Pacific Ethanol, Inc. (NASDAQ:PEIX) Q3 2018 Earnings Conference Call November 1, 2018 11:00 AM ET
Kirsten Chapman - LHA Investor Relations
Neil Koehler - President and Chief Executive Officer
Bryon McGregor - Chief Financial Officer
Eric Stine - Craig Hallum
Carson Sippel - B. Riley FBR
Craig Irwin - Roth Capital Partners
Sameer Joshi - H.C. Wainwright
Good day, ladies and gentlemen, and welcome to the Pacific Ethanol Incorporated Third Quarter 2018 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 be given at that time. [Operator Instructions] As a reminder, today's conference call is being recorded.
I would now like to turn the call over to Kirsten Chapman, LHA Investor Relations. Ma'am, you may begin.
Thank you, Mark, and thank you all for joining us today for the Pacific Ethanol third quarter 2018 results conference call. On the call today are Neil Koehler, President and CEO; and Bryon McGregor, CFO. Neil will begin with a review of the 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 for the company's quarterly results. The company also prepared a presentation for today's call that is available on the company's website at pacificethanol.net.
If you have any questions, please call LHA at 415-433-3777. A telephone replay of today's call will be available through November 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, November 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 a number of risks and uncertainties. The actual future results of Pacific Ethanol could differ materially from those statements. Factors that could cause or contribute to such differences include, but are not limited to, events, risks, and other factors previously and from time to time disclosed in Pacific Ethanol's filings with the SEC. Except as required by applicable law, the Company assumes no obligation to update any forward-looking statements.
In management's prepared remarks, non-GAAP measures will be referenced. Management uses these non-GAAP measures to monitor the financial performance of operations and believe these measures will assist investors in assessing the Company's performance for the periods being reported. The Company defines adjusted EBITDA as unaudited net income or loss attributed to Pacific Ethanol before interest expense, provision or benefit for income taxes, asset impairments, purchase accounting adjustments, fair value adjustments, and depreciation and amortization expense. To support the Company's review of the 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, please go ahead.
Thank you, Kirsten, and thanks to everyone for joining us today. Before I give my high level review of our third quarter 2018 financial results, I wanted to discuss some recent regulatory and industry developments that are of positive significance to Pacific Ethanol.
First on the regulatory side, the Environmental Protection Agency EPA is beginning a formal rule making process to allow year-round sales of E15 nationwide. This generates a significant growth opportunity for the U.S. market that overtime could result in approximately 7 billion gallons of new ethanol demand given the current gasoline market. While commercial E15 implementation will take time. This move provides an important growth path for the domestic ethanol industry and we expect the E15 sales to accelerate materially in 2019 given the cost and environmental advantages of higher ethanol blends.
Subsequent to the President's announcement, directly in the EPA on the rulemaking, two large retail chains announce large expansion plans for E15 distribution and we expect to hear other announcements soon. The EPA has committed to complete rulemaking by the summer of 2019 and the ethanol industry is working to make sure they keep to that commitment. The recent E15 announcement reflects President Trump's repeated support for the ethanol industry and for agriculture. With RIN prices now trading near 5 year lows, we see no rationale for the EPA to grant additional small refinery economic exemptions and a fewer or non-granted, this will result in stronger domestic ethanol demand in 2019.
Further, the West Coast carbon markets continue to create strong premiums for our low carbon ethanol. This week, California carbon pricing per metric ton reached record highs of greater than $190, following the upper trend over the last two years. Also leading oil and gas companies are increasing their diversification and investment in ethanol, recently Valero announced the purchase of several plants, demonstrating the positive long term view of ethanol and also providing an updated indication of valuation of ethanol production related assets.
Now turning to a review of our third quarter. Net sale for $370 million compared to $445 million in last year's third quarter. Total gallons sold were $212 million, production gallons sold were $140 million. We had a $3.8 million gross profit for the third quarter compared to a gross profit of $12.1 million in the comparable quarter last year.
Loss avails to common stockholders was $7.8 million, and adjusted EBITDA was a positive $6.3 million, compared to a loss available to common shareholders $0.5 million and adjusted EBITDA of a positive $13.2 million last year. Industry ethanol margins continue to be compressed in the third quarter with industry inventories near record highs, pointing to the need for some combination and lower production levels and new incremental demand from higher blends and exports.
As a company, we have reduced our production levels and are running at around 90% of operating capacity across the portfolio.
We remain focused on implementing initiatives and investing in our assets to reduce our cost, improve our yields and carbon scores and build sustaining value for our shareholders.
