Renewable Energy Group's CEO Discusses Q3 2012 Results - Earnings Call Transcript

| About: Renewable Energy (REGI)
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Renewable Energy Group (NASDAQ:REGI) Q3 2012 Earnings Call November 6, 2012 4:30 PM ET


Monte Bullock - Treasurer

Dan Oh - President and Chief Executive Officer

Chad Stone - CFO


Mahavir Sanghavi - UBS

Michael Cox - Piper Jaffray

John Quealy - Canaccord Genuity

Shawn Severson - JMP Securities


Good day ladies and gentlemen, and welcome to the Renewable Energy Group Inc. third quarter 2012 earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host for today, Mr. Monte Bullock, the treasurer. Sir, you may begin.

Monte Bullock

Thank you. Good afternoon everyone, and welcome to our third quarter 2012 earnings conference call. With me today is our president and chief executive officer, Dan Oh, and our chief financial officer, Chad Stone.

We are here to discuss our third quarter 2012 financial results and recent developments. Before we begin, I would like to remind everyone that this call is being webcast and is available at the investor relations section of our website at

A replay of this webcast will be available on our website for one year. The webcast includes an accompanying slide deck. The slides will appear automatically with the webcast, but you will need to advance them manually as we prompt you. For those of you dialing in, the slides can be downloaded, along with the earnings press release, in the investor relations section of our website.

Turning to slide two, we would like to advise you that some of the information discussed in this conference call will contain forward looking statements. These statements involve risks, uncertainties, and assumptions that are difficult to predict. Such forward looking statements are not a guarantee of performance. The company’s actual results could differ materially from those contained in such statements.

Several factors could cause or contribute to such differences. These factors are described in detail in the risk factors and other sections of our annual report on form 10-K and quarterly reports on form 10-Q, which are on file with the SEC. They are also described in the earnings release and other SEC filings.

These forward looking statements speak only as of the date of this call. The company undertakes no obligation to publicly update any forward looking statements based on new information or revised expectations.

Today’s discussion also includes non-GAAP financial measures. We believe these may be important to investors as a metric to assess the operating performance of our business. Please see the press release for a reconciliation of GAAP and non-GAAP measures.

With that, let me now turn the call over to our chief executive officer, Dan Oh. Dan?

Dan Oh

Thank you Monte, and thank you everyone for joining the call. I will summarize our performance during the third quarter and discuss industry conditions. I will then turn the call over to Chad for additional financial details.

First, let me address our pre-announcement in early October. Obviously we are disappointed to report an EBITDA loss, yet the situation is complex. It in no way diminishes our confidence and commitment towards our business and industry.

Chad will go over the financial details, but first let me discuss a primary cause for the swing in our guidance from positive EBITDA to an actual loss. We incurred $18 million of losses in our risk management positions, which was primarily the result of large movements in heating oil and soybean oil price indices in late September, which are shown on slides four and five.

These movements were reflected in our financial statements by adjusting the carrying value of forward risk management contracts to fair value and recognizing the corresponding loss in current earnings. A natural reaction is to ask how could this happen, and whether our risk management system is broken.

The answer is that our system is not broken, and the loss is mostly a function of timing. Let me step you through an example that illustrates this. Suppose it is August and we contract with the customer to deliver X million gallons of biodiesel in November. We agree that the customer will pay Y dollars over the spot price of heating oil at the time of delivery, quoted on NYMEX.

When we sign this contract, we are now effectively short biodiesel at a floating index price, an exposure we do not want to assume uncovered. In order to mitigate that exposure, we now short heating oil via contracts traded on the NYMEX and by long soybean oil contracts on the CME, for example, to protect against fluctuations in heating oil prices and feedstock values between the time we enter in the contracts and the time we fulfill the sale.

At the same time we enter the contract to sell biodiesel, in this example, in August, we also need to mitigate exposure to potentially escalating feedstock prices by entering into long soybean oil contracts. Those contracts can also fluctuate in value, and must be mark-to-market at the end of the quarter.

Now, suppose heating oil rises in September. Our short position in heating oil is now showing a loss if priced at the last trade. According to generally accepted accounting principles, we are required to measure contracts at fair value and recognize corresponding gains or losses in current earnings. This is what you saw in Q3.

