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Edited Transcript of VTNR earnings conference call or presentation 7-Aug-19 1:00pm GMT

Q2 2019 Vertex Energy Inc Earnings Call

CUPERTINO Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Vertex Energy Inc earnings conference call or presentation Wednesday, August 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Benjamin P. Cowart

Vertex Energy, Inc. - Founder, Chairman, CEO & President

* Christopher Carlson

Vertex Energy, Inc. - CFO & Secretary

* John Noel Strickland

Vertex Energy, Inc. - COO

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Conference Call Participants

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* Eric Andrew Stine

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Michael Edward Hoffman

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research

* Sean Marconi;Hurdle6 Capital;Founder & CEO

* Tom Bishop

BI Research

* Noel Ryan;Vallum Advisors;Senior Partner

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Vertex Energy Second Quarter 2019 Earnings Conference Call. (Operator Instructions)

At this time, it's my pleasure to turn the floor over to Mr. Noel Ryan. Sir, the floor is yours.

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Noel Ryan;Vallum Advisors;Senior Partner, [2]

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Thank you, Tom. Good morning, and welcome to Vertex Energy's Second Quarter 2019 Results Conference Call. Leading the call today are our Chairman and CEO, Ben Cowart; CFO, Chris Carlson; COO, John Strickland; and I'm Noel Ryan of Vallum Advisors, the company's Investor Relations counsel.

We issued a press release before the market opened this morning detailing our second quarter results. In conjunction with this release, we also posted a conference call presentation that is posted in the Investor Relations portion of our corporate website at vertexenergy.com. We will reference this presentation throughout the remainder of today's conference call. Please note that we recently updated the Investor Relations portion of our corporate website to provide increased accessibility to key resources while allowing users to sign up for real-time e-mail alerts. We encourage you to sign up for these real-time alerts, if you've not done so already.

I would also like to remind you that management's commentary and responses to questions in today's conference call may include forward-looking statements, which by their nature are uncertain and outside 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 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 a financial review from Chris Carlson. At the conclusion of these prepared remarks, we will open the line for questions. And with that, I'll turn the call over to Ben.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [3]

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Thank you, Noel. Good morning, everyone, and all those joining us today. This morning, we will post the -- we have posted accompanying presentation materials that I'll refer to throughout this call. We'll begin with our overview of potential capital transaction that we first announced in our press release dated July 31, 2019, followed by a review of our second quarter results.

With that, let's begin on Slide 4 of the deck. Last quarter, I provided a high-level strategic roadmap for our business, a multiyear plan designed to expand our collection operations, optimize our refining asset base, high-grade our base oil production slate and expand our production of IMO compliant marine fuels. The combination of which stand to position us for profitable growth throughout the cycle. With the Tensile transaction, we have taken a very important step towards executing on this strategy. While the Tensile transaction was more than a year in the making, the net result is a low-cost, minimally dilutive funding source that provides us with the necessary capital to support our growth plans. We believe our partnership with Tensile achieved several important strategic objectives. First, the transaction further positions Vertex to become one of the leading producers and marketers of high-purity base oils in North America. Second, this transaction serves to significantly improve our liquidity profile, adding to as much as $15.7 million in cash to the balance sheet between now and the end of 2019, subject to the successful completion of the pilot test. Third, we will continue to grow our UMO collection business while becoming a selective acquirer of other collection operations.

Turning to Slide 5, 6 and 7 for an overview of the transaction. The Tensile transaction has been structured in 2 distinct phases. Phase 1, which was closed July 26 places our Myrtle Grove assets in Belle Chasse, Louisiana into a standalone special purpose vehicle. In exchange for a 15% interest in the Myrtle Grove SPV, Tensile invested $3 million in cash to the balance sheet of the SPV and $1 million to Vertex that was used to repay debt. Vertex will retain an 85% interest in the SPV. Further, under the terms of the agreement, Tensile acquired 1.5 million newly issued shares at a 10-day average volume weighted price between July 10 and July 23 of $1.48 per share, providing cash proceeds to Vertex of 2.2 million. Separately, Tensile was granted 10-year cash warrants with a strike price of $2.25 per share. This month, we began pilot work to validate the production of high purity base oils from used motor oil. This pilot is expected to reach completion by year-end 2019.

