AgroFresh Solutions, Inc.
Q1 2018 Earnings Call Transcript

Published: 11 May 2018

[Operator:]

Good morning, and welcome to the AgroFresh Solutions First Quarter 2018 Conference Call. All participants will be in a listen only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to John Cassidy, Director M&A and Strategic Planning. Sir, please go ahead.

[John Cassidy:]

Thank you, good morning, and welcome. Today's presentation will be led by Jordi Ferre, Chief Executive Officer; and Kathy Harper, 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. Please refer to the tables attached to the slides accompanying this presentation, and the press release, which can be found in the Investor Relations section of our website, for reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures. I would now like to turn the call over to Jordi Ferre.

[Jordi Ferre:]

Thank you, and good morning, everyone. As John mentioned, I'm here this morning with our Chief Financial Officer, Kathy Harper. Please turn to Slide 3. In the first quarter, we delivered solid performance in the core and at Tecnidex while continuing to build a much more diversified business serving multiple crops and a wider product range. Revenue growth was up 17% from a year ago. Excluding Tecnidex, our revenue grew marginally from an already strong 2017 Q1, in which our revenue grew 15% over the same period in 2016, and would have been better if not for the adoption of new accounting policies, which Kathy will discuss in a minute. Cash from operations was positive in the quarter. We believe these results indicate that we are creating value, both in our core business, where we maintain our leading market share in the apple market as well as through acquisitions, such as Tecnidex, helping us expand into new crops and new products to further diversify our revenue base. Please turn to Slide 4. In the first quarter of 2018, we managed to generate organic growth in our core business in spite of a lower apple crop in the southern hemisphere, especially in Latin America, where the latest projections indicates a decrease as high as 15%. We have been able to overcome the smaller Latin American harvest by increasing our penetration of the apple market, expanding into new crops and growing our Harvista franchise. For instance, we grew SmartFresh in pears and plums in Argentina and Chile, and we increased our penetration of apples in Brazil by 60%. In the balance of the southern hemisphere, we offset volume weakness in South Africa caused by the drought with strong performance in Australia and New Zealand. Sales of Harvista increased by 70% in the quarter, with strong growth in Argentina, where we expanded our application on pears. And our new regulatory approval for cherries in United States led to strong early adoption. Revenues for RipeLock for the quarter were modest, and our main task has been to get ready for the previously announced rollout across all stores of a major U.S. retailer. All other trials remain ongoing, including those recently initiated at strategic retailers in Europe and North America. We remain optimistic RipeLock will shortly gain a foothold in the retail food industry and expect 2018 to be a turning point. Please turn to Slide 5. The integration of Tecnidex, a leader in citrus, with a strong lineup of fungicides, waxes, coatings and sanitizers, is proceeding ahead of plan with 12% organic growth compared to the first quarter of the prior year. We have reorganized their marketing, R&D, regulatory and sales functions, so they are now reporting into the AgroFresh global structure. We are working to move our European packaging operations from France to Valencia to improve efficiencies and reduce cost. Additionally, Tecnidex is looking to leverage its long-established relationships with the largest agricultural chemical companies to secure supply agreements for a broader portfolio of fungicides. Please turn to Slide 6. Diversification is an important strategic driver behind all these initiatives, and we have made great progress in the first quarter. The proportion of revenue from crops other than apples increased to 39% in the quarter, led by pears, citrus, plums and flowers. That compares with 23% in the first quarter of last year. Please turn to Slide 7. In the first quarter, we also continued to develop a strong pipeline of new technologies, through both internal research and development as well as 3 investments in innovative new companies, partnerships and joint ventures. It's Fresh! as well as our participation in the [indiscernible] TERRA are just two examples on how we are using innovative investment and collaboration strategies to enhance our capabilities. This northern hemisphere season, we will be re-launching AdvanStore. We've improved the technology to enable growers to get real-time information about their fruit via their smartphones. We are also going to be in the market with our first genomic mapping program, a technology we have developed that enables growers to test their harvested apples to determine if a specific crop has a genetic predisposition to develop disease during storage. Additionally, we are expanding our innovation center footprint. This includes opening a new lab in Fresno, California and the recently announced agreement with Pagoda to open an innovation center in China that we expect will create new growth opportunities in the world's largest produce market. In conclusion, AgroFresh had a solid quarter, where we grew and diversified our business and continue to invest in future growth through a strong pipeline for future commercialization. Now let me turn the call over to our CFO, Kathy Harper, who will go through the financial results in greater detail.

