Sprague Resources LP (SRLP) Q4 2018 Earnings Conference Call Transcript

Sprague Resources LP (SRLP)
Q4 2018 Earnings Conference Call
March 14, 2019, 1:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

See all our earnings call transcripts.

Prepared Remarks:

Operator

Good afternoon and welcome to the Sprague Q4 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. If anyone should require assistance during the conference, please press * then 0 on your touchtone telephone.

I would now like to introduce your host for today's conference, Mr. Dave Glendon. You may begin, sir.

David Glendon -- President and Chief Executive Officer

Thank you, Demetrius. Good afternoon everyone and welcome to Sprague Resources Fourth Quarter 2018 Conference Call. Joining me today are David Long, our Chief Financial Officer; Kory Arthur, our Vice President and Chief Accounting Officer; and Paul Scoff, our Vice President and General Counsel.

Before providing our prepared remarks, 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 Sprague 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 risk and uncertainties that are difficult to predict. Please refer to our 10-K for an extensive list of risk factors, which could cause our actual results to differ from anticipated results and review our 10-Q current reports and other filings with the SEC.

We also describe our business using certain non-GAAP financial measures. Reconciliations of those measures to comparable GAAP are available in our non-GAAP quarterly supplement and our fourth quarter earnings press release, both of which are posted to the Investor Relations section of our website.

First, I'd like to welcome our new CFO, David Long, to our quarterly earnings call. It's great to have Dave back at Sprague and we look forward to benefiting from his financial expertise and in-depth knowledge of our business. Before I turn the call over to David for a detailed review of our results, I'd like to briefly comment on some key developments in 2018 and our perspective on 2019 opportunities.

As we noted in our January press release, persistent headwinds in both Refined Products and Natural Gas resulted in lower adjusted EBITDA and distribution coverage than our previous guidance. In Refined Products, warmed December weather, a less supportive market structure, and limited distillate blending opportunities led to the shortfall. Notably, we also experienced basis declines in Distillate Products, which is atypical for this higher demand period.

Similarly, our Natural Gas business saw limited optimization opportunities late in the fourth quarter as North East gas price volatility was muted. Our Materials Handling business, however, continued to post strong margin growth partially offsetting these declines.

In January, the board of our general partners, Sprague Resources GP LLC, made the decision to maintain our fourth quarter 2018 distribution at 66.75 cents per unit. Given our estimates for 2019, which assume normal weather and market structure, we expect to maintain the current distribution level.

Our current plans for organic growth investments include a conversion of tankage to support an asphalt contract, the expected addition of a butane blending system to our Lawrence terminal, as well as several IT investments to drive productivity growth. We're also expanding our activity in the solar sector and in February we announced our partnership with Picktricity LLC a leader in thin-film solar installations, building on our long history of evolving to meet customer's changing energy needs. Sprague was the first to bring ultra-low sulfur diesel fuel to the Northeast in 2000 and the first BQ-9000 biodiesel certified marketer in the United States.

Our latest foray into solar offers a two-fold benefit as our flexible solar panels are an excellent way for us to expand our sustainability efforts while leveraging our existing infrastructure to reduce operating expenses. With our pilot project generating the anticipated savings, we're excited to roll this out to additional Sprague facilities as well as generating sales to third parties.

In addition to our organic growth plans, we see opportunities to reduce our cost structure through asset sales, consolidation efforts, and other cost management initiatives. Some of our smaller terminal facilities have higher and better alternative uses and we see prospects for sales at attractive multiples of their current cash generation potential. We also expect to rationalize our network of third-party sales locations and continue our efforts to realize synergies as we integrate recent acquisitions.

Now, I'll turn the call over to Dave for a more detailed review of our results. Dave?

David Long -- Chief Financial Officer

Thank you, Dave, and good afternoon everyone. As Dave mentioned, the fourth quarter was a challenging one for Sprague, but we continue to focus on driving incremental growth and cost management initiatives. Now, let me review our 2018 fourth quarter and full year results.