So, while a short position in heating oil is showing the loss, the other half of the trade you do not see reported is the long exposure via the biodiesel sales, whose price is indexed to heating oil. That “gain” is not recognized until the sale is fulfilled.

As you can see, we are essentially protecting future margins by entering the contracts for biodiesel sales at a price indexed to heating oil, feedstock purchases to fulfill the biodiesel sales, and risk mitigation versus the heating oil index.

In Q3, energy and feedstock prices moved against our risk management positions, and you saw the losses from recurrent earnings. What you did not see were the Q4 and total 2013 biodiesel sales and feedstock purchases that were protected by the risk management positions.

If you look at our risk management activity over a longer time period, which allows the timing issues to settle out, you can see the true cost of protecting our positions. Slide six reviews these results. As you can see, risk management generally is costing us around $0.02 per gallon, a very reasonable cost to protect complex economics within our business.

Now, having said that, we must also recognize that our margins were squeezed by falling RIN prices. Slide seven compares biodiesel RIN pricing to production this year, and you can see the steep decline during the third quarter. In fact, RIN prices fell 36% in the quarter, with most of the decline occurring late in September as the market reacted to August EMTS production data, which was lower than July’s.

Declining RIN prices seem to indicate the industry can supply biodiesel and RINs to meet demand for 2012. Further, the supply situation was exacerbated by the summer drought, which resulted in strong crush margins for soy processors. As they produce more soy meal in reaction to those crush margins, they also produce more oil byproduct. Lower than normal soy oil prices encourage marginal buyer refineries to produce biodiesel, even in the absence of support from RIN pricing.

So, to reiterate, yes, we are disappointed with reporting this EBITDA loss, but in no way does it threaten the durability of our business. Furthermore, our achievements in the quarter leave us optimistic about REG in the years ahead.

I will now review those operating highlights, starting on slide eight. Our company continues to grow. This past quarter, we produced 45 million gallons of biodiesel, a 15% increase versus third quarter 2011. We sold 62 million gallons, which is 40% greater than the third quarter of 2011. Revenue grew 26% year over year to $323 million, and we increased our cash balance during the quarter to over $88 million.

Turning to slide nine, let me discuss our network expansion in the west and southwest. This summer, we opened a sales terminal at our facility in Clovis, New Mexico, and followed that up with new terminal access in Long Beach, California. We intend to continue to expand our distribution through future expansion as we build out a national footprint.

On October 26, we acquired an offline biodiesel refinery in New Boston, Texas that will increase our nameplate production capacity to 227 million gallons per year. As detailed on slide 10, the 15 million gallon per year biorefinery, which is near Texarkana, was purchased for 900,000 shares of common stock and $300,000 in cash.

After our technology team performs minor upgrades to meet REG specifications, we expect to commence production in the first quarter of 2013. The plant is already feedstock flexible, so the initial commissioning costs are expected to be approximately $3 million.

Finally, we continue to make progress on the upgrades to our plants in Albert Lea, Minnesota. On completion, by the end of June, 2013, Albert Lea will be fully feedstock-flexible, which will contribute to better margins.

Now I would like to turn the call over to Chad Stone to review our financial results in more detail. Chad?

Chad Stone

Thanks, Dan, and good afternoon everyone. Please turn to the financial highlights, starting on slide 11. As Dan described, the overriding themes during our third quarter operating results were risk management and RIN prices, offsetting the margins we earned during the quarter.

To provide some context to the commodity swings, heating oil increased by 17% during the quarter, and soybean oil decreased by 11% in the last two weeks of September. Although that spread is generally good for future margins, these were adverse moves for our risk management contracts.

To illustrate how our risk management contracts are reflected in our financial results, imagine that we have future commitments to deliver 30 million gallons of biodiesel, and we’re short for 30 million gallons of heating oil futures. For every spot price increase of $0.01 per gallon of heating oil, our risk management contract would incur a $300,000 loss, which would be reflected in cost of goods sold. Similarly a $0.01 gap per gallon decline creates a $300,000 gain.

During the third quarter, heating oil steadily rose from $2.70 per gallon to $3.17 per gallon, an increase of $0.47. On the feedstock side, if we had procurement contracts for half of our future committed sales, we would still need to cover the remaining 15 million gallons of feedstock exposure by entering into long soybean oil future contracts.

