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TEPPCO Partners LP (TPP)

Q2 2007 Earnings Call

July 26, 2007, 11:30 AM ET

Executives

Mark G. Stockard - Treasurer and Director, IR

Jerry E. Thompson - President and CEO

William G. Manias - VP and CFO

Analysts

Yves Siegel - Wachovia Securities

Ross Payne - Wachovia Capital Markets

Sean Grant - Zimmer Lucas

Sam Arnold - Credit Suisse

Darren Horowitz - Raymond James

Ronald Londe - AG Edwards

Presentation

Operator

Good day everyone and welcome to the TEPPCO Partners, LP Second Quarter 2007 Earnings Release Conference Call. Today's call is being recorded. At this time, I would like to turn the conference call over to TEPPCO's Treasurer and Director of IR, Mark Stockard. Please go ahead.

Mark G. Stockard - Treasurer and Director, Investor Relations

Thank you, Jim. Good morning everyone and thank you for joining us today for TEPPCO's Q2 2007 earnings conference call. Jerry Thompson, our President and CEO, will lead the call. Jerry's comments will be followed by Bill Manias, our CFO.

During the call, we will address recent partnership development and review our Q2 financial results, including key factors impacting the results. We will also address our business environment as well as our outlook for 2007.

Before we begin, I'd like to remind everyone that the matters discussed on this call will include forward-looking statements, such as expectations regarding future results, increases in distributable cash or expenditures that are subject to many factors, risks, and uncertainties that are described in TEPPCO's filings with the SEC. We undertake no obligation to update any forward-looking statements.

Our discussion will also include certain non-GAAP financial measures as defined under SEC rules. To comply with these rules, we have provided a reconciliation of these non-GAAP measures on our Web site, www.teppco.com.

At this time, I will turn the call over to Jerry Thompson for some introductory comments. Jerry?

Jerry E. Thompson - President and Chief Executive Officer

Thank you, Mark.

TEPPCO delivered solid results for the second quarter and I'm very pleased with the performance of each of our business segments. Compared to the second quarter of 2006, net income increased 15% to $47.8 million for the second quarter of 2007 and EBITDA increased 11% to $107.2 million. Volumes on our Jonah system increased 25% to 1.5 billion cubic feet per day.

Drilling in both the Jonah and Pinedale Fields continue to be active, with 180 new wells brought on line during the first 6 months of 2007. In addition, approximately 30 rigs are currently operating on dedicated acreage to continue the pace of volume growth brought to our system.

In our downstream segment, we were able to demonstrate the value of recent expansions in the northeast portion of our system by offering additional capacity and transportation flexibility to our propane shippers. Colder winter weather continued into April this year and long haul propane volumes increased by 1 million barrels over the 2006 second quarter.

Our upstream segment also performed well, with the crude oil marketing and transportation business keeping pace with the great results in 2006. Other noteworthy events include reduced expenses in 2007 compared to 2006, as we incurred several non-recurring expenses in 2006 with the transition into the shared service environment with EPCO, completing the Jonah joint venture formation, and obtaining unit holder vote to reduce the maximum incentive distribution sharing tier from 50% to 25%.

Each of these initiatives is important to the future growth of the partnership as we execute our strategy moving forward.

Now, I'll turn the call over to Bill to update you on more specifics around the quarter results. After which I'll wrap up a review of a few of our ongoing projects.

William G. Manias - Vice President and Chief Financial Officer

Thanks, Jerry.

TEPPCO's net income totaled $47.8 million, or $0.44 per unit, compared with net income and $41.5 million, or $0.42 per unit for the second quarter 2006. Our EBITDA totaled $107.2 million. That's up 11% over second quarter 2006 EBITDA of $96.9.

Now, I'd like to start with some highlights for each of the business segments, starting with upstream. Second quarter EBITDA from continuing operations for the upstream segment was $28.3 million compared with $31 million for the second quarter of '06.

