SPRAGUE RESOURCES LP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
As used in this Quarterly Report on Form 10-Q ("Quarterly Report"), unless the context otherwise requires, prior to
May 28, 2021, references to " Sprague Resources," the "Partnership," "we," "our," "us," or like terms, refer to Sprague Resources LPand its subsidiaries; references to our "General Partner" refer to Sprague Resources GP LLC; references to "Axel Johnson" or the "Sponsor" refer to Axel Johnson Inc.and its controlled affiliates, collectively, other than Sprague Resources, its subsidiaries and its General Partner; and references to " Sprague Holdings" refer to Sprague Resources Holdings LLC, a wholly owned subsidiary of Axel Johnson and the owner of our General Partner. Prior to May 28, 2021, our General Partnerwas a wholly owned subsidiary of Axel Johnson. As used in this Quarterly Report on Form 10-Q ("Quarterly Report"), unless the context otherwise requires, effective May 28, 2021, references to " Sprague Resources," the "Partnership," "we," "our," "us," or like terms, refer to Sprague Resources LPand its subsidiaries; references to our "General Partner" refer to Sprague Resources GP LLC; references to "Hartree" or the "Sponsor" refer to Hartree Partners, LP, other than Sprague Resources, its subsidiaries and its General Partner; and references to " Sprague Holdings" refer to Sprague HP Holdings, LLC, a wholly owned subsidiary of Hartree and the owner of our General Partner. Effective May 28, 2021, our General Partneris a wholly owned subsidiary of Hartree.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report and any information incorporated by reference, contains statements that we believe are "forward-looking statements". Forward looking statements are statements that express our belief, expectations, estimates, or intentions, as well as those statements we make that are not statements of historical fact, including, among other things, statements relating to the Transaction (as defined below) and the expected benefits thereof. Forward-looking statements provide our current expectations and contain projections of results of operations, or financial condition, and/ or forecasts of future events. Words such as "may", "assume", "forecast", "position", "seek", "predict", "strategy", "expect", "intend", "plan", "estimate", "anticipate", "believe", "project", "budget", "outlook", "potential", "will", "could", "should", or "continue", and similar expressions are used to identify forward-looking statements. They can be affected by assumptions used or by known or unknown risks or uncertainties which could cause our actual results to differ materially from those contained in any forward-looking statement. Consequently, no forward-looking statements can be guaranteed. You are cautioned not to place undue reliance on any forward-looking statements. Factors that could cause actual results to differ from those in the forward-looking statements include, but are not limited to: (i) changes in federal, state, local, and foreign laws or regulations including those that permit us to be treated as a partnership for federal income tax purposes, those that govern environmental protection and those that regulate the sale of our products to our customers; (ii) changes in the marketplace for our products or services resulting from events such as dramatic changes in commodity prices, increased competition, increased energy conservation, increased use of alternative fuels and new technologies, changes in local, domestic or international inventory levels, seasonality, changes in supply, weather and logistics disruptions, or general reductions in demand; (iii) security risks including terrorism and cyber-risk, (iv) adverse weather conditions, particularly warmer winter seasons and cooler summer seasons, climate change, environmental releases and natural disasters; (v) adverse local, regional, national, or international economic conditions, including but not limited to, public health crises that reduce economic activity, affect the demand for travel (public and private), as well as impacting costs of operation and availability of supply (including the coronavirus COVID-19 outbreak), unfavorable capital market conditions and detrimental political developments such as the inability to move products between foreign locales and
the United States; (vi) nonpayment or nonperformance by our customers or suppliers; (vii) shutdowns or interruptions at our terminals and storage assets or at the source points for the products we store or sell, disruptions in our labor force, as well as disruptions in our information technology systems; (viii) unanticipated capital expenditures in connection with the construction, repair, or replacement of our assets; (ix) our ability to integrate acquired assets with our existing assets and to realize anticipated cost savings and other efficiencies and benefits; and (x) our ability to successfully complete our organic growth and acquisition projects and/or to realize the anticipated financial and operational benefits. These are not all of the important factors that could cause actual results to differ materially from those expressed in our forward-looking statements. Other known or unpredictable factors could also have material adverse effects on future results. Consequently, all of the forward-looking statements made in this Quarterly Report are qualified by these cautionary statements, and we cannot assure you that actual results or developments that we anticipate will be realized or, even if realized, will have the expected consequences to or effect on us or our business or operations. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly Report may not occur. When considering these forward-looking statements, please note that we provide additional cautionary discussion of risks and uncertainties in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the U.S. Securities and Exchange Commission("SEC") on March 4, 2022(the "2021 Annual Report"), in Part I, Item 1A "Risk Factors", in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations", and in Part II, Item 7A "Quantitative and Qualitative Disclosures About Market Risk". In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly Report may not occur. 20
Forward-looking statements contained in this Quarterly Report speak only as of the date of this Quarterly Report (or other date as specified in this Quarterly Report) or as of the date given if provided in another filing with the
SEC. We undertake no obligation, and disclaim any obligation, to publicly update, review or revise any forward-looking statements to reflect events or circumstances after the date of such statements. All forward looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in our existing and future periodic reports filed with the SEC. 21
We are a
