BlueKnight Energy Partners' (BKEP) CEO Mark Hurley on Q2 2016 Results - Earnings Call Transcript

| About: Blueknight Energy (BKEP)

BlueKnight Energy Partners LP LLC (NASDAQ:BKEP)

Q2 2016 Earnings Call

August 3, 2016 02:30 PM ET

Executives

Alex Stallings – Chief Financial Officer

Mark Hurley – Chief Executive Officer

Analysts

Tristan Richardson – SunTrust

Matt Schmid – Stephens

Edward Spilka – Praxis

Operator

Good day and welcome to the Blueknight Energy Partners Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Alex Stallings, Chief Financial Officer. Please go ahead.

Alex Stallings

Thank you, Bianca. I'll provide a brief update on financial results and Mark Hurley, our CEO will provide you an update on operational performance, projects and opportunities, the status on of the Ergon transaction and external factors, which are influencing our business. We will then take your questions after our prepared comments.

Before we begin, I would like to remind everyone that information on this call may contain certain forward-looking statements that are subject to various risk and uncertainties. These risks and uncertainties include, among other things, uncertainties relating to the Partnership's debt levels and restrictions in our credit facility, our exposure to the credit risk of our third-party customers, Partnership's future cash flows and operations, future market conditions, current and future governmental regulation, future taxation, and other factors.

If any of these risks or uncertainties materialize or should have underlying assumptions that prove incorrect, actual results or outcomes may vary materially from those expected. Please refer to Blueknight's SEC filings for a description of these risks and other risks and uncertainties that could affect our actual results.

Blueknight undertakes no obligation to update or revise any forward-looking statements contained on this call, whether as a result of new information, future events, or otherwise.

Yesterday we reported financial results for the second quarter and six months ended June 30 of 2016. Let me start off by first saying, that we do have noise in our numbers from the proposed Ergon transaction and from incremental common unit distributions related to the common unit offering we completed on July 26 of 2016 that have and will continue to affect comparability between the periods. To the extent possible, we will try to identify and call out these items to help better compare periods.

BKEP's adjusted EBITDA was $16.2 million for the three months ended June 30 of 2016 as compared to $17.2 million for the same period in 2015. Adjusted EBITDA was $29.8 million for the six months ended June 30 of 2016 compared to $30.1 million for the same period in 2015.

BKEP's distributable cash flow was $9.2 million for the three months ended June 30 of 2016, as compared to $13.3 million for the same period in 2015. Distributable cash flow for the six months ended June 30 of 2016 was $17.9 million, as compared to $24.3 million for the same period in 2015. Our distribution coverage ratio was 0.82 times for both the three months and six months periods ended June 30 of 2016.

Distributable cash flow and coverage for the three months and six months ended June 30 of 2016 included $0.3 million paid of cash paid for fees related to the Ergon transaction. Our distribution coverage also includes $0.6 million of distributions, which were attributable for the common units that were issued last week. Excluding both the Ergon related transaction fees and the incremental distributions, our coverage would have been closer to 0.9 times for the quarter.

Distributable cash flow and coverage for the first six months of 2015 included $2.3 million of cash proceeds related to the sale of common units received in connection with the settlement of the 2008 claim with the previously related entity. Distributable cash flow and coverage were also impacted by increases in maintenance capital expenditures of $2.3 million and $2.6 million for the three months and six months ended June 30, 2016, as compared to the same periods in 2015 respectively due to the timing of capital expenditures, which are typically weighted towards the first half of the year for our asphalt terminalling facilities, and as a result of unanticipated maintenance capital related to storage tanks at three BKEP Asphalt terminal facilities.

