Andersons Inc (ANDE) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Andersons Incorporated earnings conference call. My name is Kaitlin and I will be your operator for today.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today, Mr. Nick Conrad, Vice President, Finance, and Treasurer. Please proceed.

Good morning and thank you, Kaitlin. Thank you, everyone, for joining us for the Andersons 2010 second quarter conference call.

As you know, certain information that will be discussed today constitutes forward-looking statements. Actual results could differ materially from those presented in the forward-looking statements as a result of many factors including general economic conditions, weather and competitive conditions, conditions of the Company's industries, both in the U.S. and internationally, and additional factors that are described in the Company's publicly-filed documents including its 34-F filings and the prospectuses prepared in connection with the Company's offerings.

It also includes financial information of which, as of the date of this call, the Company's independent auditors have not completed their review. Although the Company believes that the assumptions upon which the financial information and its forward-looking statements are based are correct and reasonable, it can give no assurances that these assumptions will prove to be.

This conference call is being recorded and can be accessed on our website.

Mike Anderson, Chairman and Chief Executive Officer, and I will be available for questions at the end of the call. Now I'd like to turn the call over to Mike Anderson. Mike?

Thanks, Nick and good morning, everyone, on another exciting day in the grain markets.

As we announced yesterday in our press release, we generated net income of $25.2 million or $1.36 per share on revenues of $811 million. In 2009 we reported net income of $15.9 million or $0.87 per share on similar revenues. Through the first six months, our total net income stands at $37.4 million or $2.02 per diluted share. In 2009 we reported first half net income of $20.9 million or $1.14 per share.

Total revenues of $1.5 billion for the first half of the year are consistent with prior-year revenues. As we are in a number of commodity-based businesses, it is important again to remember that our revenues do not serve as a good predictor of income or economic performance. To fully understand the Company's total results for the quarter, let's look at our five business groups.

The Grain and Ethanol Group achieved an operating income of $19.6 million in the second quarter, which was significantly higher than its year-earlier result of $8.9 million. The grain business had a record second quarter performance as it benefited from unusually strong income which resulted primarily from a significant escalation in wheat basis.

The ethanol business also achieved a second quarter earnings record due to the performance of the Company's equity investments and three ethanol limited liability companies. The ethanol business benefited from higher margins locked in during prior periods.

The second quarter results from the group's investment in Lansing Trade Group were also higher than the prior year. Although revenues are not necessarily a good indicator of performance within the Grain and Ethanol Group, total second quarter revenues were $474 million which is approximately 5% lower than the prior-year's revenues of $500 million. This quarter includes $195 million of grain and ethanol sales made by the group in accordance with the origination and marketing agreements between the company and its ethanol joint ventures which is $7 million more than what was reported for those sales in the prior year.

The Grain Ethanol Group's operating income through the first six months of 2010 was a record $40.3 million in comparison to $14.7 million in the prior year. Both the grain business and ethanol business results through the first six months were impacted by the same factors noted in the second quarter results. The year-to-date results for Lansing Trade Group were considerably improved from the prior year.

Total revenues for the Grain and Ethanol Group through June were $995 million in comparison to $981 reported in 2009. The first half results include $405 million of grain and ethanol sales which is comparable to the $395 million that was reported in the prior year.

On May 1, the Grain and Ethanol Group announced that it acquired the assets of O'Malley Grain Inc. The purchase included O'Malley's two grain cleaning and storage facilities in Fairmont, Nebraska and Mansfield, Illinois with a total capacity of 1.4 million bushels. This business has allowed the group to forward-integrate into the production value chain the natural extension of the Company's grain procurement and storage business.

I also want to mention that at this time, crop condition reports in the United States show that 71% of the corn crop and 66% of the bean crop are good or excellent. At the same time last year, the ratings were 68% and 67% respectively. As long as the weather continues to cooperate, this means we could have a great harvest season.

Our Plant Nutrient Group achieved an operating income of $19 million on revenues of $228 million this quarter. This is the second-highest second quarter in the group's history. In the same three-month period of 2009, the group reported a $10.3 million operating profit on $198 million of revenue. Margins were up slightly this quarter in comparison to last year. Additionally, tons sold increased by more than a third as the industry returned to more traditional nutrient application rates on phosphate and potassium and retail farm centers built and maintained inventories versus the destocking that occurred in the prior year.

This year the Plant Nutrient Group has earned $19.7 million through the first six months on $332 million of revenues. Last year the group generated operating income of $12.4 million on $309 million of revenue.

A year ago the Plant Nutrient Group acquired Hartung Brothers, Inc. fertilizer division. This acquisition has proven to be accretive to 2010 earnings and represents a strategic expansion of the group's footprint with the product line and customer base matching existing markets.

The Rail Group, which continues to be impacted by the decline in North American rail traffic versus 2008 traffic, reported an operating income of $100,000 this quarter on revenues of $24 million. Last year the group reported $600,000 of income on similar revenues.

