American Vanguard Corporation

Welcome to the American Vanguard Corporation second quarter and year-to-date 2023 earnings call. I will now turn the call over to Bill Kuser, Director of Investor Relations. You may begin.

Well, thank you very much, Misty, and welcome everyone to American Vanguard's second quarter and mid-year earnings review. Our speakers today will be Mr. Eric Wintemuth, the Chairman and CEO of American Vanguard, Mr. David Johnson, the company's Chief Financial Officer, And also to assist in answering your questions today, we have Mr. Shane Weatherall, the CEO of Amgard Environmental Technologies, which we refer to in our filings as the non-crop business. And also Mr. Jim Thompson, the Director of Portfolio Strategy and Business Development, who is the leader of our Green Solutions Initiative. 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 as detailed in the company's SEC reports and filings. All forward-looking statements represent the company's best judgment as of the date of this call, and such information will not necessarily be updated by the company. With that said, we turn the call over to Eric.

Thank you, Bill, and welcome, everyone. As you will have read from our earnings release, and we have highlighted on slide four our Q2 sales decline, in the face of an industry-wide drop in procurement activity as the distribution channel destocked their inventory. Currently, we are seeing stable commodity prices, a strong farm economy, and low channel inventory of our domestic crop products. And as such, we expect a strong recovery in the second half of the year. The second half rebound will not likely be enough to bring us up to our original full year forecast. Sales mix for the quarter and year to date is important to note as we continue to see strong growth in our green solutions product lines. Further, given current conditions, we are closely managing expenses across the board in order to improve operating leverage. With that in mind, our downward adjusted performance targets for 2023 as compared to 22 are as follows. Slightly elevated net sales between 615 and 625 million. Similar adjusted EBITDA between 70 and 75 million. Lower net income between 20 and 24 million. Much of the downward pressure in this metric relates to interest and tax expense. Let's start with Q2 and then move onward to the full year and beyond. In our last earnings call, we mentioned that customers were becoming more judicious about inventory control in light of increased interest rates and the associated carrying costs. Those early signs of hesitancy in procurement hit us and impacted the global ag chem industry during the second quarter. as distributors abruptly slowed purchasing activity in order to destock their inventory. Like many of you, we have been reading with interest the earnings report of our public peers and observed that industry as a whole experienced a drop in the quarterly sales on average of approximately 20%. Some, particularly those who carry more generic products, experienced even more severe setbacks. By contrast, you can see on slide five, our overall net sales were down by only 10%. We break that down further as follows. Net sales of our US crop business were down 11%. And, but for the unavailability of one of our high margin herbicides, we would have done much better. We have since sourced that herbicide and believe we will be able to serve our customers going forward. Within the non-crop sector, we have seen a similar trend. That is, retailers, whether big box stores, nurseries, or garden centers, broke with the long-standing practice of having a full barn that contained 120 to 180 days of inventory and redefined it to mean 20 to 40 days of inventory. This in turn led to a drop in demand as they exhausted existing stocks, followed by smaller orders as they adopted the new approach. In effect, retail has pushed inventory carrying costs back onto the manufacturers. Consequently, net sales within our non-crop business decreased by about 20% in the quarter. Within our international business, while net sales in Mexico and Australia were strong, They were not enough to overcome the fact that China-based suppliers were loading the markets within Central America and Brazil with low-priced generic products. This altered the market dynamics, resulting in reduced demand for higher-margin products. Despite this spike in supply of generic goods, we were able to maintain our brand value in these regions and, on a consolidated basis, our international sales dropped by 6%, and experienced a 1% margin decline. Before moving to David's presentation, I want to cover some of the positive achievements of the year to date, as you see on slide six. First, after a major interruption in the supply of raw materials that were used to make Aztec, we now have two sources of both RAS that are being delivered in advance of our manufacturing campaign set to start next month and run through November. Similarly, the supplier of our high margin herbicide, Dactyl, which had been unavailable for the past three quarters, will commence production again in September in time for the fall 23 and full 24 season. Channel inventories of that herbicide are fully depleted, so we expect strong demand in Q4. At this stage, then, we know of no supply chain issues that should prevent us from serving our customers for the balance of the year and into next planting season. Second, our green solutions portfolio, which includes over 130 bio-rational and soil health products, continues to grow at a strong clip. Compared to Q2 of 22, sales of green solution products, which we sell into global markets, rose by 21%. These products are largely immune from the cycles of the chemical supply market, Further, we continue to see higher adoption of these solutions by growers. In addition, with respect to BioWake, a seed lubricant from soy protein, we are expanding uses beyond soybeans and corn to include peanuts and cotton in 2024. Third, over the quarter, we continue to repurchase our common stock on the open market through our $15 million 10B51 purchase plan. That plan concludes within the next two weeks, and our board has authorized the company to enter into another repurchase plan for up to $7.5 million worth of common stock. We continue to see value in our equity and find this to be a prudent allocation of capital. Fourth, we are happy to report that our proprietary precision application system, SimPass, is now operating on the ground in Brazil. This represents a huge step forward in the global commercialization of this at-plant technology. With a Brazilian label for counter, our nematicide product, that includes corn, soybeans, cotton, sugarcane, coffee, and bananas, we are now providing the first end-to-end solution, both product and equipment, for precision application in that country. You can see on slide seven, our first impasse unit in Brazil, and is operated by Bom Futuro, a large-scale grower who manages 500,000 hectares of soy, corn, and cotton. They have been a loyal user of Counter and in the past have found that our product gave them an average of 15% yield boost in corn. In this photo, you will see Bom Futuro's 49-row John Deere planter fitted with our Sympath system. They have already tested seven different application rates at seven to eight kilometers per hour over 30 plus minute intervals. We are pleased to report that the accuracy has been exceptional, much to the light of the Bonfurturo team and American Vanguard. Turning to slide eight, The market potential for counter in Brazil is quite large, with about 200 million acres planted across these six crops. The average interference with yield is about 15%. If we obtain only 5% of the acres, that would translate into a $400 million revenue opportunity in that country for counter alone. The fact is, we intend to register additional SIM Pass applied solutions in Brazil. That would increase the revenue opportunity all the more. At this point, let me ask David, our CFO, to make a few comments, and then we'll return to talk further about the balance of the year.