We are at or near completion of several plant level capital projects with near term paybacks. We have achieved commercial operations with successful performance stepped in of our solar project in Madera. We currently are producing at 3.5 megawatt level and following upgrades by PG&E at the local substation. We will move to the 4 to 5 megawatt level by year-end. This project lowers our electricity costs and improves our carbon score at our Madera facility, yielding over $1 million of annual operating benefit.
We've made good progress on our 3.5 megawatt cogeneration project at our Stockton, California facility, required modifications to the two generating units were completed in third quarter and the units are now install. We are currently going through startup operations anticipate the system will be a target performance by the end of the year.
Commercial operations at the Airgas CO2 plant at our Stockton facility have been pushed out slightly to the beginning of 2019. Although these operations are not under our control, but rather follow Airgas; construction schedule, we expect the plant to be producing revenue for Pacific Ethanol in the first quarter of next year.
During the third quarter, we received a new pathway from the California Resources Board for our Stockton cellulosic ethanol that adds to the premium pricing for this production and which is expected to contribute approximately $0.5 million of incremental EBITDA per year based on the current carbon market. We continue to generate the D3 RINs and are still awaiting final EPA approval of our cellulosic ethanol pathways for our Madera and Magic Valley plants.
Turning to the ethanol export market. U.S. produced ethanol continues to see growth as a blend component in gasoline around the world, due to its low cost, high octane content and contribution to reducing carbon emissions. And important reason development was the Trump administration's actions to preserve tariff free treatment of ethanol exported Canada and Mexico.
Canada is the second largest export market and Mexico although nascent is poised for increased ethanol use as a cost effective environmentally favorable substitute for MTVE. Both countries are showing year-over-year growth in U.S. ethanol purchases. The trade tariffs imposed by the U.S. and reciprocated by China however have caused China to cease purchasing any ethanol from the U.S. This has been a significant negative factor in the overall supply and demand picture for the industry this year.
At the beginning of the year, China was on pace to purchase record volumes of ethanol from the U.S. However, since tariffs began exports to China have declined to zero.
As a Company and as an industry, we encourage Trump administration to relieve the market barrier caused by these tariffs. If China sticks to its 10% ethanol by 2020 goal which we believe they will, china will need to import significant quantities of ethanol, supporting continued growth in the overall international demand for ethanol.
We expect total exports this year to reach another record high of between 1.6 billion gallon and 1.7 billion gallons, which represents about a 20% increase from 2017 levels and we expect additional growth in the export market in 2019.
With that, I'd like to turn the call over to our CFO, Bryon McGregor.
Thank you, Neil. For the third quarter 2018 compared to the third quarter of 2017, net sales were $370 million compared to $445 million. The 17% decline in sales is attributable to lower ethanol prices, fewer gallons produced and fewer third party gallon sold.
Cost of goods sold was $367 million compared to $433 million in the prior year's quarter, predominantly reflection of not only lower sales but also affected by lower corn prices and reduce production costs.
Gross profit for the quarter totaled $3.8 million compared to $12.1 million in the prior year's quarter. This decline is a result to lower ethanol margins.
SG&A expenses were $9 million, up slightly from $8.7 million. We expect SG&A for Q4 to total $9 million in line with our current guidance.
Loss available to common shareholders was $7.8 million or $0.18 per share, compared to $0.5 million, or $0.01 per share. Adjusted EBITDA was $6.3 million compared to $13.2 million in the year ago period. For the 9 months ended September 30th, 2018 compared to 2017, net sales were $1.18 billion compared to $1.24 billion.
Cost of goods sold was $1.18 billion, compared to $1.23 billion. Gross profit was $5.9 million, compared to $7.9 million. SG&A expenses were $27.2 million, compared to $22.9 million, the latter of which included at $3.6 million in one-time gains associated with legal matters in the prior year.
Loss available to common shareholders was $29.2 million, or $0.68 per share compared to $22.6 million, or $0.53 per share. Adjusted EBITDA was $12.9 million compared to $13.9 million.
Turning to our balance sheet. During the first nine months of 2018, cash flow from operations was $26.1 million compared with $21.2 million coming from the third quarter alone contributing to a stronger balance sheet. At September 30th, 2018, cash in cash equivalents were $56.1 million, compared to $49.5 million at December 31st, 2017.
For the third quarter of 2018, our capital expenditures total $3.5 million, primarily related to plant improvement initiatives, bringing our total capital expenditures year-to-date to just over $10.9 million. In light of the weak market conditions year-to-date, we have adjusted a number of capital projects it expect to limit Q4 expenditures to around $3 million, well below our full-year CapEx guidance.
