Pacific Ethanol, Inc. (NASDAQ:PEIX) Q3 2017 Earnings Conference Call November 8, 2017 11:00 AM ET
Becky Herrick – Investor Relations
Neil Koehler – President and Chief Executive Officer
Bryon McGregor – Chief Financial Officer
Eric Stine – Craig-Hallum
Sameer Joshi – Rodman & Renshaw
Jeff Osborne – Cowen
Craig Irwin – Roth Capital Partners
Good morning, ladies and gentlemen, and welcome to the Pacific Ethanol, Inc. Third Quarter 2017 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. Becky Herrick. Please begin.
Thank you, operator, and thank you all for joining us today for the Pacific Ethanol third quarter 2017 results conference call. On the call today are Neil Koehler, President and CEO; and Bryon McGregor, CFO. Neil will begin with a review of business highlights; Bryon will provide a summary of the financial and operating results; and then Neil will return to discuss Pacific Ethanol's outlook and open the call for questions.
Pacific Ethanol issued a press release yesterday providing details of the Company's quarterly results. The Company also prepared a presentation for today's conference call that’s available on the company’s website at pacificethanol.com. If you have any questions, please call LHA at 415-433-3777.
A telephone replay of today's call will be available through November 15th, 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 8th. And, therefore you are advised that time sensitive information may no longer be accurate at the time of any replay.
Please refer to the Company's Safe Harbor statement on Slide 2 of the presentation available online, which says that some of the comments in this presentation constitute forward-looking statements and considerations that involve the 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, or 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 information later in this call, a reconciling table was included in yesterday's press release.
It's now my pleasure to introduce Neil Koehler, President and CEO. Neil?
Thanks, Becky, and thanks to everyone for joining us today. Our third quarter results demonstrate both sequential and year-over-year quarterly improvements in net sales, gross profit, operating income, net loss and adjusted EBITDA. This reflects the combination of improved margins later in the quarter and the benefits of our acquisition of ICP on July 3rd. For the quarter, we recorded record total sales of 250 million gallons and company production of a record 142 million gallons.
ICP has made us a more diversified company by adding high quality alcohol products. While we do not breakout our plants performance individually, our total high value alcohol products contribute favorably to margins and represented approximately 10% of total ethanol sales during the third quarter.
As noted on our August call, we saw a slow start to Q3. Margins improved throughout the quarter with the month of September producing the best financial results. So far Q4 is off to a similarly slow start as ethanol inventories are higher than they were a year ago. However, we are encouraged by continued strong gasoline demand, increasing penetration of higher ethanol blends and growing export opportunities. With that said, we will continue to manage our facilities production levels to optimize plant profitability.
On the regulatory front, the EPA has recently renewed its commitment to a robust renewable fuels program and in weeks of uncertainty in the ethanol industry. In a letter to several senators confirming his support for the RFS, EPA Chief Scott Pruitt stated his commitment to setting final RVO levels for 2018 at or above the proposed levels. Its commitment to finalize the 2018 RVO by the statutory deadline of November 30th of this year that the EPA would finalize the decision within the next 30 days to deny the request to change the point of obligation for RINs that no action will be taken to allow ethanol exports to count toward compliance with the RFS and the promise that EPA would look at a potential change to remove artificial barriers to the year round use of E15.
We’re pleased with the EPA’s message and are optimistic that the final 2018 RVO will ultimately demonstrate the EPA's commitment to growing the renewable fuels market and strengthening the agricultural economy. We are on track with our plant improvement initiatives. We are in the final startup stages with our co-generation system at Stockton and we expect to be at full capacity within the next two weeks. We anticipate that co-generation system will reduce our annual energy cost by up to $4 million.
Our industrial scale membrane system at Madera is in operation and we are realizing energy savings of 5% reduction in natural gas cost at the plant. We are working to further optimize its performance. Overall, we estimate the energy savings, operating efficiencies and carbon premium combined will total close to $1 million annually at current market rates. We estimated for a new LCFS pathway with CARB at Madera and we continue to evaluate expanding the technology to our other plants.
We're on track to begin commercial production of cellulosic ethanol at Madera this quarter and we have submitted with the EPA for pathway approval for Magic Valley. We expect D3 and RIN approval at both facilities by early 2018 at which point we will have three of our plants producing cellulosic ethanol from corn fiber. And finally, construction of our solar system at Madera is well underway and we remain on schedule to begin full scale of operations in early 2018.
