UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended June 30, 2022
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from to
Commission file number: 001-36137
(Exact name of registrant as specified in its charter)
| (State of incorporation) | (I.R.S. Employer Identification No.) | |||||||
(Address of principal executive offices)
Registrant’s telephone number, including area code: (800 ) 225-1560
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | ☒ | |||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | |||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The registrant had 26,238,232 common units outstanding as of August 4, 2022.
Table of Contents
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| Item 1. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 5. | ||||||||
| Item 6. | ||||||||
Part I – FINANCIAL INFORMATION
Item 1 — Condensed Consolidated Financial Statements | ||
Sprague Resources LP
Condensed Consolidated Balance Sheets
(in thousands except unit amounts)
| June 30, 2022 | December 31, 2021 | ||||||||||
| (Unaudited) | |||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Accounts receivable, net | |||||||||||
| Inventories | |||||||||||
| Fair value of derivative assets | |||||||||||
| Other current assets | |||||||||||
| Total current assets | |||||||||||
| Fair value of derivative assets, long-term | |||||||||||
| Property, plant and equipment, net | |||||||||||
| Intangibles, net | |||||||||||
| Other assets, net | |||||||||||
| Goodwill | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and unitholders’ equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued liabilities | |||||||||||
| Fair value of derivative liabilities | |||||||||||
| Due to General Partner | |||||||||||
| Current portion of working capital and acquisition facilities | |||||||||||
| Current portion of other obligations | |||||||||||
| Total current liabilities | |||||||||||
| Commitments and contingencies | |||||||||||
| Acquisition facility | |||||||||||
| Fair value of derivative liabilities, long-term | |||||||||||
| Other obligations, less current portion | |||||||||||
| Operating lease liabilities, less current portion | |||||||||||
| Due to General Partner | |||||||||||
| Deferred income taxes | |||||||||||
| Total liabilities | |||||||||||
| Unitholders’ equity: | |||||||||||
Common unitholders - public ( | |||||||||||
Common unitholders - affiliated ( | ( | ( | |||||||||
| Accumulated other comprehensive loss, net of tax | ( | ||||||||||
| Total unitholders’ equity | ( | ( | |||||||||
| Total liabilities and unitholders’ equity | $ | $ | |||||||||
The accompanying notes are an integral part of these financial statements.
1
Sprague Resources LP
Unaudited Condensed Consolidated Statements of Operations
(in thousands except unit and per unit amounts)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net sales | $ | $ | $ | $ | |||||||||||||||||||
| Cost of products sold (exclusive of depreciation and amortization) | |||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
| Selling, general and administrative | |||||||||||||||||||||||
| Depreciation and amortization | |||||||||||||||||||||||
| Total operating costs and expenses | |||||||||||||||||||||||
| Other operating income | |||||||||||||||||||||||
| Operating (loss) income | ( | ( | ( | ||||||||||||||||||||
| Other (loss) income | ( | ||||||||||||||||||||||
| Interest income | |||||||||||||||||||||||
| Interest expense | ( | ( | ( | ( | |||||||||||||||||||
| (Loss) income before income taxes | ( | ( | ( | ||||||||||||||||||||
| Income tax (provision) benefit | ( | ( | ( | ||||||||||||||||||||
| Net (loss) income | ( | ( | ( | ||||||||||||||||||||
| Limited partners' interest in net (loss) income | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
| Net (loss) income per limited partner unit: | |||||||||||||||||||||||
| Common - basic | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
| Common - diluted | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
| Units used to compute net income per limited partner unit: | |||||||||||||||||||||||
| Common - basic | |||||||||||||||||||||||
| Common - diluted | |||||||||||||||||||||||
| Distribution declared per unit | $ | $ | $ | $ | |||||||||||||||||||
The accompanying notes are an integral part of these financial statements.
2
Sprague Resources LP
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) Income
(in thousands)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net (loss) income | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
| Other comprehensive income, net of tax: | |||||||||||||||||||||||
| Unrealized gain on interest rate swaps | |||||||||||||||||||||||
| Net income (loss) arising in the period | ( | ||||||||||||||||||||||
| Reclassification adjustment related to loss (gain) realized in income | |||||||||||||||||||||||
| Net change in unrealized gain on interest rate swaps | |||||||||||||||||||||||
| Tax effect | ( | ( | ( | ( | |||||||||||||||||||
| Foreign currency translation adjustment | ( | ( | |||||||||||||||||||||
| Other comprehensive income | |||||||||||||||||||||||
| Comprehensive (loss) income | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
The accompanying notes are an integral part of these financial statements.
3
Sprague Resources LP
Unaudited Condensed Consolidated Statements of Unitholders’ Equity
(in thousands)
| Common- Public | Common- Affiliated | Incentive Distribution Rights | Accumulated Other Comprehensive Loss | Total | |||||||||||||||||||||||||
| Three Months Ended June 30, 2021 and 2022 | |||||||||||||||||||||||||||||
| Balance at March 31, 2021 | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Net loss | ( | ( | — | ( | |||||||||||||||||||||||||
| Other comprehensive income | — | — | — | ||||||||||||||||||||||||||
| Distributions paid in cash | ( | ( | — | ( | |||||||||||||||||||||||||
| Increase in affiliated units as a result of acquisition by Hartree Partners, LP | ( | — | — | — | |||||||||||||||||||||||||
| Balance at June 30, 2021 | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Balance at March 31, 2022 | $ | $ | ( | $ | $ | ( | $ | ( | |||||||||||||||||||||
| Net loss | ( | ( | — | ( | |||||||||||||||||||||||||
| Other comprehensive income | — | — | — | ||||||||||||||||||||||||||
| Unit-based compensation | ( | — | — | ( | |||||||||||||||||||||||||
| Distributions paid in cash | ( | ( | — | ( | |||||||||||||||||||||||||
| Balance at June 30, 2022 | $ | $ | ( | $ | $ | $ | ( | ||||||||||||||||||||||
| Six Months Ended June 30, 2021 and 2022 | |||||||||||||||||||||||||||||
| Balance at December 31, 2020 | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Net income | ( | — | |||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | ||||||||||||||||||||||||||
| Unit-based compensation | ( | ( | — | — | ( | ||||||||||||||||||||||||
| Distributions paid in cash | ( | ( | ( | — | ( | ||||||||||||||||||||||||
| Increase in affiliated units as a result of acquisition by Hartree Partners, LP | ( | — | — | ||||||||||||||||||||||||||
| Common units issued in connection with annual bonus | — | — | |||||||||||||||||||||||||||
| Units withheld for employee tax obligations | ( | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at June 30, 2021 | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Balance at December 31, 2021 | $ | $ | ( | $ | $ | ( | $ | ( | |||||||||||||||||||||
| Net (loss) | ( | ( | — | ( | |||||||||||||||||||||||||
| Other comprehensive income | — | — | — | ||||||||||||||||||||||||||
| Unit-based compensation | ( | — | — | ( | |||||||||||||||||||||||||
| Distributions paid in cash | ( | ( | — | ( | |||||||||||||||||||||||||
| Balance at June 30, 2022 | $ | $ | ( | $ | $ | $ | ( | ||||||||||||||||||||||
The accompanying notes are an integral part of these financial statements.
4
Sprague Resources LP
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash flows from operating activities | |||||||||||
| Net (loss) income | $ | ( | $ | ||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization (includes amortization of deferred debt issuance costs) | |||||||||||
| (Gain) loss on sale of assets | ( | ( | |||||||||
| Provision for doubtful accounts | ( | ||||||||||
| Non-cash unit-based compensation | ( | ||||||||||
| Deferred income taxes | ( | ( | |||||||||
| Changes in assets and liabilities: | |||||||||||
| Accounts receivable | |||||||||||
| Inventories | |||||||||||
| Other assets | |||||||||||
| Fair value of commodity derivative instruments | |||||||||||
| Due to General Partner and affiliates | ( | ( | |||||||||
| Accounts payable, accrued liabilities and other | ( | ||||||||||
| Net cash provided by operating activities | |||||||||||
| Cash flows from investing activities | |||||||||||
| Purchases of property, plant and equipment | ( | ( | |||||||||
| Proceeds from sale of assets | |||||||||||
| Net cash (used in) provided by investing activities | ( | ||||||||||
| Cash flows from financing activities | |||||||||||
| Net payments under credit agreements | ( | ( | |||||||||
| Payments on finance leases and other obligations | ( | ( | |||||||||
| Debt issuance costs | ( | ( | |||||||||
| Distributions to unitholders | ( | ( | |||||||||
| Units withheld for employee tax obligations | ( | ||||||||||
| Net cash (used in) financing activities | ( | ( | |||||||||
| Effect of exchange rate changes on cash balances held in foreign currencies | ( | ( | |||||||||
| Net change in cash and cash equivalents | |||||||||||
| Cash and cash equivalents, beginning of period | |||||||||||
| Cash and cash equivalents, end of period | $ | $ | |||||||||
| Supplemental disclosure of cash flow information | |||||||||||
| Cash paid for interest | $ | $ | |||||||||
| Cash paid for taxes | $ | $ | |||||||||
| Assets acquired under finance lease obligations | $ | $ | |||||||||
| Cash paid for operating leases | $ | $ | |||||||||
The accompanying notes are an integral part of these financial statements.
5
Sprague Resources LP
Notes to Unaudited Condensed Consolidated Financial Statements
(in thousands unless otherwise stated)
1. Description of Business and Summary of Significant Accounting Policies
Partnership Businesses
Sprague Resources LP (the “Partnership”) is a Delaware limited partnership formed on June 23, 2011 by Sprague Holdings and its General Partner (defined below) and engages in the purchase, storage, distribution and sale of refined products and natural gas, and provides storage and handling services for a broad range of materials.
Unless the context otherwise requires, prior to May 28, 2021, references referring to “Sprague Resources,” and the “Partnership,” refer to Sprague Resources LP and its subsidiaries; references to the "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; references to “Sprague Holdings” refer to Sprague Resources Holdings LLC, a wholly owned subsidiary of Axel Johnson and the owner of the General Partner.
Unless the context otherwise requires, effective May 28, 2021, references referring to Sprague Resources, and the Partnership, refer to Sprague Resources LP and its subsidiaries; references to the General Partner refer to Sprague Resources GP LLC; references to “Hartree” or the "Sponsor" refer to Hartree Partners, LP, and its controlled affiliates, collectively, other than Sprague Resources, its subsidiaries and its General Partner; references to “Sprague Holdings” refer to Sprague HP Holdings LLC, a wholly owned subsidiary of Hartree and the owner of the General Partner.
On April 20, 2021, the Partnership and Hartree Partners, LP ("Hartree") announced that Sprague Holdings entered into an agreement to sell to Sprague HP Holdings, LLC (a wholly-owned subsidiary of Hartree) the interest of Sprague Holdings in the General Partner, the incentive distribution rights and all of the common units representing limited partner interests that Sprague Holdings owned in the Partnership (the “Transaction”). The Transaction was completed and effective on May 28, 2021 and the aggregate purchase price was $290.0 million, consisting of approximately $265.0 million attributable to the purchase of 16,058,484 common units and approximately $25.0 million attributable to the general partner interest and incentive distribution rights. The Partnership elected not to apply push-down accounting in its consolidated financial statements upon the change in control on May 28, 2021.
On June 2, 2022, in response to an unsolicited non-binding proposal received from Hartree on January 11, 2022 and following negotiations between Hartree and the conflicts committee of the board of directors of the Partnership, the Partnership, and its General Partner entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Sprague Holdings and Sparrow HP Merger Sub, LLC (“Merger Sub”), pursuant to which Merger Sub will merge with and into the Partnership, with the Partnership surviving as a direct wholly owned subsidiary of the General Partner and Hartree (the “Merger”). Under the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding common unit, other than those held by Sprague Holdings or its permitted transferees, will be converted into the right to receive $19.00 per common unit in cash without any interest thereon (the “Merger Consideration”). The common units and incentive distribution rights in the Partnership held by Sprague Holdings and its permitted transferees and the General Partner immediately prior to the effective time of the Merger shall be unaffected by the Merger and shall remain outstanding. The closing of the transactions contemplated by the Merger Agreement are expected to occur in the third quarter of 2022.
