Robert Karlovich - CFO, EVP & Treasurer Michael Krimbill - CEO

Torrey Schultz - RBC Capital Markets Darren Horowitz - Raymond James & Associates Michael Prouting - 10K Capitol

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 NGL Energy Partners LP Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. As a reminder, this conference call is being recorded today, November 7, 2017. I would now like to introduce your host for today's conference, Trey Karlovich, CFO.

Thank you and welcome. This conference call includes forward-looking statements and information. Words such as anticipate, project, expect, plan, goal, forecast, intend, could, believe, may and similar expressions and statements are intended to identify forward-looking statements. While NGL Energy Partners believes that its expectations are based on reasonable assumptions, there can be no assurance that such expectations will prove to be correct. A number of factors could cause actual results to differ materially from the projections, anticipated results or other expectations included in the forward-looking statements. These factors include prices and market demand for natural gas, natural gas liquids, refined products and crude oil, level of production of crude oil, natural gas liquids and natural gas; the effect of weather conditions on demand for oil, natural gas and natural gas liquids; and the ability to successfully identify and consummate growth opportunities, including strategic acquisitions at costs that are accretive to financial results and to successfully integrate and operate assets and businesses that are built or acquired. Other factors that could impact these forward-looking statements are described in risk factors in the partnerships annual report on Form 10-K, quarterly reports on Form 10-Q and other public filings and press releases. NGL Energy Partners undertakes no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. This conference call also includes certain non-GAAP measures, namely EBITDA, adjusted EBITDA and distributable cash flow, which management believes are useful in evaluating our financial results. Please see the partnership's earnings releases, investor presentations and annual and quarterly reports on Form 10-K and Form 10-Q on our website at www.nglenergypartners.com under the Investor Relations tab for more information on our use of non-GAAP measures as well as reconciliations of differences between any non-GAAP measures discussed on this conference call to the most directly comparable GAAP financial measures. At this time, I will turn the call over to our CEO, Mike Krimbill, for his opening remarks.

Thanks, Trey. We obviously are very pleased with the quarterly results that were finally beating our numbers, and of course, importantly, they were driven by increasing volumes in all segments and margin improvements. I think two areas in particular to focus on; one, Grand Mesa. The volume continues to grow. We have, as you may recall, our MVCs increasing by about 13,000 barrels a day on November 1. We also have Bonanza Creek, which placed a drilling rig in their acreage in July. We will begin seeing that increased production. As well as you may recall, when we went through the bankruptcy settlement, we have an increasing margin on those volumes, which equals 10% of the WTI price over $50. So we will see some increasing margins there as well. On water, all basins are experiencing volume growth in not only the water, but skim oil and company-wide, we're seeing an increase in the solids processed. We recently exceeded 800,000 barrels a day of water disposal with more being contracted and connected by water pipelines. Really for the company as a whole, we have significant available capacity in all our segments that can accommodate increased volumes. And we have already spent the capital, so our future growth CapEx will be minimal, while we continue to strengthen the balance sheet. With respect to retail propane, we announced the sale of a portion of our retail propane business this morning. We are not exiting the business but rather focusing on higher-degree day states. To get our numbers right, last year, this business produced about $20 million of EBITDA and maintenance capital was 4. In our forecast, normal winter, we have approximately $25 million for this segment. And again, maintenance capital is about 4. So, obviously, the price we look at it as $220 millions, we're keeping the winter and then closing on March 31. So on a $220 million, it's really 11 times the trailing, it's about 9 times the forecast on an EBITDA basis, and then you can compute what it is on EBITDA minus maintenance CapEx. I want to thank Shawn Coady and his team, as well the DCC, the execs were fantastic to work with. So we will wish them the best. We're not going to be terminating our relationship. We will be providing supply for those operations in the future through our NGL wholesale propane business. I think in summary, we will continue working on deleveraging and improving the coverage. So with that, we'll turn it back to Trey.