Delawarelimited partnership formed in June 2011by Sprague Holdingsand our General Partner. We engage in the purchase, storage, distribution and sale of refined products and natural gas, and provide storage and handling services for a broad range of materials. In October 2013, we became a publicly traded master limited partnership ("MLP") and our common units representing limited partner interests are listed on the New York Stock Exchange("NYSE") under the ticker symbol "SRLP". Our Predecessor was founded in 1870 as the Charles H. Sprague Companyin Boston, Massachusetts; and, in 1905, the company opened the Penobscot Coal and Wharf Company, a tidewater terminal located in Searsport, Maine. By World War II, the company was operating eleven terminals and a fleet of two dozen vessels transporting coal and other products throughout the world. As fuel needs diversified in the United States, the company expanded its product offerings and invested in terminals, tankers, and product handling activities. In 1959, the company expanded its oil marketing activities via entry into the distillate oil market. In 1970, the company was sold to Royal Dutch Shell'sAsiatic Petroleum subsidiary; and, in 1972, Royal Dutch Shellsold the company to Axel Johnson Inc., a member of the Axel Johnson Group of Stockholm, Sweden. On April 20, 2021, the Partnership and Hartree Partner, LP ("Hartree") announced that Sprague Holdingsentered into an agreement to sell to Sprague HP Holdings, LLC(a wholly-owned subsidiary of Hartree) the interest of Sprague Holdingsin the General Partner, the incentive distribution rights and all of the common units representing limited partner interests that Sprague Holdingsowned in the Partnership (the "Transaction"). The Transaction was completed and effective on May 28, 2021. On January 11, 2022, the Partnership received an unsolicited non-binding proposal from Hartree pursuant to which Hartree would acquire all of the outstanding common units of the Partnership that Hartree and its affiliates do not already own in exchange for $16.50in cash for each such common unit. The board of directors of the General Partner has delegated authority to evaluate and negotiate the proposal to its conflicts committee. The conflicts committee's evaluation process is currently ongoing. The Partnership is one of the largest independent wholesale distributors of refined products in the Northeast United Statesbased on aggregate terminal capacity. We own, operate and/or control a network of refined products and materials handling terminals and storage facilities predominantly located in the Northeast United Statesfrom New Yorkto Maineand in Quebec, Canadathat have a combined storage tank capacity of approximately 14.3 million barrels for refined products and other liquid materials, as well as approximately 2.0 million square feet of materials handling capacity. We also have access to approximately 51 third-party terminals in the Northeast United Statesthrough which we sell or distribute refined products pursuant to rack, exchange and throughput agreements. We operate under four business segments: refined products, natural gas, materials handling and other operations. See Note 8 - Segment Reporting to our Condensed Consolidated Financial Statements for a presentation of financial results by reportable segment and see Part I, Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations for a discussion of financial results by segment. In our refined products segment we purchase a variety of refined products, such as heating oil, diesel fuel, residual fuel oil, kerosene, jet fuel and gasoline (primarily from refining companies, trading organizations and producers), and sell them to our customers. We have wholesale customers who resell the refined products we sell to them and commercial customers who consume the refined products directly. Our wholesale customers consist of approximately 900 home heating oil retailers and diesel fuel and gasoline resellers. Our commercial customers include federal and state agencies, municipalities, regional transit authorities, drill sites, large industrial companies, real estate management companies, hospitals, educational institutions, and asphalt paving companies. Our customers also include businesses engaged in the development of natural gas resources in Pennsylvaniaand surrounding states.
In our natural gas segment, we purchase natural gas from natural gas producers and trading companies and sell and distribute natural gas to approximately 15,000 commercial and industrial customer locations in 13 northeastern and central states. from the Atlantic to the United States and
Our materials handling segment is generally conducted under multi-year agreements as either fee-based activities or as leasing arrangements when the right to use an identified asset (such as storage tanks or storage locations) has been conveyed in the agreement. We offload, store and/or prepare for delivery a variety of customer-owned products, including asphalt, clay slurry, salt, gypsum, crude oil, residual fuel oil, coal, petroleum coke, caustic soda, tallow, pulp and heavy equipment. Historically, a majority of our materials handling activity has generated qualified income.
Our other operating segment primarily includes the marketing and distribution of coal conducted in our
We take title to the products we sell in our refined products and natural gas segments. In order to manage our exposure to commodity price fluctuations, we use derivatives and forward contracts to maintain a position that is substantially balanced between product purchases and product sales. We do not take title to any of the products in our materials handling segment. As of
March 31, 2022, our Sponsor, through its ownership of Sprague Holdings, owns 19,548,849 common units representing an aggregate of 74.5% of the limited partner interest in the Partnership. Sprague Holdingsalso owns the General Partner, which in turn owns a non-economic interest in the Partnership. Sprague Holdingscurrently holds incentive distribution rights ("IDRs") which entitle it to receive increasing percentages of the cash the Partnership distributes from distributable cash flow in excess of $0.7676per unit per quarter, up to a maximum of 50.0%. The maximum distribution of 50% does not include any distributions that Sprague Holdingsmay receive on any limited partner units that it owns. COVID-19 In 2022, a wide array of sectors continue to be affected by COVID-19, its variants and the related supply chain disruptions brought on by the pandemic, including but not limited to energy, transportation, manufacturing and commercial and retail businesses and global economic conditions continue to be volatile. With the easing of restrictions, health advancements and other ongoing measures to alleviate the pandemic in 2021 and the first quarter of 2022, demand for refined products appears to have normalized. In order to continue to mitigate the effects of the pandemic, we continue to focus on the safety of employees and other stakeholders as well as initiatives relating to cost reduction, liquidity and operating efficiencies. The Partnership makes estimates and assumptions that affect the reported amounts on these consolidated financial statements and accompanying notes as of the date of the financial statements. The Partnership assessed accounting estimates that require consideration of forecasted financial information, including, but not limited to, the allowance for credit losses, the carrying value of goodwill, intangible assets, and other long-lived assets. This assessment was conducted in the context of information reasonably available to the Partnership, as well as consideration of the future potential impacts of COVID-19, and its variants, on the Partnership's business as of March 31, 2022. While market conditions for our products and services appear to have stabilized as compared to a year ago, the pandemic remains fluid, indicating that the full impact may not have been realized across our business and operations. The economic and operational landscape has been altered, and it is difficult to determine whether such changes are temporary or permanent, with challenges related to staffing, supply chain, and transportation globally. Accordingly if the impact is more severe or longer in duration than the partnership has assumed, such impact could potentially result in impairments and increases in credit allowances. As we strategize with regard to fiscal year 2022 and beyond, we continue to monitor the evolving impacts of COVID-19 and its variants closely and adapting our operations to changing demand patterns and the potential impact of the COVID-19 pandemic on future cash flows and access to adequate liquidity.
