Bryan Hurley – IR Lead
Carl Casale – CFO
Kevin McCarthy – Bank of America
Vincent Andrews – Morgan Stanley
Jeff Zekauskas – JPMorgan
P.J. Juvekar – Citigroup
Robert Koort – Goldman Sachs
Sandy Cogman [ph]- Susquehanna Financial Group
David Begleiter – Deutsche Asset Management
Lucy Watson – Jefferies & Co.
Monsanto Company (MON) F3Q10 (Qtr End 05/31/2010) Earnings Call June 30, 2010 9:30 AM ET
Welcome to the third quarter 2010 Monsanto Company earnings conference call. (Operator Instructions)
It is now my pleasure to introduce your host, Bryan Hurley, Investor Relations Lead for Monsanto.
Good morning to everybody on the line today for our third quarter earnings conference call. Joining me today on the call are Hugh Grant, our Chairman and CEO; and Carl Casale, our CFO. Also joining me are Will McAndrew, Manny Cruz and Ruben Mella, our IR team.
Before we begin, I’d like to remind you that we are webcasting this call. You can access the webcast and the supporting slides at monsanto.com. The replay will also be available at that address.
We’re providing you today with EPS measures on both a GAAP basis and on an ongoing business basis. In those cases where we refer to non-GAAP financial measures, we’ve provided you with a reconciliation to the GAAP measures in the slides and in the press release, which are both posted on our website.
I need to remind you that this call will include statements concerning future events and financial results. Because these statements are based on assumptions and factors that involve risk and uncertainty, the company’s actual performance and results may vary in a material way from those expressed or implied in any forward-looking statement. A description of the factors that may cause such a variance is included in the Safe Harbor language contained in our most recent 10-K and today’s press release.
Since we just provided updated quarterly and full year guidance, I’ll walk through an abbreviated summary of the quarterly results to save the bulk of the time for Carl who will take you through our full year outlook and our 2011 metrics and for Hugh to talk about progress on our near-term strategic priorities.
Let’s start with an overview of our financial results on slide four. Fundamentally, the results were in line with the revised guidance we issued last month for the full year and for the third quarter. For the quarter, ongoing earnings per share were $0.81, slightly ahead of our prior guidance. As expected, the quarter reflects the reset of the Roundup business.
On a year-over-year basis, net sales were down 6% and gross profit declined 24% to $1.4 billion for the quarter. As has been the case in the recent quarters, this was largely driven by Roundup and other glyphosate-based herbicides, which came in at a loss of $189 million on the gross profit line, reflecting the negative gross profit effect associated with the near-term adjustments from our Roundup repositioning. Carl will cover these effects in slightly greater detail in his outlook for the full year.
From the Seeds & Traits perspective, sales in the quarter were up slightly over last year, while gross profit was down slightly. Likewise, for the year-to-date, sales in the segment increased 4%, which reflects increased sales in our U.S. corn business, our global soybean business and contributions from both cotton seeds and traits and the vegetable business. The year-to-date gross profit for the segment is down 2% as the increase in sales were offset by the higher launch year COGS and the restructuring moves we discussed previously.
On the cost side of the ledger, we continue to realize a lower run rate for SG&A, supporting the expected $2 billion to $2.1 billion guidance for this full year. That run rate reflects the benefits that we’ve realized because of our restructuring program. To date, our restructuring spend for the fiscal year is $184 million, taking our cumulative total to $590 million of the projected $550 to $600 million in total spend.
The effective tax rate for the quarter was 26%, which is lower than the 30% recognized in the prior year. As was the case in prior periods, benefits from several tax items were recognized in the quarter. With our revision to earnings guidance in the last month, our tax run rate puts us in line for full year tax rate that may be better than our projected 29% to 30% range.
As is typical for this quarter, free cash flow was a use of cash. In particular for the year-to-date period, cash flow was a use of cash of $1.15 billion compared with the use of $145 million for the same period in 2009. That use of cash largely reflects the repositioning of the Roundup business, affecting net income as well as working capital and the cash portion of the restructuring charge. That’s partially offset by lower inventories from a reduction in seed production and a normalization of deferred revenue compared with the prior year.
In terms of cash deployment, we spent approximately $374 million in the quarter on share repurchases. That will allow us to close out our current three-year $800 million program a year earlier than originally planned.
Let me turn the call over to Carl, so he can expand on our outlook for the remainder of the fiscal year.
A little more than four weeks ago, we provided our revised guidance for the fiscal year following the strategic repositioning of the Roundup business. As we expected, the third quarter results were in line with that revised guidance and we’re on track to meet our full year ongoing EPS guidance range of $2.40 to $2.60 and our free cash flow target of $400 million to $500 million.