Phase 2 involves the placement of our Heartland business into a standalone SPV, similar to what we have done with Myrtle Grove, under the terms of Phase 2 closing the Tensile -- Tensile will acquire a 65% interest in the Heartland SPV while Vertex will retain 35% stake. In conjunction with this portion of the transaction, Vertex will receive $13.5 million of nonrecourse cash to our public balance sheet together with $2.2 million of cash proceeds from the shares issued to Tensile in Phase 1 closing, total cash proceeds to Vertex from the transaction is $15.7 million at the consummation of Phase 2 closing, not including the $1 million used to repay debt.

Turning to Slide 8. We anticipate the full Heartland development project will require capital investments of between $20 million and $30 million. The JV has planned up to $22 million of capital for this project. Project scope includes an expansion of our UMO gathering business, together with optimizing of the refinery to support the production of high purity base oils. The development project is expected to begin in 2020 and reach completion by year-end 2022. We expect Heartland to operate normally during the development project period.

At this time, we anticipate Heartland's development project will be onstream by the first quarter 2023. Once operational, our model anticipates that Heartland will generate between $15 million and $20 million of incremental annualized EBITDA, multiples of the $2 million of EBITDA Heartland generated in 2018.

On Slide 9, we highlight how our liquidity profile will improve pro forma for the Phase 2 closing. As of June 30, 2019, we had cash and available liquidity of $2.9 million, given the $2.2 million of cash proceeds resulting from the shares issuance, the Tensile in Phase 1, the $1 million in debt repayment, together with the $13.5 million of liquidity, we expect to receive at the closing of Phase 2, we anticipate total cash and liquidity to be $15 million to $16 million at year-end. This increase in our cash position puts us in a net debt positive position by year-end, while providing significant balance sheet optionality to grow the rest of the business.

In summary, our JV with Tensile provides Vertex with the growth capital required to grow the business on favorable terms and minimal dilution. Importantly, the terms of the transaction allows us a call option to repurchase Tensile's joint venture interest once the Heartland development project is onstream in 2023 under predetermined formulas. Given the scenario, we are effectively renting capital for 3 years until the development projects are completed, which is a win-win for all parties.

Turn with me to Slide 11 through 13 for a review of our second quarter results. We generated record results in the second quarter of 2018, making for a tough year-over-year comparison. Increased sales volumes were more than offset by less favorable spreads, together with increased turnaround transportation and transaction costs resulting in an expected year-over-year decline in adjusted EBITDA. Product spreads were mainly impacted by higher feed costs in the second quarter versus the same period in 2018.

Turning to Slide 14 and 15. Direct collections of used motor oil increased 21% in the second quarter of 2019 when compared to the same period in 2018. Direct UMO collections represent approximately 42% of our overall feedstock processed at our refineries in the second quarter versus 36% in the prior year. With the remaining feedstock being sourced from third-party UMO suppliers. On a trailing 12-month basis, the per-gallon cost of direct collections averaged $0.30 a gallon below the UMO feedstock sourced from third parties. Given that Vertex purchased more than 53 million gallons of third-party UMO over the last year, the company remains focused on increasing its direct collections.

Turning to Slide 16. During the second quarter, both Marrero and Heartland refineries operated near peak nameplate capacity. Given strong demand for company specialty petroleum-based products, including 9 days of planned maintenance during June 2019, Heartland increased total refinery throughputs by 5% in the second quarter given improved productivity results from the turnaround. As we look at the second half of the year, we anticipate a recovery in adjusted EBITDA when compared to the first half of the year. The price for high-sulfur fuel oil continues to decline as marine vessels prepare to begin consuming bunker fuels with a sulfur content at or below 0.5% in compliance with the IMO standards. We believe this dynamic will over time put significant downward pressure on UMO prices, lowering our cost of feed.

On slide 17. We show the spread between WTI and high-sulfur fuel. As you can see, the future strip indicates that high-sulfur fuel oil, the benchmark for UMO feedstock pricing, goes from $1 per barrel over WTI to $9 a barrel below WTI, 1 year from now. A net benefit of more than $10 a barrel. Historically, high-sulfur fuel has traded at a significant discount through WTI. So for the future strip reflects a return to this market structure. While we were negatively impacted by this spread during the last 3 quarters, the future strip implies a reversal in the market structure as we transition into the back half of 2019 and on into 2020. Should the paper markets be accurate, Vertex can benefit from improved margin realization in subsequent quarters. With that, I'll turn the call over to Chris to discuss our operating segment, capital structure and liquidity.

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [4]

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Thanks, Ben, and welcome to everyone joining us on the call today. Please turn to Slide 18 for a discussion of our product segments. Our Black Oil Segment, which represented 90% of total gross profit in the second quarter experienced a year-over-year decline in gross profit margin due to compressed spreads related to lower finished product values, slightly increased feedstock costs, together with planned maintenance at our Heartland facility.

