LSB Industries, Inc. (LXU) Q1 2022 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to this LSB Industries' First Quarter 2022 Earnings Conference Call. [Operator Instructions] And to get us started with opening remarks and introductions, I am pleased to turn the floor over to Vice President of Investor Relations, Mr. Fred Buonocore.

Thank you Jim. Good morning everyone. Joining me today on the call are Mark Behrman, our Chief Executive Officer; and Cheryl Maguire, our Chief Financial Officer. Please note that today's call will include forward-looking statements and because the statements are based on the company's current intent, expectations and projections, they are not guarantees of future performance and a wide variety of factors could cause the actual results to differ materially. As this call will include reference to non-GAAP results, please see the press release in the Investors section of our website, http://lsbindustries.com, for further information regarding forward looking statements and reconciliations of non-GAAP results to GAAP results. At this time. I'd like to go ahead and turn the call over to Mark.

Thank you, Fred. We are very happy to have the opportunity to speak with you today about our 2022 first quarter results. As you can see on page 3 of our presentation, it was a great start of the year as we once again delivered a record top and bottom line performance driven by the strong pricing environment of our products that we capitalized on with solid operations and effective sales and marketing efforts. I would like to thank all of our employees from making this another excellent quarter for their strong commitment to improving and growing our business. There is no question that our results have benefited greatly by the strong pricing environment, a factor that is out of our control, but it has taken a great deal of work on the part of our team, to position us to deliver the kind of results we generated in the first quarter and to give us the favorable outlook that we have for the balance of 2022 and beyond. Financial results do not mean much if we are not operating safely. Our primary goal as an organization day in and day out is to ensure that all of our employees and contractors return home safely every day. We are committed to providing a safe and healthy workplace for all employees and stakeholders by implementing high safety standards to minimize potential risk to people, communities, assets and the environment. Our entire team continues to work hard towards our zero incident goal. And we expect to make great progress in this regard over the balance of 2022. On page 4, we summarize the key drivers of our agricultural end markets. Commodity prices continue to trade well above year ago levels. The price of corn, which is a key demand driver for our business is currently at its highest level since 2012, due to multiple factors. As we discussed last call ethanol consumption and production has rebounded as U.S. miles driven have recovered from pandemic lockdowns. The EPA's recent waiver of the restriction for use of E15 ethanol through the summer, when the product is typically banned for emissions reasons, which will likely lead to even greater demand for corn, providing more support for corn prices. On top of that, global corn supplies remain constricted as a result of strong demand, coupled with ongoing drought conditions in the Western U.S. and South America and multiyear lows in global corn stocks. Another dynamic that we are watching closely is the wet weather across the U.S. corn belt over recent weeks, which has delayed the start of the planting season. At this point, however, we believe that planting activity is likely to be made up in May and June. The important takeaway from all of this is that we believe that our farm profitability will remain robust and we expect that the demand for fertilizer will be strong as farmers seek to maximize their yields, given current corn prices and the futures that call for corn prices to remain well above historic levels through 2022 and into 2023. We expect this to be the case despite prices for nitrogen products increasing dramatically over the past year. Further contributing to the increase in both corn and fertilizer prices has been the impact of the Russian invasion of Ukraine. Ukraine is one of the world's largest exporters of corn and the current unstable geopolitical situation is expected to disrupt Ukraine's corn production and their exports in 2022 and 2023. A concern that appears to be reflected in corn prices. With respect to the impact on fertilizer prices, economic sanctions enacted against Russia, one of the world's largest exporters of ammonia, urea and ammonia nitrate have further reduced the global supply of nitrogen products causing prices to increase from already elevated levels. Finally, the war in Ukraine continues to contribute to high prices of natural gas in Europe, which imports more than 40% of its gas from Russia, making ammonia production, even more uneconomical for European ammonia producers. On top of the dynamics already resulting in elevated nitrogen prices entering 2022, Russia's aggression towards Ukraine is likely to have impacts on the global ammonia market far beyond the end of the conflict. On page 5, we highlight some of the key end market drivers for our industrial and mining product sales. With respect to the commodity price inflation that I've been discussing, particularly as it relates to natural gas, one of the attractive aspects of our relationships with industrial and mining customers is that our sales tend to be based on contracts that not only give us visibility into future quarters, but in many cases also insulate us from input cost inflation. As you can see on the slide, the demand dynamics for our key industrial and mining end markets remain solid, despite disruptions on the industrial side from the widespread supply chain issues in the U.S. Overall, the demand and pricing trends we are currently seeing across all of our product lines, have us optimistic about our prospects for strong profitability and cash flow for 2022. Now I'll turn over the call to Cheryl who will discuss our Q1 results and our second quarter outlook, Cheryl.

