Welcome to the third quarter 2009 Monsanto Company earnings conference call. At this time all participants are in listen only mode. A brief 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 Scarlett Foster, Vice President Investor Relations for Monsanto.
I’d like to welcome you to Monsanto’s third quarter earnings conference call and I’m joined this morning by Hugh Grant, Carl Casale and Terry Crews from our executive team. Before we begin I’d like to remind you that we’re webcasting this call. You can access it at Monsanto’s website at Monsanto.com and the replay is also available at that address. For those of you who would like to go to our website, the slides for this call are posted on the investor relations page.
I need to remind you that this call will include statements concerning future events and financial results. Because these statements are based on assumptions and factors that involve risks and uncertainties the company’s actual performance and results may vary in a material way from those expressed or implied in any forward-looking statements. A description of the factors that may cause such a variance is included in the safe harbor language contained in our most recent 10Q and today’s press release.
In addition, we’re providing you with measures both on a GAAP basis and on an ongoing business basis. In those cases where we refer to non-GAAP financial measures we’ve provided you with a reconciliation to the GAAP measures on the slides and in the earnings press release. As has been our practice, we also have published today the preliminary numbers for our biotech trade acreage penetration by crop and by country.
Our conversation today is intended to do three things: highlight the growth potential in our seasoned trades business; bring clarity to the prospects of our Roundup Herbicide; and underscore our financial commitments both for this year and looking out to 2012. Hugh will start by discussing the strategic pass forward with an emphasis on the season trade business. Carl will take a deeper dive in to the new paradigm for the Roundup business and Terry will bring it all together with an update to our financial outlook as we finish fiscal year 2009 and prepare for 2010 all with an eye towards meeting our commitment to double gross profit in 2012.
Before we start I’d like to review the financial results for the quarter and year-to-date. As we shared with you in late May, ongoing EPS in the third quarter declined compared with the third quarter last year as the competitive dynamics for glyphosate dramatically shifted. Total company net sales and gross profit declined 11% and 7% respectively as seen on Slide Four, although margins rose over two points. These results reflect a 17% lift in season trades gross profit with a three point margin lift in contrast with a 54% decrease in gross profit from the Roundup business.
Coupled with the benefit of SG&A reductions, ongoing EPS for the quarter was $1.25. Based on our current outlook for completing the US season and starting sales in Latin America, we believe we remain on track for meeting our full year ongoing earnings guidance at the lower end of the $4.40 to $4.50 per share range.
If you would refer to Slide Five, all of our major crops reported gross profit growth and margin expansion for the quarter. While corn and soybeans are typically winding down as we complete the US planting season, corn gross profits still increased 12% and soybeans rose 26%. Corn margins were up by nearly four percentage points and soybeans by approximately three. Vegetables recorded a 22% increase in gross profit and margin expansion of some five percentage points predominately from the addition of the protected culture business.
The third quarter is the heart of the earnings season for cotton and gross profit increased 28% while margins expanded by five percentage points. The tried and true combination of new higher performing seed with the best stacked trade package is now playing out in our cotton franchise. The earnings power of the season trades business however, was overshadowed by the decline in the Roundup business. Gross profit was halved compared with that in the third quarter last year. Total volumes were down 28 million gallons as we held price for branded Roundup above the $20 per gallon level. As a result of the mix of branded and non-branded sales Roundup margins contracted to 44%.
On the cost side, SG&A as a percent of net sales was just under 16% in the quarter and expenses were down by more than $100 million. Year-to-date companywide gross profit increased 13% and margins rose four percentage points. Gross profit for all our major crops increased lead by corn and soybeans at 21% and 32% respectively. Margins received in trades increased some two percentage points. Roundup gross profit declined 3% year-over-year but margins increased nearly six percentage points as we favor price over volume in optimizing the gross profit contribution of this business.
The net result is the ongoing APS for the first nine months of the year increased 19% to $4.38 per share. Free cash flow was $827 million less than this time last year, first because of a high level of prepays we experienced in August of 2008 which normally would have been cash generated in the 2009 fiscal year. Additionally, we had a greater use of cash from working capital primarily reflecting higher seed and Roundup inventories.
In sum, we have optimized gross profit across the portfolio leading to an expected 17% growth in the season trade business and a flat gross profit from Roundup. With the benefit of some prudent cost reduction actions, we still believe we can deliver a more than 20% increase in ongoing earnings and free cash of approximately $1.4 billion. With that, I’d like to turn the call over Hugh.
Because our fiscal [inaudible], we are now nearly two months from the start of our next decade. It’s been then just shy of 10 years since we embarked in launching a unique [inaudible] in the agricultural seed built on the premises of game changing technologies [inaudible]. Interestingly as we enter the next decade we’re crossing a bridge similar to the one we traversed in 2000.
Slide Six helps visualize that time line. When we first began this journey, Roundup was a key driver of the business fueling our investments from seed and trades. By the end of fiscal year 2003 we [inaudible] tangible signs of the success of our seed and trade strategy when the gross profit of the segment surpassed the gross profit contribution of our ag productivity segment for the first time. Seeds and trades gross profit continues to grow almost double of that of ag productivity by 2007.
By 2008 however, the dynamic shifted again, this time both segments were delivering phenomenal growth. Seeds and trades gross profit increased by 28% while Roundup gross profit more than doubled to just under a record $2 billion. This year Roundup is expected to deliver gross profit of $2 billion again, albeit via a different path. The bridge that we’re crossing as we enter 2010 has a familiar look but the road diverges on the other side. Today, we need to provide you with three things: one, a greater clarity on Roundup; two, highlight the growth potential in seeds and trades; and three, solid confirmation of our financial commitments to double gross profit in 2012.
