Andersons Inc

NASDAQ:ANDE

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to The Andersons 2018 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions] And as a reminder, this conference call is being recorded.

I'd now like to turn the conference over to John Kraus, Director, Investor Relations. Please go ahead.

[John Kraus, Director, IR]

Thanks, Candice. Good morning, everyone, and thank you for joining us for The Andersons Second Quarter 2018 Earnings Call. We have provided a slide presentation that will enhance our talking points. If you're viewing this presentation via our webcast, the slides and audio will be in sync. This webcast is being recorded, and it and the supporting slides will be made available shortly on the Investors page of our website at andersonsinc.com.

Certain information discussed today constitutes forward-looking statements, and actual results could differ materially from those presented in the forward-looking statements as a result of many factors, including general economic conditions, weather, competitive conditions, conditions in the company's industries, both in the United States and internationally, and additional factors that are described in the company's publicly filed documents, including '34 Act filings and the prospectuses prepared in connection with the company's offerings.

Today's call includes financial information, which the company's independent auditors have not completely reviewed. Although the company believes that the assumptions upon which the financial information and its forward-looking statements are based are reasonable, it can give no assurance that these assumptions will prove to be accurate.

This presentation and today's prepared remarks contain non-GAAP financial measures. The company believes adjusted pretax income, EBITDA and adjusted EBITDA provide additional information to investors and others about its operations, allowing an evaluation of underlying operating performance and better period-to-period comparability. Adjusted pretax income, EBITDA and adjusted EBITDA do not and should not be considered as alternatives to net income, or income before income taxes, as determined by generally accepted accounting principles.

On the call with me today are Pat Bowe, President and Chief Executive Officer; Brian Valentine, Senior Vice President and Chief Financial Officer; and Anne Rex, Vice President and Corporate Controller. We will answer your questions after our prepared remarks.

Now I'll turn the floor over to Pat for his opening comments.

[Pat Bowe, President and CEO]

Thank you, John, and good morning, everyone. Thank you for joining our call this morning to review our second quarter 2018 performance. Before I go any further, I'd like to welcome Brian Valentine, our new Senior Vice President and Chief Financial Officer to The Andersons. Brian has enjoyed a distinguished career in accounting and finance, most recently as Chief Financial Officer of the Lubrizol Corporation, a Berkshire Hathaway company. Today is Brian's third day on the job, so we're going to go to a little easy on him today. While Brian will make our financial presentation, Anne Rex, who's done a great job as our Interim CFO, is also here to help answer any of your questions.

I'll begin by providing some color on each of our four operating units. After Brian provides a business review, I'll conclude our prepared remarks with some comments about our outlook for the balance of 2018. The second quarter reported results were much better overall than our adjusted second quarter 2017 results. The Grain and Ethanol Groups both posted stronger numbers, while the Plant Nutrient and Rail Groups performances were not as good. In addition, our reported results include asset impairment charges in our Grain and Rail Groups that were not part of our ongoing operating results. Our Grain Group results continue to improve. We posted our seventh consecutive year-over-year improvement during the second quarter. What changed most year-over-year was our merchandising results, which benefited from our ability to capitalize on increased market volatility. In addition, our Grain affiliates, and especially Lansing Trade Group, performed much better than they did last year. We did have one unusual expense during the quarter as we booked a $1.6 million impairment charge in anticipation of the early third quarter sale of our Como, Tennessee location. The Ethanol business also improved on its second quarter 2017 results. The group was able to operate its 4 plants in a highly efficient manner, leading to strong production. DDG values were also stronger. We also continued to book strong increases in our sales of E85, which are up by more than 50% for the first half of the year.

On our last call, we warned that the Plant Nutrient Group will remain challenged for the rest of 2018. And now that the prime fertilizer season is behind us, we still feel that way. Specialty nutrient sales volumes were similar to those of 2017 and our primary nutrient volumes were up modestly through the first half. However, both wholesale and specialty nutrient margins remain compressed. On a brighter note, the lawn and contract manufacturing business posted excellent results again this quarter. The overall railcar market is continuing its gradual recovery. Lease income was comparable to the first quarter but down year-over-year due to higher maintenance expenses as a high number of our tank cars are due for requalification this year, as we have discussed on previous calls. Railcars on lease and our utilization rate rose compared to the first quarter and for the fifth consecutive quarter. Most notably, we decided to scrap an additional 600 cars, taking advantage of the recent run up in scrap steel prices. This decision resulted in charges totaling $5.2 million.

