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USD Partners LP (NYSE:USDP)
Q2 2019 Earnings Call
Aug. 6, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the USD Partners LP Second Quarter 2019 Results Conference Call.

At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the prepared remarks. If you would like to ask a question at that time, please press *1. If at any point your question has been answered, you may remove yourself from the queue by pressing the # key. When asking your question, we ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require assistance, please press *0.

It is now my pleasure to turn the call over to Jennifer Waller, Associate Director of Financial Reporting and Investor Relations, for opening remarks. Please go ahead.

Jennifer Waller -- Associate Director of Financial Reporting and Investor Relations

Good morning and thank you for joining us. Welcome to our second quarter 2019 earnings call. With me today are Dan Borgen, our Chief Executive Officer; Adam Altsuler, our Chief Financial Officer; Brad Sanders, our Chief Commercial Officer, as well as several other members of our senior management team.

Yesterday evening, we issued a press release announcing results for the three and six months ended June 30, 2019. If you would like a copy of the press release, you can find one on our website at usdpartners.com.

Before we proceed, please note that the Safe Harbor disclosure statement regarding forward-looking statements in last night's press release applies to the statements of management on this call. Also, please note that information presented on today's call speaks only as of today, August 6, 2019. Any time-sensitive information provided may no longer be accurate at the time of any webcast replay or reading of the transcript.

Finally, today's call will include a discussion of non-GAAP financial measures. Please see last night's press release for reconciliations to the most comparable GAAP financial measures.

With that, I would like to turn the call over to Dan Borgen.

Dan Borgen -- Chief Executive Officer

Thank you, Jennifer, and good morning, everybody. Thanks for joining us today. We're pleased to announce another positive quarter at the partnership and our 17th consecutive quarterly distribution increase. Let me say that again. Our 17th consecutive quarterly distribution increase which is consistent with our previously stated 2019 distribution guidance. Also, we are excited to announce this quarter the successful execution of multi-year contract extensions at both our Hardisty and Stroud terminals with one of the partnership's investment-grade customers. As of today, we are 100% contracted at Hardisty and have renewed our first phase of our remaining customers. We expect the higher rates associated with these renewed contracts to begin showing up in next quarter's financial results. We look forward to reporting more on the continued momentum from these recontracting efforts in the near future.

Adam, as usual, is going to start us off with an update on the partnership's latest financial results and our liquidity position and then we'll jump back into the recent market and commercial developments. Adam, go ahead and take it.

Adam Altsuler -- Chief Financial Officer

Thank you, Dan, and thank you for joining us on the call this morning. Yesterday afternoon we issued our second-quarter 2019 earnings release which included the details of our operating and financial results for the quarter. We plan to issue our second quarter 10Q with additional details after the close of market today.

For the second quarter, we reported net income of $1 million, net cash provided by operating activities of $9.3 million, adjusted EBITDA of $12.2 million, and distributable cash flow of $8.8 million. The partnership's results during the second quarter relative to the same quarter in 2018 were primarily influenced by the lower revenues at its Casper terminal resulting from the conclusion of a customer agreement at the end of 2018. Partially offsetting this reduction in revenues were higher revenues at the Stroud terminal due to rate escalations. Additionally, the partnership experienced high variable operating costs at its Hardisty and Stroud terminals associated with higher volumes during the quarter which were partially offset by a reduction in pipeline fees.

Net income for the quarter decreased as compared to the second quarter of 2018 primarily as a result of the operating factors already mentioned coupled with the non-cash loss associated with the five-year interest rate derivative instrument that the partnership entered into in November of 2017 and higher interest expense resulting from higher interest rates as well as a higher weighted average balance of debt outstanding during the quarter.

