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Trecora Resources  (NYSE:TREC)
Q4 2018 Earnings Conference Call
March 07, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

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. Please go ahead.

Jean Young -- Vice-President, Investor Relations Contact

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'd 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.

This 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 Trecora's President and CEO, Pat Quarles.

Patrick Quarles -- President, Chief Executive Officer, Director

Thanks, Jean. And thanks to everyone joining the call this morning. I've been the CEO of Trecora now about three 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 that respect Trecora's results in 2018, including the fourth quarter were unacceptable.

Our fourth quarter results reflect a significant negative impacts of the Advanced Reformer outage, and exiting a specific custom processing arrangement in Silsbee, these economics couldn't be supported. While we executed the catalyst change on time and slightly in our budget, we incurred downgrades of the byproducts that were roughly $0.45 per gallon worse than we could have realized where the unit running. There 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 our 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 the 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 as a 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 outsource -- 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 bill (ph) 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 -- sorry 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 force 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 would join us next week. We're changing the culture of our commercial decision making, backing of decision making with analytics and capturing our fair value from the market. That's the revenue side. On the cost side, we are 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 in 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 the 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, I understand my focus is on taking actions to 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 Advance Reformer is performing according to its design criteria. We are getting most of the benefits from upgrading our existing byproducts that we were expecting. We'll continue to optimize the unit that we have made progress in our own net path. The US 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 volatile and they are under pressure both to reduce production and drive cost 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 to core into a higher and more sustainable 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.

Sami Ahmad -- Chief Financial Officer

Thanks, Pat and good morning to everyone. Our adjusted EBITDA was $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 multi-year capital program, our major CapEx spending is largely behind us and going forward, we expect our CapEx run rate to be approximately $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 Advance 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 oil sale -- 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 quarters.

In the first quarter, we expect turnaround expenses of approximately $500,000 at the Silsbee facility. We're focused, 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, especially wax's 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 benefited -- 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 a higher cost, this will allow us to have sufficient wax supply -- wax feed supply to continue to grow the business profitability. This segment also includes custom processing at the TC facility. Growth in custom processing continue to be constrained by operational and reliability issues with hydrogenation and distillation. As Pat mentioned, TC has efforts under way 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 unit.

In the first quarter 2019, TC will have turn around and related expenses of approximately $500,000 to $600,000. Moving on to a AMAK, Trecora reported equity and losses of AMAK of approximately $0.2 million in the fourth quarter 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 would like to ask the operator to open the call up for Q&A.

Questions and Answers:

Operator

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

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Good morning. Thank you for taking my questions.

Patrick Quarles -- President, Chief Executive Officer, Director

Good morning John.

Sami Ahmad -- Chief Financial Officer

Good morning, John.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Pat, you mentioned that you didn't or maybe Sami, 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?

Patrick Quarles -- President, Chief Executive Officer, Director

Yes, I think what I talked about some pressure on demand, we read about that in the press, politically they're trying to turn down production in the region. We also have, as that -- 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 will be flat in volume by the end of the year. I think we'll be down 5% or so in the oil sands -- oil sands market.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Sami Ahmad -- Chief Financial Officer

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

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yes, so, John, 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 it 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're getting. And as we engage the customer on that challenge, there ultimate it wasn't enough value in that total value chain to justify continuing.

So, we agreed effectively to exit. If the cost that you see in the fourth quarter relate to a planned turnaround that we had on the unit and significant discovery on effectively erosion corrosion of the unit given the service that was in, and that was one of the primary drivers for why we quickly conclude it was going to make sense to continue going.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

That's an interesting unit, it's got, 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.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Sami Ahmad -- Chief Financial Officer

On feedstock pricing?

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Yes.

Sami Ahmad -- Chief Financial Officer

Yes, I mean obviously you saw in the fourth quarter a sharp decline in natural gasoline feedstock pricing and that basically tracked crude more specifically Brent Crude as you know. We've seen the 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 on the non -- you know about the formula piece, there are some lead lag things going on 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.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Okay, great. And then finally, just you mentioned that some extraordinary cost heading into Q1 on both the Trecora and the South Hampton side, I think (inaudible) for both of them. When do you see those kind of coming down to neutral and fully operational without these extraordinary costs going on?

