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Green Plains Renewable Energy, Inc. (NASDAQ:GPRE)

Q3 2011 Earnings Call

October 27, 2011 11:00 am ET

Executives

Todd Becker – President and Chief Executive Officer

Jerry Peters – Chief Financial Officer

Jeff Briggs – Chief Operating Office

Steve Bleyl – Executive Vice President of Ethanol Marketing

Analysts

Michael Cox – Piper Jaffray

Matt Farwell – Imperial Capital

Brent Rystrom – Feltl

Lawrence Alexander - Jeffries

Patrick Jobin – Credit Suisse

Farha Aslam – Stephens Inc

Luke Beltnick – TPG Credit

Ben Callow – Robert W. Baird

Operator

Good day, ladies and gentlemen, and welcome to today’s Green Plains Renewable Energy, Inc. Third Quarter 2011 Financial Results Conference Call. As a reminder, this conference is being recorded.

At this time, I would now like turn the call over to Mr. Jim Stark. Please go ahead.

Jim Stark

Thanks, Nicole. Welcome to our third quarter 2011 earnings call. On the call today is - Todd Becker, President and Chief Executive Officer, Jerry Peters, our Chief Financial Officer, Jeff Briggs, our Chief Operating Officer and Steve Bleyl, Executive Vice President of Ethanol Marketing, on the call today as well for the Q&A session.

We are here to discuss our third quarter 2011 financial results and recent developments for Green Plains Renewable Energy. There is a slide presentation for you to follow along with as we go through our comments today. You can find this presentation on our website – www.gpreinc.com on the investor page under the events and presentations link. Our comments today will contain forward-looking statements which are any statements made that are not historical facts. These forward-looking statements are based on the current expectations of Green Plains’ management team and there can be no assurance that such expectations will prove to be correct. Because forward-looking statements involve risks and uncertainties, Green Plains’ actual results could differ materially from management’s expectations.

Please refer to page two of the website presentation, and our 10-K and other periodic SEC filings for information about factors that could cause different outcomes. The information presented today is time sensitive and is accurate only at this time. If any portion of this presentation is rebroadcast, retransmitted or redistributed at a later date, Green Plains will not be reviewing or updating this material.

I will now turn the call over to Todd Becker.

Todd Becker

Thanks Jim. We’re glad you could join us on the call today. First of all, we had a strong performance from our non-ethanol production segment in Q3, generating $13.7 million or 40% of our segment’s operating income. We have now demonstrated that our goal of $50 million of non-ethanol operating income can be achieved, and we are looking for ways to further increase this contribution to the bottom line.

This is a culmination of our work over the last couple of years to minimize the ups and downs in the cyclical ethanol production segment. This will allow us to remain profitable and continue to service our debt and generate free cash flows during times of margin compression. Ethanol margins did show good improvement in Q3, when compared to Q2 2011, as we generated $20.9 million of operating income from the ethanol production segment; the highest level on a quarterly basis this year. For the tenth consecutive quarter, we reported profitable results with fully diluted earnings of $0.32 a share on net income of $12.4 million.

Corn oil, again, made a significant contribution to our profitability, generating $9.6 million of operating income in Q3. For the last three quarters, corn oil production has generated over $18 million of operating income for our company. The payback on this investment was less than a year, and as a reminder, the cash flow generated by this segment flows freely to the corporate entity and is unencumbered at the ethanol plant subsidiaries. Our Tennessee agribusiness operations have helped reduce some of the seasonality typically seen in this segment.

We saw an improvement in agribusiness in Q3, generating $2 million of operating income, which was $1.5 million better than Q3 2010. The business benefitted from an excellent Tennessee soft wheat harvest. Our grain storage expansion projects have also been completed, bringing our storage capacity to 37 million bushels overall. We are confident this will be an excellent investment for the long term. We produced and sold 185 million gallons of fuel-grade ethanol; 534,000 tons of distiller’s grains; and more than 32 million pounds of corn oil from our plants during Q3 2011.

We have built a foundation of our business on risk management and operational excellence, while operating our facilities in a safe environment. It is our belief that the solid base we have constructed will allow us to sustain our business model for the long term, and it gives us confidence to continue to grow as opportunities come along.

Now I’ll turn the call over to Jerry to review our financials in more detail, and then I’ll come back and cover industry topics, the ethanol margin environment, and our current outlook for the company.

Jerry Peters

Thanks Todd; good morning everyone. Looking at the consolidated income statement for Q3 2011, our revenues were $957 million for the quarter, up 93% when compared to the comparable quarter in 2010. The increase was mainly due to an increase of ethanol we produced at our own plants, which was $56 million gallons higher than last year; as well as an overall increase in commodity prices. We acquired the Lakota and Riga plants in October of last year, and the Otter Tail plant in March of 2011, which accounts for most of the volume increase between the periods. Corn oil production contributed $15.5 million in revenues in Q3, based on 32.7 million pounds of production.

Agribusiness segment volumes were also up, as we sold 5.4 million more bushels of grain in Q3 2011, compared to 2010, and revenues were up 43% year over year. Again, commodity prices account for a large portion of the revenue increase. Higher commodity prices versus the previous year continue to affect revenues and cost of sales in each of our segments. In ethanol production, we experienced an 80% increase in the average cost of corn, per bushel, in Q3 2011 as compared to 2010. Even with the increase in corn costs, as you can see on slide four, we generated per gallon operating income before depreciation of $0.17, compared to $0.19 per gallon realized in Q3 2010. The $0.17 per gallon in Q3 2011 was a $0.05 per gallon improvement over Q2, and is well above our debt service of $0.10 per gallon, as noted on page eight of the slide deck.

