Ben Cowart - Chairman and CEO Chris Carlson - CFO John Strickland - COO

Eric Stine - Craig-Hallum Michael Hoffman - Stifel Tom Bishop - BI Research

Greetings and welcome to the Vertex Energy 2017 Second Quarter Financial Results call. at this time, all participants are in a listen-only-mode. A question-and-answer session will follow a formal presentation. [Operator Instructions]. As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Ben Cowart, Chairman and CEO for Vertex Energy. Thank you, Mr. Cowart. Please begin.

Thank you, Operator. Good morning and welcome, everyone, to Vertex Energy's 2017 Second Quarter Financial Results Conference Call. Joining me today on the call is Mr. Chris Carlson, our Chief Financial Officer; Mr. John Strickland, our Chief Operating Officer; Michael Porter, our Investor Relations consultant at Porter, LeVay and Rose. The company expects to make forward-looking statements during today's call. Statements including such words as believe, anticipate, expect and statements in the future tense are forward-looking statements. These statements involve known and unknown risks and uncertainties and are based on management's current views and assumptions regarding future events and operating performance. A number of factors could cause the company's actual future results to differ materially from its current expectations. Before we review our financial results, I'd like to discuss some key points about our business operations. We are encouraged by the continued improvements of the company's operations. We have mentioned in past conference calls, one of our goals has been to increase our throughput at the facilities. Our overall volume grew 19% in the second quarter 2017 over second quarter 2016. In addition, our collected volume for the second quarter 2017 was up 38% over the second quarter of 2016. Our progress also was demonstrated in our operating performance. Production volumes at each of our facilities were 1 million gallons ahead of our internal targets because of continuing improvements at each of our facilities. The Heartland facility continued to be a strong contributor to our performance. We benefitted from the increase in base oil prices and our spread management. As we focused on capturing additional volumes, we were at the risk of spread compression. Related to our fuel business in the Gulf Region, we suffered some compression in the second quarter that totaled $2 million as it relates to our Refining and Marketing business and primarily our Marrero facility. Two factors to understand the spread compression are: the price of Number 6 Oil index as it compares to West Texas Intermediate crude price index. We buy our feedstock off Number 6 Oil and we sell our finished VGO product off of WTI. These two indexes have been compressed over the second quarter, some over the first quarter as well. This compression was because of an abnormal run-up of the price index due to a supply shortage in the Gulf region for the Number 6 Oil product. The shortage has put a strong demand on used oil as an alternative molecule for this Gulf residual fuel market. Despite this compression at our Gulf refining business, we are happy today with the progress we've made in terms of increasing our volume and production, which will benefit the company over the long term. I'll now turn the call over to Chris Carlson, our CFO.

