Alto Ingredients Inc (ALTO) 2014 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Pacific Ethanol, Inc., third quarter 2014 financial results conference call. At this time all participants are in a listen only-mode. Later, we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions).

As a reminder, this conference is being recorded. I would now like to turn the conference to our first speaker for today's conference, Ms. Becky Harrick. You may begin.

Thank you, Andrew, and thank you all for joining us today for the Pacific Ethanol third quarter 2014 results conference call. On the call today are Neil Koehler, President and CEO, and Bryon McGregor, CFO. Neil will begin with a review of business highlights. Bryon will provide summary of the financial and operating results. And Neil will return to discuss the Company's outlook and open the call for questions.

Pacific Ethanol issued a press release yesterday providing details of the Company's quarterly results. The Company also prepared a presentation for today's call that is available on the Company's website at PacificEthanol.com. If you have any questions, please call LHA at 415-433-3777.

A telephonic replay of today's call will be available through November 6, the details of which are included in yesterday's earnings press release. A webcast replay will also be available at Pacific Ethanol's website. Please note that information in this call speaks only as of today, October 30, and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay.

Please refer to the Company's Safe Harbor statement on slide 2 of the presentation available online, which says that some of the comments in this presentation constitute forward-looking statements and considerations that involve a number of risks and uncertainties. The actual future results of Pacific Ethanol could differ materially from those statements. Factors that could cause or contribute to such differences include, but are not limited to, events, risks, and other factors previously and from time to time disclosed in Pacific Ethanol's filings with the SEC.

Except as required by applicable law, the Company assumes no obligation to update any forward-looking statements. Also, please note that the Company uses financial measures not in accordance with Generally Accepted Accounting Principles, commonly known as GAAP. To monitor the financial performance of operations, non-GAAP financial measures should be viewed in addition to and not as an alternative for the reported financial results as determined in accordance with GAAP.

The Company defines adjusted net income or loss as unaudited earnings before fair value adjustments and warrant inducements, and gain or loss on extinguishment of debt. Adjusted EBITDA is defined by the company as unaudited net income or loss attributed to Pacific Ethanol before interest, provision for income taxes, depreciation and amortization, fair value adjustments and warrant inducements, and non-cash gain or loss on extinguishment of debt.

To support the Company's review of non-GAAP information later in this call, reconciling tables are included in yesterday's press release. It is now my pleasure to introduce Neil Koehler, President and CEO.

Thanks, Becky. And thanks, everyone, for joining us this morning. 2014 is on pace to be a record year for Pacific Ethanol.

For the third quarter of 2014, we had net sales of $275.6 million. We sold a record 133.7 million gallons of ethanol. We had gross profit of $18 million. Net income was $3.7 million or $0.15 per share. Adjusted net income was $8.1 million or $0.33 per share, and adjusted EBITDA was $15.5 million.

Among our highlights for the first nine months of the year, we sold a record 378.6 million gallons of ethanol and our gross profit was $90 million. Over the last 12 months, our adjusted EBITDA was $96.9 million.

In our last call, we discussed our plans to invest up to $16 million in plant improvement projects to further reinforce our market position. These initiatives are focused on improving efficiencies, diversifying feedstock and expanding our advanced biofuel projects.

We are in the middle of several projects at each of our facilities that will further add value to our operations. We believe these plant improvement initiatives will lead to an annual EBITDA improvement of approximately $0.06 to $0.07 per gallon, representing a contribution of approximately $12 million to $14 million to our annual operating income.

In addition, we took action to further diversify our revenue streams as we recently announced an agreement with Kodiak Carbonite to sell the CO2 generated from our Columbia plant. Kodiak is constructing a liquefaction and dry ice processing plant adjacent to our facility from which it expects to purchase up to 200 tons of CO2 per day to sell to food processing and beverage producers. We expect the CO2 plant to begin operations next year and to contribute $0.01 to $0.02 per gallon in operating income annually for the Columbia plant.

Corn oil separation technology has provided a meaningful contribution to operating income at our Stockton and Magic Valley facilities where corn oil has contributed operating income of approximately (technical difficulty) [$1.6 million] in the third quarter. We are expanding the production of corn oil to our Madera and Columbia facilities and expect to begin operations in early 2015.

We are excited about our advanced biofuels initiatives. Though in the early stages, we are involved in multiple projects to develop high-value means of producing premium products that meet the growing demand for low carbon transportation fuel.

Our joint development effort with Sweetwater Energy is ongoing. As mentioned previously, while the facility will take a couple of years to commercialize, once completed, we expect to purchase cellulosic industrial sugars from Sweetwater for the production of advanced biofuels.

