Rentech Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: Rentech, Inc (RTK)
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Rentech (NYSEMKT:RTK) Q2 2012 Earnings Call August 10, 2012 3:00 PM ET


Julie Dawoodjee - Vice President of Investor Relations & Communications

D. Hunt Ramsbottom - Chief Executive Officer, President and Executive Director

Dan J. Cohrs - Chief Financial Officer, Executive Vice President, Treasurer and Principal Financial Officer for Rentech Nitrogen Partners LP


Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Brent R. Rystrom - Feltl and Company, Inc., Research Division

Matthew Farwell - Imperial Capital, LLC, Research Division


Ladies and gentlemen, thank you for standing by, and welcome to the Rentech Second Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded, Friday, August 10, 2012.

I would now like to turn the conference over to Ms. Julie Dawoodjee, Vice President of Investor Relations and Communications. Please go ahead.

Julie Dawoodjee

Thank you. Welcome to Rentech's conference call for the second quarter ended June 30, 2012. During this call, Hunt Ramsbottom, President and CEO of Rentech, will summarize our company's activities during the quarter. Dan Cohrs, our Chief Financial Officer, will give a financial review of the period and provide comments on Rentech's financial position. We will then open the lines for questions. [Operator Instructions]

Please be advised that certain information discussed on this conference call will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. They can be identified by the use of terminology such as may, will, expect, believe and other comparable terms. You are cautioned that while forward-looking statements reflect our good faith belief and best judgment based upon current information, they are not guarantees of future performance and are subject to known and unknown risks and uncertainties and risk factors detailed from time to time in the company's periodic reports and registration statements filed with the Securities and Exchange Commission. The forward-looking statements in this call are made as of August 10, 2012, and Rentech does not undertake to revise or update these forward-looking statements, except to the extent that it is required to do so under applicable law.

In addition, today's presentation includes various non-GAAP financial measures. The disclosures related to such non-GAAP measures, including reconciliations to the most directly comparable GAAP financial measures, are included in our 2012 second quarter earnings press release that is available on our website.

Now I would like to turn the call over to Hunt Ramsbottom, President and CEO of Rentech.

D. Hunt Ramsbottom

Good morning, everyone, and thank you for joining us today.

We report a solid second quarter results and increased guidance for the year for our nitrogen segment. We generated consolidated net income of $0.04 per share, driven by strong fertilizer product prices, lower prices for natural gas and reduced R&D expenses in the alternative energy segment.

Rentech Nitrogen generated strong cash flow resulting in second quarter cash distributions of $1.17 per unit. Average prices for delivered products were up significantly from last year. Ammonia at $695 per ton was 9% higher and UAN at $378 per ton was 21% higher than last year. Higher product prices and relatively low natural gas prices by historical standards contribute to gross margins of 65%, up significantly from 50% in the same quarter last year.

The weather this spring, which was warmer than usual, enabled farmers to apply ammonium, about 15 days earlier than they usually do. This shifted significant ammonia deliveries and revenues from the second quarter into the first quarter. The high ammonia usage reduced the demand for UAN this spring. In addition, the hot, dry weather resulted in poor soil and crop conditions, which led to reduced UAN application.

As the drought continued and damaged the corn crop, it became evident that yields and therefore ending inventories would be significantly lower than the earlier projections for the year. This prompted buyers to end of the market in late June for UAN purchases for the third and fourth quarter deliveries in preparation for the spring 2013 season. The drought has now affected most of the nation's corn crop with only 23% of the corn crop in good to excellent condition. This number could continue downward as the dry weather persists. Any rains from this point forward will offer little benefit to this year's corn crop.

This morning, the USDA significantly reduced its yield estimates for corn to 123.4 bushels per acre in its August WASDE report, reflecting lower yields, lower harvested acreage and lower ending stocks. As the last 3 drought years of 1983, '88 and 1991, it took 2 full years of corn crops to return to normalized inventory levels. Based on these historical precedents, many believe it will take multiple years to bring ending cornstalks back above the 1 billion bushel mark. So corn prices should be strong, while stocks are below-normal levels. Corn prices have soared over recent weeks, with 2012 corn above $8 per bushel, up 45% from mid-May when the USDA first published its corn crop estimates for the year. As we look forward, 2013 corn prices are strong, hovering in the mid-$6 range.

