American Vanguard Corporation (AVD) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the American Vanguard Corporation Fourth Quarter and Full-Year 2017 Conference Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Bill Kuser, Director of Investor Relations. Please go ahead.

Thank you very much, Darin, and welcome, everyone, to American Vanguard's fourth quarter and full-year earnings review. Our speakers today will be Mr. Eric Wintemute, the Chairman and CEO of American Vanguard; Mr. David Johnson, the company's Chief Financial Officer; and also assisting in answering your questions, Mr. Bob Trogele, the company's Chief Operating Officer. American Vanguard will file our Form 10 K with the SEC tomorrow, which will provide additional details to the results that we will be discussing in this call. 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 to 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 Wintemute.

Thank you, Bill. Hello, everyone and welcome to our fourth quarter and full-year earnings call. As always, thank you for your continued interest in American Vanguard. Let me begin by saying that I am proud of our performance in 2017, as we improve both top and bottom lines while making provision for the future growth. Overall revenues were up 14% year-over-year, including newly acquired products. Revenues for our base business rose 4% driven by strong sales in cotton and mosquito control, offsetting some weather-related soil fumigant application challenges, and an industry-wide decline in the U.S. post-emergent corn herbicide market. Further, we completed six acquisitions during the year, through which we will – which we purchased branded products and successful businesses that have broadened our portfolio, diversified the markets that we serve, and expanded our geographic market access. These mid-year and fourth quarter acquisitions were procured at attractive valuations, added over $30 million to our 2017 results, and are expected to contribute significantly to our future growth. As David will note, we were able to complete these deals without increasing our debt significantly, and in the process, actually improved our borrowing capacity by year end. This acquisition model has been a hallmark of American Vanguard's steady growth -- corporate growth and we're strategically and financially well-positioned to continue that success with additional transactions in the coming periods. Further, we have continued to drive technology in both yield-enhancing product solutions and our advanced prescription planting system, SIMPAS. In new product development, we are screening, formulating, testing and registering a new product pipeline to stimulate our business growth. In fact, in 2017, we launched 12 new products. And in 2018, we expect to launch an additional 12. And as I will discuss in more detail later, we have continued to advance the development of our SIMPAS technology as we position this important innovation for commercial launch. We've been able to invest in our future, even while improving net income by nearly 60%. I will now let David provide you with the details of our financial performance. Then, I will return to comment on 2018 expectations. David?

