TPC GROUP INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements ofTPC Group Inc. ("TPCGI") andTPC Group LLC ("TPCGLLC") and accompanying notes included in this Form 10-Q, as well as the audited consolidated financial statements and related notes thereto included in TPCGI's Transition Report on Form 10-K for the six-month transition period endedDecember 31, 2010 and TPCGLLC's Amended Registration Statement on Form S-4 filed with theSEC onSeptember 15, 2011 , which became effectiveSeptember 22, 2011 .
Explanatory Note - TPCGI and TPCGLLC
TPCGLLC is the principal wholly-owned subsidiary of TPCGI. TPCGLLC provided 100% of TPCGI's total consolidated revenue for all periods presented and nearly 100% of TPCGI's total consolidated noncash asset base as ofSeptember 30, 2011 andDecember 31, 2010 . Unless the context indicates otherwise, throughout the following discussion and analysis of our financial condition and results of operations, the terms "the Company", "we", "us", "our" and "ours" are used to refer to both TPCGI and TPCGLLC and their direct and indirect subsidiaries. Any discussions or areas in this report that apply specifically to TPCGI or TPCGLLC are clearly noted as such. Overview We manage our business and conduct our activities in two operating segments, our C4 Processing segment and our Performance Products segment. These two operating segments are our reporting segments. In the C4 Processing segment, we process the crude C4 stream into several higher value components, namely butadiene, butene-1, raffinates and MTBE. In our Performance Products segment, we produce high purity isobutylene and we process isobutylene to produce higher value derivative products, such as polyisobutylenes and diisobutylenes. We also process refinery grade propylene into nonene, tetramer and associated by-products as a part of our Performance Products segment. We produce steam and electricity for our own use at ourHouston facility, and we sell a portion of our steam production as well as excess electricity, which are reported as part of our C4 Processing segment. The primary driver of our businesses is general economic and industrial growth. Our results are impacted by the effects of economic upturns or downturns on our customers and our suppliers, as well as on our own costs to produce, sell and deliver our products. Our customers generally use our products in their own production processes; therefore, if our customers curtail production of their products, our results could be materially affected. In particular, our feedstock costs and product prices are susceptible to volatility in pricing and availability of crude oil, natural gas and oil-related products such as unleaded regular gasoline. Prices for these products tend to be volatile as well as cyclical, as a result of global and local economic factors, worldwide political events, weather patterns and the economics of oil and natural gas exploration and production, among other things.
Material Industry Trends
We receive most of our crude C4 from steam crackers, which are designed to process naphtha and natural gas liquids (NGLs) as feedstocks for ethylene production. Crude C4 is a byproduct of the ethylene production process, and the volume of crude C4 produced by the process is driven by both the volume of ethylene produced and the composition of the steam cracker feedstock. Some major ethylene producers have the flexibility to vary from light feedstocks, such as NGLs, to heavier feedstocks, such as naphtha, or vice versa depending on the economics of the feedstock. When ethylene producers process heavier feedstock, greater volumes of crude C4 are produced. However, when light feedstocks are inexpensive relative to heavy feedstocks, the producers may choose to process those light feedstocks instead, a process referred to as "light cracking," which results in lower volumes of crude C4 production. Throughout 2010 and the first nine months of 2011, NGL prices have remained attractive relative to naphtha; consequently, light cracking has been prevalent and crude C4 supply has been reduced over the same period, which has had a negative impact on our C4 Processing segment production and sales volumes. The upward trend in petroleum prices, related commodity market indices, general economic conditions and demand that created increasingly favorable market conditions for our products over the course of 2010 continued through the first nine months of 2011. Since a substantial portion of our product selling prices and raw material costs are linked 30
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to the same commodity indices (such as indices based on the price of unleaded regular gasoline, butane, isobutane or refinery grade propylene), we experienced upward trends in both our selling prices and raw material costs during 2010 and the first nine months of 2011. Over this same period of time our selling prices and margins have also been positively impacted by structurally tight supply and generally strong demand for our products. As a result of the recent weakening in global economic conditions, in the latter part of the third quarter of 2011 we began to experience softness in customer orders for some of our products as our customers anticipated weakening end-use demand for their products. Performance Products segment demand has been negatively impacted by customer destocking activities to reduce inventory levels in response to weakening end-use demand. In the C4 Processing segment, in addition to softening demand, the benchmark price for butadiene declined from$1.71 /lb. inSeptember 2011 to$1.40 /lb. inOctober 2011 as global supply and demand moved toward a balanced status. In addition, over the latter part of the third quarter and into early fourth quarter, we have seen typical seasonal weakening in the price of unleaded regular gasoline to which the selling prices and raw material costs of our fuel component products are linked. As a result of the decline in butadiene and unleaded regular gasoline pricing, we concluded that the value of our inventory of those products had been impaired atSeptember 30, 2011 and we recorded a lower-of-cost-or-market charge of$9.8 million in the third quarter, of which$9.4 million related to butadiene inventory. Although we believe we are well positioned for the long term to benefit from favorable market trends of continuing structural tightness in many of our products and modest economic growth, we anticipate a challenging fourth quarter, and we believe the market will come back into balance in early 2012. Since the end of the third quarter, we have seen further softening in demand and further decline in the benchmark price for butadiene and anticipate further decline in December. We believe this downward trend in butadiene demand and pricing reflects a temporary decline in end-use demand by our customers as they adjust their inventories and purchases due to the recent global economic uncertainty. As we have emphasized in the past, our butadiene margins per unit should be relatively stable in a stable pricing environment, regardless of the absolute level of pricing. However, as a result of the timing between the purchase of crude C4 in one period and sale of finished butadiene in a later period, per unit margins will expand as butadiene pricing trends upward and will contract as butadiene pricing trends downward. Over the course of the first nine months of 2011, we experienced margin expansion as butadiene pricing was on a continuous upward trend. In contrast, as butadiene pricing trends downward over the fourth quarter, we anticipate substantial margin contraction until pricing stabilizes at a lower level. When pricing is stable, our per-unit margins equal the value of the processing and aggregation services we provide to our customers. Aside from the negative impact of substantial declines in butadiene pricing, we would anticipate our fourth quarter 2011 Adjusted EBITDA, due to the impact of weaker economic conditions and softer demand, to be approximately 35% to 70% of our fourth quarter 2010 Adjusted EBITDA of$19 million , which reflected relatively stable butadiene pricing. Based on the October butadiene settlement price of$1.40 per pound and a current published North American spot price for butadiene of$0.95 per pound and the current level of our crude and finished butadiene inventory of 67 million pounds, the negative impact on fourth quarter Adjusted EBITDA from the decline in butadiene price would be approximately$30 million . The actual impact of butadiene pricing on our fourth quarter Adjusted EBITDA will vary based on further butadiene price fluctuations and changes in our butadiene inventory quantity, as well as discussions with suppliers to reduce inventory impact. The lower butadiene prices should have a positive impact on working capital and cash flow. We expect to generate$18 million to $27 million of free cash flow in the fourth quarter. The actual Adjusted EBITDA and free cash flow could vary significantly from the ranges provided based on actual performance and market conditions. We continue to make progress in developing the longer term growth and profit performance potential of the Company through strategic projects that capitalize on attractive long term market fundamentals, idled production assets, and the expected strength of natural gas liquids economics. We are performing detailed engineering and initial construction to restart one of our idled dehydrogenation units to produce isobutylene as a feedstock for our fuel products and performance products business. We also continue to make progress on our engineering study to produce up to 600 million pounds of on-purpose butadiene by restarting our second, idled dehydrogenation unit. We believe these opportunities have the potential to enhance our business model and operating performance, and to provide a strong foundation for long-term, sustainable growth. 31
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2011 Developments
InFebruary 2011 , we undertook a process toward restarting one of the dehydrogenation units at ourHouston facility. We own two independent, world scale dehydrogenation units with technology that allows the production of a single, targeted olefin from natural gas liquid feedstock, as opposed to steam cracking technology which generates a wide range of various olefins. The dehydrogenation units, which were previously used to produce isobutylene, were idled inOctober 2007 in conjunction with the completion of a capital project which allowed us to externally source isobutylene feedstock at ourHouston facility. From the time the assets were idled and through the first three quarters of fiscal 2009, the carrying value of the assets was not considered to be impaired because there were a number of realistic and probable alternative uses for the assets by which the carrying value would have been recovered. However, during the fourth quarter of fiscal 2009, due in large part to the decreased availability of financing and lack of opportunities for alternative uses of the units attributable to the ongoing global economic recession, and the fact that the assets had been idled for almost two years, we concluded that it was no longer likely that market conditions necessary to justify a significant investment in the assets would occur in the foreseeable future. Consequently, the likelihood of recovery of the carrying amount of these assets had been substantially reduced and, in the fourth quarter of fiscal 2009, we recorded an asset impairment charge of$6.0 million to write down the carrying value of these assets to zero. At the time we recorded the impairment we were purchasing isobutylene under a supply contract that contained pricing terms that were more advantageous than the cost of producing isobutylene from our own dehydrogenation units, taking into account startup costs. Subsequently, the supply contract under which we were purchasing isobutylene was revised, as a result of bankruptcy proceedings by the supplier, which resulted in an increase in isobutylene costs under the contract, such that self-supplying isobutylene from the dehydrogenation units became more advantageous. The isobutylene produced from the refurbished dehydrogenation unit will provide an additional strategic source of feedstock for our rapidly growing fuel products and performance products businesses. We estimate the refurbished dehydrogenation unit will produce approximately 650 million pounds of isobutylene per year from isobutane, a natural gas liquid whose production volumes continue to increase as a result of U.S. shale gas development, allowing us to evaluate a variety of sourcing options. Subsequently, onJuly 13, 2011 , we announced that (1) we received theTexas Commission on Environmental Quality (TCEQ) air permit necessary to proceed with the planned refurbishment, upgrade to air emissions controls, and restart one of our idled dehydrogenation units; (2) construction of the required new components for the system, along with refurbishment of the existing unit, began promptly following receipt of the permit; (3) we completed the primary phase of engineering on the project that commenced in January of this year; and (4) TPCGI's Board of Directors approved the next phase of engineering, which is expected to be completed by the end of 2011. The refurbished dehydrogenation unit is projected to be operational in the first quarter of 2014. OnFebruary 21, 2011 , we announced the election ofEugene Allspach as a new member of our Board of Directors, which increased its size from seven to eight members. At the time of his election to the Board,Mr. Allspach was serving as President ofE.R. Allspach & Associates, LLC , a consulting company to new business development activities in the petrochemical industry and had nearly 38 years of experience in the plastics and chemical industries.