How management assesses our operating results
Our management uses a variety of financial and operational measures to analyze our performance. These measures include: (1) Adjusted EBITDA and Adjusted Gross Margin, (2) Operating Expenses, (3) Selling, General, and Administrative (or SG&A) Expenses, and (4) Degree Days of heating.
EBITDA, Adjusted EBITDA and Adjusted Gross Margin used in this quarterly report are non-GAAP financial measures.
EBITDA and Adjusted EBITDA
Management believes that adjusted EBITDA is an aid in assessing repeatable operating performance that is not distorted by non-recurring items or market volatility and the ability of our assets to generate sufficient revenue, that when rendered to cash, will be available to pay interest on our indebtedness and make distributions to our unitholders. We define EBITDA as net income before interest, income taxes, depreciation and amortization. We define adjusted EBITDA as EBITDA adjusted for the change in unrealized hedging gains (losses) with respect to refined products and natural gas inventory, and natural gas transportation contracts, adjusted for changes in the fair value of contingent consideration, and adjusted for the impact of acquisition related expenses.
EBITDA and Adjusted EBITDA are used as supplemental financial measures by external users of our financial statements, such as investors, commercial suppliers, research analysts and commercial banks to assess:
•The financial performance of our assets, operations and return on capital without regard to financing methods, capital structure or historical cost basis;
•The ability of our assets to generate sufficient income which, when returned in cash, will be available to pay interest on our debt and make distributions to our shareholders;
•Repeatable operating performance not distorted by non-recurring items or market volatility; and
•The viability of acquisition and investment projects.
EBITDA and adjusted EBITDA are not prepared in accordance with GAAP and should not be considered alternatives to net income or operating income, or any other measure of financial performance presented in accordance with GAAP. EBITDA and adjusted EBITDA exclude some, but not all, items that affect net income and operating income. The GAAP measure most directly comparable to EBITDA and adjusted EBITDA is net income. EBITDA and adjusted EBITDA should not be considered as alternatives to net income or cash provided by (used in) operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP. EBITDA and adjusted EBITDA are not presentations made in accordance with GAAP and have important limitations as analytical tools and should not be considered in isolation or as substitutes for analysis of our results as reported under GAAP. Because EBITDA and adjusted EBITDA exclude some, but not all, items that affect net income and are defined differently by different companies, our definitions of EBITDA and adjusted EBITDA may not be comparable to similarly titled measures of other companies.
We recognize that the usefulness of EBITDA and Adjusted EBITDA as assessment tools may have certain limitations, including:
•EBITDA and adjusted EBITDA do not include interest expense. Because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and impacts our ability to generate profits and cash flows. Therefore, any measure that excludes interest expense may have material limitations;
•EBITDA and adjusted EBITDA do not include depreciation charges. Because fixed assets, depreciation, and amortization are a necessary part of our costs and our ability to generate profits, any measure that excludes depreciation and amortization expenses can have significant limitations;
•EBITDA and adjusted EBITDA do not include provision for income taxes. Because the payment of income taxes is a necessary element of our costs, any measure that excludes income tax expense may have material limitations;
•EBITDA and Adjusted EBITDA do not reflect capital expenditures or future capital expenditure requirements or contractual commitments;
•EBITDA and Adjusted EBITDA do not reflect changes or cash requirements for working capital; and
•EBITDA and adjusted EBITDA do not allow us to analyze the effect of certain recurring and non-recurring items that significantly affect our net income.
Adjusted gross margin
Management purchases, stores and sells energy commodities that experience market value fluctuations. To manage the Partnership's underlying performance, including its physical and derivative positions, management utilizes adjusted gross margin. In determining adjusted gross margin, management adjusts its segment results for the impact of the changes in unrealized gains and losses with regard to refined products and natural gas inventory, and natural gas transportation contracts, which are not marked to market for the purpose of recording unrealized gains or losses in net income. Adjusted gross margin is also used by external users of our consolidated financial statements to assess our economic results of operations and our commodity market value reporting to lenders. We define adjusted gross margin as net sales less cost of products sold (exclusive of depreciation and amortization) adjusted for the impact of the changes in unrealized gains and losses with regard to refined products and natural gas inventory, and natural gas transportation contracts, which are not marked to market for the purpose of recording unrealized gains or losses in net income. Adjusted gross margin has no impact on reported volumes or net sales.
Adjusted gross margin is used as a supplemental financial measure by management to describe our operations and economic performance to investors, commercial suppliers, research analysts and commercial banks to assess:
•The economic results of our operations;
•The market value of our natural gas inventory and transportation contracts for financial reporting to our lenders, as well as for borrowing basis purposes; and
•Repeatable operational performance that is not distorted by non-recurring items or market volatility.
Adjusted gross margin is not prepared in accordance with GAAP and should not be considered an alternative to net profit or operating profit or any other measure of financial performance presented in accordance with GAAP.