Net cash provided by operating activities and adjusted EBITDA both decreased by 19% relative to the second quarter of 2018 as a result of the operating factors already mentioned. Also, distributable cash flow decreased by 28% relative to the second quarter of 2018 as a result of higher cash paid for interest associated with higher interest rates during the quarter. As of June 30th the partnership had net leverage of 3.8 times LTM adjusted EBITDA based on its financial covenants and available liquidity of approximately $175 million including $7 million of unrestricted cash and cash equivalence and undrawn borrowing capacity of $168 million on its $385 million senior secured credit facility subject to continued compliance with financial covenants. The partnership is in compliance with its financial covenants.

On July 24th, the partnership declared a quarterly cash distribution of $0.365 per unit or $1.46 per unit on an annualized basis which represents growth of 0.7% over the prior quarter and 2.8% over the second quarter of 2018. The distribution is payable on August 14th to unitholders of record at the close of business today, August 6th. As Dan mentioned, we were pleased to announce our 17th consecutive quarterly distribution increase this quarter which is consistent with our previously stated 2019 distribution guidance.

We were also pleased to announce the successful execution of multi-year extensions at both our Hardisty and Stroud terminals with one of the partnership's investment-grade customers. The renewal contained take or pay arrangements that are generally consistent with the original agreements and monthly payments and fees that are slightly higher. The partnership expects to service the contract by using the limited remaining capacity available at its Hardisty terminal as well as by subletting excess capacity from our sponsor's Hardisty South expansion.

A quick update regarding our previously announced organic growth project at Casper. We continue to move forward and expect to complete the construction of the outbound pipeline connection by the end of November of this year. Once completed, we believe the connection will increase the terminal's access to additional pipeline networks and refineries ultimately enhancing the sustainability of Casper's cash flows. To date, the partnership has spent approximately $10.8 million on the outbound pipeline connection. Dan and Brad will talk more about the exciting developments around Casper and the potential growth associated with that new connection.

Also, as previously communicated, given where spreads are today we expected the first half of this year to be somewhat of a transition period for the partnership with lower distribution coverage than we have typically experienced. That is still the case. However, given that the spread between the WCS and WTI barrel crude oil has remained narrower than expected for a longer period of time this transition period could extend through the end of the third quarter and possibly the fourth quarter. That being said, the forward curves today continue to suggest increased incentives for our customers to utilize our terminals on both a spot and a contracted basis.

With that, I'll turn the call back over to Dan.

Dan Borgen -- Chief Executive Officer

Appreciate it, Adam. I'll ask Brad now to give us a quick commercial update on the current market and some of our successes we've had here of late. Brad.

Brad Sanders -- Chief Commercial Officer

Thanks, Dan. The current market condition spreads between Hardisty and Houston remain in the $12 and $14 level. This is consistent with what those levels have been since the beginning of the year. The current drivers are the same as well which is the government curtailment program. Now that we're in summer and the summer blends create a less of a supply story than the market. It has remained narrow. Our expectation going forward is as curtailment levels continue to reduce as we move through the balance of the year and we move into winter blends and the likelihood of turnarounds from a demand standpoint, so refiners in the US go through their turnaround periods in the fall, our expectations would be that these spreads will widen from here as we move into fall and winter.

As a matter of record, at $12 to $14 which is the current spread, we remain near capacity from a utilization standpoint at our Hardisty facility. We continue to perform strongly as an industry solution for egress out of Canada.

Moving on to commercial discussions and specifically around Hardisty and Stroud, it's already been mentioned but I'll say it again. In July of this year, the partnership renewed and extended capacity with one of our remaining investment-grade customers at the Hardisty Rail Terminal. The renewal was executed with consistent take or pay terms and net fees that are higher than the previous contracts. Additionally, we continue to work with this remaining customer to renew and extend the balance of the slots at Hardisty and Stroud which come due in February and July of next year. We look forward to reporting more on this in the future as we have updated progress that we can share.

