FMC Corporation
Q3 2015 Earnings Call Transcript

Published: 29 Oct 2015

[Operator:]

Good morning and welcome to the Third Quarter 2015 Earnings Release Conference Call for FMC Corporation. Phone lines will be placed on listen-only mode throughout the conference. After the speakers' presentation, there will be a question-and-answer period. I will now turn the conference over to Mr. Brian Angeli, Vice President-Investor Relations for FMC Corporation. Mr. Angeli, you may begin.

[Brian P. Angeli:]

Thank you and good morning, everyone. Welcome to FMC Corporation's third quarter earnings call. With me today is Pierre Brondeau, President, Chief Executive Officer and Chairman; and Paul Graves, Executive Vice President and Chief Financial Officer. Pierre will begin the call with a review of FMC's third quarter performance and business segment results and then discuss the outlook for Q4 2015 and comment on earnings drivers as we begin to look forward to 2016. Paul will provide an overview of select financial results. The slides accompanying today's call are available on our website and the prepared remarks from today's discussion will be made available at the conclusion of the call. After the prepared remarks, we will be joined by Mark Douglas, President, FMC Agricultural Solutions; Eric Norris, President, FMC Health and Nutrition; and Tom Schneberger, Vice President and Global Business Director, FMC Lithium, to address your questions. Before we begin, let me remind you that today's discussion will include forward-looking statements that are subject to various risks and uncertainties concerning specific factors, including but not limited to those factors identified in our release and in our filings with the Securities and Exchange Commission. Information presented represents our best judgment based on today's information. Actual results may vary based on these risks and uncertainties. Today's discussion will focus on adjusted earnings for all income statement and EPS references, and pro forma revenue and segment earnings for FMC Agricultural Solutions. A reconciliation and definition of these terms as well as other non-GAAP financial terms to which we may refer during today's conference call, are provided on our website. I will now turn the call over to Pierre to begin the presentation.

[Pierre R. Brondeau:]

Thank you, Brian, and good morning, everyone. As with the last quarter, we have published a slide presentation that accompanies our results and I will refer to these slides as I discuss our results and the outlook for the rest of the year. The third quarter of 2015 was marked by significant foreign exchange headwinds, the effect of which were most pronounced in the result for Agricultural Solutions. However, excluding the impact for foreign currencies, the Ag Solution business performed in line with expectation, confirming the strength of FMC's portfolio and technology in a weak global ag market. Health and Nutrition delivered another solid quarter, continuing to benefit from commercial and operating initiatives implemented over the past 12 months. Lithium continued to see strong demand for its specialty products, including lithium hydroxide, butyllithium and high purity metals. You will see from our comment today that despite difficult market condition, each of our businesses is performing well with a notable exception of our Brazil Ag business. As I will discuss during the call, we are executing a comprehensive program to protect the profitability of our business in Brazil in the current market environment, and position the business to deliver earnings growth and higher returns in 2016 and 2017. Turning now to slide one, FMC reported $831 million in revenue in the third quarter, an increase of approximately 1.5% compared to the same period last year. Adjusted operating profit for the quarter was $95 million, a 37% decrease compared to last year. Adjusted EPS was $0.42 which was $0.42 (sic) [42%] (04

[Paul W. Graves:]

