May 4, 2016
Operator
Good day and welcome to the Magellan Midstream Partners First Quarter 2016 Earnings Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Mr. Mike Mears, Chief Executive Officer.
Please go ahead, Mr. Mears.
Michael N. Mears
All right. Thank you.
Good afternoon and I want to thank everyone for joining us today and I also want to start by thanking those of you who attended our recent Analyst Day. We hope that that was a valuable use of your time and you received some good info on our assets and our growth projects.
Before we dive into first quarter earnings, I'll remind you that management will be making forward-looking statements as defined by the SEC. Such statements are based on our current judgments regarding some of the factors that could impact the future performance of Magellan.
You should review the risk factors and other information discussed in our filings with the SEC and form your own opinions about Magellan's future performance. We announced solid first quarter financial results this morning that exceeded the EPU guidance we provided in February.
Putting aside the non-cash gain and mark-to-market on our NYMEX positions, we exceeded our guidance by $0.05, primarily related to stronger-than-expected refined products and crude oil transportation revenues during the quarter. Our core fee-based activities continued to generate solid results, emphasizing the stability and consistency of our business model.
Our reported $26.9 million non-cash gain related to the transfer of our 50% interest in Osage Pipe Line to HollyFrontier in exchange for long-term refined products terminals agreements. You may recall that we briefly discussed this transaction at our Analyst Day.
I'll now turn the call over to our CFO, Aaron Milford, to review Magellan's first quarter financial results versus the year ago period in more detail, then I'll be back to discuss our outlook for the rest of the year and review the latest status of our largest expansion projects, before opening the call for your questions.
Aaron L. Milford
Thank you, Mike. Today, I'll be making references to certain non-GAAP financial metrics, including operating margin and distributable cash flow.
We've included exhibits to our earnings release that reconcile these metrics to their nearest GAAP measure. We reported net income of $207 million, earlier this morning, which is higher than the $184 million reported for the first quarter of 2015.
As Mike mentioned, the current quarter benefited by a $26.9 million non-cash gain, recognized as a result of swapping our 50% interest in Osage Pipe Line Company to an affiliate of HollyFrontier Corporation in exchange for Holly entering into new refined products commercial contracts with us. Excluding the impact of this non-cash gain and out-of-period NYMEX activity in the current quarter, adjusted earnings per unit of $0.75, exceeded our guidance of $0.70, previously provided for the current quarter.
Distributable cash flow was $205 million for the first quarter, representing a $28 million decrease in the first quarter of 2015. The decline in DCF is the result of lower realized margins from our commodity related activities and timing of maintenance capital spending.
We entered the year expecting our commodity margins to be under pressure due to lower commodity prices and expect our total maintenance capital spending for the year to be consistent with the $90 million we included in our 2016 full year guidance. Overall, our fee-based businesses performed well in the quarter and we're seeing some improvement in the commodity price environment.
I will now move on to discuss the operating margin performance of our business segments for the first quarter of 2016. Our refined products segment generated $171 million of operating margin in the first quarter of 2016, which was $12.5 million lower than the same period in 2015.
This decrease is attributable to higher operating expenses and lower product margins, more than offsetting higher revenues. Transportation and terminals revenue was $225 million for the quarter, which was $4.1 million higher than the comparable quarter in 2015.
In total, our refined product volumes were down slightly period-over-period and our average transportation rate was higher due to the mid-year 2015 tariff increase of 4.6%. Gasoline and distillate volumes were down slightly from the comparable quarter of 2015.
Our volumes were negatively impacted in the current quarter by refinery maintenance activities and diesel volumes continue to be negatively impacted by lower demand from drilling activities in Texas and the Dakotas. At this point, we still think our guidance assumptions of about 1% base business growth, volume growth for the year is reasonable.
Recall that with growth projects, we have coming online such as the Little Rock pipeline, we expect volume growth in total for the refined products segment to approach 7% for the year. Product margin decreased $4.9 million from the first quarter of 2015 to $32 million.
Lower commodity prices were mostly offset by changes in the value of our NYMEX positions used to hedge our commodity exposure. Ignoring the mark-to-market impacts of out-of-period NYMEX positions, our cash margins were more than $20 million lower in the first quarter of last year, primarily due to lower realized margins from our butane blending activities, offset partially by improved performance from our fractionation activities.
