American Vanguard Corporation (AVD) Q1 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the American Vanguard Corporation First Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bill Kuser, Director of Investor Relations for American Vanguard Corporation. Thank you. Mr. Kuser, you may begin.

Well, thank you very much, Devon, and welcome, everyone, to American Vanguard's First Quarter Earnings Review. Our speakers today will be Mr. Eric Wintemute, the Chairman and CEO of American Vanguard; and Mr. David Johnson, the company's Chief Financial Officer. Before beginning let’s take a moment for our usual cautionary reminder. In today's call, the company may discuss forward-looking information. Such information and statements are based on estimates and assumptions by the company's management and are subject to various risks and uncertainties that may cause actual results to differ from management's current expectations. Such factors can include weather conditions, changes in regulatory policy, competitive pressures and various other risks that are detailed in the company's SEC reports and filings. All forward-looking statements represent the company's best judgment as of the date of this call and such information will not necessarily be updated by the company. With that said, we turn the call over to Eric.

Thank you, Bill, and thank all of you for joining us on our call today. I hope that you have had the chance to read our press release issued at the close of market trading. As you recall, 2 weeks ago, we provided a business update, which indicated that our first quarter results would be approximately those which we are posting today. In this call, David and I want to discuss a number of points to help you better understand the reasons behind our first quarter performance, as well as near-term outlook for American Vanguard. First, the current performance challenges that we face relate entirely to our U.S. corn business, our product lines that provide protection for other crops and non-crop users are doing well, on plan, on budget. Second, the primary issue that is driving everything we talk about today is inventory, both inventory in the channel of distribution and AMVAC's own in-house inventory. Remember that in 2011, 2012 and 2013, AMVAC was facing unprecedented demand for its soil insecticides, and we responded with an all-out acceleration of production and an equitable product allocation to satisfy our customers. However, when weather disrupted that flow, inventory accumulated, and the 2014 spring selling season has been dampened as distributors, retailers and growers were down at unused 2013 material. Higher-than-normal levels of inventory in the channel account for this season's lower sales rate affect our inventory turns, influenced our production plans and ultimately affect our profitability. Third, most of the performance difficulties that we are experiencing are weather-related, caused primarily by last year's persistent wet weather, along with this year's prolonged winter. As we have told you previously, these conditions have resulted in unplanted acres, delayed planting and accumulation of many unused crop protection products. In order to gauge future demand as accurately as possibly, we recently conducted an extensive survey of our top 20 retailer customers and through additional market analysis, we have an improved understanding of inventory stocks at the retail level. We found that we have underestimated the level of inventory held by retailers since the 2013 season. Specifically, we now believe that retail outlets were holding about 30% of their annual needs, which exceeds the normal level of 15% that we had estimated. Bear in mind that corn planting has not yet begun in earnest. EDI information indicates that our corn insecticide products are moving through the channel from distribution to retail outlets. This activity tends to show that inventory levels at retailers are normalizing. Based upon this trend, we believe that channel inventories will return to normal stocking levels by the end of this planting season. This in turn, would set the stage for a more predictable supply and demand situation for the 2015 planting season. The bottom line, we firmly believe that these weather-related inventory difficulties are a temporary condition and do not diminish the fundamental value of AMVAC's products to the corn market. University studies continue to highlight resistance development. Corn growers continue to see improved yields by using our products and growers continue to invest in our SmartBox delivery system, reaffirming their commitment to use soil insecticide to combat soil insect infestation. David?

