Earnings Call Transcript - ALTO Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Pacific Ethanol First Quarter 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference to your speaker, Ms. Moriah Shilton, Senior Vice President LHA Investor Relations. Please go ahead.

Moriah Shilton, Senior Vice President of Investor Relations

Thank you, Shari. And thank you all for joining us today for the Pacific Ethanol first quarter 2020 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 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 is available on the Company's website at pacificethanol.com. A telephone replay of today's call will be available through May 28th, the details of which are included in yesterday's earnings press release. A webcast replay will also be available at Pacific Ethanol's website. Please note that information on this call speaks only as of today, May 13th, and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay. Please refer to the Company's Safe Harbor statements on slide two 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 un-audited net income or loss, attributed to Pacific Ethanol before interest expense, provision or benefit for income taxes, asset impairment, loss on extinguishment of debt, purchase accounting adjustments, fair value adjustments and depreciation and amortization expense. To support the Company's review of non-GAAP information later on this call, a reconciling table was included in yesterday's press release. It is now my pleasure to introduce Neil Koehler, President and CEO. Neil?

Neil Koehler, President and CEO

Thank you, Moriah, and thank you everyone for joining us today. First, I want to acknowledge those most affected by the pandemic, and thank our healthcare professionals and first responders fighting the effects of COVID-19. This is a challenging time for all, and we appreciate the dedication and work of all frontline workers to help bring us through this crisis. Pacific Ethanol is an essential business providing low carbon, renewable fuels, pharmaceutical-grade alcohol, and high-protein feed products. I'm pleased to report that we have operated safely with our full workforce at our operating facilities. I'd like to thank our employees for their commitment. They have been able to continue to work with physical distancing and other protective protocols now as part of our standard operating procedures. The onset of the pandemic decimated demand for gasoline and ethanol, while at the same time spurred a greater need for sanitizers and disinfectants. Our team responded proactively in two areas. First, due to lower demand and an acute negative margin environment, we initially idled over 60% of our ethanol capacity. Second, to respond to increased demand for pharmaceutical-grade alcohol, we shipped to production at our Pekin, Illinois facilities to substantially increase output of this high-value product. The overall market is recovering from a historic downturn. We entered the first quarter with a continued supply and demand imbalance, which negatively impacted margins. By the end of March, due to government stay-at-home orders in response to the spread of COVID-19 across the country, demand for gasoline and ethanol dropped over a period of several weeks by as much as or more than 50% across our markets. With the collapse in ethanol prices and margins, the industry responded quickly through an unprecedented idling of approximately 50% of capacity with an estimated 75 plants completely idled and many others slowing to minimum production. Pacific Ethanol was also quick to idle ethanol production that was not cash flow positive. Based on increasing demand and improving margins, we are gradually increasing production and are currently operating at about 50% of total capacity. The recovery has been significant in the last few weeks with recent stay-at-home orders beginning to relax and states beginning to reopen for business. The immediate effect has been positive albeit at production margins that are still challenging. Since the demand lows of April, we have seen demand increases of over 40% and three consecutive week declines in overall ethanol inventories. While there still is a long way to go in both demand and margins, we are encouraged by this trend. We will continue to monitor market trends and adjust our production levels in response to market signals. I'm pleased to report that our diversification strategy into high-value products is performing quite well. While fuel ethanol has suffered from demand destruction and negative production margins, the USP-grade alcohol and high-protein feed we produced at our Pekin, Illinois facilities have done very well. Diversification was a strategic driver when we purchased first the Pekin wet and dry mills and yeast plant in 2015 and two years later when we purchased the adjacent Illinois corn processing plant, all now functioning as an integrated campus. This strategy is producing positive results. We have produced high-quality alcohol for sale nationally and internationally for many applications for years. As a result, we were in a strong position to increase high-quality alcohol production in response to new demand for sanitizers and disinfectants. Also, with the industry's overall reduction of ethanol production and dry distillers grains, our high-protein feed products are seeing increased demand and correspondingly higher prices. We are pleased with the performance of our Pekin operations, which we expect will make a materially positive contribution in the second quarter. On the export front, the industry actually had a strong first quarter of over 500 million gallons exported, which is 30% higher than the same period last year. While exports have slowed in the second quarter with worldwide demand destruction due to the pandemic, we expect exports to pick up as other countries reopen their economies. China is the first country to emerge from the pandemic and we believe China may step in later this year as a significant buyer of U.S. ethanol as part of the Phase 1 trade deal between the U.S. and China. On the regulatory front, while the EPA has gone to the sidelines until the appeals process of the 10th Circuit is over, we do believe inappropriate and illegal granting of small refinery exemptions will be eliminated, which would restore over one billion gallons of annual demand for renewable fuels going forward. A properly and legally implemented RFS protects blenders in the midst of the current demand destruction as the annual blending obligations are converted to percentage blend rates of actual consumption and will also drive more demand in the use of E15 after markets return to normal levels following the pandemic. The support of low-carbon fuel policies and market development, which reward fuels or technology based on their life cycle carbon emission reductions, remains a core strategy of Pacific Ethanol. We are working with multiple jurisdictions to expand low carbon markets across the country, which will provide value to the low carbon ethanol we produce. Finally, in mid-April, we took a significant step to reduce our debt, as we closed on our agreement to sell our 74% ownership interest in Pacific Aurora to Aurora Cooperative for a total valuation of $52.8 million. We are also in active discussions with multiple parties regarding the sale of strategic partnerships for various other assets. I'd now like to turn the call over to Bryon for a financial review of our first quarter 2020 results.