All right. Thanks, Mike. As Mike said, this has been a good quarter, and I'm also pleased with our results. Overall, we generated approximately $90 million of adjusted EBITDA this quarter and $130 million year-to-date. Total fiscal 2018 adjusted EBITDA remains forecasted to be between $475 million to $500 million. We have delivered on what we communicated last quarter with the improvement in refined products and liquids and continued growth on Grand Mesa and in our water business. We've executed on one asset sale, and we continue to look at other opportunities. The monetization of the assets and subsequent deleveraging is significant and will allow us to reduce our debt balances and our cost of capital going forward. Briefly on the tax impact of the retail propane transaction. We will recognize a tax gain on this transaction of about $130 million or about $1.10 per unit, but the expected close in next March, this will not be reflected in this year's, the 2017, K-1s. With some of the proposed tax changes, 2018 is still relatively unknown, but at this point, we expect to generate a tax loss from depreciation and amortization that will offset this gain next tax year. Onto the quarterly results. I will start with a summary of each segment and then talk a little more on the balance sheet and our expectations for the remainder of the year. I'll start with crude oil. The crude segment generated approximately $30 million of adjusted EBITDA this quarter with Grand Mesa contributing $38 million. As a reminder, our crude marketing group supports Grand Mesa through the purchase, transportation and sale of product in the DJ Basin. That segment recognized a loss through those efforts supporting Grand Mesa during the quarter. The remainder of the crude logistics segment operated approximately a breakeven level. Year-to-date adjusted EBITDA has totaled over $55 million for this segment. These results are in line with our guidance and expectations. Financial volumes on Grand Mesa averaged at about 94,000 barrels per day for the quarter and exited the quarter just over 100,000 barrels per day. Our physical volumes averaged at about 89,000 barrels per day during the quarter. We expect to stay around this level or slightly higher for the upcoming quarter as the minimum volume commitments on the pipeline increased on November 1. There are currently 26 rigs running in the DJ Basin, and in current commodity prices and economics, we expect drilling and production to continue to increase. Our Point Comfort asset was in the direct path of Hurricane Harvey, but we are pleased to report the damage was minimal and operations resumed to normal after the storm. We also have signed an incremental agreement with Point Comfort despite crude oil to this asset as we are continuing to contract dollar [capacity. The Glass Mountain extension into the stack remains on budget and on schedule, and we continue to expect it to begin operations in early 2018. We are not making any changes to our crude oil segment's forecasted EBITDA for this fiscal year of $125 million. Moving to water. Water adjusted EBITDA was over $27 million for the quarter and almost $50 million year-to-date. Water volumes continue to grow with an average of 655,000 barrels per day this quarter. This exceeds our original volume guidance for the year, and we exited the quarter with over 700,000 barrels per day in September. The growth in the Permian Basin, most notably the Delaware, continues to outpace our expectations, and we are doing everything we can to keep up with producers in this area. We have invested approximately $13 million of growth CapEx this quarter in the water business and $46 million year-to-date, as we add disposal capacity and gathering pipelines to support our existing and new disposal customers. We are not updating the EBITDA guidance for our water business, but we do believe that we should exceed that guidance of $105 million of adjusted EBITDA for the fiscal year, driven by a continued increase in volumes and over $50 per barrel crude oil prices. We have hedged over 80% of our expected skim oil production at just over $50 per barrel from now through March 2018 to limit any direct impact from crude oil pricing changes. Additionally, we have extended our hedge position through fiscal 2019 with just over 50% of our forecasted skim volumes hedged at approximately $50 a barrel as well. Going to the liquid segment. Adjusted EBITDA for our liquid segment totaled $16 million this quarter and $15 million year-to-date, driven by higher volumes, prices and margins. The wholesale propane business exceeded budget as we expected, as prices now significantly exceed our average inventory cost, resulting in a lower weight COG per gallon. This division is now in line with our budget year-to-date. The butane business profited from increased butane prices and volumes; however, continues to be burdened by tight margins due to railcar lease costs and significant butane supply impacting differentials. Those impacts should decrease significantly for next fiscal year as we return cars and lower operating our costs and our expectation that Mariner East 2 will alleviate excess supply. Our Sawtooth storage business continues to operate below our original fiscal 2018 plan as many customers and potential customers are utilizing rail storage in lieu of the caverns. We currently do not expect to add any volumes for this year. Based on results for the past two years compared to the acquisition price of the cavern, we recorded an impairment to goodwill this quarter based on a discounted cash flow model. As a reminder, we purchased these caverns in 2015 issuing 7.4 million units, which were valued at approximately $30 per unit or $280 million in total, and $98 million in cash for total assumed purchase price of $316 million. This was the amount that was used for the purchase accounting at that time. This write-down is non-cash and does not impact any of our financial covenants. Again, we are not changing our EBITDA guidance for the liquids business unit either, which is forecasted at $85 million