Through the third quarter, our ongoing EPS is $2.49, which is squarely within our full year range. With that as the backdrop, it’s useful to walk through how we see the year closing out and then shift into the first look at the metrics and drivers we see shaping our mid-teens growth trajectory in 2011.
As Bryan noted, Roundup gross profit came in at a loss for the quarter. That’s the direct result of our repositioning actions as the quarter reflects approximately $200 million in negative gross profit impact as we implemented the first of the near-term adjustments. Practically, that gross profit impact is driven by the lower price and volume effect in the burn-down season and our accrual for the accelerated payment to close out most retailers and distributors incentive programs.
That means that we work through a good portion of the anticipated actions that’ll make up a cumulative $0.50 to $0.70 EPS effect we project as a result of the repositioning.
For the broader Ag Productivity segment, we continued to realize strong results this year, driven by a record year in the lawn-and-garden business. So for the fiscal year, we continue to expect the total Ag Productivity segment to deliver approximately $450 million to $600 million in gross profit, which includes the expected contribution of between $50 million and $200 million from Roundup and the glyphosate-based herbicides after the repositioning actions.
If we shift to Seeds & Traits, even in a challenging year, our results are coming in consistent with our previous expectations. As Bryan also mentioned, gross profit at this point in the year is down slightly from this point last year. There are a couple of key variables that influence where we stand and the ultimate landing point for the full year.
First, pending the final true-up of planted acres and returns, we continue to see our DEKALB branded corn seed shares steady but basically flat this year. Consistent with that, our overall U.S. branded corn volumes are flat year-to-date. Our worldwide volumes are down slightly. For the fourth fiscal year, once we have expected sales in Latin America in the fourth quarter, our global season trades volume will be flat for the year.
Second, the biggest upside came from mix. We had seen an increase in the trait intensity mix in the U.S. In corn, farmers continue to drive towards technology adoption with more than 75% of our branded U.S. corn portfolio in either triple-stack or SmartStax, a positive step change from 70% penetration rate in 2009. That’s mirrored in Latin America, with the increase in trait acres in Brazil and Argentina, that’s had a positive overall mix effect on the business.
Practically, that positive mix effect has been fully dropped down to the gross profit line for the segment as launch year effects on cost of goods that we discussed previously offset the per acre gross profit expansion. Specifically, we have already discussed restructuring charge to cost of goods that we took in the second quarter positioned our U.S. corn product strategy for 2011.
Some additional restructuring charges have been booked in the third quarter as we reach out globally and get our complete portfolio in position to offer the newest hybrid and the latest trait package in each area.
For the full year, our total restructuring charges for seeds and traits represented a $93 million decrease to gross profit. Additionally, both corn and soybean in the U.S. reflect a continued short-term cost of goods headwinds we discussed last quarter associated with the launch of SmartStax and Roundup Ready 2 Yield and a higher production cost from our hedge positions.
These restructuring moves were conscious choices and are now behind us, but made because they enable our product strategy going forward. When coupled with the one-time adjustment to our hedged U.S. production positions we discussed in the second quarter, these items represent a year-to-date charge to cost of goods in excess of $120 million that will not be repeated.
If not for those actions, our seeds and traits gross margins would be slightly lower than last year and reflective of incremental launch cost. Segment gross profit would have been in line with the expected contribution for our EPS guidance before last month’s reset.
Including the negative effect of the approximately $120 million in 2010 decisions, we expect Seeds and Genomics gross profit to come in at $4.6 billion to $4.7 billion for the full year. That anticipates a modest incremental increase to fourth quarter gross profit over the last year, primarily reflecting Latin American corn or more broadly we’ve given ourselves a foundation for the seeds and traits growth in 2011 and beyond.
Mathematically, to hit our $2.40 to $2.60 ongoing earnings guidance, we expect to range from minus $0.09 to $0.11 at the ongoing EPS level for the fourth quarter.
On slide five, you’ll see only there are only a couple of moving parts to the fourth quarter as we close out the year, the biggest of which is remaining Roundup repositioning actions. Within Roundup, we’ll have the pricing effect and we have volume at lower price points as well as some carryovers as we close out our distribution centers and see the full gross profit impact from the supply contract breaches.
On the seeds and traits side, fourth quarter reflects a significant contribution for our Latin American corn seed business. That includes both the repeat of gross profit related to our Mexican corn distribution change and contributions from Argentina and Brazil.
