American Vanguard Corporation

Greetings and welcome to the American Vanguard Corporation fourth quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to Bill Kuser, Director of Investor Relations. Thank you. Please begin.

Well, thank you, Roya, and welcome, everyone, to American Vanguard's fourth quarter and full year 2018 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 Tregell, the company's chief operating officer. American Vanguard will file our Form 10-K with the SEC tomorrow. That document provides additional detail to the results that we will be discussing this afternoon. 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 the 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 Wintermute. 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. I'm pleased to report strong year-over-year results at both the top and bottom lines. As you will note from our press release, net sales were up 28%, while net income increased 19%. The story is better than that, however. As David will explain during his remarks, 2017 net income included a one-time tax benefit under the Tax Cuts and New Jobs Act of about $3.4 million, or $0.11 per share. If we focus above tax charges on our statements of operations, our operating income for 2018 actually rose by 46% compared to that of 2017. We also managed to maintain our annual gross margin at 40%. Let me take a moment to delve into how we managed this result and what it means. Let's start at the top line. Our increase in net sales to $454 million in 2018 from $355 million in 2017 was driven largely by the businesses we acquired in 2017. That's OHP, AgriCenter, and domestic and Mexican product lines that were spun off from industry mergers. In 2018, our first full year of integrating these businesses, want to recognize that many team members who worked so hard to achieve these results. With acquisitions, the real work begins after closing. As I've said on prior occasions, establishing market access in LATAM is an essential part of our long-term growth strategy, and we're off to a good start. Turning to profitability, I will note that Discounting the effect of the Tax Act, about one-third of the gain was driven from our existing businesses and the balance from our newly acquired assets. We were able to achieve these gains largely due to two factors, strong manufacturing activity and a reduction in operating expenses as a percent of net sales. This is the strongest annual performance for manufacturing in our history, and I thank my operations team for it. A discussion of manufacturing in this sector would not be complete without reference to what has been happening in China. While our reliance on China's sources is well below the industry average, we are not immune to the supply chain disruptions from that country. At present, our primary point of exposure is with respect to our Bromacil product line. We're working favorably to ensure that we have sufficient supply to meet global demand. With respect to operating expenses, both David and I have reported that we have been committed across all departments to set conservative OpEx budgets, account for changes, and, wherever possible, reduce operating expenses within reason. Year over year, as a percent of sales, OpEx has dropped from 34 percent to 32 percent. From my point of view, we should be able to show further improvement in this area as we grow due to the effect of economies of scale. Before turning the presentation over to David, I would also like to cover our recent conference in Costa Rica, as well as our strategy session with our board of directors. After David's remarks, I'll return with a technology update, including CIMPAS, ENVANCE, and biologicals. I will then close with comments for our 2019 outlook. For American Vanguard, the LATAM region is ripe for growth. Our acquisition of AgriCenter in 2017 provided us with market access through a well-established business to Costa Rica, Nicaragua, Panama, Guatemala, Honduras, and Dominican Republic. Since then, we closed the acquisition in AgriVont Defensive in Brazil, which marks our first meaningful entry into the largest crop protection market in the world. AgriVont is a marketing and formulation business in Sao Paulo Province with 35 employees and annual sales of about $20 million, largely in the high-value fruit and vegetable market. In light of these acquisitions, we recently held a global conference in Costa Rica, which was attended by 40 key personnel from multiple functions throughout our global businesses. Its purpose was to take stock of what we have now, to identify opportunities for cross-selling products among these regions. to achieve greater efficiencies in procurement, and generally to capture synergies across our operations. At the conclusion of the conference, participants focused on 33 priorities for enhancing our global business, the top three of which were rolling out Sympath technology into the regions, developing our biologicals and nutrients across the businesses, and expanding advanced essential oil products into new territories. The creativity and energy of our team gives me even greater confidence in the prospects for our future global expansion. Similarly, this past week, our senior management met with our board directors to define a five-year strategy for American Vanguard. In times such as these, when change is the norm within our industry, we believe that it is important to revisit our strategy with greater frequency. Let me give you a preview of that strategic plan. We aspire to be a technology company with an international footprint that generates solid financial results through both a diverse portfolio of products and innovative solutions. We expect that our growth will come largely from those markets in which we are relatively new entrants, such as Brazil and Central America, where the available market is significant. Further, and as I will report in greater detail in our annual shareholders meeting, we intend to give our investors a five-year target for growth and performance. As we report on each period, we will update listeners on how we are doing vis-a-vis the long-term plan, including targets revenues for SIMPAS. Let us now turn from our strategy to other matters of interest to shareholders. As you will note from our 10-K, we purchased shares during the fourth quarter and subsequently continued the program through January 28. All told, we repurchased about $10 million worth of AVD stock in the open market. The program served to reduce inter-day share price volatility. Over the course of the last month, our share price has risen above $17 per share, which was the upper limit under the repurchase program. and remained at or above that level. Over the past month, our share price has increased by 12%. While issuers are limited in their ability to repurchase their own shares, we believe that our stock and our enterprise are worthy of our support, particularly when, as here, we can carry on a program without compromising our working capital needs or future prospects. Further, the program has enabled us to recover some of the share creep that had occurred over the past few years in connection with equity awards. Finally, this program has had the effect of conferring a dividend upon shareholders by reducing the number of shares upon which our EPS is based. At this point, let us turn to an update on financial performance for the quarter and the year. David?