Thank you, Ben. I will now review our financial results for the 2017 second quarter ended on June 30, 2017. All of our financial statements, unless otherwise noted, are prepared in accordance with Generally Accepted Accounting Principles. For second quarter 2017, consolidated revenue was $36.9 million, higher than the $24.4 million reported for the second quarter ended June 30, 2016. For the first 6 months of 2017, consolidated revenue was $71.7 million compared to $38.6 million for the same period in 2016. Our overall volume in the business was up 19% and the crude market prices were up approximately 6% for the second quarter in 2017 over second quarter 2016. The rise in volume reflects our continued focus on increasing our throughput at our facilities. In our Black Oil division, which includes our Marrero, TCEP and Heartland business units, revenue was $27.4 million for second quarter 2017 as compared to $19.8 million in the same period a year ago, an increase of approximately 38%. Volume increased 14% for the second quarter over second quarter 2016 and 29% for the first 6 months of '17 over the same period a year ago as a result of higher production at the Marrero and Heartland facilities. The Refining and Marketing division produced revenue of $5.2 million in the second quarter of 2017 as compared to $2.9 million for the same period a year ago, an increase of 77%. Volume for the quarter was up 54% over the second quarter of 2016 and 32% for the first 6 months of 2017 over the same period a year ago. For the second quarter of 2017, Vertex Recovery division generated $4.3 million in revenue, an improvement of 160% from $1.7 million a year ago. The increase was driven by opportunistic trading and an overall improvement in our Metals division during the period. Volume for the second quarter over the second quarter of 2016 was up 9% and increased 31% for the 6 months 2017 over 6 months 2016. For the second quarter of 2017, our gross profit was $5.4 million, an increase of 3% from a gross profit of $5.3 million during the same period in 2016. For the 6 months ended June 30, 2017, gross profit was $9.5 million as compared to $5 million for the same period in 2016. Gross profit margin was 14.7% for the second quarter of 2017 compared to 22% for the same period a year ago. For the first 6 months of 2017, gross profit margin was 13%. Our consolidated per-barrel margin decreased 13% in the second quarter 2017 compared to the same period a year ago. Gross profit for the Black Oil division was $4.4 million during second quarter of 2017, which was a 3% improvement over $4.3 million in the second quarter of 2016. Per-barrel margins for the second quarter 2017 decreased 10% as compared to the second quarter of 2016. Refining and Marketing's gross profit decreased 39% to $463,000 in the second quarter of 2017 compared to $754,000 a year ago. Per-barrel margin decreased 60% for the second quarter over same period a year ago. Vertex Recovery generated gross profit of $548,000 in the second quarter of 2017 compared to $227,000 a year ago. There was a 120% per-barrel margin increase for the second quarter of 2017 over the same period a year ago. Selling, general and administrative expenses were $5.4 million in the second quarter of 2017 compared to $4.7 million for the same period a year ago. For the first 6 months of 2017, SG&A expenses were $10.6 million compared to $10.2 million for the same period in 2016. Our SG&A is up as a result of the 2 recent acquisitions completed during the first 6 months of this year and the refinancing completed at the beginning of the year. Depreciation and amortization expenses were $3.3 million compared to $3.2 million a year ago. We reported a net loss of $2.7 million or a loss of $0.08 per share in the second quarter of 2017 compared to a net loss of $6.3 million or a loss of $0.21 per share in the same period a year ago. For the 6 months ended June 30, 2017, we reported a net loss of $6.7 million or a loss of $0.21 per share compared to a net loss of $8.5 million or a loss of $0.29 per share. Our quarterly EPS was calculated using an average of 32.3 million shares outstanding. As of June 30, 2017, our term debt was approximately $14 million. At the end of the quarter, our working capital was approximately $4.8 million compared to a deficit of $683,000 a year ago. We have stated that market conditions around our raw materials and finished products and our production rates are key factors in our 2017 guidance. When we communicated our 2017 guidance earlier this year, the average spread between WTI and Number 6 Oil was $0.27 per gallon. It was $0.15 per gallon at the end of the first quarter and $0.08 per gallon at the end of the second quarter. This change had a direct impact on our performance at Marrero, which is our largest facility. Therefore, based on market conditions, we would like to update our 2017 guidance. We expect our revenues for 2017 will be between $130 million to $140 million. Gross profit will be between $20 million and $22 million, gross profit margins between 16% and 20%, and operating EBITDA between $1 million and $3 million, which includes an anticipated $2.5 million of EBITDA in the second half of 2017. Now I'll turn the call back over to Ben Cowart, our CEO.