Carl will discuss the Roundup path in more detail but let me give you my high level view. In 2009 Roundup should be flat at $2 billion in gross profit and, we now believe it will deliver something in the neighborhood of $1 billion longer term. We harvested a significant level of operating cash from Roundup in the last two years and we’ve reinvested that cash back in to the growth side of the company or we’ve returned it directly to our shareholders. We will continue to do so.
That said, the reality is that even our amazing seeds and trade business cannot in one year offset a $1 billion decline in gross profit and yet, by 2012 the seeds and trades segment is forecast to deliver $7.3 to $7.5 billion in gross profit. Not only do we have the potential to be approaching some 300 million acres with our trades as we cross in to the next decade but, in most of the world we’ll be replacing old technology acres with new revolutionalizing farming once again and creating a value dynamic on farm that’s unmatched in our industry.
On the other side of the coin, Roundup by then will be less than 15% of the company’s total gross profit generation. So, even as we reset the financial [buff] for Roundup, we remain committed to doubling gross profit for the entire company from the 2007 basis of $4.2 billion to roughly $8.6 to $8.8 billion in 2012 as shown in Slide Seven. To be fair, when we thought Roundup would level out at $1.9 billion in gross profit, we said then that we could more than double. But, even with a lower benchmark for Roundup, the seeds and trades business is expected to grow at more than two and a half times its 2007 base and allow us to gross this doubling milestone for the entire corporation.
While it’s sometimes easy to miss in the Roundup fray, 2009 will be the year that the seeds and trades business alone will deliver more gross profit than all of Monsanto did in 2007. It’s a remarkable achievement in just two very short years. To generate more than $7 billion in gross profit from seeds and trades in 2012, the growth has to come from our domestic and our international markets as you can see on Slide Eight. The foundation for our unique position in agriculture is in the consistent, aggressive investment made in R&D coupled with an unparalleled capability to have great research and to really great products.
If you isolate the seeds and trade segment as we do in Slide Nine, a 20% compound annual growth in R&D investment has returned a 27% compound annual growth rate in gross profit. More importantly, given that it takes eight to 10 years and roughly $100 million in investments to bring a trade to market, the investment that you see in 2004 through 2009 will be tied in to the products that will propel our growth in 2012 and beyond.
As we look to the next decade of growth in seeds and trades, let’s reground ourselves in the platform that is truly the spring board for our future. The fundamental principle is simple to say and much, much harder to do, find the sweet spot among market share, trade penetration and value that optimize the gross profit. These three factors make up our golden triangle. So, let’s start with share, no matter where we are in the world we’re matching our presence in the market to the brand experience that the farmer really wants.
We alone have the diversity of germplasm and technology to serve the farmer who wants a retail experience or the farmer who wants a high touch experience or even the farmer who favors the value proposition. We’re refocusing and retooling our commercial efforts around these concepts, allowing us to continue to target one to two point share gains per year in markets around the world through 2012 as shown in Slide 10.
As we enter the next decade we’ll stand alone in the technology arena that we alone have created. Our products will be fundamentally differentiated and thus we’ll compete against our own older technologies. Our job then will be to replace every old biotech acre with a new one and gain lift the value proposition for growth. Trade penetration, the second leg of the golden triangle bottles down to our ability to execute.
As we look across our high impact technologies and Slides 11 and 12, the execution required for the growth we see in the next decade through 2012 has already begun. If you can imagine being a player in the biotech pharmaceutical arena and being able to point to the potential to launch one new product nearly every year for the next seven years. Even more, each one of those products conservatively has the potential to deliver $300 million or higher in gross revenue just in the first country of launch. If you can imagine that for a drug company, you can only imagine what this type of technology explosion will mean to our customers, the grower.
On Slide 134 we summarize for you the four big drivers of our success in 2010. We began the transition with the trade up of the original Roundup Ready Soybean trade this year to Genuity Roundup Ready 2 Yield. Right now some 16,000 plus farmers are experiencing the Roundup Ready 2 Yield on an estimated 1.4 to 1.5 million acres. That penetration we expect accelerates the seven to eight million acres in 2010 with a total market opportunity of 45 to 55 million acres.
Supporting this expanded launch are some 1,500 trials of both 2009 and 2010 products. This week also marked our submission of the regulatory package in Brazil for our insect protected Roundup Ready 2 Yield Soybean product. We’re growing the base trade of Roundup ready there nicely with 64% penetration this year and a goal to gross 75% next year. Ultimately the goal will be to convert the Brazil soybean market to the higher performing platform likely post 2012.
As many of you know, the key milestone in corn is the launch of Genuity SmartStax pending EPA approval. This will begin the next revolution in corn farming with a true all-in-one product for inset control above and below the ground alone with more robust weed control. The market opportunity is 50 to 65 million acres. As we convert our foundation of some 32 million acres of Triple Stack product this year to SmartStax and then grow beyond that pass.
Slide 14 helps you with the valuation for both of these new products and I’m pleased that we alone have demonstrated the wherewithal to simultaneous launch two such remarkable new tools for growers. In Brazil and Argentina we finished 2009 with the launches of YieldGard Cotton Borer on two million acres and a Double Stack on 2.4 million acres respectively. These are our largest cotton seed footprints globally, both at 40% or greater market share and we’ll build on that seed base as those markets move up the technology ladder.
