Monsanto Company (NYSE:MON)
Q4 2009 Earnings Call
October 7, 2009 9:30 am ET
Hugh Grant – President & CEO
Carl Casale – EVP & CFO
Terrell Crews – EVP, CEO Vegetable Business
Scarlett Foster – VP IR
Jeff Zekauskas - JPMorgan
P.J. Juvekar - Citigroup
Kevin McCarthy - Bank of America Merrill Lynch
Frank Mitsch - BB&T Capital Markets
Laurence Alexander - Jefferies & Co.
Don Carson - UBS
Robert Koort - Goldman Sachs
Mark Connelly – Sterne, Agee
Vincent Andrews - Morgan Stanley
Mike Judd - Greenwich Consultants
Bill Young – ChemSpeak
Mark Gulley - Soleil Securities Group
Greetings and welcome to the fourth quarter 2009 Monsanto Company earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host Scarlett Foster, Vice President Investor Relations for Monsanto.
Good morning to everybody on the line. I’d like to welcome you to Monsanto’s fourth quarter earnings conference call. I’m joined this morning by Hugh Grant, our Chairman and CEO; and Carl Casale our CFO. Also with me are Manny Crews, Wilma [Candrew], and Ruben [Maya], my colleagues in Investor Relations.
Before we begin I’d like to remind you that we’re webcasting this call. You can access it at Monsanto’s website at www.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 information 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 10-Q and in 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 in the slides and in the earnings press release.
And has been our practice, we also have published today the final numbers for our biotech trade acreage penetration by crop and by country.
Our conversation today is really focused on two areas. First we need to outline how we will grow our seeds and traits 13% to 15% in 2010 with the associated costs and complexities of launching two new products on a scale not seen before on farms. Carl will focus here along with the financial guidance for 2010.
Second we need to set out the milestones that will demonstrate our ability to deliver on our 2012 commitments. Hugh will address this area driven by grower preference for our seeds and traits which anchors our commitment to double gross profit in 2012.
In the longer-term context, fiscal year 2009 was a sign of the decade to come. Grower adoption of our seeds and traits created the lion share of our growth accounting for over 65% of total gross profit, growing at a 17% rate with a nearly one percentage point gross margin lift, all while we prepared to launch two game changing technologies.
Roundup gross profit declined 7% and the business has now been repositioned in the marketplace for 2010. We’ve defined a clear path to optimizing Roundup gross profit at the $1 billion target by 2012 and at that level, the entire Ag productivity segment would be only 15% of total company gross profit.
Slide four allows us to take a slightly more detailed view of the fourth quarter and full year, and the reconciliation at the end of the slide deck and in the press release provide you with the bridge from as reported to ongoing earnings.
I would note for you that the restructuring charges in the fourth quarter are reflected both in cost of goods sold at $45 million and as an expense line item of $361 million, both pre-tax. The net after tax effect is $0.53 per share in the fourth quarter and $0.52 per share for the full year.
Turning to the financial effect of our operations in the quarter total company net sales and gross profit declined 8% and 11% respectively. Somewhat better results then we originally forecast in seeds and traits coupled with significant one-time cost saving measures put in place for the last four months of the fiscal year helped bridge the forecasted gross profit gap in Roundup.
As a result ongoing EPS was $0.02 rather then our typical seasonal loss in the fourth quarter. For the full year company net sales and gross profit were up 3% and 9% respectively. Strong grower preference for our seeds and traits coupled with the extraordinary actions we took to reduce expenses to offset the Roundup gross profit decline resulted in ongoing EPS growth of 21% at $4.41.
The full year also reflected the mid point of our anticipated tax rate of 28% to 29%. If you refer to slide five, full year gross profit for seeds and traits of $4.5 billion was larger then Monsanto’s entire gross profit in 2007, speaking to the rapid adoption of our products in two short years.
Our corn platform set the pace with gross profit growth of 20% with margins expanding by nearly two percentage points to 63%. The pacesetter for corn was the US business where gross profit grew over 30% as triple-stack corn accounted for more than 70% of the growers’ choice from the DEKALB and American Seeds portfolios.
That value more then offset flat market share in both brands and less aggressive sales of triple-stack products by our licensees. Market share in Brazil and Argentina flourished grower use of our new hybrids. Share gains of one and three points respectively established the base for the future ramp of trait penetration in Latin America.
Soybean gross profit grew 20% to $871 million. In the United States the Asgrow brand grew by half a share point and American Seeds was down nearly one point. Gross margins declined two percentage points given the mix effect of selling more seed at a higher value in a year when we had only introductory levels of the Roundup Ready 2 Yield trait.
We’re just beginning to see the payoff of our increased investment for cotton growers made two years ago. The introduction of the class of 2009 varieties is helping us begin to turn the corner with growers even though Deltapine shares dropped nearly two points in a small [inaudible] market in the heart of the cotton belt.
Trait penetration and mix in India and an increase in acres in Australia led to a better then expected gross profit of $344 million, a 10% increase over the prior year with a margin lift of four percentage points.
Gross profit for our vegetable segment grew 6% to $416 million reflecting the benefit of adding the De Ruiter protected culture business. Margins decreased by two percentage points given the inclusion of $36 million for the inventory step-up related to the De Ruiter acquisition. Excluding the inventory step-up vegetable gross margins would have been 56%.
A synopsis of our final global market share numbers for the large grow crops in 2009 can be found on slide six. Results were mixed with the strongest performances coming in corn in Brazil, Argentina, India, and Europe.
