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Pacific Ethanol, Inc. (NASDAQ:PEIX)

Q3 2012 Earnings Call

November 13, 2012, 11:00 am ET

Executives

Becky Herrick - IR, Lipper/Heilshorn & Associates

Neil Koehler - President & CEO

Bryon McGregor - CFO

Analysts

Paul Resnik - Uncommon Equities

Operator

Good day, ladies and gentlemen and welcome to the Pacific Ethanol Incorporated Third Quarter 2012 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, today's conference call is being recorded.

I would now like to introduce the host of this conference call Ms. Becky Herrick. You may begin ma’am.

Becky Herrick

Thank you, operator and thank you everyone for joining us today for the Pacific Ethanol third quarter 2012 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 and then Bryon will provide details on the company's quarterly financial and operating results. Neil will return to discuss Pacific Ethanol's outlook and open the call for questions.

Before we get underway, let me first inform you that Pacific Ethanol issued a press release yesterday that provides details of the company's quarterly results. The company also prepared a presentation for today's conference call that is available for download on the company's website at, www.pacificethanol.net. If you have any questions, please call LHA at 415-433-3777. A telephone replay of today's call will be available until 11:59 p.m. Eastern Time on November 20, 2012, 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, November 13, 2012, and therefore, you are advised any 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 shows that some of the comments in this presentation constitute forward-looking statements that reflect management’s current views and estimates of future economic circumstances, industry conditions, company performance and financial results.

Forward-looking statements are based on many assumptions and factors. Any change of such assumptions or factors could produce significantly different results. Information about potential factors that could affect the company's financial results is available in the company's risk factors as updated in the company's SEC filings. To the extent permitted under applicable law, the company assumes no obligation to update any forward-looking statements as a result of new information or future events.

Also please note that the company's financial measures are 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 EBITDA as unaudited earnings before interest, taxes, depreciation and amortization and fair value adjustments. To support the company's review of non-GAAP information later in this call, a reconciling table is included in the press release the company issued yesterday.

It is now my pleasure to introduce Neil Koehler, President and CEO. Neil?

Neil Koehler

Thanks, Becky, and thank you all for joining us this morning to discuss our quarterly results. During the third quarter, we further executed on the plans we laid out at the beginning of the year to secure financial stability for the company and build a strong foundation for growth. On July 3rd, we completed a $12 million public equity offering. These proceeds combined with $10 million in senior unsecured notes enabled us to increase our ownership in the Pacific Ethanol plants from 34% to 67%. Consolidating our interest has given us greater strategic control of the plants and supports more efficient and cost effective operations.

On September 26th, we completed another public equity offering of $11 million, the proceeds from which we paid the $10 million in senior unsecured notes. We now have eliminated virtually all of our parent company debt. In addition, shortly after the close of the quarter, we obtained a new $10 million line of credit for the Pacific Ethanol plants from a group of existing lenders led by Credit Suisse. This line of credit provides near-term liquidity necessary in light of the current challenging margin environment. Over the next couple of quarters, we will be focusing on refinancing the remaining plant debt, at levels in terms that provide long-term stability for the operations of these assets.

We believe these steps have enabled us to build a stronger foundation for growth that positions us for profitability when market conditions improve. These are tough times in the ethanol business and our third quarter results reflect the challenging market environment. Nevertheless, we remain steadfast in our commitment to the long-term profitability of the business.

Ethanol producers have suffered in a year when record drought conditions in the Midwest have severely impacted the supply and price of corn. Corn costs have increased significantly while ethanol prices have not, thereby narrowing the spread. Many producers in the industry have idle facilities in response to these market conditions with now approximately 1.6 billion gallons of annual capacity currently idled. We have been moderating production at our plants and are keeping the Madera facility idled to match current demand and we’ll continue to adjust appropriately in response to market conditions.

In September, ethanol production fell to its lowest level since the Department of Energy started recording monthly biofuel production. Cash op margins in September were at historically depressed levels; while we cannot control macro factors that impact our business, we can’t control how we manage our business in response to these factors. Even with [following] margins, we have reduced the operating losses sequentially since the start of 2012. In addition, we continue to leverage the unique advantages we have as a western US marketer and producer of ethanol.

Our destination model continues to be a positive differentiator and positions us to compete successfully especially in times when market conditions are sub optimal. We have a variety of procurement options because of our western locations. We are able to access corn from a variety of suppliers and locations in the Midwest.

Local producers and international sources acceptable to western ports providing us with a steady supply of quality feedstock or keeping our transportation cost down. With our proximity to the West Coast ports, we have the option of accessing milo from South America.

We have and we will continue to procure milo when the opportunity exists to do so at lower cost in domestic corn. Milo has similar conversion properties as corn and during the third quarter, we used approximately 30% milo as feedstock in our production at the (inaudible) plant.

With margins at historic lows, ethanol production overall is down about 15% from its peak and currently annual demand exceeds domestic operating rates. Our peer had a slower pace and anticipated we are seeing an overall rebalancing of supply and demand. We will continue to monitor the market conditions and adjust our production accordingly.