Next year in Argentina we expect 65% of our portfolio will be at Double Stack. In Brazil we’re working to penetrate some five million acres with YieldGard Cotton Borer. Ultimately, our plans are to bring SmartStax in both countries in the 2013/2014 time frame pending regulatory approvals.
If you refer back to Slide 13 again, in cotton we have a major break through this year with the launch of new varieties in the United States dubbed the class of 2009. Approximately 35% of our portfolio will likely be from this new class and the class was nearly sold out. The performance reflects the added investment that we made in cotton that accelerated the recent gains. Next year we expect 65% of our projected sales will be either the class of ’09 or the class of ’10 and we’ll complete the phase out of BollGard in the US in favor of the next generation BollGard II with Roundup Ready Flex.
In veggies, our plan is to expand margins from this year’s base in the mid 50% and we’re exceeding our goals for market development and the first big products in that investment are targeted to arrive in the market place in the 2012 time frame. Margins are expected to continue to expand to a targeted 65% as we invest more aggressively in the crops that are growing faster than the overall vegetable segment and reflecting the power of our R&D and the choices we make as to which seeds are most valuable in key individual markets.
This week we also announced the five year collaboration agreement with Dole to develop new products that will enhance consumer vegetable choices. This entire base translates in to value and for us that’s value created and value shared with the grower as the sub leg of our golden triangle. After a decade of being a start up seed and trade company, we’ve become the market leader globally because we offer the best genetic performance matched to the purchasing decisions that the farmer prefers.
The [Valugard] next year will not be amongst products that position those almost as good as ours. You should expect as we move in to the next decade that we have the innovation leader with products that are unmatched for performance or for grower experience. Price in our existing portfolio matches value to experience. Globally, we’re maximizing value with modest price increases where we’re fully penetrated and in areas that are early in the adoption curve pricing tracks and cottage grower trial and drive penetration.
Pricing in 2010 will not be about our existing portfolio, greater regions will see a value lift from a greater mix of higher performing seeds with high single digit increases. The true lift comes from new technologies whether it’s the yield advantage of Roundup Ready To Yield in US soybeans or the conversion of the Brazilian corn market to biotech trades or the switch of the US cotton market to a double stack of second generation trades. All of the potential pricing for SmartStax is still to come and it must wait on regulatory approval before we can discuss value or launch size.
We’re crossing a familiar bridge as we enter the new decade. We need to remove the volatility associated with the changes that we’re experiencing in the Roundup business while we unlock the new growth potential from our seeds and our trades globally. There will be a small group dedicated to the first and it will be the remainder of the organization that is singularly focused on the latter. The task is really straightforward, optimize the golden triangle share, penetration and value, delever to the market the most robust pipeline ever to be witnessed by growers and widen the differentiation between us and our competition. If we execute, we’ll deliver double the gross profit in 2012.
With that, let me turn the call over to Carl and Terry to first add some more color to the Roundup discussions and then to consolidated all these thoughts financially.
Carl M. Casale
As Hugh noted, we’ve believed for some time that Roundup would reach its peak contribution in fiscal year 2009. If you would refer to Slide 15, although we knew that supply demand imbalance for glyphosate would ultimately correct itself, the speed and depth of the transition was unprecedented. In the face of competitor response who’s magnitude and pace far exceeded our most conservative expectations, we’ve revised our outlook.
Today, if we use US market as a bell weather, we see a price gap between our leading brand of more than $2 per acre when compared with the competition. Just last fall that gap was roughly $0.50 per acre, a gap easily overcome by the peace of mind or quality and our Roundup rewards program convey. Not only is the rate of decline in the pricing from competition more rapid than expected but the sheer volume of competitive product sitting in the distribution channel, particularly in the US is unprecedented.
Our competition has overestimated the size of the global market and employed what we would consider an aggressive approach to working capital. Let’s not forget what Roundup is, a fabulous product valued for its ability to consistently perform for growers and deliver cash flows for reinvestment for Monsanto but, one that competes in a dynamic highly volatile environment. I think of Roundup as the annuity that accompanies the greater growth stock of seeds and trades. Our goal now is to manage the volatility and to guarantee the annuity with a measure of performance which is predictable yet meaningful.
To reassess our strategy and equally importantly, to remove the distraction from the rest of the organization, we are creating a separate organization for Roundup and all of our other herbicide chemistries. The significance of this move is its simplicity one team, one focus. If you move to Slide 16 you can see that there are many levers that we can pull as we seek smoother waters. First and foremost, let me be clear that we believe the demand for glyphosate globally will continue to grow in the low single digits with an additional round of ready acres and continued conversion to conservation [inaudible] practices.
What we are facing is a changing supply environment and what we need to determine is the price, volume and share dynamic that will deliver the optimal gross profit and ultimately the optimal level of operating cash. This may entail stretch premiums and lower volumes or at the other end of the spectrum sub historic premiums and a recapture of share and volume. Both are possible but, in this highly competitive environment we’d like to wait to discuss our path forward until later in the calendar year.
At the same time, we want to convey to you our confidence and our ability to deliver approximately $1 billion in gross profit in 2012 or roughly 15% of the estimated gross profit of the entire company at that time. I have mentioned many things that have changed in the Roundup environment in recent months but one thing has not, our low cost manufacturing position. We remain confident in our ability to remain a low cost producer and in fact, have identified further areas of improvement.