On the cost side, our full year SG&A spend is trending very well and we continue to expect SG&A will come in at the $2.0 billion to $2.1 billion range for the full year. The fourth quarter will reflect the consistent SG&A level as we complete the fiscal year.
No doubt there is still some work to do to close out 2010, but we’re becoming increasingly focused on 2011. As promised on the second quarter call, we’re back today with the guidepost that we use to calibrate and track our mid-teens growth going forward.
As a CFO, let me share with you how I deal with those key metrics, which we’ve included on slide six. Quite simply, these are the metrics that matter to us, the dashboard indicators we look to where we’re tracking the operational progress and the health of the business.
On the left side, you’ll see the categories that translate progress into practical financial guidance. At this point, we can give you an early look at the directional trends in these key categories and we’ll expand and update them on our fourth quarter call once we have the 2010 endpoints.
On the right side, you’ll see the factors that affect the financial outlook. We’ve moved away from a specific line item detail on the business drivers. So we’ll be able to provide meaningful directions on the large contributors across each segment. This is a walk down the P&L, culminating in our expectation of mid-teens earnings growth on an annual basis.
If you start there, here’s how I see the rollout happening. Most importantly, we can’t achieve our mid-teens earnings growth in 2011 without double-digit gross profit growth in seeds and traits. Top-line growth will come from an increase in seed unit volume as well as mix improvement. Hugh will cover this in some more detail, but if you look at the leverage, there is three points that matter; Roundup Ready 2 Yield in the U.S., the U.S. corn product strategy and the trait expansion in Brazil and Argentina.
All in, I expect global seeds and traits volume growth in the low to mid single digits in 2011. And the reason unit volume growth matters a little more than peer share metrics is we can control what we sell, but we don’t control the development of acreage planted, although we do expect volume to be reflected in share growth at a global level. The benefit of that unit-volume growth is your portfolio remains fresher and you have less total obsolescence. So this is clearly a priority for us.
On the Ag Productivity segment, we expect to deliver steady-state gross profit in the range of $550 million to $600 million beginning in 2011. This is largely in line with what we expect during 2010. So there will be minimal contribution to gross profit growth in the coming year. But it is a significant step toward the predictability we see at steady state.
We will aggressively look at the infrastructure supporting Roundup to make sure those support systems are in line with our steady-state guidance. That process is underway. So we will be able to give you an update on those actions on the fourth quarter earnings call.
As we then move into the below the line items, the cost savings we have realized as a result of our restructuring actions have allowed us to institutionalize a reduced run rate in our SG&A for 2010. We continue to see those savings carrying forward such that we expect SG&A for next year will grow only at inflationary rate from this year’s levels.
On the R&D line, there is no debate that our R&D pipeline is our competitive differentiator and fuels the upside opportunity in our business longer term. We don’t look at this line as a means to reach our earnings goal, and we’ll continue to resource our R&D for success.
To reinforce that commitment, we’ll move to giving you a specific range for R&D spend rather than a metric that floats with sales. We will lock this down in the fourth quarter. So practically speaking, that range should represent an increase over our 2010 endpoint, with a growth rate somewhat lower than we have seen over the past few years.
The last items in our guidance dashboard relate to cash flow. The most important task is to efficiently translate earnings into cash. I said we remain on track to deliver $400 million to $500 million in free cash flow this year. This is still on track as the fourth quarter is the primary collection period in the U.S. and drives our full year cash generation.
We’ll discuss specific guidance for 2011 at our fourth quarter earnings call but I see cash generation rebounding to a significantly higher level as we see business growth and we drop off cash uses associated with our restructuring and with working capital requirements in the Roundup business.
Depreciation and amortization would be higher than what we expect this year in the $650 million range, reflecting the investments made to expand our production capabilities in seeds and Roundup over the last few years. The remaining driver for free cash flow will be capital expenditures, which I expect will be in the $600 million to $700 million range.
This means more in line with depreciation as we now have a fresh asset base. Taken cumulatively, that means we expect mid-teens growth is going to put us on track to generate significant cash levels in the next few years. Our strong balance sheet puts us in a position to access capital if a significant acquisition opportunity will present itself. So we’ll look to ways to more aggressively deploy the cash we generate directly through our owners with a priority on generating sustainable value over the longer term.
Practically, we continue to seek dividends as a priority mechanism to distribute cash for our share owners as we grow the business. We complement that with the share repurchase program focused on managing dilution now and in the future.
As you can see on slide seven, we expect to complete our current $800 million authorization a year earlier than we expected. And as we announced last month, our Board of Directors approved a new three-year $1 billion plan that we expect to begin in the fourth quarter.