Regarding APMC, that's been certainly a headline out of Canada here recently. As we have previously discussed, our sponsor executed a multi-year take or pay terminal service agreement with the Alberta Petroleum Marketing Commission or APMC. This agreement is for transloading capacity at the Hardisty Rail Terminal starting in January of 2020. The agreement will support further growth at USDG's Hardisty South expansion and will be funded by our sponsor pursuant to its development rights at the Hardisty terminal. Last month the Alberta government announced that they have engaged CIBC Capital Markets to help oversee the divestment of this crude by rail program and its transition to the private sector. This open season is currently in process and the Alberta government expects this to be completed by fall of this year. At this point, we do not anticipate any negative impact from an economic value standpoint as it relates to this agreement to USDG.

Finally, moving on to Casper, Enbridge recently announced a program to increase the capacity of the Express pipeline by up to an additional 50,000 barrels a day with the use of a drag-reducing agent and the addition of incremental pump stations. This open season is currently active and is expected to be concluded in late August. We anticipate that some, if not most, of the additional volumes resulting from the increased capacity, could be delivered to the partnership's Casper terminal in the first quarter of 2020 as outbound pipeline connections from the Express pipeline and nearby terminals are at or near full capacity. So, we are excited about that development and expect our rail terminal at Casper to benefit. We'll share news as we get that here sometime hopefully the second half of August.

Dan Borgen -- Chief Executive Officer

All right, Brad. Thanks. Could you now talk about a few of the commercial updates of the sponsor and what the status of those are, please?

Brad Sanders -- Chief Commercial Officer

Yeah. I'll talk about our Houston ship channel facility. As we talk about Canada, and we've said this before. As we think about what Express is doing and potentially creating additional egress capacity of 50,000 barrels of day that will have to seek rail takeaway. When we talk about the new APMC volumes which are reported at 120,000 barrels a day in total of which Hardisty has got a lion share of that throughput. All of those volumes will as they seek origin, CBR, or crude by rail take away all of those will need destinations. The US gulf coast is the most logical destination given the refineries in the gulf coast their complexity and ability to upgrade heavy sour crude. So, we're very purposed about solving for a deal bit and potentially future DRU bit and we'll talk a bit about that here in a second. But for any bitumen related production out of Canada to solve as a destination by rail at our Houston ship channel facility. We're progressing nicely with customers who control the barrel at the origin. We're excited about the potential of that. The industrial logic is real. The demand is now and we're hopeful to share updates on that sooner than later.

Similarly, the dynamics of what's going on in Mexico in particular and their need for imports of like products by rail. We continue to work hard to create an origin solution at our Texas deep water or our Houston ship channel facility to help build bulk, create rail solutions that are competitive and sustainable from delivery and export from the US, import into Mexico to meet Mexico's needs for incremental volume. Finally, at our Houston ship channel, we continue to work with potential customers on export opportunities for all things crude oil, all things NGLs, all things petrochemicals. For reasons we've talked to on this phone call, every new production of crude and/or natural gas and/or liquids associated with natural gas have to in some form or fashion find export egress options to support that production. So, we continue to work closely with customers on that and, again, are far enough along that we're excited about the potential of sharing announcements here sooner than later.

A quick update on Mexico. Clearly, our build bulk strategy in our Houston ship channel is supported by our rail terminal, destination terminals that we currently have in Mexico and are developing in Mexico. We have two that we currently have. Our strategy there is to keep them full and to incrementally grow those. And then we are currently in various levels of final development on three other terminals that include throughputs, storage, and switching. We're excited about our growth opportunities specific to Mexico but uniquely how it interfaces and supports our Texas deep water, our Houston ship channel type of activity.

I mentioned DRU bit. DRU lots of information, lots of folks talking about DRU. We continue to work with our partners on the Diluent Recovery Unit value and opportunity and look forward to reporting more on this in the near future. Dan, you got more to add on that?

