Pacific Ethanol's (PEIX) CEO Neil Koehler on Q4 2017 Results - Earnings Call Transcript

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About: Pacific Ethanol, Inc. (PEIX)
by: SA Transcripts

Pacific Ethanol, Inc. (NASDAQ:PEIX) Q4 2017 Earnings Conference Call March 1, 2018 11:00 AM ET

Executives

Kirsten Chapman – LHA Investor Relations

Neil Koehler – Co-Founder, Director, and CEO

Bryon McGregor – Chief Financial Officer

Analysts

Aaron Spychalla – Craig-Hallum

Craig Irwin – ROTH Capital Partners

Unidentified Analyst - B. Riley

Sameer Joshi – H.C. Wainwright

Operator

Good day ladies and gentlemen and welcome to the Pacific Ethanol, Incorporated Fourth Quarter and Year-End 2017 Financial Results 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 introduce your host for today's conference Ms. Kirsten Chapman, LHA Investor Relations. You may begin.

Kirsten Chapman

Thank you, Bruce and thank you all for joining us today for the Pacific Ethanol fourth quarter and year-end 2017 results conference call. On the call today are Neil Koehler, President and CEO; and Bryon McGregor, CFO. Neil will begin with a review of business highlights; Bryon will provide a summary of the financial and operating results; and then Neil will return to discuss Pacific Ethanol's outlook and open the call for questions.

Pacific Ethanol issued a press release yesterday providing details of the Company's quarterly results. The Company also prepared a presentation for today's call that’s available on the company’s website at pacificethanol.net. If you have any questions, please call LHA at 415-433-3777. A telephone replay of today's call will be available through March 8th, 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, March 1st and therefore you are advised that the time sensitive information may no longer be accurate at the time of any replay.

Please refer to the Company's Safe Harbor statement on Slide 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, and other factors previously and from time to time disclosed in Pacific Ethanol's filings with the SEC. Except as required by applicable law, the Company assumes no obligation to update any forward-looking statements.

In management's prepared remarks, non-GAAP measures will be referenced. Management uses these non-GAAP measures to monitor the financial performance of operations and believe these measures will assist investors in assessing the Company's performance for the periods being reported. The Company defines adjusted EBITDA as unaudited net income or loss attributed to Pacific Ethanol before interest expense, provision or benefit for income taxes, asset impairments, purchase accounting adjustments, fair value adjustments, and depreciation and amortization expense. To support the Company's review of non-GAAP 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?

Neil Koehler

Thank you Kirsten and thank you everyone for joining us today. For the fourth quarter net sales were $395 million, total gallons sold were 240 million. We achieved the quarterly record of 150 million gallons of production gallons sold reflecting the addition of Illinois, corn processing, or ICP assets in July. Net loss available to common stockholders was $13.6 million and adjusted EBITDA was negative 273,000.

Our results were impacted by several factors. First loss was primarily driven by the sharply lower average ethanol sales price per gallon during the quarter compressing production margins. The industry's historically high inventory levels negatively impacted ethanol margins in the fourth quarter. Only recently have we begun to see reductions in industry inventory levels resulting from lower ethanol production and higher domestic and export demand.

In response to high inventory levels and lower margins we began to moderate production and locations most impacted by margin compression and where we weren’t otherwise contractually committed. We also began to reduce contractual sales of third party gallons and focus our sales efforts as previously noted around our production assets where we are best able to maximize profitability and contribute to greater pricing stability. Our focus on managing production and rationalizing marketing volumes has been in part contributed to improving margins and correcting supply and demand imbalances. Industry ethanol inventories which hit a record high at the beginning of the year running 20% higher than the prior year period are now slightly lower than last year as reported by the EIA this week against higher ethanol demand. This has contributed to margins improving by about $0.15 per gallon from the lows in December.