Thank you, Eric. Good morning, everybody. As Bill mentioned, we will be filing our Form 10-K for the 12 months ended December 31, 2017 tomorrow. Everything I'm going to cover in here in brief is included in more detail in that document. Further, we have added our usual high-level sales information to the financial tables attached to the earnings release to assist you in your initial review of our performance. With regard to the financial results for the fourth quarter of 2017, the company sales increased by 33% to $116 million as compared to $87 million last year. Our fourth quarter gross margin reduced to 39% as compared to 42% last year. This was driven by the inclusion of both new distribution businesses that drive strong sales at lower margins than our pre-existing business, and some total manufacturing revenues. Along with the 33% increase in sales just mentioned, our operating expenses increased by 20%. This dynamic resulted in an improvement when comparing operating expenses to sales from 35% in the fourth quarter of 2016 to 31% in the same period of 2017. Net income for the fourth quarter included a onetime benefit of $3.4 million associated with the Tax Cuts and Jobs Act which was enacted on December 22, 2017. The act required all U.S. corporations to make an estimated onetime adjustment in their 2017 financial statements to reflect the new tax rules. Overall, net income in the quarter ended at $8.4 million or $0.28 per share in 2017, as compared to $3.9 million or $0.13 per share last year. This 2017 performance includes $0.11 per diluted share related to the onetime tax benefit noted above. When considering our 2017 full-year financial performance, the key financial issues remain consistent with last year and the last several quarters. First, as Eric mentioned, year-to-date sales were up 14% to $355 million as compared to $312 million this time last year. This improvement includes sales gain from acquisitions that amounted to approximately $31 million and approximately 4% organic growth in our core products. Second, we continue to carefully manage our factory activity, as we balance recovery of overhead costs with demand and inventory levels. In 2017, while our factory costs were up about 9%, our factory output increased by approximately 30%. As a result, unabsorbed factory costs has dropped from $17.7 million or 5.7% of net sales in 2016 to $12.9 million or 3.6% of sales in 2017, adding $4.9 million in pre-tax income for the year. Along with improved manufacturing efficiency, our inventory performance was excellent. We have acknowledged in previous calls that our target for this year was $110 million in base business inventory, that is, inventory not related to newly-acquired products and businesses. In fact, our SIOP team, that's short for sales, inventory and operations planning, which includes Eric and myself, were pleased to achieve an inventory level of $100 million or $10 million better than target. Acquired products and businesses added inventory to close out the year at $123 million, just slightly above the $121 million we reported this time last year. Our target for 2018 is to end the year at about the present level plus the impact of any acquisitions, should they occur. Third, gross margin for the year ended at 42% as compared to 41% last year. This improvement was driven by the factory performance just described, offset by the impact of the acquisition of businesses that drive strong sales, as slightly lower than our average margin levels. Furthermore, our raw material purchasing team continues to deliver a strong performance and has held our overall average purchase cost approximately flat, notwithstanding some year-on-year increases in the marketplace. Fourth, during 2017, we continue to exercise tight control of our operating expenses, which were up overall by 12% but reduced when expressed as a percentage of sales from 34.6% in 2016 to 34.1% in 2017. Some of these costs are nonrecurring in nature, for example, expenses incurred associated with completing acquisitions, and then, supporting those new business post-acquisition. In addition, we continue to energetically defend our molecules before various regulatory agencies around the world pursue the development of our new product portfolio -- of our product portfolio, including the introduction of 12 new products in 2017 and to develop our SIMPAS next-generation delivery system. Okay, our effective tax rate decreased sharply from 30% last year to 18% in 2017. The driving factor in this decrease is a onetime $3.4 million benefit from the Tax Cut and Jobs Act that I mentioned at the start of my remarks. Two offsetting factors generated this net tax benefit. On the one hand, due to a drop in the federal tax rate from 35% to 21%, we reduced our deferred tax liability at December 31, 2017 by $4.7 million, which was a benefit. On the other hand, due to the adoption of a transition tax, we and all other U.S. corporations with foreign subsidiaries are required to estimate the tax liability for deemed repatriation of historical foreign earnings, which, in our case, generated a tax expense of $1.3 million. Subsequent to the enactment of the tax reform, the SEC has issued guidance to U.S. companies, requiring us to make the best possible estimate of the impact of the act on our financial statements and to book that estimated impact in the financial statements for the year just ended. The company now has until approximately the middle of the third quarter of 2018 to refine those estimates. The process of refining the estimates is mainly focused on the latter-mentioned matter, the transition tax, which requires companies that tax accountants and auditors to review tax returns dating as far back as 1986 in order to confirm the final amount that should be paid. We believe that our estimate is reasonable. Our effective tax rate, without the onetime tax benefit, would have been 32% for 2017 as compared to 30% in 2016, and was driven by where we make our profits, specifically U.S. or international, and the level of those profits. For 2017, we have had a strong domestic performance and have continued to build our overhead structure internationally to drive future growth for that part of our business, building the structure reduced international taxable income in the short term. Looking forward, because of the impact of the tax reform, we believe that our 2018 overall effective tax rate will be in the range of 25% to 27%. Looking at the bottom line for the year, our net income improved by 59% to end at $20.3 million or $0.68 per share, as compared to $12.8 million or $0.44 cents per share last year. This includes about $0.11 per share associated with the onetime tax benefit discussed above. Finally, with regard to the balance sheet management and liquidity, we continue to carefully manage cash and working capital. In 2017, we generated $59 million from our operating activities, whereas in 2016, we generated $46 million. Over the last three years, therefore, we have generated $184 million from our operating activities. In 2017, despite having paid $82 million for six acquisitions, our year-end indebtedness rose only $37 million, that is, from $41 million at the end of 2016 to $78 million at the end of 2017. And our borrowing capacity under the credit facility increased from $105 million at the end of 2016 to approximately $140 million at the end of 2017. In summary, when looking at the year just closed, we see that sales have grown strongly, we have held margins and we have delivered on our factory performance and the inventory goals in a manner consistent with indications we have given to investors during the year. Our operating expenses increased in support of our growing business but have reduced as a percentage of sales, and our net income has increased both as a function of our business performance and as a result of the onetime benefit of the Tax Reform Act. Finally, we have closed on several acquisitions during the year that will power the company's growth in the next several years, and at the same time, improved our availability in the credit line, placing it in a strong position to continue to participate in the global agricultural market consolidation. With that, I will hand back to Eric.

