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Executives

Karen Pape – SVP & Controller

Grant Sims – CEO

Ross Benavides – CFO & General Counsel

Analysts

Ron Londe – Wachovia Securities

Barrett Blaschke – RBC Capital Markets

John Edwards – Morgan Keegan

David Fleischer – Chickasaw Capital

Genesis Energy, L.P. (GEL) Q2 2008 Earnings Call Transcript August 6, 2008 11:00 AM ET

Karen Pape

Welcome to the 2008 Second Quarter Earnings Conference Call for Genesis Energy.

Genesis has four business segments. The pipeline transportation division is engaged in the pipeline transportation of crude oil and carbon dioxide. The Refinery Services division primarily processes sour gas streams to remove sulfur at refining operations principally located in Texas, Louisiana and Arkansas.

The Logistics and Supply division is engaged in the transportation, blending, storage and supply of energy products, including crude oil and refined products. The Industrial Gases division produces and supplies industrial gases such as carbon dioxide and syngas.

Genesis operations are primarily located in Texas, Louisiana, Arkansas, Mississippi, Alabama and Florida.

During this conference call, management may be making forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. The law provides Safe Harbor protection to encourage companies to provide forward-looking information. Genesis intends to avail itself of those Safe Harbor provisions and directs you to its most recently filed and future filings with the Securities and Exchange Commission.

We also encourage you to visit our Web site at genesisenergylp.com where a copy of the press release we issued today is located. The press release also presents a reconciliation of such non-GAAP financial measures to the most comparable GAAP financial measures.

At this time, I would like to introduce Grant Sims, CEO of Genesis Energy LP. Mr. Sims will be joined by Joe Blount, President and Chief Operating Officer; Ross Benavides, Chief Financial Officer and General Counsel and Karen Pape, Senior Vice President and Controller.

Grant Sims

Thank you, Karen, and welcome to everyone. This morning, we reported for the second quarter of 2008 net income of $7.3 million or $0.17 per unit and total available cash before reserves of $26.2 million. We are very pleased with these results.

While Ross will go into more detail for the quarter, I would like to point out a few operational highlights and recent accomplishments.

All four of our segments generated improved results in the second quarter compared to both year-over-year and sequential quarterly results.

In Supply and Logistics, we saw tangible benefits from our efforts to diversify our types and sources of refined products we handle, as well as adjusting our mindset and margins to deal with substantially higher diesel fuel prices affecting our trucking operations.

In Refinery Services, our operations ran extremely smoothly, allowing us to increase volumes some 12% relative to the first quarter. Additionally, we were successful in expanding our unit margins in a rapidly accelerating commodity price environment.

In Industrial Gases, we were steady as she goes with the second and third quarter typically slightly higher than the first and fourth, reflecting minor seasonal variations in the back-to-back sales of CO2 to our industrial customers.

On May 30th, we completed an investment of $250 million in carbon dioxide pipelines with Denbury, the indirect owner of our general partner. The results for the quarter, therefore, include only one month of contribution. Otherwise, our three existing crude oil pipelines performed quite well.

Next week, we will pay a total distribution of approximately $13.3 million, or $12.4 million to our limited partners and $900,000 to our general partner, including its incentive distribution. Coverage of our total distribution for the quarter is just shy of two times.

On July 18th, we completed the acquisition of the inland marine transportation business of Grifco through a joint venture with members of the Davison family. The acquisition consideration in part, plus the capital to significantly grow the business was provided by a $75 million revolving credit facility arranged by the joint venture in an otherwise challenging bank market.

While we clearly believe our investment is an outstanding, standalone, fee-based opportunity, our whole reason for pursuing a barge operation was to enhance our other existing Supply and Logistics operations.

Joe Blount and the rest of our commercial operations team have worked hard on the integration of our assets and business segments. While it will be a continuing process, including integrating the new strategic barge operations, we believe we are starting to see the results of those efforts.