Recall that in 2015 we benefited from hedges entered in 2014 that resulted in substantially higher margins realized in the prior-year period. While the current period benefited from hedges placed in 2015, the margins are simply not as strong leading to lower margin performance from our butane blending activities in the current period.
For all of 2015, we realized gross margins of approximately $0.75 per gallon and, for all of 2016, we expect gross margins to be closer to $0.50 per gallon. While our realized margins were lower than last year, this was expected and was reflected in the full year guidance we provided for 2016.
With improving commodity prices, we're cautiously optimistic about the balance of the year. Operating expenses for our refined products segment were $11.8 million higher than the first quarter of 2015.
This increase was a result of higher environmental remediation costs, higher product handling costs due to our receiving some off-spec products during the quarter, lower value of product gains and higher asset retirement expenses compared to the prior year. Moving now to our crude segment.
Our crude segment operating margin for the first quarter of 2016 of $101 million was $16 million higher than the first quarter of 2015. Transportation and terminals revenue was $11 million higher, primarily resulting from higher average tariff rates, higher Longhorn volumes and additional storage revenue from new tank leases.
For the first quarter of 2016, our Longhorn pipeline shipped close to 270,000 barrels per day. Looking at the crude segment overall, total shipments declined due to fewer barrels shipped under our separate Houston distribution tariff structure.
Shippers on Longhorn and the BridgeTex system have choices they can make as to which tariff they use to move barrels to their ultimate destination. Both BridgeTex and Longhorn offer long-haul rates to many of the ultimate delivery points on our system.
To the extent shippers use these long-haul tariffs, these volumes do not show up as specific Houston distribution system volumes. Operating expenses for the crude oil segment were $3 million higher compared to last year's quarter as a result of higher handing costs due to receiving some off-spec product in the quarter, as well as higher personnel costs.
These increases were partially offset by more favorable product gains. The equity earnings we recognize related to our various crude oil joint ventures including BridgeTex were $8.1 million higher than the first quarter of last year, primarily as a result of higher shipments on the Double Eagle pipeline and the BridgeTex system.
For the current quarter, BridgeTex volumes average nearly 210,000 barrels per day. Lastly, our marine segments operating margin of $28 million was essentially unchanged from the first quarter of last year.
Higher revenues as a result of higher average leased storage rates were offset by higher asset integrity expenses due to timing of tank maintenance activities. Now moving to other net income variances.
Our G&A expenses increased $5.4 million in the first quarter of 2015 as a result of higher equity-based incentive compensation expenses and higher head count. Depreciation and amortization expense increased $2.1 million compared to the 2015 period, due to expansion capital projects placed into service and our net interest expense increased $2.5 million due to interest on higher debt balances being partially offset by higher capitalized interest related to project spending.
Other expense was $2.5 million lower than the first quarter of 2015. This other expense line item relates to a non-cash adjustment with a change in the differential between spot and forward prices and the fair value hedges we have in place related to our crude oil tank bottoms.
Finally, net income was impacted favorably by a non-cash gain of $26.9 million related to the Osage Pipe Line transaction mentioned earlier in the call. Overall, this was a solid quarter that exceeded our expectations.
Our realized margins from our commodity related activities faced some pressure, as expected, but our fee-based businesses continue to be resilient and growing. I will now move to a brief discussion regarding our balance sheet and liquidity position.
We had $3.8 billion of debt outstanding at March 31, 2016, with no borrowings outstanding on any of our credit facilities or our commercial paper program. Our weighted average interest rate for the first quarter of 2016 was 4.6%.
We also ended the quarter with $210 million worth of cash on hand. Also recall that in February, we issued $650 million of 5% 10-year notes.
Capital markets has certainly improved from earlier in the year with a considerable improvement in the debt markets. With our currently committed credit lines, cash on hand and access to the capital markets, we foresee no issues with funding our growth initiatives and refinancing the $250 million of debt coming due in October of this year.
As of the end of the first quarter, our debt-to-EBITDA ratio was approximately three times on a pro forma basis. We continue to enjoy a strong balance sheet and strong distribution coverage.