For the full year of 2017 net sales were $1.6 billion essentially flat year-over-year. Net loss available to common stockholders was $36.2 million and adjusted EBITDA was $13.6 million. Total gallons sold were 952 million and production gallons sold were a record 527 million. We're confident that heading into stronger 2018 supported by an improved supply and demand balance, ongoing stable corn prices, a strong export market, and increasing E15 introduction in the United States. Domestic gasoline demand in 2018 is running over 5% higher year-to-date than in 2017. Exports reached a record level of 1.37 billion gallons in 2017, a 17% increase over 2016 and we expect strong growth again in 2018.

Also in 2018 we expect to see continued incremental growth in EBIT being availability and sales. E15 was available more than 1200 stations across 29 states as the year began and we expect that to increase over 2000 stations by year-end. E15 is a great fuel for cars with higher octane rating and lower cost at the pump than the standard 10% blends. We're working diligently with the entire industry for E15 and higher blends to gain RVP parity with the standard blend which will allow it to be sold 12 months of the year across the country. The low cost low carbon high octane and growing supplied ethanol is driving new ethanol demand in transportation fuel markets.

Our focus remains on implementing initiatives that build our long term value. We are leading innovator in the ethanol industry and we are focused on making the appropriate investments to reduce cost, improve our carbon score, and support profitable operations. Our July acquisition of ICP provided us with important product diversification by way of high quality alcohol products which help support stronger margins and lessen our exposure to commodity price fluctuations in the fuel ethanol markets. Further the integration of ICP is tracking well and we're on target to achieve our goal of recognizing $4.5 million in cost synergies in 2018.

Of our two natural gas-fired cogeneration units at our Stockton California facility, one is now fully commissioned and power is being generated and used in production at the plant. Second unit is still in the commissioning stage. The innovative system allows us to supplement natural gas with waste gases from our production process to deliver usable clean electricity and sustained production back to the plant. In addition to reducing energy purchases by an estimated $4 million annually when fully operational cogeneration is expected to lower Stockton's carbon and nitrogen oxide emissions.

In terms of our previously announced plant improvement initiatives we received an updated LCFS pathway from CARB for Madera, incorporating the benefit of our industrial scale membrane system. We are realizing a 5% reduction in natural gas used at the plant. We are in the process of evaluating the technology for potential implementation at other Pacific Ethanol facilities. We continue to produce commercial levels of cellulostic ethanol at our Stockton, Madera, and Magic Valley plants. The installation of the solar system at Madera is moving ahead on budget and on schedule pending interconnection with our local utility. This system is expected to reduce our utility costs by approximately $1 million annually and lower our carbon score. With that I'll turn the call over to our CFO Bryon McGregor.

Bryon McGregor

Thank you Neil, just to know before I comment specifically on our financial performance fourth quarter 2017 is the second order in which the operating results of ICP are consolidated with our quarterly results. While we do not normally disclose detailed information on each plants contribution consistent with our reporting requirements for recent business combinations we note that for the fourth quarter ICP contributed approximately 10% of net sales and 2.3 million in pretax income.

I will now provide a few highlights of the quarter and full year 2017. For additional detail you can refer to our results in our press release or related presentation for the full financials. For the fourth quarter 2017 compared to the fourth quarter of 2016 net sales were $395.3 million down $46.4 million compared to $441.7 million largely the result of a decline in our average sales price per gallon. Total gallons sold were 240 million including record production gallons sold of 150 million primarily attributable to our ICP acquisition.

We had an overall negative gross margin for the quarter due to compressed margins from lower average sales price per gallon. Fourth quarter SG&A expenses on an absolute basis were relatively flat compared to the fourth quarter of 2016 and were in line with our 2017 guidance. It is notable that while our SG&A costs were unchanged they now include expenses related to ICP. Bottom line adjusted EBITDA was negative $273,000 compared to positive adjusted EBITDA of $27.4 million in the year ago period.