For the third quarter of 2018, we focused on reducing our total debt with $23.7 million paid in the quarter through a combination of term loan repayments and reduce usage of both term revolver and line of credit facilities.
Looking at our overall capital structure, over the past few years, we've quickly grown from a company with four plant and annual ethanol production capacity of 200 million gallons to nine plants with capacity of more than 600 million gallons, while diversifying product offerings and expanding nationally.
We have built a scalable business model to take advantage of the expected growth we see in the ethanol industry. This growth has been conservatively funded through a sensible combination of equity, long term debt and cash flow. Our balance sheet remains strong despite the current market challenges and we feel it is appropriate to maintain as part of our capital structure, the conservative level of long term debt, lowering our overall cost of capital and enhancing shareholder return on investment.
In this regard, we are actively evaluating opportunities to refinance our senior notes well in advance of their December 2019 maturity. We exited the third quarter with solid liquidity of approximately $70 million consisting of cash and accessibility under our revolving lines of credit.
With that, I will turn the call back to Neil.
Thank you, Bryon. To sum up, we believe that fair and open access for E15 year-round and properly and legally implemented RFS will support significant growth in domestic ethanol demand. And we are confident that the compelling cost octane carbon benefits of ethanol will drive both new domestic and export demand in 2019, resulting an improved margins for our company.
Our focus today is on delivering additional value with their existing assets to capitalize on positive macro trends, by cutting costs at both the operating corporate level, further diversifying our sales through additional high protein feed and alcohol products, and new initiatives to continue to lower the carbon score as our plants that can service valuable low carbon fuel markets.
With that Mark, I would like to open the call for Q&A.
Thank you. [Operator Instructions] And our first question comes from the line of Eric Stine of Craig Hallum. Your line is now open.
Hi, Neil. Hi, Bryon.
Good morning. Just on the production side, clearly you've pulled back some on production. Just wondering, if you're seeing any evidence of that in the industry and just curious I mean whether you're seeing that or when you look forward, is it E15 and potentially China coming back that get this market back in balance or just how do you see that plan out?
Yeah fair question, we've seen some reduction in production not enough given that the current inventory and the current supply and demand, balance as we move into - moving out of the driving season. So long term really mid-term, we're very bullish on incremental demand, but we are here where we are which inventories well not significantly out of balance, probably 100 million plus gallons that like to reduce, it was encouraging. This week with production up a bit from the week before albeit down over the last four week average the EI inventories were down almost 5%. So that was actually a very, very good trend at the current pricing of ethanol near historic low since they've been listed on the Chicago Board and higher gasoline prices, we are seeing that pick up in exports now even without China. But to your point with China in the mix, it would be a very different market in margin environment today. So we're also optimistic that China will come back in as well and that combination of some discipline on production and incremental demand will ride the ship.
Okay. And saying your exports, I know you're earlier really looking for growth in 2019, I mean I was curious, are you assuming anything from China in that view and then when you're thinking about growth year-over-year maybe just talk about some of the important or incremental markets that helped that?
Sure. The - in incremental albeit small increase in 2019, I would say that does not include China. So China is a wildcard, I personally believe it will come into play in 2019 and that would result in larger increases. So I think we see small increases without China and large increases with China.
We are seeing now with the deregulation Mexico some incremental increases there expected in 2019 as you recall Japan has now authorized some increment of their use of ethanol to be corn based ethanol, it had been limited to only Brazilian to produce the ETBE that they blend into their gasoline. So we see that is about 100 million gallon incrementally new market starting in 2019, Brazil at the largest importer of our ethanol will continue to be a strong user given the demand and the price point of ethanol in Brazil, so at our potential increases.
Canada, they have new programs to increase the blend rates up there, we're seeing incremental growth this year we expect to see incremental growth next year. India, as a large market as well also with their moving their blend rates up and continue to encourage ethanol years we see incremental growth there. Given the exceptionally good price point and octane basis, so areas in the Middle East and where ethanol gets used just for pure octane blending economics, we anticipate that given the current relationship between ethanol and world gasoline prices that we will continue to see growth there as well.
Okay. Maybe last one for me and I apologize that I missed this earlier. But I just wanted to confirm you did say you generated cash in the quarter, I miss that?
I mean we clearly have EBITDA numbers just over $6 million, and we're able to really focus on some debt reduction opportunities and usage of our revolvers.
