AgroFresh Solutions Inc (AGFS) 2021 Q3 法說會逐字稿

Good afternoon, and welcome to the AgroFresh Solutions Third Quarter 2021 Conference Call. (Operator Instructions) Please note today's call is being recorded.

At this time, I'd like to turn the conference call over to Jeff Sonnek, Investor Relations at ICR. Please go ahead, sir.

Thank you, and good afternoon. Today's presentation will be led by Clint Lewis, Chief Executive Officer; and Graham Miao, Chief Financial Officer. The comments during today's call and the accompanying presentation contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are considered forward-looking statements.

These statements are based on management's current expectations and beliefs as well as a number of assumptions concerning future events. Such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements. Some of these risks and uncertainties are identified and discussed in the company's filings with the SEC. We'll also refer to certain non-GAAP financial measures today.

Please refer to the tables included in the slides that accompany this presentation as well as the press release, which can be found on the Investor Relations section of our website, agrofresh.com, for reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures.

I'd now like to turn the call over to Clint Lewis.

Thank you, Jeff, and welcome to everyone on the call. AgroFresh is a trusted brand in the post-harvest industry, known for our commitment to providing quality products and solutions. Our reputation is supported by our experienced sales and technical teams that deliver a high-touch service model that customers have come to rely on. We are an organization that provides innovative end-to-end solutions. We have a diverse portfolio with an attractive margin profile and have geographic breadth with operations in over 50 countries that supports a diverse base of more than 3,500 customers.

These elements and our close proximity to our customers are the cornerstone of our market leadership in the post-harvest industry, which we aim to reinforce and grow in the years ahead. In the third quarter, which marks the start of the Northern Hemisphere season, our customers were impacted by the well-reported weather-related challenges that negatively impacted fruit quality and storage volumes, which in turn adversely impacted our SmartFresh business.

This includes the late frost in Europe impacting the pear crop in key markets such as Italy and France, and extreme heat wave in the Pacific Northwest apple growing region of the U.S., where crop yield is now expected to be down 10% to 15% from last year. In addition, our results were impacted by ongoing competitive pressures in our SmartFresh for Apple segment and a discrete shift in timing of sales in Europe with expected customer buying shifting to the fourth quarter this year versus the third quarter of 2020.

It is for this reason that it's appropriate to assess our performance on calendar year halves in order to get a full seasonal view of sales in each hemisphere. Nonetheless, as we have previously communicated, we continue to expect to generate growth in both net sales and adjusted EBITDA for the full year 2021.

As we did last quarter, we are providing you with additional disclosures on both the geographical and product solutions basis to further assist your understanding of our business, and monitor the progress of our strategy to grow through diversification. The details can be found in our supplemental earnings deck on the Investor Relations website.

Our diversification initiatives remain on track, and we expect will continue to be the engine of growth as we move ahead. We are continuing to make sequential progress towards our goal, both in terms of mix and growth. If you look at our business, excluding SmartFresh for Apple revenue, which captures all of the crops solutions and technologies, this represents approximately 41.3% of total revenues on a trailing 12-month basis as of September 30, 2021. This marks a sequential increase in our diversification mix of approximately 70 basis points from the second quarter of 2021.

Additionally, we generated diversification category growth of approximately 14.6% versus the prior year on a similar trailing 12-month basis, which is helping drive this improvement in mix. These diversification metrics are at the core of our strategy, and we are focusing our organization around them in order to drive consistent profitable growth. Our continued success with our growth by diversification strategy, also helps to build a natural hedge against certain known risks in agriculture, such as weather.

Further, diversification across products, platforms, crops and geographies minimizes the adverse impact that any one of these variables can have on our results. Shifting to some of the revenue drivers for the third quarter. As I mentioned at the top of my remarks, we were met with a number of challenges in our Northern Hemisphere markets, which disproportionately weighed on the third quarter results.

Again, we feel it is important to look at our financial performance by calendar year halves in order to reflect the full season impact rather than on a quarterly reporting basis. This is how our customers manage their business and thus, influences how we manage our business. One example of fluctuation between quarters is the timing of sales, which is a regular occurrence in our industry.

