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Edited Transcript of TREC earnings conference call or presentation 7-Mar-19 3:00pm GMT

Q4 2018 Trecora Resources Earnings Call

SUGAR LAND Mar 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Trecora Resources earnings conference call or presentation Thursday, March 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jean Young

* Patrick D. Quarles

Trecora Resources - President, CEO & Director

* S. Sami Ahmad

Trecora Resources - CFO & Treasurer

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Conference Call Participants

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* Joe Catania

* Jonathan E. Tanwanteng

CJS Securities, Inc. - MD

* Joseph George Reagor

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Mitchell Lester Sacks

Grand Slam Asset Management, LLC - CEO

* Sarkis Sherbetchyan

B. Riley FBR, Inc., Research Division - Associate Analyst

* William J. Dezellem

Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer

* Wolf Joffe

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Presentation

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Operator [1]

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Good day, and welcome to the Trecora Resources Fourth Quarter and Full Year 2018 Earnings Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Jean Young from the Piacente Group Inc. Please go ahead.

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Jean Young, [2]

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Thank you and good morning, everyone. Welcome to the Trecora Resources Fourth Quarter and Full Year 2018 Earnings Conference Call. The earnings release was distributed over the wire services after the close of the financial markets yesterday afternoon. Presenting on our call today will be Pat Quarles, President and Chief Executive Officer and Sami Ahmad, Chief Financial Officer. Chris Groves, our Corporate Controller, will also be available for the Q&A session. Following management's prepared remarks, there will be a Q&A session.

Before we get started, I would like to review the safe harbor statement. Statements in this presentation that are not historical facts are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management's beliefs and expectations only as of the date of this teleconference, March 7, 2019. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected.

These risks as well as others are discussed in greater detail in Trecora's filings with the SEC, including the company's most recent Annual Report on Form 10-K and subsequent quarterly reports on Form 10-Q. During today's call, management will also discuss certain non-GAAP financial measures for comparison purposes only. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the earnings release issued after the close of the financial markets yesterday afternoon. The webcast is accompanied by a slide presentation that is available on the company's website www.trecora.com.

At this time, I'd like to turn the call over to Trevor's President and CEO, Pat Quarles.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [3]

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Thanks, Jean, and thanks to everyone joining the call this morning. I've been in the seat here at Trecora now about 3 months. I've learned a tremendous amount about the company, what challenges we have and where our strengths lie. That has allowed me, along with my management team, to define a clear set of priorities for ourselves and the organization. We've also committed to a culture of candor and in that respect, Trecora's results in 2018 including the fourth quarter were unacceptable. Our fourth quarter results reflect the significant negative impacts of the advanced reformer outage and an exiting of specific custom processing arrangement in Silsbee, whose economics couldn't be supported.

While we executed the catalyst change on time and slightly under budget, we incurred downgrades of the byproducts that we roughly $0.45 per gallon worse than we could have realized were the unit running. They were also $0.45 per gallon worse than the third quarter. If you look back on the year as a whole, our step-down in results were almost exclusively due to poor operation of our assets and higher operating and freight costs. The markets really were not a problem. Sales volumes of our high purity petrochemicals increased over 8%. We grew wax sales volumes over 5% and we had successes driving price increases in both businesses. Our custom processing activities were not constrained by opportunity.

We've taken important steps to meaningfully improve our performance and some of those steps have already begun to show results. We are prioritizing what can be most impactful in the short run, while steadily building a foundation of long-term performance. As a manufacturing company, first and foremost our transformation begins at our plants. Dick Townsend joined the company in June of last year as Chief Manufacturing Officer and immediately began implementing his plan focused on safe and reliable operations, while providing quality products to our customers. I'm pleased to report that we have worked injury-free throughout our company since October of last year, both the fundamental and manufacturing and a key leading indicator for reliable low-cost operations.

Our second near-term priority in manufacturing is the reliable operation of the advanced reformer unit. After returning the unit to service in the first week of January, it has run reliably since. This has been accomplished through skills training in the field, improved planning, leveraging outside resources where appropriate and utilization of process monitoring and control capabilities of the unit. We're taking an identical approach to our distillation and hydrogenation units in Pasadena, Texas and are beginning to see improvements there already. However, I caution you the build to improve financial results will not be as rapid as running the reformer reliably, given the nature of that business.

Underlying safe and reliable operations is a constant commitment to driving productivity when it doesn't undermine our safety or reliability. We executed a significant forced reduction in Silsbee at the end of 2018 that will provide $2.5 million annual savings in 2019. I want to recognize the site and their leadership that we were able to accomplish this very important but distracting change without incurring an injury and brought the advanced reformer back online safely and without incident.

Our focus is broader than operations. We are pleased to welcome Joe Tanner to the company to lead our commercial activities. Joe will join us next week. We are changing the culture of our commercial decision making, backing up decision making with analytics and capturing our fair value from the market. That's the revenue side. On the cost side, we're taking short-term decisions to lower our logistics costs by doing such things as subleasing excess railcars and getting relief from our customers on supply chain costs driven by old contracts. Long term, we are investigating structural opportunities to both lower our costs and improve our execution.

