Alto Ingredients Inc (ALTO) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Pacific Ethanol Second Quarter 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Becky Herrick, LHA.

Thank you, operator and thank you all for joining us today for the Pacific Ethanol Second Quarter 2017 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 a summary of the financial and operating results and then Neil will return to discuss Pacific Ethanol'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's available on the company's website at pacificethanol.com. If you have any questions, please call LHA at 415-433-3777. A telephone replay of today's call will be available through August 10, the details of which are included in yesterday's 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, August 3, and therefore, you're 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.

In management's prepared remarks, non-GAAP measures will be referenced. Management uses these non-GAAP measures to monitor the financial performance of operations and believes these measures will assist investors in assessing the company's performance for the periods being reported. The company defines adjusted EBITDA as unaudited net income or loss attributed to Pacific Ethanol before interest expense, provision or benefit for income taxes, asset impairments, purchase accounting adjustments, fair value adjustments and depreciation and amortization expense. To support the company's review of non-GAAP information later in this call, a reconciling table is included in yesterday's press release. It's now my pleasure to introduce Neil Koehler, President and CEO. Neil?

Thank you, Becky and thank you to everyone joining the call today. For the second quarter, we recorded net sales of $405 million, gross profit of $1.7 million, a net loss of $9.2 million, and adjusted EBITDA of a positive $2.6 million. While Q2 is typically a seasonally stronger quarter this year, ethanol margins were negatively impacted by elevated production volumes and high inventories across the industry. We currently are seeing an improved spread between ethanol and corn and better plant production margins when compared to the second quarter. Gasoline demand has picked up with summer driving is now running at levels at or above last year. In fact, gasoline demand last week hit a record high as measured by the EIA. Blend days of supply have been moving lower supporting a better ethanol supply and demand balance. Also according to the EIA, ethanol inventories last week fell to the lowest level since the first week of this year. We expect demand to remain strong and continue to grow as domestic markets blend above 10% and as international markets grow to meet carbon targets and demand for octane.

Across all our facilities, we continue to implement initiatives aimed at increasing operating efficiencies, improving reliability, enhancing yields, improving our carbon scores, and reducing operating costs. Our 3.5 megawatt cogeneration system at our Stockton facility is on track to reach full capacity by the end of the third quarter. The cogeneration system will deliver steam and electricity into the plant while lowering emissions and we anticipate it will reduce our annual energy cost by up to $4 million. The Whitefox industrial scale membrane system at our Madera plant is operating very well and we expect a positive impact in energy savings, operating performance, and in our carbon intensity score.

We estimate the energy savings will include a 5% reduction in natural gas costs at the plant. Overall, we estimate the energy savings and carbon premium combined will total approximately $350,000 annually at current markets. The membrane system also improves operations during hot weather, yielding greater output and it contributes to lowering our carbon intensity score. Once we have 3 months of consistent operating history, we will be in a position to submit for a new pathway from the California Air Resources Board and evaluate expanding the membrane system to our other Pacific Ethanol plants.

In Stockton, we continue to produce cellulosic ethanol and we are on track to begin commercial operations of cellulosic ethanol production at Madera in the second half of the year. We have completed baseline testing and once the equipment is installed this month, we will do more advanced testing by introducing the proper enzymes into the system. Following that, we will file for approval from the EPA for the production of D3 RINS. We are also in a process of filing an application with the EPA for our Magic Valley facility to be eligible for producing cellulosic ethanol and we expect approval by the end of the year.

We remain on schedule to begin full-scale operations of our 5 megawatt solar power system at Madera in early 2018. The equipment has been procured and construction is underway. The system is expected to reduce our utility costs by approximately $1 million annually and lower our carbon score. At our Aurora and Nebraska facilities, we have improved production economics and plant reliability through equipment upgrades to our boilers and dryers. Also in Aurora, we received DSP approvals for both facilities, which allows us to ship undenatured ethanol for the export market.