As a result, we do not expect to access the equity markets to finance our currently identified growth projects. As mentioned in the fourth quarter call, as we move through 2016, we expect to see our debt-to-EBITDA ratio increase somewhat as our capital spending ramps up, but we'll remain well below four times.
I'll now turn the call back over to Mike to discuss our updated guidance for 2016 as well as the status of our growth projects.
Michael N. Mears
Thanks, Aaron. Based on our solid start to 2016 and looking ahead for the rest of the year, we have increased our annual DCF guidance by $10 million to $910 million for 2016.
You may recall, that as part of our initial guidance for the year, we mentioned that each $1 per barrel change in the price of crude oil would result in a roughly $3 million impact to our DCF. However, based on the forward markets, the margin between gasoline and butane has not exactly track with the historical correlation this year.
Therefore even though our revised 2016 DCF guidance has increased, partly due to a higher commodity price forecast for the year, it has not increased as much as you might expect, based on our historical crude oil price to earnings correlations. At this point, we have almost 50% of our total expected sales volumes hedged for our fall butane blending season, which equates to roughly 75% of our full year blending sales volume, either closed or hedged with NYMEX contracts.
With that said, we still expect our overall average butane blending margin to be around $0.50 per gallon for the full year, consistent with our earlier guidance for the year. With regard to distributions, we raised our quarterly cash distribution to $0.8025 per unit which puts us on a trajectory to reach our goal of 10% annual distribution growth for 2016, all while maintaining distribution coverage of 1.2 times and excess cash of more than $150 million for the year.
We also continue to expect to raise our distribution by at least 8% in 2017, while continuing to maintain a 1.2 times coverage ratio. Moving on to our growth projects, we continue to make significant progress on our current slate of construction project.
Construction of our Little Rock pipeline is substantially complete and we expect commercial operations to begin in early July. We're very excited about placing this pipeline into service and market feedback has been extremely positive about this important asset to bring new Mid-Continent and enhance Gulf Coast refined products supply to the Little Rock market.
Regarding Saddlehorn Pipeline, all pipe has been installed with hydrostatic testing underway for the Platteville-to-Cushing segment, which is expected to begin linefill in early third quarter and to be fully operational during September. For the Carr-to-Platteville segment of Saddlehorn, right-of-way acquisition and permitting work are in the final stages with pipe installation expected to commence in June.
We still expect the Carr-to-Platteville segment of Saddlehorn to be operational by the end of the year. And, finally, construction is nearing completion for our Corpus Christi condensate splitter, with testing to commence during the third quarter and commercial operations expected to begin in the fourth quarter of 2016.
Our latest growth spending estimates are $800 million for 2016 with an additional $150 million thereafter to compete the construction projects currently underway. These spending estimates are $50 million higher than the last guidance we provided, primarily due to the addition of new storage projects along our refined products pipeline system and new crude oil storage capabilities primarily at our East Houston terminal.
And as we've stated in the past, with Magellan's solid balance sheet and low leverage ratio, we do not anticipate any need to issue equity in the foreseeable future to finance the growth projects currently in front of us. As always, we continue to evaluate well in excess of $500 million of other potential organic growth opportunities with significant opportunities in all areas of our business.
We remain focused on increasing our Gulf Coast marine capabilities including additional refined products and crude oil storage in the Houston Ship Channel area and to further develop our Seabrook Logistics joint venture. We also recently announced the potential joint venture refined petroleum products pipeline we are considering between Corpus Christi and Brownsville, Texas.
These projects represent just a handful of the many opportunities we are considering. So you can clearly see the opportunities that continues to be quite healthy and could be quite meaningful to Magellan.
And no call will be complete without addressing the acquisition market. As always, we remain active in the acquisition arena and have analyzed or bid on substantially all auctions that are in progress.
As you might expect, the quality of those assets is varied and sellers still seem to expect a healthy price even in the current energy environment. However, we remain committed to maintaining our disciplined approach ensuring that any acquisitions we pursue will benefit our investors in the long-term.
And that concludes our prepared remarks. So operator, we're now ready to turn this over and open it up for questions.
Operator
Thank you. We will take our first question from the line of Barrett Blaschke at MUFJ Securities.
Please go ahead. Barrett Blaschke - Mitsubishi UFJ Securities (USA), Inc.
Hey, guys. Just one quick question.
Wondered if the shell capacities had changed at any of the segments on the terminals?