Patrick Quarles -- President, Chief Executive Officer, Director

So the -- I think you're referring to the turnaround or what -- that Sami alluded to both, that's not extraordinary, that's normal course operations of maintenance, those are 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 two out of three, went really well, on time, on budget. We did have a fair amount of discovery in one of the units at Silsbee. So, we are a bit late coming back. It didn't impact customers or our ability to supply, but we did incur a bit more cost that we are 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 -- excuse me, first quarter for maintenance costs.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

That's correct.

Sami Ahmad -- Chief Financial Officer

Yeah.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Okay, great. Thank you.

Operator

Our next question comes from the line of Joseph Reagor with ROTH Capital Partners. Your line is now open.

Joseph Reagor -- ROTH Capital Partners -- Analyst

Good morning, guys and thanks for taking the questions.

Patrick Quarles -- President, Chief Executive Officer, Director

Good morning, Joe.

Sami Ahmad -- Chief Financial Officer

Good morning, Joe.

Joseph Reagor -- ROTH Capital Partners -- Analyst

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

Sami Ahmad -- Chief Financial Officer

Yeah. 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 G&A side is no material change. I mean there were replacements, at -- certainly on the -- at the executive level in terms of staffing within G&A. There is really no appreciable change from our headcount. So, other than cost of living and that kind of inflationary adjustment, I think you ought to just assume that run rate.

Joseph Reagor -- ROTH Capital Partners -- Analyst

Okay, fair enough. And then can you just give 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?

Sami Ahmad -- Chief Financial Officer

Right, so in the last couple of 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 Trecore Chemical and then in the third quarter, we had a little bit of a supply interruption 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 will see fourth quarter '18 is actually much higher than -- 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 volumes. We are -- as we've talked, we're 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 of our business is actually doing well.

Joseph Reagor -- ROTH Capital Partners -- Analyst

Okay, thanks. I will turn it over.

Sami Ahmad -- Chief Financial Officer

Yes.

Operator

Our next question comes from the line of Sarkis Sherbetchyan with B. Riley FBR. Your line is now open.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

Morning, and thanks for taking my question here.

Patrick Quarles -- President, Chief Executive Officer, Director

Hi Sarkis.

Sami Ahmad -- Chief Financial Officer

Good morning Sarkis.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

So 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 byproducts, 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?

Patrick Quarles -- President, Chief Executive Officer, Director

Sure. So, the quick answer to the question is, yes. We do fully have capability to to upgrade all of our byproducts, so it's really the difference between selling them into the distressed market, which is what we are forced to do in the fourth quarter as depentanised naphtha versus taking them through the reformer and getting higher value.

So that's -- 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 with the drivers there, are really two-fold; 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 new catalyst in there, it's -- it's very hot, it's very active and we are learning to control it appropriately.

I think we'll have some optimization opportunities as we go forward to kind of continuing -- continuously improve it, but we're not at the $0.30 per gallon, which I would say it's kind of our target today and the 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.

Sami Ahmad -- Chief Financial Officer

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 depentanised naphtha, which is normally would be the feed. And then when you run it through the reformer, you know, there is a volume contraction as you form the aromatics, so you can't just take the fourth quarter volume and annualize it.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

Could you discuss what the contraction might be?

Sami Ahmad -- Chief Financial Officer

Yeah. I mean it's -- I mean it's -- it's common in a Advanced Reformer because your converting these straight changes into aromatics, it's somewhere around 70% to 75% yield -- volumetric yield, not mass yield, volumetric yield that you get from the feed.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

Got it. And then just kind of moving on, in prior presentations, the Company's outline 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?

Patrick Quarles -- President, Chief Executive Officer, Director

Sarkis, I think, given where I am, first three months. My focus has really been on driving everything we can drive kind of in here and now to make this thing better. A lot of that gets down to the reliability of our assets. 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.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

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?