Corn oil separation is an important part of our overall diversification strategy and we are moving forward with plans to implement corn oil separation at all Pacific Ethanol plants. Corn oil is a high value co product with multiple market applications and provides another opportunity to take advantage of our western US locations. It also further diversifies a revenue streams and contributes operating income to the plants. We will be selling corn oil to the local feed and bio diesel markets keeping our transportation and storage cost low.

And Magic Valley, the engineering and design phase is complete and we expect installation of equipment to begin later this month. We are on track to start generating revenue from corn oil production at this plant during the first quarter of 2013. At (inaudible) we expect to complete installation in startup of corn oil production by the second quarter of 2013.

At the other plants, we continue to work on the implementing corn oil production and we look forward to keeping you updated on our progress. Turning to our marketing business, we have carefully managed risk as we continue to balance output against demand and practice a conservative approach considering the current market dynamics. For example, total gallon sold by Kinergy are down about 12% year-over-year. This is an intentional outcome resulting from decreased plant production as well as tighter margins and has enabled Kinergy to operate with more stability.

Ethanol is a promising high performance biofuel that is a critical component of our nations long-term energy needs. Future demand for ethanol was supported by regulations above the state and federal levels. In 2012, the renewal fuel standard required conventional ethanol demand of 13.2 billion gallons per year; requirement goes up to 15 billion gallons per year of conventional biofuel by 2015 and 36 billion gallons by 2022 demonstrating the significant long-term demand for ethanol and other renewal fuels.

As more vehicles are improved for high level of blends gas and ethanol such as E15, the transition is an easy one for retailers. The necessary retro feed equipment is available and affordable right now. Retailers in the Midwest have already begun offering E15and others are coming on board.

As acceptance continues to grow and consumer demand follows, this is poised to be a very competitive market once E15 reaches critical mass. For consumers, E15 is a cleaner, cheaper, higher performance fuel than premium gasoline and is approved by auto manufacturers for vehicles 2001 and newer. In fact, more than 60% of the cars, trucks and SUVs on the road today are E15 approved.

Perhaps the most important to consumers is the fact that ethanol keeps gas prices down, reducing the cost of a gallon of gas by an average of over a $1 per gallon according to a 2012 report by economist at Iowa State University. In short, the demand for ethanol and E15 is significant and growing. We are well positioned to take advantage of the opportunity for E15 in the months and years ahead.

In summary, the third quarter of this year has been a very challenging time in our industry. Producers have experienced historically low margins and have had to adjust production levels and manage their businesses accordingly. We believe we have positioned Pacific Ethanol to take advantage of market opportunities once conditions improve. Our increased plant ownership improved debt terms, progress towards implementing corn oil separation and careful management of our marketing business all contributed to establishing a solid foundation for growth.

I would like to now turn the call over to our CFO, Bryon McGregor to review the numbers. Bryon?

Bryon McGregor

Thank you Neil. For the third quarter of 2012, we reported net sales of $215.9 million compared to $271.6 million in the third quarter of 2011. Net sales were down due to a 12% decrease in total gallons sold and an 11% decrease in the average sales price per gallon from the same quarter last year.

Gross loss for the third quarter of 2012 was $2.4 million compared to gross profit of $8.2 million in the third quarter of 2011. Gross loss decreased sequentially over last quarter despite a drop in average commodity margins. To put this in competitive perspective, our average commodity margin for the third quarter of 2012 which takes into account our average ethanol sales price, corn costs and total product return was 42% lower than the third quarter of 2011 and 10% lower than the last quarter.

So despite what was an even lower margin quarter, we were able to actually reduce the size of our losses through improved sourcing, risk mitigation and overall cost reduction efforts. SG&A expenses were $2.9 million in the third quarter of 2012 compared to $3.5 million in the third quarter of 2011. The year-over-year decrease in SG&A expenses was partially due to cost savings achieved through our increased ownership in the plants which enabled us to operate more efficiently using existing staff and resources to eliminate redundancies.

We expect to continue to achieve cost savings as a result of our increased ownership position in the plants. Loss available to common stockholders for the third quarter 2012 was $6.3 million or $0.05 per share compared to income available to common stockholders of $4 million or $0.12 per share in the third quarter of 2011.

Adjusted EBITDA which excludes fair value adjustments was negative $900,000 in the third quarter of 2012 compared to adjusted EBITDA of positive $2.9 million in the third quarter of 2011. This quarter’s adjusted EBITDA represents an improvement of 42% over last quarter when adjusted EBITDA was negative $1.5 million despite our enhanced ownership position and increased losses from the plants.

As a reminder, on July 13 we increased our ownership in the plants to 67% at attractive valuations compared with replacement costs and market valuations, and at a discount to our last purchase price. Our increased ownership position provides us with more control over the strategic direction of the plants. We believe the long-term outlook for ethanol fundamentally supports our consolidation of plant ownership.

