USD Partners LP (NYSE:USDP) Q2 2022 Earnings Conference Call August 4, 2022 11:00 AM ET
Company Participants
Jennifer Waller – Senior Director, Financial Reporting and Investor Relations
Dan Borgen – Chief Executive Officer
Adam Altsuler – Chief Financial Officer
Brad Sanders – Chief Commercial Officer
Conference Call Participants
Steve Ferazani – Sidoti
Operator
Ladies and gentlemen, thank you for standing by and welcome to the USD Partners LP Second Quarter 2022 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. [Operator Instructions]
It is now my pleasure to turn the call over to Jennifer Waller, Senior Director of Financial Reporting and Investor Relations for opening remarks. Ma’am, please go ahead.
Jennifer Waller
Thank you. Good morning, and thank you for joining us. Welcome to our second quarter 2022 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, 2022. 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 4, 2022. 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 discussion of non-GAAP financial measures. Please see last night’s press release for reconciliations to the most comparable GAAP financial measures.
And with that, I’ll turn the call over to Dan Borgen.
Dan Borgen
Thank you, Jennifer. Good morning, and thank you for joining us on the call today and for your continued support of the partnership.
Beginning of the second quarter, we closed the acquisition of the Hardisty South Terminal from our sponsor, as well as simplify the partnership’s financial structure by eliminating its IDRs. We feel that, this was an appropriate step to maintain our momentum into the second half of 2022 and 2023, respectively. As we continue to have detailed discussions regarding our DRUbit, by Rail network with new and existing customers to provide safer and economically competitive transportation options.
The acquisition of the South Terminal increases the size, and growth capacity of the partnership’s, asset base, while optimizing operational and commercial synergies at Hardisty. The partnership’s combined Hardisty terminal now has a design takeaway capacity of 3.5 unit trains per day, or approximately 262,500 barrels per day is well positioned to benefit from the potential future growth associated with the first DRU program.
As a reminder, we grew DRUbit by Rail network, benefits the partnership by providing opportunities for longer-term, take-or-pay revenues at Hardisty, while providing transportation safety and environmental benefits to our customers. We did have some contracts reach maturity at the end of June. But as Brad will discuss later on the call, we are fully engaged with our existing customers and potential new customers and management is focused on renewing, extending, or replacing a group that have expired at Hardisty and Stroud.
In addition, we are currently in advanced negotiations to expand and renew our existing commercial agreements with ConocoPhillips, regarding our DRUbit by Rail network. In the second quarter, our terminals performed safely and reliably and we are very pleased with our performance at both the sponsor’s DRU and Port Arthur terminals.
We continue to exceed expectations at both facilities and continue to deliver significant value to our DRUbit customer, which leads to our update on sustainability. We have refreshed our sustainability webpage and issued our inaugural USD sustainability report, as well as additional information on our sustainability program and capability. We encourage you to visit our website at www.usdg.com to take a further look.
As always, we look forward to sharing future announcements with the market about the next phase of growth at the DRU and our USD Clean Fuels initiatives. We are confident that our assets are strategically located to benefit our customers, as certain market signals continue to reveal the potential for increased demand for our services.
Next, Adam is going to give an update on the partnership’s latest financials and our liquidity position. Then, we’ll jump back into the recent market and commercial developments. Adam, please go ahead.
Adam Altsuler
Thank you, Dan, and thank you for joining us on the call this morning. Yesterday, afternoon, we issued our second quarter earnings release, which included the details of our operating and financial results for the second quarter, and we plan to issue our 10-Q with additional details after close of market today.
The partnership reported net income of $3.8 million net cash provided by operating activities of $6.2 million, adjusted EBITDA of $11.6 million, and distributable cash flow of $10.2 million. Our adjusted EBITDA was negatively impacted by approximately $2.6 million of transaction costs associated with our acquisition of the Hardisty South Terminal, and the elimination of our sponsor’s IDRs. We anticipate minimal costs associated with this transaction going forward.
The acquisition of Hardisty South Terminal from USD Group, and the elimination of our sponsor’s IDRs closed effective April 1st of this year. Total consideration for the transaction was $75 million in cash and approximately 5.75 million common units. The cash portion of the transaction was funded with borrowings under the partnership’s $275 million senior secured credit facility.
