American Vanguard Corporation (NYSE:AVD) Q3 2018 Earnings Call November 5, 2018 3:00 PM ET
William Kuser - Director, Investor Relations
Eric Wintemute - Chairman and Chief Executive Officer
David Johnson - Chief Financial Officer
Joseph Reagor - Roth Capital Partners
Peter Osterland - SunTrust Robinson Humphrey
Neil Van Horn - Guyasuta Investment Advisors
Greetings and welcome to the American Vanguard Corporation’s Third Quarter 2018 Conference Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I will now like to turn the conference over to your host, Bill Kuser, Director of Investor Relations. Thank you. You may begin.
Well, thank you very much, Erin, and welcome everyone to American Vanguard’s third quarter and nine months year-to-date earnings review. Our speakers today will be Mr. Eric Wintemute, the Chairman and CEO of American Vanguard; Mr. David Johnson, the company’s Chief Financial Officer; also assisting in answering any questions Mr. Bob Trogele, the company’s Chief Operating Officer.
After today's call American Vanguard will file our Form 10-Q with the Security and Exchange Commission, providing additional details to the results that we will be discussing in this call.
Before beginning let's take a moment for the usual cautionary reminder. In today’s call, the company may discuss forward-looking information. Such information and statements are based on estimates and assumptions by the company’s management and are subject to various risks and uncertainties that may cause actual results to differ from management’s current expectations. Such factors can include weather conditions, changes in regulatory policy, competitive pressures and various other risks that are detailed in the company’s SEC reports and filings. All forward-looking statements represent the company’s best judgment as of the date of this call and such information will not necessarily be updated by the company.
With that said, we turn the call over to Eric.
Thank you, Bill. Hello, everyone. And welcome to our third quarter and nine months earning call. As always, we thank you for your continued interest in American Vanguard. As you can see in our press release, we have continued to perform very well during the quarter and year- to-date. In the third quarter, we recorded net sales of $112 million, which were up 24% over Q3 of 2017. Quarterly net sales of our international business were up 66% and our domestic business rose 9%. While strong increase in quarterly net sales was about $7 million below analyst expectations. That difference rose primarily from reduced sales from our adverse weather conditions in Central America. As David will report later, however, our net income and EPS for the quarter exceeded analysts' consensus.
Thus we recorded higher than expected profits on lower than expected sales. For the nine-month period, our overall net sales expanded 35% with international growing 81% and our domestic business increasing by 18%. The primary drivers of these gains are four acquisitions that we completed in 2018 included AgriCenter, OHP and a slate of products in the US and Mexico that came to us through government ordered divestments. We continued to integrate and grow these businesses and expect to obtain even greater efficiencies, improve market penetration in the coming years.
Growth by acquisition has been a successful business model for nearly three decades and it continues to be a viable and profitable growth strategy, particularly in light of the high level of divestment activities that we were seen in the sector. Our pre-acquisition business was stable for both the three and nine month periods, as you will read in the forum 10-Q, this was the result of mixed performance across many crops and product lines offset by reduced sales of Dibrom following a record year in 2017.We expect the pre-acquisition businesses to rise slightly on a full your basis.
The combination of our solid traditional business with new acquisitions has us on track to post full year 2018 revenues in the range of between $450 million and $460 million. Our manufacturing performance during the third quarter and the year-to-date has been outstanding. We have focused on efficient utilization and reduction of cost while bringing more intermediates, finished products and tooling activity in-house. Interestingly approximately 50% of all pesticide products used in the United States comes from China. By contrast, we sources closer to 10% of our chemicals from that country.
We continue to navigate through the supply and tariff issues with China. At this point the only product we've identified at risk for us in the near term is Bromacil for which production had been halted several months ago. We are told that the Bromacil plant in China should be back online this week. At a time of uncertainty in the supply chain we continue to benefit from both our four efficient domestic plants and reliable third party sources in many countries. On a related note, we expected our year-end inventory level will be about a $145 million which will be $21 million higher than the year-end level of 2017.
