Edited Transcript of PYX earnings conference call or presentation 11-Feb-19 10:30pm GMT

We believe the investments we're making now will further accelerate the growth rate across our higher-margin pedigrees and ultimately, provide long-term benefits for our customers, our employees and our shareholders. We're proud of where we've come from and we're confident in where we are going.

As we continue to drive progress against our strategic goals, providing greater transparency to our stakeholders is a top priority. Therefore, we have realigned the reporting segments to better reflect the new model, under which the business is being managed. Reportable segments now separate leaf and other products and services. We believe that this change in reporting structure enables greater insight into the advancements we are making across all of our businesses and we want to clearly convey our progress from quarter-to-quarter.

Turning now to performance. We closed out the third quarter with solid results. In fact, it was the strongest third quarter sales we've had in the last 4 fiscal years. Despite challenges we faced in the North American market, including Hurricane Florence and foreign tariffs on U.S. tobacco, the cultural and operational changes we're implementing in our leaf businesses are driving positive results. This quarter was also impacted by the restructuring and asset impairment charges related to the consolidation of our U.S. green tobacco processing operations as announced in November as well as an increase in SG&A, primarily attributable to investments in our start-up new business lines. Continued investment in talent, such as the hiring of FIGR Inc.'s new President, Harvey Carroll, and enhanced capabilities for these businesses will prove to be a significant driver of growth and a key factor in our ability to compete and grow market share.

As a result of the impact of Hurricane Florence, foreign tariffs on U.S. tobacco, increased export tax in Argentina and SG&A costs associated with our new start-up business lines, we now expect revenue to be in a range of approximately $1.8 billion to $1.9 billion, with adjusted EBITDA in a range of approximately $150 million to $160 million. However, as indicated in our guidance, we anticipate continued momentum in the fourth quarter, and we remain dedicated to delivering on our long-term financial commitments.

To that end, this was a monumental quarter for our Global Specialty Products lines. Starting with legal Canadian cannabis FIGR, our wholly-owned, indirect Canadian subsidiary, continues to capitalize on opportunities in the Canadian market, following the legalization of recreational cannabis on October 17, 2018.

At the end of December, FIGR had a combined share position of 13.3% in flowers, pre-rolls and oils and continues to execute its plans to expand market share beyond Prince Edward Island and Nova Scotia. First harvest at FIGR's Simcoe, Ontario facility, FIGR Norfolk, took place on February 4, 2019. And the facility's 800,000 square-foot expansion project is anticipated to begin this spring. FIGR East's expedited expansion is progressing in line with expectations as a new 165,000 square-foot greenhouse, and a 60,000 square-foot processing warehouse are expected to be completed in the spring, with Phase 2 of FIGR East's build-out, which will add an additional 88,000 square feet of greenhouse space expected to be fully functional in November. The expansion of both entities is targeted to bring FIGR's total annual production capacity to more than 100,000 kilograms. And we'll continue to focus on increasing yield and productivity going forward.

As we pursue opportunities to expand operations and gain market share throughout Canada and beyond, where legally permissible, we are deeply encouraged by FIGR's performance since October 17, and remain laser focused on its ongoing success.

Industrial hemp also had an impressive quarter with the Criticality's launch of Korent's new line of CBD oil and e-liquid products. The flavors for the current product lines were custom-designed in partnership with Purilum, LLC, a leading flavor manufacturer and Pyxus-affiliated company. Purilum products are available through e-commerce and a number of specialty channels and are quickly starting to gain distribution. With the passage of the 2018 Farm Bill and a robust pipeline of products, there is significant opportunity to accelerate Korent's momentum.

Our e-liquids category is also growing rapidly, which is indicated by double-digit year-on-year top line growth. Nicotine River and Humble Juice are continuing to reap the benefits from distributions and service levels as a result of moving into the new expanded facility, and Bantam will launch 72 new SKUs in the coming months, a testament to its brand innovation and ongoing potential.

Across all business lines, SENTRI remains a differentiator. We believe the consumers are going to, and should have high expectations of the quality of the products they purchase, where they come from and how sustainably they are grown. That's the kind of insight that SENTRI provides. SENTRI is available across many of our affiliates' product lines, including FIGR, Korent and Bantam. We're committed to providing the same level of visibility to all of our brands in the future.