As shown on slide seven, gross profit for the Roundup business was $1.8 billion with global volumes for the year at 182 million gallons and a percent of branded materials sold flat at 58% of total volume. Price for global branded Roundup peaked above the $20 per gallon level.
Slide eight summarizes some other key results in fiscal year 2009. On the cost side SG&A as a percent of sales was just over 17%. The special cost savings program launched in May resulted in reduced expenses of $262 million largely because of lower incentives, travel limitations, and other extraordinary cost measures.
R&D as a percent of net sales was 9% as we managed a historically large number of potential new products in the regulatory approval phase prior to commercialization. Free cash flow reached $1.5 billion for the year, with operating cash flow of $2.2 billion. Three factors caused the decline in operating cash year over year.
One, we managed a lower level of accounts payable because we reduced spending. Two, we had an extraordinary level of prepaids, reflected in deferred revenue in Brazil in August of 2008. The cash effect was in the range of $400 million which was [pulled] into fiscal year 2008 from the 2009 fiscal year cash flow.
Third, we produced corn feed for a larger core market in both the United States and Argentina and inventories are higher then the prior year. This will be metered down as we change the mix for the 2010 product lineup to prepare for the launch of SmartStax.
Capital expenditures were $916 million, in line with last year as we neared completion of the major seed manufacture [inaudible] and the Roundup debottlenecking project. Over $300 million of cash was used for germplasm and acquisitions in adjacent spaces such as wheat and sugarcane and that was paid for by some $300 million in divestitures.
We repurchased $398 million worth of shares in fiscal year 2009 and are one-third of the way through our second $800 million authorization. At year’s end we can sum up the total of our efforts by looking at return on capital.
We have consistently increased return on capital through a combination of earnings growth and efficient use of capital. In 2008 and 2009 the significant levels of Roundup gross profit was towards the ROC trajectory. Nevertheless because of the strong growth in seeds and traits we were able to increase total company ROC by one percentage point to 25%.
In sum during fiscal year 2009 Monsanto optimized gross profit across both seeds and traits and Roundup and realized significant cost savings to deliver a 21% increase in ongoing EPS and free cash flow of $1.5 billion.
Finally we witnessed the end of the peak years for Roundup gross profit and used the cash flow generated by that business over the last three years to expand our higher margin seeds and traits business while sharing value with our customers and returning value to our shareholders.
At this point I’d like to turn the call over to Carl.
Thanks you Scarlett, and good morning to everyone on the line. I’ve had the opportunity to participate in these calls in my previous roles, it is now a privilege to do so as Monsanto’s new CFO. The strong legacy Terrell Crews created here has challenged me to make the best even better. This is a task I take seriously and I’m fortunate to have served with and learned from Terrell over the last decade.
And what had served us well through our first decade as a standalone company informs the second decade, specifically I’d point to four tenants. First and foremost our focus is the customer and every financial choice we make, should inform how we bring more value to growers and how we improve the return on investment.
Second, if we succeed at the first we then must execute so that we deliver to our owners consistent earnings growth as a commitment, not an aspiration recognizing the effect of resetting the earnings expectations for Roundup.
Third, growth comes with a price tag but spending must be disciplined and the last dollar spent needs to bring as much value as the first. Fourth, we should translate earnings into cash and that value should be returned to our owners through a combination of investments in future growth, dividends, and share repurchases.
These four principals are behind the commitments we have made for 2010 and have resulted in our ongoing EPS guidance of $3.10 to $3.30, assuming a 30% tax rate. Our corresponding free cash flow guidance is $900 million to $1 billion including the after-tax cash effect from restructuring of approximately $250 million.
The components of our guidance are reflected on slide nine. As you think about the quarterly break-out of the earnings, I would anticipate that we will break-even or have a modest loss in the first quarter and a small loss in the fourth.
Approximately 60% of the earnings should flow through in the second quarter and roughly 40% in the third. As we would expect, this reflects the shifts in Roundup in Latin America at the start of the year and in the US at the end with growth in seeds and traits driving the middle of the fiscal year.
The considerably lighter first quarter will not be an indicator of the year to come and we expect the business will gain strength as we move into the middle half of the year and the peak of the buying season for seeds and traits.
Our earnings base in 2010 is a direct function of the competitive dynamics surrounding the Roundup business and the clear signal from our customers that the premium for our branded product over the competition last season, out strip the value received.
By narrowing the gap on that premium Roundup becomes a $650 million to $750 million gross profit business this year as shown on slide 10. Our ability to optimize that gross profit at $1 billion in 2012 is the function of things we control, most specifically volumes and cost savings assuming that we continue to price appropriately for the value the farmer receives.
At these levels the total Ag productivity segment is 16% to 17% of our total gross profit generation in 2010. More germane to our customers and our owners is that some 85% of the business that is expected to deliver a 13% to 15% growth rate in the 2010 fiscal year.
As you review the growth projections for seeds and traits back on slide nine, it is critical to keep in mind that our ability to cross the $5 billion mark for the first time is the sole function of our ability to create new value for growers and increase their profitability on farms.
The magnitude of our long-term growth remains only the mix changes. As I just mentioned every financial and operational choice we make should drive farmer profitability. Embedded in our growth rates for seeds and traits is the underlying belief based on our technology, that we have created more value then we have priced for and that irrespective of the swings in commodity prices, the farmer should receive a positive return on the investment from the use of Monsanto seeds and traits.