As Dan mentioned, the acquisition of the Hardisty South Terminal, increases the size scale and growth capacity of the partnership’s asset base, while optimizing operational and commercial synergies with the Hardisty terminal in order to capitalize on the growth benefits associated with our sponsor’s DRU program.
And now I will go into the details from the quarter. But before I do, let me explain the impact of the Hardisty South acquisition on our historical financial statements because Hardisty South was deemed an entity under common control with the partnership, we are required to recast our historical financial statements to include Hardisty South results of operations.
Because of this our financial statements for prior periods no longer match our previously published results for those periods. While we exclude Hardisty South’s results from our adjusted EBITDA calculations for all periods prior to our acquisition, the ability to compare our Q2 GAAP liquidity and results of operations against the prior year period is impacted by this.
The partnership’s GAAP revenues for the second quarter of 2022 were significantly lower. The primary contributing factor for this was an early contract cancellation payment received by Hardisty South in the second quarter of 2021 which has not been part of the partnership. This caused revenue to be significantly higher in 2021 on a recast basis with no similar occurrence in 2022.
In addition revenue at the south terminal was lower in the second quarter of 2022 as a result of a decrease in contracted volume commitments at the terminal that became effective August 2021. The partnership also had lower storage revenue generated at Casper Terminal associated with the end of one of its customers’ contracts that occurred in September 2021, coupled with lower throughput volumes at the terminal.
Partially offsetting these decreases in revenue was higher revenue at the partnership’s West Colton Terminal, resulting from the commencement of a renewable diesel contract that occurred in December 2021. The partnership experienced lower operating costs during the second quarter of 2022, as compared to the second quarter of 2021, primarily attributable to a decrease in SG&A costs associated with the Hardisty South entities, as well as a decrease in the pipeline fee expenses.
The lower pipeline fee expense is directly attributable to the relative decrease in Hardisty sales revenue previously discussed as compared to the second quarter of 2021. In addition, subcontracted rail services costs were lower due to decreased throughput at the terminals. Partially offsetting the decrease as already mentioned were higher operating and maintenance costs at the Hardisty and Hardisty South Terminals for increased operational supplies fuel and utility costs, primarily due to increased inflation rates.
The second quarter 2021, SG&A cost includes services fee paid by Hardisty sale to our sponsor related to a services agreement that was in place prior to the partnership’s acquisition of Hardisty South. Upon the partnership’s acquisition of Hardisty South the services agreement between the acquired entities and the partnership sponsor was terminated and a similar agreement was established between those entities and the partnership.
This results in the service fee income being allocated to the partnership and therefore offsetting the expense in Hardisty South for periods subsequent to the acquisition date of April 1. Partially offsetting this decrease were higher corporate SG&A costs incurred in the second quarter of 2022 for legal and consulting fees related to the acquisition of Hardisty South of approximately $2.6 million.
Net income decreased in the second quarter of 2022 as compared to the second quarter of 2021, primarily because of the operating factors already discussed coupled with higher interest expense occurred during the second quarter of 2022, resulting from higher interest rates and a higher balance of debt outstanding during the quarter, partially offset by a decrease in commitment fees.
Partially offsetting the decrease was a noncash gain associated with the partnership’s interest rate derivatives, recognized in the second quarter of 2022 as compared to a noncash loss recognized during the same period of 2021. Net cash provided by operating activities for the quarter decreased 74% relative to the second quarter of 2021, primarily due to the operating factors already discussed and the general timing of receipts and payments on accounts receivable accounts payable and deferred revenue balances.
Adjusted EBITDA and distributable cash flow both decreased by 29% for the quarter relative to the second quarter of 2021. The decrease in adjusted EBITDA and DCF was primarily a result of the factors already discussed including the impact of $2.6 million of transaction expenses incurred during the second quarter. Additionally, DCF was positively impacted by lower cash paid for interest, taxes and maintenance CapEx during the quarter.
At the end of June 2022, contracts representing approximately 26% of the combined Hardisty terminals capacity expired. In addition, the remaining contracted capacity at the Stroud terminal also expired at the end of 2022. As Dan mentioned management is focused on renewing extending or replacing the agreements that have expired or are set to expire at the Hardisty South terminals in mid-2022 and mid-2023 with new multiyear take-or-pay commitments and is actively engaged with current and new customers.
