Monsanto Company (MON)
F4Q06 Earnings Call
October 11, 2006 9:00 am ET
Hugh Grant – Chairman and CEO
Terry Crews - CFO
Scarlett Foster – IR
P.J. Juvekar – Citigroup
Michael Judd - Greenwich Consultants
Frank Mitsch - BBT Capital Markets
Mark Gulley - Soleil Securities
Kevin McCarthy - Banc of America
Jeff Zekauskas - JP Morgan
Marybeth Connolly - Goldman Sachs
Don Carson - Merrill Lynch
Welcome to the Monsanto fourth quarter 2006 results conference call. (Operator Instructions) I would now like to turn the call over to Ms. Scarlett Foster, Vice President of Investor Relations for Monsanto Company. Please go ahead, ma'am.
Thank you, Judith and good morning, everyone. 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 by Terry Crews, our CFO. Also joining me are Brian Hurley and Dennis Chen, my colleagues in investor relations.
Before we begin, I would like to remind you that we are webcasting this call. You can access it at Monsanto's website at Monsanto.com. The replay is also available at that address. For those of you who are on the web site or would like to go to it, we also have posted slides there that accompany this call. You will find them posted on the investor information page and we will reference each of these slide sets by page number, which you will find on the bottom-right hand side of each slide.
We're providing you with EPS measures both on a GAAP 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 last slide from this morning's presentation and this morning's press release.
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 risk and uncertainty, 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 and our most recent 10-Q and in today's press release.
I would also like to remind you that EPS as we are discussing it today now reflects the stock split that was effective July 28th. Additionally, you will see on the web site that we have published our annual biotech acreage projections and this is an update from the data we provided in the third quarter and it reflects seed returns and final reporting by our customers.
So I would like to start by asking you to reference slide 4. As shown there, fourth quarter net sales were $1.4 billion, a 9% increase compared with last year's fourth quarter sales. For the full year, net sales were a record $7.3 billion, a 17% increase compared with sales in fiscal year 2005. The increase reflected the inclusion of a full year of sales from Seminis and Stoneville. Even on a pro forma basis, sales would have increased in the double-digit range, primarily because of stronger sales in corn seeds and traits and better than expected results for the global Roundup business.
Fourth quarter gross profit of $480 million was modestly lower than last year on both an absolute and percent of sales basis. In fiscal year 2006, gross profit increased 18% compared with gross profit in the prior fiscal year. On a percent of sales basis, gross profit was 48.3% versus 47.7% in fiscal year 2005 which you see rounded to 48% in both years in our earnings release.
Gross profit in fiscal year 2006 was affected most significantly by the following factors:
- By inventory step-up charges for the Seminis business which are reflected in cost of goods sold.
- As we discussed in the third quarter, by increased raw material costs for Roundup from higher energy costs and higher cost of goods for Roundup in Brazil because of the stronger Real.
- By a valuation allowance charged to cost of goods for value-added tax credits in Brazil, which we now believe that the probability of realizing them is lower.
Collectively, these items reduced gross profit by approximately $100 million for fiscal year 2006. The Seminis inventory step-up was the largest amount at $50 million in 2006 as compared with $19 million in fiscal year 2005, for a delta of $31 million. Evaluation allowance accounted for $29 million with the higher cost for Roundup production roughly the remainder. Of the three, as Terry will discuss, we would expect that we would continue to be affected by higher cost of goods for Roundup production for similar reasons in fiscal year 2007.
If you would refer now to slides 5 and 6, we list the items that affected reporting earnings in the relevant period. On an ongoing business basis, we had a loss of $0.21 per share in the fourth quarter 2006. In the same period last year, we had an ongoing loss of $0.25 per share. For the fiscal year, on an ongoing business basis, we had EPS of $1.31 versus $1.04 per share for the fiscal year 2005, for a 26% increase in EPS.
The most significant unusual item affecting both the quarter and the year in 2006 was the $0.04 per share tax charge from the one-time repatriation of $437 million in cash under the provisions of the American Jobs Creation Act. This increased our effective tax rate by 2 percentage points.
Free cash flow for fiscal year 2006 topped $1 billion compared with free cash flow in 2005 of $70 million, which included the effect of $1.7 billion in cash used for investing activities, primarily for the Seminis, Stoneville and some American seed acquisition.
Overall, results in the fourth quarter reflected a stronger than expected branded Roundup business in the U.S. Results for the full year were driven by the strength of the U.S. seeds and traits business, and particularly our performance in corn. Organic growth accounted for 96% of our growth in ongoing EPS for the fiscal year, while the addition of acquired businesses accounted for approximately 4%. Our Seminis and ASI acquisitions were both accretive to EPS this fiscal year, as we had forecast, and in both cases were actually higher than our original internal estimates.
At this time, let me turn the call over to Hugh, who's going to give you a strategic review for the outlook for fiscal year '07 and a longer-term view of our growth, both through 2010 and as a platform for the next decade.
Thanks, Scarlett and good morning to everybody on the line. As Scarlett summarized, 2006 was, by almost every measure, another outstanding year. We delivered or exceeded our original commitments on earnings, free cash and return on capital. Our seed market share grew globally and most dramatically in the United States, while trait acreage increased 12% worldwide and 6% in the U.S.
Our Seminis and American Seeds acquisitions performed particularly well. They both were accretive this year, and I'm pleased to say at levels above our original targets. Only Brazil and India fell short of some of our internal expectations, but despite economic and political difficulties, they still delivered trait acreage growth, solid seed performance, and particularly in the case of Brazil, good working capital management.