Bryon McGregor, CFO

Thank you, Neil. I'll begin with the comparison of the first quarter of 2020 results to the fourth quarter of 2019. For the first quarter of 2020, net sales were $311 million compared to $358 million in the fourth quarter, the decline resulting from a decrease in our average price per gallon sold and a reduction in both production and third-party gallons sold. Cost of goods sold was $324 million, which resulted in a gross loss of $12.9 million compared to a gross profit of $3.2 million in the prior quarter, attributable to the historic drop in fuel ethanol prices. SG&A expenses were $10.2 million, compared to $11.8 million in the fourth quarter, reflecting our cost-cutting initiatives. As previously noted, although we expect general SG&A expenses to be significantly lower in 2020, professional fees through at least the first half of the year will, out of necessity, be higher to facilitate our restructuring initiatives. Loss available to common shareholders was $25.4 million, or $0.47 per share. This loss is compared to $41.4 million, or $0.85 per share in the fourth quarter, the latter of which included a $29.3 million asset impairment charge related to the sale of our ownership interest in Pacific Aurora and a $6.5 million loss on debt extinguishment related to the amendment of our secured debt obligations. Adjusted EBITDA was negative $12.3 million compared to positive $1.9 million in the fourth quarter of 2019. Turning to our balance sheet. At March 31, 2020, our cash and cash equivalents were $26.8 million compared to $19 million at December 31, 2019. The increase reflects our efforts to monetize our working capital. Subsequent to quarter end, we received $20.2 million in cash before fees and $16.5 million in promissory notes from the sale of our 74% ownership interest in Pacific Aurora. Approximately $14.5 million of the cash proceeds were used to make principal payments on our term debt. Regarding our efforts to restructure our existing debt, we continue to work positively and move steadily forward with our lenders. With the improving market conditions, we believe these conversations will become even more constructive. Also noteworthy in May, through the Paycheck Protection Program under the CARES Act, Pacific Ethanol and PEP can receive a combined $9.9 million from the small business administration. The goal of the program is to maintain jobs in the small business sector, and we are using the loan proceeds to rehire and retain our employees and fund payroll integral to maintaining our operations to produce essential products. With that, I'll turn the call back to Neil.

