Vertex Energy, Inc. (NASDAQ:VTNR) Q3 2022 Results Conference Call November 8, 2022 8:00 AM ET
Company Participants
John Ragozzino – IR
Ben Cowart – Chairman and CEO
Chris Carlson – Chief Financial Officer
James Rhame – Chief Operating Officer
Alvaro Ruiz – Chief Strategy Officer
Bart Rice – Vice President
John Strickland – Vice President of Black Oil Operations
Conference Call Participants
Eric Stine – Craig-Hallum
Amit Dayal – H.C. Wainwright
Noah Kaye – Oppenheimer
Brian Butler – Stifel
Operator
Good morning or good afternoon, and welcome to the Vertex Energy Third Quarter Earnings Conference Call. [Operator Instructions].
I would now like to turn the conference over to John Ragozzino. Please go ahead.
John Ragozzino
Thank you, operator. Good morning, and welcome to Vertex Energy’s Third Quarter 2022 Results Conference Call. Leading the call today are Chairman and CEO, Ben Cowart; Chief Financial Officer, Chris Carlson; and Chief Operating Officer, James Rhame. Also attending the call are Chief Strategy Officer; Alvaro Ruiz; Vice President, Bart Rice; and Vice President of Black Oil Operations, John Strickland. I want to remind you that management’s commentary and responses to questions on today’s call may include forward-looking statements, which, by their nature, are uncertain and outside of the company’s control.
Although these forward-looking statements are based on management’s current expectations and beliefs, actual results may differ materially. For a discussion of some of the risk factors that could cause actual results to differ, please refer to the Risk Factors section of Vertex Energy’s latest annual and quarterly filings with the SEC. Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during our call in the press release issued today. Today’s call will begin with remarks from Ben Cowart, followed by an operational review from James Rhame and financial review from Chris Carlson. At the conclusion of these prepared remarks, we will open the line for questions.
With that, I’ll turn the call over to Ben.
Ben Cowart
Thank you, John, and good morning to those joining us on the call today. This morning, we issued a press release detailing our financial and operating results for the third quarter 2022. Simply put, we are not pleased with the full results for the quarter, largely due to previous hedges that were in place, which did not expire until September 30th. This was a slight 17% quarter-over-quarter improvement in hedge impacts, along with an additional 22% improvement on inventory charges related to backwardation. However, the impact of these items in conjunction with a few nonrecurring items resulted in consolidated adjusted EBITDA totaling $1.7 million for the quarter. which is below expectations. Chris Carlson, our Chief Financial Officer, will address financial results in greater detail momentarily.
All things considered, we are glad to be out of our previous hedge positions, and we look forward to showcasing the true value of our mobile asset moving forward. As for the remainder of the results, we’re very pleased with our operating performance. During the quarter, we have continued to transition operations, continued steady progress on our RD project and made significant improvements to the assets while doing so safely and reliably. Our team continued to execute safely on all fronts, demonstrating operational agility and flexibility in constant changing market conditions, of which I’m incredibly proud of their performance.
We continue to work extremely hard to effectively manage and more importantly, adapt and learn from each of the individual challenges and organizational gaps we encountered along the transformational journey. Operationally, we reported throughput volumes in line with our prior expectations, achieving better than forecasted operating expense per barrel results. Our product yield profile and resulting capture rate was also on target, generating attractive refining profitability per barrel on an adjusted basis. Beyond prioritizing safe and reliable operations, we focus on optimizing our refining assets, expanding our core capabilities, and increasing our knowledge and expertise.
We did this in 3 ways. First, we prioritized the maintenance and optimization of our mobile facility to best position Vertex for the fourth quarter ahead of anticipated robust market fundamentals concurrent with the roll-off of our previous hedge positions. Second, we grew and developed our employee base focused on key areas such as accounting, marketing, communications, and risk management. Third, we pursued and began engagements with industry-leading consulting groups to help us develop strategic business processes and expand our expertise on an accelerated timeline. Although we have used this quarter to cover a lot of ground and build momentum, each of these initiatives reflect our drive towards continuous improvement, serves to help us maintain a clear view of the road to a successful future.
With that, I’d like to hand the call over to James Rhame, our Chief Operating Officer, who will provide a detailed update on our operations during the quarter, including an update on the status of our renewable diesel conversion project at the Mobile facility. James?