We anticipate the run rate of maintenance capital expenditures to decrease in the second half of 2016. The Partnership reported a net loss of $18.9 million on total revenues of $43.4 million for the three months ended June 30, 2016 versus net income of $7.7 million on total revenues of $46.6 million for the same period in 2015. BKEP recorded a net loss of $18.2 million on total revenues of $84.4 million for the six months ended June 30, 2016 compared to net income of $9.3 million on total revenues of $88.9 million for the first half of 2015. Net loss for the three months and six months ended June 30, 2016 was impacted by impairment expense of $22.6 million and $22.8 million respectively, primarily related to the cancellation of the Knight Warrior, East Texas, Eaglebine/Woodbine crude oil pipeline project as previously disclosed.

BKEP also previously announced the second quarter 2016 cash distribution of $0.1450 per common unit which is equal to the previous quarter's distribution and a 1.8% increase over the second quarter of 2015 distribution. Partnership also announced the $0.17875 distribution for per preferred unit.

Additional information regarding the Partnership's results of operations will be provided in the Partnership's Annual Report on Form 10-Q for the quarter ended June 30, 2016 to be filed today – later today with the SEC. Few highlights for each of the segments. Asphalt terminalling services, segment reported $11.5 million of operating margin excluding depreciation and amortization for the second quarter of 2016 as compared to $12.7 million for the second quarter of 2015. The quarter-over-quarter decrease was primarily due to a contract renegotiation fee that was earned in the second quarter of 2015 that was partially offset by the impact of the three new terminals acquired since the second quarter of 2015.

Overall, the asphalt terminalling services segment operating margin excluding depreciation and amortization is up 7% for the six months ended June 30 of 2016, as compared to the same period in 2015.

Crude oil terminalling and storage, this segment had a good quarter, as compared to the second quarter of 2015. Operating margin excluding D&A was $5.1 million for the three months ended June 30 of 2016, as compared to $4.9 million for the second quarter of 2015, representing a 5% increase quarter-over-quarter. For the first six months of 2016, operating margin increased 15% year-over-year to $10.3 million.

As discussed in previous quarters, our operating margin was impacted by the timing of storage contract renewals. Average storage rates during the first half of 2015 were lower than the average storage rates for the second half of 2015, which have continued into 2016.

As contracts expired in 2015, we were able to increase the storage rates to better reflect current market rates, increase demand, and the change from the backward-dated crude market curve, which favors transportation to a contango market curve, which favors storage. The transition of the slope of the curve took place in late 2014.

Operating expenses for the segment decreased as compared to the three months and six months ended June 30 of 2015, primarily as a result of decreases in utilities expense.

Crude oil pipeline, operating margin of $1.9 million for the three months ended June 30 of 2016, was consistent with the same period in 2015. However, it decreased by $2.2 million, when comparing to six months ended June 30 of 2016, as compared to the previously comparable period.

Results for the three months and six months ended June 30, 2015 included a one-year temporary tariff, that was being charged from June 2014 through May 2015, on certain barrels transported on East Texas pipeline system, under a throughput and efficiency agreement. The tariff returned to a lower rate in June of 2015. Revenues of $2.2 million and $4.7 million were generated for the three months and six months ended June 30, 2015 respectively related to this increased care.

Further in late April 2016 as a precautionary measure, we suspended service on our Mid-Continent pipeline system due to the discovery of a pipeline exposure caused by recent heavy rains and the erosion of a riverbed in Southern Oklahoma. There was no damage to the pipe and no loss of product.

In the second quarter of 2016, we took action to mitigate the service suspension and work with customers to divert volumes and in certain circumstances, transported volumes through a third-party pipeline system via truck. In addition, the term of the throughput efficiency agreements on our Eagle North system expired at June 30, 2016 and in July of 2016, we completed a connection of our southeastern most portion of our Mid-Continent pipeline system through our Eagle North system in concurrent way to reverse that system. This enabled us to recapture devoted volumes and deliver those barrels to Cushing, Oklahoma.