Nitrogen usage and prices have historically increased following a drought due to the expectation of higher plantings to replenish stocks in a response to higher corn prices. These pricing patterns held true as ammonia and UAN prices marked steadily higher as the drought progressively impacted the corn crop over the last few months. We've seen prepaid sales for fall deliveries of ammonia rise from $600 per ton in early May to posted prices of $770 per ton today, while UAN prices increased from $290 per ton in late June to posted prices of $370 per ton today.

We expect the drought to continue to have favorable impact on nitrogen prices and the demand for the remainder of 2012 and '13. As a result, today we are increasing our guidance for Rentech Nitrogen for the calendar year 2012. Our new forecast calls for cash available for distribution in excess of $126 million or $3.30 per unit, up from $2.86 per unit in our previous guidance. Our new guidance is for EBITDA to exceed $130 million, up from our previous guidance of $120 million.

As of June 30, we've locked in or delivered 78% of the ammonia deliveries forecasted for 2012 at an average price of $659 and 99% of the UAN deliveries forecasted for '12 at an average price of $326. As of July 31, we've purchased or contracted at fixed prices for 84% of the natural gas required to produce the product already delivered or forecasted to be delivered during 2012 at an average cost of $3.71 per MMBtu, including transport costs. This compares to a full year 2011 average gas cost of $4.78 per MMBtu.

Although the drought will reduce farmers’ production, the Federal Reserve Bank of Kansas City has stated with higher corn prices and crop insurance, farmers’ income could approach 2011 levels, which was a record year. As a result, we expect farmers will have the cash flow necessary to support nitrogen purchases in 2012 and 2013. The ongoing drought conditions have resulted in a severe drought in water levels on the Mississippi River System. This is restricting barge traffic, which can affect some of our competitors' deliveries to the Corn Belt. Rentech Nitrogen does not rely on barges to ship our products because our customers are within a 200-mile radius of our facility typically pick up our products at our plant by truck. This is a very good example of the advantages offered by our location in the center of the Corn Belt, which has historically and continues to translate into premium pricing for the product.

We expect 2013 to benefit from the market dynamics similar to this year's. The impact of the drought on ending corn stocks will likely result in continued high prices and significant acreage planted next year. Low inventory should drive corn pricing throughout the year and support strong fertilizer demand. We've begun selling ammonia for the spring 2013 delivery at prices that exceed the average ammonia price achieved during the spring of this year of $730 per ton.

We announced last week that we've completed the DEF portion of our urea/DEF expansion project ahead of schedule. The completed work included the installation of mixing, storage and load-out equipment for DEF production. The second phase of the project, to increase urea production by 13% or 17,500 tons annually for use in DEF production, is on schedule for mechanical completion by the end of this year. The total capital budget for the project remains approximately $6 million and is fully funded.

With the early completion of the DEF phase of the project, we're currently converting a portion of our existing urea stream into DEF sooner than we anticipated. We're selling DEF to Yara North America under a long-term agreement at prices which are currently at a premium to urea used for agricultural purposes. The agreement provides Yara with exclusive rights to distribute and purchase the DEF produced at our facility based on index pricing.

The ammonia production and storage expansion is progressing on schedule. All major equipment has been ordered, and we've engaged the construction firm that has started the site civil work. As of the end of June, engineering and procurement for the project were 46% complete, with construction, 26% complete. These organic growth initiatives will be accretive to cash distributions upon their completion.

We also intend to grow cash distributions through acquisitions of related fertilizer businesses. We are actively pursuing acquisition of fertilizer assets that may benefit from our partnership structure; potential acquisitions would follow then the following general guidelines; a significant portion of their income qualifies for MLP treatment; assets we know how to operate and would provide geographic diversification for us; have an EBITDA at the range of $20 million to $50 million; and would be accretive through cash distributions.