We define adjusted unit gross margin as adjusted gross margin divided by units sold, as expressed in gallons for refined products and in MMBtus for natural gas. For a reconciliation of adjusted gross margin and adjusted EBITDA to the GAAP measures most directly comparable, see the reconciliation tables included in "Results of Operations." See Note 8 - Segment Reporting to our Condensed Consolidated Financial Statements for a presentation of our financial results by reportable segment. Management evaluates our segment performance based on adjusted gross margin. Based on the way we manage our business, it is not reasonably possible for us to allocate the components of operating expenses, selling, general and administrative expenses and depreciation and amortization among the operating segments. Operating Expenses Operating expenses are costs associated with the operation of the terminals and truck fleet used in our business. Employee wages, pension and 401(k) plan expenses, boiler fuel, repairs and maintenance, utilities, insurance, property taxes, services and lease payments comprise the most significant portions of our operating expenses. Employee wages and related employee expenses included in our operating expenses are incurred on our behalf by our
General Partnerand reimbursed by us. These expenses remain relatively stable independent of the volumes through our system but can fluctuate depending on the activities performed during a specific period.
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") include employee salaries and benefits, discretionary bonus, marketing costs, corporate overhead, professional fees, information technology and office space expenses. Employee wages, related employee expenses and certain rental costs included in our SG&A expenses are incurred on our behalf by our
General Partnerand reimbursed by us.
Heating degree days
A "degree day" is an industry measurement of temperature designed to evaluate energy demand and consumption. Degree days are based on how much the average temperature departs from a human comfort level of 65°F. Each degree of temperature above 65°F is counted as one cooling degree day, and each degree of temperature below 65°F is counted as one heating degree day. Degree days are accumulated over the course of a year and can be compared to a monthly or a long-term average ("normal") to see if a month or a year was warmer or cooler than usual. Degree days are officially observed by the
National Weather Serviceand archived by the National Climate Data Center. In order to incorporate more recent average information and to better reflect the geographic locations of our customer base, we report degree day information for Bostonand New York City(weighted equally) with a historical average for the same geographic locations over the previous ten-year period.
We hedge our inventory within the guidelines set in our risk management policies. In a rising commodity price environment, the market value of our inventory will generally be higher than the cost of our inventory. For GAAP purposes, we are required to value our inventory at the lower of cost or net realizable value. The hedges on this inventory will lose value as the value of the underlying commodity rises, creating hedging losses. Because we do not utilize hedge accounting, GAAP requires us to record those hedging losses in our income statements. In contrast, in a declining commodity price market we generally incur hedging gains. GAAP requires us to record those hedging gains in our income statements. The refined products inventory market valuation is calculated using daily independent bulk market price assessments from major pricing services (either Platts or Argus). These third-party price assessments are primarily based in large, liquid trading hubs including but not limited to,
New York Harbor(NYH) or US Gulf Coast(USGC), with our inventory values determined after adjusting these prices to the various inventory locations by adding expected cost differentials (primarily freight) compared to one of these supply sources. Our natural gas inventory is limited, with the valuation updated monthly based on the volume and prices at the corresponding inventory locations. The prices are based on the most applicable monthly Inside FERC, or IFERC, assessments published by Platts near the beginning of the following month. Similarly, we can hedge our natural gas transportation assets (i.e., pipeline capacity) within the guidelines set in our risk management policy. Although we do not own any natural gas pipelines, we secure the use of pipeline capacity to support our 25
natural gas requirements by either leasing capacity over a pipeline for a defined time period or by being assigned capacity from a local distribution company for supplying our customers. As the spread between the price of gas between the origin and delivery point widens (assuming the value exceeds the fixed charge of the transportation), the market value of the natural gas transportation contracts assets will typically increase. If the market value of the transportation asset exceeds costs, we may seek to hedge or "lock in" the value of the transportation asset for future periods using available financial instruments. For GAAP purposes, the increase in value of the natural gas transportation assets is not recorded as income in the income statements until the transportation is utilized in the future (i.e., when natural gas is delivered to our customer). If the value of the natural gas transportation assets increase, the hedges on the natural gas transportation assets lose value, creating hedging losses in our income statements. The natural gas transportation assets market value is calculated daily based on the volume and prices at the corresponding pipeline locations. The daily prices are based on trader assessed quotes which represent observable transactions in the market place, with the end-month valuations primarily based on Platts prices where available or adding a location differential to the price assessment of a more liquid location. As described above, pursuant to GAAP, we value our commodity derivative hedges at the end of each reporting period based on current commodity prices and record hedging gains or losses, as appropriate. Also as described above, and pursuant to GAAP, our refined products and natural gas inventory and natural gas transportation contract rights, to which the commodity derivative hedges relate, are not marked to market for the purpose of recording gains or losses. In measuring our operating performance, we rely on our GAAP financial results, but we also find it useful to adjust those numbers to reflect the changes in unrealized gains and losses with regard to refined products and natural gas inventory, and natural gas transportation contracts. By making such adjustments, as reflected in adjusted gross margin and adjusted EBITDA, we believe that we are able to align more closely hedging gains and losses to the period in which the revenue from the sale of inventory and income from transportation contracts relating to those hedges is realized.