for the fiscal year. Retail propane EBITDA was $3 million, right in line with our budget. This quarter is typically a breakeven quarter for this segment. However, we did see higher volumes driven by acquisitions completed last summer and gained a full quarter from those districts. In July, we completed two small propane acquisitions for a total investment of about $25 million, and we did a couple others in August that totaled about $3.6 million. I'll talk a little more on the sales transaction we announced this morning when we go over the balance sheet, but because we are entitled to keep the EBITDA from those assets through our year-end, we are not adjusting our adjusted EBITDA target for fiscal 2018 of $105 million for the retail propane segment. The sold assets make up approximately 25% of our forecasted EBITDA for this segment with about $20 million forecasted for the December through March period. As a reminder, we have forecasted this fiscal year on volume estimates using an average of the prior 3-year actual results, which includes two of the warmest winters in the past of 120 plus years. Weather and the impact it has on heating demand will continue to be the biggest driver of our retail propane segment. Turning to refined products. Refined products reported adjusted EBITDA of $22.2 million this quarter and approximately $30 million improvement from the prior quarter, driven by the recontracting efforts that we discussed and covered last quarter as well as higher volumes and margins, including in the Gulf, Southeast business and our West Texas diesel market. As we discussed last quarter, the relationship between our inventory valuation and our hedges continues to have a negative impact on year-to-date results. However, we expect to make up a large portion of this $20 million year-to-date impact in the next two quarters as the time value cost of the hedges reduces and/or product prices improve. The basis differential between our storage location and the New York Harbor, which is the hedged location, will impact our overall results for this year, although we expect that impact to be minimal. We executed on all of our contracts throughout Hurricane Harvey, which provided us with increased margins during the first half of September, although volumes were not as high as we would have liked with the refinery outages and lower inventory levels on hand prior to the storm. The lower inventories were the result of the planned seasonal change in gasoline inventories. We are maintaining our $100 million adjusted EBITDA guidance for this segment as well. Our corporate costs for the quarter were $7.6 million, $14 million year-to-date, and we continue to expect about $25 million in overhead costs for the entire year. Similar to prior years, we expect lower overhead costs in our third and fourth quarters. We declared a $0.39 per unit or $1. 56 annualized distribution for this quarter. We expect to maintain this distribution for our next quarter, which will be declared in late January and paid in February. We'll then evaluate any increase to the distribution in April once the retail propane transaction is closed, we complete any additional transactions, and we have clarity on our fourth quarter results in fiscal 2019 budget. We expect to rebuild coverage over the next two quarters to approximately 1.2x for this year, and we remain committed to a long-term target of at least 1.3x coverage on a trailing 12 month basis going forward. Pro forma for the announced retail propane sales. We would have reduced our 9/30 leverage by about half a turn. Our expected 3/31/18 leverage will be reduced by about a quarter of turn. And for this year, we will maintain our distributable cash flows and coverage. Looking ahead, we will save interest costs to offset the lost EBITDA from this business, but also benefiting from a less seasonal cash profile, higher revenues on Grand Mesa, higher revenues in our water business, continued cost improvements in the liquids segment and a normal run rate of our refined products business. Based on our guidance in the propane transaction, we currently expect to be under 4x levered on a compliance basis for our fiscal year end, status quo for any additional asset sales or transactions. This assumes no equity issuances under our ATM or otherwise with 3/31/18 compliance debt balance of just under $1.9 billion. Our expected growth capital spending for the remainder of this fiscal year is pretty minimal. We have invested about $107 million through the second quarter, which includes $ 49 million in acquisitions in water and retail. We do not anticipate any significant acquisitions for the remainder of this year. Our growth CapEx guidance, which includes acquisitions, remains $150 million to $200 million. However, we are trending to the lower end of that guidance. Our maintenance CapEx has totaled $14 million year-to-date, and we currently expect to come in slightly lower than our $30 million guidance. We are compliance with our debt ratios as of 9/30/17 and expect to remain in compliance based on our current guidance and expectations. Finally, during the quarter, we repurchased approximately $44 million of our outstanding bonds at an average price of $0.94 on the dollar. We also repurchased about 1.2 million of our common units for a total cost of $11 million or just over $9 per unit. This brings the total number of units we have repurchased to about 3.7 million units, which are to offset the dilution of the 4.4 million warrants we issued to Oaktree, of which 2.9 million have not yet vested. We remain focused on the initiatives we covered over the past two quarterly calls, addressing our contracts on Colonial, improving our results, managing our balance sheet and monetizing an asset at a very nice multiple. We are not finished, and we are working every day to continue to build stakeholder value in our partnership. We are pleased with our results for this quarter, but we will not stop working to increase our value, grow our business and protect our balance sheet. We would now open the line-up for any questions.