Subsequently, on
OnMarch 3, 2011 , we announced that TPCGI's Board of Directors approved a stock purchase program for up to$30.0 million of TPCGI's common stock. Purchases of common stock under the program have been and will be executed periodically in the open market or in privately negotiated transactions in accordance with applicable securities laws. The stock purchase program does not obligate TPCGI to purchase any dollar amount or number of shares of common stock, does not have an expiration date and may be limited or terminated at any time by the Board of Directors without prior notice. As ofSeptember 30, 2011 , TPCGI had purchased 634,791 shares under the program in the open market at an average of$23.33 per share, for a total of$16.1 million . The shares purchased were immediately retired and any additional shares to be purchased under the program will also be retired immediately. Any future purchases will depend on many factors, including the market price of the shares, our business and financial position and general economic and market conditions. 32
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OnMarch 18, 2011 , we announced that TPCGI's Board of Directors electedMichael T. McDonnell as President and Chief Executive Officer and appointed him to the Board of Directors, each effectiveMarch 22, 2011 .Mr. McDonnell replacedCharles W. Shaver in those roles.Mr. Shaver retired as President and Chief Executive Officer onMarch 22, 2011 , and retired from the Board of Directors effective on that date.
On
EffectiveJune 6, 2011 , TPCGI's Board of Directors electedRishi Varma as Vice President andGeneral Counsel .Mr. Varma replacedChristopher A. Artzer , who resigned from those roles onMarch 11, 2011 . OnAugust 9, 2011 , we announced that TPCGI's Board of Directors approved funding for the next phase of engineering to produce on-purpose butadiene, targeting the restart of the second dehydrogenation unit at ourHouston facility, coupled with construction of a TPC Group OXO-D™ production unit. Normal butane, a natural gas liquid whose production volumes continue to increase as a result of U.S. shale gas development, has been selected as the primary feedstock. Utilization of the TPC Group OXO- DTM technology allows highly efficient on-purpose butadiene production, and is expected to yield up to 600 million pounds per year of product with this project and to have the capability to expand as needed through additional phases as the market grows. This engineering phase is expected to be completed by the end of the first three months 2012. As previously discussed, the dehydrogenation asset referred to above was one of two that were idled inOctober 2007 . During the fourth quarter of fiscal 2009, due in large part to the decreased availability of financing and lack of opportunities for alternative uses of the units attributable to the ongoing global economic recession, and the fact that the assets had been idled for almost two years, we concluded that it was no longer likely that market conditions necessary to justify a significant investment in the assets would occur in the foreseeable future. Consequently, the likelihood of recovery of the carrying amount of these assets had been substantially reduced and, in the fourth quarter of fiscal 2009, we recorded an asset impairment charge of$6.0 million to write down the carrying value of these assets to zero. We have undertaken the restart project described above to realize potential improvements in feedstock costs. After completion of the project, the dehydrogenation unit, utilizing butane feed, will be used to produce butadiene in order to meet growing market demand inNorth America . As discussed above, butane is in increasing supply in the U.S. due to shale gas development, as compared to the ongoing structural shortage of supply of our traditional crude C4 supply due to light cracking at ethylene crackers. Light cracking, and the resulting tightness in crude C4 supply, has become more prevalent since the time we recorded the impairment.
On
In
OnOctober 6, 2011 ,Michael S. White was appointed Senior Vice President of Operations of the Company.Mr. White replacesLuis Batiz in this role.Mr. White most recently served as Senior Vice President, Operations for Sun Coke Energy since 2008 and Vice President, Manufacturing for Sunoco Chemicals from 2003 to 2008.