Thank you, Eric. As you all have read in our earnings announcement, our first quarter 2014 sales declined by 33% to $81 million as compared to $122 million last year. Within this number, our crop sales were down 36% at $73 million, and our non-crop sales were up 32% to $8 million. Finally, our international sales increased by 25% as compared to last year and ended at 29% of overall sales as compared to 15% in 2013. In our 10-Q filing scheduled for tomorrow, you will see a detailed description of sales by product groups. Rather than walk through those details on the call, I'm going to focus on the most important areas of our financial performance. These include our drop in net sales and gross margins, our increased inventory levels, factory costs and absorption, our progression towards controlling operating expenses and our net income result. First, as Eric mentioned, our drop in net sales for the quarter arises almost entirely from reduced demand for our corn products. Second, our gross margins are down from 44% of sales in Q1 of 2013 to 36% this year. There are a few factors driving this result. The most important impact is the drag on gross margin caused by the decision to hold back on manufacturing activity. We calculate that 2/3, or about 5% of the reduction in gross margin as a percentage of sales, is caused by increased under-absorption of factory costs. As you may recall, in 2009, we set standard production levels so that inventory values would not be unduly burdened in times of reduced factory activities such as we are experiencing at present. In this quarter, manufacturing expenses exceeded costs absorbed on activity, and as a result, we have recorded an expense. This means that inventory continues to be valued at a normal level. In addition to the impact of manufacturing under-absorption, the balance of the reduction in gross margin performance is attributed to the increased proportion of international sales, which are generally lower margin, and furthermore, some sales mix changes domestically. You will note that inventory at the end of Q1 2014 was $158 million, which is 13% above the $140 million level recorded at December 31, 2013. The primary reason for the increase in inventory this quarter is the lower-than-expected sales and the scheduled arrival of long lead time raw materials that were ordered some time before the market condition really started to become fully apparent. This takes us back to manufacturing utilization. As we work to manage down inventory, we expect that our factories will be operating under capacity for the balance of the year. To mitigate some of this burden, we have already reduced headcount at our formulation and packaging facility which is focused on packaging our corn products. We are looking at all conceivable ways to optimize our manufacturing activity while maintaining critical functions. We believe this is a short-term challenge that will start to shake loose in late 2014 or early 2015. So for the present, we are focusing on staging our campaigns so as to maximize factory use while controlling inventory and also looking to cut costs where possible. Furthermore, we are working to hold back or slow down on capital spending projects, which for this business, are mainly focused on factory capability and capacity. Management of operating expenses is critical at times like this. Eric talked about our approach to this element of our income statement in the conference call on April 10, 2014. Our target is to hold down our operating expenses to below the 2013 level. This is a delicate balance as we do not want to slow down projects that are expected to drive long-term benefits. In Q1, we recorded operating expenses of $25 million, which was 10% below the $28 million we incurred last year. Despite this control, we incurred higher advertising cost promoting our brands, but these costs were substantially offset by lower legal costs. Overall, our operating expense as a percentage of sales ended at 31% as compared to 23% this time last year. The low level achieved last year was driven by the very high sales recorded. As a result of the decline in gross profit performance, offset to a degree by reduced operating expenses, our operating income before taxes decreased by $22 million to end at $4 million. Interest expense was slightly higher in Q1 of 2014 as compared to last year. Our average borrowings increased 44% to $76 million from $52 million this time last year. Offsetting this increase, our effective interest rate on borrowings was significantly better at 2.6% as compared to 4% last year. That is the benefit of the restated credit facility we put in place in Q2 of 2013. At times like this, it is important to note that our bank group has been developed over a number of years and includes people who really understand the ag space. We had discussions with the group in which we have briefed them on our current trading. All the lenders are very supportive of the company and we will decide, most likely during Q2, if we need to make any minor short-term adjustments to key covenants as we work through this trading period. Finally, our tax rate declined from 35% in 2013 to 30% this year. This was driven by the higher proportion of international sales I mentioned earlier, which have the effect of generating higher income in tax jurisdictions with lower tax rates. As a result of all of these dynamics, our net income for the quarter ended at $2.1 million or $0.07 per share as compared to $16.9 million or $0.59 per share in 2013. Now, back to Eric.

Thank you, David. In closing, let me reinforce a few pints. Our financial performance for the quarter is rooted in what we believe is a temporary condition in the corn market. Excess inventory in the channel and in our shelves has affected our manufacturing activity as well as our gross margins and net income. We expect the distribution channel for corn products will return to more normalized levels for the 2015 season. In the meantime, we are focused on managing our working capital, controlling operating expenses, reducing plant costs and keeping inventory levels in the check. We expect solid growth of on-ground use of our corn products in 2014 as compared to 2013. Finally, we are anticipating solid performance from the many non-corn products in our portfolio. With that, I'll turn the call back to the operator for questions. Devon?

[Operator Instructions] Our first question comes from the line of Michael Cox with Piper Jaffray.

My first question is on this pace of the inventory drawdown and I was -- I guess, if you look at moving forward over maybe just the next 1 or 2 quarters, at what point would you anticipate that inventory would be a relatively flat to last year? Maybe start with that.

You're talking about inventory at our level or in the channels?

Yes, at your level, yes.

Well, I think we won't bring inventories down, well, as far as flat to last year, I think if we're talking about -- if you're talking about maybe December -- by December 31. I'm not sure we will get there before the fourth quarter because that's probably when sales of inventory of products, the corn products that we have now, will be moving out the door.

I see, okay, okay, that's helpful. And in terms of the manufacturing reductions that you're planning, is there any way you could quantify what that looks like maybe at the Alabama facility or the formulation facility?