Michael N. Mears
You're asking, if we've added storage to terminals, is that what you're pointing to? Barrett Blaschke - Mitsubishi UFJ Securities (USA), Inc.
Exactly. Yeah.
Michael N. Mears
We have put a couple tanks into service. It's gone up I think a little bit, but not materially.
We've got a number of tanks, particularly, the East Houston under construction. And off the top of my head, I don't know if any of those were put into service in the first quarter or not.
Barrett Blaschke - Mitsubishi UFJ Securities (USA), Inc. Okay.
And how have utilization rates been running on most of these, it looks like marines have been very strong.
Michael N. Mears
Yes. Our utilization rates on all of our storage, both refined products and crude oil is very high.
Barrett Blaschke - Mitsubishi UFJ Securities (USA), Inc. Thank you.
Operator
Our next question comes from the line of Gabe Moreen at Bank of America Merrill Lynch. Please go ahead.
Gabe Philip Moreen
Hey, good afternoon, everyone. Quick question on Saddlehorn, yesterday, it seemed like there was a pretty big transaction exchanging acreage in production between two producers whom I think are customers on Saddlehorn and Grand Mesa respectively.
Does that transaction change anything in terms of shipper obligations?
Michael N. Mears
It does not change anything with regards to shipper obligations to us. I can't speak for Grand Mesa, but it doesn't change anything for us.
Gabe Philip Moreen
Okay. Thanks, Mike.
And then in terms of switching gears to the Brownsville project, can you talk about who the shipper would be on that project and what kind of permits you're looking to line up for that project and sort of the timeline on those permits?
Michael N. Mears
Well, I think everyone is well aware that there is a number of projects that have been announced to move product from the Corpus Christi area into Mexico. And it's highly likely that we're all taking – talking to the same customer set and without naming a name you can, you can envision that Pemex is probably very involved in those conversations and anyone with refining capacity in the Corpus Christi area is involved in those discussions.
And so those discussions are taking place. And I think, it's probably safe to say that all of these projects aren't needed, so it's going to be a process of which one will serve the needs of the market that's long-term and which one can offer the most competitive service offering and price and we're in the midst of having those negotiations right now.
I really can't provide you any guidance as to the probability of success, because we're right in the middle of those negotiations. I would say that we feel like we have a pretty strong position – we have an existing facility and infrastructure in Corpus Christi that in our view makes an ideal origin point for our pipeline and our potential partner has a facility in Brownsville with connections to pipelines going into Mexico, but we think – we have a very complementary potential partnership in both us and our partner and relatively strong financial position to finance the project and so we think we're in a good position, but we will have to wait and see.
Gabe Philip Moreen
Okay. Thanks, Mike.
And then also lastly, it seems like there's been a couple additional announcements of upstream Permian gathering projects, I think, since the Analyst Day, can you just talk about progress about maybe participating in any of those projects, which I think you talked a bit about during the Analyst Day potentially?
Michael N. Mears
I can tell you we're still very interested in participating in gathering systems in the Permian, but I probably can't comment any further on progress on any of those activities. Unfortunately, I wish I could, but I probably shouldn't at this point in time.
Gabe Philip Moreen
Okay. Sounds good, Mike.
Thank you.
Michael N. Mears
Sure.
Operator
Our next question comes from the line of Steve Sherowski at Goldman Sachs. Please go ahead.
Steve Sherowski
Hi. Good afternoon.
I'm just trying to get a better sense of what's driving the make shift in the crude segment. I mean, I appreciate that customers are opting for the tariff that gives them – that delivers the crude directly to the ultimate destination they want to get to.
But I guess my question is then, why hadn't customers previously been opting for that all-in tariff and instead using the local Houston distribution system?
Michael N. Mears
Well, I think part of it is, we've just – let me just describe what they're doing, first of all. For example, on Longhorn, we have a tariff from Crane to East Houston and then we have also tariffs from Crane to, let's say, Texas City, and the way the shippers have been using that.
And so there is a possibility that shippers could ship to East Houston, pay that tariff and then, at some point, later ship it to downstream destinations and then just pay the distribution system tariff. The way we do our accounting and we track volumes, if they did that historically, that would count as two barrels basically.