Our board is also continuing to refresh itself. Me joining the board in the third quarter was part of that effort. Last month we announced that Karen Twitchell, board member since 2015, had been appointed Chair, replacing Nick Carter who remains on the board. As we think about 2019 and beyond, understand my focus is on taking actions that drive the greatest improvement as soon as possible. While we will not be giving specific forward-looking guidance, I'm confident we will see a step-up in our results in 2019 versus 2018. Our improvement will be driven by the reliability of our assets, productivity opportunities and capturing greater value through commercial initiatives. The advanced reformer is performing according to its design criteria. We're getting most of the benefits from upgrading our existing byproducts that we were expecting. We'll continue to optimize the unit, but we have made progress and are on that path.

The U.S. Gulf Coast industry investments continue and the U.S. economy is strong. This gives us confidence that the market growth continues to provide opportunities for our specialty petrochemical business and our specialty wax business. I believe that the technical challenges we have seen with respect to custom processing are fixable. Demand in the oil sands market remains volatility and they are under pressure both to reduce production and drive costs out of their systems. I do think we have risk on oil sands demand.

Lastly, we remain committed to monetizing AMAK. We are in discussions with a leading global investment bank with strong mining expertise. Please note that there are challenges to this process given the complexity of its location and our minority share. We'll keep you apprised as we pass key milestones in that process.

We are committed to the safety of our employees, the reliability of our assets, the high quality of our products and the overall competitiveness of our company. I've been speaking with our key investors along the way and plan to continue to do so. By prioritizing the most meaningful outcomes and implementing needed changes, we believe we'll return Trecora to a higher and more stable level of financial performance.

Now I'll turn the call over to Sami Ahmad, our Chief Financial Officer, for a more detailed discussion of our results.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [4]

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Thanks, Pat and good morning to everyone. Our adjusted EBITDA as $2 million for the fourth quarter and $20.3 million for the full year 2018. Overall as Pat remarked, operational inefficiencies and higher plant operating costs largely drove the poor fourth quarter and full year 2018 performance. I'll talk more about our fourth quarter in a moment.

We believe our outlook is more optimistic. Having recently completed a multiyear capital program, our major CapEx spending is largely behind us. And going forward, we expect our CapEx run rate to be approximate $10 million per year. Additionally, going forward we expect to use free cash flow that's generated for debt reduction.

Regarding AMAK, at year end we received approximately $5.3 million of cash from AMAK's partial repurchase of its outstanding shares from its existing shareholders. Our ownership in AMAK remains at 33.4% and at this time it is uncertain if we will receive additional cash from AMAK in 2019.

Let us now begin by looking at our key financial metrics in the fourth quarter and full year 2018. And by the way, you can see that on Slide 5 of the posted presentation. Total revenue in the fourth quarter was $74.7 million compared with $66 million in the fourth quarter of 2017, an increase of 13.2%. For the full year 2018, revenues were $288 million, which is an increase of about 17.5% from 2017. Earnings per share on a diluted basis was a negative $0.22 per share for the fourth quarter and negative $0.10 per share for the full year 2018.

Let me spend some time talking about adjusted EBITDA. Adjusted EBITDA for the fourth quarter for TREC was $2 million. This excludes a charge of $2.3 million for restructuring and severance-related costs and this was related to executive terminations in 2018 and the previously announced reduction in workforce at our Silsbee, Texas facility. This restructuring charge is broken out separately for you under G&A in the income statement in the earnings release. Adjusted EBITDA for the full year was $20.3 million and this figure also excludes the $2.3 million restructuring charge. Adjusted EBITDA for 2017 was $31.7 million.

Focusing on the fourth quarter a little bit, adjusted EBITDA for the fourth quarter 2018 declined by approximately $3 million from the third quarter of 2018. This was largely driven by the advanced reformer outage at the specialty petrochemicals facility in Silsbee, specifically byproduct volumes of approximately 6.4 million gallons in the quarter had to be sold at a significant negative margin. Byproduct volumes are produced, as you know, along with our prime products. Byproduct margin in the quarter was a negative $0.19 per gallon and this compares to a positive $0.29 per gallon in Q3 when the advanced reformer ran for a large portion of that quarter. This had a negative impact of approximately $3 million in the quarter. With the advanced reformer unit now running normally, we don't expect to see this negative impact. Additionally in the fourth quarter we incurred costs related to exiting an uneconomical custom processing arrangement at the Silsbee facility. As a result, we incurred one-time costs of approximately $1.1 million in the fourth quarter.

CapEx for the quarter and the full year 2018 was $6.2 million and $25.3 million, respectively. Included in the CapEx for the fourth quarter was approximately $3 million for the advanced reformer catalyst change-out. Debt at year end stood at $103.3 million, including revolver balance of $18 million with additional revolver availability of approximately $20 million.

Operating cash flow for the quarter was approximately $8.8 million and approximately $20 million for the full year 2018. Depreciation and amortization for the quarter was $4.3 million and $14.4 million for the full year. G&A expenses for the quarter was $5.3 million and $23.1 million for the full year. As a percent of revenue G&A was 8% for 2018 full year, compared with approximately 10% in 2017. Finally, looking forward for 2019, we expect our effective tax rate to be approximately 21%.