Thank you, Eric. Good afternoon, everybody. As Bill mentioned, we will be filing our Form 10-K for the 12 months ended December 31, 2018, tomorrow. Everything I'm going to cover 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 early review of our performance. With regard to the financial results for the fourth quarter of 2018, the company's sales increased by 13% to $131 million as compared to $116 million last year. Our fourth quarter gross margin improved to 40% as compared to 39% last year. This was driven by a strong manufacturing performance offset by increased sales from the Central American business, which drive lower margins than our pre-existing business. Along with the 13% increase in sales just mentioned, our operating expenses increased by 14%. This resulted in operating costs expressed as a percentage of sales remaining approximately flat quarter to quarter at 32%. We managed our interest expense well. However, we did incur a charge of $1.4 million related to the settlement of a derivative instrument, a forward cover contract. This should be considered as a one-time non-recurring cost that related to cash management associated with the Brazilian acquisition completed in January 2019. Offsetting this expense, we recorded one-time gains in the quarter of approximately the same amount associated with the quarterly reassessment of the fair value of deferred consideration on the 2017 acquisitions and an adjustment in the fair value of an equity method investment. Operating income improved by 34% to end at $11.4 million as compared to $8.5 million in the fourth quarter of the prior year. Net income in the quarter ended at $7.4 million or 25 cents per share in 2018 as compared to $8.4 million or 28 cents per share last year. Fourth quarter 2017 earnings per share were impacted by a one-time tax benefit of $3.4 million associated with the Tax Cuts and Jobs Act, which added 11 cents per share to net income for that quarter. Without this impact, Q4 2017 earnings per share would have been 17 cents per share as compared to 25 cents per share in the fourth quarter of 2018. When considering our 2018 full-year financial performance, the key financial matters remain consistent with last year and the last several quarters. First, as Eric mentioned, year-to-date sales were up 28% to $454 million, as compared to $355 million this time last year. This revenue improvement is largely driven by sales from products and businesses acquired in 2017. Second, we continue to carefully manage our factory activity as we balance recovery of overhead costs with demand and inventory levels. In 2018, while our factory costs were up about 5%, our factory output increased by approximately 30%. As a result, underabsorbed factory costs dropped from 3.6% of net sales in 2017 to 0.4% of net sales in 2018. Our inventory levels did increase and ended at $160 million. There were a few reasons for the increase. First, we acquired inventory in the fourth quarter associated with 2018 acquisitions. Second, the businesses acquired in 2017 have generally increased inventory levels from somewhat unsustainably low levels at the time of various acquisitions took place. We will work on the supply chain over 2019. Third, some inventories were purchased late in the fourth quarter as we managed logistics from China, balancing the threat of tariffs and the associated shortage of freight capacity from that region. Finally, we made the decision to manufacture at a higher level than usual in the final quarter because our 2019 manufacturing plan is tight. We had previously signaled an inventory target for December 31st, 2018 of $146 million. We added approximately $5 million related to acquisitions in the fourth quarter of 2018, and the balance of $9 million is associated with the other factors I just provided. Our target for 2019 is to end the year at approximately $140 million. Third, gross margin for the year ended at 40% as compared to 42% last year. This change was driven by the impact of the 2017 businesses and product acquisitions that drive strong sales at slightly lower gross margin levels than our pre-existing business mix, partly offset by the strong factory performance just described. In addition, our purchasing team continues to deliver a strong performance on raw material sourcing and has held our overall average purchase costs approximately flat, notwithstanding some year-on-year increases for individual raw materials in the marketplace. Fourth, during 2018, we continued to exercise tight controls over our operating expenses, which were up overall by 19%, but reduced when expressed as a percentage of sales from 34% in 2017 to 32% in 2018. In absolute terms, operating expenses increased by $23 million. The newly acquired products and businesses accounted for approximately $21 million, which was offset by the release of acquisition-related accruals for deferred consideration in the amount of $6 million. Other cost increases included some legal expenses and accruals for short-term and long-term incentive compensation. The main message is that we are working to manage operating expenses as a percentage of sales so that this key ratio improves each year demonstrating that we are driving operating leverage improvements as the scale of the business expands. Fifth, our effective tax rate increased from 18% in 2017 to 27% in 2018. The driving factor in this increase is the effect of the one-time $3.4 million benefit from the Tax Cuts and Jobs Act I discussed earlier. Furthermore, in the second quarter of 2018, we recorded an expense in the amount of $1.1 million as we finalized our calculations related to the transition tax. Absent these two adjustments, our effective rate in 2017 would have been 32% and 24% in 2018. Looking forward to 2019, our rate will be affected by the balance of profit earned by domestic or international jurisdiction, and we are presently expecting to achieve a tax rate in the range of 24% to 26%. Looking at the bottom line, in 2018, our pre-tax income improved by 35%. Net income improved by 19%. again impacted by the one-time tax adjustments just discussed, and ended at $24.2 million, or 81 cents per share, in 2018, as compared to $20.3 million, or 68 cents per share, last year. Finally, with regard to the balance sheet management and liquidity, we continue to work carefully to manage our cash resources, and notwithstanding quarter-to-quarter changes, we are focused driving the business to maintain a low leverage position. During 2018, we considered a number of acquisition opportunities and utilized our credit facility to make four acquisitions in the second half of the year. Along with borrowings associated with the 2017 acquisitions, This resulted in borrowings totaling $97 million at December 31, 2018, as compared to $78 million this time last year. At both balance sheet dates, our leverage is flat at 1.6 times EBITDA. Year over year, EBITDA improved by 25% to end at $61 million for 2018, as compared to $49 million in 2017, We are seeing many opportunities to grow our business and are utilizing our credit line to make selective acquisitions as they occur. In summary, when looking at the year just closed, we see that sales have grown strongly. We have delivered on factory performance improvements. And notwithstanding the impact of strong sales growth at lower margins, we have slightly improved our consolidated gross margin performance. Our operating expenses improved when expressed as a percentage of sales, and both our operating income and net income improved strongly. Finally, we have again had a very exciting year and closed on four acquisitions that we expect will power the company's growth rate in 2019 and beyond. With that, I will hand back to Eric.

