Monsanto Company F2Q10 (Qtr End 02/28/2010) Earnings Call Transcript

| About: Monsanto Company (MON)

Monsanto Company (NYSE:MON)

F2Q10 Earnings Call

April 7, 2010 9:30 am ET


Bryan Hurley – Investor Relations

Hugh Grant – Chairman and Chief Executive Officer

Carl M. Casale – Chief Financial Officer

Dr. Robert T. Fraley, Ph.D. – Chief Technology Officer


Vincent Andrews - Morgan Stanley

Kevin McCarthy - BofA Merrill Lynch

Donald Carson - UBS

Jeffrey Zekauskas - J.P. Morgan

Jason Young – Morgan Stanley

David Begleiter - Deutsche Bank

Analyst for P. J. Juvekar - Citi

Analyst for Robert Koort - Goldman Sachs

Laurence Alexander – Jefferies & Co.

Charlie Rentschler – Morgan Joseph


Welcome to the second quarter 2010 Monsanto Company earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Bryan Hurley, Investor Relations lead for Monsanto. Thank you, Mr. Hurley. You may begin.

Bryan Hurley

Thank you, Operator. Good morning to everyone on the line. Welcome to Monsanto’s second quarter earnings conference call. I am joined this morning by Hugh Grant, our Chairman and CEO and Carl Casale, our CFO. Also joining me are Will McAndrew, [Manny Cruise] and [Ruben Maya], my colleagues in Investor Relations.

I would like to remind you this call is being webcast and can be accessed at The replay is also available at that address. We are providing you today with EPS measures on both a GAAP basis and on an ongoing business basis. In those cases where we refer to non-GAAP financial measures, we have provided you with a reconciliation to the GAAP measures in the slides and in the earnings press release which are both posted on our website.

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 in our most recent 10-K and in today’s press release.

So that we can save the bulk of the time for Carl and Hugh’s comments on today’s news about our 2010 guidance and our long-term growth plan I will give an abbreviated summary of our quarterly and first half results.

Our financial results for the quarter and for the first half of the fiscal year are summarized on slide four. As will be the case throughout the year, the reset of the Roundup business from 2009 to this fiscal year colors all other comparisons to the prior year. For the quarter, ongoing EPS was $1.70. Gross profit declined 17% to $2.1 billion while overall gross margins declined 8 percentage points to 54%. The largest driver for the year-over-year change was Roundup which also shows up particularly starkly on the gross profit line in the quarter.

Practically, Roundup gross profit in the quarter was breakeven. That is primarily because of the price reductions to reestablish and maintain historical price premiums as well as the fact the inventory that was first sent to the market had a pronounced COGS effect reflecting the higher production costs of last year. Additionally, our mix in the first half of the year is weighted to our lower margin supply volume so the higher COGS effect is magnified.

Globally, branded prices were in the $10-12 per gallon range except for the U.S. where pricing fell slightly below that band. Within seeds and trades there was an increase in gross profit of 2% over the last year. Corn gross profit grew slightly in the quarter but margins continued to be down relative to fiscal year 2009. On the positive side, results in Latin America were better than our expectations as favorable weather in Argentina ad a slightly better start to the second season in Brazil resulted in fewer corn acres lost than previously though. U.S. corn gross profit was essentially flat relative to last year.

Part of that reflects a timing shift as we expect to recognize a higher percentage of trade royalties from licensees in the second half of the fiscal year compared with last year. More pronounced was the fact that cost of goods dampened gross profit contribution within the corn portfolio. This reflects higher year-over-year costs associated with our U.S. corn hedge position as well as the incremental launch year production costs for SmartStax.

Soy bean gross profit was slightly ahead of last year and margins were 61% which is in line with last year. As previously discussed, the U.S. late harvest means a larger percentage of our total soy bean volume will occur in the second half of the year. That was partially offset by stronger results in Brazil because of the larger soy bean crop and a significant increase in the penetration of our first generation Roundup Ready trade.

Additionally in the quarter our pre-tax restructuring expense was $84 million. This included a $54 million charge to our U.S. corn cost of goods as we have made the decision to exit some product lines in our U.S. branded corn business and to streamline our products used across multiple brands and to enable the strategy for new hybrids for the 2011 season.

Year-to-date the Roundup reset likewise dominates the comparisons with our prior year performance. For these first six months gross profit for the company is down 30% or $1.2 billion. The majority of that decrease came from the Ag productivity segment while overall season trade gross profit was down slightly versus last year as the second quarter effects influence the year-to-date results. Our ongoing EPS for the first half of the year was $1.68, putting us more than halfway to the lower end of our $3.10 to $3.30 target for the year.

The effective tax rate for the first half of the year was 28%. As was the case in the first quarter benefits from several tax items were recognized in the second quarter which puts us in line for our projected tax rate of 29-30% for the full year. As we expected, the second quarter was a significant source of cash generation which begins to offset the use of cash we saw in the first quarter. Cumulatively free cash flow was a use of $89 million for the first half of fiscal year 2010 compared with a source of $1.1 billion for the first half of last year.

Let me turn the call over to Carl so he can expand on our outlook for the remainder of fiscal year 2010.

Carl Casale

Thanks, Bryan. Good morning to everyone. As we cross the midpoint of the year we have a good view of our performance and how that [constructs] the remainder of the year. As many of you know my background is in operations so as CFO my assessment isn’t just on the financials but how the business generates the financials.