Within our Refining & Marketing Segment, gross profit increased due to a reduction in low-margin business within the segment, coupled with improved spreads on existing business.

Within our Recovery Segment, gross profit margin declined materially during the second quarter, given less favorable sales volumes and pricing on metals.

The Marrero refinery operated above peak nameplate capacity during the second quarter while total sales volumes declined 2% year-over-year. At Heartland, utilization improved to 97% of capacity during the second quarter, up from 93% in the prior year period. Utilization at Heartland improved despite a 9-day turnaround at the facility during June. In July, we completed 21 days of planned maintenance at the Marrero refinery. Rain and flooding related to Tropical Storm Barry extended planned maintenance at Marrero, 9 days longer than initially expected. Currently, both the Marrero and Heartland refineries are operating at peak rates.

Finally, turning to a discussion of our balance and capital structure on Slide 19. We are currently in compliance with all of our debt covenants under our term loan and other credit facilities. Net term debt to trailing 12-month adjusted EBITDA was 6x as of June 30, 2019 versus 2.6x as of June 30, 2018, mainly due to a decline in trailing 12-month adjusted EBITDA. On a pro forma basis, assuming completion of Phase 2 of the Tensile transaction, we expect to take net leverage to 0 by year-end 2019.

In connection with the Tensile transaction, our lending group agreed to amend and extend the company's existing asset-based term loan. Under the terms of the credit agreement, the lending group agreed to extend the maturity date of the loan from February 1, 2020 to February 1, 2021. Assuming we close Phase 2 of the Tensile transaction, we intend to reduce outstanding indebtedness under the facility by up to $9 million. We continue to have cash and access to our banking facilities, which are sufficient to support the operations of the business.

With that, I will turn the call over to the operator as we take questions from those joining us on the call today.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

We'll go first to Eric Stine with Craig-Hallum.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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Just maybe starting on the collection side that the 42% mix in the quarter, I mean, it seems heavy on track to exceed your goal for 2019, which I think was 35 million gallons. So just maybe some thoughts, given what you're seeing in Q2 and now here early in Q3, where you think that can ultimately go? And I mean, if you're able to ballpark on that, either 2019-2020 goal or long-term goal, what it means for EBITDA?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [3]

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Yes, Eric. This is Ben. We, we're very pleased with the performance of our collection business looking at our trailing 12 -- contribution margin of $0.30. So obviously, it's very accretive. So you can kind of calculate from that contribution margin, how that affects our bottom line. We definitely are ahead of our game plan. I don't want to lock all that in through the end of the year because we do see the collection market or the Street requiring some adjustments in pay-for-oil based on where oil prices are and just what we see is a long UMO market. So we've got plenty of cushion to work from based on what we plan to do versus our run rates at the moment. So I think we're in a really good place from a collection standpoint, and obviously, it's a real focus long-term for the company. And we do believe we can maintain these double-digit growth rates on an organic platform, not to mention picking up smaller acquisitions as we go.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Got it. And that's a good segue, I guess, to my next question. I mean, now with the Tensile transaction. I know that the Phase 2 needs to close, but provided that it does, I mean, is that something that you think accelerates that acquisition plan? Or I mean, are there acquisitions, and I know they're small, but are there ones in the past that you've passed on because of your balance sheet that now you will be able to look at and maybe speed that growth in collections?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [5]

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Yes, that's a good question. And the answer is, yes. The development of the collection business in the Heartland region will fall under the new joint venture with Tensile. So we will have the capital, and that's a big part of what our goals are for the Heartland growth over the next 3 years.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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Got it. Okay. Maybe last one for me. Just thinking about Group III base oil and what you're doing, the Penthol agreement, I know that's something that is there and is really helping set the stage for now what you're coming with at Heartland and then eventually Myrtle Grove. I know there's not a lot of domestic production at Group III, so maybe how that fits in, and how you think you're positioned as you move down the line here with Heartland and then at Myrtle Grove?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [7]

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Yes, good question. And our import business with Penthol is going really well. The market is growing really well. Our focus as a priority, is obviously, to place all of our available allocation from the Abu Dhabi refinery, ADNOC, through this Penthol relationship into the market. So we are covering the whole North American market from the U.S. primarily, but into Mexico and Canada. And we're gaining market share at a very solid pace. So we do believe that the market will outgrow our ability to supply strictly from that import opportunity. And so we will continue to develop high-purity base oil production. Even at the level we're operating today, we're able to substitute Group III molecules in a lot of lubricant blend. So we're seeing more and more demand for our production that we have in hand today, and that's a big reason why we're partnering with Tensile to continue expanding our ability to produce these high-purity base oils, obviously, having the Myrtle Grove assets -- a lot of capital already spent in that direction properties permit. It allows us to really stay ahead of the game as far as meeting these new market demands for these Group IIIs and high-purity base oils.