Reflecting on the past year, we're proud of the progress we have made in delivering against our One Tomorrow strategic initiatives. We will continue to update you on our evolution as we work to transform people's lives so that together, we can grow a better world.

Now I'll ask Joel to speak to our performance for the third quarter of fiscal 2019. Joel?

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Joel L. Thomas, Pyxus International, Inc. - Executive VP & CFO [4]

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Thank you, Pieter. For the third quarter, total sales and other operating revenues increased 9.8% to $524.5 million versus last year's same quarter. This increase is primarily due to a 14.2% increase in volume attributable to larger crop sizes in Africa, partially offsetting this increase were delayed tobacco shipments from South America, lower volume in North America, attributable to Hurricane Florence, foreign tariffs on U.S. tobacco and a decrease in average sales price.

Cost of goods sold increased 11.3%, versus last year's third quarter to $449.8 million, mainly due to increased volumes. Gross profit as a percentage of sales decreased from 15.4% for the quarter last year to 14.2% this year. This decrease is primarily due to unfavorable changes in product mix in North America and South America, higher conversion cost in North America, due to Hurricane Florence and higher conversion cost in South America, attributable to crop size normalization.

SG&A for the third quarter increased $7.4 million to $41.7 million versus the same quarter last year. Our SG&A as a percentage of sales increased from 7.2% last year to 8% this year. These increases were primarily driven by the inclusion of new start-up business ventures in the current year, the increased cost associated with developing and supporting them.

The other products and services segment had SG&A cost of $9.6 million. Other income increased $7 million to $8 million for the 3 months ended December 31, 2018. Receipt of insurance proceeds from the fiscal 2016 fire in Zimbabwe drove this increase.

Restructuring and asset impairment charges of $1.7 million for the quarter were primarily related to a cost-saving and restructuring initiative to consolidate the company's U.S. green tobacco processing operations in Farmville, North Carolina, into the Wilson, North Carolina facility, and repurpose the Farmville facility for storage and special projects.

Additionally, we purchased $9.4 million of our existing senior secured second lien notes, due 2021, at a discount, resulting in debt retirement income of $1.3 million and a remaining face amount of $635.7 million.

For the 9 months ended December 31, 2018, when compared with the same period last year, total sales and other operating revenues increased 0.7% to $1,210.4 million. This increase was primarily due to a 5% increase in volume, attributable to larger crop sizes in Africa. Delayed tobacco shipments in South America, lower volume in North America, attributable to Hurricane Florence and foreign tariffs on U.S. tobacco and a decrease in average sales price partially offset this increase.

Cost of goods sold increased 1.4% from last year to $1,045 million for the 9 months ended December 31, 2018. This increase was primarily due to the increase in volume. Gross profit as a percentage of sales decreased from 14.3% last year to 13.7% this year. This decrease was primarily due to higher conversion costs in North America due to Hurricane Florence, unfavorable changes in product mix in South America and the exchange impact on local currency denominated costs, primarily in Europe.

SG&A, when compared to the same 9 months last year, increased 16.2% to $118.8 million. SG&A as a percentage of sales increased from 8.5% last year to 9.8% this year. These increases were primarily due to the inclusion of new start-up business ventures in the current year and increased costs associated with developing and supporting them. The other products and services segment had SG&A costs of $23.9 million.

Other income increased 36.4% from the same period last year to $13.5 million for the 9 months ended December 31, 2018. The receipt of final insurance proceeds from the fiscal 2016 fire in Zimbabwe drove this increase.

Restructuring and asset impairment charges of $3.5 million for the 9 months ended December 31, 2018, were primarily related to the restructuring initiative in North Carolina. Additionally, we purchased $27.3 million of existing senior secured second lien notes at a discount, resulting in debt retirement income of $1.8 million and a remaining face amount of $635.7 million.

Looking to the end of fiscal 2019 and beyond, we remain committed to improving profitability and efficiency and driving unprecedented growth across our operations. Now I'd like to turn the call back over to Pieter for some closing remarks.

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J. Pieter Sikkel, Pyxus International, Inc. - Chairman, President & CEO [5]

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Thank you, Joel. As we look to close out fiscal 2019 with strong results and set ourselves up for a tremendous fiscal '20, we're encouraged by the opportunities available and our team's ability to execute. Building up this quarter's momentum in the leaf business and the continued progress we are seeing in each of the start-up new business lines, we expect a strong fourth quarter.

