Alto Ingredients, Inc. (ALTO) Q2 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Pacific Ethanol Inc. Second Quarter 2019 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 call is being recorded. I would now like to turn the conference over to your host, Ms. Moriah Shilton. The floor is yours, ma'am.

Thank you, Patty. And thank you all for joining us today for the Pacific Ethanol second quarter 2019 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 is available on the company's website at pacificethanol.com. A telephone replay of today's call will be available through August 8, 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, August 1, and therefore you are advised that the 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 two of the presentation available online, which says that some of the comments in this presentation contain 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 believe 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 financial information later in this call, a reconciling table was included in yesterday's press release. It is now my pleasure to introduce Neil Koehler, President and CEO. Neil?

Thank you, Moriah. And thank you, everyone, for joining us today. Before discussing our second quarter results and the current state of the ethanol industry, I would like to comment on our previously announced strategic initiatives to strengthen our balance sheet, improve our liquidity and reduce our debt. We're actively engaged in discussions which could lead to the sale of production assets, new financing arrangements, the formation of new strategic partnerships or some combination of these alternatives. And once included, we expect them to meet our stated objectives. We look forward to providing you substantive updates when we have agreements to announce. We're working collaboratively with our lenders who have shown confidence in the credit strength of the Pekin facilities and the management of the company and in the long-term value of the industry. As previously we noted, our letters have extended credit terms under our Pekin loan to provide additional time to conclude our strategic initiatives. Turning to our second quarter results, gross margins were slightly better than in the first quarter, but continue to be near historic lows. Our team did an admirable job in controlling costs and running efficiently under the adverse market conditions. Our net sales were $346 million, down nearly $10 million from Q1, dur primarily to the flooding on the Illinois and Mississippi Rivers, upon which we largely depend on to transport product from our Pekin facilities. The plants have now returned to full production with higher river levels subsiding in mid-July. Net loss available to common shareholders was $8 million compared to a loss of $13.2 million in the prior quarter. Even with lower sales, we saw a significant improvement in adjusted EBITDA, which was a positive $7.2 million compared to a positive $1.6 million in the first quarter. I'd now like to spend a couple of minutes discussing the current state of the industry. The ethanol industry continues to be oversupplied. This is primarily driven by two factors. First, the Environmental Protection Agency has granted over 2.6 billion gallons of small refinery exemptions over the last two years to the oil industry, approving all 54 requests in that timeframe, which is unprecedented. This abuse of the renewable fuel standard has dampened demand for our product. Both the volume of ethanol consumed and ethanol blend rates declined in 2018, albeit slightly, for the first time annually in at least 10 years. As a company and as an industry, we are working diligently to have the EPA followe the letter and intent of the RFS by limiting small refinery exemptions to those refiners that truly experienced disproportionate hardship and complying with the RFS and to reallocate the weight gallons, so that ethanol volume requirements will be as statutorily directed. The RFS requires a minimum of 15 billion gallons per year of conventional biofuels in US gasoline. If implemented appropriately and legally, the demand for our product will grow, margins will improve and consumers will benefit from a low cost, high-octane and clean-burning advantages of ethanol. We call on the Trump administration to stand behind the commitment to supporting agriculture and ethanol producers and fix this serious problem. Second, tariff policies have eliminated exports of US ethanol to China, a fast-growing ethanol capital market that will exceed 4 billion gallons annually as China moves to a 10% ethanol blend. China's domestic ethanol production capacity is approximately 1 billion gallons per year, creating a huge opportunity for US exports. A resolution of the trade disputes between the US and China should result in an immediate and significant increase in US ethanol exports to China. As promised by President Trump and promulgated by the EPA, arbitrary and outdated restrictions on selling E15 have been lifted to allow retailers to sell E15 year-round. This is a very important milestone that the industry has spent years working to achieve. We are already beginning to see additional E15 gallons being sold at gas stations. While this is an important step for increasing demand, incremental growth in demand will be modest in the near term as it takes time to convert joint stations to sell E5. Nevertheless, given the lower price of E15 versus E10 at the pump, the lower carbon content of the fuel and the octane value of ethanol to the refiners, we expect to see year-on-year growth in the selling of E15, which should accelerate over the coming years, position the industry for substantial demand growth. The industry continues to overproduce relative to demand and inventories remain high. As a company, our operating capacity was 80% in the second quarter as we have idled production of 45 million gallons at our Aurora East plant as previously announced and reduced rates at other facilities. We are moderating plant production to levels that support balancing the overall supply against expected demand to enhance our profitability. We continue to operate our nationwide production and marketing businesses efficiently and cost-effectively, managing what continues to be a challenging margin environment. We have reduced operating costs across all our plants and continue to focus on yield improvements, energy reductions and a reduction in carbon intensity, all contributing value. We remain focused on managing our SG&A costs, in fact, showing a $1.5 million reduction from last quarter. Pacific Ethanol is well positioned in the California and Oregon low carbon markets with both production and marketing assets benefiting from significant values attributed to the California low carbon fuel standard and the Oregon Clean Fuels Program. In addition, Airgas has commenced commercial operations at the CO2 plant at our Stockton facility and we expect this will generate approximately $1 million in operating income each year. Finally, we have amended our contract with Siemens' Dresser-Rand to appropriately reflect the continued development of the cogeneration system at our Stockton facility. Improvements to the system shall allow for greater operating range and system durability, combined with the recent introduction of the CO2 plant at the site. We have mutually agreed on new milestones for commercial operations with corresponding scheduled future payments, which will result in a positive cash flow impact of approximately $8 million in 2019. We remain confident in this enhanced system to deliver over $4 million in value annually in a combination of energy savings and carbon reductions. I'd now like to turn the call over to Bryon for a financial and operational review of our second quarter 2019 results.

