the works, as we've seen in some other situations fairly recently.

No, there have been no board conversations, at least there's only been one board meeting with the new majority owner, and that was not a topic of conversation at that time. Okay.

You have a follow-up question from Rob Epps. Bob Epps, please go ahead.

Yes, and in your comments, you mentioned that you had a credit facility for acquisitions and opportunities. Given that you had that credit facility, why reduce the distribution?

We do have the credit facility. Obviously, we have leverage targets associated with that as well, and we tend to think of that credit facility as there to support potential acquisitions. as opposed to ongoing or recurring growth capex. So, again, we're going to balance all those factors as we contemplate or as the board contemplates appropriate distribution levels. But, no, I think it's not lost on anybody that our coverage ratios have been relatively tight or under one at points in the last couple of years. And so we think it's both appropriate to reinvest and have appropriate coverage levels going forward.

Is your credit facility for term debt or for revolving?

It's a revolving credit facility. Right.

There are no further responses in the queue at this time.

Thank you, everyone. Appreciate the time.

Ladies and gentlemen, this concludes today's conference. Thank you for participating. Have a wonderful day, and you may all disconnect.