Trecora Resources' (TREC) CEO Simon Upfill-Brown on Q2 2016 Results - Earnings Call Transcript

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Trecora Resources (NYSE:TREC)

Q2 2016 Earnings Conference Call

August 04, 2016 02:00 AM ET

Executives

Don Markley - Director, IR

Simon Upfill-Brown - President and CEO

Connie Cook - CFO

Analysts

Joseph Reagor - ROTH Capital Partners

Sarkis Sherbetchyan - B. Riley & Company

Greg Eisen - Singular Research

Bill Dezellem - Tieton Capital

Kurt Caramanidis - Carl M. Hennig, Inc.

Colin Lee - Luzich Partners

Operator

Good day, and welcome to the Trecora Resources Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Mr. Don Markley, Investor Relations. Please go ahead, sir.

Don Markley

Thank you, Melissa, and good afternoon, everyone. Welcome to Trecora Resources second quarter 2016 earnings conference call. The earnings release was distributed over the wire services after the close of the financial markets earlier today. Our call today will include Simon Upfill-Brown, President and Chief Executive Officer; and Connie Cook, Chief Financial Officer. Following management's prepared remarks, there will be a question-and-answer session.

Before we get started, I would like to review the Safe Harbor statement, which is found on slide two. Statements in this presentation that are not historical facts are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management's beliefs and expectations only as of the date of this teleconference, August4, 2016. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected. These risks, as well as others, are discussed in greater detail in Trecora's filings with the SEC, including the Company's Annual Report on Form 10-K for the year ended December 31st, 2015 and subsequent Quarterly Reports on Form 10-Q. This webcast is accompanied by a slide presentation that is available on the Company's website, www.trecora.com.

At this time, I’d like to turn the call over to Trecora's President and CEO, Simon Upfill-Brown. Go ahead, Simon?

Simon Upfill-Brown

Thanks, Don, and thanks to everyone joining the call this afternoon. As shown on slide three, I’ll begin today with a brief discussion of the second quarter highlights. I’ll then pass the call over to Connie for a more detailed discussion of the financial results. Following that, I’ll review progress at South Hampton Resources and Trecora Chemical, and conclude with an update on developments at AMAK before taking your questions. We achieved solid profitability [indiscernible] in the second quarter and maintained a highest quality and purity standards in the industry, while managing through some customer maintenance turnaround and other volume shortfalls, along with some pricing pressure due to the challenging energy market.

At South Hampton, lower volumes and average selling prices impacted revenues in the quarter. However, we do not see any systemic volume issues in our market and there is a strong and growing pipeline of other international opportunities. We also benefited from the increased capacity from our new D Train unit, as this allowed us to continue extensive maintenance and refurbishment on both A Train and C Train during the quarter. At Trecora Chemical, record wax sales and a greater custom processing activity drove solid year-over-year revenue growth. Additionally, we initiated reduction at the recently acquired BASF facility or as we call it B Plant, which demonstrated its value by processing a wax order just weeks after we acquired the facility.

On slide four, gross margin in Q2 was 23.7%; down 90 basis points year-over-year, although up 120 basis points sequentially. Operating incomes was $5.9 million, a decrease of approximately 38% year-over-year, but just 4% sequentially. Adjusted EBITDA margin of 18.1%, while also up sequentially, was lower by 270 basis points year-over-year. Our diluted earnings per share was $0.48, compared with $0.25 in Q2 of 2015. EPS in the quarter benefited by approximately $0.34 per diluted share, as the result of both a bargain-purchased gain on the acquisition of B Plant along with equity and earnings of AMAK due to positive settlement again with the former operator of the mine in Saudi Arabia. Detracting these two gains, estimated second EPS was $0.14 per diluted share. As in the slide, I believe the accounting adjusted for the value of B Plant and the scores why we felt so positively about the acquisition of the facility from BASF.

Turning now to slide five, second quarters were $48.9 million, a decrease of 17.7% year-over-year as petrochemical sales volume decreased 13.3% and average sales prices of petrochemical products decreased by 13.1% from the year-ago period. The decline in ASP was primarily driven by a year-over-year decline in fixed stock cost of 21.4% per gallon. However, on a sequential basis, feedstock costs rose by 7.9%, meaning that we did not get the positive lag effect on gross margin this quarter that we received most of last year when feedstock costs were going down progressively.

Slide six confirms the upward slope for feedstock prices we experienced during the recent three-month period. During the second quarter, we continue to make progress on our capital project initiatives, designed to increase capacity and profitability. We will cover our progress as well as other recent developments during the rest of the prepared remarks.

Now, I’ll turn the call over to our CFO, Connie Cook, who review of the financial results.

Connie Cook

Thank you, Simon. Slide seven presents our income statement for the second quarter and first half of 2016. I will begin with a discussion of the quarter. As Simon mentioned, second quarter revenue decreased 17.7% year-over-year to $48.9 million, compared with $58.4 million in second quarter of 2015.The decrease in revenue was due to lower petrochemical sales volume of 13.3% to 17 million gallons, down from 19.6 million gallons in the second quarter of 2015.Revenue was lower due to a 21.4% decline in per gallon feedstock cost that translated into lower average selling prices. Our average selling price was 13.1% lower in the second quarter of 2016 than in the second quarter of 2015.Foreign sales volume for 2Q of ‘16 was 3.6 million gallons versus 3.8 million gallons in the second quarter of ‘15. This includes a 31.6% decrease in the second quarter of ‘16 volume to our oil sands customers.

