Earnings Call Transcript - REX Q2 2022

Operator, Operator

Greetings, and welcome to the REX American Resources Fiscal 2022 Second Quarter Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded Tuesday August 30, 2022. I would now like to turn the conference over to Doug Bruggeman, Chief Financial Officer. Please go ahead.

Douglas Bruggeman, CFO

Good morning, and thank you for joining REX American Resources fiscal 2022 second 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 in 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 first review our financial performance and then turn the call over to Stuart for his comments. Sales for the second quarter increased by 23% as we experienced higher pricing for ethanol, distiller grains, and corn oil. Ethanol sales for the quarter were based upon 71.4 million gallons this year versus 69 million last year. We reported a gross profit of $16.6 million this year versus a gross profit of $14.2 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 20%, dried distiller grains improved by 21%, and corn oil pricing improved by 53% for this year's quarter over the prior year's second quarter. Corn cost increased by 21% and natural gas pricing increased by 113% 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. Gross profit comparison between years also benefited slightly from fewer ethanol contracts, sold net of freight in the current year, which leads to higher sales. SG&A increased for the second quarter to $9.1 million from $6.2 million in the prior year, $1.1 million of the increase is due to the increase in the number of ethanol contracts that require the freight to be paid by us compared to the prior year and approximately 900,000 from increased incentive compensation. We had income of $3.6 million from our unconsolidated equity investment in this year's second quarter versus income of $1.8 million in the prior year. The majority of the increase was a result of funds they received from the COVID-19 relief grants from the USDA. The company's interest and other income in the current year includes approximately $7.8 million of income from COVID-19 relief grants. The consolidated plans also received from the USDA in May. The discontinued operations reflected in the prior year numbers are from the refined coal business, as we ended those operations on November 18, 2021. There was no impact in the current year. We reported a tax provision from continuing operations of $4.3 million for this year versus the provision of $1.8 million in the prior year, primarily reflecting the higher level of income in the current year. These factors led to net income attributable to REX shareholders from continuing operations of $11.2 million for this year's second quarter versus $5.7 million in the prior year. Total net income per share from continuing and discontinued operations attributable to REX shareholders was $0.63 for this year's second quarter versus $0.44 in the prior year. I would like to point out all outstanding shares for all periods have been retroactively adjusted to reflect the recent 3-for-1 common stock split. Stuart, I'll turn the call over to you.

Stuart Rose, Executive Chairman

Thank you, Doug. As we move into the current quarter, we remain profitable so far. There are challenges in the ethanol sector, which Zafar Rizvi will elaborate on. Our carbon capture project is making progress, especially with the positive developments from the Inflation Reduction Act, and Zafar will cover that, too. Regarding our finances, we have over $245 million in cash, and our cash flow has been significantly bolstered by the carryforward of previously earned tax credits. We are utilizing this cash for buybacks, purchasing shares on price dips. Last quarter, we bought back 221,883 shares on a split-adjusted basis. We are also exploring profitable opportunities in alternative energy, and we're currently assessing the Inflation Reduction Act for any new prospects for our company. We continually seek ethanol plants but have not yet identified any suitable options. Our current ability to invest has improved, allowing us to achieve returns between 2% and 4%, compared to almost zero the previous year. This should enhance our cash position and positively impact our income in the upcoming quarters. I will now hand the call over to Zafar to discuss ethanol and carbon capture. Thank you.