David? Thank you, Eric. With regard to our public filing, we plan to file our Form 10-Q later today. Moving to slide 10, as Eric mentioned, the second quarter of 2023 has seen continually challenging operating performance for the company, with overall revenues down about $15 million, or 10%, as compared to the same period of 2022. For the second quarter of 2023, under our new accounting approach for freight and logistics, on slide 11, You see that our gross margin percentage ended at 32% of sales as compared to 33% of sales in 2022. The lower overall gross margin performance was driven by the increased share of international sales and generic price competition in both Central America and Brazil. From a manufacturing perspective, our factory performance was broadly in line with last year. On slide 12, you can see that for the three months ended June 30th, 2023, operating expenses increased by less than 1.5%, despite significant inflation pressures. There are several factors driving this result, including increased travel expenses and continued investment in various R&D activities in support of our growing business, substantially offset by lower incentive compensation accruals reflecting business performance. As you can see from slide 13, we did make a small operating profit in the quarter. In addition, during the quarter, we incurred a one-time tax expense in Brazil that did not relate to Q2 financial performance. The expense was associated with withholding taxes on intercompany loans granted to our Brazilian holding company to facilitate the purchase of our operating entity in Brazil. We were required to convert the loans to equity in order to meet thin capitalization rules in Brazil. such a conversion requires approval from the Brazilian central bank. We submitted the necessary documentation to the central bank in 2022. In May 2023, without notice, the Brazilian central bank issued the approval and the company was required to execute the conversion of the loans immediately. The one-time expense is a current expected net cost. With regard to the overall loss, it's worth noting that it was driven by the tax expense and that this is only the second time The company has recorded a loss in the last 55 quarters and comes more than 13 years since the last reported loss. On slide 14, you can see that for the six months ended June 30, 2023, operating costs decreased by $742,000. This was achieved despite strong inflationary pressure and as a result of careful focus on expense control. The main drivers were similar to those described for the second quarter. As you can see from slide 15, it was a challenging first half of 2023 with sales down 13%. Interest rates have increased more than threefold to 6.9% versus 2.2% last year. And our use of working capital has increased about 17% as customers are transitioning from buying early to buying as late as possible. driving interest expense up $3.7 million. As a positive, and as I have just discussed, operating expenses were down for the first half of 2023 as compared to the same period of 2022. On the graph on slide 16, you can see that at the end of the second quarter of 2023, our inventory increased compared to previous quarters. We're at $237 million at June 30th, 2023 as compared to $182 million. at the same point of 2022. The company came into 2023 with a strong demand forecast and set our manufacturing plan in response. We had some challenges with supply chain in the first quarter and the second quarter that are now behind us. However, we do have some elevated inventories of certain products that we expect to sell in the final quarter of 2023 or the first quarter of the following year. In addition, our inventories have been impacted by the abrupt U.S. market change from buying early to buying late, driven by customer decisions in the face of elevated interest rates, and by aggressive actions by Chinese manufacturers in Central and South America. The graph on slide 17 shows that debt ended at $161 million at the end of the second quarter of 2023 as compared to $101 million at the same point of 2022. We anticipate our debt to seasonally decline by year end. With that, I will hand back to Eric. Thank you, David.

