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Alliance One International (NYSE:AOI)

Q1 2015 Earnings Call

August 06, 2014 5:00 pm ET

Executives

Joel L. Thomas - Chief Financial Officer and Executive Vice President

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

Analysts

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

Karru Martinson - Deutsche Bank AG, Research Division

Hale Holden

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

Operator

Good day, ladies and gentlemen, and welcome to today's Fiscal Year 2015 First Quarter Results Conference Call hosted by Alliance One International. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's presentation, Joel Thomas, CFO. Mr. Thomas, you may begin.

Joel L. Thomas

Thank you, Lea. With me this afternoon are Pieter Sikkel, our President and Chief Executive Officer; and John Heffernan, our new Vice President and Treasurer, who joined AOI last week. John brings more than 25 years of experience in domestic and international finance, treasury and capital markets. Prior to joining AOI, he held financial roles at several multinational corporations, including Duke Energy Corporation and Caterpillar, Inc. John has a proven track record of creating programs to diversify funding and enhance operational flexibility. He has worked in Africa, the U.S., Europe and Asia, leading financial organizations and managing joint ventures and partnerships. We are very pleased that John has joined our team.

Now we need to cover a few legal disclosures. Our discussions this afternoon will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations of future events. Such statements include, but are not limited to, statements about future financial and operating results, plans, objectives, expectations and intentions and other statements that are not historical facts. Such statements are based on the current beliefs and expectations of Alliance One's management and are subject to significant risks and uncertainties. If underlying assumptions prove inaccurate, or known or unknown risks or uncertainties materialize, actual results may differ materially from those currently anticipated, expected or projected.

Factors that could cause Alliance One's results to differ materially from those expressed or implied by the forward-looking statements can be found in Alliance One's most recent annual report on Form 10-K and other filings with the Securities and Exchange Commission.

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

Now our results. Our first quarter is usually a lower-revenue quarter in comparison to other quarters during the year, driven by the timing of crops from the growing regions where we source supply. This year's first quarter is consistent with past experience. Also, opportunistic sales and shipments last year that had been delayed from fiscal year 2013 did not occur this year.

In addition, this year's challenging weather conditions in some parts of the world and global markets that have entered oversupply have delayed purchasing green tobacco. As such, our outlook for this year remains the same, with the slow start that reduced first quarter sales versus last fiscal year expected to have the same impact in the second quarter, but should normalize and result in similar full year revenue with improved profitability.

Accordingly, volumes sold declined 37.5%, to 47.7 million kilos, and sales and other operating revenues decreased 35.1%, to $249 million. Despite these impacts, average sales prices remain consistent due to product and customer mix in Asia and Europe.

Gross profit increased 23.2%, to $35.1 million this year; and gross profit as a percentage of sales improved to 14.1%, from 7.4% last year, mainly due to improved operating performance. The prior year included charges for unrecovered tobacco supplier advances and currency movement impacts. As well as this year, foreign currency hedges and exchange gain and loss were positive.

Selling, general administrative expenses improved 11.7%, to $31.3 million, driven by lower incentive compensation and reduced professional fees, mainly related to our monitorship that was completed last year. Restructuring and asset impairment charges were $2.2 million last year, driven primarily as a result of our processing joint venture in Turkey that was finalized this last March.

Interest costs decreased 6.7% from the prior year, to $26.9 million, related mainly to lower average borrowings, partially offset by higher average rates. Our effective tax rate was 13.9% this year, compared to a negative 2.5% last year. The variance in the effective tax rate between this year and last year is mainly related to net exchange losses on income tax accounts, lower foreign income tax rates and certain losses for which no tax benefit has been recorded. Cash taxes increased just over $0.5 million, to $2.6 million.

For the quarter ended June 30, 2014, net loss narrowed versus last year to $18.6 million, or $0.21 per basic share, compared to a net loss last year of $36.9 million, or $0.42 per basic share.

Working capital and cash cycle improvements are important again this year. These, combined with enhanced factory efficiencies, should further improve our operating results. Inventories are well-positioned at $1,014,400,000, 10.6% below last year's quarter end, with uncommitted inventories within our stated range. Our inventory position has benefited from the deconsolidation of a Brazilian subsidiary, following completion of the joint venture with China Tobacco in March. Additionally, we are working to further reduce sharing inventory levels versus last year though on a disciplined buying approach that should reduce net debt levels.