Although we generated $47 million of gross profit for Q3, a 48% increase over Q3 2010, consolidated selling, general, and administrative expenses increased $2.7 million quarter over quarter, which is the result of the larger scope of our business in Q3 2011 versus 2010, and due primarily to the acquisitions we completed over the last 12 months. Our consolidated operating income increased by approximately $12 million, or about 70% in Q3 2011 compared to last year. Again, corn oil accounted for about $9.6 million of that $12 million increase.

Interest expense was higher, by $2.9 million, due to higher debt levels as a result of the acquisitions we made, and the convertible notes we issued late last year. Our effective tax rate remained at about 36%, and as a result of higher pre-tax income, tax expense increased $3.9 million compared to last year. Earnings before interest, income taxes, depreciation and amortization, or EBITDA, increased $15.5 million for Q3 to $41.6 million, and on a trailing 12 month basis, totaled approximately $147.4 million. Our liquidity remains strong, with a total cash position, as of September 30, of just over $154 million.

During Q3, we utilized about $12.5 million of cash for principle payments on our term debt, about $8.5 million for capital expenditures, and about $14 million for the share buyback we completed. As of September 30, we total ethanol plant debt was $471 million, or $0.64 per gallon. We have worked consistently to drive this ratio down, and when you look over the past two years, we’ve reduced ethanol plant debt per gallon by $0.22, even with the addition of three ethanol plants over the last 12 months. In the agribusiness segment, we’ve been working to expand our revolving credit facility to finance more and higher priced grain inventories.

As we noted in the release yesterday, we expect to close in the next few days on a $195 million revolving credit facility and a $30 million term loan for this business. This new line of credit should provide more flexibility for future growth, if necessary, through a $55 million accordion feature, and an ability to use repurchase agreements during periods of peak need. With these new facilities, we believe our agribusiness operations are well positioned financially to maximize the opportunities in this business. Todd, I’ll turn it back to you.

Todd Becker

Thanks, Jerry. Throughout the ethanol cycles of the last three years, where you’ve seen volatility in the ethanol margin environment, our platform has stood the test of time and continues to generate consistent profits, which is what we have told you we are focused on. Our optimism about the future of ethanol in the US remains intact, in light of all of the ongoing noise and news that comes out of our nation’s Capitol. The fact is that we believe ethanol is competitive with gasoline without the tax credit.

Our five main fundamentals, which we have outlined in the past, are still very much intact; first, the RFS expanse of 13.2 billion gallons in 2012, which provides a consistent demand base for our product. I’m sure you’ve seen the renewable fuel standard has come under attack in recent weeks by the House of Representatives; although we don’t believe any attempt to modify the RFS will be successful, we plan on defending it vigorously as it is the only significant piece of national energy policy that reduces our dependence on foreign oil today.

Secondly, export demand remains strong, as the US has exported 641 million gallons for the first eight months of 2011. We are on pace to export 800 million gallons by the end of the year. We believe the overall export fundamentals are in place for a solid finish to 2011, and a good start to 2012. Third, ethanol remains a discount to wholesale gasoline through all of 2012, to both obligated parties and discretionary blenders, both have an incentive to blend at maximum levels.

Fourth, along with the profitability mentioned already, sub-grade 84 octane production is in full-swing in the United States. In many of the largest markets, gasoline cannot leave the terminal without blending with 113 octane ethanol, which by the way, we believe provides the refiner with an additional $0.04 to $0.05 per gallon of profit. And finally, the E15 initiative remains a potential demand increase over the next 12 to 24 months. NASCAR has now run E15 over one million miles and has stated that they had better performance with very little impact in mileage; we hear some teams actually have seen a mile miles per gallon increase.

While the macro industry factors are solid, for Green Plains it is about risk management, operational excellence, and providing a safe work environment for our employees. We know this sounds repetitive, but it is what will continue to make us successful in the commodity processing business. We continue to employ very comprehensive risk models in the execution of our margin management strategy. In terms of our outlook for the remainder of 2011, as you can remember, we started to lock Q4 margins in October of last year, in 2010, for 2011.

We are mostly done with Q4 from a financial crush standpoint, but it has been challenging in recent weeks to attract some of the final new crop corn needs, as the physical corn basis around our ethanol plants and in the United States remains very high for this time of the year. This could have some effect on how we finish up the year, depending on the timing of the completion of harvest, and farmer’s willingness to sell their new crop corn. We have never seen basis levels this high across the corn belt at this time of the year.

As we have told our shareholders since the inception of our company, sudden spot margin improvements will provide a limited benefit to us and that is the case in Q4 as well. Our margin management strategy causes us to lag rapid margin expansions, but outperform during margin contractions. While we still believe our ethanol segment will perform well in the quarter, we will not change our strategy to accommodate a quick win. If we took that view, our performance year to date would not have been as good. We operate and lock and look at margins as far as 18 months out forward, and start to lock margins away when we can service debt and provide returns for our shareholders. A good example of that is the daily Q3 crush for our platform average, since the beginning of the year $0.10 a gallon, while we achieved much better levels. We did not start to lock in any large amounts until we saw a Q3 expansion in June.

When the crush expanded, we moved quickly to lock away the margins you saw today, even though spot margins during the month may have been higher at times. We have over $1 billion of capital invested in our business today, and we believe besides the consistent risk management strategies, scale is extremely important to maintaining our low cost producer status, which is vital to our business and managing the volatility around our markets. Corn oil extraction technology deployment was a valuable project for us to embark on in October 2010. As we did with out ethanol production, we are working on de-bottlenecking this process as we learn more about the technology and we believe we can see marginal improvements in extracting the residual oil out of the process. We do expect a strong quarter from agribusiness, with a good harvest activity near all of our elevators.