That said, to be very conservative, our long term gross profit projections of approximately $1 billion for Roundup assume that glyphosate acid prices remain in the $3 per kilo range for the foreseeable future. To provide some context for that number, the acid price was $10 per kilo in August of 2008, $6 per kilo in September and $3 this June. Our working assumption we’ve forecast around our gross profit at $1.9 billion was competitive acid price of $6 per kilo.
For us converting gross profit in to free cash is our key operational consideration. Historically, if you’d turn to Slide 17, the EBIT delivered by the ag productivity segment in total has ranged from $250 million to better than $1.5 billion since 2004 with operating spend in the range of 20% to 25% of net sales in the year’s prior to 2008. While we don’t disclose spending on an individual product level, Roundup by itself would have a lower spend than the entire segment but still with opportunity for further refinement.
Some of this cost will naturally erode as sales erode, some will continue to be reevaluated under our new strategy and some has already been cut as indicated by our announced restructuring. This one-time charge of $350 to $400 million is primarily designed to reset the spending level associated with the Roundup business either directly or in corporate support. All costs on the table are for consideration and nothing is deemed sacred.
Our guidance for future gross profit for the Roundup business considers the benefit of the restructuring action. All in, considering some efficiencies in business support, continued tight working capital management and ongoing depreciation and amortization of approximately $150 million, you could reasonably estimate operating cash flows less maintenance cash flow spending of approximately $400 million for a Roundup gross profit contribution of $1 billion.
As Hugh mentioned before there is no great Roundup Ready without great Roundup and this is priority one in the assessment of the strategy for Roundup in our portfolio. Priority two is delivering results in a predictable, meaningful range that are in turn reinvested in the growth engine of seeds and trade. The future consistent base line of free cash flows from Roundup coupled with Roundup ready franchise considerations will ultimately determine how the die is cast for this business.
Make no mistake, today marks a clear reset in expected contribution from Roundup. We are grateful for the contribution from the business for the past two years where it has allowed us to secure assets like Agroeste and Cristiani in corn in Latin America and De Ruiter in protected-culture vegetables while further bolstering an already solid balance sheet. With that I’d like to turn the call over to Terry who can share with you the outlook from this rebalancing of our expectations for our portfolio.
Terrell K. Crews
Carl and Hugh have laid out the keys today for how our gross prospects for the seeds and trades business while we reset the expectations for Roundup. As CFO there are three things financially I want to add to that discussion. One, we need to confirm our ability to meet our ongoing EPS target for 2009; two, we need to give you some early indicators for 2010; and three, we need to recommit to our goal for doubling our 2007 gross profit by 2012.
As Carl described, Roundup’s contribution to Monsanto’s value is expected to peek in fiscal year 2009 at roughly $2 billion. We believe we can complete this year with sales volumes of approximately 200 million gallons as we indicated in late May. For those 200 million gallons, roughly 70% were sold by the close of the third quarter while holding branded net selling prices at an average of more than $20 per gallon globally. We still need to deliver another $500 million in gross profit in the fourth quarter and it will be a function of our success in closing out the US season and the pre-season sales in Latin America.
If you turn to Slide 18, we’re comfortable that the seeds and trades business can deliver gross profit towards the upper end of our prior guidance of $4.4 to $4.5 billion. This 17% increase reflects the combination of value creation, market share growth and expanded trade penetration across the segment. Corn gross profit is still on track to grow by 20% for the full year to approximately $2.6 billion with a one to two percentage point margins landing on a 62% to 63% margin for the year. We anticipate soybean’s gross profit will grow by more than 20% to approximately $900 million with margins of roughly 62%.
We continue to believe that we will deliver share gains of up to one point in both the [DeKalb] and American seeds corn and one point in Asgrow for soybeans all depending of course by the final planting acreage numbers. Cotton and vegetable seeds are on track to meet their financial year goals of approximately $300 million and $450 million in gross profit respectively. Both of these crops anticipate margin growth of approximately two percentage points reaching the 72% mark for cotton and the 55% mark for vegetables. In the case of vegetables this margin expansion is being achieved even against an inventory step up associated with the De Ruiter acquisition that will reduce the gross profit contribution from vegetables by $36 million in 2009.
Turning to Slide 19, even with the flat gross profit from Roundup on a year-on-year basis we can see a path to our fifth consecutive year of 20% or greater ongoing earnings growth in 2009 and a lift in gross margin this year of more than three percentage points. We would now expect SG&A for the full year to trend towards 18% on an even lower net sales figure as compared with our prior guidance of approximately 19%. These costs savings will help offset the decline in Roundup versus our original expectations. We also expect R&D as a percent of sales to be in the 10% range.
We anticipate an additional upside in taxes as the expected effective tax rate for the full year will likely range between 28% and 29%. The majority of this benefit comes from discreet events that happened in the first half of this fiscal year. We expect to end 2009 with a modest gain in the fourth quarter that will allow us to deliver the low end of our $4.40 to $4.50 in ongoing EPS guidance and our free cash flow of $1.4 billion. While our spending reductions will allow us to deliver on our EPS commitment for the full year, some portion of the cash benefit will occur in fiscal year 2010.
Some significant fourth quarter expenses such as marketing programs are reflected as accruals now with the actual cash payments going out the door in the first quarter. As Carl referenced, we have announced a restructuring today of $350 to $400 million with most of the actions being taken against the Roundup business along with some product rationalization primarily in the vegetable business as we complete the integration of Sementes and De Ruiter.
