American Vanguard Corporation (AVD) Q2 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the American Vanguard Corporation’s Second Quarter 2018 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. It is now my pleasure to introduce your host, William Kuser, Director of Investor Relations. Thank you, sir. You may begin.

Well, thank you very much, Jessie, and welcome everyone to American Vanguard’s second quarter and mid-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 to assist in answering any questions you may have Mr. Bob Trogele, the company’s Chief Operating Officer. This afternoon, American Vanguard has filed the Form 10-Q with the SEC, for the quarter ended year providing additional details to the results that we will be discussing in this call. Let’s begin with 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. Hello, everyone and welcome to our second quarter and mid-year 2018 earnings call. As always, thank you for your continued interest in American Vanguard. As per our press release, we reported strong financial results for the second quarter and first half of 2018. Net sales were up 39% for the quarter and 43% for the half year, and net income rose by 29% and 32% for the respective periods. I will let David give you a detailed analysis of our financial performance in a moment, but first, I want to give you a higher level perspective. Our gains in net sales for both periods were driven by the foreign acquisitions that we completed in the second half of 2017. As you may recall these include AgriCenter, a leading distributor in Central America. OHP, a specialty distributor serving the U.S. horticulture market; three domestic products, Parazone, a herbicide; Equus, a fungicide, and Abba, an insecticide; and a slate of products in Mexico. These deals which were obtained for reasonable consideration with no adverse impact to our borrowing capacity have proven to be sound investments. Further, we continue to demonstrate the ability to integrate new product lines into our global portfolio successfully. While new product sales are certainly a bright spot, there is more to our overall results. As business managers, we must also focus on changes in our performance in order to identify potential trends and assess the future health of the enterprise. During the second quarter and first half of 2018 for example, while we saw growth from our new products, we also experienced a modest decline in sales of existing product lines, as well as in overall gross margins. These are subjects deserving a further inquiry. First, let’s focus on how our existing product lines fared during the reporting period and then focus on what trends we expect going forward. As you will note from my comments in the earnings release, sales of our existing product lines varied. We also had mixed performance within the same crop market. On the plus side, soil fumigants did well, while late rains in 2017 prevented fumigation in some areas, we enjoyed better conditions this year. Similarly, sales of our Dacthal, an herbicide that is used on high-value crops, such as onion and broccoli, showed continued improvement. In the corn market, however, we had mixed results; impact, and a post-emergent corn herbicide, demonstrated its enduring brand value by showing gains, while corn soil insecticides were flat in the U.S., and Aztec declined in the international market. In the cotton market, we also had internal variation. On the one hand, sales of Folex, a harvest management tool, increased in the midst of increased cotton acres. On the other hand, Bidrin, a foliar insecticide, decreased in light of lower early-season pest pressure and higher levels of channel inventory. In light of the 20% to 30% reduction in peanut acres, Thimet sales also declined. As you can tell by this brief discussion, our traditional products addressed many markets and each of these markets is subject to many factors including weather, channel inventory, pest pressure and competition. Because our core business is diversified, however, it has been historically stable in spite of these many market factors. In fact, until the second quarter, we had succeeded in recording improved quarterly sales in our traditional business for 11 consecutive quarters. As our newly acquired products become successfully integrated into our core business, we expect that the entire portfolio will continue to grow steadily over time. Now, let’s turn to gross margin percentage. We achieved a gross margin percentage of 40% during both the second quarter and first half of the year. This figure represents a decrease from 44% and 43% during the comparable periods in 2017. First, let me note that we expected this change as we knew that we would be adding a significant volume of newly acquired lower margin products to our top line in 2018. Second, a gross margin percentage of 40% is historically typical of our consolidated businesses. In fact, it’s just north of the average percentage over the past four fiscal years. Third, the 2017 percentages against which we are presently comparing ourselves were above our norm and were driven by the sale of high-margin products. One of the factors that helped us to attain the 40% gross margin in 2018 is our factory performance. As I mentioned in the earnings release, we had an extremely strong quarter from our factories. During the period, factory activity not only absorbed all manufacturing costs, but also yield a net benefit. I cannot remember another time in our history when we have had what I would call factory overabsorption. I would like to commend our Vice President of Manufacturing, John Rizzi, and his entire team for this result. One can reasonably ask whether we can maintain this level of gross margin. I believe that we can. As you know, gross margin is not entirely dependent upon factory activity. It is also driven by product mix. During the third quarter, while we will be entering AgriCenter’s peak season, meaning a higher volume of lower margin products, we also expect continued strong manufacturing activities coupled with the sale of higher-margin products such as Dibrom and soil fumigants. As factory activity eases in the fourth quarter, sales of AgriCenter products will also cycle downward, while sales of the higher-margin products will continue. All told then, gross margin percentage should be stable for the balance of the year. Having stolen his thunder on at least two subjects, I will turn over to David for a more complete picture of our financial performance and then return with some thoughts on supply chain, acquisition, SIMPAS and 2018 targets. David?

