Alto Ingredients, Inc.

Good afternoon and welcome to the Aalto Ingredients Incorporated third quarter 2022 results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, Please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Kirsten Chapman, LHA Investor Relations. Please go ahead.

Thank you, Gary, and thank you all for joining us today for the Alto Ingredients Third Quarter 2022 Results Conference Call. On the call today are Mike Kandris, CEO, and Brian McGregor, CFO. Alto Ingredients issued a press release after the market closed today, 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 altoingredients.com. A telephone replay of today's call will be available through November 14th, the details of which are included in today's press release. A webcast replay will also be available at Alto Ingredients' website. Please note that the information on this call speaks only as of today, November 7th. You are advised that time-sensitive information may no longer be accurate at the time of any replay. Please refer to the company's safe harbor statement on slide two of the presentation available online, which states 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 alto ingredients 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 ALTO Ingredients filings of 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 believes that 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 before interest expense, interest income, provision and benefit for income taxes, asset impairments, loss on extinguishment of debt, acquisition-related expense, 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 today's press release. On today's call, Mike will begin with some financial highlights and review our vision and quarterly activities. Brian will then provide additional detail on our Q3 2022 financial results. Then Mike will wrap up with a summary before opening the call for Q&A. It is now my pleasure to introduce Mike Kandra, CEO. Please go ahead, Mike.

Thank you, Kirsten, and thank you, everyone, for joining us today. We are excited about our recent developments and look forward to sharing them with you. In the quarter, we continued our efforts to improve our long-term position by upgrading equipment and operating systems. This will increase plant efficiency, reliability, redundancy, and capacity. And we have plans for larger capital intensive growth programs. We entered into a six-year term loan for up to $125 million announced today. recognizing the importance of accelerating our diversification growth strategies, including carbon capture, sequestration, corn oil, protein, and yeast expansion, as well as RNG and natural gas pipeline installations. As previously noted, we expect these projects to contribute significantly to both our top and bottom lines and to further insulate our results from commodity and margin swings. While expected, third quarter was challenging, and our results were negatively affected by low commodity margins driven by record corn basis, logistical constraints, and repairs and maintenance associated with the maintenance shutdown of our ICP facility. I am proud of our team who skillfully managed supply chain constraints and logistical issues and prevented disruption with our customer base. Brian will review the financial details later, yet I'll highlight year-to-date through September 30th, 2022, we have capitalized over $25 million of infrastructure improvements and spent an additional $3 million in related costs that flow through cost of goods sold further impacting both operating margins and our bottom line results. Now I'll review our progress on our major CapEx projects. At our Idaho plant, the first phase of the CoPro Max system to increase corn oil extraction is completed, and we are pleased that the yield has grown significantly, meeting our initial expectations. Given these positive results, we plan to proceed with similar installations at our other dry mills. The second phase to separate produced enhanced protein is on schedule to be completed in Q1 2023. Once the system is fully operational and tested, we will evaluate and schedule additional deployments. Regarding our corn storage expansion in Illinois, we are well into our construction, which we expect to complete before year-end. The doubling of our storage will enable us to hold corn reserves during holidays, winter weather, and through logistical issues with the supply chain. We expect this increased storage capacity to reduce the volatility of our production input costs. Regarding our efforts to enhance our specialty alcohol, we prioritized upgrading the equipment at our wet mill and have made great progress this quarter. This additional equipment, including a demethylizer column, has been delivered and installed, and we expect these upgrades to be fully operational in Q1 2023. With this best-in-class equipment and our recently achieved quality certifications, we will now be able to meet the highest quality requirements and service additional beverage customers at both our ICP distillery and Pekin wet mill. This will provide production redundancy, providing surety of supply to our customers, and enable us to improve our product mix and capture higher premiums in the alcohol value chain. In addition to our stated projects, we have also taken advantage of opportunities to replace and upgrade older equipment, specifically at our Pekin campus. For instance, the two new boilers we recently purchased, when installed, will increase efficiency, improve reliability, and reduce energy cost. As mentioned earlier, we entered into a term debt financing for up to $125 million. By increasing our financial flexibility with a supportive partner focused on our growth and development, we have created the ability to execute our CapEx strategy for long-term success. Circumventing the need to rely solely on organic cash flow, this financing will facilitate the timely completion of capital projects that are larger in magnitude, scope, and cost benefit to all stakeholders by building a more stable business. With our bolstered capital resources, we plan to undertake these key projects simultaneously. Consistent with our sustainability improvement program, we intend to add new natural gas and renewable natural gas pipelines to connect directly to nearby major hubs. This will increase our access to more competitive natural gas, better address our future energy needs, including supporting carbon capture, and improve our ability to monetize the renewable natural gas we currently produce at Flair. Overall, this will further reduce our carbon footprint and enhance the value of our products. This project is in the design and permitting phase and is expected to be completed in 2024. Additionally, after 24 years of being a valuable and reliable supplier to the pet food industry, we intend to commercially develop primary yeast through an aerobic fermentation process at our wet mill. Extending our brand along the value chain is a natural progression to other high-quality and increased margin markets, including flavors, nutrition, production, baking, and meat supplies. Although primary yeast production has a different process and different market, many existing as well as prospective customers have expressed interest in this product for years. Finally, our capital raise facilitates our decision process and speed to begin carbon capture sequestration. The options initially focused on just selling our CO2 to various pipeline developers at levels not attractive to us. The Inflation Reduction Act with changes to the Q45 and the benefits of producing clean ethanol are significant. As such, we are working with and are currently in ladder stage negotiations with various parties to finalize the best option for Alto's carbon sequestration future. To this end, We are finalizing the selection of both our front end engineering and design partner and our carbon transportation pipeline and sequestration developer. In summary, we are highly motivated to further reduce the impact of commodity exposure. These efforts are improving our position to capture a variety of new opportunities and drive profitable growth. With that, Brian, over to you for a review of the financials.