On an overall basis, we continue to be confident we will finish the year with a stronger quarter than we just completed. BioProcess Algae and Green Plains recently announced the successful completion of the first round of poultry feed trials. We’re excited about what we have seen in these feed trials, as there has never been any large scale poultry feed trials done in algae before. We will continue with further testing; and we are now working on developing a replacement for the fish meal market, which is approximately a 10 million metric ton market annually, on a global basis. These are big markets we are focusing on; we believe that the economics for these markets provide profitable opportunities for BioProcess Algae in the future. Initially, as we grow up the platform, we will go after the higher value nutraceutical and Omega 3 markets, but can see moving to feed markets as we continue to expand our algae production capabilities.

What we think about every day is the path to profitability; if there’s no path, then a project will come to a stop, but nothing is telling us that we should stop this project. We continue to invest capital as a partnership, and we’re going to continue to commercialize this technology. We should break ground on a five acre farm later this year, and begin producing algae next year from these reactors. Hopefully, by the middle of next year, we’ll begin developing a 400 acre facility at Shenandoah, Iowa, taking the CO2 from our plant, converting it into biomass, then further into feed, food, or a fuel product.

We announced a stock repurchase in early September; our largest investor, NTR, was looking to rebalance some of their renewable energy portfolios. We bought back $28 million of their stock at $8.00 a share. NTR has been with us since the beginning, and remains our largest and one of the most committed shareholders we have, at over 23% of our shares outstanding. We think that was a good transaction that gave them some liquidity, but also demonstrated our confidence in our long term strategy to deploy capital in a stock repurchase. As well, at $8.00 a share, it is about the cheapest ethanol plant you can buy in the United States today, of the highest quality.

In closing, the M&A front has been quiet, but we continue to search out opportunities, both externally and organically, to grow our company. At this time, we are evaluating several potential opportunities in all parts of our business and remain focused on growing all of our business segments profitably, and providing long term value for all of our shareholders. I want to thank ou for calling in today, and now I’d like to start the question and answer session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions.) We’ll take our first question from Michael Cox from Piper Jaffray.

Michael Cox – Piper Jaffray

Good morning, congratulations on a nice quarter, guys. My first question is on visibility into ethanol production margins as you look ahead to 2012. I’d be curious how successful you’ve been at looking ahead and locking in margins, in light of the basis movement you described here in corn recently.

Todd Becker

Yeah, the curve has provided some opportunities using very conservative estimates on what it’s going to cost to buy your physical corn. I think nobody really knows, after the first of the year, where the US domestic corn basis is going to go, but I think using historical basis levels, then anybody’s calculations today will probably not work for the next 12 months. So I think you have to use a much firmer outlook on the physical corn basis, the crops all over the corn belt. With that said, we have seen some opportunities in Q4 of next year, again, to lock in margins actually in kind of the mid-20s cents per gallon, based on again, conservative estimates on the corn basis. We saw some opportunities here recently in January, and Q1 to lock in some margins kind of mid to high-teens-ish kind of numbers. The middle of the year is still playing out, with really no visibility, but this time last year we had no visibility as well. And then finally, when you look at it, and whenever we see those opportunities, we’ll obviously take a look at locking margins away up forward. But we want to make sure this year, as we did last year, that we get some physical corn bought before, so we know exactly what our corn costs will be over the coming 12 months.

Michael Cox – Piper Jaffray

Sure, that makes sense. In terms of capital deployment, with the progress you’re making in the BioProcess algae, I guess how do you assess the priorities between putting more money into that project versus kind of growing the core business or, I guess M&A as well, but I’d be curious how you think about prioritizing investments in the different growth opportunities.

Todd Becker

To date, obviously our investment has been more on the development side of the BioProcess Algae platform; we look at the five acres that we are going to break ground on here hopefully in the next couple of months, we’ll only get broken ground if there’s a profitable outlook for those five acres of product. Right now, we see good interest in the raw wholesale algae that would come off those five acres, and we believe from a CAPEX and OPEX standpoint, if we build the five acres it will be profitable. But again, it will just compete for capital the same way everything competes for capital in our platform.

When you look at the kind of bigger – I’ll look, if we build the 400 acre facility, and then spread that across all of our plants, obviously capital needs will be much greater, and we wouldn’t move forward unless we saw a very high return on capital from that standpoint, with very good uptake agreements in place. So all those kind of have to come in for us to deploy capital, and don’t forget; we’re only 35% of the partnership, so there’s 65% of other partners that have to deploy. Then at that point, we’ll make the determination whether it’s a debt or equity infusion as well.

And so we think that if we continue to build; if you see us continue to build, you’ll know that we have – it’s a profitable venture and it has competed for capital well. When we look at our other segments, obviously they have to think about it the same way. So if we look at expanding our terminal business, expanding our grain business, or even looking at additional ethanol production, they all compete for capital from the parent.

Michael Cox – Piper Jaffray

Okay, that’s helpful. And my last question, on the agribusiness side, a healthy increase across the board, and I’d be curious as to your outlook on the fertilizer side, in particular. I know you’ve made some good strides there, stepping up your share, but as you look at application rates for the fall and looking into the spring, what’s your outlook there?

Todd Becker

From our standpoint, we’ll be very steady from what we’ve seen in the past in terms of sales from the last – we’ve improved last year, and I think we may see a small improvement this year. But in general, application rates could be similar. I don’t have those statistics right in front of me. But really, from our standpoint, I think what we’ve been able to do is stabilize those earnings, make them consistent. And really where our growth is coming from is by making investment in the space, with the additional storage we built this year; especially in Tennessee, where we’ve seen great returns on space. Especially around the soft red harvest this year; so fertilizer, we don’t see a ton of growth coming out of that, we see more coming out of the earnings again to our assets.