Thank you, Neil. For the second quarter of 2019, net sales were $346 million compared to $356 million in the first quarter. As Neil mentioned, the sequential decrease in sales is due in large part to force reductions in production at our Pekin facilities in response to flooding along the Illinois and Mississippi Rivers. Cost of goods sold decreased roughly $16 million sequentially to $342 million and we generated a gross profit of $4 million compared to a gross loss of $2.3 million in the first quarter, reflecting the combination of improved crush spreads, reduced input costs and lower operating expenses, including labor, repair and maintenance. We reduced SG&A expenses by approximately $1.5 million sequentially to $6.7 million due to a reduction in payroll and benefits, lower-than-expected health insurance costs and a reduction in professional services as we continue to manage our controllable costs. Loss available to common shareholders was $8 million or $0.17 per share, a $5 million improvement when compared to $13.2 million or $0.29 per share in the first quarter. Adjusted EBITDA was positive $7.2 million, a significant improvement over both the $1.6 million in the first quarter of 2019 and the $1 million in the prior-year's second quarter. Turning to our balance sheet, at June 30, 2019, cash and cash equivalents were $16.5 million compared to $21.8 million at March 31, 2019. While lower sequentially, our total liquidity including excess availability was $29.1 million which we believe is adequate for our current needs. Also, subsequent to quarter-end, we entered into an amendment to extend the payment and covenant terms of our Pekin credit agreement with CoBank to November 15, 2019. Consistent with the CoBank extension, we have finalized an agreement with Wells Fargo, extending additional availability under the Kinergy line of credit to the end of November. We are pleased our lenders continue to support us and show confidence in Pacific Ethanol. Our capital expenditures through the first six months of 2019 total just over $1.4 million, mostly attributable to ongoing repair and maintenance of our facilities. With that, I'll turn the call back to Neil.

Thank you, Bryon. As I mentioned in my opening, as an industry, we are working to change politically motivated demand destruction. And as a company, we continue to operate efficiently and cost-effectively in a challenging margin environment. In tandem, we are working diligently on our strategic initiatives. Long-term, we remain confident that the compelling cost, octane and carbon benefits of ethanol will drive both new domestic and export demand, and we're taking the necessary steps to best position Pacific Ethanol to benefit when market conditions improve. With that, Patty, I'd like to open the call for questions.

[Operator Instructions]. Your first question comes from the line of Mr. Craig Irwin. Your line is open, sir.

Good morning and thank you for taking my questions. Can you update us on the potential for plant sales and other methods that you might be considering to raise cash to facilitate the refinancing that you're going to have to do most likely before the end of November?

Craig, I can't really say more than what we said in the prepared remarks since we don't have anything definite to announce at this time, but we are very encouraged by the discussions that we are having at a number of levels.

Okay. Have you changed the investment banker that you're using to try and sell those plants, given that the one you originally nominated had next to no experience in marketing ethanol plants for sale?

That's actually not true. They have had experience with ethanol assets and we are currently still working with Piper Jaffray in that regard. There are a number of ethanol assets that are up for sale that have been announced and we're not seeing a lot of – really seeing no transactions being announced. It's not the greatest environment to be selling ethanol assets. That's why we're considering that among the other initiatives that we are pursuing.

Okay. And then, last question, if I may, is a question I get from institutional investors. Looking backwards many years ago, you did actually put the company into bankruptcy. Is there anything today that would significantly influence your decision-making process where that is either potentially off the table or something that would not be considered if you are unable to refinance the debt?

