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TPC Group Inc (NASDAQ:TPCG)

Q22012 Earnings Call

August 3, 2012 10:00 am ET

Executives

Mike McDonnell - President and Chief Executive Officer

Miguel Desdin - Senior Vice President and Chief Financial Officer

Analysts

Daniel Rizzo - Sidoti & Company

Edward Yang - Oppenheimer

Greg Goodnight - UBS

Operator

Good day, ladies and gentlemen, and welcome to the TPC Group quarterly earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today’s conference, [Mr. Dan Lewis]. You may begin.

Unidentified Company Representative

Thank you, Ashley. Good morning everyone and welcome to today's conference call to discuss TPC Group’s second quarter 2012 earnings results. With me today are Mike McDonnell, President and Chief Executive Officer; along with Miguel Desdin, Senior Vice President and CFO.

While management will not be referencing slides today, we have posted a presentation online that includes supplemental financial information about the quarter and full year. These slides along with other quarterly financial results can be found in the Investor Relations section on our website at tpcgrp.com.

Please note the a slide in the presentation which refers to the forward-looking statements and says that statements made during this call that refer to management’s expectations and/or future predictions are forward-looking statements intended to be covered by the Safe Harbor provisions of the Securities Act, as there are many factors which could cause the results to defer from our expectations.

We also do not plan to update any forward-looking statements during the quarter. Please note that information recorded on this call speaks only as of today August 03, 2012, and therefore, you are advised that time sensitive information may no longer be accurate at the time of any replay.

In addition, some of our comments may reference non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures, and other associated disclosures are contained in our earnings release and on our website.

And with that, I will turn the call over to Mike.

Mike McDonnell

Thanks, [Dan]. Good morning, everyone, and thank you for joining the call. This morning, we will review our second quarter results, both as reported and underlying and the drivers behind our results. We will continue to provide the high level of transparency that we began a year ago, discussing our inherently stable, services based business model generates consistent underlying earnings. Finally, we will provide and update on current market conditions and our strategic growth projects.

Our second quarter underlying results of $37 million which exclude the temporary impact of butadiene price changes of $13 million compare well versus our best ever quarter one year ago when we experienced stronger market demand, customer inventory restocking and normal feed stock supply quantities.

Our better than expected results this quarter were achieved in spite of the challenges of temporarily reduced feed stock volumes, softer end user demand and destocking. As you recall, our feed stock constraints in the first and second quarters of this year were due to the abnormally high concentration of planned ethylene plant outages that we communicated during previous investor calls.

Our second quarter results really confirm the resilience of our fee-based business model and the inherent value of our aggregation, processing, logistics and other services that we provide for our suppliers and customers. The results reflect our strategies of service fee expansion, operational excellence and targeted volume growth.

Our employees did a terrific job in working with our suppliers and customers to manage through the challenging feedstock constraints during the quarter. Overall the company continued to execute well.

In addition to the solid underlying earnings for the quarter, we generated $26 million in free cash flow as a result of lower working capital requirements that resulted from the decline in butadiene pricing.

As we anticipated and communicated since late last year, the U.S. ethylene industry experienced an unusual number of extended turnarounds during the first half of 2012. As a consequence we were challenged by the reduced amount of available crude C$ feed stock which negatively impacted our volumes of all products in C4 processing segment and one product in our performance products segment. At the same time, market demand for butadiene derivatives such as in synthetic rubber has been soft and many customers report that destocking activities are underway.

As a result of the C4 feedstock constraints and softer demand for butadiene compared to the prior year, our C4 processing segment sales were down 13% in the first six months of the year which reflect a consistent 13% decline in both the first and second quarters.

Our performance products segment sales volume was down 7% in our core products, mainly as a result of the temporary feedstock restrictions in one product line as well as some demand softness.

Now, I would like to address butadiene supply demand and pricing. The structural shortage of butadiene due to light cracking based on cost advantage of ethane from shale gas is now firmly in place and widely understood. This structural shift couple with demand growth will continue to drive butadiene pricing upward over the longer term.

Our customers understand this long term structural issue and place a premium on our ability to provide them with security of supply for the future. While the long term trend is for pricing to move up, butadiene can also exhibit short term volatility as we have seen over the past several years. As we foreshadowed during our first quarter investor call, butadiene pricing fell significantly over the last several months.

During the second quarter, we saw the contract price of butadiene decrease 26% to $1.09 and then down another 16% between June and July. Recall that butadiene price increased 49% during the first quarter to $1.46 per pound. This volatility is due in part to the fact that demand and supply are driven by different sets of factors and these trends are expected to continue until on-purpose production becomes a significant factor in supply.