We expect the restructuring to reduce our annual future cost by $160 to $180 million with half of it being realized in 2010 and the full savings will be realized in 2011. As we’ve readjusted our expectations for Roundup we need to give you our view as to how our strategic decisions will play out financially in 2010. To that end, I would point you to the path for 2012. We anticipate Roundup will provide the annuity of $1 billion in gross profit with an estimated $400 million in operating cash less maintenance capital spending.
We have the potential to be in that ballpark in 2010 depending on the decisions we make competitively to find the sweet spot among share, volume and price coupled with the cost savings we’re targeting from the announced restructuring. Partially offsetting the decline in Roundup in 2010 will be by almost any measure another year of stellar performance from our seeds and trades sector. Gross profit for this segment should cross the $5 billion mark in 2010 in line with our 20% compounded annual growth rate from 2007 to 2012.
This growth will be driven by the value of new seed launches, trade expansion and the conversion of the portfolio in to the next generation of yield enhancing products. We will of course give you full 2010 earnings guidance as we do every year during our fourth quarter earnings call in October as we finalize our operational plans, make adjustments for spending and determine our tax rate.
We anticipate that fiscal 2010 will mark a nearly decade long transition to a pure place seeds and trades leader in the global agriculture industry. Our next fiscal year will mark the first time that seeds and genomas becomes a contributor of more than 80% of the total company’s gross profit generation.
If you turn to Slide 20, by balancing value, share and trade penetration we believe the seeds and trade portfolio alone can generate 20% plus ongoing earnings growth as we look from 2007 to 2012. As the seeds and trades grow even stronger we’re crossing in to a different space with a different set of benchmarks and metrics. These are pegged much closer to the performance of our biotech pharmaceutical peers rather than a more traditional chemical comparison.
As you think about the seeds and trades segment by itself, you should expect margins of 60% plus which reflects the high value of our trades but somewhat offset by the fact that we do have to produce the fiscal seed itself which has a higher cost of goods sold so it is a blended margin. On its own SG&A as a percent of sales is in the mid 20s given the high touch approach across all of our channels. R&D as a percent of seeds and trade sales is in the mid teens and this is an area where we have benefited greatly from the contribution of Roundup through the funding or our technology driven approach to farming.
From 2004 through 2008 seeds and trades generated sufficient cash on its own to not only manage our recent capital investments but to also return cash directly to shareholders as shown on Slide 21. About 40% of the EBITDA was derived from Roundup and was used predominately to fuel the investment in innovation and growth in seeds and trades. Based on the cash generating power of our seeds and trades business, we will continue to maintain our dividend and are continuing to repurchase shares under our existing authorization with more than $300 million of shares repurchased in the first three quarters of this fiscal year.
So, in summary, we expect 2009 to be another year with a 20% growth rate for ongoing EPS. We have a path to reduce the volatility associated with Roundup and still a clear line of site on exceptional growth from an unparalleled seed and trade franchise as we enter our second decade as a technology leader in agriculture. With that, I’ll turn the call back over to the operator.
(Operator Instructions) Your first question comes from Mark Connelly – Sterne Agee.
Mark Connelly – Sterne Agee
When I look at your cotton and your soybean numbers it looks like we’re starting to see a little bit of step change in the performance there and I’m wondering if you could talk about whether there is a step change out there somewhere in the distance on Sementes as well?
Mark to answer the question, I think you’re right in your observation, we are seeing a step change in cotton and in soybeans. We’ve been talking about it in beans for a while, without adding more resources there we’re seeing the uplift in Roundup Ready to Yield and as I mentioned with the class of 2009 the class of 2010 we’re seeing some nice graduation results with improvements in our molecular market technologies and improved [inaudible] there. In Sementes it’s probably 2012 before we see the big leaps but we’re seeing smaller incremental improvements.
Mark Connelly – Sterne Agee
What’s driving that though Hugh? It’s GM in the other business but what is it at Sementes that is going to create that breakthrough level of performance?
The driver in Sementes is the same as we’ve seen in cotton in the last year, it’s not just biotech markets markers. So, once you have those street signs identify that means navigating and identifying improved performance becomes easier. In the last two years we’ve generated an enormous amount of markers in our Sementes and our veggie business. I don’t know Terry if you’ve got anything to add to that?
Terrell K. Crews
I would just add to the fact that we’re beginning to see marker capability, we’re also beginning to progress towards working with other companies to collaborate and create opportunities for vegetables at the market place that show better nutritional value, better appearance, such as the one we announced with Dole. As an example, we’re now looking at opportunities to improve lettuce so you can get the nutritional value of a romaine lettuce with the taste value of an iceberg. So, the combination of using marker capability to improve things on the farm for growers in combination with now beginning to advance marker capability that gives us a better tasting more stable, better looking vegetable at the fruit stand will enable us to grow this business.
I think Hugh is correct, you see some step up in 2011 and some in 2012 as well. But, just to bring it back 2010 we will also be through the inventory step up on De Ruiter so we’ll begin to see the benefits of the protected-culture market there also.
Your next question comes from Vincent Andrews – Morgan Stanley.
Vincent Andrews – Morgan Stanley
My question would be, you’ve raised the expectation for gross profit growth out to 2012 for seeds and trades from 2.25 to 2.5, what has changed in that mix that gets you that extra .25 if you will?