Slide 11 bears this out. If we use SmartStax as the new standard for corn production, you can see that the farmer received a significant boost in the return on its seed investments. Even when we take the [bear] case of $1.95 corn, which is the floor set by the government for corn pricing in the United States, the farmer experiences a 20% return on its incremental investment if he chooses SmartStax over DEKALB triple-stack.
This pricing conversation correlates to my second tenant. If we succeed in increasing grower profitability our execution then drives our earning growth. Slide 12 serves as a reference. As the 2010 selling season starts, we have some new tools that we believe will open the farm gate wider for Monsanto.
First among these are the launches of Roundup Ready 2 Yield and SmartStax at levels unprecedented in our history and thus in the industry. How we ensure broad grower experience in 2010 dictates our ability to fully serve the needs of farmers in 2012.
In the US we’re focused on the sales teams, which now sells only seeds and traits so that there are more touches per customer. Our experience shows that if we can get trial on farm, the grower can directly experience the benefits and the profitability generated by our technologies. The challenge for our sales team is to accelerate grower experience with not one, but two blockbuster products through two channels that offer unique grower purchasing experiences.
Aggressive launches that propel long-term growth come with a cost and grower trials in one year don’t immediately translate into share shifts. But financially it is money well spent to accelerate grower experience with these two products by spending a bit more in 2010 to ensure SmartStax arrives on farm in the top yielding hybrids in the largest possible quantities.
The financial effect of all this will be corn gross profit growth targeted at 19% range but with flat margins while soybeans are expected to advance 9% on an absolute gross profit basis but also with flat margins.
Farmers ultimately determine our sales mix based upon what makes the most sense for their farm. In 2009 more then 70% of everything purchased from DEKALB or American Seeds portfolio was a triple-stack. In 2010 farmers will have more stack corn products and more combinations available to them as some 75% plus of everything we expect to sell in DEKALB and American Seeds will be triple or SmartStax as we show on slide 13.
Behind that triple-stack package will be some 10% of our DEKALB and American Seeds portfolios that are proven germplasm performers on farm, and for that solid return farmers will have the choice to pay the same or less then they did in 2009.
Execution drives cotton and vegetables as well, and both are poised to shine in 2010. Given the better then expected gross profit for cotton in 2009 we now expect gross profit in 2010 to increase by 9% to approximately $375 million.
Next year our plan is for 65% of the Deltapine brand to be from new seed varieties with higher yields launched in either 2009 or 2010. This leading germplasm also gives growers the best protection package on the market with the double, double-stack of two second generation traits, the Bollgard II by Roundup Ready Flex leading to a modest up tick in margins that already top 70%.
The vegetable segment is expected to continue to expand margins in 2010 to over 60% and increase gross profits to roughly $525 million. Our third tenant espouses that you must invest in order to grow, but you have to ensure that the last dollar spent provides as great a return as the first.
As we announced last month, the company increased its restructuring reserve of $550 to $600 million of which $290 million after-tax or $0.52 per share was recorded in our fiscal fourth quarter with the remaining charge of $0.19 to $0.25 per share expected to be expensed in fiscal year 2010.
Approximately 70% of the total restructuring charge or roughly $250 million after-tax will have a cash effect with the remaining non-cash portion for asset write-offs related to site closures and consolidation.
Slide 14 shows the annual cost savings from this program totaling $220 to $250 million primarily from reductions in corporate spending, some savings from R&D, and a lower cost of goods sold, and SG&A for Roundup and seeds and traits.
We expect approximately 35% of the annual savings will be realized in 2010 with the full benefit realized in 2011. Our expansion of the restructuring plan reflected a forward-looking review that asked where could we make a change that would in turn accelerate growth.
As a result we took more actions in seeds and traits then originally planned closing inefficient facilities and aggressively paring product lines particularly in vegetables. The seeds and traits numbers also reflect a heavy reallocation and restructuring actions related to corporate overhead which benefits the seeds and traits business on a go forward basis.
As you can see on slide 15 total company SG&A as a percent of sales is expected to be in the 18.9% to 19.5% percent range. We believe the relevant benchmark for SG&A is 2008 given the extraordinary and non-replicable measures taken to reduce costs in 2009. Therefore we anticipate 2010 on an absolute basis to be around 3% or 4% lower then 2008.
The leverage in the seeds and traits business is actually better then the percentages make it appear. Now that the Ag productivity business has been reset, 80% of the corporate overhead is allocated to seeds and traits versus 50% in 2009 which effects a comparison from 2009 to 2010 for that segment spend.
In terms of R&D we expect to spend 10.5% to 11.5% of sales in 2010 to fund future projects that will drive grower profitability through the next decade. The absolute dollar increase of 15% reflect the number of projects that we have back loaded in phase three and four of the pipeline where we enlarged scale field trials and global regulatory reviews.
That said, we do not base the dollars we spend on a percent of our sales. Our philosophy employs a bottoms up review based on the promise of technologies in our pipeline. Projects are reviewed twice a year to ensure they deliver an adequate return on investment.
The speed at which these projects move through the pipeline, the velocity of that invested dollar, is one of the determinants of how large the expenditures can reach. The other factor is simply people capacity with a natural limit as to how many projects our scientists can manage at any given time.
We periodically review our processes and will continue to revisit this to ensure we are maximizing the power of each dollar invested in our technology efforts. Finally our earnings must translate into cash that we return to our owners.