At this point in 2006, we're putting 2007 in the bag right now, literally, as our seed production facilities are running at full speed as we speak. We have made our bets on the coming growing seasons both in the U.S. and globally, and that informs our financial projections. As I think our shareowners know by now, we view guidance as a commitment, not an aspiration. We're committed then to 15% to 20% growth rate for ongoing EPS off of the higher base that we delivered in 2006 with continued strong generation of free cash. From 2007, 2010 is well within our sight, and in this timeframe we have a unique window of opportunity to extend our leadership and establish the platform that will drive our growth not just through the end of the decade, but well beyond.
It starts with, and is dominated by, corn. Every part of our portfolio has a unique and significant role to play in contributing to earnings growth while we continuously bring what's arguably the most exciting R&D pipeline in agriculture to fruition. This is a time then not of complacency, but of acceleration.
In our June call, we outlined five factors that we expect to drive our growth into the next decade. Since then, with the pending acquisition of Delta and Pineland, we have added a sixth. If you refer to slide 7, I want to reference these as the basis for our conversation today and for our conviction that there's continued growth and leadership at Monsanto:
- Our growth in the U.S. corn market is far from over;
- We see international corn seed share growing;
- Our biotech traits are poised to advance internationally;
- We have added the potential acceleration of our cotton business pending the completion of the acquisition of Delta and Pineland;
- We expect Seminis to generate a higher gross margin going forward; and finally,
- Our pipeline should allow for the launch of three select pit products with greater commercial certainty.
So how then do our 2006 results inform our ability to take advantage of this window of opportunity? Let's start by taking a look at the opportunity in U.S. corn. In 2006, we came into our own as a provider not just through the best technology in corn, but as the provider of the best-yielding corn. If you refer to slide 8, you will see the results of a survey of 2,000 farmers. The top three reasons that a farmer bought DeKalb seed this season had to do with superior performance, like yields and plant health. That stands in direct contrast to competitors' seeds where discounts were the major driver behind purchase. This validates once again that performance trumps discounts.
Now that we've counted returns and the final reporting by our distributors through the end of September, we can say with greater confidence that our branded market share in the U.S. grew by just over 3 points. It's the greatest gain that we have made since DeKalb and Asgrow were purchased in the late '90s. Over five years, this represents a 9 point gain in market share.
With the seed being harvested right now and the market there that we have in hand, we believe we have a path to another 1 to 2 point share gain for our U.S. national brands, not only in '07, but annually through 2010.
Our confidence reflects only the tip of our breeding iceberg is in the marketplace today, as we show on slide 9. The last five years of market share gains have come predominantly from inter-company, international processes. Only this year did we see complete hybrids that were the result of molecular breeding in our portfolio, and even they were still less than 1%. Next year, we're more than double that to 2% to 3%, and then effectively double that number again by 2008. Most importantly, this breeding powerhouse has the ability to uniquely source three different channels. That's three different choices for farmers to use a Monsanto-enhanced seed.
Of course, when we talk about growth in the U.S. and we talk about corn, we have to talk about traits. As you see on slide 10, we crossed some significant milestones with the penetration of corn traits in the U.S. this year. Most significantly with our Triple Stack product which reached 6 million acres in its second year on the market.
If you turn to slide 11, you see another view of how this penetration story translates to opportunity. We have established a platform that has reached roughly 50% of the 150 million trait acres that could be penetrated in the United States. That's both the accomplishment and the opportunity. We've the opportunity to double the penetration for the current commercial trait portfolio, the equivalent of another 75 million acres of market potential. While we may not be on every acre, as there are competing traits and we recognize and we plan for that, this chart illustrates that the size of the pie is substantial.
So our second growth objective is built on a foundation of replicating our success in corn seed globally. While the improvements aren't as dramatic yet, we're equally pleased with the market share gains that we made in corn around the world in 2006. And if I could point to one highlight on slide 12, I draw your attention to our market share in corn in France, which has grown 5 points over the last two years and 9 points since 2002. As a result of this, this growing season, for the first time ever, DeKalb now shares the market leader position in France. France is Europe's largest growing corn growing region at 7 million acres. So outside the U.S., we're targeting to grow our total branded corn market share by 1 to 2 points annually, also through 2010.
The gains we're making in seed share around the world establish the platform that allows us to launch biotech traits globally, which is our third growth driver as we look towards the next decade. As a starting point on slide 13, we delivered some impressive acreage growth in 2006, most nobly: 19.4 million planted acres of Roundup-ready soybeans in Brazil, which is up 58%; 8.4 million acres of Bollgard cotton in India, up 171%; and 678,000 acres of biotech cotton in Australia, which represents a 90% penetration rate.
Doing business in these emerging markets and these emerging market countries is always an exercise in balance; navigating the right business course in a unique mix of economic, political and intellectual property variables. In Brazil this year, it has been the macroeconomic conditions that have dominated the headlines for agricultural companies over the last year. I'm quite pleased to be able to say today that against that challenging economic backdrop, our overall business in Brazil did just fine. 2006 wasn't our best year, but it was a year in which we generated operating cash and advanced our biotech strategy.
Given the difficult economic conditions for farmers there, I would gladly take those successes and build on them in the future. The place to do that is where the growth opportunity in Brazil lies, and that's in seeds and biotech traits. Today, corn and soybean seeds and traits in Brazil are only a third of the total country's sales. We still have some heavy lifting to do before Brazilian seeds and traits are the significant gross profit contributor that we'd anticipate them to be by the end of the decade, but the platform has been established with soybeans with the potential to expand further in corn and cotton in the future.
In 2006, we saw planted acres of Roundup-ready soybeans grow better than 50% to more than 19 million acres, or approximately 35% of the total number of soybean acres planted. For the first time, we used the dual payment system of both safe seed collections and fresh seed sales. New seeds went from zero in 2005 to 20% of the acres planted in 2006, and grain delivered to the elevator accounted for 80%.