The primary factor driving the lower EBITDA was lower equity earnings from our investment in Seaway. Those lower equity earnings were primarily related to lower long haul transportation volumes on the system, as well as a reduction of our financial interests from 47% to 40%, as stipulated by the Seaway Partnership Agreement. Our future sharing ratio going forward will be at 40%.

Pro rata share of EBITDA from Seaway Pipeline for the quarter was $3.3 million, compared with $7 million for the second quarter in 2006. Long haul transportation volumes on the Seaway averaged only 115,000 barrels per day in 2007, compared with 246,000 barrels per day in the second quarter of 2006.

Now, the good news is that one of the primary drivers for the negative volumes was the temporary shutdown of several refineries for maintenance purposes. So if these refineries come back on line volumes at Seaway should increase.

Partially offsetting the lower equity earnings, we had lower operating expenses in upstream of $1.8 million compared to the second quarter. This is primarily the result of reduced product measurement expenses and some of the transition costs that we incurred in 2006.

Our crude oil marketing and transportation revenues remain solid and were within 99% of the record levels in the second quarter of 2006. Both the flexibility of the upstream systems and our ability to react to changes in market dynamics helped diminish the impact of the temporary shutdowns of the several regional refineries.

Now, let me move on to downstream. Downstream EBITDA from continuing operations increased 10% to $33 million. That's up from $29.9 million for the same period in 2006. Transportation revenues increased $5.6 million, or 11%, primarily due to general tariff rate increases that took effect in the second half of 2006 and the first half of 2007.

In addition, we experienced a higher percentage of long haul transportation movements in the second quarter of '07. As Jerry mentioned earlier, propane transportation to the Midwest and northeast market areas served by the TEPPCO system increased by 1 million barrels due to colder weather, which continued into April of this year.

Operating, general, and administrative expenses decreased $1.2 million, primarily due to decreased pipeline integrity expense and transition expenses incurred in 2006. That was somewhat offset by increased operating expenses and power costs.

I also want to remind everybody that TEPPCO sold its interest in Mont Belvieu Storage Partners in March of this year. And during the second quarter of 2007, we recorded about $1.1 million of expenses related to project... product measurement settlements and other miscellaneous items as we worked through closing adjustments related to the sale.

TEPPCO's pro rata share of EBITDA from Mont Belvieu Storage Partners was $2.5 million for the second quarter of 2006. And as you can see by our results for the second quarter of 2007, we've more than made up for this loss in EBITDA through growth in our other areas of business.

Now, we've discussed in prior calls how we use Centennial Pipeline to offload volume from our main products line to increase overall capacity to revenues.

What our long-term objective is to get Centennial profitable on a standalone basis. And for the quarter, for the second quarter of 2007, our portion of Centennial's EBITDA was $850,000, compared to $250,000 in the prior year second quarter. This improvement was due to an increase in volume of about 22,000 barrels per day in the second quarter.

Now let me move on to midstream. Midstream EBITDA from continuing operations increased 27% to $46 million, from $36.1 million for the second quarter of 2006. The largest contributor to this increase was a 25% increase in the natural gas gathering volumes on the Jonah system, which average 1.53 Bcf per day, compared to 1.22 Bcf per day in the second quarter of 2006.

I also want to remind everybody that as you review the financial information accompanying our press release, please note that effective August 1, 2006 Jonah was deconsolidated and is now reported as an equity investment.

Our NGL systems performed well during the quarter with a revenue increase of 4% and a total volume increase of 7% over the second quarter of 2006. The Panola system experienced the largest volume increase, with volumes increasing 35% to 67,000 barrels per day. And that's thanks to the completion of an additional pump station on the system, which increased capacity and allowed us to tie additional plants to the pipeline.

On the expense side, excluding the impact of deconsolidating Jonah, operating, general and administrative expenses decreased approximately $5 million during the second quarter compared to last year. And that's primarily attributable to favorable gas imbalance valuations and the nonrecurring expenses from 2006 related to the joint venture formation and shared service transition costs. Now, partially offsetting those decreases were higher pipeline integrity costs.