On July 3, we closed our acquisition of Illinois Corn Processing or ICP, which is a 90 million gallon per year dry mill facility located adjacent to our existing facilities in Pekin. We now have 9 production facilities with combined annual production capacity of 605 million gallons. ICP expands and diversifies our production footprint, improves profitability, and presents significant domestic and international growth opportunities. The acquisition adds specialty high-quality alcohol products to our production, which diversifies our revenue with a less volatile and more predictable revenue stream. It also adds to our profitability as the high-value beverage and industrial grade alcohol products are priced at a premium to fuel ethanol.

The consolidation of the ICP facility with our 2 Pekin, Illinois plants provides us with a combined operating capacity of 250 million gallons per year at that location. We have identified some early benefits to the consolidation of our Pekin facilities and we expect to achieve cost savings estimated at $4.5 million within the next 12 months through a combination of synergies including SG&A, logistics, and other cost advantages. As we are still early in the integration process, we plan to provide an update on cost synergies on the third quarter conference call when ICP's financials are consolidated and we have improved visibility. The transaction is immediately accretive to the company as demonstrated through the pro forma in the Form 8-K/A filed this Monday.

In addition, we have already gained some of the expected synergies and have a plant that performs well versus current industry production margins. We have also identified and are evaluating opportunities to improve yields, increase plant capacity utilization, and enhance ICP's production processes through additional capital investments both in the near and long term. We look forward to sharing more details with you over the coming months.

On the regulatory front, last week, a U.S. appeals court ruled that the EPA fundamentally misinterpreted its authority under the national Renewable Fuel Standard or RFS to lower the federal biofuel mandates blending volumes. In the decision, the judge vacated the EPA's decision to reduce total renewable fuel volume requirements for 2016 and sent the rule back to the EPA for further consideration. While the implications of this action remain unclear, this is a significant victory for the ethanol industry, the RFS program, and consumers. In addition, last month, the EPA put out its proposed 2018 volume obligations for the RFS, which it expects to finalize this November. The proposal is to keep the conventional biofuel requirement at 15 billion gallons, the same in 2018, which is a positive support for higher level ethanol blends. However, the EPA proposed [small] decreases in the cellulosic biofuel and the advanced biofuel requirements compared to 2017.

Over the past several years, Pacific Ethanol has been investing in several advanced biofuels initiatives to help meet the growing need for these innovative low carbon fuels. Together with other producers and stakeholders in the industry, we will be communicating with the EPA during the public comment period to support a final rule that sends the appropriate market signals to drive new investments into these advanced biofuels. The availability of E15 continues to expand across the country due to the increased demand for high-quality, affordable, environmentally friendly transportation fuel. Nearly 900 retail stations in 29 states sell E15 representing a 200% increase over 2015. E15 is expected to be at almost 2,000 locations in 2018 providing a strong case for year-on-year increases in the demand for ethanol. With that, I'll turn the call over to our CFO, Bryon McGregor for a financial review.

Thank you, Neil. Before I begin, I'd like to note that as our acquisition of ICP closed on July 3, we will consolidate its financials beginning with our third quarter results. For the second quarter 2017 compared to the second quarter of 2016, net sales were $405 million compared to $423 million. Cost of goods sold were $404 million compared to $405 million. Gross profit was $1.7 million compared to $17.7 million in the second quarter of 2016 which reflects a decrease in production margins compared to the prior year. SG&A expenses were $8.8 million compared to $6.1 million. The year-over-year increase in SG&A was primarily attributable to higher professional expenses associated with the ICP acquisition as well as increased benefits and non-cash compensation adjustments. We expect acquisition cost to also have some impact on SG&A in the third quarter. Interest expense was $2.7 million compared to $6.5 million. Net loss available to common stockholders was $9.2 million or $0. 22 per share. This compares to net income of $4.7 million or $0.11 per share in the year ago period. Adjusted EBITDA was $2.6 million compared to $20.4 million in the year ago period.