We have created a productivity culture here at The Andersons in the last 3 years and continue to optimize our operation and drive out inefficiencies. As we shared last quarter, we achieved our $20 million run rate productivity goal a year early, and we're making good progress on our newest run rate additional savings goal of $7.5 million this year, which we expect to reach by the end of 2018. I'll speak later on in the call about our outlook for the remainder of 2018.

Brian will now walk you through a more detailed review of our financial results.

[Brian Valentine, SVP and CFO]

Thanks, Pat, and good morning, everyone. We're now on Slide 5. In the second quarter of 2018, the company reported net income attributable to The Andersons of $21.5 million or $0.76 per diluted share on revenues of $911 million. These results include the $6.3 million of impairment charges related to the railcars in the process of being scrapped and the sale of the Tennessee grain facility that Pat discussed in his opening remarks. The estimated earnings per share impact of these 2 charges was $0.17 per diluted share. Our results were considerably better than those of the second quarter of 2017, when our revenues of $994 million generated a reported net loss of $26.7 million or $0.94 per diluted share, and adjusted net income attributable to The Andersons of $15.3 million or $0.54 per diluted share. 2017 adjusted results excluded the $42 million noncash goodwill impairment charge for the wholesale fertilizer business.

As we noted last quarter, new revenue recognition rules, effective beginning this year, changed the way certain transactions are recorded, particularly in the Grain Group. Total company second quarter 2018 revenues would have been almost $1.1 billion or 10% higher than the comparable 2017 sales under former revenue recognition rules. Several discrete tax items raised the company's effective tax rate for the second quarter of 2018 to 26.6%. We continue to expect that our 2018 full year effective tax rate will be between 23% and 25%, but we are still evaluating the full impact of tax reform. Total company EBITDA increased $8.8 million or 17% to $59.7 million compared to second quarter 2017 adjusted EBITDA of $50.9 million. Excluding the current quarter impairment charges, EBITDA would have been almost 30% higher year-over-year.

Slide 6 shows the changes from adjusted pretax income to reported pretax income by segment for the same two periods. We improved our Grain Group results again in the second quarter despite the impairment charge. The primary driver of improvement for the base grain business was merchandising margins as margins on grain sales improved year-over-year. Lansing Trade Group's results also were much better. The Rail Group's results were below those of last year due to the $5.2 million of charges related to the scrapping of railcars. Unallocated net company level expenses for the second quarter of 2018 fell by $7.8 million. However, the second quarter of 2017 included a $6.7 million loss from the former Retail Group. Net of the Retail loss, we incurred $1.1 million less in other net unallocated corporate expenses year-over-year.

Now we move to the bridge graph for the first half of the year on Slide 7. Year-to-date, pretax Grain results are about $8 million better than for the same period last year and up $9.5 million, excluding the impairment charge. Though the base grain business continues to strengthen, more than $6 million of the significant improvement is attributable to Lansing Trade Group. For the Plant Nutrient Group, $4.7 million of the $6.6 million earnings change relates to the 2017 gain on the sale of the Florida farm centers. In addition to the charges on railcars held for scrapping, the decline in Rail Group results was driven by lower service and other income and a reduction in car sale income. The change in the other segment relates to a first half 2017 loss by the former Retail Group of $13.6 million.

Now, we'll move on to review of each of our business units, beginning with the Grain Group on Slide number 8. Our Grain Group continued to build earnings momentum in the second quarter. The group reported pretax income of $9.9 million, a $3 million improvement over the same period of 2017, and excluding the impairment charge, 2018 performance improved by more than 60% over 2017. Base grain earned pretax income of $4.5 million in the second quarter versus $4.1 million for the second quarter of 2017. Solid merchandising efforts, coupled with continued strong income derived from our storage capacity, drove the group's performance.

Grain's affiliates, and especially the Lansing Trade Group, significantly improved their year-over-year results, combining for pretax income of $5.4 million in the second quarter, almost twice the $2.8 million recorded in the same period of 2017. Lansing's improvement spanned its entire business portfolio.