The Phase V expansion project is moving along and the first portion of the Bridger compressor station reached mechanical completion yesterday. This is very significant, as this will reduce the system operating pressures and will contractually trigger higher gathering fees.

That concludes the review of the segments. Let me talk a little bit about our financial position. At mid-year, TEPPCO had total debt outstanding of approximately $1.6 billion. During the second quarter, we issued 300 million of 7% subordinated notes due 2067.

We used the net proceeds to temporarily reduce borrowings outstanding under our Revolving Credit Facility. We'll use the increased liquidity under our revolver to fund the remaining growth capital and Phase V investments during the second half of this year.

These subordinated notes pay interest at a fixed rate of 7% for the initial 10-year period, after which the interest rate will become floating. And because of the long data maturity and other characteristics of the notes, Moody's and Standard and Poor's each assigned a 50% equity content to the notes.

Now, if you include the equity content of the subordinated notes, our debt-to-capitalization ratio was 49% at mid-year. And for the latest 12 months, our debt-to-EBITDA ratio, excluding discontinued operations and gains on asset sales and including the equity content of our subordinated notes, was 3.3 times. In addition, we had total liquidity of nearly $500 million under our $700 million Revolving Credit Facility.

The partnership currently anticipates the total CapEx for 2007 will be approximately $300 million. Now, that includes $250 million for organic growth projects and system upgrades and $50 million for maintenance capital. In addition, TEPPCO expects to invest about $160 million in 2007 for capital contributions to Jonah, which will be primarily used to fund the Phase V expansion in well connections.

Now, that adds up to about $460 million in capital spending and investments for the year. And with our current liquidity situation, we believe that we will not need to raise additional equity capital during the remainder of the year to adequately fund this $460 million in CapEx.

And with that, I'll turn it back over to you, Jerry.

Jerry E. Thompson - President and Chief Executive Officer

Thanks, Bill.

You can now see why I'm pleased with the excellent performance of each of our segments during the second quarter. To wrap things up, I would like to summarize some of the progress we have had on our projects this year.

As Bill mentioned, our capital spending, including the investment to fund the Phase V expansion on Jonah, is the largest the partnership has undertaken. I believe we have an excellent project engineering support to complete these projects within budget and an equally dedicated operations staff to operate and maintain the facilities in a safe and efficient manner, both environmentally and financially. I'm also confident that our commercial groups will continue to identify additional excellent opportunities for growth.

In addition to the completion of the Bridger compressor station that Bill mentioned earlier, during the third quarter TEPPCO expects to place into service 900,000 barrels of crude oil storage capacity at Cushing; begin service for crude oil storage and pipeline transportation to a refinery in New Mexico, complete a crude oil pump station and a related pipeline connection and storage on the South Texas system; and complete a refined products pipeline serving Memphis International Airport. Combined, these projects are expected to generate approximately $9 million of EBITDA annually.

On our longer-term project for the construction of a... of the Motiva products terminal, work is progressing at a solid pace. We are in the process of preparing the site for construction and securing the necessary building permits. We still anticipate $85 million of spending on this project in 2007, with the total project cost of approximately $240 million and a completion date by year-end 2009.

In addition to these projects, we are continuing to work on several other potential projects to continue to grow the partnership and we will continue to provide updates to you on new projects as they are further developed.

We're excited about the excellent start we've had so far in 2007 and we're optimistic about the underlying business fundamentals for the rest of the year. As always, we appreciate the continued support of our investors and look forward to the second half of 2007.

With that, we are now ready to take questions.

Question and Answer

Operator

[Operator Instructions]

And we'll take our first question from Yves Siegel from Wachovia Securities.

Yves Siegel - Wachovia Securities

Yes. Thank you. Good morning, guys.

Jerry E. Thompson - President and Chief Executive Officer

Good morning, Yves.

Yves Siegel - Wachovia Securities

Could you just touch on the maintenance CapEx number? It looks like it moved up a little bit. Why it's moved up and looking out to 2008, if you will, what kind of maintenance CapEx do you think you'll see?