As we move forward, we are driven by our purpose of transforming lives so that we can grow a better world and we continue to explore additional value-added products that allow farmers to expand and diversify their income. We know that as we push Pyxus International to its fullest potential, we will drive value for our shareholders and continue to be a company we can all be proud to be a part of.

On that note, operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Mary Gilbert with Imperial Capital.

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Mary Ross Gilbert, Imperial Capital, LLC, Research Division - MD of Institutional Research Group [2]

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I had a couple of questions. One, with regard to the leaf business and the impact on the SG&A line associated with the startup, it sort of infers that in looking at the guidance of $150 million to $160 million that there is $36 million of SG&A expenses associated with the new businesses where we're not getting that revenue generation. So it infers that leaf EBITDA, if we didn't have the new businesses, but which we're very happy you do, would really be like $186 million to $196 million? Am I correct in thinking that? And then I just had a follow-up with regard to the disclosure that you provided regarding the new businesses, particular FIGR and the fact that you expect 100,000k -- or 100,000 grams of production and does that infer $500 million to well over $600 million in revenues once your, both FIGR East and Norfolk, are 100% up and running?

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Joel L. Thomas, Pyxus International, Inc. - Executive VP & CFO [3]

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Yes. I think on the first part of your question related to the impact that the SG&A costs are having from the new business versus the timing of the revenue and the profitability, you're exactly right. This is something that we talked about before but now that we've broken apart the pieces of business, you can see it more clearly. And I think this is one of the areas that we heard loud and clear from folks. And as these businesses now are starting to build very quickly, albeit, still in start-up phase, we've broken them apart and now you can start to see it a little bit better. So hopefully, that's going to be helpful. And then as it relates to where the Canadian business is going, our interstate right now at 1 million and 1 of square feet, with roughly a third of that being completed sometime this fall will -- with 2/3 still to come in Simcoe, once we get to the interstate about 18 to 24 months from now, will put us in a position to have 100,000 kilograms and where prices will be -- we'll kind of have to wait and see, but it looks very promising.

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Mary Ross Gilbert, Imperial Capital, LLC, Research Division - MD of Institutional Research Group [4]

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Yes. So we're not crazy in thinking even -- again, depending on pricing, that maybe you can lower pricing, even though pricing is higher right now, you could get up to 500 million. And then finally, just on the leaf business, are there any concerns in terms of deliveries in Q4 coming out of Brazil, like Universal highlighted? Or that could move into Q1 of 2020? Or do you feel very good about the deliveries for Q4? And then I'll pass it on.

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J. Pieter Sikkel, Pyxus International, Inc. - Chairman, President & CEO [5]

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I think, really, in this guidance, we've really extracted the multitude of the risks that we have in Q4. And other than unexpected storms, I really don't see an issue in the deliveries out of this quarter. Really, non-calling of vessels would be the biggest event, but we haven't really seen issues in terms of containers that we had last year and so forth. So at the moment, we're looking in good shape.

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Operator [6]

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Up next is Karru Martinson with Jefferies.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [7]

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Just looking at your EBITDA where we stand today, is it right to think about the upcoming quarter that you have the visibility in strength in tobacco business and the drag really is pretty much the other operations that are continuing to lose money near-term here?

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J. Pieter Sikkel, Pyxus International, Inc. - Chairman, President & CEO [8]