Now let me walk you through some key metrics of the business segments, starting with specialty petrochemicals. EBITDA for the specialty petrochemical segment was $2 million in the fourth quarter and $22.7 million for the full year 2018. In the third quarter of 2018 the EBITDA for the segment was $6.2 million. Total sales volume in the fourth quarter was 25.1 million gallons, compared with 22.8 million gallons in the fourth quarter of 2017 and 21.6 million gallons in the third quarter of 2018.

Prime product volumes in the fourth quarter was 18.7 million gallons and this compares with 17.1 million gallons in the fourth quarter of 2017 and 17 million gallons in the third quarter of 2018. In the fourth quarter, we benefited from an uptick in demand in the oil sands which we have not really seen continue into the first quarter 2019. Prime product sales grew 8.5% year-on-year, largely driven by the higher sales to the oil sands. We saw modest growth across our major markets in polyethylene and polyurethane. Polystyrene market growth was strong, but largely driven by some one-time opportunity sales that we had in the first quarter of 2018.

As I mentioned previously, the big drivers in the decline in adjusted EBITDA from Q3 to Q4 was the impact of the advanced reformer outage on byproduct margins and the costs related to the exit of the custom processing arrangement at the Silsbee facility. Both of these are limited to the fourth quarter. In the first quarter, we expect turnaround expenses of approximately $500,000 at the Silsbee facility. We're very focused on managing operating costs at the Silsbee facility above and beyond the announced reduction in workforce. And these include initiatives to reduce freight and logistics costs, which Pat touched on and which have increased significantly year-over-year.

Moving on to specialty waxes, the specialty waxes segment, which is based at our Trecora Chemical facility in Pasadena, Texas, had EBITDA of a negative $0.1 million in the fourth quarter of 2018 and $1.8 million for the full year. The segment had EBITDA of $0.4 million in the third quarter of 2018. Sales volumes increased 5.3% year-on-year, while average pricing was up 9% as the business benefited from an improved wax sales mix. The decline in sales volume from Q3 to Q4 was largely due to seasonal factors. By year end 2018, we were successful in securing additional wax feed supply. While at higher cost, this will allow us to have sufficient wax feed supply to continue to grow the business profitably. This segment also includes custom processing at the TC facility. The growth in custom processing continued to be constrained by operational and reliability issues with hydrogenation and distillation. As Pat mentioned, TC has efforts underway to fix the unit. B Plant revenues were about $2.9 million in 2018 and that's up 3% from 2017. Operating expenses at TC increased significantly from 2017 due to higher costs for labor and equipment maintenance, including operating challenges with the hydrogenation and distillation units. In the first quarter 2019 TC will have turnaround and related expenses of approximately $500,000 to $600,000.

Moving on to AMAK, Trecora reported equity in losses of AMAK of approximately $0.2 million in the fourth of 2018 and $0.9 million for the full year 2018. Importantly, as a result of improved operations, AMAK had net profit before depreciation and amortization of $26.7 million in 2018 and this compares to $5.6 million in 2017 and $2.2 million in 2016. AMAK sold 58,000 dry metric tons of concentrate in 2018 compared to 2017. AMAK is in the process of completing the update on reserves for a revised life of mine. This is expected in the second quarter. Additionally as Pat mentioned, we're in discussions with a major global investment bank to help us sell our interest in AMAK.

With that, this concludes our prepared remarks and at this time I'd like to ask the operator to open the call up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jon Tanwanteng with CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [2]

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Pat, you mentioned that you didn't -- or maybe Sami did -- that you didn't see activity from the oil sands in the first quarter and they did a lot in Q4. Can you quantify what kind of risk you're seeing in 2019 from a year-over-year basis from the oil sands customers?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [3]

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Yes, I think what I'd talked about was some pressure on demand and we've read about that in the press. Politically they're trying to turn down production in the region. We also have, as the crude prices have come down, these are effectively manufacturing operations and they're doing a lot of focus on just their costs and opportunities to become more efficient. So if I look year-on-year for oil sands, '18 versus '19, I doubt we'll be flat in volume by the end of the year. I think we'll be down 5% or so in the oil sands in use, oil sands market.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [4]

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Got it, and can you remind me how big it was as a portion of revenue in 2018?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [5]

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I don't think we've disclosed it in terms of percent of revenue, Jon. But it's fair to say that it's a large portion of our prime products business.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [6]

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Okay, got it. With regards to the custom processing arrangement you exited, how big was that on a sales basis and can you replace that customer quickly with what you have in the pipeline?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [7]

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So Jon, candidly, it's an example of opportunities we have in the company to better kind of understand what we're doing. You won't really see an impact, I think, from a revenue perspective going forward, because as we really dug into our numbers I think we were coming to realize that the costs associated with that deal weren't adequate whatsoever for the revenue that we were getting. And as we engaged the customer on that challenge, ultimately there wasn't enough value in the total value chain to justify continuing. So we agreed effectively to exit. The costs that you see in the fourth quarter relate to a planned turnaround that we had on the unit and a significant discovery on effectively erosion, corrosion of the unit, given the service that it was in. And that was one of the primary drivers for why we quickly concluded it wasn't going to make sense to continue going.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [8]

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Okay, got it. And then will you be turning that around to a different arrangement or project or client at some point?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [9]

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Yes, it's an interesting unit. It's an HDS unit with hydrogenation capability. So we think there could be uses for it, potentially either externally or internally at the Silsbee site. And we're working on both.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [10]

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Okay. Sami, you usually have a chart for import pricing on the presentation and I'm not sure I noticed it this time. But what are the trends that you've been seeing? What are you expecting in 2019?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [11]

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On feedstock pricing?