This clear linkage allows us to talk frankly about where we see the business in the midpoint of the year. Looking at both financials and the operations the $1.70 we delivered in ongoing EPS in the second quarter is a solid quarter. However, projecting from there it tells me fiscal year 2010 will be more challenging throughout. That is important because how we adjust in 2010 will set us up for longer term growth Hugh will discuss shortly.

Before we get into the details, let me give you my view of where we are going for the remainder of 2010. Most importantly if you go to slide five we remain committed to delivering ongoing EPS in the $3.10 to $3.30 range that we laid out at the beginning of the year. At this point I expect ongoing EPS will be at the lower end of that range. The $1.68 we have delivered through the first half of the solid data points to this end reflecting a little less than 55% of the low end of our full-year range.

There are three drivers for this refinement in guidance. First, as it relates to season trades this was a year we knew was a legwork year. I think about progress pragmatically. In areas where we needed to cross thresholds to create the runway for growth we are doing so. 2010 will give us the foundation we need whether that is Latin American trades, SmartStax or Roundup Ready 2 Yield. [Inaudible] our broad portfolio in seasoned trades gives us flexibility to maximize gross profit there are not enough upsides this year to reach the higher end of our guidance. Given the reduced corn acres in Latin America and the challenges to our U.S. growth which I will speak about more, our season trades gross profit will be more limited than we originally projected.

Second, in the Roundup business the competitive dynamics within generic glyphosate remain acute resulting in systemic price competition. This has the potential to strain our full-year Roundup performance and put pressure on our ability to meet our projected gross profit expectations. We now see Roundup gross profit at plus or minus $600 million for the year.

Third, offsetting the two impacts I just mentioned is greater operating leverage as a result of our restructuring efforts. We have uncovered some additional operational flexibility as a result of our lower SG&A run rate and that creates benefits in both 2010 and beyond. Those are real challenges reflecting what has proven to be a transition year but against that backdrop we are comfortable in the operational path of our 2010 guidance. It means we have a little more than 45% of our earnings to come in the second half of the fiscal year to get to the low end of our EPS range. Practically, I would anticipate that third quarter EPS will be somewhat below last year. The balance of the second half growth will come in the fourth quarter as the fourth quarter transitions from seasonal loss to a positive contributor to EPS reflecting the full effect of our SG&A leverage and supplemented by contributions from our Latin American corn and Roundup business.

Let me walk you through the details of how these factors come together in our outlook for the business. I want to begin with Roundup on slide six. As you recall our Roundup priorities revolved around reducing branded prices to reset premiums, decreasing our overall volumes and optimizing our low cost advantage. Through the first half of the year here are the trends we see. Volume is actually trending ahead of our plan as are full-year volume projections slightly better than our 250 million gallon target. Today worldwide net selling prices are within the $10-12 per gallon range for branded Roundup. However, in the U.S. pricing remains slightly below that range as competitive generic inventory has moved out of the system slower than we would have anticipated, suppressing farm gate prices below what we would expect with the current Chinese asset price in a range of $3 per kg or higher.

Just last week the other U.S. manufacturers of glyphosate filed an anti-dumping claim with the U.S. government over Chinese imports which speaks to the overall generic pressure we have observed. Further, we are starting to see early evidence of competitors using generic glyphosate as a loss leader to sell other chemical products in their portfolios creating some margin compression in the channel that threatens to keep farm gate prices from fully rebounding with seasonal refills. In some cases we have used further incremental volume incentives in the channel to keep our premiums in line with these lower prices.

Through the first half of the year our gross profit has been limited. In the second half of the year we expect to sell a higher mix of branded volume at a lower realized cost per gallon which bridges our full-year expectations. Throughout the year we expect to fully utilize the $100-150 million in planned sales incentives as well. The primary application season in our biggest market still lay ahead and by the third quarter we will have stronger indicators whether we will see price improvement in the U.S. Absent stronger prices for the seasonal fill I would expect branded prices for the year to come in below our $10-12 price band.

If that occurs I believe we may fall shy of our original $650-750 million gross profit range for the year putting us in a more probable range of plus or minus $600 million in gross profit in this transition year.

As I shift to season trade I want to tackle both the strategic and operational factors for the year. Strategically here were three things that mattered for season trades in 2010; expanding penetration in Latin America, and establishing SmartStax and Roundup Ready 2 Yield in their launch years. Given the trade expansion in Argentina and Brazil we discussed in the first quarter I feel good about that objective. Now that we have the bulk of the U.S. sales in hand I feel good about where we have landed for SmartStax and Roundup Ready 2 Yield.

If you move to slide seven here is where we stand. First of all we don’t have final totals since there are a small number of acres outstanding and seed returns are yet to be determined. The acres for SmartStax and Roundup Ready 2 Yield are in the adjusted ranges we shared with you in the last month. We expect all in acres for SmartStax to be right around 3 million acres and Roundup Ready 2 Yield right around 6 million acres. In context that is three times our historical average launch for a corn trade in the largest commercial scale launch in soy beans.

Second, and perhaps more importantly, what matters was getting exposure on farms to facilitate adoption going forward. To that end we have broad trials. For Roundup Ready 2 Yield we have more than 40% of our branded customers trying Roundup Ready 2 Yield this year. Likewise, more than 20% of our branded customers are trying SmartStax in year one. So we are very comfortable we have trial quantities with the right hybrids and varieties across a broad base of farmers to create the platform for adoption in 2011 and forward.