Sprague's quarterly adjusted gross margin decreased by 17% or $13.7 million to $68.4 million as compared to the fourth quarter of 2017. While adjusted gross margin for the full year increased by 5% or $12 million to $274 million. The decline on our year on year quarterly result was attributable to weakness in our Refined Products and Natural Gas businesses which were partially offset by strength in our Materials Handling business.

For the full year, a strong performance by Materials Handling combined with an increase in Refined Products largely due to annualized in our Coen acquisition led to a modest year on year increase despite weakness in our Natural Gas business. I'll provide more detail of the underlying results of each of these businesses shortly.

Operating expenses were flat in the fourth quarter relative to a year ago. Our total yearly operating expenses of $88.7 million reflect an increase of 23% primarily due to annualizing Coen's operating expenses, increased boiler fuel and stockpile expenses associated with our Materials Handling business, and employee-related costs.

SG&A expenses decreased in Q4 and for the total by 28% to $17.5 million and by 8% to $80.8 million respectively. These year on year declines were primarily driven by reductions in incentive compensation and M&A costs and partially offset by increased expenses attributable to the Coen acquisition.

Net cash interest expensed $9.1 million for the quarter was 25% greater than the fourth quarter 2017 and cash interest for the year increased by 35% or $8.6 million to $33 million. The year on year increase in cash interest expense is principally attributable to additional debt levels related to financing the 2017 acquisitions and 2018 capital improvements and higher interest rates on our floating rate debt.

Maintenance capex for Q4 and full year decreased by $1.6 million or 41% to $2.3 million and by $1.8 million of 15% to $10.6 million respectively. Maintenance projects included upgrades to docks and storage tanks, IT applications, and dredging activity.

Expansion capex for 2018 was $6.8 million compared to $26.9 million in 2017 with 2017 including a number of acquisition and organic growth projects such as conversion of tanks to support gas line throughput at our east province terminal. In 2018, we executed on a number of growth projects that included dock and tank work, additional equipment at our Coen business, development of new IT applications, additions to our ethanol and biodiesel blending abilities, and improvements in our asphalt handling capabilities.

During the fourth quarter, distributable cash flow was negatively affected by lower adjusting gross margin performance and increased operating interest expenses. As a result, distributable cash for the fourth quarter decreased by 52% to $15 million. For the year, distributable cash flow year on year declined by 28% to $52.6 million. Our distribution ratio was 0.9 times for the fourth quarter and 0.8 times for the trailing 12 months on December 31st. Now for a discussion of our business segments.

Our Refined Products business demonstrated a decline in adjusted gross margin in Q4 relative to a year ago of 17% or $7.8 million but our full year results were up year over year by 6% or $8.5 million. Sales volume and adjusted gross margin increased both on a year over year, quarterly, and annual basis as a result of higher discretionary sales offset by less attractive market conditions to purchase and store refined products. Other significant full-year factors in our Refined Products business include the transition of Kildare's asphalt business from direct sales to material handling as well as the impact of a full year of acquisitions, in particular, the Coen Energy transaction completed in October of 2017.

Our Natural Gas business adjusted gross margin for the fourth quarter and full year declined year on year by 43% or $8.8 million and 11% or $7.2 million respectively. Despite sales volume declines being relatively flat year on year, unit margins declined by 9% given a combination of fewer pipeline capacity optimization opportunities particularly in the fourth quarter of 2018 and decreased competitive intensity of some of our key markets.

Our Materials Handling business delivered a solid increase year on year of 24% or $3 million in the fourth quarter and 24% or $11 million overall in 2018. The source of these year on year gains on a quarterly and annual basis is largely connected to Kildare's asphalt and liquid handling services, salt stockpiling activity in Q4 2018, and heavy lift activity in our Searsport terminal. While the market for materials associated with paper production was weaker relative to 2017.

