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Calumet Specialty Products Partners, L.P. (NASDAQ:CLMT)

Q2 2008 Earnings Call Transcript

August 6, 2008 1:30 pm ET

Executives

Jennifer Straumins – SVP

Bill Grube – President and CEO

Pat Murray – VP and CFO

Analysts

Darren Horowitz – Raymond James

Ethan Bellamy – Lehman Brothers

Todd Wood [ph] – Wood & Company [ph]

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Calumet Specialty Products earnings conference call. My name is Sue and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would like now to turn the presentation over to your host for today's call, Jennifer Straumins, Senior Vice President. Please proceed.

Jennifer Straumins

Thank you, Operator. Good afternoon, and welcome to Calumet Specialty Products Partners investors call to discuss our second quarter 2008 financial results. During this call Calumet Specialty Products Partners will be referred to as the Partnership or Calumet. Bill Grube, our President and CEO, will lead off the call in a summary discussion of the business, to be followed by Pat Murray, our CFO, who will discuss our financial results. Following the presentation, we will hold the line open for a question-and-answer session.

During the course of this call, we will make various forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Such statements are based on the beliefs of our management, as well as assumptions made by them and, in each case, based on information currently available to them. Although our management believes that the expectations reflected in such forward-looking statements are reasonable, neither the Partnership, its general partner, nor our management can provide any assurances that such expectations will prove to be correct. Please refer to the Partnership's press release that was issued yesterday, as well as its latest filings with the Securities and Exchange Commission for a list of factors that may affect our actual results and could cause them to differ from our forward-looking statements made on this call.

Now I'd like to turn the call over to Bill Grube, the President and CEO of Calumet.

Bill Grube

Thank you, Jennifer. This continues to be a very difficult environment for all refiners, including Calumet. Historically high crude prices continue to pose significant challenges during the quarter. We have implemented multiple rounds of specialty product price increases to customers during this volatile period. We expect the recent reduction or termination of production by – of certain specialty products by other major suppliers, namely Marathon and Citgo, will have a favorable impact on Calumet, placing additional specialty products volumes in the market from our Shreveport refinery expansion project.

The completion of the Shreveport refinery expansion project in May, 2008, the continued integration of Penreco, our increased hedging of specialty products, input prices, and working capital reductions, all of which were previously announced second quarter initiatives, had a positive impact on our second quarter results. We can provide no assurances as to the timing or magnitude of continued improvement in our operating results; and to the extent we experience rapid escalation of crude oil prices, our operating results could be adversely affected.

As of May, 2008, the Shreveport refinery expansion project was operational. We invested approximately $147.7 million in capital expenditures at the Shreveport refinery in the six months ended June 30, 2008, of which $115.5 million relates to the Shreveport expansion project. From December 31, 2005, through June 30, 2008, the Partnership invested approximately $473.1 million in the Shreveport refinery, of which $369.9 million relates to the Shreveport refinery expansion project.

The Shreveport expansion project has increased this refinery's throughput capacity from 42,000 barrels per day to approximately 60,000 barrels per day. For the three months ended June 30, 2008, the Shreveport refinery had total feedstock runs of 41,000 barrels per day, which represents an increase of approximately 6,000 barrels per day from the first quarter of 2008. As part of this project, we have enhanced the Shreveport refinery's ability to process our crude oil. As of June 30, 2008, we were processing approximately 13,000 barrels per day of sour crude oil at the Shreveport refinery. In certain operating scenarios, we expect we will be able to increase our sour crude throughput rates up to approximately 25,000 barrels per day.

The total cost of the Shreveport refinery expansion project is estimated to be approximately $375 million, an increase of $25 million from our previous estimate. This increase is primarily due to increased construction labor costs to avoid further delays in the project's completion. The $375 million aggregate cost estimate of the expansion project significantly exceeds Partnerships' original estimate.

We remain committed to an active hedging program to manage commodity price risk in both our specialty products and our fuel products segments. Due to the current volatility in the crude oil price environment and the impact such volatility has had on our short-term cash flows, all our product pricing is adjusted, we have implemented modifications to our hedging strategy to increase the overall portion of input prices for specialty products which we hedge. Significant – specifically, we are targeting to hedge crude oil prices for up to 75% of our specialty products production. We continue to believe that a short-term time horizon of hedging crude oil prices for three to nine months forward for the specialty products segment is appropriate, given our ability to increase specialty products' prices within this timeframe.