If you take that all in, what matters is how it then forms our opportunity. As I wrap up, I’d tell you that from my vantage point as CFO, what matters going forward is that with the decision last month, that fundamentally changed the Roundup strategy to support our traits business, Monsanto now effectively becomes a pure-play seeds and traits company.
If you look at slide eight, you will see two things. The gross profit contribution this year from the entire Ag Productivity segment will only be about 10% of our total. And as we go forward, the natural growth in our seeds and traits business will make that comparative contribution even less material. That means that seeds and traits growth is what matters.
You will see the historical perspective on our growth. If you focus that snapshot on the last couple of years, the seeds and traits business has been in line with our mid-teens growth trajectory. Taken in combination with our operational plans, that tells me that the opportunity is realistic and attainable. That means in the near term, we shift our focus very intently to execution and on implementing our plan.
With that, let me turn the call over to Hugh who’ll walk you through the key business developments we are currently working on.
Thanks, Carl, and good morning to everybody on the line. As Carl just noted, this is a period for our company where execution matters. We came through a number of business challenges in 2010, and we’ve made the difficult decisions that effectively cleared the decks for our path going forward.
Practically, over the next year, we will be a company that’s clear in our priorities, that’s what we say we will and enhance credibility to our results. To that end, in the short time since we were last with you, there has been a lot of activity on a couple of critical areas that shape our plans and our near-time implementation.
On our second quarter call, I told you that one of the things that informed our strategic decision-making was the direct feedback that we got from our farmer customers. As you would expect, our dialog with farmers is continual and the feedback that we’ve been getting from the most recent conversations is encouraging.
Fundamentally, the feedback that we get loud and clear is that new technology does create value, but they need more products at more price points to allow them to manage the risks that they take everyday on their farm when they try out so many new products that come so quickly. The beauty is it’s always in our control; we don’t have to go out and invent something, we just have to take what we have and work with our customers. I think that’s happening and while I recognize that these are early qualitative indicators, I believe farmers are telling us that we’re addressing the issues that matter and we’re making progress.
So if we take that as a step in the right direction, let me go from there to a couple of the other areas where we feel we’ve made some progress that moves us towards operationalizing some of the key factors for the 2011 season.
Let me begin with Roundup on slide 9. If you look at our quarterly financial statement, you can’t miss the fact that we’ve begun to move on the actions that we outlined for you a little more than four weeks ago. Carl covered the financial relevants, so I won’t belabor the details.
I want to touch on how we see the strategy coming together. First, in the last week, the Chinese government has taken action to remove the value added tax or VAT rebate on glyphosate, that’s a good step forward, covering one of the two big areas of effective Chinese subsidies. This move is another signal pointing to the structural changes that we suggested would occur in an increasingly genetic glyphosate industry.
So in the near term, I really don’t see that changing our forecast or the strategy for Roundup. More importantly, a lot has been written lately about the pending demise of Roundup as an effective herbicide and what that in turn [ph] means for a biotech franchise. I can tell you that’s misplaced, and if anything, there is a new practical opportunity emerging. Basically we felt Roundup as the centerpiece of simple affordable weed control. In the process, it creates the incentive for farmers to proactively get ahead of weed resistance broadly rather than reacting once resistance has become an issue.
I think cotton becomes a bit of a case study for the strategy. Part of the reason that resistance has been delayed in corn is because of the widespread use of multiple herbicides as a part of the standard regiment. As we move forward on our Roundup positioning, this is exactly the practice that we will build on. We will wrap other active ingredients around Roundup to create a complete weed control system. With Roundup coming down in price and with the ability to pair that with effective genetics, that means that for less than what you spend for weed control today a farmer gets a total weed control package that actually fights against weed resistance before it’s ever an issue.
That simple, cost effective weed control program then sets the stage as we transition into multiple modes of action via our next generation biotech traits. The leading edge of that is dicamba tolerance in soybeans. And the early indicators from this years field trials continues to confirm for us that our dicamba control is excellent and will be an ideal complement to our Roundup Ready system.
If we move entirely to the seeds and traits side of the business, there is a couple of areas where we’ve developing some interim data points that inform how we’re thinking about 2011. The first of these is in Roundup Ready 2 Yield where I believe we’re seeing some legitimate momentum coming together, which is captured in slide 10. I recognize that the proof will be in the performance once farmers check their yield monitors this fall, but we’re seeing an increasing number of players make the substantial bet that the performance will be there.