Petrochemical product sales were $39.2 million, representing 80.2% of total revenue for the second quarter of 2016. Specialty wax sales were $5.2 million, an increase of 19.5% from the second quarter of 2015, and a quarterly record. We generated $4.5 million in processing fees during the quarter, compared with $2.7 million in the second quarter of 2015.The increase is partly due to fees associated with the customer who reimbursed with us for installation expenses plus the mark-up. Second quarter deferred revenue was$4.5 million, a sequential increase of approximately $1 million from the first quarter of 2016.As I mentioned in the first quarter call, we made certain reclassifications to the 2015 statement to conform to the 2016 payments. These reclassifications did not affect net income as previously reported.

To continue, cost of sales, including depreciation totaled $37.3 million, about 16.7% decrease compared to $44.8 million in the second quarter of ‘15. The decrease was primarily due to lower volume for feed process and average fee cost per gallon. Gross margins for the quarter was 23.7% versus 24.6% in the second quarter of 2015, as a result of lower average sales price partially offset by fewer by-product sales which generate lower margins. On a sequential basis, gross margin increased by 120 basis points, driven by fewer sales of weaker margin by-products and better pricing in the by-product compared with the first quarter. G&A costs were $5.5 million, up from $4.9 million in the second quarter of ‘15.We saw increases in health insurance premiums, directors ‘fees, officer compensation and consulting fees. Operating income was$5.9 million for the second quarter of 2016 versus $9.5 million in the second quarter of 2015, a decrease of 37.9% and down from $6.1 million in the first quarter of 2016, which was a decrease of 4.1%.

During the second quarter, we recorded a bargain purchase gain on the recently acquired B Plant from BASF of approximately $11.5 million. Additionally, equity in earnings for AMAK was$1.8 million, reflecting further benefit as part of its settlement with former operator at the mine.Net income attributable to Trecora resources was $12.1 million or $0.48 per diluted share, compared to net income of $6.4 million or $0.25 per diluted share in the second quarter of 2015. We estimate that EPS benefited by a $0.34 per diluted share from the bargain purchase gain and equity in earnings to the AMAK. Now, moving to year-to-date results, revenues decreased 11.7% year-over-year to $101.1 million, compared with $114.5 million in the first half of 2015.As mentioned previously, the decrease in revenue was due to a decline in Paragon feedstock cost, which translates into lower average selling prices on slightly lower volumes at petrochemical sales.

Volume of petrochemical sales declined slightly to 37.4 million gallons from 37.7 million gallons in the first half of 2015.Foreign sales volumes were 7.9 million gallons versus 8.9 million gallons in the first half of 2015.Oil sands volumes decreased 3.2% during the first half of 2016.Petrochemical product sales were$81.8 million, representing 81% total revenue for the first half of 2016.Specialty wax sales were $9.7 million and we generated $9.5 million in processing fees. Cost of sales, including depreciation, totalled$77.7 million, a decrease of 8.3% compared with $84.8 million in first half of 2015.The decrease was again driven by the reduction in feedstock prices. Year-to-date gross margin was 23.1% versus 26.0% in the first half of 2015.G&A costs were $10.9 million versus $10.1 million in the first half of 2015, an increase of 8.2%.The increase in G&A was for the same reasons that I mentioned earlier. Operating income was$12.0 million versus $19.2 million in the first half of 2015,a decreased of 37.4%.Net income attributable to Trecora Resources was $19.3 million or $0.77 per diluted share, compared to net income of $12.2 million or $0.48 per diluted share in the first half of 2015.

As noted earlier, net income benefited from a bargain purchase gain on B Plant of $11.5 million, as well as equity and earnings for AMAK $7.2 million or an estimated combined $0.48 per diluted share on an after-tax basis. Slide eight shows the EBITDA and adjusted EBITDA calculations for the quarter. EBITDA for the quarter was $21.6 million, compared with $13.9 million in the first quarter of 2016 and $11.2 million in the second quarter of 2015.Adjusted EBITDA, which excludes the bargain purchase gain on B Plant, equity in AMAK earnings or losses and share-based compensation was $8.9 million for the second quarter of 2016, compared with $9.2 million in the first quarter of 2016 and $12.3 million in the second quarter of 2015. Adjusted EBITDA margin was 18.1% compared with 17.6% in the first quarter of 2016 and 20.8% a year ago. EBITDA for the first half of 2016was $35.5 million compared with $23.3 million in the first half of 2015.Adjusted EBITDAwas$18 million compared with$24.9 million in the first half of 2014 [ph]. Adjusted EBITDA margin was 17.8% compared with 21.7% a year ago.

Slide nine provides a brief summary of some of the positives and negatives which we encountered during the second quarter that impacted our margins. As you can see, lower feedstock cost per gallon decreased lower margin by-product volume and higher processing fees positively impacted profitability for the quarter, whereas lower petrochemical sales volume, higher sequential feedstock cost, higher deferred sales and increased maintenance and repair expenses related to turnaround negatively impacted profitability in the quarter. Slide 10 presents our balance sheet. As of June 30, 2016, cash was $9.3 million compared with $18.6 million at the close of 2015.If you recall, we drew $15 million on D train construction loan in December, 2015, which caused us to have a greater amount of cash on hand than we would normally. Inventory was $20.1 million compared with$15.8 million at year-end 2015.We had implemented a new savings stock policy, which caused inventory balance to rise. We also generally prefer to carry higher inventories during hurricane season.