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [12]

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Yes.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [13]

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Yes, I mean obviously you saw in the fourth quarter a sharp decline in natural gas lean feedstock pricing and that basically tracked crude, more specifically Brent crude as you know. We've seen an uptick in feedstock pricing over the last number of weeks. It's roughly back to where it was in the early part of fourth quarter and I'm referring to Mont Belvieu natural gasoline. For the most part, we've been able to -- you know about the formula piece. There's some lead lag things going on in the formula side. On the spot side, we've had a little bit of give-back, but we've been able to maintain most of that.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [14]

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Okay, great, and then finally just you mentioned some extraordinary cost heading into Q1 on both the Trecora and the South Hampton site. I think $500,000 for both of them. When do you see those kind of coming down to neutral and you're fully operational without these extraordinary costs going on?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [15]

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So I think you're referring to the turnaround work that Sami alluded to at both. That's not extraordinary. That's normal course operations of maintenance. Those were planned turnarounds of a variety of units, fairly extensive at TC and then just one particular unit in the case of Silsbee. Those are completed. I'd say frankly 2 out of 3 went really well, on time, on budget. We did have a fair amount of discovery in one of the units at Silsbee. So we were a bit late coming back. It didn't impact customers or our ability to supply. But we did incur a bit more cost than we were anticipating. But that is all now complete. And so the numbers that we talked about reflect the completion of that activity and not real uncertainty remaining for the first quarter for maintenance costs.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [16]

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Okay, great. And then just a final one from me, do you plan to be running your full byproduct volume through the reformer starting this quarter?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [17]

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That's correct.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [18]

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Yes.

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Operator [19]

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Our next question comes from the line of Joseph Reagor with Ross Capital Partners.

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Joseph George Reagor, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [20]

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So just two items, first one, you guys have some guidance on capital expenditures going forward. But could you give us a little bit more guidance on what you expect G&A level to be with all the restructuring changes?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [21]

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Yes, so that was -- so obviously we carved out the costs related to that and that's why we showed that separately. I think what you can expect on the G&A side is no material change. I mean there were replacements certainly at the executive level in terms of staffing within G&A. There's really no appreciable change from a headcount. So other than cost of living and that kind of inflationary adjustment, I think you ought to just assume that run rate.

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Joseph George Reagor, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [22]

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Okay, fair enough, and then can you give us a little bit more color on the wax volumes? The wax volumes went down, but your revenue went up. And is that something we should look at going forward that you're gaining more pricing power or is that kind of a one-time seasonal quarter?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [23]

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Right, so in the last couple quarters, Joe, you're probably referring to the wax volume chart, the bar chart with the trend line on it. Remember, in the first half of the year we were pulling down inventory at Trecora Chemical. And then in the third quarter, we had a little bit of a supply interruption or issues related to wax feed. And then in the fourth quarter it's seasonal. So when you look at fourth quarter '17, a year ago, you'll see fourth quarter '18 is actually much higher than -- or not much higher, but along that level. So there's nothing structural there. We've been able to secure more wax feed. So that will help us continue to grow volume. As we've talked, we are upgrading our sales mix. So you see that in the price change year-on-year, more into the HMA1 and PVC and some of the higher-value markets. So the wax component or business is actually doing well.

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Operator [24]

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Our next question comes from the line of Sarkis Sherbetchyan with B. Riley FBR.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [25]

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So I just want to kind of come back on the reformer unit. So I think if I look at 2018, you sold over 20 million gallons of byproduct. You said the reformer is operating, and assuming we have another 20 million gallons in '19, do you expect that volume to be processed fully or some percentage of that? And then also what's the margin per gallon uplift you're expecting?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [26]

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Sure. So the quick answer, of course, is yes, we do fully have the capability to upgrade all of our byproducts. So it's really the difference between selling them into the distressed market, which is what we were forced to do in the fourth quarter is (inaudible) naphtha versus taking it through the reformer and getting the higher value. So that is the expectation we have for 2019. As we said, we've been running really reliably throughout the first quarter thus far. If you look at the uplift we've been getting, it's been essentially a bit below $0.30 a gallon. What the drivers there are really twofold. One is kind of how the aromatics markets are performing in terms of price and our ability to get maximum conversion of benzene and toluene production across the reformer. On the production side, I'd say the unit is performing according to design. Of course we have a new catalyst in there. It's very hot. It's very active. And we're learning to control it appropriately. I think we'll have some optimization opportunities as we go forward to kind of continuously improve it. But we're not at the $0.30 per gallon, which I would say is kind of our target today. And a big piece of that was the benzene pricing element, which has improved and we would expect to improve seasonally as we go through the rest of the year.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [27]