Thanks, Pierre. Before I discuss cash flow on slide nine, let me start by explaining the changes we made to the tax report in this quarter. As the schedules to our press release clearly explain, our adjusted tax rate is intended to reflect the underlying tax rate related to business operations. We have always looked to remove those items that are unrelated to the businesses in presenting our tax rate. However, one item that has been causing increased unpredictability in our reported rate is related to currency movements. For us, historically, that has meant the Argentine peso, the Norwegian krone and of course the Brazilian real. Simply put, we finance and operate our businesses in these countries in a currency that is different than the local currency, but are forced to re-measure certain financial assets and liabilities into local currencies for U.S. GAAP tax purposes. This re-measurement creates adjustments to our U.S. GAAP tax rate without any corresponding impact on our profits before tax. Historically, these items have been small and have not had a material impact on our reported tax rate. However, movements in the euro last year and the Brazilian real this year have created larger distortions to our tax rate than we have ever seen previously. To put this into context, if we had not made this change in presentation, our effective adjusted tax rate in the third quarter of 2015 would have been negative. Clearly, this would not have been a reflection of our true adjusted tax rate associated with our underlying business and would not have helped any of you understand our business performance any better. Looking forward, and with expectations of larger movements in the Argentine peso and continued volatility in the Brazilian reis, we do not expect this issue to go away. Consequently, we've decided to present our tax rate, such that it excludes these discrete re-measurement items. We have recalculated our tax rate under this method for each of the last six quarters and included the revised adjusted net income in our press release schedules. Let me now move to cash flow performance on slide nine. As you know, in the current environment, we have placed a significant focus on cash generation. We appreciate that the combined effects of the acquisition of Cheminova, the sale of Alkali and foreign currency movements make it more difficult to extract underlying cash flow performance from our financial statements this year. So I'll now walk you through the major components. Through the first nine months of 2015, our EBITDA is almost $100 million less than the same period last year. Despite this, when you look at operating cash flow generated from continuing operations, you can see that FMC generated double the cash flow in 2015 compared to the same period of 2014. Part of this improvement can be attributed to lower cash outlays in areas such as capital expenditure and taxes, allowing us to fully offset the temporarily higher interest expense and pension payments. We will continue to be very disciplined in capital spending and look to further optimize our tax position as we take advantage of the opportunities presented to us by Cheminova's footprint. However, the bulk of the improved operating cash flow performance has come from working capital. So far this year, total cash released from working capital across all three segments is approximately $75 million, the majority of which has been from Ag Solutions. While still well below what we're looking to achieve, it represents an improvement over the same period last year of over $300 million, a period when working capital continued to consume cash. This improvement can be largely tracked to lower levels of receivables and inventory. Ag Solutions has generated cash from receivables in all three quarters of 2015, something it only achieved in one quarter last year. And in two of the three quarters so far this year, that has seen a reduction in inventory compared to last year, when inventory actually increased in each of the first three quarters. We continue to focus on these two largest drivers of working capital and expect to see the year-on-year improvement in performance continue into the fourth quarter. We expect Ag Solutions to generate a modest positive cash flow from working capital, as higher receivables are largely offset by reduced inventory levels. Taken together, we forecast that our cash generated from working capital in 2015 will be almost $350 million better than 2014, which will more than offset the decline in EBITDA over the same period. This focus on cash flow is reflected in a strengthening balance sheet. Our quarter-end net debt was just under $2 billion, slightly better than our prior forecast. Our debt consists almost entirely of medium and long-term maturities with our only short-term maturities, namely our commercial paper balances, largely covered by cash on hand. Approximately 50% of our outstanding debt is fixed rate debt. We are expecting net debt to remain broadly flat at year-end. Out net debt to EBITDA ratio currently sits at just above 3 times, largely due to the lower than expected EBITDA. As our EBITDA improves and we continue to generate cash from working capital and exercise discipline in all areas of spending, we expect this ratio to improve rapidly as we progress through 2016. With that, I will hand the call back to Pierre.

[Pierre R. Brondeau:]

Thank you, Paul. As you have heard, our Ag Solutions business faces a challenging market environment, but on the positive side, the issues we face are largely in Brazil and the impact of its currency. Ag Solutions performance in the current market environment reinforce the strength of FMC proprietary portfolio and technologies. We will continue to invest in our technology pipeline and in the value we bring to growers. Our Health and Nutrition and Lithium business will deliver solid performance this year and are positioned for a strong 2016. We are taking aggressive actions to protect our 2015 financial performance and position FMC to deliver earnings growth next year, in what we expect will continue to be a challenging ag market. We are very confident that the lower cost of operating post restructuring, our focus on the technical differentiated parts of FMC portfolio, the improved regional balance and our unique asset-light manufacturing model will position FMC Ag Solutions for a strong growth as soon as the market starts to turn. I want to thank you for your attention. And with this, I am going to turn the call back to the operator for questions. Operator, please.

[Operator:]

Your first question comes from the line of Aleksey Yefremov from Nomura Securities. Please go ahead.

[Aleksey Yefremov:]

Yes. Good morning, everyone. Could you discuss the credit terms that you extend to farmers in Brazil currently and how do they – how are they different from what you had earlier this year?