Long-term debt, including the current portion but excluding loan fees was $78.1 million, compared with $82.3 million at year-end 2015. We made principal payments on both our acquisition and term debt of approximately $4.2 million. Capital expenditures for the quarter were $10.8 million, these included the acquisition of B Plant, construction on the hydrogenation, distillation unit project, the new advanced reformer unit and new cooling tower and a new custom processing unit along with various improvements throughout those facilities. We had $35.6 million in working capital as of June 30th, 2016, and ended the quarter with a current ratio of 2.7 to 1. Shareholders’ equity increased to $162.7 million from $142.1 million as of December31, 2015.This concludes the financial review and with that, I’ll turn the call back over to Simon.

Simon Upfill-Brown

Thanks, Connie. Moving to slide 11, while our D train capacity expansion project positions us handle the anticipated intermediate-term increase in petrochemical demand, we remain focused on producing high-quality products with outstanding customer service. As these initiatives proceed, quarterly petrochemical sales volume was 17.0 million gallons, down 13.3% year-over-year. The decrease was mainly attributable to the decrease of prime product volumes of 11.2%.Excluding oil sand shipments, prime product volumes were lower by 8% year-over-year, up but 1.4% sequentially. In addition to the volume decline at our major Canadian oil sands customer, were not only did the forest fires in Alberta, as many of you know, of course a significant production cutbacks during the quarter, but the facility also took down time on one of their two production lines for a maintenance turnaround for most of June, which by the way continued well into July.

For PE, polyethylene, production facilities took maintenance turnarounds during the quarter and we experienced volume shortfalls at three other major customers. One of these is the Canadian Syncrude facility, which as we’ve mentioned before, is shut down for the foreseeable future due to the explosion and fatalities experienced there in January. Another is a customer in Latin America, where small local suppliers come back online and is significantly reducing prices to gain a share of the business. We have, however, retained approximately 28% of those volumes. And the third is a US refiner that had a major maintenance turnaround in late Q1 and Q2 to improve long-term efficiency. We expect to retain the bulk of this customers reduced volume now that the facility is back online. We are very close to our customers and have a clear grasp of why shortfalls occur. We see no systemic problems in our market, some of our customers are up a little over last year and some are down, and we will continue to work closely with them to meet their demand and service expectations.

We continue to see aggressive pricing from our North American competitor in spot markets. We believe this is primarily due to the very high inventories and consequent low prices of gasoline. Quarterly by-product volume decreased 21% over the second quarter of 2015, which benefited our gross margins in the quarter. By-product prices were approximately $0.11 per gallon above our feedstock cost in the second quarter, a significant improvement compared with the first quarter of this year and the fourth quarter of 2015,but were down from $0.22 per gallon in the second quarter of ‘15. We are excited about the potential of our new advanced reformer unit to significantly increase the value of all by-products beginning in the second half of 2017. Second quarter deferred sales volume was 1.7 million gallons, a sequential increase of approximately 0.2 million gallons and over $1 million. Petrochemical capacity utilization was 45%, compared with 74% in the second quarter of 2015 and 56% in the first quarter 2016. Capacity utilization was based on the 11,000 barrels per day of fresh feed in 2016 and 7,000 barrels per day in 2015.

International petrochemical volume was up to approximately 21% of total volume from 19% a year ago. We continue to ship initial pool volumes to the new PE facility in the Middle East and are working hard to supply their on-going demand, once that unit is up and running at full rates. The Philippines PE unit has started using our pentane and everything is going well thus far. Follow-up discussions in order to capture on-going business are scheduled for September. We expect the Thai PE facility to start rolling our product in September also, as most of the 27 ISO containers are now in hand in Thailand. Slide 12 presents our capital project and expansion summary at South Hampton. As mentioned, the new advanced reformer unit will significantly enhance the value of our by-product stream, as well as provide a secure and reliable source of hydrogen for South Hampton’s high-purity pentane production and custom processing campaigns.

During the quarter, we were pleased to receive the construction and operating permit from Texas commission on environmental quality. Construction of the air max process unit is underway and will be completed by the middle of next year. We anticipate this unit could provide an EBITDA gain of approximately 13 million per year once completed. The addition of D train at SHR has minimized capacity constraints and created room for growth and allow for maintenance and efficiency upgrades on both A train and C train. This work has now been completed. We are starting up C train to prove its capacity and are using A train for new product trials and production. It is still early in our efforts on new products, but our existing customers are asking for our support on these products, so we are optimistic that they will also provide some substantial growth in the future. The additional capacity should satisfy the growing demand we expect to see through 2021, where we anticipate a potential 60 to 70 increase in pentane volumes, above the 53 million gallons sold in 2015. We continue to track several new polyethylene production projects in North America that would require between 6 and 7million gallons of isopentane annually, along with a significant new oil sands mine customer looking for initial pool volumes in 2017.