Moving to Slide number 9, the Ethanol Group's performance exceeded its second quarter 2017 results by about 30%. The group earned second quarter pretax income of $6.1 million or $1.4 million more than in the second quarter of 2017. The Ethanol team's continuing efforts to optimize the performance of its four plants were rewarded by 5% more ethanol gallons produced and DDG values improved year-over-year.

Turning to Slide 10, the Plant Nutrient Group earned pretax income of $15.1 million in the second quarter compared to adjusted pretax income of $16.2 million in the second quarter of 2017. While both primary and specialty nutrient tons were up year-over-year, the volume increase was not enough to overcome margin compression. A bright spot for the group was the lawn and contract manufacturing business, which continued a great first quarter start through the rest of its primary spring season.

Moving to Slide number 11, the Rail Group generated $900,000 of pretax income in the second quarter compared to $5.9 million last year. The decrease in income was the result of the strategic decision to scrap about 600 long-term idle railcars, while scrap prices are at four year highs. Total charges of $5.2 million were recorded, including a loss of $500,000 on 100 cars scrapped during the quarter and an impairment charge of $4.7 million on the remaining 500 railcars, which were in the process of being shipped to scrap yards at the end of the quarter.

In addition to generating approximately $4.2 million in cash, scrapping these idle railcars will reduce annual operating costs by about $1.4 million. It also should improve the railcar utilization rate by about 2 percentage points. For the second quarter, utilization rates averaged 89.5% compared to 87.9% last quarter and 84.4% in 2017. Improved utilization was offset by higher maintenance costs, resulting in base leasing pretax income of $2.1 million, which was $800,000 lower than last year's result. The group recorded a loss from car sales of $3 million, as gains from scrapping railcars retired due to age were more than offset by the loss from scrapping the idle railcars previously described. Railcar repair volumes rebounded from a tough start in the first quarter, which allowed the repair business to achieve its highest quarterly revenue and profit ever.

And with that, I will turn the discussion back to Pat.

[Pat Bowe, President and CEO]

Thanks, Brian. As we look forward to rest of the year, we expect our 2018 net income to be considerably better than our adjusted 2017 results of $1.15 per diluted share. The Grain Group recorded its seventh consecutive significant year-over-year quarterly improvement. The Grain operating environment should remain strong through the second half. Volatility in both physical and futures markets should continue to show us opportunities like we had in the second quarter. U.S. corn and soybean crop conditions are very good. Strong U.S. and global demand for a big U.S. crop will lead to good opportunities for owners of space and handling capacity with trading insights. These conditions provide both us and our affiliates a good operating environment. Volatility exist today because of a very strong demand because concerns persist about continued trade disruptions and because non-U. S. crop prospects are deteriorating. The group will continue to focus on optimizing its assets and continue to grow its risk management and specialty foods businesses.

The Ethanol Group continues to succeed in driving plant production efficiency. All four plants are running well. The group has been able to lock in forward margins on almost half of third quarter production and small amounts for the following 2 quarters. In addition to closely monitoring the progress of the new ELEMENT plant currently under construction with ICM in Kansas, the group continues to evaluate projects that will improve plant efficiency and produce higher-value coproducts. The biggest unknowns for Ethanol are policy and trade-driven, both domestically and internationally. The year-round E15 waiver that we expect will be granted in the near term will clearly help. The impacts of small refiner exemptions and RIN pricing have not yet had a significant impact on domestic blending due to high oil/gasoline prices and low corn/ ethanol prices. But like others in the industry, we're monitoring these conditions closely. Ethanol exports are running well ahead of last year's record pace and have helped to keep us in good supply-demand balance. We're optimistic that the group's 2018 second half results will exceed those of 2017.