If I shift to the operational look our projected U.S. growth for the year doesn’t offset the first quarter downside in Latin America. There are a couple of key reasons. Number one, in corn while we saw both higher volumes and pricing reflecting a mix improvement in our trade offerings, that benefit was offset by higher levels of cost of goods in the corn portfolio. On slide eight you will see that practically we expect more than 75% of our branded U.S. corn portfolio will either be SmartStax or TripleStax, a positive step change from the 70% penetration in 2009.

With combined SmartStax and Monsanto TripleStax acreage projected at 32 million acres we are seeing a mix upgrade realized through trade penetration. The offset to this is largely driven through the cost of goods line with increased cost of goods related to our U.S. hedged corn position and SmartStax launch costs, limited the gross profit lift in the corn portfolio. Additionally, we booked a restructuring charge that hit the gross profit line. Fundamentally we are accelerating the movement from the existing hybrids into new trade packages to help enable the new product strategy to fuel this growth.

Number two, in soy beans we previously discussed the timing shift of the late harvest in the U.S. shifted a greater percent of our full-year sales into the second half of the season. Finally, the limited U.S. growth also influences our share. Given the increases in corn and soy bean acreage projected last week with the USDA our current sales volume would indicate our Dekalb corn share will likely be flat with [highly] competitive years. Our branded soy bean share is likely to be down pending a true up of acres and returns.

For the remainder of the year we don’t expect the trajectory on the U.S. corn and soy bean to change significantly so it is unlikely there is additional upside to be reflected in the second half of the season. From a practical standpoint there are two areas to highlight related to earnings generation for the rest of the year. First, cotton and vegetables deliver significant levels of our remaining fiscal year gross profits and both are tracking well with our expectations and may potentially present some margin upside.

Second, we expect the positive fourth quarter this year will be driven by our SG&A leverage but will also include contributions from the corn business and Roundup in Latin America. Practically, we expect a repeat of approximately $40 million of gross profit related to the mix and distribution system we highlighted in the first quarter. Additionally, we anticipate an improvement over last year’s early Latin American season. That reflects the positive momentum from trade penetration as well as a better outlook for corn conditions compared with the drought conditions last year which also impacted Roundup sales across corn and soy bean acres.

The last of the large drivers for the fiscal year performance is our operational leverage shown on slide 9. As we run the business I focus on two things; the operating margin which yields gross profit and operating leverage which includes SG&A but not R&D. Tracking that operating leverage allows us to run our business more efficiently. In the first quarter we noted SG&A was running below our budget plans and now that we have seen SG&A come in below for the second straight quarter I feel comfortable that we have a repeatable, structural benefit. I expect that will continue through the rest of the year, resulting in a full-year SG&A in the $2.0-2.1 billion range, largely in line with 2009.

This will result in SG&A as a percent of sales close to 17.5% to 18.5% in fiscal 2010. Likewise, we remain on track to deliver 1/3 of the $220-250 million in annual cost savings in fiscal 2010 and the full savings in 2011 at a cumulative cost of $550-600 million in restructuring costs. Taken in combination our SG&A reductions and realized SG&A savings create operational leverage that complements our operating plans in delivering our earnings growth guidance.

Finally, from an operations view our commitment to deliver on our promise for earnings per share extends to cash generation as well. If you move to slide ten, guidance for free cash flow remains in the $900 million to $1 billion range. Reflecting the fact that we expect to be at the low end of our EPS guidance we now expect operating cash to be in the $1.9-2.1 billion range. Capital expenditures were $119 million below expenditures last year and given that I expect the full-year to be at the low end of our $750-850 million range.

So even in a more challenging earnings environment we are converting earnings to cash. That speaks to part of our ongoing opportunities as we continue to see disciplined balance sheet management supporting our growth opportunities. Likewise, cash generation paired with a strong balance sheet highlights our opportunity to repatriate cash to our owners. We continue to view that as a priority and are focused on our current $800 million share repurchase authorization. We repurchased $124 million of stock in February, bringing us to the halfway point of the current authorization. Likewise we have maintained our dividend reflecting our focus on returning cash directly to our owners.

When I take a step back as CFO I told you I would focus on both the financials and the operations. That look leads me to a couple of conclusions in 2010. On the minus side, while we can get to our cash flow goal and at the lower end of our ongoing EPS range it has been tougher than we planned even in a legwork year. On the plus side those execution issues are largely within our control so we are applying the lessons to make the necessary adjustments. But none of this changes the fundamentals of our business and that is true whether we are looking at it financially or strategically.

We have a strong balance sheet and the discipline to turn earnings into cash underscoring the strength of our growth opportunities and strategically no one is better positioned to realize the growth in agriculture than we are. We clearly have the best products today and our unrivaled technology pipeline creates greater opportunity as we bring even greater innovation to farming. We are clear on where we stand. We have already begun to apply the lessons learned from this year to reform our operational approach going forward.

With that let me turn the call over to Hugh.

Hugh Grant

Thanks very much Carl. Good morning to everybody on the line. Carl just gave you our frank assessment about what the data points this year tell us about our 2010 outlook. We expect to get to the lower end of our [inaudible] ongoing EPS range. It will be tougher than we would have liked but there is a path.

A higher priority for me is to ensure that we clear the path for the most predictable and sustainable earnings in the future and that begs the question what do these data points tell us about where we stand, what we have learned and what that means for the operational path now through 2012. Given the troubling economic climate we have endured for the better part of the last two years, the temptation for most companies would be to pin difficult times on that macro upheaval. We are not doing that.