[Operator Instructions]. And our first question comes from the line of T.J. Schultz from RBC Capital Markets.

First on growth CapEx, as far as that trending lower, just given the growth in the water volumes, what do you need or expect to need to spend there as it seems that that's captured the bulk of the spending here recently? I guess as we think about your comment on available capacity in your segments to capture more volumes, how much room is there in the water segment versus needing more growth capital?

By basin, like the Eagle Ford, we have plenty of capacity there, same as the Pinedale. We drilled one extra well up in the Bakken, and we have significant capacity available in the DJ. So the place where we see dollars being spent are really the Delaware side of the Permian. We probably have a dozen or more permits. The newer model is with these water pipelines coming in, we don't need, for instance, the truck unloading base at every location that we used to build. So we just need some tankage, which reduces our CapEx. So bottom line, I think we have about $30 million slated for the next six to eight months on the water side.

Okay. On Sawtooth, is that still a strategic fit for you all, kind of what's the competitive dynamic there going forward, any color on cash flow expectations for that asset or that has troughed?

Well, certainly, we believe it's troughed. We like the asset. If you look out west, there's a little storage at Adamana and Bumstead in the Southwest, but that's it. And so we have a pretty significant amount of capacity there. What originally we anticipated when prices were $90, we'd see a lot more liquids coming out of the Powder River in the Bakken and some fuel-grade butane, which didn't happen. Well, we think we troughed. We see a path to increase EBITDA significantly, so we are doing everything we can. As you know, the stored seasons only start April 1 through March 31. So we will know more in the next three to four months for next year.

Okay. I guess still in liquid segment, the railcar leases rolling off, kind of what percentage roll-off this year and then next year?

So we have about 700 cars that roll off between now and the end of this year, which we will get the benefit for next year an average of about $1,000 per car per month. So it's a pretty significant savings expected for next year. We may have to use some incremental cars, but if we were to do that, we would expect that to be at a much lower rate. So we're expecting $6 million to $8 million of cost savings next year from the roll-off of railcars.

Okay. Great. And I guess just last, if you could maybe clarify your thoughts on the distribution. We've seen others with yields in this range recently cut distributions to accelerate, delevering, is that a consideration or is the plan to execute kind of into your guidance and coverage range and just give it more time?

We've been pretty consistent here and firm, but we're not cutting our distribution. We did that once in the past, we're not doing it again. We indicated we're going to maintain the $0.39 for this year and then look to recommend a book to the board that we would increase the distribution with really the caveat being that we hit our forecasted numbers of $475 million to $500 million. So definitely no cut, and there's been no discussion of a cut. All the discussions are about increasing as we [indiscernible] beat our numbers.

And our next question comes from the line of Darren Horowitz from Raymond James.

Mike, my first question for you. Within refined products, as it relates to addressing your contracts on Colonial, it look like the space on Colonial was negative $0.01 during the quarter on average and I know your guidance was to take that 20,000 barrels of discretionary line space to 0 for the duration of the fiscal year. So as you guys sit today looking at what -- including for New York Harbor basis over the next three to six months, where do you think the variability around that forecast could be?

So we don't believe that there will be much variability on that forecast from line space as it trades. Again, we've recontracted to the point that line space is relatively indifferent. Our current expectation is that line space will be positive $0.01 or $0.02 through the next, call it, six months to eight months. Should it be positive, that would be a benefit, call it, $5 million to $6 million roughly to our expectations. But at this point, we're not expecting any significant change and again if it remains minus one or even worse based on how our contracts are now structured and how we manage the pipe, we would not have any negative impact.