Dan Borgen -- Chief Executive Officer

Yeah. Thanks, Brad. Just a reminder on the DRU. We currently hold three patents on our DRU process. We're proud to say we've got that completed. We hold the trademark for DRU bit and as Brad said we have the very highest level of momentum on that project than we've ever had. We look forward to, as we previously stated, talking about that more late summer and early fall announcing some real positive steps there. We still believe that the DRU is the best solution for the heavy barrel coming out of Canada to relieve some of the pipeline pressure, allow the lighter crudes to flow through the pipes, take the heavy through a DRU system. And as Brad said, deliver those to strategic markets in the gulf coast and perhaps other places. But we feel as good as we've ever been about that and are in very deep conversations with existing customers around that.

With that, I'll open it up for questions and be happy to entertain any and all.

Questions and Answers:

Operator

At this time, I would like to remind everyone that if you would like to ask a question to press *1 on your telephone keypad now. Again, that's *1 for any questions. We'll pause for just a moment to compile the Q&A roster.

The first question will come from Derek Walker with Bank of America.

Derek Walker -- Bank of America Merrill Lynch -- Analyst

Thank you. Good morning, guys.

Dan Borgen -- Chief Executive Officer

Hey. Good morning, Derek.

Brad Sanders -- Chief Commercial Officer

Hey, Derek.

Derek Walker -- Bank of America Merrill Lynch -- Analyst

Just a couple for me, Dan. Maybe just starting with the Hardisty contracting. It sounds like the lease rates were a little bit higher than the prior contract. How does that compare to the other renewals at Hardisty? Can you just get a little more granular for how that leasing agreement works between the sponsor and USDP?

Dan Borgen -- Chief Executive Officer

As far as the renewals, you're right, Derek. They are more than a little bit higher in both term and price. So, we feel very good about that. Obviously, as you heard Brad say we are at and trending toward full capacity at those. Obviously, with that, it's a good time for renewals and extensions because of the ongoing demand that we have for the assets. We currently have a good line of activity around the growth of that asset and we feel very good about that. As we look at -- And I'll have Adam comment more on the passthrough nature of the agreement. But, obviously, that just shows the increased demand and the capacity that we have with the partnership assets. We look forward to that continuing based on the continued commitments that we are getting and the renewal extensions that we are getting.

Adam, do you want to speak to the passthrough?

Adam Altsuler -- Chief Financial Officer

You bet. Derek, really just based on the timing of some of these renewals and during this renewal cycle, the initial customers in some cases increase their commitment to the terminal. In doing so, basically got to full capacity as of today. And so, as some of the remaining renewals we have with the one Stroud customer, as we sign those, those actually are now overflowing to Hardisty South. In order to service those, Hardisty One at the partnership is really just subletting spots from Hardisty South and it's a passthrough nature. But when and if there's capacity that becomes available at Hardisty One then those slots will revert back to the partnership.

Brad Sanders -- Chief Commercial Officer

Isn't those scheduled?

Adam Altsuler -- Chief Financial Officer

Thanks, Brad. We also plan on going to the city bank MLP conference next week and we will update our contract summary to try to simplify that in our investor presentation.

Derek Walker -- Bank of America Merrill Lynch -- Analyst

Thank you. Maybe just a little bit around the transition. Coverage is sort of around 0.9 and you've done a great job recontracting. How should we think about coverage in the second half with Hardisty as you mentioned fully recontracted?

Adam Altsuler -- Chief Financial Officer

Yeah, I think there's a couple of things to discuss there. One is the higher rates kick in during Q3. You will see an impact there and that will kind of push the distribution coverage to trend back toward our target of 1.15 times as well as Q4. And then, as Brad mentioned, with regard to Casper the open season on Express. We still have a lot of confidence in that and it's been publicly announced. It's really more just a push in time and it's going to be in January of next year. While we still believe that's going to happen, it's just going to happen a little bit later. That will also help toward trend back toward the 1.15 times coverage.