Given current and expected market conditions, the partnership’s estimates for future heavy crude oil production in Western Canada and the current availability of egress targets management believes that the partnership will have the opportunity to renew and extend or replace the agreements that recently expired, during the second half of this year or early in 2023.
As of June 30, the partnership had approximately $4 million of unrestricted cash and cash equivalents, and undrawn borrowing capacity of $43 million on a $275 million senior secured credit facility, subject to the partnership’s continued compliance with financial covenants. As of the end of the second quarter, the partnership had borrowings of $232 million under its revolving credit facility and a partnership was in compliance, with its financial covenants as of June 30.
The partnership’s acquisition of Hardisty South has treated a material acquisition, under the terms of its senior secured credit facility. And as a result, the partnership’s borrowing capacity will be limited to five times its 12-month trailing consolidated EBITDA through December 31 2022.
At which point, they will revert back to 4.5 times the partnership’s 12 months consolidated EBITDA. As such the borrowing capacity and the senior secured credit facility, including the unrestricted cash and cash equivalents was approximately $47 million as of June 30. Subsequent to the quarter end on July 27, the partnership settled its existing interest rate swap for proceeds of $7.7 million.
The partnership plans to use the proceeds from this settlement to pay down outstanding debt on a senior secured credit facility. The partnerships simultaneously entered into a new interest rate swap, that was made effective as of August 17 and the new interest rate swap is a five-year contract with the same $175 million notional value, that fixes the secured overnight financing rate or SOFR to approximately 2.7%, for the notional value of the swap agreement instead of the variable rate that the partnership pays under a senior secured credit facility.
For the second quarter, the partnership declared a quarterly cash distribution of $0.1235 per unit or $0.494 per unit on an annualized basis, the same as the amount distributed in the prior quarter. The distribution is payable on August 12, to unitholders of record at the close of business on August 3.
The partnership’s Board determined to keep the distribution unchanged from the prior quarter, and to evaluate the distribution on a quarterly basis going forward and we’ll take into consideration, updated commercial progress including the partnership’s ability to renew, extend or replace existing customer agreements at the Hardisty and Stroud terminals as well as recent changes to the market.
As Dan mentioned, we are extremely focused on expanding our commercial agreements at our terminals, as well as our current growth initiatives at the DRU and USD clean fuels and we look forward to sharing more updates in the future.
And with that, I’d now like to turn the call back over to Dan.
Dan Borgen
Thanks, Adam. Now I’ll ask Brad, to give us a detailed update on the WCS market, recent market events and an update on our commercial. Brad?
Brad Sanders
Dan, thank you. I’ll start with a market update on Canadian fundamentals. There’s a couple of headwinds that are negatively impacting WCS values currently. One headline of course is, the SBR release the strategic petroleum reserve release totaling approximately 200 million barrels, which was announced beginning November 21 of last year and there will be releases through October of this year. This would equate to an additional 765,00,4000 [ph] barrels a day of supply in the US Gulf Coast. So naturally, there are competing alternatives for Canadian heavy in the Gulf Coast and that has driven replacement costs for heavy alternatives, and ultimately WCS values in the Gulf Coast lower and that naturally impacts the cost of — or the value of WCS at Hardisty as well.
So current values are WCS minus 21 21.5 at Hardisty and 9 9.5 discounted to WTI in the US Gulf Coast. Again, that’s simply because there are — the release of SBR barrels created competitive alternatives. But additionally, high nat gas prices and hydrogen prices make upgrading heavy sour grades more expensive. So this translates to cheaper WCS values, to ensure upgrading margins are positive and WCS is competitive for upgrading purposes.
In addition, we see the Canadian market in transition earlier this year. Inventories were at historical low levels, due primarily to the shut-in of production as a function of extremely cold temperatures, during winter. Since the beginning of this year, inventories have begun to build and that’s driven by that production coming back online, but more importantly production — new production that was announced to come on in 2022, is now revealing itself.
So inventories now are in normal type levels. And heading into the second half of the year, our expectation is that inventories will build from here. Additionally, in August apportionment on the two major export pipelines were announced. And our expectation is given this new supply, that’s coming online and given the egress options that are available that we will see apportionment continue through the balance of the year.