Trends and factors affecting our business
In addition to the other information set forth in this report, please refer to our 2021 Annual Report for a discussion of the trends and factors that impact our business. 26
Our current and future results of operations may not be comparable to our historical results of operations. Our results of operations may be impacted by, among other things, swings in commodity prices, primarily in refined products and natural gas, and acquisitions or dispositions. We use economic hedges to minimize the impact of changing prices on refined products and natural gas inventory. As a result, commodity price increases at the end of a period can create lower gross margins as the economic hedges, or derivatives, for such inventory may lose value, whereas an increase in the value of such inventory is disregarded for GAAP financial reporting purposes and recorded at the lower of cost or net realizable value. Please read "How Management Evaluates Our Results of Operations." The following tables set forth information regarding our results of operations for the periods presented: Three Months Ended March 31, Increase/(Decrease) 2022 2021 $ % (in thousands) Net sales
$ 1,813,315 $ 1,036,134$ 777,181 75 %
Cost of goods sold (excluding depreciation and impairment)
1,729,078 924,782 804,296 87 % Operating expenses 23,235 19,232 4,003 21 % Selling, general and administrative 28,720 25,239 3,481 14 % Depreciation and amortization 8,126 8,482 (356) (4) % Total operating costs and expenses 1,789,159 977,735 811,424 83 % Operating income 24,156 58,399 (34,243) (59) % Other income (1) 2 (3) (150) % Interest income 28 67 (39) (58) % Interest expense (10,572) (8,815) 1,757 20 % Income before income taxes 13,611 49,653 (36,042) (73) % Income tax benefit (provision) 4,335 (871) (5,206) (598) % Net income
$ 17,946 $ 48,782$ (30,836) (63) % 27
Reconciliation with adjusted gross margin, EBITDA and adjusted EBITDA
The following table sets forth a reconciliation of our consolidated operating income to our total adjusted gross margin, a non-GAAP measure, for the periods presented and a reconciliation of our consolidated net income to EBITDA and Adjusted EBITDA, non-GAAP measures, for the periods presented. See above "Management's Discussion and Analysis of Financial Condition and Results of Operations - How Management Evaluates Our Results of Operations - EBITDA and Adjusted EBITDA" of this report. The table below also presents information on weather conditions for the periods presented. Three Months Ended
March 31, 20222021
(in thousands) Reconciliation of operating income to adjusted gross margin: operating income
$ 24,156 $ 58,399
Operating expenses and expenses not allocated to operating segments: Operating expenses
23,235 19,232 Selling, general and administrative 28,720 25,239 Depreciation and amortization 8,126 8,482 Add/(deduct): Change in unrealized loss (gain) on inventory (1) 15,369 (26,257)
Change in the unrealized value of natural gas transport contracts (2)
41,923 21,116 Total adjusted gross margin (3):
$ 141,529 $ 106,211Adjusted Gross Margin by Segment: Refined products $ 54,126 $ 51,033Natural gas 71,351 41,089 Materials handling 13,130 12,076 Other operations 2,922 2,013 Total adjusted gross margin $ 141,529 $ 106,211Reconciliation of Net Income to Adjusted EBITDA Net income $ 17,946 $ 48,782Add/(deduct): Interest expense, net 10,544 8,748 Tax provision (4,335) 871 Depreciation and amortization 8,126 8,482 EBITDA (3): $ 32,281 $ 66,883Add/(deduct): Change in unrealized loss (gain) on inventory (1) 15,369 (26,257)
Change in the unrealized value of natural gas transport contracts (2)
Gain on sale of capital assets outside the normal course of business, including gain on insurance recoveries
- (2) Other adjustments (4) 31 35 Adjusted EBITDA
$ 89,604 $ 61,775Other Data: Ten Year Average Heating Degree Days (5) 2,586 2,606 Heating Degree Days (5) 2,603 2,539 Variance from average heating degree days 1 % (3) % Variance from prior period heating degree days 3 % 17 % 28
(1)Inventory is valued at the lower of cost or net realizable value. The adjustment related to change in unrealized gain on inventory which is not included in net income, represents the estimated difference between inventory valued at the lower of cost or net realizable value as compared to market values. The fair value of the derivatives we use to economically hedge our inventory declines or appreciates in value as the value of the underlying inventory appreciates or declines, which creates unrealized hedging losses (gains) with respect to the derivatives that are included in net income. (2)Represents our estimate of the change in fair value of the natural gas transportation contracts which are not recorded in net income until the transportation is utilized in the future (i.e., when natural gas is delivered to the customer), as these contracts are executory contracts that do not qualify as derivatives. As the fair value of the natural gas transportation contracts decline or appreciate, the offsetting physical or financial derivative will also appreciate or decline creating unmatched unrealized hedging losses (gains) in net income. (3)For a discussion of the non-GAAP financial measures EBITDA, adjusted EBITDA and adjusted gross margin, see "How Management Evaluates Our Results of Operations." (4)Represents accretion expense related to asset retirement obligations. (5)For purposes of evaluating our results of operations, we use heating degree day amounts as reported by the NOAA Regional Climate Center. In order to incorporate recent average information and to reflect the geographic locations of our customer base, we report degree day information for
Bostonand New York City(weighted equally) with a historical average for the same geographic locations over the previous ten-year period. 29
Analysis of operating segments
Three Months Ended
March 31, 2022compared to Three Months Ended March 31, 2021Three Months Ended March 31, Increase/(Decrease) 2022 2021 $ % (in thousands, except adjusted unit gross margin) Volumes: Refined products (gallons) 565,668 515,845 49,823 10 % Natural gas (MMBtus) 17,661 18,835 (1,174) (6) % Materials handling (short tons) 631 466 165 35 % Materials handling (gallons) 88,154 57,859 30,295 52 % Net Sales: Refined products $ 1,666,830 $ 916,201$ 750,629 82 % Natural gas 125,844 102,575 23,269 23 % Materials handling 13,093 12,046 1,047 9 % Other operations 7,548 5,312 2,236 42 % Total net sales $ 1,813,315 $ 1,036,134$ 777,181 75 % Adjusted Gross Margin: Refined products $ 54,126 $ 51,033$ 3,093 6 % Natural gas 71,351 41,089 30,262 74 % Materials handling 13,130 12,076 1,054 9 % Other operations 2,922 2,013 909 45 % Total adjusted gross margin $ 141,529 $ 106,211$ 35,318 33 % Adjusted Unit Gross Margin: Refined products $ 0.096 $ 0.099$ (0.003) (3) % Natural gas $ 4.040 $ 2.182$ 1.858 85 % Refined Products Refined products net sales increased $750.6 million, or 82%, compared to the same period last year, with the 66% higher average sales price the key factor. Volumes were 10% higher, also contributing to the higher net sales. Prices were generally on an upward trend throughout the period as concern over inventory levels persisted. The price increases were particularly evident following the late February invasion of the Ukraineby Russiaand the associated geopolitical unrest. Volume gains were higher for all product groups, with the increase the highest for distillates. The percentage increase in volume was particularly strong for transportation fuels, with Sprague's gain for both gasoline and on-road diesel well above that for the overall United States. Residual fuel volumes were also higher during this time period, partly due to the escalation in prices of competing fuels such as natural gas and coal. Refined products adjusted gross margin increased $3.1 million, or 6%, compared to the same period last year as a result of the higher volumes. Overall unit margins were 3% lower compared to the same period last year due to less attractive conditions to purchase, store, and hedge oil inventory as well as margin pressure in the escalating price environment. These negative factors were particularly impactful to our Canadian operations.