However, this dual system required more finesse than we anticipated to make it work. On the safe seed side, the second straight year of drought hurt overall soybean yields, which in turn reduced the fees that we collected after harvest. On the new seed front, the Roundup-ready trait had not been bred by our licensees into enough of the most popular varieties. The seed dealers had to do more than we initially anticipated to entice growers to try and use the seed. The combined effect of the drought and the new seed discounts meant that the average price across the dual system, weighted to reflect the acres and pricing variables, ended up around $3.50 an acre in 2006, which was significantly less than our original forecast.
The question then becomes, how do you adjust for the realities of the dual system and really dial up the business plan to make sure that those acres translate into greater gross profit in the long-term? Not unlike our experience in the U.S., we believe that the answer lies in increasing penetration. For 2007, therefore, we've created a new pricing system that provides incentives to both grow total acres and shift more and more of our sales to fresh seed. Collectively, we are looking to expand to 45% of the planted acres in Brazil using a rough estimate of 50 million planted acres. So if you did a third year to third year comparison, a 45% penetration rate would put Brazil on par with what we experienced historically in the U.S.
So on slide 14, you’ll see that there are a number of different payment options that will determine the final price, and if you balance all of those variables, we believe the weighted average price on a gross basis across the entire system could be somewhere in the range of $2.50 to $3.00 an acre. Importantly though, the pricing should provide the initial push to speed the conversion to new seed from safe seed. Of the increased acre base for 2007, we expect to more than double the amount sold in new seed. I think this is the kick that we think the market needs to make Roundup-ready viable for the full $50 million acre market by the turn of the decade.
In 2006, we told you that the EPS contribution for the dual system would land in the range of $0.025 to $0.05 on a post-split basis, and that's where we ended up, even with the lower price points. With the new seed conversion beginning in '07, we expect the EPS contribution will pause for a year, effectively remaining in the same range as '06 before we can expect more substantial acreage and EPS growth as we prove value in uncharted regions of Brazil.
So while Brazil's challenges have been economic, India's have been political. Despite an unexpected government edict to control price on our Bollgard cotton, we were able to adjust and still generate positive net income in this area. Planted acres of Monsanto's Bollgard cotton nearly tripled from last year's 3.3 million planted acres to 8.4 million acres this year. It's incredible acceleration and it suggests that in a market where the average farmer only grows a few acres, more than a million farmers saw enough value in Bollgard to buy it new this year.
At the same time, however, there is a gap between what we believe should be reflected in the price and what the government has set in the form of price controls. We also recognize that India is India, and while we have put on the Supreme Court docket, relief, if any, from the court process will not necessarily come quickly. So we certainly don't expect legal proceedings to solve commercial issues and our preferred model is to find a business solution that meets our customers' needs while protecting our intellectual property and meeting our financial goals.
As a result, we're currently working with the licensees to develop a business strategy for the long run that addresses the complexities that we're facing in India and put to rest future pricing challenges and bring some clarity to the market. So as we move ahead on the dual path of pursuing a decision at the Supreme Court and continuing our discussions from a business standpoint, I think it's safe to assume that we've been conservative in our evaluation for this modeled area as we enter fiscal year 2007.
So these are the vagaries of doing business in emerging markets. Our task is to continue to take a well-reasoned, disciplined approach to manage the risk that's inherent in emerging economies, recognizing that if you're going to be successful in global agriculture, you have to manage effectively in uncertain environments and changing landscapes.
I think most importantly, our guidance -- and this is true again in 2007 -- assumes the most probable case in these economies based on an average of our past experience in each world area. Even given the complexities of these markets, our projected EPS growth rate of 15% to 20% for 2007 continues to speak to the strength of our strategy.
As one of the world's largest producers of cotton, India then is a perfect segue for our growth of cotton, which has been added as our fourth growth driver. The impetus for adding cotton as a new contributor to growth came from our proposed acquisition of Delta and Pine Land with hard work and the transactions are moving forward. We made our initial Hart-Scott-Rodino filing and we've received our second request from the Department of Justice.
As you will see in slide 15, the most significant opportunity in cotton is to upgrade the portfolio to a second-generation stack that would be a significant source of value and gross margin enhancement. This is true across the board in cotton from the U.S. to Australia to India. Roundup Ready Flex this year was a shining example of how to launch a second-certain generation trait, and it's a surrogate for the growth that we expect from our cotton franchise through the end of the decade. Roundup Ready Flex was launched in 2.1 million of the approximately 15 million acres of cotton planted this year, or 14% of the 2006 market opportunity.
From a pricing perspective, the value created for and shared with farmers equated to a greater than 30% premium at the retail level over our first-generation product. Of those 2.1 million acres, 80% of the time Flex was in a stacked combination with our second-generation Bollgard II trait for insect protection. The total available market for that double-double combination is 8 million to 12 million acres in 2010, which recognizes both the variation in the size of the cotton market and the size of the market for insect-protected traits.
Our most global business is Seminis, which is our fifth driver of growth, both before 2010 and as a platform for new differentiating growth when we enter the next decade. When we acquired Seminis, we said we expected it to be modestly accretive in fiscal year '06 and a significant contributor to EPS in '07, and both of these predictions are still true.
Since the third quarter conference call, we have nearly completed the Seminis portfolio rationalization. We have narrowed our commercial and our research focus for the 25 crops that you see listed on slide 16. This reduced the crop portfolio by about 60%. Sales on a pro forma basis were essentially flat for the full year as we implemented a couple of key initiatives to set the stage for our new commercial focus, notably optimizing our distribution channel inventories and exiting the small businesses.