Zafar Rizvi, CEO

Good morning. Thank you, Stuart. As I mentioned in our previous quarterly call, the operating environment at the beginning of the second quarter of 2022 showed some improvement. However, since then, it has been challenging for a number of reasons, including serious logistic problems caused by railroads that resulted in delays of shipments. With an increase in inventory, we had no choice but to slow down the plant's production. We are also seeing 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 profit margins and production. The USDA estimates a 0.9% decrease in yield and 5% less production of corn this year compared to 2021-2022 crop year, and approximately 20% of the corn production is within an area experiencing drought. The USDA corn report this week showed 39% of Nebraska, 51% of South Dakota, and 69% of Illinois corn along with 54% of total corn production rated good to excellent this year. However, even in Illinois, we expect to yield less corn this year compared to last year. On the bright side, ethanol sales and dried distillers grains exports have increased compared to last year through June 2022. Additionally, the non-food corn oil price continues to increase and is expected to increase more. Despite the challenges, at this very early stage of the third quarter, as Stuart mentioned, we expect the quarter to probably be profitable. As I mentioned in our previous call, we are also evaluating several other projects that would increase production, efficiency, and energy saving, as well as reduce water consumption. Some of the small projects we were able to complete, and some are expected to complete in the third quarter. We are still in the process of analyzing capital-intensive projects before they can be undertaken and implemented. All of these projects are in a very early stage and may not materialize. Let me share the progress of our carbon sequestration project. As I mentioned in the previous call, we are working with the University of Illinois on drilling a carbon sequestration well. The first test well at One Earth Energy was successfully drilled to a total depth of around 7,100 feet, with almost 2,000 feet of Mount Simon sandstone encountered. The geological models predict that the movement of CO2 injection into the subsurface is complete. The rare core analysis and well logs indicate very good reservoir quality, and well tests are being performed to further support this data. The well tests include performing a water injection test in the well itself to evaluate the expected movement of CO2 as well as the expected plume area and storage capacity in the subsurface area. The water injection will also provide more information about the reservoir, and we are testing an additional backup storage zone, in case it is needed for more capacity. This can take a week or sometimes longer. The 3D seismic process is expected to be completed by the end of August, and the design of the compressor facility and the bidding process are complete. We are in the process of removing contracts. The Class 6 permit documents are in the near-final draft stage and are expected to be completed very soon. The EPA requires extensive support documents and complete analysis before granting a Class 6 permit. Our goal is to provide all documents and information with the application. We will continue to evaluate further as we make progress and decide on the injection well location. Once again, this is a highly technical and time-consuming project, and it will take time to make material progress. We cannot yet predict as a result of the simulation models whether we will be successful or not. In summary, we are pleased to announce once again a profitable quarter in a very challenging environment, as well as successfully progressing with our carbon sequestration project. We are very appreciative and thankful for the hard work of our colleagues in achieving these results. I will hand over to Stuart for further comments. Thanks, Stuart.

Stuart Rose, Executive Chairman

Thank you, Zafar. In conclusion, we were helped this quarter by both direct funds from the government and the Inflation Reduction Act, which should help us with our carbon capture project, assuming we can get permitted and built. But most importantly, we performed among the best plants in the country, and again, it’s because we have good locations, good plants, and generally good corn areas. But the greatest asset we have, and it's going to help us with everything we have going forward, is we feel that we have the best people in the industry, and we think that's a real reason why we outperform the industry significantly better than the industry over the life of the plants. I'll now leave the forum open to questions.

Operator, Operator

Thank you. Our first question is from Jordan Levy with Truist Securities. Please go ahead.

Jordan Levy, Analyst

Hi, Stuart. Congratulations on a good quarter and also on what seems like pricing progress on the capture side of things. Maybe we could just start off there. Stuart, you mentioned the Inflation Reduction Act and some positive read-throughs there. Maybe can you just talk to the increase in Section 45Q as it relates to your carbon capture project? It's been, I think, a little while since we last walked through the potential economics at One Earth with the CO2 emissions there. So maybe if we could just walk through the potential benefits?

Stuart Rose, Executive Chairman

The new bill now offers about $85 per ton in credits for carbon captured and stored, up from the previously expected $50 per ton in 2025. I'll have Zafar discuss the economics. Once the hole is completed, our goal is not just to capture our own carbon; we are designing the hole to accommodate more than just our needs. While we currently do not have any contracts with others, our design aims to allow for capturing more carbon than we produce. We believe that creating the hole is crucial, and we anticipate that finding partners willing to purchase carbon will be easier than the construction process itself, which has been our primary focus. Zafar, would you like to discuss the economics?