Adding to that, I think line two is about a 25% positive, the distilled line. We're waiting for on line one is to see the Gulf Coast refineries come back on stream. I think next week, I read there is another 500,000 barrels a day of refining capacity that will be starting up. So to Trey's point, we expect to see the prices in the Gulf Coast fall, which would give us the opportunity to get line one positive.

Darren, you ruined my goal. My goal is to go through the entire conference call without saying the word line space.

I apologize for that. Maybe I will switch to a different segment. It looks a little more positive on the crude oil side of the business outside of what's happening with the step function higher in Grand Mesa committed [volumes and what should come from that. Looking at the base business, in addition to Glass Mountain becoming operational and just hopefully some sequential volume pick up, what else can be done in that business to where you're comfortable with stable sequential EBITDA, the gross, and then the incremental that comes from Grand Mesa is purely that just incremental?

So a couple of things. One, we are seeing improved basin differentials, which is helpful to the marketing business. We've driven our costs down pretty much as well as they can go from what we can control. However, we do have some contractual commitments that roll off over the next, call it, 18 months to 24 months that will also reduce our costs and provide for incremental EBITDA in that business. Those are probably the primary factors. Additionally, with Point Comfort in Oklohoma coming online, we are working to contract those assets out as we continue to add volumes on those assets and that will also contribute to incremental EBITDA rather than a breakeven profile for the rest of that business.

Okay. And then last question for me, a s it relates to additional asset sales and making further progress on the deleveraging initiatives that you talked about, has anything changed with regard to what you consider? I know last time, you had mentioned that you could sell a package of water assets, but it probably wouldn't be either in the DJ or South Texas Eagle Ford, possibly something in the Bakken area. How does that look and is there any update with regard to timing and/or potential magnitude and what that could mean to the debt profile?

So as we've said publicly, we are looking at some other assets. What we said historically was that we were looking in four of our five segments, retail propane, liquids, crude and water. We're continuing to evaluate opportunities. I'd say we are highly focused on deleveraging the balance sheet. Retail propane is a huge step. As we said on the last call, we were targeting something in the $200 million range, and we achieved that. Obviously, something in the water business wouldn't be of that size, but it would contribute and would help. But we are also very pleased with the results we're seeing from water and our expectations over the next 12 months plus. So at this point, what I would say is that we'll continue to look at opportunities, but we're not announcing anything else at this time.

Our next question comes from [indiscernible] NTB Financial.

Just a quick question. I would like to have a general comment -- it's a general question actually. What's happening on possible tuck-in, short-haul pipeline acquisitions, which Trey and I discussed before? What's the possibility of those coming into the -- you getting those under your belt?

Obviously with Grand Mesa, Glass Mountain with our other assets, we are looking at opportunities to add any -- gathering our transportation infrastructure. Those are the types of assets that we would like to own. They need to be strategic and accretive, it's a competitive landscape. We don't have anything to announce at this point in time, but if we were to look at something, I think you would be in the key basins in the U.S. We made it pretty clear that we wanted to be in the Permian, the DJ, the Eagle Ford, the STACK, Merge [, Mid Continent area, those are really the basins that we focus on, maybe a little bit in the Bakken, but those are the key areas.

Also to add, we're not looking at M&A or purchasing someone else's system. We'll be looking at a couple opportunities to build our own. So if we're fortunate enough to do it, it'll be at an attractive return, not something single digit.

Next question comes from Michael Prouting with 10K Capitol.

I had a question somewhat related to a question that's already been asked in terms of deal reaching the balance sheet and also securing a distribution. As you look across your portfolio of businesses, it seems like an obvious opportunity to disposal of asset that aren't returning a good return on capital and obviously you guys say it's a pretty high hurdle there given the leverage and also the rescue [pipe, Oaktree would be basic crude business. So I am just wondering how do you see the opportunities there for divestitures?