On
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TPCGI and TPCGLLC Results of Operations
The following table provides unaudited sales volumes, revenues, cost of sales, operating expenses and TPCGI Adjusted EBITDA (defined below) by reportable segment (amounts in thousands) for the three and nine month periods endedSeptember 30, 2011 and 2010. The table also provides a reconciliation of TPCGI Adjusted EBITDA to TPCGI Net Income, the GAAP measure most directly comparable to Adjusted EBITDA. The amount of sales volumes, revenues, cost of sales, and operating expenses are the same for both TPCGI and TPCGLLC. Please refer to this information, as well as our unaudited condensed consolidated financial statements and accompanying notes included in this Form 10-Q, when reading our discussion and analysis of results of operations below. Revenues, cost of sales, operating expenses and Adjusted EBITDA in the table below are derived from our unaudited Condensed Consolidated Statements of Operations. There are no significant differences in miscellaneous corporate expenses between TPCGLLC and TPCGI, discussed in note 4 to the table below. Adjusted EBITDA is not a measure computed in accordance with generally accepted accounting principles inthe United States (GAAP). A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statements of operations, balance sheets, or statements of cash flows (or equivalent statements); or includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. As a complement to financial measures provided in accordance with GAAP, management believes that Adjusted EBITDA assists investors and lenders who follow the practice of some investment analysts who adjust GAAP financial measures to exclude items that may obscure underlying performance outlook and trends and distort comparability. In addition, management believes a presentation of Adjusted EBITDA on a segment and consolidated basis enhances overall understanding of our performance by providing a higher degree of transparency for such items and providing a level of disclosure that helps investors understand how management plans, measures and evaluates our operating performance and allocates capital. Since Adjusted EBITDA is not a measure computed in accordance with GAAP, it is not intended to be presented herein as a substitute to operating income or net income as indicators of the Company's operating performance. Adjusted EBITDA is the primary performance measurement used by our senior management and TPCGI's Board of Directors to evaluate operating results and to allocate capital resources between our business segments. We calculate Adjusted EBITDA as earnings before interest, taxes, depreciation and amortization (EBITDA), which is then adjusted to remove or add back certain items. The items removed or added back have historically consisted of items we consider to be non-recurring in nature and which we believe distort comparability between periods, as well as certain non-cash items such as stock-based compensation and unrealized gains and losses on derivative financial instruments. As indicated in the table below, during the first quarter of 2011 we revised our previous definition of Adjusted EBITDA to no longer remove the effect of non-cash stock-based compensation and unrealized gains and losses on derivative financial instruments, because they are recurring in nature. For comparison purposes the following table shows Adjusted EBITDA for all periods presented under both the revised definition and the previous definition used for the six-month transition period endedDecember 31, 2010 . As shown below in the reconciliation of TPCGI Adjusted EBITDA to TPCGI Net Income, the US GAAP measure most directly comparable to Adjusted EBITDA, under the revised definition of Adjusted EBITDA, there were no adjustments to EBITDA for any of the periods presented. Our calculation of Adjusted EBITDA may be different from the calculation used by other companies; therefore, it may not be comparable to other companies. 34
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Results by operating segment are as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 2011 2010 2011 2010 Sales volumes (lbs)(1): C4 Processing 669,067 587,128 1,941,515 1,762,832 Performance Products 149,063 161,563 487,145 473,229 818,130 748,691 2,428,660 2,236,061 Revenues: C4 Processing $ 713,492 $ 397,876 $ 1,806,890 $ 1,122,152 Performance Products 121,788 101,567 376,873 309,849 $ 835,280 $ 499,443 $ 2,183,763 $ 1,432,001 Cost of sales (2): C4 Processing $ 645,110 $ 350,594 $ 1,587,691 $ 984,109 Performance Products 103,213 77,546 313,805 239,018 $ 748,323 $ 428,140 $ 1,901,496 $ 1,223,127 Operating expenses: C4 Processing $ 25,179 $ 23,484 $ 78,542 $ 73,426 Performance Products 10,416 9,386 31,301 27,615 $ 35,595 $ 32,870 $ 109,843 $ 101,041 TPCGI Adjusted EBITDA-as previously defined during the six months endedDecember 31, 2010 (3) C4 Processing (4) $ 33,479 $ 23,799 $ 130,933 $ 64,617 Performance Products (4) 8,056 14,635 31,663 43,216 Corporate (5) (6,832 ) (5,313 ) (20,545 ) (20,068 ) $ 34,703 $ 33,121 $ 142,051 $ 87,765 TPCGI Adjusted EBITDA-current definition (3) C4 Processing (4) $ 33,479 $ 23,799 $ 130,933 $ 64,617 Performance Products (4) 8,056 $ 14,635 31,663 43,216 Corporate (5) (7,124 ) (5,714 ) (21,687 ) (18,933 ) $ 34,411 $ 32,720 $ 140,909 $ 88,900
(1) Sales volumes represent product sales volumes only and do not include volumes
of products delivered under tolling or similar arrangements, in which we do
not purchase the raw materials, but process raw materials for another party
for a specified fee.
(2) Does not include operating expenses, depreciation and amortization expense or
the
(3) See above for a discussion of Adjusted EBITDA and the revision during the
first quarter of 2011 of our previous definition of Adjusted EBITDA to no
longer remove the effect of non-cash stock-based compensation and unrealized
gains and losses on derivative financial instruments, because they are
recurring in nature. See below for reconciliations of TPCGI Adjusted EBITDA
to TPCGI Net Income for the periods presented. Net Income is the most
directly comparable GAAP measure reported in the Consolidated Statements of
Operations.
(4) TPCGI Adjusted EBITDA for the three and nine month periods ended
of which
relates to the Performance Products Segment.
(5) There are no significant differences in miscellaneous corporate expenses
between TPCGLLC and TPCGI. 35
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The following table provides a reconciliation of TPCGI Adjusted EBITDA (current definition) to TPCGI Net Income (in thousands) for the three and nine month periods endedSeptember 30, 2011 and 2010. Net Income is the most directly comparable GAAP measure reported in the Consolidated Statements of Operations and Comprehensive Income. Three Months Ended Nine Months Ended September 30, September 30, 2011 2010 2011 2010 TPCGI Net income $ 9,381 $ 12,775 $ 55,087 $ 31,236 Income tax expense 6,409 6,875 29,827 17,430 Interest expense, net 8,648 3,220 25,657 10,733 Depreciation and amortization 9,973 9,850 30,338 29,501 TPCGI EBITDA 34,411 32,720 140,909 88,900 Non-cash stock-based compensation 292 401 1,142 957 Unrealized gain on derivatives - - - (2,092 ) Adjusted EBITDA as previously defined during the six months ended December 31, 2010 34,703 33,121 142,051 87,765 Non-cash stock-based compensation (292 ) (401 ) (1,142 ) (957 ) Unrealized gain on derivatives - - - 2,092 TPCGI Adjusted EBITDA $ 34,411 $ 32,720 $ 140,909 $ 88,900 The cost of our raw material feedstock purchases is usually determined by application of index-based formulas contained in many of our raw material supply contracts. Through these index-based formulas our raw material costs are linked to commodity market indices (such as indices based on the price of unleaded regular gasoline, butane, isobutane or refinery grade propylene) or to the selling price of the related finished product. The selling prices for our finished products are also typically determined from index-based formulas contained in many of our sales contracts and, in most cases, the indices used to determine finished product selling prices are the same indices used to determine the cost of the corresponding raw material feedstock. The linkage between the costs of our raw material feedstocks and the selling prices of our finished products to the same indices mitigates, to varying degrees, our exposure to volatility in our material margin percentage (which we define as the difference between average revenue per pound and average raw material cost per pound as a percentage of average revenue per pound).
The following table summarizes the primary indices which impact our revenues and raw material costs by segment.
Finished Product Revenues Raw Material Costs C4 Segment Butadiene Butadiene Butadiene Butene - 1 Unleaded regular gasoline Unleaded regular gasoline Raffinates Unleaded regular gasoline Unleaded regular gasoline MTBE Unleaded regular gasoline Unleaded regular gasoline Performance Products Segment High purity isobutylene Butane Unleaded regular gasoline Diisobutylene Butane Butane Polyisobutylene Butane Butane Nonene Refinery grade propylene Refinery grade propylene Tetramer Refinery grade propylene Refinery grade propylene 36
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The following table summarizes the average index prices for each period presented. Three Months Ended Nine Months Ended September 30, September 30, 2011 2010 % Chg. 2011 2010 % Chg. Average commodity prices: Butadiene (cents/lb)(1) 172.6 93.5 85 % 136.4 83.8 63 % Unleaded regular gasoline (cents/gal)(2) 288.9 200.1 44 % 285.7 205.7 39 % Butane (cents/gal)(3) 188.4 138.2
36 % 183.4 145.6 26 % Refinery grade propylene (cents/lb)(1) 67.1 44.4 51 % 71.3 47.3 51 %
(1) Industry pricing was obtained through the
(2) Industry pricing was obtained through Platts.
(3) Industry pricing was obtained through the
Three months ended
Revenues, cost of sales, operating expenses, general and administrative expenses, depreciation and amortization expense and lower-of-cost-or-market adjustment were the same for TPCGI and TPCGLLC for each period discussed below.