For the full year 2017 net sales were $1.6 billion consistent with the year ago period as a decrease in our average sales price per gallon was offset by higher total gallon sold including record production volumes. Significantly lower corn crush margins in 2017 as compared to 2016 negatively impacted our gross margin for the year and our gross profit was $5.9 million compared to $54.4 million in 2016. As a percentage of revenue SG&A remained consistent in 2017. For 2018 we expect SG&A expenses to continue to approximate $34 million for the year or $8.5 million per quarter. Bottom line adjusted EBITDA was $13.6 million compared to the $8.9 million in 2016.

I would now like to briefly discuss the new Federal tax bill that was in place by quarter end. Under the new tax bill we revalued our deferred tax liabilities, resulting in a tax benefit of $300,000. Given that a significant amount of our tax deferred -- excuses me, given the significant amount of our deferred tax assets are comprised of net operating losses and are fully reserved, we expect any taxable income in 2018 would be offset and thus we would not expect an effective tax rate of any significance for the near future.

Now turning to our balance sheet cash and cash equivalents were $49.5 million at December 31, 2017 compared to $64.3 million at December 31, 2016. Cash usage was primarily driven by our ICP acquisition. For the fourth quarter of 2017 our capital expenditures totaled $8 million primarily related to planned proven initiatives. This brings our 12 month total $21 million. For 2018 we currently expect our capital expenditures to approximate our 2017 spend. We may adjust the amount based on industry economics and company performance. With that I will return the call back to Neil.

A - Neil Koehler

Thank you Bryon. Going into 2018 we are encouraged by the continued strength in gasoline demand, increasing penetration of higher ethanol blends, and growing export opportunities. The long term growth in demand for ethanol continues to be supported by the octane, carbon, and cost benefits of ethanol. Key to our strategy is to leverage our operating platform to drive growth. Our strategically located biorefineries enable us to serve multiple markets the diversity of our production geography technology stocks on logistics help mitigate exposure to commodity price risks and our focus on innovation supports our goal to increase efficiency and yields through the implementation of plant improvements. With that Bruce I'd like to open the call for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question comes from the line of Eric Stine from Craig Hallum. Your line is now open.

Aaron Spychalla

Yeah hi, good morning it's Aaron Spychalla on for Eric. Thanks for taking the questions.

Neil Koehler

Good morning Aaron.

Aaron Spychalla

Morning, first maybe on exports, can you kind of talk about your kind of overall expectation for 2018 and some of the markets that are driving that may be specifically China with their kind of E10 goals over time and then Brazil with the ethanol there?

Neil Koehler

Yes, as I have said in the prepared remarks 17% increase year-over-year from 16 to 17 to net 1.37 billion gallons. We anticipate a similar if not greater growth rate in 2018. There have been sort of the conventional rule. Wisdom has been gravitating around the 1.6 billion to 1.8 billion gallons and certainly based on the exports that we're seeing in Q1 that appears to be a fair number. We are now involved with exports with quite a bit of our product out of Nebraska going down to the Gulf. So we are definitely seeing the uptick in demand ourselves.

As it relates to China they were virtually nothing in 2017 and have already booked a few hundred million gallons certainly 200 million gallons of ethanol in the first half of this year. So we are seeing strong demand and supported their initiative to have 10% ethanol blends in place by 2020. And there's a huge gap there between their 1 billion gallons of production and 3.5 billion gallons requirement that that 10% would represent. So we do see that. While they can be up and down we see China as a very positive in this year and potentially years to come.

Brazil with their initiatives to continue to support local blending as part of their carbon reduction targets under the tariffs protocols they still need ethanol. They are structurally short and even with the tariff there, even though there is some discussion that the tariff might be lifted they continue to be a very, very strong market as well. Seeing growth in the historic markets India with the cost benefits and octane benefits in markets like the mid-East. We're seeing that pick up and in other Asian markets as well. So Canada continues to be -- Brazil and Canada continue to be the workhorses in terms of the outlets for our exports that we are seeing growth in other markets as well.

Aaron Spychalla

Alright good, thanks for the color there. And then maybe on kind of rents overall and potentially E15 can you just kind of give your latest thoughts on some of the meetings that are occurring or might be occurring and just whether if you get the year round waiver for E15, I mean do you think that offset some of the stuff that's been kind of rumored on the give side of things?