The Partnership owns, operates and/or controls a network of refined products and materials handling terminals located in the Northeast United States and in Quebec, Canada. The Partnership also utilizes third-party terminals in the Northeast United States through which it sells or distributes refined products pursuant to rack, exchange and throughput agreements. The Partnership has four reportable segments: refined products, natural gas, materials handling and other operations.
•The refined products segment purchases 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 sells them to wholesale and commercial customers.
•The natural gas segment purchases natural gas from natural gas producers and trading companies and sells and distributes natural gas to commercial and industrial customers.
•The materials handling segment offloads, stores and prepares 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.
6
•The other operations segment primarily includes the marketing and distribution of coal and certain commercial trucking activities.
See Note 2 - Revenue for a description of the Partnership's revenue activities within these business segments.
As of June 30, 2022, the Sponsor, through its ownership of Sprague Holdings, owned 19,548,849 common units representing 74.5 % of the limited partner interest in the Partnership. Sprague Holdings also owns the General Partner, which in turn owns a non-economic interest in the Partnership. Sprague Holdings currently holds incentive distribution rights ("IDRs") that entitle it to receive increasing percentages of the cash the Partnership distributes from distributable cash flow in excess of $0.7676 per unit per quarter, up to maximum of 50.0 %. The maximum distribution of 50 % does not include any distributions that Sprague Holdings may receive on any limited partner units that it owns.
Basis of Presentation
The Condensed Consolidated Financial Statements included herein reflect all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the Partnership’s consolidated financial position at June 30, 2022 and December 31, 2021, the consolidated results of operations for the three and six months ended June 30, 2022 and 2021, consolidated statement of changes in unitholders' equity for the three and six months ended June 30, 2022 and 2021, and the consolidated cash flows for the six months ended June 30, 2022 and 2021. The unaudited results of operations for the interim periods reported are not necessarily indicative of results to be expected for the full year. Demand for some of the Partnership’s refined petroleum products, specifically heating oil and residual oil for space heating purposes, and to a lesser extent natural gas, are generally higher during the first and fourth quarters of the calendar year which may result in significant fluctuations in the Partnership’s quarterly operating results.
Going Concern Assessment
Pursuant to FASB ASC 205-40, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern, the Partnership is required to assess its ability to continue as a going concern for a period of one year from the date of the issuance of these condensed consolidated financial statements. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year from the financial statement issuance date. This evaluation initially does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date the financial statements are issued. When substantial doubt exists under this methodology, the Partnerships’s management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Partnerships’s ability to continue as a going concern. The mitigating effect of the Partnerships’s plans, however, is only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued.
The Partnership’s Credit Agreement matures on May 19, 2023 and has not been renewed as of the date of the issuance of these condensed consolidated financial statements. On June 2, 2022, the Partnership entered in a Merger Agreement with Sprague Holdings and Merger Sub, pursuant to which Sprague Holdings will acquire the common units that it does not already own. As the Merger Agreement is subject to customary closing conditions and because the pending Merger may affect how, or
7
if, the Partnership elects to obtain a maturity extension, management has deferred the process to extend the maturity date of its Credit Agreement..
While we plan to renew or extend the terms of the Credit Agreement prior to the stated maturity date, until such time as we have executed an agreement to refinance or extend the maturity of the Credit Agreement, we cannot conclude that it is probable we will do so. Accordingly, the Partnership concluded that there is substantial doubt about its ability to continue as a going concern for a period of at least twelve months from the date of issuance of these financial statements.
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. The financial statements do not include adjustments relating to the recoverability and classification of recorded asset amounts or other amounts and classifications of liabilities, other than obligations under the Credit Agreement classified as current, that might result from the outcome of the uncertainties described above.
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 continued to be volatile. With the easing of restrictions, health advancements and other ongoing measures to alleviate the pandemic in 2021 and through the second 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 a number of 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 June 30, 2022. While market conditions for our products and services appear to have stabilized as compared to the onset of the pandemic, the pandemic remains fluid. 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, the Partnership continues 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.
Significant Accounting Policies
The Partnership's significant accounting policies are described in Note 1 - Description of Business and Summary of Significant Accounting Policies in the Partnership’s audited consolidated financial statements included in the 2021 Annual Report and are the same as are used in preparing these unaudited interim Condensed Consolidated Financial Statements.
Recent Accounting Pronouncements
8
2. Revenue
Disaggregated Revenue
In general, the Partnership's business segmentation is aligned according to the nature and economic characteristics of its products and customer relationships which provides meaningful disaggregation of each business segment's results of operations. The Partnership operates its businesses in the Northeast and Mid-Atlantic United States and Eastern Canada.
The refined products segment purchases 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 sells them to wholesale and commercial customers. Refined products revenue-producing activities are direct sales to customers, including throughput transactions. Revenue is recognized when the product is delivered. Revenue is not recognized on exchange agreements, which are entered into primarily to acquire refined products by taking delivery of products closer to the Partnership’s end markets. Rather, net differentials or fees for exchange agreements are recorded within cost of products sold (exclusive of depreciation and amortization).
The natural gas segment purchases natural gas from natural gas producers and trading companies and sells and distributes natural gas to commercial and industrial customers. Natural gas revenue-producing activities are sales to customers at various points on natural gas pipelines or at local distribution companies (i.e., utilities). Natural gas sales not billed by month-end are accrued based upon gas volumes delivered.
The materials handling segment offloads, stores and prepares for delivery a variety of customer-owned products. A majority of the materials handling segment revenue is generated under leasing arrangements with revenue recorded over the lease term generally on a straight-line basis. Contingent rentals are recorded as revenue only when billable under the arrangement. For materials handling contracts that are not leases, the Partnership recognizes revenue either at a point in time after services are performed or over a period of time if the services are performed in a continuous fashion over the period of the contract as these methods represent a faithful depiction of the transfer of goods and services.
The other operations segment primarily includes the marketing and distribution of coal and certain commercial trucking activities. Revenue from other operations is recognized when the product is delivered or the services are rendered.
9
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net sales: | |||||||||||||||||||||||
| Refined products | |||||||||||||||||||||||
| Distillates | $ | $ | $ | $ | |||||||||||||||||||
| Gasoline | |||||||||||||||||||||||
| Heavy fuel oil and asphalt | |||||||||||||||||||||||
| Total refined products | $ | $ | $ | $ | |||||||||||||||||||
| Natural gas | |||||||||||||||||||||||
| Materials handling | |||||||||||||||||||||||
| Other operations | |||||||||||||||||||||||
| Net sales | $ | $ | $ | $ | |||||||||||||||||||
| Net sales by country: | |||||||||||||||||||||||
| United States | $ | $ | $ | $ | |||||||||||||||||||
| Canada | |||||||||||||||||||||||
| Net sales | $ | $ | $ | $ | |||||||||||||||||||
Contract Balances
Contract liabilities primarily relate to advances or deposits received from the Partnership's customers before revenue is recognized. These amounts are included in accrued liabilities and amounted to $9.3 million and $9.8 million as of June 30, 2022 and December 31, 2021, respectively. A substantial portion of the contract liabilities as of December 31, 2021 remains outstanding as of June 30, 2022 as they are primarily deposits. The Partnership does not have any material contract assets as of June 30, 2022 or December 31, 2021.
3. Leases
4. Accumulated Other Comprehensive Loss, Net of Tax
Amounts included in accumulated other comprehensive loss, net of tax, consisted of the following:
| June 30, 2022 | December 31, 2021 | ||||||||||
| Fair value of interest rate swaps, net of tax | $ | $ | ( | ||||||||
| Cumulative foreign currency translation adjustment | ( | ( | |||||||||
| Accumulated other comprehensive loss, net of tax | $ | $ | ( | ||||||||
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5. Inventories
| June 30, 2022 | December 31, 2021 | ||||||||||
| Petroleum and related products | $ | $ | |||||||||
| Coal | |||||||||||
| Natural gas | |||||||||||
| Inventories | $ | $ | |||||||||
6. Credit Agreement
| June 30, 2022 | December 31, 2021 | ||||||||||
| Working capital facilities | $ | $ | |||||||||
| Acquisition facility | |||||||||||
| Total credit agreement | |||||||||||
| Less: current portion of working capital facilities | ( | ( | |||||||||
| Long-term portion | $ | $ | |||||||||
On April 13, 2022, 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 second amendment (the "Second 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 on May 11, 2021 and the Second Amendment, (the "Credit Agreement"). Upon the effective date, the Second Amendment increased the committed U.S. dollar revolving working capital facility from $465.0 million to $535.9 million, the uncommitted U.S. dollar revolving working capital facility from $200.0 million to $255.0 million, and the multicurrency revolving working capital facility from $85.0 million to $96.6 million. In addition, the Second Amendment included transition changes from LIBOR to the Secured Overnight Financing Rate ("SOFR") plus a SOFR spread adjustment ("Term SOFR") and extended the permitted expiration of letters of credit from six months to one year after the applicable facility termination date. The Second Amendment was 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").
At June 30, 2022, the revolving credit facilities under the Credit Agreement contained, among other items, the following:
•A committed U.S. dollar revolving working capital facility of up to $535.9 million, subject to borrowing base limits, to be used for working capital loans and letters of credit;
•An uncommitted U.S. dollar revolving working capital facility of up to $255.0 million, subject to borrowing base limits and the sole discretion of the lenders, to be used for working capital loans and letters of credit;
•A multicurrency revolving working capital facility of up to $96.6 million, subject to borrowing base limits, to be used for working capital loans and letters of credit;
•A revolving acquisition facility of up to $450.0 million, subject to covenants, to be used for loans and letters of credit to fund capital expenditures and acquisitions and other general corporate purposes; and
•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 billion and 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 June 30, 2022, indebtedness under the Credit Agreement bore interest, at the Borrowers’ option, at a rate per annum equal to either (i) the Eurocurrency Rate (which is the Term SOFR Rate for loans denominated in U.S. dollars and Term SOFR 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 June 30, 2022, loans denominated in U.S. dollars, the alternate rate was 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
11
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 %. For loans denominated in Canadian dollars, the alternate rate was the Prime Rate which is the higher of (a) the Canadian Prime Rate as in effect from time to time and (b) the one-month Eurocurrency Rate for U.S. dollars as in effect from time to time plus 1.00 %.
At June 30, 2022, the specified margins for the revolving working capital facilities varied 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 ranged 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 ranged from 0.75 % to 1.25 % for loans bearing interest at the Base Rate and 1.75 % to 2.25 % for loans that bore interest at the Eurocurrency Rate and (z) the multicurrency revolving working capital facility ranged from 1.00 % to 1.50 % for loans that bore interest at the Base Rate and 2.00 % to 2.50 % for loans that bore interest at the Eurocurrency Rate.
At June 30, 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 that ranged from 0.375 % to 0.500 % per annum and (y) the revolving acquisition facility at a rate that ranged from 0.375 % to 0.500 % per annum. Overdue amounts bore interest at the applicable rates described above plus an additional margin of 2 %.
The working capital facilities are subject to borrowing base reporting and as of June 30, 2022 and December 31, 2021, had a borrowing base of $591.3 million and $750.0 million, respectively. As of June 30, 2022 and December 31, 2021, outstanding letters of credit related to the working capital facilities were $76.9 million and $80.6 million, respectively. As of June 30, 2022 and December 31, 2021, outstanding letters of credit related to the acquisition facility were $19.6 million and $18.8 million, respectively. As of June 30, 2022, excess availability under the working capital facilities was $223.9 million and excess availability under the acquisition facility was $73.0 million.