There is no doubt in my mind that farmers aren’t betting against the technology since 40% of our U.S. branded customers are using Roundup Ready 2 Yield this year. But just as importantly, the industry is now validating the technology. Earlier this month, DOW signed on as a commercial licensee for Roundup Ready 2 Yield. We now joined Syngenta as another major soybean player who had the chance to evaluate both Roundup Ready 2 Yield and the competitive options and voted to go with Roundup Ready 2 Yield. And these are decisions that they’ve made with data that they’ve generated independently using competitive comparisons.
The two of these companies are a brand and our licensee partners more than two-thirds of the soybean industry has embraced the new Roundup Ready 2 Yield platform. Likewise, just a couple of weeks ago, an independent insurance provider in the Ag sector unveiled that the biotech yield assurance program for 2011 built on Roundup Ready 2 Yield.
This is a nice incentive for farmers to try Roundup Ready 2 Yield. More importantly, when you make you living on the risk calculation on payouts for crop performance as these guys do, it takes a lot to show this level of support. So the fact that they’ve made the determination that the yield advantage is statistically strong enough to extend greater coverage is another signal I think that the industry isn’t treating Roundup Ready 2 Yield as a possibility, but the likely platform going forward.
The second big area is within our U.S. cotton product strategy. I mentioned that I felt that the feedback that we’ve gotten from our customers has been encouraging, and I’d say that this is particularly true when it comes to the feedback on our cotton product strategy.
If you go to slide 11, I’d assert that deals [ph] in this industry can offer a family of reduced-refuge products in the form of a double stack, a triple stack and an all-in-one eight gene stack. This is a truly differentiated product portfolio, and to be clear, I continue to expect that because of that technological differentiation we will be the premium-priced seed.
Increasingly, that value proposition is really us versus us rather than us versus the competition. So our implementation is focused on getting our relative value propositions against a couple of products right for the grower.
Going forward, we expect our differentiated products will become even more differentiated with refuge in a bag, or RIB. The reality is, these products would represent the industry’s only single bag RIB option. In fact, I’m happy to be able to say that in the last few days, we’ve submitted an application to the U.S. EPA for a 5% RIB for VT Double PRO in the cotton belt.
That means pending EPA approval, we expect to make the leap from refuge-reduction to RIB in both SmartStax and Double PRO beginning in 2012. That’s important because the refuge matters to farmers and it ensures the durability of the technology.
Planting and managing the refuge is complex and it’s inconvenient. But we have just completed new market research that indicates that 97% of growers who use insect protected cotton do plant refuge acres in some configuration. And maybe more importantly, almost half of the farmers indicated that they would be likely to switch brands to get a 5% RIB product because of the simplicity of a single bag solution.
Directly related to that cotton strategy as well as Roundup Ready 2 Yield momentum is our pricing approach. To be blunt, I recognize that one of the biggest areas of outstanding questions revolves around our pricing. In the last couple of weeks, we’ve rolled out our initial trade pricing to our seed licensee partners. So we’ve taken the first step on this pricing journey. And to be fair we’ve intentionally played the specifics of our pricing closer to our breast, because that’s an advantage that we don’t need to offer our competitors.
So if you go to slide 12, you’ll see we’ve given you an indexed look at the gross profit per acre expectations for our complete cotton product strategy. This is the all-in bag price index from a 2010 triple stack and weighted across our zones. So I’m modeling it, and is more directional than is absolute.
But more importantly, I think it illustrates a couple of key things. Most importantly, we’ve done what we said we would. We’ll generally keep prices in line on our triple stacks; we’ve narrowed the premiums for SmartStax to recognize the upfront risk-sharing, and we’re inserting new products into the value ladder.
The same basic premise holds in soybeans. We’ve made the adjustments to our pricing approach for Roundup Ready 2 Yield that gives farmers the incentives to make the leap from Roundup Ready 1. Generally speaking, we’ll give farmers the option of choosing the seed treatment, and we’ll adjust the premium to be closer to Roundup Ready 1.
These are steady-state ranges; so you’ll see that we’ll realize a set change in the margin contribution from SmartStax and Triple PRO over our triple stacks offerings.
In 2011, we’ll actually carry in about a million acres of SmartStax at the higher cost position for this year. The margin uplift then will a bit muted for the launch costs and the carry-in inventory workout [ph] through 2011. Now, for SmartStax, it’s somewhat below its steady-state landing point this coming year.
And that leads me to a quick word about production. By calibrating how we deploy this family, we’ll be able to maximize our summer production for each product while minimizing our higher cost winter production. The benefit is reflected in our margin progression. We will get to these steady-state ranges in 2012, a year earlier than we would have with greater winter production.