We continue to work with Edeniq on the commercial production of cellulosic ethanol from corn kernel fiber. Corn fiber has been qualified by the US Environmental Protection Agency as a cellulosic feedstock under the renewable fuel standard.

We are piloting anaerobic digestion in our Stockton facility with the aim of further lowering our carbon intensity and producing advanced biofuels.

The Magic Valley plant lends itself to greenfield development of additional production capacity from wheat straw. In collaboration with Enercon, we are evaluating the feasibility of a bolt-on cellulosic project at this facility.

And, finally, we are analyzing various configurations of cogeneration, particularly at our California plants where electricity prices are high and we receive a low carbon premium for the ethanol we produce. In all of these initiatives, we will focus our attention and investment on the integration of new commercially available technologies with the prospect of highly attractive returns.

We are proud of our record over the last several years of improving operating results by applying new process engineering solutions and ingredients to reduce cost and increase efficiencies. We will continue with this approach as we add capacity to diversify our feedstock and reduce the carbon intensity of our transportation fuel.

Late in the third quarter and early in the fourth quarter, the ethanol industry experienced some margin compression. Along with the seasonal drop in transportation fuel demand, the industry experienced a reduction in the overall crush margin compared to that of recent quarters. The industry experienced a similar pattern during this period last year.

Overall, we believe these conditions reflect a seasonal drop (technical difficulty) with our industry. We're already seeing the short-term conditions rebalance as a record corn crop is harvested and exports of ethanol accelerate. We remain confident in the growing long-term demand for ethanol and our ability to create value with our differentiated model.

Even with the recent drop in fuel prices, ethanol continues to trade at a significant discount to wholesale gasoline. We believe this underscores the intrinsic value of ethanol as a high octane clean-burning transportation fuel as well as the cheapest available liquid transportation fuel on the market. Going forward, E15 is slowly gaining traction and will ultimately have a sustained positive impact on the domestic demand for ethanol.

Net exports of ethanol continue to be a bright spot for the industry. According to the IEA -- EIA, I mean -- US exports of ethanol rose 50% over the same period last year and they are on pace to reach up to 1 billion gallons for the year. Given the price, octane and carbon advantages of ethanol, we expect US exports to further increase this quarter and next year.

And, with that, I will turn the call over to our CFO, Bryon McGregor, for a review of the financials. Bryon?

Thank you, Neil. During the third quarter of 2014, we reported net sales of $276 million, up 18% compared to $234 million in the third quarter of 2013. Gross profit was $18 million this quarter, which compares to $3.5 million in the third quarter of last year.

SG&A expenses were $4.4 million compared to $2.5 million in the third quarter of 2013. We are committed to controlling our SG&A and targeting approximately $4 million to $4.5 million quarterly going forward.

This quarter's operating income was $13.6 million. We increased operating income by $12.6 million on a year-over-year basis.

We recorded a $4.4 million expense in fair value adjustments and warrant inducements for the quarter, comprised of $1.5 million in warrant inducements in July, as well as $2.9 million for warrant exercised adjustments at an average stock price of [$19 per share], or $4 per share over the closing stock price on June 30. An increase in the market price per share of our common stock over the prior quarter results in higher fair value -- fair values and A corresponding expense, which is locked in upon exercise of the warrants.

As of October 29, our warrant balance totaled just under 1 million shares at a weighted average exercised price of $8 a share.

Interest expense, net, was lower than expected at $1.1 million. This compares to $4.5 million in interest expense, net, in the third quarter of 2013 and $400,000 below our guidance of $1.5 million per quarter.

Our effective tax rate for the quarter was 40% and we expect it to remain at similar rates in future quarters.

Net income available to common stockholders was $3.7 million or $0.15 per diluted share. This compares to a net loss of $5.3 million or $0.40 per diluted share in the year ago period. Adjusted net income, which excludes the impact of fair value adjustments and warrant inducements and gain/loss on extinguishment of debt, was $8.1 million or $0.33 per diluted share, compared to an adjusted net loss of $3.5 million or a $0.26 loss per diluted share in last year's third quarter.

Adjusted EBITDA was $15.5 million, an increase of $12 million compared to an adjusted EBITDA of $3.4 million in the third quarter of 2013.

Among our highlights for the nine months ending September 30, 2014, net sales were $851 million, up 23% compared to the $693 million last year. Net income available to common stockholders was $7.8 million or $0.35 per diluted share, compared to a net loss of $10.3 million or a $0.91 loss per diluted share in the year ago period.