Based on that volume, a $0.01 decline in the spot price per pound of soybean oil would result in a $1 million contract loss, which is also reflected in cost of goods sold. In the last few trading days of September alone, soybean oil dropped from $0.56 to $0.50 per pound.

So in light of these commodity movements, our risk management expense for the quarter was $18 million, or $0.29 per gallon sold, which is reflected in cost of goods sold. Approximately half of the risk management expense was associated with fourth quarter and 2013 future business.

What you’re not yet seeing is the improved margin from energy price increases and feedstock decreases. That will be booked in the future. So for example, the heating oil price increase of $0.47 per gallon would have resulted in a margin improvement of approximately $6.8 million in the fourth quarter if that price held.

So over time, our risk management expense functions like an insurance premium. As Dan noted earlier, referring to slide seven, over the last three years our risk management “premium” averaged $0.02 per gallon, but ranged from as much as a $0.33 per gallon gain to a $0.29 loss.

Turning again to the RIN market, at the start of the quarter, RINs were $1.24, but ended the quarter at $0.71. The sharp decline in RIN pricing resulted in negative adjustments to the carrying values of RINs in our inventory, which increased our cost of goods sold by $8.2 million.

Now getting into the operating results on slide 11, in the third quarter of 2012, we produced 45 million gallons of biodiesel, a 15% year over year increase, and sold 62 million gallons, a 40% year over year increase. Our sales were higher than production due to the draw-down of finished goods inventory and also more third-party biodiesel sales.

Revenue was $323 million, a 26% year over year increase. The 40% increase in gallons sold was offset by a 22% year over year decline in average selling price per gallon. The average selling price was impacted mainly by the decline in RIN prices.

Revenues from co-products, feedstock sales, demurrage, and storage amounted to $24.9 million in the quarter. Gross profit of $2.8 million was down 95% year over year, resulting in a gross profit of 0.9%. As we addressed earlier, gross profit was severely impacted by the risk management losses and the RIN price declines. Our total risk management loss of $18 million reduced gross profit by 5.5%.

Selling, general, and administrative expense declined 10% compared to the second quarter last year due to lower stock compensation as outstanding equity compensation vested following the completion of our IPO. SG&A declined to 3.1% of our revenue compared to 0.3% in third quarter 2011.

The significantly lower gross profit, combined with controlled SG&A expenses, resulted in an operating loss of $7.1 million. Third quarter interest expense of $1.2 million decreased by $1 million year over year. The decrease was attributable to the decrease in debt and a lower interest rate on our Wells Fargo line of credit, compared to our previous working capital financing instruments.

We had an income tax benefit of $2.2 million during the third quarter, as a result of the reduction of our full year projected income. In the fourth quarter, we expect to use our remaining valuation allowance of $2 million and expect an effective tax rate of 20%. For 2010, we’re modeling an effective tax rate of 35%.

GAAP net loss was $6.9 million, or a loss of $0.24 a share, and to model REG for the fourth quarter, we expect our fully diluted share count to be 34.8 million shares. As we regularly note, adjusted EBITDA is a helpful measure of our economic performance because it adjusts for several noncash and other items that we believe are less informative to the underlying economics of our business. Having said that, please be sure to study the reconciliation of GAAP net income to adjusted EBITDA included in the press release.

In Q3, adjusted EBITDA was negative $2.3 million, or an $0.08 loss per share. Year to date adjusted EBITDA was positive $37 million, or $0.24 per gallon, a $1.10 gain per share. As we noted, the adjusted EBITDA was driven mainly by risk management and the decline in RIN value.

Now like to turn the balance sheet, on slide 12. We strengthened the balance sheet by continuing to pay down debt and investing in our Albert Lea plant upgrade. We generated cash in the quarter and cash flow from operations in the quarter was $6.2 million, down 61% from Q3 2011. Our cash balance increased by $1.2 million to $88.2 million, as we continued to reduce our outstanding debt and invested $2 million on capex.

Accounts receivable increased by $10 million sequentially to $40.1 million, in line with sales growth, and DSO is 11 days versus 10 days at the end of Q2.

Inventory declined $19 million sequentially from 22 days of sales to 11, and the inventory decline was balanced between raw material and finished goods.