Operating income from leasing was considerably lower during the second quarter when compared to the prior year due primarily to lower utilization rates and the corresponding carrying cost of vital assets. This quarter the group did recognize $1.7 million in gross margin from the sale of rail cars and related leases, whereas last year $800,000 was recognized on similar transactions.

The average utilization rate, which is the percentage of the fleet in service for the quarter, was 71% in comparison to 80.6% for the same period last year. As of the end of June, utilization had increased to 71.4%. The group now has approximately 22,800 cars and locomotives, which is down slightly from its earlier total due to the recent scrapping of over 1,000 rail cars. Maintenance expense for the quarter was $95 per car per month in comparison to $123 per car per month last year.

Quarterly gross profit of the rail car business showed modest improvement from the prior year. Through the first six months, the Rail Group had operating income of $1.1 million and revenues of $50 million. In the same period of 2009, operating income amounted to $1.5 million and revenues were consistent with this year at $50 million. These results included gains on scrapping and sales of rail car and related leases of $4.3 million in 2010 in comparison to $1.1 million for the same six-month period of 2009.

The American Association of Railroads reported last week that rail freight traffic for the first 28 weeks of the year is up 7.3% from 2009, albeit down 13.2% from 2008. This is definitely a positive sign that the industry could be headed in the right direction.

During the quarter the Rail Group made a significant minority investment in a short-lying railroad, Iowa Northern Railway Company. This investment has already proven to be accretive to earnings. Iowa Northern operates a 163-mile class 3 railroad, has a fleet of 21 locomotives and 500 rail cars. It is also involved in the development of logistics, terminals, designed to aid the trans-loading of various products.

The Turf and Specialty Group earned operating income of $2.5 million on $41 million of revenue. Last year the group reported $3 million of income on $40 million of revenue in the second quarter. Turf products tonnage was up slightly from year-to-year. Gross profit per ton decreased due to product mix. Expenses were up in the second quarter due to the purposeful investment in R&D of new products and additional repair and maintenance.

Through the first half of 2010, the group's operating income was $5.2 million on $83 million of revenue. Comparatively, through the first six months of 2009, the group achieved record operating income of $6.1 million and revenues were $84 million. It was just over two years ago that this unit, along with several partners, was awarded a $5 million grant by the State of Ohio for research and development. This work grant is proceeding well is being utilized to further develop technologically advanced and proprietary products.

The Retail Group had operating income of $2.1 million in the second quarter. This compares to $2.9 million last year. Total revenues of $44 million for the second quarter were approximately 11% below the $49 million in revenues reported for the same period in 2009. If the impact of closing the Lima store in the third quarter of 2009 is removed, same-store sales for the quarter declined 4%.

The group's year-to-date operating loss is $700,000 in comparison to a profit of $200,000 through the first six months of 2009. The retail business's total revenues of $74 million through the first six months were $9.3 million less than last year, although $5.7 million of this decline related to the loss of sales from the Lima store which we closed last year.

The group's margins and customer counts have decreased slightly this year; however, the average sale per customer has increased slightly. The group is continuing to manage expenses and reduce inventory levels.

Now I'll turn the floor over to Nick for his treasurer comments.

Thanks, Mike.

For the second quarter 2010, the Company's effective tax rate was 36.6%. The Company's June 30 year-to-date effective tax rate was 39%, up 2.3% from June 30, 2009 year-to-date rate. This increase is mainly due to a one-time increase in income tax expense of $1.5 million recorded in the first quarter of 2010 resulting from the Patient Protection and Affordable Care Act. We are projecting our full-year 2010 tax rate to be 38.2%.

For the second quarter 2010, the Company's interest expense totaled $4.7 million, down $500,000 from the second quarter of 2009. As of June 30, year-to-date interest expense was $9.3 million, down $1.6 million compared to 2009.

During the 2010 second quarter, the Company had no short-term bank debt outstanding. Consequently, for the second quarter, average short-term borrowings were down $10.9 million from the same period of 2009. Year-to-date June 30, 2010, average short-term borrowings as compared to 2009 were down $33.7 million.

The Company's short-term investments during the second quarter averaged $83.1 million, an increase of $21.4 million from the 2009 second quarter. As of June 30, 2010, our year-to-date average short-term investments were approximately $63.6 million compared to $10.3 million in 2009.

Earnings before interest, taxes, depreciation and amortization for the second quarter 2010 were $53.4 million versus $38.7 million for the same period in 2009. Year-to-date, EBITDA totaled $89.5 million, an increase of $29.4 million from the same period last year. The second quarter's pre-tax earnings included approximately $6.7 million in equity in earnings of affiliates versus approximately $800,000 in the same period last year. Year-to-date equity and earnings of affiliates was a profit of $68.6 million, up $19.5 million from June 30, 2009. EBITDA has been adjusted for the non-controlling interest.

Turning to the balance sheet, current assets decreased to $632.3 million by the end of the second quarter from a year-earlier balance of $647.1 million. The majority of this decrease was in margin deposits and commodity derivative assets current. Margin deposits totaled $7.4 million at the end of the second quarter compared to $38 million for the same period last year. Commodity derivative assets current ended the second quarter at $14.2 million, down $34.5 million from the same 2009 period.