The weighted average interest rate was 4.3 % at June 30, 2022 and 3.2 % at December 31, 2021. No amounts are due under the Credit Agreement until the maturity date. However, the current portion at June 30, 2022 represents both the amounts of the working capital facility and the acquisition facility.
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 June 30, 2022.
7. Related Party Transactions
12
beginning in June 2021. At June 30, 2022 and December 31, 2021, total amounts due to the General Partner with respect to these benefits and overhead costs were $13.0 million and $13.4 million, respectively.
During the three and six months ended June 30, 2022, the Partnership made oil and natural gas product purchases from Hartree totaling $49.7 million and $58.8 million, respectively, and generated sales of natural gas products to Hartree of $2.1 million and $2.8 million, respectively. There were no amounts recorded for tank fee and storage revenue for the three and six months ended June 30, 2022 as the lease agreement expired in 2021 and was not renewed. As of June 30, 2022, the Partnership is party to four credit guarantee arrangements with third party beneficiaries, totaling $73.0 million in credit support, for which Hartree acts as the guarantor.
During the three and six months ended June 30, 2021, the Partnership recorded tank use and storage fee revenue of $0.2 million and $0.7 million, respectively, from lease agreements entered into with Hartree, a related party. In addition, the Partnership made net inventory purchases from Hartree totaling $29.8 million and $97.8 million for the three and six months ended June 30, 2021, respectively. As of June 30, 2021, the Partnership had a receivable of $0.5 million from Hartree related to certain fees paid on their behalf.
8. Segment Reporting
The Partnership has four reportable segments that comprise the structure used by the chief operating decision makers (CEO and CFO) to make key operating decisions and assess performance. When establishing a reporting segment, the Partnership aggregates individual operating units that are in the same line of business and have similar economic characteristics. These reportable segments are refined products, natural gas, materials handling and other operations.
The Partnership's refined products segment purchases 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 sells them to its customers. The Partnership has wholesale customers who resell the refined products they purchase from the Partnership and commercial customers who consume the refined products they purchase. The Partnership’s wholesale customers consist of home heating oil retailers and diesel fuel and gasoline resellers. The Partnership’s 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. The refined products reportable segment consists of two operating segments.
The Partnership's natural gas segment purchases natural gas from natural gas producers and trading companies and sells and manages distribution of natural gas to commercial and industrial customer locations across 13 states in the Northeast and Mid-Atlantic United States and Canada. The natural gas reportable segment consists of one operating segment.
The Partnership's materials handling segment offloads, stores, and prepares 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. These services are 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. The materials handling reportable segment consists of two operating segments.
The Partnership's other operations segment primarily consists of the purchase, sale and distribution of coal, and commercial trucking activities unrelated to its refined products segment. Other operations are not reported separately as they represent less than 10% of consolidated net sales and adjusted gross margin. The other operations reporting segment consists of two operating segments.
The Partnership evaluates segment performance based on adjusted gross margin, a non-GAAP measure, which is net sales less cost of products sold (exclusive of depreciation and amortization) increased by unrealized hedging losses and decreased by unrealized hedging gains, in each case with respect to refined products and natural gas inventory, and natural gas transportation contracts.
Based on the way the business is managed, it is not reasonably possible for the Partnership to allocate the components of operating costs and expenses among the operating segments. There were no significant intersegment sales for any of the years presented below.
The Partnership had no single customer that accounted for more than 10% of total net sales for the three and six months ended June 30, 2022 and 2021, respectively. The Partnership’s foreign sales, primarily sales of refined products and natural gas to its customers in Canada, were $99.4 million and $72.9 million for the three months ended June 30, 2022 and 2021, respectively, and $200.3 million and $139.2 million for the six months ended June 30, 2022 and 2021, respectively.
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Summarized financial information for the Partnership's reportable segments is presented in the table below:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net sales: | |||||||||||||||||||||||
| Refined products | $ | $ | $ | $ | |||||||||||||||||||
| Natural gas | |||||||||||||||||||||||
| Materials handling | |||||||||||||||||||||||
| Other operations | |||||||||||||||||||||||
| Net sales | $ | $ | $ | $ | |||||||||||||||||||
| Adjusted gross margin (1): | |||||||||||||||||||||||
| Refined products | $ | $ | $ | $ | |||||||||||||||||||
| Natural gas | ( | ||||||||||||||||||||||
| Materials handling | |||||||||||||||||||||||
| Other operations | |||||||||||||||||||||||
| Adjusted gross margin | |||||||||||||||||||||||
| Reconciliation to operating income (2): | |||||||||||||||||||||||
| Add/(deduct): | |||||||||||||||||||||||
Change in unrealized gain (loss) on inventory (3) | ( | ||||||||||||||||||||||
Change in unrealized value on natural gas transportation contracts (4) | ( | ( | ( | ( | |||||||||||||||||||
| Operating costs and expenses not allocated to operating segments: | |||||||||||||||||||||||
| Operating expenses | ( | ( | ( | ( | |||||||||||||||||||
| Selling, general and administrative | ( | ( | ( | ( | |||||||||||||||||||
| Depreciation and amortization | ( | ( | ( | ( | |||||||||||||||||||
| Other operating (loss) income | |||||||||||||||||||||||
| Operating (loss) income | ( | ( | ( | ||||||||||||||||||||
| Other income | ( | ||||||||||||||||||||||
| Interest income | |||||||||||||||||||||||
| Interest expense | ( | ( | ( | ( | |||||||||||||||||||
| Income tax (provision) benefit | ( | ( | ( | ||||||||||||||||||||
| Net (loss) income | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||
(1)The Partnership trades, 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, which is a non-GAAP financial measure. Adjusted gross margin is also used by external users of the Partnership’s consolidated financial statements to assess the Partnership’s economic results of operations and its commodity market value reporting to lenders. In determining adjusted gross margin, the Partnership 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. These adjustments align the unrealized hedging gains and losses to the period in which the revenue from the sale of inventory, prepaid fixed forwards and the utilization of transportation contracts relating to those hedges is realized in net income. Adjusted gross margin has no impact on reported volumes or net sales.
(2)Reconciliation of adjusted gross margin to operating income, the most directly comparable GAAP measure.
(3)Inventory is valued at the lower of cost or net realizable value. The adjustment related to change in the 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 the Partnership uses to economically hedge its 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.
(4)Represents the Partnership’s 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 (gains) losses in net income.
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Segment Assets
Due to the commingled nature and uses of the Partnership’s fixed assets, the Partnership does not track its fixed assets between its refined products and materials handling operating segments or its other operations. There are no significant fixed assets attributable to the natural gas reportable segment.
9. Financial Instruments and Off-Balance Sheet Risk
As of June 30, 2022 and December 31, 2021, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximated fair value because of the short maturity of these instruments. As of June 30, 2022 and December 31, 2021, the carrying value of the Partnership’s margin deposits with brokers approximates fair value and consists of initial margin with futures transaction brokers, along with variation margin, which is paid or received on a daily basis, and is included in other current assets or other current liabilities. As of June 30, 2022 and December 31, 2021, the carrying value of the Partnership’s debt approximated fair value due to the variable interest nature of these instruments.
The following table presents financial assets and financial liabilities of the Partnership measured at fair value on a recurring basis:
| As of June 30, 2022 | |||||||||||||||||||||||
| Fair Value Measurement | Quoted Prices in Active Markets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | ||||||||||||||||||||
| Derivative assets: | |||||||||||||||||||||||
| Commodity fixed forwards | $ | $ | $ | $ | |||||||||||||||||||
| Futures, swaps and options | |||||||||||||||||||||||
| Commodity derivatives | |||||||||||||||||||||||
| Interest rate swaps | |||||||||||||||||||||||
| Total derivative assets | $ | $ | $ | $ | |||||||||||||||||||
| Derivative liabilities: | |||||||||||||||||||||||
| Commodity fixed forwards | |||||||||||||||||||||||
| Futures, swaps and options | |||||||||||||||||||||||
| Commodity derivatives | |||||||||||||||||||||||
| Interest rate swaps | |||||||||||||||||||||||
| Total derivative liabilities | $ | $ | $ | $ | |||||||||||||||||||
| As of December 31, 2021 | |||||||||||||||||||||||
| Fair Value Measurement | Quoted Prices in Active Markets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | ||||||||||||||||||||
| Derivative assets: | |||||||||||||||||||||||
| Commodity fixed forwards | $ | $ | $ | $ | |||||||||||||||||||
| Futures, swaps and options | |||||||||||||||||||||||
| Commodity derivatives | |||||||||||||||||||||||
| Interest rate swaps | |||||||||||||||||||||||
| Total derivative assets | $ | $ | $ | $ | |||||||||||||||||||
| Derivative liabilities: | |||||||||||||||||||||||
| Commodity fixed forwards | |||||||||||||||||||||||
| Futures, swaps and options | |||||||||||||||||||||||
| Commodity derivatives | |||||||||||||||||||||||
| Interest rate swaps | |||||||||||||||||||||||
| Total derivative liabilities | $ | $ | $ | $ | |||||||||||||||||||
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Commodity Derivative Instruments
The Partnership utilizes derivative instruments consisting of futures contracts, forward contracts, swaps, options and other derivatives individually or in combination, to mitigate its exposure to fluctuations in prices of refined petroleum products and natural gas. The use of these derivative instruments within the Partnership's risk management policy may, on a limited basis, generate gains or losses from changes in market prices. The Partnership enters into futures and over-the-counter (“OTC”) transactions either on regulated exchanges or in the OTC market. Futures contracts are exchange-traded contractual commitments to either receive or deliver a standard amount or value of a commodity at a specified future date and price, with some futures contracts based on cash settlement rather than a delivery requirement. Futures exchanges typically require margin deposits as security. OTC contracts, which may or may not require margin deposits as security, involve parties that have agreed either to exchange cash payments or deliver or receive the underlying commodity at a specified future date and price. The Partnership posts initial margin with futures transaction brokers, along with variation margin, which is paid or received on a daily basis, and is included in other current assets or other current liabilities. In addition, the Partnership may either pay or receive margin based upon exposure with counterparties. Payments made by the Partnership are included in other current assets, whereas payments received by the Partnership are included in accrued liabilities. Substantially of all of the Partnership’s commodity derivative contracts outstanding as of June 30, 2022 will settle prior to December 31, 2023.
The Partnership enters into some master netting arrangements to mitigate credit risk with significant counterparties. Master netting arrangements are standardized contracts that govern all specified transactions with the same counterparty and allow the Partnership to terminate all contracts upon occurrence of certain events, such as a counterparty’s default. The Partnership has elected not to offset the fair value of its derivatives, even where these arrangements provide the right to do so.
The Partnership’s derivative instruments are recorded at fair value, with changes in fair value recognized in net income each period. The Partnership’s fair value measurements are determined using the market approach and includes non-performance risk and time value of money considerations. Counterparty credit is considered for receivable balances, and the Partnership’s credit is considered for payable balances. In accordance with fair value standards under GAAP, there was a $4.0 million gain and $12.8 million gain recorded during the three and six months ended June 30, 2022, respectively, associated with the quarterly fair value measurement of the credit risk associated with our refined product and natural gas derivative assets and liabilities. There were no such amounts recorded in 2021.
The Partnership determines fair value based on a hierarchy for the inputs used to measure the fair value of financial assets and liabilities based on the source of the input, which generally range from quoted prices for identical instruments in a principal trading market (Level 1) to estimates determined using significant unobservable inputs (Level 3). Multiple inputs may be used to measure fair value; however, the level of fair value is based on the lowest significant input level within this fair value hierarchy.