We noted earlier that gallons sold outpaced gallons produced in the quarter, and the drawdown of finished goods reflects part of that difference. We did use some cash to pay down accounts payable, which declined $7 million sequentially to $35 million. Cash is now 27.6% of our equity, compared to 26.3% at the end of Q2.

Turning to slide 13, at the end of Q3, the company had a total of $73.5 million of term debt, down from $76.6 million at the end of Q2. Debt remains a manageable 14.2% of capitalization, up slightly from 13.8% at the end of Q2, due to the reduction in equity from the GAAP net loss. Book value per share was up to $10.91 in the quarter, a bit less than one-third of our book value, and consists of cash.

These financial results demonstrate the agility of the business to absorb risk management losses and margin pressure from RIN pricing, yet exit the quarter a finally stronger company than we entered.

I’ll now turn the call back to Dan to discuss our outlook. Dan?

Dan Oh

Thanks, Chad. We would like to provide the following financial guidance with respect to to fourth quarter and 2012 based upon our current outlook as shown on slide 14. Keep in mind that our guidance assumes a number of factors. Foremost, the guidance assumes no change in the price of heating oil, soybean oil, [unintelligible] grease, [unintelligible], or RINs.

Of course, these values are highly likely to change during the quarter. However, we will not attempt to predict for you the level of magnitude of change.

With that backdrop, in the fourth quarter we expect to sell between $34 million and $37 million gallons. We expect that adjusted EBITDA will range between breakeven and $10 million for the quarter. Industry demand for 2013 is now established at 1.28 billion gallons, due to the finalization of the 2013 RVO.

I would note that there are still upside catalysts to that demand. Although we are not operating with the expectation for the Blender’s Tax Credit to be in place, should it be reinstated, we have conducted our business in a manner which would create attractive incremental economics.

As well, the 2014 RVO is unknown at this time, but is expected to be published during the year, and could create incremental demand. We will offer our own outlook for the first half of 2013 at the next earnings call.

Now let me summarize, and then we will move on to the Q&A. We are disappointed to report the adjusted EBITDA loss in the third quarter. We are also pleased with the durability and agility of our business. Despite the challenging environment in the third quarter, this year we still expect to generate cash, grow the business significantly, and sustain our strong balance sheet.

Furthermore, with expanded capacity and feedstock flexibility across most of our fleet, we are well-positioned to capitalize on the 2013 RVO and capture our share of next year’s 1.28 billion gallon market.

Now I would like to turn the call over to the operator for the question and answer segment of our call. Operator?

Question-and-Answer Session


Certainly. [Operator instructions.] Our final question comes from Mahavir Sanghavi from UBS. Your line is open.

Mahavir Sanghavi - UBS

A question on the 2012 and the fourth quarter guidance. I’m just trying to make sure I understand, based on your risk management explanation. You said part of that loss that you incurred in Q3, you should be able to offset that with some sales in the fourth quarter. Is that right? And the second question on that, can you give us a sense of what the RIN assumption is for the fourth quarter in your guidance?

Chad Stone

The second part, I think the way Dan described the guidance was assuming RINs were constant. So they’ve traded down into the $0.40 range and more recently have come back into the upper $0.50s and traded into the $0.60 per RIN. So we’re assuming that RINs are level. We do have visibility into the portion of the risk management losses that we’re protecting, the fourth quarter business as well as some 2013 activity. So that’s reflected in the guidance.

Mahavir Sanghavi - UBS

And then maybe a question about the 2013 RIN pricing that you’re seeing right now, roughly about mid-$0.70s or so. What does that RIN price reflect in terms of the industry supply and demand dynamic based on what you guys are looking at? If I just look at the EPA data, it shows me that the industry will be producing at roughly 1.2 or so billion gallons. And that was the RIN pricing at the end of the September quarter. So I’m just trying to see if there’s a core relation between what the RIN pricing is reflecting versus the supply and demand dynamic we should expect if there is one.

And then the second question is more of a longer-term question. Given the volatility in your results over the past three quarters, I’m wondering if it would be possible for you guys to give us a sense of more a yearly or maybe longer term operating model that you try to manage your business to.