This year, we saw some sales shift from the third quarter to the fourth quarter, which distorts comparability. While this will have a positive contribution for the fourth quarter, it does entirely offset the weather impacts we are experiencing the season. Nonetheless, we continue to anticipate generating growth in both net sales and adjusted EBITDA for full year 2021.

From a geographical perspective, our Europe, Middle East and Africa region, which also had the largest sales contribution for the quarter, experienced significant headwind with a 17% decrease in sales versus the prior year period. More specifically, key European markets such as France and Italy, were met with a late frost that significantly decreased the size of the pear crop. In fact, the industry reports that the pear crop may be down by as much as 70% of versus the 2020 harvest.

Further influencing the regional climb was timing of sales recognition as I referenced previously. We estimate that this delay was approximately 10 to 14 days, which is expected to be recognized in the fourth quarter of this year. Our second largest market, North America, grew 5% during the quarter. However, growth was constrained by an unprecedented heat wave that impacted apple production, particularly in the Pacific Northwest. This is, in turn, having a negative effect on quality and yield, which has resulted in lower volumes and storage.

We expect this dynamic to be more visible in our fourth quarter results, and we anticipate a year-over-year sales decline in North America as a result of the lower storage volumes. Rounding out our geographic exposure are the other markets of Latin America and Asia Pacific, which grew by 38% and 28% in the third quarter, respectively.

From a product solutions perspective, the delayed harvest and unfavorable weather events had a clear impact on our SmartFresh for Apple business, which decreased 12% in the third quarter. However, due to the timing dynamics that I mentioned, we expect to drive sequential improvement in this category in the fourth quarter, although it is still expected to be down versus prior year.

The important message here is that this isn't an execution issue, but rather a direct function of weather and its related impact on our customers. Our weather exposure also included pears, which weighed on our other 1-MCP solutions category, which decreased 8% compared to the third quarter of 2020.

This category primarily consists of SmartFresh diversification for crops other than apple plus Harvista and EthylBloc. While both Harvista and EthylBloc generated growth in the quarter, it wasn't enough to offset the impact to the European pear business, which was primarily the driver of the decline.

Our fungicides and disinfectant category grew 46% and was the largest contributor to growth with a $1.3 million increase versus the same quarter last year. Results were driven by increased citrus production in Morocco. Additionally, we experienced incremental growth in fungicide penetration in Latin America which is supported by new commercial partnerships. Sales of coatings grew 59% for the third quarter. Coatings is a strategic focus for the business and will become an increasingly important component of the business going forward as we seek broader diversification.

We anticipate the coatings business to expand further with the introduction to VitaFresh Botanicals, which is our plant-based edible coating solution to preserve freshness, extend shelf life reduce food loss and waste and result in superior eating experiences.

We recently participated at Fruit attraction, which is one of the main international trade shows for the horticulture sector. The response from the industry to our VitaFresh Botanicals line continues to build, and we believe it demonstrates a key opportunity to diversify and grow beyond palm fruits to other important market segments such as citrus and avocados.

In summary, we were met with a series of dynamics in the third quarter that we needed to contend with. The reality is that weather and seasonal shifts in harvest timing are common in our business, which is why it's important to evaluate the business in seasonal halves. In spite of these headwinds, we continue to advance our diversification efforts, which is visible in the 15% growth that we generated in the trailing 12 months period ending September 30, 2021.

Our ability to grow through this challenging environment speaks to our team's focus and resilience to continue to drive business across multiple crops, products and geographies while continuing to support our customers at a return. I continue to be encouraged by the progress we are making towards developing new capabilities and the experienced team we have at our company to advance our growth through diversification strategy.

I'll now pass the call to Graham to speak to some of the financial highlights. Graham?

Thank you, Clint, and good afternoon to everyone. The third quarter starts our Northern Hemisphere season. Net sales for the third quarter of 2021 decreased 6.8% to $49.2 million compared to $52.8 million in the third quarter of 2020. Excluding the impact of foreign currency exchange, revenue decreased 7.1%. As Clint mentioned, the majority of the net sales decrease was driven by lower fluid volumes in storage, resulting from challenged growing conditions and weather impacts that reduced fruit quality.