Details on the methods and assumptions used to determine the fair values are as follows:
Fair value measurements based on Level 1 inputs: Measurements that are most observable and are based on quoted prices of identical instruments obtained from the principal markets in which they are traded. Closing prices are both readily available and representative of fair value. Market transactions occur with sufficient frequency and volume to assure liquidity.
Fair value measurements based on Level 2 inputs: Measurements derived indirectly from observable inputs or from quoted prices from markets that are less liquid are considered Level 2. Measurements based on Level 2 inputs include OTC derivative instruments that are priced on an exchange traded curve, but have contractual terms that are not identical to exchange traded contracts. The Partnership utilizes fair value measurements based on Level 2 inputs for its fixed forward contracts, over-the-counter commodity price swaps, interest rate swaps and forward currency contracts.
Fair value measurements based on Level 3 inputs: Measurements that are least observable are estimated from significant unobservable inputs determined from sources with little or no market activity for comparable contracts or for positions with longer durations.
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The Partnership enters into derivative contracts with counterparties, some of which are subject to master netting arrangements, which allow net settlements under certain conditions. The Partnership presents derivatives at gross fair values in the Condensed Consolidated Balance Sheets. The maximum amount of loss due to credit risk that the Partnership would incur if its counterparties failed completely to perform according to the terms of the contracts, based on the net fair value of these financial instruments, exclusive of cash collateral, was $137.8 million at June 30, 2022.
Information related to these offsetting arrangements is set forth below:
| As of June 30, 2022 | |||||||||||||||||||||||
| Gross Amount Not Offset in the Balance Sheet | |||||||||||||||||||||||
| Gross Amount of Assets/Liabilities in the Balance Sheet | Financial Instruments | Cash Collateral Posted | Net Amount | ||||||||||||||||||||
| Commodity derivative assets | $ | $ | ( | $ | ( | $ | |||||||||||||||||
| Interest rate swap derivative assets | |||||||||||||||||||||||
| Fair value of derivative assets | $ | $ | ( | $ | ( | $ | |||||||||||||||||
| Commodity derivative liabilities | ( | ( | |||||||||||||||||||||
| Fair value of derivative liabilities | $ | ( | $ | $ | $ | ( | |||||||||||||||||
| As of December 31, 2021 | |||||||||||||||||||||||
| Gross Amount Not Offset in the Balance Sheet | |||||||||||||||||||||||
| Gross Amount of Assets/Liabilities in the Balance Sheet | Financial Instruments | Cash Collateral Posted | Net Amount | ||||||||||||||||||||
| Commodity derivative assets | $ | $ | ( | $ | ( | $ | |||||||||||||||||
| Interest rate swap derivative assets | |||||||||||||||||||||||
| Fair value of derivative assets | $ | $ | ( | $ | ( | $ | |||||||||||||||||
| Commodity derivative liabilities | $ | ( | $ | $ | $ | ( | |||||||||||||||||
| Interest rate swap derivative liabilities | ( | ( | |||||||||||||||||||||
| Fair value of derivative liabilities | $ | ( | $ | $ | $ | ( | |||||||||||||||||
The following table presents total realized and unrealized gains (losses) on derivative instruments utilized for commodity risk management purposes included in cost of products sold (exclusive of depreciation and amortization):
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Refined products contracts | $ | ( | $ | ( | $ | ( | $ | ( | |||||||||||||||
| Natural gas contracts | ( | ( | |||||||||||||||||||||
| Total | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
There were no discretionary trading activities for the three and six months ended June 30, 2022 and 2021. The following table presents gross volume of commodity derivative instruments outstanding for the periods indicated:
| As of June 30, 2022 | As of December 31, 2021 | ||||||||||||||||||||||
| Refined Products (Barrels) | Natural Gas (MMBtus) | Refined Products (Barrels) | Natural Gas (MMBtus) | ||||||||||||||||||||
| Long contracts | |||||||||||||||||||||||
| Short contracts | ( | ( | ( | ( | |||||||||||||||||||
17
Interest Rate Derivatives
We enter into interest rate swaps to manage exposures in changing interest rates. We swap the variable SOFR interest rate payable under our Credit Agreement for fixed LIBOR or equivalent SOFR interest rates. These interest rate swaps meet the criteria to receive cash flow hedge accounting treatment. Counterparties to the Partnership’s interest rate swaps are large multinational banks and the Partnership does not believe there is a material risk of counterparty non-performance. The Partnership expects to continue to utilize interest rate swaps to hedge cash flow risk and to manage its exposure to SOFR interest rates for the foreseeable future.
The Partnership's interest rate swap agreements outstanding as of June 30, 2022 were as follows:
| Beginning | Ending | Notional Amount | |||||||||||||||
| January 2022 | December 2022 | * | |||||||||||||||
| January 2023 | March 2023 | * | |||||||||||||||
| April 2023 | December 2023 | * | |||||||||||||||
| January 2024 | December 2024 | ** | |||||||||||||||
| January 2025 | December 2026 | ** | |||||||||||||||
| January 2027 | January 2027 | ||||||||||||||||
* During the months of May through October, one interest rate swap agreement decreases by $ | ||
** During the months of May through October, two interest rate swap agreements decrease by $ | ||
The Partnership records unrealized gains and losses on its interest rate swaps as a component of accumulated other comprehensive loss, net of tax, which is reclassified to earnings as interest expense when the payments are made. As of June 30, 2022, the amount of unrealized gains, net of tax, expected to be reclassified to earnings during the following twelve-month period was $5.2 million.
10. Commitments and Contingencies
Legal, Environmental and Other Proceedings
On July 26, 2022, a purported unitholder of the Partnership filed a lawsuit, entitled Mark Giddings vs. Sprague Resources LP, et al., in the United States District Court for the Southern District of New York. The plaintiff alleges that the preliminary information statement filed by the Partnership with the SEC on July 7, 2022, contains materially incomplete and misleading information and omits material information with respect to the Merger, rendering the preliminary information statement materially incomplete and misleading in violation of Sections 14(a) and 20(a) of the Exchange Act. The plaintiff seeks, among other things, (i) injunctive relief enjoining the Merger, (ii) in the event the Merger is consummated, the rescission and setting aside of the Merger or an award of rescissory damages to the plaintiff (iii) an injunction directing the Partnership, the General Partner and our board of directors to disseminate an amended information statement that is not materially incomplete or misleading, and (iv) costs and attorneys’ fees. The Partnership believes that the claims asserted in this lawsuit are without merit and intends to defend itself against all claims. Additional lawsuits arising out of or relating to the Merger Agreement and the transactions contemplated thereby may be filed in the future.
The Partnership is subject to a tax on sales made in Quebec from product it imports into the province. During an audit by the Quebec Energy Board (QEB) of the annual filings, the Partnership initiated legal action seeking a declaration to limit the applicability of the tax to direct imports, as well as the periods subject to review. Since filing this legal action in June 2018, the Partnership has been assessed $9.0 million of tax, including interest and penalties, for the period of 2007 to 2021. Similarly, since the filing, the Partnership has been assessed $10.3 million, including a 15 % penalty and interest, from the Ministry of the Environment, and the Fight Against Climate Change (known as MELCC) under separate regulation that was in effect for the period from 2007 through 2014. The Partnership is disputing this assessment on the same basis as set out in the QEB legal action described above. The Partnership has accrued an amount which it believes to be a reasonable estimate of the low end of a range of loss related to these matters and such amount is not material to the consolidated financial statements.
On September 14, 2020, a purported class action complaint was filed against Sprague Operating Resources, LLC ("SOR"), one of the Partnership’s subsidiaries, in the U.S. District Court for the District of Rhode Island. The complaint, since amended,
18
alleges causes of action for private nuisance, public nuisance, and negligence, each based on emission impacts to nearby occupants from the Partnership’s oil and natural gas facility located in Providence, Rhode Island. The complaint also alleges that the amount in controversy exceeds $5.0 million. At this early stage in the litigation, the Partnership cannot predict whether the plaintiff will succeed in getting the court to certify a class. Based upon the information currently available to it, the Partnership believes that the complaint is without merit and intends to vigorously defend against it.
In May 2021, the New York City Department of Citywide Administrative Services (DCAS) initiated legal action against SOR, alleging that the SOR failed to pay the city $8.5 million in biodiesel tax credits for product purchased for the period of 2017 through 2019. SOR is disputing the claim and the Partnership has accrued an amount which it believes to be a reasonable estimate of the low end of a range of loss related to this matter and such amount is not material to the consolidated financial statements.
The Partnership is involved in other various lawsuits, other proceedings and environmental matters, all of which arose in the normal course of business. The Partnership believes, based upon its examination of currently available information, its experience to date, and advice from legal counsel, that the individual and aggregate liabilities resulting from the resolution of these contingent matters will not have a material adverse impact on the Partnership’s consolidated results of operations, financial position or cash flows.
11. Equity and Equity-Based Compensation
Equity Awards - Performance-based Phantom Units
Effective March 5, 2021, the board of directors used its discretion to terminate all phantom unit awards granted in 2018, 2019 and 2020. In consideration for this termination, the board of directors paid a higher 2020 cash bonus, issued 172,702 vested common units to each of the Partnership's Named Executive Officers and certain other employees and issued new long-term incentive awards payable in units or cash which vest over a three-year service period. The 2020 cash bonus amounts were expensed during the year ended December 31, 2020 and accrued for as of December 31, 2020. The Partnership accounted for the cancellation of the previously outstanding phantom unit awards and the issuance of the vested units and long term incentive awards as a modification which resulted in immaterial incremental compensation expense.
Unit-based compensation is included in selling, general and administrative expenses. Unit-based compensation expense for the six months ended June 30, 2022 was $0.1 million as compared to $0.2 million for the six months ended June 30, 2021. The Partnership didn't have any unrecognized compensation cost related to performance-based phantom units as of June 30, 2022.
Equity - Changes in Partnership's Units
The following table provides information with respect to changes in the Partnership’s units:
| Common Units | |||||||||||
| Public | Sprague Holdings | ||||||||||
| Balance as of December 31, 2020 | |||||||||||
| Units issued in connection with employee bonus | — | ||||||||||
| Director vested awards | — | ||||||||||
| Units issued in conjunction with IDR Reset Election | — | ||||||||||
| Increase in affiliated units as a result of acquisition by Hartree Partners, LP | ( | ||||||||||
| Increase in affiliated units as a result of change in beneficial ownership of Hartree Bulk Storage LLC | ( | ||||||||||
| Balance as of December 31, 2021 | |||||||||||
| Units issued in connection with employee awards | — | ||||||||||
| Balance as of June 30, 2022 | |||||||||||
IDR Reset Election
On February 11, 2021, Sprague Holdings provided notice to the Partnership that Sprague Holdings had made the IDR Reset Election. Pursuant to the IDR Reset Election, Sprague Holdings relinquished the right to receive incentive distribution
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12. Earnings Per Unit
13. Partnership Distributions
The Partnership's partnership agreement sets forth the calculation to be used to determine the amount and priority of cash distributions that the common unitholders will receive.
Cash distributions for the periods indicated were as follows:
| Quarter Ended | Payment Date | Per Unit | Common | IDR | Total | |||||||||||||||||||||||||||
| December 31, 2021 | February 9, 2022 | $ | $ | $ | $ | |||||||||||||||||||||||||||
| March 31, 2022 | May 11, 2022 | $ | $ | $ | $ | |||||||||||||||||||||||||||
In addition, on July 25, 2022, the Partnership declared a cash distribution for the three months ended June 30, 2022, of $0.4338 per unit, totaling $11.4 million. Such distribution will be paid on August 10, 2022, to unitholders of record on August 5, 2022.
14. Subsequent Events
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | ||||
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 LP and 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 Partner was a wholly owned subsidiary of Axel Johnson.
As used in this 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 LP and its subsidiaries; references to our "General Partner" refer to Sprague Resources GP LLC; references to "Hartree" or the "Sponsor" refer to Hartree Partners, LP and its controlled affiliates, collectively, 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 Partner is a wholly owned subsidiary of Hartree.