Dan Oh

With respect to RINs - and these are opinions - the pricing reflects a relatively private market that often gets posted daily based on reported trades on [OPUS], which are not weighted average trades, but the trades they reported each day. What we find over time, as I think you may have noticed, is that people respond quickly to EIA and EMTS that as that gets published on a monthly basis. Some people try and track those more frequently as they have visibility into the EMTS system.

But quite frankly there are two things that have yet to be known, and I think that’s one reason why RIN prices are not leaning forward as hard right now. We need to see the 2014 RVO. 2014 RVO has a lot to do with whether or not there’s significantly greater demand next year or not based on carry-forward opportunity.

And then we also need to see whether or not we’re going to see a drought repeated or not in the southern northern hemispheres, because that has a whole lot to do with crush margin and feedstock availability. So right now the EMTS numbers imply, as the RIN values probably imply, that this year is going to be well-covered, and people aren’t certain about what the demand is going to be for next year based on these uncertainties.

So I can’t tell you what the price is going to be next year. What I do believe is that our business model is flexible and it will take advantage of the margin movements as they occur from a low-cost producer oriented business.

From an annual model perspective, we intend to come back next quarter and give the first half view. We are thinking about whether or not it makes sense to do the first half or the full year, and we really have to come out with that as we interact with marketplace because the volatility makes us want to be predictive, but at the same time be predictive in a window that we have better assurance around our views.

And I think we need to see some of these things unfold over the next 90 days to be able to know whether we’re going to give a year or semiannual view. Right now I would recommend a semiannual view, but we’re not fixed to that opinion yet.


Our next question comes from Michael Cox from Piper Jaffray. Your line is open.

Michael Cox - Piper Jaffray

At any one point in time in a quarter, what percentage of your upcoming quarter’s worth of volume is covered by one of these risk management strategies?

Chad Stone

I would say generally as we enter into the quarter we’re going to have a feeling for 80% of the book going into the quarter.

Michael Cox - Piper Jaffray

So 80% of the next quarter’s volume would have some sort of forward sale and hedged input cost associated with it? And that’s been practice for some time now.

Chad Stone

For the next 90 days, basically, yes.

Michael Cox - Piper Jaffray

And that’s been the practice that you’ve operated under for some time now?

Dan Oh

Yeah, I think the right way to think about it is we tend to sell forward not much more than 80% of our business 90 days. Now, whether that 90 days is all on as we go into the quarter or not depends a whole lot around the business. But as we put business on, we’re trying to practice risk management in a way that both sides of the deal are understood in terms of margin expectation.

Michael Cox - Piper Jaffray

In terms of the acquisition, are there other opportunities out there of similar sized facility? I know this was something that you’ve worked toward since going public, but could you maybe speak to the set of opportunities that are in front of you on that front?

Dan Oh

So we don’t wish ill on anyone. We think we’re an excellent partner for folks to join with who need to join a larger organization and we believe it’s increasingly difficult for independent businesses in a market that’s consolidating and demands efficiency. There are quality businesses out there that are logical partners with whom we’d like to do deep business, and that might include acquisition.

And as we pursue our consolidation and growth strategy, we tend to look in larger cities at smaller plant opportunities that are within the 20 million gallon range. And then in the Midwest, and in the south Gulf area, because of volumes of sales or volumes of feedstock, you can have larger facilities. We do think there are other opportunities out there that are appropriate on both sides that we can do something with, but we don’t intend to announce them until they’re done.

Michael Cox - Piper Jaffray

You had noted that trying to predict 2013 is difficult without a 2014 RVO, and given the delays in getting the 2013 RVO, that seems like a stretch to get any visibility on 2014 for some time now, which leaves you exposed. So I’d be curious what sort of contingency plan you have in place, or what sort of operating environment you would expect if we have such a lengthy delay in the 2014 RVO.

Dan Oh

Well, the primary way that we manage market volatility is by using risk management practices that are consistent with our risk management philosophy and then putting business on as it profitably prices. So because we are in this nearby raw material market for the most part, and do not rely on vegetable oil in any significant percentage, the prices tend to adjust as we move through the market.

And whether the RINs are going up or down, RINs are an excellent indication of what I consider the basis for the additional economics necessary to deliver fuel. But as RINs go down, you often also see feedstock go down, and you often see feedstock decline in price, especially at the lower, less-refined grades of feedstock.