Thank you, Mike. I'll provide some additional color around our results and metrics for the third quarter of 2022. As stated on our call in August, we entered a late harvest with high corn basis and low corn inventories. To create a silver lining, reduce our relative use of corn, and minimize the impact of short-term higher commodity prices, we scheduled much of our fall repair and maintenance for August. However, the third quarter was also hindered by continued supply chain constraints. and rail interruptions causing additional plant outages of over six days, contributing to negative margins at our western facilities. As the single largest receiver of corn on the Union Pacific system, we are working closely with the railroad and suppliers to improve the consistency and timely delivery of corn supply to our western facilities. For the third quarter of 2022, net sales were $337 million, up from $306 million in the third quarter of 2021, reflecting primarily the addition of our Idaho plant production. Alcohol sales were $253 million. Production gallons sold reached 76 million, up 32% from third quarter 2021, as the Idaho plant came online. Specialty alcohol contributed 23 million gallons, increasing 18% over the third quarter 2021, due to expanded capacity and increased demand. And we expect to exceed our contracted volume of 90 million gallons for 2022 by year end. Cost of goods sold were $357 million versus $309 million in the third quarter of 2021. This increase included the charges associated with the uncapitalized portion of our infrastructure upgrades as well as the logistical and service disruptions, higher corn basis, and greater delivery costs. Notably, corn basis costs significantly increased in the quarter by approximately $11 million. Also, we recorded $3 million of non-cash net loss on our forward derivative positions. SG&A expenses were $7 million, including expenses related to our Eagle alcohol acquisition and higher stock compensation expenses. compared to $6 million in the third quarter of 2021. The resulting net loss available to common shareholders was $28.4 million, or 39 cents per share, compared to $3.5 million, or 5 cents per share, in the third quarter of 2021. Adjusted EBITDA was negative $20.6 million, compared to positively adjusted EBITDA of $3 million in the third quarter of 2021. Our cash and cash equivalents were $28.5 million as of September 30, 2022, compared to $57.4 million at June 30, 2022, reflecting our quarterly loss and capital expenditures. In addition, we have $30.7 million of availability under our asset baseline of credit. During the quarter, we spent $15 million in CapEx in anticipation of our recently announced capital raise. In September, we announced a $50 million share buyback program. During the quarter, we purchased approximately 250,000 shares for an aggregate of $1 million. We will provide periodic updates on the program's progress. Our working capital at September 30th remains strong at $132 million. Announced today, we fortified our capital resources by closing a six-year term loan for up to $125 million. The term loan allows for periodic draws in an aggregate amount up to $100 million, with an additional $25 million available subject to satisfying certain conditions. This financing will reimburse our strategic upgrades, increase our working capital, and fund our larger capital-intensive long-term projects. In addition, we renew our evolving line of credit, improving our borrowing terms, and extending the maturity date by another five years. Looking ahead, While fuel demand typically slows in the late fall and winter periods in comparison to the rest of the year, we are encouraged by recent crush margin improvements over the September lows, particularly in the last half of October and November month to date. Sorry for the interruption. I'll start again. While fuel demand typically slows in late fall and winter periods in comparison to the rest of the year, we are encouraged by recent crush margin improvements on the September lows, particularly in the last half of October and November month to date, which began with the corn harvest and resulting improvements in corn bases. We expect this strengthening in margins to translate into much improved results in the fourth quarter. Regarding our contracts for specialty alcohol for 2023, We expect to maintain or grow share with our existing customer base while adding new accounts in the beverage category once our peak in GNS production system improvements are online in early 2023. Based on our equipment and operating system upgrades, we expect to see modest improvements in P&L in early 2023. With funding from the new term loan and associated accelerated investment in further diversification of our specialty alcohol and essential ingredient products, we expect to add over $20 million annually in EBITDA growth by the end of 2023, an additional $30 million annually by 2025. And this does not yet include expected results from projects under development, including primary yeast expansion and carbon capture and sequestration. We look forward over the coming quarters to discuss the progress we've made. With that, I'll turn the call back to Mike.