However, we also saw the first fruits of our efforts to instill a gross profit mentality in our Seminis operations. Gross profit, if you exclude the effect of the inventory step-up charged to cost of goods in both years, improved from 58% in 2005 to 61% in 2006. Our first round of improvements from our Seminis strategy has paid off nicely this year. Additionally, we were able to increase prices for our base seed germ plant. Combined with the fact that 20% to 25% of our current sales are new products, we believe that there continues to be additional pricing opportunities in this refined portfolio.
The line of sight to 2010 also points to a final growth factor for the launch of our high-impact technologies, or HITs. Perhaps the most significant of the three before the end of the decade is Roundup Ready to Yield soybeans. Roundup Ready to Yield has the potential not only to leapfrog current commercial trajectories, which is what qualifies it as a HITs project, but to also redefine our position in the soybean market.
On slide 17, we show the launch acres for the major traits that we've brought to the market. Given the new process for developing, testing and breeding a trait, coupled with an accelerated commercial and seed production process, when we bring Roundup Ready to Yield to market, we will do so in acres that are a multiple of the historical launches that we've seen. With Roundup Ready to Yield in Phase III of our pipeline, we remain on a path towards commercialization by the end of this decade. In fact, this year, we conducted more than 45 trials, spanning 25 locations on more than 11,000 soybean lines, and we submitted the U.S. regulatory packages in late June. So the harvest is in its final stage and when Rob Fraley gives his pipeline update in our first quarter call, we expect that this and the other HIT projects will be front and center of our discussion.
So Terry will be outlining the financial implications of our strategy, but before I turn the call to him, let me summarize where we have been, and more importantly, where we are going. As we show on slide 18, if we are successful at the six growth factors we have outlined and we do them without wavering from the pace of performance that we have established in the last five years, I think we will accomplish two things:
First, we will bolster our gross profit generation, creating a lift that will translate growth into richer company-wide earnings. Secondly, we should be able to extend our leadership. That means we will help facilitate the expansion of the overall industry, or expand the pie, if you will, and we will have an even more significant share of that industry value adding a larger slice of the pie. By the end of this decade, our target for gross profit as a percent of sales is between 51% and 53%. That target reflects our constants in both the favorable shift in profitability from an increasingly seeds-and-traits-oriented business, and the continuation of strong annual earnings growth through the end of this decade.
So in the ag space, I think we have a rare opportunity to grow now while we grow for the future, and we and we alone are in control of that destiny. So with that, let me turn the call over to Terry.
Thank you, Hugh and good morning to everyone on the line. As Hugh has discussed, 2006 was an extraordinary year by almost any measure. As CFO, I'm particularly pleased that we were able to exceed our targeted EPS growth rate, and most importantly, to more than convert those earnings into free cash with a continued focus on working capital, particularly in areas like Brazil.
The combination of growth with financial discipline has allowed us to accelerate the improvement in our return on capital as well. I would like to review some of the 2006 financial highlights in the context of how they create the base for new growth in fiscal year 2007 and beyond. If you go back to the investor day last November, we set out metrics for both 2006 and 2007.
On a post-split basis, here's what we have committed to for 2006 and what we have accomplished as shown on slide 19. We originally projected ongoing EPS growth of up to 20%, which put us in the range of $1.18 to $1.25. We've delivered $1.31, or 26% growth over 2005, which establishes a much higher base from which we have to deliver additional growth in 2007. This was accomplished on the strength of our seeds and trait business, particularly in the U.S. and particularly in U.S. corn, and despite a drag from raw material cost in our chemical portfolio.
We improved gross profit on both an absolute and percent of sales basis, despite the factors that Scarlett outlined that reduced gross profit. Gross profit is the metric that drives our growth, far more than net sales growth. We believed originally that the seeds and traits segment would generate $2.3 billion in gross profit in 2006. It came in at just under $2.5 billion. Roundup topped our $600 million gross profit target, but was in the band that we would have expected at $648 million. The all other segment of ag productivity came in as anticipated, just over $400 million.
We projected SG&A as a percent of sales at approximately 22% and we were slightly above that range at 22.5%, given the inclusion of historically higher SG&A from Seminis, and R&D as a percent of sales continued to trend at approximately 10% of sales.
Free cash came in above our $825 million to $900 million commitment at over $1 billion, with capital spending just above our original estimate of $350 million. We also covered some items not in our original free cash guidance, specifically the one-time payment for the licensing agreement with the University of California of $100 million and a contingent payment related to the Seminis acquisition of $125 million.
Our earnings were the greatest contributor to free cash generation, but we continue to keep a tight rein on working capital, particularly receivables. Receivables as a percent of sales have dropped below 20% at year end, a first for us. While our tight credit policies in Brazil may have cost us some risky sales, it paid off in a positive operating cash. Excluding the Seminis business, receivables as a percent of sales in Brazil dropped to 36%, down from 48% in fiscal year 2005. Our tight credit policies continued to pay off in Argentina as well, where receivables as a percent of sales were 18%, down from 23% in 2005, even with slightly higher sales in 2006.
We were able to return some of that cash to shareholders through $120 million in share repurchases from a program that started in February. We have an authorization to purchase another $680 million in shares over the next three years. All of these factors culminated in a return on capital of 11.2%. This is well above even our forecast for the 2007 fiscal year. We had originally envisioned a progression from 10% in 2006 to 10.5% in 2007.
As Hugh referenced, most of what we define as success in 2007 is literally being harvested as we speak. It's a little bit early for us to be making preliminary projections on specific trait acreage trends, but we have a line of sight that allows us to give you some higher-level guidance for 2007, so if you would please turn with me to slide 20.