Thank you, Chris. Capital investments in our facilities and focus on increasing volumes continue to have a positive impact on our business operations. Although we experienced spread compression in our Refining, Marketing and Marrero operations during the second quarter, we were encouraged by the rise in our collected volume and the financial performance of our Heartland facility. As noted, our business was impacted by carrying costs totaling $750,000 for our TCEP and Myrtle Grove facilities for the second quarter 2017 and $1.6 million for the first six months of 2017. I want to give a brief update on these 2 facilities. First, we've stated on past calls we would explore opportunities at the TCEP facility when there was an oversupply of feedstock and a market for the finished products at the facility. In the third quarter, we have made some improvements at the facility and completed 2 of the 3 required pilot rest runs and the results have been positive. As for the Myrtle Grove facility, we have contracted a consulting firm to help us explore the best strategic options. With the improved base oil economics, including the markets and technology, we believe the facility can have long-term value to the company. However, we plan to have further updates on the third quarter conference call regarding both of these facilities. We continue to be pleased with our volume growth and market penetration of our Group III base oil import business, which allows us to further our relationships as a high-purity base oil producer and marketer to the lubricant manufacturers in North America. Overall, we are confident in our business model and the stability of the business operations for the long term. Although we are disappointed with the margins at our Refining, Marketing and Marrero operations for the second quarter, we continue to focus on operational improvements and are pleased with our progress thus far. Before we take questions, I want to let the listeners know that if you have any follow-up questions or comments please feel free to contact Porter, LeVay and Rose, our Investor Relations representative, Marlon Nurse, at 212-564-4700. I also want to mention that a digital replay will be available by telephone approximately 2 hours after the call's completion, until December 1, 2017. Details on how to access this replay can be found in our recent press releases and on our Investor Relations section of our website at vertexenergy.com. Operator, we're now ready to take a limited number of questions pertaining to the matters discussed on this call and in our 10-Q. Remember, we're unable to discuss any information or business plans which are not publicly available. Thank you.

Thank you. Ladies and gentlemen, at this time, we’ll be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Eric Stine with Craig-Hallum.

I just wanted to start with the charge for oil, and maybe if you could talk a little bit about that. Just curious, with oil in Q2 being weak and volatile, were you able to increase the amount you charge for oil? So maybe a number in the quarter. And then what are you seeing today and expectations for the remainder of 2017?

So charge for oil, obviously with the demand on residual fuel, it puts a demand on used motor oil at a street level. So as most of the industry has seen, the charge for oil has slipped somewhat compared to last quarter. We have been focused on collection growth and so we have increased our collections year-over-year 38%. And so, when we measure our cost of our collected oil, we measure it against the oil that we purchase from third-party suppliers at our refinery. And we have actually had an improvement year-over-year for the second quarter in our contribution margin even though our charge for oil did slip for the second quarter probably by the tune of $0.08 to $0.10 a gallon.

Okay. I mean and I know that you've certainly got some things going on in the market, but I mean, still, 2017 we should think about, and it would be characterized as you're still running for volumes at your facilities, but also it's collection volumes and that's going to impact margin short term. But is that a fair way to characterize it?

Well, that would be a fair expectation, for sure, based on the growth and the expansion of volumes and especially the collection volumes because they are a much better laid-in price. Unfortunately, this second quarter was more impacted not by that, but just by a sheer spread compression between two indexes that we don't have any control of. We purchase our feedstock off of Number 6 Oil index and we had a budgeted discount to that index that we hit spot-on for the second quarter. We did not miss that at all. And then we sell our finished products, on average, as a premium over West Texas Intermediate crude and we were slightly off by $0.32 a barrel, which is not much at all. So we really got, we got hit by just the volatility in the fuel markets, which is part of our strategy. A lot of times, I've been very pleased to have a portion of our business on the fuel side compared to all of our product in a base oil type of business model. I think this past quarter we would have been much happier if were making all base oil, but it doesn't always work out that way.

Right. Okay. And then just on the acquisition side, I see that after the end of the quarter, it looks like you made another small acquisition. I mean should we still be thinking about 25 million is kind of the collected or the collection volume goal for the year? Or is that something that potentially you come in higher than that given some of the strides you've made?

Yes, I think our run rate right now is probably more in-line with a 27-plus million gallon annualized volume. So we're ahead of our original targets.

Good to hear that. All right, last one for me. Just I guess this is a little bit more long-term, but you've got the -- you're making progress with Penthol and the Group III base oils. Just wondering, as you look out, what that means for timing of potentially introducing lubricants into the market. I know that's something that you have thought about long term.

