AgroFresh Solutions, Inc.
Q3 2020 Earnings Call Transcript

Published: 8 Nov 2020

[Operator:]

Good afternoon and welcome to the AgroFresh Solutions Third Quarter 2020 Conference Call. All participants will be in a listen only mode. After the today’s presentation there will be an opportunity to ask questions. Please also note, today’s event is being recorded. At this time, I’d like to turn the conference call over to Jeff Sonnek, Investor Relations at ICR. Sir, please go ahead.

[Jeff Sonnek:]

Thank you and good afternoon. Today’s presentation will be led by Jordi Ferre, 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.

[Jordi Ferre:]

Thank you, Jeff, and good afternoon, everyone. Please turn to Slide 3. We had a solid performance in the third quarter, which represents the start of the northern hemisphere apple season. As a reminder, the northern hemisphere season continues through the fourth quarter and the season in total represents about 2/3 of our annual revenue. Revenues increased 7.8% versus the prior-year period and gross profit margin increased 280 basis points to 74.4%, which demonstrates the strength of our value-added service platform. Additionally, our cost optimization initiatives continue to deliver strong results. SG&A expenses improved by 10% in the third quarter and 15% for the first 9 months compared to the prior-year periods. When taken together, our operational improvements and cost containment efforts drove a 530 basis point improvement in our adjusted EBITDA margin for the first 9 months of 2020, resulting in adjusted EBITDA growth of 14.8% despite a 3% decrease in sales. Thanks to the preventive measures we put in place in preparation of the northern hemisphere season, we have been able to deliver uninterrupted service to our customers in spite of the challenges presented by the COVID-19 situation. I am truly proud and humbled by the determination that AgroFresh technical and operational staff exhibited in such a difficult environment. I also want to recognize the efforts by our corporate team to successfully close comprehensive refinancing transaction in July. This transaction was a significant milestone for AgroFresh as it substantially improved our capital structure and established a highly advantageous collaboration with our new strategic investor, Paine Schwartz Partners. Together with the support of an improved capital structure, we are working diligently to accelerate on those strategies, which include organic and external opportunities. Turning to Slide 4. The fundamentals of our SmartFresh business remains solid through the first 9 months of 2020 amid a challenging operating environment and shifting market dynamics that were brought about by the pandemic. We saw a return to normal harvest timing in Europe this year versus last, which caused SmartFresh revenues in that region to increase 25.5% during the first 9 months of the year versus the prior-year period.

[Graham Miao:]

Thank you, Jordi, and good afternoon, everyone. Please turn to Slide 10. The third quarter begins our northern hemisphere season. As we have noted on numerous occasions, we think it’s most valuable to look at the business in halves versus quarters to consider seasonal fluctuations that can shift sales between the quarters of each half. Net sales for the third quarter of 2020 increased to 7.8% to $52.8 million compared to $49 million in the third quarter of 2019. Excluding the impact of foreign currency exchange, which increased the revenue by $1.1 million compared to the third quarter of 2019, revenue increased 5.6%. The net sales increase was primarily a result of growth of SmartFresh in Europe due to the normalization of harvest seasonality versus the prior year, increased traction with Harvista in European markets and positive contributions from Tecnidex. Net sales for the first 9 months of 2020 were $105.8 million, a decrease of 3% versus the prior-year period. The impacts of foreign currency translation reduced the revenue by $2.7 million for the first 9 months of 2020. Excluding this impact, revenue decreased approximately 0.5%. A slight decrease in net sales on a constant currency basis was primarily the result of geographic mix, where the relative strength of its EMEA and APAC regions were offset by relative weakness in the North America and the Latin America regions.