[Mark A. Douglas:]

Hi, Aleksey, this is Mark. The credit terms are not fundamentally different this year to any other year. You know very well, all the people that follow the ag space, that a lot of the terms are on crop terms and we currently have the same terms this year that we've had in the past.

[Aleksey Yefremov:]

Thank you. And as a follow-up, can I ask a question on pricing? How do you see the opportunity in raising local prices in Brazil to offset the remaining 50%, 60% of FX headwinds? Could you do some of that in the fourth quarter or early in 2016? Thank you.

[Pierre R. Brondeau:]

Price increase in Brazil is very much a factor of weather diary. So what we are saying is, if the real versus dollar is in a stable situation, we will, over time, recover a very large part of what we have lost in currency. Now, our ability to do it will go anywhere from six months to a year-and-a-half, two years, depending upon the market channel and the demand. What we have visibility for right now is the fourth quarter. So we believe in a stable currency environment, what we just said is, we'll recover about 40% of the currency impact in the fourth quarter. That's what we have put into the fourth quarter forecast and we believe it's highly achievable. The question mark for us and the most interesting conversation we will have in February, when we announce our Q4 results and forecast for 2016, is, is the real showing sign of stability where it is today and what is the market demand, because that's when the opportunity comes to increase price without suffering the negative impact of currency. So right now, focused on fourth quarter, we will recover about 40% and then filling up the gap will depend upon the stability we'll see in the real.

[Operator:]

And your next question comes from Don Carson with Susquehanna Financial. Please go ahead.

[Don Carson:]

Yes. You've expressed some caution about the outlook for next year in crop chemicals globally because of channel inventories. Can you specifically discuss the level of channel inventories in Brazil as well as in the U.S.?

[Mark A. Douglas:]

Hi. Yeah. Don, it's Mark. I'll start with Brazil first. You've seen a lot in the press recently about channel inventories predominantly around insecticides and herbicides in Brazil. Insecticides due to weather and low pest pressure, so we see elevated channel there. In North America, it really depends on the types of products. Certainly, insecticides, we see higher channel inventories both for foliar and soil insecticides. We've had basically three years of very low pest pressure and so you could imagine, the channel inventories builds up there. For us, we had a very good year in North America with our pre herbicides, the Authority brands and we see normal to slightly higher channel inventories there. And then on fungicides, fungicides are pretty normal in North America.

[Don Carson:]

And as a follow-up, does the expansion of Intacta acreage this fall in Brazil have any impact on your soy insecticide business down there?

[Mark A. Douglas:]

Intacta has been in the market now – this is, I think, its third year. Obviously, the acreage is growing. It does impact the number of sprays for certain types of pests, and yes, we along with others are impacted there. But we have other products that take out the secondary pests. For instance, our TALISMAN insecticide is very good on stink bugs, which is a growing pest in soy area in Brazil. So we expect to see increase in usage of those types of products. So there are always pluses and minuses when you see these new traits introduced.

[Don Carson:]

Okay. Thank you.

[Operator:]

Your next question comes from John McNulty from Credit Suisse. Please go ahead. John P. McNulty - Credit Suisse Securities (USA) LLC (Broker) Yeah. Good morning. Thanks for taking my question. So we saw a pretty solid – or you guys saw a pretty solid jump that you articulated in the cash flow for 2015. I guess, do you have – can you give us some granularity if the Ag markets play out the way that right now you're expecting them to, what can we see in terms of further cash improvements in 2016?

[Paul W. Graves:]

It's Paul. Let me try and tackle that one. Most of the opportunities I'm sure you're aware are comes through our Brazil receivables balance and as we looked into next year and obviously we're not forecasting a rapid recovery in demand in Brazil, we would expect to see the trend that we've seen in the first three quarters of this year of releasing cash out of working capital continue. We've I think been pretty consistent when we've said that to unwind the positions that we have as the market slows down will take at least a full season, which takes you into sort of second quarter and third quarter of next year before we'll start to see the benefits. As I said, we've generated from working capital across the business something in the region of about $75 million of cash out of our working capital. I would expect that we could do much better than that, if the market continues as it is, because we will start to see an acceleration of the release in the Brazilian receivables balances. John P. McNulty - Credit Suisse Securities (USA) LLC (Broker) Okay. Great. That's helpful. And then, with regard to the head count reductions in Brazil, I mean Brazil has been one of the crown jewels and obviously it's a tough market right now, but it may not always be. I guess, how do you gauge or how do you set up a system where you don't end up kind of tarnishing permanently the crown jewel by cutting too deeply into the heads?