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The one thing I would add to that, Sarkis, is that there is volume contraction when you go take the feed and run it through the reformer. So in the fourth quarter we were selling (inaudible) naphtha, which normally would be the feed. And then when you run it through the reformer, you know, there's a volume contraction, as you form the aromatics. So you can't just take the fourth quarter volume and annualize it.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [28]

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And can you discuss what the contraction might be?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [29]

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Yes, I mean it's common in advanced reformer, because you're converting these straight change into aromatics. It's somewhere around 70-75% yield volumetric yield, not mass yield, volumetric yield that you get from the feed.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [30]

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Got it, and then just kind of moving on, in prior presentation the company has outlined potential incremental annual EBITDA from the newly installed projects, right? The range was I think $28 million to $36 million by 2022. Are those targets still valid? Can you provide maybe some updates for us?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [31]

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Sarkis, I think given where I am in these first 3 months, my focus has really been on driving everything we can drive kind of in the here and now to make this thing better. A lot of that gets down to the reliability of our assets. So we've talked about getting our commercial portfolio cleaned up. I'm not really ready yet to talk about that 2022 number. I think there's just too much yet to be demonstrated in our capabilities to really execute on what we have in. So I'd say right now our focus is on 2019 and just continuing to drive and pull every lever we have available to us.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [32]

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That's helpful. Thanks for that, and then with regards to the cost reduction from the December reorg, can you maybe break down what portion of that $2.5 million I think it was, relates to COGS versus G&A?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [33]

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Yes, it's all -- there's no G&A in that. It's really plant operating costs. And it's really related to when we completed the advanced reformer project and capital work was done, construction, labor and associated kinds of costs. We had before it was on the balance sheet and then it had to be demobilized. So that's what that's all related to. And it's localized at Silsbee. So it's not both plants. So it's just the South Hampton facility. And the expected benefit as we disclosed, is about $2.5 million on an annual basis. And as Pat mentioned, you know obviously we're already seeing the benefit of that cost reduction here in the first quarter.

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Operator [34]

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Our next question comes from the line of Rosemarie Morbelli with G.research.

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Joe Catania, [35]

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This is Joe Catania on for Rosemarie. Looking at the release, I noticed and you discussed this as well that you hired Joe Tanner for heading up commercial. I seem to recall there being another hire for commercial some time mid last year. Is this a replacement or this is just building out the team or what's the dynamic there?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [36]

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Yes, it's a replacement. You're recalling Mike Humby. He left during the fourth quarter.

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Joe Catania, [37]

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Okay, thank you. And can you give a little bit more color on the oil sands demand? I know you've talked about it a little bit here. But everything I've heard previously from you guys is expect this demand to grow. And now it looks like it's getting pulled back a little bit. Can you give a little bit more detail on that?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [38]

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Sure. Listen, I think as we all appreciate, oil markets are volatile and extraordinarily dynamic. If you think about what's going on in North America and the development, particularly of shale oil production and the pressure that has put on other kind of channels of production, of crude; I think it's impacted the oil sands and they're feeling that pressure today economically. They're also constrained, as you know, by pipeline offtake out of Alberta. So their netbacks on crude are not the WTI numbers that we see posted in Oklahoma and Texas. I mean they're materially lower on netbacks. So economically that's just driving them one, to consider alternatives for production in other parts of the continent. And secondly, again, since it's effectively mining and manufacturing, and like any good manufacturer, they're driving efficiencies in their processes and they focus on ways to become more efficient. And part of that is looking at their solvent consumption. So for those reasons, I mean I just as I've gotten into this, I just want to raise some caution about those long-term expectations of growth.

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Operator [39]

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Our next question comes from the line of Bill Dezellem with Tieton Capital.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [40]

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Sami, would you please repeat the numbers that you said from a byproduct perspective in terms of what you're loss per gallon was in the Q4 and what the profit for gallon was in the Q3?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [41]

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Certainly, Bill. Let me just go to that page of my script and I will be happy to repeat that. So what I mentioned is that in the fourth quarter because of basically what we talked about having to sell the byproduct at below feed, the negative margin was $0.19 per gallon. In the third quarter, when the unit ran not for the full quarter, but it ran for a large portion of the quarter and the aromatics prices were decent, the margin was $0.29 per gallon. So that's the delta you saw that Pat referred to.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [42]

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Understood. Okay, thank you. And just to make sure that we're doing this math correctly, you take the 6.4 million gallons of byproduct that you sold and multiply that times the $0.19 per gallon loss and that ends up providing the loss of $1.2 million on the byproducts alone, not taking into account the differential between breakeven and what you otherwise should have had as a profit.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [43]

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Yes.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [44]

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And did I also hear correctly that we wouldn't take the 6.4 million gallons and multiply it times, say, the $0.29 because you do have a loss of roughly 25% of volume, when you do upgrade and run the byproduct through the advanced reformer?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [45]

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Yes, there's volume contraction that's a result of the reforming process, yes.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [46]