We also expect general North American growth and continue to work on developing new business in Asia and other parts of the world. The combination of all these factors indicate that we’ll resume annual volume growth in the middle of next year. Moving to slide 13,Trecora Chemical achieved solid quarterly revenue growth of approximately 32% versus the second quarter of 2015 and its second best quarterly revenue ever. This notwithstanding a seven day outage for maintenance turnaround in the month of May. Second quarter specialty wax revenues were a record, up almost 20% and custom processing fees were up nearly 78% compared with the same quarter of 2015.Note that our best ever revenue quarter at TC was the first quarter of this year, but as we’ve mentioned previously, the first quarter included the recognition of approximately $1.7 million in non-use processing fees from a single customer, paid rateably throughout the year but recognized annually at the end of the first quarter for accounting purposes. This particular contract has now terminated.

Our quality technical improvements in wax production are resulting in customer acceptance and follow-up orders in our major wax markets. We received trials and small orders for our newest Fischer tropes substitute wax, one new qualification and increased volumes for PVC lubricants and generated sequential sales growth of over half a million pounds through our European distributor, all of which validate the improvements made. Custom processing benefited from increased volumes from existing customers and closure on a number of new contracts and small trial campaigns. We are pleased regarding the progress we are making at TC and increase in demand for our products. During the quarter, we successfully integrated the 6.5 million acre B Plant with TC. B Plant has already added value at TC by initiating its first production run, which was a new higher purity specialty was that could not be handled at TC due to capacity constraint.

The team continues to review several projects to utilize more of the equipment at B Plant and thus to drive future revenue growth, while helping TC achieve significant operating efficiencies, thereby enhancing the value of the combined facilities. Construction of our hydrogenation and distillation project remains on schedule and is expected to come online in January 2017.This unit will help us leverage existing relationships with our petrochemical customers and drive new custom processing business. Once this project is complete, we are well-positioned to double custom processing revenues in 2017, compared with 2014, and potentially deliver approximately 6 million incremental EBITDA per year. On slide 14, you can see some of the background - some of the process on our hydrogenation and distillation project. In the background of six 30,000 gallon tanks we showed you being lifted into place last time. The eight have now been insulated and pipe work and electronics are being added. In the fore ground is the extensive rebar work for the foundations to hold the new reactors and distillation tower. The concrete will be poured in a matter of days.

On slide 15, on the left-hand side, there is shot of the tops of the three white foam evaporator sat B Plant, with a degasser in the background. These have been reassembled and are now back and up for commissioning and trials later this month. The middle photo shows a lovely white alpha olefin wax being formed on one of the [indiscernible] belts at B Plant after being processed an original TC assets. The final photo is a pallet for the same wax being prepared for shipment in one of the new B Plant warehouses. Turning now to an update on AMAK on slide 16. Second quarter results at AMAK reflected the on-going benefit from our positive settlement with the former operator of the mine in Saudi Arabia. This time it was a result of $9.2 million of spare parts that were handed over to AMAK by the terminated contract operator. Earlier this year, we announced that AMAK had initiated extensive renovation work to improve production efficiencies and precious metal recovery. The renovation, work including installation of new equipment, remains on schedule to be finished in the fourth quarter of 2016. An extensive exploration program is underway for both the new [indiscernible] gold-mining lease and the existing copper and zinc mine. AMAK expects to see the benefits of this program later this year and early in 2017.We expect to start processing historical dumbs at Gyan later this year.

Last month, AMAK sold 3.7 million shares at $5.33 per share to existing shareholder Arab Mining Company or Armico, to provide additional funds for on-going exploration work and mine start-up activities. Trecora did not participate in this offering, thereby reducing its ownership percentage at AMAK to 33.4% from 35.3%.At this share issuance price, Trecora has 26.1 million shares, valued at approximately $139 million. Turning to slide seven [ph] for a summary. During the second quarter, we recorded solid profitability levels while managing through a limited number of customer volume shortfalls, as well as challenges in energy prices and competitive pricing environments for spot business. As I noted earlier, while prime product volume is lower at South Hampton, it is not evident of any systemic problems with our business. Based on our current visibility, we expect to resume annual growth volume in mid-2017. At Trecora Chemical, we continue to generate record wax sales and remain focused on high-value markets. We see significant interest in our custom processing capabilities and also will take advantage of the opportunities with the expanded capacity and enhanced efficiencies from B Plant. We also made significant progress on our key capital projects which are focused on increasing capacity and improving profitability.

Taking a quick look at slide 18, our total investment of close to $100 million on the full - $100 million on the four projects listed was undertaken in anticipation of the significant chemical industry expansion that is expected to come online in the coming years. We believe the added and our capacity expansion have the potential to drive an additional $28 million to $36 million in annual EBITDA beginning in the 2018 to 2020 timeframe, which justifies the large capital expenditure. It is, of course, easy to talk about significant EBITDA growth, the hard part is making it all happen. Our team is committed to getting this done. The exciting market environment combined with our successful track record of serving the largest and most demanding customers in the chemical industry is the foundation for driving long-term shareholder value. This concludes my prepared remarks.

At this time, I’d like to ask Melissa to open the call for Q&A.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question will come from Joseph Reagor with ROTH Capital Partners.

Joseph Reagor

Good afternoon, guys, and thanks for taking the questions.

Simon Upfill-Brown

You’re welcome, Joe.

Joseph Reagor

Thanks. So, I guess, it’s fair to say there was a number of kind of one time-ish item during in the quarter, some of which all kind of lag into Q3 a little bit, but impact of volumes at South Hampton, but you also mentioned some additional competition and maintaining a certain percentage volumes, can you give us kind of ballpark of what maybe the lost volume is there?