The Company's cash and cash equivalents increased $24.5 million compared to the same period last year, ending the second quarter at $204.3 million. As you may know, the contract [low] for September corn futures was $3.33 on June 29, 2010 and September wheat futures low was $4.43 on June 9, 2010. Since the quarter-end, there has been significant appreciation in grain prices, particularly wheat. Today, for example, September wheat futures have traded at $1.785.

Since the 2009 second quarter, accounts and notes receivable have increased $1.9 million. Plant Nutrient receivables were up $4.9 million, Turf & Specialty were up $3.8 million, and retail was unchanged. Grain and Ethanol and rail receivables were down $5.5 million and $1.4 million respectively.

Inventories ended the second quarter 2010 at $238 million as compared to the June 2009 balance sheet of $205 million, an increase of $32.9 million. Grain and ethanol inventories were up $22.2 million and Plant Nutrients inventories were up $16.2 million compared to the second quarter 2009. Turf & Specialty and Retail inventories were down $2.3 million and $3.7 million respectively. Rail inventories were about unchanged.

Net working capital at the end of the second quarter was $299.3 million, a decrease of $38.1 million from the 2009 second quarter.

Total assets at June 30, 2010 were $1.2 billion compared to $1.1 billion from the year-earlier second quarter end. Other assets increased $55 million, ending the second quarter at $209.7 million versus the 2009 second quarter balance of $154.6 million. This increase was attributable to other assets and notes receivable ending the second quarter at $41.2 million, an increase of $25.8 million, as well as investments in and advances to affiliates ending the quarter at $168.1 million, an increase of $30.2 million for the same period 2009 -- from the same period 2009. Property plant and equipment along with rail car assets leased to others added $68.3 million.

Depreciation totaled $18.8 million on June 30th. Total capital spending including investments in affiliates through June 2010 was $35.6 million versus $7.4 million for the same period 2009, excluding rail cars. Rail car purchases and sales were $9 million and $12.6 million respectively. For year-to-date June 30th, rail car purchases and sales in the same period of 2009 were $12 million and $5 million respectively.

Our long-term debt totals $381.7 million, a decrease of $32.8 million from 2009's second quarter ending level. Our long-term funded debt to equity is 0.62 to 1. When non-recourse debt is excluded -- non-recourse long-term debt is excluded, it is 0.59 to 1. The Company's 2010 average interest rate for all long-term debt was 5.75%.

As of June 30, 2010, the Company's total equity was $442.6 million, an increase of $58.3 million from the 2009 second quarter.

Finally, on July 22nd, we paid our third quarter 2010 dividend of $0.09 per share.

Back to you, Mike.

Thanks, Nick. Before we take your questions, I'm going to cover a few more points.

We are pleased with the results our team delivered in the second quarter. Grain and Ethanol and Plant Nutrient groups led our earnings results. Both the grain and ethanol businesses had record second quarters and the Grain and Ethanol Group achieved a six-month earnings record. Plant Nutrient Group had its second-highest second quarter, being surpassed only by the unprecedented 2008 earnings that resulted from high margins recognized on inflating nutrient prices during the second quarter of 2008. As we review these results, we are again reminded that our strategy of purposeful diversification is successful and allows us to remain a strong and profitable company, and we are excited about our long-term outlook.

Many of you I know are wondering, what does the remainder of 2010 hold for the company? As we look to the rest of the year, now it appears that we will have a reasonably good crop in the U.S. and in most of our drawing areas. In addition, a likely early harvest along with the recent run-up in wheat price suggests that we will plant more wheat acreage this fall. Also based on the current supply and demand situation, it's reasonable to assume that we should see a modest increase in corn acreage next spring, although the current wheat price activity relative to corn could work against that theory.

All this bodes well for our grain and fertilizer businesses. The strong escalation of the wheat basis in the second quarter, however, suggests that some of the space income from wheat moved into the second quarter. We would note that due to the volume of wheat we have recently been buying, we've seen a drop-off in the wheat basis since the end of June. All this suggests that our space income in the last half of the year may be lower than what we experienced last year. It's also important to remember that in this agricultural industry, many factors such as weather can impact crops as the year progresses.

In regard to ethanol, we have locked in a significant percentage of our last half 2010 ethanol production at near breakeven margins based on our view of the near-term supply/demand situation in ethanol and to protect our first half income. That logic has been somewhat challenged by the recent increase in spot margins, but we still believe that the likely increases in production of ethanol will weigh on forward margins until we're able to blend it higher than a 10% rate. As a result, we know that the last half results in our ethanol business, which we would expect to be profitable, will be well below our 2009 results.

We believe that our Plant Nutrient Group will have an improved level of profitability this year in comparison to 2009 as is demonstrated by the second quarter results. We see our Rail Group continuing to be impacted by the slowdown in the Rail industry. However, based on recent activity, it's more likely that we have reached the bottom of this down cycle and the worst should be behind us.

