Rishi A. Varma – Vice President, General Counsel, Secretary
Mike McDonnell – President and Chief Executive Officer
Miguel Desdin – Senior Vice President and Chief Financial Officer
Edward Yang – Oppenheimer
TPC Group, Inc. (TPCG) Q3 2012 Earnings Call November 2, 2012 10:00 AM ET
Good day, ladies and gentlemen, and welcome to the TPC Group quarterly earnings call for the quarter ended on September 30th 2012. At this time, all participants are in listen-only mode, and later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s conference, Rishi Varma, the company’s General Counsel.
Thank you, Bethany. Good morning everyone and welcome to today’s conference call to discuss TPC Group’s third quarter 2012 earnings results. With me today are Mike McDonnell, President and Chief Executive Officer; along with Miguel Desdin, Senior Vice President and Chief Financial Officer.
While management will not be referencing slides today, we have posted a presentation online that includes supplemental financial information about the quarter. 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 November 02, 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.
Thanks, Rishi. Good morning everyone and thank you for joining the call. This morning we’ll review our third quarter results and provide an update on current market conditions and on our strategic growth projects. I’m pleased with our third quarter adjusted EBITDA $39 million versus $28 million last year excluding the impact of butadiene market price changes in both periods.
The butadiene price impacts on EBITDA were a negative $5 million in this quarter and a positive $6 million in the prior year quarter. Because butadiene market price changes have only a very temporary impact on our as reported earnings, excluding these impacts provides a much better measure of the performance of the company.
Our strong results this quarter were achieved in spite of challenging volume conditions by capitalizing on several market and business drivers. First we achieved significantly higher margins in our fuel component products that are used in gasoline blend stocks to improve octane values.
Market values for gasoline and octane enhancing components were very favorable in the quarter. Second, we drove improved volumes and margins and key product lines within our performance product segment through a number of strategic initiatives including targeted volume growth and higher margin customer and market segments and margin improvement actions. Segment margins also benefited from lower butane prices in the quarter. The reason overall volume in the segment was flat year-over-year was that we implemented a successful yield improvement project late last year that reduced the volume of a negligible margin byproduct.
Third, our multiple operational excellence initiatives continue to generate year-over-year benefits and operating efficiencies across our plans and logistics networks. We’re making good progress and a number of yield and cost projects that are impacting our performance products segment in particular. These drivers more than offset the 15% lower volumes resulting from weaker demand conditions that we experienced in the third quarter, demand was negatively impacted by difficult North American and global economic conditions and uncertainty as well as continued destocking in downstream markets in response to lower than expected demand.
This destocking was particularly notable in the synthetic rubber chain. This demand weakness has reduced current demand levels for butadiene and has moved the market from a supply constrain condition that we saw in the first half of this year to a demand constraint condition that we’re currently seeing.
Since butadiene supply from North American ethylene plants has now returned to more normal levels after the abnormal number of plant, ethylene plant turnarounds during the first half of this year, the domestic supply of butadiene has been sufficient to balance the current market at these lower demand levels, without much need for imports.
In addition to the strong earning’s performance, we also generated $30 million and free cash flow during the third quarter, partly as a result of lower working capital requirements driven by the decline and butadiene pricing during the quarter.
Our third quarter results illustrate the resilience of our contractually fixed fees and margins of our business model. Our diversification for markets between chemicals and fuels and the inherent value of the aggregation, processing and logistic services that we provide at the industry. I also want to recognize the great job done by our employees to optimize the business during very challenging marketing conditions. Overall the company continues to execute well.
Now I’d like to address butadiene supply demand and pricing. The long-term structural shortage of butadiene due to like cracking by ethylene producers based on cost advantage ethane from shale gas is now widely recognized and accepted as a permanent shift. The majority of the structural decline in butadiene supply in North America took place in the 2007 to 2009 time frame and is now relatively stable.
As ethylene producers are now maximizing the amount of ethane they can use in their existing ethylene production units. Overtime, we expect continued demand growth for products derive from butadiene such as tires, other rubber products, nylon and engineer plastics causing butadiene prices to rise over the longer term.