Neil Koehler

No question and there's lots of discussion and lots of political intrigue out there. And there is a meeting today in the White House and from our industries view and we're very united in this position it's a very simple equation. The rent prices are high because we're not getting enough market access to blend more ethanol and other renewable fuels as the renewable fuel standard is intended to do. And the RVP parity for E15 and higher blends would immediately resolve that issue. The EPA has a discretion to make that happen. It would resolve if it were done today result in significantly more E15 blended this summer. And with the ethanol that we sell at a discount to gasoline attached to that is basically a free rent. So it is a very, very simple equation that if we put more ethanol into the mix through tempered, to the 15% blends that we would resolve any rent price volatility. Rents would drop to single digits and the renewable fuel standard would continue to be the great success that it is. There's no reason to trade that for anything because that is such a simple straightforward solution that protects the integrity of the RFS and continues to build this industry and provide the economic, environmental, and energy security benefits that our fuel is delivering every day.

Aaron Spychalla

Alright, thanks for the color and then maybe last for me, just on corn basis in light of corn prices kind of increasing here recently. Can you just talk about that and what you're seeing in the market today and kind of your outlook here in the near term, can you kind of keep that same basis number?

Neil Koehler

We've definitely seen basis under pressure, exports of corn have been up, there have been logistical issues. The Board price has been at or in some cases below the cost of production so there has certainly been a sentiment on the part of farmers not to sell at these prices and hold on, on farm storage and elevators to the corn. And as the ethanol industry and other users of corn need the product, they had to bid it up through basis. So we certainly have seen a firming of basis probably even a bit more out West given that the freight issues. So basis is up in the quarter but we anticipate given that we have plenty of corn in storage and had a huge crop and projected to be another strong planting this spring that in the relative short-term that will resolve itself and we will get basis numbers that are more historically normal over the last one to two years.

Aaron Spychalla

Great, sounds good. Thanks for taking the questions, I will hop back in the queue.

Operator

And our next question comes from the line of Craig Irwin from ROTH Capitol, your line is now open.

Craig Irwin

Good morning and thanks for taking my questions. I wanted to ask a little bit about spot margins, what you're seeing across the platform today and how volatile they've been in the last number of weeks?

Neil Koehler

There's been a fair amount of volatility in margins in the ethanol industry for years and that continues. As I stated earlier we definitely saw a pretty significant falloff in margins in the fourth quarter. And it is all about supply and demand and days of supply and it's got to be at historic high at levels and has come down since then. The demand piece has been very good. On the gasoline side and on the export side and we also have seen production levels moderate. So we're basically at the same level of production year-to-date that we were a year ago and that's that first time I think in a year or two that we can say that. So we're definitely seeing a little more discipline on the production front with incremental increases in demand and that has supported better margins. They're not anywhere where they should be given some areas where basis is higher. We're still at breakeven or in some cases negative margins and in other markets we're seeing decidedly positive margins. So it's trending in the right direction. Q1s tend not to be great margin environments for the ethanol industry. We actually have been encouraged by seeing here in February before we even get into March an improvement. But it is still clarifying itself on the forward curve and we anticipate better margins and in March forward and are doing everything we can to support that development through our own cost initiatives as well as keeping a lid on our own production levels.

Craig Irwin

Thank you for that. So the second question I want to ask about is about your slowdowns. Can you maybe quantify the impact your slowdowns on the gallons or sort of percent of capacity basis?

Neil Koehler

I would say that it's being evaluated daily and it moves up and down but we're in that 10% reduction level and in some plants more than that in other plants less than that.

Craig Irwin

Okay and then another question, I know you guys are much more conservative or have been over the last year about calling out onetime items -- unusual items on the expense side that you've been really no longer capitalizing certain expenses that -- maintenance expenses that maybe some others would have in the past. Can you maybe discuss the fact if there any significant items on the P&L that hopefully would not be in the back end of 2018?

