Earnings Call Transcript - REX Q3 2022

Operator, Operator

Greetings and welcome to the REX American Resources Fiscal 2022 Third Quarter Conference Call. During the presentation, all participants will be in a listen-only mode. Afterward, we will conduct a question-and-answer session. I would now like to turn the conference over to Mr. Doug Bruggeman, Chief Financial Officer. Please go ahead.

Douglas Bruggeman, CFO

Good morning and thank you for joining REX American Resources fiscal 2022 third quarter conference call. We'll get to our presentation and comments momentarily as well as your question-and-answer session. But first, I'll review the Safe Harbor disclosure. In addition to historical facts or statements of current conditions, today's conference call contains forward-looking statements that involve risks and uncertainties within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements reflect the company's current expectations and beliefs but are not guarantees of future performance. As such actual results may vary materially from expectations. The risks and uncertainties associated with the forward-looking statements are described in today's news announcement and the company's filings with the Securities and Exchange Commission including the company's reports on Form 10-K and 10-Q. REX American Resources assumes no obligation to publicly update or revise any forward-looking statements. I have joining me on the call today, Stuart Rose, Executive Chairman of the Board, and Zafar Rizvi, Chief Executive Officer. I'll review our financial performance and then turn the call over to Stuart for his comments. Sales for the third quarter increased by 8.5% as we experienced higher pricing for ethanol, distiller grains, and corn oil. Ethanol sales for the quarter were based upon 66.3 million gallons this year versus 69 million gallons last year. We reported a gross profit of $11.3 million this year versus a gross profit of $25.2 million in the prior year. For the current year quarter, improved selling prices were offset by higher corn and natural gas pricing. Ethanol pricing improved by 8%, dried distiller grain and corn oil pricing both improved by 25% for this year's quarter over the prior year third quarter. Corn cost increased by 17% and natural gas pricing increased by 56% for this year's quarter, compared to the prior year as inflationary pressures and the impact on commodity pricing from the Ukraine-Russia conflict continued. Corn pricing was also impacted by higher corn basis based upon reduced availability of corn as we approach the harvest season. Gross profit comparison between years benefited slightly from fewer ethanol contracts sold net of freight in the current year, which leads to higher sales. SG&A increased for the third quarter to $7.9 million from $6.3 million in the prior year. The increase is primarily due to an increase in the number of ethanol contracts that require the freight to be paid by us compared to the prior year, which we classify as SG&A cost. We had income of $661,000 from our unconsolidated equity investment in this year's third quarter versus an income of $349,000 in the prior year. The company's interest and other income in the current year increased dramatically to $2 million versus $35,000 the previous year, primarily reflecting increased yields in our cash. The discontinued operations reflected in the prior year's numbers are from the refined coal business as we ended those operations on November 18 of 2021, and there was no impact in the current year. We reported a tax provision from continuing operations of $1.2 million for this year versus the provision of $4.3 million in the prior year, primarily reflecting the lower level of income in the current year. These factors led to net income attributable to REX shareholders from continuing operations of $3.2 million for this year's third quarter versus $13.3 million in the prior year. Total net income per share from continuing and discontinued operations attributable to REX shareholders was $0.18 for this year's third quarter versus $0.85 in the prior year. I would again like to point out all outstanding shares for all periods have been retroactively adjusted to reflect the three-for-one stock split, which was effective on August 5, 2022. Stuart, I'll now turn the call over to you.

Stuart Rose, Executive Chairman

Thank you, Doug. Going forward, in the current quarter, we remain profitable, but crush spreads are still challenging, which our CEO Zafar Rizvi will discuss in his segment. We've made significant progress in carbon capture, which again will be discussed by Zafar Rizvi in his segment. In terms of our cash, we have approximately $290 million in cash, very little or no debt. We continue to look for investments in ethanol companies although nothing is imminent. We're also making major investments in carbon capture, which will be discussed later in the call. We also now can earn meaningful interest on our cash and with $290 million we expect our interest income to go up during the current quarter and during the following quarters. We buy back stock on dips. We bought back approximately 250,000 shares in the quarter. We have Board authorization for another 875,000 shares. Zafar Rizvi will now discuss our ethanol and carbon capture operations. Thanks.