Thanks, Mark, and good morning. Turning to page 6, you'll see a summary of our results for the first quarter of 2022. Our strong top and bottom line performance relative to 2021 reflects the increased pricing for our products across all our businesses. Our first quarter adjusted EBITDA of over $101 million is a company record. Additionally, in the first quarter we generated adjusted EPS of $0.69, and we expect strong profitability to continue in the coming quarters. Our strong profitability has contributed to our greatly improved liquidity situation. We currently have more than $400 million of total liquidity. On March 8, 2022, we completed a tag-on offering of $200 million of senior secured notes due 2028 bearing an interest rate of 6.25%. The purpose of raising these additional funds is to better enable us to pursue the organic and inorganic growth opportunities that we have identified for 2022, including de-bottlenecking of our facilities to increase production capacity and other growth projects. With respect to the timing of the offering, our intention was to get out ahead of a rising interest rate environment. Even following that new debt issuance, we ended the first quarter with a leverage ratio of below 1.5x trailing 12-month EBITDA. And we expect that to decline further during 2022. Notably, we now expect our annualized interest expense to be approximately $45 million, a modest increase relative to our previous interest expense guidance. As a result of the new notes. Page 7 bridges our first quarter adjusted EBITDA of $101.1 million to adjusted EBITDA for the first quarter 2021 of $17.3 million. The light green bar illustrates the substantial impact selling price strength continue to have on our results. The positive selling price impact is shown net of increased variable of costs, primarily raw material costs, which increased by approximately $19 million versus the first quarter of 2021. Our natural gas costs rose substantially over the course of 2021 and through the first quarter of 2022 and have further increased in the second quarter. As the green bar indicates, however, thus far, the benefit of increased selling prices has far exceeded the rising price of natural gas. And we expect that dynamic to persist throughout the year. Also partially offsetting the benefit of higher product selling prices was a sales volume headwind representing approximately $6 million of EBITDA related to the impact on volume of delayed fertilizer purchases by farmers, particularly ammonia due to wet weather in certain areas of the U.S. Additionally, from an LSB-specific perspective, in the second half of 2021, we increased our nitric acid production and sales in favor of building inventory of HDAN and selling that inventory in the first quarter, which is what we have historically done. While we made this shift in mix in order to capitalize on the higher margins for nitric acid, it did translate into lower HDAN inventory headed into the first quarter of 2022 and therefore lower first quarter sales of that product. We expect this product mix shift to continue in the future. Additionally, costs were higher in the period by approximately $3 million, primarily related to nonrecurring transaction related expenses. Page 8 illustrates the strong bottom line improvement we delivered over the past several quarters and years. This is a result of the favorable pricing trends, the operational improvements we have made at our facilities, new customer contracts and investments we have made to optimize our product distribution and mix. We expect to further benefit from these factors in the second quarter and throughout the full year of 2022. Regarding our second quarter 2022 outlook, we continue to benefit from significantly stronger fertilizer pricing as compared to a year ago. NOLA UAN benchmark pricing is currently around $625 a ton, more than double its level at this time last year. Additionally, the Tampa ammonia benchmark price settled at $1,425 a metric ton in May versus $545 a metric ton last May. Putting it all together, we currently expect continued improvement in adjusted EBITDA and expect the second quarter of 2022 to exceed the first quarter of 2022 top and bottom line results by approximately 50% to 70%. as Mark mentioned, the delay to the start of the planting season, due to the wet weather through the corn belt is something we are watching closely. As of today, we believe that this forecasted range for sequential improvement is a reasonable indication of our outlook for the second quarter. For the full year 2022, market fundamentals are expected to remain strong across our end markets, making us optimistic and about our prospects for another record year of growth in profitability and cash flow. We expect this strong growth in spite of the turnarounds we will be conducting at our Pryor and El Dorado facilities during the third quarter. Before handing the call over to Mark, I would like to point out that while we do have a net operating loss carryforward of approximately $600 million, that should shield us from paying taxes for a number of quarters. We do have to record a provision for income taxes on our income statement. We expect our effective tax rate to be approximately 17% for the full year. And now I will turn it back over to Mark.