Our customers understand this long-term structural issue and place the premium on our ability to provide them with security of supply for the future. While the long-term trend is for pricing to increase butadiene can also exhibit short-term volatility as we’ve seen over the past several years, this year for example, we saw butadiene monthly contract price increase from $0.98 per pound in December of 2011 to a $1.55 per pound in April of this year and then turn downward to $0.84 currently for November.
This volatility is due mainly to the fact that demand and supplier driven by different sets of factors in this market, and the market price is the principle market clearing mechanism to balance supply with demand in the short-term. Currently butadiene supply is driven by ethylene plant operating rates and the composition of the feed slices that feed those ethylene plants. While demand is driven by end used demand for synthetic rubber, nylon and other products that require butadiene.
Butadiene is expensive to store and has limited storage life which further exacerbates these short-term supply and demand and balances and the result of price swings. As I said previously, the decline of butadiene price during the third quarter generated an unfavorable impact of $5 million to our P&L, due to monthly price changes between purchases of butadiene and crude C4 at the market price in the month of the purchase and sales of finished butadiene to our customers at the market price when the butadiene was sold.
Simply put, we buy and sell butadiene at the posted monthly contract prices during the relevant periods. Beyond a temporary effective price changes which has to do with the time differences between purchases and sales of butadiene our margins do not benefit from higher butadiene prices, nor do they suffer from lower butadiene prices.
We turn our inventories every 20 days so portion of our purchases in a given month are sold in the following month at a potentially different price. These price differences between purchases and sales generated the $5 million impact in the quarter. At the same time, the decline in butadiene price had a positive impact on our cash flow during the quarter because of the reduced amount of working capital investment required to run the business.
This impact of butadiene price changes is separate from our stable underlying butadiene margins that are based on fixed fees per pound of butadiene process through our infrastructure. These fees represent our margins for aggregation, storage, logistics, processing and ratable supply of butadiene that we obtain from ethylene plants and deliver to our customers.
Now I’d like to give you an update on the current market conditions. Demand continues to be week across many of our products and markets. We do expect further destocking activity by many of our customers as they continued to react as slower than expected demand and the desire to control working capital as we approach year end.
For the present, supply and demand seemed rebalanced at the current level of demand. This is led to relatively stable pricing for butadiene as we’ve seen over the past several months. We’re also seeing normal seasonal decline in margins in our fuel related products following the third quarter. This occurs each other after the end of the summer driving season. Based on these factors, and assuming a constant butadiene price for the rest of the year we continue to affirm our full year 2012 adjusted EBITDA guidance target of approximately $130 million.
And with that, I’ll now turn the call over to Miguel to discuss our financial results for the quarter.
Thank you, Mike. I’ll spend a few minutes discussing the financials for the quarter and then touch on each of the reporting segments.
As we reported in our press release, third quarter 2012 revenue was $511 million which was down 15% compared to the third quarter 2011 driven by both lower volumes and lower selling prices. Sales volume was 693 million pounds was down 15% year-over-year and 7% sequentially. Third quarter volumes primarily in C4 processing continue to be negatively impacted by weak butadiene demand and lower crude C4.
The average unit selling prices for both segments were down reflecting at the substantial decline and the butadiene contract price as well as lower prices for butane and propylene to which a large portion of our isobutylene and propylene derivative selling prices are linked. Fuel product selling prices were higher which reflected the higher price of unladed regular gasoline.
Gross profit was $79 million in the third quarter 2012 compared to $77 million in the third quarter 2011. The $2 million increase reflected higher gross profit in the performance products segment of $6 million partially offset by a decrease in the C4 processing segments. The improved gross profit and performance products reflected a better product mix and a favorable comparison due to the negative impact in the prior year of customer inventory destocking.
The low growth profit for C4 processing reflected the impact of 19% lower volume and an $11 million negative year-over-year impact from a 22% decline in the price of butadiene compared to an increase of 12% a year ago. The downward trend in butadiene price in the current year quarter had a negative impact on gross profit of $5 million while the upward trend a year ago had a positive impact of $6 million.