[Kathy Harper:]

Thank you, Jordi. Good morning, everyone. Let me review the financial highlights for the first quarter of 2018. Turning to Slide 9. Net sales for the first quarter were $38 million, up 17% compared to $33 million in the first quarter of 2017. Tecnidex accounted for $5.6 million of the improvement, with organic growth in our core business up slightly. In the first quarter of 2018, we adopted ASC 606 revenue recognition. While the sales impact of the new revenue recognition policy are minor, it did cause us to defer nearly $1 million of revenue that would have otherwise been recognized in the quarter. Absent the adoption of ASC 606, organic growth would've been about 3%; total revenue would have been up approximately 20% in the first quarter. SmartFresh revenue from apples was 60% of total revenue compared to 74% in the year-ago quarter. We also saw an improvement in apple market penetration, as growers who previously did not treat applied SmartFresh to their stored apples this quarter for the first time. Beyond apples, SmartFresh revenue in the quarter was attributable to pears, plums and flowers. Harvista revenue growth was up 70%. Please turn to Slide 10. Margins in the first quarter were 72%, primarily reflecting a shift in product mix in the core business as well as the anticipated lower margins from Tecnidex. However, the adoption of ASC 606 shaved about 3 basis points off margins. Taking into account the change in revenue recognition, margins in the quarter came in just shy of our expectations for the impact of Tecnidex and the faster growth in Harvista revenues. Turning to slide 11. Selling, general and administrative expenses in the quarter were down slightly from a year ago. Efficiency and productivity improvements offset Tecnidex related increases as well as ongoing expenses associated with our strategic initiatives and intellectual property litigation. We expect integration efforts at Tecnidex as well as further efficiency and productivity enhancements to reduce costs in the coming quarters. We're focused on driving down operating expenses. Research and development costs were down year-over-year in the quarter. Interest expense was $8 million for the quarter, down $2 million from a year ago. The decrease was driven by lower noncash accretion expense on contingent consideration. Cash interest expense was $15 million for the quarter. In the quarter, we recorded a $2 million gain on foreign currency exchange. Please turn to slide 12. For the first quarter, EBITDA was $10.3 million, flat with the year ago quarter. EBITDA for the first quarter of 2018 is net of a number of onetime expenses, including stock compensation, severance and other expenses totaling more than $2 million as well as the revenue deferral attributable to ASC 606. In the year-ago quarter, EBITDA actually included about $1.3 million of onetime benefits, primarily due to changes in the Dow agreement. Tecnidex contributed $1.3 million to EBITDA in the first quarter of this year. Turning to slide 13. The company also continues to generate positive cash flow with cash from operations of more than $3 million in the first quarter of 2018. Capital expenditures were $2 million for the first quarter of 2018 for continued SAP and infrastructure spending along with the new R&D lab. The balance sheet at March 31, 2018, was strong, including significant liquidity. Cash on hand was $57 million. March 31 balance was a net of $17 million of cash used in the first quarter to settle outstanding liabilities determined by agreement with Dow, renegotiated last spring, and a term loan payment that had been accrued in the fourth quarter but paid in January 2018. Now I'll turn the call back to Jordi, for a discussion of our outlook for 2018, before opening the call to Q&A.

[Jordi Ferre:]

Thank you, Kathy. Please turn to slide 15. Results in the first quarter demonstrate our commitment to sustained growth and provide a roadmap for long-term success. The continued strength in our core markets reflects the strong relationships we have built with our customers as well as our reputation for innovation and technical expertise, providing growers peace of mind to manage their harvest fruit. That culture and reputation extends to Tecnidex, a newly acquired business that has started delivering as expected. We anticipate top line revenue growth in 2018, both organic as well as from Tecnidex. As was seen in the first quarter, the ongoing transition of our product mix and the integration of Tecnidex will result in some gross margin compression in 2018. We also expect operating cost to stabilize, all of which should lead to improved cash flow, which we will use to fund our growth initiatives. Thank you for your support and continued confidence. We look forward to continuing to deliver strong performance in 2018 and beyond.

[Operator:]

[Operator Instructions] Our first question today comes from Daniel Jester from Citi.

[Daniel Jester:]

So first off, I was wondering, just coming back from China, Jordi, and signing this agreement to try to expand your footprint there. Can you just talk a little bit more about what the ultimate opportunity is there? And then secondly, on China, there's some tariffs on U.S. apple imports into China. I'm wondering if you can comment on that. What kind of impact you expect? And what kind of commentary you're hearing from your customers in the U.S. about that?