Obviously our earnings reset inherently means a lower level of free cash flow and we’re forecasting $900 million to $1 billion for fiscal year 2010 inclusive of the after-tax cash effect of approximately $250 million for the restructuring. A lower level of earnings must be offset by heavy focus on managing working capital and leveraging capital expenditures without damaging customer purchases or forestalling growth.
Capital expenditures are expected to be in the $750 to $850 million range as we continue to support new platforms and seed expansions globally by adding [drying] capacities. We will continue to maintain the financial discipline that gives us a clean balance sheet and the opportunity to use that balance sheet for opportunistic acquisitions.
For the total company we expect inventories as a percent of net sales to migrate back to 2008 levels in the low 20’s as a percent of sales as we turn over to the new platforms in corn, soybeans, and cotton, particularly in the US and Latin America.
We’ll be prudent with our credit and stringent where economic conditions dictate. As a result we’re targeting accounts receivable as a percent of sales to remain flat, in the mid teens range. If you look at slide 16, the growth for our business and the health of our balance sheet gives us the flexibility to reinvest for our customers and our owners while returning additional value through dividends and share repurchases.
Share repurchases are an effective way to offset share dilution which we continue to believe is an appropriate use of cash. We also believe it remains important to consistently pay out a portion of earnings back to our owners as dividends and then allow you to decide how best to invest that cash outlay.
As Scarlett mentioned the trajectory for ROC in 2008 and 2009 is skewed by the Roundup gross profit expansion. For 2010 we would anticipate a decline in ROC of some 900 basis points as the ROC uplift from seeds and traits will not be able to offset the decline in gross profit contribution from Roundup. Going forward as Roundup stabilizes we should reclaim the lost ground on ROC.
In summary our 2010 ongoing EPS guidance of $3.10 to $3.30 takes into account the new outlook for Roundup and the continued growth in seeds and traits. Our ability to deliver on this commitment will be a direct function of our ability to improve the farmer’s return on his investment, to execute the delivery of new value on farm, to leverage our spending but not starve our growth, and to deliver the cash results of the first three back to our owners.
At this point let me turn the call over to Hugh, for our outlook for 2010.
Thanks a lot Carl, and good morning to everybody joining us on the call today. In November, 2007, in an auditorium in St. Louis not too far from here, we laid out a path that translated grower adoption of our technologies worldwide into a company growth plan that would allow us to double gross profit in five years.
In another short month we will revisit those plans with you in an auditorium in Research Triangle Park in North Carolina, the home of our newest, and I think our most exciting research facility yet. We believe today as we did in the fall of 2007, that the growth of this company is directly correlated to the value of our seeds and traits.
As a result we’re holding true to our commitment of more than doubling total company gross profit in 2012 over that 2007 base as we show on slide 17. Carl has outlined the task in front of us for 2010. Admittedly the growth rate in 2010 for seeds and traits drops a tick from the last two years as we enter a completely new year of product launches.
But the plans that we’re implementing in 2010 are critical as they are the slingshot that propels us through the milestones that we expect will deliver a 20% CAGR on our seeds and traits business from 2007 through 2012.
Many of the choices that define 2012 are being made today. To paraphrase Carl, they’re all being measured against four core beliefs. One, that our success is forever linked to the farmers’ success. Two, that our commitments are only as good as our ability to deliver new value on farm.
Three, that the growth has to be funded, but prudently. And four, that the value that we create must be shared with our customers and with our owners. If you turn to slide 18, you can see that we’re bridging $2.8 to $3 billion in gross profit in seeds and traits from 2009 through 2012.
There are three buckets of roughly equal size that make up the components of this growth. So let’s just take a look at them.
First, there’s grower adoption of Roundup Ready 2 Yield and SmartStax and the associated market share growth as shown on slide 19. If we provide the compelling returns that we believe these two technologies promise, [we can see] a path to servicing some 65% to 75% of the market opportunity with these traits and our brands and our brands through our licensees in 2012.
Second, our plans assume that we continue to advance yields in corn, soybeans, and cotton through our breeding programs and that heightened yield advantage is reflected in our financial performance and our market share. This will be the most difficult executional challenge as we face reenergized competitors servicing different market segments with a multiplicity of pricing strategies and product offerings around the world.
The fight for the hearts and minds of growers has never been fiercer. As a result the necessity has never been greater to break through the background’s noise and clutter so that the farmers directly experience innovation and the greater returns the innovation will bring them on their farm. Carl has alluded to some of the things that we’re pursuing for our customers in 2010 and we’ll be sharing more with you at our November investor meeting.
Third, if we demonstrate the same level of grower return on investment outside the US as we have here, we believe that we can grow our international [grow] crop business by another 70% by 2012. As we show on slide 20, by 2012 growers in Brazil and Argentina will be experiencing the yield [inaudible] and on farm productivity that a double stack of Roundup Ready and YieldGuard corn borer have provided to US growers for nearly a decade, as shown on slide 21.
With the market share of 41% in Brazil and 49% in Argentina, the base of positive farmer returns from our germplasm far out strips the base in the US that launched the waves of innovation on farm here in the last 10 years.
As we track the path through 2012, when entering that period of significant growth in our seeds and traits, we will invest for that growth as Carl referenced, but it will be prudent investment with SG&A as a percent of sales in the mid to high teens and R&D as a percent of sales in that historical 10% range.
On an absolute basis our gross profit growth should outpace our spend. We will benefit from that leverage but we won’t short the tools that our sales people need to reach our customers nor will we shortchange the innovation investment needed to bring our [inaudible] pipeline to the farmers’ field.