The system is expected to reduce our utility costs by approximately $1 million annually and lower our carbon score. And the integration of ICP is going very well with anticipated savings of $4.5 million annually over the next nine months. While we expect to produce savings in SG&A, most of our savings are expected to be achieved in reducing operating and logistical costs. To date the integration of personnel, IP and accounting services is effectively complete and we have begun internalising logistical and storage services. We expect the latter activity to accelerate and results in material benefits to be reflected in our financial results in the coming quarters.
With that I'd like to turn the call over to our CFO, Bryon McGregor.
Thank you, Neil. Just as a note before I begin the third quarter 2017 is the first quarter in which the operating results of ICP, which we acquired July 3rd are consolidated with our quarterly results. For the third quarter 2017 compared to the third quarter of 2016, net sales were $445.4 million, compared to $417.8 million. Cost of goods sold were $433.4 million compared to $411.4 million.
Gross profit was $12.1 million compared to $6.4 million. SG&A expenses were $8.7 million compared to $6 million reflecting increased benefits, non-cash compensation and transaction costs associated with the acquisition of ICP. As Neil previously noted, we have effectively completed the integration of ICP, the cost of which impacted our Q3 results. Accordingly, we expect SG&A expenses for the fourth quarter to approximately $8 million.
Interest expense was $3.8 million compared to $3.9 million. Net loss available to common stockholders was $521,000 or $0.01 per share. This compares to a net loss of $3.8 million or $0.09 per share in the year ago period. Adjusted EBITDA was $13.2 million compared to $9.3 million in the year ago period. For the first nine months of 2017, net sales were $1.2 billion consistent with the year ago period. Gross profit was $7.9 million compared to $25.1 million. Net loss was $22.6 million or $0.53 per share compared to $12.6 million or $0.30 per share. Adjusted EBITDA was $13.9 million compared to $31.3 million.
Turning to our balance sheet, cash and cash equivalents were $56.9 million at September 30, 2017 compared to $68.6 million at December 31, 2016. Although our cash reserves are modestly lower year-over-year, our working capital remains strong at over $120 million and our excess cash and loan availability exceeded $105 million at quarter end.
In September, we refinanced $47.4 in promissory notes related to the ICP acquisition. To repay the notes, we use $6 million of cash on hand and $42 million in proceeds from new term and revolving debt financing with CoBank, which improved our balance sheet and provided a lower cost borrowing.
Now I’ll provide an update to our capital expenditure activities and expectations. For the third quarter of 2017, our capital expenditures totaled $6.1 million primarily related to plant improvement initiatives. This brings our nine month total to $12.3 million. We reaffirm our expectation of full year CapEx will be less than $20 million.
With that I'll turn the call back to Neil.
Thank you, Bryon. As I mentioned, Q4 is off to a slow start reflecting higher year-over-year ethanol inventories. However, higher oil and gas prices and relatively low ethanol prices have resulted in additional export volumes being booked and providing a strong incentive for higher ethanol blending. In the last week, we have seen an increase in ethanol prices and some improvement in margins.
We are encouraged by continued strong gasoline demand increasing penetration of higher ethanol blends and growing export opportunities. Ethanol remains the lowest cost source of octane in the world and in today's economics the lowest cost source of liquid fuels. In support of the growing demand for ethanol around the world, we will continue to evaluate and make investments in initiatives that promote production efficiencies, diversify our products and revenues, improve our carbon score and improve plant profitability.
With that Suzanne I'd like to open the call for questions.
Thank you. [Operator Instructions] Your first question comes from the line of Eric Stine from Craig-Hallum. Your line is open.
Hi, Neil. Hi, Bryon.
Good morning, Eric.
So good performance in the quarter I mean especially in light of market conditions what stood out to me was basis is that I mean clearly you were opportunistic there did very well there. Just curious kind of trends you're seeing, what your expectation would be for fourth quarter? And is that something that you were able to lock in? I mean was that a holdover from locking something in from Q2 or something you were able to lock-in in Q3 and could help going forward.
To your point we are – we're opportunistic on basis and from our experience there are points in time where clearly it looks like a good time to lock forward. While as you know we don't do a lot of forward hedging. We do take positions on basis that did benefit us in the quarter. We do have some basis on for Q4 that is better than current market as well. So we do expect that to continue to be strength of our portfolio. We have seen with this very large harvest. It’s just generally we’re seeing relatively weak basis in the market. So we are being patient.