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Operator [8]

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We'll take our next question from Michael Hoffman with Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [9]

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If we could focus a little bit on the Tensile transaction. So your objective at Heartland is both a capacity throughput as well as an upgrading of the grade of the output? And is that going to -- are we going to expand the capacity and the current level of grade and prove it and then upgrade to Group III? Or how's that all going to flow?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [10]

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So Michael, the investment with Tensile is for the whole business. So building our collection business out at a much faster pace, is a big part of that, building out our infrastructure. So we acquired another 4 acres adjacent to the plant. And we've already got it cleared and fenced off. And so there's a need logistically inside the facility to streamline all our logistics input, output, expand our rail. We're going to do that. We've got plans if we need to add more front-end capacity, we're able to do that. We're working on back-end capacity for more base oil production. We've already made capital investments in that direction. So this will help us round that out. We continue to improve the quality of our production. So that will be a continuation as well. And so Heartland really is just going to round out and be completed under the [daily] structure with Tensile, and we're going to be able to accelerate that with their capital. So that's the plan there. And obviously, Myrtle Grove is the bigger play for us. So the Heartland and Myrtle Grove business, they're in the same box, if you will. It's all based on moving to more high-purity base oil to go into the market. Now Myrtle Grove will serve the bunker market as well. So it will be a much bigger facility that it really addresses both our market focuses.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [11]

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So just to be clear, the current 1,500 barrels a day at Heartland doesn't change or it does change?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [12]

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Well, day 1, it doesn't change. And we really have to see if the market needs more front-end UMO capacity. What we have changed is our base oil output. So we believe that we can source high-purity VGO molecules straight to our hydrotreater, which we've already started to do, and so we'll fill the base oil capacity that way, and then we'll assess what incremental returns are to expand more front-end capacity, if needed.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [13]

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And so why -- how's the accounting going to work from our standpoint? This is going to come through below the operating line as an equity or another income line?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [14]

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That is correct, Michael. It will be below the line as an equity position in the SPV.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [15]

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Okay. And when -- that's only affected. So this is likely not to impact 2019 financials, this is going to be a 2020 probably financial impact as far as the moving of that EBITDA out of above the line down below the line on a proportional basis?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [16]

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That's what we anticipate at the moment that it would be a January 1 event.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [17]

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Okay. Be nice if it was as clean as that wouldn't it? Okay. Let's talk a little bit about how you arrived at the value of that business to put it in though. Can you talk a little bit about the process that was gone through? Why that's -- those are the right numbers to put 100% of that into the SPV?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [18]

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So a couple of things. Michael, we did go out, we did talk to interested buyers of the Heartland business, just to have some kind of benchmark on, what people thought the value would be if it was acquired because there's always interest in that business and what we do. So that was part of the process. Second is the cash flow of the business. We got a pretty good multiple on 2018 cash flow. So we looked at that. We looked at what we sold the Bango refinery for and how that transaction was valued. We did appraisals on the full asset. So we got a replacement cost value. And then we looked at how we can monetize the business going forward and the structure that we were able to get in the transaction. So all of that led to the valuation of the existing assets. So keep in mind, when we acquired the asset, I think, we paid $8 million, Chris, it's where that asset was purchased in distress. We had to invest some capital back into the plant and kind of really turn the business around. And so we feel like the transaction was very accretive to the shareholders. And with the terms that we have to repurchase the business, then we're -- we feel really good about the valuation. That is one thing that took time was to get the deal right. So when we started the deal, we really were in need of cash and liquidity back to the public company, and the business has performed much better. And so the transaction today, could require much less of private equity capital that we got to pay back in order to accelerate the growth. So that's good. And we're able to keep some of the value. As we indicated, there's $22 million set aside upfront to start the growth process. So that's -- part of that consideration is our money as well. So we're well-funded with this transaction Heartland to really move it forward. And I know it was a long answer. I hope I made that clear.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [19]