For the six months of 2017, we increased our first half 2017 net sales by 3% to $792 million and we dramatically reduced our interest expense to $5.3 million in the first half of 2017 compared to $12.8 million in the same period last year. This is primarily due to the refinancing of debt in December 2016, which provided significantly lower interest rates. Now turning to our balance sheet, cash and cash equivalents were $91.4 million at June 30, 2017 compared to $68.6 million at December 31, 2016. As part of our acquisition of ICP, we paid $30 million in cash as the acquisition closed July, 3, this will be reflected in our cash position at September 30, 2017. As part of the purchase price of the acquisition, we issued approximately $46.7 million in secured promissory notes. As we noted at that time, our intention is to refinance these seller notes in the near future. We are working with CoBank to secure long term financing in a similar amount which if consummated will have terms similar to the existing non-recourse loan at the company's Pekin facilities.

During the second quarter, we issued additional senior secured notes for approximately $14 million bringing the note total to approximately $69 million with no material changes to existing terms. So far in the third quarter we are focused on maintaining the strength of our balance sheet. We have closed an agreement to expand our borrowing capacity of Kinergy credit facilities with Wells Fargo from $85 million to $100 million, reduce the cost of the facility and extend the maturity date for an additional 2 years.

Now I'll provide an update to our capital expenditure activities and expectations. For the second quarter of 2017, our capital expenditures totaled $2.1 million primarily related to plant improvement initiatives. This brings our 6 month total to $6.2 million. Given the recent weakness in the industry production margins, our intention to operate conservatively, we are deferring $20 million of capital expenditures for the second half of 2017 from the $46 million in guidance we provided last quarter. Included in the revised plan is a $16 million in previously announced projects including Stockton cogeneration, the Madera cellulosic initiative and solar projects. The remainder of the uncommitted funds represent investment opportunities in projects that produce the highest near term return for the company and its shareholders. It is important to note that this amount does not yet include potential capital improvement projected in ICP. The information regarding these projects will be provided over the coming months. With that, I'll turn the call back to Neil.

Thanks, Bryon. We remain encouraged by the long term demand for ethanol as supported by the growing need for high octane and low carbon renewable fuels in both domestic and international markets. While volatility in the ethanol markets persist, we are continuing to make operational and strategic improvements that lessen our exposure to such factors and position us to gain share in the renewable fuels market. We are focused on increasing operating efficiencies, improving plant reliability, enhancing yields, improving our carbon scores, and reducing operating costs. Our acquisition of ICP in July provides multiple cost synergies, further diversifies our production with high-quality premium priced alcohol products representing a less volatile revenue source, and it increases our opportunities and access to export markets. Amanda, with that, we are ready to begin the Q&A session.

Thank you. (Operator Instructions) Your first question comes from the line of Eric Stine from Craig-Hallum.

I was just wondering if we could just start on 3Q and obviously I know that these -- this can change pretty quickly, but you mentioned starting to see it in the EIA data. Just in terms of conditions here going forward, I mean is this a trend that you see continuing given seasonal plant shutdowns and also have heard some industry participants talking about shifting production to industrial grade?

Yes I think the shift to industrial grade is -- there is -- some of that's happening. Obviously we acquired some of that. I think that's less of a factor in the overall supply/demand, but what we are seeing is strong gasoline demand. We really worked off an overhang. The problem with Q2 was that we left Q1 with quite a bit of inventory because gasoline demand in Q1 was fairly anemic relative to the year before running about 2.5% behind and now we're running at levels that are above a year earlier. So strong domestic demand, strong exports, decline in inventories getting down to days of supply that are pretty well correlated with better margins and we are seeing that. We do anticipate that that should continue to be the case. We do have a little less exports in Q3. So that would be one negative, but they should come back stronger in Q4, but we believe that the strong gasoline demand will pick up the slack here in the summer months. And we also have stable corn prices. That was a bit of a factor as well in Q2 as these corn markets trade on the weather and there was concern about the heat and some areas in particular Dakotas with declining growth and yields. So we saw some spikes in corn prices that -- where ethanol didn't really follow. We're seeing a pretty stable corn price. It's become clear that we will have a -- just a fine crop, maybe slightly lower yields than the USDA is predicting, but still a good strong crop. So we are constructive on the second half of the year, certainly more so than the first half.