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Okay, and then also to make sure that I'm clear, in the fourth quarter you had more byproduct volume than you have in past quarters, because you had more prime product volume. So in essence, what's normally a good thing, having higher prime product volume, actually in a sense worked against you because you had more byproducts that you then sold at a loss.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [47]

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Yes, that's actually a good point. So there were a couple of things that were going on. One was we had more prime products and so generated more byproducts. Secondly, with the reformer unit not running, you were selling the feed rather than the product coming out of the reformer unit and that's the volume contraction. And obviously the margin was severely negative.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [48]

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Whereas in future quarters, when you have success growing prime product volume, then with the advanced reformer running, you'd actually also make money on the byproduct as opposed to losing money, as you did in the Q4?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [49]

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Right. One thing to clarify, I didn't mean a negative margin on prime product. Prime products were fine. Yes, it's the byproduct and historically when you look at it, prior to the reformer, advanced reformer, yes. The margin just kind of bounced around zero. Sometimes it was positive, other times depending on what was going on in the fuels market, it would be negative. And it bounced around zero.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [50]

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Great, thank you. And then Pat, what are you wanting to see out of Joe Tanner that you've not had up to this point?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [51]

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Well okay, to be clear, when I stepped in we had nobody in the seat. So there's lots of opportunity here. I think as an organization what I found is one of kind of the foundational pieces that we need to dramatically improve is our planning, one, to understand where we're going and why. And then of course kind of the commercial experience to know how to drive those outcomes into negotiations with customers, with service providers on supply chain, as well as procurement. So I've worked with Joe in the past and we think about the business in a very similar way. We will start with analytics to understand where we are with respect to a business case. And we'll apply our experience and business acumen, if you will, to go and drive successful outcomes in the different negotiations that we have. So I know Joe will bring that and I'm looking forward to him starting next week.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [52]

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What's the magnitude of the either lost opportunity in the past or the forward opportunity that you see from what you just described?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [53]

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Yes, I don't have a number for you. But it's going to be significant in my mind. As an example and this is of course we got this accomplished before Joe arrived. But we've gone through a renegotiation of one contract, for instance, that allowed us to do a variety of things. We've modestly upgraded the fee. We were able to reduce the ratability of our volumetric commitment which allowed us to reduce the size of our railcar fleet. And we also better represented the cost of our logistics that the customer should be bearing. So if you think about that, that's really all 3 or at least 3 of the key elements of a contract where we had the opportunity to improve our value capture. And it's at that level of detail as we go through contract by contract that we're going to see improvements as time goes forward. I don't want to set the expectation that we sit here for a month and go through a bunch of analysis of our business and the next month everything changes. This takes time as we roll through contracts, as we engage our supply chain partners to make the changes we need to make. But it will put us on the right path. I think we'll see really good value creation through it.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO and Chief Compliance Officer [54]

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Pat that sounds like there are millions of dollars of profit potential over the course of the year. Are there also not immediately but over time, millions of potential incremental profit per quarter?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [55]

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Yes, as I said earlier, I'm not going to set a number out there right now beyond a very short horizon that I've had to go and make this thing better. Millions of dollars, I don't disagree that we have an opportunity for significant improvement. Whether it starts next quarter, I don't want to set that expectation, frankly. We're on the path. We're already making positive contributions. And that should just continue to gain momentum in the weeks or in the months and quarters ahead.

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Operator [56]

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Our next question comes from the line of Mitchell Sacks with Grand Slam Asset Management.

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Mitchell Lester Sacks, Grand Slam Asset Management, LLC - CEO [57]

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I'm trying to get my hands around gross margin in both businesses. And I was kind of hoping you could kind of just back me into, if I look at last quarter and I kind of give you the add-backs for byproduct and for the unprofitable tolling business, it still has you at a bit of a lower gross margin than you kind of historically operated the business. And so the question is sort of 2 parts on this part. One is you've kind of been in the mid-to-upper teens gross margin historically. Is that an area that we should be looking at? Is that achievable? How do I think about that kind of going forward and having looked at last year and fourth quarter?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [58]

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Sure. So Mitch, I think if you reflect back on the comments the company made over the last year, there's an element that we haven't really talked much about today, but were certainly true for the last year was the escalation in logistics costs, right? And I think that's been a topic on these calls in the past. And they remain a real headwind for us today. It reflects not costs with just straight freight. It relates to cost of things around our fleet that have escalated. And it relates to kind of the size of the fleet that we've been maintaining to meet customer requirements. I think all of those present opportunities to improve and need to improve to get us back up to that high-teen type gross margin.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [59]

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And just to add to that, Mitch, in terms of the bridge that you were describing in terms of the one time and so on, so the other piece is the impact of the cost reduction. We said $2.5 million annually. In prior to 2018, those costs -- a substantial portion of those costs weren't there. The third item that has really affected operating cost is at TC or the Pasadena facility. And that cost structure has grown really because of the difficulties we've had on the HD unit. And so we're looking at costs up and down the line across both sites.