Our Plant Nutrient Group continues to be impacted by unfavorable margin conditions. Because the group's year is significantly influenced by its performance in the first half, we think we'll be challenged to equal our full year adjusted 2017 results. On a positive note, primary nutrient prices are beginning to stabilize and improve, and inventory appreciation is starting to return to the market for the first time in 3 years. The group is focused on reducing its cost and expenses through manufacturing excellence and growing the top line to improve sales execution. We're also building on the momentum in our lawn and contract manufacturing business. The Rail Group continues to gradually improve its utilization and increase of number of cars under lease. Robust GDP growth signals a continued uptick in demand, which should cause lease rates to begin to rise. We expect the repair business to deliver solid second half results. Not counting the charges resulting from the idle scrap car program we took this quarter, and as we shared on prior calls, we continue to think that full year 2018 results will be 15% to 20% below those of 2017 due to tank car requalification costs and the loss of a car sale income source due to the change in revenue recognition rules.

In closing, our 2018 company results to-date are much better. We feel momentum building and believe our near-term prospects are improving, except in the Plant Nutrient Group, which will need more time to recover. We're also confident that we'll achieve our targeted additional $7.5 million of pretax run rate productivity savings by the end of 2018. We look forward to a stronger finish to 2018.

I'll now turn it over to Candice, who will help us entertain your questions.

[Operator]

[Operator Instructions] And our first question comes from Farha Aslam of Stephens.

[Farha Aslam, Stephens]

My question is on Grain. Pat, could you share with us what benefit The Andersons could garner from the global wheat crop? You're -- a delivery point for wheat, and globally, wheat is burning up?

[Pat Bowe, President and CEO]

Yes. It's interesting, Farha. Let's talk about all three crops because things have changed quite a bit since the last call where we have -- we've been experiencing in last couple of years a global glut wheat supplies. The wheat situation has changed with the crop, with dry conditions in Eastern Europe, Russia and Australia and parts of Europe. So we're starting to see a declining balance of wheat supplies on global stocks. Now while that hasn't completely reversed itself, near term, we think that income from VSR will maintain for us, one to two ticks in the near term. But longer term, this could be a good opportunity for exports for the U.S. as we get into a position where we can price wheat into the global market. So that's kind of encouraging long term.

Quite a different story in corn. As you know, with the large U.S. crop last year, global stocks are still declining due to weather issues in EU, South America, Russia, Ukraine and our U.S. exports have been really strong and should continue strong, especially at current price levels. So we have a pretty bullish outlook on exports and movement of corn, which is a good thing for handlers of grain.

And lastly, beans are a bit the other side, with red bean stocks are more than adequate at this time. Crops are good in South America, in the U.S., and stocks should probably increase if the weather remains really good with crop conditions here. We've had terrific rains here just this week, the crop conditions across the grain belt are in really good shape, maybe a little bit dry in some spots in Michigan. But overall, for us, a really terrific-looking crop out there. So things look better overall for fundamentals in the Grain business.

[Farha Aslam, Stephens]

And as a follow on for Rail. Could you just share with us what the cost is for the recertification and kind of your growth outlook going into next year for that Rail Group?

[Pat Bowe, President and CEO]

Sure, as we talked about before, we're working for our tank car recertification programs and it's about $3 million approximately for the cars we have to put through recertification this year, and that we have that in our outlook for the Rail Group. We are seeing utilizations increase. The reason for scrapping these cars, we had some longer-life cars and with the steel tariffs in place, nearby scrap prices have risen to four year highs. And we look at all factors, types of cars, length, the age of our fleet, and so we made that decision to do that now, to take advantage of those higher prices. That will help us with utilization rates going into the next quarter. And we're just seeing a steady, nice uptick in utilization and traffic on the rail lines. What we need to now is get a reversal and get rates moving up on lease rates, that's just starting to happen. We haven't seen a big move up yet in lease rates, but we think it should improve.

[Operator]

And our next question comes from Heather Jones of Vertical Group. Your line is now open.

[Brandon Groeger, Vertical Group]

This is Brandon Groeger on for Heather. A couple of quick questions from me. Lansing results improved year-over-year. Do you expect Lansing performance to continue to be strong year-over-year for the rest of 2018?

[Pat Bowe, President and CEO]

Yes. I think, Lansing results we expect to be strong, just like ours. So the fundamentals of the base grain business, it looks good, just like it does for us for those reasons I mentioned earlier. So we expect Lansing Trade Group to continue a strong performance in the second half.

[Brandon Groeger, Vertical Group]

And what are your updated thoughts on when the Plant Nutrient market might turn around?