And are you looking for quantification in terms of numbers or you're looking for a quantification in terms of what we're going to be producing and what we're scaling down and all of that sort of thing?

Yes, I guess, kind of the latter, maybe in just percentage terms if you're to -- what you produced last year and what that would look like this year.

So last year, we ran, and we ran basically for 10 months 24/7 on the granular side. And that's the biggest manpower that we have. And we've now brought that down to kind of a 50% level. We have a variety of different products that we do make, not all of them in corn, but it is predominantly driven by corn. But we have some international products that get made there as well. So I would think that from a granular production in 2014 versus 2013, we're probably going to be down 50-plus percent. A lot of that -- we'll have a good idea when we see the final volume which -- we'll have a decent look probably, well certainly by next call, but sometime in July, we'll have a pretty good idea of how well this season turned out.

Okay, that's helpful. And then my last question is, as we get past Q1 and into the second quarter, from my understanding, the product mix starts to change a little bit, and less intensive on the corn soil insecticide. Should we anticipate the pace of revenue declines to begin to moderate as we get into maybe the cotton season in the latter part of the year? Is it possible that we see this inflect positively by the third quarter?

Yes, I think third quarter really doesn't have much with corn. There's a little bit of September sales, but most of corn -- the corn sales for '15 -- or '14 are certainly done by June, for the most part. In fact, we do have some sales in July, but the corn soil insecticides will be done. So I think, yes, Q3 would tend to be -- look more normal from that standpoint.

Our next question comes from the line of Daniel Rizzo with Sidoti & Company. Daniel D. Rizzo - Sidoti & Company, LLC: So you're talking about corn price are you just talking about the insecticide or is there also inventory problem with the herbicide products as well?

There was higher-than-normal amount of Impact left in the channel as well, not quite to the degree that there was of the corn soil insecticides. Again, it has a longer -- the corn soil insecticides go down at time of planting and that's it. The Impact can be used all the way up to 45 days before harvest. So it has a much longer season. Just -- I made reference to the part that we didn't have -- we have good vision of what's in inventory at our distributor's level through EDI, but we have not had good vision of, and what we will be looking -- focusing on going further, and I think as far as I understand from our customers and talking with retailers, this was kind of an unprecedented season for them. They're normally at about 15% is what they manage to. And as we've gone back and looked, we see that's closer to a 30% level. And they do anticipate ending at about 15%. So part of the reasons they would have -- normally a retailer wouldn't hang on because you can return it to distribution for full credit. But with price increases, they kind of look at the concept of, "I'm going to use it next year, I might as well hang on to and -- rather than turn it back and wind up having to pay a higher price for it for the next season." Daniel D. Rizzo - Sidoti & Company, LLC: Okay. And then I think you said that the corn plantings haven't really begun yet. Isn't that late now that it's May 1?

It is, it is late. I was in Des Moines yesterday and actually about 60 miles north of Des Moines, it was snowing. So it is a long, colder winter than normal. Last year's plantings were late as well. But this is a late time for planting. That being said, they're probably starting -- I think they're looking at starting maybe 2, 3 days from now, that the outlook looks pretty good for the week following. So I think we'll start seeing some heavy planting going on over the next 2 weeks. Daniel D. Rizzo - Sidoti & Company, LLC: So would that suggest that some of the problems that happened last year with wet weather are now happening with cold weather whereas because of the delayed season that they might be switching to soybeans which has a shorter growing season and they might also limit the use of insecticides and herbicides?

It certainly could. There are couple of things on the soybean corn issue. One is the ratio, again, we talked about before that if corn prices is 2.5x less than soybeans or more than that, if it's 3x less, then that would favor soybeans. But if it's 2.5x or down to 2x soybeans, they they'll favor corn. As it stands now, it's -- we're running at about 2.75 so it definitely favors beans. That being said, there is predicted to be downside from the 20 -- 96 million acres and right now, 91 seems to be the number that people seem to be focused on. So 5 million-acre reduction in corn on a market where we're participating in 5 million acres isn't necessarily a huge percentage of our acreage. But with regards to -- if planting weren't to start for another 4 weeks or so, yes, it would probably have a bigger effect. But I think as planting goes as we think starting up kind of next week, the week after, there should be plenty of time to make that decision for corn for those who want to grow corn.

[Operator Instructions] Our next question comes from the line of Brent Rystrom with Feltl.