Our last substantive topic is the full year 2023 outlook. In doing so, we focus first on things that are clearly within our view. As we have listed on slide 18, channel inventory of our corn soil insecticides is down to 12% of the amount that was actually applied last year. In fact, Aztec, our leading corn soil insecticide, is down to only 7.5%. Both of these numbers are historic lows. We believe this creates significant headroom for demand over multiple product lines with respect to the 24th season. Second, the farm economy is relatively strong. Given stable commodity prices and expected levels of planted acres of row crops. In spite of incrementally higher US interest rates, growers should be poised for investing in 2024, particularly those who have minimized inventory of crop inputs. Third, we're in close contact with our key accounts. These are national distributors that market and sell the majority of crop inputs within the US. As part of our usual planning purpose, process, we meet with each of these customers and map out a plan for selling into the next season. These are the same customers who typically participate in early pay programs, by which they commit cash to us before the season in exchange for discounts on our products. These payments are indicative of customer commitment and help us to meet working capital needs. At present, we anticipate normal prepay activity. We expect that these factors taken together will support better demand in the second half of the year. Specifically, we anticipate that domestic sales will be approximately flat within the last year, while our international business will grow 3% to 5%. Before turning to the full-year targets, let me spend a moment on timing. Will our view into macroeconomic 10s is limited, we can safely assume that growers will need crop inputs in time to plant their crop next season. Thus, even if distribution continues to exercise fiscal austerity, they will eventually need to replenish their stocks, even if the orders come closer to the season. Consequently, at least with respect to the domestic crop markets, we expect the fourth quarter will likely be significantly stronger than the third. Turning to slide 19, based on our best assessment of our markets, channel inventory, and other factors, we are targeting 2023 performance as follows. Net sales between 615 and 625 million, which would represent a modest growth of 1% to 3% over full year 22. Gross profit margin of 32%. Operating expenses as a percent of sales between 25% and 27%. interest expense of $9 to $10 million, tax rate of 27% to 29%, debt to EBITDA targets are unchanged from last year, net income between $20 and $24 million, and adjusted EBITDA of between $70 and $75. In short, following lower than expected performance in the first half of 2023, we see a rebound for the balance of the year. Despite uncertainty within the sector, we are poised to meet customer demand and to take advantage of depleted inventory levels and a reasonably strong farm economy. At the same time, we will continue to advance our other growth strategies, Green Solutions and Simpass, both here and in Brazil. In keeping with prudent capital allocation, we will be back into the market investing in our own stock. Before closing, I want to leave you with a final thought as per slide 20. We have always placed a premium on financial discipline and operating efficiency. Within current market conditions, it is especially important that we continue that imperative. To that end, we have challenged multiple teams across all functions to focus on ways to increase operating leverage both over the balance of 23 and throughout 24. These projects include such things as cost of raw materials, inventory days on hand, accounts receivable and accounts payable timing, factory efficiencies, discretionary spending, and selling expenses, to name but a few. We'll report on the progress of these efforts in future calls. With that, I'll turn the call over to the operator to take any questions you might have. Misty?

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. Again, to ask a question, press star 1 on your telephone keypad. And I'll just wait a few moments for the queue to build. Okay, our first question is going to come from Chris Cass with Loop Capital. Your line is open.