The prior year impact consisted of a positive price impact of $15 million partially offset by a $9 million low of cost or market right down on butadiene inventory last September. EBITDA for the third quarter was $33 million, adjusting for the impact of the butadiene price changes in both periods resulting an underlying EBITDA of $39 million in the current year quarter versus $28 million last year.
As a result of the items previously discussed, the company generated net income of $7 million or $0.46 per diluted share versus net income of $9 million or $0.58 per diluted share a year ago. The year-over-year decrease was largely driven by increase cost of $4.5 million associated with the proposed merger.
Turning to the balance sheet at the end of September the company had totaled debt of $348 million and the cash balance of $165 million, resulting a net debt of $183 million. At September 30th, the company’s net debt capital ratio was approximately 36% and net debts of trailing 12 month EBITDA was approximately two times.
Cash increased $30 million in the third quarter consisting of cash generated from operating activities of $45 million partially offset by capital expenditures of $15 million. Net cash from operations included net income of $7 million depreciation and other non-cash expenses of $14 million and a decrease investment in working capital of $24 million. The lower working capital consisted primarily of lower trade receivables due to the decline of selling prices and raw material costs for butadiene.
From a liquidity perspective in addition to the $165 million of cash, we also had full availability under our $175 million revolver at the end of September.
Turning to the operating segments, C4 processing revenue was down 43% driven by 19% decrease in volume and a 30% decrease in average selling price. The lower sales volume for the segment reflected lower volumes across all product lines with lower butadiene volume resulting from weaker demand and lower fuel product volumes do impart to lower crude C4 supply.
Gross profit and EBITDA for the segment were down $5 and $7 million respectively, reflecting the lower sales volume and negative impact on margins of the changes in butadiene pricing partially offset by better margins for fuels products. The performance product segment revenue was down 15% versus the prior year quarter, almost all of that was a result of a 14% decrease in average selling price, as sales volume was down less than one percent.
The lower average unit selling price reflected lower pricing for butadiene and propylene which our commodities that are largely pass through in our isobutylene and propylene derivative contracts. Gross profit and EBITDA for the segment will reach up $6 million compared to the prior year. The increases reflected a favorable product mix that included reduced volume with low margin byproducts, as a result of the successful year improvement initiatives, and the negative impact on the prior year quarter of customer inventory destocking.
I’ll now turn the call back to Mike.
Thanks, Miguel. Let’s provide a brief update on our strategies to grow the long-term value of the company. We continue to make good progress on our two strategic projects drive step change growth in the future. Our board of directors recently approved our strategic project to produce isobutylene from natural gas liquids by refurbishing one of our two idled dehydrogenation units at a total cost of $265 million. This project will supply isobutylene for our performance products and fuels products businesses and we expect start up of the refurbished unit in the second half of 2014.
Our second strategic project will produce on purpose butadiene from cost advantage natural gas liquids leveraging our idled and under utilized assets and our proprietary OXO-D technology, the lowest cost commercially proven technology for on-purpose butadiene. The project will provide our strategic customers with long-term security of supply and favorable economics on to help meet their requirements for a mission critical product that is expected to be critically short into the future. Our preliminary engineering work for this project continues to move forward, were currently in the early stages of optimizing the process design and our proprietary technology to further improve our advantage.
We continue to expect start up of on purpose butadiene production in late 2016 or early 2017 and our strategic customers are very committed to the project. We expect these two large projects to drive our longer term growth and profit performance by capitalizing on attractive markets, projected long term shortages in butadiene, (inaudible) existing production assets and future supply of cost advantage butane from the shale place.
We also remain very focused on our strategies to expand our service fees and contractual margins in our C4 processing segment, achieved targeted volume growth and margin expansion and our performance product segment and drive operational efficiencies across all of our operations, these strategies are well on track.
Finally, as you know, on August 27, 2012 we announced an agreement to emerge with investment funds sponsored by First Reserve Corporation and SK Capital Partners. Then on October 5th, 2012 we’ve received a Nonbinding Proposal from Innospec and Investment Funds affiliated with Blackstone Capital Partners indicating their interest in pursuing an acquisition of TPC Group.