Before getting into the details, I would like to take a moment to share our thoughts about a couple of topics getting a fair amount of attention in the midstream space.

Regarding trading, we can unequivocally state we do not speculate. Our approach on crude oil and refined products is to run a back-to-back physical marketing program while taking advantage of blending opportunities if and when the market allows.

Regarding refining, we provide services upstream, inside the fence and downstream of a number of diverse refining operations, diverse in terms of location, size, design, ownership, etc. While we obviously care that refineries run, we have no direct exposure to crack spreads in general or the economics specific to any particular refining operation.

With that, I will turn it over to Ross Benavides, our CFO, who will review the financial results reported for the quarter.

Ross Benavides

Thank you, Grant. For the 2008 second quarter, we generated income of $7.3 million or $0.17 per unit. In the comparable period in 2007, we recorded a net loss of $1.4 million or $0.09 per unit.

During this call, we will focus our discussions on the second quarter of 2008 by comparing it to the first quarter of 2008 rather than the second quarter of 2007 as the second quarter 2007 did not include the operations acquired from the Davison family.

The first quarter of 2008 reported net income of $1.6 million or $0.04 per unit. Results from our Pipeline Transportation segment increased by $2.2 million to $6.8 million or 47% as compared to the first quarter of 2008. Substantially, all of the improvement related to the CO2 pipelines acquired from Denbury on May 30, 2008. That only included one month of activity.

Revenues from crude oil tariffs and sales of pipeline loss allowances increased by $300,000 or 4%.

Operating costs increased by $100,000 or 5.7%.

Volumes increased on the Mississippi and Texas system by 9% and 8% respectively, while volumes declined on the Jay System by 19% due to maintenance issues at a producer separation plant and at our own operations, both of which have been alleviated.

We acquired our Refinery Services segment and the Davison transaction in July of 2007. During the second quarter of 2008, this segment contributed $17.6 million or an increase of almost 30% over the first quarter of 2008.

Sales volume of NaHS increased between quarters by 12% to 46,655 dry short tons. Contribution margin per dry short ton increased from $260 to $342. During the second quarter, we were successful in increasing the sales price of NaHS to compensate for increases in caustic soda prices and to maintain or expand the contribution of NaHS sales to our segment margin.

Segment margin from Industrial Gas activities in the 2008 second quarter increased by $300,000 from the first quarter to $3 million. Our CO2 supply business is a seasonal business and the first quarter of the year is typically the slowest. As compared to the second quarter of 2007, this segment's contribution improved by $100,000 with average sales volume in the second quarter of 2008 increasing by 4,929 Mcf per day.

Supply and Logistics segment margins increased $3.2 million from the 2008 first quarter to $9.5 million for the second quarter. The Supply and Logistics segment experienced significant improvements in segment margin due to increased availability of products for blending and an improvement in the availability of barges in terms of both general availability and river levels to access our terminals to move product out of our facilities.

Operational difficulties at some of the refineries from which we've purchased refined products resulted in reduced volumes being available to us during the first quarter.

General and administrative expenses increased by $600,000 from the first quarter of 2008 to $9.2 million in the second quarter. Excluding amounts for bonus plan and stock appreciation rights and planned expenses, G&A expenses decreased by $200,000.

Net interest costs increased during the second quarter by $400,000 due to a higher average outstanding debt balance due to borrowings from our revolving credit facility to fund the drop-down transaction with Denbury.

Income tax expense was a $1.4 million benefit in the first quarter of 2008 and a $1.6 million increase in the expense in the second quarter of 2008. The second quarter tax expense increase reflected the tax cost of restructuring some of the refinery service operations that were in taxable corporations. Having restructured these operations to generate qualified income for MLP purposes, we expect a significant reduction in income tax expenses going forward.

The year-to-date results were very solid as well. For the six-month period, we reported net income of $9 million or $0.21 per unit. 2007 reported $200,000 or $0.02 per unit.