Okay. And if my math is right was that like $15 million $20 million from operations for the quarter?
Okay. All right. Thanks a lot.
And our next question comes from the line of Carter Driscoll of B. Riley FBR. Your line is now open.
Hi, this is Carson Sippel on for Carter Driscoll. I just had a couple of quick questions. First, so there are roughly 1,500 E15 gas stations across the country, what incentives are there in place this number could increase in the coming years?
Well, the biggest incentive is the price of ethanol. If you blend ethanol with a 10% blend to bring it to a 15% blend, you're lowering your cost by anywhere from a nickel to a dime. And the retail business is highly competitive and so having that cost advantage is a large incentive. We as an industry have a program called priming the pump that helps with the modest investments that some stations have require to put in blender pumps et cetera. So there's eight there, there have been time to time USDA grants available as well to aid with infrastructure. But the real driver is just the pure economics that that ethanol lowers the cost and makes you more competitive on history and increasingly with carbon certainly out west becoming a factor the ability to blend more ethanol, more low carbon ethanol is going to be very significant in meeting clients under various low carbon fuel requirements.
Got it. Thank you. And then more specific to the company itself, so it seems like third party gallons have gone down to clearly for the past two quarters, do you expect this decline to continue or do you think you'll begin increasing this number moving forward?
I think we're at a pretty good run rate right now as we've said publicly before is that we really revaluated some of the third party business in where we were not able to make money and it wasn't strategic and tributary to our production assets, we pulled back. So that was a very intentional strategy and it has resulted in significantly improve profitability in our marketing business. So but right now, we feel that we're in a pretty good place and that we're always evaluating that both in terms of where we might decrease and where we might increase.
Got it. Last one for me is can you provide a quick update on the legal claim for the boiler?
It is - it is still in litigation and we are still optimistic that we will be successful in that outcome but as it is true with the legal actions hard to handicap timing but we're pushing hard to have resolution in 2019 on that subject.
Sounds good. Thank you.
[Operator Instructions] Our next question comes from the line of Craig Irwin of Roth Capital Partners. Your line is now open.
Good morning and thank you for taking my questions.
Good morning, Craig.
Can you please walk us through the sequential impact on the sunset of the boiler repairs and the integration expenses for Aventine?
The integration - with the integration Aventine is completely and ICP and their $1 million the synergies that are being recognized by the point out the boilers that has been a significant drag over the last three years to the tune when you add up all of the other. The last time, the repairs the repairs and maintenance that rental boilers, the litigation it's been a $27 million drain to the company over the last three years.
Other than the ongoing litigation which we expect to recover significant amount of money from those expenses are behind us. So that is that when you run the numbers on $9 million a year, you can see the large impact that has. In a positive light to with the ICP integration, the access to the water, we cut our expenses on logistics by over $2 million on ethanol by moving the barges through our own dock, we're improving our knapsacks as the water barrels today are more valuable than moving product out by rail. We're finishing the movement of our distiller's grain which all goes out by water as well to our own dock, which is another $1 million of savings. We're reducing our rail fleet where we now have realized almost $5 million $6 million of annualize savings going forward on reducing our real fleet with another 100 cars coming out in April. So these are - those are some high level items of how we really have reduced our cost and much better position going forward.
Great. Thank you for that. So then for those of us that believe that the logical outcome of the trade dispute with China, is that China is a very large customer this Ag going forward and that we find a way to be friends not enemies. That kind of points to a fairly high value for port access for loading ethanol going west particularly that's not rail right, can you maybe talk a little bit about whether or not your existing facilities have the capability to add a loading terminal on the water. What you feel about the rail supply into your existing facilities? How you would go about permitting and potentially constructing that and if this is something that you've looked at as a potential investment of the next couple years?
It is something you've looked at - the only facility that we have currently would be appropriate would be stocked in well served by 2 railroads, on the largest inland port on the on the West Coast. It can take large amounts of it doesn't currently have the infrastructure the dock for loading ethanol and so there would be a fair amount of construction and in piping and docking, but as China and Asia generally picks up we do anticipate quite a bit of demand for moving products ethanol in particular of the West Coast.
And it is - it is something we're evaluating for ethanol that would be outside of our own production because our focus their particular in West Coast is to add value on carbon and you don't get that on. So our best FX for our own ethanol are close to home but as we do have a diversified portfolio in the portfolio in the marketing company, we are looking at that option as well.