James Rhame
Thank you, Ben. Good morning. I’ll begin with a brief report on our health, safety and environmental performance. During the third quarter, we had 0 OSHA recordables at the mobile site and 4 OSHA recordables in the legacy business, all minor in nature. 0 environmental recordables across our legacy business and 2 environmental recordables and 1 Tier 1 process safety event at our mobile site. These events have been fully investigated and action has been taken to prevent recurrence.
Moving on to operational performance, beginning with our legacy business. Our Columbus refinery saw its largest spread on netbacks for our base oils ever during the third quarter of 2022. The site did occur some downtime for equipment replacement and does have a planned turnaround scheduled for the fourth quarter of this year. In Louisiana, our Marrero operations also saw improvement on netback spreads in the third quarter, achieving record-high run rates at the refinery. Marrero does not have a planned downtime in the fourth quarter.
Turning now to our mobile operations. Third-quarter throughput volumes at Mobile refinery averaged approximately 68,000 barrels per day or 91% of operating capacity, in line with our updated guidance of 68,000 to 69,000 barrels per day. We continued processing of crude diet consisting of WTI, LLS, and local sweet crudes. Total production of finished high-value light products such as gasoline, diesel and jet fuel represented approximately 69% of total production versus 67% in the second quarter of 2022, reflecting the type of improved yield efficiency which we expect to continue in the fourth quarter following completion of the recent turnaround work.
Our fuel-only gross profit per barrel for the quarter was $18.18 driving a capture rate of 52% of the benchmark Gulf Coast 2-1-1 crack spread, which came in at $34.82, in line with our guidance of 50% to 54% capture rate. On a realized basis, including the impact of hedging and one-time adjustments, gross profit was $7.73 per barrel. During the quarter, we successfully completed a catalyst change on our distillate hydrotreater and #1 reformer, and we’re able to clean the #1 crude unit. We are pleased to have completed these operations on time and on budget and have since seen the yield benefits of changing the catalyst on both units.
Total throughput volumes were restored to full operational capacity as of early October and continue to remain at or above these levels currently. The combined impact of performing the recent maintenance operation at Mobile benefited overall facility performance, maximizing throughput capacity and enhancing yields ahead of the anticipated historically robust heating oil demand season. We remain confident in our recent decisions to extend the schedule associated with the RD conversion and address necessary maintenance operations as it positions the company extremely well to enter the fourth quarter. As expected, refining margins quarter-to-date have been some of the highest in the industry has ever witnessed. And with the benchmark 2-1-1 Gulf Coast crack spread averaging $43.90 during the month of October.
Now turning to our renewable diesel conversion project. As previously disclosed in September, we extended our project timeline for the renewable diesel conversion project by approximately 3 months. The decision not only reduces the total planned downtime of the unit during the conversion, it also significantly reduced the risk of any further unanticipated operational delays caused by supply chain disruptions. I am pleased to report that progress on development and construction activities are advancing as planned with the conversion project tracking on time and on budget for targeted mechanical completion during the first quarter of 2023 and initial production anticipated in the second quarter of 2023 at a budgeted total CapEx of $90 million to $100 million.
The majority of the engineering and procurement activities are now complete and significant milestones and the actual construction progress have been achieved to date. Recent procurement delays on critical bulk items have been resolved with 100% of pipe and valve fittings have recently arrived at the fabrication shop. Pipe schools have been delivered on with all schools currently projected to be on-site prior to the end of the year. Some of our prior loan lead equipment delay concerned expected on or around feed-out in January. To date, the project has safely completed a combined made to date by the team who continue to prioritize the safety of site operations.
With that, I would now like to hand the call over to Chris Carlson, Chief Financial Officer, who will review our financial results for the quarter as well as provide our outlook for the fourth quarter of this year.
Chris Carlson
Thank you, James, and welcome to those joining us on the call today. For the 3 months ended September 30th, 2022, Vertex reported net income attributable to common shareholders of $22.2 million or $0.28 per share on a fully diluted basis versus net income attributable to common shareholders of $7.9 million or $0.12 per share on a fully diluted basis in the third quarter of 2021. We reported adjusted EBITDA of $1.7 million in the third quarter of 2022 versus $1.5 million in the prior year period. On a stand-alone basis, the Mobile refinery generated a $500,000 loss in adjusted EBITDA, while our legacy operations at Heartland and Marrero contributed a combined $2.2 million in adjusted EBITDA.