To remind folks on the phone, when barrels are apportionment, effectively a percent of the production in Canada is stranded in Canada and that ultimately leads to price discounting and inventory builds until inventories get to a level where prices have to discount to inset crude by rail activity. So this pattern of supply eventually exceeding pipe takeaway capacity and driving the demand for a crude by rail egress solution has been part of Canadian history and ultimately has led to the investment in assets like the USD assets of course and Stroud to simply ensure barrels don’t get stranded and that the industry in total avoids the extreme price discounts, that can reveal themselves during these macro periods.
Naturally this environment is supportive for our efforts to renew, expand and replace agreements that have expired at Hardisty and Stroud, not only with our existing customers but potentially new customers. So our expectation is that over the balance of this year that our negotiations with these customers will likely lead to renew and extend and/or replacement contracts.
From a DRU commercialization standpoint, recently I’ve – not recently obviously, over the last six months we’ve accomplished two key milestones. One is the DRU and PAT capability and performance are exceeding original plan. And then secondly from a commercial standpoint, the value that we had materialized would drive the investments of the DRU and PAT have also exceeded or met original plans.
And as a reminder that is the diluent cost savings at Origin, the competitive rates with the railroads as a function of safety and environmental benefits and then the destination value that our customer is seeing is customer – I’m sorry as a function of customer blending benefits. So given these milestones and potential advantages relative to egress alternatives, we are focused on transitioning 100% of our rail capacity to support the growth of our DRUbit by Rail network.
As mentioned by both Dan and Adam, we’re in advanced negotiations with our current customer to grow and extend our existing agreement and we’re in similar type negotiations and discussions with new customers given DRUbit by Rail’s advantage egress economics relative to pipe alternatives and we look forward to making announcements, hopefully soon on advancing both of those.
Finally, moving on to our efforts from the USD Clean Fuels standpoint and development standpoint. Recently the Inflation Reduction Act, which was introduced into Congress, highlights the type of tailwinds that are driving the continued need for advanced biofuels growth and solutions. In particular, this new proposal will invest approximately $370 billion in energy security and climate change programs over the next 10 years. The objective of this program is to lower energy costs, increase cleaner production and reduce carbon emissions. They do this by providing grant funding for biofuel logistics, providing and introducing sustainable aviation fuel credits, which are new, extending the blender tax credits for renewable diesel and biodiesel and clean fuel production credits. But maybe more importantly, the agreement calls for comprehensive permitting reform with the objective of unlocking domestic energy projects that reduce costs for consumers and help our long-term emissions here in the US.
And as we know and part of our vision is policy drives incentives, as stated above and then incentives drive investment. And as clean fuel’s policies transition, this will continue to drive demand for advanced biofuels. And in that regard, we are in a number of advanced negotiations with existing and potential new customers in support of building infrastructure solutions that support renewable diesel, biodiesel, sustainable aviation fuel, ethanol and renewable diesel feeds in geographic areas that support current and future policy and incentives. So, we are very excited about the potential of this space. As I mentioned in our last quarter, we have uniquely organized to pursue these and we look forward to sharing future announcements on progress in this area. Dan, that’s it.
Dan Borgen
Thanks, Brad. And with that, we’ll open the call up…
Question-and-Answer Session
Operator
[Operator Instructions] We’ll take our first question from Steve Ferazani with Sidoti. Your line is open.
Steve Ferazani
Good morning everyone. Hopefully and get these questions here. Wanted to ask about the expected financial impact of the nonrenewals into 3Q. I mean if I walk through the volumes you’re talking about looks like that accounts for about $4 million of EBITDA in Q1 if I look at your page 44 of your slide deck. Is that reasonable to think that that’s $4 million coming out of 3Q given where things stand right now?
Adam Altsuler
Steve, it’s Adam. Thanks for bearing with us through that. I’m not sure what happened there. So, I appreciate you paying attention to the details. As we mentioned about 26% of the combined Hardisty Terminals capacity expired on June 30 and the remaining contracted capacity at Stroud expired on June 30. We can’t give exact amounts of adjusted EBITDA because by doing so we would be sharing some commercially sensitive information with regard to our customers. But I think directionally the percentages that we’ve given are a reasonable starting point to calculate the loss of EBITDA. So I think by using the investor presentation, using the percentages, I think that’s a good way to approach it.