Rather, my focus is on the feedback and the lessons that we can apply directly to how we do business. To that end, the first half of 2010 has surfaced some new market realities and has crystallized some lessons that shape our thinking which we show on slide 11. There are three of these in particular. Number one, we refuse to achieve our growth objectives to the detriment of our customers. In the course of the last two months my team and I have gone out in the field and personally met with more than 1,200 farmers ranging from large to small, from some of our best customers to some of our most difficult.

We heard consistently in these visits that we have the best products and we heard consistently that the value that we create with our technology innovations is real. But we also heard that how we share that value with our customers can either be an enabler of growth or an impediment. That tells me we can either make a stubborn push for the targets we have set for ourselves and strain those value customer relationships or we can do more work with our customers and let the growth come more naturally.

That is going to change some things. I would like to say it is pure altruism but the reality is it is the right thing to do for the business today and tomorrow. That leads me to my second point. We are operating in a very dynamic competitive environment right now. Our focus has been on bringing out new products. Some of our competitors have been less successful matching our new product innovations and have been more focused on taking bigger price gaps against us. That competitive price focus is a near-term factor. So we have to be as flexible and as innovative in our pricing as we already are in our product development.

That is especially true now that we have entered the era of selling yield trades rather than insect and weed control ones. As the value proposition of our new products demonstrate themselves over our own first generation trades I am confident we will earn the premium price position. Likewise, we believe firmly the long-term adoption of advanced technology is economically inevitable. We just have to be more conscious of how we are getting our value to our farmer customers.

My third point shifts to Roundup. As Carl described we are seeing early evidence of margin compression at multiple points leading to lower farm gate pricing. If that becomes more than an observation and it gives way to new structural norms I believe there will be a new ceiling on the long-term pricing environment in the glyphosate industry. Given what we know right now with Roundup and with the different approach we will take with our seed customers I have to be pragmatic in my outlook and say upfront we recognize it is unlikely we will reach our goal of doubling of 2007 gross profit by 2012.

As you can imagine, we didn’t reach this conclusion lightly. We recently confirmed the feedback that we got from farmers with the very rigorous internal evaluation. As an aggressive competitive organization, moving away from our original set of goals is difficult for us to accept but it is the right thing to acknowledge now. While there may be options and we can accelerate the push for 2012 it is clear that achieving that objective could involve making sharp [tandem] choices that to me are not in the long-range interest of this business.

So our operational plan going forward is focused on two keys; major flexibility and implementation and bigger certainty in our performance. As I mentioned we have just completed a first class review of this plan, applying the lessons that I have just described. The upshot of that analysis is very clear. We expect to deliver mid teen’s annual earnings growth going forward. We will couple that growth with the cost discipline to ensure that cash follows earnings so we expect to deliver strong annual cash and return on capital levels.

Make no mistake, as our business evolves we expect to deliver double digit earnings growth because of the opportunity that our technology and innovation continues to create. As always, we will earn this right one selling season, one quarter and one year at a time. Our upcoming third quarter earnings report will be our first change to back this with proof points so I will commit that by then we will present to you the fiscal milestones that turn this plan into reality for 2011 and the milestones we will measure our progress by.

There are still some technical operational elements that we will finalize between now and then. I do want to walk you through our planning assumptions and core building blocks that demonstrate we don’t take these commitments lightly and we are coming out of the gate renewed, re-energized and ready for this future growth.

So here is how I see this plan set up. Firstly, we are committed to Roundup. We have already done the massive re-engineering, scaled the business for more than $1 billion that came off of the gross profit peak and even with the potential for structural changes in the industry we still believe this can be a sustainable, cash generating business. But perhaps more importantly, Roundup is more than just a casual complement to our seed business. It is a fundamental pillar that supports our expanding Roundup ready trade franchise.

Whatever we do, having a secure supply of Roundup is key to our future trade opportunities. Our teams are working in ways that Roundup can be deployed more directly as part of a comprehensive weed control system that helps sell the value of our Roundup Ready trade products. If you take a step back and we consider our Acceleron seed treatment platform as an example, it is fundamentally a package of commodity ingredients but it is delivered in a way that enhances the value of the seed that we sell.

This, I think is a model for Roundup in the future. In an era where weed control systems and resistance management strategies are relevant to the seed purchase decision of farmers, we see a real opportunity for Roundup taking a more prominent role to help to create a total quality package of value for our customers. As we begin to expand this total system with the inclusion of new trade platforms like dicamba tolerant, the ability to offer a complete weed control system can be a true differentiator so we will be looking at the options of how to do that.

Second, this is a plan built on a revitalized product strategy as shown on slide 12. I said the farmers told us that we have the best products. I am convinced we have an unmatched toolkit. Simply put we have more tools at our disposal than we have had at any other point in our history and that is in stark contrast to the situation that many of our competitors now find themselves in. Frankly, it should be a bigger advantage than it has been.

To be clear our confidence in our products is unwavering. I have seen the data and in particular I believe that as the farmers take stock of Roundup Ready 2 Yield and SmartStax this fall they will see what we know; these products work. We have been expanding yield advantage over our competitors and this platform advantage will allow us to grow our share and expand trade penetration.

So over the next two seasons we will be more aggressive in deploying a full range of products particularly in corn. As I am sure you would expect this plan continues to revolve around SmartStax which is the cornerstone product with an immediate fit for the core, high value, central corn belt area. In the future, that will be complemented by a [inaudible] Double Pro and Triple Pro. We now see those three products coming together in a compelling value add as SmartStax and a family of refuge reduction products.