Adjusted net income was $49.9 million or $2.26 per diluted share compared to a loss of $10 million or an $0.88 loss per diluted share in the same period of last year. And adjusted EBITDA grew by $68 million to $79 million for the first nine months of 2014, which compares to adjusted EBITDA of $10 million in the first nine months of 2013.

Now turning to our balance sheet, cash and cash equivalents were $56 million at September 30, 2014, compared to $5 million at December 30 -- 31, 2013. This reflects $2 million spent to date of the $16 million in planned capital expenditures approved by our Board in the second quarter of this year. This improved liquidity had a significantly positive impact on working capital, which increased to approximately $93 million from $51 million at December 31, 2013.

As discussed last quarter, the remaining $17 million in planned term debt is subject to costly make whole provisions that will be repaid or refinanced when it is economically advantageous to do so. Including the $13 million outstanding on our asset-based line of credit, we have a combined debt position of $30 million.

With our $56 million cash balance, we are effectively debt free with a net cash position of $26 million. With that, I would like to return the call to Neil.

Thanks, Bryon. We are very pleased with the Company's performance this quarter and year to date. We remain very encouraged by the outlook for the industry and our Company. We are reinvesting in our production business to initiatives in focused in on improving efficiencies, diversifying feedstock, creating new revenue streams, and furthering our advanced biofuels initiatives.

We continue to generate strong cash flows and improve our balance sheet through retiring debt when advantageous to do so. We believe we are very well situated to improve our long-term profitability and expand our share of the renewable fuels market.

Operator, with that, we can begin the Q&A session.

(Operator Instructions) Eric Stein, Craig-Hallum.

It is Aaron Spychalla on for Eric Stein. Starting on transportation costs for corn, can you talk about what you saw towards the end of the quarter, and maybe what you are seeing so far into 4Q? It seems like those costs might have eased a little bit, but how should we think about that here going forward?

Sure. Generally, as we have seen this year on the rail logistics have been fairly constrained. That has given us a significant benefit on average over the year. With our ethanol basis, it has run higher than that average number, Chicago over to L.A., where we price a good majority of our ethanol.

On corn, generally, it has been a little more stable throughout the year, but as you alluded to, at the end of the quarter with the onset of the harvest in soybeans and corn, we have seen an increase in our delivered basis to the West Coast. There has been a premium on the freight that trades in the secondary market, and that did impact our corn basis place late in the quarter and early this.

We did see corn basis get as high as almost $2 a gallon -- I'm sorry $2 a bushel, delivered to the Western United States. But, over the last couple of weeks, as the bean harvest is now almost complete and we are moving to corn, we are seeing a significant relaxation of those pressures and prices, to where we are seeing basis get back to more normal and expected relationships.

Okay. Good. Thanks for the color. And then, a good quarter considering the price volatility that we saw. But could you maybe touch on the trading business, presuming that business might have been slightly negative on the quarter, again, making the quarter performance look even that much better? Can you just kind of talk through that a little bit? And now with prices stabilizing here quarter to date, is that something we should think about as getting back to that kind of flat to slightly profitable run rate?

Sure. We don't break out those earnings separately, but what I can say and we have said before is that that is a very profitable business for us, and a very important part of our strategy in terms of our market share and market position. What you do find in that business is that there is price risk in a very volatile market on the ethanol that we purchase from third parties and have inventory that is both in transit and in terminals in our destination markets.

And so what we did see in the third quarter was over the quarter, and really most of that coming in the last month of the quarter, a $0.50, $0.60 drop in the price of ethanol. So there clearly was an impact on the trading business. We did have a write-down of inventory at the end of the quarter and now, since the quarter ended, we have seen actually prices coming back up and so that is a benefit.

So the way we think about it is, on average, it is a very predictable, stable business that makes a couple of pennies a gallon on a gross profit basis with some significant volatility within shorter periods of time.

Okay, sounds good again. Congrats on the quarter and nice job.

Jeff Osborne, Cowen & Company.

A couple questions; I was wondering, Neil, you mentioned the basis is kind of returning to closer than expected relationship levels. Is that, in your mind, kind of the $1.25, $1.50 level? Or just maybe give a little bit more clarity as to where you are now and any expectations for change to the quarter would be helpful.

Sure. If you look at that tariff rates for corn from group 3, Nebraska, which is really what drives the pricing for us, that, depending on our plan, is anywhere from $1 a bushel to $1.25. What we are also seeing is that the basis in the Midwest as the crop comes in that we can buy corn at something under Chicago. So, normalized would be more in that $1, $1.25 rather than the $1.25 to $1.50 that you mentioned.