As is typical, we do not expect our Turf & Specialty Group to be accretive to earnings in the second half of the year due to the cyclical nature of the business, which means we no longer expect them to exceed their prior-year earnings record. Further, it is expected that the retail business will continue to face sales pressure.

The net impact of all this is that that we would expect our last half 2010 results, we'd expect those results to be somewhat similar to our last half 2009 results, but additional factors could and will likely cause this to change. As you know, our ability to predict results going into the harvest is somewhat challenging. I would also remind everyone that historically our third quarter results are generally substantially below our fourth quarter results, and this year should be no different.

This concludes my prepared remarks. Nick and I will be happy to answer questions. So, Kaitlin, we'll turn it back to you.

(Operator Instructions)

Your first question comes from the line of Farha Aslam of Stephens Incorporated. Please proceed.

Hi, good morning.

Good morning, Farha.

Congratulations on a great quarter.

Thank you much.

A couple of questions for you, Mike. Starting out with, you discussed the drop-off in the wheat basis, but this year the crop is coming in much earlier than it did last year. Can you balance kind of those two factors for the grain group?

We did come in a little bit early, but the early wheat that we were buying really was frankly not that much volume as a result of the much lower acreage last year. Frankly the pickup in buying that we've had occurred in late July and into August here, I would say directly related to the escalation of the wheat market has brought more wheat into the market, and as a result of that, late in July and into August, we've been dropping our near-buy wheat base and forward wheat basis, i.e. next summer's wheat basis also, simply because we've been buying at a pretty good pace which we're quite pleased with.

If you recall, in 2008 first quarter -- well, you probably don't recall -- but 2008 first quarter, we had a big drop-off in wheat basis that negatively impacted results and we said, "Hey, this will come back." We feel the same way about what's going on right now. But the challenge is understanding when.

Second quarter, for several years we've had a situation where the wheat basis in Toledo was substantially below the delivery market price, and by the end of the second quarter, our wheat basis had got to about 15 under the July option which I recall basically convergence.

Right.

So we had the benefit of not only the full carry we earned in the spreads but appreciation from basis levels that were way under the option, the levels that approached the option, and that's when I mentioned that we probably moved some base space income into the second quarter. We feel great about the position but there's this element of timing that comes into bear and we own an awful lot of wheat across the company and feel really, really good about the ownership.

Okay. And then just the changes in the wheat contract, how does that affect the Andersons?

Yeah, the big change in the wheat -- there are some quality changes, I won't talk about -- but the big change is in the way the storage is calculated for wheat that's on delivery. And that storage rate affects the spreads between the front-end futures and the next-month futures or the next-period futures when there's an excess of supply over demand and grain on delivery. If there's lack of supply, what I'm going to say really doesn't matter.

The historical storage rate for grain delivery is basically about $0.05 cents per bushel per month and for years we had an issue of the wheat basis, as I mentioned earlier, being way below the futures price and it was not converging, which is one of the theories of a good functioning future market, is that when you approach the delivery period over a period of time the cash and the futures will align, and they weren't doing that.

So one of the things that was changed is the storage wheat -- only for the wheat, not for the other grains -- that allows for the expansion of the $0.05 storage rate wider than that based on market conditions. And in fact, at the current timeframe, the storage rate from the July to September is an $0.08 storage rate, $0.05 plus $0.03, and the September-December storage rate has not been defined yet. And the way it gets defined is if we remain at 80% of full carry of the July to September -- or September to December futures contract, between now and Sept. 1, then the storage rate will go from $0.08 to $0.11.

And based on what has occurred so far, unless something materially changes in the relationship with September and December wheat, it's highly likely that the storage rate will go from $0.08 to $0.11. What that means is if we have wheat on delivery, we earn a higher storage rate. And to the extent that we own wheat in the country and we have -- and we execute our spreads in a manner that takes advantage of that, we have the opportunity to earn that additional carry.

On the other hand, we're in a highly volatile market situation right now. Nick mentioned where wheat prices are today and the near-buy wheat of September and December futures months have escalated substantially higher than -- moving higher at a faster rate than next year's May and July and September.

So in the end, with where we're sitting today with the surplus of wheat we have, if it's not called off delivery, it's highly likely we earn more storage. If the dynamics in Russia and some other parts of the world create more demand for U.S. wheat than we see, all that could have an impact the other way.

Okay, that's helpful. And then when you look at your Plant Nutrients Group, in the quarter, was there any material benefit from the mark-up of inventory?

Yes, good question. No, margins were just modestly higher -- and margin is made of what we buy for and what we sell for plus appreciation -- we have some benefit of that in the quarter, but it's not material. I would call that $19 million, a pretty sound combination of volume and more regular margins as opposed to something unusual in there. Different certain products might have had a different answer on that. So, 37% up in volume, 4% roughly increase in the margin -- margin per ton.

