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Alliance One International (NYSE:AOI)

Q1 2014 Earnings Call

August 09, 2013 5:30 pm ET

Executives

Joel L. Thomas - Vice President and Treasurer

J. Pieter Sikkel - Chief Executive Officer, President, Director and Member of Executive Committee

Robert A. Sheets - Chief Financial Officer, Chief Administrative Officer and Executive Vice President

Analysts

Karru Martinson - Deutsche Bank AG, Research Division

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to today's Fiscal Year 2014 First Quarter Results Conference Call hosted by Alliance One International. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Joel Thomas, Vice President and Treasurer. Mr. Thomas, you may begin your conference.

Joel L. Thomas

Thank you, Annette. To all our stakeholders, we would like to thank you for joining us on our call today. We appreciate you making yourselves available late on a Friday afternoon in the summer. Due to the timing of our recent refinancing efforts, our quarter close process was delayed. As such, we completed our 10-Q earlier today in time to release this afternoon. The management team is traveling starting later this weekend and out of place for over a week. As such, we decided to have our call this afternoon versus waiting for an extended period after the release of results. Again, we apologize for the late notice and call timing.

With me this afternoon are Pieter Sikkel, our Chief Executive Officer and President; and Robert Sheets, our Chief Financial Officer, Chief Administrative Officer and Executive Vice President.

First, we need to cover a few legal disclosures. Our discussions this afternoon will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations of future events. Such statements include, but are not limited to, statements about future financial and operating results, plans, objectives, expectations and intentions and other statements that are not historical facts. Such statements are based on the current beliefs and expectations of Alliance One's management and are subject to significant risks and uncertainties. If underlying assumptions prove inaccurate, or known or unknown risks or uncertainties materialize, actual results may differ materially from those currently anticipated, expected or projected. Factors that could cause Alliance One's results to differ materially from those expressed or implied by the forward-looking statements can be found in Alliance One's most recent annual report on Form 10-K and other filings with the Securities and Exchange Commission.

Any replay, rebroadcast, transcript or other reproduction of this conference call other than the replay as provided by Alliance One has not been authorized and is strictly prohibited. Investors should be aware that any unauthorized reproduction of this conference call may not be an accurate reflection of its contents.

Now our results for the quarter. For the first quarter ended June 30, 2013, we reported a net loss of $36.9 million or $0.42 per basic share, compared to a net loss last year of $30.7 million or $0.35 per basic share. Our first fiscal quarter is usually a lower revenue quarter in comparison to other quarters during the year, driven by the timing of crops from the growing regions where we source supply. This year's first quarter is consistent with past experience. Sales and other operating revenues increased 7.3% to $383.9 million, primarily due to delayed shipments from the end of fiscal year 2013 in Europe and Asia that occurred during the quarter, as well as increased sales prices due to higher green costs in Brazil for the current crop.

Gross profit decreased 31.5% to $28.5 million when compared to last year and gross profit as a percentage of sales decreased from 11.6% last year to 7.4% this year. Prior year gross profit included $13 million of loss of derivative financial instruments related mainly to the Brazilian real that were offset by lower U.S. dollar operating costs of tobacco sold in future periods. This year, derivative financial instrument losses were $3.3 million, also primarily due to the Brazilian real that depreciated versus the U.S. dollar during the period and also will be offset by lower U.S. dollar operating costs of tobacco sold in the future.

Additionally, current year gross profit and gross profit as a percentage of sales were impacted by approximately $11 million of expense, mainly related to reducing the estimate for the recovery of farmer advances in Zambia, the negative impact of certain appreciating foreign currencies against the U.S. dollar, primarily in Africa, that are not fully absorbed by customers, and the higher costs of the current Brazilian crop, which were not fully offset by higher sales prices. To address the unforeseen challenge with Zambian suppliers, going forward, we are further enhancing our agronomy staff and credit procedures there to recover the highest level of current and future farmer advances as possible.

Selling, general and administrative costs decreased 1.7% to $35.5 million compared to the prior-year quarter and included $2 million of FCPA monitoring expenses that will end later this fiscal year, and once complete, will help to improve future SG&A costs. Restructuring and asset impairment charges were $2.2 million this quarter due to our agreement for a joint processing venture in one of our foreign locations that will reduce future processing costs. Increased interest costs related to higher average borrowings and higher average rates were partially offset by increased interest income. Mainly due to the reduction in gross profit, pretax income decreased $14 million compared to last year. Cash taxes paid were $1.9 million this year versus $5.7 million last year.

We are in global undersupply of burley and higher-quality flavored tobaccos. Our uncommitted inventories remain within our stated range of $50 million to $150 million, and total inventory is well positioned at approximately $1,134,000,000 versus approximately $987 million last year. Increased inventory versus last year is related to planned sales growth in Asia, the largest fastest-growing global market. We anticipate lower year-end inventory levels versus last year with increased sales that should also help to reduce year-end debt levels.