We feel that as farmers are now finishing the harvest there could very well be some additional break in the basis throughout the system. In certain areas, particularly Illinois, we have seen historically low basis numbers where typically we would be an option or above at our plants in Illinois, we have seen basis that is slightly under the board continues to be a very low basis. Nebraska has been able to pick and choose with the product going west when sellers are wanting to book the trains we've been able to layer in some pretty good basis for those plants as well.
Got it, thanks for that color. Maybe just turning to the regulatory front, I mean, obviously that's the concerns there have eased a fair amount as of late, but maybe could you just talk about the advanced biofuels component of the RVO and I know you've got a number of initiatives around cellulosic, but just how maybe that impacts taking it to other plants going forward?
We’ll be cautious. We have, as I mentioned prepared remarks, now three plants that are teed up for that. I think that if there is no risk around the RFS, it's not on the conventional side. In fact we're cautiously optimistic that as EPA considers a reset of the RFS that they're required to do now under statute and having missed on these advanced targets for a number of years and on the total RFS numbers that we could actually see a boost in the conventional numbers. But there is some risk around the advanced – Scott Pruitt, Secretary Pruitt has made clear that he doesn't want the EPA to be creating that market.
And that being said the statute does have aggressive targets and it also has statutory requirements that at a minimum we're providing a market for the existing and projected advanced biofuels that are in the pipeline. So we do feel good about the corn fiber. We think that it is something that will continue to spread throughout our platform and the industry and that the RFS will provide a support for that.
Okay. Last one for me just related to exports and obviously where ethanol’s price right now, it is opening some things up just maybe some early thoughts on your expectations for 2018 and some of the key markets that you would look at to drive them.
We're pretty bullish as are others in the industry on exports even with some of the trade barriers that have been erected in Brazil and China. What that has done has raised significantly the price of ethanol on those markets. So we expect to see Brazil continuing to be a large importer of ethanol from the United States. U.S. ethanol continues to be far and away the lowest cost source of not only liquid fuels, but ethanol. We have various initiatives throughout the world to continue to include higher levels of biofuels to meet economic and environmental goals. China has announced their desire to be at a 10% ethanol blend by 2020.
There’s definitely been a resurgence in construction of ethanol plants in that market, but they're going to in our view need some incremental gallons to bridge between where they are today, producing less than a billion gallons and the objective of 10%, which would be about 4 billion gallons. There’s actually been quite a bit of chatter in the trade this week with the ethanol price being as low as it is that there is finally with the year where we've exported nothing to China that there appears to be some activity that not only in the balance of 2017, but into 2018.
India continues to increase with the ethanol being so competitively priced from an octane standpoint. You start seeing some incremental use in Oman and the Emirates, where they're using this octane to distribute throughout the Middle East and in other areas. So our overall expectation and its consistent with what I think we've heard from some other companies is that we should be pretty close at that 1.3 billion gallons, which would be a record of exports for 2017 and 2018 will be something greater than that whether it's 1.4 could even be higher than that. I think if you factor in which really is hard to do right now, but if indications are correct that China does become again a good market, we could see very, very strong exports next year.
Okay, thank you.
Then your next question comes from the line of Sameer Joshi of Rodman & Renshaw. Your line is open.
As far as the CapEx goes, I think, I heard Bryon reiterated that CapEx would be less than $20 million for the year and for the first three quarter it was in the $12.3 million range. Going forward, are these –is this excess CapEx or additional CapEx expected for the Madera and solar improvements there. Are you’d making any further changes to the ICP for that additions upgrades?
Yeah at this point the balance of the year is projects that have been ongoing, as you mentioned, the solar certainly the cogen some other items throughout the platform, but it doesn’t include any specific new additions. At ICP we continue to evaluate the opportunities, but through our management practices and the great operating team that we have there at ICP through just our own housekeeping and chemistry use and repairs and maintenance that have been ongoing. We've been able to already improve the production output of that facility.
Okay, staying on ICP, you mentioned in the remarks that your ongoing overall OpEx is at level – SG&A level is expected to be $8 million as compared to $8.7 million this quarter. That’s a reduction of around $700,000. And your overall annual operating savings from the ICP acquisition are expected to be $4.5 million. So does the $8 million number that you gave include the annualized savings of $4.5 million?