Okay. And when you look at the demand, I mean, with the grain prices, we're hearing farmers are really being active booking, is there going to be something unusual in the fiscal third quarter versus normal? Or do you think it's really going to be in the fourth quarter where this farmer interest in applying nutrients shows up?

I mean, third quarter -- let's go back to 2008. The basic wholesale network, from retail farms to the network, stocked up substantially on fertilizer betting on the belief that the high grain prices would hold, and they ended up taking significant markdowns. We have had escalation in phosphate prices in particular and some nitrogen prices. Phosphates trading above trend if you throw out that '08 experience. Potash is still somewhat above trend, although it's not recently gone up, but then it can go down as much. Nitrogen, there are issues around just it's trading lower than maybe the trend.

But there's -- on the one hand there's the excitement about the likelihood of an early harvest and fall fertilization that's augmented by this escalation in grain prices based on non-U.S. supply factors, so our farmers benefit from that, but working against that is the nervousness if you're in the chain of taking on inventory and the timing of taking on inventory. So there's that rub. So I suspect for the most part, to the extent that we see some activity, it will be more fourth quarter, and again it depends just on how -- in the end how aggressive the farmer will be in buying fertilizer and putting it down. I don't see the distribution network wanting to get too long ahead of that. There's still some scar tissue that's out there.

Okay. And my final question, I'm going to pass it on, is on rail. How many rail cars did you scrap and do you anticipate to continue to scrap rail cars post the quarter?

We scrapped a little over -- during the quarter we scrapped about 440, and I think our total that we scrapped, just over a thousand during the year. And we might scrap around 300 more. So we're about done with that. And I would say we are seeing activity pickup for leasing. So we would expect utilization to improve between now and the end of the year.

Great. Thank you very much.

Yes.

Your next question comes from the line of Heather Jones of BB&T Capital Markets. Please proceed.

Good morning.

Good morning, Heather.

Good morning, Heather.

Good morning. Very good quarter.

Thank you.

I have some questions on wheat. Before I go there, you talked about rail leasing activity picking up, it sounds like rates have stabilized but you may scrap -- scrap activity may not be as pronounced in the second half. So, do you believe that you could generate profits in Rail in the back half?

Yes, that's a great question. We've seen a little uptick in our -- on our repair shops that looks like that will continue, that last year was at negative. I have reason to believe that we -- that although we have to overcome the likelihood that we won't have as much income from the financing sales and scrapping, I think there's a reasonable shot that we can make some money.

But it's -- I'm not going to attempt to be overly bullish, we have to still work out inventory that's being stored, but I sure like the fact that the trend is definitely, definitely changing. And if we're able to get more cars back in service, and it looks like we will this last half, then that sets up for starting next year on the plus side of the equation. But we're not seeing really bullishness in rates generally across cars, but it actually, absolutely has stabilized and we're seeing some demand.

And one other benefit is every car that we lease out is likely something that we're not paying storage for anymore. So it's a double win.

Okay. And in the Plant Nutrient, it looks like you had a negative price mix for the quarter. And first, am I -- is that analysis correct? Because it looks like your volumes were up a third but I thought sales were only up like 15% or something.

I have to look that up. I know our total margin was slightly better. Average price per ton was down, which is reflective of -- it was down 15%, 16%, so that may be what --

Right, right.

-- driving that. And that's reflective of the fact that nutrient prices are continuing to be, for the most part, had been going down as we came out of last year and into this year and as we relieved our inventory. Now they've started escalating back up again late in the second quarter and then into this quarter, so I would expect that revenue per ton as we move forward will be heading back up again.

Okay. Then moving on to wheat, just wondering, because if you just look at the face of it, there was significant basis contraction in Q1 and Q2. And in the last --

Correct.

Right. In the last five or six weeks it's widened considerably and on the face of it looks like it could be a pretty substantial hit, but it sounds -- your comments sound as if what you've been doing is buying in wheat as the basis has weakened so that it's not going to be as big a marked-to-market hit as it would look on the face of it. Am I understanding that correctly?

I think your first assumption is correct, that, one, as we take -- as you know, we've been long wheat for quite some time, so the wheat we owned, as we came through the end of June, we had all that appreciation. Now as that particular wheat we still own and we have -- the basis has actually dropped down a bit. But there's been nice carry from July to September and from September for December. So we may have gone down against the July, but by the time we get back to the December, even if it's 30 under -- or 40 under December, that's still well above where the July was. Are you following me?

Yes.

But in addition to that, we have been buying on the way down and we've also been able to sell. But it will be a hit, and we have some much ownership that each $0.05 or $0.10 is a big deal. And that's why I brought up 2008 again. For that which we own and we have space, it's just fundamentally a timing issue. And it's -- and to the extent that we have good carry into futures markets, we will earn that carry, in my opinion, and eventually come back to this convergence point.

If the market -- if the global market wants more wheat than we might have projected in the USDA supply/demand balance table just recently, if it wants more and there's a demand for wheat, well, then that basis would come back more rapidly. But of course then we would be selling our inventory out too.