We are still seeing some slight premiums on freight. That could be with us through the quarter. We would expect certainly by Q1 of 2015 that to get back to freight trading at parity, if not even some discounts. We also now are seeing an offset on that Chicago/L.A. ethanol basis which, in the quarter, averaged about $0.20, which is more that normal level. Given the freight premiums we were seeing, that then didn't offset the (technical difficulty) being higher and we are seeing that now. Like, yesterday, we were at $0.27. So we are also seeing some offset of any corn premiums we are paying by a higher ethanol basis today.

Okay. Great to hear. And then, as that kind of all flows through, how do we think about EBITDA per gallon trends through the quarter? And maybe just reflect on kind of the cadence of that metric through the third quarter. But then, more importantly, how do we think about it for the fourth quarter?

Well, we do not offer any specific guidance on margins. I think what is pretty well understood is that we do a limited amount of forward hedging of our margins, and that we are more impacted by the spot market. And if you just look at industry average type margin environments, again, albeit with a lot of volatility even day to day, we are in that $0.30 per gallon margin environment today.

That is less than we averaged through most of 2014. We actually saw that at lower levels at the last quarter end of and the beginning. And we have seen a nice uptick here in the last week or two which we expect to continue.

We saw the inventory reports out yesterday from the DOE and the inventories were down 5% to levels that were the lowest that they have been since May of this year. And that was also remarkable in that production was up 5%. We have seen draws in inventory where you would expect it, given the very significant increase in exports we have experienced here of late out of the Gulf and off the East Coast.

So we see a very snug supply-demand balance. We did see a little length coming out of the Labor Day weekend in the industry, and that seems to have lifted the acceleration of exports, tightened up quite a bit. So we are bullish on margins going forward in the fourth quarter and into next year.

Great to hear, just two other quick ones. Bryon, I may have missed it. Did you give the CapEx figure for the quarter? And then if you can put that in perspective on the broader $16 million in initiatives that you talked about on the last call, how you expect that to flow through over the fourth quarter and the first half of 2015, just so we can model the cash flow burn from a CapEx perspective would be helpful.

Sure. As I mentioned, I think went through it fairly quickly, but of the $16 million, we spent approximately $2 million. So we have got -- and as we have talked about half of that $16 million would consist of the two corn oil facilities. We would expect somewhere around 3 to 3 1/2 -- well, let's put it this way. I would expect somewhere over the next three to six months to have spent most of that $16 million.

Okay.

And then I would add that we have -- just our maintenance CapEx is approximately $1 million per plant per year. So that $16 million would be on top of that, would be the maintenance CapEx.

I understand. And then, the last question is, can you just update us on how you are tracking in terms of yield per bushel? I think in the past you are around 2.74 or 2.75. Just are you getting any greater throughput through the average of the four plants with some of the initiatives that you have?

Yes, we are. We are definitely seeing that and have certainly been closer to the 2.8 level.

Katja Jancic, Sidoti & Company.

Neil, you mentioned that you expect the exports to continue to grow, especially next year. What are your expectations? How much of ethanol do you think we can export and which markets?

Good question. We are seeing exports go to quite a number of countries. Canada is our largest export market. The Philippines has been a large market. We are seeing increases in India, and we are even some small amounts of ethanol that we are exporting to China. We see that as a huge opportunity over the next couple of years.

Brazil continues with their drought and smaller harvest and growing demand, and looking to going to higher level of blends, particularly in their inner harvest period to become a large destination, sometimes the second or third largest for US exports. We are seeing a fair amount into the Middle East for octane. We are seeing a number of countries initiate programs to lower CO2 emissions, and ethanol is the single most effective way to do that.

Plus, you have the economics with ethanol on a forward curve, trading anywhere from $0.40 to $0.60 to $0.75 less than gasoline. There is just a very compelling economic rationale for the exports. And given the high octane nature of the fuel to be able to buy that at a discount gasoline.

If we are on a run rate right now in Q4 that feels about 1 billion gallons a year, we would expect that next year that becomes a baseline. We are seeing -- not with our Company, because our model is all about selling within 100 miles of our plants. That is our highest value proposition, but the industry overall is seeing bookings on exports to go out a number of quarters, so a greater forward commitment on exports than I think the industry has ever seen, and that bodes well.

The capacity is there to do more from an infrastructure standpoint. I think arguably, if these relationships stay the same, the bigger issue will be just the amount of ethanol that we can produce. We have domestic demand at close to 13.5 billion gallons and inching up with the introduction of E15. And if you add 1 billion gallons, you are at 14.5 billion. That is pretty much the capacity of the industry to produce right now.

So could we do 1.2 billion? That is possible and it might happen. So we are very optimistic on the export picture.

You also mentioned that the amount for E15 is increasing. Can you comment more on that?

On E15?