Third-quarter results benefited from a continuation of strong operational reliability, elevated refined product margins, and robust demand for conventional fuels, offset by the notable one-time items recorded during the quarter. The third quarter net income includes a previously noted unrealized commodity derivative gains, which amounted to $47.7 million during the quarter and a realized derivative loss of $38.7 million. Additional factors impacting reported third-quarter financial results include a loss on an inventory intermediation agreement related to continued backwardation in the crude and product markets in the amount of $17.9 million, a gain on the change in derivative liability in the amount of $12.3 million related to the warrants associated with our outstanding convertible bonds and $2.9 million of expenses related to the Shell acquisition.
Due to the number of significant moving parts embedded in our financial results this quarter, I would like to briefly touch upon each of these items to provide a better understanding of how they arise and what can likely be expected in quarters to come. First, the impact of the Q2 and Q3 commodity derivative hedging activities, while quite significant over the prior 2 quarters will not impact our results in the fourth quarter or beyond as all contracts have expired as of September 30th, 2022. These hedges were put in place with the best intentions of ensuring our ability to continue to service the significantly increased debt load taken on to fund the Mobile acquisition and protect the cash set aside for the RD conversion project. However, an unusually large run in refining margins turned these contracts against us over the past 2 quarters.
The loss on our inventory intermediation agreement of $17.9 million is related to the continued backwardation in the crude and products market, similar to what we experienced in the second quarter of 2022, where the impact was $23.1 million, a 22% reduction quarter-over-quarter. We continue to keep a close eye on the shape of the futures curve and are currently evaluating possible risk mitigation strategies to limit our exposure to such losses going forward. Finally, we recorded a $12.3 million gain on changes in derivative liability, which is a non-cash item. This benefit relates to the change in recorded value of warrants outstanding, which were issued in conjunction with our convertible note offering used to finance the purchase of the mobile facility.
Due to the decline in our stock price following the announcement of second quarter 2022 results, a sizable change in the value of these warrants was recorded, which is what is reflected by this change in value. As long as these warrants are outstanding, this will impact us quarter-to-quarter as a noncash item. As of September 30th, 2022, the company had total liquidity, including restricted cash of $122.3 million versus $98 million at the end of the prior quarter. Vertex had total net debt outstanding of $364 million at the end of the third quarter of 2022, including lease finance obligations of $45.4 million, implying a net debt to trailing 12-month adjusted EBITDA ratio of 2.5x as of September 30th, 2022.
During the fourth quarter, we intend to operate Mobile at between 73,000 and 75,000 barrels per day, positioning us to capitalize on continued strength in the market. OpEx per barrel is expected to be $3.50 to $3.75 per barrel for the quarter, and our capture rate on the benchmark Gulf Coast 2-1-1 crack spread is forecast to be approximately 50% to 54%. Total capital expenditures for the fourth quarter are expected to be between $35 million to $40 million.
I’d like to now turn the call back to Ben to provide some final comments before we open it up for Q&A.
Ben Cowart
Thank you, Chris. As we look towards the end of the year and into 2023, refining margins are anticipated to remain at elevated levels. Domestic fuel demand remains strong. The global refining complex continues to operate at a reduced capacity and domestic gasoline and distillate inventories remain well below average. Following the work performed at the site and the progress that the team has made during the third quarter. We’re looking forward to showcasing these improved efficiencies and highlighting the performance of the business as we close the fourth quarter out going into 2023. With that, we will open the line for questions. Operator?
Question-and-Answer Session
Operator
[Operator Instructions]. The first question comes from Eric Stine from Craig-Hallum.
Eric Stine
So obviously, given the hedge, given everything going on, a lot of millions in the number for the third quarter, before moving on from that, so just to be clear, I mean, all these adjustments, the inventory loss and backwardation that was adjusted out of EBITDA. I do want to confirm that because at least the looks of it right now, that is something backwardation that is going to be the reality here for at least the foreseeable future.
Chris Carlson
Yes, Eric, it is. And it was backed out of adjusted EBITDA.
Eric Stine
Okay. All right. Good. And then the hedge being gone for the fourth quarter, it sounds like from your commentary, trying to get a lot of the noise out of the results. And although you did it back when you took on mobile with good intentions, fair to say that unless things change dramatically in the market, you likely will not be putting on a hedge at least for the foreseeable future.
Chris Carlson
That’s correct.
Eric Stine
Okay. Maybe just an update on the UMO process. I know that’s certainly something that you’ve been operating it as if you are going to own that going forward. But I also know there’s a lot of interest in the market. It looked like the results were below what the run rate has been over the last couple of quarters. But maybe just some discussion on that and curious what your thoughts are going forward.