During the second quarter of 2008, we added approximately three million barrels of crude oil collar derivative instruments, including hedges, out to the second quarter of 2009. We have successfully implemented strategies to minimize inventory levels across all of our facilities to reduce working capital needs. As an example, effective May 1, 2008, Calumet entered into a crude oil supply agreement with an affiliate of our general partner to purchase crude oil used at our Princeton refinery on a just-in-time basis, which has eliminated crude oil inventory historically maintained at this facility of approximately 200,000 barrels.

During the second quarter of 2008, we reduced our overall inventory levels by approximately 600,000 barrels, or approximately 30% from inventory levels as of March 31, 2008. We continue to execute this working capital reduction strategy during the remainder of 2008 and expect to make further reductions.

As discussed during the second quarter of 2008, the Partnership experienced adverse financial conditions associated with historically high crude oil costs, which negatively affected specialty products’ gross profit. Also contributing to these adverse financial conditions have been significant cost overruns and delays in the start up of the Shreveport refinery expansion project. Compliance with the financial covenants pursuant to the Partnership's credit agreement is tested quarterly, and as of June 30, 2008, the company was in compliance for all financial covenants.

As we have covered on this call, the Partnership is taking steps to ensure that it continues to meet the requirements of its credit agreements and currently forecasts that it will be in compliance in future periods. While assurances cannot be made regarding our future compliance with these covenants, the Partnership anticipates that our continued product pricing strategies, the integration of the completed Shreveport refinery expansion project, continued integration of the Penreco acquisition, and other strategic initiatives we have previously discussed on this call, will allow us to maintain compliance with such financial covenants and improve the Partnership's adjusted EBITDA and distributable cash flows earned year-to-date.

Failure to achieve our anticipated financial results may result in breach of certain of the financial covenants contained in our credit agreements. If this occurs, we will enter into discussions with our lenders to either modify the terms of the existing credit facilities or obtain waivers of noncompliance with such covenants in the event the Partnership fails to comply with the financial covenant. There can be no assurances of the timing or – of the receipt of any such modification or waiver, the term or costs associated therewith, or our ultimate ability to obtain the relief sought.

The Partnership's failure to obtain a waiver of noncompliance with certain of the financial covenants or otherwise amend the credit facilities would constitute an event of default under its credit facilities and would permit the lenders to pursue remedies. These remedies could include acceleration of maturity under our credit facilities and limitation or elimination of Partnership's ability to make distributions to its unitholders.

Following is a summary of our quarter-over-quarter sales volumes by segment. Specialty products segment sales volume for the second quarter of 2008 was 30,088 barrels per day as compared to 24,692 barrels per day for the same period in the prior year, an increase of 5,396 barrels per day, or 21.9%. This increase is primarily due to incremental sales volumes associated with our Karns City and Dickinson facilities acquired in January, 2008.

Total fuels products segment sales volume for the second quarter of 2008 was 30,264 barrels per day as compared to 25,044 barrels per day in the same period for the prior year, an increase of 5,220 barrels per day, or 20.8%. This increase is primarily due to higher diesel fuel production, subsequent to the completion of the Shreveport refinery expansion project.

As announced on July 15, 2008, the Partnership declared a quarterly cash distribution of $0.45 per unit on all outstanding units for the three months ended June 30, 2008. The distribution will be paid on August 14, 2008, to unit holders as of the close of business on August 4, 2008.

I would now like to turn the call over to Pat Murray for a review of our financial results.

Pat Murray

Thank you, Bill. Now we'll provide a brief review of the financial results for the quarter ended June 30, 2008, for Calumet. Net income for the three months ended June 30, 2008, was $41.8 million compared to net income of $37.4 million for the same period in 2007. The Partnership's performance for the second quarter of 2008, as compared to the same period in the prior year, was positively impacted by higher gross profit in our fuels products segment, offset by lower gross profit in our specialty products segment.

Net income was also positively affected by increased unrealized gains on certain crude oil collar derivative instruments not designated as hedges and a one-time gain of $5.8 million on the lease of mineral rights on the real property at our Shreveport and Princeton refineries to an unaffiliated third party, which have been accounted for as a sale. These increases were partially offset by increased interest expense, due primarily to higher debt levels from financing both the Penreco acquisition, which closed in January, 2008, as well as the completion of the Shreveport refinery expansion project, which was operational in May, 2008.