With this production approach, we stay on track for a significant ramp-up across the SmartStax family, expecting mid to teens total acreage in 2011. So in terms of the addressable opportunity and our first real year of having this family approach, we will replace almost half of our flagship, triple stack acres. From there, the beauty of this production approach is, we can then use this year’s farmer purchases and grow our feedback to inform how we ramp up each product within the family for 2012 without having to do any extraordinary production.
So if you take all of that together, you get exactly where Carl indicated we’d be even with multiple price points across the market, the average margin that we’ll realize goes up.
Since we were never going to take SmartStax to every acre at equal prices, that average margin benefit is the reason that matching the cost position to the market segment makes good economic sense for us, and more importantly for our grower customers.
And if you build on the direct feedback from farmers with the feedback that came from our licensee partners recently, I tell you that the product strategy and the pricing approach were well received. It’s still early communications, but the feedback suggests that we’ve been responsive and that there’s some excitement building moving forward.
So as we ramp up and step back and then recognize that as good as you can feel at this point, a lot of this only really matters once growers see the products perform and start voting with their purchases. But if I end where I began, if our task is executing on the operating front, those purchases are born off [ph] a lot of the work that gets done well before seeds ever reaches a bag.
And in that regard I feel good about a couple of key things. Firstly, we’ve done what we needed to do with Roundup and will now focus on using our crop protection business to support season trades; and secondly, with the experience and the agility to use our products and our leadership to use 2010 as the pivot point to create mid-teens growth opportunities.
So with that, we’ll turn the call back to Bryan and look forward to your questions.
We’d now like to open the call to your questions. As we typically do, I’ll ask that you please hold your questions to one per person so that we can take questions from as many people as possible. You’re always welcome to rejoin the queue for a follow-up question. With that, Rob, if you don’t mind opening the lines, I think we’re ready to get started.
(Operator Instructions) Our first question comes from the line of Kevin McCarthy with Bank of America.
Kevin McCarthy – Bank of America
I have a two-part question on seed pricing. First part would be what is the all-in pricing assumption that is embedded in your forecast of double digit growth in the seeds and genomics platform, in gross profit terms for fiscal 2011? And the second part would be, more specifically, you had some preliminary talks with your licensees at this point. I was wondering if you could comment on the magnitude of the reduction in the premia for both Roundup Ready 2 Yield seed and SmartStax. And if those premia were ex last year, would they be half of ex or more or less? That kind of color would be helpful.
I’ll maybe cover the second and let Carl talk to the first. The feedback from licensees, you have to be so careful at this time of the year. We’re going to be probably more cautious than we have been traditionally. But the feedback from licensees was very encouraging, because they felt that they had been hurt.
So on SmartStax versus Triples and on Roundup Ready 2 Yield versus Roundup Ready 1, and beans, we gave growers the optionality on seed treatment. It’s my expectation that many of them will go ahead and use that seed treatment, but if they are optioned out.
And that move in itself reduces the premium by about half from where we were previously. It reduces the premium from about $20 to about $10. And then we skin it down, a piece of that remaining 10.
On SmartStax, ballpark, half or more wouldn’t be too far away. It’s probably moving towards that magical number of the one-third to two-third value share. So as we migrate to them these premiums and we look to cotton pricing, the clear feedback that we got on all the modeling that we did after the fact. And we’ve tried our best to drive that one-third/two-third value share. And I anticipate that that’s going to be received well as we run into this fall.
And then your first question. Carl?
Just in terms of general pricing trends, Kevin, Hugh talked about basically the trade platform, but the other thing that impacts the price benefit of the mix effect for next year will be, we will launch our new best hybrids obviously at a premium to what they’re replacing.
But the nuance and the effect is, it’s just not the delta between next year’s price and the previous year’s price; it’s the delta between next year’s price and the four or five-year old hybrids that they’re replacing in the portfolios. So you get a nice lift there as well. So there’s a mix effect on the genetics, as well as a mix effect on the trade upgrade that Hugh mentioned as well.
Kevin McCarthy – Bank of America
Just as a quick follow up to that, as I think about first generation soybeans and triple stack corn, would it be your intention to hold prices stable for the first generation, or prior generation products or make an adjustment?
Broad philosophy, we would anticipate holding them price stable, Kevin. We’ve got one or two geographies, we need to a lot of cleanup. We’d hold stable and key upfront [ph].
Our next question is from the line of Vincent Andrews of Morgan Stanley.
Vincent Andrews – Morgan Stanley
I’m looking at the Roundup gross profit through nine months and it’s minus-103, and you’re still talking about doing $50 million to $200 million for the full year and you didn’t narrow your guidance range, which for a quarter as small as 4Q seems pretty wide. So I guess I’m just wondering how you’re going to do what looks to be $150 million of GP at least in Roundup in the fourth quarter.