CAUTIONARY NOTE 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 Merger (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) our ability to complete the Merger in a timely manner, or at all; (ii) greater than expected operating costs, customer loss, business disruption and employee attrition as a result of the proposed Merger; (iii) diversion of management time on the proposed Merger and changes in management and other personnel before the closing of the Merger; (iv) 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; (v) 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; (vi) security risks including terrorism and cyber-risk, (vii) adverse weather conditions, particularly warmer winter seasons and cooler summer seasons, climate change, environmental releases and natural disasters; (viii) 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; (ix) nonpayment or nonperformance by our customers or suppliers; (x) 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; (xi) unanticipated capital expenditures in connection with the construction, repair, or replacement of our assets; (xii) our ability to integrate acquired assets with our existing assets and to realize anticipated cost savings and other efficiencies and benefits; (xiii) our ability to successfully complete our organic growth and acquisition projects and/or to realize the anticipated financial and operational benefits; and, (xiv) the inability to amend or extend the maturity of our Credit Agreement. 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.
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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.
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Overview
We are a Delaware limited partnership formed in June 2011 by Sprague Holdings and 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 Company in 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’s Asiatic Petroleum subsidiary; and, in 1972, Royal Dutch Shell sold 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 Holdings entered into an agreement to sell to Sprague HP Holdings, LLC (a wholly-owned subsidiary of Hartree) the interest of Sprague Holdings in the General Partner, the incentive distribution rights and all of the common units representing limited partner interests that Sprague Holdings owned in the Partnership (the “Transaction”). The Transaction was completed and effective on May 28, 2021.
On June 2, 2022, in response to an unsolicited non-binding proposal received from Hartree on January 11, 2022, the Partnership, and our General Partner entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Sprague Holdings and Sparrow HP Merger Sub, LLC (“Merger Sub”), pursuant to which Merger Sub will merge with and into the Partnership, with the Partnership surviving as a direct wholly owned subsidiary of our General Partner and Hartree (the “Merger”). Under the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding common unit, other than those held by Sprague Holdings or its permitted transferees, will be converted into the right to receive $19.00 per Common Unit in cash without any interest thereon (the “Merger Consideration”). The common units and incentive distribution rights in the Partnership held by Sprague Holdings and its permitted transferees and the General Partner immediately prior to the effective time of the Merger shall be unaffected by the Merger and shall remain outstanding. The closing of the transactions contemplated by the Merger Agreement are expected to occur in the third quarter of 2022.
The Partnership is one of the largest independent wholesale distributors of refined products in the Northeast United States based 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 States from New York to Maine and in Quebec, Canada that 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 44 third-party terminals in the Northeast United States through 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 Pennsylvania and 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 14,000 commercial and industrial customer locations across 13 states in the Northeast and Mid-Atlantic United States and Canada.
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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 operations segment primarily includes the marketing and distribution of coal conducted in our Portland, Maine terminal, and commercial trucking activity conducted by our Canadian subsidiary.
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 June 30, 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 Holdings also owns the General Partner, which in turn owns a non-economic interest in the Partnership. Sprague Holdings currently 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 $0.7676 per unit per quarter, up to a maximum of 50.0%. The maximum distribution of 50% does not include any distributions that Sprague Holdings may receive on any limited partner units that it owns.
Going Concern Assessment and Management's Plans
Pursuant to FASB ASC 205-40, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern, the Partnership is required to assess its ability to continue as a going concern for a period of one year from the date of the issuance of these condensed consolidated financial statements. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year from the financial statement issuance date. This evaluation initially does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date the financial statements are issued. When substantial doubt exists under this methodology, the Partnerships’s management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Partnerships’s ability to continue as a going concern. The mitigating effect of the Partnerships’s plans, however, is only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued.
The Partnership’s Credit Agreement matures on May 19, 2023 and has not been renewed as of the date of the issuance of these condensed consolidated financial statements. On June 2, 2022, the Partnership entered in a Merger Agreement with Sprague Holdings and Merger Sub, pursuant to which Sprague Holdings will acquire the common units that it does not already own. As the Merger Agreement is subject to customary closing conditions and because the pending Merger may affect how, or if, the Partnership elects to obtain a maturity extension, management has deferred the process to extend the maturity date of its Credit Agreement..
While we plan to renew or extend the terms of the Credit Agreement prior to the stated maturity date, until such time as we have executed an agreement to refinance or extend the maturity of the Credit Agreement, we cannot conclude that it is probable we will do so. Accordingly, the Partnership concluded that there is substantial doubt about its ability to continue as a going concern for a period of at least twelve months from the date of issuance of these financial statements.
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. The financial statements do not include adjustments relating to the recoverability and classification of recorded asset amounts or other amounts and classifications of liabilities, other than obligations under the Credit Agreement classified as current, that might result from the outcome of the uncertainties described above.
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 through the second quarter of 2022, demand for refined products
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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 June 30, 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 Evaluates Our Results of Operations
Our management uses a variety of financial and operational measurements to analyze our performance. These measurements include: (1) adjusted EBITDA and adjusted gross margin, (2) operating expenses, (3) selling, general and administrative (or SG&A) expenses and (4) heating degree days.
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, trade 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 revenue, that when rendered to cash, will be available to pay interest on our indebtedness and make distributions to our equity holders;
•Repeatable operating performance that is not distorted by non-recurring items or market volatility; and
•The viability of acquisitions and capital expenditure 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.
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We recognize that the usefulness of EBITDA and adjusted EBITDA as evaluative 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 and amortization expense. Because capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate profits, any measure that excludes depreciation and amortization expense may have material 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 requirements for capital expenditures or contractual commitments;
•EBITDA and adjusted EBITDA do not reflect changes in, or cash requirements for, working capital needs; and
•EBITDA and adjusted EBITDA do not allow us to analyze the effect of certain recurring and non-recurring items that materially affect our net income or loss.
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, trade suppliers, research analysts and commercial banks to assess:
•The economic results of our operations;
•The market value of our inventory and natural gas transportation contracts for financial reporting to our lenders, as well as for borrowing base purposes; and
•Repeatable operating 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 as an alternative to net income or operating income 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.
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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 Partner and 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 Partner and 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 Service and 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 Boston and New York City (weighted equally) with a historical average for the same geographic locations over the previous ten-year period.
Hedging Activities
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 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
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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 that Impact 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.
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Results of Operations
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 June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Net sales | $ | 1,278,310 | $ | 657,672 | $ | 620,638 | 94 | % | |||||||||||||||
| Cost of products sold (exclusive of depreciation and amortization) | 1,261,935 | 659,803 | 602,132 | 91 | % | ||||||||||||||||||
| Operating expenses | 22,092 | 19,148 | 2,944 | 15 | % | ||||||||||||||||||
| Selling, general and administrative | 21,941 | 16,719 | 5,222 | 31 | % | ||||||||||||||||||
| Depreciation and amortization | 8,049 | 8,258 | (209) | (3) | % | ||||||||||||||||||
| Total operating costs and expenses | 1,314,017 | 703,928 | 610,089 | 87 | % | ||||||||||||||||||
| Other operating income | — | 9,725 | (9,725) | N/A | |||||||||||||||||||
| Operating loss | (35,707) | (36,531) | 824 | (2) | % | ||||||||||||||||||
| Interest income | 115 | 77 | 38 | 49 | % | ||||||||||||||||||
| Interest expense | (9,242) | (8,587) | (655) | 8 | % | ||||||||||||||||||
| Loss before income taxes | (44,834) | (45,041) | 207 | — | % | ||||||||||||||||||
| Income tax provision | (461) | (562) | 101 | (18) | % | ||||||||||||||||||
| Net loss | $ | (45,295) | $ | (45,603) | $ | 308 | (1) | % | |||||||||||||||
| Six months ended June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Net sales | 3,091,625 | 1,693,805 | $ | 1,397,820 | 83 | % | |||||||||||||||||
| Cost of products sold (exclusive of depreciation and amortization) | 2,991,013 | 1,584,585 | 1,406,428 | 89 | % | ||||||||||||||||||
| Operating expenses | 45,327 | 38,379 | 6,948 | 18 | % | ||||||||||||||||||
| Selling, general and administrative | 50,661 | 41,958 | 8,703 | 21 | % | ||||||||||||||||||
| Depreciation and amortization | 16,175 | 16,741 | (566) | (3) | % | ||||||||||||||||||
| Total operating costs and expenses | 3,103,176 | 1,681,663 | 2,819,333 | 168 | % | ||||||||||||||||||
| Other operating income | — | 9,725 | (9,725) | N/A | |||||||||||||||||||
| Operating (loss) income | (11,551) | 21,867 | (33,418) | (153) | % | ||||||||||||||||||
| Other (loss) income | (1) | 2 | (3) | (150) | % | ||||||||||||||||||
| Interest income | 143 | 143 | — | — | % | ||||||||||||||||||
| Interest expense | (19,814) | (17,402) | (2,412) | 14 | % | ||||||||||||||||||
| Income (loss) before income taxes | (31,223) | 4,610 | (35,833) | (777) | % | ||||||||||||||||||
| Income tax benefit (provision) | 3,874 | (1,433) | 5,307 | (370) | % | ||||||||||||||||||
| Net (loss) income | $ | (27,349) | $ | 3,177 | $ | (30,526) | (961) | % | |||||||||||||||
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Reconciliation to 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 June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Reconciliation of Operating Income to Adjusted Gross Margin: | |||||||||||||||||||||||
| Operating (loss) income | $ | (35,707) | $ | (36,531) | $ | (11,551) | $ | 21,867 | |||||||||||||||
| Operating costs and expenses not allocated to operating segments: | |||||||||||||||||||||||
| Operating expenses | 22,092 | 19,148 | 45,327 | 38,379 | |||||||||||||||||||
| Selling, general and administrative | 21,941 | 16,719 | 50,661 | 41,958 | |||||||||||||||||||
| Depreciation and amortization | 8,049 | 8,258 | 16,175 | 16,741 | |||||||||||||||||||
| Other operating (income) (5) | — | (9,725) | — | (9,727) | |||||||||||||||||||
| Add/(deduct): | |||||||||||||||||||||||
| Change in unrealized (gain) loss on inventory (1) | (21,998) | 5,369 | (6,629) | (20,888) | |||||||||||||||||||
| Change in unrealized value on natural gas transportation contracts (2) | 56,673 | 35,592 | 98,596 | 56,711 | |||||||||||||||||||
| Total adjusted gross margin (3): | $ | 51,050 | $ | 38,830 | $ | 192,579 | $ | 145,041 | |||||||||||||||
| Adjusted Gross Margin by Segment: | |||||||||||||||||||||||
| Refined products | $ | 29,868 | $ | 27,165 | $ | 83,994 | $ | 78,198 | |||||||||||||||
| Natural gas | 5,755 | (2,725) | 77,106 | 38,364 | |||||||||||||||||||
| Materials handling | 12,799 | 12,694 | 25,929 | 24,770 | |||||||||||||||||||
| Other operations | 2,628 | 1,696 | 5,550 | 3,709 | |||||||||||||||||||
| Total adjusted gross margin | $ | 51,050 | $ | 38,830 | $ | 192,579 | $ | 145,041 | |||||||||||||||
| Reconciliation of Net Income to Adjusted EBITDA | |||||||||||||||||||||||
| Net (loss) income | $ | (45,295) | $ | (45,603) | $ | (27,349) | $ | 3,177 | |||||||||||||||
| Add/(deduct): | |||||||||||||||||||||||
| Interest expense, net | 9,127 | 8,510 | 19,671 | 17,259 | |||||||||||||||||||
| Tax provision | 461 | 562 | (3,874) | 1,433 | |||||||||||||||||||
| Depreciation and amortization | 8,049 | 8,258 | 16,175 | 16,741 | |||||||||||||||||||
| EBITDA (3): | $ | (27,658) | $ | (28,273) | $ | 4,623 | $ | 38,610 | |||||||||||||||
| Add/(deduct): | |||||||||||||||||||||||
| Change in unrealized (gain) loss on inventory (1) | (21,998) | 5,369 | (6,629) | (20,888) | |||||||||||||||||||
| Change in unrealized value on natural gas transportation contracts (2) | 56,673 | 35,592 | 98,596 | 56,711 | |||||||||||||||||||
| Gain on sale of fixed assets not in the ordinary course of business including gain on insurance recoveries (5) | — | (9,725) | — | (9,727) | |||||||||||||||||||
| Other adjustments (4) | 31 | 35 | 62 | 65 | |||||||||||||||||||
| Adjusted EBITDA | $ | 7,048 | $ | 2,998 | $ | 96,652 | $ | 64,771 | |||||||||||||||
| Other Data: | |||||||||||||||||||||||
| Ten Year Average Heating Degree Days (6) | 604 | 611 | 3,190 | 3,217 | |||||||||||||||||||
| Heating Degree Days (6) | 563 | 520 | 3,166 | 3,059 | |||||||||||||||||||
| Variance from average heating degree days | (7) | % | (15) | % | (1) | % | (5) | % | |||||||||||||||
| Variance from prior period heating degree days | 8 | % | (33) | % | 3 | % | 4 | % | |||||||||||||||
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(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)On April 29, 2021, we sold the Oswego terminal to an unaffiliated buyer. In connection with the sale, we recorded a net gain on the sale of $9.0 million for the quarter ended June 30, 2021, which is included within other operating income in the consolidated statements of income. The remaining $0.7 million of other operating income relates to a gain associated with a parcel of land sold at the Bronx terminal.