Nearly 70% of that increase will come from new businesses and another 10% will be from our expedited procurement of goods to get ahead of potential tariff increases. We will continue to optimize the balance between factory efficiency and building inventory whether through procurement or manufacturing to meet demand and to convert into cash for ongoing operations.
With that overview, I will now ask David to give you his analysis on our financial performance. I will then return to talk my outlook going forward the acquisition of TyraTech, our collaboration with Procter and Gamble in consumer pest sprays; progress on SIMPAS development and our share repurchase program. David?
Thank you, Eric. Good afternoon everybody. As Bill mentioned, we will be filing our Form 10-Q for the three and nine months ended September 30th, 2018 after the call. Everything I'm covering here is included in more detail in that document.
With regard to the financial results, as Eric just detailed, the company sales for the third quarter of 2018 increased by 24% to a $112 million as compared to sales of $90 million this time last year. Within that overall improvement, our international sales continue to grow in importance and represented 36% of net sales in the third quarter as compared to 27% this time last year. While discussing our quarter sales performance, there are two factors that resulted in us falling short of the consensus of a $119 million. The first step was that we experienced unusually wet weather in the Central America region, which impacted Agricenter sales by approximately $5 million.
Second, we made decisions not to compete on price on one of our product lines preferring instead to sacrifice some revenue and to maintain margins. Our third quarter gross margin ended at 41% which exceeded the range we indicated in the last call of 38% to 40% in part the shortfall of sales just mentioned which are lower margin and their absence contributed to the slight improvement in our third quarter margin performance. During the quarter, our operating expenses ended at 30% of net sales compared to 35% this time last year. On an absolute basis, our operating expenses increased by 7% due to several factors.
The main driver is the addition of businesses acquired in the final quarter of 2017 which were not part of operating expenses in the comparable prior year financials. In addition, we have recorded increased legal and incentive compensation expenses. As an offset to these increased operating expenses at September 30th, 2018 we reassess the fair value of liabilities for deferred consideration and reduce the company's expected future earn out payments by $4 million covering both OHP and AgriCenter.
With regard to the effective tax rate during the third quarter of 2018 we completed the assessment of the transition tax which was introduced in December 2017 as part of the 2017 Tax Cuts and Jobs Act. In the process of completing our review, we have changed our original estimate for the tax due on historical international earnings and reported a one-time expense of $1.1 million as a consequence. Our effective rate for the quarter including the one-time expense was 33%. The underlying rate by which I mean excluding the one-time transition tax expense was 23.1% for the quarter, which compares well with the guidance we have given in previous calls for a rate between 25% and 27%.
Our rate was better than the range because our three months international performance were stronger than we used as a basis for our guidance. In comparison, our effective rate for the three months ended September 30th, 2017 was 31%. Overall, net income for the quarter increased by 60% to $6.5 million or $0.22 per share as compared to $4.1 million or $0.14 per share at this time last year. For the nine months ended September 30th, 2018, net sales ended at $323 million, a rise of 35% when compared to the same period of 2017.
Further, gross margin continued at 40% as compared to 43% for the same period of the prior year. The gross margin level of 40% reflects the solid strength of our brands, our strong manufacturing performance and the inclusion of the businesses and products acquired in 2017 that drive high sales and lower average margins as compared to our pre acquisition product portfolio. Our operating expenses when expressed as a percentage of sales were 32% of sales for the first nine months of 2018 as compared to 35% for the same period of the prior year. The reported operating expenses are net of adjustments at $5.4 million following the reassessment of the fair value of deferred earn-out liabilities that we have made at each balance sheet date as required by US GAAP.
Our net income for the first nine months of 2018 amounted to $16.8 million or $0.56 per diluted share as compared to $11.8 million or $0.40 per diluted share in the same period of 2017, a 42% period -over- period increase. From my perspective the key financial issues for the company remain consistent. First, we continue to follow a disciplined approach to planning our inventory activity, balancing overhead recovery with demand forecasts and inventory levels. In both the three and nine months ended September 30th, 2018, our factories have performed strongly and helped us generate the 41% gross margin performance I just discussed.