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I think you better look at it -- we're, obviously, now reporting 3 segments, so we've got North America, we've got the rest of the world and then other products, so if you break apart those, you can clearly see the drag that North America is creating, both from the hurricane and the tariffs. We were hoping that we'd start to see certain export volumes move out as trade issues got resolved. But at this point in time, we don't think that those will happen in time for those shipments to take place. So those are really removed from this guidance. But you can really see the drag that North America's had on the globe. The Other Regions segment really is having a very good year. You can see very considerable growth in terms of sales, and we expect that to continue throughout the year. That's significantly driven by Africa, but in general, all regions are doing pretty well, including South America. And then yes, the other products and services, clearly, we're building those businesses, we're investing significantly behind it, both in terms of capital and branding and marketing, building the right team to take us into the future. And I think that's incredibly important for us to have the right talent behind those businesses and we believe we've achieved that. So our holdup is product and as we see these build-outs come online and, hopefully, Health Canada, in particular, will expedite the licensing of those build-outs, then very rapidly we see growth in product availability and we can build on the market share we've already gained in the limited areas that we're distributing product and brand at this stage and build those out into other areas. And just the initial capacity coming online is 15, 16 fold increase in terms of production. That's very significant and you can really see how you can rapidly build-out the revenue and the sales and start to match it up better with the SG&A support and the marketing support that we're putting behind the businesses. Also, here in the U.S. with Farmville and with Criticality, we've just received the certificate of occupancy in our new facility there, a few more tests to do in the borders and everything else, but we'll be in production very soon. And we've got a very nice pipeline of products lined up to launch throughout the year, and we're looking forward to seeing how Korent, in particular, does in the marketplace as the U.S. consumer increasingly has access to CBD products of different variants as we move forward. So we're excited by that as well.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [9]

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Okay. And you guys now bought back a little over 9 million of bonds in the quarter, but traditionally, fourth quarter is your cash-generative quarter, should we expect additional buybacks as we finish off the year?

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Joel L. Thomas, Pyxus International, Inc. - Executive VP & CFO [10]

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Karru, we'll have to take a look but, I think, at this point, we're pretty focused on everything we've got to get done for the fourth quarter. So we'll have to wait and see what materializes.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [11]

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Okay. And then lastly, I was not on the third quarter call -- I'm sorry, second quarter call last quarter, but I think there was talk of doing a refinancing in 2019, and given the changes in guidance and all the moving parts, how do you guys approach that now?

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Joel L. Thomas, Pyxus International, Inc. - Executive VP & CFO [12]

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Well, Karru, I think that part of the discussion that's already occurring in the marketplace is related to really 2 distinct different components to the business. And of those 2, 1 is separated between North America and the rest of the world, related to Leaf, those 2 segments and then we have our third segment, which is our other businesses. And so at any rate, as you kind of think about the way that, I think, the marketplace is looking, both at value as well as financing those businesses, there's clearly sort of a separation as you're looking at it, both related to valuation and the requirements going forward. So I think that's where a lot of the discussions are. And I think as we go into thinking more about the refinancing between now and when we need to do it out in 2021, it's going to be front and center in the conversation.

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Operator [13]

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Next, we have Bryan Hunt with Wells Fargo.

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Bryan Cecil Hunt, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [14]

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My first question is on the Leaf business. The U.S., given their current tariff regime, it becomes a relatively smaller supplier to the rest of the world and you move leaf production around the world. I saw today in a story that grower registrations in Zimbabwe are up more than 45%. So I was wondering when you look at the changing landscape for leaf sourcing, 1, are you involved in moving leaf, such to Zimbabwe and Brazil aggressively for next year? And 2, does this new footprint change your long-term outlook for leaf profitability relative to what you outlined at your Analyst Day?

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J. Pieter Sikkel, Pyxus International, Inc. - Chairman, President & CEO [15]

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I still feel that there's significant opportunities as we outlined at Analyst Day, but I think we're starting to get the indications in for the coming crop for outside of North America, thus it's generally looking pretty positive and we're pretty happy with what we're seeing coming in. But at the same time, we remain focused on the U.S. market. Now we've done the restructuring, clearly that creates significant efficiencies going forward, and we remain very focused on the U.S. farmer and the U.S. product and there are -- we still believe there are opportunities there and when these trade issues get resolved then there will be demand for that product as well. So with the restructured operation here, with things normalizing in terms of tariffs, we still see U.S. opportunities and, actually, improved profitability coming from those operations with the restructuring that's taken place. This morning, I was -- we were actually talking to Secretary Perdue of the Agricultural Department, to discuss how quickly we can get these issues resolved and obviously, I think we're all working together to try and get that done, which will allow contracting in the U.S. to take place to more normalized levels and give the farmer a crop to grow and a market to access. But the issues aren't just with China, also, we're looking in Europe, so there's a balance in there. But in general, with the restructuring, with where we believe things will turn out, I think we still see a good opportunity for a nicely profitable North American operation as well.