Now after separating the fertilizer and alternative energy business last year, we spent time evaluating our priorities on how to further increase shareholder value. As we evaluated alternatives, we were and continue to be mindful of the challenges in the domestic alternative energy sector. We will not invest in lower-term projects. We're looking for high returns on our invested capital. The strategy we develop and are currently executing reflects this thinking. Our strategy can be summed up as follows: invest in higher return-related businesses with operating assets, cash flow and proven technologies; and secure commercialization agreements with potential partners who have the balance sheet to deploy our technologies while continuing to reduce our R&D costs.

We are currently pursuing a 2-part plan to enhance shareholder value. Part 1 of the plan is to create a business platform with strong cash flow generation that potentially qualifies for an MLP structure, and could be taken public within 2 to 3 years. These opportunities fit within the following general guidelines: have long-term contracts for products and required inputs; use conventional technologies; generate unlevered returns in the mid-teens and higher; are financeable through bank debt; have capital requirements that are manageable with our current resources and still allow us to maintain a comfortable liquidity position; and are on a global and growing market that is undersupplied and will leverage our existing manufacturing expertise. Our commitment is contingent on detailed diligence, valuation and, of course, economics.

Part 2 of the plan is to continue to reduce our cost structure. Our cost-reduction initiatives are on track. Cash, SG&A and R&D expenses declined sequentially, as well as year-over-year. We've committed to reduce our R&D spending by at least 50% next year to less than $10 million, after we complete the DOE's requirements for our integrated biorefinery project this year.

We have produced syngas from the Rentech-ClearFuels gasifier during multiple campaigns for the IBR project. We've experienced some operational challenges, which are normal for a startup of new technologies, and they have taken longer than we expected to resolve. However, we expect to conclude the IBR project by the end of this year. These R&D costs are included in our guidance.

We've been looking at domestic alternative energy projects in which we might invest up to $40 million, if the project was fully funded and allowed us to deploy our technologies. We don't see high-return opportunities in this challenged domestic alternative energy landscape, so we are no longer pursuing opportunities requiring this level of capital commitment. However, we are willing to put much smaller amounts of capital in the potential opportunities to deploy our technologies in conjunction with partners who have large balance sheets. We are currently in negotiations with potential partners to commercialize our technologies. We cannot guarantee that we'll be able to secure successful partnerships with any of these parties we're speaking with. Regardless of the outcome of these discussions, we are committed to the 50% reduction in R&D expense next year.

We will maintain a comfortable cash position as we implement our strategy, balancing cash used for stock repurchases and higher NPV investments in a new line of business that generates cash flow. Our strategy also includes maintaining control of Rentech Nitrogen, which is implementing its own growth initiatives.

In summary, we continue to execute on this plan. We are encouraged by the progress we're making. We've been very deliberate on our execution. And we've been operating with a focus to create the most value for our shareholders.

I'll now hand the call over to Dan for additional color on the quarter. Dan?

Dan J. Cohrs

Thank you, Hunt. Good afternoon, everyone. The second quarter was very solid, with higher product prices and lower gas costs driving gross margins to 65%. Revenues were slightly down for the quarter compared to the quarter last year because product deliveries were lower. That was mainly due to timing, driven by weather. As I said, the gross profit margin hit 65% this quarter. That's a big improvement over 50% gross margin last year, and even that was a very strong margin.

SG&A increased from the prior quarter by about $3.2 million. The bulk of that increase is at Rentech Nitrogen, and those expenses are primarily because Rentech Nitrogen became a public company, along with some noncash compensation expense as we put in equity incentives for the management team. At Rentech, total SG&A increased slightly from the prior year quarter, but the cash SG&A actually declined by almost $1 million. The fact that SG&A increased was due to noncash compensation expense increasing.

Research and development expense declined to $4.1 million this quarter from $8 million in the quarter last year, and we'll continue to see that come down as we complete the IBR project as we go through this year. That led to net income for Rentech consolidated of $9.5 million or $0.04 per share.

We ended the quarter with consolidated cash of $208.7 million, about $164 million of that was held at Rentech and the balance at Rentech Nitrogen. For the 6 months, trends were very similar, although revenues for the 6 months were up as opposed to down in this recent quarter. The profitability measures followed similar trends and profitability was up year-over-year.