Net income for the six months ended June 30, 2008, was $38.4 million compared to net income of $65.6 million for the same period in 2007. Partnership's performance for the six months ended June 30, 2008, as compared to the prior year, was negatively impacted by lower gross profit in our specialty products segment, partially offset by increased gross profit for our fuel products segment. Net income was also positively affected by increased unrealized gains, uncertain crude oil collar derivative instruments not designated as hedges, and a gain on the lease of mineral rights on the real property at our Shreveport and Princeton refineries to an unaffiliated third party, which has been accounted for as a sale. These increases were partially offset by increased interest expense, due primarily to higher debt levels from the financing both of the Penreco acquisition, as well as completion of the Shreveport refinery expansion project.

We believe the non-GAAP measures of EBITDA, adjusted EBITDA, and Distributable Cash Flow are important financial performance measures for the Partnership. EBITDA and adjusted EBITDA, as defined by Partnership's credit agreements were $65.5 million and $48 million, respectively, for the three months ended June 30, 2008, compared to $42.5 million and $43.5 million, respectively, for the same period in 2007. Partnership's Distributable Cash Flow for the three months ended June 30, 2008, was $36.9 million as compared to $37.9 million for the same period in the prior year.

Adjusted EBITDA for the quarter ended June 30, 2008, compared to the same period in the prior year, was partially impacted by increased fuel products segment gross profit, offset by decreased specialty products gross profit. Adjusted EBITDA was also partially affected by a gain on the lease of mineral rights on the real property at Shreveport and Princeton refineries, which were accounted for as a sale.

EBITDA and adjusted EBITDA for the six months ended June 30, 2008, were $77.8 million and $62.9 million, respectively, as compared to $75.3 million and $75.9 million, respectively, for the same period in 2007. Partnership's Distributable Cash Flow for the six months ended June 30, 2008, was $50.1 million as compared to $66.2 million for the same period in 2007. We encourage investors to review the section of the earnings press release found on our website entitled Non-GAAP Financial Measures and the attached tables for discussion and definitions of EBITDA, adjusted EBITDA, and Distributable Cash Flow financial measures and reconciliations of these non-GAAP measures to the comparable GAAP measures.

Gross profit increased $0.4 million, or 0.7%, to $60.9 million for the three months ended June 30, 2008, from $60.5 million for the three months ended June 30, 2007. Gross profit by segment for the three months ended June 30, 2008, for specialty products and fuel products was $21.5 million and $39.4 million, respectively, compared to $40.6 million and $19.9 million, respectively, for the same period in 2007.

The $19.1 million decrease in specialty products gross profit is primarily the result of the rising cost of crude oil outpacing increases in selling prices in this segment, partially offset by the recognition of increased LIFO inventory gains of $50.2 million, as compared to the same period in the prior year, due to the liquidation of lower cost inventory layers. The LIFO inventory gains were achieved as part of the implementation of our working capital reduction initiative.

The $19.5 million increase in the fuels products segment gross profit is primarily due to increased sales volume due to the Shreveport refinery expansion project and the recognition of increased LIFO inventory gains of $9.6 million, as compared to the same period in prior year, as part of the implementation of our working capital reduction initiative. These increases were offset by a decline in fuel refining margins per barrel, as market prices for our fuel products did not keep pace with the rising cost of crude oil.

Selling, general, and administrative expenses increased $3.0 million to $9.4 million for the quarter ended June 30, 2008, from $6.4 million for the same period in the prior year. This increase is primarily due to additional selling, general, and administrative expenses associated with the Penreco acquisition, which closed on January 3, 2008, with no similar expenses in the comparable period in the prior year.

Transportation expenses increased $7.1 million for the quarter ended June 30, 2008, to $21.2 million, as compared to $14.0 million for the same period in the prior year. This increase is primarily related to additional transportation expenses associated with the Penreco acquisition, with no similar expenses in the comparable period in the prior year.

Interest expense increased $7.4 million to $8.5 million for the quarter ended June 30, 2008, from $1.1 million for the same period in the prior year. This increase was primarily due to an increase in indebtedness as a result of a new senior secured term loan facility, which closed on January 3, 2008, and includes a $385 million term loan partially used to finance the acquisition of Penreco. This increase was partially offset by an increase in capitalized interest as a result of increased capital expenditures on the Shreveport refinery expansion project.

Gain on sale of mineral rights was $5.8 million for the quarter ended June 30, as compared to zero for the quarter ended June 30, 2007. This increase was due to a gain of $5.8 million, resulting from the lease of mineral rights on our real property at our Shreveport and Princeton refineries to an unaffiliated third party, which have been accounted for as a sale.