Got it and maybe just sticking with the demand side. First, a lot of noise out of Brazil in potential for either tariffs or quotas. I mean I know that, well, I mean I'm just curious what your thoughts are there and what you think a potential outcome is and I know that they're targeting maybe a month from now when that decision is made. So any thoughts there is helpful.

Well, they've deferred that decision twice. I don't really think Brazil wants to instigate a trade war with the United States and that would be a way to do it. So there is that factor and the other factor is that Brazil continues to be on an annual basis structurally short of ethanol and they need the gallons. So it may impact the economics to some degree. It may shift trade flows, but they still need the gallons and that becomes a factor in the overall global supply and demand. So we continue to see Brazil as a strong market for ethanol. The other factor is that they have the swing between sugar and ethanol. Sugar prices were declining in and around the $0.13 a pound and back now close to $0.15 a pound. So that's another factor supporting the shift to as much sugar production as possible in Brazil and impacting their levels of ethanol production, which creates even more of the demand for importing our ethanol.

Right, okay. Last one for me. Just coming back to corn, any color you can give on basis. I know that corn had been touching that $4 range for a bit, has pulled back, but hearing that in certain parts of the country, you can get corn well below the board price, So just how -- what you're seeing from basis here in 3Q and is that something that you may lock in?

Yes certainly there is a bit of an inverse relationship between the board and the basis. So when the board goes up, you tend to see farmers stepping out and selling and that does create an opportunity to lock in basis and we have locked in some basis for Q3 that is better than current market. So that is encouraging. Basis generally has been fairly friendly towards ethanol producers particularly in Illinois, we've seen some of the lowest basis than we've seen in years. Typically, that market trades closer to option price and we've seen numbers that have been closer to $0.10, even $0.12, $0.14 under the board. We also are seeing good supplies going west and have been able to lock in a decent basis for our Western plants. So it's a pretty good position that we're in corn and looking at a good crop with a good strong carry out going into next year.

Your next question comes from the line of Craig Irwin from Roth Capital Management.

So Neil, I was really happy to hear you mentioned the D.C. Circuit Court case -- court decision from last Friday. Earlier this week, I was at the EPA hearing in D.C. and a few people politely reminded EPA, hey, you guys broke the law -- your position with RFA gives you a really good view sort of on the broader strategy of the ethanol industry and a lot of people really look to you for your leadership as far as how to approach some of these complicated problems. So the arguments on the other side haven't changed, they are all tired and old and we only need to look at Brazil to see that 27.5% ethanol isn't going to cause all the gas tanks out there to rot and all the cars to fail on the road. So can you maybe describe for us the path forward after the Circuit Court decision, what it would look like as far as industry actions to make sure EPA follows the law, the way that Congress wrote it and that we see RVOs for the whole biofuels industry that are more in line with the spirit of the law rather than what we've seen under the Obama administration over the last number of years?

Sure. Well it's really up to the EPA to take the vacating of the 2016 and decide what to do with it. We think that a very straightforward path would be for them to go back and add the 500 million gallons back to the 2016 RVO and require and maybe give refiners a little extra time to retire an additional 500 million [RINs]. So we -- by law, you're right, they did break the law and the court of appeals determined that and the industry and the market needs those 500 million gallons back in one way, shape or form. They could appeal it to the Supreme Court. I don't expect that they will do that because I think there is a very good straightforward path that is not draconian, is not going to be disruptive to markets, but will -- which is why this is a very large victory for the industry, will absolutely help accelerate the introduction of higher level blends. We've already seen a reaction in the RIN market, RIN prices have been moving up since that decision and it provides that much more incentive to buy that gallon of ethanol that has a RIN attached, that actually sells with that RIN attached at a price that's at or below the price of gasoline, take advantage of the octane, have a cheaper product as E15 on the street than going out and having to buy $0.85, $0.90 RIN. So we are seeing the infrastructure in place. We continue to see resistance from the major oil companies, but we have a lot of support from the large chains of independents that are starting to implement the higher blends and we think that this case will be absolutely catalytic in helping accelerate that development and also very importantly just takes away any future threat that the EPA could come back and again use the very flimsy claim of now not legal claim that inadequate infrastructure is tantamount to inadequate supply and invoking the supply waiver under the RFS. They can no longer do that. That's been made very clear. So we do see it as a very positive development and as an industry, we will, to your point advocate very strongly and did in Washington as you heard from all areas, the biofuels industry, it was a very united voice from all biofuel participants. It's so great that you -- please follow the law, do what it's supposed to do, which was to expand markets for clean burning biofuels. Great that you're protecting the conventional number, but you need to increase the advanced biofuel number cause we are ready and able to produce more advanced biofuels than the current RVO proposal is suggesting.