The quarter at Rentech Nitrogen was really driven by product deliveries. That's why revenue was down. If you look at total product deliveries, they declined from 213,000 tons last year to 160,000 tons this year. That was mostly driven by UAN declining from 129,000 tons to 92,000 tons in the quarter this year. Ammonia declined slightly from 43,000 down to 40,000. And during the quarter, we had $74,000 of revenue from the sale of emission credits from the operation of an N2O catalytic converter at one of our nitric acid plants.

Hunt discussed the robust pricing environment for our fertilizer products and the fact that we've locked in most of the EBITDA for the year. The high product pricing that we're seeing, as well as lower gas costs, are driving that increase in gross margin. If we look at gas going through cost of goods sold, this quarter, we hit a number of $3.64. And remember that, that number includes transportation costs, which typically run about $0.40. So this quarter, we're at $3.64 compared to last year, $4.71. So we're now seeing the real benefits of lower gas prices flowing through our cost of goods sold. Remember, there are some significant lags between the time we actually purchased the gas and the time that, that cost rolls through our cost of goods sold. This all led to Rentech Nitrogen reporting EBITDA of $66.8 million for the first half of the year, which puts us well on our way to hitting our guidance of exceeding $130 million for the year.

On May 15, Rentech Nitrogen made a cash distribution to its common unitholders for the period from the IPO, which was November 9 of last year, through the end of the first quarter of $1.06 per unit, a total of $40.7 million. On August 14, Rentech Nitrogen will pay second quarter cash distributions of $1.17 per unit, approximately $45 million. This will bring cumulative distribution since our IPO to $2.23 per unit, a total of $85.7 million. Of that amount, $1.70 per unit relates to 2012 and $0.53 relates to the period from the IPO through the end of last year. The second quarter distribution is payable to unitholders of record as of August 7 and will be paid on August 14. The next distribution covering the third quarter is expected to be paid on or about November 14.

Rentech will receive $27.2 million in second quarter distributions for a total of $51.8 million in cumulative distributions from Rentech Nitrogen since the IPO. Rentech's cash balance as of June 30 pro forma for this distribution would have been about $191 million. Given Rentech Nitrogen's forecast of cash available for distribution in excess of $126 million and our ownership of 60.8%, Rentech would receive an excess of $77 million in cash distributions related to the results of 2012. Note that, that last payment covering the fourth quarter of 2012 would actually occur in early 2013.

During the second quarter, we repurchased about 9.1 million Rentech shares under our $25 million share repurchase program. The average price of the repurchased shares was $1.81 for an average purchase price of $16.4 million. About $8.6 million worth of shares can still be repurchased under the existing plan. The plan has a duration of 1 year ending in February of 2013.

We've elected to keep our convertible notes outstanding for the time being. We believe that the 4% coupon that we're paying buys us a relatively inexpensive option to refinance the notes later, taking advantage of one of our more highly valued currencies and preserve our cash for potential investments in a high-return business. If we don't make the high-end NPV investments that we're currently seeking, then we expect to use our cash to retire those bonds at par.

I'll now turn the call back over to the operator, and then Hunt and I will answer questions.

Question-and-Answer Session


[Operator Instructions] And our first question comes from the line of Lucas Pipes with Brean Murray, Carret & Co.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

A quick follow-up question about a potential new line of business. First, thank you very much for highlighting all of those parameters. That's very helpful. And so just one quick follow-up. Would you limit this to kind of the domestic market? Or would you also consider foreign investments on that front?

D. Hunt Ramsbottom

I think initially, we're limiting our investments for the near-term to the North America market. But we would look potentially abroad eventually. But once we build the infrastructure and get the momentum in North America, then we would consider other areas that we see potential.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Great. And then the way I understood it, you're not considering the $40 million investment anymore. Could you kind of walk us -- [indiscernible] kind of give more traditional business unit, could you kind of walk us through the thinking there and what led you to this conclusion?