It bears repeating on slide 22 that we expect to launch roughly one new product every year for the next seven years and we’ll ensure farmers’ experience that value first hand with launch sizes that will outpace anything that we saw in our first 10 years as a seeds and traits company.
So I would wrap up by reiterating our commitment that earnings should convert to operating cash, and that we will continue to return that value through a combination of investments, acquisitions, share repurchases, and dividends.
By the time that we complete 2012 we have the potential to return to an ROC target in the range of what we achieved in 2009. If we can do so, clearly based on the strength of our seeds and traits business, we’d be in the top quartile on an ROC basis of the companies in the S&P 100 today.
So in closing, even as we reposition [ourselves] for 2010, we remain on track to deliver on our commitment to more then double the gross profit that we delivered in 2007. This was an aggressive commitment when we made it two years ago. Its even more so given the volatility on Roundup that’s being managed across the life of this five year plan.
Yet it’s the value that’s created by the innovation imbedded in our seeds that drives this growth as it was in 2007 as it is today, and as it will be in 2012. The path from 2009 to 2012 is a challenging one. But it’s a doable one. The success is in our hands and its up to us to execute against this customer focused strategy to deliver on these commitments.
So with that, I’ll like to turn the call over for your questions.
(Operator Instructions) Your first question comes from the line of Jeff Zekauskas - JPMorgan
Jeff Zekauskas - JPMorgan
I have a two part question, one is on corn and one is on soy, in the trait acres that you were kind enough to provide us the US YieldGuard corn bore traits go from about 42 million last year to 36 million this year, versus 39 also in 2007, can you talk about why that is and secondly, in soy in your Ready 2 Yield soybeans, is that premium product priced at a premium to your key competitors Y Series soybeans or is it priced equivalently to the Y Series soybeans.
Thanks for the two questions, I’m going to be talking about beans and ask Carl to say a few words on corn, we priced our Roundup Ready 2 Yield against the incremental yield that we deliver so we’re not pricing it against the competitors offerings. We’re pricing it against the new bushels that we deliver on farm and that’s the deal that we have with the grower and if we’re successful in delivering those incremental bushels, its going to be a significant product.
But that’s been our pricing philosophy.
That’s a reflection of the fact that [Pioneer] has been a licensee of our YieldGuard trait but they’ve also been converting the portfolio over to Herculex. So that’s basically a mirror trait as they’ve been substituting YieldGuard out of that portfolio for the Herculex.
Your next question comes from the line of P.J. Juvekar - Citigroup
P.J. Juvekar - Citigroup
I hear you’re point about high returns the grower gets from SmartStax, but the grower is much less profitable this year according to many studies. So what are the implications of that on seed pricing on the existing portfolio for 2010.
I’d look at two ends of our portfolio, one end is SmartStax on 200 bushels per acre corn and a 10% yield improvement and if you take last week’s corn price at $3.50, that’s a 20 brand new bushels at $3.50 is $70 of value and that $70 of value times three acres in a bag more or less is $200 of brand new value.
So whether its last week’s price of $3.50 or today’s price of $4.00, or the doom and gloom pricing of $1.95 there’s a very positive economic return at that far end of the portfolio and then the other end, and I’ll maybe ask Carl to talk about this but I always talk about racehorses and thoroughbreds and the other end our seed offering this year for the first time, we’re looking at work horses. And maybe you can say a few words about the work horses Carl.
So a couple of quick points, so first of all, I understand the question, but if you think about producer regardless of whether corn is $2.00 or $4.00, its all about output because they stay in business by minimizing cost per unit produced and the way you do that is to maximize output. So to Hugh’s point, as long as we can demonstrate a fair and positive return on that incremental investment, that’s a choice that increasingly the producer will make.
And while there is not correlation over time of the adoption of our technology commodity price basically for that reason. But to the extent that farmers want a broader choice of price points across the portfolio, as Hugh pointed out we’re providing that for 2010. So if a farmer wants a proven hybrid, a work horse that they’ve had on their farm before, they have the option to buy that basically at the same or lower price then they did in 2009.
And at the other end of the spectrum, if they want the absolute highest yielding potential that a SmartStax hybrid represents, they can make that choice. So we’ll provide broader choice across our entire portfolio so our customers don’t have to seek that choice in a competitive platform.
P.J. Juvekar - Citigroup
Just to clarify, so 8% or 10% price increase that you had announced, that’s a combination of all of these products put together.
Yes, that’s an all in blended price across the portfolio and that pricing is reflected in our guidance.
And then just to add to that, those work horses would be flat pricing year on year. So we’ve introduced that concept this year for first time and that concept is also baked into our guidance.
Your next question comes from the line of Kevin McCarthy - Bank of America Merrill Lynch
Kevin McCarthy - Bank of America Merrill Lynch
Couple of questions on soybeans, you had indicated in the press release that you saw higher then expected returns in soybeans and I see the American Seeds share slipped a little bit, I was wondering if you could comment on whether those are related or independent, and as you head to next year, what would your expectation for share be given the higher acreage for Roundup Ready 2 Yield in the portfolio.
We anticipate in this coming year our ambition is a one to two point share increase and we see Roundup Ready 2 Yield carrying a fair piece of the water on that if we’re successful in delivering these yield increments. So that changes the slope of the curve I think.
I think it was just within the competitive range. And I think that we would expect to grow across the portfolio one to two points this year. Relative to the second part of your question around the return rate on beans, that was definitely an anomaly and what happened was given the nature of the year farmers literally didn’t know, they wanted to plant corn, but they didn’t know if they would be able to.
