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Holly Energy Partners L.P (NYSE:HEP)

Q3 2012 Earnings Call

November 01, 2012 4:00 pm ET

Executives

M. Neale Hickerson - Vice President of Investor Relations of Holly Logistic Services, L.L.C

Bruce R. Shaw - President of Holly Logistic Services L.L.C.

Matthew P. Clifton - Chairman of Holly Logistic Services Llc - General Partner of Hep Logistics Holdings Lp - General Partner, Chief Executive Officer of Holly Logistic Services Llc - General Partner of Hep Logistics Holdings Lp - General Partner and Chairman of Executive Committee

Analysts

Brian J. Zarahn - Barclays Capital, Research Division

Cory J. Garcia - Raymond James & Associates, Inc., Research Division

Operator

Welcome to Holly Energy Partners' Third Quarter 2012 Conference Call and Webcast. [Operator Instructions] Please note that this conference is being recorded. It is now my pleasure to turn the floor over to Mr. Neale Hickerson. Mr. Hickerson, you may begin.

M. Neale Hickerson

Well, good afternoon, everyone. I'm Neale Hickerson from Holly Energy Partners. I'd like to welcome you to Holly Energy's third quarter 2012 earnings conference webcast. With us today are Matt Clifton, Chairman and CEO; Bruce Shaw, our President; and Doug Aron, our Executive Vice President and CFO. We also have other senior management team members with us here today to assist in the Q&A portion of our call. This morning, we issued a press release announcing the results for our quarter ended September 30, 2012. This press release can be found on our HEP website at www.hollyenergy.com.

For our call this afternoon, Bruce will begin with prepared remarks and comments regarding our financial performance. Matt will then follow up with some additional remarks. And at the conclusion of these prepared remarks, our team would be available to take your questions.

Before we turn things over to Bruce and Matt for their comments, we want to make the following Safe Harbor disclosure statement. This statement is made under the Private Securities Litigation Reform Act of 1995. In summary, this Safe Harbor statement says that statements in our press release and on this conference webcast with partnership or management expectations or predictions of the future are forward-looking statements and are intended to be covered under the Safe Harbor provisions of federal securities laws. There are many factors that could cause actual results and outcomes to materially differ from our expectations, including those we've described in our 10-K and other filings with the SEC. These statements are not guarantees of future outcomes. This call may also include a discussion of non-GAAP financial measures that we use in analyzing our financial results. Please refer to today's press release for required reconciliations to GAAP financial measures and other related disclosures, information on where you may find this reconciliations and disclosures and a full reading of our Safe Harbor statement. And lastly, please note that information presented on our call today speaks only as of today, November 1, 2012, and any time-sensitive information provided may no longer be accurate at the time of any webcast replay or rereading of the transcript of our call.

And now, I'd like to turn things over to Bruce Shaw.

Bruce R. Shaw

Thank you, Neale, and good afternoon, everyone. Before I cover HEP's financial results for the third quarter, I want to remind you that we closed the UNEV transaction on July 12, 2012, and the UNEV result are now included in HEP's financial statements. 100% of UNEV revenues and operating expenses are included on HEP's income statement with 25% of UNEV net income backed out being noncontrolling interest.

Also, GAAP rules require us to adjust our historical financial statements as if UNEV were a consolidated subsidiary for all periods that we were under common control of HollyFrontier. For more detailed accounting-related questions, we'll be happy to follow up with anyone after the call.

Now to the results. On Friday, October 26, we announced the 32nd consecutive increase in our quarterly distribution to $0.925 per unit, a 6% increase over the $0.875 per unit we declared for 2011's third quarter. Our distributable cash flow for the quarter ended September 30, 2012 was $40.4 million, up $14.7 million from the same period the previous year.

Net income attributable to HEP for the third quarter was $24.5 million or $0.68 per unit versus $16.7 million for the same time period in 2011. Distributable cash flow and net income compared to the year ago period both increased due to the financial contribution of the assets HEP acquired from HollyFrontier in November of 2011, increased pipeline volumes and annual tariff increases. Distributable cash flow also benefited from the UNEV interest acquisition. As a remind, the majority of HEP revenues and therefore income in DCF were supported by minimum commitments from our major customers. These commitments as of September 30, 2012 totaled about $250 million per year or $62.5 million per quarter, and amount to 85% to 90% of our total revenue. These totals now include HEP's 75% of the UNEV minimum commitments, as well as increased commitments in HEP's base business due to July 1 contractual PPI-related increases.

Operating expenses of approximately $21.3 million for the quarter were higher than 2011's third quarter amount of $16.4 million, primarily due to the inclusion of operating costs associated with our recently acquired interest in the UNEV Pipeline, the assets we acquired last November serving HFC's El Dorado and Cheyenne refineries and year-over-year increases in maintenance service, payroll and power costs. Going forward, UNEV will add approximately $2 million to $3 million per quarter to OpEx depending on throughput levels and early stage operation expenses.

We don't expect operating expenses in the fourth quarter to be materially different from 3Q even though maintenance expenses typically slow down somewhat due to weather. G&A expenses were $1.4 million for the quarter, slightly under our historical average quarterly run rate.