Currently butadiene supply is driven by ethylene plant operating rates and the composition of the feed slates, while demand is driven by end use demand for synthetic rubber, nylon and other products that require butadiene. Butadiene is also difficult and expensive to store, exacerbating these short term supply and demand imbalances and the resultant price swings.

Since decline of butadiene price in the second quarter generated and unfavorable impact of $13 million to our P&L, due to the monthly price changes between the purchases of butadiene, the crude C4 at the market price in the month of the purchase and the sales of finished butadiene to our customers at the market price when the butadiene was sold.

We turn our inventories every 20 days, so the effect is short lived but a portion of our purchases in any given month are sold in the following month at a potentially different price. These timing differences between purchases and sales generated a $13 million impact in the quarter. At the same time, this effect resulted in significant favorable cash flow during the quarter.

This impact of butadiene price change is separate from our stable underlying butadiene margins that are based on fixed fees per pound of butadiene processed through our infrastructure. These fees represent our margins for aggregation, storage, logistics, processing and ratable supply of crude C4 components that we obtain for methane plants.

Overall, our results for the quarter were achieved by driving our strategies of service and fee expansion, operational excellence and targeted volume growth. Our operational efficiency initiatives and high return capital projects continue their positive contributions through cost reductions, improved reliability and enhanced logistics capabilities that provide greater value to our customers.

Now, I would like to give you an update on the current market conditions. Currently demand continues to be relatively weak but stable across our products and markets. Downstream destocking activity in butadiene derivatives such as synthetic rubber for tires is also dampening demand at this time.

One the supply side, crude C4 supply from U.S. ethylene plants has increased now that the period of abnormally high turnaround is complete. Consequently, supply and demand conditions for C4 components are now more balanced at the current level of demand. This should translate into a relatively more stable pricing for butadiene until demand improves from current levels. The August contract price for butadiene is a rollover from July consistent with this view.

Looking at the full year, if butadiene pricing remains relatively flat for the rest of the year as some projections are currently indicating, we anticipate that our full year 2012 EBITDA target of approximately $140 million would be impact unfavorably by about $10 million. The $140 million target consists of $130 million of underlying earnings and $10 million of favorable butadiene price impact that was anticipated for the year.

Our underlying earnings which exclude that BD price impact continue to track our full year target on an underlying basis, despite the headwinds of market demand softness and once again, we are demonstrating the resilience of our service based business model.

With that, I will now turn the call over to Miguel to discuss our financial results for the quarter.

Miguel Desdin

Thank you, Mike. I will spend a few minutes discussing financials for the quarter and then touch on each of the reporting segments.

As we reported in our press release, second quarter 2012 revenue was $690 million, which was down 13% compared to the second quarter 2011 driven by lower sales volumes. Sales volume of 744 million pounds was down 13% year-over-year but up 17% sequentially. Sales volume in the second quarter continued to be negatively impacted by the abnormally high concentration of plain cracker outages.

The overall average unit selling prices for both segments were essentially flat compared to the prior year quarter, thus had a negligible impact on the variant. Gross profit was $68 million in the second quarter 2012, compared to $115 in the second quarter of 2011. The $47 million decrease reflected the impact of butadiene price changes in both quarters and the lower sales volume. Gross profit reflected a $40 million negative year-over-year impact from 26% decline in the price of butadiene in the current year quarter compared to an increase of 47% in the prior year quarter.

The downward trend in butadiene price in the current year quarter had a negative impact on gross profit of $13 million. That includes a $2 million lower cost to market write down on butadiene inventory at June 30. The upward price trend in the prior year quarter had a positive impact on gross profit of $27 million.

EBITDA for Q2 was $24 million, adjusting for the impact of the butadiene price changes in both periods, results in an underlying EBITDA of $37 million in the current year quarter versus $45 million last year.

As a result of the items previously discussed, the company generated net income of $3 million or $0.21 per diluted share versus net income of $34 million or $2.12 per diluted share a year ago.

Turning to the balance sheet, at the end of June, the company had total debt of $348 million and a cash balance of $135 million, resulting in net debt of $213 million. At June 30, the company's net debt to capital ratio was approximately 41% and net debt to trailing 12 months EBITDA was approximately 2.3 times.

Cash increased $26 million in the second quarter consisting of cash generated from operating activities of $39 million, partially offset by capital expenditures of $13 million. Net cash from operations included net income of $3 million, depreciation and other non-cash expenses of $14 million and a decreased investment in working capital of $24 million.

