Ag Growth International Inc. (AFN) Earnings Call Transcript

Good morning. My name is Suzie, and I will be your conference operator today. At this time, I would like to welcome everyone to the AGI's Third Quarter Results Release and Conference Call. [Operator Instructions] Thank you. Mr. Tim Close, you may now begin your conference.

Good morning. And thank you for joining us this morning to review our Q3 results and outlook. I'm very pleased to have Jim Rudyk, our new CFO, joining me this morning. Jim joined AGI in late September and brings an impressive career across several industries with experience including finance and operational roles that bring relevant experience to AGI. As we move into the next stage of our growth, the experience Jim brings to the table will be critical in navigating and implementing improvements in our system, operations; and bringing leadership to our global finance teams to facilitate our ongoing growth. We will start with a summary of the quarter, then discuss the significant accrual we are taking in the quarter, and close with a detailed review of our regional results, fundamentals and outlook. Just a quick reminder that the cautionary language of both forward-looking information and the use of non-IFRS measures contained in Q3 release also applies to the discussion during today's call. As indicated over the prior three quarters, 2020 has been setting up for a Q3 weighted performance, with our Commercial production schedules weighted to Q3. A relatively short and early harvest across North America also contributed to the Q3 weighting. However, the COVID crisis acted to significantly offset these positive elements in the quarter, with a material impact on Commercial projects globally. Development of Commercial projects slowed or projects were postponed due to the varying regional conditions due to COVID. Our customers have been dealing with limited access to sites, availability of resources and uncertainties in end markets, which all contributed to lower our Commercial sales globally and, in particular, in North America. That said, our Commercial sales remained at 94% of Q3 2019 and 92% year-to-date versus 2019. All factors taken together and at a consolidated level, Q3 2020 was a record third quarter for AGI in terms of sales and adjusted EBITDA. It was also a record quarter overall for adjusted EBITDA, just beating Q2 from 2019, which was our prior high watermark. This strong performance in the quarter again highlights the benefits of our diversification investments over the prior 5 years, demonstrates the resiliency of our business and confirms our place in the global food infrastructure, with demand fundamentally driven by global consumption. Now before we get into the details of our results, we'd like to address the incident that occurred during the quarter. On September 15, we reported that there was a collapse at a customer's project of a commercial grain storage bin that was manufactured by AGI. The cause and the responsibility for the incident has not been determined. And there is an investigation underway. As disclosed this morning, the company has taken a $40 million accrual in the third quarter in accordance with accounting and other disclosure obligations on the basis of potential remediation of equipment that was supplied by AGI to this Commercial facility and one other facility. The accrual represents AGI's estimate in consultation with our external advisors of the direct costs involved, including cleanup and equipment remediation at the two sites. AGI's contracts contain exclusions for indirect or consequential damages. While AGI has accrued $40 million in this quarter, we believe that this amount will be partially offset by insurance coverage and result in a lower net impact. We are working with insurance providers and external advisors to determine the extent of this cost offset. If the investigation determines that AGI contributed to or caused the incident, AGI will take responsibility for the action and related remediation. This incident accrual is in addition to the previously reported $20 million in costs and accruals taken over 2019 and 2020 that was due to the rework of equipment supplied by AGI to the same commercial facility where the incident occurred. The rework was required to address issues with the equipment design and supplied only to this facility. We want to stress that the incident that occurred in September and the rework are isolated and discrete. They're also extremely rare. AGI manufactures thousands of bins each year, and we are involved in hundreds of projects each year for different customers around the world. Our engineering team has significant experience designing and providing leading products in our industry. Quality control and safety and security of our customers will always be our top priority. Over the past 3 years and in response to market demand, AGI developed a large hopper storage product as an extension of our storage product line. AGI sold 35 of these hoppers to two different customers constructing grain storage projects. There are a total of 15 hoppers on the site of the incident and 20 hoppers on the second site. After the grain bin collapsed, under an abundance of caution AGI immediately issued a demand to each customer to suspend the use of the hopper. And we are supporting our customers to ensure that we mitigate the impact of the incident. As noted, the cause of the incident has not been determined. In the meantime, AGI has responded by conducting a thorough analysis of the company's relevant processes, procedures, systems and engineering tools. We are committed to strengthening our business as a result of this experience. We welcome questions about the incident after the prepared remarks. However, please note that we will be able to provide more details on the cause of the incident, potential required remediation and the accrual pending the findings of the investigation. Let's return to a more detailed review of our Q3 results, our fundamentals and our outlook. This record quarter is a result of very strong results in North American farm, Brazil, India, EMEA and our technology group; and offset by lower Commercial results in North America. As indicated throughout 2020, the strong performance of our Farm business in North America continued in Q3, with sales climbing significantly year-over-year and up year-to-date. The robust performance is driven by core demand, with solid crop volumes across North America driven by an annual increase of planted acres and favorable weather conditions, resulting in good crop yields and a sizeable crop. Farmers continue to invest in mandatory equipment and systems required to handle these crops, position themselves with adequate storage capacity to effectively market their crop. Demand has been broad based across North American regions and products, with inventories across our dealers currently at low levels, leading to expectations for solid early order programs and sales as we