Thank you, Eric. Good afternoon, everybody. As Bill mentioned, we filed our Form 10-Q for the three and six months ended June 30, 2018, just a few months ago. Everything I’m covering here is included in more detail in that document. With regard to the financial results, as Eric just detailed, the company’s sales for the second quarter of 2018 increased by 37%. Eric may have misstated the percentage at 39% a few months ago to $107 million as compared to sales of $78 million this time last year. Within that overall improvement, our international sales continued to grow in importance and represented 40% of the net sales in the second quarter as compared to 28% this time last year. Our first quarter gross margin ended at 40%, as Eric mentioned, this was in line with indications we gave last call. During the quarter, our operating expenses ended at 32% of net sales compared to 35% this time last year. On an absolute basis, operating expenses increased by 26% due to several factors. These include the expenses associated with the addition of newly acquired products and businesses, the build-out of our international structure and continued work to defend and develop our product portfolio. These increases were partially offset by lower incentive compensation accruals and a benefit of $1.5 million associated with the GAAP-required quarterly reassessment of the fair value of liabilities under the business purchase agreements completed in 2017. Our tax rate ended the quarter at 23%, which compared with 27% for the same period of the prior year, the reduced rate primarily driven by the introduction of the Tax Cuts and Jobs Act in December 2017. Overall, net income for the quarter increased by 30% to $5.6 million or $0.19 per share as compared to $4.3 million or $0.15 per share this time last year. For the first half, as Eric detailed, our net sales ended at $211 million, a rise of 42% when compared to the same period of 2017. Further, our gross margin continued at 40% as compared to 43% for the same period of the prior year and operating expenses, when expressed as a percentage of sales were 32% of sales for the first six months of 2018 as compared to 35% for the same period of the year. This performance demonstrates that we are achieving economies of scale from our expanded business even while investing in our mid-term and long-term future as we incur expenses for regulatory and product development work and our SIMPAS packaging technology development. Our net income for first half of 2018 amounts to $10.3 million or $0.34 per diluted share as compared to $7.8 million or $0.26 per diluted share in the same period of 2017. As I mentioned when I spoke to you at the end of the first quarter, you may also notice that the financial statements at June 30, 2018, include an adjustment to retained earnings in the amount of $2 million. This beneficial adjustment predominantly relates to the change in revenue recognition rules that occurred on January 1, 2018 and affects all public filers in the USA. This did not affect our net income reported for the quarter or six-month periods ending June 30, 2018. From my perspective, the key financial issues for the second quarter and year-to-date are as follows: first, we continue to follow a disciplined approach to planning our factory activity, balancing overhead recovery with demand forecasts and inventory levels. In the three months ended June 30, 2018, our underabsorption factory cost was at the best level of performance in recent years, with a net overrecovery during what is regularly one of our best manufacturing quarters. On the year-to-date basis, our underabsorption is tracking below 0.5% of sales compared to 4.4% last year and resulted in $5.8 million in additional gross profit in the first half of 2018 versus the same period of 2017. The performance beat our long-term strategic target for this metric of 3% of sales. Having said that, as we have indicated in previous calls, we remain on track in 2018 to beat our 2017 factory performance. Second, during the quarter, consistent with our manufacturing plan for 2018, our inventory increased by approximately $20 million. The bulk of the increase relates to falling through on our manufacturing plan for the current year, which generally builds inventory in the first two quarters and plans to reduce in the final two quarters. In addition, we have both additional inventory, to serve the new businesses that we acquired in 2017. During the second quarter, we have continued to focus on implementing our inventory planning process before the new acquisitions and have now determined that we will likely end the year with inventory closer to $140 million than the $130 million I forecast when I spoke to you at the end of the first quarter of this year. Fourth, our effective rate ended at 24.4% year-to-date as compared to 27.5% for the same period of the prior year. Notwithstanding the first half performance, we continue to expect that our 2018 full-year rate will be in the range of 25% to 27%. Fifth, with regard to liquidity, at the end of the second quarter, availability under our credit lines stood at $137 million as compared to $143 million this time last year. This is remarkable, considering that we borrowed $82 million in the second half of 2017 to complete multiple acquisitions. Indebtedness, as of June 30, 2018, was $79 million as compared to $26 million this time last year. The difference is driven by the borrowings that we made to fund those 2017 acquisitions. At December 31, 2017, debt was at $77 million. Finally in an effort to support investors’ understanding of the business and its financial performance in the earnings release, we have reported EBITDA for the three and six-month periods ending June 30, 2018 and including a reconciliation statement between net income and EBITDA. Our EBITDA improved by 18% in the quarter to $14 million, whereas net income improved by 30%. As I just described, the difference in growth rate is caused by first, the impact of the Tax Cuts and Jobs Act; and second, the fact that depreciation is relatively flat year-on-year and therefore constitutes a smaller percentage of taxable income. For the six-month period EBITDA improved by 22% to $27.3 million as compared to $22.4 million for the same period in the prior year. In summary, when looking at the start of 2018, we can say that we have started strongly, having achieved a significant increase in net sales, recorded gross margin that are in line with our projections, achieved better than forecast factory output and gained economies of scale for our operating costs. We have improved on the tax rate we predicted when we last spoke to you. This all came together in a 30% improvement in net income for the quarter and 32% year-to-date. Furthermore we have maintained a strong balance sheet along with sufficient borrowing capacity to execute on our acquisition strategy as opportunities arise. With that, I will hand back to Eric.