Hi, good afternoon. So, you know, a common theme for global, you know, chemical companies coming through the last, I don't know, six, nine months has been inventory destocking. In ag chem specifically, it feels like more like the mother of all destocking cycles. And a lot of your peers have talked about it. And, you know, maybe there's different magnitudes and different geographies and the different product categories. But you added something that I hadn't heard was, I mean, it's somewhat intuitive, but just the copious amounts of glyphosate that are, you know, kind of entered certain regions. I'm curious about if, you know, given the pricing of glyphosate is now, you know, back to below pre-pandemic or pre-supply crunch levels, and that's kind of putting pressure on the overall crop protection chemicals market. Has that changed the competitive intensity anywhere to the extent that it's influencing or affecting your market share positions for any of your core chemical products?

That's a great question, Chris. I remember years ago, Back in, I think it was the 80s, we had our distributors telling us, hey, you guys want to get into glyphosate? And we said, no, it's not going to be a good fit for us. And I know a lot of people have made a lot of money over the years, but when you get in a situation like this, similar to 2009, it's a pretty painful position. Our number one herbicide impact is a great marriage partner with glyphosate and glufosinate. it targets weeds that escape both of those chemistries. And so although there's such a swing and so much pressure put on the chain to take these surplus volumes of glyphosate and glufosinate, we see the continued use of our products, I won't say completely immune, because it is a I mean, it is dependent on weeds escaping, but we've seen a good hold of our market in those geographies. So I guess I would, you know, there are broadcast, you know, wide spectrum herbicides in that arena. I think that's a pretty tough market today. But as far as I mean, again, I think glyphosate goes out at like 22 ounces per acre, and we go out at about three-quarters of an ounce per acre. And as you may recall, we were for years Monsanto's roundup partner for corn. So they're complementary.

Okay. Okay. Then I mean, I guess getting at a similar question, Just with the breadth of the inventory destocking across the industry and the impact it's had on demand in the current period, maybe the last couple of quarters, or I guess it's really been pretty abrupt in crop protection chemicals maybe this quarter. Has that affected any aspect of the competitive landscape? Has anybody sort of responded by just getting much more aggressive? You mentioned, obviously, the generic producers out of China for glyphosate specifically, but that's maybe somewhat unique to that product line. Just wondering more generally if there's any more noticeable changes in competitive intensity across the board.

Yeah, so I mean, certainly as people are scrambling to get their products moved and through the channel, there has been pricing pressure, which, you know, which we've seen in all of our entities, whether it's Mexico, Australia, all the Central America countries, Brazil, and, you know, even in the U.S., I mean, certainly there are products that we sell that have multiple registrants where we saw a lot of pressure in our non-crop business. But that's really not a focus for us. I mean, again, our focus has been to try to channel our energies on the products where we do have stronger margins, and those margins generally come with we've got some uniqueness, whether it's the active ingredient itself or we've got mixtures that are different. I think you can kind of see that effect in our green solutions area where we don't know exactly where that market has played out given that there are very few pure I'll call it green solutions companies or biological companies that are public. But I think, Jim, you might comment on that, but I think I think we believe it's down some, but we still grew that market by 21%. So I don't know if that kind of answers your question, but I'll ask Jim maybe just to show some color on green solution if that's okay.

Sure, sure. Yeah, same themes, Eric. In the green solution side, we did see some buyer behavior that I think is – similar to what you saw on the chemistry side, but to a lesser effect. So we saw a little bit of pressure, but overall it's really offset by our two biggest geographies, the U.S. and Latin America, growing at a very, very fast clip. And the growth is also driven by new products that are still being registered and further penetration of our existing products. So that's been able to offset any negative effects we see. We didn't quite grow as fast as we thought we would this quarter, but nonetheless it's – a good acceleration of growth year over year. So we expect that to continue on.

So Chris, I don't know if that's your... Yeah, that's helpful. And then just one other one. You had mentioned historic low inventory levels for a couple of products. Could you just remind us the method by which you gauge those inventory levels and the confidence level around the... the normalization of demand as we sort of egged it this year headed into the growing season, at least for North America.