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Yes. And then last on this, just from an accounting standpoint. Chris, when will the gain show up in the financials? Is that a 2020 event as well? Or is that actually a fourth quarter event?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [20]

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It could be fourth quarter, but I would expect it to be Q1 2020.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [21]

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Okay. Let's talk about the UMO market, if we could. So earlier this week, there was a $4 barrel drop in #6. If everybody's got their fingers crossed and their toes crossed hoping IMO starting to have some impact. That would seem to be some early sign of an impact. But what's it telling us also about sort of the state of used motor oil, geographically? Like, is what are the conditions of the market in the Gulf say in comparison to the Midwest or the Northeast or the West Coast?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [22]

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Okay. So those are 2 good questions, separate in themselves because high-sulfur fuel oil pricing is a proxy to used motor oil values. So if high-sulfur fuel index comes down, then UMO that's tied to that index will automatically come down in proportion. So Monday, it did fall $4 a barrel below WTI. So this is heading quickly back to historical levels. I will add, yesterday, it fell another $2-plus a barrel. So a lot of folks think that once the supply and demand balance breaks the other way, where high-sulfur fuel is fixing to get oversupplied in the global market that this number will fall fast. So that's a 2-day indication, $6 a barrel is a big move off of WTI, where other products like the diesel market that we supply the finished product to, didn't really move much on crude. So there may be an indication that things are starting to move, we'll see. Two days is kind of early. And in my opinion, what we've seen in the last 9 months, was, as everyone moved away from manufacturing these high-sulfur fuel oils and redirect those high-sulfur fuels to other markets like utility markets, the market actually got short. So, so far, IMO has done nothing but hurt us for the first 9 months because it's driven a -- it's created a shortage on high-sulfur fuel that caused the price to go up, but we do believe that it's going to come off hard and come off fast. So 2 days, again, is early, but it is an indication of what everyone expects to happen related to that index.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [23]

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Okay. And then what about the UMO market itself, what's the sort of supply-demand balance of -- geographically? Are we long oil, short oil in any particular parts of the country? How's that trend playing out?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [24]

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Yes. Our exposure related to IMO is primarily in the Gulf Coast. So -- and most of your exports of high-sulfur fuel that go to utility plants, historically, have left the Gulf Coast, many times blended with a percentage of used motor oil. Those exports have been brought to a crawl at best, there's still some -- what they call tenders where the ships come in to buy fuel, primarily for Mexico. Mexico is close, so we can still supply Mexico with utility fuel at the moment because the Mexican refineries who produce a lot of high-sulfur fuel oil are able to sell those high-sulfur fuel barrels into the bunker market. We believe once the bunker market closes off to high-sulfur fuel that the Mexican refineries, obviously, will be supplying their own utility demand before they're looking to the U.S. for higher-cost high-sulfur fuel. We also see the refineries moving away from production of high-sulfur fuel here in the U.S. because they have the complexity or the hardware in the refineries to digest those high-sulfur fuel molecules and convert them to low sulfur products that are in demand. Other refineries worldwide don't have that same complexity. And so I think what we've seen is a lot of these smaller refineries, moving those high-sulfur fuel barrels into some of these utility markets that has preemptively closed this arbitrage off from the U.S. to those fuel demands that are in third world countries, islands that are now being supplied by smaller refineries. So that has put a very bleak demand for UMO blend stock to go into these high-sulfur utility blends. So what we've seen now, and we've been seeing it all year is that, there's less and less of UMO being purchased for blending, for utility. And that business has changed drastically, so far this year. So that's caused UMO to start to back up in the Gulf Coast first. And we see that across the market, both now -- we see it in inventories. So it's affected our inventories. We've tried to overbuy. So far, for the last 9 months, beyond our refining capacity and then resell if there is spot demand, we're not seeing any spot demand that can take slack off our inventory. So we're having to slow even for ourselves. We're having to slow down the purchase of UMO. And that's causing it to back up at suppliers' locations at this point.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [25]

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So if I follow that thread, that's putting that much more pressure on independent UMO collection? Which is advantageous for you because if you're buying them they're weaker, and if you're taking it away from them organically, it's making that a more favorable scenario?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [26]

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Yes, I don't like to say it that way, but it just -- there's just a lot of used oil out there, which makes a better buying opportunity for our refinery demand. I think we need all these guys as far as collecting the oil. And so we're working hard to create more capacity. That's why we're looking at our TCEP plant in Houston, where we can hopefully bring that back on towards the end of the year and take some pressure off the market. But basically, it is on our favor.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [27]

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All right. Last thread on this, and I'll hand it off. You said your spread narrowed on the front-end because of some of these issues around UMO being disrupted by a tight H #6 market and the relationship, that's reversing. So by definition, we should see the spread move in your favor in the second half, plus high utilization rates. And that all combines to produce better EBITDA in the second half?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [28]

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Yes. I agree.