Thank you, David. We have all heard news accounts of the extreme measures being taken by the central government of China against chemical manufacturing plants, citing noncompliance with environmental laws. Numerous facilities have been closed or have their operations suspended suddenly and without warning. These actions have affected our entire industry, including not only production facilities within China, but also plants throughout the world who depend upon them. To date, thanks to the efforts of our supply chain team, we have been able to minimize supply disruptions. Nevertheless, we continue to monitor this matter closely, while developing relationships throughout the globe to mitigate the risks of sourcing key materials from any one country. Further, we are regularly communicating the ever-changing sourcing dynamics with our sales and marketing team globally, so that we can ensure we have the right inventory at the lowest possible cost. In addition, the plant closures if undoubtedly heard extensive news coverage of the trade war between U.S. and China. We have seen tariffs and retaliatory tariffs imposed by both sides on various products, ranging from metals to sorghum to chemicals. It is often not possible to predict, which product will be targeted next. However, we continue to monitor closely the United States Trade Representative, which on August 2, floated the idea of increasing a proposed duty on Chinese sourced chemicals, including crop inputs and intermediates from 10% to 25%. It is uncertain whether or when this duty may be imposed, but we can say that such a duty would affect the cost of goods for our industry, which in turn would likely lead to price increases. Now let’s turn from China and towards the current environment for acquisitions. As we reported in our last call, we continue to see businesses and product lines being divested in many markets and regions. We are in discussion with a number of larger competitors, who are in the throes of consolidation and are looking to optimize their portfolios. Further we, are investigating a number of standalone opportunities that would help us to improve market access and expand our technology portfolio. With our borrowing capacity, we are well positioned to pursue deals that make sense to us. Now, let me comment on the continuing development of our SIMPAS precision application system. During our last call, we reported on the extensive field trials being conducted by Simplot Grower Solutions on about 3,000 acres of multiple farms within Colorado and Idaho. Those trials, which are nearly complete, are aimed at demonstrating that our variable rate technology can be combined with Simplot’s prescription technology, in effect making prescriptive application of crop inputs to targeted areas of the field. Simplot will submit both in-season data, such as imagery and pest pressure, and yield data to XSInc to assess the performance of SIMPAS. We expect to have those results in hand by fourth quarter of 2018. As we look forward to 2019, we’ll be targeting additional users to demonstrate both liquid and granular meters and will increasingly involve U.S. EPA for their direction on how best to ensure compliance and appropriate stewardship of this technology. Before making my closing remarks, I will provide an update on our targeted parameters for 2018. Our overall business is expected to achieve total net sales of between $450 million to $470 million. As I mentioned earlier, we expect our gross margin percentage to remain stable. Further, while first half operating expenses totaled $68 million, we continue to expect that our full-year total will likely be in the neighborhood of $150 million. In light of recent federal tax reform, we expect that our corporate tax rate for all jurisdictions will likely be in the 25% to 27% range. And finally, we expect to continue our recent rate of annual cash generation in the neighborhood of $50 million. In closing, I would say that we are seeing the benefits of a sound investment and operational efficiency. Through 2018, we have grown the business through both manufacturing efficiencies and to a lesser degree, economy of scale. Considering that this is a year of integration, I am pleased with our progress through the midpoint. I can assure you even while maintaining our financial discipline; we will continue to invest in our future through product development, SIMPAS technology and acquisitions. In short, the opportunities for growth are abundant and we are poised to act upon them. Now, I’ll be happy to answer any questions you may have. Jessie?