Simon Upfill-Brown

Are you talking about the accounts in Latin America?

Joseph Reagor

Yes, the Latin American…

Simon Upfill-Brown

That’s probably of the order of four or five rail cars a month. It’s a unit that does not require the really, really, really ultrapure pentane, you can get away with slightly lower purity product, which is why they’re able to use this local supplier, who historically has been very, very unreliable. Our expectation is that we will probably able to grow our share back overtime, but when people give the product away; it doesn't seem to us to be much benefit in chasing those prices down.

Joseph Reagor

Okay. And then, you kind of looking in to Q3 and I know that company policy on guidance, but can you give us I guess what key items to be thinking about as far as which direction volume should head, it sounds like they should be much improved because a lot of these one-time times were a lot like the PE maintenance, but are there any other things that are coming in line that we should be adding in?

Simon Upfill-Brown

The difficulty for us is always and we mention this on every call, it’s the volumes from the big Canadian oil sands guy, he has a - his shutdown continued a little bit into this quarter, he has another shutdown planned for the other production train in October, which although that is in the fourth quarter, it could impact volumes in the third quarter, so that’s the big unknown, everything else looks pretty good, Joe, on the whole, I mean the refiner that we mentioned, they have reduced their uptake by improving their efficiencies. We don't really know where that's going to end up overtime, but that that might also mean a slight reduction continuing into the third and fourth quarter, but there's a lot of other good stuff happening, so we don’t give guidance because it's so difficult to predict what those volumes are going to be.

Joseph Reagor

Okay. I think that gives us some context though, so that’s helpful. Switching gears a little bit to Trecora Chemical, and firstly, we say thank you for adding the segment data breakdown, it makes the questions a little easier to formulate, but looking at kind of the gross profit line or operating profit, it looks like margins were bit under pressure during the quarter despite the higher revenues even if ignoring Q1 is kind of a weird quarter because of the one-time sales contracts, but looking at our historical quarters, [indiscernible] margin for a little bit later, is there something we can attribute that to? Was there start-up cost for the B Plant? Was there higher marketing cost? Something we could find it too whether it’s - to expect it going forward or kind of a rebound there?

Simon Upfill-Brown

Well, there are a couple of things and Connie can pile in on probably here… One is, we’re starting to move really large volumes on purpose PE wax that we distribute for a third-party into Latin America, those are really good margins, but they're lower than our average. So that impacts the margins a little bit. The other thing is, in order to allow us to take all the wax volume from our one supplier, we have been selling a product and we spoke about this last time into China and Turkey and other parts of the world that is a much lower quality wax. This is a temporary exercise for us while we ramp up volumes in the higher value markets, but we could not keep on building wax inventory, so we made a conscious decision to sell the stock. It’s both positive margin, but it’s much lower margin. It requires a lot less processing in the facility than our high performance wax does, but those are the two major items to reduce some margins. Connie, did I miss anything?

Connie Cook

No, I think that’s right.

Joseph Reagor

Okay. With that as a backdrop, it sounds like essentially inventory is being getting drawn down there, so the inventory build year-to-date is mostly South Hampton, should we expect inventory levels to stay elevated this year or to kind of turn back down towards normal?

Simon Upfill-Brown

My expectation is that they will turn back down to normal. When we had only D train running, while the other units were being refurbished and upgraded generally, inspected and maintained, we were concerned that if we had a D train outage, we might be unreliable. So we added to inventory in order to handle that, and then, the other thing is the - it’s hurricane season, and so we like to have a little bit more inventory during hurricane season. So, my expectation is probably not by the end of this quarter, probably be still slightly elevated inventory levels, but by the end of the year we should be back down to normal, Joe.

Joseph Reagor

Okay. Alright, that’s helpful. I’ll turn it over, thank you.

Simon Upfill-Brown

Thank you.

Operator

Our next question will come from Sarkis Sherbetchyan with B. Riley & Company.

Sarkis Sherbetchyan

Yeah, good afternoon, guys.

Connie Cook

Hi.

Simon Upfill-Brown

Hi, Sarkis.

Sarkis Sherbetchyan

So, first, just can you help me understand, I guess, your second half outlook for volumes this year? I think in last quarter’s call you mentioned that you’d expect it to be flat year-on-year, at least on the entire year, but now kind of coming into this quarter; it seems like volumes are going to be down year-over-year, maybe can you help me understand just kind of the mechanics of that?

Simon Upfill-Brown

Are you asking me to give you guidance Sarkis?

Sarkis Sherbetchyan

Yeah, I’m asking to help frame just kind of the volumes…

Simon Upfill-Brown

I think you heard what I said to Joe, I mean it’s very difficult for us to forecast the volumes based on the issues that we have predominantly up in Canada. So it's tough to predict. The rector there of the business remains particularly strong, there is no - even as I mentioned it a couple of times, there are no systemic issues anywhere, but I think maybe in the third quarter and in the fourth quarter, although it’s really tough to predict, we certainly want to be up on - up on last year and there is a possibility that we could be down on last year-- for this quarter, and then the growth really kicks in in 2017.