Thank you, Brian. The team has created the financial flexibility to accelerate the next phase of our transformation. During 2022, we have diligently completed strategic repairs and maintenance to diversify our product offerings, increase production yields, and improve plant efficiency. With the recent capital proceeds, we will implement additional projects, furthering our specialty alcohols and essential ingredients diversification strategy. As we broaden our products and execute on our capital plan, we expect to minimize the effect caused by commodity pricing fluctuations and enrich our margin profile. And as Brian indicated, generate an incremental $50 million of EBITDA annually by 2025. and this does not include the significant benefits financially of carbon capture and aerobic yeast. We are excited about the future and look forward to delivering additional value to all our stakeholders. With that, I'd like to open the call for questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question is from Eric Stein with Craig Hallam. Please go ahead. Hi, Mike and Brian.

Hi, Eric. Hey, so maybe just before getting to the capital projects, just some commentary on the contracting season, and obviously it sounds like you're confident in growth there, but just maybe how the conversations are going. I know you have some new certifications that you got early last year, but you had kind of missed the window. How those are playing into it, and I don't know if you're willing to give kind of a thought of what the year-over-year increase might be in terms of contracted. But any details there would be great.

Sure. So as we indicated last year about this time, we're actually with our – it was a slow report last year as well, given late harvest. And so I think it was during our fourth quarter results that we indicated that we had contracted 90 million gallons of volume for 2022. And we are well on our way to exceeding that amount, you know, probably approximate 100 million by year end. Our expectation is to be able to match that or exceed that number in 2023. And that's before we actually bring online our improvements to the specialty alcohol production. And that will be done in you know, early 2023 and we expect to continue to be able to sell into that market. So I would expect, you know, production and or sales to exceed, you know, that which we've done last year. So year over year over year improvement in that volume.

Okay. And then, I mean, on the specialty alcohols, then we should think about that more as not necessarily contracted, right? I mean, the volume sold more back half loaded, but just not contracted.

No, we expect to have contracted volume for the full year of 2023. And then with full operation of the demethylizer column and the other improvements that we've made at that facility, the idea is to be able to sell into the highest grade beverage line throughout the year. So much like we did last year, you see incremental sales throughout the year. So we saw approximately 10 million gallons of additional specialty alcohol sales in 2022, and we would expect to be able to do the same in 2023.

Okay. No, that's great. Maybe just obviously more details. Sounds like you're getting close to taking further steps on carbon capture. I mean, anything you can share there? Does this make it more or less likely that you partner with someone. You know, it sounds like direct sequestration may be more the route that you're going. You know, any details, you know, there would be helpful as well.

Yeah. What I'd say, Eric, is that obviously with the recent changes, this is a a very significant item for not only us, but the industry. And one of the reasons, one of the primary reasons we wanted to be able to enhance our financial capabilities in working with Orion, we wanted to be able to pursue a multitude of options. So we have identified some very good options for us. Again, we're... We're taking bids from various contractors that will provide us with front-end feed engineering. That's the compression stage kind of behind the fence line, and people to actually do the sequestration of pipelining. So it could be that we would partner with somebody, but we haven't gone that far yet. We're evaluating the opportunities. The good news is with this financing in place, this has really risen to the top. of something we want to get done and we want to get it done quickly.

Got it. Thanks a lot. The next question is from Amit Dayal with HC Wainwright. Please go ahead.