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Mitchell Lester Sacks, Grand Slam Asset Management, LLC - CEO [60]

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Okay, and then with respect to the wax business, are you going to be having this higher cost feed come in, but you're able to sell a higher grade of wax. How do we sort of think about gross margins in that business and does that business ever get to gross margins that are similar to your South Hampton business?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [61]

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Yes, so I think I don't have the math for you in my head, Mitch, on the difference in gross margin ultimately between those two businesses. I think on the increment, we're having success driving those higher-value products that are justifying the sourcing of these higher-cost feeds, right? The higher cost feeds also put us in a more reliable supply position, because this diversifies our supply base. So I think we're directionally heading in our ability to upgrade. I think last year you also saw a lot of focus on our inventories that drove high volumes, but not necessarily high value. So that will come out of our mix as we move forward as well.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [62]

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And the other thing that's really going to drive gross margin or adjusted EBITDA margin, however way you want to look at it in the wax business or TC, Mitch, is really going to be custom processing revenue growth. And you know, that's been lacking, so we've had the costs related to it certainly in 2018. But we haven't had the commensurate revenue growth on custom processing. So it's both prongs on the wax side and the custom processing side.

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Mitchell Lester Sacks, Grand Slam Asset Management, LLC - CEO [63]

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And then with respect to the custom processing, you know, how close are we to having that HD unit to a point where you can market it with a high degree of confidence that you can make the profits that you expect to make on each individual transaction?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [64]

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Yes, I think the way we need to be thinking about the hydrogenation unit is no longer as binary, either it's working or it's not working. Because it's working today. We actually had successful production across the unit prior to the turnaround in the first quarter. Now what we have to do at this point now is be selective in ramping up, I'd say, the complexity of the products and the type of custom processing service that we do on that unit as we go forward. But we're already beginning to baseload it with what I would just call relatively straightforward type products. And now that we've returned from our turnaround, we're back at that production. But now it's going to be a matter of just incrementing up higher value use of it and higher utilization of it. But it's -- from an operability perspective, it's just continuing to really improve over the past quarter.

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Mitchell Lester Sacks, Grand Slam Asset Management, LLC - CEO [65]

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So I guess maybe a better way or different way to ask the question then would be to say, where are you at in terms of selling to capacity on that unit? Are you still at a very low state or are you starting to get real either demand or flow-through?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [66]

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We're at a low rate today. We've got lots of ability to continue to drive that.

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Mitchell Lester Sacks, Grand Slam Asset Management, LLC - CEO [67]

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And is there a demand for that?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [68]

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There is. We think there could be internal demand as well as demand as a custom processing service. But again, when we talk about demand it's not -- maybe monolithic is the wrong word, right? Each project, each conversation we have with a customer really often reflects a different product and the different needs that they have across that unit with different needs and kind of characteristics. So again, we have to be selective on what's a good fit for us today, given our capabilities. And then as our capabilities improve, we can get more complicated.

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Operator [69]

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Our next question comes from the line of Wolf Joffe with EVR.

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Wolf Joffe, [70]

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If the oil sands volumes are down 5% year-over-year in 2019, what should that result in for a total impact to South Hampton's volume growth in 2019?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [71]

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I would expect that total volume can be down a bit. It's a big chunk of our sales portfolio. I mean we're seeing reasonable growth on other end uses. As I mentioned briefly in my comments, investment along the U.S. Gulf Coast in the chemical industry continues. We had a startup of a major polyolefin unit in the last weeks and we have business associated with that unit. As they continue to line out their production that demand increases. So it will be flat to slightly down, I think, year-on-year, generally speaking.

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Wolf Joffe, [72]

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Okay, did you achieve higher gross profit per gallon on prime volumes in the fourth quarter versus Q3?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [73]

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Yes, I mean our margins did improve. We touched on that (inaudible) stock declines. So, yes.

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Wolf Joffe, [74]

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Okay, and if we assume South Hampton volumes are flat in Q1 versus Q4, and obviously it sounds like the reformer is not working; how much EBITDA can South Hampton generate in Q1, again, assuming flat volumes with the reformer now working?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [75]

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The reformer in the first quarter, we said it started up in early January and it's working according to design.

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Wolf Joffe, [76]

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Well, I think given where your leverage is and obviously you guys say that you're expecting improved financial performance; it would help your shareholders if you could actually put some numbers around this. And so if we just assume that your volumes are flat in Q1 versus Q4, again, how much EBITDA can South Hampton generate with the reformer now working?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [77]

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So if you think about kind of the components we talked about earlier, so start with our adjusted EBITDA in the fourth quarter, about $2 million. With the reformer running, right, so we're going to get the upgraded byproducts versus the significant downgrade. Quarter-to-quarter that's about a $3 million improvement. We have the exit of this custom processing arrangement at Silsbee behind us. That was roughly $1 million that hurt us in the fourth quarter and we have executed the cost reductions that we've been talking about, which began to benefit us in January. So that's over half a million dollars. So if you just take those kind of 3 drivers that gets you from $2 million to north of $6 million run rate or almost $7 million run rate in the first quarter. Now offsetting that, we talked about the turnaround work that we have at both sites and that's roughly $1 million. So if you just take those headline numbers, that's about $5.5 million quarter-to-quarter.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [78]

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And then also adding to that is prime product volumes were strong in the fourth quarter, and as we mentioned, you know we're going to see weakness in that, particularly related to oil sands. So you would adjust for that.