Thank you, Cheryl. As I mentioned earlier in the call, natural gas prices have played a major role in increasing the selling prices of our products. Page 9 illustrates how the spread between U.S. and European natural gas prices widened over the course of 2021 and continued in a very volatile manner through the first 4 months of 2022. The historically high gas feed stock costs prompted a number of European producers to curtail production during the third and fourth quarters of last year exacerbating what was already a global shortage of ammonia and other nitrogen products in the face of rising demand. After surging in late February, following the Russian invasion of Ukraine, European natural gas prices have ease to around $30 in MMBtu. At the same time, LNG exports from the U.S. are increasing causing gas prices in the U.S. to rise to approximately $8 in MMBtu. Although some European production has come back online, the impact on supply and pricing throughout the global nitrogen market has been very pronounced. We believe the ammonia price trends we discussed earlier will persist through 2022 and into 2023, even if European gas costs decline further in the coming months. The bottom line is that this dynamic represents a significant advantage to U.S.-based nitrogen producers. We intend to capitalize in this strong pricing environment to generate significant free cashflow that will allow us to pursue opportunities to grow our business and create value for our shareholders. Page 10 shows a summary of our growth priorities for 2022. The primary mantra of our company is 'Protect what matters'. This is in reference to the health and safety of our employees and is a guiding principle of how we operate. So far in 2022, we have made meaningful progress in advancing our safety programs. Additionally, we continue to invest capital at all 3 of our facilities to promote safe and reliable operations. With respect to organic growth initiatives, we are very excited about the opportunities we have to meaningfully increase the production capacity of our plants through de-bottlenecking. Over the course of this year, we plan to evaluate multiple potential projects at our facilities that we believe will have merit and would expect to ultimately lead to a significant increase in our sales volumes and profitability. We are also targeting approximately $15 million of capital investment in 2022 for margin enhancement projects to optimize our storage and distribution capabilities, as well as to upgrade additional ammonia into higher-value downstream products. We are in the process of finalizing our project evaluations, but generally expect these projects to return $7 million to $8 million of annual EBITDA when fully operational. In addition to the opportunities we've identified to expand our volumes and profits from our existing portfolio of assets, our recently recapitalized balance sheet provides us with the flexibility to profitably increase our scale through accretive M&A activity and we are evaluating a number of prospects. As we've talked about on our last few of our calls, we believe that blue and green ammonia represent a compelling opportunity for us to become a leader in the emerging clean ammonia and energy markets. Our existing knowledge in ammonia manufacturing, handling, storage and logistics, positions us extremely well to become a significant player in this arena and to help create a more sustainable and environmentally friendly world in a way that we believe can deliver long term value, both socially and financially. Given this opportunity, we are pursuing projects that we believe can make us a producer of clean ammonia and hydrogen within the next several years. As many of you may have read in the press release that was issued last week, we have announced our first blue ammonia project, which we've highlighted on page 11. In late April, we announced that we entered into an agreement with Lapis Energy to develop a project to capture and permanently sequester CO2 generated in the course of ammonia production at our El Dorado facility. Lapis is a Dallas based vertically integrated energy infrastructure development firm focused entirely on decarbonization through carbon capture and sequestration or CCS. They were founded in 2020 by a team of industry leading experts. As part of our agreement, Lapis will fund the full capital requirements of the project. Our project has commenced and we expect to be operational by early 2025 subject to the approval of a Class 6 injection well permit. Once we're operational, the project will initially capture and permanently sequester, approximately 450,000 metric tons of CO2 per year in underground saline aquifers, right under our El Dorado site. We believe that we have the potential to increase this quantity in connection with the de-bottlenecking projects we are evaluating at that facility. The sequestered CO2 will reduce LSB Scope 1 GHG emissions by 25% from current levels while qualifying for federal tax credits under the internal revenue code, section 45Q that are currently $50 per metric ton of CO2 captured beginning in 2026, but under evaluation by Congress to increase to $85 per metric ton of CO2. As Lapis will fund the full capital requirements of the project, including owning the carbon capture facility, they will receive the 45Q credit. They will purchase the captured CO2 from us, enabling us to produce and sell over 375,000 metric tons of blue ammonia annually that we expect to be a higher value product compared to the conventional ammonia we produce and sell today. This is the first CCS project announced in the state of Arkansas and a third CCS project from ammonia produced in the US. We are proud that LSB is taking a role as a leader in the decarbonization of hydrogen and ammonia. We believe we can become a key to combating climate change as well as an initiative that we expect to generate significant long-term value for our shareholders. Before I hand the call back to the operator for the Q&A session, I'd like to mention that we'll be participating in the Stifel Cross Sector Inside Conference on June 9 in Boston and the Sidoti Virtual SmallCap Conference on June 15 and 16. We hope to speak to many -- to -- with many of you during these events and to see you in person at the Stifel event for the first time and quite some time. That concludes our prepared remarks. And we will now be happy to take any questions. Thanks.