[Pat Bowe, President and CEO]

That's a good question. So these take crop cycles, right? So we just finished the crop cycle for Plant Nutrient here in this quarter. Margins were pretty compressed, it was a very competitive market for wholesale distributors like ourselves. If you look on the positive side, commodity fertilizer prices have increased, so maybe coming off the bottom we've seen a little bit of a bounce. That's a better long-term signal for the market. It also has been encouraging to see that we've had some carrying charges come back to the market we haven't seen for three years. So those are long-term positive trends. Having said that, we had quite a bit margin compression in both specialty and commodity this year, so we've got a lot of work to do to make our plants more efficient and get our sales team sharper at the point of attack to have a successful campaign next year. We still like this business, we think there's a lot of upside in it. But we're cautious about the financial results in the near term.

[Operator]

And next question comes from Eric Larson of Buckingham Research Group. Your line is now open.

[Eric Larson, Buckingham Research Group]

Just a couple of questions. Number one, just a little bit of follow on the Lansing Trade Group. They have actually a quite a nice -- a broader diversified portfolio to trade against other than just grains. I think they do a lot of frac and others things or they used to. Can you help us a little bit so we have a better feel for what the cadence might be and on the business lines there for the second half for Lansing?

[Pat Bowe, President and CEO]

So I commented earlier about Lansing in the fundamental Grain trade, which somewhat similar to ours, they have a bigger western presence and a hard wheat presence in the market, and then there looks like there's going to be some good trading opportunities in wheat, as we mentioned earlier. They do have a very diversified portfolio and feed ingredients. They're a large domestic feed ingredient player, which has been good. As a DDG trader, DDG values have improved, a little bit stronger in the Western -- I mean, sorry, in the Eastern Belt than the Western Belt, seen changes in global tariffs, if China situation was to be able to be resolved, which we're optimistic that it will be. That will be a shot in the arm for Lansing on DDG exports, but that remains to be seen. They also have very interesting pet food ingredient business that does quite well, and a frac sand business, and frac sand businesses improved. It's still not part of the results for last year, but a very stable, solid business there. So overall, Lansing results should be better in the second half, as I mentioned earlier.

[Eric Larson, Buckingham Research Group]

Now one quick follow up question and by the way, welcome Brain as well. This question would probably, normally be for Brian, but we're going to give him a free card out of jail on this one today. The -- can you help us again with how we look at the accounting change? You deferred income -- you deferred a whole bunch of revenue or revenue was down about 10% in the Grain business. If you're deferring revenue in the future, have you also deferred income? Can you give us -- help us a little bit with maybe how that might work on the earnings and the EBITDA side?

[Anne Rex, VP, Corporate Controller]

I'm going to try to answer that one for you. In the Grain revenue adoption for the new standard, what we had to do was actually net down our revenue. So there is no deferral of revenue. It's just a change from grossed up sales and cost of sales to a net number.

[Operator]

[Operator Instructions] Our next question comes from Ken Zaslow of BMO Capital Markets.

[Ken Zaslow, BMO Capital Markets]

So I kind of always try and ask this kind of question and I'd like progress on this. Can you talk about examples of how the new hires have contributed to the improved performance? Is it more that the improvement just has come because of the biggest better operating environment? Or do you think that there has been some internal improvement and the new hiring direction made a difference and can you kind of parse those 2 out?

[Pat Bowe, President and CEO]

I think that's a good question. So in the past 2 years, we've been working on our talent and succession plans of all our businesses. We've had some retirements. Recently had our Rail Group President, Rash Shah, who led that business and been with the company 40 years retire this past month. And Joe is in now, capably running that business. Has been a CEO in the Rail business industry before and is -- we've not missed a beat, in fact, there has been a great addition to the team. Corey who's been here now almost as same time as I've been here, he has really got a great handle around the Grain business. Our Grain business is showing lots of improvements. Our Ethanol business is run by Mike Irmen, who's been here for some time and we have a very solid team in Ethanol. And then we've made a change in fertilizer, and Jeff Blair coming in is really shaping up. We've got a lot of improvement to do there. We said we've had some weakness here, we need to strengthen our point of attack in sales, we think there's costs we can take out of the back office. We're implementing SAP deployment there. So there's a lot of work and he's got a lot of enthusiasm driving that business. So great to have Brian in here as CFO, we feel good about our talent. And I'm glad you asked the question. We just have to keep focusing on the bottom line performance of the company and driving improvement, and that's what we're all about right now.