In managing our factory operations, we were judicious about building inventory to meet the needs of the season. As you will note from our financial statements, inventory remains flat with the level at the end of the second quarter of 2018 and is up approximately $40 million when compared to December 2017. Of that increase approximately 75% or $30 million of the increase was for inventory that we purchased not inventory that we manufactured. The level of purchased inventory increased during the nine month period for three reasons. First, the products we acquired during 2017 were at very low level at the end of 2017 as we were resolving supply chain challenges.
Secondly, at the end of the third quarter our newly acquired distribution businesses are at the high point of their annual seasonal cycle as compared to a low point at December 31st, 2017. And third, the company has purchased certain products from China ahead of any potential tariffs. Second, our effective tax rate ended at 28.2% year-to-date as compared to 29.2% for the same period of the prior year. As discussed earlier, the current tax of current year includes the one-time charge related to the transition tax, but for the one-time charge the effective tax rate for the nine month period would have been 23.8%.
Notwithstanding this first nine month performance, we expect that our Q4, 2018 tax rate will be in the range of 25% to 27%. Third, with regard to liquidity, at the end of the third quarter availability under our credit line stood at $105 million as compared to $125 million this time last year. This performance includes increased borrowings which the company made in the fourth quarter of 2017 to buy the two distribution businesses OHP and AgriCenter. Indebtedness as of September 30th, 2018 was $97 million as compared to $77million this time last year.
At December 31st, 2017 debt was $77 million. Finally, in an effort to further support investors understanding of the business and its financial performance in the earnings release we have reported EBITDA for the three and nine months periods ending September 30th, 2018. And included a reconciliation statement between net income and EBITDA. Our EBITDA improved by 45% in the quarter to $17 million, whereas net income improved by 60%. As I just described, the difference in growth rate is caused by the economical prices paid by the company for the acquisitions in 2017, which results in amortization expense which hasn't increased in proportion with the expansion of the business generated by the acquisitions, offset partly by the interest expense resulting from borrowings made to facilitate those acquisitions.
For the nine-month period EBITDA improved by 30% to $45 million as compared to $34 million for the same period of the prior year. In summary, when looking at a year-to-date financial results we can say that we have recorded significantly stronger sales, achieve gross margins that are in line with our projections, better than forecast factory output and gained economies of scale for our operating costs. We have improved on the tax rate we predicted when we last spoke to you. This all came together in a 60% improvement in net income for the quarter and 42% year-to-date.
Furthermore, we have maintained a strong balance sheet along with sufficient borrowing capacity to execute on our acquisition strategies as opportunities arise.
With that I will hand back to Eric.
Thank you, David. We expect the fourth quarter to be our strongest of the year as top and bottom lines, upside for Q4, should include sales from AgriCenter, soil fumigants in our Parazone and Equus brand. I will cover other forecasted full-year metrics at the end of my comments. First, however, I want to comment on the development of our SIMPAS precision application system. As you recall in 2017, we validated the operation of the system and found that the performance of our wireless control system, the accuracy of our meters and the durability of the system exceeded expectations. In 2018, AMVAC work with Simplot Grower Solutions to demonstrate large-scale prescriptive application of AMVAC's Counter 20G insecticide to address well-defined nematode management problems.
Combining SIMPAS variable rate application technology with SIMPAS smart farm prescriptions enables growers to target crop protection and nutritional products in a precise manner. In all trials, SIMPAS technology performed very well, yield data is being analyzed by an independent third party and those results will be available by year-end.
During the planting season of 2019, we are targeting additional customers for use of the SIMPAS system equipped with both granular and liquid meters dispensing multiple products. Thereafter we expect to be in position to begin commercialization of this proprietary technology in 2020. We continue our collaboration with TRIMBLE on synchronizing SIMPAS with their superior geo-positioning software. Specifically TRIMBLE is helping to develop a universal interface that will enable SIMPAS to be plugged into most tractor displays.
Additionally, we have conducted market demand and pricing assessment of this technology with TRIMBLE Vantage retail network to determine a detailed commercialization plan for SIMPAS hardware by retailers who are experts in precision AG. Also related to SIMPAS, we continue to expand our intellectual property portfolio. Recently, we received approval of a low rate application patent from the European Union having claimed similar to the patents that we have been granted by the US Patent and Trademark Office.