So I can't sit here and even attempt to suggest where we'll be at the end of September, exactly where we'll be in the end of December, but consistently we have been saying owning this wheat when there's carry in the market is a very good thing, and yet we've had some really lumpy quarter space income result as a result of the point you make.

Well, I mean, not that you have your druthers, but if you had your druthers, would you prefer that the demand actually materialize in the U.S. and so you actually -- the basis contracts very quickly and you ship it out? Or would you prefer to hold it for a while and just wait for the basis to take care of itself over time?

If I had a preference, this is the economist, it depends. I mean, we're jammed full -- we've been jammed full of wheat for some time, so we have to sell wheat all the time. So we do like, if you say I have my druthers, the wheat pops up a little bit, we sell it, and then we buy more and it goes down.

Right.

But you don't always have your druthers on that. We're hopeful as a storage facility that if the demand truly is there, that it's not so strong that it just cleans out our stocks.

Right.

But I'll tell you this, if prices stay where they are, we already see the activity that's going on with the booking of new crop wheat next spring, we've got an early harvest in the north, we've got wheat prices $3 and something above corn, there's going to be an awful lot of people planting wheat. So if the demand materializes and it takes it out, I suspect we'll refill.

So if I have my druthers, we're able to sell a little bit based on some demand that comes, but not so much to take too much of our stocks away, from a [selfish] perspective.

Okay. And then --

And I just -- and I truly don't get concerned about a $0.40 drop in basis, that we take a $0.40 write-down on our inventory, as long as we have space for it and we can carry it, because then it comes back. And a situation like that, if it goes $0.40 lower, virtually assures that the spread stays wide and we can earn that carry.

I guess my two final questions, you're talking about how full you are on wheat, is, first, do you have ample room for what's going to -- looks like it's going to be a very big corn harvest.

We'll just stay with that. We're going to be challenged on logistics for the fall because of our desire to -- with where we could own this wheat to -- and we've had the same situation for years, but we will have a big fall harvest and there is going to be demand for not only space but put-through capacity on corn. We'll be in good shape to handle the corn property to the extent that there's demand and there's freight available. Because we can put it through, but to the extent that it wants to lodge in the space, we'll be challenged.

Okay. And it doesn't seem likely, but suppose we have a situation like '08, '09 where there's -- I mean the basis spread for wheat gets very large. Is there any talk about -- on this variable storage rate with the CBOT, allowing you to become more aggressive in raising the storage rate so that you don't have it languish at $1, $2 bushel discounts like it did for a while.

Well, VSR, the variable storage rate, I described what can happen, how it could go to $0.11. There's also what they call [third tick] where it could, if it averages 80% of full carry with $0.11 storage rate, then it can go up to $0.14 storage rate. So it can go one more move beyond that. And I think the size of those charges are such that it would surprise me if basis could -- you used the word languish, I like that word -- surprise me if wheat basis could languish at numbers like we experienced before.

Okay. Okay. Thank you. Congratulations again.

Thanks.

Thanks.

Your next question comes from the line of Mike (Inaudible) of Piper Jaffray. Please proceed.

Hey, guys. I'm on for Mike Cox today.

Okay.

Wondering about SG&A expenses for the balance of the year, how are you guys thinking about those expenses? On an absolute level they remain fairly constant as a percent of sales, do you think?

That's a good question. One of the reasons that we're up right now this year, some of it -- a lot of it is embedded in compensation in part. So, some of that, as we've taken on some acquisitions, headcount is up a bit, so that part of it would continue up. But we also, as we're accruing our performance incentives, our variable pay, we will, well, accrue that based on the size of the earnings that we have. So, a fairly sizable increase in the SG&A is in our variable labor.

Percentage-wise, I'm going to say that's maybe 60%, in that range. And I hope that piece continues. At the same time, I gave you a kind of a viewing of the last half of the year, and if that plays out, that piece of it will go up or down depending on kind of the actual results.

Sure.

So, feel pretty good about the fact that the vast majority of the increases are tied to both growth and performance.

Okay, very good. And then kind of sticking with the acquisition theme that you brought up, are there any other opportunities that you guys see to add elevator capacity through lease or acquisition?

We have interest -- we have interest, we've expressed that before. We also know that it's got to fit kind of the footprint that we have and also got to fit the right price. And I would say right now, with what's occurring and the returns you can get on space, right at this moment, for the most part, in my opinion, not a great time to buy. Now I say that at this moment.

Sure.

That can change literally monthly, and we've got our line in the water and we're talking and we're looking for opportunity. We also have the reality of this recent spike in prices again, brings back the issue of that number of those in the elevator system that hedged, a whole challenge of managing margin cost. So that dynamic sometimes -- that has created some opportunities for us to put these put-through agreements that we have in place where we -- someone else operates the facility and then we manage the other pieces of it. So we'll continue to look for things like that.

Okay, very good. And one final question I guess, you'd mentioned the percent of ethanol production that you had booked going forward, is that -- and you said it was substantial. Is that -- do you think that's like 15% or is it higher?