Starting with EPS, when we met in St. Louis last November, we gave an early estimate of 20% EPS growth over our 2006 base; at the time, a projection of $1.41 to $1.50 per share. We're now committing to an ongoing EPS in the range of $1.50 to $1.57, or a 15% to 20% growth rate off of the higher 2006 base. On a quarterly basis, we would expect to follow our historical pattern of a modest first quarter with the bulk of our earnings in the second and third, followed by a loss in the fourth quarter.
Given some extraordinary events that have benefited first quarter earnings in fiscal year 2006 and the economic situation in Brazil, it would be reasonable to assume that EPS in the first quarter of 2007 will be smaller than first quarter of 2006.
There are several factors to consider about our 2007 fiscal year, and let me begin with some of the conservative assumptions. First, we are assuming that we would not have any relief from higher raw material costs, nor from the higher Real in Brazil. As a result, we don't anticipate today that we'll receive any benefit to gross profit or to earnings from improvements in these two areas as compared to 2006 within our chemical business.
Second, we believe that the coming growing season will continue to be difficult from a financial perspective for Brazilian farmers. Our credit policies will remain tight and we will once again pass on sales, rather than take on a risky receivable.
As Hugh mentioned, the potential EPS contribution from Roundup Ready soybeans will be in the same $0.025 to $0.05 per share range we experienced in 2006.
Third, as Hugh mentioned, our financial assumptions about India by necessity have to remain conservative and cautious until we can get further clarity from the courts and find a business resolution with our customers. As we work through both the political and the business remedies in India in the coming months, we will provide you with more definitive projections on this market.
More than offsetting these conservative assumptions are our assumptions for growth. Specifically, the majority of growth is expected to be organic growth this year. Given the difference from its contribution to 2006 EPS and its projected full contribution of $0.10 to $0.125 expected in 2007, Seminis could account for approximately one-third of the EPS growth.
Additional growth will be primarily a function of growth in U.S. corn seeds and traits business and the expansion of stack and second-generation traits in both corn and cotton. In 2007 we would now anticipate a gross profit contribution from the seeds and genomic segment in the range of $2.8 billion. While Roundup gross profit will remain in the $600 million band and the remainder of the ag productivity segment will likewise fall in $400 million band.
On the expense side, R&D will again fall in the 10% of sales range and we should be moving SG&A as a percent of sales towards the 21% to 21.5% range in 2007.
We would continue to expect free cash generation of $875 million to $950 million, which includes a $60 million contribution that has already been made to our pension plan for the 2007 fiscal year. Our operating cash assumes growth from earnings but less contribution from working capital than we have seen in the past few years. CapEx will fall in the range of $400 million as we are investing in the expansion or construction of seed production facilities to match our market share growth, particularly in corn.
We will continue to use free cash to repurchase shares and as we have historically, we will continue to review the return of free cash to shareowners through dividends.
Our free cash guidance assumes we will continue to make smaller seed acquisitions across the portfolio when we have the opportunity to bolster market share and performance. Guidance also assumes that we’ll continue to make technology investments that augment our internal discovery and development program so that we are always accessing the best in new leads and in new ideas. Our projects don’t make assumptions about the outcome of Delta and Pine Land transaction, nor about the resolution of solutions petition to come out of bankruptcy. As the status of either these two events change, we will adjust our guidance accordingly. And as always, we assume that there is no change in the status of collecting a fee on Roundup Ready soy beans in Argentina and there is no contribution to earnings or free cash from those events.
Return on capital in 2007 will depend on the timing of the potential close of the Delta and Pine Land acquisition as to how the timing will affect seasonal working capital that we acquire. That said, we would anticipate another level of improvement in ROC and another 100 basis point would not be unreasonable as a baseline assumption.
Looking out to 2010 as we have shown on slide 21, if we make reasonable assumptions about our growth opportunities for the business, we can see a path to crossing the 50% gross margin mark soon and moving toward a 51% to 53% gross margin at the end of 2010. We are not trying to project a specific EPS growth path or the curve of the line, but financially this gives you another indicator of our confidence and enthusiasm for the growth potential of the business, even factoring the difficulties of doing business in countries like India and Brazil.
From both a commercial and financial perspective, 2006 gave us a strong platform upon which we can expand globally in 2007. we are in a unique position within the agricultural industry to project double-digit earnings growth, substantial cash generation and continued commercial expansion in 2007. We then expect to accelerate the penetration of our seeds and traits as we approach 2010.
There is an air of excitement and urgency about the Company to ensure that we deliver on our commitment to take advantage of the opportunity to rapidly bring the greatest value to farmers globally, both from what we have in hand today and what will emerge from our pipeline from now until the end of the decade. We alone control our ability to achieve these goals and we view the guidance and milestones that we've laid out for you today as commitments and an honest reflection of what we believe the business can do, considering both the upsides and the challenges that we'll manage.
Thanks, Terry. I would like to go ahead and open the call to your questions and as always, I want to ask that you please hold your questions to one per person, so that we can take questions from as many people as possible. You are always welcome to rejoin the queue for a follow-up question. So Judith, if we could go ahead please and open up the call.
(Operator Instructions) Our first question comes from the line of P.J. Juvekar - Citigroup.
P.J. Juvekar - Citigroup
Good morning. Is it fair to say that what you are trying to do in Brazil is to maximize your penetration before the competition gets there by 2010?
No, I think it’s a part of it, P.J. I think it partly describes our strategy. I think we have a unique window in Brazil and a number of these emerging markets to really drive penetration and advance the competition. I also think in a market like Brazil and we saw this development as harvest progressed, and green made its way from the fields to the elevator that the key for us in this market is to do two things simultaneously. Drive penetration aggressively and secure that penetration with fresh certified seed. It became obvious that the path that we were on with our POD, our grain collection system, we weren’t going to get there.
So I think as I mentioned in my remarks, I think our goal of getting to 45% penetration next year, is achievable, and we need to drive it hard with fresh certified seed. So, I would agree with your statement, but I would go one step further in terms of the opportunity in this market.