Now I'll cover a few details relating to shortfalls billed and deferred revenue recognized during the quarter. As a reminder, the payments we received for quarterly shortfall billings under the minimum commitments in certain contracts are included in distributable cash flow in the current accounting period, but classified as deferred revenue so not recorded as revenue on our income statement until such time as they can be recognized.

Deferred revenue recognition results primarily from shortfall billings in prior quarters, for which clawback rights were used or expired. Shortfalls billed for the third quarter 2012 for shipments below commitments totaled $4.1 million, including shortfall billings for UNEV. Offsetting this amount and recognized as revenue in the quarter were total forfeitures and clawbacks of $1 million.

As of September 30, 2012, we have $9.3 million in deferred revenue recorded on the balance sheet. This includes the deferred revenue balance assumed in the UNEV purchase. These deferrals will be recognized in revenue in the future as the shippers' contractual clawback rights are utilized or expired. The total for shortfall amounts billed in the fourth quarter of 2011, which remains outstanding and for which clawback rights expire on December 31, 2012, was approximately $800,000.

EBITDA for the quarter was $49.8 million, benefiting from the previously discussed higher pipeline volumes, tariff increases and EBITDA from the November 2011 acquisition as compared to last year's third quarter. Adding shortfall billings and subtracting recognized deferred revenue, this quarter's EBITDA total would have been $52.2 million.

For 2012, we expect our maintenance capital expenditures to be $7 million to $8 million, and we currently forecast our expansion capital expenditures to be approximately $15 million to $20 million. The majority of the expansion dollars will be spent on increasing the capacity and flexibility of our Permian Basin crude pipeline system in order to accommodate increasing crude production in the region. Total capital expenditures in the third quarter totaled $6.7 million, bringing year-to-date CapEx, including expansion and maintenance, to $18.7 million. As a reminder, these CapEx numbers excluded the effect of recast, the recast required by HEP's acquisition of HFC's UNEV interest.

In June 2012, we upsized our revolving credit facility to $550 million, extended the term through June 2017 and secured better pricing. We also retained the $200 million accordion feature. As of September 30, 2012, we had $431 million borrowed under the facility. As a reminder, in conjunction with the closing of the UNEV transaction on July 12, we borrowed $260 million under the credit facility to fund the cash portion of the consideration.

We currently have $119 million in liquidity remaining. We have $450 million aggregate principal amount of senior notes outstanding made up of $150 million 8.25% notes due 2018 and $300 million of 6.5% notes due 2020. Though we're currently slightly higher than our long-term target of 3.5 to 4x for debt-to-EBITDA range, we expect this ratio to decrease over time. The distribution declared on October 26 will result in about $31.7 million to be paid November 14, 2012 to unitholders of record as of November 5. Now I believe Matt has a few comments before we turn to questions. Matt?

Matthew P. Clifton

Thanks, Bruce. We're obviously very pleased with our third quarter results and our continued ability to raise quarterly distributions to our unitholders. As Bruce mentioned, this marks our 32nd consecutive increase in per unit quarterly distributions. We believe our ability to raise our distributions in every quarter since our 2004 IPO is a testament to the security and stability of our cash flow streams and the success of our team in growing our asset base in a significantly yet peacefully prudent manner.

HEP's operating team record of successfully integrating and safely operating our expanding set of assets demonstrates the quality of our employees and our front-line managers. I'd like to take just a few minutes to highlight the unique reliability of our cash flow streams and the location advantage of our asset base that we believe differentiates HEP.

HEP's revenues which continue to be 100% fee-based are in -- underpinned with contractual minimum revenue guarantees for our major customers. As Bruce mentioned, these guarantees represent over 85% of our revenues which, combined with the exclusively fee-based nature of revenue, provides a unique level of security to our distributions. Over the last 11 months, our combined $600 million plus acquisition of storage, terminal in UNEV assets continued our model of 100% fee-based revenue underpinned with minimum revenue guarantees. UNEV was further secured with a 3-year commitment of $1,250,000 per quarter of gift bags from RGP.

Additionally, over the last 2 years, the location of our Midcon, Rocky and Southwest assets and their proximity to fast-growing domestic crude oil supplies had provided incentive for our shippers to increase their refinery production and accordingly, our pipeline throughput levels. Effectively, they have used substantially lower raw material cost advantages to take market share away from costal-based competitors, thus increasing our heritage pipeline throughput levels during a period of lackluster and nationwide gasoline and diesel demand growth.

This favorable environment for our refinery customer has also dramatically improved the financial condition of our largest contractual customers. By far, our largest customer, HollyFrontier, the owner of RGP, has grown over the last few years to be one of the most financially secure independent refineries in the country. They've done this through improved profitability, opportunistic refinery acquisition and the merger of Holly and Frontier in July 2011. The growth of RGP has not only improved the already strong financial condition of our largest contractual guaranteed customer, but has is provided additional attractive logistic acquisition opportunities that HEP has capitalized upon.