If you pair that with our potential for first refuge and a byproduct in 2012, there is a unique value that this family can offer for our farmer customers. I find that deployed as a family there is a dual benefit. For us, we retain more flexibility to promote adoption and create the margin upgrade opportunity in new acres and more importantly for our customers we will be providing more options as they evaluate the right technology progression for their farm.

That leads me to a third point on slide 13. A revitalized product strategy enables us to evolve a more dynamic pricing model. As part of our listening session with those 1,200 growers we have the feedback this year that for SmartStax and Roundup Ready 2 Yield adoption our all-in, up front pricing made adoption decisions much tougher for the grower. We have experienced both pricing for penetration and no up-front all-in pricing we employed with SmartStax and Roundup Ready 2 Yield. With that full data set it tells me that penetration pricing is probably the better option both for us and for our customers.

We have always focused on maximizing trade penetration and creating the upgrade opportunity for our farmer customers. So our number one pricing priority is to embed our product planning with an approach that brings us back to the fundamentals of penetration pricing. If you [inaudible] we can use our product portfolio in combination with our established zone-based pricing and we will create more products at more price points. So in some cases we may adjust our value spread relative to competitors. In others, we will bring in new products at brand new price points and even more we will be looking to enhance our value proposition with the inclusion of additional meaningful benefits.

This pricing strategy isn’t finalized today but broadly I see this as our tool to improve our value proposition for each farmer, invigorate adoption and grow into sustainable pricing and with more products and more price points we are better positioned to beat the competition in the marketplace based on mix and not pure price.

At the end of the day our opportunity revolves around incremental margin upgrades that we earn when a farmer sees the value and puts a new trade on a new acre on his farm. Make no mistake on this, we still have the premium price products but we recognize that [inaudible] and how we share that value that we create with the growth.

Finally, and Carl mentioned this in his remarks, this is a plan that will have greater operational leverage than we have had over the past decade. Today we are a different business than we were just three short years ago and this is one of the areas where that is most clear. As we have grown the SG&A we have employed has grown proportionately but if our core premise is that our opportunity is increasing the trade [intensity] and realized margin per acre there is a structural efficiency that we realize because it shouldn’t take more resources to simply add another trade to a bag that is already headed to a farmer’s field.

In that case, the structural benefit that carries forward indicates to me that we can turn a greater percentage of our generated gross profit into earnings and into cash. Not to be lost in that is the opportunity to use that cash more aggressively and repatriate it in ways that directly benefit our owners. Likewise we are looking at that and we will be able to tell you more about our cash strategy as we lay out the stages of this plan going forward.

So as I step back and I look at where we are and more importantly where we are going I can tell you two things are important. Number one, this operational plan is something that my Executive team runs but perhaps most importantly it is a plan that ultimately I own. My top priority is doing what is right for the long-term health of this business while doing what is right for our customers. Number two, as I think about the outcome of our planning process the path may be somewhat varied from the prototype that we envisioned way back in 2007 but the destination is the same.

This is a path that will allow us to deliver strong earnings growth consistently in an ever changing market environment. We recognize that gross profit is a major enabler for creating growth and delivering earnings but strong season trades gross profit contribution is important. With gross profit as the basis complemented by increased discipline in SG&A we see significant growth in our operating margins without compromising our critical R&D investments.

Quite simply that allows us to generate annual earnings growth in the mid teens, turn earnings into cash and reach strong return on capital levels. As I conclude there is no doubt in the last six months some things have changed and that causes us to do something differently going forward. Just as importantly some things haven’t changed. We are the leader in this industry. We have the best products and we have the best pipeline and those same fundamentals continue to speak to the opportunity we believe in the future.

So with that let me turn the call back to Bryan and we will open up the lines for your questions.

Bryan Hurley

Thanks Hugh. Operator, I think we would now like to open the call for questions. We have tried to leave a couple of extra minutes here for questions. As we typically do, I will ask that you please hold your questions to one per person so that we can take questions from as many people as possible during this time. You are always welcome to rejoin the queue for a follow-up question. With that, operator, let’s open up the line.

Question and Answer Session


(Operator Instructions) The first question comes from the line of Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Can you help us understand what the base is for this mid teens EPS growth and I think in particular what I am talking about is let’s just assume the number for 2010 is $3.10, you have $150 million at least of Roundup goods in the channel that if I am correct don’t recur next year. You have this charge now for this rationalization in corn. You have some SG&A savings coming in and then you have some winter production costs that it is unclear how much if any of them are going to occur next year given the change in strategy. I think you have a corn hedge. Can you help us understand what the actual base is for the mid teens growth?

Hugh Grant

Thanks for the question. Let me try and frame how we think about mid teens at this part in our plan and process. Then I will maybe ask Carl to talk about some of the chapters in the books you describe. As we think of it mid teen’s we are thinking about 13-17% as our band for growth. Some years will be stronger and some years will be weaker but that is the kind of spread we are looking for going forward. I think it is important to call that out so you are not guessing what we are thinking about here. That is the kind of spread. You are right there are a number of moving parts this year, some of which don’t recur next year. I will maybe ask Carl to do a broad dissection of some of the areas we described.

Carl Casale

Sure. We are still pretty early in our planning process. Hugh mentioned the product strategy that is going to be deployed and what the ultimate mix of those products is and to your point how much winter nursery we choose to do is ultimately going to impact what COGS are and obviously margins as well. We are still working our way through that so we are not in a position today to say what that is going to be.