Consistent with its judiciary duties, our board is carefully considering and evaluating this proposal and has authorized discussions with Innospec and Blackstone. The purpose of today’s conference call is to discuss our third quarter results and we don’t intend to comment further on these developments at this time. We appreciate you focusing your questions on our quarterly results and thanks for your understanding.
And now we’re happy to take your questions.
(Operator Instructions) Our first question comes from the line of Edward Yang with Oppenheimer. Your line is open.
Edward Yang – Oppenheimer
Hi, good morning guys.
Good morning, Ed.
Edward Yang – Oppenheimer
Mike, you mentioned dialing back on raw crude C4 imports as you had sufficient supplies domestically. Is there any margin differential there for you domestic versus imports and did that also help C4 margin in the quarter?
No there was not really any appreciable margin difference between the two and our number – our revenue and profit is largely drive from the service fees that we’re using in processing. Our key is always to meet our customer needs and because our needs were a bit lower now demand, we were able to satisfy that with the domestic supply.
Edward Yang – Oppenheimer
Okay, got you. And the margin you did see some nice margin expansion in that segment, could you elaborate on your comment on fuels, you said that you maximized the strong pricing there. Would that just a normal seasonal boost or did you see more favorable conditions above and beyond normal seasonality?
Yeah, I think a little bit more than normal seasonality as you probably noticed the gas pump and also the pricing differential between premium and regular unleaded gasoline, those indicate a higher value for octane enhancing components and so we were able to capitalize on that in our business through some of our products that are used directly as blend stocks and others that are further processed few of those blend stocks to raise the octane value, a lower octane containing gasoline components to create blends that meet the market need.
So, but I think it was a little bit stronger than we’ve typically seen it in the past in the last set but longer than we typically see in the past. It’s now kind of referring back to the normal pattern that we typically see after the end of the summer driving season then getting closer to year end as gasoline this fall.
Edward Yang – Oppenheimer
Okay got you. And you mentioned the customer destocking, your pounds in terms of volumes have been down for about four quarters now on C4, would you has it I guess in terms of how much further customer destocking in the synthetic rubber space can go? I would probably think that we’re kind of in the latter stages of destocking at this point.
Yeah I think, I think you’re probably right on that. It’s always very difficult to get visibility across a wide range of customers because that destocking is not only in synthetic rubber but also in tires that are distributed around the world. So there is a long supply chain here, but we did see a bit of a step down I think broadly I think everyone has seen that in the second half of this year versus the first half. And so customers are reacting to that and if demand stabilizes from here I expect that most of that destocking will take place by the end of this year, remember our customers typically like to manage their working capital levels too to year end.
And they don’t this coming year have the same problem as last year of a shortage, remember last year’s – this year’s first quarter and there are supply restrictions who are certainly impacting their decisions around destocking late last year. So in the absence of that I think they made destock a little heavier this year and the fourth quarter which again leads me to believe that it’s probably for the most part than it’d be over by the end of this quarter, and then we’ll resume more normal demand patterns in the first quarter of next year.
Edward Yang – Oppenheimer
Okay, and just finally I know you’re limited in terms of what you could discuss regarding Innospec but they did have some positive things to say on their call yesterday about their initial impressions from due diligence. Is there anything that you could share with your meeting with Innospec and first impressions?
Unfortunately not, as a public company we really are bound by disclosure of regulations but I do want to say that once the board has made it’s determination that is in the best interest of TPC Group shareholders will certainly make an announcement to that effect.
Edward Yang – Oppenheimer
Understood. Thank you.
(Operator Instructions) I am showing no further questions. I would now like to turn back to management for any further remarks.
Thank you. We remained focused on disciplined execution of our strategies to drive value and we’re very excited about our many near term and long term opportunities ahead. In closing, I’d like to recognize and thank our dedicated employees for embracing the values of TPC to deliver better than expected results once again. And thank you all for joining the call this morning.
Ladies and gentlemen, that does concludes your conference. You may all disconnect, and have a good day.
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