Neil Koehler, President and CEO

Thank you, Bryon. We are encouraged by the alignment of interest of our stakeholders, which is supported by the performance we are seeing, particularly at our Midwest operations. Our continued marketing and sales of ethanol to all our customers with our ability to manage costs at idled assets have been challenging. Times have been tough during the ethanol margin squeeze. However, the substantial increase in demand for our production of high-quality alcohol, combined with the PPP loans and sale of our ownership of Pacific Aurora, have improved our liquidity as transportation fuel markets are now improving as well. As the market normalizes, we remain convinced of the compelling cost, octane, carbon, and health benefits of ethanol and the related long-term demand. We are actively working to best position Pacific Ethanol through its diversified platform to capitalize on the opportunities ahead for the ethanol industry and our company. Shari, with that, I'd like to now open the call for questions.

Operator, Operator

Thank you. Our first question will come from Eric Stine with Craig-Hallum. Please go ahead.

Eric Stine, Analyst

Hi, Neil, hi, Bryon.

Neil Koehler, President and CEO

Good morning, Eric.

Eric Stine, Analyst

Good morning. You mentioned it a little bit in your comments there. But just on the strategic review, maybe if you could give a little more color. I know the last go around you talked about being in active discussions with multiple parties. Curious how that's trended. And also curious, I know we've seen modest market improvement here. Is that something that – potentially that you've seen a pickup in terms of interest and discussions as a result?

Neil Koehler, President and CEO

Well, I think with the significant downturn in the industry and the economy here and worldwide, it’s not a surprise that even – not having the ability to go look at ethanol plants, let alone put in meaningful bids for them certainly slowed that process down. We've refocused it more on looking at the opportunities to partner and to look at other strategic relationships. We're certainly open to continuing to monetize assets, but that process has been pretty slow currently.

Eric Stine, Analyst

Got it. Yes. No surprise there. I mean, is it something where you feel – well it sounds like you feel like partnerships or other angles are sufficient to accomplish your goals there?

Neil Koehler, President and CEO

Yes. And as we're seeing the market improve, we're seeing better performance out of our assets as well. And so that's all positive.

Eric Stine, Analyst

Okay. Maybe just turning to the overall market. I know you – while the market you've also been very thoughtful on the production side. Just curious though, this has been easily the worst market that anyone's ever seen for a lot of reasons. Is this something that you think potentially means a structural change to the amount of production that's out there? Or do you think that what we've seen in the past market gets really difficult, things come offline and then the moment improves, productions right back? Just thoughts does this time differ from the past or do you expect a similar dynamic?

Neil Koehler, President and CEO

Time will tell. We're cautiously optimistic after a very challenging period, with many plants going down both in hot and cold idles. When a plant is cold idled and workers are laid off, it's not an easy process to ramp back up. The financial damage has been significant due to the large drop in demand and the shutdown of plants. We anticipate a gradual increase in production, and as markets improve both domestically and for exports, we hope to see a more balanced market. New domestic demand, especially with higher blends, is essential. I'm not sure we'll return to total gasoline demand. Therefore, it's crucial to focus on eliminating SREs, promoting E15 in key markets, and increasing exports to countries like China. The recovery we’re seeing is promising, with gasoline demand now only slightly over 20% down from pre-COVID levels, recovering from a drop of 50%. However, ethanol demand has lagged behind, which we need to address to reduce inventories. Based on recent figures showing about 11.3 billion gallons of ethanol demand and an annualized gasoline market of 113 billion gallons, assuming a 1 billion gallon export run rate, the annualized ethanol demand would be 12.3 billion gallons. Currently, we’re producing about 9.5 billion gallons weekly, which has helped significantly lower inventories over the past three weeks. We've reduced our inventories by 13% from their peak, but they remain 15% higher than last year. We need to continue producing less than demand to allow inventories to decrease and reach a more balanced state while maintaining production levels. So, we are cautiously optimistic.

Eric Stine, Analyst

Okay. Thanks for that color. Maybe last one for me and this is pretty recent. I just saw this morning. But I see a proposal for an infrastructure proposal that looks like from Democrats, I mean it's very early in the process but potentially $0.45 a gallon from the government for production from Jan 1 to May 1. Maybe not necessarily on this specific proposal, but do you think that eventually the ethanol industry does get some government assistance since I know that's been an area of frustration here over the last call it four to six weeks?