On the Roundup side one of the things we definitely believe we are seeing right now and we are waiting to see whether it will persist through the course of the year is the margin compression we are seeing in the channel as generic products are moving out slower. Also we are seeing evidence that competitors are using glyphosate as a [loss] meter to sell other products in their portfolio. If that persists we might be looking at a lower level of GP target sustainably for the long-term for the business. All of those things are going to have an impact as well.

The hedging impact that was a one-time effect that we took this year. Along with the cost of goods obsolescence that you mentioned from restructuring. The obsolescence is just clearly correlated to the change in product portfolio we are affecting right now largely driven by obsolescence predominately of Triple Sacks we are going to move out of the portfolio to make room for these new products we are going to sell that will be featuring more value.

The hedging was basically a de-designation we did on some hedges. We basically hedged our corn position anywhere from 1-2 years in advance to basically lock in what our cost position is going to be. Those hedges were basically placed against higher expectations for market share that hasn’t occurred. So basically that is the simple math on why we did that as well. Simply the 13-17% band width we are looking at right now where we sit is take off of the $3.10 we are planning to achieve for 2010.


The next question comes from the line of Kevin McCarthy - BofA Merrill Lynch.

Kevin McCarthy - BofA Merrill Lynch

With the seed selling season largely behind you now and the USDA prospective planning numbers out last week I was wondering if you could comment on your market share expectations for U.S. corn and soy beans?

Hugh Grant

The denominator continues to bounce around so we are perhaps not in the ground yet. If we were calling it today and I think Carl mentioned it on the call we would think our corn share would be around flat. In beans we would anticipate we have lost share this year. That would be titrated based on the last minute shuffling on how big the crop is. I think those would be fair calls. I am not happy about it but I would say that would be our best estimate today.

Kevin McCarthy - BofA Merrill Lynch

What would be the approximate magnitude of the loss of share in soy beans be?

Hugh Grant

We haven’t scaled that yet.


The next question comes from the line of Donald Carson – UBS.

Donald Carson - UBS

A question on pricing for penetration. Based on our calculations and of course lower corn and soy prices it seems you are asking for 50% of the value created. Traditionally you have priced more to get 1/3 of the value creation. Is that the kind of shift you are talking about? What, if any, implications does this have for your previous volume targets in 2011 and 2012 for both SmartStax and RR2?

Hugh Grant

Let me try and frame this. When you talk of the penetration pricing the immediate reaction is broad based price cuts. I sat through a number of these feedback sessions with growers and they are pretty clear in their feedback. Here is how we are thinking about it and I will maybe ask Carl to fall in, but in some areas geographically we will move in price relative to the competition. We are not going to declare that today but directionally we will narrow that gap. In other areas we will bring in a new suite of products and that will be based in corn, largely on our new Double Pro and our VT Triple Pro and they will work underneath the SmartStax umbrella. Those will give us the opportunity to create pricing ladders and bring growers into the products at different price points and at different experience points.

Then in the last area that we have been working on in the last couple of months we are taking a hard look at our value proposition where we can bolt on benefits and have the choice of the option of selling those at the same price. A great example of that is the migration from refuse reduction to [rip] and we have not priced [rip] into our future value expectations. So that is a benefit for the grower that would not be seen as a price move but would add a great deal of incremental value to that bag.

So we are looking for more products at more price points. Some of this will be straight price and some of it will be mix and I anticipate over the next few seasons we will continue to command a premium because we sell better performing material. It is how we present that. I think the feedback I have personally from growers is if our price points were different their adoption curves would be different. So driving that experimentation in the first three years is critically important off the base we have established in 2010.

Carl maybe you can address the last question on volume going forward?

Carl Casale

Maybe just focus on 2011 and originally we said for SmartStax and Roundup Ready 2 Yield both of them kind of the 16-18 million acre range for 2011. So as I think about those numbers and think about demand, supply and scale, the demand side with the number of users we have trying this year we have more than adequate demand to support 16-18 million acres in both crops. On the supply side obviously we will have adequate supply of very strong varieties to meet the Roundup rate yield targets.

On the 16-18 on corn if you think about SmartStax as a family of products, the original SmartStax concept, the Vt Double Pro for that really low pressure acre out west and Vt Triple Pro for the rotational crown grower if you add that together we would still be in that same range of availability for next year.

Then the last point we are still pretty early in planning but from a scale standpoint as we think about these three products I would think about the core SmartStax market being that corn, on corn high yielding environment, core Midwest and that is a 50 million acre market just to help kind of scale what our thinking is right now.

Donald Carson - UBS

Any preliminary thoughts on 2012 where you initially thought you might be above 30 on [inaudible] SmartStax?

Carl Casale

Kind of where we are at right now is focusing on delivering 2010 and planning 2011. So we haven’t gone there yet.


The next question comes from the line of Jeffrey Zekauskas - J.P. Morgan.

Jeffrey Zekauskas - J.P. Morgan

In the press release as I understand it the gross profit target for the Ag productivity segment as a whole is now around $600 million. I guess what that means is the Roundup number is somewhere in the high 2’s, all things being equal, and previously you were roughly at 650. I wonder if that is correct? Secondly, in changing your longer term target from a gross profit target to an EPS target I guess when I try to translate it, it looks to me like you have cut your 2012 gross profit target by about $1.6 billion from maybe $8.7 to about $7.1. Is that correct order of magnitude or is that not correct?