Revenues
Total revenues for the quarter endedSeptember 30, 2011 were$835.3 million , an increase of$335.8 million , or 67%, compared to total revenues of$499.4 million for the prior year quarter. The increase in revenues reflected a 53% increase in the overall average unit selling price, due to rising commodity prices across most of our product line portfolio, and a 9% increase in overall sales volume. The higher average unit selling price for the current year quarter reflected the favorable trend over the past year in overall market conditions for our products as well as the upward trend in petroleum prices and related commodity market indices to which a substantial portion of our product selling prices (and raw material costs - as discussed above) are linked. C4 Processing segment revenues of$713.5 million for the third quarter of 2011 were up$315.6 million , or 79%, compared to the prior year quarter. The increase was driven by both higher selling prices and higher sales volume, which reflected higher commodity prices, stronger global demand from our customers and structurally tight supply of our products due to ethylene crackers processing lighter feedstocks. The average unit selling price for the segment increased 57%, which had a positive impact of$260 million , and sales volume was up 14%, which had a positive impact of$56 million . The average benchmark price for butadiene was up 84% compared to the prior year quarter and average selling prices for butene-1 and fuel-related products were also higher due to a 44% increase in the average price of unleaded regular gasoline. The increased sales volume consisted primarily of an increase in sales of fuel component products as butadiene volumes were consistent with the prior year quarter. Performance Products segment revenues were$121.8 million for the quarter endedSeptember 30, 2011 compared to$101.6 million for the comparable prior year period, an increase of$20.2 million , or 20%. The improvement reflected the positive impact of a 30% increase in average unit selling price for the segment, partially offset by the negative impact of 8% lower sales volume. The positive impact of the higher average unit selling price was$28 million and the negative impact of the lower sales volume was$8 million . The higher average unit selling price reflected a 36% increase in the average price of butane, which is a major pricing component of our isobutylene derivative products, and an increase of 51% in the average price of refinery grade propylene, which is a major pricing component of our propylene derivative products. The lower sales volume reflected the combined effect of timing of customer orders, customer inventory destocking, and an overall softening in market conditions in the latter part of the current year quarter. 37
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Cost of sales
Total cost of sales (which excludes operating expenses, depreciation and amortization and the lower-of-cost-or-market adjustment discussed below) was$748.3 million for the quarter endedSeptember 30, 2011 compared to$428.1 million for the comparable prior year quarter. The overall$320.2 million , or 75%, increase reflected 66% higher average raw material cost and the 9% increase in sales volume. C4 Processing segment cost of sales was$645.1 million for the quarter endedSeptember 30, 2011 compared to$350.6 million for the comparable prior year period, which represents an increase of$294.5 million , or 84%. The increase was driven primarily by 62% higher average unit cost of sales, which increased cost of sales by$246 million and, to a lesser degree, the 14% higher sales volume which had a$49 million impact. The higher average unit cost reflected higher raw material costs across the entire product portfolio within the segment. Cost of sales for the current year quarter included a favorable butadiene pricing impact of approximately$15 million while the impact on the comparable prior year quarter was negligible. Average butadiene inventory values coming into the current year quarter were lower than the average cost of butadiene contained in the raw material crude C4 purchased during the period, whereas butadiene values coming into the prior year period were consistent with the cost of raw materials purchased during the period. C4 Processing segment cost of sales as a percentage of segment revenues was 90% and 88% for the quarters endedSeptember 30, 2011 and 2010, respectively. Performance Products segment cost of sales was$103.2 million for the three months endedSeptember 30, 2011 compared to$77.5 million for the prior year period, which represents an increase of$25.7 million , or 33%. The increase reflected the effect of 44% higher average unit cost of sales, partially offset by the 8% decline in sales volume. The higher average unit cost increased cost of sales by$32 million while the lower sales volume decreased cost of sales by$6 million . The higher average unit cost reflected higher raw material costs across all product lines within the segment. High purity isobutylene raw material costs are linked to unleaded regular gasoline prices, which were up 44% compared to the prior year period. Isobutylene derivatives raw material costs are linked to butane prices, which were up 36%. Propylene derivatives raw material costs are linked to refinery grade propylene costs, which were up 51%. Performance Products segment cost of sales as a percentage of segment revenues for the three month periods endedSeptember 30, 2011 and 2010 were 85% and 76%, respectively. The increase in the percentage of cost of sales to revenues reflected the impact of an unfavorable sales mix for the polyisobutylene product line, the negative impact on high purity isobutylene margins as a result of an unfavorable relationship between butane and gasoline prices in the current year quarter compared to the prior year quarter and higher sales volumes of by-product streams which carry near breakeven margins. The cost of our raw material feedstock purchases is usually determined by application of index-based formulas contained in many of our raw material supply contracts. Through these index-based formulas our raw material costs are linked to commodity market indices (such as indices based on the price of unleaded regular gasoline, butane, isobutane or refinery grade propylene) or to the selling price of the related finished product. The selling prices for our finished products are also typically determined from index-based formulas contained in many of our sales contracts and, in most cases, the indices used to determine finished product selling prices are the same indices used to determine the cost of the corresponding raw material feedstock. The linkage between the costs of our raw material feedstocks and the selling prices of our finished products to the same indices mitigates, to varying degrees, our exposure to volatility in our material margin percentage (which we define as the difference between average revenue per pound and average raw material cost per pound as a percentage of average revenue per pound). Although these index-based pricing formulas provide relative stability in our material margin percentage over time, it is not perfectly constant due to various factors, including those listed below.
• Although most of our supply and sales contracts contain index-based
formulas, varying proportions of our raw material purchases and finished
product sales are done on a spot basis or otherwise negotiated terms. In
addition, while many of the index-based formulas in our contracts are simply based on a percentage of the relevant index, others apply adjustment factors to the market indices that do not fluctuate with
changes in the underlying index. In periods when market indices are high,
the use of non-fluctuating adjustment factors tends to reduce the material
margin percentage; and conversely, in periods when market indices are low
the non-fluctuating adjustment factors tend to increase the material margin percentage. 38
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• We may purchase raw material feedstocks in one period based on market
indices for that period, and then sell the related finished products in a
later period based on market indices for the later period. Changes in
selling prices of finished products, based on changes in the underlying
market indices between the period the raw material feedstocks are purchased and the related finished products are sold, lessens the effect of the matching indices and causes variation in our material margin
percentage. The magnitude of the effect on material margin percentage
depends on the magnitude of the change in the underlying indices between
the period the raw material is purchased and the period the finished
product is sold and the quantity of the inventory impacted by the change.
• Finished product selling price formulas under some of our sales contracts,
primarily in the Performance Products segment, are based on commodity
indices not for the period in which the sale occurs but for either a prior
or subsequent period. The effect on profit margins of these selling price
formulas is diminished during times of relatively stable market indices,
but can have a substantial effect during times of rapidly increasing or
decreasing market indices, which can impact our material margin
percentage.
Across-the-board increases in the market indices used in our index-based raw material costs and finished products selling prices for the quarter endedSeptember 30, 2011 versus the comparable prior year period were the drivers behind the higher overall average selling price and the higher overall average raw material cost noted above. The 53% increase in the average selling price equated to$0.35 per pound and the 66% increase in the average raw material cost equated to$0.34 per pound, for an improvement in overall average material margin of$0.01 per pound. As a result of the combination of factors noted above, which have an impact on material margin percentage, the material margin percentage for the three months endedSeptember 30, 2011 was 15% compared to 22% for the prior year period. Operating expenses Operating expenses incurred during the three months endedSeptember 30, 2011 were$35.6 million compared to$32.9 million for the comparable prior year period. The major components of the$2.7 million , or 8%, increase were higher salaries, wages, benefits and other personnel related expenses of$3.1 million , higher maintenance expense of$0.9 million , higher expense for safety and compliance consulting, training and other activities of$0.6 million , higher sales and use tax expense of$0.3 million , partially offset by lower property tax expense of$2.1 million . The lower property tax expense reflected a reduction in the property tax valuation for ourHouston facility as a result of an arbitration settlement with the local taxing authority which resulted in a reduction of current year property taxes as well as partial refunds of previously paid property taxes for 2008, 2009 and 2010.
General and administrative expenses
General and administrative expenses of$7.6 million for the three months endedSeptember 30, 2011 were up$1.5 million compared to the prior year period. The major components of the increase were higher personnel related expenses of$0.4 million and higher contract services and professional fees of$0.9 million , which included legal and other fees related to the registration of our 8 1/4% Senior Secured Notes.
Depreciation and amortization expense
Depreciation and amortization expense was$10.0 million for the three months endedSeptember 30, 2011 compared to$9.9 million for the prior year period. The comparable amounts of depreciation for the current and prior year periods reflected depreciation on new projects completed over the past year, none of which were individually significant, offset by the effect of assets becoming fully depreciated over the same period.
Lower-of-cost-or-market adjustment
The$9.8 million lower-of-cost-or-market adjustment in the three month period endedSeptember 30, 2011 was recorded to recognize the loss in value of certain inventories as ofSeptember 30, 2011 based on estimated recoverable amounts. Of the total charge,$9.4 million related to butadiene and$0.3 million related to fuel products in the C-4 Processing segment and$0.1 million related to isobutylene derivative products in the Performance Products segment. The$9.4 million charge related to butadiene reflected the decline in the butadiene benchmark price from$1.71 /lb. inSeptember 2011 to$1.40 /lb. inOctober 2011 . 39
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Interest expense, net
TPCGI interest expense, net for the quarter endedSeptember 30, 2011 was$8.6 million , compared to$3.2 million for the prior year period. The increase reflected the impact of our long-term debt refinancing inOctober 2010 , in which we repaid the full$268.8 million principal amount of our term loan with proceeds from the issuance of$350.0 million 8 1/4% Senior Secured Notes due in 2017 (the "Notes"). For the prior year period, the interest rate on the term loan wasLIBOR plus a spread of 2.50%.