Thank you for that. Second question I wanted to ask is about -- a little bit about geography. So as one of the primary suppliers of ethanol into the State of California, you have a neighbor that's pretty interesting. Mexico seems to be taking the right actions to move towards 10% ethanol blend rates with the approval of a 10% blend just back a number of weeks ago. How do you see this impacting ethanol demand in California? I know there's complexities in there because of LCFS scores and what people are choosing to deliver into the state, but if Mexico was to take 300 million gallons to 500 million gallons more over the next few years, how would you see this impacting development of demand across the State of California?

I think the real impact is just the overall global domestic and global supply demand. I mean clearly in the U.S. until we get past the 10% and see wide adoption of higher blends and continue to see growth in international markets, we have a little bit of a supply/demand concern given that the industry continues to increase its capacity to create and even some new plants are now being built. So we need new markets, we need them domestically and internationally and Mexico, it's one of the bright spots. It could be as much as 1 billion gallon market if 10% ethanol were to be in all the blends. I think your 300 million to 400 million right now is a reasonable target because the MTB crowd down there is still hanging on to their market share and have at least for the time being locked ethanol out of the large urban markets, but the early adopting areas outside of those do represent that 300 million, 400 million gallons and many of them are closer to the U.S. border. California specifically, while we continue to have the LCFS which we anticipate be well beyond 2020, is going to continue to be more of a specialty market. So I don't see a lot of California produced gallons going to Mexico, but certainly, we look at Aurora and Nebraska and the logistics have been able to rail product down to Mexico from there. That's an immediate opportunity for us. We are down there taking a look at the opportunities and talking to the blenders. Infrastructure is being put in place. As the overall supply/demand balance tightens and we see growth markets like Mexico, that does tend to support a higher ethanol basis to destination markets like California. So I do think that you'll see a positive impact on the overall industry and you will also as markets expand, see a stronger ethanol basis and ethanol pricing in California.

(Operator Instructions). Your next question comes from the line of Sameer Joshi from Rodman & Renshaw.

So most of my questions have been answered, but just a couple, one related to the cost savings. I think when it was announced the ICP acquisition, the number $3 million as cost savings was mentioned, but on this call I think I heard a $4.5 million number. Was I hearing wrong back then or how do we reconcile that?

You were not hearing wrong, that was the number. We were being -- till we got deeper into it, we're being very cautious and as we have dug in deeper and no more, we are seeing additional advantages and opportunities. It's both in SG&A as mentioned and other cost savings in terms of being able to consolidate one corn buying position, we think we can get a lower corn price that way and then we really have in both our feed, distillers grain, yeast, and ethanol identified a tremendous amount of savings in logistics and how we move products to market. And that probably is what singularly increased that number as we've explored opportunities to take out third-party costs that we had been paying on all 3 of those areas and internalizing it and are now very efficient and integrated complex there in Pekin.

That's actually great. So on a SG&A alone basis, should we expect your annualized or are the quarterly operating expenses to be in the $7 million range going forward once the operations are integrated? Right now they are around $6 million.

Yes, Sameer, I think we provided guidance historically at around $7.5 million before ICP, but that was before ICP, but I don't have a number for you yet. We still need to finish our integration analysis. So I'll probably have a number for you next quarter. As we mentioned on our prepared -- or in my prepared remarks indicated that the numbers were higher this quarter due to the acquisition and some other adjustments. So I think hopefully that gives you enough to go on at least for a quarter and then we'll give you some more details later on.