[Jordi Ferre:]

Thank you, Graham. Please turn to Slide 14. In summary, we are pleased with our ability to manage through the uncertainty and disruption caused by the global pandemic this year. We delivered a solid quarter and year-to-date performance with significant improvements in both gross and adjusted EBITDA margins while completing a comprehensive refinancing of our debt in July. Our team is energized by the progress and focused on our key growth initiatives, Harvista, FreshCloud and crop diversification of which Tecnidex is a key component as we expand into new geographies. Our energy is matched by that of our new strategic investor, Paine Schwartz Partners, and we are working together to accelerate growth into new technologies, crops and geographies. The post-harvest market is becoming increasingly important in food waste prevention and we are prepared to lead the industry through innovation and grow the marketplace. With that, operator, please open the call for questions.

[Operator:]

Our first question comes from the line of Gerry Sweeney with ROTH Capital.

[Gerry Sweeney:]

I’ll just start with the revenue, a little bit lighter versus my model and sound a little bit probably versus your internal expectations. Any way you could bucket out maybe some of what happens? Harvista wasn’t as strong as you anticipated. You had some competition and there may have been 1 or 2 other headwinds. Anyway, quantitatively or qualitatively sort of bucket out how much each of those was or were? And I’ll take it from there into that.

[Jordi Ferre:]

Yes. I’ll take that, Gerry. I think that what we have to understand is the -- your expectation that you’re referring is to us. So let’s talk about Harvista. It’s true that we have come to the season expecting more disruption caused by the COVID-19 pandemic in terms of labor management. Interestingly enough, in spite of all the reports that we had seen of labor management issues with people not being able to travel, workers not being able to travel, at the end there was enough labor to support. And therefore, the benefit of Harvista, which is one of many that is to manage labor, was not such a relevant topic as it was. We’re having a good season, but we were expecting a lot better growth in North America than we expected. I’m saying we have a good season with Harvista. It’s not a bad season, but we were expecting a lot more growth. Okay, so that’s one.

[Gerry Sweeney:]

Yes, I think it just didn’t arise, right, as much as --?

[Jordi Ferre:]

Right. The opportunity that we had expected, and we put a lot of betting on the benefit of labor management did not pan out, I mean, as we expected this year in terms of labor management, as I explained. So that happened. As you could see, though, overall our business still grow and we’re still going to grow Harvista similar to what we did last year. So you did that. On the other hand, as you saw, there was a lot of positives as well from Harvista. In terms of -- I think the other question you had is how to compartmentalize what happened with maybe with SmartFresh. Well, I think…

[Gerry Sweeney:]

Poor competition or…

[Jordi Ferre:]

Yes, yes. So I think one thing as I understand your expectations. If we look at -- let’s first explain a little bit on seasonality, right? Last year, we had a particularly late season, especially in Europe, and you saw that that was not an issue. In North America, the pattern that we’re seeing in the season is similar to last season in general from a timing perspective. And yes, I made a reference to some competition came in as part of one of the issues. It happens. We saw that happening in 2018. And in 2019, we were able to regain some of the share that we lost based on the comparison with our service. I think what you need to focus this year is look at our margins that we’re doing well. Some people came -- had some impact, I’m not also trying to say that it was a dramatic impact, had some impact. So we may have lost some share that we regained last year. But overall, I took a look at the big picture, right? I think the big picture is margins remain strong. We are increasing our service. I think you heard about FreshCloud. I think we’ve got a winner here. And that’s what we’re looking at that, at the fundamentals. What we were not going to do is because somebody came with use low-value proposition follow or do something. The market may try some of these propositions. And then eventually, we think, as we’ve seen in the past, that they will come back to a much better solid service that we provide and approve. So it happened, okay? It’s not the main reason, as I said. But that also, I think the crop size and especially the peak rates that we’ve seen -- that were a little bit lighter than they had expected in the industry. The industry came in August predicting an overall 3% decrease in the apple crop and then you had some lower peak rates, which is basically how many of the apples are picked and going into storage. It was a little bit lower than we had expected. We’re still trying to evaluate what was the impact from the total apples that were actually treated in storage. We will do that when the season is over, but there was a little bit of an impact in volume of apple stored, that we were not expecting as well.