Natural gas net sales increased
$23.3 million, or 23%, compared to the same period last year due to a 31% gain in average sales price. Volumes declined by 6% compared to the same period last year partially offsetting the impact of the higher prices on net sales. Natural gas adjusted gross margin increased $30.3 million, or 74%, compared to the same period last year due to an increase in adjusted unit gross margins. The gain in adjusted unit gross margins reflect higher prices and generally more volatile market conditions compared to last year, impacted by periods of cold weather and geopolitical tension following the invasion of Ukraineby Russia. Price increases and higher volatility occurred in the cash as well as the forward markets leading to supply, inventory, and forward position optimization opportunities. In addition, in accordance with fair value standards under GAAP, there was an $8.4 milliongain associated with the quarterly fair value measurement of the credit risk associated with our natural gas derivative assets and liabilities. 30
Table of Contents Materials Handling Materials handling net sales and adjusted gross margin were
$1.1 million, or 9% higher than the same period last year. The gain was mostly due to an increase in the Canadian operations, reflecting a higher level of 3rd-party storage. Margins in the U.S.operations were up slightly at $0.1 millionhigher than last year, with gains in salt, pulp, and general stevedoring requirements more than offsetting a decline in asphalt. The largest changes were the reduction in asphalt margin because of the sale of the Oswego, NYterminal in late April 2021and the termination of the asphalt contract at the Everett, MAterminal at the end of 2021 and the gain due to the higher salt margin following the low activity last year.
Net sales from other operations increased
$2.2 million, or 42%, driven primarily by higher coal volumes and prices compared to the same period last year. The increased coal prices reflect the higher price environment for this commodity that began in the latter part of 2021 as well as a further spike in prices following the Russian invasion of the Ukrainein late February. Adjusted gross margin was $0.9 millionor 45% higher than last year, due largely to increased coal margins, with a higher contribution from the Canadian trucking operations also a factor. Operating Costs and Expenses Three Months Ended March 31, 2022compared to Three Months Ended March 31, 2021Three Months Ended March 31, Increase/(Decrease) 2022 2021 $ % (in thousands) Operating expenses $ 23,235 $ 19,232$ 4,003 21% Selling, general and administrative $ 28,720 $ 25,239$ 3,481 14% Depreciation and amortization $ 8,126 $ 8,482$ (356) (4)% Interest expense, net $ 10,544 $ 8,748$ 1,796 21% Operating Expenses. Operating expenses increased $4.0 million, or 21%, compared to the same period last year, primarily reflecting an increase of $1.1 millionof insurance related costs, $1.0 millionof utilities, $0.8 millionof employee related costs, $0.6 millionof stockpile and boiler fuel expenses, and $0.3 millionof vehicle fuel expenses.
Selling, general and administrative expenses. SG&A spending increased
Depreciation and amortization. Depreciation and amortization were roughly stable, with the increase in amortization expense offset by the decrease in amortization expense.
Interest Expense, net. Interest expense, net increased
$1.8 million, or 21%, compared to the same period last year primarily due to increased net borrowing rates.