Thank you, David. Allow me to take a few moments to cover our pillars of growth, including our breadth of portfolio, the benefits of our newly-acquired businesses and exciting developments in technology innovation. Then, I'll leave you with some closing comments. Well, we have been a meaningful player in the Midwest corn market and it's important to note that over the course of the past couple of years, we've become increasingly diversified with respect to both markets and geography. In fact, during 2017, our leading business was in the high value fruit and vegetable market, which accounted for 28% of our overall sales. In 2018, this weighting will shift even further with the full-year inclusion of the AgriCenter business, which is roughly 75% positioned in this category. Our market-leading position in potatoes represented 17% and should remain firm for 2018. During 2017, corn accounted for about 18% of our revenues, down from nearly 40% that it constituted four years earlier, and we expect that percentage will move down to about 13% in 2018. As we have reported, cotton, sugar and peanuts are also important drivers of our revenue. And our non-crop business, led by our mosquito products, should continue to contribute meaningfully to both the top and bottom line. In short, we are addressing many markets in many seasons throughout the globe. This has been one of the reasons for our relative lack of volatility and performance trends over the past three to four years. Now, let's review the incremental businesses that we acquired in 2017 and the expectations we have for them in 2018. First, the three products that we acquired from Adama last June. In recent years, these products have generated annual sales of around $30 million in a U.S. market that exceeds $250 million per year. From a standing start, we sold over $16 million in the second half of 2017, and expect to achieve 2018 sales that are significantly higher than the annual sales of prior years. Second, Syngenta products in Mexico acquired in August. Sales in recent years have been approximately $8 million to $10 million per year. We anticipate $2 million to $3 million in quarterly sales during 2018. And these are well-recognized branded products in Mexico and we expect to expand their sales in future years. Third, OHP business for horticultural applications in the United States acquired in October. This business has generated between $20 million and $25 million in annual revenues. It complements our existing turf and ornamental franchise, and increases our non-crop segment by approximately 50%. We have maintained the existing talented organization. I expect that this business should increase meaningfully in size over the next several years. Fourth, the AgriCenter distribution business in Central America acquired in November. This company has generated an excess of $50 million in annual sales during recent years, and we believe that it will be a major platform for substantial additional Central American growth for American Vanguard. We are continuing to evaluate additional targets since currently, the landscape for acquisitions is robust. Nevertheless, it bears repeating that we will only pursue deals that are accretive to the company. We intend to remain ambitious but conservative with our traditional commitment to purchasing at reasonable EBITDA multiples and maintaining a strong balance sheet. Now, let me comment on our SIMPAS precision application system. Our 2017 testing validated the operation of this system, and the feedback that we have received about the ease of use and reliability of this system has been excellent. The performance of our wireless control system, the accuracy of our meters and the durability of this system have been remarkable. Starting next month, Simplot Grower Solutions will continue the development of this advanced soil treatment technology, with prescriptive applications of our [indiscernible] counter. The opportunity to combine SIMPAS' variable rate application technology with Simplot's SmartFarm prescription and post-harvest analysis will give participating farmers the ability to target crop protection and nutritional products in a precise manner. In 2019, we will be prescriptively applying multiple granular and liquid products with many growers. This should enable us to commence full commercialization of this proprietary technology in 2020. Looking forward to 2018, we are aiming to achieve the following targets. Our base business and recent acquisitions are expected to boost total net sales by 27% to 35%. We expect to post gross profit margins in the 38% to 40% range, recognizing that in any given quarter, the product mix of our businesses may influence that parameter. While continuing geographic expansion and technology development efforts, we are seeking to keep operating expenses within $150 million to $160 million range. As David indicated earlier, our overall corporate tax rate should be around 25% to 27%. And finally, we expect to continue our recent rate of annual cash generation in the neighborhood of $60 million. This is an exciting time for the company. We are active on many fronts, including the integration of new businesses, the launching of new products and the advancement of technology innovation. Also, industry consolidation continues to provide acquisition opportunities. And in the midst of this, we are maintaining strict financial discipline in improving our balance sheet. All in all, I am optimistic about our future and hope that you share in that optimism. And I'll be happy to answer any questions you may have. Darin?