Just couple of quick questions, Eric. The Western -- the West part of the Western part of the corn belt particularly Nebraska, Southwest Iowa, sounds like the planting is off much faster there and it's much drier. Does your data show you anything different in those areas than, say, Eastern Iowa or Southern Minnesota, we're probably 2 to 3 weeks from planting yet?

Well, I think you're saying further along in Iowa than they...

Well, Wester Iowa, Southwestern Iowa and Nebraska. I've heard pretty good progress this week because of the lack of rain. I was down in Southeast Minnesota yesterday and there's standing water in the field, the dishes are filed to the rims and overflowing. So I'm just curious if you're seeing data from your EDI in that Western part of the corn belt that shows anything -- did it show of an uptick compared to, say, Northern Iowa or Southern Minnesota?

I don't recall that it has shown that. I mean, I certainly -- the Southern markets have moved along because they're pretty well-established. But I didn't check specifically the look at Nebraska, but I will go look at that. But we're looking at it every day and kind of checking to see where this goes. Now keep in mind, this measures what our distribution sells to retail. It doesn't tell us the retail activity itself to the grower.

Yes, all right. From a kind of an odd perspective, when you look at late planting like this, this reminds me of like back in 19 -- maybe '91, we had a year where we had a late planting, it was kind of a cool year. Even though the soybean to corn ratio favors beans, you kind of look at a year where the beans -- if farmers intuitively look at how cool and how wet it's been, this is going to be a tough year to phase out beans. So if we get towards the insurance stage in early June for beans, and farmers are seeing poor progress in getting beans going, what happened back in '91 is we shifted heavy back into corn because farmers felt they could finish the corn crop out with the time left that, that beans wouldn't have enough time to reach maturity. Any particular thoughts on if we did see kind of a resurgence to corn planting in late May, early June, would you have an ability to respond to that in these corn sites?

Yes, very good point. I think it's fair to say that we talked with distribution. We have all of our inventory positioned where deliveries can be made within a day. So most of the corn area we can service by the following day. So I think they're all aware of that. We talked with our customers, and the good news is, from their standpoint there, nobody is saying, "Hey, financially, we've been told not to bring in more material." They've all said, "We'll order as much as the demand is there." So there's -- I think where we saw in the first quarter, customers reluctant to take material as they move their inventory down then they will -- no problem in taking material and no problem from our standpoint on reacting and delivering.

Okay, my final question then is could you give us an update on the liquid corn soil insecticide? Kind of where's that at and what are your thoughts on it?

Yes. So we -- I think there are about 10 companies that we are looking to take position on. And I think so far we've seen 8 take position. It does appear, because we ask the questions, the same situation that we were facing with our granular insecticide, they were facing with the liquid insecticide. So they had fairly large carryover of FMCs product and working that down. But we're pleased with the penetration that we've gotten. It's early to hear the results, but based upon most of these companies have done some of their own testing because a lot of them have their own proprietary fertilizers, and they -- our product mix is very, very well. So we think we'll have a good building platform for next year based upon what we've accomplished this year.

Our next question comes from the line of Chris Kapsch with Topeka Capital Markets.

A couple of questions. Just wondering if you could -- given the negative delta and the gross margins year-over-year, that we're demonstrating in the first quarter, now you have a better sense for how you plan to throttle your production back. Just any sort of guidance on just the order of magnitude, the hit year-over-year to gross margins for the balance of the year?

I think, as we're looking at it here, second and third quarter, again, this depends on the product mix too. So it's not just a function of utilization of the assets. But if we had to kind of throw a forecast of maybe expect similar type impact in Qs 2 and 3, we're looking, depending on what happens here in this quarter, that Q4 may rebound back for us.

And given the slow-moving products, has this affected the pricing dynamic at all? Can you all speak to what the pricing situation is? I think you had implemented price increases coming in, I'm just wondering if those have been conceded.

Interestingly enough because this was a question I asked yesterday with our customers, and they have not seen any margin erosion with the corn products. We had thought that farmers would kind of wait and eventually people would start discounting to move product, but we're not seeing that at this point. So that's a very encouraging sign for us. I know on our previous discussion, there was -- if we were to discount the product, would the grower be more inclined to use our product and the feedback we're getting is, no. I mean, if people have a problem with corn rootworm -- or secondary pests, they're going to use an insecticide. That's kind of the bottom line.

Okay. And then you mentioned that given the bloated inventories internally, that -- and given your balance sheet now that you're looking closely at covenants. Can you just talked through what sort of the key covenants are that you're keeping an eye on and what would be -- what's the risk here in terms of having to amend covenants? And what sort of penalties could you be thinking about if we don't get more of a normalization here, I guess, exiting 2014?