With regard to liquidity, as of year-end, Sprague had availability of $162 million in its working capital line and $174 million in its acquisition line which we believe provides adequate bargaining capacity to finance near to medium term growth without the need for additional sources of capital.

At December 31st, our permanent debt ratio as defined in our non-GAAP supplement posted to our website was 3.6 times.

With regard to 2019 guidance, we are targeting full year adjusted EBITDA of $105 million to $125 million and intend to maintain distributions at their current level.

At this point, I'd like to open the call for any questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you have any questions or comments at this time please press the * and then 1 key on your touchtone phone. If your question has been answered or you wish to remove yourself from the queue, please press the # key. Once again, if you have any questions or comments, please press * then 1. One moment for questions.

And our first question comes from Jeremy Tonet with JP Morgan. You may proceed.

Brian Carlin -- JP Morgan -- Analyst

Hey, good afternoon. This is Brian Carlin in for Jeremy. I was wondering if you could talk a bit about the coverage for 2019. I'm maybe trying to understand what you feel the right level is for Sprague for coverage but maybe more importantly what avenues you might see if these market headwinds persist in the future? Are there things like asset sales or maybe IDR waivers that you would consider?

David Glendon -- President and Chief Executive Officer

Hi, it's Dave Glendon. I'll answer that and I think there is a lot embedded in that, but I'll try and be responsive to each part of it. Yes, we clearly understand that the market is seeking higher coverage levels and we intend to get to higher coverage levels over time. We're not providing guidance for 2019 coverage levels. We're limiting it to EBITDA guidance, but yes, we anticipate expanding our coverage and growing our coverage. As we have stated many times in the past, we believe that coverage level of $1.2 million or so is absolutely appropriate from a long-term perspective for this business.

You may have noted that I did mention potential asset sales on the call today. There are a couple of our smaller locations where the convergence of sulfur specifications has enabled us to consider selling a couple of potential assets which is one mechanism.

On the IDR front we've always said at the appropriate time we'd consider going the way of the IDRs. At least in today's world, the math is very difficult to make work along those dimensions if you look at any reasonable valuation of the IDRs relative to our current yield. It would be exceptionally difficult to swap IDRs for the common unit so I think that would be unlikely to be pursued at this time. But again, depending on how the units evolve, we do believe that that's an appropriate mechanism to deploy at some point in time.

Brian Carlin -- JP Morgan -- Analyst

That's very helpful. Thanks. Just another one kind of looking at the operation on the Natural Gas side. You mentioned few pipeline capacity optimization opportunities and some increased competitive intensity in your core market. Did one or the other drive the weakness more so? And then can you talk a bit more on the increased competition?

David Glendon -- President and Chief Executive Officer

Yes. I'd say that the former drove it more, to be honest with you. What we saw in 2018 particularly was very heavy maintenance on the pipelines. So, as some of the expansion projects for pipelines in the northeast were not improved or were delayed, the pipelines stayed engaged in very heavy maintenance which just meant for more constrained operations over the course of 2018, particularly in the latter part of the year. So, the level of competition for new accounts varies from market to market, period to period. And so, we episodically do see competitors being more or less aggressive in the pursuit of additional customers. We saw a little bit of that in the latter part of 2018, but it was lesser of an impact than the former factor which we sited.

Brian Carlin -- JP Morgan -- Analyst

Okay. Great. Thanks. That's it from us.

David Glendon -- President and Chief Executive Officer

You're welcome. Thank you.

Operator

Once again, ladies and gentlemen, if you have any questions or comments, please press *then 1. And we do not have any further questions in queue. I would now like to turn the call back over to Dave Glendon for any closing remarks.

David Glendon -- President and Chief Executive Officer

Thanks again, Demetrius, and thanks everybody for making the time today. We look forward to keeping you updated on future conference calls.

Operator

Ladies and gentlemen, thank you for attending today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.

Duration: 16 minutes

Call participants:

David Glendon -- President and Chief Executive Officer

David Long -- Chief Financial Officer

Brian Carlin -- JP Morgan -- Analyst

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