[Pierre R. Brondeau:]

Yeah. It is a very important question. The work we did was really to preserve the ability of Brazil to grow and to grow earnings. So the way we did it, we didn't go at it by cutting costs and that's it. As you can see, our Brazil organization has evolved over the last two years into an organization which has used maybe a bit too much its position of strength with customers to increase sales in more generic product. Now, in normal times, with the real at that time pretty strong, it made more sense. We were making some profit out of it, but I can tell you, in a situation like the one we have today, the terms which are given to farmers, the weakness in the real do not allow us to have those kind of sales because they do not bring any profit to the company once all of the costs are removed, including the cost of hedging. So what we did? The first step we did was to remove sales, and we say, this year it's going to be about $250 million, to remove sales we had which were not profitable. Once you adjust to a size, where you pretty much have a country reaching sales about 60% of what it was before, then you can adjust your technical sales and, most importantly, support functions to serve a business, which is smaller but having the same type of profit and much higher margin. So that's the way we did it. We believe, we protected through this process our technology group, our research group, our technical sales but really eliminated all of the non-profitable sales and used that to reduce organization. We believe that we will be at least as capable of organization to benefit from growth in Brazil than we were before, if not better.

[Operator:]

Your next question comes from Frank Mitsch with Wells Fargo Securities. Please go ahead.

[Frank J. Mitsch:]

Good morning, gentlemen. Hey, Paul, I really appreciated the discussion on working capital savings and noticed that inventory is down $100 million sequentially to a level of $900 million. A couple of questions. Where can you get that to? And then also on the discussion on the cost reductions, the increase to $140 million to $160 million. What is the expense associated and the pace of those expenses necessary to achieve those cost reduction targets?

[Paul W. Graves:]

Let me pass over to Mark first to talk about inventory, because most of the opportunities in inventory are going to be in the Ag business.

[Mark A. Douglas:]

Yeah. As you could see, we have reduced inventories. And what we are doing is we're taking advantage of the Cheminova acquisition to look at the combined businesses and understand the flow of materials. We are essentially reducing the channel inventories within our own supply chain. So we're not putting customer supply at risk and we're tending to shift products away from formulating ahead of the season to formulating at the latest possible time. So we're carrying less formulated inventory, but we're carrying active ingredient inventory, which allows us to reduce the total amount but still have flexibility at the customer level. So it's been successful so far. We have more programs in place. I can't actually, Frank, give you a number for the reduction, but you will see it go down as we head into 2016 and probably through the first half of the year.

[Pierre R. Brondeau:]

All right, Frank, let me take your question on the cost to realize the synergy. The cost to realize the total $140 million to $160 million of synergy, which of course, includes all of the costs for the integration of Cheminova consulting costs. So it's not the cost which is only associated to the incremental part. The total costs for the $140 million to $160 million will be in the range of $120 million to $130 million. We have, of that cost, about $65 million were spent so far in the process. And most of the rest of the spending will take place in 2016 and a very large part in the first half of 2016.

[Frank J. Mitsch:]

All right. Terrific. And coming back, Mark, on the Ag side, Pierre mentioned that there was a holdup in Argentina to receive some approvals. And I was wondering if you guys could give a little more color on that and what the order of magnitude opportunity that could present for you if and when you do get those approvals?

[Mark A. Douglas:]

Yeah. We have – Frank, we have ongoing business in Argentina and essentially what we do is, we currently import fully formulated materials into the country. The Argentine government has changed some of the rules where it's a little more difficult to get fully formulated products in. So we are looking at a strategy in Argentina where we will import the active ingredients and then formulate in Argentina itself. That should allow us more flexibility in terms of taking advantage of the market down there. For us, that market is pre herbicides for soy, a big market for us. We use our Authority brands based upon sulfentrazone. Currently, today, we are in the $80 million to $100 million of revenue range. We see that growing despite a difficult market. So it's significant for us. Getting the import licenses has been frankly a bit of a pain over the last year or so, but eventually, that will free up because the growers down there do need the technology to get the highest yields for especially the raw crops of soybeans.