[Operator Instructions] We'll hear first from Steve Ferazani at Sidoti.

Congratulations on the blue ammonia announcement. You said you were going to work pretty quickly on that, and indeed you, you announced it already. I just want to get a sense, and I think you were pretty clear on this, but financial impact over the next couple of years, which sounds like it is going to be absorbed entirely by Lapis, but is there anything we should expect? And then just to clarify, into 2025, the benefit to you will be the higher prices of potentially higher prices of blue ammonia. Is that how we should be looking at it?

Yes. So Lapis is going to fund 100% of the capital costs. And we will have minimal outlay between now and when we go into operation in 2025. From a revenue generating point or profitability standpoint, they will own the carbon capture equipment, so they'll capture the 45Q credit, but they will purchase, for a price, the CO2, that we generate out of the facility. And that coupled with what we think is a modest premium that we can sell blue ammonia for over current gray ammonia today should be the profitability that we would expect to start to see in 2025.

Great. Cheryl, if you could just restate that the EBITDA guidance for Q2. I just want to make sure I heard that correctly.

Yes. 50% to 70% above the first quarter of 2022. And that's almost 4x above the second quarter of 2021.

Great. When I think about -- when I see the numbers you report and your volume was a little bit lighter, and you went through the issues with weather, wherever your EBITDA and operating margin were particularly strong. I'm looking at your sequentially, your cost of sales because natural gas prices were higher. Production was higher, but your cost of sales was lower, and I'm trying to figure out if that's a mix issue or what. Because you're even -- the number hit my estimate, despite the lower volume and natural gas prices were higher. What led to that?

So we are upgrading more product and we do shift -- we are shifting towards more nitric acid, so of course that's impacting the margin. With terms of some of that higher gas cost it's sitting in -- some of that's sitting in inventory, right? Cause we did build some inventory because of the delayed season. And so you'll see some of that come through in Q2.

And that leads to my next question, which is how much -- because it looks like your inventory is, as you said higher, does that mean you can catch up in terms of volume in 2Q? As some of these weather issues -- if we see less wet weather, can you catch up on volume in Q2?

Yes, we believe so.

Okay. Fair enough. And then last one for me before I turn over. And I know everyone hates talking about taxes, but the miss was entirely on that tax expense. Can you explain that a little bit, given your NOLs?

Right. So, we do have the NOLs, so we don't expect to be a cash tax payer, but we do of course still have to record the expense on the provision line and we would expect that to average around 17% effective tax expense for the year.

And that's entirely noncash?

Entirely noncash.

Next we'll hear from Rob McGuire at Granite Research.

Congratulations on the quarter.

Thanks Rob.

Have you experienced any issues using Union Pacific accepting shipments delivering on time? Anything similar to what CF experienced during the quarter?

Right now, we think we're in good shape.

Can you discuss any trends that you are seeing with this year's spring planting season so far? Is there any substitution going on from one nitrogen product to another?

Well, it's probably a little early to see that. But we would expect that with delayed planting, we are certainly behind the 5 year average of where we would be to where would be normal for this time of the year. That would probably see less ammonia put on the ground and more UAN or urea in our case, it would be advantageous to see UAN put down.

All righty. And then would there be any production downtime associated with the blue ammonia product project at El Dorado as you implement?

Well, that's a great question. I don't believe so. But I guess it remains to be seen and we wouldn't see any of that until sometime in the second half of 2024.

And then are there any milestones that we should be looking for in terms of when we would expect, say, the Class 6 well to be approved? Or what should we be thinking of in terms of watching this project progress?