Sami Ahmad -- Chief Financial Officer

Yeah. It's all -- there's no G&A in that, it's really plant operating costs and it's really related to, you know, 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 that 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 South Hampton facility. And the expected benefit as we disclosed, is about $2.5 million on an annual basis and as Pat mentioned, obviously we're already seeing the benefit of that cost reduction year in the first quarter.

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

Great. I'll take the rest offline. Thank you.

Sami Ahmad -- Chief Financial Officer

Okay, thanks.

Operator

Our next question comes from the line of Rosemarie Morbelli with G. Research. Your line is now open.

Joseph Catania -- G. Research -- Analyst

Good morning. This is Joe Catania on for Rosemarie. Thanks for taking my question. 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 sometime mid last year. Is this a replacement or is this just building out the team or what is -- what's the dynamic there?

Patrick Quarles -- President, Chief Executive Officer, Director

Yes, it's a replacement. You're recalling -- yes, you're recalling Mike Humby, he left in the fourth quarter.

Joseph Catania -- G. Research -- Analyst

Okay, thank you. And can you give a little bit more color on the oil sands demand. I know you've talked about a little bit here. But everything I've heard previously from you guys is expect this demand to grow and outlook said it's going to pull back a little bit. Can you give a little bit more -- more detail on that?

Patrick Quarles -- President, Chief Executive Officer, Director

Sure. Listen I think, as we all appreciate oil markets are volatile and extraordinarily dynamic and if you think about what's going on in North America, on the development, particularly shell 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 off take out of Alberta, so there are 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 part of that, is looking at their solvent consumption. So for those reasons, I mean I just -- as I have gotten into this, I just want to raise some caution about long-term expectations of growth.

Joseph Catania -- G. Research -- Analyst

Okay, thanks (inaudible).

Operator

Our next question comes from the line of Bill Dezellem with Tieton Capital. Your line is now open.

William Dezellem -- Tieton Capital -- Analyst

Thank you. Sami would you please repeat the numbers that you said, from a byproduct perspective in terms of what your loss per gallon was in the Q4, and what sort of profit per gallon was in the Q3?

Sami Ahmad -- Chief Financial Officer

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 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.

William Dezellem -- Tieton Capital -- Analyst

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 in $0.19 per gallon loss and that ends up providing the loss of $1.2 million on the byproducts alone. Now taking into account the differential between breakeven and what you otherwise should have had as a profit.

Sami Ahmad -- Chief Financial Officer

Yes.

William Dezellem -- Tieton Capital -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yeah, there is volume contraction. That's a result of the reforming process. Yes.

William Dezellem -- Tieton Capital -- Analyst

Okay. And then also to make sure that I'm clear that 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?

Sami Ahmad -- Chief Financial Officer

Yeah, 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.

William Dezellem -- Tieton Capital -- Analyst

Whereas in future quarters, when you have success growing prime product volumes, then -- as it -- 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?

Patrick Quarles -- President, Chief Executive Officer, Director

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

William Dezellem -- Tieton Capital -- Analyst

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?

Patrick Quarles -- President, Chief Executive Officer, Director

Well, OK, 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 and supply chain as well as procurement. So I worked with Joe in the past, we think about 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 different negotiations that we have. So, I know, Joe will bring that, I'm looking forward to starting next week.

William Dezellem -- Tieton Capital -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yeah, 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 to get this accomplished before Joe arrive, but we've gone through a renegotiation and 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, to think about that, that's really all three or at least three 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.

William Dezellem -- Tieton Capital -- Analyst

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?

Patrick Quarles -- President, Chief Executive Officer, Director

Yes, 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. Where then it starts next quarter, I don't want to set that expectation, frankly. We're on the path. we are already making positive contributions and that should just continue to gain momentum in the weeks or in the months and quarters ahead.

William Dezellem -- Tieton Capital -- Analyst

Great, thank you both.

Sami Ahmad -- Chief Financial Officer

Thank you.