Thank you. [Operator Instructions] Our first question is coming from the line of Joseph Reagor with Roth Capital Partners. Please proceed with your questions.

Good afternoon guys and thanks for taking the questions. Two things, I guess, first one, some of your margins improved during the quarter, it sounded like, because of increased usage of your factories. And when I look at the balance sheet, the inventory level increased a decent bit during the quarter. Did that play a role in those factory efficiencies? And is that an intentional build of inventory ahead of the third quarter?

Probably to a smaller degree. I think our inventory build was on some of the newer products that we acquired and the timing of bringing those in from China. That’s probably the bulk of it.

Okay. And so you don’t feel like that really impacted the factory efficiency during the quarter?

We have scheduled and run, I think – we probably, maybe run a little bit more of our Folex than we might have at the beginning of the year. I’m thinking about it. But now I think typically, second quarter and third quarter are both relatively strong quarters for production, particularly for metam sodium, our soil fumigant, which there’s a substantial amount of product that goes into third and fourth quarter. And we have to position that throughout the United States.

Okay, fair enough. And then, on the insecticide segment, sales climbed about 17% or so year-on-year. Can you give us a little bit more color on what drove that? Was it some timing last year that was different this year? Or were there specific products where you saw some competitive pressures or full inventory channels?

Let me take a look here. Where are we as far as our insecticides? So we’re talking about the growth here. So I’m just trying to think. So I’m looking at insecticides. Let’s see. Yes, this is driven in the granular stuff. So our regular insecticides are off slightly. As we break out granular insecticides, let’s see. Yes, those are also down. So yes, I’ve got our insecticides down here. What numbers are you looking at, Joseph?

So I was looking at $39.4 million in 2Q 2017 versus $32.7 million in 2Q of this year.

He’s talking about it being down.

Oh, being down. I thought you – yes. No, I thought you were saying that we were up. We’re down.

All right. Got it.