[Frank J. Mitsch:]

Thank you so much.

[Operator:]

Your next question comes from the line of Laurence Alexander from Jefferies. Please go ahead.

[Laurence Alexander:]

Good morning. So two questions. One, as you look at the corporate cost reduction, what happens once you resume, you get back on a growth trajectory in 2017, 2018? Do you see that being a flat run rate or should it start growing in line with sales?

[Pierre R. Brondeau:]

So the change we are making really is a very sustainable change. So – of course, there is always inflationary cost, but those are not cost reduction, which are temporary holding back on hiring people. Those are fundamental change in our processes, the way we operate, benefiting from the synergies of Cheminova, so those are permanent change which are to remain. The spending has to remain at the same level when we go back on a top line growth.

[Laurence Alexander:]

Okay. And then just putting together all the factors you called out, it seems as if – just to be clear on the message – that there is a tailwind of about $150 million to $175 million for your EBITDA in 2016, but then you have your FX and the contraction in the crop section chemicals to offset, is there anything else in terms of possible tailwinds that you sort of see as a possible swing factor?

[Pierre R. Brondeau:]

The big tailwind – as you say, we released all of the numbers we see which we control and we feel very comfortable to deliver. Then, there is the question of growth synergies with Syngenta, we are very careful with – sorry, is it Syngenta – with Cheminova. We have a difficulty to really quantify that. We know it's happening, we know it's in line with our expectation. But the problem is when you are in a down market, to requantify growth synergies is always difficult. So there is growth synergies which we have not factored here. There is growth for a specific product where we have very strong market demand. And the last one which could be significant is price increase depending upon FX, but that's a difficult one to forecast, because if FX stays where it is today and there is a decent fourth quarter this year, which mean, even in the slightly down market, we will have opportunities to increase price in Brazil to recover the gap we have today. But if we continue to have a volatile real next year, we're going to be back in the situation which will be challenging. So, hopefully, by the time we get to the February call, we will know if we have full month or not of real stability and then we should be able to make a little bit better of a prediction around price. So it's a specific growth on the technical product, specific growth synergies with Cheminova and price would be a tailwind you could have in addition to what you see here.

[Laurence Alexander:]

And then, probably, can you give any granularity around taking the Cheminova products and relaunching them in the U.S. progress estimate or when that should become a material call-out?

[Mark A. Douglas:]

Yeah, Lawrence. This is Mark. We are obviously in negotiations now for the 2016 season in North America and this will be the first time we've had the portfolio of Cheminova to sell to the major distributors and co-ops. We are focusing on the fungicide portfolio that Cheminova brought to us. They have some excellent products there that we've not had access to. So they will be put into our programs and then there are some other herbicides that Cheminova brought that we will also be putting into the program. So early stages as we are today but as we've always said, we believe that one of the reasons for the acquisition to be strategic in North America was our access to the major co-ops and distribution. We are taking advantage of that and we will be selling those fungicides and herbicides through that channel.

[Laurence Alexander:]

Okay. Thank you.

[Operator:]

Your next question comes from line of Peter Butler from Glen Hill Investments.

[Peter E. Butler:]

Good morning. Good morning. Pierre, if this was the third quarter 2016 conference call, obviously in late next year, what would you guys be hoping for to see in a relatively good case entering 2017? The odds on having a surprisingly good rebound in earnings in 2017?