Brad Sanders -- Chief Commercial Officer

Fall spreads and winter spreads should help with throughput at our various terminals and certainly Casper.

Dan Borgen -- Chief Executive Officer

Does that answer that for you, Derek?

Derek Walker -- Bank of America Merrill Lynch -- Analyst

Yeah. It did, Dan. Thank you. Maybe just another follow-up if I may just around the AP, Alberta government contract. I know that process is still ongoing. Do you have any involvement in that as far as how that contract may transition? It sounds like there won't be any negative impact on your side. Just what's your involvement in that process and how you think that will --

Dan Borgen -- Chief Executive Officer

Yeah. Let me help you there, Derek. Good question. APMC, obviously, there was a government change, a new Premier. Premier Kenney has voiced his willingness to transfer that and desire to transfer that and get government out of the market, if you will, and transition those into the private sector. I think you've seen that there have been public announcements by many of our existing customers and some that are not our customers today that are very interested in those spots and those slots that we have contracted multi-year with the government.

Just a reminder, our contract with the government is backed by the full faith of the Crown as well. And as part of that agreement, we have approval rights for whoever that goes to. So, the government and CIBC having acknowledged that and are working closely with us through their process. So, in terms of approving who those slots go to in whole or in part we have those approval rights to see those transitions, so transition to the private sector.

Also, it's stated publicly by the government and through their process, the government continues to stand behind those. Our rates were a market rate with the government. We have very little concern if any that there would be any change in the economic results to the partnership and certainly the government has also said publicly that they would be standing behind those agreements as those transfer over to the private sector. There're multiple parts of those agreements. We're just one of those. There's a rail car component. There's a rail freight component. There're terminal agreements. There's a number of different pieces of that. It's multi-faceted. Not necessarily complex but multi-faceted. I think what you've seen publicly from the industry's comments is being able to utilize the slots to dip in further into the curtailed barrels that were set by the government and allowing them to move more barrels. The Energy Minister and others of the government have voiced their positiveness around that. It doesn't say that that's going to happen but I would say that it makes sense because that was the intent of those rail slots to move additional barrels out of and clear additional barrels out of the market.

All that said, we remain very bullish and strong around that agreement. APMC, the government has been extremely forward-leaning about their intent around those agreements acting as a full customer of ours all the way through this process, whether it be rail car or on terminal activities. We remain very, very bullish around those agreements and look forward to working with existing customers and new customers to see a successful transfer of those into the private sector. Hopefully, that helps the overall egress of the barrel out of Canada. Does that help with that, Derek?

Derek Walker -- Bank of America Merrill Lynch -- Analyst

It does. Thanks, Dan. If I may, maybe just one last one for me. I appreciate the update on the DRU but maybe just get a little color around how some of those conversations have gone with potential customers. Do you see a potential FRD in the second half of this year? Do you have a better sense of what the scope of a potential project would look like? Any thoughts there would be helpful.

Dan Borgen -- Chief Executive Officer

Sure. Let me say, we're in sensitive discussions with customers today. I would say that there is, as I said earlier in my comments, there are very strong and multi-level discussions going on with existing customers and new customers around the success of the implementation of the DRU. And certainly, the customers are engaged at very senior levels. Obviously, a project like this would take multi-years, I'll call it 10-plus year commitment. Those types of commitment generally take the most senior level signoffs of authority. We are in active discussions with various customers around those multiple levels and are finalizing agreements as it relates to that. Our publicly stated bill time for the project is approximately 28 months. We have covered a lot of ground over the last couple of years around that from an engineering standpoint, starting that project and getting that done. With that said, we also need to finalize the commercial agreements to underpin the commercial success of the DRU.

