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Sprague Resources LP (NYSE:SRLP)

Q2 2014 Earnings Conference Call

August 13, 2014 10:00 am ET


David C. Glendon - President and CEO

Paul A. Scoff - VP, General Counsel, Chief Compliance Officer and Secretary

Gary Rinaldi - SVP, COO and CFO


Theresa Chen - Barclays


Good morning, ladies and gentlemen, and thank you for joining the Second Quarter 2014 Sprague Resources Earnings Call: My name is Ryan. I'll be the operator in the event and at this time all participants are in listen-only mode. However, later we will be opening the lines to facilitate questions and answers (Operator Instructions). As a reminder, we are recording the event for replay. And now it's my pleasure to pass the call over to Mr. David Glendon, President and CEO.

David C. Glendon

Thank you, Ryan. Good morning everyone and welcome to the Sprague Resources second quarter 2014 earnings conference call. Joining me today are Gary Rinaldi, our Chief Operating Officer and Chief Financial Officer; Paul Scoff, our Vice President and General Counsel; and John Moore, our Vice President and Chief Accounting Officer. Following my introductory remarks, Gary will review our financial results. We'll then open the call to questions. But first, I'd like Paul to provide our forward-looking statement disclaimer and discuss our use of non-GAAP measures.

Paul A. Scoff

Thank you, Dave. As a reminder, some of today's call will include forward-looking statements. While Sprague believes these statements to be reasonable as of today's date, future results are subject to many risks and uncertainties that are difficult to predict and outside of management's control. Any forward-looking statements we make are qualified by the Risk Factors in our most recently filed SEC Form 10-K and future filings with the SEC. Sprague Resources LP undertakes no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise.

I would also like to remind listeners that we hedge our Refined Products inventory and Natural Gas inventory and transportation capacity with the best available derivative instruments to minimize commodity price risk. Since derivative gains and losses are reflected in our GAAP financials without the accompanying offset for physical positions, our GAAP reported net income will often experience large swings.

Periods of market price increases can be associated with net losses related to our derivative hedges and have a resultant negative impact on GAAP earnings. We believe it is important for our unitholders to understand how Sprague's underlying business is performing regardless of which way commodity markets move. Therefore we adjust our results for the unrealized portion of our derivative hedges and report adjusted EBITDA and adjusted gross margin.

You can find a discussion of our use of these non-GAAP measures as well as reconciliations between these non-GAAP measures and their most comparable GAAP figures in our press release in the Investor Relations section of Sprague's Web-site, Dave?

David C. Glendon

Thank you, Paul. Once again, I'd like to welcome everyone to Sprague Resources second quarter 2014 conference call and remind listeners that figures provided on this call exclude the impact of Kildair on our second quarter 2013 results in order to make year-over-year comparison more meaningful. Tables which include historical Kildair results can be found accompanying this morning's press release on our Web-site.

Sprague's second quarter results were in line with our internal expectations and closed an outstanding first half of 2014. Adjusted gross margin for the second quarter was $25.8 million and adjusted EBITDA and distributable cash flow were both $3.5 million. Those amounts place Sprague's first half performance at a significant increase relative to 2013. Adjusted gross margin is running $29.7 million or 35% ahead of last year; adjusted EBITDA for the first two quarters is 56% higher than the same year ago period; and distributable cash flow at $47.5 million is more than double our pro forma results in the first half of 2013.

While our distribution coverage ratio for the second quarter was 0.4 times, I want to remind listeners that the seasonal nature of our business is expected to result in higher first and fourth quarter coverage, offset by lower coverage in the second and third quarters. We are maintaining full year 2014 adjusted EBITDA guidance between $70 million and $80 million and still expect distribution coverage for the year to be well above our target of 1.2 times.

Given the strong start to 2014, Sprague's Board of Directors declared the first distribution increase to unitholders after only our third quarter as a public company. On July 29, Sprague's general partner declared a quarterly cash distribution of $0.4275 per unit or $1.71 on an annualized basis, representing a 3.6% increase over the distribution declared for the first quarter of 2014. The increase is consistent with our previously issued guidance of targeting annual distribution growth of 6% to 8%. The distribution will be paid on August 14 to unitholders of record as of August 8.