[Gerry Sweeney:]

So I mean, just maybe to summarize, I didn’t seem to imply that there was an extreme amount of competition. I was just trying to figure out, as Harvista not a strong competition was there and crop size down. And did I catch in your commentary maybe, has some of the crop shifted to the fourth quarter, or was that…

[Jordi Ferre:]

No. I think what happened is if you look at the produce of last year, the European…

[Gerry Sweeney:]

Was a late off, right?

[Jordi Ferre:]

Was a late harvest, definitely. If you look in the U.S. 2 years ago, we had a particularly early harvest. So last year, it was later than 2 years ago. I think this year, we’ve seen a similar pattern in the U.S. to what we saw last year in terms of timings.

[Gerry Sweeney:]

So there could be some carryover to the fourth quarter?

[Jordi Ferre:]

There could be some carryover to the fourth quarter.

[Gerry Sweeney:]

Okay. That’s fine. A little bit here and there.

[Jordi Ferre:]

Yes. I think what, we always say, Gerry, one thing it’s very important that because the quarters like in this particular case, the third quarter is in the middle of the season as well as the -- as well as the first quarter is in the middle of the southern hemisphere season. You have to remember that the best balance of the season is done when the 6 months are elapsed.

[Gerry Sweeney:]

Got it. And just sticking with harvest, I know you had some higher expectations for it and that it didn’t pan out, which is fine. But have there been any other like impacts to how COVID has impacted post-harvest industry, anything else that we should be aware of now that…

[Jordi Ferre:]

Well, I think I mentioned -- I think we saw a little bit of a less propensity in some customers to invest in quality enhancing tools, right? A little bit of the uncertainty. So we saw some customers that probably were less open to invest in quality.

[Gerry Sweeney:]

Okay. And then I know and you said FreshCloud, you think it’s a winner. I think you mentioned some commercial success with a larger customer. Can you give us a little bit more detail on what’s happening there? Maybe what you’ve learned, what’s the cloud experience, etcetera?

[Jordi Ferre:]

Yes. So as, we’ve been talking about FreshCloud now for almost 3 years. And we have been communicating openly to the market, our evolving strategy. We started offering more particular service in digital services. I think we evolved to something now that would have a very good platform, which is basically the quality management of the entire supply chain of our customers. And I think that’s a very relevant. We have a -- what I mentioned during the call is that we have -- in the particular case of Harvest View, we had processed about 12,000 samples of apples. And we did that successfully. What does it mean? It means that we have proven that our software works, is stable and is ready to be taken to a much broader adoption, right? So that’s very, very important. And I think that the fact that -- and you will hear more on news and press releases about adoptions of our system is a proven that we have a winner here. That’s what I meant. I think we’re bringing something that the industry doesn’t have, which is a better management of the quality of their fruit through the process -- through the supply chain, right? Instead of having systems that don’t talk to each other, the integration and the measurement of what really makes success or not in the treatment of the fruit and how the fruit is handled and where is the fruit coming in, which plot -- what is the plot being used. So everything there that you see, how you manage that is where we can bring an advantage. Why we can bring that advantage? Because we have people around the world that have been providing a service every day. They do know how to manage quality through the fruit operations. I think that’s what we bring as value. We don’t bring value only because we have a good software. That’s because we have a way to put algorithms together and to do machine learning that really can provide very valuable feedback to customers. So they make good decisions. So it’s a much more holistic approach than what you saw 2 years ago when we launched particular individual products. We now have a solution that actually customers adopt and that’s how they manage their business. And as I said before, you may hear some individual press releases in with more details about some of these adoptions that I just mentioned.

[Operator:]

Our next question comes from the line of Amit Dayal with H.C. Wainwright.

[Amit Dayal:]

I appreciate you taking the questions. With respect to sort of the strong margin and EBITDA trends, is this been driven by your ability to control costs better? Or are you seeing some benefits from pricing as well? Any color on this would be helpful.