So they double ordered both corn and beans to ensure that if they couldn’t get their corn in, at least they’d be able to secure the bean varieties that they wanted to and so they did get corn in, albeit late, which then allowed the beans to come back and that’s what increased the return rate year on year.
Kevin McCarthy - Bank of America Merrill Lynch
On Argentina, your main competitor I think outlined a week or two ago, some pretty ambitious expectations for share gains there, you’ve shown this morning you expect a 3% increase in corn in Argentina this year, can you comment on what is driving that, who might be losing share with these large gains, and what you would expect for the next season there.
I think the piece in Argentina is going to be a head to head between the two companies and we feel pretty good about our technology lineup with the new double stack but we’ll see how it goes.
Your next question comes from the line of Frank Mitsch - BB&T Capital Markets
Frank Mitsch - BB&T Capital Markets
You mentioned your outlook for the various quarters of fiscal 2010 and obviously the first quarter materially down year over year, is that predominantly coming from the Roundup area and what has been the reaction of farmers to your lowing the price of Roundup, are you seeing the expected volume pick up that you would have anticipated.
Your assumption was right, virtually the total decline is related to the Roundup business or said conversely, the big spike that we saw the last few years was the run up on Roundup and if you think about first quarter 2009, that would have been the high watermark for basically Roundup and it began to decline from there, so that’s the base that we’re coming off of.
Relative to how farmers are receiving the price, its being received well but the season is just getting going. So we’re just starting the selling process in Latin America and a little bit in North America but its really early yet.
Your next question comes from the line of Laurence Alexander - Jefferies & Co.
Laurence Alexander - Jefferies & Co.
I just wanted to touch on your philosophy on pricing once more, as you think about if market share starts to shift against you, how do you weigh the disciplined approach on pricing against adverse market share shifts. At what point would you adjust your pricing strategy to reflect that the growers feel that they’re not getting the value from the corn that you think they’re getting.
I think it’s a big question and we will spend quite a bit of time in November talking about this and about some of the additional probes that we’re looking at here. But if you look at it simplistically, I think what we’re seeing is that there’s the emergence of customers that have tried our technology, who are loyal supporters and who embrace the technology because of the returns that they see and that’s one group.
And then there’s another group who have still to try and are still on the edges and I think our job as you look at 2010, 2011 and 2012 and I’ll tell you when we talk about 2010 we talk about 2010, 2011, 2012, its all in the same sentence for us because I think what we need to do in 2010 is we need to drive adoption with our second group and we need to let them enjoy the benefits that the first group have.
And that’s to your point, I think its less pricing philosophy, its more getting a chance to participate in the technology.
We have to have a balanced approach to it because if you think about our existing customer base, those that buy DEKALB, we were at 70% triples last year, we’ll be at 75% this year which is bumping right up against the 80% max that they can plant on farm.
And that’s why we’re so bullish on SmartStax as a tool because clearly there’s a demand for it for our existing customer to plant a more valuable product and upgrading that base to our more valuable product provides immediate margin lift to the business and quite frankly the greatest driver of near-term growth.
That said, you’ve got to continue to acquire new customers so that you can continue that growth trend and increasingly with our share growth over the last few years, we’re getting into the loyal customers of our leading competitor and we have to get that trial on farm to continue to secure it.
Your next question comes from the line of Don Carson - UBS
Don Carson - UBS
Question on slide six on your US corn share, I know that at one point that you had expected DEKALB to be up almost two and ASI up one, and I see that Holden’s licensee slipped a bit too, what do you attribute the lower then expected gains in market share to, is it a performance issue, a distribution issue, and I know you’re going to have a SmartStax next year and the next few years and that will help out on market share but I’m just wondering is your, I know in the past you’ve expressed a goal of a 45% US corn seed share by 2012, is that still a valid share target.
Yes, I think actually that the question leads more on as to how do you feel about 2010 and how did 2009 go, I think at least let me interpret it that way. So I’m disappointed in 2009 because our goal was one or two share points of growth and that’s our stated goal for this coming year.
But I think early on in 2009 we laid out a triangle that said we were going to optimize not just our share but we were going to look at penetration and our technology and Carl has talked about the ramp and so on in triples.
And I feel very good about that and also about our pricing and we increased pricing 25% to reflect the value that we were delivering on farm. So whereas we didn’t grow share we had very strong pricing success and spectacular technology penetration success inside our brands.
So as I look to 2010, why do I think 2010 is different? If you look at 2010, 2011 and 2012, the new technologies that we’re bringing, Roundup Ready 2 Yield in beans, SmartStax in corn, I think represent a competitive [inaudible] point, because they’re going to lift the bar one more time in terms of the performance that we deliver on farm regardless of commodity prices.
And that distances us from competition. The competition has been ferocious this year and we’ve seen a lot of price discount. And the second one I would point to is, we talk about [divisionalization], and we’ve talked about a lot from the point of view of separating the business, to Carl’s when he talked about restructuring, we refocused and through an even greater level of focus on our sales team in our seed businesses and I think that’s the sleeper and what we’ve done from a [divisionalization] point of view.
And then the last one is again Carl’s point on these thoroughbreds. So we’ve introduced the concept that for 5% to 10% our hybrid lineup, we’ll have flat pricing in those so farmers who don’t want to look at the technology or are taking a slower approach in adopting it, we’ve got a bunch of thoroughbreds in there that they can wrap their arms around for the 2010 season.