Turning to each business segment; Sprague's Refined Products' second quarter performance decreased slightly as several Northeast states transitioned to lower sulfur heating oil for July 1 deadline, prompting increased competitive pricing pressures and lower sales volumes as market participants reduced inventories of high sulfur fuel to ensure compliance.

However, Sprague continued to benefit from our acquisition of the Hess commercial fuels business at the end of 2013 with higher diesel sales in the second quarter partially offsetting the lower year-over-year contribution from heating oil. Gasoline margins and volumes were down slightly from the previous year while residual fuel results were negatively affected by an unfavorable market structure.

Sprague's Refined Products team continued to strengthen its position in key markets in the second quarter by signing a multiple year exclusive terminal operating agreement with Dunellen Inc. for over 1 million barrels of distillate storage at its capital terminal in East Providence, Rhode Island. This agreement extends Sprague's marketing presence to both sides of Providence Harbor and allows our team to capitalize on one of the region's largest and most convenient terminal assets.

On July 2, Sprague signed another multiyear exclusive terminal operating agreement in the New Haven Connecticut market with New Haven Terminal, Inc. for 700,000 barrels of distillate petroleum storage. Together, these facilities extend our Northeast network of proprietary terminals and position us to capture additional volume.

Sprague's second quarter Natural Gas performance was also solid. The Natural Gas team continues to build on its position in our core Northeast footprint. The cooler weather in the second quarter resulted in lower volumes compared to the second quarter of 2013. Reduced price volatility led to fewer opportunities to leverage our asset portfolio, accounting for most of the quarter's adjusted gross margin decline. Our sales team continues to attract new customers with products and services that allow customers to astutely manage their natural gas supply while meeting their budget objectives.

Finally, Sprague's Materials Handling segment once again provided a valuable diversification benefit to our earnings stream in the second quarter by posting a 5% year-over-year gross margin increase. Higher handling revenue from salt shipments was a primary driver for the quarter given lower customer inventories exiting this winter compared to 2013. Increased heating charges and windmill handling revenue also served to offset lower results in dry and liquid bulk activities, which declined due to vessel timing differences.

Now, I'd like to turn the call over to Gary for a more detailed review of our results.

Gary Rinaldi

Thank you, David, and good morning everyone. I'll now provide some additional detail on Sprague's second quarter results. Sprague's operating and financial results are in line with our historical second quarter experience and expectations. Sprague's performance year-to-date remains strong and we continue to expect outstanding results for 2014 as a whole.

Sprague's adjusted gross margin was $25.8 million in the second quarter of 2014 compared to $28 million for the year ago quarter, a decrease of 8%. Adjusted EBITDA totaled $3.5 million, a $4.5 million decrease compared to the second quarter last year. However, distributable cash flow increased by $2.7 million.

For the six months ended June 30, Sprague's adjusted gross margin was $114.4 million, a $29.7 million or 35% increase versus 2013, and adjusted EBITDA was $53.1 million, a 56% increase over the six months ended June 30 last year. Distributable cash flow for the first half of 2014 increased by $27.5 million or 138% compared to the first half of 2013.

Sprague's operating expenses increased 13% or $1.4 million to $12.4 million during the second quarter of 2014 relative to the second quarter last year. The majority of the higher operating expenses were attributable to our Bridgeport terminal which was acquired in the third quarter of 2013. The balance of the operating expense increase was due to higher terminal maintenance and utility expenses, partially offset by lower costs related to bulk handling activities in our Materials Handling business due to vessel timing differences.

Sprague's SG&A cost decreased to $100,000 in the second quarter of 2014 compared to 2013. The decrease is primarily related to lower incentive compensation and associated employee benefit accruals as well as lower sales commissions tied to gross margin. This was partially offset by higher professional fees associated with being a public company.

Now turning to our business segments; sales volume in our Refined Products business increased 14.7 million gallons or 6% compared to the second quarter of 2013. Net sales increased 10% to $768.8 million as a result of higher volumes year-over-year.

The increase in total volume was primarily due to higher distillate sales totaling 16.1 million gallons period over period, as a significant gain in ratable diesel volumes more than offset lower sales in heating oil and gasoline. Residual fuel volumes were in line with last year's second quarter results. As David mentioned, the Hess contract assumption entered into at the end of 2013 has added favorably to both our first and second quarter results, providing increased ratable diesel volumes.