Yes. Got it. Okay. So, yes, Bidrin is our cotton insecticide. That was down primarily. It’s got two new seasons. It was the early season, which is kind [indiscernible] and then the bug pressures in the second half, and it’s kind of the third quarter. I think we mentioned that Thimet was down as peanut acreage was down in that 20% to 30%. And then, Aztec, which is more of a timing issue. There’s a relative sizable sale into Korea that happened in the second quarter of the last – this year – I mean last year that will happen in the third quarter of this year. So those are probably the drivers there.

Okay. Thank you. I’ll turn it over.

Thank you. Our next question is coming from the line of Chris Kapsch with Loop Capital. Please proceed with your question.

Hey, good afternoon, guys. I had a follow-up question on the commentary around Impact. And last year, I think it was – you characterized that particular product or business as it’s seen sort of intensified competitive pressures. And now this year, despite sort of a tough backdrop for corn, you’re seeing higher sales. So, I’m just wondering if – what the driver is there. Has the competitive dynamic changed? Or is this just the function of perhaps a more pronounced resistant situation with glyphosate? Or anything else going on there?

Well, I think the key to this was getting the price reduction down, which again, you may remember in the third quarter last year, we took down the price and in fact, credited material that was in the channel to trade. So I think we feel a little more stable with the pricing today and, I think, responded well in the marketplace because of it. Bob?

Yes. Thanks. Hi, Chris. We also had a delayed planting season. It was very wet in April, May. And therefore, the fields were just, I would say, more dirty at the end of the season, which fits very well into Impact. And then we also launched a new solution into that segment called ImpactZ, which was received very well by the trade. So that’s what drove it.

I see. That’s helpful. And then just maybe, you could just comment more generally about sort of the backdrop that you described, particularly as there’s presumably a lot of crop chemical folks having issues with sourcing active ingredients out of China, and yet in North America, you have somewhat challenged farmers at least for some of the cash grow crop. So I’m wondering, is that resulting in any sort of dislocations that you can leverage to your advantage? Is it changing the competitive dynamic? I mean you mentioned the idea of having to raise prices. I think you’re talking about the industry more generally. But there’s a time when I’m not sure the growers are enthused about paying more further input. So maybe if you can just talk about how that – how you see the competitive dynamic evolving against that backdrop. Thanks.

So we’ve – it varies by product. I mean, some products are in an extremely tight supply and have doubled or even tripled in cost. Others, there have been an abundance, and we’ve seen some products actually decrease. But we need – a normal duty out of China is in that 6.5%. When you talk about, the talk was to move it to 16.5%, and now the talk is to move it to 31.5%. And those types of increases are not – we don’t anticipate we’re going to bear them. So whether we put through a tariff surcharge, which may make more sense in a volatile trade war, but in some manners, things have to change, and then consumers will have to decide what they want to put in place.

Has any of the dislocation resulted in opportunities for you guys to, say, pick up either pricing or even share, I guess, as some of the competitive – competitor products may have insufficient supplies of the intermediates?

Yes, it does. We’re looking at replacement costs, and in some cases, we’ve moved prices up, knowing that there will be a period of time for inventories in the market to clear rather than to try to compete now, when we know something is just going to get more expensive. So we’ve – in some cases, yes, we’ve moved prices up and we’re – and that’s one of the reasons why we do have a little bit more inventory, because we’re anticipating future supplies to be increased as far as cost.

Okay. Thanks for the extra color.

Thank you. [Operator Instructions]. Our next question is coming from the line of Jim Sheehan with SunTrust. Please proceed with your question.

Good afternoon this is Pete on for Jim.

Hi, Pete.

Have you seen an impact from a shift in the global mix between corn and soybean acreage? And what is your overall outlook for corn product volumes?