Zafar Rizvi, CEO

Thanks, Stuart. Good morning, everyone. As I mentioned in our previous quarterly calls, challenging logistic problems caused by issues with the railroad and availability of corn were slowing down our production. The availability of corn in South Dakota due to a drought last year and again this year resulted in a decrease in corn yield, which led to an increase in the price of corn greater than the ethanol price. On top of that, the high price of natural gas is also negatively affecting the profit margin in the ethanol industry, as Doug mentioned earlier. The USDA November corn report shows the corn yield dropped 26% in Nebraska and 10% in South Dakota. Nebraska saw about 2.9 million bushels dropped and in South Dakota, 78 million bushels were dropped compared to last year. In South Dakota, where our Nugen plant is located, it increased 13% in Illinois, where our One Earth Energy plant is located. Sorry for that. The USDA also reported corn production increases in Illinois, North Dakota, and Minneapolis and production drops in all other corn-producing states. The worst affected states are nearly all western states: Nebraska, Kansas, South Dakota, and Texas. The November USDA reports show an expected output of 13.91 billion bushels for the 2022-2023 crop year compared to approximately 15 billion bushels in the '21-'22 crop year, a decrease of 8%. On the bright side, ethanol and distiller dried grain exports have increased compared to last year through September 2022 and the non-food corn oil price continues to increase and is expected to increase even more. Ethanol exports in 2022 totaled 1.12 billion gallons, compared to 873 million gallons for the same period last year, a 27% increase. Despite all these issues and difficulties, as long as we continue to source corn at a reasonable price and railroad efficiency and logistics improve at this very early stage, as Stuart mentioned, we expect that the fourth quarter could be profitable. Let me now share the progress of our carbon sequestration project. These are the bullet points. The first test well at One Earth Energy was successfully drilled to a total depth of around 7,100 feet. The 3Ds seismic testing and water movement tests are completed and we are very pleased with the results. Several other tests and modeling work were performed to verify the maximum injection pressure, reservoir quality, rock core analysis, expected movement of the CO2 bloom. The test results show the location is a very good target for carbon sequestration. The design of the compression facility is complete. The contract to build the compression part of the facility has been signed and long lead time equipment has been ordered. The pipeline to injection well operator identification number have been received. The work on the pipeline FEED study is expected to be finished by January 2023. The Class 6 permit for three injection wells with a capacity to store 90 million tonnes of carbon has been completed and submitted. We continue to complete several other documents required by different government agencies, but most documents that require lead time are completed or expected to be completed very soon. Once again, this is a highly technical and time-consuming project. It requires considerable time to make progress, but we are pleased that we started four years ago and have now achieved some big milestones. As I also mentioned in our previous call, we are also evaluating several other projects that would increase production efficiency and energy savings as well as reduce water consumption at our plants. We believe the completion of some of these projects will lead to a greater benefit under the Inflation Reduction Act passed by Congress. The Section 45Q cash payment for carbon sequestration increased to $85 per metric ton from $50 per metric ton. The clean fuel production 45G, which has led to a reduced carbon intensity score, would provide a much better return than 45Q. In summary, we are very pleased to announce once again a profitable quarter in a very, very difficult environment as well as very good progress with our carbon sequestration projects. Hitting these carbon sequestration milestones and achieving a ninth consecutive quarter of positive income cannot be accomplished without the hard work and dedication of our colleagues. We are very appreciative of their efforts in achieving these positive results. I will give back the floor to Stuart Rose for additional comments.

Stuart Rose, Executive Chairman

Thank you, Zafar. In conclusion, the ethanol business remains steady and our carbon capture business has been helped significantly by government legislation along with great progress by Zafar Rizvi and his team. We continue to consider we have the best plants among the best plants in the industry; our locations are good, especially the one that is right in the middle of what we consider the best carbon capture area of the country. But more importantly, we truly believe it's the collaboration we have among the best employees in the industry. Most companies in the industry were not profitable; we had a profitable quarter and we continue to consider our employees to be among the best. We believe that the real reason why we're doing better than most is the dedication of our employees, and I think that separates us in ethanol, and I hope that it will continue and will separate us in carbon capture. I'll now leave the podium open to questions.