Neil Koehler

Nothing that I would call out specifically Craig and you are right, we are very conservative in that regard and try not to make excuses by way of those unless they really rise to a very extreme level. I will say that we are very focused on keeping our repairs and maintenance costs under control. Cost containment initiatives whether it is chemicals or repairs and maintenance, whether it's labor, energy, all of the aspects. We have a great operating team that is working on that. We have been modernizing certainly the older facilities we have in Peking and do feel that the cost structure of those plants and that which we can control on an operating performance in 2018 will be noticeably better than in 2017.

Craig Irwin

Great and then last question I guess 2 PM today is a big meeting particularly given we should say the drama in the Tuesday meeting, people being ambushed by unreasonable demands. Some people are believing that the irrational demands made by a senator who's either looking for his next job or desperately fighting to keep his seat. They've actually opened the door to some concrete action near term so on the diesel side people I met with yesterday were optimistic that this could actually help get the five year reinstatement of blenders and producers. I'm assuming that that it could help with the RVP waivers and some other items that the ethanol industry has been asking for. What's your best scenario as far as ethanol regulations that could come out of this meeting?

Neil Koehler

Well, that's an scenario which I'm not predicting because I think the political stalemate really continues. But the best and most appropriate outcome is what I outlined which is on the ethanol side, there's RVP parity for higher blends. That is pure and simply the way to resolve any concern about rent prices. The industry as I said we'll talk about rent transparency and if there's way to regulate that market to downplay any distortions on the web speculation. Those are things that can be on the table but notions of rents for exports or rent caps I mean these are demand destroyers and are completely inconsistent with the letter and intent of the RFS. And as long or ending the program in 2022, as long as those are the demands from the other side there isn’t going to be any deal and will continue to have a stalemate. Right now existing law is our friend and on our side to support the continued growth of renewable fuels. So cautiously optimistic at the end of the day which may not be today, it may be some time from now that standard minds will prevail and the appropriate public policy will move forward.

Craig Irwin

Great, thanks again for taking my questions.

Operator

And our next question comes from the line of Carter Driscoll from B. Riley. Your line is now open.

Unidentified Analyst

Hi, this is Carson Siple [ph] on for Carter Driscoll. Given the overall supply of ethanol, do you think do you think you need to be in the industry consolidation or do you think the export markets can make up for it?

Neil Koehler

Well I think both are possible. We haven't seen much in the way of M&A activity in the ethanol industry for a while. Do we think more is possible, absolutely. You have six players, we're number six that controlled about 50% production. It would be not uncommon in a commodity business like this as it matures or five or six players to actually control something closer 60% or 70%. So that would be healthy but not necessarily seeing that in the near term. On overall supply demand we are cautiously optimistic on that. If you look at the numbers last year we produced 15.8 billion gallons so even if we're producing, today's rate is 16 billion even if we end up producing 16.2, 16.3. You run those numbers and you have 14.4 or so and that's just on a 10% blend and add 1.7 billion to 1.8 billion gallons of exports. And incremental E15 of whatever it might be on the low end of 50 million, it could be high as 150 million. You then start seeing a drawn on inventories and a much better supply demand balance if not tightening up particularly in the driving season and a scenario that supports better margins.

Definitely we've had an overhang on supply but you look at it in terms of days of supply, running it about 24 days. You can look at the numbers historically and 2020 to 2021 and lower do support strong margins but also point out that with that force being an increasing piece of it the supply chain is longer. So it could be something that is only a couple of days off where we are to really have it and be a much more snug supply demand balance. And we're talking about 150 million gallons of the billion gallons -- roughly billion gallons of inventory out there. So it wouldn't take much of a draw to tighten this up and support a better and more sustained margin and we're seeing this on the sources and uses. We are seeing a scenario that would suggest that we should see a tightening as we move into the second and third quarters.