As of June 30, 2014, available credit lines and cash were $656.2 million, comprised of $126.2 million of cash and $530 million of credit lines, including $8.5 million exclusively for letters of credit, all consistent with our internal expectations.

As we drive our business forward, our global plan includes continued emphasis on sustainability with further roll out of our integrated production system, which is important to our customers. Our integrated production system enhances our dedicated global supplier base, improves product quality, increases farm family income, supports local communities where we operate and reduces the impact our business has on the environment. Success in these areas combined with attention to our customers' evolving longer-term requirements in a cost-effective manner are anticipated to improve our results and enhance long-term shareholder value.

Lea, we'd like to take questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] And first, we'll go to Bryan Hunt of Wells Fargo.

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

My first question is the last thing you mentioned there, Joel. You mentioned your integrated production system is important to customers. I was wondering, can you provide as an example when a customer has either, one, awarded you incremental business and/or, two, maintained the business with you all, given the societal benefits you provide through your IPS?

Joel L. Thomas

All of our larger customers today have their own sustainability programs, and so they're looking at their suppliers as part of their programs. And so what we've tried to do is make sure that our programs dovetail in nicely with theirs. And as we move forward, there's only going to be more emphasis in this regard, not less. And we think that it really helps to provide a competitive advantage, especially when compared to a lot of the smaller players around the world that don't have a focus in this regard. So it's not something that we've really provided much more guidance on or a deeper view on at this point.

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

Okay. Next, you reiterated guidance for the year and -- despite the very slow start to the top line. I was wondering what factors give you the confidence in being able to produce similar sales for the fiscal year, given the down 35% in Q1?

Joel L. Thomas

Yes. Q1, as we've mentioned, is historically a low quarter for us. And when we look at, one, our order book, that is a good order book as we look out across the year, and then look at the tobacco that is available for us to buy in each one of the locales where we're buying, it meets up nicely and puts us in a position where we feel comfortable with regards to being able to hit a revenue number that's similar to the prior year and see profitability does improve, versus the prior year, with margin improvement -- margin percentage improvement as well.

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

Okay. And then my last question is, looking at working capital, working capital was down year-over-year by over $100 million. I think maintaining that level might be difficult going into Q4. I was wondering what might be the kind of the best and worst case scenario for you all, thinking about working capital by the time you get to the end of the year?

Joel L. Thomas

Let me go ahead and jump in there. When we think about working capital, and, in particular, in this year, we've done a lot of focus on our cash cycle and working capital. Inventory is a big component of that. We've had a little bit slow start to the year related to our buying. It's picking up nicely and we're right where we thought we were going to be. And as we look to the end of the year, we're trying to drive to an inventory level that's below where we were this last year. And it really comes down to winding up the timing of sales and shipments with when our production cycle is going to be ready to meet those shipments and those sales. So we think we've got a good plan in place, and if we're able to hit the plan, we should see some improvement.

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

And my last question -- excuse me, I got all choked up earlier. Working capital does that to me.

Joel L. Thomas

Working capital does that to me, too, Brian.

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

And then my last thing is, I'd be remiss if I didn't ask about the culmination of Lorillard and Reynolds. There was a lot written up in the press about potential ramifications to your business, inventory disruptions, pressure on pricing. Can you give us just a little bit more insight into that combination and what you potentially foresee as an impact to your business?

Joel L. Thomas

Yes. Both Reynolds and Lorillard and Imperial, when you look at the 3 customers that are involved in that transaction, are all very important customers to us. We play a vital role in their supply chain. And as we think through the consumption of those products and how they break up into those brands, we feel as though we're very well positioned. And it's an opportunity, and that's how we're approaching it. And we see good things on the horizon related to the announcement of the merger and the spinoff of some of those brands.

Operator

And Karru Martinson of Deutsche Bank has our next question.

Karru Martinson - Deutsche Bank AG, Research Division

So just educate me a little bit. When supply goes up here on a global basis, I mean, I'm just wondering, how does that exactly translate into the lower sales for you? Because, I mean, I would imagine that your end customers are still kind of producing the same amount of cigarettes quarter in, quarter out. So why does it affect your sales to the magnitude that we saw here in the first quarter?