move into Q4. Our Farm system sales continue to grow in the key U.S. market, double-digit year-to-date organic growth in this strategic category. As a reminder, we expanded from our portable grain handling products in the U.S. with our acquisition of Global Industries in 2017. With this acquisition, AGI gained a small regional market position in grain systems. We have been integrating our products, sales and dealer development since the acquisition. We are seeing positive traction in this market and believe our combination of market-leading design services, storage, handling, conditioning and technology products; coupled with additional dealer tools and service, will lead to steady continued organic growth. Despite an earlier and much drier harvest across North America, we expect stable sales in the Farm category into Q4, holding our gains in the year and confirming our traction across the category and our growth in the U.S. Farm systems business. We expect positive conditions to continue into 2021, starting with solid [ earlier ] programs now and continuing into the fall in both Canada and the U.S. Q3 was a record result in Brazil in both sales and EBITDA. Sales increased 55% sequentially and 52% year-over-year. We narrowly beat our previous best sales figure. EBITDA increased substantially in the quarter as margins grew to double-digit numbers closer to our consolidated results, as we grew sales, achieved favorable product mix and saw the benefits of recent Lean initiatives. We continued to have a very positive environment in Brazil. Favorable weather, increased acreage, better seed and nutrient usage, strong fundamental crop demand, low interest rates and low inflation are all leading to a steady increase of Farm level investments in the infrastructure to store grain and to maximize profitability from sophisticated grain marketing. We expect these conditions to continue into Q4 2021 and beyond. Our pipeline and backlog remain strong in Brazil, leading to good visibility on continued momentum on our sales. We do expect more volatility in margins as we optimize product mix, balance Farm and Commercial projects and optimize manufacturing efficiencies. Overall, we are very pleased with our progress in Brazil. India delivered record Q3 numbers despite the significant COVID impact. Sales grew 44% year-over-year off a solid Q3 2019. And EBITDA margins expanded significantly year-over-year as we continued to work on manufacturing and SG&A efficiencies. We also achieved favorable product mix in the quarter in India. Our teams continued to successfully execute on our market expansion strategies in India, taking us from our traditional focus on midsized rice processors into both the markets for smaller and larger processors while growing our integrated systems sales. We achieved this expansion through product and service developments designed to address the nuances at both ends of the market. We also saw positive traction in larger projects in the quarter. Our expert sales returned to pre-COVID levels, which served to augment our sales growth in what is traditionally a slower quarter in India. Overall conditions remain favorable in India, with a good monsoon season leading to growth in rice production and facilitating a substantial increase in rice exports from India. Despite COVID, the earlier monsoon season and a strong Q3, our pipeline and backlog remain equal to this point last year, setting up for continued performance into Q4. We're also positive on the environment heading into 2021 and expect to maintain our momentum in this strategic market. We also have strong results in Italy, with solid growth in year-over-year sales and substantial margin growth, as we continue to see the impact of a recent investment in our automated production facility and product development efforts over the past 18 months. Commercial project demand is now returning. As we move through the COVID crisis, and we are seeing broad-based strength across the region, that activity level is picking up in Eastern Europe, Russia, Africa and the Middle East. This increasing activity puts our pipeline and backlog in a strong position. And current intake levels point to an increasing profile for our Italy backlog going into the end of 2020 and into 2021. Over the past 3 years, we have been moving our sales, engineering design teams; as well as our products and, ultimately, our manufacturing, into each of our strategic regions: Brazil, Italy, Southeast Asia and India. This deliberate and strategic effort, in addition to the challenges from COVID, have combined to lower our Commercial sales into international markets from North America. This does naturally serve to offset the sales growth from the regions. However, these moves act to make us more competitive in niche reach, positions us to better serve our customers and build closer relationships that lead to a more sustainable, defensible business, with improving margins and products best configured for the nuances of each market. Our technology business, AGI SureTrack, continues to grow. SureTrack is a market-leading grain monitoring and automated conditioning platform that extends to a grain marketing and overall farm management platform. The foundation of this business is a robust suite of IoT sensors integrated into our system, providing live monitoring and data feeds to our Farm and Commercial customers. This platform is having a positive impact across our equipment and playing a strategic role in our market expansion that goes beyond the technology platform. We currently have been selling SureTrack equipment to customers using a subscription model, which spreads out the revenue over several years. However, to look at the underlying performance of the SureTrack business, we look at how the business performs on a retail equivalent basis, which would show what sales and earnings would be if we recognized the sale upfront versus over a number of years. The challenge with the subscription model is that it can make the early reporting results look weak as the costs get recognized upfront but the revenue is spread over many years. If we look at the SureTrack business on a retail equivalent basis, SureTrack sales increased 45% year-to-date over the very strong organic growth numbers posted in 2019. On this same basis, SureTrack would've contributed significant positive EBITDA year-to-date instead of the significant drag in the year-to-date period. The production of SureTrack equipment was relocated to a new facility in the quarter, substantially increasing our capacity and driving key manufacturing efficiencies. From the sales perspective, we are introducing additional financing options for our customer and revisiting our subscription model, which we expect will result in stronger recognized sales. The SureTrack platform continues to grow. We are very excited about the positive contribution of this business going forward. I will turn the call over to Jim for a more detailed review of the quarter.