Fair enough. Thanks for that. At the macro level, we saw the announcement of ADM trying to refocus on their [prairie] operations to industrial and beverage grade and of course your ICP acquisition is in line with that, but do you see industry-wide more such move towards this kind of adaptations or at least acquisitions similar to yours?

We really don't. If that is a -- you look at the U.S. market for fuel at 14.5 billion gallons, the market for the high-grade ethanol in the U.S. is a little over 400 million gallons. So it's a very small market, very few number of producers that produce the grade for those markets particularly the higher quality beverage opportunities and 1 plant deciding to ship 50 million gallons into that market could really see the premiums erode very quickly and it's a significant investment, that's why we felt so good about our acquisition. We're not -- we're just owning a plant that produces the high alcohol that already had a market. So it's not as if we're expanding into that market. We're just replacing it with ownership and so, it'd be very difficult for us as a company to justify going to another plant and saying, yes, we're going to put in $15 million, $20 million, $30 million and that's the kind of numbers you're talking about to produce a high-grade ethanol to then have the consequence be seeing pricing erode in that area. I would point out that, I think some people misunderstood what ADM was saying. As I understand their announcement and a follow-up question that was asked, it's not as if they are shifting production to beverage. They are taking 100 million gallons offline of fuel grade immediately. So that's a great contributor to helping to tighten up the supply/demand balance and they are going to refocus just on the higher grades that they're already producing at that plant, maybe there will be some incremental growth, but the real announcement was they are reducing capacity at that plant to take out the fuel and to support and simplify the process there and focus on the high-grade.

That's great. Actually I just have one more if I may. Bryon, the number $16 million for CapEx that you mentioned, does it include any expense at the ICP side?

No. So I guess my story is hold on, be patient, wait till the third quarter. We're working through that. We'll give you back -- we'll come back with some ideas as to what we think we would be spending, but I think that you should be -- you should expect that consistent with our message of being conservative and given where numbers are today that we expect that number to be fairly small.

Your next question comes from the line of Chris Souther from Cowen.

It's Chris on for Jeff. Most of my questions have been answered. I just wanted to see if you could provide a bit of color on the third-party sales as it relates to the ICP merger, having kind of better access to export markets potentially makes those third-party margins more attractive. Could you guys see is -- going higher than kind of the 110 million to 120 million gallon per quarter range we've seen lately?

I think it's possible particularly in a market that's been a bit long. The third-party business has been very competitive and in some areas, just not worth the cost of capital. So we have not been as focused on growing that part of the business, but it's very important that we protect the business we have because it's so synergistic with our production -- the whole production marketing model to really trade around our assets and so to your point, we are evaluating what opportunities this creates. To make money in the third-party business, you really -- you need to have something -- some hooks, some differentiation whether it's terminals, whether its access to the water, which this gives us. So it is possible. I would say that's not a high priority right now for us, but it is certainly an asset that can be leveraged to look at those sorts of opportunities.

Got it. That's helpful. And then, it kind of seems like you were kind of alluding that 2/3, 1/3, I'll call that an all mix would probably stay pretty static within the ICP. I just wanted to see though, when you're talking about kind of the co-products between alcohol and ethanol, how does that -- do they have kind of similar returns?

Yes. So it's a dry mill, so where the added investment of that plant has been is in the fairly extensive equipment to produce that very high quality ethanol, but in terms of co-products, it's the same co-products dry distillers grain and corn oil. We actually see an opportunity to improve the performance in that area, particularly on the corn oil side. The output has been a little less than what we consider to be standard for our plants and we're addressing that to increased corn oil, but it's more or less the same co-product platform that you have in any dry mill.

(Operator Instructions) We have no further questions at this time. I will turn the call back over to Mr. Koehler.

Thanks Amanda and thank you all for joining us today. We appreciate your support and interest in the company and look forward to speaking with you soon. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may now disconnect.