As of June 30, 2008, total capitalization consisted of partners' capital in the amount of $310.6 million and outstanding debt of $389.6 million, comprised of borrowings of $377.0 million under the term loan facility, with an unamortized discount of $16.2 million on the term loan facility, borrowings of $25.9 million under the revolving credit facility, and a long-term capital lease obligation of $2.9 million. The $89.0 million decrease in partners' capital from December 31, 2007, is primarily due to the distributions to our partners of $36.5 million and a $90.8 million increase in other comprehensive loss as a result of the decrease in the fair market value of our derivative instruments. These decreases were partially offset by net income of $38.4 million.

As of July 31, 2008, Partnership had outstanding borrowings of $377 million under the term loan facility and outstanding borrowings of $102.4 million under the revolving credit facility, with availability for borrowings of approximately $110.7 million under the revolver.

And now I'll turn the call back over to Bill.

Bill Grube

Thank you, Pat. This concludes our remarks. We will now be happy to answer any questions you may have. Operator, would you please confirm if there are any questions?

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Darren Horowitz from Raymond James. Please proceed.

Darren Horowitz – Raymond James

Good afternoon. Darren Horowitz with Raymond James. Bill, first question for you, and this goes back to some of the prepared commentary that you were discussing earlier on. When we are trying to look at EBITDA for this quarter on a pure, continuing operations basis, you can obviously look at your adjusted EBITDA, which is net of the realized, and unrealized adjustments on the derivatives, and you would remove the inventory sales on the mineral rights, obviously, because that is onetime in nature, as you discussed, but is that the proper way to look at what your core operations from continuing operations – from a continuing basis would be on EBITDA, a loss of $18 million?

Jennifer Straumins

I'll answer that for you, Darren. No, we've had a lot of things change in the marketplace. I mean, we've been running – we've been watching crude run up. Crude's gone up $10 plus a month. We've matched those with price increases. We've had between six and eight price increases starting in February across all product lines. And now that crude is coming down, obviously that's going to allow us to catch up with crude or maybe even be a little bit ahead of crude in our margins. So certainly that $18 million loss is not where we are going forward, plus second quarter did not have a full quarter's impact of the Shreveport refinery expansion project in there. We won't see that until this quarter.

Darren Horowitz – Raymond James

Okay. Let me ask the question a slightly different way. When you're looking at working capital and working capital reductions from that point going forward, in the prepared commentary you had said that you're going to continue working this strategy through the third quarter of this year. Given that you've reduced your overall inventory levels by about 30% relative to the end of March, how much more is left to go? How much more of a working capital or a monetization of inventory can we expect in the third quarter?

Pat Murray

I wouldn't say that there is a significant amount of additional inventory that can be reduced, but there are opportunities in the inventory categories, as part of our Penreco acquisition, that's an area that we're evaluating. We can't – we undertook a very significant inventory reduction in the second quarter, which we certainly think made sense to do in light of where commodity prices were, but we're also cognizant that it does take inventory to run the business, and we have to be able to operate as well. So we would not anticipate that there would be significant reductions to the extent in the second quarter, but we do think there are some opportunities for a further reduction.

Darren Horowitz – Raymond James

Sure. Can you quantify how much inventory you're keeping right now, just as a measure of us trying to gauge that working capital reduction? I mean, is it 100,000 or 150,000 barrels of excess inventory that you can monetize?

Bill Grube

Of excess or of total inventories?

Darren Horowitz – Raymond James

Of inventory that you might be opportunistically reviewing the potential sale of?

Bill Grube

Probably between 100,000 and 200,000 barrels is what I would guess at this point in time.

Darren Horowitz – Raymond James

Okay. I appreciate that clarity. And just one final question. Also in the prepared remarks, when you're discussing your credit agreement covenant compliance, and you're talking about the substantial assistance that this FIFO inventory reduction, mineral rights sales yielded, if you were to back those two things out, would you have been in compliance this quarter?

Pat Murray

If you would back out the two instances, we would not have met compliance, but, obviously, the credit agreements are based on GAAP earnings, and so we were clearly in compliance based on that.

Darren Horowitz – Raymond James

Sure. Okay. Thanks, Pat, I appreciate it.

Operator

(Operator instructions) And your next question comes from Ethan Bellamy with Lehman Brothers. Please proceed.

Ethan Bellamy – Lehman Brothers

Good afternoon. Are there any other assets similar to the mineral rights that you can sell to raise cash?

Jennifer Straumins

Not really. We've got some idled equipment at the Shreveport refinery that we've looked at selling a number of times over the years, but it's certainly not something that we're counting on. We weren't counting on this mineral rights lease either. It just happened to be going on this quarter, and –

Ethan Bellamy – Lehman Brothers

Okay.