Frankly, year 3, 45% I think if you look at the long term in the Brazilian market, there is no reason to assume that we can’t reach the penetration levels that we have reached historically in the U.S.
P.J. Juvekar - Citigroup
Hugh, you have also said that you control your own destiny. But what about competition? It looks like there are board approvals in Kondapur for Syngenta and then we had [inaudible] last year. So do you expect competition to come up and how does it impact your profitability?
Well I think markets are efficient and there is always competition there, but the way we have looked at this and we have always factored in our planning, farmers measure yield, so in the countryside right now, as combines are crunching through those crops, P.J., the only thing the farmer cares about is return on investment and what’s the yield on that been? With 3% share growth, a strong 3% share growth this year and 9% over the last few years, that’s not just biotech traits, that’s performance in germplasm.
So as we face up the competition, it is performance in the base germplasm, it’s our ability to continue to drive that germplasm and load that with double and triple stacks that will keep our preeminent position.
So, I see competition coming and I am not complacent about that, but what we will need to do is continue to be the first pick from farmers looking towards who fills that grain bin most successfully.
Our next question comes from the line of Michael Judd - Greenwich Consultants.
Michael Judd - Greenwich Consultants
Good morning. I was just wondering if you could provide a little bit more color on some of the market dynamics in the Brazilian market related to currency and various other issues that you think are important? Thank you.
Thanks for your question, Mike. I will maybe ask Terry to do this because there has obviously been a great deal of speculation and interest around pricing. I preface it by saying now a piece of this is us taking the bull the horns and looking at how we can accelerate our fresh seed purchases. We got to 20% in the first year, which is quite an achievement, but we need now to look at how we drive that harder. But frankly, a piece of it has been the economics and the weather impacts in Brazil, so I will maybe ask Terry to dissect that one level further for you.
I will take one step back first and talk just about generally what’s happening in Brazil, because there are pressures in Brazil economically in the entire industry because of basically dollar pricing for commodities and Real costing for farmers so that’s put a squeeze in the overall market. Really, when we look at our Brazil business, two aspects of the business, the seed business and the chemical business where we have actually seen some of our largest challenges have been on the chemical side of the business as it relates to the overall economic environment there. So, we have faced challenges in that area and we maintain tight credit policies and we said in the call we expect to do that in 2007 as well. We have seen the benefit of that in terms of improved operating cash coming out of Brazil.
As it relates to the seed side, I would like to say part of that is weather related in that our processing, our average processing is affected by two things within Brazil. The actual price we charge on both POD and the actual price we charge for fresh seed or certified seed. The other effect is yield, because on the POD system which represents about 80% of our business, we are really processing based on output of the farm rather than on input, even though the technology really helps the farmers in either situation. But based on that we actually sell about 40% or a little bit more of our price drag in Brazil just driven by the fact that yields were off and we had less yield coming off the farm. That just led to our need to continue to try to move towards certified seed, to try to drive penetration. That was a part of the price moves that we then made on our certified seed business.
So, if you look at Brazil in total, really three factors: one is the continued economic pressures on the chemistry side of the business; second is the need for us in the seed side of the business, even though we had good success in penetration this year, to continue to drive penetration and move more towards a certified seed business.
Michael Judd - Greenwich Consultants
Just as a follow up on that. What do you expect the total acreage is in corn and soybeans? Not for your share, what you are selling but the entire market? The people are projecting there is going to be some contraction in the Brazilian market. Do you have an estimate in that regard, please?
Our assumption, generally, going in in the area of soybeans id that we are going to somewhere around 50 million acres. It is possible that it could be down some by that, somewhere in the neighborhood of 5%. We believe it will effect the amount of penetration it will see this year in our technologies though, going into this season.
Our next question comes from the line of Frank Mitsch - BBT Capital Markets.
Frank Mitsch - BBT Capital Markets
Good morning. Since I'm limited here in the terms of the number of questions I can ask, I won't ask how many games you think it will take the Mets to win this upcoming series, whether four or five, six or seven. But Hugh, you talked about competition becoming more significant in the 2008 timeframe, and obviously you outlined a very strong case for your continued market share gains in DeKalb and Asgrow for the balance of this decade.
But what are you factoring in, in terms of potential losses of royalties from Pioneer Hybrid as they transition over to Herculex? Is that something that's going to be a major decline in the '08 timeframe or a modest decline? How do you think that that plays out in terms of your royalty streams?
I am not smart enough to make a segue to the Mets part of the question, Frank, so, I think its going to be small. It’s a relatively small number, and I’d remind you we’ve talked this morning about spectacular growth in Corn Rootworm and that number is zero because they elected not to use our Corn Rootworm and they are not present on that platform. So, I think its going to be a relatively small number.
I think the key for us -- and I am always, as you know well, I am always very careful in my confidence factors -- but the key for us in our continued success, the reason we grew 3 share points this year, the reason we are forecasting a 1 to 2 share point gain on a year-on-year basis going out is strength of germplasm combined with great traits. I think we’ve won this year and stole share from competition based on the raw performance of that germplasm. As I said earlier, that’s all the farmer cares about. He cares about how much yield he takes of that particularly with bioethanol coming this becomes even more important. So small numbers as they exit these platforms and my job is to continue to drive the competitive advantage in our base germplasm as well as traits.
Frank Mitsch - BBT Capital Markets
So net-net, as we look out into 2008 I guess I was a little bit surprised that you didn’t address 2008 in terms of formal guidance, but perhaps that’s going to be coming over the next quarter or so. But as I look out into 2008, whatever net decline you see on the royalty side you are more than making up in terms of your market share gains, is that the proper way to look at that?