[Jordi Ferre:]

Yes, I came back from China and signed with Pagoda the agreement. In China, obviously, the expectation is to build solutions that go well with the Chinese market. What we found there is that the retailers and ecommerce has a lot of influence in how the supply chain goes to consumer, especially in Tier 1 cities. So that's the reason why went with a retailer in this particular case as our partner, because as we develop solutions together, the idea is to implement them immediately in their supply chain and as well as extend that to other type of retailers. Pagoda, 50% of their fruit volume is imported. So there'll be a lot of as well exports into China that we will look at, put solutions through. In terms of the potential of that, look, I can give you some numbers. It depends how successful we're going to be, but this could be in the millions of dollars, obviously, if we are able to create the solutions that really work there. In terms of your other question about the impact of tariffs on apples in China, I have not heard anything that will impact our business in this way other than they'll still be [Indiscernible] storage, those apples potentially for other markets. So I think from [Indiscernible] as a solution, [Indiscernible] see that as negative.

[Daniel Jester:]

Okay. And then, on gross margin in the quarter, obviously, there was some onetime issues with this revenue recognition change. But if you adjust for that, 75% gross margin in the quarter, can you sort of give us a little bit more granularity about how you envision you're proceeding? Obviously, there's this revenue recognition item, but also Tecnidex. So sort of any kind of color you can help us bridge 2018 versus 2017 would be helpful.

[Jordi Ferre:]

I can take that, yes. The other thing also I would like to say on gross margin that we have to consider is that we're still in the middle of the southern hemisphere season. So we will have a better balance on how gross margin is evolving when we finish the first half. But I think we've been clear that our aim is to grow this business. We put a goal to get to 500 million in about five years. And to do that, there will be, over time, a certain margin compression in terms of percentage. Obviously, we'll be still better off in that, but our margins not being able to sustain at 80%, as we have, basically because as you incorporate other solutions and launch other products, the mix is going to go down in terms of percentage. And I think that's okay if you can actually grow the top line and so become a more profitable company. So that is the way I see it. Again, there is a margin compression in this quarter [indiscernible] 70%. So that's in line with what we have given in the past.

[Kathy Harper:]

And one more thing here. Just to put a little bit of a finer point on it. The core business sales mix [indiscernible] SmartFresh and Harvista actually [indiscernible] expecting. Tecnidex [indiscernible] sales into our portfolio [indiscernible]. And so it's a little shy but not far off of what we expected.

[Jordi Ferre:]

But what I want to be clear [indiscernible] say that there's no decline in pricing [indiscernible].

[Daniel Jester:]

Great. And then, just one last one from me. I know it's probably early days to talk about it, but any sort of expectation for how you see the northern hemisphere apple season progressing this year?

[Jordi Ferre:]

I think here is what I feel. Of course, our two markets are Europe and the U.S. So let me start with an easy one on Europe. So Europe, as you remember, we communicated last year about the April frost that reduced the volume by 30%. That event did not happen this year. So it is fair to expect that the volume of apples in Europe will be up, and we hope that is going to recover to a normal volume. Now how is that going to translate into our business? As I explained last year, and it doesn't change, is you still have a lot of other variables like penetration, supply and demand and other things that would effect that. But I would say, from a crop size, that's looking to be optimistically up because of no events in weather. In North America, U.S., how the season is looking? I hear some predictions that say that the apple crop may be down this year. I'm talking about the Pacific Northwest, yet Michigan, which last year was affected severely also by a frost. There was no weather events that tells me that it will go back to the situation we had last year. So I think in Michigan [indiscernible] I think Pacific Northwest. Again, some predictions [indiscernible] what I [indiscernible] still going to be right now. Experience tells me, since I've been here that those numbers may vary. But we are going to develop [indiscernible] areas even in [indiscernible] expect it, but we have solutions like [indiscernible].

[Operator:]

[Operator Instructions] Our next question comes from Francesco Pellegrino from Sidoti & Company. Please go ahead with your question.

[Francesco Pellegrino:]

So I just wanted to take a step back and talk about the long-term strategic roadmap that you guys have outlined in regards to eventually getting to annual sales of $500 million. I know we're talking about partnerships, joint ventures, acquisitions. I know Harvista had some nice growth during the quarter. It's off of a small base. Can you maybe just talk a little bit more towards where you see a majority of this growth coming from? For example, do you see 50% of this growth coming from acquisitions, 20% from JVs? Just because, at the end of the day, it's going to really help us better understand maybe where return on capital is going to be over that 5-year period?