So I think the volumes that we’ve been able to produce this year quarter-on-quarter are indicative of the strength and durability of the model, and the fact that we’re not going on the general practice long unless we’ve got - and I don’t mean long on risk, but long on orders - both sides matching. I think we’re in a position that works well.


Our next question comes from John Quealy from Canaccord Genuity. Your line is open.

John Quealy - Canaccord Genuity

I may have missed this. Did you talk about third-party gallons for Q3, or your expectations for Q4?

Dan Oh

Third-party gallons were 13 million gallons for the third quarter, 21 million gallons for the full year, for the year to date number.

Chad Stone

I did not mention them. And for the fourth quarter we didn’t provide any specific guidance on that.

John Quealy - Canaccord Genuity

In terms of just percentage of business, would it be a similar percentage, or maybe a little bit more given the ramp down in volumes in Q4 from Q3?

Chad Stone

I might expect it to be lower.

Dan Oh

Yeah, I would expect it to be lower and for us to be more reliant on our own production. Certainly there have been announcements in the public domain and media around facilities not running as much, and when facilities don’t run as much, we don’t have as much available to trade.

John Quealy - Canaccord Genuity

And then just quick, a follow up on New Boston. Can you give us an split for the model in terms of how much raw feedstock you think is free fatty acid versus other as we try to sensitize that model?

Dan Oh

The New Boston facility is feedstock flexible. So it’s a 15-million-gallon nameplate, so if it were running on refined vegetable oil you’d run it at nameplate, but since it has the feedstock flexibility it can run on lower-cost feedstock, similar to like a Newton or a Danville, but at a smaller scale. Does that answer your question?

John Quealy - Canaccord Genuity

Yeah, but in the near term, when we kick it off in the first half of ’13, where do you think it will be? More sort of [Seneca], fatty acid side, or not that high powered?

Dan Oh

One of the reasons we liked having it down in the south is that it should be able to run multi-feedstock much more closely to year-round. So when that business kicks off, we’re going to be testing and running it based on high free fatty acid material and are endeavoring to bring it online and tune it up over time so that it performs much like Newton.


[Operator instructions.] Our next question comes from Shawn Severson from JMP Securities. Your line is open.

Shawn Severson - JMP Securities

I know you’re not in the business of speculating here or betting, but what are you hearing from your contacts in Washington on the lobbyist side, and the industry’s lobbyist side, for the RVO? And then any idea of timing for the RVO and then Blender’s tax credit? Just kind of what you’re hearing for timing on both of those.

Dan Oh

We were hoping we’d get through this call without any political commentary, Shawn. [laughter]

Shawn Severson - JMP Securities

I mean, just generally, what is the industry sort of thinking of in terms of the Blender’s tax credit specifically?

Dan Oh

I think on the Blender’s tax credit, our colleagues at the National Biodiesel Board who are working on it would say that there’s a chance it will get passed in the lame duck session. They’re not sure what the odds are, but they’re a whole lot better than they were a few months ago when there wasn’t anything ready to pass. So we don’t know what’s going to happen politically, and some might know better in a few days. But I don’t know how to call that, except that it’s got a chance now that it didn’t have a few months ago.

Shawn Severson - JMP Securities

And could you explain some of the dynamics? I know the RIN prices should adjust if they get reinstated, let’s say. But could you just talk about maybe which is better for you, or how the dynamics would interact with RINs, and then reinstatement of the Blender’s tax credit?

Dan Oh

Well, I’ll offer a couple of opinions. First, I think the entire value chain is better off if the Blender’s credit comes back. In particular because it would provide better blending economics for distributors and those who handle fuel to pay for and install storage and sometimes handling to be able to blend biodiesel into the system. And that should be supportive of demand.

And what we saw in the past is that the Blender’s credit would be shared up and down the value chain on a negotiated basis, and that depended on supply and demand of feedstock or demand for fuel, or who was available to run. It should, as it provides more value, make RINs less important, but we don’t know at all if there’s going to be any economic tradeoff that matters.


And I show no further questions. I’d like to turn the conference back over to Dan Oh for closing remarks.

Dan Oh

Thank you, operator. Thank you for participating on today’s call, and for your continued support. We look forward to reporting to you again next quarter on our progress.

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