There are couple of capacity increases in polyethylene that come online later this year and like next year there are not the big jumps in volume, but we should be able to benefit a little bit from those, and then a lot depends on what happens with the three - the one that leased in and the two Asian facilities that I mentioned that we can glean some that business, and then there's another one in Asia that we’re working very hard on. If we can get some of that business this year, that should result in increased volumes, and so that there are all those sort of potential ups and then a few of these downs that we mentioned earlier, some of which will continue.

Sarkis Sherbetchyan

Yeah, that’s actually certainly helpful. And then, if I can maybe ask around the few facilities that kind of come online here in maybe the next 12 months as really to polyethylene, are you designed into their technology? Essentially do they use your volume?

Connie Cook

Ones that are coming on year and the dollar…

Simon Upfill-Brown

A couple of them do. They are existing customers.

Sarkis Sherbetchyan

Okay. Perfect. And then, I guess, as it relates to the by-product volume, certainly if you're selling less of your prime, should we expect you to produce less of your by-product which means that margin shouldn't be poor kind of given what's going on in that market and typically you don't earn a margin there?

Simon Upfill-Brown

The issue with the by-product volume is that it depends very much on what our feed looks like. If the pentanes in our feed drops, we will need more feeds to make the pentane volume, as a result to make more by-products. We’ve been working very hard all along to reduce the amount of by-product that we produce, but it's a little bit feedstock dependent rather than overall volume - prime product volume depended though that’s another one that’s very difficult for us to predict going forward, but rest assured, we do whatever we can to minimize that. And of course, the real upside on the by-product volume happens in next year when the advance reformer comes online.

Sarkis Sherbetchyan

Yep, correct. So, I guess that differently between now and when the advance reformer comes online with respect to the pentanes that you are procuring, are you seeing anything that’s outside of your normal bands as far as it relates to producing the by-product?

Simon Upfill-Brown

No. For now, it looks really good, but you never know, right, that's the issue for us. The specification for our feedstock is very wide, so the supply that can meet specification and have significantly lower pentanes in the feed, but right now, it's pretty good, Sarkis.

Sarkis Sherbetchyan

Good. Thanks for answering the questions; I’ll hop back into the queue.

Simon Upfill-Brown

Thank you.

Operator

Greg Eisen from Singular Research has the next question.

Greg Eisen

Thanks, good afternoon. First, about the volumes this quarter kind of year-over-year, volumes to revenue down and yet your gross margin held in pretty well considering on a percentage basis, would you care to comment on what were the factors that really allowed you maintain the gross margin in the mid-20s there so close to last year’s level?

Simon Upfill-Brown

Yeah. Sure, Greg. The primary reason in our view is the lower by-product volume, two things, there is the lower by-product volume and although the selling price for the for the by-product was higher than in the first quarter of this year and the fourth quarter of last year, it was not higher than the second quarter of last year, but we did supply a lot less volume and that helps with margins, because when it’s above the feedstock price, it’s still below the total cost to produce, so it has a negative gross margin, the by-products do, so if you have less of them it helps your overall gross margin.

Connie Cook

Processing fees were also up.

Simon Upfill-Brown

And processing fees were up too, yes, that helps…

Greg Eisen

Processing fees, sure. So, they had something less volume out there was by-products had essentially had a loss, you’re running a better overall gross margin?

Simon Upfill-Brown

Yes, exactly.

Greg Eisen

Okay, very good, very good. Next question, on your capital spending, I think last quarter, you suggested that we should expect around $40 million for the rest of this year, this quarter is about $9 million if I am not mistaken, there will be a $31 million for the second half of this year, am I doing the math correctly?

Simon Upfill-Brown

Connie, do you have those numbers? But it was more like $50 million for the whole year; I don’t know what did we spend in the first quarter? You remember…

Greg Eisen

I think the number should be $9.7 million for the first quarter, just backing out Q2 versus year-to-date from this earnings release. That’s the math I’m doing, looking at my model.

Simon Upfill-Brown

Why did we spend year-to-date?

Connie Cook

We spend year-to-date $16.4 million, well actually $18.4 million including the plant. And as far as the large capital projects that we got there are going on, we spent about $10 million on them at this point in time.

Simon Upfill-Brown

And a lot depends on what particularly of the advanced reformer roles into next year, so that’s a little bit difficult to predict. But I would say, probably close to somewhere between $20 million and $30 million for the second half of this year is a good capital number.

Greg Eisen

Only the $30 million? Okay. I understand what you’re saying about the reformer now, how much will be this year versus next year? So total would be the same but it’s a timing issue. Moving on, about the Saudi Arabian - question about the Saudi Arabian subsidiary investment, I should say, I guess I was surprised by the stocks there, right, I didn’t anticipate that there would be a sale, maybe I wasn’t listening, but at this point, does that business - does AMAK have sufficient capital to get its projects done on time without having to come back to the market?

Simon Upfill-Brown

Yes, I mean you were listening, because I think we said last time that we didn’t think that a capital raise would be necessary. This was done for insurance purposes to make sure that there was sufficient capital, particularly to get through the start-up period, because you never know when a plant’s being down for a year, how quickly it comes back up. And if there was a delay in the start-up and it lags for months or so, then it's really good to have the cushion. And that's why the AMAK went through with the raise and they had a very willing buyer, so it was a sensible thing for the AMAK guys to do to grab onto that opportunity.

Greg Eisen

Got it. Insurance, I understand insurance very well. In this commodity, the income items from the AMAK was essentially a one-time gain on getting materials back from the contractor, are there any other lurking opportunities for income similar to that that we should know about that could be a plus to earnings down the road?