Yes.

Yes. There is still a very limited number of stations. I think we're up to about 100 stations in the United States that are offering E15, but we have seen quite a bit of growing interest in the industry. It is very focused on this.

It becomes a very important part of growing the domestic demand for ethanol and we are seeing initiatives with a number of retailers that are interested. The industry is doing its part to help on capital improvements to make those upgrades, fairly simple upgrades, but still cost of bit of money to be able to distribute the product. The EPA has clearly given the green light for what amounts to 2/3 of the vehicles and closer to 80% of the vehicles miles traveled to be suitable. And we are optimistic that it will be an incremental growth in 2015 and will accelerate significantly in 2016.

Now, with the decline in the oil prices, does that raise any concerns at all?

It doesn't today because what we had was -- when ethanol was -- when oil was at $100 and ethanol was trading at closer to $1 discount, now with oil at $80, we are still trading at a $0.40, $0.50 discount, even in the near months, and greater as you go out on the curve. So we are still seeing -- for a product that frankly has a value that is higher than wholesale gasoline to be still selling at such a discount, it seems like oil prices have stabilized in and around the $80 number, and many expect that to go back.

But it would take a much lower price of oil to create any concerns, from our perspective, on the value proposition and the margin opportunities with ethanol producers today.

Craig Irwin, ROTH Capital.

Congratulations on a strong quarter. First question I wanted to ask was about corn oil. I noticed it was about $0.05 a gallon, just over $0.05 a gallon. There seems to be some headway and headwind there for improved performance. I was wondering if maybe you could update us on how far along you are in maybe adjusting the grind or any adjustments that you make to Stockton and Magic Valley to optimize that.

And then, if you could again update us on whether or not Madera and Columbia are going to be brought online for corn oil production in the fourth quarter or after the fourth quarter, and the timeline for us to see the financial benefit from that.

Sure. The projects at the Boardman and the Madera facility are in process now. And what we have guided in our prepared remarks was that those projects would be online in the first quarter of 2015. So they will make a contribution, not this quarter, but next quarter and we are excited about bringing that online.

There is opportunity. We're always working on trying to optimize the corn oil production through fine-tuning the equipment, the use of an additive as well as the work that we have done on the front end to increase the grind and to be able to liberate more of that corn oil. So we are, on an incremental basis, seeing some opportunities to increase that and increase the contribution to operating income.

The bright spot on that is that the corn oil is actually, particularly out West, with some of the rail logistics on getting competing corn oil out here, has maintained a pretty solid value relative to corn. Even with the recent declines in corn prices, corn oil has not come down at that kind of rate. So we are seeing a better relationship between corn oil and the price of corn.

Great. Now, when I look at some of your public competitors, they often had close to $0.07 a gallon. Now I know a number of them started a couple of years earlier than you, but is that something that, over the next few quarters, is probably more achievable out of the corn oil production? Or is there something fundamentally different where we should expect different performance based on the type of plants and location?

No. We are able to achieve industry-standard, if not a little better, we believe, as we move forward and implement the new systems. The $0.05 is a pretty conservative number. I think we more historically said between $0.05 and $0.07, and that moves with both the performance of the equipment in those markets. But, no, we do believe that we should be at industry-standard, if not slightly better than performance on our corn oil systems.

Great. Thank you. My next question was about the CO2 dry ice project at the Columbia facility. Can you maybe give us a little bit more details on the timeline for that to come online and how this project started, whether or not is it possible you could do something similar to your other plants in the future. And whether or not this could potentially impact your carbon footprint calculation for the plant, something that obviously goes into EPA's RIN eligibility criteria as you could maybe move into a new category under the best of scenarios.

Sure. The CO2 is very sensitive to freight. That is actually what makes our plants being fairly close to some large CO2 markets attractive. What made Boardman particularly attractive is that we are part of a whole food processing complex that is in there at the Port of Morrow. There is a number of users locally of CO2 and we are matching to that local market.

And with Kodiak, they are coming in and capitalizing the equipment. Essentially, it is a royalty over the fence. They are the ones that then produce the product and will sell it for local distribution and the production of the dry ice and the compressed gas.

Because it gets used in operations where that CO2, in the case of dry ice, for instance, that CO2 still ends up being released from the atmosphere. So it was being released from our fermenters. Now it is going to be released through the near-term use of dry ice.

So, in that application, there actually is not a net benefit on the carbon, but we would need to sequester that in some other more permanent way looking -- ADM has a project where they are taking CO2 from their facility, injecting it into wells, that sort of thing. There is potentially the opportunity, which is more advanced technology, to convert the CO2 into plastics or some other more permanent fixture where you have shown that you could capture that carbon.