Michael Cox – Piper Jaffray

Okay, great; thanks a lot guys.

Todd Becker

Thanks Michael.

Operator

And we’ll take our next question from Matt Farwell, from Imperial Capital.

Matt Farwell - Imperial Capital

Good morning. I just want to look into a couple of things. First is on your commentary about basis. What is the historical average, and how far away is the basis currently, at this point?

Todd Becker

If you take a look at, go up to even northwest Iowa, and typically this time of the year you could be paying $0.25 to $0.40 under for corn across the dump. While some of that still happens from off-farm, typically to buy any commercial – any real quantities of corn, some kind of commercial, if you’re an ethanol company, it’s taking at least $0.05 under to kind of $0.05 over-ish kind of values. So we’re at $0.25 to $0.40 higher than historically on corn. If you go to Indiana, where the harvest hasn’t really started yet, and that’s part of the problem, is that harvest got pushed back because of rain; you know, Indiana this time of year could be a $0.10 under market, and you’re paying at high as $0.41 to $0.60 over for corn across Indiana today, and Ohio.

So you’re seeing a pretty significant increase, so a lot of people look at sort of the Bloomberg simple crush, and say “Oh, my goodness. Look at how big margins are.” But I think you have to discount some of that. I mean, they’re still good, but you have to discount some of that because of the higher cost of physical corn, than we’ve ever seen in the past. What you have to remember is our carry-out last year was about a month of usage, so with the crop getting pushed back, you really went into those stocks pretty hard, which left most of the commercial and farm space empty by the time we get to harvest. So a lot of that’s getting put away, getting put in storage, getting put on deferred pricing, and they locked down the farm.

So it just takes more and more to get – and we saw a break in the harvest of corn from kind of the mid to high $0.07’s to low $0.06’s, and even into the $0.055 range. If you look at that, you’re getting close to cost of production in kind of – including land costs, in Iowa and Nebraska, and you’re just not going bring that much corn out of storage at that point. So the job of the market is do the basis first, then the spread next, then the price; hopefully that will react as well.

Matt Farwell - Imperial Capital

And based on what you’ve seen so far for new crops, in the moisture and density specification, can we anticipate a reduction in conversion yields for the coming year?

Todd Becker

It’s a little early to say. We’ve seen some areas with lower yields, to start, because of the high moisture that came in early; and then as the crop dries out, those yields start to pop back up. It’s a little early to say, except the first indications is that yields will probably not be as good as last year, across the industry. But again, it’s a little early to come to final conclusions. It won’t be a dramatic difference; but in general, with the little bit wetter crop, maybe a little lower test weight, and the starch, you might see a slight drop in yields this year.

Matt Farwell - Imperial Capital

Slight meaning, you were in the sort of high 2.7 range?

Todd Becker

Actually, the last 12 months, this crop here, we were in the 2.82-ish range.

Matt Farwell - Imperial Capital

Right, but prior to this year?

Todd Becker

Prior to last year, I think the year before that we were about 2.77, 2.76. We will be, I’m not sure we’ll still achieve the 2.82, 2.83 levels, but I would say there’s still a chance that it’ll be above 2.80 this year.

Matt Farwell - Imperial Capital

And lastly, we’ve seen a pretty large bump in ethanol production nationwide. Would you characterize that as plants coming back online after scheduled maintenance? Or it is a result of the improvement in margins?

Todd Becker

Yes. It’s a little bit of both, right? So we went down into mid-850 today, in terms of daily production, barrels per day; and now we’re back around 905 to 910 barrels per day, which kind of runs you – and year to date, I think we’re still running over 900,000 barrels per day, which is running into more of that 13.8, 13.9 mark. I don’t know that there’s any new production coming out because of margins. I don’t think actually there was a lot of production taken off, really since Q2; the drop came for scheduled maintenance.

You have to think when you are scheduling your maintenance for Q3 and Q4, when you were looking out at a curve in March, April, May, looking at when you’re going to schedule your down times, there was no visibility at all and the lowest margin environment was late September, early October. And that ended up being a good margin environment where you had to take your plant down, because you scheduled it a long time ago. But yeah, I think in general, we’ll still be over 900,000 barrels per day for the year, and then we’ll see how we end up for next year.

But if you look at that, running at 13.8, 13.9, and with demand at a 13.2, with exports next year, it could be again, 400 to 600 million gallons. You potentially go right up to those levels, and so I think there still could be good supply and demand equilibrium albeit we’ll have a bit of wait and see on different parts of the curve.

Matt Farwell - Imperial Capital

Okay great, thanks for the color.

Operator

And we have a question from Brent Rystrom from Feltl.

Brent Rystrom – Feltl

Good morning guys. Just a couple of quick questions for you, Todd. I don’t know if you saw the data yesterday out of Datagro out of Brazil, but they cut the higher ethanol production there again, another 3%, down now 20% from where the year kind of thought it was going to start. Does that imply, the next four or five or six months, some upside to export volumes?

Todd Becker

Yeah, I think – we’ve seen very good demand through the end of the year, and some of that is due to good competition versus a tax credit expiring domestically versus export; we’ve seen very good physical demand in Q1 from an index standpoint. Obviously financial margins will a little bit of time to transpire, but there is good physical demand in Q1 at a better rate differential than we’ve seen at this time of the year last year for Q1. Not seeing much in Q2, hearing some products talking about moving north again, out of Brazil and into the US; but I think that will be a politically always difficult when you’re in a short sugar crap and you’re fighting for ethanol production with very high levels.