Thank you, Graf and everyone. Brian, maybe for you, you know, when you're talking about around $20 million adjusted EBITDA improvements expected in 2023, you know, what should we benchmark this against? You know, should we use sort of a 4% to 6% gross margin normalized level type calculations to, you know, to arrive at the 20 million adjusted EBITDA improvements for next year. I know you've had variances last, you know, fourth quarter of 21 was very strong. And this quarter, it looks like the third quarter this year is a little bit of an anomaly too. I just wanted to see what would be sort of a normalized level of EBITDA prior to all of these improvements. you know, and where we can come out, you know, with the 20 million improvements you're expecting?

I mean, it's a great question. And, you know, we, as you mentioned, it's a challenge to be able to forecast, you know, commodity prices, particularly where things have been so dramatic, either with inflation or, you know, war in Europe, other things, and then supply constraints and logistical constraints. That being said, if you look over the last five year history of the industry, you're looking at somewhere between 15 and 20 cent EBITDA margins. So whether you want to use an average, what that would translate in for us is you're probably looking at somewhere around north of 30 to $40 million as a baseline. EBITDA and then you want to incrementally add these numbers on top of that. Our expectation is this year is definitely an anomaly, especially after what was a bit of a volatility rate last year but finished on a very strong note.

Are you seeing improvements already? I know we're a month and a half almost into the fourth quarter. How are margins and You know, other pricing coming through so far?

Yeah, we've seen significant improvement, especially over the last three to four weeks. You know, off of September lows, as I mentioned in the prepared remarks. And it looks it'd probably be too premature to forecast a 2024 like we saw last or at Q4 last year, duplicating that, but particularly in light of the fact that we are You know, corn supply still are, and corn basis is higher than it was last year, but we're seeing much stronger margins in this fourth quarter. But I guess what I'd also emphasize, and that's why, as you see in, you know, the emphasis and most of the material comments that we've made is that our goal and desire is to continue to further our diversification and move away from what is otherwise clearly a volatile market. and be able to provide stability and earnings.

Understood. No, that's right. How many days was the maintenance-related shutdown for in the third quarter, Brian?

Yeah, about a week, week and a half. But then you think about that, there's a multiplying vacuum. You have to bring it down and then bring it back up and the impacts associated with that. And then on top of that, repairs and maintenance, unusual or unusual. of maintenance that have come along with that.

And these are all done, right? There's nothing in the fourth quarter along these lines?

That's correct. There may be still a little bit of, well, we may be doing some just normal types of scheduled outages, but nothing material.

Okay, understood. So that's all I have for now. I'll take another question. Thank you.

Thank you. Again, if you have a question, please press star then 1. The next question is from David Bastian with Kingdom Capital Advisors. Please go ahead.

Hey, good afternoon, guys. Hi, David. I just wanted to touch on a couple things real quick. One was I know you guys had talked about hedging out a lot of your input costs like utility, natural gas last year. Where are you at for that in 2023?

Yeah, we've locked our positions, and particularly through the winter strip, on natural gas and as well on electricity through much of the year.

Got it. I heard on your last question that you expect your baseline EBITDA to be around $40 million or so given historic crust margins. It sounds like even at zero, then you guys would still be cash flow positive with where you're at with your current upgrades before the new stuff comes online?

That's correct.

Okay. And then on these Section 45 credits, it's $85 a ton and 650,000 tons roughly for the location? That's correct.

That's correct. Just peaking, David, right?

Okay. That's in its current capacity, right, on the three facilities.

All right. And you're in the final stages of getting this locked down, so can we hope to actually hear something on this on the Q4 call, you think?

Possibly. There is some working with people that have to go out and secure the spot to sequester. Sometimes want to get that done ahead of time before announcing just for the ability to not let the prices go crazy on them. To be able to do that with farmers or wherever you are going to sequester the CO2. But our hope is we're pretty far along. We have been evaluating our options for a while now and Again, as I mentioned, the motivation to lock in some really good financing with a really good partner that understands kind of where we're heading as a company was very important to us and will allow us to accelerate that decision.

Gotcha. And so if I'm doing some back-of-the-envelope math, that gets me to $50 million or $60 million a year for you guys. even if you have to put $80 or $100 million in up front. That's a pretty fantastic IRR if this is online in three to four years. Is that about right here?

And that would be just based on just the carbon tax credit. That doesn't include any of the benefits that you get in uplift in price for product associated with the low-carbon footprint, right? So your blue ethanol, clean fuel, sustained aviation fuel, right?

Blue ethanol. Got it. Thank you. That's very helpful. Good to hear.

This concludes our question and answer session. I would like to turn the conference back over to Mike Kandris for any closing remarks.

Yeah, this is a very exciting time for us, and I want to thank everybody for joining us today and for your continued support. We look forward to chatting with you next quarter end. Thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.