The lower working capital consisted of lower trade receivables inventory and trade payables during the quarter due primarily to the substantial decline in selling prices and raw material cost for butadiene. From a liquidity perspective, in addition to the $135 million of cash, we also had full availability under of $175 million revolving credit facility at the end of June.

Turning to the operating segment. The C4 Processing segment revenue was down 13%, driven by a 13% decrease in sales volume. The lower sales volume primarily reflects the crude C4 supply restrictions from the abnormally high concentration of plain cracker maintenance outages in the first half of 2012.

Gross profit and EBITDA for the segment were down $45 million and $46 million respectively, reflecting the negative impact on margins of the change in butadiene pricing in the two quarters and the lower sales volume.

The Performance Products segment revenues were down 15% versus the prior year quarter as a result of 16% lower sales volume. The lower sales volume reflects a negative impact of crude C4 feedstock restrictions previously discussed as well as longer than expected maintenance outage by one of our suppliers and a reduced level of very low value by-product volume, which occurred as a result of operational cost improvement.

Gross profit and EBITDA for the segment were each down $1 million, compared to the prior year, as the impact of the lower sales volume more than offset the impact of slightly better average unit margin.

I will now turn the call back to Mike.

Mike McDonnell

Thanks, Miguel. I am very pleased with our progress in developing our two strategic projects to drive step change growth in the future. TPC is ideally positioned to capitalize on three key industry dynamics that are in our favor over the long-term.

First, attractive long-term market fundamentals in our core markets driven by the global megatrend of mobility, second, the structural tightness in crude C4s as a result of the shift to lighter cracking, resulting in increasing value of butadiene, a mission critical product, as well as other C4s and third, the anticipated favorable economics of natural gas liquids providing plentiful and cost advantage butane feedstock for the future.

Our strategies also leverage assets and capabilities that we already have. Two idled dehydro units, underutilized capacity or infrastructure and our proprietary technology and knowhow in the production of on-purpose isobutylene and butadiene.

The first project is the restart of one of our idled dehydrogenation units to produce isobutylene from cost advantaged isobutene, to be used as an additional source of feedstock for our growing performance products and fuel products businesses.

This project will allow us to capture the favorable economics of the isobutene to isobutylene spread and we are now finalizing the detailed engineering, cost and schedule for full approval. We will communicate details on the project in the near future.

The second project is on-purpose butadiene from cost advantaged natural gas liquids using our proprietary OXO-D technology, the lowest cost commercially proven technology for on-purpose butadiene. We are also drawing on our decades of prior operating experience in making butadiene on-purpose. The long term structural shortage of butadiene is now widely acknowledged. This project will allow us to capture a substantial portion of the butane to butadiene margin on the butadiene we produce.

The project will provide our strategic customers with long-term security of supply, stable formula pricing and favorable economics on a mission critical product that is projected to be critically short into the future. Engineering work and discussions with strategic customers on long term off take agreements are progressing in parallel.

Overall, we expect our strategic projects to drive step out earnings growth in the future. These projects combined with our current strategies of service and fee expansion, operational excellence and targeted volume growth provide a strong foundation for sustainable earnings growth and increasing returns on invested capital.

Finally, before we take your questions, I am sure you have all seen recently that there has been some speculation in the market place about TPC regarding a potential transaction. It's TPC's policy not to comment on rumors or speculation regarding possible transactions. As such, today's call is to discuss our second quarter earnings and we ask you to focus your questions on our results.

And now we are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Daniel Rizzo of Sidoti & Company. Your line is open.

Daniel Rizzo - Sidoti & Company

Hey, guys,

Mike McDonnell

Hi, Dan.

Operator

I apologize. It looks like he may have disconnected. Our next question comes from Edward Yang of Oppenheimer. Your line is open.

Edward Yang - Oppenheimer

Hi, good morning, guys. Could you provide us with an update on the contract negotiations around the service and logistic fees?

Mike McDonnell

Sure, I would be happy to give you a little progress update here. These are long term relationships and so we are collaborating continuously on ways we can serve our customers better and new things that they need, new services and so forth. So that’s all part of the discussions we are having right now regarding fees and expansion of services that we can bring.

Those discussions are in early days still, with the target of completion by year-end and they are going well. I think we are all on our side and our customers are excited to move into the future here and address their concerns of security and supply of butadiene, the liability, (inaudible) the independence that TPC offers to the market place in terms of processing and so I think we are on track.

Edward Yang - Oppenheimer

Okay, and at what point does it makes sense to also look at the extraction fees on the supply side? That hasn’t changed in a while as well.