[Ken Zaslow, BMO Capital Markets]

Okay. Just -- but is there a way to parse out -- it has been -- your results are improving, but is it -- can you parse out how much is actually the internal improvement that you're actually taking on? Or is it just, hey, the environment's better and we're enjoying it, we're embracing it, that's great. But is there something underlying -- creating some sort of other potential?

[Pat Bowe, President and CEO]

I think that we've taken an aggressive stance on other performing assets in lines of business, and eliminated those. We had to take some write offs on some of those, as you all know, in the last couple of years. We restructured talent to drive performance of businesses. We've taken a hard, aggressive stance at productivity, drove out $20 million of run-rate cost, that's helped our bottom line. We continue to keep a focus on this, what we call, ANDE Excellence, and keep driving that culture of accountability. Having said that, you have to have some tailwinds or headwinds to determine your absolute fate. We've had some volatility come back to the Grain market, that's helped us. So fundamentals of Grain have improved. I'd have to say, in Ethanol, we're executing very well. Our plants are performing at very high efficiency and at low cost, and that shows up in the bottom line of our P&L in Ethanol, which is a direct result of trading the markets well and operating our plants well.

As mentioned before, rail has slightly improved over time and now it's condition -- the macro conditions of Rail, absolutely drive what the lease rates will be over time. And PN, we've got some work to do. And then -- and we have the right guy to help shape that business. So I'm kind of restating what I said earlier, but we feel good about the team, we like the leadership we have in place now. And now it's about execution.

[Operator]

Our next question comes from Eric Larson of Buckingham Research Group.

[Eric Larson, Buckingham Research Group]

Just a quick question. As a follow-up on Ethanol and we know -- Pat, we know that the DDG issue last year with vomitoxin and maybe it was also another mold that was hurting you on your by-product credits. How much of the improvement this year is a result of just better DDG pricing due to that unusual circumstance?

[Pat Bowe, President and CEO]

So the -- look, first of all, go back to -- we only had vomitoxin, there was no other toxin present last year. So just on DDGs, it's up probably about 20%. It's interesting the market overall started out stronger in DDGs across the board. And recently in the Eastern Belt, DDGs are trading still over 100% of local corn values, a little less so in the West. So that's helped. But a big part of it has really been our production, so we're 5% up in gallons produced over last year and are very efficient to when it comes to energy use in yield and productivity. So I think the focus on productivity and really driving lowest cost at our plants has been the real reason for success in Ethanol.

[Eric Larson, Buckingham Research Group]

And then just one other final question. Pat, you've done a lot of work in rightsizing some assets, focusing on ROIC. Obviously, you're doing things with railcars and your Tennessee elevators et cetera. Can you share maybe a little more insight now as your past some of these things, what else may have, things to do that can give you a significant boost to your overall returns and operating performance going forward?

[Pat Bowe, President and CEO]

Sure. I think there's a lot of work to do when it comes to driving accountability and border line performance of every single business. We're hard at work on that. Most of the low-hanging fruit in productivity has been picked, but there's more still to come. We will fully continue to work getting our deployment of SAP through fertilizer, that will help with the back-office cost. We're working a lot on ANDE Excellence at each of our sites on cost and working through procurement right now. And I can say that having the right people in the right place, especially in sales at the point of attack, especially at the farm, can help us. We're also always evaluating bolt-on technologies to facilities as well as bolt-on acquisitions. We've done a few, we've added a little bit to the food space, in Grain. We still think there's some good opportunities for M&A, but we want to be smart in execution of those and we'll pull that trigger when the right opportunities come.

[Operator]

And that concludes our question-and-answer session for today. I'd like to turn the conference back over to John Kraus for any closing remarks.

[John Kraus, Director, IR]

Thanks again, Candice. We want to thank you all for joining us this morning. I also want to mention again that this presentation and slides with additional supporting information will be made available later today on the Investors page at our website at andersonsinc.com. Our next earnings conference call is scheduled for Tuesday, November 6, 2018, at 11:00 a.m. when we will review our third quarter 2018 results. We hope you can join us again at that time. Until then, be well.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.