So there may be opportunities and we certainly are looking at that. But, right now, the immediate opportunity is in these more conventional applications. And we are looking at the opportunity to do that at one or more of our other facilities as well.

Great. My next question is about the 3 million warrants that struck since June 30 -- 3 million, give or take. Can you share with us what the activity was, maybe, at the back end of the quarter and since the end of the quarter, whether or not this sort of coincided with the more significant volatility in your stock or if this was sort of evenly-paced over the last several months?

A certain portion of it occurred at the beginning of the quarter. Thus, the high price for the warrants and the adjustments for the warrants -- exercises at an average price of $19 per share.

As I mentioned on the call, that may have caused some confusion. Normally, if there were no exercises of the warrants, then if we carry that same balance of warrants from beginning of quarter to end of quarter, you would just adjust between your ending price last quarter and the ending price this quarter, which would actually translate into a positive gain. That being said, we did have exercises.

We had the inducement and between those two things, the average at a higher price thus translated into an adjustment and an impairment for that. We had a little bit of exercises after the end of the quarter and it's not quite as compelling when the stock has traded off as much as it has. But, in any case, that is where we -- so when we announced -- or in my prepared comments I mentioned that we were just under 1 million shares now -- or 1 million warrants.

Okay. A last question is more of a big picture question. Neil, you said many times in your prepared comments that you are optimistic about some pretty robust exports in 2015 and that you see continued strength in exports in the fourth quarter. It doesn't sound like anything is fundamentally changed for 2015.

If anything, maybe the industry will be tighter than where it was in 2014. But that coincides with the long expected seasonal swing in inventories exiting in the summer driving season. Everybody expected this. It happens every year. But we saw a really exaggerated move in your public market valuation.

Can you help us understand whether or not the same dynamics that really benefited you in the first couple of quarters of this year have potential to deliver similar positive results in 2015? And if you could maybe give us some guideposts as far as what to look for out there that would indicate that we really do see some pretty exciting results, again, from Pacific Ethanol over the next string of quarters.

Sure. I mean, generally, as we mentioned, we are bullish on the supply-demand balance being very tight and that contributing to strong margins for the industry overall. We did see the seasonal change. You are right. There was quite a change in not only our equity evaluation, but other ethanol stocks.

In our humble view, that was a bit of an overreaction. And we are seeing strengthening in the overall environment.

One of the issues we had on the exports was that the spot price for ethanol, given a very strong and tight supply-demand, the near price was very high. And so, it did slow down the bookings of future exports because you could get more money in the spot market than sell out forward. And so when we saw that significant price drop, and it was particularly in the near month of September, that was what really brought on a lot of new export interest. So that was the market being efficient and making sure that we had enough exports priced in to keep a tight supply-demand balance, and that is what we see going forward.

In our particular situation, what really benefited us last year other than just a very efficient operating platform of plants, but was a high ethanol basis that was caused by rail logistic challenges that were not just weather-related, but related to the railroads generally continuing to be overwhelmed by the amount of business that they have to manage. And that is still the case. So when the market got a little soft, we saw that basis come in as folks were trying to move additional amounts of ethanol, both export and the US version of export, which is out to the large markets on the coast.

That has already started to expand. We have an issue with new railroad regulations that should be finalized by the end of this year and will have an impact, we believe, even in 2015, which could tighten up the railroad situation even more, could raise the price of moving ethanol by rail.

Remember that we do not move any of the ethanol we produce by rail. It all comes by truck. So the $1000, $2000 a car lease rates that are common, if you are looking for incremental rolling stock in ethanol, plus the cost to retrofit cars, plus the impact on the railroad, who may see their velocity decrease in the movement of flammables. All of that is going to raise the price of moving ethanol from the Midwest to our market and we will be the net beneficiary of that, in that those are costs that we avoid. So we are there to benefit from those higher values.

So in terms of what you might look for, it is pay attention to what we are seeing on corn basis and what we are seeing in terms of the ethanol basis from the Midwest, Chicago, to the Western markets and off the L.A. postings.

Nathan Weiss, Unit Economics.

A couple of quick questions. First, on the $0.06 to $0.07 in margin improvement, is that entirely a result of the $16 million CapEx program or does that include additional projects?

I am not sure I understood the question, Nathan, because -- could you repeat that?

You mentioned a $0.06 to $0.07 per gallon margin improvement.

Yes. Got it. Yes. (multiple speakers) that is a result, principally, of the $16 million spend.

That is a pretty good return. (multiple speakers) above and beyond?