No, we had -- I forget what we told you last quarter exactly, but we're in the roughly above three-fourths locked in --

Okay.

-- through the last part of the year, and as we talked before, the margin structure in the last half has never been very good. We think we'll be above breakeven, but we're purposely preserving the year.

And this situation, we've got some more production capacity still coming on, not huge amounts, but with the current domestic projected consumption being less than what we see the production, and we've been building stocks of ethanol and we haven't moved yet on the ability to go above a 10% blend, we've just said, hey, we're going to -- we're just going to, until some of the stuff gets resolved, until the mandate catches up, we're going to be willing to lock some stuff in, and now what's going on in Brazil right now where sugar price is through the roof, ethanol prices are up there, our exports are increasing, spot margins are back to really nice, healthy levels. So that one could easily say, well, you don't look too good against that. And I'd say, yes, we don't look good against that.

The [farmer margin] is still not all that healthy. And frankly, some of the nervousness just around what's going on in the commodity market driven by wheat, but then this is also a feed grain story, is if there's a response on the corn side, then we've got to be sensitive to that in the ethanol mix. So that was a long-winded answer to say --

That was good. Yes.

-- about three-quarters.

Yes. No, that was perfect. Thank you, guys, for the questions.

Yes.

Your next question comes from the line of Eric Larson of Soleil Securities. Please proceed.

Yes, good morning, everyone.

Hey, Eric.

Grain prices up as high as they are, can you -- you know, obviously you're going to have the finance these inventories, can you give any idea of what -- how your financing costs might look in 2H? And what is your incremental financing rate for crop inventories?

You know, Eric, we still had a really nice support from the banking community, and so our cost of credit won't change between second quarter and third quarter, between first quarter and fourth quarter. We're in a long-term, syndicated facility, the maturity is in September of 2011. And so we're not going to see any change in the interest cost to us during this period of time, providing of course that we perform as we think we will. So that's the good news.

The other good news is that we've got great liquidity. We have $475 million of lines of credit and we feel pretty good about the ability to access additional capital. We do -- we have indicated we've got an accordion that's available to us above that, and our expectation is we're well-situated to not only fund our activities but to take advantage of some of the opportunities that Mike outlined earlier that may come our way should -- [they start running] on the margin side.

Yes. No, I'm less concerned of your ability to finance it. What -- interest expense, what do you think the incremental increase in interest expense could be over the next six months or so?

Well, we've already disclosed kind of our borrowing cost, that's kind of in the --

Right.

-- in terms of the rate structure. So I would say, are you asking me on a per bushel basis or are you asking me on an absolute basis?

Absolute basis.

I think it's a little bit tough for me to kind of guess that. You know we ended the quarter with a lot of cash and the margin calls that we've had and normal corporate users will consume that cash, along with our normal pattern in the fall of acquiring inventory. So I think if things play out the way Mike kind of sketched here in terms of the last half, in terms of volume purchases that we expect, I think there shouldn't be a huge surprise there. But it's all a function of what the market does over the next six months.

Sure. We talked a lot about the wheat basis this morning. But the corn basis, particularly just a month ago was very, very wide. And that incrementally has to be of value as well. Can you give me any more flavor of what you're looking out on the corn basis going forward?

Well, the value to us on the corn basis, to the extent that we have space for corn, which we have some, is that we'll put that away and store it and earn good carry, which -- so we will do that. The vast majority of our space is allocated to wheat, but we still have a huge amount that's allocated to other grains. So that will be good for us -- well, I shouldn't say the vast majority. That's an overstatement. A significant amount of our space, and we have a significant amount allocated to corn.

And the way things are setting up, in most of our drawing area, with the higher prices, good-looking crop, potential for good acquisitions, we should be acquiring corn at really nice basis levels and carrying it into next year. And it looks like it should come in earlier this year. Well, last year was really late. I'd say earlier than normal, much earlier than last year. And in the absence of a surprise with the frost we should have better quality in store. So that's a positive outlook for us.

Yes. No, there's no doubt. The only issue with corn right now is it's actually maturing a little bit too quickly. So already a lot of it's already dented in July. We've never seen corn dented that early. So I guess the question --

Lansing is getting grain, corn down in Louisiana right now, harvested in -- great quantities.

There might be some areas in the north that are harvesting not too far away from Labor Day which is basically unheard of.

Correct. Absolutely. It's going to put an interesting strain, as everybody kind of winds up logistics, just getting the freight position right will be interesting this year. Last year --

It will.

-- everybody had shifted back a little last year, and that created a heartache. This year it's shifted forward a little.

Yes, it's the same old story, it's just a different -- it's just a different month for the same old story, right?

Exactly.

Yes.

You got it, Eric.

All right, thanks, guys.

Yes.

Thank you.

Your next question comes from the line of Brent Rystrom of Feltl. Please go proceed.

Hey, Brent.

Yes. Hi, guys, how are you? My congrats as well.