Segment margin for the six months ended June 30, 2008 increased $50.6 million to $64.2 million. Approximately $41 million of that increase is attributable to a $31.2 million increase in the Refinery Services segment and a $10.6 million increase in the portion of the Supply and Logistics business segment acquired from the Davison family in July of 2007.

A $2.1 million of the increase is attributable to the Denbury drop down acquired in 2008. Of the remaining $6.7 million improvement attributable to year-to-date results for pre-Davison operations, $4.3 million is attributable to the Pipeline segment, $2.1 million is attributable to the crude gathering portion of the Supply and Logistics segment and $200,000 is attributable to the Industrial Gases segment.

Pipeline Transportation segment margins increased by $6.4 million to $11.5 million for the first half of 2008. $2.2 million of the improvement was attributable to the Denbury drop down transaction, $3.3 million was attributable to increased volume and tariffs on the crude oil pipeline, including the effect of higher crude oil prices on pipeline loss allowances, and $800,000 for a reduction in pipeline operating costs primarily attributable to a variance in the cost of our SAR plans between periods.

Volumes increased on all three pipeline systems during the first half of 2008.

The Supply and Logistics operations increased from $3 million to $15.8 million. The crude gathering operations experienced favorable variances in crude price differentials, as well as volumetric gains.

Cost of operating our crude truck fleet, primarily in the form of fuel costs, reduced the effects of these favorable variances.

Industrial Gas segment margin increased by $200,000 to $5.8 million in the first half of 2008.

CO2 sales revenue increased by $600,000 and our share of equity and earnings of joint venture decreased by $400,000. CO2 sales volumes increased by 5,395 Mcf per day. The average sales price per Mcf increased by $0.01 per Mcf and the average transportation right per Mcf increased by $0.01.

While earnings from joint ventures declined, distributions remained consistent at about $1.2 million.

G&A expenses for the first half of 2008 increased from $8.9 million in the 2007 period to $17.7 million. The $8.8 million increase can be broken down to $5.3 million relating to the new Davison operations, $1.6 million relating to bonus plan expenses, $5.2 million attributable to additional fees for professional service and staff increases at our corporate offices. These increases were offset by $3.3 million decreases in SAR plan expenses.

Net interest expense increased by $3.2 million to $3.7 million for the first half of 2008.

The Davison acquisition was partially financed with borrowings under our credit facility beginning on July 25, 2007.

In December 2007, reduced our debt with an equity offering. On May 30, 2008, we increased our debt to fund the drop down transaction. For the six-month periods, average outstanding debt was $113.5 million greater in the 2008 period and our average interest rate was 3.9%.

That concludes our discussion of financial results. Grant will now discuss our plans going forward.

Grant Sims

Thank you, Ross. The solid performance during the second quarter reflects the efforts of our dedicated employees to begin to realize the value of the almost $1 billion worth of acquisitions we made over the last year or so.

As I mentioned in my earlier remarks, integration is a process. We have got a long way to go, but Joe and I and the rest of our team believe we have put together a solid group of assets whose best days are hopefully in front of it.

In addition to our focus on continuing the successful integration of our existing assets and businesses, we will continue to seek opportunities to make further acquisitions, including tuck-in and bolt-on type opportunities.

While the financial markets could currently be characterized as challenging, we have as yet had no problems being able to finance any opportunity that we've considered worth pursuing.

Obviously, we are benefiting from the relatively low cost of debt and somewhat of a lower quarterly run rate of maintenance capital, primarily driven by the relatively young age of the Davison truck fleet.

Notwithstanding those considerations and assuming the continuing integration and performance of our businesses, we are comfortable continuing our distribution guidance that we would reasonably expect to be able to grow our distribution at a 15% to 18% annual rate for at least the next two years.

That concludes our prepared remarks for this conference call. At this time, I will turn it back to Claudia to take questions from the audience.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from Ron Londe with Wachovia Securities. Please state your question.