I think one thing that we see is from our platform, with four or so plants we have that can make export spec now, we have been producing and shipping Brazilian spec ethanol. We don’t sell it; we sell it delivered to whatever port they want it in the US, and then they load it on a boat. But we’ve seen good demand for Brazilian spec ethanol; we’ve been hearing there’s some continued reduction on the spec to get more ethanol in to temper their market. So we have the view that at least for Q1, we’ll continue to see export demand, and we’ll have to wait and see what the Brazilian looks like after that.

Brent Rystrom – Feltl

And when you say seen some things that it might go the other way, I’ve been seeing data about export licenses being pulled in Brazil to export ethanol here. Is that kind of what you’re referring to for the back half of next year?

Todd Becker

Well, you’re hearing in Q2 and Q3 that there is some product that with the California market wants to move up north, based on the different [rins] that they get for that product; but in general, I would think that again, as you say, the licenses to do that will again face challenges this year, as they faced last year, when they saw Brazilians starting to think about coming to the US. I think the government stepped in down there and got pretty tough on those guys, because there are shortages already in Brazil.

Brent Rystrom – Feltl

Not to mention the port problems they have usually getting out of there. Out of curiosity, any thoughts on bidding for acres this winter? When you look at kind of where the fertilizer prices are setting, it implies that corn’s going to have to be someplace between 670 and somewhere in the 8’s, with prices sitting up where they are now. It’s likely they’ll pull back some next year, but any thoughts on how you think the bidding might go here, next quarter, for you guys? How that might impact you?

Todd Becker

I’m a bit confused. The what?

Brent Rystrom – Feltl

Well, basically from a bidding process, essentially different industries bid up the price of various products to try to force –try to lead [makers of corn] into the 92 or whatever the number might be…

Todd Becker

Okay, I got it.

Brent Rystrom – Feltl

Just thinking how you might think about that, and how we might think about how that could impact for Q2 operations.

Todd Becker

Well, I think if you look at cost of production right now, and you take a sample kind of middle of Nebraska to farm, and you look at their production costs versus fertilizer, and land cost, they need to be over $5.00 a bushel right now to break even. So with a 30 under Nebraska corn basis, futures have to be at least $5.30 to break even, and then you have to go up from there to compete with soybean. I think that the US farmer is in a rotation of more corn, and especially with the economics that they’ve been able to realize that some of these higher spikes, into the mid-sevens again, and again probably not selling much today.

They came into the crop about 40% sold or so, so a lot of those are at the higher levels, so they’re in very good position right now, financially, and I think when they look at the last couple of years, where they got their best returns, it was consistently from corn, and I would expect that they’ll try and plant the maximum amount that they can and there’s early numbers out; 93, 94, we don’t have a view yet just on that. But I think that if they’re going to plant something, they’re going to continue to try and plant corn and see if they can get a yield bump next year versus this year.

Brent Rystrom – Feltl

Alright, my final question then, just any thoughts you might have on the Chinese situation? Officially coming out and saying they’re going to need five million tons this year, and talking about the significant growth for the next several years? How does that weigh into your consideration for how you might have to compete for that?

Todd Becker

I think that is the single biggest component to the corn market that we’re going to have to watch in the next five years, the China demand. Whether it’s going to be a five million ton or a 20 million ton need; we look at them, I think they’re well bid on the breaks. When corn got into the mid-fives, again, I think the Chinese were well bid for some more. I think they understand the sensitivities of not buying too much, to drive us to very low [carryon] levels, but I think they’re there to support the corn market and I think that is not going to go away anytime soon. And that is obviously impactful to long term agricultural pricing in the US.

Brent Rystrom – Feltl

Thank you.

Operator

And Lawrence Alexander from Jeffries has a question.

Lawrence Alexander - Jeffries

Good morning. I guess a quick question on the BioAlgae. Is anything, as you’ve been working through this process and the initial demonstration phase, has anything changed in your assumptions about your capital requirements for scale up? How quickly you would scale up? Your sort of initial response from other people in the downstream markets who may or may not be interested in the product?

Todd Becker

Nothing’s changed so far. I think since we’ve opened up the horizontal reactors in Shenandoah, coming out of the building with the water from the large verticals, we’ve seen even more interest now that people have seen that we can produce. When you look at the five acres that are coming on, there’s going to be approximately a little under a ton a week produced off those five acres, and kind of dry wholesale algae is what we’re looking at from that production; a little less than that on a per week basis. But I think that again, making sure that there’s an end use market and first and foremost, it’s mostly around high value nutraceuticals and Omega 3s and then the fish meal, and I think it’s a function of it you have the product, there’s demand for it. Especially from the dry wholesale perspective. So nothing’s changed from that standpoint. We have still lots of interest around the product, and getting the hands on the product, we have a lot of people’s hands both in poultry fish meal, companion animals, all the way into refiners and other uses of high value nutraceuticals. They have our product in there hands and they’re testing it and telling us what they need. For example, an Omega 3, in an animal, you’ve got to make sure the color doesn’t affect some of the waste that comes out of the animal; so you might want to grow a darker variety instead of a more green variety. So those things are things that we have to do for some of our interest these days. When you look at it from OpEx, CapEx standpoint, so far everything we’ve seen from a scale up perspective is staying steady to what we’ve been indicating in the past, and we believe that we can continue to drive even more cost out of our capital expenditure model as we continue to scale up. We’ve seen great productivity out of our horizontal reactors; we’re harvesting them almost on a daily basis, and then converting it to dry wholesale algae and getting as much into as many people’s hands as we can.

Lawrence Alexander - Jeffries

And are you yet seeing any interest from people who have other high concentration to sources looking at the technology? Or is it the interest mostly coming from downstream?