Operator

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

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

Hey guys. I'm trying to get my hands around gross margin in both businesses and those kind of hoping you could kind of just backed 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 a bit of a lower gross margin than you kind of historically operated the business and so the question is sort of two 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? Is that -- how do I think about that kind of going forward and having looked at last year and fourth quarter?

Patrick Quarles -- President, Chief Executive Officer, Director

Sure. So, Mitchell, I think if you reflect back on the comments the Company made over the last year that the element that we haven't really talked much about today. But we're certainly true for 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 only cost with just straight freight, it relates to cost, the things around our fleet that have escalated and it relates to kind of the size of the fleet that we have been maintaining to meet customer requirements.

I think all those present opportunities to improve and need to improve to get us back up to that high teen-type gross margin.

Sami Ahmad -- Chief Financial Officer

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. We -- prior to 2018, those costs -- substantial portion of those costs weren't there. The third item that has really affected operating costs is that 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.

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yes. So I think, I don't have the math for you in my head, Mitch, on the difference in gross margin ultimately depend on 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 costs feeds. Right. It also -- the higher cost feeds also put us in a more reliable supply position because we can source -- and 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 higher volumes, but not necessarily high value. So that will come out of our mix as we move forward as well.

Sami Ahmad -- Chief Financial Officer

And the other thing that's really going to drive gross margin or adjusted EBITDA margin. However, where you want to look at it, at 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.

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yeah, I think the way we need to be thinking about the hydrogenation unit, it 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. What we have to do at this point now is be selective and 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 are already beginning to baseload it with what I would just call relatively straightforward type products, and now 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 values of it and higher utilization of it. But it's -- from operability perspective, it's just continue to really improve over the past quarter.

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

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

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

And is there demand for that?

Patrick Quarles -- President, Chief Executive Officer, Director

There is, we think there could be internal demand as well as demand as a custom processing service. But again, it's -- we're talking about demand, it's not a monolithic, is the wrong word, right? Each project, each conversation we have with the customer really often reflects a different product and a different need 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 as our capabilities improve, we can get more complicated.

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

Okay, thank you.

Sami Ahmad -- Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Wolf Joffe with EVR. Your line is now open.

Wolf Joffe -- EVR -- Analyst

Hi.

Patrick Quarles -- President, Chief Executive Officer, Director

Good morning.

Sami Ahmad -- Chief Financial Officer

Good morning.

Wolf Joffe -- EVR -- Analyst

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?

Patrick Quarles -- President, Chief Executive Officer, Director

I would expect the total volume can be down a bit. It's a big chunk of our sales portfolio and we are seeing reasonable growth on other end users. As I mentioned briefly in my comments, investment along the U.S. Gulf Coast in the chemical industry continues. We had a start-up of a major polyolefin units in the last weeks and we have business associated with that unit. And 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.

Wolf Joffe -- EVR -- Analyst

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

Sami Ahmad -- Chief Financial Officer

Yeah, I mean, our margins did improve, we touched on that -- stock declines. So, yes.

Wolf Joffe -- EVR -- Analyst

Okay. And if we assume South Hampton volumes are flat in Q1 versus Q4, and obviously it sounds like the reformer is now working. How much EBITDA -- how much EBITDA can South Hampton generate in Q1? Again assuming flat volumes with the reformer now working?

Sami Ahmad -- Chief Financial Officer

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

Wolf Joffe -- EVR -- Analyst

Well, I think given where your leverage is and obviously you guys say that you expect improved financial performance, it would hold 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?

Patrick Quarles -- President, Chief Executive Officer, Director

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. We with the reformer running, right? So, we're going to get the upgrade of byproducts versus the significant downgrade, quarter to quarter that's about a $3 million improvement. We're going to -- 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 begin to benefit us in January. So that's over a $0.5 million.

So, if you just take those three drivers that get you from $2 million to north of $6 million run rate and 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.

Wolf Joffe -- EVR -- Analyst

Thank you.

Sami Ahmad -- Chief Financial Officer

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

Wolf Joffe -- EVR -- Analyst

Understood, thank you for the -- thank you for the assistance there. My last question is, the presentation published to accompany third quarter earnings call, say that the 10 x-units (ph) would operate in the fourth quarter supported by the old reformer. Did that not occur?