You’re right. As has been for a long time, last quarter has ebbs and flows in Roundup. And we’re unevenly distributed, because a lot of our branded business falls in the backhand of the year. And you see Brazil and Argentina wakening up again in the backhand of the year. So, Carl, maybe a lot better color on what that spread looks like and how we see the Roundup business unfold.
As we look at Roundup business for the fourth quarter, I would say there is probably three big variables that are going to drive the performance for the business. Hugh just mentioned one of them, which is we’re very front-loaded with our supply business in the first half of the year and we’re back-loaded with the brand on the second half, obviously which commands higher prices.
The second is the intention is, is that the producer will benefit from our new pricing predominantly in FY ’11 not yet in â€˜10. And then the third one is the timing of the remaining actions around repositioning our Roundup business. But those are the three moving parts that are going to generate that range and that outcome. And that’s why that range is still wide.
Vincent Andrews – Morgan Stanley
Okay. I guess you’re still very comfortable that you can do north of $50 million in the fourth quarter?
Yes, we’re comfortable with the $50 million to $200 million range for the full year on the Roundup business.
Our next question is from the line of Jeff Zekauskas with JPMorgan.
Jeff Zekauskas – JPMorgan
Can you update us on the percentage of corn and the soybean sales that you sell in North America relative to what you sell offshore? What your expectations are for 2010?
I mean just rough numbers in terms of impact on the business, we’re probably two-thirds in North America, one-third rest of the world. And if you include Latin America in that, you’d probably get north of three-quarters, Jeff, in terms of where our corn business is.
Jeff Zekauskas – JPMorgan
And then finally, Carl talked about a number of extra charges that you have this year. But I would imagine that total management compensation expenses, the bonus expenses, is probably down this year. So what’s the delta in terms of compensation expense for 2010?
This year, it’s going to be significantly down, Jeff. So we haven’t broken out and given our results and the performance this year. It’s going to be very similar for bonuses and comp.
The way I think about that kind of in forming 2011, our SG&A guidance that we just gave for 2011, which is inflationary above our current run rate of $2 billion to $2.1 billion, would include a normalized run rate on incentives embedded within that. So an anticipation that we’re going to achieve the desired performance within the business and pay incentives at the target level, and that’s inclusive in that guidance.
And then the only other piece that I would add, Jeff, the one-third, two-third split is really rough. The piece that gets masked is the emerging technology penetration in Brazil and Argentina. So we’ve seen a really, really fast ramp on singles, the doubles. And after 10 years, we’re seeing Brazil approving products at a pretty rapid clip. So that traditional mix will change as we see technification in those cotton markets.
Our next question is from the line of P.J. Juvekar with Citigroup.
P.J. Juvekar – Citigroup
As you lower prices for SmartStax and Roundup Ready 2 Yield, can you give your acreage expectations for those products? Do the acres go up as you lower prices?
P.J., I think if you look at cotton first, I made the comment on us versus us and us versus competition and a piece of this work has been narrowing the premiums between our product offerings and in certain additional products in there. So the way we are with the news today that we’ve now submitted for a double stack with refuge reduction, we’re thinking about that family of refuge reduction products with narrowed premiums between that range to drive file and adoption. We just planned for the production acres in the last few weeks and I’ve seen corn if you look at that whole family, mid teens acres projection for the coming year, and we’ve got a little bit more conservative from the winter production, because of the dramatic effect that it has on margin lift.
So, I think trajectory wise, we’re going to be in the zone. On soybeans, a lot of this is going to be based on what we yield out of those production acres this year. But we’re still seeing mid teens for Roundup Ready 2 Yield. And it’s hard, I think we learned the lesson last year is, it’s been a warm wet season, it’s been spectacular growth. But just like farmers, I’d feel a whole lot better with another six to eight weeks under my belt before I opine on what our yields are going to be.
P J Juvekar – Citi
Okay. And you said that you are going to hold the base pricing on your product. My guess is that your competitors are going to react; they are not going to make it easy for you to take share. So, what are you building in for that and is there any risk that the entire pricing curve in the industry comes down?
I mean I can only speak to my products and my strategies. So, what they choose to do is their call. I think from the research that we’ve done and the conversations that we’ve had, the key for us is to drive adoption and encourage growth, put the foot in the water and try these products. And when we get to that, so, we’ve moved, as you know well, we’ve moved a 50-50 value share. As we dial back to one-thirds, two-thirds I believe that we will see grower adoption. And with grower adoption that performs these technologies we should be in good shape.