As of June 30, 2013, available credit lines and cash were approximately $591 million comprised of $148 million of cash and approximately $443 million of credit lines, consistent with internal expectations. On August 1, 2013, our senior secured revolving credit facility was amended and restated. It provides approximately $303 million in commitments through a syndicate of banks that reduces approximately $210 million in April 2014 and matures on April 2017. Pricing remains the same, and covenants and baskets were modified to reflect current and future business opportunities. Also on August 1, 2013, we issued $735 million of Senior Secured Second Lien Notes at 98% of face value for proceeds approximately $720 million with a coupon of 9.875%. Maturity is July of 2021, and the notes are secured by a second priority pledge of specific collateral.

On August 2, 2013, proceeds from the new note issuance were used to redeem all $635 million of our outstanding 10% senior notes due 2016 at a price of 105% plus accrued and unpaid interest. Remaining proceeds were utilized to pay fees and expenses and to deposit in an account sufficient funds to complete our pending cash tender offer for up to $30 million of our currently outstanding $115 million of 5.5% Convertible Senior Subordinated Notes due 2014. Our refinancing extends the maturities of the majority of our long-term debt, provides good terms and conditions and positions the company with a solid capital base as we move forward.

For the full year, our expectation is that volume, revenue and profitability will improve versus last year based upon our internal plan. Our global team is focused on working capital efficiency and is driving to improve our cash cycle, while the benefits of our factory improvements should become more evident with increased volume as we move forward. Combined with further operational improvements, we are striving to increase long-term shareholder value.

Operator, at this time, we'd like to move forward with questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take your first question from Karru Martinson from Deutsche Bank.

Karru Martinson - Deutsche Bank AG, Research Division

Just to start with inventory. When you guys said that you'll be below inventory levels of fiscal year 2013, so we were kind of at $904 million at that point. We're $1.134 billion today. Are you saying that you're going to take about $230 million of inventory out? And is that going to be cash that's -- from working capital that's going to drop to the bottom line, or how should we think of that?

Joel L. Thomas

If you look at the $903.9 million from the prior year, we believe that we will be inside of that number by the end of the year. And that should provide some improvement related to debt and cash as it relates to inventory.

Karru Martinson - Deutsche Bank AG, Research Division

Okay, so working capital will be a source of cash this year?

Joel L. Thomas

We think there's an opportunity to improve the cash cycle and we think that working capital can be a source, yes.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And given that we had a short crop last year in various parts of the globe, particularly in Southern Africa and you talk about the Brazil -- higher Brazil crop costs coming in. But when does pricing catch up to all of these higher costs? I mean, what's the cycle here that we should be thinking of?

J. Pieter Sikkel

Well, I think as we've talked about before, pricing -- the best point for -- and position for our business is when we are in slight oversupply of tobacco situation. That's when we can best purchase at the correct qualities and pricing from the farmers, use our significantly improved assets and low cost of conversion and we have good negotiations with customers, and that's when you start to see real improvements in profitability in our business. Fortunately, this year, South American prices have -- particularly in the second half of the purchasing cycle, have been stronger than we expected and even led us to pull back a little bit on what we expected to purchase. In terms of crop sizes, for this year, the -- really, if you're looking outside of China, flue-cured crop sizes have only increased by about 1%, which is a little bit less than we expected. Burley crop sizes have increased about 18%, but are still below -- 100,000 tons below what they were 2 years ago. Oriental is up by about 10%, and we're seeing significant shortages of sun-cured tobacco coming in later in the year. But I would expect -- once we get into next year's crops is when we expect to see crop sizes better matched with demand.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And when you guys talk about your full year plan kind of ending the year, up on volume, revenue and profitability and certainly saw the comment here, due to anticipated customer shipping schedules. I mean, what are -- what's the level of confidence on those schedules and the level of commitments from your customers to give you the confidence there?

J. Pieter Sikkel

Well, I think we've seen strong demand for our product. Majority of what we've been purchasing is committed, and we have a very good indication of what the shipping cycles are for those tobaccos. We've pretty much finished purchasing in South America, we've finished purchasing in most of Africa, although the Tanzanian crop is still coming in. I think in Asia and Europe, we're pretty solid on the crop sizes and know what to expect. The only question that really remains or significant question is how big the U.S. crop size will be. That was initially expected to be a considerable increase on last year. With the high level of rainfall that we've seen in the last couple of months, we're looking at crop sizes that are probably similar or slightly below last year's levels. So the question is there on how much volume we will get. But I would say, we're very positive towards everything we've stated in terms of all 3 measures, volume, revenue and profitability, to achieve significant improvements over the prior year.