Patrick Quarles -- President, Chief Executive Officer, Director

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.

Sami Ahmad -- Chief Financial Officer

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

Patrick Quarles -- President, Chief Executive Officer, Director

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

Wolf Joffe -- EVR -- Analyst

I guess, if the old reformer was working, there would have been upgraded somewhat, right?

Patrick Quarles -- President, Chief Executive Officer, Director

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

Wolf Joffe -- EVR -- Analyst

Okay.

Sami Ahmad -- Chief Financial Officer

Historically, when we had the old reformer there was -- the margins for byproducts floated around zero cents per gallon plus or minus, there was not sufficient uplift above feed.

Patrick Quarles -- President, Chief Executive Officer, Director

And then maybe just to be clear, sometimes we confuse ourselves even, we talk about reformer, there is the old Aromax unit. And then there is a reformer there, right? The old Aromax unit is out of commission, it was -- passed its useful life, that was not available to us in the fourth quarter.

Wolf Joffe -- EVR -- Analyst

Understood, thanks for your help.

Patrick Quarles -- President, Chief Executive Officer, Director

Yep.

Operator

Our next question comes from the line of Jon Tanwanteng with CJS Securities. Your line is now open.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Sami Ahmad -- Chief Financial Officer

Yeah. 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.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Okay, great. And 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 earn or generating in cash flow?

Sami Ahmad -- Chief Financial Officer

Well, I'm not going to give you guidance, John, you know that. But what I will say is the Company broadly speaking, has a target. We need to deleverage four times is not where we want to be. Where we would like to get to, is around 2.5 to 3 times, 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 that, those levels.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Okay. Great. Can you help me, maybe just what's your cash tax bill expects to be this year?

Sami Ahmad -- Chief Financial Officer

Yes, I mean, cash tax should be minimal, because we have in oils from the basically the capital investments that we have made and tax depreciation. So, it shouldn't be material or effective rate, as I mentioned will be 21%. The only thing -- 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. Those kinds of things and you get to positive free cash flow number.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Patrick Quarles -- President, Chief Executive Officer, Director

Yes, I think the process itself is going to define it's value, and that's why we wanted to work with global recognized and investment bank that has expertise in mining and our expectation is -- due the process and the due diligence of how the mine is performing, life of mine calculations and where it's headed operationally, that's going to be the basis for defining its value. We are really encouraged frankly by the path AMAK is on, right, that we've seen, they had a change of management about two years ago. Turned around, how they go about their business. We saw and 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 away positively on the market's view of its value.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

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

Sami Ahmad -- Chief Financial Officer

So, good cash flow for -- good proxy for cash flow. Yes.

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Okay, great, thank you so much.

Sami Ahmad -- Chief Financial Officer

That's why I gave that number. Okay, thanks a lot.

Operator

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

Patrick Quarles -- President, Chief Executive Officer, Director

We certainly thank everybody for joining today and for your questions. 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 to how manufacturing company should run and I'm pleased with it, I want to thank Dan (ph). As for kind of 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. In addition, I'll be available for one-on-ones at the 31st Annual ROTH Conference in Dana Point, Orange County, California on March 18th and 19th. And we look forward to updating you on our progress in the coming months. Operator, this concludes our remarks.

Operator

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.

Duration: 62 minutes

Call participants:

Jean Young -- Vice-President, Investor Relations Contact

Patrick Quarles -- President, Chief Executive Officer, Director

Sami Ahmad -- Chief Financial Officer

Jonathan Tanwanteng -- CJS Securities, Inc. -- Analyst

Joseph Reagor -- ROTH Capital Partners -- Analyst

Sarkis Sherbetchyan -- B. Riley FBR -- Analyst

Joseph Catania -- G. Research -- Analyst

William Dezellem -- Tieton Capital -- Analyst

Mitchell Sacks -- Grand Slam Asset Management -- Analyst

Wolf Joffe -- EVR -- Analyst

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