Bottom line, we'll strive to continue leverage our great assets and great locations and our synergistic relationship with HFC to continue to grow in a fiscally prudent manner consistent with our model of stable and secured fee-based revenue streams and the maintenance of a strong balance sheet and substantial liquidity position. We believe this approach will continue to drive top-tier total unitholder returns over the long term. In conclusion, I'd like to congratulate Bruce Shaw for his promotion to President. Bruce has worked alongside me for many years at Holly Corp and then at HollyFrontier, and has led our corporate development efforts at HEP since our IPO. Bruce has also served as CFO for HEP for several years. I know Bruce will do a great job in this expanding role. I'd also would like to welcome Doug Aron as our Chief Financial Officer. Doug also serves as Chief Financial Officer for RGP HollyFrontier. It will be great to have Doug directly involved in this important role. With that, I'll turn it back to Neale.

M. Neale Hickerson

Thanks, Matt. And Matt, I'm going to ask Paula to repeat the procedure for asking questions. We're ready to move to that portion of our call.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Brian Zarahn of Barclays.

Brian J. Zarahn - Barclays Capital, Research Division

In the third quarter, can you give a little bit color as to UNEV's contribution to EBITDA and volumes?

Matthew P. Clifton

Bruce, I'll kind of handle this and without getting into too many details, basically, we've structured the UNEV acquisition with the level of minimum shipping guarantees and the GP gift bags that under the most conservative assumptions are UNEV's results will be accretive to distributable cash flow, and that was the case at this time. It gets a little confusing the way we have to book deferred revenues to these guarantees to really get into EBITDA streams. But I think the important thing is to focus on -- that this UNEV acquisition is going to be a accretive to our distributable cash flow under the most conservative of assumptions. And we really expected the throughput levels to be at or slightly below our guarantees, shipment commitments, particularly during the summer months, then we'll just see how things ramp-up in the winter months when demand usually falls off in the Rockies.

Brian J. Zarahn - Barclays Capital, Research Division

Do you have any preliminary read until the winter to what volumes could be about relative to your expectations -- prior expectations?

Matthew P. Clifton

I think it's a little hard to tell. We've had some downtime with some Rocky Mountain refineries that was -- is affecting things. They're back up now. And as we get further into the winter, we'll just -- we'll see what develops. But we do -- there has been some of beginning increases on west coast prices over the last couple of months. It had come back down, but as we get into the winter, there's usually a fair differential in pricing between the Salt Lake City area and the UNEV area -- I mean Las Vegas area.

Brian J. Zarahn - Barclays Capital, Research Division

And on the Permian projects, can you give us an update of completion date for that expansion?

Matthew P. Clifton

Well basically, what we've been doing over last several months is we've been making some relatively quick fixes with at least connections and some minor changes on our pipeline to get to increase rates by about 10,000 barrels a day. We've been further developing a longer-term projects that we talked about. It will probably take over the next 12 months for us to get fully implemented. And when kind of the final phases of getting long-term shipping commitments to secure that. Say, I'd hate to get out ahead of ourselves, but we're pretty close to having that defined

Brian J. Zarahn - Barclays Capital, Research Division

And last question, if I may, on the distribution, this is the second consecutive quarter where the bump exceeded $0.01. Should we think that this could about a new run rate or probably somewhere between $0.01 and $0.015.

Matthew P. Clifton

I think like most companies, we look at this thing on a quarterly basis. And right now, we feel very comfortable about $0.015 based on the results we have. We have very good coverage ratios. So I think that we'll be looking at this level and hopefully we'll be able to maintain that type of increase going forward.

Operator

[Operator Instructions] Your next question comes from Cory Garcia of Raymond James.

Cory J. Garcia - Raymond James & Associates, Inc., Research Division

Just wanted to circle back on sort of the Delaware basin and what you guys are seeing in the Permian today. Given the amount of pie growth that obviously everyone's seen and forecasted over the next couple of years. Just curious as to your thoughts on the role -- perhaps trains -- unit trains manifest as sort of the loading type of dynamics out of that play, and whether that's an area of growth that you guys might pursue.

Matthew P. Clifton

We've seen -- in the Permian, we've seen, to a small extent, some initial movements by rail out. We look at that as a kind of a short-term solution. There's a lot of activity on them ensuring that over the long term, they'll build the right infrastructure in place and the right pipelines to get barrels to the gulf or expanded barrels to cushion. So we think that's -- right now, we're focused on pipeline solutions. And quite frankly, it's taking us a little longer to define the project, not so much on what was under our control, but where shippers would want to be moving directionally to expand the capabilities out the Midland area to the Gulf Coast versus historic movements to cushion. But I think, we probably will see some amount of rail in the Permian but -- which we don't really see that as a big driver in the future.

Cory J. Garcia - Raymond James & Associates, Inc., Research Division

And yes, you know where spreads are today. Clearly, the shippers don't really have too many options. So I appreciate the color.

Operator

[Operator Instructions] At this time, there are no further questions. I would now like to turn the floor back over to Mr. Neale Hickerson for any closing remarks.

M. Neale Hickerson

We appreciate everyone participating and listening today, and we look forward to sharing our full year results with you on the first part of 2013. Thanks a lot, everyone.

Operator

Thank you. This does conclude today's teleconference. Please disconnect your lines.

[Audio Gap]

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