Thank you, Tim. I'm very excited to be part of the AGI team, and I am looking forward to helping us execute our strategy as we continue to grow the company. To start off, as Tim mentioned, we had very strong results, as sales and adjusted EBITDA in the third quarter of 2020 were $282.5 million and $51.8 million respectively, compared to $261.1 million and $39.1 million in the prior year. Looking at sales. Robust Farm demand in North America and solid results in Brazil, EMEA and India contributed to a strong performance in Q3 2020 despite the headwinds presented by the emergence of COVID-19. Our results reflect the resilience of our business in the face of COVID-19 challenges as well as the benefits of diversification across geographies and product lines. From a product platform perspective. Our Farm business was very strong due to high customer demand from solid crop volumes across North America. Demand has been broad-based across North American regions and products, and inventories across our dealers are currently at low levels, which will lead to sales in Q4 that are consistent with the prior year. Our Commercial business continued to be lower than prior year as customers cautiously manage their large capital projects as a result of the COVID-19 challenges. From a geographical perspective. The U.S. and international businesses showed strong double-digit sales growth, while Canada was slightly up year-on-year. Our international business results, led by the strong performance in EMEA, Brazil and India, was due to the previous focus and investment in those areas and continue to represent strong growth opportunities. Our overall sales backlog remains consistent with the prior year. We expect to see continued strength in our Farm business through the first half of 2021 due to the depleted dealer inventory levels and strong prop volumes in North America, as well as some rebound in our Commercial business as those customers start to make decisions on pent-up capital projects. Turning now to our gross margins and adjusted EBITDA. Our results in Q3 2020 reflect a very strong operational performance across our businesses and geographies as our gross margin in the quarter increased to 34% in 2020 from 31% in 2019. It is significant that the gross margin percentage was achieved despite COVID-19-related operational protocols at all of our facilities. Our gross margin growth was a result of a continued strong Farm performance, as well as sustainable increases in our international business margins that resulted largely from strategic capital projects in EMEA and strong momentum in Brazil. As a percentage of sales, our adjusted EBITDA margin of 18.3% increased 336 basis points from prior year. The strong results were driven by the large improvement in gross margin and our steady management of SG&A costs. With respect to our earnings outlook. Overall, we expect adjusted EBITDA for 2020 to be in line with our 2019 results. And we are looking forward to an encouraging first half of 2021. My final commentary relates to our liquidity position. As you may recall, we amended our credit facilities in April given the substantial uncertainty caused by the emergence of COVID-19. The amendment enabled us to suspend our covenant tests until October 31 and also provided us with increased liquidity. Although our covenant tests were suspended at the end of Q3, our net senior debt to adjusted EBITDA ratio of 2.89x is consistent with the prior year ratio and remains well below the pre-suspension requirement of 3.75x. We do not have any covenant concerns now or going forward. In April 2020, we also expanded our credit facility to add flexibility and additional liquidity. And as at September 30, 2020, we have $164 million of undrawn revolver capacity plus a $100 million untapped accordion. Our strong results, reduced growth CapEx needs and our modified dividend payout will give us higher free cash flow and a much stronger balance sheet. So with that, we will turn it back to the operator to take any questions.