It does, but that fold at $700,000 delta is not all attributable to ICP. It includes additional – it not only includes the acquisition cost rate and some – and the like. So that's a little inflated. But in addition, additional professional costs and things, but it – the $8 million is reflective in going forward the savings that we would expect in the SG&A side and that’s correct.
Okay, good. And sort of the interest rate number, I see it is sequentially higher even though you refinanced and the overall debt number may actually be lower in this quarter compared to previous. Can you reconcile those, the higher interest costs versus lower interest – over lower debt levels?
We have clearly the higher balance. We carried the seller notes for the ICP transaction through a material portion of the quarter. And so, when we were able to refinance with CoBank, want to believe it was basically for just one month out of the three. We were able to lower that cost to be in line with the rest of our term debt and noting that it's significantly lower than it has been historically, our interest costs.
Historically, yes, that is true. Okay, as far as the ethanol prices, I think the latest price is around $1.38. Do you have any visibility or what – on the ground what are you looking at? Do you – when do you see these excess inventory levels to rundown and ethanol prices to rebound? I know I am trying to make you to predict the future, but what do you see from the ground?
Well, what we see from the ground and what we see historically is when you get down to these levels of $1.40 and also relative to what now is some higher gasoline and oil prices, so a very large spread of about $0.25 discount ethanol to gasoline. And given the inherent value of ethanol that's what does as the traders have gone to say there's no better cure for low prices than low prices and we are seeing a pickup in demand and we are seeing a slight decreased inventories.
So we would expect to see inventories come off a bit, but it’s difficult in fourth quarter for them to come off too much, that’s been part of the problem as they typically going into the fourth quarter would have dropped more in the third quarter that we have seen this year. We are running at levels that are about four or plus percent I believe higher than last year. So that would help. We did see – the report just came out this morning just see a slight drop in inventories.
So kind of one data point encouraging, but I think the – really it’s – the exports if what we’re hearing out there is coming through fruition that we see a very strong quarter in exports that would also help to draw the inventories and get us back into a better balance. We look ahead to 2018. So taken away what happens in the here and now, Q4 could be choppy and difficult, but our view on 2018 when you consider pretty flat maybe slightly increasing gasoline demands of 14.4 billion gallons of domestic use.
And if we were truly to see a export number that’s 1.4, even excess, you’re then getting to level that are very well matched with the supply based on current run rates. And we would then – with the incremental E15 inclusion that could be 200, 300 million gallons. We could start to seeing a much snugger supply demand balance. So we’re reasonably constructive on 2018 and cautious on Q4.
Got it. Thanks for taking my questions guys.
And your next question comes from the line of Jeff Osborne of Cowen. Your line is open.
Hey, good morning guys. First of all just a clarification, was the 10% on ICP Bryon was that of gallons or revenue?
That was dollar revenue.
Dollar revenue, perfect. And then you indicated that you were able to drive a little bit of incremental yield. Is there any initiatives notable for 2018 that you can discuss as it relates to the ICP’s facility in particular?
We're evaluating that now in the overall context of our capital plan that is certainly an opportunity we have been able to get the production levels up there and we've been very encouraged with what we can do just with the tools that we already have on hand. How much more we'll do is under evaluation.
Got it. And then just a nitpick question, but will the 10-Q when that comes out will that have more detail on the ICP, so we’ll be able to see organic versus inorganic growth of the company or no?
Yes, it will as part of the regulatory requirement and in an acquisition we will be providing some additional color on ICP specifically.
Got it. And then just two other quick ones. I think when you started the year you talked about $46 million in CapEx. We’re now looking for less than half of that. Should the $20 million or so that you've deferred, should we think about that being a good run rate for next year or are you going to take more of a wait and see approach as we get through the choppy Q4 and see if things turn the corner for 2018 and the overall market gets better than maybe spend that middle of the year second half?
I would say it’s wait and see, active wait and see as we evaluate. We have these projects that are not required, but we feel as the – as our business continues to grow and we want to improve our position in the market that we have some very good projects to do. But you have to have return on those investments and that's what we're monitoring and calibrating around. Certainly projects that have that one to two year payback even in the lower margin environment, we will continue to move forward with and there are some of those that have been on the drawing board in deferred. And then there are larger projects that are more transformational that you know given our view of the growing market and particularly where we have a competitive advantage on low carbon. We do expect to be moving forward on some of those as well.