As a result, we are currently operating the one Oklahoma Mainline System, which is a combination of both the Mid-Continent and Eagle pipeline systems instead of the two separate systems. We continue to evaluate the timing of and long-term repair necessary to allow us to operate the two separate Oklahoma pipeline systems, as well as the potential overall financial impact. The timing costs and overall potential – financial impact of re-establishing a second Oklahoma pipeline system is dependent on the overall scope of our condensate pipeline project, which we continue to evaluate.

Mark will share further thoughts on this project in his remarks. The three months ended June 30, of 2016 did include $1.6 million of crude oil sales, arising from product loss allowances in the three months ended June 30, of 2016, there were no set such sales of crude oil arising from PLA sales in the three or six months ended 30 of 2015. Operating expenses have decreased primarily as a result of decreases in maintenance and repair and compensation expenses, crude oil trucking and producer field services.

Operating margin increased to $1.1 million for the three months ended June 30, of 2016 compared to $0.4 million for the three months ended June 30, of 2015 primarily due to the sale of crude oil and due to increased distances in average hauls. Operating margin decreased for the six months ended June 30, of 2016 as compared to the comparable period in 2015 due to continued pressure on trucking and producer filed service rates, due to the decline in crude oil prices and a decrease in overall transported volumes.

A few other items. General and administrative expenses increased slightly to $4.8 million for the three months ended June 30, of 2016 compared to $4.7 million for the three months June 30, of 2015, this increase is primarily due to half a million of transaction fees related to the Ergon transaction, offset by decreases in compensation expense and insurance premiums. G&A expenses were consistent for the six-month period ended June 30, 2016 as compared to the same period in 2015. We expect incremental expenses of approximately $1 million to $1.5 million in the third quarter of 2016 related to Ergon transaction fees.

Liquidity, our consolidated total leverage ratio was 4.4 times to 1 at June 30 of 2016, which is an increase from year end, as a result of our asphalt terminal acquisition in February of 2016. As of July 28 of 2016 we have aggregate unused commitments under revolving credit facility of approximately $147.7 million in cash on hand of $23 million.

From a capital investment perspective, our net expansion capital expenditures totaled $4 million for the six months ended June 30 of 2016. We are currently estimating expansion capital expenditures of $8 million to $9 million for all of 2016, not including the acquisitions that we previously announced and discussed.

Net maintenance capital expenditures for 2016 totaled $5.6 million. For the year, we expect maintenance capital expenditures to be in the $7 million to $8 million range, net of reimbursable expenditures.

With that I will now turn it over to our CEO, Mark Hurley, Mark?

Mark Hurley

Yeah. Thank you, Alex. And thanks to all of you who dialed in today. I will first remind you every one of the exciting announcement we made in just about two weeks ago with Ergon buying our general partner and as of part of the same deal, BlueKnight acquiring nine Ergon terminals.

I am happy to say that this transaction remains on track. All necessary filings have been made and we expect no significant issues in getting it closed. We had initially targeted a closing by September 30, but I think there is a good possibility we will be able to close before that. We also had a very successful equity raise just last week that was substantially oversubscribed. So, we believe investors had so far responded positively to the overall Ergon transactions. This deal marks a new era for the company and it will no doubt be transformative for the Partnership.

With respect to second quarter results, I will begin with our asphalt business, which remains very good. We anticipated strong volumes and revenues this year and that is playing out the way we planned. Alex did point out that we had some special one-off items last year that make the year-to-year comparison a little more difficult in Q2, but the base business is in very good shape and growing. Operating margin for the segment of our business was up 7% year-to-date. And I will point out that the two acquisitions we made over the last 15 months are performing very well and involve our investment expectations.

Another segment that is doing very well is our crude oil storage business, most of which is done at our Cushing, Oklahoma terminal. Our operating margin for this segment was up 15% year-to-date as compared to 2015.