Karru Martinson - Deutsche Bank AG, Research Division

All right. And just lastly, I would just add with my comment, I certainly understand that management was all in place and timing for the call, but I think most people would agree, Friday, 5:30, probably not the best time for future calls, if we could.

Robert A. Sheets

Trust me, Karru, we don't like the Friday evening either. It's just that due to the certain delays and travel commitments that we had, we felt it was best to have the call rather than wait for a week. And yes, as Joel said, we do apologize for the lateness of this, but occasionally, you're going to run into this. And this is not ever -- Friday is never in our plans.

Operator

We'll move to your next question, that will come from Ann Gurkin from Davenport.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Wanted to start with a point you were just talking about, about second half weighted. And we have this same scenario set up for fiscal '13 and you missed fiscal '13. So how can we be confident that you're going to make numbers for fiscal '14 with the back second half loaded scenario again?

J. Pieter Sikkel

Well, I think as I just mentioned, we've almost finished purchasing most of the African crops we have invested in our facilities in Africa. We have higher capacity in per hour -- capacity throughputs in Tanzania, Malawi and Zimbabwe, and therefore, we expect to be able to process and get ready for shipments significantly faster at the higher levels of crops that we purchased this year. That should allow us to not have such a back-end weighting in quarter 4, as we've had in previous years, and allow us to push part of quarter 4 back into quarter 3 and obviously get what we are expecting in quarter 4 earlier in quarter 4. And that really gives us a higher degree of confidence than we've had in the past.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And this year, Q4 was shipping into Q1, and it looks to me like that did not happen. Can you explain what happened? Q1 was much weaker than what we were looking for. I know it's a seasonally weak quarter, but we thought there would be some benefit from that delayed Q4 shipment from '13. And so I'm just curious, what else is in those numbers that's making it so down?

J. Pieter Sikkel

We've had -- I think I mentioned in the last call that we expected the recovery of those volumes over the first 3 quarters, not all in quarter 1. That's pretty much showing as we expected. I think you can also look at the higher level of customer advances in the quarter. That suggests that the customers, where we were expected to maintenance are still [ph] in the quarter that paid for more tobaccos, but that's moving -- part of that is moving into quarter 2. Other than that, we did see movements out of Asia and Europe pick up, but we didn't have that much carryover inventory because of the small African crops into this fiscal first quarter. And I think that affected the overall volumes that you're seeing within the quarter itself.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then in the release, you talked about lowering or reworking processing volume business or something like that. Can you give some more detail on that? And are there more opportunities to reduce that processing volume cost more?

J. Pieter Sikkel

I think we're always looking in every market in which we're in to reduce our conversion or processing cost, that's why we've invested heavily in certain countries in recent years. And in this situation, although we haven't announced where it is yet but we will hopefully shortly, we were able to get into a situation where we could increase the throughputs in one facility that would definitely reduce costs and then potentially have some other benefits as well. But we will remain focused on that all over the globe. We've always said we want to be the low-cost provider in every market in which we're in, and we're laser-focused on achieving that target.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

And then with the outlook for, if you want to call it tight crops or undersupply of crops this year, should we be concerned about fixed cost absorption that it's going to become more of an issue this year because of the smaller-than-expected crops, for example, in the U.S. and burley in particular? Is that a scenario we need to be cautious about?

J. Pieter Sikkel

I think we've said already that we're expecting higher revenues, volumes and profitability for the year. So I think that really shows you where we expect to be on fixed cost absorption as well.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then my last question has to do with this debt refinancing you just did, and kind of your comments, your opinion of how the process went and the rate you had to pay and the amount that was taken down. I was just thinking if you could just give some color on how you think that whole process, debt refinancing experience took place?

Joel L. Thomas

Yes, Ann, the change of position that the Fed took in May caused the markets to look a little bit different than they had in the prior, call at 6, 7 months, and that delayed us coming into the market. Ultimately, we've got good support in the market related to our name and the market-based pricing that we were able to achieve was really a reflection of where the market is. So at the end of the day, we're excited about having a new 8-year deal and a new -- or an extension on our revolving credit facility. We've got the covenants and terms and conditions that allow us to do what we need to do to push the business forward and grow. So we feel as though we're very well positioned, and it just takes one more thing off the table, so.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then just, Joel, if you could just identify one-time items to think about. So the $2.2 million restructuring, the $11 million in Zambia, $3 million for currencies, is there anything else in those numbers we should think about as kind of one-time items?

Joel L. Thomas

Yes, restructuring of $2.2 million, there was the monitor of $2 million that you mentioned, FX is $3.3 million and those would be sort of the major ones and probably a little bit more of farmer debt that we looked at when we modified our estimates, so.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then, Robert, do you care to guess about the tax rate this year?