That's good. So we've got a check and balance system that's there. So obviously we keep track of the sales that go to our distributors. We then are able through electronic data index to see the sales that they make to the retailers. The retailers' movement to the farmers is one that we have an assumption for. Generally, farmers at the end of the season return their product to the retailers, and the retailers return to distribution. So this year, and of course, bolstered by the fact that we had we had maybe 30% of the Aztec that we wanted to get into the market available. We saw that there were virtually no returns. I mean, there were returns, but again, the total amount as a percent of our sales in 22 is down to 7.5%. And generally, I think the rule of thumb has been if you can get down to 20% to 22%, you're doing really good. But it probably averages closer to norm is in that 30% range. So I think we check that with what goes out and what comes back. And then we do a balance of what the beginning inventory was and what the now stated inventory is. And so we're able to see if there's anything unusual. We also do spot checks with our bigger retailers to just confirm that these are the numbers that we have. Can you confirm this is actually what you have? And of course, there are payment programs that are associated with the sale of inventory. So it's a fairly honest system that we have a high level of confidence in.

Got it. Helpful. I'll leave it at that. Thanks.

Our next question is going to come from Jerry Sweeney with Roth Capital. Your line is open.

Hello, this is Brandon Rogers on for Jerry Sweeney. Hi, Brandon. I just had a few questions. One was around the SMPOS solution. I saw that you are operating now in Brazil. I was wondering if you could just comment on the multi-year targets that you indicated in prior calls. if there's any additional investment required or if things are going to go forward just as is.

Yeah, so the targets that we've given up to now, I think, have been without any thoughts towards Brazil because we weren't sure how the adoption would go. Our target is to get 19 systems running with large farmers this year. And based on their experience, I think we'll have a better feel for market adoption in Brazil. Within the US, we had a beautiful 23 season operating for about 100 different systems that were out there. We had virtually no complaints. And we were able to do our infield kind of field check system for the time. That went well. We also, and that's kind of important to be able to develop or return on investment story. In addition, we began initial with our liquid for the first time. We also did our first time disposable, call it poly bag, that's what we intend to use for biologicals that are not going to be able to be returned and refilled. And so we have some tweaking to do on that design. The system didn't hold the bags quite as well as we had hoped. So we made a minor adjustment to that so that they will ride steady under heavy rock conditions where of the unit the planter is jumping around quite a bit so um so we'll we'll uh we'll have a much better feel uh as we get to our next through this third quarter uh third quarter is a very large quarter um in brazil so we'll have a better better feel with how that looks um and uh and so when by the time we get to our next conference we can update both and i think also Jim mentioned Q3 is a big core part. So we'll focus on updating those targets at the next conference call.

Got it. And then I just had one other question kind of around the cost reduction initiatives. Considering the challenging market conditions, you mentioned a few of the different initiatives that you're going to go forward with, but can you give any additional color around some of the inputs within the cost reduction initiatives?

I mean, inventory sticks out. Obviously, you know, we've had, we've produced in advance, and we're, we were paying 2.7, now we're paying 6.9. And I've told our team, look, our customers have done a great job, it's our turn now. So, we're going to focus on bringing down or improve our working capital inventory. I mean, given what we went through on Aztec, that is one where we said we're going to continue to buy key to raw materials until we've got 100% of what we need for the 24th season. And I mentioned we'll start that campaign next month. So we will have 100% of our of our technical needs. We won't have it all formulated by the end of the year. But some of the other products, we need to focus on being a little bit more prudent on when we bring inventory in. Again, our suppliers in the various countries have pushed us to, as they're trying to make their numbers, to buy larger stocks. We told our team, that's it. We're not going to be Mr. Nice Guy to everybody. We need to adopt a similar policy, but we're not bringing inventories in to cover six months. There is ample supply of most of our products, and as such, we need to be more prudent. So that would be one area. We had started a year, I guess about 12 months ago, an initiative on factor efficiencies. We've identified different yield factors, different run times, turnaround times. So we've got a team that's working on that. We just brought up an individual, 25 years with DuPont, the Sigma black belt in the chemistry operation standpoint. And we are looking for him to help us as well. develop better practices, efficiencies, and kind of run with that. But we've identified quite a few areas where we think we can gain efficiency. And of course, we're looking at all of the metrics with operating expenses, not just the plant efficiencies, to see what we can do to lower operating costs in this environment.