Ron Londe – Wachovia Securities

Yes, yesterday, the Denbury released their earnings and they had a statement concerning the drop downs to Genesis as related to lease financed or sales. Could you kind of go over that statement and kind of give us a feel for how that would affect any drop downs from Denbury in the future?

Grant Sims

Okay. Yes, basically they received a ruling that, in essence, allows them to treat all of their CO2 facilities as intangible drilling assets. And so therefore, they get an immediate tax write-off, and as a result, drop down structured like the free state was, which is a sale to us and we entered into a transportation agreement with them or will probably be discontinued because of the tax basis being zero. They can't very well turn right around and sell it and recognize a taxable gain and expect to enter into an acceptable return with us. But drop down structured similar to the NEJD, which was structured as a direct financing lease. The primary reason for structuring it that way to begin with was because of a low tax basis issue in the deal that would still be an acceptable structure. I think also it's important to note that if you had the opportunity to listen to the conference call that Denbury did mention that they are certainly exploring other options and ways to structure things to use Genesis as a financing vehicle on a go-forward basis.

Ron Londe – Wachovia Securities

Okay. Can you kind of give us a feel for what the positives and the negatives are from the standpoint of whether it is a sale or a leased finance?

Grant Sims

Basically, it has to do with – from a Genesis perspective, it is done as a lease, we don't have a step up in depreciable tax basis. So it's not as efficient from a distribution tax shield point of view as a straight up sale. So that's kind of, if you will, the negative we see in it. But it is still accretive, absolutely accretive from a cash flow point of view. But again, I think that whether or not we structure something for CO2 pipelines or CO2 assets specifically that doesn't preclude us working with Denbury to come up with other ways and options to effect mutually beneficial drop down transactions.

Ron Londe – Wachovia Securities

Okay, thank you.

Operator

Our next question is coming from Barrett Blaschke with RBC Capital Markets. Please state your question.

Barrett Blaschke – RBC Capital Markets

Good morning, guys. And just wanted to know, given that the acquisition market has been relatively pricey, any outlook for organic growth for Genesis?

Grant Sims

We are constantly examining investment opportunities off of our existing footprint, but I think that we have, as I stated, I think that we, as we go through time, that we are discovering new opportunities to get more out of our existing assets and that is a process that we hope to continue as we go.

Barrett Blaschke – RBC Capital Markets

Okay. And one housekeeping question on the Supply and Logistics segment. What are the total gathering and marketing barrels per day running at this point?

Grant Sims

We don't have that right in front of us, but I think it is around 30,000 barrels a day to 35,000 barrels a day on the crude oil side.

Operator

Our next question is coming from John Edwards with Morgan Keegan. Please state your question.

John Edwards – Morgan Keegan

Yes, good morning. Just a quick question, follow-up on the situation with Denbury, kind of a follow-up to Ron's question. With respect to that, is there any implication as far as impact to timing, with having to do a lease – would that take longer to do or would it require you to say, put that into place after new pipes come online so that it gives full effect to the, in effect, expensing at the Denbury level, and then you would wait and the following calendar year, you would enter into a lease. Is there any impact with respect to that?

Grant Sims

We really haven't – this is a relatively new development and we really haven't pursued all of those questions. I think that we had – we previously anticipated the possibility of a $100 million to $150 million drop down transaction at the end of the first quarter of 2009 and we, at this point, don't really have a view one way or the other of whether or not the timing – (a) whether or not it will even occur, but (b) whether or not the timing is effected.

John Edwards – Morgan Keegan

Okay. Alright. And then the profit per barrel in Supply and Logistics looked pretty high this quarter. I know you didn't give out – we were guessing in that 30,000 to 35,000 range that you just gave. Is that –?

Grant Sims

That's only – that 30,000 barrels per day to 35,000 barrels per day response was only on the crude oil side and that's not by any stretch of the imagination everything that's reported in Supply and Logistics.

John Edwards – Morgan Keegan

Okay. I am just trying to get an idea of sustainability. If things were quite strong on a per unit – I mean we only have the units that we have, but we are trying to get a sense or a feel for sustainability going forward in terms of potential margin there.