William G. Manias - Vice President and Chief Financial Officer

Well, I'll use this, Bill, it's been historically around $50 million and we're expecting it to be $50 million this year. On a calendar year basis, we saw pipeline integrity expenses go up a little bit and I think that's more a function of timing than anything else.

So we've completed our 5-year program this past year and we really are seeing pipeline integrity expenses on the whole go down. So I... $40 to $50 million going forward is probably a good run for us on a current asset base.

Yves Siegel - Wachovia Securities

Okay. So there is nothing unusual there?

William G. Manias - Vice President and Chief Financial Officer

No, nothing unusual.

Yves Siegel - Wachovia Securities

Okay. Could you also, the $9 million of EBITDA, the projects that Jerry mentioned are going to generate, what was the CapEx on those projects? You guys have that?

William G. Manias - Vice President and Chief Financial Officer

I'll have to add a few numbers up for you, Yves.

Yves Siegel - Wachovia Securities

Okay. And then, while you do that, Jerry, my last question, and you probably don't want to talk about it, but any color on future growth CapEx going forward? Do you still feel pretty comfortable that you can sort of bring home the magnitude of the projects that you've outlined before?

Jerry E. Thompson - President and Chief Executive Officer

Yes. That's a fair question, Yves, and of course I can't give you a direct answer to it, other than to say that we are continuing to work very aggressively on all of those projects. We're still very optimistic that we'll be able to bring those projects home. But discussions are still underway on those major projects.

To answer your first question, it was about $54 million worth of total capital associated with those projects.

Yves Siegel - Wachovia Securities

That's a nice return. Okay. So the follow-up to your answer, how... any different stance on prospects for ethanol or prospects for a crude oil pipeline down to the Gulf?

Jerry E. Thompson - President and Chief Executive Officer

Well, again, I think the business fundamentals still support the Canadian crude oil pipeline to the Gulf. There continues to be strong interest, both on the refining side and the Canadian producer side for that solution.

On the ethanol side, the latest news is increasing the ethanol mandate. During the State of the Union address, the president was looking at about 30 to 35 billion gallon per year market for ethanol in the US gasoline pool. That would represent about 20% of today's gasoline consumption. And, again, if we're going to get to those levels as a nation, we're going to have to have a more efficient distribution infrastructure to support those kinds of volumes and get them to market.

Yves Siegel - Wachovia Securities

Thank you.

Operator

Moving on, we'll take our next question that will come from Ross Payne from Wachovia Capital Markets.

Ross Payne - Wachovia Capital Markets

Thank you. Kind of a follow-on to Yves, his question there, Exxon and EMB have announced their pipeline south out of, I guess, Illinois to the Gulf. How does that impact your plans to get crude south either from there or from Cushing south into the Gulf?

Jerry E. Thompson - President and Chief Executive Officer

The two likely hubs in the US for Canadian crude would be Patoka, Illinois, which is where Enbridge and Exxon have announced that they would originate barrels south to the Gulf, and then Cushing, Illinois. Of course we have a large asset base in Cushing.

We have the Seaway partnership that terminates in Cushing. We also have our main products pipeline that runs near the Patoka area. So either one of these two routes to the Gulf, TEPPCO has a lot to offer in either one of those solutions with the existing right-of-way, with the existing pump stations, power to those pump stations, the personnel to operate those pump stations.

Once you get the crude to the Gulf then TEPPCO has good connectivity to the Texas City and Houston refiners who are interested in Seaway. And we also have excellent working relationships with all of the refiners on the Gulf Coast. So we think that TEPPCO could be a very meaningful partner in either one of the projects' routes to the south, bringing more than just the financial sponsorship to the project.

Ross Payne - Wachovia Capital Markets

Does that mean that you would be a party to this one or just to another alternative to it?

Jerry E. Thompson - President and Chief Executive Officer

I think we're open to discussions on any route. Again, we've said before the capital required for a pipeline, either out of Patoka or Cushing, is a little more than TEPPCO could take on individually. So we would have to have partners.