That’s exactly right.
Frank Mitsch - BBT Capital Markets
All right great. Thank you.
Our next question comes from the line of Mark Gulley - Soleil Securities. Please go ahead.
Mark Gulley - Soleil Securities
Yes a couple of questions regarding market share. Hugh, you gained 300 bips of market share in North American corn, but we hear that some of those gains were concentrated in the center of the corn belt -- Illinois, Iowa and Minnesota. What can you attribute your success in the center of corn belt? Perhaps as a follow-up to that, why won’t you more successful maybe western/eastern corn belt, assuming my premise is correct?
I think it’s a function of headroom. So we grew, you are right, we had more significant growth there, but it was the areas of the country where we had more room for growth, we had a longer run and they are a bigger market segment as well, Mark. So it’s apples and oranges. I am absolutely delighted with the performance of germplasm and how far we came in one season in some of those key market areas.
Again, this happens, it kind of links back to the previous question. This happens one field at a time, it doesn’t even happen one farmer a time. So when you win by those kind of margins in some of the areas that you have described, that’s a whole bunch of fields that flipped over in the space of one year.
Mark Gulley - Soleil Securities
Okay, and secondly back to Brazil, maybe you can help me do a bit of math here, its kind of tough to do on the fly. If you are going to from average selling price of $3.50 to call it $2.75 in Brazil, reflecting the split between fresh and safe, can you kind of tell us what the price cut is in fresh in order to get down to this $2.75?
Let me ask Terry for a little bit of color on that for you.
Maybe the best way to talk about it is just talking about 2006 and it might be the easiest way to explain. We expect to see not the same kind of move, but a similar type of effects. There are two things that you have to think about. There is a POD price and a certified seed price. Again, with the expectation of certified seeds, it is going to be somewhere in the 20% range of the total business. So the certified seed would account for 20% and it gives you an average price. And then within the POD price there is an assumption around yields and what we would expect to see in yields. So, where we were last year, we moved the price down in total on certified seed. We had a total price move downward of somewhere north of $1.50ish an acre, and it came about 40% as a result of yield and the rest due to a price move on certified seed. Our assumption coming into this year is that we will see some effect on the yield as well. It's a combination of both price move on the certified seed as well as the effect of yield on the POD system.
Mark Gulley - Soleil Securities
Okay, I will come back for a follow-up later. Thanks.
Our next question comes from the line of Kevin McCarthy - Banc of America. Please go ahead.
Kevin McCarthy - Banc of America
With regards to the India issue, am I correct in understanding that the government imposed price will stand until a decision is reached by the court? If that is the case, can you quantify the government-imposed price relative to what Monsanto’s free market price would be for BT cotton in India?
The first part of the question, that’s right Kevin, until we get through this -- I am a little bit reluctant to talk too much about that until we get through this court hearing. Because we are in the middle of negotiations with our licensees and we are also arguing the case in front of the Supreme Court in India. So, there is an obvious delta there. I think we should be paid more than we are being paid at the moment, but I’d rather not quantify that’s the time being.
Kevin McCarthy - Banc of America
When you expect to hear from the court?
Well, I think we’ve been very careful in speculating on these kind of dates that are outside our ability to control. I think the Indian Court system takes a lot from the British Court system. So, this could take some time. I think in the interim, we are continuing to negotiate with our licensees and trying to get a commercial solution to this rather than be a victim of the time delays in the Indian Court system.
Kevin McCarthy - Banc of America
At the risk of beating a dead horse on Brazil, even the $3.50 per acre that you had for fiscal ’06 is a small fraction of what U.S. growers pay for weed control in soybeans. So, I am curious as to why it’s necessary to reduce from that level, when penetration is only 35% compared to 90% plus? Is it strictly ability to pay and, are you seeing any loopholes for example in Southern Brazil and the value capture system?
I don’t think it’s beating a dead horse, let me try and take one more run at this. Without being defensive, three or four years ago the Brazilian farmer was paying nothing for this technology. We blazed a trail with a grain collection system where we deducted value from harvested grain. The last two years in Brazil, they faced catastrophe droughts in parts of the region, and when you base your value capture system on harvested grain, you rise and fall on the value of grain harvested. As Terry pointed out, half of this year’s price decline, more or less, rough numbers, half of this year’s price decline is because farmers harvested an awful lot less beans in parts of the country.
So, we are committed strategically to harvest and volume in Brazil, but we need to drive this as we do in the U.S., the system where we are charging for value in the bag of fresh seed. So, the concession that we have made is more designed to ramp up penetration and convert, over the space of three to four years from a system that paid nothing to a system that paid from harvested grain, to a system that pays for fresh certified seed. We will take a year’s pause in terms of our aspirations and in order to drive it up, because I think strategically it’s the right thing to do.
Kevin McCarthy - Banc of America
Okay, appreciate the thoughts and look forward to following up offline.
Our next question comes from the line of Jeff Zekauskas - JP Morgan.
Jeff Zekauskas – JP Morgan
Hi, good morning. I have a two-part question. The first part is, can you tell me why gross profit in corn seeds for the quarter was down year-over-year, given that there are more double stacks and triple stacks? Why Roundup sales and profitability were so good in the quarter, so unusually high?
The second part of the question is does your guidance for next year include the effects of the acquisition of Delta and Pine Land? And if it doesn't, what's the range including it?
Well let me just summarize: so corn in the fourth quarter marginally down. Roundup significantly up, and the impact Delta and Pine Land on our guidance?