And now, I want to give you an update on our contract renegotiation process at Cushing. I believe we mentioned in previous communications that we had all of our contracts at Cushing reaching exploration by the second quarter of next year. We put a high priority on getting these contracts extended or renegotiated, and I'm happy to say that we've reached agreement with either existing customers or new customers on more than 80% of our capacity, and negotiations are ongoing for the remainder. The new agreements range in duration from one year to five years. Rates are stable and we're taking the opportunity to better stagger exploration terms.

We're confident we'll get the balance of our capacity extended very soon as the crude storage market is currently very strong. We're contracted today and we intend to remain that way. As to our crude oil pipeline business, our top priority, has been on getting our Oklahoma mainline service restored, following the erosion of the riverbed in Southern Oklahoma, which forced us to shut this system down. It was excellent effort by operations and engineering team, we've now restored service on this system and we expect volumes will be increasing over the next several weeks. Because of the need to reconfigure our Oklahoma system, as a result of this service disruption, we will push back the startup of our condensate pipeline project to first half of next year.

However, we remain very optimistic about the project, volumes and drilling activity in the SCOOP and the STACK plays, remain good even in the weak crude oil price environment. As a result, I think that between the strong fundamentals in these areas, coupled with the small amount of capital necessary our condensate pipeline project has a good future.

Looking ahead our priorities and strategy will remain unchanged, of course the number one priority is getting our Ergon transaction completed. But beyond that, we will continue to focus on one strengthening our balance sheet. Two keeping a strong focus on cost control and three, continuing to look for accretive transactions and organic projects. I do want to reiterate that the Ergon transaction will not change our growth focus in a manner, in which we intend to grow.

We've had success over the last year particularly the smaller acquisitions and our enthusiasm for finding these opportunities will not waiver.

Operator that is the end of my prepared comments. We're now ready to open up for lines to Q&A.

Question-and-Answer Session

Operator

We will now begin the question and answer session [Operator Instructions] The first question comes from Tristan Richardson with SunTrust. Please go ahead.

Tristan Richardson

Afternoon, guys.

Alex Stallings

Hi, Tristan.

Mark Hurley

Hi, Tristan.

Tristan Richardson

Just curious on the renegotiation effort. You talked about the contracts looking more attractive in the second half of 2015, during that renegotiation period. As you talked about that 80% of renegotiations taking place, could you just talk sort of about pricing trajectory in the current year as you look forward?

Mark Hurley

Yeah. I mean, we don't give out specific prices on or specific pricing on specific deals. But I will tell you that, I think if you look at which the rates that we're now seeing compared to those to history, the rates are pretty much at the average, just slightly better. And so, when I think – I think when you take into consideration some of the contracts that we have rolling off, of the board and some of the new ones that we have, we will be at least on par with where we have been or slightly have that.

Tristan Richardson

Great. That's helpful. And then just on the advantage system, could you just talk a little bit about how activity there is trending and how that would sort of impact the equity earnings line as we look forward?

Mark Hurley

Yeah. We just in terms of what's going on fundamentally, we certainly have, I think the rig count and even in the Delaware Basin which is a very kind of bullish area has been roll-off by about 70%. And so, we've seen the impact there just as we have in other places. The rates on the volumes on the pipe have declined by, I would say about 30% to 40% but they've leveled off, so we saw that initial decrease over the last half of last year and first part of this year, but we have actually seen things remain pretty steady from the end of the first quarter through what we are currently seeing now. And so, if where we are now kind of represents a longer term or median term expectation for the rig count, the volumes are hanging in there and I attribute that to the fact that it's fundamentally just a very good area.

As far as the impact on earnings, I'll let Alex talk to that one.

Alex Stallings

Yeah, Tristan. From the impact on earnings perspective, I mean I think that what you're seeing and what you'll see kind of for the second quarter is really kind of where we projected it kind of going forward for now. I mean we are basically showing it holding steady with essentially where it is today, so which is down a little bit from where it was in probably Q1 and definitely down from where it was in 2015, but to Mark's point we've seen that – we've seen it kind of level off. And so, I think when you see the quarter results for the second quarter, I think that's really kind of when we flat lined it right now.