Thank you. All the rest of my questions have been answered. Appreciate it.

Our next question is going to come from Chris from Loop Capital who has a follow-up question. Chris, your line is open.

Yes. Thanks for the update on SimPass. But I'm curious about, I mean, that obviously has a growth trajectory that is part of the 2025 growth target framework that you put out. And I'm just wondering how, at this point, given where you are resetting 2023 expectations to, how do you want investors to think about those growth targets and what's the right way to think about progress towards those? Are you planning on recasting those or when would you communicate something, an update along those lines and what kind of visibility you have in terms of continued progress towards those sorts of numbers? Thank you.

Yeah, so we haven't I mean, on the CIMPAS and the green solutions, at this point, we don't have a thought that we would be resetting those. But a lot of that's going to depend on what we see over the next couple months. But with regard to the growth targets that we laid out of, I think it was the 907 and the 140 by 25, yeah, we expected to make a lot better progress this year moving EBITDA up into the 90 range. And the fact that we're going to be well short of that would kind of indicate that we're behind. So I think we'll have a pretty telling as we get through the balance of this year. Are we going to leap forward in 24? Because if we've taken six months out of 23, and if demand stays the same, then we should have a big jump in 24 with a full year of normalized buying. But we just went through the last couple weeks about 10 different budget meetings for the 24 season. In there are forecasts for 25 and 26. And so we haven't had time to digest that. We need to obviously pull that together. I think we want to have our budget kind of figured out here by next month, and then kind of drill down on the 2025 and 26 outcome. And so I would think by our next call that we'll have the ability to upgrade the target graphs.

OK.

Our next question is going to come from John Roberts with Credit Suisse. Your line is open.

Thank you. The 6% volume decline that you saw in international, that was less than the other volume declines you saw. Was it a similar inventory correction just off of higher growth rate that's there, or was it a much smaller inventory correction?

No, I think – I mean, we – We've had initiatives for growth in Mexico. They continue to perform strongly. Australia also did well. And as I said, our Greenhouse Green Solutions piece did also well. I mean, there was definitely generic price pressure in Mexico. I mean, we heard this from everybody, that the people were sitting long on inventories and were pushing things through. And actually, you know, we had, you know, usually this happens in that last couple days of the month. We have things that we think shipped and, you know, that didn't get out so we could bill. But I think it was, you know, we generally have a pretty kind of specific portfolio of products. I mean, our counter is, you know, doing well in Brazil. You know, we have... Our Bromacil, our Crowbar, which is used in the agave market, has performed well. So I think generally, I mean, we had good supply positions where we were able to meet demand. And so I think, yeah, I mean, I was pleasantly surprised. I do think as I looked at our peers, you know, as they've broken out the various segments, it does seem like North America got hit you know, as hard as any place. We don't have much of a market in Europe, so, you know, that's not there. But I know a number of companies did have difficulty, certainly in Brazil. And I think, you know, if you've got, if you have countries where your products, you know, were in tight supply and there was a flood of orders and you filled those orders, whether it was in time for the 22 season or those were carried over into 23, I think those, you know, those are definitely an issue. But we, you know, again, we don't play in a lot of the big volume generic chemistry. So that's probably a main reason.

And then on slide 11, why was U.S. crop gross profit only down 9% when sales were down 11%? Normally, we think about gross profit being down more than sales would be down. Was that price rise coming through as an offset?

Yeah, we did have some improvements, and particularly our soil fumigant has improved in profitability. That's our single biggest product. So I think it's largely product mix. And again, we have a good portion of the products that we sell in the U.S. we are proprietary on. They have the healthiest margins along both crop and non-crop.

Thank you.

And as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. To ask a question, press star 1 on your telephone keypad. Okay, doesn't look like there's anybody else in queue, so I'll turn it back over to you for any closing remarks.

Okay, thank you, Misty. And again, really appreciate your people taking the time to listen to the call today. Great questions from the three of you. Thank you. And we look forward to updating you as our Q3 unfolds and what the balance of the year will look like for our Q4. And then at the next call, maybe some some thoughts about our longer-range targets. Okay, thank you very much, everybody. Bye.