[Jordi Ferre:]

No problem. I'm happy to respond to that. I think we've been also vocal because that question came up is that how you're going to get to $500 million. The roadmap that we have is approximately 50-50. In other words, 50% will come from acquisitions, the first one being Tecnidex. And over the next five years, we still plan to engage in more transactions that will get us to that approximately $200 million, $300 million landmark. In terms of your question about organic, we consider any technology agreement or any rights that we made -- buy from technologies as part of our organic. So organic would include the projected growth of Harvista, would include RipeLock, plus a number of technologies that we are planning to launch in the next 12, 18, 24 months. I mentioned in my presentation that we have a strong pipeline. This has been one of the key objectives during the past 1.5 years is to build a strong pipeline beyond our core technology of 1-MCP. You can understand that a lot of these initiatives remain confidential. And as those unravel, we will be able to provide more color in terms of commercialization timings and potential. So one thing though, I would -- I signal in my presentation as well is the relaunch of AdvanStore, which will incorporate some of the technology that we've been working on. I think that's going to be a lot better product now to market, then it will be a big service to growers. So understand that I cannot give you color about what we have in the pipeline, but you will be hearing in the next months as we relaunch and we make announcements.

[Francesco Pellegrino:]

I know you've been cutting back a little bit on your R&D. But when I just think about the company's business model in regards to acquiring certain formulations and then expanding those formulations out of current end market uses for specific crops and expanding it towards -- or leveraging it towards more crops. At the end of the day, what are you guys thinking about in regards to R&D? Because I know a lot of investors might cringe when they hear increases in R&D. But actually, when I think about the return on invested capital that you could potentially be generating from your R&D investments, I would think that, that's going to be a pretty big contributor to earnings contribution. I'm just wondering if maybe we could see an acceleration in that expense line.

[Jordi Ferre:]

It's possible. We remain very committed to research and development. We are a technology company, we consider ourselves. We have some of the people in the industry to provide guidance and to create innovation solutions. We make them work. I would disagree with you, Francesco, that we're cutting down on R&D. I mean, this is just 1 quarter. We're more or less in line with the last year. What's happening is, as you hear, that we are opening Fresno and China and other things, what we're doing is, we are keeping the budget that's flat -- or a number that's flat. What we're doing is, we're reorganizing and we're reassigning some of the resources that were invested in the past. In other words, before we used to spend a lot of money on looking at 1-MCP and other forms of 1-MCP and how to launch new products around the technology. What we've done now is we cut back on that and readdress the funds into areas where we think it's going to give us a better return in the future. However, as I said, R&D is always to be reevaluated, and it's possible that, over time, you will see an increase when we feel that this -- there's going to be a return on some of these technologies that may need more resources, right? So I would not agree that we're cutting. I think it's just you're looking at one quarter. We spend -- for the size of our company, I always say that our expenditure in R&D is substantial, and so we want to keep it this way, except that we're going to refocus our resources -- or we are already refocusing resources in projects that are not necessarily related to our core technology, as I explained.

[Francesco Pellegrino:]

Okay, that makes a little bit more sense. As a technology company though to see it for 8% in the quarter as a percentage of total revenue, I mean, is a little bit light. Where do you see that R&D spend as a percentage of revenue for the full year? Maybe next year, maybe over the long term, where would you like that number to be? Because to really support this initiative or investment thesis for the business that it is a technology company, I would think that you'd have to really get some sizable R&D spend significantly above where you currently are.

[Jordi Ferre:]

Well, Francesco, it's an easy -- it's easy for me to answer. We've been consistently spending about 10% of our revenue in R&D. And we continue to be above that number. And as I said, as we grow and we get into new initiatives, it is very possible that we have to ramp some of our investments to -- as a means to accelerate launch. If that's the case, we will do that, and we will explain to the market. At this point in time, we do not see a change in proportion of our R&D expenditure this year.

[Francesco Pellegrino:]

Got it. So as the opportunities come around via your acquisitions, your JVs, you'll consider a ramp up. That makes a lot more sense, I appreciate that.

[Operator:]

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

[Jordi Ferre:]

I would just like to, again, thank everybody for the support that you continue to provide. And just rest assure that the management and the whole team at AgroFresh continue to work very hard to make this always a better business. Thank you.

[Operator:]

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