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Operator [29]

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We'll take our next question from Tom Bishop with BI Research.

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Tom Bishop, BI Research [30]

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Let me just get a quick fix on what's the latest as far as the capacities of the 2 facilities are, Marrero and the Heartland?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [31]

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Yes. Nameplate, we're using $65 million -- $65 million at Marrero and $20 million at the Heartland facility.

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [32]

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Annually.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [33]

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Annually. These are million gallons on an annual basis. So $85 million in refined capacity.

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Tom Bishop, BI Research [34]

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And I missed the -- what's the pay-for-oil or whatever that figure is now.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [35]

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What we're -- what we're putting out there Tom, is the contribution margin of $0.30 a gallon for what we collect versus what we're having to pay for third-party supply.

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Tom Bishop, BI Research [36]

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Yes, but I meant, what -- as far as your own collections, what are you paying or getting paid?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [37]

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Yes. We -- I don't even think we have that number, but it is -- I mean, we're paying something, it's not a charge. So we're in a low pay-for-oil, Chris, probably single-digits or something like that.

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [38]

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Yes.

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Tom Bishop, BI Research [39]

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As far as IMO 2020, that's a big pipeline to fill every fuel tank and ship by January -- yes, January 1. So are we seeing any signs of this low-sulfur fuel oil being -- the inventory of that going up?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [40]

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Well, early signs, Tom, as we were just discussing that high-sulfur fuel price plummeted in the last 2 days. And the commentary from Platts, which tracks that industry, just says there's no buyers in the market for that high sulfur fuel. So that's an indication that things are starting to transition. We know in other parts of the world, that's been -- that's been the case. We just hadn't heard or seen much out of the U.S. at this point as far as ships switching over.

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Tom Bishop, BI Research [41]

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Okay. As far as Marrero goes, that extended shutdown, that 21 days, that was unusually long, I guess, because of 9 days due to weather, flooding. What kind of impact is that going to have on earnings?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [42]

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Yes, we did have a turnaround planned, and we've kind of communicated that for the Marrero facility. We -- what we've done, and John can elaborate on this, but we did some 10-year maintenance, just getting ahead of IMO 2020. And we had some metallurgy that we thought could cause some issues in the near-term, next 2 or 3 years. So we made some big moves on this turnaround, such as replacing the top of our column and replacing several heat exchangers and several things that ensures our ratability. We've done a great job. The plants run almost at nameplate for the last 18 months, I guess. And so we want to maintain that level of safe operating performance at the refinery. And we think that with the UMO market being long, that refinery is going to be in need, and with the IMO market being short of low-sulfur fuel, that refinery is going to be in need. And so we decided to go ahead and do some big overhaul in the refinery. We were in the middle of that when Barry hit the Gulf Coast. So the problem is when you're doing these long leads, you got big cranes, you got lots of people there. And safety is always first. We had to shut down those operations, multiple times during the week of that storm. And it really just kind of hung around for almost a week.

So that's the story of the additional time and why we just had more exposure to that storm than we normally would under regular maintenance turnaround.

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Tom Bishop, BI Research [43]

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Right. Well, part of my question is, was there a similar or at least shorter maintenance a year ago in the same quarter? Are we going to see a year-over-year hit to EPS?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [44]

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Well, you're not going to -- you didn't have the 9 days. That's the difference in comparison to last year, right?

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Tom Bishop, BI Research [45]

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Yes. But did you even have to...

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [46]

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Tom, a normal turnaround down there is 10 days. We had we primed this and for 13 days, is what it was because we had the tower, we replaced the top of it. We spent some CapEx money put new heat exchangers in so we can run higher rates. And the weather did not allow us to do lifts because the 30 mile an hour winds constantly. Contractor employees that live in the New Orleans area, some of them were told to stay home. So we had several days there that kind of interrupted this huge 10 years, like Ben said, this is a 10-year turnaround is what it was.

So we're going to digest that, obviously, in the third quarter. And -- but we got some big momentum on the other side at Heartland. And even what we're doing going forward at Marrero, that we don't see that being hugely disruptive to our operating performance for the third quarter.