Sure. I mean, if you look at some of the things we mentioned that are not part about $16 million, whether it be the -- looking at the potential to add fermentation capacity, which would both incrementally increase overall production, we now have a permit at our Idaho facility to produce up to 70 million gallons, so looking at what it takes to add incremental capacity to do that and also improve yields by having longer fermentation times.

Certainly, the cogeneration projects that I mentioned become higher capital, but also have some significant return by lowering our energy costs and improving our carbon scores. The anaerobic digestion, that could be a $10 million, $12 million project at any one of our plants. It could also have a very significant benefit in terms of reducing cost and carbon, adding premium value to the ethanol that we sell.

So, yes, we are -- the initial round where the incremental projects had got a very attractive return profile, I mean we are looking at returns that are in the 18-month to three-year maximum type returns. And, really, most of them are in that less than two-year type category. And now we also are evaluating these higher cost projects that also have a very attractive return.

Very good. Now, the EPA has recently talked about potentially qualifying a plant -- have 100% of the output of cellulosic ethanol if 25% of the feedstock qualifies. Have you looked at that and could that be a potential for one of your plants?

Yes, we are evaluating what exactly that means and certainly where we talked about in Idaho we feel we have the best uniform and high-volume source of cellulose feedstocks and wheat straw that we would look at that opportunity. 25% is still a pretty aggressive number for any of our plants, but we certainly are evaluating all opportunities.

What type of margin impact would you estimate that would have?

Well, the challenge -- the margin impact is hard to characterize now because we are still fine-tuning not only the technology that we use, but the price. And that is the real challenge with cellulosic ethanol, is that the capital costs are so high. We are mitigating that by looking at bolting on and being able to integrate and use some of our existing capital base.

But you are still talking about, if corn ethanol is $2 a gallon to construct, you are looking at capital costs of $5 to $10 a gallon on that cellulosic ethanol. So you need a pretty high added value to justify that, and that is where it is a little frustrating with what the EPA has done to kind of take some of that certainty out of how much cellulose ethanol is going to be required. We think that they will continue to move in the direction of making that a clearer picture.

We also have the added advantage where the picture in California is actually extremely clear that carbon prices are going to go up, credit prices are going to go up and we believe will result in premiums of pricing for cellulosic ethanol, particularly in California of upwards of $1 a gallon, which would then justify those higher capital costs. So we are encouraged. It is just a little premature to say what kind of margin advantage we would have.

Certainly, we are not going to endeavor to spend that kind of capital unless we are very confident that it is going to be a significant margin improvement.

Okay. And then, last question. Have you got your hands in any of the new corn crop and been able to evaluate kernel size and potential yield impact going forward?

Yes. We are starting to finally see new corn delivered to our facilities. Kernel size is great. The starch content is very good. We are actually seeing some increases in corn oil production as well.

So we were definitely getting some of the bottom of the bins there late in the quarter and early this before the new crop, which just in the last week or two has started to work its way into the pipeline and into our plants. And directionally it looks very good.

Jim McGillery, Chardon.

Can you just give us an update on that Madera plant and how it is operating, and anything incremental on that plant?

Sure. If you look at our overall production, we are running about 93% of capacity. So, frankly, a little less than we saw the prior quarter. And there have been some impacts of the new plant, when you restart a plant, certainly have been working out kinks.

So it was not running at full capacity in the quarter, but is pretty close to that now. So the plant is great. Its efficiencies are great. Its yields are great. We are excited about the corn oil and it is operating extremely well.

Aria Cole, Cole Capital.

A quick question on distillers dry grain. Earlier in 2014, when the Chinese were involved, what portion of demand was being purchased by them? And can you give us an update now on the current status of any purchases by China and when something might be expected?

Sure. So again, our own model is all wet distillers grain, sold in our local dairy and cattle feed markets. But certainly from an overall industry standpoint, the Chinese have been an important part of the picture in the last year -- about the middle of the year before the Chinese slowed down the exports, 15% to even close to 20% of total dry distillers grain production was going to China. And that is now -- there is some existing businesses being finished up, but that has slowed to a trickle.

And that absolutely had a fairly material impact on distillers grain pricing in both directions. When the Chinese were highly demanding of the product, we saw distillers grain on a relative to corn basis moved to 130% even 140% the value of corn. Since the Chinese have stopped demanding as much, we are now seeing more historically normal relationships where distillers grain is selling at a discount to corn 80%, 90% and we anticipate that.

You can see it in our co-product return and everyone in the industry. It took a lower price to essentially regain both domestic markets that had been priced out and also to encourage other exports. And we are seeing an increase in the exports to other markets, and we are also seeing an increase in domestic use, which is keeping that market well-supplied and supply-demand balanced, but at a lower level.