Terrell K. Crews
Most of that is seeing the benefit of the acquisitions that we’ve added in the past couple of years that strengthen the performance of that business. When we laid out our initial numbers we didn’t include any acquisitions and since that time we’ve acquired De Ruiters, Cristiani and Agroeste so we expect those businesses to contribute to the success of seeds and trades and that’s what is giving us the belief that we can get to that seeds and trade number now.
Vincent Andrews – Morgan Stanley
So every other assumption for the existing business is the same?
Terrell K. Crews
Yes, they’re still the same. We still expect the similar market share growth that we’ve talked about across our portfolio so everything is the same on our existing business.
Your next question comes from Mark R. Gulley – Soleil Securities Group.
Mark R. Gulley – Soleil Securities Group
I know we have to wait three months until we get official guidance for next year but, given Terry’s comment that gross profit in Roundup could be $1 billion in fiscal ’10 but given the lift in gross profit you just alluded to in seeds and trades it would appear as though the potential for earnings to be largely flat in 2010. Can you give us any color on that please?
Terrell K. Crews
I’ll begin. Your calculator and my calculator would work the same. I think the reality is if Roundup falls to that level we could see results below flat. The situation is this and it’s not that – we’re going to go ahead and share as much as we can on 2010 but there’s a lot of strategic decisions that we have to make in the next couple of weeks and the next month on where we’re going to go with pricing on seeds and trades and where we’re going to go with pricing on Roundup and what approach we’re going to use for the Roundup market for next year, where our spending is going to be and then there’s some smaller items such as our tax rate which we just haven’t accessed yet for 2010.
But, the math don’t lie, if you lose $1 billion of GP, if that were to occur in Roundup it would be difficult to offset that even with a stellar performance in seeds and trades. Seeds and trades will be stellar, there’s no question about that, we’re still talking about an 18% growth curve between here and 2012 to achieve our 2012 numbers so by any stretch of the imagination that’s great news for the seeds and trade business but we are dealing with a real downside in Roundup.
Just to add to that, I think the reality is that Roundup is going to be smaller, probably smaller faster and more precipitously than we expected. The danger is that it fogs or obscures the extraordinary growth in seeds and trades. 2009 we’re going to have more gross profit in our seeds and trades than we generated across the board in 2007. As Terry said in this remarks, despite the downturn in Roundup, we’ll have a seeds and trades gross profit equally probably 80% of our total business that year. So, I think getting lost in the Roundup drama, the danger in that is you don’t see the extraordinary growth that we’re anticipating between now and 2012 in our seed businesses.
Your next question comes from Jeff Zekauskas – J. P. Morgan.
Jeff Zekauskas – J. P. Morgan
Your corn seed revenues for the nine months are up about 17% and I guess I thought that your average price realizations were probably above that so is it the case that corn seeds volume has grown through the nine months or has it [trenched]? Sort of where do things sit?
Terrell K. Crews
You’re right in your numbers. What we see is while we’ve seen some share growth we’ve also seen some mix dynamics as well between the actual seed we sell. Any time we see share growth we see that. So, there’s some mix and plus there’s an increase in our business outside of the US so we’re seeing the mix effect of the global side of the business as well as we’ve grown share both in Brazil and Argentina and those are both different pricing points. So, when you take the combination of all of that, that’s what we’re looking at is about a 17% growth and as we said for the full year we would expect GP to still be up about 20%.
Jeff Zekauskas – J. P. Morgan
So did corn seeds grow through the nine months or didn’t they in terms of volume?
Terrell K. Crews
Yes, they did grow through the nine months.
Your next question comes from Don Carson – UBS.
Don Carson – UBS
A question on seed pricing, I know last year you sort of gave a hint to your plans for seed price and I realize you’re doing some strategy now but two subparts to this, one in the past as Roundup pricing has come down, one of the levers you have is to bump up the Roundup Ready tech fee by an equivalent amount. Of course, it’s hard to separate that out now from the price of the seed so I’m just wondering if that’s a consideration on how you manage the Roundup decline? Secondly, is it your expectation that just on base seed that the market can support another price increase next year and couple that with lower production cost should that lead to margin improvement even before you get to trade expansion?
Don, thanks for your two questions, maybe I’ll do some headlines and ask Carl to comment on value transfer. On price, as we look out to next year and we’re still working through this but I would anticipate on our existing hybrids and existing biotech trades I would be thinking about price increases in the high single digits. Then, as you think about our new technologies, Roundup Ready Yield and ultimately SmartStaxs and our new technologies in Brazil we will continue our philosophy of pricing them to value and then letting that value with the farmer.
So, that’s independent of the vagaries of crude oil and commodity prices. That’s kind of how we’re laying out our stall. On the shift between Roundup value and our seed value, I wouldn’t hold your breath on that. That’s not how we’re thinking about this. We’re fighting a significant onslaught of genetic material and I don’t think we’re going to be looking at value transfers there. We’re going to be recapturing share but maybe Carl you’ve got a few more words on that.
Carl M. Casale
Sure, I mean as Hugh said what we’re very focused on is the Roundup franchise in and of itself and the dynamics of what’s occurring in the marketplace and then the other side is what we’re doing about it. If you take a step back and reflect on what’s occurred the asset price has gone from $10 a kilo down to about $3 right now. That spurred a lot of purchasing in markets, particularly in the United States and we expect that ending inventories of genetic material this year are probably going to be about 40% of net year’s consumption so inventories are quiet high and that’s leading to a third dynamic in the market place which is people attempting to liquidate inventory to generate cash which is further depressing selling prices.