Todd Becker

No, the interest is coming from there as well. We have several discussions with CO2 sources, from small scale local utilities to large scale utilities, and any and all of the above. They look at this as a potential to CO2 absorption, not just sequestration, where they can then create a biomass that can be used for many sources. So yes, we have interest from that sector as well. But again, for us, this is all about not getting ahead of ourselves; making sure we put those five acres in the ground and making sure we can grow and harvest the algae at the production rates that we say; scale up against the CapEx, keep out OpEx steady and produce a product that’s profitable, and we believe that that’s what the five acres will show the market and it definitely will make the decision on the bigger scale ups. But I think that when we look at the parties that look at from a CO2 standpoint, we actually have some reactors at a refinery today going off CO2, and so we would expect that that initiative would also increase over the coming year.

Lawrence Alexander - Jeffries

When did you put the reactors at the refinery?

Todd Becker

It’s just a small scale double – single vertical reactor that is sitting at a refinery today at very early testing. So it’s nothing that’s hugely material, but we wanted to get at least our first view of what that looks like. We would expect that we’ll have other opportunities to place other reactors at other locations as well.

Lawrence Alexander - Jeffries

And then on the M&A pipeline, can you characterize at least sort of the mix? Is it fairly balanced between upstream and downstream acquisitions? Or have you shifted your focus in one direction or the other? Any sense of what the landscape looks like? And also, are valuation (inaudible) coming down, or are they moving up?

Todd Becker

In terms of – we are looking at all three of our segments. We are looking at several, both organic as well as external opportunities in agribusiness. We are evaluating opportunities all the time from that perspective. We also think there are some opportunities again next year to expand our own space ownership, and build some additional space; especially in our Tennessee assets. I think we’ll probably begin to evaluate those opportunities; externally we have several opportunities that we’re looking at today, valuations are really all over the place, depending on whether it’s a single elevator or a business that’s in place today. In the ethanol segment, there’s several opportunities that are out there today, around some pretty good plants, but valuations are still continue to remain high. It takes, from our perspective, we think it takes at least $1.20 to $1.30 a gallon to buy high quality, right technology, right location, ethanol plant. And those bids, we think, are well supported. So when you look at that, we have to look at that over the long term to say is that really, do we want to plug capital into that? When it’s maybe a bit below our current valuation, but that is what it takes to buy, in our opinion, a good ethanol plant in a good location. And then downstream, we have several terminal projects under valuation right now, both from small scale to large scale, but we’ll see where those end up. But we are putting a lot of time and attention in our downstream business. Between distribution of additional products as well as building out our blendstar terminal platform, and we’ve now moved to Nashville, as we’ve been testing our systems for blended gasoline. We are just about kicking off a large scale initiative in that area as well, across some of the other facilities. Any and all of the above from the standpoint of expansion, and we are heavily focused on growing all of our platforms.

Lawrence Alexander - Jeffries

Thank you.

Operator

(Operator instructions). We’ll move on to Patrick Jobin, from Credit Suisse.

Patrick Jobin – Credit Suisse

Great, thanks for taking my question, and an impressive quarter. So it seems like you’ve demonstrated that you can take advantage of the volatility and attractively secure margins above the curve, and Q4 is looking relatively strong over the last few quarters, but the basis is reducing some of that. So I guess previously you had stated that Q4 might be up relative to Q3, from a margin perspective. I guess where do you see Q4 ending up, just from a range, if you had to put it on today?

Todd Becker

I think overall, the business will perform; at this point it’s showing that it will perform better overall than Q3, and in all of our segments at this point. We still have some work to do on the final physical corn purchases at some of our plants, but at this point, based on final yields as well, there’s a couple of points we’re looking at that we discussed on the call; yield, basis levels, and some final things around those. In general, we’re still tracking higher than Q3. I think people, when they look at the spot margin, and maybe temper that a bit with higher corn basis levels; you know, we locked in October over the last year, so again, while we may stare at our board and be frustrated that we’re not achieving the absolute highest spot margin, we stared at our board in Q2 and we’re really happy that we weren’t achieving the absolute lowest spot margins either. So I think we’re still close to what we’ve been saying in terms of Q4, and we still expect a sequential growth quarter versus Q3.

Patrick Jobin – Credit Suisse

Okay, and then on the corn oil segment; I guess now all nine plants are operating; how should we look at the run rate contribution there? And you suggested maybe some de-bottlenecking efforts for more extraction; I guess what do you think the potential is, or how should we look at that segment over the next few quarters?

Todd Becker

I think what you’re starting to see is a pretty good run rate. We had about 30 million plus pounds of oil; we said we thought we’d produce 100 million pounds, and we’re producing closer to 120 million pounds right now. And then also looking at – we think there’s opportunities for some increases in that, but again, marginal, and not large steps, if we see them. But we’re continually de-bottlenecking some of our under-performing units right now, that maybe are lower yield than the platform. So we think there’s a little bit of upside still there, but we have to wait and see what we can actually get out of it. Some of it depends on the quality of the corn, as well, and the ability to get the oil out of the kernel while not degrading the quality of the DEGs. But keep in mind, we’ve also seen a drop in bean oil prices, from the highs in the high 50s, to more of a low 50s; but what’s interesting is we’ve seen (inaudible) stay pretty consistent in the low 40s, so $0.40 to $0.43 a gallon. From a competitive standpoint, on a gross basis, and then you have to take out the cost of the DEGs and some other expenses to get us on a net basis where we get our $9.6 million right now with run rate. A big answer there, but in general, de-bottlenecking is going well, the prices are hanging in there from a comparative standpoint, even though bean oil prices have come down, and overall we expect the segment to perform well over the next 12 months. One thing we have done, which we did not mention, and I’m glad you asked the question, is that we have a little less than a third of all our corn oil locked in for next year already, at some lower type levels from what we’ve seen year to date. So we got ahead of the curve a little bit, and we’ll continue to focus on locking in more corn oil for all of next year, as we lock in the baseline recurring earnings stream from this segment.