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Wolf Joffe, [79]

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Understood, thank you for the assistance there. My last question is the presentation published to accompany your third quarter earnings call said that the Penhex units would operate in the fourth quarter, supported by the old reformer. Did that not occur?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [80]

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Yes, that did occur, but that old reformer really has very little contribution. Effectively what that did, it helps us meet our hydrogen balances around the site. But economically, it really doesn't contribute.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [81]

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And capacity-wise, it's much, much smaller than the new reformer.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [82]

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Yes, listen. I want to be candid with everybody, right? So I think if you reflect back on expectations that were set in that call versus how the fourth quarter turned out, I think it was a miss. I think it was a miss on our part, because we didn't fully reflect the downgrade that was going to happen, as those byproducts didn't get converted, didn't get upgraded.

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Wolf Joffe, [83]

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Okay, so if the old reformer was working, they would have been upgraded somewhat, right?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [84]

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It has very low conversion to aromatics and conversion to aromatics is where the value creation is. So that doesn't really drive much value. We get some hydrogen off of it, as I said, to balance the site. But that's not an economic driver for the results.

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [85]

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If you look at historically when we had the old reformer, there was the margins for byproducts floated around $0.00 per gallon, plus or minus. There was not sufficient uplift above feed.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [86]

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And then maybe just to be clear, because sometimes we confuse ourselves even, we talk about reformer. There's the old [Air Max] unit and then there's the reformer there, right? The old Air Max unit is out of commission. It was past its useful life. That was not available to us in the fourth quarter.

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Operator [87]

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Our next question comes from the line Jon Tanwanteng with CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [88]

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Just a couple more from me. Sam, how do you stand with your bank covenants and debt in the quarter?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [89]

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Yes, so we ended the quarter in compliance. We had availability on the revolver in terms of incremental debt of approximately $20 million. And as I've said in the past, we have a very supportive bank group. We are in regular contact and discussion with them. And in the future if we need some more relief, we work in partnership with our banks.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [90]

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Okay, great. And then where do you expect to be by the end of the year in terms of net debt and leverage, just given a ballpark for what you expect to earn or generate in cash flow?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [91]

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Well, I'm not going to give you guidance, Jon. You know that. But what I will say is the company, broadly speaking, has a target. You know, we need to deleverage. 4x is not where we want to be. Where we would like to get to is around 2.5x to 3x, as we've mentioned before in terms of debt-to-EBITDA. So that's really another turn of EBITDA in terms of debt reduction that we have to achieve. And that's going to come both ways. I mean we're going to pay down debt, and hopefully as Pat said, we're going to grow the denominator also in terms of EBITDA to get to those levels.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [92]

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Okay, great. Can you help me maybe just what your cash tax bill is expected to be this year?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [93]

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Yes, I mean cash tax should be minimal, because we have NOLs from basically the capital investments that we have made and tax depreciation. So it shouldn't be material. Our effective rate, as I mentioned, will be 21%. The other thing I'd like to add is that from a free cash flow standpoint, it should be positive. I mean as I mentioned, CapEx is $10 million on a run rate basis and you can do the calculation on EBITDA, interest and those kinds of things. And you get to a positive free cash flow number.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [94]

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Okay, great. Finally just any thought or color on the AMAK value that you might expect to get in the market, especially relative to I guess the valuation that was received when you had your shares repurchased earlier this year?

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [95]

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Yes, I think the process itself is going to define its value and that's why we wanted to work with global recognized and investment bank that has expertise in mining. And our expectation is through the process and the due diligence of how the mine is performing and a life-of-mine calculations and where it's headed operationally; that's going to be the basis for defining its value. We're really encouraged frankly by the path AMAK is on, right? We've seen that they had a change of management about 2 years ago, turned around how they go about their business. We saw really consistent improvement throughout last year on their production and therefore profitability. And we expect that to continue this year and we think that's going to weigh positively on the market's view of its value.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [96]

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Okay. Was that net profit number you gave before depreciation and amortization a good proxy for cash flow from the mine?

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S. Sami Ahmad, Trecora Resources - CFO & Treasurer [97]

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It's a good proxy for cash flow, yes.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [98]

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That's why I gave that number.

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Operator [99]

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And that concludes today's question-and-answer session. I'd like to turn the call back to Pat Quarles for closing remarks.

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Patrick D. Quarles, Trecora Resources - President, CEO & Director [100]

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Listen, I want to thank everybody for joining today and for your questions. I also really want to thank our employees for the work that they've done over these last several months. I still find it -- I'm grateful for their attention to detail and keeping themselves and everyone around them safe since October. As I said earlier, that's foundational in how manufacturing companies should run and I'm pleased with it and I want to thank them. As for further engaging with our shareholders, I'll be presenting at Gabelli's G.research 10th Annual Specialty Chemical Conference in New York next week on March 13 and I'll be available after for meetings. And in addition, I'll be available for one-on-ones at the 31st Annual Roth Conference in Dana Point, Orange County California on March 18 and 19. And we look forward to updating you on our progress in the coming months. Operator, this concludes our remarks.

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Operator [101]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.