J. Pieter Sikkel

Well, I mean, I don't think it's just a measure of supply going up. I think we refer to weather conditions as well. And I think one of the things that we talked a lot about last year was inflated leaf costs for tobacco purchasing. And if I remember it correctly, we pointed to about $31 million worth of inflated cost last year that affected our results. Clearly, this year, we are very much targeting to purchase tobacco according to the pricing of its quality, and that's what we're doing on a global basis. And that and the acceptance of the farmers not to get an inflated price for their tobacco this year has delayed purchasing in various markets around the globe. It's not just us. It's the market in general. So we've seen, in particular, in South America, slow purchases of the crop. In fact, we're still buying in Brazil, which is very late in the year for us. And it's been, to some extent, slow in some other regions of the globe as well. And all in all, when you buy slow, that means you pack slow and that means the tobacco start moving out in later quarters than on a normal crop cycle, and that's really what's occurring at the moment. Now the nice thing, we've invested significantly in our factory facilities, particularly in Africa, but at other parts of the globe, so we do expect to be able to catch up in terms of processing volume because those factories have a higher capacity than they did even 2 years ago. So that's where we're looking to be able to catch up in the second half of the year, in terms of shipments.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And certainly, I was very encouraged by the strong gross margin that you guys demonstrated in the quarter. I mean, as your end customers look out at, I guess, these kind of gross margins, are the purchase orders and the commitments that you have such that you can kind of protect those margins? Or do you feel that in a global oversupply, some of that has to be kind of shared with your end customers?

J. Pieter Sikkel

I think -- look, all our customers are aware they want a sustainable farmer base and they want a sustainable supplier base. And we've got to -- we've done -- made a huge amount of steps in recent years in reducing conversion cost. We've got the opportunity to get the right green leaf cost this year. And clearly our customers are well aware that what we need in order to continue to enact the programs that they value, including IPS and a sustainable farm base. So yes, we do expect margins to improve. We have good discussions with customers on a global basis and in various markets around the world. And yes, we do expect margins to improve, as we have stated publicly.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And you guys seem to have held the line very well on kind of halting that vertical integration trend from a couple of years back. I mean, is there anything going on, on the front? Are you seeing any signs of that coming back? Or has the tide really kind of turned on that one?

J. Pieter Sikkel

I don't think we would make any public statements on that until something occurred. But obviously, the more that we can be cost-effective, have a sustainable and secure farmer base that can guarantee cigarette production into the future, the more likely it is that those who are vertically integrated might turn to us. And obviously, we will continue to look at opportunities with our customers where that might be the right thing to do.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And just lastly, last year, we had an $11 million charge for the Zambian write-off. What's the kind of the bad debt outlook and what are some of the steps that you've taken to help prevent that from happening and certainly encouraged not to see that again this quarter?

Joel L. Thomas

Unrecovered farmer advances are a part of the business and will always be part of the business. It's just like any portfolio of where you've put capital out and you have a balance coming back to you. And so, we're like any other -- it's like any other loan portfolio, for the most part. And so as we look out, we're trying to take best practices from various places in the world and trying to make sure that we have them in the various locales where we've got bigger exposures or bigger risks. And then looking at the specifics of the locale and making modifications to try and make sure that we've got the best programs possible to recapture as much as we put out to the farmer. So in the case of Zambia, we made some changes there related to our management team, as well as our processes. And they seem to be working fairly well, and so we continue to move forward.

Operator

And now we'll go to Hale Holden of Barclays.

Hale Holden

I had a couple of quick ones. For the Brazil joint venture, I was wondering how much of the 10% decline in inventory was related to the deconsolidation there, and how much was sort of by your own efforts?

Joel L. Thomas

Yes. We've not put out specific numbers on that, Hale, but it was definitely included in those numbers.

Hale Holden

Okay. Second question is on the Jordan facility, is there any sort of Middle Eastern geopolitical risk there? I don't really know where in country that's located.

J. Pieter Sikkel

It's located in the south, but I think we saw some improvement, actually, in our value-added services division this quarter. And while there is still unrest in the Middle East, we were actually pleased to see that we are starting to move a little bit in terms of sales from that facility. But geopolitically, I don't think there's a major risk there.