Ross Payne - Wachovia Capital Markets

Thank you very much.

Operator

[Operator Instructions]

Moving on, we'll take our next question from Sean Grant from Zimmer Lucas.

Sean Grant - Zimmer Lucas

Hi, guys, good morning.

Jerry E. Thompson - President and Chief Executive Officer

Good morning, Sean.

Sean Grant - Zimmer Lucas

I just wanted to ask about, I know you've mentioned it a little bit on the call so far, you have a pretty sizeable backlog of projects. I'm just wondering when you could comment on timing of a potential announcement? Sort of when we would see a go ahead on... with some of these projects?

Jerry E. Thompson - President and Chief Executive Officer

Yes, any potential announcement would be late third quarter, early fourth quarter.

Sean Grant - Zimmer Lucas

Okay. Great. That's all I had. Thanks.

Operator

[Operator Instructions]

Moving on, we'll take our next question from Sam Arnold from Credit Suisse.

Sam Arnold - Credit Suisse

Hi, guys. Just a quick question for you and I apologize if you've already discussed it. I've been jumping on and off the call. But the volumes on Seaway, could you talk a little bit about the refinery downtime? Does this have anything to do with McKee or are these other refineries that just had normal downtime?

Jerry E. Thompson - President and Chief Executive Officer

Yes, it is associated with McKee. There are also several mid-continent refiners and upper tier refiners that move crude on Seaway that have been down either for planned maintenance or unscheduled maintenance.

Sam Arnold - Credit Suisse

Okay, like Wynnewood or something or some others?

Jerry E. Thompson - President and Chief Executive Officer

Yes.

Sam Arnold - Credit Suisse

Okay.

Jerry E. Thompson - President and Chief Executive Officer

And Coffeyville and Whiting, Indiana. All of those temporary shutdowns of those refineries or contaminates of operation of those refineries have impacted our volume movements on Seaway.

Sam Arnold - Credit Suisse

So it is more of a one-time event you would say? Except for... I guess, how do you see it impacting you longer term as kind of, if it is true, that BP reverses their line and you start getting more and more of a flood of volumes to Cushing. I think you had mentioned in your press release that some of your margins were down on actual terminaling operations in Cushing. Is that just because there is... I would think it would have been at the opposite. I guess could you explain that?

Jerry E. Thompson - President and Chief Executive Officer

Yes. Basically, it's because of pricing dislocations caused primarily with McKee being down. They were a large consumer of West Texas intermediate crude. And as they shut down and stopped consuming that crude that just put a temporary dislocation in the pricing differentials between West Texas intermediate, Louisiana light sweet, and --

Sam Arnold - Credit Suisse

Okay. So it's your terminaling pricing is kind of based off of that differential? Because I would think, okay, people are pumping down and they need to store it somewhere if they can't take it to McKee. So you would have a little bit more pricing power because, hey, where are you going to go? I guess that's not the case?

Jerry E. Thompson - President and Chief Executive Officer

Well, again, it's... it all fits into the overall market dynamics.

Sam Arnold - Credit Suisse

Okay. All right. And then, I don't know if you mentioned this earlier as well, is there any update on potentially reversing Seaway or --

Jerry E. Thompson - President and Chief Executive Officer

Well, again, that's one of the options that's still on the table. It really depends on how much refiners along the Gulf Coast want initially of heavy Canadian crude whether reversing Seaway makes sense.

Sam Arnold - Credit Suisse

Okay. And you said it would be like it there's two actual lines, so it would be the refined product line I think that you said would be reversed?

Jerry E. Thompson - President and Chief Executive Officer

No, there's two portions of Seaway. One is a crude line and one is a refined products line. It would be the crude line that we --

Sam Arnold - Credit Suisse

It would be the crude line, okay.

William G. Manias - Vice President and Chief Financial Officer

As part of the function.