Neil Koehler, President and CEO

Yes. I mean, we are as we mentioned, an essential business providing very needed goods, both on the fuel side and the high-quality alcohol and protein to the economy. We have over 350,000 workers in this industry, many of whom are now not working. It’s hard for the farmers and hard for the biofuel producers. And, yes, we do believe that it's appropriate for government assistance to get this industry and others back on their feet. We were encouraged to see that provision in the House bill. It's just a process, and who knows what final form it might take. But we do believe it's appropriate, and we think that we will see some additional support for the ethanol industry.

Eric Stine, Analyst

Okay. Thank you.

Neil Koehler, President and CEO

Thank you, Eric.

Operator, Operator

Thank you. Our next question will come from Sameer Joshi with H.C. Wainwright. Please go ahead.

Sameer Joshi, Analyst

Yes. Thanks, Neil; thanks, Bryon, for taking my question. I hope you're staying safe and healthy.

Neil Koehler, President and CEO

Thank you. I hope you are as well. We are.

Sameer Joshi, Analyst

Yes. Thank you. So the SRE EPA ruling has not been challenged. Do you think it will be applicable nationwide, or will it only apply in certain regions?

Neil Koehler, President and CEO

That's a good question. We believe it will be very challenging not to implement it on a national level. Before deferring to the appeals process, the EPA had shown a tendency to apply it nationally. The principles certainly do apply across the country. As you mentioned, the Tenth Circuit ruling only affected those specific refiners. However, if the EPA does not apply this nationally, we expect there will be follow-up legal challenges because that would be the only reasonable conclusion. We're currently waiting to see what happens next. The Tenth Circuit quickly and unanimously decided not to rehear the case, with the next step being the Supreme Court. As of now, neither the oil companies nor the EPA has appealed to the Supreme Court, but they have until early July to do so. While this is the current law, it will be interesting to observe how it is incorporated into the EPA RVO proposals. The EPA has decided to wait and see if there will be an appeal to the Supreme Court. We think it's quite unlikely that the Supreme Court will take up the case, even if there is an appeal. Nevertheless, we anticipate that the oil companies may attempt to appeal this issue to the Supreme Court. We will have to wait and see what unfolds.

Sameer Joshi, Analyst

Understood. So the ruling stands until appealed, right? I mean, are there any extra SREs that you are seeing in the recent past?

Neil Koehler, President and CEO

No, we have not seen any additional exemptions. There is a considerable backlog, possibly around 20 cases from 2019 in front of the EPA, and they have indicated they will not address these until the appeal process is finalized. This is relevant to the Tenth Circuit, which handles a significant portion, about 30%, of the refined product in the U.S. Currently, it is the law, and granting any exemptions to refineries in the Tenth Circuit would violate those regulations.

Sameer Joshi, Analyst

Understood. Thanks for that color. On the balance sheet for PEIX, I think during the last call, you had talked about a Chief Restructuring Officer either a formal or informal role, but they were going to be in charge of negotiating long-term plans for servicing debt. Is there any more color you can provide on that?

Bryon McGregor, CFO

I'd say Sameer, outside of what we've indicated in our prepared remarks, just to add to that again that discussions and negotiations continue productively. The recent improvements and also the strength of the products that we're making at our profitable plants are contributing and helpful towards those negotiations. We'll give you more as we can.

Sameer Joshi, Analyst

Understood. And just one more housekeeping issue. There is a long-term asset held for sale of around $16.5 million. Is that also associated with the sold plant, or is that something else?

Bryon McGregor, CFO

Yes.

Sameer Joshi, Analyst

So we should not see that in the next Q statement?

Bryon McGregor, CFO

That's correct.

Sameer Joshi, Analyst

Okay. Got it. Thanks, Bryon. Thanks.

Operator, Operator

Speakers, I'm showing no further questions from the queue at this time. I would now like to turn the call back over to you for any further remarks.

Neil Koehler, President and CEO

Thank you, Shari, and thank you all for joining us today. I appreciate everybody's support. Hope everybody is staying safe and healthy. We will get through all this together, and we are encouraged by some of our recent developments and look forward to talking to you next quarter. Have a great day.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.