Unidentified Analyst

Great, thank you and then also if you don't mind could you address your capital availability and the flexibility given the rising interest rates? Thanks and I'll get back in the queue.

Bryon McGregor

Oh yes, sure we still have significant excess availability in cash reserves on hand. And our work that we did or continue to do but the work that we completed in December of 2016 significantly lowering our overall capital, cost of borrow certainly would benefit us as rising interest rate environment. So we're still looking at from a historic basis significantly lower cost of borrow for our company than what we've seen in the past.

Unidentified Analyst

Great, thank you.

Operator

And our next question comes from the line of Sameer Joshi from H.C. Wainwright. Your line is now open.

Sameer Joshi

Good morning. Just -- question first, what is the actual total production capacity of all your plants?

Neil Koehler

605 million gallons per year.

Sameer Joshi

600, great, yes. Talking about the Stockton cogen given that I know one of them was commissioned earlier recently and then do you on the call I heard you mention there is another unit that is possibly coming on, what is the timing on that and is the 1 million cost savings that you spoke about only for the first unit or for both units?

Neil Koehler

Yeah, on cogen it's $4 million of annualized savings and so the one unit is running pretty much at capacity. So that would annualize pretty close to half of that. The -- as we have mentioned before this is sort of -- it is standard natural gas cogeneration technology with serial number 1. Very innovative technology and on the ability to use a oxidizer to burn the waste gases off at the facility rather incinerate them through a thermal oxidizer and it's very good technology and having some fine tuning issues on the units which has taken more time to get both of them up. One is now where it needs to be, the other is still in fine tuning and we anticipate that that will certainly be up and running and fully operational in Q2 at the latest.

Sameer Joshi

Okay, and there any plans to replicate this growth of the other plants under the facilities?

Neil Koehler

The cogeneration.

Sameer Joshi

With the cogeneration.

Neil Koehler

Yes, that it is particularly valuable where we have a very high electricity rates which would be California. So certainly as we get this up and prove its performance and verify that is generating the savings and the efficiencies we would look at expanding that first to Madera.

Sameer Joshi

Okay, moving to the ICP acquisition, I know you spoke about the 4.5 million savings and costs and then your current SG&A costs are fairly -- slightly lower but it includes the ICP costs, are you actually realizing those 4.5 million combined like it's difficult to see it from where we stand?

Bryon McGregor

Right, on an annualized basis as we go into 2018 we are realizing about 3 million of that 4.5. So some other initiatives that are mostly around logistical opportunities and savings through optimizing the use of the direct access we have now to the river. We fully implemented that on ethanol and barging and we're in the process on distillers grains most of which we export from Peking so that would be the largest opportunity to have some other smaller opportunities as well. But we expect that to be in place certainly in the last half of the year at the latest on that.

Sameer Joshi

Okay, and then one last one, you mentioned your CAPEX for 2018 should be approximately at the same levels as 2017 which was 21 million, can you provide a little bit more granularity on where this will be spent?

Neil Koehler

Mostly what we have identified in that budget number, our projects throughout that platform that are both necessary for just basic maintenance CAPEX as well as some initiatives that have already been in place finishing up solar, certainly finishing up the cogen, we have some dryer work at Peking. Some items that are really both very quick payback in terms of new projects and very necessary just to maintain safe and efficient operations at all the facilities. So it's a base load. As Bryon mentioned depending on where margins are in market conditions we certainly have other innovative projects that we could do. But are going to be very careful to make sure that we're stewarding our capital resources prudently and we'll monitor that and calibrate that as the year progresses.

Sameer Joshi

Great, thanks, I will take my rest of the questions offline, thanks.

Neil Koehler

Thanks Sameer.

Operator

[Operator Instructions]. And I'm showing no further questions at this time. I would like to turn the call back to Neil for any closing remarks.

Neil Koehler

Thank you Bruce and thank you all for joining us today and your continued support of Pacific Ethanol and we will work hard to improve the operating results of the company and deliver profitability. And look forward to talking to you next quarter.

Operator

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.