A couple of quick questions for you. When I was out there a couple of weeks ago, we were talking about, down in Hart and Logan County, Hancock, starting to see the effects of the nitrogen leaching, particularly on those corn stocks. I would assume that you're feeling pretty good about fertilization sales. I'm wondering, are your agronomy centers seeing guys start to lock in prices right now, particularly what's going on the last couple of days with pricing?

Well, you know, it's not -- it's easier said than done locking in pricing when you talk about nitrogen. In fact there's been on the part of nitrogen producers, there's been a reluctance -- there's been a reluctance to forward price as much as maybe there historically has been in the past. So it's not as easy to lock in.

But I would say that we are experiencing some prepaid business and we would expect to experience that as we come into this time of the year, because of the very reason you talked about. But I wouldn't say at this time that it's anything unusually high or strong. Again part of it is just a little bit of nervousness about now that we've had a little escalation of prices, it's paying too much.

Certainly the ground is in a position to handle [PNK] and the pricing of the grain supports it, but we're not -- we're just not seeing a willingness to go lock in too much.

Okay. From a regional perspective, looking basically in the three states the core of your company operates in. I'm kind of doing a back-of-the-envelope pricing, but where wheat is right now, it looks like for a farmer it could be as much as 40%, 50% more profitable, not from a revenue perspective but when you consider all the inputs. Has that happened historically in your region? And when it has happened, have you seen massive shifts in kind of the percent of planting to various crops? Have you seen those shifts significantly --

That's a great question, and we do not have much experience of a time coming into wheat planning where we've had this dynamic of wheat prices versus feed grain or bean prices, with $3-and-some-cent over corn. And your point about the profitability, wheat is a cheap crop to plant and you can take risk on not necessarily the best seeds too when you've got a dynamic like this. And add on top of that, we're going to have an early harvest. So we do see shifting that goes back and forth for price, because of price, but we've not quite had a situation like this. I'm not going to say it's never happened, it probably has, but in recent --

You'd have to come back to like '73 or something, right?

Yes, you've got -- that's before my time of being active in the grain business. We're going to see a shift. We're going to see a broad shift if the pricing stays up here. Then the question is, do farmers lock it in ahead of time or do they plant or not? But we would expect to see a sizable increase of volume of wheat, if the level of wheat stays in the vicinity of where it is and if the relationship to corn stays in the vicinity of where it is. You put in a revenue insurance, overlay that above it, it's a pretty doggone good look on nice profitability.

And that trickle effect creates a feed grain story. Okay? Where's the acreage for the corn? I'm not talking U.S. just now, I'm -- it's a world macro thing. And this is a dynamic that's occurring real-time in discussion and I would say that there are not answers, it's more discussion topics, and you're on a hot one. Personally I'd love to see the U.S., given what's going on globally in some of the production, there are some supply concerns, personally I'd love to see a little relaxation of the CRP, the Conservation Reserve Program, for next year, to allow a few more acres and allow the ability for some more acres to come in or at least the option of producers to have that --

You mean beyond the 4 million rolling off in September?

Correct.

Yes.

Correct.

Out of curiosity, are you guys seeing any discussions, you know, what we've been seeing here in the upper Midwest is test weights down in the 51-pound kind of range for corn. Are you guys hearing anything about how the corn is looking this year relative to --

Corn, our feeling is corn from a quality perspective, general statement, should be very good.

All right, so the test weights should recover back maybe to 55, 56?

Or above 54.

All right. All right. And then just a broad-based question but I think kind of an interesting one given the investment in LTG, obviously they tend to go a little more long and short on these things. How are they feeling about these moves in the last month?

First of all, long and short, they do have a crop trading business, but Lansing does not do -- does very little flat price speculation in its cash grain or its crop business. They will do some and they'll take positions in spreads within the limits they have prescribed, and the volatility creates the risk of volatile results but it also, especially when there's dislocation of grain, creates some opportunity. But in general, I think most of us in the grain trade have had a prospective, and I'm not talking about just Lansing, Andersons, that wheat spreads would stay at a carry through next year. And with this escalation nearby, the spreads on the back side next March, May, July, September, if crunched in, and I would say we're sitting here right now saying we believe that will likely turn around, and if not, to the extent there's positions, we'll take a little hit on that particular one.

But, no, they're feeling good right now with their basic overall mix in dealing with I would say the nervousness and the opportunity to manage the volatility. But again, they do not take hardly any flat price long or flat price short positions.

All right. And then final question, I know they operate geographically a little broader area, have they had any particular benefit from the soybean shortage in Eastern Nebraska and Western Iowa?

I really don't -- I really don't have the specific knowledge to answer that.

All right. I'll follow up with you.

Yes, that's a deal.

Shoot me the question, Brad, and we'll get to you.

Okay, we'll take another question or two.

There are no further questions in queue at this time.

Well, perfect.

Okay. Thank you, everybody. Thanks for joining us. Next conference is Thursday, November 4th, at 11 o'clock to review the third quarter. Hope you can join us. Have a great day. See you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.