Carl Casale

I will start on the Ag productivity piece and then turn it over to Hugh for the second part of your question. On the Ag productivity GP we are thinking about our Ag Roundup business being in that plus or minus $600 million of GP. The other Ag productivity of about 3.25 is additive to that, not inclusive.

Hugh Grant

On the second piece, the 1.6 on order of magnitude approach seems very high. I think today’s conversation was we are going to back off our commitment in doubling. We are going to have a completely different product strategy around our seed business particularly corn. We are going to revert to a tried and trusted approach on penetration pricing to drive earlier adoption. Your 1.6 if you take the 13-17 and layer it at $3.10, it feels tough.

I will tell you, from the school of hard knocks I don’t think you are going to be seeing us laying out long-term targets. The wisdom of saying let me tell you where we are going to be in five year’s time we are kind of retrenching from that today. We will give you some metrics. We will give you some guide posts, we will give you some of the key drivers. I think the cockpit is going to have a lot fewer dials on it going forward than what we have done in the last couple of years.


The next question comes from the line of Jason Young – Morgan Stanley.

Jason Young – Morgan Stanley

A question on guidance going forward, when you look back at the history of guidance how much of a competitive disadvantage do you think it is giving you in certain instances? The one that kind of comes to mind that I think about it might have been 3-4 years ago when you laid out we think Roundup sustainably could be a $1.8 billion gross profit business in the future. If I am sitting in Western China I am thinking [ne ha ma] let me go turn on the let’s see plan right now.

Hugh Grant

I think the [ne ha ma] was absolutely right. It kind of ties to the previous question on how many dials we need in the cockpit. So we have said this morning we started our planning process a little bit more than two months early. As we are working through that we are critically conscious of how much of our hand we have to play to give you an indication of how we are thinking about this revitalized approach and on the flip side how much our hand we have to show that is the playbook for our competition. I think we are going to be much more conscious of that going forward particularly as we pivot a new pricing approach and pivot and new product strategy.

I know that is going to frustrate members of your community but it is the right thing to do for the long-term health of the business.

Jason Young – Morgan Stanley

I think from a long-term shareholder perspective I would agree that is the right thing to do. When you spoke about institutionalizing a lower run rate for SG&A and you have also cut investing activities and cash flow a little bit, can you talk just about other than the natural tailwinds from increased trade penetration and getting there in terms of SG&A what is actively being is being cut and what is sacrosanct for both of those buckets?

Carl Casale

If you look at the structural benefit we gained from restructuring a year ago probably the most dramatic change that occurred from an SG&A standpoint was the separation of our chemical sales organization from our seed sales organization and the resizing of the chemical organization given the fact we had $1 billion plus of GP coming out of that business. In addition to that the internal infrastructure from everything from finance to human resources there was some simplification and additional benefit there.

Where we haven’t gone is basically looking at R&D as a source of leverage. That is who we are as a company long-term. We want to maintain the discipline we have and the SG&A run rate we have got and we have seen flow through on basically the commercial side of the organization as well as what I would call the supporting infrastructure for the business and preserve the R&D capabilities because that is our lifeblood and our future.


The next question comes from the line of David Begleiter - Deutsche Bank.

David Begleiter - Deutsche Bank

On SmartStax pricing, first the $130 per acre price you referenced last August, what price would you have had to have this year to realize your launch targets? Can you ever get back to that $130 per acre price you referenced last August? If so how many years will it take?

Hugh Grant

I think that is one we would reserve judgment on and we will give you some indicative pricing on it but it kind of ties into the previous question. We sold SmartStax, we saw some of the natural discount at year-end through the trade as the last of that was sold out. The focus now is getting it planted and seeing what yield benefits are. I think rather than me giving you an absolute price, we have done a ton of research in this but I would rather lay out what our product strategy is and start coloring in the map on those value ladders than believing with my [inaudible] in the competition right now. I hate to be coy but you can put that in the coy category in that one.


The next question comes from the line of Analyst for P. J. Juvekar – Citi.

Analyst for P. J. Juvekar - Citi

Referencing your market share loss in soy beans can you elaborate a bit on what is really driving that share loss? Is it purely farmer push back on price, holding price under the previous strategy or is it stronger competitive offerings? Can you provide a little color and maybe what the lessons learned are for soy in 2011?

Carl Casale

On the soy side, it is just like corn. It is a very, very competitive marketplace. Basically what happened when our Roundup Ready 2 Yield came in at the lower end of the range 100% of that offset wasn’t picked up by our Ready 1 and there were some competitive products that moved into that space and picked up some market share there as well. The lesson learned is it is a very, very competitive market. As Hugh said we are rethinking right now what our pricing strategy is in corn and soy so we can reinvigorate the growth of the business.

P. J. Juvekar - Citi

So with the new strategy you expect to regain share next year?

Carl Casale

We are still pretty early in our planning process and we are not calling market share gains right now. Strong unit volume growth across the business is an important metric of health just as we think about operating this business for the long-term. We are not in a position to start talking about market share targets for next year yet.

Hugh Grant

Here is how I look at it. We thought through this through the back end of the year. In the spring of 2015 Roundup Ready 1 patents will expire and the technology will be free in the market. The competitive dynamic if you think about 2011, 2012, 2013 and 2014 the competitive dynamic is proven the performance around the yield and the performance of that versus a free technology.