Further, we just filed a patent application that embodies our technology for applying both liquid and granular inputs in or near the placement of the seed during planting. This seed product placement technology will give SIMPAS users greater efficiency at lower rates with a higher level of accuracy all that time of plan. Also in the area of technology, we reported separately this morning American Vanguard has agreed to acquire all of the outstanding shares of TyraTech at 3.15 pence per share or approximately $4.5 million. That deal is set to close on November 8th, Thursday of this week.
As you may recall, we have been a minority shareholder in TyraTech since 2012 and both AMVAC and TyraTech have been partners in a related joint venture AMVAC. We're interested in TyraTech for a number of reasons. First, the proprietary technology involves the use of essential oils such as thyme and eugenol in various formulations that control insects by targeting specific nervous system receptors found only in invertebrates. Consequently, their products are safe for use in proximity to people and their pets.
Second and that's has been a licensee of this technology for use in consumer professional pest control and agricultural applications. So we know that it works. Third, by acquiring TyraTech we will have the opportunity to expand this technology into the mosquito repellent and animal health markets. On a related note, today our majority owned subsidiary Envance announced a global joint development and license agreement with Procter and Gamble to develop new consumer pest control products based on this essential oil technology.
By entering into collaboration with P&G, Envance has secured a world-class commercial partner with proven consumer product knowledge and a global go to market capabilities. As P&G asserts Envance's proprietary innovations facilitate insect control alternatives to the use of traditional insecticides which addresses rising consumer need to control insects with products that are safe and effective around people and pets. P&G has already begun commercialization of this technology for using in their new range of tests spray products under the trade name Zevo.
We encourage you to explore this exciting new product at Zevo, that zevoinsect.com. From technology we turn to shareholder value. Today, we announced that our Board of Directors has approved the repurchase of $20 million worth of our common stock in the open market depending on market conditions over the short and mid term. Why are we doing this? We believe that it is important for us to show support of the value of our equity particularly when as now our financial performance continues to be strong in spite of volatile conditions in the stock market. Our credit agreement permits us to make repurchases up to this level and our remaining borrowing capacity gives us ample resources for pursuing acquisition targets.
While we intend to continue our long-standing dividend policy, which gives shareholders a share of our profitability, we believe that these repurchase initiatives will further enhance total shareholder value. Now an update on our target parameters for 2018. We expect to achieve total net sales of between $450 million and $460 million. Gross margins at the upper end of our 38% to 40% range. Operating expenses around $150 million. A tax rate for all jurisdictions of approximately 27%. And as I mentioned, we expect the fourth quarter to be our strongest of the year both in terms of revenues and profits.
In summary, we are doing well both top and bottom lines are up strongly for the three and nine months. Our acquisition strategy continues to bear fruit as we successfully expanded in new territories and markets. We're deriving great benefit from our domestic factories in the face of supply chain uncertainty. Our financial discipline has remained firm even as we invest in technology development and pursue exciting developments like TRIMBLE and Procter & Gamble.
With respect to 2019, we expect to be roughly in line with analyst current expectations. We should see growth across most all product categories, continued strong manufacturing performance and controlled operating expenses as we invest in technology and remain active in the acquisition market. Against that backdrop, we have sufficient confidence in American Vanguard that we are investing in our own share repurchase. We hope that you share that confidence.
And I'd like to open up to any questions you may have. Sherry?
Our first question is from Joseph Reagor with Roth Capital Partners. Please proceed with your question.
Good afternoon, guys and thanks for taking the questions. I guess first thing looking at kind of the sales mix during the quarter it seems like the insecticides have continued to kind of lag last year's pace at least on like a nine month basis. Is that all being driven by weather? Is the China tariff thing an issue there? And like how should we think about that normalized getting into 2019?