So, against that environment, there are three things that we’re doing, the first one is working to lower manufacturing base, our cost base and that work is underway right now. The second bucket, and we announced it today, is to restructure the business to size the support of the business with an expectation of reality that we’re probably going to be looking at $3 acid for the foreseeable future and a correlating billion gross profit contribution from Roundup. The third bucket of work that is underway as well is what is the ultimate price, volume, share combination that’s going to generate the results we want. That last piece of work is the one we’re still working on. We want to get through the over the top season this year because that will provide some more color to that decision set for us.
Your next question comes from Robert Koort – Goldman Sachs.
Robert Koort – Goldman Sachs
Carl, maybe you can talk a little bit about the 2012 plan in Roundup. I guess the profit level there is maybe 50% higher than the prior trough. I know you’ve got a little more capacity and maybe a little bit more mix shift towards branded but could you just sort of characterize why the future trough looks so much healthier?
Carl M. Casale
When we went through this cycle last time, the floor at that point was about $600 million of gross profit and we’re talking about $1 billion now. So, there are basically two things that drive that incremental $400 million of GP. One is we continued to lower our all in manufacturing cost base so gross margin per unit will be higher today than it was previously. The other one is we have the option to sell more volume over this time period than we did last time so it’s a combination of those two that will yield the higher price. Again, that’s in an environment that anticipates $3 acid.
Robert Koort – Goldman Sachs
Should we infer the isolation of Roundup as a prelude to something from a corporate action standpoint? There would see that there’s sufficient clarity as part of that productivity as the biggest piece so is this something to look forward to down the road?
Everything is possible but I think what we have done in the divisionalization and streamline this is much more focused on getting to a future state where we optimize profit and increase the dependability on this. To [inaudible] point it’s throwing off $400 million of cash when it reaches that position, it’s a decent product. But, we’ve always been open to that conversation we just need to reclaim a lot of lost volume this year and lay out our stall and get ready for 2010 coming. So, I’d never say never but the real focus in the first round of this is getting a [bite] that’s fighting away.
Your next question comes from Frank Mitsch – BB&T Capital Markets.
Frank Mitsch – BB&T Capital Markets
Just following up on Bob’s question, do you see any reasons that you would want to add to your crop protection chemicals business? Obviously there’s a lot of speculation in the market right now about what Dow’s going to do with its business which is obviously more predominately more crop protection. Does that add anything to that part of the Monsanto portfolio?
As we’ve looked at it, the pieces that we’ve been focusing on is seed treatments and as we continue to increase the value that we deliver to the grower and as we continue to drive yields, and that’s what he’s really looking at, then the application of chemicals at seed treatments is an area that we’re really impressed in and we have a big customer [inaudible] way than we’ve been looking at that in corn. Then, our new soybean products they’ll be treated so as we’re delivering 11% more yield we’re protecting that with chemicals so that our new Roundup Ready Yield products will be treated.
We’re also looking at that in the veggie area as well. As you improve the performance of these vegetable seeds how do you protect them from funguses and disease from the start. But [invention] of a whole bunch of generic chemistry and the same conversation where we’re saying next year 80% of our profit will be in sale of or seeds and trade growth, I think there’s a bit of strategic detour. So, I think we’ll get this Roundup business cleaned up. We always said it would eventually get back to more reasonable levels but I don’t see us having a broad chemical portfolio, that isn’t who we are.
Frank Mitsch – BB&T Capital Markets
Looking more broadly then, given that you have so much free cash flow that you’re generating, what are the areas that you would be focused more on in terms of M&A today?
I think it’s more of the same Frank. The three that I’ve always talked about and I think we’ve delivered on is repatriating cash to shareowners either in dividends or buybacks and the other one is continuing to look for expansions in our seed platform and expansions in our technology. The seed platform I’m guessing as we look forward it’s going to be more international than it is domestic. And, we still think there’s opportunities in the vegetable framework as well.
It’s interesting, if you look at agriculture compared to a lot of the space right now, we don’t see evidence of distressed sales. We don’t see things coming in the market that are fire sales but, we continue to kick the bushes and knock on doors and my experience in this segment is that nothing is ever for sale until it’s for sale. So, we will continue to use that cash to try and transfer from lower margin chemical business to higher margin future performance seeds and trades business, that’s kind of how we’re looking at it.
Your next question comes from P.J. Juvekar – Citigroup.
P.J. Juvekar – Citigroup
A question for Terry, gas conversion has been slow this year, I know you had prepaid last year which is distorting comparisons but you also mentioned that you have higher Roundup and seed inventories than last year. So, can you tie all that together and tell us how you get to your $1.4 billion free cash flow target?
Terrell K. Crews
You’re right it has been a bit slower and the two major things that’s got to occur is that the Roundup collections which are going to occur in the fourth quarter from the sales in the third quarter. What happened is the entire Roundup season in the US moved later which moved all those collections to later in the year and so a lot of that comes in the fourth quarter now when last year it came in in the third quarter so we have that factoring in.
Also, a lot of the inventory reductions that we’re going to be making consistent with the plans that we laid out, we’ll see the cash benefit of that also in the fourth quarter as well. Just a remainder, on the Roundup season last year was really a lot different than any normal season because of the shortage of the product, there was a lot of product that was procured earlier in the season pretty much globally and we saw a lot of that cash come in the second and third quarters of last year. A lot of that is going to come in the fourth quarter of this year. I still feel comfortable with our ability to get to the $1.4 billion but it is going to have a lot more collections in the fourth quarter than what we’ve had in 2008.