Great. Thank you for that. My next question is really about asset value. You consolidated your Western plans at what $0.30 a gallon and then you bought Aventine for I guess about $0.50 a gallon. This is a big discount to some of the private transactions in the market. What would you consider liquidation value of your plants if you were to just sell them? Would you would you expect to get a dollar a gallon if you if you were to sell them the way green planes this move with some of their plants?
And what would you consider potential cut it up and sell real estate value, I mean it seems where the stock is now that we could even be below those levels if we factor in the debt and look at where the stocks trading?
I can't disagree with you, that's obviously not our focus, our focus is to recognize the real value which is operating these assets that be for performance. And to your point is they are undervalued given the current equity valuations, they are great assets a diversified assets, all I can say in terms of market value is that you have to look at recent transactions and that isn't that dollar plus range that the most recent transactions of the Green Plains facilities to Valero.
So if you run that map you can quickly see that there is a huge disconnect between the inherent valuation of the plants based on recent transactions and our current enterprise valuation. There's negativity in the ethanol world and we brought it on ourselves to some degree as an industry, we've got too much production, we need the incremental markets and demand and with both the E15 and China, you're looking at the opportunity in the direction in a much more positive margin environment valuations will take care of themselves.
Thank you for that. So my last question is about the litigation that started or should start relatively soon, let's hope looking to force EPA to reallocate the gallons from Scott Pruitt foray into appropriate small refinery waivers. Do you have any strong views on the potential of a case and would you potentially have interest in participating and in litigation with some of your peers in the ethanol industry?
Well we are participating through our trade association, the renewable fuel association in which I am the current Chairman. So we're very active in that we do feel very strongly that that what would happen under Pruitt watch, on a small refinery exemptions was absolutely not legal and that we have a very strong case, really waiting until the final RVOs come out because to be able to bring lawsuits on these topics and to be able to prosecute them. We need for that final rule to be out because there is a possibility we're not expecting it but they could be reallocating gallons in the final rule.
Again not expecting that and do anticipate that the lawsuit will be prosecuted with vigor after that point. So it is - it is our views those gallons should be reallocated, our views that there is no basis upon which to be granting these small refinery exemptions. So at a minimum with the pending E15 those are listed on the EPA website. Those should not be granted, there's no rationale and that alone will help improve demand relative to that the demand of the past couple of years, where we saw over 2 billion gallons of small refinery exemptions taken away demand.
Great. Thanks again for that. And congratulations on the quarter which actually quite a bit better than - then I guess I hear so that's strong execution.
Thank you, Craig.
And our next question comes from a lot of Sameer Joshi of H.C. Wainwright. Your line is now open.
Yes. Good morning Neil, Bryon.
Thanks for taking my questions. I just want to confirm that in your prepared remarks, did you mention that you're currently operating at 90% capacity?
And given the higher inventory and the fact that summer months behind us, do you expect these 90% of operations for the next this quarter?
That is our expectation. We will continue to evaluate that if anything we could bring it down some as well.
Just following-up on one of the previous questions. The third party sales, are there any other factors apart from cost reductions that are playing into your decision to lower the volume there?
No. We really - we were the incumbent in these markets we could have continued to maintain those sales and even grow them. But it was purely an analysis financial analysis of where we should pass put our resources whether it be working capital and where we could maintain profitability and certain markets, certain areas that really we just didn't have the much of a strategic value Arizona being a good example, trading dollars and very competitive market it was why would we do that, so purely a financial analysis and decision to refocus that part of our business the way that we have sustained possibility.
Okay. Most of the other questions have been answered but just one clarification on the cogeneration at Stockton. Did you expect that to be operational by end year or first quarter next year? And then follow-up on that is when do you expect the full $4 million savings from that?
We do anticipate it to be fully operational by the end of the year. We have - had dates coming on so we know there are some caution there but everything looks very good and the issues that were slowing that installation down appear to be behind us. And when the things starts could be in the first quarter a little bit of up and down as there is some fine tuning but would we would more or less anticipate the full opportunity in savings for the calendar year 2019.
Just a quick follow-up, so if everything else stays same in terms of costs, do you expect $9 million quarterly cut run rate to come down based on these savings as well as the Madera solar plant?
No. Those wouldn't show up and SG&A lines it would be under your operational lines.
Under the operational. Okay. Got it. Thank you. Thanks for taking my questions.
Sure. Thank you, Sameer.
And I'm showing no further questions at this time. I would now like to turn the call back to Neil Koehler for closing remarks.
Thank you, Mark and thank you all for joining us today and your continued support of the Pacific Ethanol, we look forward speaking with you soon. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.