Jerry E. Thompson - President and Chief Executive Officer

Right. And we talked about utilizing the refined products line in crude service to bring crude south into Cushing from the Gulf Coast.

Sam Arnold - Credit Suisse

I got you. Okay. That makes sense. All right. Thank you.

Operator

Moving on, we'll take our next question from Darren Horowitz from Raymond James

Darren Horowitz - Raymond James

Thank you. Good morning. Just had one more follow-on question within the upstream segment. On the operating expense line, you mentioned that there were some lower operating expenses and I was wondering when we're looking at this, what do you think about those lower operating expenses perpetuating?

Obviously, the margin is going to expand as volume consumption comes back into place, but do you think that you can continue to ratchet down lower operating expenses and maybe that drive the margin to expand even more than we currently expect?

William G. Manias - Vice President and Chief Financial Officer

This is Bill. What we had last year was an unusual year. It was a transition year for us in a lot of aspects. We were transitioning to a shared service environment. And in the second quarter, we had, and I'm speaking about the businesses as a whole here too, not the specific segments. We had the formation of the Jonah JV where we were going through the proxy process.

We had a lot of expenses... we had expenses from severance that we're still dealing with from the beginning of the year. All of those expenses are one-time expenses and they make up the bulk of the difference of what you see between 2007 and 2006.

So we don't expect those to reoccur. We did mention this during our call last year that we were incurring the expenses and that they would be going away and you can see that in the results of the second quarter.

Darren Horowitz - Raymond James

Okay. So it's nothing that you can directly attribute to better operational execution. It's merely just a truing up, if you will, on a year-over-year basis.

Jerry E. Thompson - President and Chief Executive Officer

Oh, the specific $1.8 million that Bill mentioned is more truing up year-over-year as we transitioned, but, as a general rule, we're looking for operating efficiencies throughout all of our operations and trying to bring operating costs out of the system to improve margin.

We've got several initiatives underway, particularly around the maintenance of our assets to improve the efficiency and productivity of our maintenance workforce. So we're continuing to look for those opportunities throughout the entire system.

Darren Horowitz - Raymond James

Okay, that's helpful. I was just trying to differentiate between what was really truing up and what was really ratcheting down costs in that specific segment. Thank you.

Operator

Moving on, we'll take our next question from Ron Londe from AG Edwards

Ronald Londe - AG Edwards

Thanks. Maybe you've covered this because I've been jumping on and off the call, but I was curious what the producers out in the Jonah Field and Pinedale are saying about their drilling plans given what's going on with natural gas prices in the Rockies right now.

Jerry E. Thompson - President and Chief Executive Officer

Well, what we're seeing right now is, again, roughly 30 rigs continuing to work on our dedicated acreage in both the Jonah and Pinedale Fields. In Canada, last year, announced that they were bringing in some built-for-purpose rigs to improve the efficiency of their drilling.

So we still continue to see a lot of drilling activity and new wells coming on. Again, we had 180 wells in the first half of '07 that were connected into the system, so we still see a fairly robust drilling program.

Ronald Londe - AG Edwards

Okay. Do you have any input of where gas prices would have to go for that to... for that drilling to slow down?

Jerry E. Thompson - President and Chief Executive Officer

Well, Jonah has probably, if not the lowest one, one of the lowest production costs of any natural gas field in the country. Again, there are good long haul transportation pipelines out of the area to handle the current production. Those will have to be increased of course as the field continues to expand and increase production.

But, again, we'd have to see a more significant reduction in natural gas prices than what we've seen over the last quarter to have a meaningful impact on drilling.

Operator

At this time, there appears there are no further questions. Mr. Stockard, I'll turn the conference back over to you for any additional remarks.

Mark G. Stockard - Treasurer and Director, Investor Relations

No, we don't have anymore comments. We appreciate everybody's participation in the call today and we look forward to the next quarter. In the meantime, feel free to give us a call if you have any additional questions about TAPPCO.

Operator

Thank you. That will conclude today's conference. We thank you for your participation. At this time, our phone audience may now disconnect.

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