(6)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 Boston and New York City (weighted equally) with a historical average for the same geographic locations over the previous ten-year period.
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Analysis of Operating Segments
Three Months Ended June 30, 2022 compared to Three Months Ended June 30, 2021
| Three Months Ended June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands, except adjusted unit gross margin) | |||||||||||||||||||||||
| Volumes: | |||||||||||||||||||||||
| Refined products (gallons) | 293,810 | 289,458 | 4,352 | 2 | % | ||||||||||||||||||
| Natural gas (MMBtus) | 10,895 | 11,692 | (797) | (7) | % | ||||||||||||||||||
| Materials handling (short tons) | 407 | 507 | (100) | (20) | % | ||||||||||||||||||
| Materials handling (gallons) | 96,697 | 124,444 | (27,747) | (22) | % | ||||||||||||||||||
| Net Sales: | |||||||||||||||||||||||
| Refined products | $ | 1,189,213 | $ | 589,142 | $ | 600,071 | 102 | % | |||||||||||||||
| Natural gas | 70,510 | 51,360 | 19,150 | 37 | % | ||||||||||||||||||
| Materials handling | 12,871 | 12,725 | 146 | 1 | % | ||||||||||||||||||
| Other operations | 5,716 | 4,445 | 1,271 | 29 | % | ||||||||||||||||||
| Total net sales | $ | 1,278,310 | $ | 657,672 | $ | 620,638 | 94 | % | |||||||||||||||
| Adjusted Gross Margin: | |||||||||||||||||||||||
| Refined products | $ | 29,868 | $ | 27,165 | $ | 2,703 | 10 | % | |||||||||||||||
| Natural gas | 5,755 | (2,725) | 8,480 | 311 | % | ||||||||||||||||||
| Materials handling | 12,799 | 12,694 | 105 | 1 | % | ||||||||||||||||||
| Other operations | 2,628 | 1,696 | 932 | 55 | % | ||||||||||||||||||
| Total adjusted gross margin | $ | 51,050 | $ | 38,830 | $ | 12,220 | 31 | % | |||||||||||||||
| Adjusted Unit Gross Margin: | |||||||||||||||||||||||
| Refined products | $ | 0.102 | $ | 0.094 | $ | 0.008 | 9 | % | |||||||||||||||
| Natural gas | $ | 0.528 | $ | (0.233) | $ | 0.761 | 327 | % | |||||||||||||||
Refined Products
Refined products net sales increased $600.1 million, or 102%, compared to the same period last year, with the 99% higher average sales price the key factor. Volumes were 2% higher, also contributing to the higher net sales gain. The near doubling of the average sales price was a result of prices remaining high following the price escalation spurred on by the late February invasion of the Ukraine by Russia and the associated geopolitical unrest. The volume gain was a result of an increase in gasoline, with distillate and heavy oil volumes lower than the same period last year.
Refined products adjusted gross margin increased $2.7 million, or 10%, compared to the same period last year, due to a combination of the higher volumes and an increase in the average unit margin. Although the environment to purchase, store, and hedge oil inventory was poorer than the same period last year, realizations on sales to customers were adequate to lead to the slight increase in the average unit margin.
Natural Gas
Natural gas net sales increased $19.2 million, or 37%, compared to the same period last year due to a 47% gain in average sales price. Volumes declined by 7% compared to the same period last year partially offsetting the impact of the higher prices on net sales. In addition, in accordance with fair value standards under GAAP, there was a $3.8 million gain associated with the quarterly fair value measurement of the credit risk associated with our natural gas derivative assets and liabilities.
Natural gas adjusted gross margin increased $8.5 million, or 311%, compared to the same period last year. The increase in adjusted unit gross margins reflect the higher price and more volatile market environment in the cash and forward markets leading to supply, inventory, and forward position optimization opportunities.
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Materials Handling
Materials handling net sales and adjusted gross margin were $0.1 million, or 1% higher than the same period last year. The increase was a result of a gain in the Canadian operations, reflecting a higher level of third-party storage as well as revenue gains due to annual escalation of rates on existing tank lease contracts. Margins in the U.S. operations were $0.3 million lower, with reductions in petcoke and furnace slag handling more than offsetting increases in windmill handling, china clay, lease revenue, and heating charges paid by tank leaseholders.
Other Operations
Net sales from other operations increased $1.3 million, or 29%, driven by a combination of a gain in the Canadian trucking operations and higher coal prices. Adjusted gross margin increased $0.9 million, or 55% driven by a transition in our Canadian trucking operations from utilizing third-party haulers to company drivers at the beginning of March 2022, which resulted in the costs of the company drivers recognized as an operating expense. The increased coal prices reflected a 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 Ukraine in late February. Adjusted gross margin was $0.9 million or 55% higher than last year, due to a combination of increased coal margins, along with the impact of reclassifying the drivers costs at the Canadian trucking operations.
Six Months Ended June 30, 2022 compared to Six Months Ended June 30, 2021
| Six Months Ended June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands, except adjusted unit gross margin) | |||||||||||||||||||||||
| Volumes: | |||||||||||||||||||||||
| Refined products (gallons) | 859,478 | 805,303 | 54,175 | 7 | % | ||||||||||||||||||
| Natural gas (MMBtus) | 28,556 | 30,527 | (1,971) | (6) | % | ||||||||||||||||||
| Materials handling (short tons) | 1,038 | 924 | 114 | 12 | % | ||||||||||||||||||
| Materials handling (gallons) | 184,851 | 182,303 | 2,548 | 1 | % | ||||||||||||||||||
| Net Sales: | |||||||||||||||||||||||
| Refined products | $ | 2,856,043 | $ | 1,505,342 | $ | 1,350,701 | 90 | % | |||||||||||||||
| Natural gas | 196,354 | 153,935 | 42,419 | 28 | % | ||||||||||||||||||
| Materials handling | 25,964 | 24,771 | 1,193 | 5 | % | ||||||||||||||||||
| Other operations | 13,264 | 9,757 | 3,507 | 36 | % | ||||||||||||||||||
| Total net sales | $ | 3,091,625 | $ | 1,693,805 | $ | 1,397,820 | 176 | % | |||||||||||||||
| Adjusted Gross Margin: | |||||||||||||||||||||||
| Refined products | $ | 83,994 | $ | 78,198 | $ | 5,796 | 7 | % | |||||||||||||||
| Natural gas | 77,106 | 38,364 | 38,742 | 101 | % | ||||||||||||||||||
| Materials handling | 25,929 | 24,770 | 1,159 | 5 | % | ||||||||||||||||||
| Other operations | 5,550 | 3,709 | 1,841 | 50 | % | ||||||||||||||||||
| Total adjusted gross margin | $ | 192,579 | $ | 145,041 | $ | 47,538 | 33 | % | |||||||||||||||
| Adjusted Unit Gross Margin: | |||||||||||||||||||||||
| Refined products | $ | 0.098 | $ | 0.097 | $ | 0.001 | 1 | % | |||||||||||||||
| Natural gas | $ | 2.700 | $ | 1.257 | $ | 1.443 | 115 | % | |||||||||||||||
Refined Products
Refined products net sales increased $1,350.7 million, or 90%, due primarily to the substantially higher oil price environment compared to the same period last year. In addition, the 7% increase in volumes was a contributor to the higher net sales. The higher volumes were primarily due to gasoline, though distillates also contributed to the volume gain. The increase in gasoline volumes was due to significantly higher activity with a major customer. The distillate volume gain was a combination of marine fuel and on-road diesel.
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Refined products adjusted gross margin increased $5.8 million, or 7%, compared to the same period last year driven by the 7% increase in volumes. The average unit margin was down slightly, primarily as a result of substantially less attractive market conditions to purchase, store and hedge oil inventory. The Canadian operations was a significant contributor to the weaker unit margins, again due to the weaker market conditions to purchase, store and hedge oil inventory compared to the same period last year.
Natural Gas
Natural gas net sales increased $42.4 million, or 28%, compared to the same period last year, due to a 36% higher average sales price, partially offset by a 6% decrease in volumes. Natural gas adjusted gross margin increased by $38.7 million, or 101%, compared to the same period last year, as a result of a 115% gain in the average adjusted unit gross margin. The increase in adjusted unit gross margins was primarily due to enhanced supply and inventory optimization opportunities for both the cash and forward markets. In addition, in accordance with fair value standards under GAAP, there was a $12.3 million gain associated with the quarterly fair value measurement of the credit risk associated with our natural gas derivative assets and liabilities.
Materials Handling
Materials handling net sales and adjusted gross margin both increased $1.2 million, or by 5%, compared to the same period last year. This increase was a result of a $1.3 million gain in our Canadian operations due to increased storage revenue from further tank leases, annual escalation of rates on existing tank leasing contracts, and revenues from further railcar activities. Gross margin in the U.S. was $0.2 million lower, with a $0.8 million reduction in asphalt the primary factor. The decline in asphalt margin was due to a combination of the completion of the Everett, MA terminal lease at the end of 2021 and the sale of the Oswego, NY terminal in late April 2021. An increase in road salt gross margin of $0.7 million due to higher handling requirements largely offset the reduction in asphalt.
Other Operations
Net sales from other operations increased by $3.5 million, or 36%, due to higher coal prices and volumes as well as a gain in the Canadian trucking operations. 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 Ukraine in late February. Coal volumes also increased as demand was strong during the winter period. The increase in sales from the Canadian trucking operations was due to the transition from utilizing third-party haulers to company drivers at the beginning of March 2022, with the costs of the company drivers recognized as an operating expense. Adjusted gross margin was $1.8 million, or 50% higher than last year, again due to a combination of coal and the Canadian trucking operations. The higher coal margin was the primary factor leading to the increase, with the Canadian trucking operations increase a result of reclassifying the drivers costs to an operating expense.