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Tom Bishop, BI Research [47]

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Well, plus you'll have IMO 2020 starting to benefit you to offset this as well, right? During Q3?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [48]

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Yes. Well, you'll get it back. Trust me, when this starts to set in because this refinery is going to have to run with its tongue hanging out just to meet the needs on both sides of the refinery. Take the supply out of the market as best we can and supply as much low sulfur fuel back into the new market.

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Tom Bishop, BI Research [49]

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That's music to my ears. And I think it's a great idea that you got this maintenance done out of the way, and cleared the decks of what's coming with IMO 2020.

One thing I'm a little unclear about at Myrtle Grove. You're having this pilot test. That's the only thing that's certain. Is that in preparation for the changes you want to make? I mean, I don't see a Phase 2 at Heartland -- at Myrtle Grove. So is this pilot something to do with what you're going to do up in Heartland? Or I don’t understand what's going on there?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [50]

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Yes. Think about it this way. We've got a high-purity base oil partner. Our big play is Myrtle Grove, is kind of where the assets are sitting, that can really make a difference in the market. We need to get the pilot work done. Heartland is already in the market, and it's already making progress. So it's -- the lead indicator of where we're going to end up at the Myrtle Grove site, and so it just kind of all ties together. And so we will be using some of the pilot data at the Heartland facility. But its biggest impact will be at the Myrtle Grove development. And so there's no second phase to Myrtle Grove in the current transaction, other than Tensile's first right to invest up to $50 million to develop that Myrtle Grove site. So that's all they need at this point.

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Tom Bishop, BI Research [51]

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Okay. I didn't see that. Well, so -- but that would be the plan is to then whatever your pilot plant concludes there at Myrtle Grove to eventually take that to get that facility up and running?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [52]

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Yes. Yes, Myrtle Grove is a long-term development opportunity for the company and our shareholders.

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Tom Bishop, BI Research [53]

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Okay. Will that -- will that pilot plant continue to produce revenue? Or is it just a kind of a test that's not going to be an ongoing source of some minor amount of revenue?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [54]

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Yes, it's going to be a test that we'll have not -- it won't have any ongoing revenue.

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Tom Bishop, BI Research [55]

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Okay. And I have a problem with adding back depreciation with the determination of adjusted EPS. A lot of people do back out amortization, but I'm not clear if I understand your adjusted EPS calculation. Or how much is depreciation also?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [56]

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Depreciation is right at about $1.3 million on average. And then amortization makes up the balance, getting you to that $1.7 million.

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Tom Bishop, BI Research [57]

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So why are you backing out depreciation, I don't think most people do that.

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [58]

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It's just been consistent with our presentation and how we've been doing it.

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Tom Bishop, BI Research [59]

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Okay. And finally, what's going on with metal prices? That was a very big drop. Percentage-wise, how much of a drop was it?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [60]

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Yes. That's a good point, Tom. I think anybody that's been exposed to the metals market has seen this take place. Year-over-year, it's about 40%. And for the second quarter over the first quarter, and it recovered. And it fell very fast, like 38% to 40% in the second quarter. So we do have a small exposure related to our oil filter business, and that continues to grow as our used oil collection business grows. So that affects our metals pricing for the filters until we can adjust our charges for that raw material coming off the street. So that's in process as far as picking that margin back up. But the bigger thing is, we've got a barge or marine scrap business in Louisiana that we just had to slow down. We had some fixed costs there that we chose to carry, and we just wasn't going to get in the market and work on thin margins and take on a bunch of exposure until the market bottomed out. And it has and metals are -- we already have seen increases in metal prices that are picking back up. This is primarily related to the tariffs on Turkey. And at first, that served good. And then what it has done is it flooded the scrap market with steel, and so the price has come down. And now the market, the manufacturers have soaked up all that availability, and they're starting to pay back up for products. So it's just -- I think it was just a bubble or a hump in the metals market related to a major change with Turkey on the steel tariffs.

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Tom Bishop, BI Research [61]

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Well, I'll tell you, there is a lot of intertwining factors that affect your business like no other that I can't cover.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [62]

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I agree. Yes. The good thing is, everything we do, we can back it back up. We're actually -- we charged to take oil filters off the street. And we recently increased our charges for that. And so that gives us a little bit -- it's kind of like used motor oil, you can't -- it's not crude that you can just turn off in the ground if it doesn't make money. It has to get moved. So just given the time, we can make our adjustments to any market condition, and that's primarily the way we look at it in the metals as well. But you're correct. You've got to be on your toes in this business.