[Operator Instructions] And your first question will be from Jacob Bout at CIBC.

I'd like to have a few more details on the $40 million accrual. Trying to understand what the probability weighted estimate actually means. Could the cost actually be higher than $40 million?

Jacob, I appreciate the question. As we stated, we're still going through that investigation. So this is a good estimate of the direct costs that we think are involved here. So as we get through that, we'll obviously be finding more clarity. But we're comfortable with that accrual at this point.

But just to understand this correctly, so that's your estimate. But that wouldn't be necessarily the total cost?

I think that's our estimate of the total cost, Jacob.

And if the claim goes against you, what would insurance cover?

Yes, again, we're working through that with our insurance companies. We're working with our advisors. And our position is that it covers the direct result of the incident. But we certainly have our initial position. But we are going through this investigation, so we're incorporating those factors as they become more and more clear. So we've indicated that we think it'll be an offset here, I think a partial offset. We think that that's a good-size number. But we'll be working through it over the coming weeks and months.

And then, the bin failure at the two sites -- similar circumstances at both sites?

No. No. Distinctly different application. And the two sites that we've indicated here that are involved in the accrual, those are very similar. Those are both grain facilities.

But to be clear, you're the equipment provider at both sites? You're only the equipment provider at both sites?

That's right. Our role is as the equipment provider to the two sites.

So not involved in the construction or any of that…

That's correct.

Onsite preparation? Okay.

That's correct.

And from a historical perspective, has [ Quest Deal ] ever seen anything similar to the bin failures that we've seen with the hopper line?

Look, there are incidents with bins around the world. But they're very different products. So it's very difficult to draw comparisons here. There are issues in commissioning. And they can be for a wide variety of circumstances from construction, the foundation and civil works and weather instances, as well as other factors. So there are bin incidents around the world. But it's really hard to draw comparisons to any specific example.

Last question for me. Changes that you'd made or are considering from internal controls perspective?

Yes, absolutely, yes. We've been taking a deep dive across all of our internal control systems, people; and have made changes, are making changes in order to strengthen our processes, the systems and tools we're using across the board. We can always do that. We can get better, and we are committed to getting better. And those changes are -- a lot of those are in hand and in scope right now. We're in stride in making those or have made a significant amount of changes to bolster our procedures and policies both internally and even in external resources.

Specifically what are you considering?

We've implemented new engineering systems. From a [ FEA ] analysis perspective, we've changed and added to those processes. So the bid review processes, every commercial bid that comes in now is administered very early on in the process and gets senior engineering review at a very early process. And that guides then the design and the steps going forward on every single Commercial project worldwide. Product development has been strengthened across the board and has new leadership in product development, product management, worldwide. And we're adding to that team, have added to that team, in North America. We've built out a very good team engineering-wise in EMEA, in Brazil, in Southeast Asia, where we just added some more leadership to that group in Southeast Asia. And in North America, we've made changes to that team and added to the team, added talent across the board. I guess I would add to that that we are -- as one of the biggest grain bin manufacturer in the world, we have a significant amount of expertise across AGI and bringing that together in new ways to ensure early and additional review across existing products is being done right now, and then a significant change to product development processes that will benefit and mitigate this type of possible event going forward.