Patrick Jobin – Credit Suisse

Great, thank you.

Operator

And our next question comes from Farha Aslam with Stephens Inc.

Farha Aslam – Stephens Inc

Hi, good morning. Congratulations on a great quarter. When you look at the [VTECH] past credit expiring at the end of this year, that’s definitely driving demand into year end. About how much ethanol can be stored and used in Q1 of next year?

Todd Becker

As we said, typically ethanol storage rates over the last couple of years have been from the 15 to 30 days of storage. You get much above 25 to 28, you’re starting to stretch storage capacity. With everything in transit, everything else in terminals and everything else that you have in storage in the industry, so I don’t think you’ll have high storage at the end of the year, mainly because a lot of big export programs are at the end of the year. You are seeing some things happening around people pre-blending some of their needs and getting in blended positions, but while we might have thought that that would cause a drop in demand in Q1, we’re not really seeing any drop in demand right now at all. In fact, we’re seeing a very robust demand, at least from placing physical product. Now, the margin is not as robust as we like to see right at this moment, but placing physical product at better freight differentials than we’ve typically seen is something that we’ve been able to achieve, and I think that just tells you that demand will remain good. It’s not like nobody’s buying ethanol in 2012 because there’s no tax credit. In fact, we’ve seen really no drop off in demand for our product out of our plants to this point, for Q1.

Farha Aslam – Stephens Inc

Great, that’s helpful. And then in terms of the margin environment, Q1 margins tend to be very volatile for ethanol. Just looking at faces and all the things you see, do you think Q1 margins in 2012 can be comparable to 2011? Or do you see it shaping up like – 2010 was an extraordinary Q1.

Todd Becker

I think that has yet to be determined. We have seen, in Q1, in the high teens and we have seen in the high single digits in the range so far. Compared to Q4 next year, which we’ve seen kind of in the mid 20s, but you can get huge amounts of volume on there, but we did some stuff early. So it is still yet to be determined. It’s much like the discussion we had earlier in the year on Q3, where there really were no visible margins at all, and then we achieved $0.17 to $0.18 per gallon type numbers. So I think it’s going to be a little bit more wait and see for Q1, but with the demand as good as we’ve seen it, and we’re optimistic that we can see good margins, but at this point it’s still middle of the range, so we’ll have to wait and see for a little bit longer while they develop.

Farha Aslam – Stephens Inc

Understood, your demand comments are helpful. When we look at agribusiness and trying to make that buy versus build decision, about how much does it cost to build new capacity, and in terms of commercial, what are the ranges you’re seeing in the M&A environment?

Todd Becker

We’ve been able to build new capacity, depending whether it’s flat or upright, kind of in that average $1.50 to $2.25 per bushel type range, depending on the quality of the space. If we put upright higher ration bins that we attach onto a facility, so they’re definitely in the higher end of the range. If we put flat storage on like we did; for example we built a flat storage facility in our Otter Tail ethanol plant. That’s not actually agribusiness, but that was on the much lower end of the range. But that tells you kind of the range. In terms of acquisition, I think the acquisition positions range somewhat similar. For high-quality assets – again, for assets that have a lower quality side that you have to do some CapEx upgrades as well as space upgrades to them, those will trade at a further discount for larger-scale acquisitions. Acquisitions with earnings streams, those will trade at a premium. It's really all across the board depending on location, who's selling, quality of assets, and what the expansion opportunities are.

Farha Aslam – Stephens Inc

Okay, very helpful. Thank you.

Todd Becker

Thank you very much.

Operator

And we'll take a question from Luke Beltnick from TPG Credit.

Luke Beltnick -TPG Credit

Hey guys, my first question just a modeling one. What was the D&A figure for the quarter for the corn oil segment?

Todd Becker

I don't know. It's a small number. It's about $600,000 for the quarter.

Luke Beltnick -TPG Credit

Okay. Got it. And out of curiosity, what's roughly the percentage of the ethanol production margins you guys had locked in before the quarter began?

Todd Becker

Before Q3 began or before Q4?

Luke Beltnick -TPG Credit

I guess each of them.

Todd Becker

Like we said, in early June we had very little margins locked in. Probably by the 10th of July, we had most of the quarter put away. When we saw the margins expand from negatives to mid-teens, we opened up the floodgate and let the [letter] marketers and traders lock it all away as quickly as possible to make sure that we had a good quarter. Our – as we call it – our process and machine worked very well when we saw the margin expansion and we were done very quickly for the quarter.

Luke, I'm going to correct what I just said as far as our depreciation amortization run rate. I was looking at a trailing 12; for the quarter it was about 300,000.

Luke Beltnick -TPG Credit

Okay, thank you. Going into Q4, do you have a lot locked in, or did you have a lot locked in? Where does that stand?

Todd Becker

We were mostly done for the Q4 before the quarter started; except for some physical corn we needed to buy, so we still have some open gallons but nothing that could materially take - initial margins were locked in August, and some of that will even offset the gains on the – some of those were offset by some of the basis strength in the US today. Net-net we're basically close to being done for the Q4 as we came into the quarter, as well.

Luke Beltnick -TPG Credit

Okay. And go back to the Q3; did you say you outperformed the number had you been just (inaudible). Do you know what the difference is? Have you run the numbers? Had you just been through the quarter roughly what margins where to look like?

Todd Becker

No, what we did is – if you take the daily average since January for Q3 through Q3, the average on our platform was $0.10. So that's the number we look at because we lock risk every day. During the quarter, it was definitely into higher levels than that if you were spot during Q3, and the same really in Q4, as well. If you look back at Q1 and Q2, that's probably offsetting the same amount of blocking in what we had versus the actually daily spot as well; but we look at it compared to beginning of the year to the end of the quarter. It was an average of $0.10.