Refined Products adjusted gross margin declined $1.7 million to $14.5 million in the second quarter as lower heating oil unit margins and volumes and an unfavorable market structure for residual fuel combined to outweigh the gain from the increased diesel sales. For the six months ended June 30, 2014, Sprague's Refined Products team generated adjusted gross margin of $59.4 million, an increase of 31% versus the first half of 2013.

In our Natural Gas business, second quarter 2014 volumes were 3% lower resulting from comparatively cooler weather. The higher average selling price in the second quarter offset lower volumes and drove Natural Gas net sales to $67.3 million, a 5% increase relative to the year ago quarter.

Natural Gas adjusted gross margin decreased $900,000 to $2.7 million in the second quarter compared to $3.6 million last year. The decrease was primarily due to a combination of reduced margin generation opportunities from the optimization of transportation assets and storage utilization and to a lesser extent reduced demand from cooler than normal temperatures. For the first two quarters of 2014, Sprague's Natural Gas team has posted an adjusted gross margin of $38 million, an increase of 58% over the first half of 2013.

Finally, Materials Handling net sales and gross margin increased $400,000 or 5% to $8.3 million in the second quarter versus last year. Results were driven by higher year-over-year handling revenue from salt shipments, an increase in asphalt heating charges and stronger coal and windmill handling activity. This was partially offset by lower pulp volumes and vessel timing differences for gypsum and furnace led products. For the six months ended June 30, 2014, Sprague's Materials Handling team has generated gross margin of $16.4 million, an increase of 13% relative to the first six months of 2013.

With respect to liquidity, Sprague ended the first quarter with $139.8 million borrowed under the working capital facility and $107.9 million outstanding against the acquisition line. Sprague's available liquidity on its acquisition line with $142.1 million at the end of the second quarter which can be further expanded by accessing accordions up to an additional $200 million, providing strong liquidity and capacity for acquisitions. At the end of the second quarter, Sprague's permanent leverage ratio was 1.3x adjusted EBITDA on a trailing 12 month basis.

Turning briefly to capital expenditures, Sprague's maintenance CapEx was $700,000 for the second quarter, a $1 million decrease from the second quarter of 2013. While Sprague's maintenance CapEx is generally higher than the second and third quarters, this year's decline was due to the timing of certain projects shifting to the third and fourth quarters.

Sprague's second quarter performance resulted in distributable cash flow of $3.5 million compared to $856,000 for the second quarter of 2013. Sprague's distributable cash flow represents distribution coverage of 0.4x for the quarter, and on a trailing 12-month basis Sprague's pro forma distribution coverage was 2x.

As David mentioned, in early July, Sprague's Board of Directors approved an anticipated change in the Company's incentive compensation plan that resulted in a $3.6 million increase to distributable cash flow, which represents our estimate of the year-to-date incentive compensation that will be settled in partnership units. While material in the second quarter, the change in the incentive compensation plan primarily relates to the distributable cash generated in the first quarter.

Distributable cash flow for the first half of 2014 was $47.5 million, resulting in distribution coverage of 2.8x for the period and 1.4x on estimated full-year 2014 distribution. Compared to the first half of 2013, Sprague's distributable cash flow has increased more than 138% year-over-year.

Our strong results in the first and second quarters have allowed us to maintain our previous full-year 2014 adjusted EBITDA guidance between $70 million and $80 million, which does not include the impact of any acquisitions or the anticipated drop-down of Kildair. We expect 2014 maintenance CapEx to total between $6.5 million and $7 million and we continue to target annual distribution growth of 6% to 8%. Please note that this guidance is based on assumptions such as demand for our products and services, weather and changes in market structure.

Finally, a brief update on Kildair. Despite unseasonably cold temperatures and early and heavy snowfall, the $30 million expansion project to add a transload crude oil storage and handling operation to the Kildair terminal was completed by June 1, on budget and a full month ahead of the contractual requirement. Kildair has begun receiving railcars of inland crude oil and expects to load its first crude vessel in the third quarter. Kildair's team continues to evaluate additional material handling opportunities to utilize the remaining available storage capacity acquired in 2011.

Kildair expects to achieve an adjusted EBITDA between $18 million and $21 million for 2014, which will include seven months of crude storage and handling operations. Kildair's maintenance CapEx is being managed in a similar fashion to Sprague's current asset base with a long term annual target of approximately 8% to 10% of adjusted EBITDA. Like Sprague, Kildair's guidance is based on assumptions which include demand for its products and services, weather and changes in market structure.