Simon Upfill-Brown

Unfortunately, not. We’ve had two sequential quarters of best profits ever from AMAK and all the while the mine is being down, so - but no, that’s - it is as far as we know, there is nothing else that will come out of this. The reason we were not able to claim this gain in the first quarter was that the spare parts have not been properly valued, so we didn’t want to take a gain, and then have to adjust it in the second quarter, we just wait until the second quarter until all those spare parts were valued by a third-party, who valued them $9.2 million, and then we took that gain here now in the second quarter.

Greg Eisen

Understood. I guess my last question is more about kin of forward thinking global question, volumes were I guess less than I might have anticipated for this quarter, but being that as it may, is there anything that happened in this quarter which mitigates what we’ve discussed previously about where you see the market going for your products over the next few years and the entire demand thesis for why you’re investing? Is there anything you’ve changed in the big picture?

Simon Upfill-Brown

No, not at all. The view is very optimistic pentane growth going forward, and you know we’d not expected any volume increases this year over the previous year, we did not forecast some of the specific turnarounds and fires in the Canada, et cetera, and a couple of the other items that we mentioned, but no, there is - every indication is that our the D train, C train will be delivering the goods for us in 2017 and beyond.

Greg Eisen

Okay, good. I’ll let someone else go, thank you.

Simon Upfill-Brown

Thank you, Greg.

Operator

Our next question will come from Bill Dezellem from Tieton Capital.

Bill Dezellem

Thank you. I also have a group of questions, first of all, a couple of clarifications that I missed in your opening remarks, the 17 pentane volume that you're anticipating relative to 2016,would you say that again, please?

Simon Upfill-Brown

We’re expecting pentane volumes from polyethylene facilities, Bill, to be on the order of 6 million to 7 million gallons a year, but that’s going to ramp-up over the course of 2017,’18, ‘19 and beyond. That’s just North American pentane volume, right, it doesn’t include some of the other Asians stuff and Middle Eastern stuff that we’ve touched on. And then, the other big incremental piece of volume is from the mine-- in the second mine in Canadian oils and, which comes online in the middle of next year. And we're optimistic there of getting approximately 10 million gallons a year of incremental volume.

Bill Dezellem

Alright, so the mine is a next year phenomenon whereas the polyethylene plant happened over the course of three to four years?

Simon Upfill-Brown

Yeah, and some of that even maybe starts late this year into next year, depending on how these capacity expansions come online, etcetera.

Bill Dezellem

And that may be a good segue to my next question, I think you referenced two new plants, and I thought they were polyethylene plants but maybe not that were taking volumes may be as early as September, did I hear that right? And if so, would you now fill in the blanks please?

Simon Upfill-Brown

One is, they’re both in fact doing trials right now, one is already started and we have follow-up discussions with them in September for their on-going business. Our product is running very well in the unit and we will have discussions in September about their on-going business. The other one has the volume on-site now and we’ll start their trial - it’s a fairly large trial, it’s 27 iso containers that will start in September, and those are all in Asia, one in the Philippines, one in Thailand.

Bill Dezellem

Okay.

Simon Upfill-Brown

And they’re using high-technology catalyst and that's why they like our purity levels.

Bill Dezellem

Right, alright, thank you. That’s very helpful. And then, CapEx, you talked about$20 million to $30 million the rest of this year, and then I believe the press release mentioned that in the second half of next year, you'll go down to your more normal run rate of $8 million per year, which is $4 million in the second half of next year, what are you anticipating roughly in the first half of ‘17?

Simon Upfill-Brown

So that would be 30, 50 this year, 80, so… probably $20 million.

Connie Cook

I would say $20 million to $30 million.

Simon Upfill-Brown

Yeah, $20 million to $30 million.

Bill Dezellem

So really is similar to the second half of this year, that $20 million to $30 million?

Simon Upfill-Brown

Right.

Bill Dezellem

And so, if I'm even be more fine-tuned with it, you’re really looking at $10 million to $15 million per quarter for the next four quarters?

Simon Upfill-Brown

That’s about right.

Bill Dezellem

That is helpful. And then, relative to the mine, there was a reference that tailings processing may begin as early as this quarter, what are the swing factors that lead to tailings processing this quarter versus next quarter? And how do you think about the earnings implications of beginning at tailings processing process?

Simon Upfill-Brown

Well, the ideal to do it is before the start of the copper and zinc mine just so they can focus on just the precious - bringing up the precious metal circuit ahead of everything else. So, it allows a sort of a more gradual startup of the zinc - of the mine overall starting with the precious metals, and then going to the copper and zinc, which contain precious metals, right. So, it just simplifies things a little bit.

I don't expect significant revenue in the third quarter from the mine build. The reason being that it takes a while if you're just making gold and silver to sell that product within Saudi Arabia, so I doubt they will be any actual sales during the third quarter. If there's any new revenue, it’s likely to come in the fourth quarter and as significant amounts of revenue are going to depend on the startup of the copper and zinc mine.

Bill Dezellem

Thank you.

Simon Upfill-Brown

Thank you, Bill.

Operator

Ladies and gentlemen, due to time constraint, we ask that each person limit their questions to two. Thank you. And our next question will come from Kurt Caramanidis from Carl M. Hennig, Inc.