Ben Cowart
Yes. So Eric, we still have the work in progress as far as tendering interest in certain assets. We’ve made enough headway to – and again, you’ll see this in the [Q] to pull out the Gulf Coast part of that work, and we see the synergies and integration with those assets into what we’re doing in Mobile. So I really hope we would have everything at a speaking level today. I think we’re pretty close to resolve and where things stand on the balance of the business, and that’s the state of that process.
So the legacy business is a very small portion of the company today. And so I know the numbers aren’t going to come through in detail like we presented them in the past. But the legacy business has certainly done well. It actually had a really good quarter. It’s just the detail that we’re providing now under the new reporting doesn’t provide the granular view of that because there’s so much more to talk about related to Mobile and where we’re heading with the business.
Operator
The next question comes from Amit Dayal from H.C. Wainwright.
Amit Dayal
Just to begin, Ben, could you clarify what the hedging-related number is that won’t show up in fourth quarter? I know there are some numbers in the paragraph in the press release, but if you could just clarify for everyone what that amount is that impacted 3Q but won’t show up in 4Q? The cash one.
Chris Carlson
Yes, that’s right. So this is Chris. So in our deck, there’s a schedule that breaks out the adjusted EBITDA. And in that is the adjustment of the hedge that is no longer on. It’s right at $46.9 million that, again, as of 9/30, there’s nothing outstanding at this point.
Amit Dayal
Okay. And then what’s throughput a little lower in 3Q? I recall maybe you said it was going to be around 72,000 to 74,000 barrels. Maybe I got it wrong but just wanted to clarify that.
James Rhame
Yes. We came out — this is James. Thank you. We came out in September and said we moved our projection down. We had an issue during the quarter with third-party docs and our ability to access crude, and that affected us about 3,500 barrels a day on average across the quarter, and that was the majority of the miss from 68 to 72. The rest was us doing some of the work we did. And even though we returned on time, we didn’t get crude all the way back up, but we reprocessed every bit of that. So that’s what that [the difference] and we did that in September.
Amit Dayal
Okay. Got it. And are those issues resolved for — I mean, do you expect any of those issues to resurface in the fourth quarter?
James Rhame
No. What we did was we have contracted another vessel that allow us the ability to move crude in by water without delays. That’s not to say there’s not risk, but we continue to knock those risks down and work with our crude suppliers to make sure we have enough crude to run.
Amit Dayal
Just one last one for me. With respect to the RD ramp, how are you seeing RD ramping in 2023? I know you’re starting initial production in Q2. From there, from a modeling perspective, how should we be thinking about setting our projections in terms of the ramp?
James Rhame
Yes. So our plan is we’ll go through commissioning in the — at the end of the first quarter – end of the second quarter. We will ramp up to approximately 8,000 barrels a day of renewable diesel. We will in turn into the first quarter of 2024, finish the Phase II and up to ramp to the next level, which is projected to be 14,000 barrels a day.
Operator
And next question comes from Noah Kaye, Oppenheimer. Please go ahead.
Noah Kaye
So just to reflect what I’ve heard so far. It sounds like hedging rolls off and we’re going to have a pretty clean 4Q. Normalized production rates, no impact from hedging. Somewhere at this point in terms of $15 to $20 per barrel, if you’re doing 50% to 54% capture of what’s a very elevated refining margin. So it seems like a very healthy setup so far. If we look at cash generation off of that, I think that’s really where I want to take the questions because you generated an awful lot of cash this quarter. Next quarter, as you ramp up, how do we think about puts and takes in terms of cash generation, any build-in working capital needs impacts or continued backwardation? What should we be thinking about in terms of cash generation?
James Rhame
Yes. It’s a good point. We definitely anticipate a significant generation of cash from a backwardation perspective, we’re still seeing backwardation in the futures market. So I don’t expect much change from what we reported. As far as uses of cash looking forward, we’re going to continue to focus on self-funding the RD project, continue on focusing improving the balance sheet and then looking at mobile refinery projects that will produce higher return long term. And then, I guess, third, pay down debt.
Noah Kaye
Are we going to see some of that debt pay down in the fourth quarter?
James Rhame
I don’t know if it will be Q4, but we’ll definitely be looking at Q4, Q1.
Noah Kaye
Okay. Great. And then just in terms of the product slate, yes, I think we’re going into a pretty unprecedented time in terms of heating oil and diesel demand. It seems like a good setup. Anything we should be thinking about in terms of the skew or the mix of the product slates because the refinery is built to produce more distillate on the balance.