Regarding the expected drop-down of Kildair, it would be premature at this time to speculate on any terms for the transaction. Our sponsor's expectation is that the transaction may occur in the fourth quarter of 2014 or in the first quarter of 2015.

I would now like to take a moment to recognize Sprague's transportation fleet which this spring was awarded the New York State Motor Truck Association's Grand Safety Award for 2013, recognizing Sprague's best-in-class safety record and an overall safety culture considered better than all first place finishers in every size category. The Sprague's fleet overall commitment to safety programs, policies and procedures were recognized to be superior to many nationally based companies with much greater resources than Sprague.

I am proud to report awards like this to our unitholders because they allow a glimpse of the quality of our employees and their dedication to our values that have repeatedly enabled Sprague to achieve best-in-class performance throughout our history.

This concludes my remarks, and Dave would like to wrap up with some final comments before we take questions. David?

David C. Glendon

Thank you, Gary. Before turning to questions, I'd like to close with a discussion on the acquisition outlook. Our team continues to evaluate multiple potential transactions across each business segment, which is the result of our long-term strategy of relationship building, resulting in Sprague being seen as the preferred acquirer. Although we cannot give assurances regarding any specific acquisitions, we remain confident Sprague will close at least one moderately sized transaction in 2014 in addition to the potential Kildair drop-down.

In closing, Sprague's strong financial results in the first half of 2014 are a testament to our ability to work together as a team and deliver value for our customers and unitholders. I'm inspired by the attitudes and commitment of our employees to meet the needs of our diverse customer base everyday and finding ways to continue the 144 year tradition of innovating our product offering. We have had an outstanding 2014 year-to-date and I'd like to thank the Sprague team for their efforts in achieving those results.

Now, we'll open the call for questions.

Question-and-Answer Session


(Operator Instructions) We have a question coming through from Theresa Chen with Barclays.

Theresa Chen - Barclays

I have a question about the Refined Products segment. The color and comments around the multistate condition from high to low sulfur heating oil, are there going to be more states coming online doing that or is that primarily over? I'm just thinking about if this is going to be a continual headwind into next year or not.

David C. Glendon

Let me answer on two ways, Theresa. One, there are a couple of additional Northeast states which are scheduled to convert and gradually lowers the sulfur in heating oil over the next four years. So what we've had is two of the Northeast states have not yet made the initial transition to the 500 ppm standard that three or four of the states made on July 1 of this year. So there will be additional conversions taking place again in 2016 and then further reductions in sulfur standards in 2018.

Having said that, I don't view it as a headwind at all. I think this was a transitional period or candidly we chose to reduce our inventories in advance of the deadline to ensure we were in compliance, and as others were also emptying their tanks of the higher sulfur product, there is understandably a little bit more competition for the incremental demand which is limited at this point in the year anyway.

So, I don't, I wouldn't consider it a headwind on a go forward basis. In fact in previous calls, I've talked about the change in sulfur standards is offering opportunities for entities like Sprague who can be nimble in responding to those transitions and committed to the heating oil market despite the changes in sulfur specifications.

Theresa Chen - Barclays

Okay. So I guess it seems like in the future the market will be better prepared for this kind of event?

David C. Glendon

And again, don't get me wrong, I think the market was prepared for it, it was just a – you've got your inventories that you're trying to reduce and clean-out your tanks in advance of the transition to lower sulfur. So, I hope I haven't given the impression that we or others weren't prepared for it. It was a known event and we chose to reduce our inventories in advance of that just given the timing of supply considerations.

Theresa Chen - Barclays

Understood. And then, would you mind just commenting about current quarter trends in volumes and margins in both Natural Gas and Refined Products and how that's going now?

David C. Glendon

We generally don't comment much on the current quarter issues, specific guidance to the quarter. I would say it's consistent with our expectations just as the second quarter was consistent with our expectations.

Theresa Chen - Barclays

Okay, great. Thank you.


We have no other questions in the queue. So I'll pass it back to David for any closing remarks.

David C. Glendon

Thank you very much, Ryan, and thanks everybody for joining. I look forward to continuing the dialog with many of you and answering any further questions that folks have.


Okay, so ladies and gentlemen, thank you all for your time and your participation, and have a great day.

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