Gross profit margin declined from 74.4% to 69.4% compared to the prior year period. The margin variance was due to product mix, which was primarily influenced by the decrease in SmartFresh for Apple revenue. The lower gross margin also reflects the impact of product mix. as a result of diversification growth. While we always strive to maximize margin, our primary focus is on generating gross profit dollar growth consistent with our growth through diversification strategy.

Research and development costs were $3.3 million in the third quarter of 2021 compared to $2.9 million in the prior year period and was driven primarily by the timing of projects. As you think about the full year, we anticipate R&D to align with approximate pre-COVID spending levels. Our R&D investments take form of innovation and product development, technical services to support our customers and the regulatory expertise to help us expand our registrations to new crops and geographies.

SG&A expenses decreased 9% to $12.3 million in the third quarter of 2021 as compared to $13.5 million in the prior year period. This decrease was due to a focus on cost control. We continue to be focused on expense discipline and a thoughtful resource allocation as we focus the organization around growth and the revenue-generating activities. So as you think about reported SG&A for the full year 2021, we have been working hard to offset some severance and other nonrecurring items associated with the realignments we made across our organization in the second quarter.

As a result, reported SG&A on a dollar basis is trending towards flat to down slightly versus prior year. On a normalized basis, excluding these items, we continue to feel good about driving year-over-year cost efficiencies in 2021 despite the low prior year base that was advantaged by reduced COVID-related expenses. Third quarter 2021 net income was $0.8 million. This compares to a net loss of $29.7 million in the prior year period.

As a reminder, during 2020, the company recorded a $24.7 million of valuation allowance against the carryforwards of cumulative net operating losses related to the change of control for federal income tax purposes associated with the Paine Schwartz investment, which resulted in an increased tax provisions.

Adjusted EBITDA was $20.5 million in the third quarter of 2021 as compared to $25 million in the prior year period. Adjusted EBITDA margin declined to 41.6% in the third quarter of 2021 versus 47.3% in the prior year period, and reflects the product mix headwind we encountered and lower sales volumes associated with our SmartFresh business. The adjusted EBITDA margin for the trailing 12 months ended September 30, 2021, was 36.6%.

As a reminder, our adjusted EBITDA margin performance should also be viewed in total for the year to align with the respective Southern and the Northern Hemisphere seasons, where our higher second half sales volumes translate to correspondingly higher margins for the business. The strength of our operating cash flow continued in the third quarter, and the cash provided by operations was $26 million for the year-to-date period, ended September 30, 2021, versus a cash use of $0.4 million in the comparable prior year period.

Adjusting for the onetime benefit of $14.4 million of litigation proceeds this year and $4.6 million of nonrecurring income in the prior year period. Normalized operating cash flow from operations was approximately $11.6 million for the first 9 months of 2021, an increase of approximately $16.5 million versus the normalized prior year period. The increase in normalized cash flow from operations was mainly driven by lower cash interest and working capital improvements.

For the 9 months ended September 30, 2021, capital expenditures were $2.9 million compared to $2.1 million in the prior year period. We continue to expect our annual capital expenditures to range from 2% to 5% of sales, consistent with our asset-light business model. From a balance sheet perspective, cash as of September 30, 2021, was $43.3 million. Total debt was $264.8 million and our $25 million revolver was undrawn as of September 30, 2021.

This concludes our prepared remarks. Operator, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Joel Jackson with BMO Capital Markets.

I have a few questions, so I'm going to ask them one by one. Graham, Clint, can you help me -- you walked through a lot of the building blocks, what would happened in Q3 and how you see the year still playing out? Can you help me very high levels? So year-to-date through 3 quarters, sales are up about $4 million this year and EBITDA is down about $1 million. Can you walk me through how we get from sales up for EBITDA down $1 million.

The year-to-date, right?

Yes. Yes.

How did we get to -- just to clarify your question, Joel.

The sales are trending up $4 million year-to-date through 3 quarters, you've done $4 million of high revenue, but EBITDA has declined about $1 million. How do we get from that from X to Y?

Okay. So there are actually a couple of reasons. So yes, top line growth was driven by our diversification in other products and for other crops. And then the -- as we see the evolution of our product mix, and from a high concentration in -- for SmartFresh for Apple to more diversified other products for other crops. So the margin -- gross margin profile has evolved.