Operator, Operator

Thank you. Our first question comes from Jordan Levy with Truist Securities. Please proceed.

Jordan Levy, Analyst

Good morning, all, and really nice execution again this quarter. Maybe I'll start out with your clear progress on the CCS side. If I think about that project moving forward along with the clean fuel credit and the IRA that starts I think in 2025, could you just help us think about how those two items might play together as we get into some of the out years, assuming CCS progresses and what that means for the business?

Stuart Rose, Executive Chairman

Zafar?

Zafar Rizvi, CEO

Yes. Jordan, the 45Z and 45Q. 45Q is a direct payment up to $85 per ton and 45Z is a tax credit, which you receive if you reduce the carbon intensity, which is currently at most ethanol plants at approximately 70 CI score. If you reduce it below 50, you get a per-gallon basis tax credit on each gallon you produce. When you do carbon sequestration, you can reduce approximately 30 points from the CI score. Additionally, land use reductions can help reduce it further. For instance, if you start at around 70 and reduce by almost 48 points total, you could potentially achieve a zero CI score, but that requires significant changes in processes. If we are able to achieve that reduction, it would translate to nearly a dollar per gallon of our ethanol production. So, if we are producing 150 million gallons, achieving that score could represent as much as $150 million in benefits; however, we are not tax experts, but that's our understanding at this time.

Jordan Levy, Analyst

And I'm certainly no tax expert either, but that's a great explanation. Maybe just to clarify, did you mention that you're working on something to get that 18-point reduction on the land use side?

Zafar Rizvi, CEO

When we accomplish the carbon sequestration, if we store the carbon underground, we receive approximately 30 points for that effort, while the land use factor is also accounted for in the CI score calculation. This adds up to yield significant reductions.

Jordan Levy, Analyst

So you're effectively looking at nearly a 50-point reduction just due to the carbon capture.

Douglas Bruggeman, CFO

None of these numbers that Zafar mentioned include the potential higher selling price of zero carbon or low carbon ethanol, which is an important factor as well.

Zafar Rizvi, CEO

Exactly. Generally speaking, ethanol plants have a CI score of around 70 to 72. When we incorporate the carbon sequestration benefits and land use reductions, we can see a significant improvement in our score that would be helpful.

Jordan Levy, Analyst

Got it. That's helpful. Next, there have been some headlines regarding Rovio's potential developments coming out in the next day or so. Just curious about your thoughts if we assume mandates for ethanol roughly held flat over the next three years.

Zafar Rizvi, CEO

I think we are hearing it's approximately still going to be at 15 billion for ethanol, which they may increase to overall 21 billion, but we understand that it's probably going to stay at 15 billion for the ethanol, but we're not sure until it's released.

Stuart Rose, Executive Chairman

One thing that would be important is that so far the Biden administration has held firm on no waivers. They have the ability to grant waivers, but under the current administration, it's been good with very few if any waivers. If there are no waivers, it can actually indicate a decent increase in demand.

Zafar Rizvi, CEO

Yes. And hopefully, this trend in exports continues, as previously noted, we are ahead compared to last year, and if exports increase, it will also be beneficial for us.

Jordan Levy, Analyst

Got it. That's helpful. Lastly, if we could revisit the topic of CCS. Zafar, could you go over your previous remarks again? Can you clarify the next steps as we move into early next year? I know you mentioned that most long-term items are progressing well.

Zafar Rizvi, CEO

Yes, Jordan. We have a lot of work to do, because we still have to obtain several permits from various government agencies. While permits typically take less time than the Class 6 permit— which can take from six months to 18 months— we are currently processing many other required permits. We cannot start digging the injection well until we receive the EPA permit. We are preparing the bid to move forward, and once we receive the permit, we should be ready to start the injection well. A lot of work will be happening next year. Our goal is to complete this project by the end of 2024, but we may need more time; we are trying to achieve that.

Jordan Levy, Analyst

And since you filed for three permits, I would assume that you're considering some third-party volumes as well.