Steve Ferazani
Perfect. When I think about the impact of the Hardisty South in the quarter, obviously sequentially your EBITDA was up and DCF was up even with the $2.6 million in onetime costs. When we look at — when you announced the deal you guided for 2023 EBITDA and you gave a pretty wide range of $14 million to $18 million. Can you give any kind of sense of where you are on a run rate now, or any kind of color? I know you’re contractually it’s challenging but can you give us any kind of sense of the near-term contribution for those added assets?
Adam Altsuler
Sure. That’s a good question. I mean as far as — so that guidance was given with regard to 2023. So as far as 2023m we still feel very good about the macro as Brad mentioned. We feel good about the direction it’s going and I think it’s safe to say we feel good about our strategically located assets and how they fit into the larger picture in 2023. The underlying macro supports directionally where we think we’ll be. We’re not giving guidance for 2023 at this point or a run rate with regard to 2022. I think, just based on the information we shared on the percentages of the volumes around Hardisty and the remaining capacity at Stroud, I think again directionally, I think that’s the right way to approach is to take a look at our investor presentation and look at the percentages. I will also say, I think, keep in mind, Q3 will be a little bit noisy as well because we did unwind the interest rate swap and we received about $7.7 million of proceeds and that will be counted as adjusted EBITDA next quarter.
But other than that, I think, we feel good about 2023. I think we’re going to continue to evaluate this on a quarterly basis based on further commercial progress and where the market sits at the time and we’ll continue to give you updates and hopefully as much guidance as we can.
Steve Ferazani
And then I get one more in about the distribution which you had — but you have been raising it pretty consistently. You still have a very high coverage ratio. Obviously, there’s some dramatic near-term uncertainty in. When you’re thinking about the distribution and reasons to not raise it how much of that was – obviously, you want to start repaying that debt and deleverage pretty quickly out of that acquisition. Also you want to start replacing some of these or get renewals on these contracts. Is it a bit of both one or the other? And what would get you back on track to raising the distributions again?
Adam Altsuler
Yes. I think, our general view is directionally we still think we’re in a good place. The timing with some one-off events that have happened around the world as Brad mentioned have impacted certain spreads and have impacted kind of the timing and the speed at which we’re increasing the distribution.
So at this time we’re just going to take it quarter by quarter and it’s up to the Board’s discretion as it always is. And so to answer your question, I think, obviously further commercial progress will be — will dictate how we manage the distribution policy going forward.
Steve Ferazani
Okay. Fair enough. Thanks, Adam. Thanks, Dan.
Adam Altsuler
You bet. Thank you.
Operator
We have no further questions on the line at this time. I will turn the program back over to Mr. Dan Borgen for any additional or closing remarks.
Dan Borgen
I appreciate everybody on the call today. And Steve thanks so much for your questions, always very thoughtful and insightful. So just a reminder, we’ve been through the renewal and extend and some of these contracts two times or three times and so we feel confident. We always like going into the renewal cycle with obviously the strongest macro and market drivers that we can.
And so we’re seeing that building now with inventory builds in Canada with the arcs widening we’ve got as Brad said the headwinds around the SBR releases, but that will be adjusted into it and we’ll start to see more and more aggressive spreads and therefore as we see those then we have a real kind of driver for renew and extend.
The customers that we’ve had have for the most part all renewed and extended previously and so we look forward to being able to do that. We would like to have them today certainly. Or we’re going to have them next week, probably not, but we will look for them as the market continues to drive that to our strategically located assets as Brad had mentioned.
So we feel very good about that been there done that before and we look forward to continue to keep the market updated as we renew and extend those. We are very bullish about our DRU and our plan of renewing and converting a lot of our DRUbit — to our DRUbit program obviously longer term 10-year-plus agreements, pipeline competitive environmentally beneficial, lowering the CI carbon intensity by over 30%.
So we feel good about that as well and moving into our clean fuels business, and transitioning more into our cleaner side of the business we really feel good about that growth strategy and where we’re headed there and our customers the investment-grade customers that we have for that program. So anyway, I just wanted to reiterate that and summarize that at the end of the call here. So we appreciate everybody on the call. We appreciate the market support and we look forward to announcements in the short-term. Thanks again.
Operator
On behalf of our clients, I would like to thank you for joining. This concludes our program.
Be the first to comment