A reminder, the first phase of the DRU that we are looking to build would be 100,000 of dilbit in and a 70,000 barrel a day out which would obviously free up 100,000 barrels a day out of an existing pipeline. So, if you're a customer and you need more pipe capacity and you can free that up and put that into a DRU and into a DRU bit barrel and then have that DRU bit barrel go to market and have that be the most efficient move from a new pipeline build, that just makes all kinds of industrial logic. We have been talking about this for some time. Any time you plow new ground it takes some time and the right market conditions for that to happen. But I think during these multiple cycles that we've had in the industry you see a lot of customers who are saying we've got to take control of our own destiny a bit more. We've got to strategically invest in our future takeaway opportunities that create the best netbacks for our produced barrel. We've gained tremendous success in the commercialization of that. As we've stated prior, we look forward to announcing the completion of those commercial discussions late summer/early fall. We feel as good as we have ever felt, Derek, around where we are in those discussions at multi-levels with customers. Does that help with that?

Derek Walker -- Bank of America Merrill Lynch -- Analyst

It does. Thanks, Dan. That's it for me. Appreciate it.

Dan Borgen -- Chief Executive Officer

Okay. Thanks, Derek. Hopefully, we'll be seeing you again when we can. We appreciate all your support. It means a lot. Thank you.

Operator

At this time, there are no further questions. I would like to turn the conference back over to Dan Borgen for any closing comments.

Dan Borgen -- Chief Executive Officer

Okay. Thanks. I appreciate it. As usual, Derek has great questions and we appreciate the support. Our contract renewal discussions at Hardisty and Stroud have been very successful to date with our recent announcement representing the first phase of our completed renewal of the last remaining customer. We've been able to do that at multi-year terms and higher rates. So, again, evidencing the strong support for our assets and where that's heading.

In addition, we've previously discussed several operating cash flow projects at our sponsor today that could be possible drop-down candidates for the partnership in the future. We covered many of them from our Mexico business. Let me just add to that the tenor and scope of the agreements that we're seeing down there from investment-grade, dollar-based globals or North American nationals that underpin both storage distribution in those selective markets continue to remain really bullish. We're getting those agreements done at rates that are commercially successful.

We also have the activities at the Houston ship channel as Brad mentioned that we're gaining great ground on that. Again, for every barrel that leaves Canada needs a destination and the biggest consumption point that we have in North America for those barrels is in the US gulf coast for the heavy barrel. We continue to see high demand for that and look forward to announcing things around that in the very near future. Short-term we've got good momentum on that and good agreements. Obviously, that type of asset does not happen overnight. I know I'm weary talking about it as well, but it is a major asset. It's strategic. The connectivity, we have gotten connectivity agreements completed in there. We've done a lot of work to get that to the point where we now can continue to expand the cash flow. Reminder, we have cash flowed positive day one since we've owned that asset and continue to feel very strongly about its strategic nature. We're seeing that confirmed with the commercial agreements that we're getting from customers.

In addition to that, we hope to announce those kinds of things in the next couple of months. Let me just say this. We remain extremely diligent on our efforts for dropping down contracted assets into the partnership as our assets continue to trend to full contracted utilization. As you heard, we are at or full capacity in the partnership assets and certainly upstairs with the sponsorship and trending to that. We're looking for those opportunities. We want to be able to efficiently grow the partnership as appropriate. We're going to do it with contracted, long-term, mid- to long-term cash flows by our investment-grade counterparties and we feel very strongly about that. We've got huge momentum in the business today, more so than we have ever had with our renewal extensions, our DRU activities, our growth at the sponsor, deep water, Mexico, and elsewhere. We look forward to announcing those things very, very soon.

With that, I'll say thanks again for the time on the call. I know people are busy. We look forward to talking with you all soon and announcing some very exciting new developments in the business. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.

Duration: 36 minutes

Call participants:

Jennifer Waller -- Associate Director of Financial Reporting and Investor Relations

Dan Borgen -- Chief Executive Officer

Adam Altsuler -- Chief Financial Officer

Brad Sanders -- Chief Commercial Officer

Derek Walker -- Bank of America Merrill Lynch -- Analyst

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