Kurt Caramanidis

Thank you. And I only have two. First question is, are the - is feedstock going down with crude this month, so would we expect maybe a little bit better margin going into the third quarter?

Simon Upfill-Brown

It was earlier, yesterday and today, it’s been up again, so it’s better hard to predict, Kurt. That has been a little bit of a decline over the last little while, last 10 days or so, but who knows. At this point, it's really tough to predict.

Kurt Caramanidis

Definitely. As far as the mine, let’s say a year from now, are portions worth $150 million and we decide to cash out, Connie, how do we value that? Are we looking at like a 35% tax rate when we cash that out? How was that - how-ish, because I don’t think the market really pays attention to what the value of that is? And how can we look at a net value of net of tax?

Connie Cook

Well, that’s something that we’re still trying to determine. We’ve actually engaged a firm to help us figure out the best way to handle the taxes on that, because we would actually be here with taxes in Saudi and then taxes in the US as well, so we’re trying to come up with the best way to handle that.

Kurt Caramanidis

Okay. If we get a President Trump and we get a tax holiday, some of the plans are about a tax holiday where we maybe get a 10% one-time, would that accelerate the thought process?

Connie Cook

Sure, it would.

Simon Upfill-Brown

I am sure it would. The difficulty is, as you know Chris, is the - ours is a minority holding, to find a strategic who would like to buy a minority holding is pretty hard, but you never know. The main thing is, we’ve got to get the expiration data completed, [indiscernible] compliant, have the mine making money at low commodity prices, all those things would really help with the potential of selling this entity. That’s pretty good at the moment the way things going, I mean zinc is approaching $2,300 a metric ton, so that's significantly up on where it was earlier this year. So, I think we have a lot of positive signs at the mine, acts coming together on a very steady basis and some potential improvements in commodity prices.

Kurt Caramanidis

Yeah, it seems like it, thanks for taking my call.

Simon Upfill-Brown

Thank you, Kurt.

Operator

And our last question today comes from Colin Lee with Luzich Partners.

Colin Lee

Hi, good afternoon.

Simon Upfill-Brown

Hey, Colin.

Colin Lee

Your slide on page 18 was that very helpful, I was wondering if you can discuss about what are like the risks - like what are the most pressing risk in a downsize scenario that would make those numbers harder to hit, like what kind of environment?

Simon Upfill-Brown

Well, each one has its own specific risk factors, right, I mean D train depends primarily on pentane volumes. If we don't get pentane volumes, we won’t run D train as hard. The advanced reformer unit depends more on things like BTX prices, benzene, toluene and xylene prices. We were pretty conservative in our estimates there, so I don't think there's a lot of risk, but you never really know what's going to happen to BTX. One of the theories is that as they require lower and lower sulphur in the gasoline pool, the refiners are going to have to hydrogenate harder, which means they are going to have less octane in their gasoline, which means they’re going to have to add octane to the gasoline and toluene especially, but also xylene and some benzene is often used to increase octane.

So, there is some concern that BTX might be tight, so that could in fact help that unit, but that's probably the biggest risk. We don’t see any technology risk with the advanced reformer, because it’s being run in a number of places already very, very effectively. For the hydrogenation and distillation unit, that depends on us finding the right project that fit the capabilities. We have a very extensive list at this point all of which we’re working on, all of which-- the customers are very interested in laying claim to that capacity, but you never know when the time comes along, will they actually sign contract and commit.

I don't expect that to be an issue, there is very limited capacity for high-pressure hydrogenation on the Gulf Coast here and I don’t we’ll have any difficulty selling that capability. B Plant depends on custom processing capabilities that require things like reactors and white foam evaporators. I mentioned on TC, there is a lot of interest in those capabilities and we seem to be doing more and more trials and signing up more and more contracts, so that does depend on people coming along with their custom processing requirements for those capabilities, but that one also, I think, is very doable.

Colin Lee

Got you. And then, on that page, I think what will be helpful if you breakdown the CapEx number by each project and put in what you spent year-to-date and how much more to go…

Simon Upfill-Brown

Okay. We could do that. I can tell you what the totals are for each one.

Colin Lee

That will be great.

Simon Upfill-Brown

It’s about 30 for D train and that's done. It’s 46 for the advanced reformer. It’s 20 for the hydrogenation distillation and it’s3 all in for the B Plant acquisition. We paid $2 million last month and there is potential earn out of another close to a million, 700,000.

Colin Lee

So for the advanced reformer, how much of the 46 have you spent?

Connie Cook

At this point in time, we’ve only spent about $3 million through the end of June.

Collin Lee

And then, how about the hydrogenation unit?

Connie Cook

With $0.03 fix.

Collin Lee

Okay. So it seems like in total, you’ve spent $41 million so far on those core projects?

Simon Upfill-Brown

Yeah, that’s about right. And the total is just about 100.

Collin Lee

Yeah. Great, that was very helpful. Thank you.

Simon Upfill-Brown

Thanks, Collin.

Operator

And that does conclude our question-and-answer session today, now I’d like to turn the call back over to management for any additional or closing remarks.

Simon Upfill-Brown

Thank you, Mellissa. Thank you, everyone, for joining us today. If you have any follow-up questions, please get in touch and we look forward to talking to you again in three months’ time. Thank you all very much.

Operator

That does conclude our conference for today. Thank you for your participation.

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