Thank you, David. Our next area of discussion is technology. We begin with Sympaths. our precision agricultural technology, which will enable the grower to apply multiple inputs, both granular and liquid, at varying rates, in multiple rows, as per an agronomist's prescription. As I've reported in past calls, we are on the cusp of commercializing this technology. In the first year of field testing, we demonstrated that the units, including the meters, functioned as planned. In the second year, we demonstrated that one could apply inputs prescriptively. That is, that we could place varying defined amounts of material in various parts of the field. This year, we'll be demonstrating that multiple products can be applied concurrently with accuracy in the same field. The development of CIMPAS has many layers. While we are testing granular products for efficacy and safety, both internally and externally, we are beta testing liquid application. With each year of field trials, we gather data to show that yield benefits of SimPass. At the same time, we are building test units in greater numbers, cartridges for various inputs, and even a bulk filling station, which will serve as the model for product distribution. Further, we have begun testing our systems with other input suppliers and continue working with Trimble on the development of a universal interface. Our team is on track for a soft launch in 2020, followed by a hard launch in 2021. By 2023, we expect to make seed synchronization available. This will give growers unprecedented flexibility to choose enhanced seed treatment at time of plant. Moving next to N-VANCE, I am pleased to see the continued successful commercialization of the Zevo product line by Procter & Gamble, which is our development partner in essential oil technology. I encourage you to go to P&G's Zevo website for more details. These products are being marketed in retail channels for consumer use. With this technology, which is safe for pets and children, we are poised to expand into other markets, such as agriculture. and turf and ornamental. As I noted earlier, our teams in the Americas are keen to bring advanced technology into those regions as a complement to their biological product offerings. Also in the realm of technology, we continue to develop our own lines of biologicals. At present, we have seven biological products in late stages of testing with intended launches in 2020 and 21. and a pipeline of other solutions with varying universities in early-stage development. In addition, our agri-center business continues to develop nutrient products through both GreenPlant and its research center, and is also working with developmental partner Viator to develop tailor-made biological solutions for growers in that region. We'll look to import LATAM biological and nutrient solutions into the U.S. and other markets. From technology, we turn to market expansion and recent activity. In addition to the agrivent acquisition in Brazil, we recently closed on the acquisition of the Assure2 product line from Corteva. Assure2 is an herbicide used primarily on soybeans in the U.S. and canola in Canada. As part of the transition, we have also obtained an exclusive license from Corteva to apply Assure 2 to Enlist Corn, which is a traded corn upon which it is safe to use Assure 2. Corteva plans to launch Enlist Corn within the next two to three years. As Enlist Corn comes to market, sales of Assure should benefit significantly. In addition, Assure 2 gives us entrée into the soybean market within the United States, while complementing our herbicide portfolio that is currently led by impact. My final topic is the outlook for 2019. The first quarter is shaping up as expected, except in two areas. First, wet weather is delaying some growers from applying BAPEN in California and the Pacific Northwest. While we can likely make up for lost sales outside of California, we could lose about $1 million in revenue of VAPAM in California. Second, I spoke earlier about our Bromacil supply. Due to delays in restarting the factory, we're likely to miss about $2 million in new sales into Mexico. Fortunately, the more diverse we become, the less impact an individual product has on our overall performance. In the coming year, we expect to see solid demand for our products, both domestically and internationally. We forecast net sales to be within the range of 490 to 510 million, based on our current product portfolio. If we're able to make additional product or business acquisitions, we'll adjust that target range appropriately. We believe that our product mix and manufacturing performance should allow us to deliver profit margins in the 38 to 40 percent range. With discipline management of operating expenses, we are targeting 155 to 165 million with an OpEx to sales ratio of about 31 percent. Our tax rate should be between 24 and 26 percent on average for all jurisdictions. In closing, I would say that we have taken another important step in the expansion of our business. We entered the year celebrating our 50th anniversary, and I'm excited to see us approaching the half billion mark in net sales. I'm also pleased with the trajectory that we have established. While maintaining financial and operational discipline in our existing operations, we are reaching into new markets, such as Brazil and LATAM, that have excellent prospects for growth. In the course of integrating these businesses, we share business plans and technology roadmaps, This, in turn, creates an environment of innovation, as the collective team sees new opportunities for both existing products and new technology. Further, with a foothold in these new markets, we are better positioned to expand through strategic acquisitions. In short, I am pleased with how well we are performing on this larger platform and look forward to continuing what we've already started. With that, Roya, we'll turn this over to any questions that the audience has.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You'll press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Joseph Rieger with Roth Capital Partners. Please proceed.