So the covenant is our ability to borrow based on EBIT. And so -- and discussing with the banks and David you may want to elaborate. They've all stepped up and said, "If we do a temporary waive on that" -- they're certainly willing to do that. That did not sound like they were going to hit us very hard to make that slight adjustment. Again, we've been with this group for 20-some years. So they're all seasoned on that. But David, anything you want to...

Yes, I mean, we've talked to the lenders and they're very -- they understand the ag market, they understand what's going on, and have indicated that a modest adjustment to the key consolidated funded debt covenant for a period of a few quarters would not be problematic.

It seems like it's on a rolling sort of 12 months basis on the quarterly?

It is. Yes.

Okay. So if there was something that you need to amend, they would, I'm guessing third quarter would be the worse because that factors in your fourth. Is that what you're looking at? Something around second, third quarter?

I don't know that we're going to get -- I don't think we're having issues second quarter. Again, it kind of depends on how...

Second quarter pans out.

Yes, second quarter pans out and -- but potentially, we could get tighter in third quarter. And of course we want to make sure we have plenty. I mean our position has always been to make sure we've got plenty of dry powder for acquisitions and that sort of thing as well.

Our next question comes from the line of Jim Larkins with Wasatch.

My question was answered. It was just in regards to the covenants with the banks.

[Operator Instructions] Our next question is a follow-up question from the line of Chris Kapsch with Topeka Capital Markets.

Just a general question about your view of the sort of the adoption trajectory of your market with -- you said obviously, this corn rootworm resistance issue, is becoming more pronounced over time. But you've also stated that you feel that when using this product in conjunction with the biotech traits that growers do get better yields. I'm just wondering, like if -- can you really tell, like -- is the market still -- the market growth trajectory and the market growth assumptions still valid? Because it's been obviously obscured by what's going on here with this inventory whipsaw. And can you put some parameters around what you feel sort of the acreage numbers are, and once we sort of looked to 2015, if in fact, things normalize, what sort of market are you really addressing and what are the key adoption drivers?

As I said, we do expect growth of pallets on the ground this year versus last year. And I think we are, at this point, would be speculating, but I would think those same factors would continue to increase in 2015 versus 2014. So we do continue to see, expect growth in the market. There is a function of the price of corn. Growers can make good money at $5, but the lower that price gets, of course, obviously looking at ways to trim their inputs. There's a large market out there for us that we have not penetrated. We will continue to push our message which is it is solid business sense, it makes -- it's a good return on investment to make a soil insecticide application. And that's the message we'll continue to -- our core group of growers that will continue to use corn soil insecticides I think is a solid base. What we're focusing on is making sure that people understand it's a good business decision to make that application. So that's probably what will be driving. And again, every year, you keep -- today, there were 3 more counties in Illinois that came out and said that they had confirmed resistance to trade for, I think, a total of 6 and they said, "In the next couple of weeks, we may up that to 8 counties." So it's on everybody's mind. People know that it's moving in that direction.

As this I guess the understanding or awareness increases, is it -- one of the ways to combat which practice that's been absent obviously is crop rotation. And then I guess, obviously, the adoption of refuge-in-a-bag is another way, so I'm just wondering if you have any visibility on how -- if, in fact, the return to the practice of crop rotation is going to be pronounced this year to affect ultimately the pallets on the ground, as you put it, or ultimately, does refuge-in-a-bag--- I assume your product will still be used in conjunction with that, with that technology rather than that being an alternative to the use of a soil insecticide. Is that right?

I mean, certainly there are those that do not advocate the use of an insecticide. The concept of rotation certainly, that helps with pest pressure. The idea of using kind of multiple traits or pyramid traits, so to speak, can help. We've got some great illustrations, pictures taken from fields that were refuge-in-a-bag fields that were not treated alongside those that were treated, and you can see a great or a good percentage of the corn lying down in the one field and it's -- it can be fairly dramatic. Our -- there is also a group of people saying, "Don't use soil insecticide when you use pyramid tapes." But those are also some of the same researchers that advocating that EPA and seed growers or seed suppliers must go and establish a 50% refuge in order to maintain the traits. I don't see that happening. But that's the kind of level that they believe would have to happen in order to preserve the traits on a long-term basis.[Technical Difficulty]All right. Well, we seem to be having some difficulties.

Technical difficulties.

So if any of you are still on the line, I guess we could...

They can basically call and ask any additional questions and I can take them.

Yes, you could call for Bill Kuser, any additional questions you have. Thank you for joining us today and look forward to updating you in the future.