Zafar Rizvi, CEO

I can speak briefly, as you know, Jordan. We haven't finalized the numbers yet because we are evaluating the total cost of the compressor machine, the compressor facility, and other factors related to the well. However, we believe we will be profitable at this stage with the $85 credit, building on the previous forecast that anticipated profit at the $50 credit level. One advantage we have now is that we can accommodate transportation by rail or truck to our facility, and as Stuart mentioned, we will have more capacity for the well than we require for our own ethanol facilities. This allows us to bring materials from other locations instead of waiting for the lengthy and costly pipeline process, which could range from $3 billion to $4 billion. This will help us enhance our capacity for sequestration. Ultimately, we believe the $85 credit, especially since it can be available in cash for the first five years, is significantly more beneficial than the $50 tax credit.

Jordan Levy, Analyst

Thanks for that. And maybe just along that line of questioning, so it seems like everything you're doing right now is to get all documentation in order to submit to the EPA for the permit. I guess maybe do you have a sense of what that timing is looking like at the EPA level or what we should expect over the next few quarters in terms of updates on that project?

Stuart Rose, Executive Chairman

I think as we have pre-built some of this discussion with them, the EPA takes somewhere between a year to 18 months. But we have been working with people who have previously submitted these kinds of permits. That's the reason we're taking every practical step possible to document every single detail, including any financial guarantees required. That way, the EPA does not delay for asking for more applications or papers or other further documents. As you know, once you submit this application and if it's not complete, then the EPA can contact you after three or four months and say, I need this document. So you submit that document, and then they will start reviewing that document. It takes longer for them to reach a conclusion. Our goal is to submit it with all documents as we have seen previously, they ask for before we submit the application. So we are in the final process, and we hope that we will submit it by the end of September or, at the latest, the middle of September.

Jordan Levy, Analyst

Got you. That's all. That makes sense. Moving over to the ethanol side, maybe for Zafar, you talked about an increase in the number of contracts where you all were responsible for covering freight and you also discussed the ongoing logistical challenges with rail delays. Maybe if we could just dive in a little deeper on the logistical challenges that are going on and anything that can be done to mitigate any of that?

Zafar Rizvi, CEO

I think I'm going to speak generally, not specifically at each location. But I think what we're finding is that the railroad industry really is not functioning properly. They certainly, we have seen in some cases where a train is ready to pick up, and they're supposed to arrive on Friday, but they may not show up until the next Friday, or even the following Sunday. So they are delaying pick-ups by seven, eight, nine days. I think basically what they are continuously telling us is that they have a shortage of crews and workers and they cannot find drivers, which is causing further delays. And I think one thing which I keep stressing to other people is that as long as the railroad has a semi-monopoly, that nobody can use their tracks unless they pay a huge switching fee, as President Biden previously mentioned, is causing transport delays. Unless the federal government closely looks at eliminating that limited switching fee and allows every freight company and railroad company to switch each other, they will face delays and transportation problems. Unless this situation improves, we are entirely dependent on rail, and if they don't have drivers, we're stuck with no choice to call someone else to come and pick up our freight and load the cars, which is indeed a major problem.

Jordan Levy, Analyst

Got it. No, I really appreciate the color. I'll leave it at that.

Stuart Rose, Executive Chairman

Thank you, Jordan.

Operator, Operator

Our next question comes from the line of Pavel Molchanov with Raymond James. Please go ahead.

Pavel Molchanov, Analyst

Thanks for taking the question. So first, you talked about being interested in acquiring some ethanol plants. Given all the changes in the ethanol market in the last two and a half years, with prices as well as feedstock going from record lows to record highs and everything in between, what does the valuation landscape look like for existing plants?