Robert A. Sheets

Well, Ann, actually our tax rate should be stabilizing somewhat. But tax rate for the full year at this stage, I wouldn't venture a guess. Our projection, we estimate, might be as high as probably 59%, somewhere in that range on a tax rate basis. But we don't anticipate our cash taxes to be anywhere near that.

Joel L. Thomas

Yes, our traditional cash taxes, Ann, kind of in that $9 million to call it $17 million range and based on the projections for this year, we're probably at the higher end of that range.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then just one more question. With low uncommitted inventories, I guess your competitor is calling out the lower carryover shipments and the margins on that business. And can you just walk through kind of how your margins are shaping up your business? And is there a concern with lower uncommitted inventories, carryover stock, absolute crop, is that something we need to be concerned about in your numbers for this year?

J. Pieter Sikkel

I think, I mean, we would always prefer committed inventory to uncommitted inventories.

Robert A. Sheets

But having said that, we need a certain level of uncommitted inventories as well.

J. Pieter Sikkel

Well, committed carryover, of course, is something that normally adds to our results in each quarter. But and I think we've always known that this year, we would have a plan that was more weighted to current crops than it was to older crops. That's been in our budgetary process right from the beginning. And we think we're certainly exercising at -- on that part of the plan, and we'll be able to continue that throughout the year. We've got to watch what's going on here in the U.S. But at the moment, we've taken the recent estimates into account and we still feel confident making the statements that we had.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

I would think you'd be in the position to realize the benefits of all your hard work over the past several years in restructuring operations. I think that should start coming through numbers over the next 12 to 18 months, better cost and mix and [indiscernible] is that fair?

J. Pieter Sikkel

Yes, correct. As crop sizes move up and we are predicting increased crop sizes again next year, you really will start to see the effects of the efficiency improvements that we've made over those increased volumes. A lot of those were hidden particularly last year and coming into the early part of this year because of the low crop sizes, they came at the same time as those investments came into place. But they're all up and running now. Our last major upgrade was Zimbabwe. That line opened 3 weeks ago, and it's running to expectations as we speak.

Operator

We'll move next to Bryan Hunt from Wells Fargo.

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

I was wondering if you could make a qualitative comment on your profitability outlook. You said you expect profitability to be up year-over-year. I mean, what metrics should we use, gross profit, operating income, EBITDA? And maybe, perhaps using the 2 20 in the EBITDA from the most recent bond deal would be a good guidepost for most of us?

Joel L. Thomas

Yes, Bryan, we believe that operating income will be up over the prior year and that would flow through to -- in EBITDA measurement as well.

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

Okay. And then you all talked about moving some volume to a more profitable region of the world. Is there CapEx involved in hitting that target and achieving that goal?

Joel L. Thomas

Our CapEx that if you look at our depreciation and amortization, in the mid-30s, Bryan, with the majority of that being depreciation, we need to invest in the business in sort of the $25 million to $30 million range to meet maintenance needs. And then, we will look at projects that have fairly quick returns or will help us to further the business, but again, with pretty rapid results back. So nothing's really changed related to CapEx.

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

So CapEx probably in the $40 million to $45 million range would be a good projection for the year, is that fair?

Joel L. Thomas

That would probably be the upper end of the range.

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

Okay, great. And then maybe a bit more color on the collectible or receivable write downs from your farmers in Africa. Can you give us an idea for the magnitude of those receivables were as a percentage of the total receivable from those farmers in that country?

Robert A. Sheets

Bryan, Zambia was a challenge for us this year. It was fairly high percentage. We're still evaluating that estimate. We're still receiving tobacco and buying tobacco in Zambia, but based on the information we had, that was probably – tag it with the percentage.

Joel L. Thomas

Yes, we really haven't put a percentage out there, Bryan. And...

Robert A. Sheets

We've just finished evaluating the issues.

Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division

Okay. And my last question, I mean when we think about risks for this year that are unforeseen, with the short crop, are you at risk of missing collectibles or having to write down receivables from farmers again later this year? I mean whether it's from farmers that just don't deliver because their crop spoils or theft or other issues?

J. Pieter Sikkel

I think we're mainly entering into crops where we have very minimal advances.

Robert A. Sheets

Correct.

Operator

And that does conclude our Q&A session today. At this time, I would like to turn the conference back to Mr. Thomas for any additional comments.

Joel L. Thomas

Thank you for joining our call this afternoon. The call will remain available for playback for any interested persons through 8:30 p.m. on August 14. Our financial results and Form 10-K, as well as other information can be accessed on our website, www.aointl.com. Additionally, I'm available by phone should anyone have further questions. Again, thank you for participating in our conference call this afternoon and have a good weekend.

Operator

And that does conclude today's teleconference. We thank you all for your anticipation.

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