Jennifer Straumins

But we're expecting to make our earnings through operations in the third quarter.

Ethan Bellamy – Lehman Brothers

Okay. Your customers are obviously aware that crude has come in recently. If it stays at current levels, will they be pressuring you to reduce your prices in specialty products, or can you maintain the book that you have now?

Bill Grube

We –

Jennifer Straumins

I think the answer to both of those questions is yes. Obviously, crude is down about $30 from its peak, and we expect that customers will start to point that out to us, if they haven't already. At the same time, oil is tight in the market right now, and with two of our major paraffinic competitors announcing their exit from the industry and another – several other competitors are getting ready to go into the turnarounds, we feel pretty good about our book of business.

Ethan Bellamy – Lehman Brothers

Okay. With respect to the one-time items, it looks like distributable cash flow for the quarter also goes negative. Have you considered any other options for shoring up the cash flow profile, like a temporary reduction or elimination of the incentive distribution rights or the payments to the GP or the subordinated units?

Jennifer Straumins

We're not in the IDRs at this point in time, and any of those other items would be addressed as necessary.

Ethan Bellamy – Lehman Brothers

Okay. Thank you.

Operator

And your next question comes from Todd Wood [ph] from Wood & Company [ph]. Please proceed.

Todd Wood – Wood & Company

Thank you for hosting the call. In the press release you've referred to Shreveport feedstock runs at 41,000 barrels per day versus an estimated capacity of 60,000. Is that 60,000 capacity something that you expect to achieve in the near future, or are market conditions preventing the full run?

Jennifer Straumins

No, market conditions – the 41,000 barrels per day was a weighted average over the course of the quarter. The project was up and running in early to mid-May, and we've continued to tweak production, and these are new units. Our operators have had to learn how to operate, and they've done a very good job, and we are expecting to operate at current – at higher rates than what we operated in the second quarter. However, at the same time we continue to optimize feedstocks and look at economics from our marketing department. So we will be running the barrels that are economical to run.

Todd Wood – Wood & Company

Okay. That's great. Can you give us a sense of where the average contracts are made for specialty products? Is it reflecting, on average, crude at $120 or –?

Jennifer Straumins

What I can tell you is since the beginning of the year we've announced about $1.50 of price increases from where we were in December. Those price increases – the first of those started the first part of February. Unfortunately, we don't tell you where we're at versus crude, but our announced price increases are public information, so I can give you the $1.50.

Bill Grube

Per gallon.

Todd Wood – Wood & Company

Okay.

Jennifer Straumins

Per gallon.

Todd Wood – Wood & Company

Okay.

Jennifer Straumins

This would be since the first part of the year.

Todd Wood – Wood & Company

And a general question on hedging. Can you provide us with – well, as crude declines, do you anticipate that the, maybe, average sold puts – potential losses there are going to be offset by improved margins? Can you – if you can just describe a bit philosophically how you're putting your hedge book together and how it will respond in a declining environment that we're in now. That would be helpful.

Jennifer Straumins

Sure, and that's why we hedge in the shorter term, and anywhere from three to six months out, and as – we're not to that point yet where we're hitting those lower limits, but once we get there, we would expect that margins would continue to be strong enough, in the near term, to offset any hedging losses we would have on those barrels.

Todd Wood – Wood & Company

Okay. And you referred to Marathon and Citgo exiting the market. Is there any quantification of the volumes that they were supplying that you can provide us?

Bill Grube

About 15,000 barrels a day of lubes and about 3,600 barrels a day of wax.

Todd Wood – Wood & Company

You said 30,000?

Jennifer Straumins

No, 3,600 barrels a day of wax.

Todd Wood – Wood & Company

Okay. So it's, overall, a substantial–

Jennifer Straumins

It's a pretty good percentage.

Bill Grube

Yes, it's a lot of the wax market that got up and walked away when they quit.

Todd Wood – Wood & Company

Okay. I don't want to monopolize the call, so I would definitely like to follow up later with a few more questions. Thank you again for your time.

Jennifer Straumins

Thank you.

Operator

This concludes the Q&A. I would like now to turn the call back over to Jennifer Straumins for final remarks.

Jennifer Straumins

Thank you. This concludes our earnings conference call for the second quarter. Thank you very much for your participation in the teleconference, and please note that this will be available for replay using the instructions contained in our press release. Have a great day, everybody. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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