Yes, the imported supply gives us an opportunity to develop our own finished lubricant product line. We've done a good bit of work this year. I don't see us putting finished lubricants in the market in 2017. It's certainly a part of our strategy for next year.

Thank you. Our next question comes from the line of Michael Hoffman with Stifel. Please proceed with your question.

On the revised guidance, if I take the midpoint, you're down sequentially pretty, it's pretty healthy decline in top-line revenues because you did $71 million in the first half or $72 million; you're dropping to $63 million. But a pretty healthy, then, incremental improvement in the margin because to hit the midpoint of the gross margin you'd be at $11.5 million on that $63 million. So can you help us with how that's coming to play given the supply-demand issue probably hasn't changed much on the fuel oil issue?

Well, I guess specifically as it relates to revenue, I mean, again, as everybody on the all knows, a lot of it is market-driven. So with the range of $130 million to $140 million for the year-end number, I think we should be right in target with that based on current market prices.

Okay. So you're suggesting that your selling prices are down that much on good volume, then.

No, we're not planning on volumes to be down at all.

No, selling prices. Your selling prices are down on good volume.

Yes. So, Michael, we're looking at the forward pricing as far as setting these targets out front. So whatever crude futures and diesel futures are, as well as 6 Oil futures, that is, the volumes are going to continue to grow, but we don't anticipate market pricing that basically drives revenue to be as good or where we were. I guess, Chris, is that?

That's correct.

Yes.

Okay. So all right. That's what I thought was going to be the case, particularly after this last question talked about volumes being ahead of plan. But the margin, then, that you're proposing is, that's an 18% gross margin on the second half. So where am I getting the operating leverage on reduction in selling price? Because I assume that's going to put continued pressure on your spread compression.

No. No, that's a good point and I'm glad you asked that question. Because the spread compression came from the other side. it didn't come from the top down; it came from the bottom up. So 6 Oil prices that basically set the cost of feedstock for the refinery had, I hope, to be an artificial increase over the first and second quarter causing used oil prices at the gate at the refinery to go up. WTI drives the fuel prices for diesel and the marine fuels that we sell, et cetera. So when we look out to the future markets, we're saying; okay, WTI is probably going to be in this range, maybe lower on a forward curve, but we anticipate, based on the forward curve of residual fuel prices, for that to fall back in line somewhat, where we pick our spread back up. So we got squeezed in the first and second quarter and from the place at the end of second quarter we see that opening back up based on what the forward curves look like for paper swaps for residual fuel.

Okay. That's what I wanted and thought you were going to say. And that's the important part of the message; is that the pressure you've been suffering is easing.

Yes, that's right.

So the uncontrollable is easing and you've got more volume. So we should start to see some operating leverage through the G&A, things like that, as well.

That's correct. That's right.

So, where do you fall out on the balance sheet? Because it appears you've increased debt sequentially pretty healthy. So is that a working capital need and then you'll come back out of that? How do I think about where the balance sheet settles out for the year from a leverage standpoint?

Yes, I would definitely say it's a working capital need short term. And we still have availability with our lender to draw more into on the term debt for the balance of this year and into next year. So again as we look at future acquisitions and opportunities, we've got availability with our lender to expand that.

Okay. But is your debt levels going to stay for remainder of the year at where they finished the second quarter?

I would expect our term debt to go up a little bit particularly if we come across any other acquisition opportunities.

Thank you. [Operator Instructions]. Our next question comes from Tom Bishop with BI Research. Please proceed with your question.

Almost a year ago you mentioned that you were in the process of monetizing Myrtle Grove and the Cedar Terminal. And I'm not sure what the delay has been. Could we start with just exactly what's at these 2 facilities and whether they are in tandem, one is right with the other? Or are there 2 separate facilities, Myrtle Grove and Cedar main facility? And then I just have a couple more questions about this.