Got it. And the last question just now that we're several quarters into you folks having Midwest facilities. Can you just talk about the export market in general as it relates to your overall business in terms of gallons perhaps just qualitatively or quantitatively it would be more helpful, but just – over the past couple of quarters are you seeing greater levels of export? You always mention that as more of an industry dynamic, but specific to Pacific Ethanol. Can you just talk about your percent of production that's being exported if any?
Sure, it’s a small percent. Our plants even in Midwest, particularly in Illinois, continue to be well positioned for domestic use along the barge system in Illinois and unit trains as well. Nebraska that is our one facility where we spread well to the Gulf and our position for exports and good question because we just did finally get not only our DSP finalized there, which is required for export in the undenatured ethanol that is about half of all the exports are that sort of play in that market. It's important to have that capability. We have it. And next week we’ll be shipping our first train out for export.
Good to hear. Thanks a lot.
Unit trains, yeah. You’re welcome.
And your next question comes from the line of Craig Irwin of Roth Capital Partners. Your line is open.
Hi, I apologize. Most of my questions have been asked, but I do have two that have not yet been addressed on the call. So the first is, Kinergy. In the past, falling prices you called out as tailwinds. I think there has been a couple of quarters where that was a negative contribution to the overall profitability of the company. With the rising energy prices, obviously bullish ethanol prices, have you seen any benefit materialize your Kinergy as far as profit contribution in the quarter? And then second part of Kinergy is, ICP, should we continue to think about sort of similar profit profile as those assets are fully integrated?
In answer to your question, we really didn't see in the quarter much of a rising price. We saw a drop in corn prices, and that's where we saw some – primarily where we saw the margin improvement. What we've found in our Kinergy business is that it's obviously very valuable as a marketer for our assets, the other assets that we market for and trading around those assets. We have a number of areas sort of pure trading, where I'd say the whole industry has been challenged and you will see in our Q when it comes out that Kinergy actually had $750,000 of net loss. So if it actually had broken even or make money, it would have put us into – from the breakeven position we were to profitable.
So it’s still a very important and valuable asset and you’re right as prices increase, we're able to monetize that. But we're actually taking a pretty hard look at are the third-party aspect of our Kinergy trading business and maybe backing out some markets has become very, very competitive in some areas. And again, where it has value trading around our assets, we're very committed to that business and growing that business. But we're looking at allocating it differently to make sure that Kinergy, which has always been profitable for us, will continue to be so. In terms of your – the ICP question, I'm not sure I understood. I mean, Kinergy is the marketer of the fuel ethanol for all of the company in the higher alcohol. ICP has its own brand, has its own name, and we've maintained ICP as the marketer for the nonfuel ethanol.
Okay, okay, thank you for that. So then second question I had is really about China, so this year, one of the headwinds on the market has been the absence of DDG sales into China and the absence of significant Chinese imports, and of course, some minor smuggling. Looking at the macro, the percentage of arable land that China has and the significant population they have points to them being a very strong customer for U.S. agriculture over the next decades, and they are not short-term players.
People that sit down with Branstad, our ambassador over there, acknowledged that this is something that’s top of mind, getting ethanol as a U.S. export through China. Can you maybe comment maybe from your position at RFA or maybe from your own direct interactions running Pacific Ethanol? How you see the China potentially shaping up as a customer? And what this is likely to mean given your unique geography being significantly weighted towards West Coast and some of the margins that would be impacted by additional demand going west?
China obviously is a huge market for all products, including the agricultural and fuel. And as I said earlier, we are hearing that they may be stepping back in on the ethanol side. Then we've all heard their ambitious objective to have 10% ethanol by 2020. As it relates to – so that's very encouraging after being out of the market this whole year. In the case of DDGs, the world is protein-short, China is protein-short. Agree that given their limits to land and water, that importing our DDGs makes sense.
But it's just – they're very hard to predict. China is a wildcard. But I would say the fundamentals that suggest that they should be importing U.S. ethanol, and they should be importing DDGs. Having said, they have tariffs on both. And how that plays out, we'll just have to watch. But fundamentally, with the growing market that they represent on all these products, it should be encouraging to see some development in that regard.
Thank you for taking my questions.
[Operator Instructions] And I would like to turn the call back over to Mr. Neil Koehler for his closing remarks.
Thank you. Susan, thank you and thank you to everyone for joining us today and your continued support Pacific Ethanol and we look forward to speaking with you next quarter. Have a great day.
Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day and you may all now disconnect.