For the nine months ending September 30, 2012, net sales were $619 million, compared to $659.4 million in the same period of 2011. For the first nine months of 2012, loss available to common stock holders was $14.5 million compared to income available to common stock holders or $4.2 million in the same period of 2011.

For the first nine months of 2012, adjusted EBITDA was negative $5 million compared to adjusted EBITDA of positive $5.6 million in the same period of 2011. Turning to our balance sheet, cash and cash equivalents were $18.7 million at September 30, 2012, compared to $5.7 million at June 30, 2012.

We raised $11 million in gross proceeds from the public equity offering that closed on September 26. In early October, we used $10 million of the proceeds to fully repay senior unsecured notes that would have come due in April 2013, with the remaining proceeds contributing to working capital.

At September 30, our current liabilities were $62.1 million, which included the $10 million of the senior unsecured notes we paid in early October, compared to $58.4 million at June 30, 2012.

As of September 30, we had total unused lines of credit of nearly $23.5 million, with immediate access to $4.9 million and availability. After the close of the quarter, we announced securing a new $10 million line of credit for the Pacific Ethanol plants. This secured loan will immediately provide liquidity for plant operations in the current challenging market environment. It also provides for a lower interest rate than the current plant debt, with an option to capitalize interest payments through maturity in June, 2013.

In accordance with goals we established all this year, we continue to address restructuring the plant (inaudible), which we have found to be more advantageous in times of greater market volatility. This new line of credit for the plant provides us with the near term liquidity to operate the plants while continuing our work in this matter.

We remain committed to maximizing long-term value, and ensuring stability by carefully managing current cash balances and approving terms of the remaining plant debt.

With that I would like to return the call to Neil.

Neil Koehler

Thanks Bryon. We remain diligently focused on implementing the strategies now that will allow us to thrive when market conditions improve. We have taken steps to strengthen our balance sheet, reduce costs, enhance liquidity and reinvest in core assets. The industry is right for growth over the next several years and we will continue to take advantage of long-term opportunities despite near term challenges.

We remain committed to our key strategies for growth, which include improving yields and driving cost efficiencies at the plants, continuing to evaluate opportunities to introduce additional revenue streams, exploring opportunities to produce advanced bio flues within our existing plants using locally sourced alternative feed stocks, enhancing liquidity and obtaining favorable terms for refinancing the remaining plant debt and reducing expenses, growth market share and building the foundation for profitability.

The steps we have taken during the third quarter have positioned us for growth. We remain steadfast in our commitment to the long-term value and promise of our business. We look forward to keeping you updated on our progress.

With that Kevin I would like to open the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Paul Resnik with Uncommon Equities.

Paul Resnik - Uncommon Equities

With regard to your reacquisition of the plants; can you put some numbers on that, why your acquisition costs were down has been relative to replacement cost per gallon?

Neil Koehler

Sure, if you look at the averages of all of the purchase we have made and as we have been reacquiring these assets on an enterprise value basis both the debt and the equity comes in right around $0.75 a gallon or slightly less. We think that’s highly attractive, certainly replacement cost are above $2 a gallon. The most recent acquisition we have seen even in these depressed market conditions was a purchase of a plant at Nebraska by Flint Hills subsidiary coke and that was close to a $40 per gallon.

So we are feeling very good about the oil and price, and as I think Bryon mentioned as we have been incrementally buying the price has been coming down a little bit. So it’s strategy is working well and we feel we have a very low cost of these assets.

Paul Resnik - Uncommon Equities

With regard to corn oil, what impact if any does that have on WDG production when you start getting corn oils byproduct?

Bryon McGregor

Paul, the corn oil right now is in that product and it comes through both the west storage grain and the liquid feed that we sell. So any corn oil that's extracted means you are selling not much less WDG, but added a very good trade because you are levering up something that has four to five times more value as pure corn oil than it does as a component in the distiller grains.

Paul Resnik - Uncommon Equities

And lastly the Madeira plant, obviously these are very difficult times to start up the fourth plant. How long would it take to start that plant up once you had made that decision?

Bryon McGregor

We have kept the Madeira plant in impeccable condition for starting up. We have a very good oil staff that is at that facility continuing to maintain all of the equipment, keep it greased, keep it turned, keep it clean and within 60 to a maximum of 90 days, but really closer to 60 days we could start that plant up.

Obviously in this environment when people are idling plants, we are not immediately focused on starting up that plant, but I will tell you that as we look forward with the low carbon fuel standard in California and what we believe will be the increasing demand for what is becoming a smaller supply of lower carbon ethanol to meet California’s increasing compliance requirements under the low carbon fuel standard, we do believe that the ethanol from that facility is going to be in demand in the future.

Operator

(Operator Instructions) I'm not showing any further questions at this time. I would like to turn the conference back to Neil for closing remarks.

Neil Koehler

Thank you all very much for participating in the call today, and we look forward to speaking with you next quarter. Have a great day.

Operator

Well ladies and gentlemen this does conclude today's presentation. You may now disconnect and have a wonderful day.

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