Again, as we have said, I mean, we're looking across our asset portfolio. We have a pretty vast asset portfolio and any opportunities that would, as you hit on effectively delever or reduce our cost of capital. Our current public debt is trading at about 7% and as you pointed out, we do have some prefers, that trade around 9% publicly as well as the Oaktree preferers, which is a 10 in 3 quarters coupon. So we do need to clear those hurdles. Obviously, we have some assets which can do that, but we also have some of those assets we are very bullish on their future and would plan to keep those in the portfolio. So it's really looking at what value you can realize today versus the value that you expect to realize in the future and how that translates into reducing your capital costs. I think that's the key. We're not other than -- there are some assets that we would not consider transacting on Grand Mesas, is probably the key one. We're not actually in any of our entire business lines. We like the diversity of the portfolio, but what we did with retail propane is a good example of ability to monetize an asset as a nice multiple, help to delever the balance sheet, but continue to focus in the retail propane space and grow in, as Mike mentioned, states with more heating-degree days.

Okay. I just want to like the way you're talking about that. And just to push a little bit harder on the divestiture side, and congratulations by the way on the valuation of [indiscernible] retail propane assets that you saw. I'm relatively new to the company. It's not clear to me why you are in the retail propane business at all, and especially given the multiple you got on the disposal of those assets, why not look at exiting that business altogether?

When we started up the MLP a few years ago, we wanted to be in businesses that will be commodity based and others that were not commodity based, and retail propane is one that we view as not being affected by rig counts or low crude prices. In fact, low energy prices help increased demand on the retail propane. So we see this as a hedge of our commodity based businesses. It's also an annuity that the key then is to buy the right return, you're not going to necessarily grow it organically. But if you can buy it at a 15% or 16% return, it's a good steady asset. We look at it much like a utility within the business. So we are very much like retail propane. But we do see the southern half of the U.S. in a warm winter, you have a disproportionate decline in your volumes because of the effect of windows and where your house heats up during the day and then your heat does not come out at night. So we will definitely stay in the retail propane business.

Okay. I understand what you're saying there although, given the high cost of capital and also the extraordinary seasonality of that business is still not obvious to me that's a business you should be in, but I appreciate your comments.

Well, we don't disagree with the extraordinary temperature changes we've had recently because it is tough the last two years having been so two of the probably warmest 10 in history.

Yes. I was referring more to the seasonality of the business in terms of -- the cash flow is obviously coming in or at least the revenues being generated in colder months. And it just seems given the high cost of capital and the high indebtedness of business with that kind of seasonality and variability of cash flow, it is just not a business that you should be in.

Well, we sold a piece of it, so we're keeping the rest though.

Your next question comes from the line of Lin Shen from HITE Hedge Asset Management.

This is Matt actually. We're both listening. So on the Grand Mesa, if you clarify the sort of over-earning is the right word, but the earnings above-expectation here this quarter, was that based on excess margin solely from higher volume or was it based on getting a higher margin on all of the volume?

Higher volume. So under our shippers contracts, those shippers have their set rate, their set volume, they were generally in line with those volumes. The incremental volume is generated through our own marketing business where they were able to purchase volumes in the basin, move those volumes along the pipeline. They're paying the pipeline their full tariff. So as we've explained before, NGL benefits as a whole, our crude marketing business loses EBITDA, Grand Mesa makes EBITDA.

Got it. And then do you see any impact on Grand Mesa from some of the new pipelines that Tallgrass is -- where extensions related to Tallgrass is working on?

Not as much. Our understanding is that their extension to Platteville is focused on -- is for condensate. We're not transporting condensate, unless it's blended into a portion of our product that meets our quality specs. We're also not competing at Platteville. So that's a differentiation as well. Obviously, it's a competitive market, we'll continue to compete, but we like the geography that we're focused on, we like the customers and producers that we're servicing, and we continue to think that our volumes will continue to grow on that pipeline.

And then last question, just a follow-up on the divestiture processes. So I guess just clarify, are there actual processes going on right now for assets in other segments or are we serving early exploratory phases in those other segments?

We've been working on multiple processes for the past five to six months. We're continuing to evaluate opportunities and I think that's probably what we'll say on that point.

And I'm not showing any further questions at this time. I would now like to turn the call over to Mike Krimbill for any closing remarks.

Well, these calls are of always easier. We have good news, so this has been fun. And we will be back to you hopefully with more good news. Thank you.

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