The Chinese situation is interesting. There is a lot of talk about GMO. In our view, it is related more to their own very large stockpiles of domestic grains, particularly corn. And then now with the global supply being so plentiful and price so attractively, I think they are working down their existing stocks.

And, while we don't anticipate it anytime soon, I think that China will be back at some point as a buyer of distillers grain. It is the lowest cost source of protein feed in the world today, and that makes it attractive for all markets, including China.

And just to follow up, if we -- if you just kind of compare the gross margin dollars you are earning on your wet distillers grain, what is the difference in the environment where the Chinese are involved in the market versus when they are not today? What is the net differential in terms of profit impact for you?

Well, it is all integrated. So there is a contribution that you get from selling distillers grains and contribution from ethanol. So what we really saw in the earlier in the year when distillers grain prices came off rather significantly, ethanol price has really picked up the slack. And you really didn't see a negative margin impact to the industry.

So it is really more what is the overall supply-demand of products and where, then, is the contribution coming from. So it is hard to isolate because of the integration of the products and the production process. I can say that if you look at a metric that we provide, which is the co-product return, if you held everything constant for every 1% change in our co-product return, has an impact of about $0.02 per gallon.

Got it. And then one final question; it might be difficult to answer. But, clearly, your Kinergy trading business makes good profits, some over time. How would one try and go about trying to place a value on that business? People understand on the -- how to value your ethanol facilities much more easily. But how do you place a value on the Kinergy business?

Well, that is -- we obviously think it is a very important part of our value and our value proposition, not only in the EBITDA it generates to the overall Company, but to the strategy of our being able to always be selling out in front of our production and growing our markets and becoming a very relevant supplier in the seven Western states that we currently market and have very significant market share. So it has real enterprise value there.

Trading companies, typically if you take an EBITDA, and if we say we essentially can earn about $0.02 a gallon over what now is a run rate of over 500 million gallons -- take whatever multiple. I think trading companies -- you know, three, four, five multiples plus the cash that is included in that business. So that is not something that we spend a lot of time thinking about in terms of that specific valuation. It is more the significant added value that it brings to our overall enterprise valuation.

Thank you and best of luck going forward.

George Noble, Noble Partners.

Congratulations on the quarter. I wanted to ask you a question I have asked you in the past about capital allocation. You mentioned a few minutes earlier, you said you thought the market was a bit of an overreaction on the stock price. Had you been in a position to repurchase stock, do you think you would have been in the market buying stock?

That is hard to speculate. I think we have clearly identified our current focus on spending capital. We do anticipate that the margin environment will continue to be very healthy. We will continue to generate strong cash flows. So, in terms of capital allocation, I think we have given a pretty good guide on how we are spending that capital today.

We also think it is important to maintain a strong cash balance to deal with the volatility -- the seasonal volatility that we do experience in this industry. From that, would reconsider both stock buybacks and dividend as a potential use of capital? Certainly, that would be something that we would consider as well as the cash continues to flow.

Do you have to buy up the remaining minority interest in some of your plants before you can buy back stock?

No.

No. Okay. So, given the implied valuation of your capacity right now, why wouldn't you think about buying back stock at (technical difficulty) these sorts of levels? I mean, it seems to me an investment in your own company is a pretty economical thing to do at current levels. What am I missing?

Well, it is a fair question. I don't know that you are missing anything, other than at this point in time we have certainly made the capital allocation choice that spending capital on these very attractive returns at our plants, from both generating margin today and margins in the future and enterprise valuation is our best investment in capital. As we move forward, we will continue to evaluate all other opportunities to spend our capital, including a potential share buyback program.

And, George, we actually -- we evaluate that on an ongoing basis. It is not something that is a new idea and it certainly, as you think about a company, it is certainly part of a good capital management program. So we appreciate the questions and it is something that we look at every day.

Do you need a Board authorization? You don't have an authorization in place, do you?

We do not yet.

Is that something that you are going to try to get in place?

Considering all options. When we have a Board decision on that, we certainly would let the market know.

I think that will go a heck of a long way towards putting a more appropriate valuation on your equity. I don't think it would require a tremendous amount of money for you spend either, if you just had an authorization in place and send a message market by making some purchases I think will go a long way. It wouldn't take a lot of money.

Appreciate the perspective.

And I am showing no further questions or comments at this time, and I would like to turn the call back over to Mr. Neil Koehler for any closing remarks.

Well, I just want to again thank everybody for joining us today. We are very proud with the results for the quarter and the Company's performance year to date, and we really appreciate the continued support of Pacific Ethanol. And we look forward to speaking with you all soon. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's conference. You may now disconnect.