If they just shipped all the way to Texas City under the Longhorn tariff, it would count as one barrel. The tariffs obviously, the sum of those tariffs are not materially different.
And if you look at our data, you can see that the volumes are down and that simply because we're not double counting that same barrel now for the most part, but the average tariff rate is up. One material thing that happened in the quarter that I think is driving that is we just recently completed an enhanced connection to the Texas City refineries off of our distribution system.
So I think that's changing the way they're moving their barrels somewhat.
Steve Sherowski
Got you. That's helpful.
So on a go forward basis, would you expect it to be more consistent with the first quarter than prior quarters?
Michael N. Mears
We would...
Steve Sherowski
In terms of volumes relative to an higher tariff rate?
Michael N. Mears
That's correct.
Steve Sherowski
Okay. And then just moving to Brownsville real quickly, does TransMontaigne currently own or currently – yeah, currently own the pipelines on the Mexican side of the border?
Michael N. Mears
I don't.
Steve Sherowski
That you're referring to in the press release?
Michael N. Mears
I don't believe they do. I believe that they own the lines from their terminal to the border, but they don't own them once they cross the border.
Steve Sherowski
Got you. Okay.
That's it for me. Thank you.
Michael N. Mears
Yeah. All right.
Operator
Our next question comes from the line of Jeremy Tonet at JPMorgan. Please go ahead.
Jeremy B. Tonet
Good afternoon.
Michael N. Mears
Good afternoon.
Jeremy B. Tonet
Following up on that last question as far as bringing project into Mexico or to Mexico with the potential JV there. Could you just speak to your thoughts as far as building into Mexico and the other side, the border itself, is that something where you're seeing an opportunity and there is interest or any thoughts there?
Michael N. Mears
We're not pursuing that at this point. I mean, at this point, we don't have an interest in doing that, I can't say, we won't at some point in the future.
But the project we're looking at right now would not involve that. It would just be to Brownsville.
Jeremy B. Tonet
Okay, great. And then, just wondering, if you could give us updated thoughts on counterparty or shipper risk and how that stands and I know there was some issues that you had mentioned in the past, and are there any updates there?
Michael N. Mears
Right. There's really been no change, since the detail we provided to you in the first – in the call back in February.
And just to highlight that, we feel with one exception on our BridgeTex pipeline that we have good credit quality with all of our counterparties. Certainly, we have a couple trading entities that are counterparties, but we have no reason to believe at this point that those parties present any kind of significant credit risk to us.
And, again, we have the one instance on BridgeTex where we have a party that's not performing under the contract. And we don't expect them to do in any of our forecast or guidance.
Jeremy B. Tonet
Great. That's helpful.
That's it from me. Thanks.
Michael N. Mears
All right. Thank you.
Operator
Our next question comes from the line of Shneur Gershuni at UBS. Please go ahead.
Shneur Z. Gershuni
Actually Shneur Gershuni, but good afternoon, guys. Just wanted to follow-up on this 2015 to Mexico, lot of folks are talking about building assets to the border and so forth, but we also have probably a huge surplus of railcars out there given everything that's changing the atmosphere, do you see that as a risk that you sort of had product moving by rail into Mexico rather than pipelines as kind of an alternative, I was wondering if you can sort of share your thoughts on that?
Michael N. Mears
Well, I would categorize it as a risk to the project development, I mean, clearly the parties that are going to make the decision to support one or the other have that decision to make and we're talking to those parties and people who are proposing to provide the rail facilities, we're talking to those parties. It's really going to be the decision of those parties as to what service level they want long-term and they're in the process of evaluating that right now.
If the pipeline were in place today, I wouldn't consider risk – rail risk. I think that the parties would use a pipeline, because it would be lower cost and provide a higher service level than the rail.
But I've also heard arguments, why people would be interested in rail at this point in time. And so, again that's clearly an alternative, service option that the potential customers could choose and I've said we're right in the middle of them evaluating that and figuring out what they want to support.
Jeremy B. Tonet
Thank you very much, guys.
Michael N. Mears
Sure.
Operator
There are no further questions at this time. Please continue.
Michael N. Mears
All right. Well we want to thank everyone for your time today and we thank you for you continued interest in Magellan.
Have a good afternoon.
Operator
This concludes today's call. Thank you for your participation.
You may now disconnect your line.