Do you think you've taken a reputational hit here? Because it looks like Commercial backlog is down quite a bit.

Well, I guess your reputation is defined in moments like this. We are stepping up and supporting our customers in every way we can. We are very committed to that across the board in every instance. And these are the times where that reputation is built and cemented in. And we are very committed to that. We build, as I said, thousands of bins. We have robust expertise in this around the world. There's hundreds of projects, both Farm and Commercial projects, around the world that we are implementing and working on every day, every year. And that points to a foundation of reputation we have to date. And we intend to maintain that credibility and reputation going forward.

Next question will be from David Newman, at Desjardins.

So just to -- not to belabor the point, but just on the -- besides the insurance recoveries, any recourse that you might have with suppliers on materials and things like that? I mean, I know you're still doing your investigation. But as you go back in the supply chain, is there any other areas that you can offset some of the accrual?

Good question, David. I think it would really come down to the final determination around cause, causation. And there is certainly that possibility. I think we'll determine that as we go forward and an investigation comes to conclusions.

And then, just on the guidance, you're calling for flat EBITDA year-over-year, which implies 4Q on a squeeze-out could look a little bit softer. Is it related to the sort of Commercial COVID? Because obviously, the Farm outlook looks very, very good and looks like it could continue to move through the next couple of quarters here. Obviously, strong crops, et cetera, and then inventory is depleted. But if you look at the Commercial side, it seems like COVID weighed a little bit heavier. And is that really what you're kind of looking at? What's causing, I guess, the little less confidence on the fourth quarter in terms of your outlook?

Well, a couple things. We've been trying to stress throughout 2020, and even end of 2019, that this year was setting up to be Q3 weighted. And that was our production schedules in Commercial globally -- and in Farm were weighted to a Q3, coming into 2020. So that allocation between the quarters is not unexpected. I guess I'd say [ often about ]. An early harvest then augments that. Because you pulled -- a late harvest would see some of the rush, the final year rush, in Q4. And that harvest happened in Q3 across North America. And it was dry. Dry and early, generally speaking. So that augmented the weighting to Q3 as is. So in that context, Q4 looks quite strong. As you noted, inventory levels at our dealers are low. They'll be replenishing those as we move through Q4. Our early, early programs are set up to do that to well load our production across our facilities, particularly in Farm. So we see it setting up nicely into the back end of this year and then position us well into '21, both on the Farm side -- now COVID has, no question, had an impact in Commercial globally. And so we noted that in this quarter, places like India, places like EMEA, strong results despite the COVID impact. We do expect to see a rebound in Commercial as we move into Q4 and into 2021. Just simply, there are straightforward maintenance-related or scheduled automation or expansion projects across the board that have been postponed in 2020 that we see now picking up at the tail end of this year and into next year. That quoting activity is rebounding globally. And we'll set up for further expansion of our backlogs into -- expected expansion of our backlogs into Q4 and into 2021.

And just last question for me, just on the Commercial side. When you talk to your customers internationally, obviously a lot of decision-making has been deferred because of COVID, et cetera; but also because of the White House and changing policies every other day. So if you get more stability in the White House, and Pfizer and a vaccine and things like that, are you seeing some early sort of -- kind of looking at the files and maybe starting to work on sort of deferred projects, starting to restart them?

Well, for whatever reason, I think it's just to the delays in COVID -- whether it's geo-specific or political reasons -- activity is picking up worldwide and across the board, whether it's in processing, food or grain or [ FERC ]. So we see that positive rebound activity happening now. Look, some parts of the world were dramatically affected by COVID in the Commercial space. Those parts of places like Southeast Asia were just completely shut down. There was zero access, zero travel, zero access to sites. And you can see that across the reporting of those regions. Other places have made progress. Places in EMEA in particular have made more progress and a little bit more travel during this period. So it's a little bit case-by-case across regions. But overall, we do see activity returning.