Ben Cowart
Yes. No, this is Ben. You’re correct. And really, a lot of work has been put into the yields and adjusting the refinery to maximize our margins. Our distillate yields, which includes jet fuel is almost half of our output today, which is pushing where the refinery has been in the past. So they’ve done an excellent job to position us well related to those yields. Our products, in general, including gasoline is almost 3/4 of our production. So I think yield-wise, as you’ve seen, we had a 2% improvement quarter-over-quarter. And as James indicated, coming out of the turnaround and doing the work around the catalyst and our reformers and our diesel hydrotreater, we’re seeing more improvements, and so we’re pretty set. We’re in a good position.
Noah Kaye
Great. Maybe just a last one for me on the renewable diesel side. Can you talk about the status of feedstock contracting? How much supply do you have line of sight to? Can you comment on the diversity of your supplier base? And basically, any considerations we should be thinking about as you look to start ramping up the facility in 2Q?
James Rhame
Yes. Thank you. This is James. I’ll answer that. Bart Rice is one leading our acquisition of feedstocks. What we do see is we’re initially going to start up on bean oil, but we’re looking at alternatives to that shortly after startup. We are working with a tremendous number of suppliers. As you can see, none of them can supply all of our needs, but we’re working with those not just from a different supply point but a different mode to bring in to make sure that we’re maximizing the feed in front of the plant and how do we get it in the plant is where we’ve been working also. So that’s – we’re close to finalizing those and hope to finalize that, of course, in the fourth quarter and get everything lined up, so we’re prepared for start-up.
Operator
The next question comes from Brian Butler from Stifel.
Brian Butler
Can you hear me?
Ben Cowart
Yes.
James Rhame
Yes.
Brian Butler
Got you. Great. So I guess you talked about the crack spread, I think, in October, somewhere around $44. Is that where we’re at in early November here? And how should we think about that for the rest, not that you can forecast the crack spread, but is there anything major that suggests that’s going to be going up or down?
James Rhame
Yes. We’re projecting October at 43, 90. We’re continuing to see strong distillate margins, and that’s what’s driving that a good bit. And we do not see much impact in the quarter. But again, me looking in the future, I’m always wrong. But as you can see from the industry inventories, they’re extremely low going in the heating oil season, and that’s really what’s the basis of it. And we’ve got our projections, of course, from IHS and other professionals that are out there.
Brian Butler
Okay. That’s helpful. And on the supply chain and the building out the hydrocracker, is there any more risk of disruptions at mobile for the upgrade? Or at this point, is everything in place in supply chain issues or something of the past?
James Rhame
Yes. We believe there’s something of the past. We’re doing every 2 twice a week. We have a swap team watching parts coming in. We have 3 items that are long lead items that will show up right about feed-out time or pretty close to it. Everything else will be on-site prior to us taking feet out of the unit, which is how I want it to be done and what the industry expects to be done. So we feel very confident where we are.
Brian Butler
Okay. And then on the feedstock, the prior question, how does this compare to your original expectations on where you thought feedstock would be for the RD part of this, can you give some color on that?
James Rhame
We’re finding more people available to us for feedstocks than we originally projected. The volumes aren’t perfect all the way through, but it looks like that’s a problem that’s solvable, and we do have many people wanting to work with us. And as I stated before, Bart Rice has done an excellent job reaching out and developing that.
Brian Butler
Okay. And then maybe last one, just on some of the accounting. On the backwardation, so that sounds like that’s going to be again in the fourth quarter. Directionally, is that continuing to go down? And that is a cash item.
James Rhame
Yes. Due to the intermediation agreement structure, it is a cash item that runs through our P&L. And yes, to your point, we’re still seeing backwardation as we look forward.
Brian Butler
Is that the same level as 3Q? Is that the right way to think about it? Or is that gradually improving, and it’s going to be something less than that $18 million?
James Rhame
As of right now, the values are right in line with 3Q.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Ben Cowart for any closing remarks. Please go ahead.
Ben Cowart
Thank you, operator. Thank you, everybody, for joining the call. Thank you for the interest in Vertex. We are working hard on this end to really showcase the value from our new acquisition in Mobile as we come through the fourth quarter and on into the first quarter. Things are moving well. Our teams are coming together. So we’re very pleased with the progress we’ve made, and we look forward to communicating between now and the close just as to the – some detail on that progress as we go forward. Thanks for dialing in.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Goodbye.
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