TPCGLLC interest, net was slightly higher in both periods since it does not include interest income on TPCGI's invested cash and cash equivalents.
Other, net
Other, net for both TPCGI and TPCGLLC the three month periods endedSeptember 30, 2011 and 2010 consisted primarily of income from our investment inHollywood/Texas Petrochemicals LP , which is accounted for under the equity method.We andKirby Inland Marine , Inc. formed this joint venture to operate four barges capable of transporting chemicals. Other, net for TPCGLLC differs slightly from TPCGI due toDelaware franchise taxes.
Income tax expense
The effective income tax rates for both TPCGI and TPCGLLC the quarters endedSeptember 30, 2011 and 2010 were 40.6% and 35.0%, respectively. The effective rate for the 2011 period was based on the projected effective rate for the year endingDecember 31, 2011 , and the effective rate for the 2010 period was based on the projected effective rate for the six-month transition period endedDecember 31, 2010 . The projected effective rates for both periods were based on the federal statutory tax rate of 35%, adjusted for the impact of projected permanent differences, and state income taxes. The effective tax rate for the 2011 period was higher than the federal statutory rate due primarily to an increase in projected tax depreciation for 2011, which resulted in a lower projected Domestic Production Deduction and thus a higher projected effective rate for 2011. Net income Net income for both TPCGI and TPCGLLC for the three months endedSeptember 30, 2011 was$9.4 million compared to$12.8 million for the comparable prior year period. The primary components of the$3.4 million decrease were higher cost of sales of$320.2 million , the lower-of-cost-or-market charge of$9.8 million , higher interest expense of$5.4 million and higher operating and selling, general and administrative expenses of$4.2 million , partially offset by higher total revenues of$335.8 million .
Adjusted EBITDA
Adjusted EBITDA for the C4 Processing and Performance Products operating segments were the same for TPCGI and TPCGLLC for each period discussed below. Total TPCGI Adjusted EBITDA may differ slightly from total TPCGLLC Adjusted EBITDA due to minor differences in miscellaneous corporate expenses. Due to the insignificance of the differences the discussion of total Adjusted EBITDA and corporate expenses below will be from the TPCGI perspective only. Adjusted EBITDA (as currently defined - see below for further discussion of our revisions to our previous definition of Adjusted EBITDA) for the three months endedSeptember 30, 2011 was$34.4 million compared to$32.7 million for the comparable prior year period. The$1.7 million , or 5%, improvement reflected the favorable trend over the past year in overall market conditions for our products as well as the upward trend in petroleum prices and related commodity market indices to which a substantial portion of our product selling prices and raw material costs are linked, partially offset by the$9.8 million lower-of-cost-or-market charge primarily related to the impact of the 18% decline in the butadiene benchmark price that occurred subsequent toSeptember 2011 . 40
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C4 Processing segment Adjusted EBITDA for the quarter endedSeptember 30, 2011 was$33.5 million , which was$9.7 million , or 41%, higher than the$23.8 million for the comparable prior year quarter. The increase reflected improved margin between revenue and cost of sales of$21.1 million , which was partially offset by the lower-of-cost-or-market adjustment of$9.7 million discussed above and higher operating expenses of$1.7 million . Average unit margin between revenue and cost of sales for the segment was up 27%, and had a positive impact on the overall margin of$14 million , while the 14% higher sales volume had a positive impact of$7 million . The overall C4 Processing segment margin improvement reflected both unit margin and volume improvements for butadiene and fuel component products. As discussed under cost of sales above, C4 Processing segment Adjusted EBITDA for the quarter endedSeptember 30, 2011 included a favorable butadiene pricing impact of approximately$15 million while the impact on the comparable prior year quarter was negligible. Performance Products segment Adjusted EBITDA for the three months endedSeptember 30, 2011 was$8.1 million , which was$6.6 million , or 45%, lower than the$14.6 million for the comparable prior year period. The decrease consisted of lower margin between revenue and cost of sales of$5.4 million and higher operating expenses of$1.0 million . Average unit margin between sales and cost of sales for the current year quarter was 16% lower than the prior year quarter which primarily reflected more favorable market conditions and opportunistic higher margin spot sales in the prior year quarter. The lower average unit margin had a negative impact on the overall margin of$3 million and the negative impact of the 8% lower volume was$2 million .
Corporate and other expenses consist of general and administrative expenses and other, net discussed above.
We have revised the previously reported corporate expense component of Adjusted EBITDA for the prior year quarter endedSeptember 30, 2010 to no longer remove the effect of non-cash stock-based compensation because it is recurring in nature. Under the previous definition, non-cash stock-based compensation of$0.3 million would be added to the reported amount for the quarter endedSeptember 30, 2011 and Adjusted EBITDA would be$34.7 million , which is the comparable amount to the previously reported amount of$33.1 million for the prior year quarter.
Nine months ended
Revenues, cost of sales, operating expenses, general and administrative expenses, depreciation and amortization expense and lower-of-cost-or-market adjustment were the same for TPCGI and TPCGLLC for each period discussed below.
Revenues
Total revenues for the first nine months of 2011 were$2,183.8 million , an increase of$751.8 million , or 53%, compared to total revenues of$1,432.0 million for the comparable prior year period. The increase in revenues reflected a 40% increase in the overall average unit selling price, due to rising commodity prices across most of our product line portfolio, and an increase of 9% in overall sales volume. The higher average unit selling price for the first nine months of 2011 reflected the favorable trend over the past year in overall market conditions for our products as well as the upward trend in petroleum prices and related commodity market indices to which a substantial portion of our product selling prices (and raw material costs - as discussed above) are linked. C4 Processing segment revenues of$1,806.9 million for the nine months endedSeptember 30, 2011 were up$684.7 million , or 61%, compared to the first nine months of 2010. The increase was driven by both higher selling prices and higher sales volume, which reflected higher commodity prices, growing global demand from our customers and structurally tight supply of our products due to ethylene crackers processing lighter feedstocks. The average unit selling price for the segment was up 46%, which had a positive impact of$571 million , and sales volume was up 10%, which had a positive impact of$114 million . The average unit selling price for butadiene increased 62% compared to the comparable prior year period and average selling prices for butene-1 and our fuel-related products also increased due to a 39% increase in the average price of unleaded regular gasoline. The increased sales volume consisted primarily of an increase in sales of fuel component products. Performance Products segment revenues for the first nine months of 2011 were$376.9 million compared to$309.8 million for the comparable prior year period, an increase of$67.0 million , or 22%. The improvement reflected the 41
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combined impact of an 18% increase in average unit selling price for the segment and 3% higher sales volume. The higher average unit selling price and higher sales volume contributed$58 million and$9 million , respectively, to the overall improvement. The higher average unit selling price reflected a 26% increase in the average price of butane, which is a major pricing component of our isobutylene derivative products, and an increase of 51% in the average price of refinery grade propylene, which is a major pricing component of our propylene derivative products. The increase in sales volume consisted primarily of higher sales of propylene derivative products, which reflected both strong demand and plant operating improvements.