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Operator [63]

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And we'll take a follow-up question from Michael Hoffman with Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [64]

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Just one last one for me. You did change your calculation of adjusted EBITDA. It's actually more conservative. And I was curious if that was driven by this refinancing going on?

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [65]

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I think the presentation and the press release might be a little bit different. Last quarter, what we started doing was a trailing 12 months. So you've got a 3-month comparison and then a trailing 12 months. I'm wondering if that's the difference that we're seeing.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [66]

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I think you also added -- let me see here, I got to get it open, bear with me. I think you added something to it as well. I might not get to this quickly. I'll have to follow-up with you. But I'm pretty sure you added something to the calculation.

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Christopher Carlson, Vertex Energy, Inc. - CFO & Secretary [67]

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We can look at it.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [68]

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Yes. No problem, Michael. We can certainly look at it with you and clarify anything.

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Operator [69]

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We do have a question coming through from Sean Marconi with Hurdle6 Capital.

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Sean Marconi;Hurdle6 Capital;Founder & CEO, [70]

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Can you guys talk a little bit more about the pilot test that you have to run basically get Phase 2 closed?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [71]

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Not anymore, Sean. Obviously, it's pretty proprietary in the technology that we're developing. What we're doing at Heartland and what we plan to do there, as far as what that means. It's just -- in general, it's a threshold pilot related to throughput yields, taking all our equipment that we got on the ground and equipment we use at Heartland. It's just -- and there's some equipment we plan to add that all has to be factored into the pilot test. We've already run a lot of our own pilot. So this is what you would call a very formal process that has certain backing to it. So I think it's just putting some certainty around the future business plan, which is wrapped around making high purity base oils.

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Sean Marconi;Hurdle6 Capital;Founder & CEO, [72]

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Yes. And going into that real quick. Currently, you're selling a Group II+ product at Heartland. Can you talk about the spread between the Group II+ versus selling a Group III product?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [73]

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No, not really because it's all market-driven. So whatever I say on the call now could change, materially, a week from now. There is a spread between Group II and Group III because there's a threshold between Group III that is required for full synthetic lubricants and other full synthetic products that you can't get to with a Group II product. But there's a lot of Group III product that's blended down in other formulations that a Group II+ can substitute. So that spread between our product in Group III can narrow quite a bit and can open up. It's just trying to pin that down would be misleading at this point.

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Sean Marconi;Hurdle6 Capital;Founder & CEO, [74]

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I can respect that. And then one last quick question. Do you have any updates on getting TCEP fired up?

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [75]

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No more updates other than our work's done, we haven't seen a spec from IMO, that's any different than the high sulfur spec, right? And we're in ready mode, and we're going to have to ease into the market, once the market opens up. So trying to forecast volumes, spreads and all those things until the vehicle is back on the highway and back running. We'll have more handle on how quick all that integrates into the new spec. So -- but we feel positive, assuming that the specs for the fuel don't change other than sulfur, then we're pretty confident we're ready to go. So capital, we've got a little bit of work that we're doing at the plant, but nothing material.

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John Noel Strickland, Vertex Energy, Inc. - COO [76]

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We're just ready to go and wait for the polling 5 specs to come out, so we can go...

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [77]

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And the market demand.

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John Noel Strickland, Vertex Energy, Inc. - COO [78]

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In the market.

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Operator [79]

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And that does conclude our question-and-answer session today. Mr. Cowart, I'll turn the call back over to you for any closing comments.

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Benjamin P. Cowart, Vertex Energy, Inc. - Founder, Chairman, CEO & President [80]

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Okay. Thank you, Tom, and please turn to Slide 20. In conclusion, Vertex is well positioned to benefit as we look ahead for the remainder of 2019 into 2020. The impact of IMO 2020 is already evident into future markets, serving to reduce UMO feed costs while increasing demand for IMO-compliant middle distillates, entering the fourth quarter of this year. Looking at the end of this year, Phase 2 closing of the Tensile transaction represents a major transformational event for us with the potential to add significant liquidity to our business while also allowing us to pursue high -- highly accretive development projects at our Myrtle Grove and Heartland facilities. Over the next several weeks, our management team will be attending the D.A. Davidson, diversified industrials conference in Chicago, together with Craig-Hallum-sponsored marketing events. In the interim, should you have any questions, please contact Noel Ryan at Vallum Advisors at (720) 778-2415 or at ir@vertexenergy.com.

Thank you, everyone, for joining us on the call. This will conclude our call for today.

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Operator [81]

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Thank you, ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.