It certainly is nothing that we are considering at this time. It is a very different situation when we put our plant assets into a bankruptcy, not the company, back in 2009. If you look at this, the value of our assets, the 600 million gallons in replacement; obviously, well over a billion gallons of value; on our balance sheet, close to $700 million compared to plant debt of $140 million, there's plenty of asset coverage there. That's why, among other opportunities, selling assets is one possibility. Bankruptcy is not an attractive option, nor is it one that we're considering.

Great. Good luck with those asset sales. Thank you.

You're welcome.

Your next question comes from the line of Mr. Eric Stine. Your line is open, sir.

Hi, Neil. Hi, Bryon.

Good morning.

Good morning, yeah. Just curious on the production and the industry production. For some time since early this year, we've been hearing a lot about production coming offline, people being more rational in response to the margin environment. But, really, the inventory levels have still trended to historically high levels. But now in the last week or so, it seems like there may be some people out there ready to actually act on that and see real change to the production level. So, just curious what your thoughts are on that. I know you're doing that internally, but what you're seeing from other players in the market.

Yeah. So, there's lots of rumoring out there and it's hard to fully assess until you actually see the numbers. And to your point, inventories remain high. But the margin environment has gotten brutal enough and corn base is quite elevated particularly in the Eastern corn belt that it is really making the production cuts more real. So, we are hearing about it. We're seeing it. There have been some announced plant closures of late. And if you look at the production numbers over the last two weeks, they're down about 3%. And since they peak this year in June, early June, they're down little over 6%. So, at that rate, 1.030 million barrels per day and given very strong gasoline demand, we actually now – if you combine the domestic demand with export demand, at those production levels, we should start seeing inventories come down. And that's, obviously, very necessary. That's what correlates to better margins, is less inventory and getting closer to that 20 days of supply, albeit just a few weeks of data points here. But we appear to be trending in that direction. The inventory, the headline was that they were at a record high this week. And the way the EIA measures that, that is true. But if you consider the in-transit, the in-transit inventory actually has come down the last couple of weeks. You're seeing that in large builds in the Gulf. That's all destined for – mostly destined for export. So, that will be leaving the system. And over the last two to three weeks, the inventories actually have come down when you consider the in-transit inventory. So, we are encouraged by that trend and it needs to continue.

Okay. Thanks for that. And then, I know you and the entire industry are very concerned about the SREs. And I know there is recently a lawsuit about that. When you look at what the potential outcomes are, do you view that more as something that can be fixed going forward or do you think that there could be something where they make up for past volumes, whether it's an incremental $500 million on top of what the RVO is for 2020.

It's not only possible. It's what is legally required by the court. So, we're going back into court as an industry. That's when the RVO came out for next year and did not include the $500 million and the EPA basically is snubbing their nose at a court order. That's unacceptable and not right and not legal. So, we are working very hard to communicate to the EPA and to the White House that the $500 million at a minimum needs to be added back to the 2020 RVO. As it relates to the SREs, we also are pushing for reallocation of the last gallon, the 2.6 billion gallons that have been waived over the last couple of years and to spread that out over the reset of that renewable fuel standard. A good starting point will be that the 38 exemptions that are requested or in front of the EPA that at least some significant number of those are denied. We do expect in the next month that we will hear on that. And there is a lot of very focused direct advocating on that because that is what should happen. And then, the very important part going forward, and it's very clear in the renewable fuel standard, that the minimum 15 billion gallons of conventional biofuels is 15 billion gallons. And if there are to be waivers, the exemptions need to be reallocated to the balance of the obligated parties. So, this is a threshold issue for the industry. It's a threshold issue for the administration to stand behind what has been a very explicit commitment to the biofuels industry.

Yeah. Yeah. Okay, thanks. Maybe last one for Bryon just on the production costs. Obviously, came down and it was a pretty good margin in light of what's going on in the overall market. Should we look at that as the Pekin boiler costs being in the past? Is this in part a result of that? And then, maybe an update on just potential thoughts of getting back any of the costs associated with that?

It certainly reflects none of that. We had a year ago, same period, we were just finishing up some of the old boiler repairs and replacements. So, there was – I think we spent $6.5 million over the first six months of last year in finalizing or getting the final – the new boilers in place and returning the rental boilers and the like. I think that it actually also reflects improvements that we've been able to make at our facilities, whether it's in energy usage. A lot of focus that we continue to talk about is starting to be reflected in those numbers you had asked about. In regards to those boiler repairs, we remain confident in our position with regards to our legal position. These boilers weren't – they were something we inherited. We tried to do the right thing, get them repaired. They didn't – the repairs demonstrated that they were actually – that the boilers weren't manufactured correctly and they weren't adequate, and so we replaced them. And we feel confident in our position. Our hope is to be able to get significant recovery of those costs, but that's a long process.