Hale Holden

That's great. And then my last question is if you can give us an update on the e-cigarette liquids kind of joint venture, and where you are on that and if there's any updated outlook on it?

J. Pieter Sikkel

Well, we're excited about what Purilum is doing. It's -- obviously, that company didn't have a major effect on quarter 1 results. But at the same time, we are shipping out product. I think Ballantyne Brands announced that we were supplying domestic liquids to them. I think those are in over 40,000 stores at the moment and expected to increase. At the same time, Purilum will open its new facility at the end of August. At that time, it will also start filling cartomizers, also for Ballantyne Brands for domestic cigarette. And I believe the company has a lot of inquiries in working with major and smaller players to potentially provide services and liquids to the industry around the country. So we're -- I think we're excited by the potential -- already the existing business and the potential future business for Purilum.

Operator

And we'll take another question from Ann Gurkin of Davenport.

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

I just want to start with discussions just about the industry in general, and has the outlook for oversupply changed at all since our last conference call?

J. Pieter Sikkel

Ann, I think the oversupply situation, we're very similar to where we were when we had in the last conference call. Crop sizes haven't moved that much. There was a little bit of additional tobacco that come out of Zimbabwe, a little bit above expected on the flue-cured side. But other than that, crop sizes are remaining within our estimations for the year. The main factors I think we're looking forward to next year, is that we do expect reductions, particularly in flue-cured production. And China did publicly announce just recently that they have reduced their domestic growing area by 170,000 hectares, about 16%. So we are expecting China to reduce their domestic crop volume. And so overall, if you look on a global basis, once we move into 2015, we should start seeing reductions in production.

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

Okay, great. And then Q1 experienced some shipment delays. Is there any issue with customers accessing barges to move the lease? I know with a large grain, anticipated grain harvest, is that causing any kind of delay in accessing barges?

J. Pieter Sikkel

We did not have unanticipated movement in quarter 1. In fact, it pretty much came in exactly as we had budgeted it for this year when we're already expecting the slow purchasing of the crops, and we weren't really affected by any other crops or any other movements. So far, shipping and logistics, we haven't seen an effect on our movements of tobacco. The delays that we have are related to the timing of the purchasing and timing, therefore, timing and processing, but not port issues.

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

Okay, great. And then I always like to ask you all about China because I feel like you had really good exposure there. And I guess I heard a statement that in China, the absolute level of cigarette consumption is flattening out, and so I'd be curious as to your response to that statement and your prospects for selling into the Chinese market?

J. Pieter Sikkel

Well, I think, yes. The first half of the year, China's cigarette production increased by 0.5%, which is still an enormous number. The sales of the top 28 brands represented almost 80% of those sales, and I think increased by over 5%. So the key there is what is happening with the domestic production, what is happening with top-quality cigarette production, and then how that relates to whether the Chinese need high-quality international tobacco to feed that cigarette production. So although, yes, the total production numbers have slowed, at the same time, we're still positive on the market, particularly related to the consolidation of the brands and the continued upward movement of premium brands within the market.

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

Great to hear. And as you look out over the next several years, how do you see your geographic business and footprint matching the growth of where customers are sourcing leaf?

J. Pieter Sikkel

Well, we believe, I would say, that we're well positioned. We've seen the premium position of brands from most of our major customers around the globe, whether you talk about premium brands in China or flagship brands or however people choose to describe them. And generally, that means a requirement for better quality tobaccos for their usage. And when we look at our sourcing profile, where we are, whether that be in flavor, flue-cured markets or top-quality Oriental markets, where we made our investment in Turkey last year, we feel that we are in pretty good shape as far as future demand is concerned. And -- but of course, we always will, and we always continue to assess the future prospects of any one country that we're in. But at the moment, we're pretty satisfied with our profile.

Operator

And there are no further questions at this time. I would like to turn the call back over to the presenters for any additional or closing remarks.

Joel L. Thomas

Thank you, Lea. The call will remain available for playback for any interested persons through 8:30 p.m. on August 11. Our financial results on Form 10-K, as well as other information, can be accessed on our website, www.aointl.com. Additionally, I'm available by phone should anyone have further questions. Again, thank you for participating in our conference call this afternoon.

Operator

And that does conclude today's conference. Thank you for your participation.

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