So in insecticides I mean the biggest difference quarter over or year-over-year quarter was the Dibrom, and -- I'm sorry, non-crop, yes but it was insecticides right yes. So that we had a record year last year and so that was down, insecticides were down. From cotton, our Bidrin that the pest pressure was not as strong as we expected, and of course we had Texas that kind of burned up in a drought and then of course later in the season hurricanes that hit the Eastern Seaboard. I think that's those are predominantly the two factors on the insecticide.
Okay and then on the weather loss sales in the $4.75 million. Do you think you can make any of that up in the fourth quarter?
Yes, the projections are stronger for fourth quarter for AgriCenter as they do believe certain portions of that will pull the curve in the fourth quarter. So, yes, portion of that is timing.
Okay then shifting gears on the $20 million share repurchase, can you give us kind of a framework of your thoughts, obviously the company's valuation is pulled back with a number of your peers over the last call it six months but if we were to see a rebound in the share price so for the short term would you guys continue to exercise that or is that you're going to be a diligence process to see where price --your share price is that when you use it?
I think it'd be more the latter. We do --we have in the past had programs underway to help with shareholders prep as we have plans that occur and employees purchasing stock under stock purchase program. This obviously is a bigger number so I think it'll be a combination. We want to repurchase the shares that might have caused dilution but also we will look at the price and make determinations what's prudent some levels we get back 24 north then we may scale back.
Our next question is from Jim Sheehan with SunTrust. Please proceed with your question.
Good afternoon this is Pete on for Jim. Looking forward do you see any more areas where you might walk away from volumes just as a way to improve margins as you did during the quarter?
Yes. I think it was --it's more a timing issue. I think, yes, this was more specific to our Parazone where we saw prices fall. I think there's volatility that occurring from expectations of tariffs equated with inventory that people might want to sell. So I think for us it is a little bit more of timing where we felt moving in third quarter prior to product coming in we have product that we did not pay the higher tariffs with and that result, if we delayed we'd be able to make more money on it. I don't --we don't have anything planned going forward whether we would hold back. That was an opportune system where we just said it makes sense for us to hold for a quarter.
Our next question is from Bruce Winter, Investor. Please proceed.
Yes, thank you. Mr. Kuser does a wonderful job presenting American Vanguard and investor conferences; I think it would benefit the stock price if his work was more broadly publicized like with links on your website. And my only question is could you please repeat the commercialization plan you have for SIMPAS?
Sure and just that thanks for the compliment, Billy. It's great asset to the company. We did just this last week redo our website and so I think we're --
We redid the AMVAC chemical website and henceforth we will be reviewing and enhancing the AVD, the corporate website. So that's a work in progress but I appreciate your comment, Bruce, that's always important to be able to communicate the message because we actually think that our message is a lot stronger than perhaps we're being given credit for. So thank you for that comment.
So next week at Dallas why don't you tell everyone about next week in Dallas?
I certainly will. I will be there next Wednesday. Will you be there as well?
No but it's on the internet. So that --it'd be nice to having a link on your website et cetera, et cetera.
Excellent, excellent suggestion. That is a conference that is going to be webcast and we can certainly tie that into the website. Excellent suggestion.
Thank you for work.
Yes, thank you.
With regard to SIMPAS, the plan here is that for 2019 season, we want to get multiple products going down both liquid and granular and prescriptively as I said this year we did a granular product down prescriptively. We want to now get multiple products also the target is to have Trimble's system. We have originally we are doing this with an iPad, but in collaboration with them they indicated that they would be able to bypass the iPad and go straightly on to the screen in each of the cabs that were whether it was John Deere or a Case IH or Kenzie that it would adapt straightly in that. So I think growers are not minded having some the SmartBox screen inside of their cab, but we're trying to improve every part of this.
And this be one less screen that they need to have in their cab. With that then we will --we'll be testing these multiple products, getting this linked into the cabs themselves. So that when you hit 2020 we should be able to do this without a glitch. And my people are -- I'm always pushing to go faster. Our people are quite quick to point out that you get one first launch and so we have been a little more conservative. I think 2019 was my original target, and the 2020 we should be all set to go.
So who's going to figure out how to determine what to tell the machine to do? And who's going to manufacture and service and sell the machines?