34
Operating Costs and Expenses
Three Months Ended June 30, 2022 compared to Three Months Ended June 30, 2021
| Three Months Ended June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Operating expenses | $ | 22,092 | $ | 19,148 | $ | 2,944 | 15% | ||||||||||||||||
| Selling, general and administrative | $ | 21,941 | $ | 16,719 | $ | 5,222 | 31% | ||||||||||||||||
| Depreciation and amortization | $ | 8,049 | $ | 8,258 | $ | (209) | (3)% | ||||||||||||||||
| Interest expense, net | $ | 9,127 | $ | 8,510 | $ | 617 | 7% | ||||||||||||||||
Operating Expenses. Operating expenses increased $2.9 million, or 15%, compared to the same period last year, primarily reflecting an increase of $1.1 million of employee related costs, $0.7 million of insurance related costs, $0.4 million of stockpile and boiler fuel expenses, $0.4 million of vehicle fuel expenses, and $0.3 million of utilities.
Selling, General and Administrative Expenses. SG&A expenses increased $5.2 million, or 31%, compared to the same period last year largely driven by an increase of $2.3 million in legal expenses, $2.1 million in incentive compensation expense, $0.4 million in employee related costs, and $0.1 million in insurance related costs.
Depreciation and Amortization. Depreciation and amortization was approximately flat as increased depreciation expense was offset by decreased amortization expense.
Interest Expense, net. Interest expense, net increased $0.6 million, or 7%, compared to the same period last year primarily due to increased net borrowing rates.
Six Months Ended June 30, 2022 compared to Six Months Ended June 30, 2021
| Six Months Ended June 30, | Increase/(Decrease) | ||||||||||||||||||||||
| 2022 | 2021 | $ | % | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Operating expenses | $ | 45,327 | 38,379 | $ | 6,948 | 18% | |||||||||||||||||
| Selling, general and administrative | $ | 50,661 | 41,958 | $ | 8,703 | 21% | |||||||||||||||||
| Depreciation and amortization | $ | 16,175 | 16,741 | $ | (566) | (3)% | |||||||||||||||||
| Interest expense, net | $ | 19,671 | 17,259 | $ | 2,412 | 14% | |||||||||||||||||
Operating Expenses. Operating expenses increased $6.9 million or 18%, compared to the same period last year, reflecting an increase of $1.8 million in insurance related expenses, $1.8 million of employee related costs, $1.2 million for stockpile and boiler fuel expenses, $1.2 million for utilities, and $0.6 million of vehicle fuel expenses.
Selling, General and Administrative Expenses. SG&A expenses increased $8.7 million or 21%, compared to the same period last year largely driven by an increase of $3.8 million in legal expenses, $3.3 million in incentive compensation expense, $0.6 million in employee related costs, $0.3 million in insurance related costs, $0.2 million in marketing costs, and $0.2 million in IT software related costs.
Depreciation and Amortization. Depreciation and amortization was approximately flat as increased depreciation expense was offset by decreased amortization expense.
Interest Expense, net. Interest expense, net increased $2.4 million, or 14%, compared to the same period last year primarily due to increased net borrowing rates.
35
Liquidity and Capital Resources
Liquidity
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 June 30, 2022, we had a working capital deficit of $519.7 million.
As of June 30, 2022, the undrawn borrowing capacity under the working capital facilities of our Credit Agreement was $223.9 million and the undrawn borrowing capacity under the acquisition facility was $73.0 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 six months ended June 30, 2022, the amount drawn under the working capital facilities of our Credit Agreement fluctuated from a low of $187.3 million to 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.
Going Concern Assessment
The Credit Agreement matures on May 19, 2023, and has not been renewed as of the date of the issuance of these condensed consolidated financial statements. While the Partnership intends to renew or extend the terms of its Credit Agreement, until such time as we have executed an agreement to refinance or extend the maturity of the Credit Agreement, we cannot conclude that it is probable we will do so, and accordingly, this raises substantial doubt about our ability to continue as a going concern. See "Going Concern Assessment and Management's Plans" above for more information.
Credit Agreement
On April 13, 2022, 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 second amendment (the "Second 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 dated May 11, 2021 ("First Amendment") and the Second Amendment, the "Credit Agreement"). Upon the effective date, the Second Amendment increased the committed U.S. dollar revolving working capital facility from $465.0 million to $535.9 million, the uncommitted U.S. dollar revolving working capital facility from $200.0 million to $255.0 million, and the multicurrency revolving working capital facility from $85.0 million to $96.6 million. In addition, the Second Amendment included transition changes from LIBOR to the Secured Overnight Financing Rate ("SOFR") plus a SOFR spread adjustment ("Term SOFR") and extended the permitted expiration of letters of credit from six months to one year after the applicable facility termination date. The Second Amendment was 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").
At June 30, 2022, the revolving credit facilities under the Credit Agreement contained, among other items, the following:
•A committed U.S. dollar revolving working capital facility of up to $535.9 million, subject to borrowing base limits, to be used for working capital loans and letters of credit;
•An uncommitted U.S. dollar revolving working capital facility of up to $255.0 million, subject to borrowing base limits and the sole discretion of the lenders, to be used for working capital loans and letters of credit;
•A multicurrency revolving working capital facility of up to $96.6 million, subject to borrowing base limits, to be used for working capital loans and letters of credit;
•A revolving acquisition facility of up to $450.0 million, subject to covenants, to be used for loans and letters of credit to fund capital expenditures and acquisitions and other general corporate purposes; and
36
•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 billion and 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 June 30, 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 Term SOFR for loans denominated in U.S. dollars and Term SOFR 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 June 30, 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%.
At June 30, 2022, for loans denominated in Canadian dollars, the alternate rate is the Prime Rate which is the higher of (a) the Canadian Prime Rate as in effect from time to time and (b) the one-month Eurocurrency Rate for U.S. dollars as in effect from time to time plus 1.00%.
At June 30, 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 June 30, 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 June 30, 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.
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Capital Expenditures
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:
| Capital Expenditures | |||||||||||||||||
| Expansion | Maintenance | Total | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Six Months Ended June 30, | |||||||||||||||||
| 2022 | $ | 1,402 | $ | 5,180 | $ | 6,582 | |||||||||||
| 2021 | $ | 1,691 | $ | 4,108 | $ | 5,799 | |||||||||||
We 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
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| (in thousands) | |||||||||||
| Net cash provided by operating activities | $ | 266,205 | $ | 159,152 | |||||||
| Net cash (used in) provided by investing activities | $ | (6,364) | $ | 5,326 | |||||||
| Net cash (used in) financing activities | $ | (254,058) | $ | (161,495) | |||||||
Operating Activities
Net cash provided by operating activities for the six months ended June 30, 2022 was $266.2 million. Cash inflows for the period were the result of a decrease of $200.7 million in inventories primarily due to less attractive market conditions to purchase, store and hedge oil, $68.6 million representing the net impact in our derivative instruments as a result of contract activity and changes in commodity prices during the period, and a decrease of $2.6 million in other assets driven by changes in collateral. These inflows were partially offset by cash outflows as a result of a decrease of $4.1 million in accounts payable and accrued liabilities primarily relating to the timing of invoice payments for product purchases, and a net loss of $27.3 million.
Net cash provided by operating activities for the six months ended June 30, 2021 was $159.2 million. Cash inflows for the period were the result of a decrease of $52.9 million in inventories largely due to a reduction in seasonal inventory requirements, net income of $3.2 million, and a decrease of $54.3 million in other assets driven by changes in collateral, decrease of $34.7 million in accounts receivable and $29.9 million representing the net impact in our derivative instruments as a result of contract activity and changes in commodity prices during the period. These inflows were offset by cash outflows as a result of a reduction of $19.1 million in accounts payable and accrued liabilities primarily relating to the timing of invoice payments for product purchases.
Investing Activities
Net cash used in investing activities for the six months ended June 30, 2022 was $6.4 million and primarily resulted from $1.4 million related to expansion capital expenditures and $5.2 million related to maintenance capital expenditure projects across our terminal system.
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Net cash provided by investing activities for the six months ended June 30, 2021 was $5.3 million, and primarily resulted from the sale of Oswego terminal generating $11.1 million in proceeds partially offset by $1.7 million related to expansion capital expenditures and $4.1 million related to maintenance capital expenditure projects across our terminal system.
Financing Activities
Net cash used in financing activities for the six months ended June 30, 2022 was $254.1 million, and primarily resulted from $226.9 million of payments under our Credit Agreement due to financing requirements and distributions of $22.8 million.
Net cash used in financing activities for the six months ended June 30, 2021 was $161.5 million, and primarily resulted from 117.4 million of payments under our Credit Agreement due to reduced financing requirements from accounts receivable levels, the reduction of inventory levels and distributions of $34.9 million.
Impact of Inflation
While inflation in the United States and Canada has 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 six months ended June 30, 2022 and 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.
Critical 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 impacting our business, see "Recent Accounting Pronouncements" included under Note 1 - Description of Business and Summary of Significant Accounting Policies to our Condensed Consolidated Financial Statements.
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| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | ||||
Market risk is the risk of loss arising from adverse changes in market rates and prices. The principal market risks to which we are exposed are commodity price risk, interest rate risk and market/credit risk. We utilize various derivative instruments to manage exposure to commodity risk and swaps to manage exposure to interest rate risk.
Commodity Price Risk
We use various financial instruments as we seek to hedge our commodity price risk. We sell our refined products and natural gas primarily in the Northeast. We hedge our refined products positions primarily with a combination of futures contracts that trade on the New York Mercantile Exchange, or NYMEX, and fixed-for-floating price swaps in the form of bilateral contracts that are traded “over-the-counter” or "OTC". Although there are some notable differences between futures and the fixed-for-floating price swaps, both can provide a fixed price while the counterparty receives a price that fluctuates as market prices change.
As indicated in the table below, we primarily use futures contracts to hedge light oil transactions and swaps contracts for hedging residual fuel oils. There are no residual fuel oil futures contracts that actively trade in the United States. Each of the financial instruments trade by month for many months forward, allowing us the ability to hedge future contractual commitments.
| Product Group | Primary Financial Hedging Instrument | |||||||
| Gasolines | NYMEX RBOB futures contract | |||||||
| Distillates | NYMEX Ultra Low Sulfur Diesel futures contract | |||||||
| Residual Fuel Oils | New York Harbor 1% Sulfur Residual Fuel Oil swaps contract | |||||||
In addition to the financial instruments listed above, we may periodically use the ethanol futures contract that trades on the Chicago Board of Trade, or CBOT, to hedge ethanol that is used for blending into our gasoline. This ethanol contract is based on Chicago delivery. There are also swaps alternatives available in the market to hedge ethanol. In addition, we also use Rotterdam Barge 0.1% Sulfur Gasoil swaps as the primary means to hedge Kildair's marine gas oil positions.
For natural gas, there are no quality differences that need to be considered when hedging. Our primary hedging requirements relate to fixed price and basis (location) exposure. We largely hedge our natural gas fixed price exposure using fixed-for-floating price swaps that trade on the Intercontinental Exchange ("ICE") with the prices based on the Henry Hub location near Erath, Louisiana. The Henry Hub is the most active natural gas trading location in the United States. Although we typically use swaps, there is also an actively traded NYMEX Henry Hub natural gas futures contract that we can use. We primarily use ICE basis swaps as the key financial instrument type to hedge our natural gas basis risk. Similar to the natural gas futures and ICE Henry Hub swaps, basis swaps for major locations trade actively for many months. These swaps are financially settled, typically using prices quoted by Platts. We also directly hedge our price exposure in oil and natural gas by using forward purchases or sales that require physical delivery of the product.
The following table presents total realized and unrealized gains (losses) on derivative instruments utilized for commodity risk management purposes. Such amounts are included in cost of products sold (exclusive of depreciation and amortization) for the periods presented.