Yes. So we'll start with Cedar Marine Terminal. That's our home for our TCEP technology in Houston. And it's a separate operation to the Myrtle Grove site. So we shuttered TCEP based on pricing of feed and feed availability. We've kept the plant and the terminal in ready mode. We've actually, this quarter, been working on some R&D and run some pilot runs with the anticipation that there may be some opportunity to bring the plant back online. We don't know that for sure. And so we have explored different options for that site. It's a very strategic asset for other things that could add growth and diversification to our business. So we've been exploring those opportunities with the CMT facility. The Myrtle Grove site is an extension to Marrero. It's a different location, but it allows us to hydrotreat our distillate that the Marrero facility produces and produce --

And so you're using it for that?

No. No, we've never used it for that. We acquired the asset with the hydrotreaters and the equipment and the fractionator, et cetera, and we have been working on infrastructure and, now, putting a book together with a consulting company that will help us evaluate that site for that purpose. And so we are hoping to have more information in our third quarter conference call as to where that stands. Obviously, the base oil markets have improved somewhat and if we were operating that site today and producing the volume of base oil that the site is capable of producing then the picture would be much different. And so with that in mind, we want to slowly evaluate that opportunity.

I understand there's a fair amount of storage there.

That's correct.

Is that being utilized?

Nope. No, we're not operating the site. So we're doing infrastructure improvements for the future development of the site one way or the other. And the tankage is there. We have one brand-new hydrotreater on the ground ready to go into service. We have a completely renovated fractionation column and a 9 million gallon tank farm facility. So there's a lot of infrastructure in ready condition. There's still a lot of work to do on the site.

9 million gallon tank farm. Is that what you said?

Yes, that's correct.

So is the problem there partly is you just don't have the feed for the facility?

No, the Marrero facility is already producing the feedstock. The biggest issue is the additional capital to complete this facility and the timing. So we don't want to be in the market raising capital today based on where our stock is, and we're very careful about the market conditions not to bring a large amount of base oil into the market at the wrong time. So both of those have slowed us down somewhat, but we do think that there are some other options that we're exploring that allow us to move in that direction.

Do you have any idea, just a broad range, of what the facility would be worth if it sold? I assume that's one of the options.

Yes, I think it's a strategic asset for the industry so if you get outside the industry then it's a Brownfield location and so that's part of our challenge. We would feel like we were giving it away at some of those values; let's just say $15 million type number. So we think it has far more value to the company and to our market position if we stay and see that through.

Into production, you mean?

That's correct.

[Operator Instructions]. We do have a follow-up question from the line of Tom Bishop.

Could you just remind us why the Marrero margins compressed, but those of Heartland didn't? Is it because Heartland is producing VGO? Is that the?

Yes. It's the reverse. Heartland produces Group II-Plus base oil. And so the base oil market was nice and strong through the second quarter, where the Marrero facility produces a distillate fuel primarily for the shipping industry. And that is tied to the WTI crude market and the feedstock is tied to a residual fuel market and the residual fuel price went up exponentially compared to crude. And so that took the cost of our third-party feedstock with it and that's where the spread compression came into play.

Okay. I've heard that several times now during the conference, but I didn't quite understand why the feedstock price went up so much. Because that's where the margin compression was, right?

Yes. So we purchase our used oil from third-party suppliers at the gate of the refinery based on a discount to the residual fuel index. So if that discount is set and then the 6 Oil index and the WTI index compresses on their own then we lose that spread between WTI and 6 Oil.

Well, I was trying to figure out why it did compress. I mean what was the pressure due to on the feedstock?

Yes. That's a good question. As we understand it, there was a refinery in Mexico in the Gulf that produces a large amount of residual fuel. This refinery caught on fire in the first quarter and the refinery has been out of operation since then. And so it put a short condition on the residual fuel in the Gulf that has brought the value of used oil up with it. Anything to add, John?

Okay so then any forecast on when that's likely to resolve?

Tom, not right now. We're still looking into that to see when it might come online. I think the average barrel per day of that refinery was 55,000 barrels a day of resid. So that's why the demand of 6 Oil has went up to cause a compression between Number 6 and the WTI. And we'll know more probably in the next couple of months, is what I'm hearing.