P.J. Juvekar – Citigroup
Just quickly on SmartStax, you need a decision by the EPA by August to make your goals for 2010?
No, we don’t. We still feel confident that we’ll make our plan and goals in 2010 P.J., so we don’t.
P.J. Juvekar – Citigroup
So the decision by the EPA could come next year and you’ll still be able to make the plan?
Yes, it would, that’s absolutely correct. I’m hesitant because our policy for 10 years has been we’ve never speculated on regulatory events or when those approvals come and that’s a good philosophy. There are others that don’t follow it but it’s kind of served us well. But, we’re still feeling pretty cool on our SmartStax’s position.
Your next question comes from Steve Byrne – Banc of America Merrill Lynch.
Steve Byrne – Banc of America Merrill Lynch
Just another one on Roundup, Terry your unit COGS on the round up business have been in the $7 to $8 a gallon range. Can you split that up for me how much is fixed versus variable and if you were able to push volumes from say 200 million gallons to maybe even getting closer to 300 million or at least high 200s, how much of a unit COGS benefit would you receive from that?
We’ve always been a bit shy in splitting this out Steve as you can attest to but I’ll let Terry take a swing at it. We’re bringing more capacity on the back end of this year so as you know it’s a [inaudible] as we cut the tape on our expansion but maybe Terry you could make a broad comment and then maybe Carl say a few words on what we’re seeing with generic material and what our estimates are and cost positions there.
Terrell K. Crews
Steve, I want to reiterate that I didn’t give out the $7 to $8 costs, the glyphosate that you quoted but I think the reality is yes, there’s definitely a push from plant occupancy, it’s the way to think about operating the glyphosate business. Part of the value of the last expansion we put in was in fact to lower that cost position so just by definition that means we’re better off, or we’re wise to utilize the plants. We haven’t shared a fixed variable break down of that but when you think about the overall in the billion dollars, that’s certainly incorporating a possible decision to more fully utilize the plant. Carl, I don’t know if you want to add?
Carl M. Casale
The other piece on the COGS, so Terry addressed the fixed cost piece and then on the variable piece we see some opportunities and again, it’s in the billion dollar GP number but consolidation of SKUs, formulations and the associated leverage that goes along with that from raw materials purchasing, we think is a significant opportunity. Again, that number as well as utilization numbers are factored in to the billion GP number.
Steve Byrne – Banc of America Merrill Lynch
Carl, can you clarify for me the price spread that you have on chart 15, whether or not that $10 a gallon price spread is based on the way you account for price or whether that is more of a retail price spread?
Carl M. Casale
That would be our assumption of farm gate Steve, what the farmer is actually experiencing.
Your final question comes from Laurence Alexander – Jefferies & Co.
Laurence Alexander – Jefferies & Co.
One last brief question on glyphosate, as you look at the inventory levels downstream and the distributors holding what would now be relatively high cost inventory versus whatever price point you arrive at for next year, do you need to compensate the distributors? And if so, would that be a cash impact this year or would it be an impact next year?
Terrell K. Crews
I think we still have to make our decisions about how we’ll approach the markets so it would be premature to talk about whether there would be some involvement in compensating distributors. I think when we think about the cash affect for next year, we’re still going to be driving forward to keep the cash within the year when we make the sale. Just by definition if you go to the model that says you’re going to run a billion GP company with a $400 million or so cash flow, that says you’ve got to run a top working capital model. I’m really pleased with what the teams has done in running a top working capital model through the past several years and that’s paid great dividends and enabled us to make great acquisitions.
So, one of the things that has to be inherent with this change is that we’ll continue to run a top working capital so I would expect to still see the cash benefit to occur in the year in which the sales occur. How we go about handling that with distribution is still a decision to be made.
Carl M. Casale
The other thing I would point out is as Terry said, we run with pretty tight inventories and the inventory bubble in the market place isn’t ours, it’s the competitive generics that are sitting with all the inventory.
That’s the usual thing.
Laurence Alexander – Jefferies & Co.
So you’re comfortable with the 20% inventory level that you highlight on the slide?
Carl M. Casale
Yes, that’s well within historic norms.
That’s the change, we’re seeing much more generic material in the channel and it’s been oversupplied and overbought but we’ll slug our way through that. Let me just wrap up, thanks very much for the questions this morning. I think you can take from this call that we didn’t supply every answer today but I hope that we left you with three things. The three things that we try to really focus on in this call were: number one, much greater clarity on Roundup as the story evolves; number two, continued confidence in our leadership in seeds and trades; and three, a view to 2012 that confirms our commitment to double the gross profit of this business over the life of our five year plan.
I think it is one thing to say we have a rich pipeline that’s unequalled on farm, it’s another thing to see it. So, I would encourage all of you to join us for our fourth annual fiscal stop tour for investors on August 13th and 14th. As many of you know as devotees, we’re in remote locations and the hotel space is always limited so I’d encourage you to sign up early as we’ve already reached the quarter’s sale out on our capacity. I think the early sign up indicates that there’s absolutely no substitute in the middle of the summer for pulling on your boots, walking the fields and talking to our customers, the growers.
Ultimately, we’re only successful for you if we are successful for them. So, I hope you take the time and spend a bit of time with our customers this summer. So many thanks for your questions and your support this morning. We look forward to seeing many of you in Iowa. Thanks very much.
This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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