Zafar Rizvi, CEO

At this stage, that's likely because we do not have enough capacity for our ethanol facility, but we know there will be a lot of future demand for the wells. We want to ensure we have the permits ready for when they are needed.

Jordan Levy, Analyst

Got it. Thanks, guys.

Stuart Rose, Executive Chairman

Thank you, Jordan.

Operator, Operator

Our next question comes from Chris Sakai with Singular Research. Please proceed.

Christopher Sakai, Analyst

Yes. Hi, good morning.

Stuart Rose, Executive Chairman

Good morning.

Christopher Sakai, Analyst

Can you talk more about our REX experiencing any logistical challenges with rail?

Stuart Rose, Executive Chairman

I think the main concern we have is that there is a strike and you can hear it from the news; during 2019-2021, the railroad laid off a lot of personnel due to changes in demand. Currently, we see some issues where railcars are at our plants, but there is no driver available to pull them; they are supposed to be moved by Monday but are delayed until Saturday or Sunday. This inconsistency causes production and shipment delays, and we have limited storage at our facility. Although we've increased our storage compared to other ethanol facilities, there is a point at which tanks can fill up, forcing us to back down production until railcars can be dispatched.

Christopher Sakai, Analyst

Okay, thanks. As you head into winter, can you comment on how an increase in the price of natural gas will affect profitability?

Zafar Rizvi, CEO

I think it does significantly affect us. We try to ensure we have enough natural gas to support our operations ahead of the winter. Currently, natural gas prices are trading around $6.93 per unit; this was $6.35 last month and $5.42 last year, showing a significant jump. This uptick is notable and has a major impact on profits, with a 56% increase in costs taking a substantial portion away from our margins, as Doug mentioned earlier.

Christopher Sakai, Analyst

Okay. Thanks for the answers.

Stuart Rose, Executive Chairman

Thank you.

Operator, Operator

Our next question comes from Pavel Molchanov with Raymond James. Please proceed.

Pavel Molchanov, Analyst

Thanks for taking the question and you provided some useful perspective on natural gas. Let me zoom in on corn. When we look at the futures curve, it basically points to $5, $6 a bushel practically forever, and we went through a decade pre-COVID with $3, $4 corn. Is $6 corn going to be the new normal on a permanent basis in your view?

Zafar Rizvi, CEO

At this stage, it seems likely that the areas experiencing drought are affecting supply. The western states, particularly Nebraska, Kansas, South Dakota, and Texas, show a need for increased prices. The shipping costs significantly increase overall real costs, especially when transport needs arise from one area to another. We see some areas facing extremely high basis levels, sometimes up to $1.20. This means it will be challenging for ethanol facilities to operate efficiently under these cost structures.

Pavel Molchanov, Analyst

Okay, let me turn to our regulatory topic. It seems like it's been a long time coming, but we’ve heard of E15 potentially being allowed for year-round use. There is a new bill from Senator Fisher in Nebraska to authorize that without going through the EPA waivers. Do you think that bill has a good chance of passing?

Zafar Rizvi, CEO

I believe this time, it looks to be a good chance for passage because all the players seem to agree that E15 is a beneficial option. If we can ensure that E15 can be sold year-round, it would help create a stronger demand for ethanol and increase its market presence.

Pavel Molchanov, Analyst

Okay. Lastly, you mentioned exports and those can vary from quarter to quarter, but what's your general impression on the export window to China and where do things stand?

Zafar Rizvi, CEO

We haven't seen much in terms of exports to China this year. Most of it has been directed to Canada, South Korea, the Netherlands, India, and the UK. India is starting to rapidly fulfill its own domestic demand but has not yet become a significant player like it has in the past. We expect Canada and South Korea will continue to leverage their needs from us.

Pavel Molchanov, Analyst

Right, okay, consistent with what we're seeing. Thank you, guys.

Stuart Rose, Executive Chairman

Thank you, Pavel.

Operator, Operator

There are no further questions at this time. Please continue with your presentation or closing remarks.

Stuart Rose, Executive Chairman

Okay. I'd like to thank everyone for listening and we'll look forward to talking to you at the end of next quarter. Thank you very much.

Operator, Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.