Cost of sales
Total cost of sales (which excludes operating expenses, depreciation and amortization and the lower-of-cost-or-market adjustment discussed below) was$1,901.5 million for the nine months endedSeptember 30, 2011 compared to$1,223.1 million for the first nine months of 2010. The overall$678.4 million , or 55%, increase reflected a 48% increase in average raw material cost and the 9% increase in sales volume. C4 Processing segment cost of sales was$1,587.7 million for the first nine months of 2011 compared to$984.1 million for the first nine months of 2010, which represented an increase of$603.6 million , or 61%. The increase was driven primarily by 47% higher average unit cost of sales, which increased cost of sales by$504 million and, to a lesser degree, the 10% higher sales volume which had a$100 million impact. Cost of sales for the nine months endedSeptember 30, 2011 and 2010 included favorable butadiene pricing impacts of approximately$50 million and$14 million , respectively, as average inventory values coming into both periods were lower than the average cost of raw materials purchased during the respective periods. C4 Processing segment cost of sales as a percentage of segment revenues was 88% for each of the nine month periods endedSeptember 30, 2011 and 2010. Performance Products segment cost of sales was$313.8 million for the first nine months of 2011 compared to$239.0 million for the comparable prior year period, which represents an increase of$74.8 million , or 31%. The increase reflected the combined effect of 28% higher average unit cost of sales and 3% higher sales volume. The impacts of the higher average unit cost and higher sales volume were$68 million and$7 million , respectively. The higher average unit cost reflected substantially higher raw material costs for all product lines within the segment. High purity isobutylene raw material costs are linked to unleaded regular gasoline prices, which were up 39% over the prior year period. Isobutylene derivatives raw material costs are linked to butane prices, which were up 26%. Propylene derivatives raw material costs are linked to refinery grade propylene costs, which were up 51%. Performance Products segment cost of sales as a percentage of segment revenues was 83% for the first nine months of 2011 compared to 77% for the first nine months of 2010. The increase in the percentage of cost of sales to revenues reflected a current year negative impact on propylene derivative product margins from an upward trend in refinery grade propylene pricing while the comparable prior year period, in contrast, was positively impacted by a downward trend in propylene pricing. In addition, the current year period high purity isobutylene margins were negatively impacted by an unfavorable relationship between butane and gasoline prices compared to the prior year period and the overall percentage of cost of sales to revenues was negatively impacted by higher sales volumes of by-product streams which carry near breakeven margins. The cost of our raw material feedstock purchases is usually determined by application of index-based formulas contained in many of our raw material supply contracts. Through these index-based formulas our raw material costs are linked to commodity market indices (such as indices based on the price of unleaded regular gasoline, butane, isobutane or refinery grade propylene) or to the selling price of the related finished product. The selling prices for our finished products are also typically determined from index-based formulas contained in many of our sales contracts and, in most cases, the indices used to determine finished product selling prices are the same indices used to determine the cost of the corresponding raw material feedstock. The linkage between the costs of our raw material feedstocks and the selling prices of our finished products to the same indices mitigates, to varying degrees, our exposure to volatility in our material margin percentage (which we define as the difference between average revenue per pound and average raw material cost per pound as a percentage of average revenue per pound). Although these index-based pricing formulas provide relative stability in our material margin percentage over time, it is not perfectly constant due to various factors, including those listed below.
• Although most of our supply and sales contracts contain index-based
formulas, varying proportions of our raw material purchases and finished
product sales are done on a spot basis or otherwise negotiated terms. 42
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In addition, while many of the index-based formulas in our contracts are simply based on a percentage of the relevant index, others apply adjustment factors to the market indices that do not fluctuate with changes in the underlying index. In periods when market indices are high,
the use of non-fluctuating adjustment factors tends to reduce the material
margin percentage; and conversely, in periods when market indices are low
the non-fluctuating adjustment factors tend to increase the material margin percentage.
• We may purchase raw material feedstocks in one period based on market
indices for that period, and then sell the related finished products in a
later period based on market indices for the later period. Changes in
selling prices of finished products, based on changes in the underlying
market indices between the period the raw material feedstocks are purchased and the related finished products are sold, lessens the effect of the matching indices and causes variation in our material margin
percentage. The magnitude of the effect on material margin percentage
depends on the magnitude of the change in the underlying indices between
the period the raw material is purchased and the period the finished
product is sold and the quantity of the inventory impacted by the change.
• Finished product selling price formulas under some of our sales contracts,
primarily in the Performance Products segment, are based on commodity
indices not for the period in which the sale occurs but for either a prior
or subsequent period. The effect on profit margins of these selling price
formulas is diminished during times of relatively stable market indices,
but can have a substantial effect during times of rapidly increasing or
decreasing market indices, which can impact our material margin
percentage.
Across-the-board increases in the market indices used in our index-based raw material costs and finished products selling prices for the first nine months of 2011 versus the comparable prior year period were the drivers behind the higher overall average selling price and the higher overall average raw material cost noted above. The 40% increase in the average selling price equated to$0.26 per pound and the 48% increase in the average raw material cost equated to$0.24 per pound, for an improvement in overall average material margin of$0.02 per pound. As a result of the combination of factors noted above, which have an impact on material margin percentage, the material margin percentage for the nine months endedSeptember 30, 2011 was 18% compared to 22% for the prior year period.
Operating expenses
Operating expenses incurred during the nine months endedSeptember 30, 2011 were$109.8 million compared to$101.0 million for the comparable prior year period. The primary components of the$8.8 million , or 9%, increase were higher salaries, wages, benefits and other personnel related expenses of$4.8 million , higher maintenance expense of$3.2 million , higher sales and use tax expense of$1.4 million , higher expense for safety and compliance consulting, training and other activities of$0.7 million and higher selling expense of$0.4 million , partially offset by lower property tax expense of$2.0 million . The higher maintenance expense included a write-off of$1.1 million of previously deferred turnaround cost as a result of accelerating the timing of a planned turnaround at theHouston facility. The lower property tax expense reflected a reduction in the property tax valuation for ourHouston facility as a result of an arbitration settlement with the local taxing authority which resulted in a reduction of current year property taxes as well as partial refunds of previously paid property taxes for 2008, 2009 and 2010.
General and administrative expenses
General and administrative expenses of$23.0 million for the nine months endedSeptember 30, 2011 were up$0.4 million compared to the prior year period. The overall increase primarily reflected higher personnel related expenses.
Depreciation and amortization expense
Depreciation and amortization expense was
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Lower-of-cost-or-market adjustment
The$9.8 million lower-of-cost-or-market charge in the nine month period endedSeptember 30, 2011 was recorded to recognize the loss in value of certain inventories as ofSeptember 30, 2011 based on estimated recoverable amounts. Of the total charge,$9.4 million related to butadiene and$0.3 million related to fuel products in the C-4 Processing segment and$0.1 million related to isobutylene derivative products in the Performance Products segment. The$9.4 million charge related to butadiene reflected the decline in the butadiene benchmark price from$1.71 /lb. inSeptember 2011 to$1.40 /lb. inOctober 2011 .
Interest expense, net
TPCGI interest expense, net for the first nine months of 2011 was$25.7 million , compared to$10.7 million for the comparable prior year period. The increase reflected the impact of our long-term debt refinancing inOctober 2010 , in which we repaid the full$268.8 million principal amount of our term loan with proceeds from the issuance of$350.0 million of 8 1/4% Senior Secured Notes due in 2017. For the prior year period the interest rate on the term loan wasLIBOR plus a spread of 2.50%.
TPCGLLC interest, net was slightly higher in both periods since it does not include interest income on TPCGI's invested cash and cash equivalents.
Unrealized gain/loss on derivatives
We had no derivative instruments in place at any time during the nine months endedSeptember 30, 2011 . We had an unrealized gain of$2.1 million during the comparable prior year period that consisted entirely of a gain on an interest rate swap related to our term loan that expired onJune 30, 2010 .
Other, net
Other, net for both TPCGI and TPCGLLC for the first nine months of 2011 consisted primarily of income from our investment inHollywood/Texas Petrochemicals LP , which is accounted for under the equity method. The comparable prior year period for both TPCGI and TPCGLLC also includes income from sale of scrap materials.We andKirby Inland Marine , Inc. formed this joint venture to operate four barges capable of transporting chemicals. Other, net for TPCGLLC differs slightly from TPCGI due toDelaware franchise taxes.
Income tax expense
The effective income tax rate for both TPCGI and TPCGLLC for the nine months endedSeptember 30, 2011 was 35.1% and the effective income tax rates for TPCGI and TPCGLLC for the nine months endedSeptember 30, 2010 were 35.8% and 35.5%, respectively. The effective rate for the 2011 period was based on the projected effective rate for the year endingDecember 31, 2011 . The effective rates for the 2010 period was based partly on the actual effective rate for the fiscal year endedJune 30, 2010 and partly on the projected effective rate for the six-month transition period endedDecember 31, 2010 , as a result of the change in fiscal years that took effect onJanuary 1, 2011 . The projected effective rate for 2011 was based on the federal statutory tax rate of 35%, adjusted for the impact of projected permanent differences, and state income taxes. The effective tax rate for the current year period was slightly higher than the federal statutory rate due primarily to an increase in projected tax depreciation for 2011, which resulted in a lower projected Domestic Production Deduction and thus a higher projected effective rate for 2011.