So the manufacturing of it we have the same company that has been doing ours SmartBox manufacturing, it's call World-Class. They'll be doing initially the assembly and selling units additionally to Trimble. Trimble has
90 outlets in the United States, retail outlets that sell equipment that are expected to begin marketing the products. I think as far as who's writing the prescription and that's really what we call it telling the Machine what to do. SIMPAS is the first company that has stepped up and said we've got the agronomist capable of being able to write the prescription. We have other companies that have expressed interest that I think will follow along shortly. That will also look to have their agronomist be able to write prescriptions to apply multiple products at time of plant both in a prescription level and as I talked about this new patent that we filed for which would allow us to time the product that goes down with the seed.
And it doesn't mean it has to go on top of the seed or right at the seed if there are any products that might have any sort of phytotoxicity that might affect germination. They can go as a side dress. The whole point is that we now are able to link the application of our products time it with the seed coming out, and that's another big, big step forward for us.
And we now have a follow up question by Joseph Reagor with Roth Capital Partners. Please proceed.
Hey, guys. Just one more thing, looking at working capital it's consumed about $70 million so far this year, 75 million-ish, it looks like that's going to at least partially reverse in Q4. Is that the correct assessment and is that also where the $20 million or so is coming from to target share repurchases?
[Multiple Speakers] So the first question was about $70 million. We don't have that right.
I didn't think it was that big.
So I thought you said we're at $15 million so far this year.
Well the changing working capital is greater than that because we've got the cash inflow from the business, generated from the business, so then that was $15 million.
Yes. So net $15 million. We're expecting as you said strong cash flow in the fourth quarter.
Yes, we normally have. We only have -- inventory comes down and payments come in from customers so that tends to finish the cash cycle and we do tend to see a better quarter for the year.
Okay and so that will give you guys kind of the extra cash you need to move things forward with decreasing--
Yes. If you look at the change in working capital from December 31st, 2017 it's $53 million. So maybe we need to just check.
Yes. I guess I'm looking at share --yes, yes we would generate I think we'd expect to generate more than $20 million in the fourth.
And our next question is from Neil Van Horn with Guyasuta Investment Advisors. Please proceed.
Neil Van Horn
Yes. Could you just summarize again the impact of the tariffs either on chemicals you import from China or other countries and conversely tariffs would be levied on sales from you to China or other countries? How that exactly plays out?
Sure. I mean the easiest one is with China to date and we've not sold a product and we do not have registrations for product in China. I will say that the Chinese companies and government are very interested in SIMPAS or something that we do believe will happen. We do have some registrations that we are looking to get there but for now there is no impact and certainly in the mid term. With regards to products that we have imported and I mentioned about including raw materials it's about 10% of the products that we purchase or manufacture.
And the duties have been in that call 5% 6% range historically. With the new act of tariffs effective October 1st that was increased by 10%. So you're looking at 15% to 16% and scheduled to go into effect, the 1st of January would be an additional 15%. So that would put products that were in the 5% up 25%% to 30% to 31%. So a lot of companies are looking to India and other countries. There's also the coupling that a lot of supply out of China has been disrupted largely environmental compliance issues. So with regards to ourselves, we have purchased some products in advance of October 1st.
We have some products scheduled that we are purchasing in advance of January 1st which is certainly leading to part of why our inventories have increased because we think it's prudent to purchase prior to these duties. And on a go-forward basis, as I mentioned product Bromacil still doesn't --is not subject to those duty increases. It's a product that we purchase from China for our international business, but more recently we did purchase their domestic business of which we are now in a position to service that market as well. So I don't know if they tied up all your questions or not.
Neil Van Horn
Well it ties it up but it's a screwed up mess that's for sure.
Well, we tend to be politically neutral on phone calls but --
But you may be right.
No, I mean it's I think what has occurred in the past isn't always necessarily a fair and balanced situation, and somebody's just addressing that today.
Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.
Okay, thank you. And I appreciate everybody's participation in today's call. And we look forward to updating you on further progresses. We look to increase shareholder value. Thank you.
Thank you. This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.