Afternoon, guys, and thanks for taking my questions. Sure. So, first thing, it appears you guys may have reclassified some sales from the other, you know, including plant growth category to herbicides, herbicides, or maybe even into insecticides. Is that something we're going to get, like, quarterly? numbers on to revise those, you know, backwards looking? Backwards.

So, in other words, 8,000... For each quarterly... For 2018 is what you're wanting, Q1, Q2, Q3? Yeah, exactly.

You know, from a modeling standpoint, kind of.

Yeah, we will. So, this was AgriCenter, and then that, you know, First period, we had a lot of integration pieces to do. But at this point, yeah, we basically had them break down their sales into categories. And we'll do the same thing with agribot and defensive.

Yeah. Okay. So as we move forward, we'll be able to get the historicals to correct our model.

You will.

Okay. The other thing being, you had a few acquisitions already announced this year. Is there any additional color you guys can give us as to the magnitude of those, you know, maybe as a group rather than individually?

Yeah, so Ash was actually in December 31st, right? Are you talking about acquisitions in 18, or are you talking about the acquisitions in 19?

In 19, there was two small things announced right at the beginning of January, and then there's another one where you're applying for – bankruptcy approval.

Right, right. So, yeah, defensive agribot, yeah, you know, again, revenues in that $20 million. On the second one, this is, you know, it's subject still to approval from the bankruptcy court. We're not purchasing the company. We're purchasing a number of their registrations and the inventory that is associated with them. And I think until we see what happens through the bankruptcy court, and this is also open to others that could come in and make another bid as well, I think it's probably a little premature to give what those numbers are going to be until we get a final ruling from the court.

Okay. Well, thanks for the color on the earlier stuff. Thanks.

Thank you. Our next question comes from the line of Jim Sheehan with SunTrust Robinson Humphrey. Please proceed.

Thank you. Now that you're in Brazil, could you talk about what you would do to offset the currency volatility there? Are you planning to do any hedging?

Well, given that our hedges that we did on the purchase price didn't work out well, I don't know that we're going to – too much in the way of hedging. I think one that we'll try to work through is working the price in U.S. dollars as to what we're trading in Brazil. And that should help in that regard. So just as in LATAM, a lot of, even though the currencies may be there, the actual sales are tied to the then price of the currency. So that's kind of, I think, the effect that we'll try and do. Bob, I don't know if you've got any thoughts on that.

No, I think right now we feel that the currency to the dollar is probably favorable. And secondly, we have a population down there that's very good at collecting receivables so we feel comfortable with where we are presently. Now, if we grow into segments where there's more volatility, then that might change.

We'll obviously have to reconsider as the business grows.

Thank you. In the U.S. market, as it appears, there may be some shifting of acreage from soybeans to corn. Can you talk about how that might affect your business situation?

Well, generally, that's a good thing for us. But we haven't had a soybean portfolio to work with. But we do have a strong corn portfolio. And inputs into corn are typically a lot bigger than inputs into soybeans. But soybeans are slanted much heavier towards herbicides. So we had Imaziquin, but we've got Insure now, Assure. But then, assuming we are successful with the acquisitions from the product lines from Willowood, there are quite a few products there that go into soybeans as well. So, Bob, I don't know if you have any color.

Yeah, I would just say, too early to tell. The China trade result is still out there and unknown. And then, you know, it really depends on the weather conditions for planting here in the next, you know, four to six weeks. But we're positive that corn will be up, at least for the seed sales that our customers have signaled that they got in the fourth quarter.

Thank you. And on SimPass, could you talk about how your business model will work, how you actually collect revenues? what are you considering as a sales target in the first three years?

So as I mentioned, we will give further color on that at our annual shareholders. We've got numbers that we have put forward in our strategic plan. We're going back and testing more of that. We'll have an idea about how well applications go this year, and then we can start giving some guidance. As far as collection of revenue, there's the sale of the product, there's the sale of the equipment, and then there's the prescription and the actual use that the farmer does and what fees he might be involved in with regards to the license to utilize the SIMPAS system. So, that kind of gives you the areas of revenue, but as I said, the specific numbers will outline that a little bit more in our June timeframe.

Thank you.

Thank you. Again, if you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You'll press star 2 if you'd like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for additional questions. Thank you. We have no further questions in queue at this time. I'd like to return the floor back over to management for closing remarks.

Thank you, Roya. Again, we really appreciate you taking the time to listen to our call and appreciate the questions that you've asked. And I look forward to giving further updates in the near future. Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.