Tristan Richardson

That's helpful. Thanks, guys. And then just a quick one on asphalt, could give us a sense of what the acquired terminals are – recent acquisitions contributed to the quarter, just to get a sense of sort of organic growth in the asphalt terminalling business?

Mark Hurley

I'll give you some general guidance. And we bought those terminals were – one acquisition was in kind of the low teens and the other was in the high teens and we bought them at about, expecting about a seven to seven-and-a-half of multiple and I think, they are probably coming in more now like a six-and-a-half. So volumes grew, through all of the acquired terminals have been higher than what we had put in our investment case and so we see the benefit of that on the revenue side.

Tristan Richardson

Great. That's helpful. And then, I guess, just one last one, on the nine terminals, sort of pending, you may have answered this on the acquisition call – I don't quite recall, but did you talk a little bit about, third-party opportunities for these nine terminals or the seven-year contracts that you've got with take or pay terms with your new sponsor, I mean is that largely for the bulk of the capacity in these terminals?

Mark Hurley

Can you repeat, I didn't quite follow the question, Tristan, can you repeat that again, I'm sorry?

Tristan Richardson

Sure, Mark. I guess, I was just thinking about, the nine terminals you are acquiring, is there third-party opportunities within those facilities or your contracts with Ergon largely relate to the bulk of the capacity?

Mark Hurley

I'm sorry, I'm sorry, those are, those are exclusive to Ergon.

Tristan Richardson

Got you. Okay.

Mark Hurley

And that's typical of the model that we have, most of our terminals with a couple of rare exceptions are exclusive to the customer who is there.

Tristan Richardson

Great. Mark that's helpful. Thank you guys very much.

Mark Hurley

Sure. Thanks.

Operator

The next question comes from Matt Schmid with Stephens. Please go ahead.

Matt Schmid

Hi. Good afternoon, guys.

Mark Hurley

Hi, Matt.

Matt Schmid

Yes, sticking with the asphalt terminalling, it continues to be a solid segment, but just thinking about the current quarter, looking back at third quarter of 2015, it was very strong at about $15 million of operating margin. I know you've all added a couple of terminals, but is last year a fair call for there is some one-time issues going on a year ago that we should be thinking about?

Mark Hurley

Are you talking about third quarter of – are you talking about second quarter of 2015 or are you talking about third quarter of 2015?

Matt Schmid

Third quarter of 2015?

Alex Stallings

Yeah. Third quarter of 2015 would be and typically what is happening is that we end up our earnings kind of spike in Q3. And so, we would expect something similar to happen this year, so typically our best quarters in asphalt are going to be in Q3. So we are – our forecast anticipate the same thing this year, and that's typically when we start seeing that the terminals kind of exceeding sort of improved, but minimums and so we end up usually recognizing some incremental throughput revenues, so we anticipate seeing the same thing in 2016.

Matt Schmid

Okay. Great. That's helpful. And on trucking, I know, it's not likely to be a big earnings driver, but in order any signs of this rationalization of business is from a competitive standpoint or any reduction in competition you're seeing out there or is it still pretty challenged?

Mark Hurley

We have not seen – in terms of company is being rationalized, we have not seen that happen. I think what we've seen rates impacted very, very deeply and I think a lot of fleets have downsized, but in terms of consolidation of companies, we haven't seen a lot of that going on.

Matt Schmid

Yeah, I would – I would say – I was actually in our Oklahoma City office yesterday, and talking to a couple of the guys that bought it. And I think, you may start seeing some of that, I think to Mark's point, I mean I don't – hopefully we've seen a lot of rationalization yet, and we still seem to see trucking – trucking companies almost giving away business, but there seems to be maybe some signs of life there in that many of these companies that are really providing services at below cost, they're starting to see some kind of fractionalization maybe in their – in kind of the eggshells there. So I actually kind of came away yesterday a little – a little bit more optimistic that we may start seeing a rationalization. But I think to Mark's point, I don't know if we've seen it yet but I think we may just be right on the edge of that right now.