Luke Beltnick -TPG Credit

Okay. Switching this a little bit to E15; any updates on what you're hearing in terms of the rollout in the various states as well as what's going on in Washington with (inaudible) and subsidies? How do you see this rolling out?

Todd Becker

Well, we still have some regulatory things to get through around getting all the specs all approved; and there's still lawsuits that are going on. EPA is defending those lawsuits so we're still dealing with that as well. In terms of rollouts, there are going to be – in our opinion – it's got going to be significant for a little while here. We'll start to see more regional early-adopter type rollouts. Blender pump initiatives are high on the list and I think that there will still be capital available, either from a tax standpoint or a direct investment standpoint in blender pump infrastructure and that's where a lot of our focus lies. There are plenty of challenges on E15 that the EPA will have to defend, but when you look at all the data and you look at (inaudible) the data is all in our favor and we think there will be some point in 2012, some rollouts. Steve, you're a little closer to that. You want to comment on what you know?

Steve Bleyl

Yeah, it's all revolving around the RVP issues; trying to get the RA gasoline we need to blend with so that we can still be on the spec for the RVP because E15 does not get the right numbers on that to warrant a waiver.

Todd Becker

Some markets really can’t go to it right now, and some can, so we’re focusing on the ones that can.

Luke Beltnick -TPG Credit

So if you had to pick numbers for incremental gallons blended for 2012 to 2013, do you care to venture a guess?

Todd Becker

I think '12 will be minimal, still. I think '13 is when you can see a pretty good uptick through all of the stuff that we're working on into the hundreds of millions of gallons, potentially. People want it if it’s economic.

Luke Beltnick -TPG Credit

Yeah, exactly. It seems it's such a political regulatory quagmire at this point; that's the hard part.

Todd Becker

Go back and look at the history of each hand. It took 30 years to get 10% into the fuel supply so we're not going to do it in a year and get to another 5%. It'll take several years to get that activated and integrated.

Luke Beltnick -TPG Credit

All right, final question; just on the cash. Any idea what you're going to do? You're sitting on a lot. Are you earmarking that for acquisitions and CapEx additional capacity build, debt pay-down, share buyback, how are you guys viewing that?

Todd Becker

We always view part of our cash as defensive. We use – and at any given time – right now $40 to $50 million dollars a day just locking margins away. Our balance sheet has been – when you're talking about return on investment of cash – we always flow in and out of these numbers. We always get kind of a pop at the end of the quarter based on payments that come in and those type of things; but in general we are earmarking our cash for additional growth opportunities, additional ability to lock in large amounts of margins when they appear in front of us, and we use $28 million of our cash that's earmarked now for the stock buyback - $14 million already, $14 million coming out. Then we're going to generate more free cash over the next coming quarters as well. We are looking at it as growth opportunities first, margin management second, and then beyond that we'll make the decision if there's anything left over at that point, other than being defensive to look at other opportunities that are - the other things you mentioned – but at this point we're not focused on that.

Luke Beltnick -TPG Credit

Thank you.

Todd Becker

Thank you.

Operator

We'll take our final question from Ben Callow from Robert W Baird.

Ben Callow – Robert W. Baird

Sorry. Thanks for taking my question. As your business has grown and you have substantial cash flow going, how does your threshold change for acquisitions? And then along those lines, I know we talked a lot about the US market but is there something outside of the US that you could look to entertain businesses outside the US? And as we go further along down the line could you move further downstream onto the refining side of the business at all? Thank you.

Todd Becker

Thanks. Our threshold, it would always – our allocation of capital always was something that we challenge yourself on to make sure we invest in best and highest returns and uses of that capital. We've seen great opportunities over the last couple of years to buy assets. It started out at $0.82, $0.94, and a dollar a gallon, even though we build some at $1.50 and $1.60 and $1.70 a gallon. I think those does to buy those cheap ethanol refining assets are over for a good-quality, high-quality asset and you need to be at $1.25 - $1.30 range which – by the way – I still believe, from a return standpoint is a very compelling story as well as from our valuation standpoint, more and more transactions that happen in that $1.25/ $1.30 range, we believe just shows the true value of our asset base, versus maybe what it’s valued at today. So from that standpoint, we look at all the different aspects of our business. I think you see now, with 40% of non-ethanol operating income, we’ve validated capital very well from that standpoint. In terms of looking outside the US, it hasn’t really been our focus.

I still believe long term, the winning solution is to be able to have flows both from the US and other producing countries into different demand points to be able to maximize the (inaudible) but today, I don’t think there’s a big initiative by anybody to have multi-country ethanol assets into one single metric, but maybe some of the biggest agribusiness players out there that are doing some of that today. Finally, going further downstream, oil refining into gasoline hasn’t been on our radar screen, but anything around distribution handling and trade is; and we’re focused on growing our blended gasolines sales segment, and looking at other fuel distribution opportunities downstream. I think ours will just be offshoots of what we do already, where we have natural abilities to scale quickly and use our commodity flows to gain a foothold in a market. But in terms of going fully into a refining asset, I don’t envision Green Plains doing that at this point.

With that, with no other questions, we appreciate everybody being on the call today. As you can see, we continue to remain very optimistic about our business. We maintain our strategies, very comprehensive risk strategies around locking margins; I think you’ve heard that story before. We are going to continue to try and grow all business segments, but the achieving 40% of non-ethanol operating income and achieving the run rate of over $50 million a year, I think gives an understanding that we are building potential recurring income streams that show the quality of our asset base, and we appreciate everybody coming on the call today. Thank you very much.

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Source: Green Plains Renewable Energy's CEO Discusses Q3 2011 Results - Earnings Conference Call
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