Net income
Net income for TPCGI for the first nine months of 2011 was$55.1 million compared to$31.2 million for the comparable period in 2010. The primary components of the$23.9 million increase were the positive impacts of higher total revenues of$751.8 million , partially offset by higher cost of sales of$678.4 million , higher operating expenses of$8.8 million , the lower-of-cost-or-market charge of$9.8 million , higher interest expense of$14.9 million and higher income tax expense of$12.4 million . TPCGLLC net income for the 2011 and 2010 periods of$55.1 million and$31.4 million , respectively reflect minor differences in miscellaneous corporate expenses and income taxes. 44
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Adjusted EBITDA
Adjusted EBITDA for the C4 Processing and Performance Products operating segments were the same for TPCGI and TPCGLLC for each period discussed below. Total TPCGI Adjusted EBITDA may differ slightly from total TPCGLLC Adjusted EBITDA due to minor differences in miscellaneous corporate expenses and income taxes. Due to the insignificance of the differences the discussion of total Adjusted EBITDA and corporate expenses below will be from the TPCGI perspective only. Adjusted EBITDA (as currently defined - see below for further discussion of our revisions to our previous definition of Adjusted EBITDA) for the nine months endedSeptember 30, 2011 was$140.9 million compared to$88.9 million for the nine months endedSeptember 30, 2010 . The$52.0 million , or 59%, improvement reflected the favorable trend over the past year in overall market conditions for our products as well as the upward trend in petroleum prices and related commodity market indices to which a substantial portion of our product selling prices and raw material costs are linked, partially offset by the$9.8 million lower-of-cost-or-market charge primarily related to the impact of the 18% decline in the butadiene benchmark price that occurred subsequent toSeptember 2011 . C4 Processing segment Adjusted EBITDA for the first nine months of 2011 was$130.9 million , which was$66.3 million , or 103%, higher than the$64.6 million for the first nine months of 2010. The primary driver behind the increase was improved margin between revenue and cost of sales of$81.2 million , which was partially offset by the lower-of-cost-or-market adjustment of$9.7 million discussed above and higher operating expenses of$5.1 million . Average unit margin for the segment, which was 44% higher, had a positive impact of$67 million and the 10% higher sales volume had a positive impact of$14 million . The overall C4 Processing segment margin improvement reflected both unit margin and volume improvements in all product lines. As discussed under cost of sales above, C4 Processing segment Adjusted EBITDA for the nine month periods endedSeptember 30, 2011 and 2010 included a favorable butadiene pricing impact of approximately$50 million and$14 million , respectively. Performance Products segment Adjusted EBITDA for the nine months endedSeptember 30, 2011 was$31.7 million versus$43.2 million for the comparable prior year period. The$11.6 million , or 27%, decrease reflected lower margin between revenue and cost of sales of$7.8 million and higher operating expenses of$3.7 million . The impact on the overall Performance Products margin of the 3% higher volume was$2 million , and the negative impact of 14% lower average unit margin was$10 million . Current year margins for the segment reflected the negative impact on propylene derivative product margins from an upward trend in refinery grade propylene pricing while the comparable prior year period, in contrast, was positively impacted by a downward trend in propylene pricing. In addition, the current year period high purity isobutylene margins were negatively impacted by an unfavorable relationship between butane and gasoline prices compared to the prior year period. Also impacting the comparison to the prior year were more favorable market conditions that resulted in opportunistic higher margin spot sales that generally did not occur in the current year period.
Corporate and other expenses consist of general and administrative expenses, unrealized (gain) loss on derivatives and other, net discussed above.
We have revised the previously reported corporate expense component of Adjusted EBITDA for the prior year nine months endedSeptember 30, 2010 to no longer remove the effect of non-cash stock-based compensation and unrealized gains and losses on derivative financial instruments, because they are recurring in nature. Under the previous definition, non-cash stock-based compensation of$1.1 million would be added to the reported amount for the nine months endedSeptember 30, 2011 and Adjusted EBITDA would be$142.1 million , which is the comparable amount to the previously reported amount of$87.8 million for the prior year period.
Liquidity and Capital Resources
Our financing arrangements consist principally of the Notes and a
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The Notes are fully and unconditionally and jointly and severally guaranteed initially by all of TPCGLLC's material domestic subsidiaries. Each of the subsidiary guarantors is 100% owned by TPCGLLC, and there are no subsidiaries of TPCGLLC other than the subsidiary guarantors. TPCGLLC is a direct wholly owned subsidiary of TPCGI. TPCGI and its only other wholly owned subsidiary,Texas Petrochemicals Netherlands B.V. , are neither issuers nor guarantors of the Notes. AtSeptember 30, 2011 , we had total debt of$348.0 million and cash on hand of$82.4 million . Debt outstanding consisted of$348.0 million of the Notes and no borrowings under our Revolving Credit Facility. As ofSeptember 30, 2011 , we were in compliance with all covenants set forth in the indenture governing the Notes and the credit agreement governing the Revolving Credit Facility.
Sources and uses of cash
Our primary source of liquidity is cash flow generated from our operating activities and borrowing capacity under the Revolving Credit Facility. Our primary uses of cash are working capital, capital expenditures, contractual obligations, debt service and stock repurchases or dividends. We expect to have adequate liquidity to fund our liquidity requirements over the foreseeable future. This expectation is based, however, on estimates and assumptions regarding, among other things, our sales volumes, our feedstock purchase volumes, market prices for petrochemicals, capital and credit market conditions, and general industry and economic conditions. If one or more of these factors materially differs from our estimates, we may need to obtain additional financing to conduct our operations, which may not be available on acceptable terms or at all. Availability under the Revolving Credit Facility is limited to the borrowing base, comprised of 85% of eligible accounts receivable and 65% of eligible inventory, as redetermined monthly. Up to$30 million of the facility may be used for the issuance of letters of credit. The Revolving Credit Facility also includes an accordion feature under which the lenders may agree, upon our request, to increase their commitments to an aggregate amount not to exceed$200 million . The Revolving Credit Facility matures onApril 29, 2014 . AtSeptember 30, 2011 , we had total debt of$348.0 million and the ability to access the full$175.0 million of availability under our Revolving Credit Facility, while still maintaining compliance with the covenants contained therein and in the indenture governing the Notes. Amounts borrowed under the Revolving Credit Facility bear interest, at our option, at a rate equal to either (a) the Eurodollar Rate (as defined in the credit agreement governing the Revolving Credit Facility) plus 3.00% to 3.75%, or (b) the base rate (as described below) plus 2.00% to 2.75%, in each case depending on the ratio of our consolidated debt to consolidated EBITDA (as defined in the credit agreement governing the Revolving Credit Facility), with a lower leverage ratio resulting in lower rates. The base rate equals the highest of (i) the administrative agent's prime lending rate, (ii) the Federal Funds Rate plus 1/2 of 1%, or (iii) the one-month Eurodollar Rate (as defined in the credit agreement governing the Revolving Credit Facility) plus 1%. A commitment fee is payable on the unused portion of the Revolving Credit Facility in an amount equal to 0.50% per annum if average availability is less than 50% of the total commitments, or 0.75% per annum if average availability is 50% or more of the total commitments, in each case based on average availability during the previous fiscal quarter. The Revolving Credit Facility is secured with a first priority lien on TPCGLLC's cash, accounts receivable, inventory and certain intangibles, and through cross-collateralization with the Notes, a second priority lien on all of TPCGLLC's other assets, including fixed assets. The Revolving Credit Facility is guaranteed by all of the material domestic subsidiaries of TPCGLLC and provides for customary events of default.