I would say – hi, Pete. this is Bob. I would just say that there have to be soybean growers that are disappointed with the high price going into the spring market. We saw an increase in soybean acres, as you saw. I think we’re going to probably see a shift – a slight shift back to corn for the coming season. But again, all the talk about the China tariffs on soybeans, you have to be able to shift your supply situation elsewhere, meaning down to Brazil and down to Argentina. And one would question whether or not you can do that in the short-term. So, I would say in the midterm, if the trade war continues, then you’ll see a shift further to South America away from soybeans, which would then favor corn growing in the United States. And sadly enough, that would favor us, because we’re probably – I said our portfolio, is more focused in corn, and I’m saying that sarcastically. So more corn on corn, better for CSIs and for our herbicides. But we are all trying to build our soybean portfolio, but we’re such a small player, so we can only really gain either way. So, that’s kind of our view of things. But I think it’s too early to make the call as far as major shifts.

All right, great. Thanks. Are you seeing any negative margin impact from rising freight and logistics costs in the U.S?

We are. We’ve definitely seen – I mean there’s a shortage of – I think the 188,000 truck drivers in the United States. And then if you go towards hazardous freight, which some of our freight is, those become even more difficult. So, just getting trucks is a real challenge. Our team has done a fantastic job. We haven’t had any major disruptions to deliveries of anything, and our customer service and, again, logistics department, have done a great job to secure the freight that we need. And I think maybe we had some challenges last year during the hurricane when we’d get calls from the government and say, can you have this delivery here by – calling at 4 o’clock – can you have it here by 9 a.m. the next morning, 600 miles away? So, those kind of challenges are there. But definitely, we’re seeing increases in the freight costs.

All right. Thank you.

Thank you. The next question is a follow-up coming from the line of Joseph Reagor with Roth Capital Partners. Please proceed with your questions.

Hey guys, just add one more for you. Following the announced sale of Arysta by Platform, do you think there’s going to be any opportunities to do like what you have done before and buy some of the – let’s call it, duplicate product lines there?

Certainly, there is that possibility. We’ve – I mean I think that deal has to go through. But there are definitely overlapping chemistries there. I don’t know that there’s going to be forced divestitures, but there could be, and Bob have, your thoughts?

Yes. I think, if there maybe one or two forced divestitures, but I think probably, one of the things they’re going to be looking at is maybe looking at their portfolio of breadth, because Arysta had quite a few active ingredients. UPL has quite a few active ingredients. So, I think that will probably sort itself out after they get the FTC approval. We don’t really see any major FTC issues for them in the U.S., but that’s for the FTC to call.

Okay. But fair to say that if there’s any opportunities there, you’ll have a look like you usually do?

Yes.

Okay. Thanks guys.

Thank you. The next question is a follow-up coming from the line of Chris Kapsch with Loop Capital. Please proceed with your question.

Yes. Also, along the lines of M&A, but curious about given the shifts in the macro backdrop, with the commodity prices coming down, with all this uncertainty about tariffs and the implications, the supply chain challenges and so forth, is that translating into maybe, a more willingness on behalf of any would-be sellers than there might have been prior and therefore creating an opportunity for you? Or is it too early to see any sort of change in willingness or even the expectations in terms of transaction values?

I would say Chris, that’s too early to say, because a lot of the deals are still, I would say, in transition, meaning the merger is happening. Two, there are still ones, which are not settled, like the UPL-Arysta one by the FTC. I would say probably more so on the manufacturing side, we may in future, have opportunities to produce more things in the United States as – and we’ll probably bring in more raw materials, and maybe – as you know, our company can sympathize, but that’s too early to say. It really depends on how this plays out with the China trade deal that is going to come or not come.

Fair enough. We’ll keep tabs. Thanks.

Thank you. [Operator Instructions]. Thank you. It appears we have no additional questions at this time. So, I’d like to pass the floor back over to Mr. Wintemute for any additional concluding comments.

Thank you. And on behalf of everybody here at American Vanguard, we appreciate your time and attention to our call and look forward to updating you with more news in the future. Thank you very much.

Ladies and gentlemen, this does conclude today’s teleconference. We thank you for your participation. You may disconnect your lines at this time.