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from James Sheehan of SunTrust Robinson Humphrey. Please proceed with your question.

Thank you. In 2020, you're going to be doing full commercialization of SIMPAS, as you just said. What are you expecting your annual sales and profitability to be on that product in 2020?

We haven't given a target on that at this point. A number of things need to be accomplished which, in order to get to that spot, what we have done recently is confirm the system works according to plan. We also need the construction of the refill stations that will go along with this, that all works to plan. Our packaging – we're looking at initial launch of three products per row and we're just finalizing what those packages will look like. The granular meters are proving out. The liquid meters are going to be tested over the next several months and we'll continue into the actual planting season for 2019. With the products that we will have available, our portfolio products, we've got timelines that have a number of products available on '19, and for '20, we have an expanded portfolio. But right at this point, we still need to make sure that the formulations will work, whether they're going to be liquid, what the viscosity would be, if they're granule, what percentage they will be, and then, getting approval for registrations because it's likely to be different formulations. So, the bottom line is until we get a clearer picture of what the breadth of products that we have available for 2020, it's probably difficult to make that call.

And on SIMPAS spending, what do you roughly expect to spend on development in 2018? And considering that, along with any acquisition due diligence you might do, would you consider reporting an adjusted or non-GAAP EPS in 2018 to adjust for those numbers?

Well, I think -- we did a number of acquisitions this past period. I think we reported what the amount is if we spent on those. And I think in '18, I guess if we had a diligence that was -- could material recently we’ll divulge that. And with regards to this SIMPAS system, I think we did about $2.8 million in 2017, but we're getting to the point now we're finalizing -- we're doing the equipment itself in some kind of huge -- and without that $2.8 million, we capitalize $600,000 so expense of $2.2 million. For 2018, we will probably exceed that $2.8 million. However, I think we would expect the majority of that, at this point, to be capitalized, so it would not be a hit to our earnings.

And then, with respect to raw materials, are you experiencing significant inflation in raw material inputs from China? And if so, how much pricing do you need to offset that?

Yes, yes, we are in certain products. We have -- I think you're aware that many factories have been shut down in China and it has interrupted -- there is kind of a ripple effect when that occurs. So, those products that are in tight supply certainly have increased as far as our mechanism for passing that through or capturing some gains because we might have product in a short situation. Bob, if you're -- if you could unmute and maybe you have something more you'd like to add to that.

Can you hear me, Eric?

Yes, we can.

Yes, so Jim, we anticipate shortages and price increases to hit the market in Q2 as distributor and suppliers would replenish inventory. That's what we're hearing from the market and from competitors. I would say we're in a good position where we produce our own products. We've strengthened our Chinese procurement team to ensure a competitive position in what we source. Our commercial teams are actively monitoring the markets and customers for price increase opportunities or where shortages occur and we can fill that gap with our own products that we produce.

Our next question comes from Chris Kapsch of Loop Capital Markets. Please proceed with your question.

Yeah, just to follow up on that discussion, as it relates to your gross margin outlook for 2018, so you're saying that you – in your implied or in your guidance for the margin percentages for 2018 for the – at the gross line, that you do not anticipate any net impact from raw materials. Maybe you can just also talk, in that context, to talk about what your expectations are for your factory overhead cost absorption, if that's embedded in the guidance as well.

Sure. Well, as far as raw materials, overall, I think we feel pretty comfortable...

[Indiscernible] 1%.

Yeah. [Indiscernible].

We put a 1%.

We put a 1% and -- 1% what we gain but overall pricing...