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Refined products contracts | $ | (37,995) | $ | (19,503) | $ | (171,054) | $ | (39,277) | |||||||||||||||
| Natural gas contracts | 4,112 | (34,447) | 172,873 | (33,138) | |||||||||||||||||||
| Total | $ | (33,883) | $ | (53,950) | $ | 1,819 | $ | (72,415) | |||||||||||||||
Substantially all of our commodity derivative contracts outstanding as of June 30, 2022 will settle prior to December 31, 2023.
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Interest Rate Risk
We enter into interest rate swaps to manage exposures in changing interest rates. We swap the variable SOFR interest rate payable under our Credit Agreement for fixed LIBOR or equivalent SOFR interest rates. These interest rate swaps meet the criteria to receive cash flow hedge accounting treatment. Counterparties to our interest rate swaps are large multi-national banks and we do not believe there is a material risk of counterparty nonperformance. Additionally, we may enter into seasonal swaps which are intended to manage our increase in borrowings during the winter, as a result of higher inventory and accounts receivable levels.
Our interest rate swap agreements outstanding as of June 30, 2022 were as follows (in thousands):
| Beginning | Ending | Notional Amount | |||||||||||||||
| January 2022 | December 2022 | 425,000 | * | ||||||||||||||
| January 2023 | March 2023 | 475,000 | * | ||||||||||||||
| April 2023 | December 2023 | 450,000 | * | ||||||||||||||
| January 2024 | December 2024 | 500,000 | ** | ||||||||||||||
| January 2025 | December 2026 | 450,000 | ** | ||||||||||||||
| January 2027 | January 2027 | 300,000 | |||||||||||||||
* During the months of May through October, one interest rate swap agreement decreases by $100 million. This decrease is not reflected in the notional amount in the table above. | ||
** During the months of May through October, two interest rate swap agreements decrease by $100 million each. These decreases are not reflected in the notional amount in the table above. | ||
We expect to continue to hedge our floating rate debt with fixed-for-floating interest rate swaps to manage our exposure to LIBOR or SOFR interest rates. Based on a sensitivity analysis for the twelve months ended June 30, 2022, we estimate that if short-term interest rates increase 100 basis points or decrease to zero, our interest expense would have increased approximately $3.0 million and decreased approximately $0.1 million, respectively. These amounts were estimated by considering the effect of the hypothetical short-term interest rates on variable-rate debt outstanding, adjusted for interest rate hedges.
Derivative Instruments
The following tables present our derivative assets and derivative liabilities measured at fair value on a recurring basis as of June 30, 2022:
| As of June 30, 2022 | |||||||||||||||||||||||
| Fair Value Measurement | Active Markets Level 1 | Observable Inputs Level 2 | Unobservable Inputs Level 3 | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Derivative assets: | |||||||||||||||||||||||
| Commodity fixed forwards | $ | 21,203 | $ | — | $ | 21,203 | $ | — | |||||||||||||||
| Futures, swaps and options | 261,852 | 261,852 | — | — | |||||||||||||||||||
| Commodity derivatives | 283,055 | 261,852 | 21,203 | — | |||||||||||||||||||
| Interest rate swaps | 15,818 | — | 15,818 | — | |||||||||||||||||||
| Total derivative assets | $ | 298,873 | $ | 261,852 | $ | 37,021 | $ | — | |||||||||||||||
| Derivative liabilities: | |||||||||||||||||||||||
| Commodity fixed forwards | 274,141 | — | 274,141 | — | |||||||||||||||||||
| Futures, swaps and options | 158,325 | 158,260 | 65 | — | |||||||||||||||||||
| Commodity derivatives | 432,466 | 158,260 | 274,206 | — | |||||||||||||||||||
| Interest rate swaps | — | — | — | — | |||||||||||||||||||
| Total derivative liabilities | $ | 432,466 | $ | 158,260 | $ | 274,206 | $ | — | |||||||||||||||
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Market and Credit Risk
The risk management activities for our refined products and natural gas segments involve managing exposures to the impact of market fluctuations in the price and transportation costs for commodities through the use of derivative instruments. The prices for energy commodities can be significantly influenced by market liquidity and changes in seasonal demand, weather conditions, transportation availability, and federal and state regulations. We monitor and manage our exposure to market risk on a daily basis in accordance with approved policies.
We maintain a control environment under the direction of our Chief Risk Officer through our risk management policy, processes and procedures, which our senior management has approved. Control measures include volumetric, value at risk, and stop loss limits, as well as contract term limits. Our Chief Risk Officer and Risk Management Committee must approve the use of new instruments or new commodities. Risk limits are monitored and reported daily to senior management. Our risk management department also performs independent verifications of sources of fair values. These controls apply to all of our commodity risk management activities.
We use a value at risk model to monitor commodity price risk within our risk management activities. The value at risk model uses both linear and simulation methodologies based on historical information, with the results representing the potential loss in fair value over one day at a 95% confidence level. Results may vary from time to time as hedging coverage, market pricing levels and volatility change.
We have a number of financial instruments that are potentially at risk including cash and cash equivalents, receivables and derivative contracts. Our primary exposure is credit risk related to our receivables and counterparty performance risk related to the fair value of derivative assets, which is the loss that may result from a customer’s or counterparty’s non-performance. We use credit policies to control credit risk, including utilizing an established credit approval process, monitoring customer and counterparty limits, employing credit mitigation measures such as analyzing customer financial statements, credit insurance with a third party provider and accepting personal guarantees and forms of collateral. We believe that our counterparties will be able to satisfy their contractual obligations. Credit risk is limited by the large number of customers and counterparties comprising our business and their dispersion across different industries.
Cash is held in demand deposit and other short-term investment accounts placed with federally insured financial institutions. Such deposit accounts at times may exceed federally insured limits. We have not experienced any losses on such accounts.
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| Item 4. | Controls and Procedures | ||||
Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information required to be disclosed in the Partnership's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Partnership's reports under the Exchange Act is accumulated and communicated to the Partnership's management, including the President and Chief Executive Officer and the Chief Financial Officer of our General Partner, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
As of June 30, 2022, the Partnership carried out an evaluation, under the supervision and with the participation of management (including the President and Chief Executive Officer and Chief Financial Officer of the General Partner) of the effectiveness of the design and operation of the Partnership's disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based on this evaluation, the General Partner's President and Chief Executive Officer and Chief Financial Officer concluded that the Partnership's disclosure controls and procedures were effective as of June 30, 2022.
Changes in Internal Control Over Financial Reporting
There have been no changes in our system of internal control over financial reporting during the three months ended June 30, 2022 that have materially affected, or are reasonably likely to materially affect, the Partnership’s internal control over financial reporting.
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PART II—OTHER INFORMATION
| Item 1. | Legal Proceedings | ||||
From time to time, we are a party to various legal proceedings or claims arising in the ordinary course of business. For information related to legal proceedings, see the discussion under the caption Legal, Environmental and Other Proceedings in Note 10 - Commitments and Contingencies to our consolidated financial statements included in Part I, Item 1 of this Quarterly Report, which information is incorporated by reference into this Part II, Item 1.
| Item 1A. | Risk Factors | ||||
Other than the risk factors set forth in this report and below, there have been no material changes from the risk factors discussed in Part I, Item 1A “Risk Factors” included in our 2021 Annual Report. Additional risks not currently known to us or that we currently deem to be immaterial also may materially affect our business, results of operations, financial condition, and the price of our common units.
The Partnership operates in a competitive environment in which operating and market risk exposure may be impacted by global events.
In February 2022, Russia invaded Ukraine resulting in the United States, Canada, the European Union and other countries imposing economic sanctions on Russia. These actions have not had and are not expected to have a material impact on the Partnership’s financial condition or results of operations. However, the fluidity and continuation of the conflict may result in additional economic sanctions and other impacts which could have a negative impact on the Partnership’s financial condition, results of operations and cash flows. These include inflationary pressures on raw materials and energy; supply chain and logistics disruptions; volatility in interest rates; and, heightened cybersecurity threats.
We may have difficulty attracting, motivating and retaining employees in light of the proposed Merger.
Uncertainty about the effect of the proposed Merger on our employees may have an adverse effect on the combined organization, particularly given we will no longer be part of a publicly traded entity. This uncertainty may impair our ability to attract, retain and motivate personnel until the Merger is completed. Employee retention may be particularly challenging during the pendency of the Merger, as employees may feel uncertain about their future roles with the combined organization. In addition, we may have to provide additional compensation in order to retain employees, which will increase our administrative expenses even if the Merger does not close. If our employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to become employees of the combined organization, we could experience adverse disruption in our business.
We are subject to business uncertainties and contractual restrictions relating to the Pending Merger, which could adversely affect our business and operations.
In connection with the Merger, it is possible that some customers, suppliers and other persons with whom we have business relationships may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationship with us, which could negatively affect our revenues, earnings and cash available for distribution, as well as the market price of our common units, regardless of whether the Merger is completed.
Under the terms of the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the Merger, which may adversely affect our ability to execute certain of our business strategies. Such limitations could negatively affect our business and operations prior to the completion of the Merger.
The Merger is subject to conditions, including certain conditions that may not be satisfied on a timely basis, if at all. Failure to complete the Merger, or significant delays in completing the Merger, could negatively affect the trading price of our common units and our future business and financial results.
The completion of the Merger is subject to a number of conditions. Accordingly, completion of the Merger is not assured and is subject to risks. If the Merger is not completed, or if there are significant delays in completing the Merger, the trading price of our common units and our future business and financial results could be negatively affected, and we will be subject to several risks, including the following:
•we may be liable for damages to Sprague Holdings under the terms and conditions of the Merger Agreement;
•negative reactions from the financial markets, including declines in the price of our common units due to the fact that current prices may reflect a market assumption that the Merger will be completed; and
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•the attention of our management will have been diverted to the Merger rather than our own operations and pursuit of other opportunities that could have been beneficial to us.
We will incur substantial transaction-related costs in connection with the Merger.
We expect to incur a number of non-recurring transaction-related costs associated with evaluating and completing the Merger. These fees and costs will be substantial regardless of whether the Merger is completed. Non-recurring transaction costs include, but are not limited to, fees paid to financial, legal and accounting advisors, filing fees and printing costs. We will not recover these costs if the conditions to closing the Merger are not satisfied, which would have an adverse impact on our financial condition as a stand-alone business.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | ||||
None.
| Item 3. | Defaults Upon Senior Securities | ||||
None.
| Item 4. | Mine Safety Disclosures | ||||
Not applicable.
| Item 5. | Other Information | ||||
None.
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Item 6. Exhibits
The exhibits listed in the accompanying Exhibits Index are filed or incorporated by reference as part of this Form 10-Q.
EXHIBIT INDEX
| Exhibit No. | Description | |||||||
2.1† | ||||||||
2.2*† | ||||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 3.4 | ||||||||
| 3.5 | ||||||||
| 3.6 | ||||||||
| 3.7 | ||||||||
| 3.8 | ||||||||
| 10.1 | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1** | ||||||||
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| 32.2** | ||||||||
| 101.INS* | Inline XBRL Instance Document - The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document. | |||||||
| 101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation | |||||||
| 101.DEF* | Inline XBRL Taxonomy Extension Definition | |||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase | |||||||
| 101.PRE* | Inline XBRL Taxonomy Extension Presentation | |||||||
| 104* | Cover Page Interactive Data File (Formatted as Inline XBRL and contained in Exhibit 101) | |||||||
| * | Filed herewith. | |||||||
| ** | Furnished herewith in accordance with Item 601(b)(32) of Regulation S-K. | |||||||
† | Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules have been omitted. The registrant hereby agrees to furnish supplementally to the SEC, upon its request, any or all omitted schedules. | |||||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| SPRAGUE RESOURCES LP | ||||||||
| By: | Sprague Resources GP LLC, | |||||||
| Its General Partner | ||||||||
| Date: August 4, 2022 | /s/ David C. Long | |||||||
| David C. Long Chief Financial Officer (on behalf of the registrant, and in his capacity as Principal Financial Officer) | ||||||||
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