So that overall gross margin, as you see, as reported on a reported basis, in the aggregate, the margin -- the gross margin declined year-over-year. And our -- as a result, so the incremental top line growth did not translate proportionately to a higher -- although we do see incremental gross profit. But in terms of margin impact, you see the product mix played a role. Now to offset that gross margin evolution, we have a cost...

Graham, your line cut out for most of that answer. I was checking if there are people on the line, too. Could you repeat the answer. You cut out for most of it, to be honest.

Okay. I'm sorry. Just...

Can you hear us now, Joel?

Yes, just testing, can you hear us now?

I do. Yes.

Okay. Let's try it again. Just please stop us, if you lose us again. Go ahead, Graham.

Okay. So the top line growth of 4% reflected the -- our diversification into other products, particularly Harvista, fungicide products and coatings. So as you see diversification take hold, the proportion of our apple -- SmartFresh for Apple business decreases as a percentage of total revenue, right? Now that would have -- that has a consequence on the gross margin impact. Because it's a SmartFresh for Apple historically, and it continues to be carrying a higher gross margin than other products.

So as you see the product mix evolution and its impact on gross profit, right? And then -- so you will see the less profit in terms of incrementally from -- resulting from the top line growth. So that's the product mix impact on gross profit. To offset that impact, we control our costs to offset. So you see year-over-year, our total operating expenses improved for the 3 quarters year-to-date.

And then from an EBITDA perspective, right, year-over-year, you will see that we consistently disclose what's in adjusted EBITDA. So it's a comparison to the last year in terms of what's in the nonrecurring noncash charges. So it's the difference between the 2, you see the carry-through from the P&L top line, gross profit, operating expenses all the way to adjusted EBITDA. Now just the details are in the appendix we provided on the website for a full reconciliation of adjusted EBITDA to net income.

Joel, first of all, are you able to hear Graham clear that time?

Yes, that was good. Yes. You cut it a little bit -- sorry, on the first time but not the second time. Yes.

Okay. Great. And again, frankly just stop as we -- so the only thing I would just add to Graham's commented, part of this is as we look at it specifically and discretely in the third quarter. And the other is you just think about the natural evolution of the business, right? So clearly, in the third quarter, you saw a much more pronounced adverse impact at gross margin because of one, the mix dynamic that Graham discussed as we continue to advance our diversification efforts, but also because of the headwind that we had that impacted both SmartFresh Apple, but also SmartFresh as we use in pears given the weather impact that we had both in Europe and Pacific Northwest.

So you saw a more pronounced impact in the third quarter than you would have in the other quarters given the weather headwind and where that specifically impacted. On a more broader basis, again, I think it's important to understand the transition that the company is and will continue to go through as we try to drive diversification across other products and platforms across other crops and across other geographies.

Clearly, what we will continue to be critically focused on is net gross profit dollars coming into the organization, but you are going to see a migration in the gross profit margin as we have more of that product mix impact. The last thing I would say, Joel, is that from a margin density, the 1-MCP platform, obviously, is the most margin dense product that we have.

So whether it's in apples, pears, Harvista or as we apply it in other crops, that clearly will have the greatest gross margin percentage. But as we have a more complete solution to our customers to both meet their needs but also as a competitive buttress against other competitors, we need to make sure we're having a more fuller suite of products. And that's where, again, you're going to get that mix dynamic. So let me stop and pause there and see if that's clear.

Yes. So Joel, this is a really good question. Thank you for that. If I may add a couple more points that the -- for SmartFresh -- for us, SmartFresh as a franchise. Not only for apples, but also for other crops. And we are making a lot of progress in registering for label expansion for new crops for leveraging our global footprint and for dual expansion as well.

That also is a high-margin business. So SmartFresh diversification for other crops, AgroFresh has a superb advantage and a market positioning to capitalize that value going forward. The second point I would also add is year-to-date for the 3 quarters may not provide a full picture of our financial profile. So keep in mind that Northern Hemisphere, so we talked about -- Clint talked about some shift from the third quarter shift of sales, particularly in Europe from the third quarter into the fourth quarter.

So typically, our second half, right, versus the first half, top line accounts for over 60%. Bottom line adjusted EBITDA typically would account for, let's say, over 70%, right, 75-ish percent of the total year. So the year is not over year yet fourth quarter will play a big role in our full year picture. And as Clint also talked about, for the full year, we anticipate full year growth, both on the top line and the bottom line.