Overall, on average, yeah.

Right, right. So, I think our expectations are that we will not have a negative effect to our margins from increased materials. I think one of the things that we've put through our whole organization in this time of volatility that they can't make commitments through the course of the year. And of course, a lot of customers would love to see kind of annual price contract, so to speak, and that's not something that we can't do this in this instance. Your other question was with regards to absorption. So...

Yeah.

Yeah. So absorption, I think you're saying, what, maybe [indiscernible]?

We're anticipating that we'll get to about 3% of sales this year, and we're...

[Indiscernible] okay.

...sliding back to where we're at in 2017.

Yeah. So, we do look for an improvement.

Okay.

And that, again, the overall margins, we have been, I'll call it low to mid-margin-40s, but again, with – particularly with distribution business that we picked up in Costa Rica, we end the fact that it's fairly significant sales that will bring us down a couple of percent.

Okay. That's just a math on those -- the flow-through of those lower margin distribution sales. A cut like, I mean, 200 basis points or is that just ballpark?

Yeah, probably. Yeah.

Okay. And then, so – just so I want to understand the top line, also if you just parsing out those numbers in terms of the deals that you've done annualized at some like roughly $100 million – $110 million to $115 million you did. Those businesses contributed, call it, $33 million in 2017, but I guess should we just expect that the difference there is what those deals will contribute in 2018? I just don't know what the seasonality is and/or some of the precise timing of when those deals close. But is that the one way of just simply thinking about what you expect? And are those business, do you expect them to grow on an apples-to-apples basis into 2018? Any sort of color along those lines would be helpful.

Okay. So, I think I was talking about before, I don't think with this initial year, we see growth in the Mexico business. We said that was kind of in the $2 million to $3 million a quarter range, getting to that $8 million to $10 million kind of level. And that went closed the end of August but we really kind of started up in the middle of September with it. The acquisition from Adama for the three products in the United States, that ended kind of the middle -- or we acquired in kind of the middle of June, and that product line we did well with. These are products that are -- do have ties to China, and therefore, have some volatility but we're feeling pretty good about our procurement that we've made at least to second quarter needs of 2018. The business in Mexico -- I mean, in Costa Rica, there's pretty aggressive growth targets for them, and so, we do expect a meaningful growth there. And with regard to OHP, I think of those 12 products that we launched in 2017, four of those were with OHP and I think they've got another four scheduled for the next year. So, they're on path for meaningful growth as well. So, I'm trying to think of that answering those questions.

I think the numbers were reasonable.

Yes. So I -- yes.

And then, hey, Eric, just so -- just to understand that a lot accomplished in '17, six were all these acquisitions but you have greater ambitions. Can you just talk about maybe what the scope is of what would be on your wish list for acquisitions and scope in terms of what would be ideal to further fill up the portfolio and what's the magnitude of what you'd like to do? And then, if you could just talk about the bandwidth of the organization to absorb these deals, how is that all going? Is it -- or how do you feel about the integration of these product lines and the ability to manage these and additional deals on a go forward basis?

So with regard to the acquisition opportunities, we certainly do -- we do have our kind of a wish list that we talked to various basics about -- and bigger, larger basics. And we've got one right now that I'm working on that I think I started 15 years ago, and I'm hoping by next quarter to have concluded it. So, we do have things that we target and -- but we're fairly -- I mean, when it kind of really comes down to it, we're somewhat agnostic to whether it fits the perfect spot in our product line or not. It's more looking at the financial matrix and what we could do with the molecule. So we could say, gee, we've got plenty of corn [indiscernible] but if the right opportunity came along, we would add to it. So, it looks -- it kind of look more at the prudence of the financial uptick and what'll add to our earnings overall. There are -- every time you have these mergers come together, there are kind of forced divestitures. But then after afterwards, there's the portfolio rationalization. So, we do know that there are products that are going to be sold in that process. And we have some timelines where people are saying, okay, we're going to have this by this time and that. So, I'm optimistic that we're going to continue on in 2018 and 2019 with additional acquisitions. As far as absorbing, some of them are more challenging than others, as you might imagine. I think our U.S. crop team did a remarkable job in incorporating the three acquisitions from Adama and are doing very well, and I expect 2018 to be very strong here and beyond, and able to do that with really out and without any real OpEx. Sales staff, I think we've added maybe one or two more people to handle that business. So, the OHP came with the – just a breadth of knowledge of existing people and having been a U.S. operation company, I think, generally, David had say it's pretty clean.