Mike McDonnell

That hasn’t changed. Over time we are looking at elements of those supply agreements as well, again, with the thought of how can we collaborate even better together with our suppliers and bring value to both sides.

Edward Yang - Oppenheimer

Okay, and moving on to performance materials. You did see a bit of a margin uptick and you mentioned some of the issues there that led to that. Where are you in terms of your pricing there relative to raw materials? I know your pricing has somewhat of a lag to raw materials and solid walls have come down. Do you expect some additional margin upwards there?

Mike McDonnell

Ed, I think generally speaking our pricing there is going to be in the mid-teens on cents per pound basis. We do expect a little bit of an uptick just with improvement that we made in our contracts over time.

The issue with the lag on the contracts really is only in an environment where butane prices or propylene prices rise or fall pretty sharply within the period. I think for the most part we catch up pretty quickly. We moved a lot of these contracts from quarterly lag in the old days to now monthly lag or non-existent lag which is even better.

So we are making progress along a number of fronts on that side and I think you will start to notice the difference here over the course of next couple of quarters.

Edward Yang - Oppenheimer

All right, thank you very much.

Operator

Our next question comes from Daniel Rizzo of Sidoti & Company. Your line is open.

Daniel Rizzo - Sidoti & Company

Yes, I am sorry, I don’t know what just happened there.

Mike McDonnell

I am glad you made it back in.

Daniel Rizzo - Sidoti & Company

Yes, I actually feel it all the time. So it seems like the two (inaudible) are going well. I just wanted to know if you have a time frame for when there will be a, is this still looking for 2014 or 2015 for just commercial production levels?

Mike McDonnell

Yes, that’s right. For the isobutylene project we are still expecting some time mid 2014 for commercial production, the first startup of the unit. Well, obviously, that implies that 2015 will be the first full year.

Daniel Rizzo - Sidoti & Company

Okay, and then, you indicated that destocking was somewhat of a headwind for the third quarter and is still kind of going on. How long do you think that is going to last?

Mike McDonnell

I think, probably another month or two, provided demand stays stable, where it is and that’s currently our projection at this point in time.

Daniel Rizzo - Sidoti & Company

Okay, and then, finally, could you just remind us what percentage of your contracts are being renegotiated right now towards until the end of the year?

Mike McDonnell

A little over half.

Daniel Rizzo - Sidoti & Company

Okay, all right, thank you, guys.

Operator

Our next question comes from Greg Goodnight of Union Bank. Your line is open.

Greg Goodnight - UBS

Actually, UBS. Good morning, gentlemen.

Mike McDonnell

Hey, good morning, Greg. How are you?

Greg Goodnight - UBS

Doing well. I need your help in interpreting BASF's recent announcement that they are going to be adding 155,000 metric tons of butadiene capacity in Antwerp. I wasn’t aware that there were a lot of new crude C4s coming on the market and apparently this doesn’t look like a first intent plant from the announcement. Are you there?

Mike McDonnell

Yes.

Greg Goodnight - UBS

Okay, have you seen the announcement? How should I interpret those? Are they going, say internalize some of the crude C4s that are produced in Europe reducing the amount of trade, potentially coming over here or wherever? Can you please give me your interpretation of this announcement?

Mike McDonnell

Hi, Greg. A good bit of that new capacity would be to process their own crude C4 stream. We cover a little bit more of that value rather than selling that in to the European extraction capacity. So that’s my take on that and I think what they will do is also just make crude C4 and butadiene just more valuable in the U.S.

Greg Goodnight - UBS

Okay, so could I interpret this capacity as not being incremental capacity but more replacing capacity elsewhere? This is not going to add to butadiene supply in Europe, I would presume.

Mike McDonnell

Yes. For the most part, no.

Greg Goodnight - UBS

Okay, and to your knowledge.

Mike McDonnell

Europe is always is the highest cost in the world for production of crude C4. So that has to be kept in mind also.

Greg Goodnight - UBS

Okay, they are investing, they say, high double digit million Euro range. So I mean this is significant investment for them. So anyway, I appreciate the color you have given me on that. That’s all I had.

Mike McDonnell

Thanks, Greg.

Operator

I am not showing any further questions. I would now like to turn the call back to Mr. Mike McDonnell for any further remarks.

Mike McDonnell

We remain very focused on disciplined execution of our strategies to drive value and we are very excited about our many near term and long term opportunities ahead. In closing, I would just like to recognize and thank our dedicated employees for embracing the values at TPC to deliver better than expected results and thank you all for joining the call this morning.

Operator

Ladies and gentlemen, thank you participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

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