Cash and capital resources
Our primary liquidity needs are to fund our working capital requirements, operating expenses, capital expenditures and quarterly distributions. Cash generated from operations, our borrowing capacity under our Credit Agreement (as defined below) and potential future issuances of additional partnership interests or debt securities are our primary sources of liquidity. At
March 31, 2022, we had a working capital deficit of $99.6 million. 31
March 31, 2022, the undrawn borrowing capacity under the working capital facilities of our Credit Agreement was $250.9 millionand the undrawn borrowing capacity under the acquisition facility was $48.3 million. We enter our seasonal peak period during the fourth quarter of each year, during which inventory, accounts receivable and debt levels increase. As we move out of the winter season at the end of the first quarter of the following year, typically inventory is reduced, accounts receivable are collected and converted into cash and debt is paid down. During the three months ended March 31, 2022, the amount drawn under the working capital facilities of our Credit Agreement fluctuated from a low of $413.8 millionto a high of $564.9 million. We believe that we have sufficient liquid assets, cash flow from operations and borrowing capacity under our Credit Agreement to meet our financial commitments, debt service obligations, contingencies and anticipated capital expenditures. However, we are subject to business and operational risks that could adversely affect our cash flow. A material decrease in our cash flow would likely have an adverse effect on our ability to meet our financial commitments and debt service obligations. Credit Agreement On May 11, 2021, Sprague Operating Resources LLC(the " U.S.Borrower") and Kildair Service ULC(the "Canadian Borrower" and, together with the U.S.Borrower, the "Borrowers"), wholly owned subsidiaries of the Partnership, entered into a first amendment (the "First Amendment") to the second amended and restated credit agreement dated as of May 19, 2020(the "Original Credit Agreement"; the Original Credit Agreement as amended by the First Amendment, the "Credit Agreement"). Upon the effective date, the First Amendment increased the acquisition facility from $430 millionto $450 millionwas accounted for as a modification of a syndicated loan arrangement with partial extinguishment to the extent there was a decrease in the borrowing capacity on a creditor by creditor basis. The Credit Agreement matures on May 19, 2023. The Partnership and certain of its subsidiaries (the "Subsidiary Guarantors") are guarantors of the obligations under the Credit Agreement. Obligations under the Credit Agreement are secured by substantially all of the assets of the Partnership, the Borrowers and the Subsidiary Guarantors (collectively, the "Loan Parties").
As further described in Note 14 to the condensed consolidated financial statements, subsequent to the quarter ended
U.S.dollar revolving working capital facility of up to $465.0 million, subject to borrowing base limits, to be used for working capital loans and letters of credit;
• A multi-currency revolving working capital facility of up to
• A revolving vesting facility of up to
•Subject to certain conditions, including the receipt of additional commitments from lenders, the ability to increase the
U.S.dollar revolving working capital facility to up to $1.2 billionand the multicurrency revolving working capital facility to up to $320.0 million. Additionally, subject to certain conditions, the revolving acquisition facility may be increased to up to $750.0 million. At March 31, 2022, indebtedness under the Credit Agreement bears interest, at the Borrowers' option, at a rate per annum equal to either (i) the Eurocurrency Rate (which is the LIBOR Rate for loans denominated in U.S.dollars and CDOR for loans denominated in Canadian dollars, in each case adjusted for certain regulatory costs, and in each case with a floor of 0.25%) for interest periods of one, two (solely with respect to Eurocurrency Rate loans denominated in Canadian dollars), three or six (solely with respect to Eurocurrency Rate loans denominated in U.S.dollars) months plus a specified margin or (ii) an alternate rate plus a specified margin. At March 31, 2022, for loans denominated in U.S.dollars, the alternate rate is the Base Rate which is the highest of (a) the U.S.Prime Rate as in effect from time to time, (b) the greater of the Federal Funds Effective Rate and the Overnight Bank Funding Rate as in effect from time to time plus 0.50% and (c) the one-month Eurocurrency Rate for U.S.dollars as in effect from time to time plus 1.00%. 32
dollars in effect from time to time plus 1.00%.
March 31, 2022, the specified margins for the working capital revolving facilities vary based on the utilization of the working capital facilities as a whole, measured on a quarterly basis. The specified margin for (x) the committed U.S.dollar revolving working capital facility range from 1.00% to 1.50% for loans bearing interest at the Base Rate and from 2.00% to 2.50% for loans bearing interest at the Eurocurrency Rate, (y) the uncommitted U.S.dollar revolving working capital facility range from 0.75% to 1.25% for loans bearing interest at the Base Rate and 1.75% to 2.25% for loans bearing interest at the Eurocurrency Rate and (z) the multicurrency revolving working capital facility range from 1.00% to 1.50% for loans bearing interest at the Base Rate and 2.00% to 2.50% for loans bearing interest at the Eurocurrency Rate. At of March 31, 2022, the specified margin for the revolving acquisition facility varies based on the consolidated total leverage of the Loan Parties. The specified margin for the revolving acquisition facility range from 1.25% to 2.25% for loans bearing interest at the Base Rate and from 2.25% to 3.25% for loans bearing interest at the Eurocurrency Rate. In addition, the Borrowers will incur a commitment fee on the unused portion of (x) the committed U.S.dollar revolving working capital facility and multicurrency revolving working capital facility ranging from 0.375% to 0.500% per annum and (y) the revolving acquisition facility at a rate ranging from 0.35% to 0.50% per annum. Overdue amounts bear interest at the applicable rates described above plus an additional margin of 2%. The Credit Agreement contains various covenants and restrictive provisions that, among other things, prohibit the Partnership from making distributions to unitholders if any event of default occurs or would result from the distribution or if the Loan Parties would not be in pro forma compliance with the financial covenants after giving effect to the distribution. In addition, the Credit Agreement contains various covenants that are usual and customary for a financing of this type, size and purpose, including, but not limited to, covenants that require the Loan Parties to maintain: a minimum consolidated EBITDA-to-fixed charge ratio, a minimum consolidated net working capital amount and a maximum consolidated total leverage-to-EBITDA ratio. The Credit Agreement also limits the Loan Parties ability to incur debt, grant liens, make certain investments or acquisitions, enter into affiliate transactions and dispose of assets. The Partnership was in compliance with the covenants under the Credit Agreement at March 31, 2022. The Credit Agreement also contains events of default that are usual and customary for a financing of this type, size and purpose including, among others, non-payment of principal, interest or fees, violation of certain covenants, material inaccuracy of representations and warranties, bankruptcy and insolvency events, cross-payment default and cross-acceleration, material judgments and events constituting a change of control. If an event of default exists under the Credit Agreement, the lenders will be able to terminate the lending commitments, accelerate the maturity of the Credit Agreement and exercise other rights and remedies with respect to the collateral.