I think – yes, I mean the approval would be a great milestone. But the time frames to get approval lots of conversation about that. I think the milestone for this project is the actual filing of the Class 6 permit application. Once we get that on file – we won’t file unless we believe that the project backs up all the assumptions that we have today, the saline formation is more the than large enough to handle the CO2 that we expect to put into the ground and we have a high likelihood of getting the Class 6 permit approved. So I think the real milestone would be the filing of that Class 6 permit application.

[Operator Instructions] We'll hear from DeForest Hinman at Walthausen & Co.

Just as it relates to the guidance, can you help us with some of the mechanics there? I think last quarter you discussed some of the realizations that you were seeing. Can you kind of talk about product realizations in the April time period? And then any color on the expectations on the tonnage side? I don't know if the whole number makes sense. I'm just looking at some of the math you had volumes down in the first quarter, but I think last year you did 400,000 tons of product in the second quarter.

Yes. DeForest, we don't -- I mean, we don't generally give out volumes from quarter to quarter. I think as Cheryl mentioned, volumes are down a bit in this first quarter due to some of the delayed application. And I think the question was, do we expect to make it up and we do. So we have got product sitting in inventory that should be sold in the second quarter, in addition to all the production that we have in the second quarter. As far as realized prices we are sold forward on some on UAN for the quarter. We are not sold out for the second quarter by any mean and we have done that by design, as we believe that the strategy will yield higher net back prices for UAN. On ammonia, the bulk of our ammonia is really sold pursuant to a contract that we have, with quote out of El Dorado and that's Tampa linked. So we like the high Tampa prices right now. And so, as we have said in calls earlier, it's indexed to Tampa at a slight discount. So other than that, I think we're experiencing pretty current prices in the marketplace and that should drive of us to have a very significant increase in our second quarter.

Okay. That’s helpful. And then just any update on the M&A side, I know we have been looking at some deals, talking to different people, is this current strength in the market delaying things, because everybody’s making so much money, it is hard to delineate what the appropriate multiple is any color you can provide in terms of timing you did raise the debt so we have that sitting on the balance sheet now kind of a negative arbitrage. So I think shareholders would like to have a better idea of what, what is that money going to be used for? Did I lose you?

Mr. Hinman? This is the operator. I do show our speakers are still connected. Allow me to check their line.

Okay.

DeForest, are you there?

Yes, I'm back. Hello? I don't know if I got cut off or you got cut off.

Yes, I mean, I was saying that we have got a significant organic growth opportunities through de-bottlenecking and we think that those could have, and should have, if we move forward with them, significant additional EBITDA generation on an annual basis, but they will take a meaningful amount of capital. So cash is fungible, whether they are used for internal projects or they are used for M&A. On the M&A side, as we said before, there's nothing that's imminent that we are I can talk about timing of anything and until you sign a purchase agreement, there's no reason to talk about the timing of anything. From a market standpoint, I would just say that generally speaking, people don't buy at full multiples at high market prices and people don't sell at multiples at low market prices. And usually there's a middle ground as these are long live assets and you get a look at it over multiple cycles. So I think if there is a strategic nature to transactions, then people become more reasonable. And if it's just buying an asset then maybe it's not the right time buy an asset.

Okay, great. That's helpful. And then just on this carbon sequestration project, it just seems very interesting, especially if you have a third party putting up all the capital, I mean, the return on that's phenomenal. Can you just help us understand how that is structured, any color in terms of what they would be paying you for that carbon and you did touch on the potential for the change to the tax credit in the future, is the contract currently structured in such a way that if it did change in the future, we would be able to benefit further from that, from that change.

Yes. So we have built into the contract, a dollar per ton that they’re going to pay us, under the current $50 per ton tax credit regime. If it increases to $85, we will have a outsized portion of that will come back to us.

And we'll take a follow-up question coming from Rob McGuire at granite research.

Just one other question here. Can you give us an idea of UAN pricing relative to your EBITDA guidance for the quarter, what we should be thinking about?

Well, we’ve got less than 50% sold forward. So that means that greater than 50% of our sales volume for the quarter, we should be able to capture current pricing.

Ladies and gentlemen, this does conclude today's question and answer session. At this time, I am pleased to turn the floor back over to our management team for any additional or closing remarks.

Well, thank you for participating in our first quarter earnings call and for your interest, as we said earlier, we’ll be attending a couple of conferences this quarter. So we hope to see you there. Thanks so much.

Ladies and gentlemen, this does conclude today's LSB industries' first quarter conference call, and we do thank you all for your participation. You may now disconnect your lines, and we hope that you enjoy the rest of your day.