[Pierre R. Brondeau:]

So, Peter, the way we are looking at where we are today – and I have to say that it feels like we are right now at a position of stability going forward for the company. I think we have infrastructure in place, the integration is well advanced, the cost savings are coming as we are expecting. So the first step for us, beside delivering on Q4, is really to position FMC for earning growth regarding of the market demand in 2016. That's why we started to try to give a sense for the earnings driver we control, which we expect to participate in the earnings growth for the company next year. Your question is the right one in terms of the market demand. In the third quarter or when we are talking about the third quarter results, if we see a situation which starts to unlock in Brazil and Latin America, it will be the definitive signal that the turn of the market is going to take place in 2017. If it is the case, then we are in a strong position because, by that time, integration will be finished and our cost structure will be very, very solid, will be lean. Without losing potential for growth, our portfolio technically will be strong and we have new product coming from technology in 2017, 2018, and 2019. So – but that's when you are going to get your first signal. If we see a Q3-Q4 very challenging in Brazil and Latin America, then we'll have to understand where is the channel in other countries because then you've to have to worry that's going to be slow recovery in 2017. We are still thinking right now all the indicators are pointing toward a 2017 recovery, but you are correct that third quarter call next year will be – we should have a better indication.

[Peter E. Butler:]

Okay. Thanks for the help, Pierre.

[Pierre R. Brondeau:]

Thank you.

[Operator:]

Your next question comes from the line of Brian Maguire from Goldman Sachs.

[Brian P. Maguire:]

Hi, there. Thanks for taking my question. Pierre, there's been a lot of increasing chatter about the need for consolidation in the agricultural chemical space. And one of the larger companies in that space, last week, mentioned that every company is talking to each other in this environment. Just wondered if you could comment on that, if you're kind of having any discussions with folks and I guess given your balance sheet probably not in a position to do any acquiring, but do you see yourself as a target and would you entertain anyone in those discussions?

[Pierre R. Brondeau:]

Well, there is no questions that there is lots of talk which are going on in the industry, which will most likely lead to some sort of consolidation. I think everybody is talking to everybody and everybody is watching what everybody else is doing. So right now it's like playing chess, everybody is making a move and waiting. Lots of discussion are taking place. How this is going to unfold? I don't think many people know it. I don't even know if anybody know, but certainly there is discussion which will lead to some consolidation. Where FMC stands in such a situation? First of all, we believe we are a strong company which can strive no matter what is the results for the company, but we will be doing good for our shareholders. So, what is right for shareholders, what is right for employees and what is right for our customer is what we will do, but we know we have a strong responsibility to all the shareholders. All I can tell you is the only thing I can tell you for sure is we are not an active buyer of a large company. I don't think today it would be reasonable. We made our move, we've acquired Cheminova. We believe we have a strong geographical footprint and we don't have the balance sheet to make a major acquisition. So, for us, we are in the execution phase. Now, if two companies get together and there is antitrust issues and they have to drop, sell some product or technology which are of interest to us, absolutely, we will look into buying those technologies, if they fit our portfolio, but that's about the limit of our productivity in term of being on the acquiring side.

[Brian P. Maguire:]

Okay. Just one last one, if I could, on the – I appreciate the increased disclosure on the slides, with the Ag volumes showing them down 25% there, just wondered if you could break that out. How much of that was impacted by divestments? And then maybe if you could give some color regionally, if there are any pockets of strength within that number.

[Pierre R. Brondeau:]

I think if you look at the 20%, 25% reduction, it's a reduction about $215 million of sales for the business. There is two buckets to it – there is about – there is the third-party sales, which we walked away from in Brazil and that's about $120 million. And the rest are just volume we lost about $95 million across the world, which are much more linked to the market. If you look at the $44 million, I would say three quarters of that number is earnings loss, which are coming from the $95 million, more the market-driven losses, where maybe one fourth of the $10 million is linked to the $120 million of third-party sales we voluntarily walked away from. In general, most of the loss of sales took place in Latin America and mostly Brazil, overall, and especially because that's a place we've walked away from third-party. We also saw reduction of sales in other regions of the world. Channel inventories are pretty high in North America and in Europe. Remember, we also had the situation where we are going to direct model in Europe, so we're going to go. We have sales which are being moved from this year into next year. So overall, it's across the board. The big difference I'd say, which is very important is the sales loss outside of Brazil and Latin America are generating very little earnings loss. We believe our earnings are essentially flat outside of Brazil around the world. And then, for some reasons, we have much more leverage around large facilities, cost control in North America, in London, or in other places in Asia. So that's the overall picture.

[Brian P. Maguire:]

Very helpful. Thank you.

[Operator:]

Thank you. This concludes the FMC Corporation third quarter 2015 earnings release conference call.