And that’s why I think 2010 is going to have a different feel then 2009.
As Hugh pointed out, SmartStax is a binary [trader] event. Its no longer my triple is better then your triple. You either have 5% [inaudible] and we do think that that’s a game changer in getting farmers experienced with that trait, we think can help reinvigorate our share growth again.
Don Carson - UBS
Do you think it’s a distribution issue at all, I mean DEKALB has always gone through dealers, ASI is largely direct, and your competitors revamped their direct to grower sales force, do you see any disadvantages, are you rethinking the DEKALB distribution approach.
As we talked before, every distribution channel has benefits and has shortcomings. The benefit we gain from DEKALB is the broadest distribution coverage. But it is a non-exclusive channel. We have to get their hearts and minds focused on seed as apposed to say fertilizer and some other things and that’s one of the reasons why we refocused our organization so that when they’re working with those dealers, they’re doing more then talking about seed to get them energized to go to farm.
The other thing is too is we do have our direct ASI channel for the marketplace and that has served us very well and as we’ve talked about before the limitation of a single channel of the marketplace, it limits your ability to capture share on farm.
We’ve done the research and its been well documented so by having multiple channels we can actually compete for a higher share of farm. So that said, we like our DEKALB channel. What we have to do is when you’re coming to the market with this many game-changing technologies over this time period, we really have to help our channel and our own sales people get up to speed on communicating this value to the farm.
But that’s a challenge we’ve got regardless of channel.
Your next question comes from the line of Robert Koort - Goldman Sachs
Robert Koort - Goldman Sachs
You had advertised going into the 2009 season having a 9% or 10% yield advantage in DEKALB and we did see some static market share, I recognize [refuge] reduction is key but it seems like SmartStax is a similar yield benefit so why would you not run into some of the same competitive pressure or at least reluctance from the farmers maybe to adopt a higher price point technology. And then secondly, around SmartStax, it seems maybe you’ve hit a wall here in terms of adopters of technology, at least in the short run. And I think your goal on SmartStax is basically double what you’re selling in triples today. So can you give me a time frame on when you might get to that goal or what is it that you can do to push those guys over the edge that want to buy the work horse and don’t want to buy the novel technology.
So again the first differentiation or distinguishment I would make is our existing customer base [inaudible] potential new customers. Within our existing customer base, those and if you think about DEKALB, those are farmers that place their absolute premium on yield. And in that environment our existing customers bought more higher valuable product from us in 2009 at a 25% higher price then they did the year before because they get the value that our technologies provide to them because they’ve seen it.
And so as we think about the growth of our franchise, we have to acquire new customers because at some point in time, you’re going to maximize your penetration, your existing customer base, and not only your penetration but of your most valuable products and so we have to acquire new customers and basically sell them those new products as well.
The thing about SmartStax is we’ve said that the market opportunity is 60 million acres potential which is what we’ll compete for, but increasingly again its going to be showing non-DEKALB, non-American Seeds customers the value that SmartStax can bring them on farm versus the alternative, double or triple that they’re planting today.
That’s going to be the task. And again, that’s why we refocused our sales organization to get that task.
Your next question comes from the line of Mark Connelly – Sterne, Agee
Mark Connelly – Sterne, Agee
I just wanted to enquire what the impact of Brazilian farmer profitability will have on your soybean margins. I think there’s expectations for record crop next year and it seems like farmers are already kind of struggling with profitability this year at current prices.
I think that that’s the operating environment in Brazil pretty continually. I think the biggest impact that it has is it contains the expansion of the planted acreage down there is generally what we see happen. But from a pricing standpoint within our Brazilian bean business we really don’t see this current economic environment having an adverse effect on us.
Your next question comes from the line of Vincent Andrews - Morgan Stanley
Vincent Andrews - Morgan Stanley
Maybe you could walk us through, it sounds like you have some winter production costs this year in both corn and soy related to SmartStax and Roundup 2, it might be helpful if you could put some dollar figures around that and how much of it will recur on a go forward basis and if that’s something we should anticipate as you commercialize all the new products in the pipeline.
Kind of reverse order, this is what we would expect to see as we continue to bring things like Drought forward, if you think about our customer base that places an [inaudible] on yield, our commitment to them is to get them these high yielding products as quickly as we possibly can. When we do that we create more value for them. We can share in that value and of course that ultimately creates value for our owners.
So I kind of think of it as an investment to pull that MPV curve forward and its one that it just makes a ton of sense and I think that we would continue to replicate as well.
I was just going to reiterate the drought piece instance, I think it caught people by surprise this year on the magnitude it had on production and the impact of that. We spent a lot of time talking about it and that’s why 2010 is a slingshot year because the conventional way of doing this is you would spread over two years.
We plant a little bit in 2010 and then we do a little bit more in 2011 and we go prime time in 2012. So we are taking that cost. The farmer doesn’t see that cost penalty so we still deliver SmartStax on farm. We eat that cost ourselves but the competition sees that penalty. Because they face a wall of very early stage so by accelerating production and doing that winter piece, it really increases the competitor separation.
But is a little bit of a headwind this year. I think to the future, you shouldn’t judge it today but if we go into 2012, 2013 and Drought continues to perform the way we’re seeing it in trials this year, I would guess we’d be making that call one more time. So I don’t think this is episodic. I think we’ll do it linked to, I think as you look forward, we’ll continue to do this where we see the kind of magnitude of performance gap that we’re delivering.