Off-balance sheet arrangements
We have no off-balance sheet arrangements.
Our terminals require investments to maintain, expand, upgrade or enhance existing assets and to comply with environmental and operational regulations. Our capital requirements primarily consist of maintenance capital expenditures and expansion capital expenditures. We define maintenance capital expenditures as capital expenditures made to replace assets, or to maintain the long-term operating capacity of our assets or operating income. Examples of maintenance capital expenditures are expenditures required to maintain equipment reliability, terminal integrity and safety and to address environmental laws and regulations. Costs for repairs and minor renewals to maintain facilities in operating condition and that do not extend the useful life of existing assets will be treated as maintenance expenses as we incur them. We define expansion capital expenditures as capital expenditures made to increase the long-term operating capacity of our assets or our operating income whether through construction or acquisition of additional assets. Examples of expansion capital expenditures include the acquisition of equipment and the development or acquisition of additional storage capacity, to the extent such capital expenditures are expected to expand our operating capacity or our operating income.
The following table summarizes expansion and maintenance capital expenditures for the periods indicated:
Table of Contents Capital Expenditures Expansion Maintenance Total (in thousands) Three Months Ended March 31, 2022
$ 826 $ 1,963 $ 2,7892021 $ 798 $ 1,333 $ 2,131We anticipate that future maintenance capital expenditures will be funded with cash generated by operations and that future expansion capital requirements will be provided through long-term borrowings or other debt financings and/or equity offerings. Cash Flows Three Months Ended March 31, 2022 2021 (in thousands) Net cash provided by operating activities $ 92,923
Net cash used in investing activities
Net cash used in financing activities
$ (86,413) $ (83,220)Operating Activities Net cash provided by operating activities for the three months ended March 31, 2022was $92.9 million. Cash inflows for the period were the result of an increase of $8.8 millionin accounts payable and accrued liabilities primarily relating to the timing of invoice payments for product purchases, a decrease of $136.2 millionin inventories primarily due to less attractive market conditions to purchase, store and hedge oil compared to last year, $84.1 millionrepresenting the net impact in our derivative instruments as a result of contract activity and changes in commodity prices during the period and net income of $17.9 million. These inflows were partially offset by cash outflows as a result of an increase of $81.1 millionin accounts receivable and an increase of $82.1 millionin other assets driven by changes in collateral. Net cash provided by operating activities for the three months ended March 31, 2021was $88.5 million. Cash inflows for the period were the result of a decrease of $67.2 millionin inventories largely due to a reduction in seasonal inventory requirements, net income of $48.8 million, and a decrease of $20.6 millionin other assets driven by changes in collateral. These inflows were offset by cash outflows as a result of an increase of $28.3 millionin accounts receivable driven by a combination of higher sales prices and volumes, a reduction of $17.0 millionin accounts payable and accrued liabilities primarily relating to the timing of invoice payments for product purchases and $9.6 millionrepresenting the net impact in our derivative instruments as a result of contract activity and changes in commodity prices during the period.
Net cash used in investing activities for the three months ended
March 31, 2022was $2.6 millionand primarily resulted from $0.8 millionrelated to expansion capital expenditures and $2.0 millionrelated to maintenance capital expenditure projects across our terminal system. Net cash used in investing activities for the three months ended March 31, 2021was $1.9 million, and primarily resulted from $0.8 millionrelated to expansion capital expenditures and $1.3 millionrelated to maintenance capital expenditures projects across our terminal system.
Net cash used in financing activities for the three months ended
March 31, 2022was $86.4 million, and primarily resulted from $73.2 millionof payments under our Credit Agreement due to financing requirements and distributions of $11.4 million. Net cash used in financing activities for the three months ended March 31, 2021was $83.2 million, and primarily resulted from 62.7 million of payments under our Credit Agreement due to reduced financing requirements from accounts receivable levels, the reduction of inventory levels and distributions of $17.4 million. 34
Impact of inflation
While inflation in
the United Statesand Canadahas been relatively low in recent years, it has accelerated in the last 12 months. Although we do not believe that inflation had a material impact on our results of operations or financial position for the three months ended March 31, 2022and 2021, a high rate of inflation in the future may have an adverse effect on our operating results depending upon how inflationary pressure impacts the sales price of our products versus the product costs and operating expenses necessary to generate and support the selling of these products. In addition, inflation could materially increase the interest rates on our borrowings under our Credit Agreement or any future debt.
Significant Accounting Policies and Estimates
Part I, Item, 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" discusses our Condensed Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. These estimates are based on our knowledge and understanding of current conditions and actions that we may take in the future. Changes in these estimates will occur as a result of the passage of time and the occurrence of future events. Subsequent changes in these estimates may have a significant impact on our financial condition and results of operations and are recorded in the period in which they become known. We have identified the following estimates that, in our opinion, are subjective in nature, require the exercise of judgment and involve complex analysis: the fair value of derivative assets and liabilities, goodwill impairment assessment, and revenue recognition and cost of products sold. The significant accounting policies and estimates that have been adopted and followed in the preparation of our Condensed Consolidated Financial Statements are detailed in Note 1 - Description of Business and Summary of Significant Accounting Policies included in our 2021 Annual Report. There have been no changes in these policies and estimates that had a significant impact on the financial condition and results of operations for the periods covered in this Quarterly Report.
Recent accounting pronouncements
For information on recent accounting pronouncements affecting our business, see “Recent Accounting Pronouncements” included in Note 1 – Description of Business and Summary of Significant Accounting Policies to our Condensed Consolidated Financial Statements.
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