The future on 3% is certainly open.

It spread it up. The futures are showing the spread to open back up probably 50% where it was at the beginning of the year. So we feel good about that. We're working every day to help put our VGOs at Marrero more into the DMA diesel market, which will help with the selling values of it. We do some of that already, but we think we are anticipating selling more into that market by the end of the third quarter, for sure.

So the hedge, Tom, to if this spread stayed the same, it's create more value on the sell side, which we're making good progress, and collect more with your own trucks, which we are making good progress on.

Good. Finally, the Penthol status, Group III base oil there. How much of a contribution is that making? And if you can, I can't recall if you told us what you get on each gallon that you place.

Yes. We share on profitability with Penthol as our partner. So the business is only 1 year in startup and we've already endured all our startup cost. I don't have the number exactly. We fold that into our Vertex Recovery business. So you can see that Vertex Recovery has improved significantly year-over-year. I wouldn't say that that's all related to the Group III business, but it is on track and meeting our objectives. As far as the break-out, we don't break that business out financially so you'll see that in the Vertex Recovery business.

Well, is it going to plan or --?

Yes, it's at or better than what we had planned.

[Operator Instructions]. Our next question comes from the line of Jack Lasday, [ph] who is a private investor.

Ben, somebody just spoke about futures indicating a recovery of the spread. I know that at one point you had talked about doing some hedging. It seems like we're always on the wrong side of these spread compressions. Is there not a way to hedge just so that you can ensure somewhat of a better cash flow, a better profit situation going forward?

Yes. So I think we've done a good job, Jack, of weathering the volatility of the crude market, the WTI market, and we use a hedging strategy to do that. So a perfect example is our guidance was based on $53 crude, but we haven't really had to come to the call and say that crude prices has really hurt us. What you're talking about or what the problem is here is the relationship between two indexes. It's immaterial to the products that we're buying and the products that we're selling. These are contracts that we already have tied to those indexes and when those indexes collapse, we have this, this has happened very rarely for us over the years. Unfortunately, once the compression has taken place, you would have to short those 2 indexes or try to, you'd have to bet that those indexes are going to go the other way and buy paper today and that would really be speculation, which we don't do in the business. We're a physical operation. Hindsight being 20/20, at the beginning of the year when we had a $0.27 a gallon spread, we would have bought paper on both sides and locked the spread in. But that's, again, to some degree, speculation and if the market went the other way, people would ask, well, why did you lock in that spread? You could have made a lot more money. So we've never tried to manage in between those two indexes. We've just kind of let the market go where it goes. So it's just one of those situations that I don't think anybody really had foresight that this refinery would create the shortage of residual fuel.

But then you said that once you had the orders locked in, wouldn't that have been a good time to have then hedged and locked in your profits if you have the capability of hedging at that point? Not to speculate, but you already said that you had the sales in place so you knew what that number was going to be. Wouldn't that have been an appropriate time?

No, the only thing we have in place is contracts to supply and contracts to sell. And we still have a lot of spot business. So if we started the year off and said, we like the spread between WTI and 6 Oil; we'll lock that in, well, we still have operating risk and we still have all the spot volumes that go into the business that are at risk. So you don't want to over-commit yourself to something that you don't control. And so we've never done that on that trying to capture a margin spread. We always say if we're buying at the discount to 6 Oil and we're selling at a premium to WTI, then that, over the years, has been a very, fairly stable model. And this obviously is not the case for what we've just seen.

So are the spreads still not recovering at this point due to this Mexican situation?

The forward curve has improved a little bit and we've kind of built that back into our model.

That's all the time we have for questions today. I'd like to turn the floor back to management for closing comments.

Okay. Well, thank you, everybody, for joining us today on the call. And again, we'll make sure we're available through Porter, LeVay and Rose. Marlon Nurse will be glad to take any calls and line up any other following calls with management. And again, Marlon can be reached at [212] 564-4700. Thank you again for calling.

This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.