Stuart Rose, Executive Chairman

Building a new plant would cost over $225 million. Currently, there are no quality plants available for sale, only subpar ones. Years ago, we sold a 100 million gallon plant, in which we had a 25% stake, for about $200 million. Most ethanol plants are unique since the government currently supports them, and they can readily capture pure CO2 emissions. With the new $85 incentive, those with carbon capture could see substantial returns. Additionally, ethanol plants can now sell their CO2, which adds to the revenue potential. The industry is optimistic, but I don’t believe any high-quality plants would sell for less than their replacement cost or the cost of establishing a new one. In recent years, some plants were available, but we have been actively looking to purchase and have not found any that meet our criteria. As of now, there are no good opportunities on the market.

Pavel Molchanov, Analyst

Right. Okay. So in that context, given that you ventured into carbon capture, I'm curious if you have any interest in getting into renewable natural gas production, landfill, or dairy gas?

Stuart Rose, Executive Chairman

No, not at this time. Nothing is impossible, but we have looked at it. It’s a different business, especially today due to the new regulations. It's just something among many, many things we're studying related to the new act. But at this point in time, we have no imminent plans and nothing to pursue other than studying that industry for now.

Pavel Molchanov, Analyst

And along those lines, with carbon credit pricing in Europe close to EUR100 a ton now, which is significantly higher than the subsidies given domestically through Section 45Q. With that in mind, would you consider looking at carbon capture projects somewhere in the European Union?

Stuart Rose, Executive Chairman

Sure. We'd look at anything. Carbon capture is going to be a big part of our business.

Pavel Molchanov, Analyst

Understood. Thank you, guys.

Stuart Rose, Executive Chairman

Thanks.

Operator, Operator

Our next question is from the line of Chris Sakai with Singular Research. Please go ahead.

Chris Sakai, Analyst

Hi, good morning.

Stuart Rose, Executive Chairman

Hi, Chris.

Chris Sakai, Analyst

Can you talk more about the Inflation Reduction Act and when you are going to see benefits from that? Can you quantify how much benefit you'll see?

Zafar Rizvi, CEO

I think, as I mentioned earlier, we are currently focusing on carbon sequestration. There are numerous other potential benefits; some are exploring solar projects or other energy-saving initiatives that can yield significant tax credits and more. Specifically regarding carbon sequestration, with the new $50 tax credit, we initially projected profitability. Now, with the increase to $85, this will certainly aid in enhancing our profitability. As Stuart noted earlier, our well has the capacity to absorb more carbon than we can manage from our ethanol facility alone. Therefore, the $85 enables us to transport additional carbon by rail or truck from nearby locations while still maintaining profitability with those projects. Consequently, there is a positive impact from the tax reduction credit legislation.

Chris Sakai, Analyst

All right. Thanks. And then can you talk about are you seeing any more gas stations offering E15? How that's going?

Zafar Rizvi, CEO

Let me say that, I was in a meeting with the agriculture secretary last Monday, and he announced there was $100 million for E15 infrastructure bills and other initiatives. So certainly, we have seen some of those in grower states like Iowa, Nebraska, and even some parts of Illinois and Indiana. We have seen more and more retailers offering E15. Additionally, there are also incentives being offered such as tax credits to encourage more E15 pumps, and it’s certainly helping us lift sales this year as it continues. Assuming E15 remains available all year round, that would really grow the market. If it can only be offered seasonally, it will be more challenging. However, with this new $100 million announcement from the agriculture secretary, it should certainly help us as well.

Chris Sakai, Analyst

Okay. Thanks.

Stuart Rose, Executive Chairman

Thank you.

Operator, Operator

And there are no further questions on the phone lines at this time. I'll turn the presentation back to the speakers.

Stuart Rose, Executive Chairman

Okay. Thank you. We'd like to thank everyone for listening, and we will talk to you again at the end of this quarter. Thank you very much. Bye.

Operator, Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.