In order of magnitude, if you look like on a unit of corn, winter production is about twice as expensive as producing domestically. So its really expensive and on beans its even more punitive because if you think about putting a bag on an airplane and flying it home, the plane doesn’t care whether its hauling beans, that are a unit and a quarter per acre, or basically a unit of corn that plants two and half acres.
And so that’s why it doesn’t take a lot of units of winter production beans to have a really extraordinary impact on the COGS line.
Vincent Andrews - Morgan Stanley
Can you give us any sense of sort from a, how much quicker relative to prior trait launches you could be sort of no longer production constrained because of this choice to kind of do two years of winter production in one year.
So a couple of ways to think about it is, we’ve said that from standing start to no biological constraints its plus or minus four years. But relative to the ramp up that we’re doing on SmartStax right now, a good way to think about it is that in three years we’ll have as many acres of SmartStax as we had triples last year.
And so we’re actually ramping that up pretty quickly and that’s intuitive because that’s the immediate 15% expansion on your existing customer base. Creates that opportunity pretty quickly for us.
Vincent Andrews - Morgan Stanley
And do you want to give us a quick sense of what that would be for Roundup 2 as well in year three.
Probably the same.
And that’s the key on why this is a slingshot year because we nail this and it puts us in such a great position in 2011 and 2012.
Your next question comes from the line of Mike Judd - Greenwich Consultants
Mike Judd - Greenwich Consultants
If I look at I think its slide 14 here, it looks like there’s a much larger reduction in SG&A on the seeds and genomic side then there is in the Ag productivity side and can you just flush that out a little bit.
A large portion of, so if you take a step back and look what we did across the enterprise, dramatic reductions in direct SG&A in our Roundup division to size that to what it was going to be going forward. A tremendous amount of portfolio clean up in the vegetable seed business and the corporate restructuring as well. What we would call supporting functions.
Now that was all the work or heavy lifting that was done and then when we turn around and we got the appropriate allocations back to the businesses, we used to be 50/50 of our overhead allocated to our seeds and traits and our Roundup division, its now 80/20 to the seeds and traits side of the business.
And so that’s why its disproportionately benefiting from the work that was just done.
Your next question comes from the line of Bill Young – ChemSpeak
Bill Young – ChemSpeak
A two part, Hugh I wasn’t clear on one of your answers, were you implying that it was the pricing that led to some disappointing market share in corn meaning flat, and how has your market share been doing in the Holden’s foundation feed area.
Here’s the funny thing, just when the dust settled at the end of this year, looking back at 2009, the weird thing about 2009 for I think all companies is we all ended up about flat. There wasn’t really much shift between companies. Your second question on Holden’s I think the shift we saw is where licensees had been acquired the [inaudible], but in terms of real organic growth the industry was flat across the board this year.
So in a world of flatness I feel really good because we priced for the value that we deliver and that was a tough call, but it was the right thing to do given the technologies that are coming and we increased our technology penetration in a difficult market. But I think if you, and its always hard to do this because the data is never really laid out, but if you look across the board this year I think you’ll see a world of flat share pretty much across the competing companies.
Relative to Holden’s one of our competitors introduced a pro access offering for that channel. Some of them have been acquired as well so that channel has been contracting.
Bill Young – ChemSpeak
What’s your share there, roughly.
Its probably just below 20% now once you subtract out those companies who have been bought or those companies who chose to join a pro access channel.
Your final question comes from the line of Mark Gulley - Soleil Securities Group
Mark Gulley - Soleil Securities Group
On page 18 you talked about how the $3 billion increase in gross profit for seeds and genomics is in kind of three buckets and you addressed two of those buckets, but you didn’t address the third once, which I think is other row crops. It seems like a pretty ambitious goal to get a billion dollars extra in gross profit from that bottom slice of the pie, could you talk about that a bit please.
So its our germplasm improvements are imbedded in there and it’s a funny piece because we’re spending $0.50 to the $1.00 on biotech and that gets all the air time and there’s about $0.50 on the $1.00 goes in our breeding and our breeding is kind of the sleeper because breeding keeps improving every year.
And if you look at it real, real rough numbers, in the US business I would guess we see a ton and our entire germplasm every four or five years. So the line up of hybrids that we have today will be completely obsolete in the next four or five seasons. And as we continue to drive that germplasm improvement through that $0.50 investment, we are seeing increased performance on farm and we place the value of that increased performance.
And that’s that third bucket and I think you’re right. Its an untold story and its one that never gets much air time.
So thanks very much and I think we’re a few minutes over so I’ll wrap, and I’ll wrap by beginning by thanking you for your questions this morning. I guess in my close I’d go back and underscore the four points that we’ve made several times today.
One, that our success is absolutely linked to the farmers’ success. Two, that our commitments are only as good as our ability to deliver new value on farm, and that’s how we’ll be measured. Three, that our growth has to be funded but it will be funded prudently. And four, that the value that we create has to be shared with the farmer customers worldwide, and with our owners.
So in a short months’ time, we’ll be meeting with many of you in North Carolina and we’ll lay out our plans at that time through 2012 with a peak into the middle of the next decade. We believe today as we did in the fall of 2007, that the growth of this company is absolutely directly correlated to the value of our seeds and traits on farm.
So we look forward to having you join us as we reiterate our commitment of more than double in our total company gross profit in 2012 over the 2007 base. So let me close by thanking you today for your time, your support, and your participation. Thank you.
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