[Graham Miao:]

Yes. Amit, it’s Graham. I’ll take this one. It’s a combination of both. Yes, you will see that as you saw in our reported financial statements, while our top line for the quarter did experience some softness and lower than what we expected, as Jordi talked about. But we did have our price discipline because we believe in the value-added services that we provide to our customers. And then from an EBITDA perspective, a large majority of the contribution was due to cost optimization. And we did that proactively. We actually started that discipline to look at our operating costs and structure in a more holistic way, starting 2018. So this trend, we have been a positive trend that we had and the efforts that we are making have been continuing in 2020. So the top line and then also the benefit and in addition to the cost optimization, which is why you see not only we are improving our gross margins, but also we are improving our EBITDA margins.

[Amit Dayal:]

So, Graham, on these trends, do you think there will be continuity to this? Or should we expect some variance depending on which part of the season you’re in?

[Graham Miao:]

Yes. So that’s a good question. We look at the year-to-date. Each individual quarter can vary. And then the way we look at it is for the total year and we believe for the entire 2020, the positive trend and the margin improvement will continue throughout the year for this year into Q4. And then as just a reminder, Q3 and Q4 combined constitute a majority of our business for the full year.

[Amit Dayal:]

Got it. Jordi, with respect to your comment on Harvista and maybe this quarter, not coming out as strong as you might have initially anticipated, do you think that sort of bleeds into 4Q as well? Or do you potentially make up some of that in 4Q and you saw it coming maybe a little bit stronger than --?

[Jordi Ferre:]

Yes. Well, I think one thing I want to remind you and everybody else, we still grew -- we have expectations in the U.S. We still grew the franchise by 8% this quarter, right? And there’ll be some of it as well in the fourth quarter. That’s what we are seeing as well. So that is still the projection that we are showing growth for Harvista this year, as I spoke before.

[Amit Dayal:]

Understood. In the press release, you talked about some competitive pressure in the U.S. from the low-touch, low-value providers, I guess. How are you sort of dealing with that? Is that sort of infringing on your business in any meaningful way? Or is this just sort of a nuisance in the near term?

[Jordi Ferre:]

If it was impacting my business in a meaningful way, we will be presenting some other kind of results, including our profitability. I would say they’re not fundamentally affecting our business, right? What happens is when somebody comes in and offers low-value, there’s some customers that decide to try that. And so there is a little bit of a short-term impact on volume. It’s not significant because otherwise, as I said before, you would see other numbers. And you make it significant if you want to make it significant. We don’t make it significant. In other words, our margins are strong. Like Graham said, our price disciplines are very clear, high-value service is very clear. So you may have a short-term impact, but fundamentally the business is not impacted. That’s how I look at it, especially looking at the things that we’re doing to introduce new tools, like I mentioned before, like FreshCloud. The FreshCloud Quality Inspector to me that’s a much more holistic solution. So our choice is to become and continue to be an innovator on a value-added service and we’re not trying to change that because somebody comes with short-term pressures of low-value and some customers, not a fundamental large part of the customers, decide to try that product. They will see. I think, as I said in ‘18, we had some entrants as well and we gained again in ‘19 because they compare and realize that it’s really not worth it to go for just a low-value proposition. Okay?

[Amit Dayal:]

Got it. Yes. So the other question I had, maybe last question, is Harvista being sold as a package with SmartFresh. So are you selling these independently? And is that cannibalizing --?

[Jordi Ferre:]

No, they’re not coming -- they’re complementary. They’re not cannibalizing. And yes, we offer advantages in pricing if you buy both. Now you have to understand that the industry is different because Harvista goes more to the growing side and SmartFresh goes to the packing side. So if you’re an integrated player, there might be advantages of bundling both together, but there’s some of them that are not that integrated. So there is not such a -- there is, of course, but it’s not across all customers necessarily that the bundling may have an impact.

[Operator:]

It appears there are no further questions at this time. I would like to turn the floor back to Jordi for closing comments.

[Jordi Ferre:]

Thank you. Thank you, everyone, for attending our third quarter earnings call. We appreciate the interest and support that you are showing to our company and the management team continues to be committed to work to make this company very strong. So thank you again.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.