D. Hunt Ramsbottom

I mean, it's really quite simple. I mean, when you look at the sector, certainly in the U.S., it's a challenged environment. And you look at some of the peers in the alternative energy sector, and it's a struggle in that marketplace for public peers. And we've looked at a lot of private enterprises. And it's a sector right now, I think, over the long haul, might do well. But in the short-term, I think it's very challenged. So when we look at our capital deployment between share repurchase, between this potential business line and the returns you get on these first-of-a-kind technologies, it appeared to us that, that spending that amount of capital for that -- those investments versus what I've outlined, we like what we see versus what I've outlined versus that. And I would say that we would be willing to do a significantly lesser amount if -- again, I've always said that there's opportunities more, I think, outside the United States for these types of technologies. Certainly, today, that's the case in light of the natural gas phenomenon here. And if the partners that we're talking to have the reach and we can strike these partnerships and make them take the technologies forward, we'd be willing to participate a little bit if we saw a pipeline of activity that they could sell multiple units of our technologies. So when we were looking at this initially, I think a few months ago when we outlined the $40 million, I think it's just -- we see other opportunities with better returns, at least initially, and we want to balance that with working with these partners that could potentially take us to markets that we don't have the reach.


Our next question comes from the line of Brent Rystrom with Feltl and Company.

Brent R. Rystrom - Feltl and Company, Inc., Research Division

Just curious, would you ever consider, given that you're just down the road from it, the frac sand industry as one of the places to go?

D. Hunt Ramsbottom

No. We don't have expertise in that business today. And so we've not pursued that at all.


[Operator Instructions] Our next question comes from the line of Matt Farwell with Imperial Capital.

Matthew Farwell - Imperial Capital, LLC, Research Division

I'm just wondering if you can discuss the project outlook. You've mentioned in the RNF call, you're looking at potential acquisitions on the fertilizer in the ag space. Just talking about alternative energy type projects here. What do you consider to be the primary focus of management at this point?

D. Hunt Ramsbottom

Well, I think as we -- as the company matures here, there's -- the focus of the nitrogen guys is on nitrogen, and we've got the alternative, or called the alternative energy folks, focusing on this other line of business and the technologies. So I think as I've said prior, as these business lines grow, I think we will continue to add staff in there. But I'm very confident in the team in the ag side. They've executed flawlessly when we purchased the plant in East Dubuque. It was a flawless integration. And as we acquire businesses in that side of the equation, that's the same team that's in place. And I expect it will have flawless execution there. And as we develop this new line of business, we are looking to hire some folks in that space. And when we acquire a platform company, we expect expertise will come with that. So I think as we mature as a corporation, you'll see these business lines will be more segregated. And again, there'll be still the shared executives -- some shared executives at the corporate level. But I think if those businesses grow, they'll be more bifurcated, if you will.

Matthew Farwell - Imperial Capital, LLC, Research Division

Okay. You gave us some guidance for next year on R&D. Can you provide any update on what SG&A might look like in '13?

D. Hunt Ramsbottom

I think SG&A in '13 will be pretty similar to what you see now. And I think I say that because if we're successful in this new structure that we're approaching, that it will require the folks on the SG&A line, frankly, development activity, back-office structure that we have in place today. So the focus would be on the R&D reduction. But I wouldn't count on -- if we are successful in these business lines, I wouldn't count on a lot of SG&A reduction in corporate here.

Matthew Farwell - Imperial Capital, LLC, Research Division

Last August, I think it was when you established a plan. I think some might call it a void to fill. Have you renewed that? Or is there any status update on that plan?

D. Hunt Ramsbottom

Well, that was really for the NOLs that we have, the protection plan for the NOLs. So as we work through those NOLs, the plan will eventually go away because there won't be any NOLs. So as the NOLs go, which probably will go away pretty swiftly here as we have net income, that plan goes away because it was simply to protect the NOLs.


And that was our last question. I'll now turn the call back over to you, Ms. Julie Dawoodjee. Please go ahead.

Julie Dawoodjee

Thank you. We'd like to thank everyone who participated on the call today. As we've outlined, our outlook for this year is positive for both businesses. Please contact me if you have any questions about the quarter. Thank you.


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

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