Yeah. Okay. Thanks a lot.

Thanks, Eric.

[Operator Instructions]. Your next question comes from the line of Mr. Sameer Joshi. Your line is open, sir.

Hey, Neil. Hey, Bryon. Thanks for taking my question.

Good morning.

Good morning. Just to follow-up on Eric's question there. So, going forward, do you expect SG&A to remain at similar levels because of the continued realizations of these benefits? Or because production may go up, do you expect some increase moving forward in the SG&A?

I wouldn't say it's directly related. Especially SG&A, I wouldn't say it's directly related to production. There may be some correlation, but most of it had to do with, again, the combination of professional costs, some labor savings. We as well – we're self-insured. And our claims were significantly lower for the first half – for first quarter – excuse me, second quarter this year. So, our hope is that we will continue to be able to demonstrate that our people are healthy and good and working hard and we have good preventative program as well. So, it's still a little bit difficult, and that's why I didn't provide particular guidance. But I'm guessing that it will be somewhere – our hope is that it will be – on an ongoing basis at these levels. It may creep up a little bit. Just depends on what's happening in people's life.

Okay. Thanks for that. And then, as regards the macroeconomic and global demand, how do you see the 3 billion gallons shortfall that China has versus their production – what portion of that do you expect US to gather and how quickly once the trade disputes are resolved? And also, how does it play with the Brazilian ethanol?

The China demand is pent-up and ready to go. It's actually the one – the resolution of the trade dispute is the one most immediate shot in the arm for the ethanol industry that we could see here in the near term. There have been some discussions, again, obviously handicapped. When the trade dispute resolved is difficult, but it will get resolved at some point, and that will result in ethanol exports to China. We see that as a minimum 1 billion gallon market for US producers and it could be closer to 2 billion. It will take some time as trade dispute, among other things, has slowed their conversion to E10. So, what was initially a 2020 objective to get 10%, I'm not sure how that could happen today, but they would ramp into that and it appears that the commitment and the objective of doing that is still very much in play in China. Of late, there have been discussions about – as an interim step that agricultural products would be purchased by China and ethanol is in that discussion. Again, hard to handicap what happens and when, but we certainly have made it very clear that ethanol needs to be part of the discussion and it is. It's kind of a win-win. China needs and wants the ethanol and it would be very helpful to the overall industry. As it relates to Brazil, they continue to increase their own demand. Their sales of hydrous ethanol keep reaching record highs as the pure ethanol is selling at a very nice discount to gasoline. If you look at their – between their 27% blend and their pure ethanol, they now have a market penetration of ethanol in the gasoline market that's about 55%, which is pretty remarkable. Wish we could say the same thing here in the United States. That just shows that, when a country is committed and when consumers have choice at the pump, ethanol is a winner. But they have their renewable bio program that will be implemented over the next number of years which is going to further increase the demand for ethanol in Brazil. So, we continue to believe that US ethanol exports will be the ethanol of choice in world markets. There will be some competition from Brazil, but feel very strongly that US ethanol will be the principle player and that Brazil will not only continue to keep their ethanol at home, but will be an export opportunity to import ethanol to Brazil.

Okay. Thanks for the color on Brazil. That is helpful. As regards US government – coming back to the discussion you had with the previous two callers, I am seeing July spreads at round $0.29 currency relative to $0.32 and $0.34 in the previous two quarters. For example, in the second quarter, it was around $0.34 on average. Are you seeing even like in the last week or so that the crush spreads have improved a little bit from the $0.29?

We have seen that. It's again too early to call it a trend. But, yes, it's really the first half of July – most of July, they really took a turn for the worse and, as you point out, was worse than the second quarter. And in the last few days, combination of the corn bases lightening up as well as the ethanol spreads improving, we have a few pennies improvement in the crush spread.

Okay, great And then, one last one, I know Bryon mentioned CapEx. So, the first two quarters around $1.4 million and mostly for maintenance kind of expense. But for the next two quarters, is there anything planned improvements or any – what is the level of CapEx?

We provided originally guidance at about $4 million number. I would expect it to come in around that number.

For the whole year, right?

Yeah. For the full year.

Okay. Thanks, Bryon. Thanks, Neil. Thanks for taking my call.

You're welcome.

Thanks, Sameer.

I'm now showing no further questions at this time. I would now like to turn the conference back to Mr. Koehler. Sir, you may continue.

Thank you for joining us today and thank you for your continued support of Pacific Ethanol. We 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.