Jeff Zekauskas – JP Morgan
If I can beginning just commenting on the corn seed, really it is nothing more than it is a small quarter. What happens in our fourth quarter is the wrap up of returns and some of the last sales of the season. But most of the effect that we see from the strong growth in the technology and the share gains actually occur before we get to the fourth quarter, the fourth quarter is really very modest. We also see in the fourth quarter a shift of the business away from the U.S. to some of our international markets where we are not showing, where we don’t have technology sales and it is more the element there, that we have that effect. That is really just seed sales, so it is a lower margin. Nothing at all as an indicator to a negative as it relates to the technologies or to seed sales.
Relative to Roundup in the quarter, Roundup was good largely because we had strong applications of Roundup in the U.S., and we had strong volume growth in the U.S., pricing move toward the upper end of our band. As a result, compared with last year where we were actually reducing working capital associated with Roundup, the combination of the two of those improved our fourth quarter Roundup business, essentially all driven by the U.S..
Relative to Delta Pine Land and its effect on guidance, it would really be impossible at this point for me to say what that would be. As you know, the businesses are seasonal in nature anyway, cotton is probably even more seasonal than any other business, as its lumped in a very few short months and depending on when the transaction occurs could completely change the dynamic of whether it’s a profitable or a negative.
I think overall the first year operation to say it is going to be something that’s modestly diluted would still be a true statement, if we look at an overall picture for a year. But it would be really impossible at this point to predict how it would affect our 2007 guidance because we just don’t know when the transaction will close.
The focus is on getting the deal done.
Our next question comes from the line of Marybeth Connolly - Goldman Sachs.
Marybeth Connolly - Goldman Sachs
Thank you, good morning. A quick question on growth rate for EPS and I’ll preface it by saying you had very impressive growth and I don’t mean to pick on you. But just to delve a little further, I think that most would have assumed roughly a 20% growth rate and I realize that ’06 was off of a higher base than you had anticipated. So, the 15% to 20% EPS growth that’s implied by your guidance range for ’07, should we infer at all that there is a slight deceleration in growth as a result of economic conditions globally or competition heating up towards the end of this decade? I'm just trying to dig a little bit deeper on the longer-term growth rate.
Well, I guess, just thinking about the growth rate first of all, we are working off of a higher base, and where we're looking at right now actually even 20% is within our guidance to begin with. So it is the upper side of our guidance to say that we would grow at 20%, so it's not like we've abandoned at 20% and we have left that in, even off of a higher base in 2006.
So right now, even if we hit our low growth rate of 15% and the guidance is still actually at the same level as our high point from our November call. So we don't really view it as a deceleration actually, it's just that we're now growing even a larger pie or a larger profitability level, and we still are incorporating within that guidance a 20% growth curve. So we really don't view this as any kind of departure from our expectations of growth going forward.
I would just add, your question was is it competition as the global economies, as the earthquakes, hurricanes and floods, and our view on guidance continues to be non-aspirational, these are commitments. As we sit here today we are literally harvesting seeds that we will plant next spring. So, as we look at this, I think a 15% to 20% growth rate is a commitment off a higher base and we will review the season as it unfolds, but it’s not a competitive effect, it is the reality of acceleration on top of significant acceleration last year.
Our last question comes from the line of Don Carson - Merrill Lynch.
Don Carson - Merrill Lynch
Yes, thank you. A question on the upcoming corn season. Hugh, you’ve mentioned obviously that triple-stacked corn is going to be the big driver of near-term profitability. With the surging corn prices and strong ethanol demand, we are hearing talk of maybe up to 85 million acres of corn planted. Just two questions. One, what is your assumption in corn plantings next spring? And if we see that kind of upsurge, have you geared up your production enough to meet the demand for triple-stacked seed in the 85 million acre corn environment?
Well a magnificent problem in agriculture, Don, so the short answer is yes. So, we are not speculating despite the temptation, we will not speculate on this call on how big it could be in the U.S. corn market. As I always say, I am sure as we go through the winter season there is going to be more acres in newsprint than there is acres of corn, speculating on how big this is. What we think, given our margins there, we have done our traditional budget on our standard 80 million acre crop. We think we could accommodate some of the upside that the ethanol demand is creating on paper at the moment.
Don Carson - Merrill Lynch
So, it seems then that if there is upside to that 80 million acres that’s above and beyond what you’ve provided for your guidance then?
There are a few ifs in there, Don, but I would love to have that challenge coming into springtime next year.
Just to link it back to the previous question, we make planning assumptions in agriculture based on parameters of what we see in the year unfolding. We are assuming that around 80 million acres of corn will be the U.S. crop and until the seed goes in the ground next spring, that’s a fair assumption. If it is bigger than that then that’s a wonderful opportunity for technology providers like Monsanto.
So, let me just wrap here. I appreciate your hanging with us a little bit longer today. I just wanted to outline where I started and come back to that. We have six objectives that we have designed to drive our growth through the end of this decade and these six objectives, I think, they are opportunities that represent more than financial metrics. They are also our competitive indicators, and if we accomplish our objectives over the mid term, if we do these six things well, I think we have a unique window of opportunity to further expand our leadership in this market.
So, as the last question referenced with the change in agriculture landscape, the dynamic in this market shifts and it shifts in favor of companies that make reasoned decisions quickly, appreciate the pace of change in this industry and mould their business to the ever-changing farm landscape.
So, emerging economies like Brazil and India compound that complexity but they also represent continued opportunity. I believe our advantage is that we say what we are going to do and then we do it, even with a few challenges. What others have aspired to do, we execute year-in and year-out and the growth in our unique segment of the ag industry isn’t over by a long shot. The data that we are just starting to see roll-in is the proof that Monsanto’s strategy and thus our ability to earn a larger share of a growing pie is backed by real, tangible performance. That's what counts on a year-on-year basis.
So, I appreciate your support. Thanks for joining us this morning and I appreciate your questions. Thanks very much.
Ladies and gentlemen, that does conclude the conference call for today.
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