The Revolving Credit Facility includes covenants that restrict, subject to specified exceptions, our ability to:
• create or permit liens on assets;
• incur additional indebtedness or issue redeemable equity securities;
• guarantee indebtedness; • merge or consolidate with a third party; • sell or otherwise dispose of assets; • pay dividends or effect stock buy-backs; • issue or sell stock of subsidiaries; • make loans, investments and acquisitions; 46
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• make voluntary prepayments or redemptions of subordinated indebtedness;
• enter into agreements that limit our subsidiaries' ability to pay
distributions to or enter into transactions with us;
• maintain cash balances in excess of
cash to prepay loans under the Revolving Credit Facility; and • enter into receivables financings or securitization programs. Although the Revolving Credit Facility restricts acquisitions, investments and the payment of dividends, respectively, acquisitions, investments and dividends are permitted, subject to restrictions under other indebtedness, if (a) pro forma current and average 90-day historical availability each exceed the greater of$50 million or 50% of the total commitments, or (b) pro forma projected, current and average 90-day historical availability each exceed the greater of$25 million or 25% of the total commitments and we meet a minimum consolidated fixed charge coverage ratio. Finally, the Revolving Credit Facility requires a minimum consolidated fixed charge coverage ratio should availability be less than the greater of$15 million or 15% of the total commitments.
Distributions to TPCGI from TPCGLLC
A portion of the proceeds of theOctober 5, 2010 issuance and sale of the Notes, along with cash on hand, was used to fund a$130.0 million distribution by TPCGLLC to TPCGI to be used by TPCGI for dividends, stock repurchases or other returns of capital to its stockholders. The$130.0 million distribution was made in installments of$61.4 million onDecember 30, 2010 ,$5.0 million onMarch 4, 2011 and$63.6 million onMarch 14, 2011 . TPCGI used theDecember 30, 2010 distribution of$61.4 million to purchase 2,154,188 shares of its common stock at a price of$28.50 per share in conjunction with its modified "Dutch auction" tender offer that expired onDecember 23, 2010 . OnSeptember 30, 2011 , in accordance with conditions set forth in the credit agreement governing our Revolving Credit Facility agreement and the indenture governing the Notes an additional$15.0 million was distributed by TPCGLLC to TPCGI.
Purchase of Shares under Stock Repurchase Program
OnMarch 3, 2011 , TPCGI announced that its Board of Directors approved a stock repurchase program for up to$30.0 million of its common stock. Purchases of common stock under the program have been and will be executed periodically in the open market or in privately negotiated transactions in accordance with applicable securities laws. The stock repurchase program does not obligate TPCGI to repurchase any dollar amount or number of shares of common stock, does not have an expiration date and may be limited or terminated at any time by the Board of Directors without prior notice. During the first quarter of 2011, TPCGI purchased 282,532 shares under the program in the open market at an average of$27.59 per share, for a total of$7.8 million . No shares were purchased during the second quarter of 2011. During the third quarter of 2011, TPCGI purchased 352,259 additional shares under the program in the open market at an average of$23.53 per share, for a total of$8.3 million . Total shares purchased to date under the program are 634,791 shares at an average of$23.33 per share, for a total of$16.1 million . As ofSeptember 30, 2011 , the remaining amount available for stock repurchases under the program was$13.9 million . Subsequent toSeptember 30, 2011 and through the filing date of this Form 10-Q, there have been no additional shares purchased. The shares purchased were immediately retired and any additional shares to be purchased under the program will be retired immediately. Any future purchases will depend on many factors, including the market price of the shares, our business and financial position and general economic and market conditions. 47
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Cash Flow Summary
The following table summarizes changes in cash and cash equivalents for TPCGI and TPCGLLC during the nine months endedSeptember 30, 2011 and 2010 (in thousands): TPCGI TPCGLLC 2011 2010 2011 2010 Cash flows (used in) provided by: Operating activities $ 44,509 $ 52,595 $ 44,757 $ 52,198 Investing activities (32,587 ) (11,888 ) (32,587 ) (11,888 ) Financing activities (15,123 ) (6,589 ) (83,605 ) (9,609 )
Change in cash and cash equivalents $ (3,201 )
Operating activities For the nine months endedSeptember 30, 2011 , TPCGI had positive net cash flows from operations of$44.5 million . The primary components of the operating cash flows were net income of$55.1 million plus depreciation and other net non-cash expenses of$39.4 million , partially offset by an increased investment in working capital of$47.0 million and deferred plant turnaround costs of$5.8 million . The increased investment in working capital during the nine months endedSeptember 30, 2011 reflects the upward trend in selling prices of our products and the costs of our raw material over the course of the period. Increased investment in trade accounts receivable and inventory (discussed below) were partially offset by increased levels of trade accounts payable, which also reflect the impact of higher raw material costs. The deferred turnaround costs, related primarily to a major turnaround project at ourHouston facility during the first quarter of 2011, will be amortized until the next scheduled turnaround. Operating cash flows for TPCGLLC for the nine months endedSeptember 30, 2011 were$44.8 million . The minor differences between TPCGI and TPCGLLC operating cash flows primarily reflected the difference in net income and intercompany transactions. Our inventory atSeptember 30, 2011 of$164.6 million was$75.4 million higher than the$89.3 million atDecember 31, 2010 . The increase in inventory value reflected the combined effect of a 6% increase in physical inventory volumes and a 74% increase in overall average cost per pound. The higher volume reflected an increase in days of inventory on hand from 19 days atDecember 31, 2010 to 20 days atSeptember 30, 2011 , which reflects reduced shipments in the latter part of the third quarter due to customer inventory destocking activities and softening market conditions. The higher average cost per pound reflected the higher values for butadiene and fuel related products, for which selling prices are linked to gasoline prices, which were on an upward trend over the course of the first nine months of 2011. The impacts of the higher volume and higher average cost were$5 million and$70 million , respectively. Trade accounts receivable were$269.9 million atSeptember 30, 2011 compared to$177.1 million atDecember 31, 2010 . The increase reflected significantly higher sales inSeptember 2011 compared toDecember 2010 due to the impact of higher selling prices, partially offset by the impact of lower sales volume. Days of sales outstanding atSeptember 30, 2011 was 31 days, which is slightly lower than the 32 day average over the past year, compared to 33 days atDecember 31, 2010 . Trade accounts receivable were more than 98% current at bothSeptember 30, 2011 andDecember 31, 2010 . For the nine months endedSeptember 30, 2010 , TPCGI generated positive net cash flows from operations of$52.6 million . The primary components of our operating cash flows were net income of$31.2 million plus depreciation and other net non-cash expenses of$50.5 million , and a federal income tax refund of$39.8 million , partially offset by an increased investment in working capital of$61.4 million and plant turnaround costs of$5.7 million . The increased investment in working capital during the nine months endedSeptember 30, 2010 reflects the upward trend in selling prices of our products and the costs of our raw materials over the course of the period. Increased investment in trade accounts receivable and inventory were somewhat offset by increased levels of trade accounts payable, which also reflected the impact of higher raw material costs. The federal tax refund represented the recovery of prior year taxes paid as a result of the carry-back of the fiscal 2009 net operating loss. The deferred turnaround costs related primarily to a major turnaround project completed at theHouston facility. 48
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Net operating cash flows for TPCGLLC for the nine months ended
Investing activities
During the nine month periods endedSeptember 30, 2011 and 2010, we invested$32.6 million and$11.9 million , respectively, in the form of capital expenditures. Capital spending during the first nine months of 2011, in addition to baseline spending, included$7.7 million for the new lab at theHouston facility and$5.6 million for the primary phase of engineering related to the refurbishment and startup of one of our dehydrogenation units discussed above. The remainder of the 2011 spending to date has consisted primarily of various plant safety-related projects and profit adding projects, none of which are individually significant. The new lab building was completed in August at a total cost of approximately$9.5 million . The relatively low level of capital expenditures in the prior year period reflected baseline capital spending following completion of our major capital investment initiatives in early fiscal 2009. Financing activities Cash used for financing activities during the first nine months of 2011 was$15.1 million , consisting of$16.1 million to purchase shares under the stock purchase program discussed above, partially offset by cash received on exercise of stock options. The net use of cash for financing activities for the first nine months of 2010 was$6.6 million , which consisted primarily of debt issuance costs of$4.9 million , repayments of insurance debt of$2.6 million and repayment of the term loan of$2.0 million , partially offset by cash received on exercise of stock options of$3.0 million .
Financing activities for TPCGLLC consists of the distributions to TPCGI discussed above.
Off-balance sheet arrangements
We do not currently utilize any off-balance sheet arrangements to enhance our liquidity and capital resource positions, or for any other purpose.
TPC GROUP LLC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
KL ENERGY CORP – 10-Q/A – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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