So hopefully, going into the second half and maybe into next year, maybe we will see that getting a little more reconciled.

Matt Schmid

Okay. Thanks, guys. That's all I had. I appreciate the color.

Mark Hurley

Yeah.

Alex Stallings

Thank -thank you, Matt.

Operator

[Operator Instructions] The next question is from Mike [indiscernible]. Please go ahead.

Unidentified Analyst

Yeah. Good afternoon, guys.

Mark Hurley

Good afternoon.

Unidentified Analyst

First one, I guess maybe what you're thinking as far as the distribution for the rest of this year coverage wise and maybe looking forward with and without the Ergon transaction?

Alex Stallings

Yeah. I think, what we've said and I think we said this a couple of weeks ago when we talked about the Ergon deal, is it's something we'll continue to evaluate obviously quarter – quarter to quarter. But I think that at least near-term, we're not anticipating a lot of change in the distribution. And I think, we'll work through this transition with Ergon, but I don't think there will be a lot of change in kind of our distribution policy, I think though, kind of to what Mark maybe discussed last time in Ergon comment but we definitely think the – the Ergon transaction and just kind of where we'll be positioned kind of going forward we definitely, think it will lead to distribution growth and we are still very focused on distribution growth as we move into longer-term. Mark do you have any other thing to add on that.

Mark Hurley

I agree 100%, I think we have a choice now, this transaction is accretive for us and creates definitely additional cash flow and our choice now is to further strengthen our balance sheet or to start increasing distributions and I think we are going to put a priority on strengthening our balance sheet for few quarters. And then get more aggressive with the distribution. So I see something three quarters, four quarters, five quarters down the line from that.

Unidentified Analyst

Okay, great. And then on the growth CapEx for the remainder of this year. Any guidance as to which segment is that mostly asphalt.

Alex Stallings

No – most of the growth capital, there is a little bit and again it's pretty small, I mean, we really don't have any what I would call significant projects, I mean there are mostly some similarly small bolt-on activity and at some the facilities and you know really it's pretty, I would say it's probably 25% to 30% asphalt and then the rest of its probably around the pipeline systems. I mean it's really – really we have very minimal kind of required expansion capital needs, a lot of it is just – is just again trying to finish up some projects or doing some pretty small bolt-ons.

Unidentified Analyst

Okay. Thanks very much.

Alex Stallings

Thanks, Mike.

Operator

The next question comes from Ed Spilka with Praxis. Please go ahead.

Edward Spilka

Hi, guys. I'm just curious to understand why at Cushing where you have record storage levels, it just resulted in average pricing?

Alex Stallings

Yeah. I think a lot of it goes to just – there is two things that kind of drive pricing at Cushing. One is just the overall demand for storage, plus the other is just affordability of storage. And so, when you look at the contango and the degree of tango – contango in the forward curve, which you would see today is about $0.70 per month for the next three months going out. And so, once customer takes into account, cost of carrying that money and some profit margin, it kind of get you back to kind of a market rate per storage, and I think that's having more of a factor right now than anything else.

Edward Spilka

Okay. Thank you.

Mark Hurley

If it's much higher than where it is today, it would be kind of cash flow to negative for the customer.

Edward Spilka

Okay. Thank you.

Mark Hurley

Sure.

Operator

That's all the questions we have at this time. This concludes our question-and-answer session. I'd like to turn the conference back over to Mark Hurley for any closing remarks.

Mark Hurley

Yeah. Thank you very much, Jeff. I want to thank all folks who dialed in today, and once again we feel very good about our story at BlueKnight with the Ergon transaction just having been an outstand and hopefully closing here in the next few weeks. And so, if you have any follow up questions, please feel free to contact Alex or myself, but otherwise have a great afternoon.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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