So second question of 3. The second question would be, so if I think about the rate of how you're selling newer products, diversified products like in SmartFresh, I guess in order to get the EBITDA better, you obviously have to sell those new products and diversified products faster. If it doesn't go as fast as you want, you need to reconsider dropping more costs from SmartFresh.

I guess maybe the way I would look at it, if I'm understanding the question correctly, I would say on a sequential basis, you're continuing to see double-digit growth in that diversification strategy. So tangible examples of our continued ability to grow that business on a double-digit basis. And again, today, that ratio of SmartFresh Apple compared to all other solutions is now kind of just slightly below 59% on SmartFresh Apple and therefore, 41% in the diversification category and again, growing double digits.

So clearly -- and I think we've been consistent in this regard, the strategy to drive consistent growth for this company is going to be continuing to advance that diversification strategy, and we continue to be encouraged by the progress, but there's more progress that we need to make with our question full stop.

With respect to SmartFresh Apple business, the way I would define the approach and the resourcing against SmartFresh Apple is what we call a defend strategy, right? With the loss of patent on the SmartFresh Apple business. And therefore, with the continued presence of additional generic and branded competitors across other markets, we need to make sure that, first of all, our customers continue to tell us that they see and appreciate and value the quality of the product that we have and the quality of the service in which we have.

But clearly, we will continue to be challenged around the price and what that spread is, but our focus will be defending that, but the SmartFresh Apple business in and of itself is not going to be a material driver of growth other than just ebbing and flowing with crop size in any given season. And therefore, our resourcing of that needs to be commensurate with what a defense strategy is while we reallocate our effort and our resources to continue to accelerate the other crop and product diversification growth.

That's really helpful. And then my last question would be now as looking at 2022, can you give us some building blocks, what would top line growth be for SmartFresh Apple, for other SmartFresh, for fungicides and coatings like Tecnidex areas? And what -- when you look at the cost side, what might be the puts and takes on the cost side from inflation or other productivity programs you have ongoing?

Joel, we are currently not in a position to provide financial guidance. But with that being said -- and we continue to look at our business in halves, right? So for the year -- for this year, we remain confident that we will -- we expect to deliver both top line and the bottom line growth over last year. And we see that in -- can talk about the overall mega trends, why we are excited that were in this business and to generate profitable top line growth.

Yes. I would say also, and again, manage around guidance. But if I say that at a very high level, again, the -- our goal, our aspiration, our commitment and the strategies that we are and will continue to employ are to drive consistent, profitable growth and that growth both at top and bottom line. Again, we believe on a full year basis, you will see top and bottom line growth for 2021. And, Joel, specifically then to your question in 2022 -- again, it is reasonable to both say and expect that we will see, again, top line growth and bottom line growth in 2022. And again, we will see an increasing contribution of that diversification strategy being the biggest engine of that growth as we move forward.

(Operator Instructions) Ladies and gentlemen, at this time, I'm showing no further questions. I'd like to end the question-and-answer session and turn the conference call back over to management for any closing remarks.

Yes. First, so I want to thank everybody for their attendance. I also want to thank Joel for his set of questions because I'm sure that maybe touched on a number of different questions. I know with a number of you will be having follow-up discussions about our performance in the third quarter. I guess I would just punctuate 2 things as we transition to close this call.

Again, we're a business that you need to evaluate both on seasons and halves. That is the way our customers manage their business, and therefore, it's the way that we manage our business. And I continue to reiterate that our expectation is for full year consolidated growth at the top line and the bottom line in 2021.

The last one is, again, just an understanding and appreciation from a company that was historically disproportionately focused on one key platform of 1-MCP and one crop that was largely global apple crop. And the team has continued to make progress about diversifications around different products and platforms across different crops, across different markets and geographies, and we continue to be encouraged by the progress that is making.

Clearly, that will have a migration with respect to the gross margin percentage from what was historical to what is, I think, more reflective of that more broader diverse portfolio but we still believe we will have really good margins, both at gross margins and EBITDA margin and will be a cash-generative business. So thank you for your continued engagement and support of AgroFresh.

Thank you. Ladies and gentlemen, this does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.