As we think about 2011 and we think about the gap it created this year we need to make sure that farmers get that choice and see the value of this technology in a meaningful way in 2011. It is as simple as that.


The next question comes from the line of Analyst for Robert Koort - Goldman Sachs.

Analyst for Robert Koort - Goldman Sachs

The new information you gave us surrounding the 2012 time period, how much of this in seeds is derived from volume versus pricing?

Carl Casale

I will take a bit of a stab at it. Where we are at right now and what do we know? We know we are resetting our product strategy going forward. We will have three unique and discrete products we will be bringing to the marketplace. Since those products bring different value they will be at different price points in the marketplace. So really as we think about 2011 the two things that are really going to drive that and it relates to an earlier question as well is ultimately what is our mix of those prospects. We will calculate that as we move the plan forward. Then also what is the cost of goods impact or implications of that mix.

Some of those products don’t carry any third-party royalty obligations. Some of those products may not have to take to winter nursery. So that will bundle what the margin opportunity for those products are for 2011. As Hugh said we are not making any calls for 2012 at this point in time.

Hugh Grant

I would only add one thing and it ties back to an earlier question and that is we will be driving the product strategy that is kind of back to the future. So we will tie back our early experience on penetration pricing. When you take a penetration pricing approach which is more focused on rapid adoption than I think assume there will be a volume driver within that. So rather the analytics on how big is the gap between price and volume I think really with the new strategy we will be focusing more on that volume driver effect and we will populate that through a broader range of product offerings. We will also try to get faster, earlier trial by growers. That was the feedback from 1,200 growers this year and when you get told the same thing often enough it becomes very compelling.


The next question comes from the line of Laurence Alexander – Jefferies & Co.

Laurence Alexander – Jefferies & Co.

First could you quantify expected price mix for corn and soy this year? Second, just to go back to Vincent’s question on the basing effect, would you be shocked to have a $3.75 EPS in 2011?

Carl Casale

The $3.75, as we mentioned earlier we are committed to $3.10 for 2010. As we are planning forward with what we see, and again we are pretty early in the process for 2011, we see $3.10 as a base and 13-17% growth range is kind of what we are looking at right now. That is the way I would think about that question for 2011.

Regarding the corn/soy price mix, I am sorry could you help clarify that question for me a little bit?

Laurence Alexander – Jefferies & Co.

What do you think the total price mix contribution to sales would be in corn and in soy for this year given you have most of your orders in by now?

Carl Casale

I would say the biggest difference we are seeing is predominately on the mix effect. Particularly on corn is where the benefits come. As we mentioned, that has been offset by the higher launch costs associated with SmartStax and Roundup Ready 2 Yield that we talked about previously but also with the new news around the obsolescence we chose to take as part of the overall strategy and basically the hedging issue we had as well.


The next question comes from the line of Charlie Rentschler – Morgan Joseph.

Charlie Rentschler – Morgan Joseph

You talked about a lot of things but not R&D. You are spending at over $1 billion a year clip, over $3 million a day. I wonder what your commitment is to that going forward?

Hugh Grant

This is one of the first things that Carl looked at when we came into the job as CFO. As we talk about leverage this morning and as we talk about stepping back from our doubling in 2012 there is a way you can achieve doubling in 2012, you just rip out R&D expense. I think you win the battle and lose the war quite frankly. As we look at leverage we look at operational leverage over our commitment to answer your question directly, our commitment and continued investment in R&D still holds true. We will obviously look for efficiencies but the heart of who we are is as a technology driven company.

We spent a lot of time on this call talking about pivoting and new product strategy, I think getting much more aggressive in the penetration pricing and product strategy approach but our firm belief and you hear this clearly from growers as you sit down and talk to them in their own backyard innovation is the trump card. Innovation that drives yield that makes the grower more efficient is the trump card. So as we look to the future out beyond 2012 and the long-term viability of this business it begins and ends on our ability to deliver that innovation to growers here and around the world.


So is this to say you would not cut R&D over the next couple of years?

Hugh Grant

We will look at efficiencies but we are not going to sacrifice for the sake of doubling roll we are not going to sacrifice R&D projects.

Bryan Hurley

I hope we have left enough time here for questions but I would like to save the last minute for Mr. Grant to make a couple of concluding remarks.

Hugh Grant

Thank you Mr. Hurley. I will be really brief. I think we covered a lot of ground this morning. I appreciate your patience. I appreciate the opportunity to walk through how we see the business today and give you the beginnings of the flavor of how we see a revitalized product strategy moving forward and rebuilding momentum in our business.

Let me be really clear about this, as we apply the lessons of this transition year 2010, nothing and it kind of ties to the previous question, nothing has changed in our fundamental view of the business. We have the best products in this industry and today we have more of them than anyone else. We are the leaders commercially and in our long-term pipeline. We have the experience and the agility to use these products and our leadership to use 2010 as a pivot point to regain momentum. Achieving our $3.10 and $3.30 in ongoing EPS this year as Carl has described sets us up for mid teens earnings growth, at 13-17% going forward. It enables the conversion of earnings to cash and the strong return on capital going forward. It puts us in a relatively elite class of companies when we increase the dependability and the certainty of [doing well].

So I am resolute in that unique opportunity. I am focused on our implementation and I am personally committed to this business. I see what a tremendous lineup of products under development today and entering the marketplace can deliver through the next few years and beyond. We are looking forward to the opportunity to prove that out to you when we reconvene in our third quarter call. Thanks very much for joining us this morning.


This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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