Grant Sims

I mean that's we are working very diligently to increase the reliability and repeatability and sustainability of all of our activities in the Supply and Logistics and we really feel that a missing piece of that in historical periods has been the river access, the barging capabilities and that is a new arrow in our quiver to make that a sustainable margin generating business.

John Edwards – Morgan Keegan

Okay. And then last question, you indicated the NaHS volumes were up 12% I think Q-over-Q. Is there any way we can obtain those volumes because I didn't see it disclosed?

Grant Sims

It will be in the 10-Q, which I gather we would hope to file around Monday – no later than Monday.

John Edwards – Morgan Keegan

Okay, great. Alright. Well, thank you. Great quarter.

Operator

Our next question is coming from David Fleischer with Chickasaw Capital.

David Fleischer – Chickasaw Capital

Hi, Grant. I guess I may be the third person to try to ask this question, but maybe I'll ask it in a little different way and then I have got a second question. Many have looked at you and we have heard most from you about the acquisitions and nice accretion from those acquisitions. However, it does appear, as you've just touched on a little bit that in a couple of your segments, there has been some decent internal growth, particularly in Refinery Services, it does look as if from the first quarter to the second quarter there was growth from volumes, as well as margin, but the volume is the side I guess I am most interested in. Trying to understand how sustainable those gains might be and whether there might be further such gains and what you see as the growth opportunities within various segments, particularly Refinery Services, but perhaps also in shipping and barge and towing [ph] what your internal growth strategy might be there.

Grant Sims

On Refining Services, yes, we went from a little under 42,000 dry short tons of NaHS sales to just a little under 47,000 on a sequential quarter basis. Based upon our existing Refinery Service arrangements, that's probably about the maximum that we can do. But as we have also discussed publicly in some time in the fourth quarter that we will have a new facility coming on in Woods Cross, Utah, which on a quarter basis we would anticipate to be in the 6,000 dry short tons to 7,000 dry short tons per quarter. So we do have an anticipation of an increase in that from a volume driven by the addition of another location in the fourth quarter.

Regarding the barrels that – we have found in the three quarters that, in essence, we've all been together with the Davison assets that, as I described it earlier, kind of the missing link to sustained steady throughput through our terminal facilities in North Louisiana has been access to barges to give us the options to market the product that we are able to gather via truck and/or rail into those locations. And so we just got it on July 18, so it's – again, that's an integration effort that we hope to significantly increase our margins and throughputs of our existing facilities as we go through time.

David Fleischer – Chickasaw Capital

Okay. I appreciate your desire to be conservative there and show us what you do rather than tell us what you're going to do. But let me ask one other separate question. You reiterated your 15% to 18% distribution growth target for the next couple of years. At the same time, you just reported essentially 100% or 200% coverage of your distribution, 100% excess coverage here, two times coverage. With growth prospects being talked about, what sort of coverage ratio do you feel you want to have going forward because there seems to be a little inconsistency here or let's call it between your coverage ratio and some others out there?

Grant Sims

David, I think that we are continuing in a growth mode in that we have – I am not sure that we have ever arrived at a coverage ratio that we're targeting. It's more of taking a look at what we have in front of us from a capital requirement point of view, growth opportunity point of view, being conservative managing the leverage so that we have the financial flexibility to be opportunistic on things that make sense that will create long-term value for the partnership. So I don't know where the ultimate target is, but I think we have, at different times, talked about maybe a target of – ultimate target of something in the range of 1.2 to 1.3 that we would be very comfortable with.

David Fleischer – Chickasaw Capital

Okay, thanks very much.

Operator

(Operator instructions). It appears we have no further questions. I would like to turn the floor back over to management for any closing comments.

Grant Sims

Well, thank you very much and we look forward to visiting with you at least in 90 days. Thank you very much.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Genesis Energy, L.P. Q2 2008 Earnings Call Transcript
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