[Indiscernible]

Right. AgriCenter is more complex, and David one of the reasons we're talking to you on March 12 rather than March 1 is that you can imagine with, I think there's 6 different countries involved and 115 people that have never heard of [indiscernible] before. So, I think right now, we're getting all the internal controls laid out with induced testing them in the third quarter. So, I think we've generated a lot more from our auditors this year. So, I'm just – I'm talking integration from that side. As far as their performance, kind of really, really talented team of people that are motivated. We actually are just granting them into our stock – employee stock grant program. That was something that they were all very excited about and I think that's a tool that we use to motivate our team. And so, then, there were a couple of other major acquisitions which wound up going elsewhere that we were in position, we had commitments from the banks to make them. But in the end, it was – it did not go to us, and a part of that probably because we were not the highest bidder. So, had those two come into play, I think we probably would all get caught here at the office. But I think right now, where we are, we're in a position to absorb more acquisitions and do so without any major disruption to our organization.

[Operator Instructions] Our next question comes from Jay Harris of Axiom Capital Management. Please proceed with your question.

David, I'm a little confused. You had, in 2017, onetime benefit in your GAAP numbers from the new tax bill.

Yeah.

I think you mentioned something in your comments about due diligence expenses. I don't know if you quantify them or not.

It's all detailed in the – it is detailed in the 10-K.

Which is not available until tomorrow.

Yeah.

He's looking it up now.

I think it's $1.3 million with the diligence related costs.

In Q4.

No, not the year.

Oh, in the past year. Okay.

But it is heavily weighted to…

And are there any other -- was there any other expenses that would not be appropriate to look at for an ongoing operation or just those two categories?

Well, I think we had some legal expenses that were higher than normal.

Yes, legal expenses.

That's about kind of...

$4 million higher, I think.

Yes. And that's related to the Thimet container importations, MTs..

A year or so ago, American Vanguard established a business relationship with a large rapidly-growing Chinese agricultural chemical company that also had some operations in Australia. And I believe you were going to try to do things together with this company. Has anything ever materialized?

Yes. We have put our two businesses together. We've hired in Australia. We've hired a experienced general manager to run the business. And we have basically divided Australia into four territories and we've hired individuals to manage those territories. As you may remember, they had about 65 registrations. I think we, in Australia, we had about nine or 10. But the SmartBox is probably the kind of the bigger piece for us, as we switched over from Lock 'n Load to SmartBox, and I think growers really seem to like that. So yeah, we've gotten ourselves organized and put together in that region. So, I think we're poised for a nice growth in Australia. Keep in mind, too, that Huifeng is a strong player. I think they're number three in the Chinese market. They are -- materials that they have that they will manufacture that will go through our Australian entity, but also through this, I'll call it somewhat volatile sourcing time with China, they're key in being able to bring in key products as well. So yeah, and we're -- Australia looks like good work, yes.

Did you try with them to acquire any labels? I think you talked that at point in time about being able to put together between the two companies a fairly large amount of purchase dollars.

Right.

Did you bid with them on any opportunities?

There were peripheral involved in one of the acquisitions. The company that we were making that bid with wanted us to be the negotiating partner, so to speak, in the whole operation. But yeah, we're both evaluating opportunities. There are several different opportunities that we looked at and said, okay, what's your level of interest, what's ours. And in one case, yes, we were both interested in one of the properties but we continue as opportunities come to look at what we might do together.

Thanks very much. Continue the good job.

Okay. Thank you.

[Operator Instructions] If there are no further questions, I'd like to turn the call back to Mr. Eric Wintemute for closing comments.

Thank you, Darin, and again, everybody on the phone, thank you very much for joining us. And we're pleased with the year. We're pleased with the outlook for 2018 and beyond. And look forward to talking with you shortly about our Q1 performance. Thank you.