So, in each one of these segments, P J, we will continue to be the premium priced product. So, from the perspective of what happens if price spirals, I think we will continue to be premium priced in every single one of these segments, because of performance. And if you think over the last couple of years with flat share growth in corn, we have about a third of the market. Our biggest competitor is about a third of the market. And the remaining companies are the remaining third.
And despite price disparity, we held share. So, the share growth from our biggest competitor came from others. So, I think we’ve done a ton of work in this. We’re still operationalizing and rolling out our sales team. The key for us is sharing the value that we create aggressively and I think that prompts growth despite our premium prices.
P J Juvekar – Citi
And I’m just looking for a clarification. You said that you got rid of dealer incentive programs on Roundup, I just want to make sure I understand that you are keeping the Roundup rewards program or are you getting rid of that as well; thank you.
P J, this is Carl. The key component of the revised or reset Roundup strategy is that when you get pricing approaching generic levels, what you continue to provide the benefits of Roundup rewards, which we will, that makes it a pretty compelling offer relative to the alternatives that are out there.
So, given that in the Americas the purpose of Roundup now is to support our Roundup Ready franchise and Roundup rewards is an integral part of that, we will be maintaining it. In fact, we will be looking for, perhaps, ways to enhance the offering going forward.
Our next question is from the line of Robert Koort of Goldman Sachs.
Robert Koort – Goldman Sachs
Could you talk a little bit about what you think a farmer would need to see in his SmartStax performance this year to embrace the product and want to buy more next year.
So he is looking for a yield improvement over his triples? I guess two or three things; he’s looking for yield improvement over his triples. He knows he had bucks in the field even though he hasn’t seen them for the last couple of years. So, he is hedging on normalized weather and he’s looking for the performance and new hybrids that he hasn’t seen.
The other piece, Rob, as you talk to these guys, a lot of them are maxed out on refuge management. They’ve taken triples as far as they can on their farm and he is looking for the edge on refuge management. But the awareness amongst that community on RIB in 2012, they are absolutely focused on it.
So, I would say, as yield, it’s a quick peak on our new hybrids, which he still hasn’t really had the feel for and it’s that next level of refuge management. Carl, I don’t know ifâ€¦
Yes, that’s exactly right. I mean, the way that a farmer is thinking about it and with what we’ve done with our premiums, a farmer doesn’t need to see more dead bugs in SmartStax versus triples, they just need to get the benefit of refuge reduction, which we built in, regardless of whether it’s a wet year or a dry year.
So, in anticipation of refuge in a bag coming in 2012, with what we’ve done with our premiums we think if there were no additional benefits other than just refuge reduction, this is a pretty compelling opportunity for the farmer.
Robert Koort – Goldman Sachs
And can you just refresh my memory, how many unique isolines were developed for this year on SmartStax versus taking the existing triple and adding it on this SmartStax trade package? And then what does that look like as you go into 2011 in terms of numbers that are available?
The SmartStax were basically new isoline conversions, it’s a different product than what the triple product was in the marketplace. Basically, about 40% of the genetics in SmartStax this year are brand new genetics that aren’t shared with the triple-stack product.
Robert Koort – Goldman Sachs
How many specific hybrids were out in ’10 for these trials and that how many do you think will be out in ’11?
We have dozens this year and we will continue to ramp that up. So, we are not constrained by basically 12, 13-ish, we should have full availability across the whole portfolio.
Our next question is from the line of Sandy Cogman [ph] of Susquehanna Financial Group.
Sandy Cogman – Susquehanna Financial Group
Question around the Ready pricing. How has the increased incidence of glyphosate resistant weeds impacted the perception that farmers had surrounding the value of the Roundup Ready trait in corn, soy and cotton? I mean I understand that you reimbursed some farmers for the cost of additional herbicides to control pigweed in cotton.
As a follow up, what impact will this have on your per acre returns for Roundup Ready cotton and do you anticipate extending this practice to any other crops?
Yes, Sandy, thanks for the question, I’ll start and I’ll let Carl comment. So there has been a lot of coverage on the whole Roundup resistance conversation. Let me try and frame this for you, it’s predominantly an issue of the south; not exclusively, but predominantly.
And within the south it’s predominantly an issue in cotton. So, we see very little incidence in corn. And the reason that you see very little of it in corn is the range of chemistries are applied in corn. And there is a lesson and a learning in that. It’s emerging in soybeans particularly in the south and cotton is the first piece of work to be done.
Our strategy puts it directly at your question on how does this influence this. The grower is looking for help, that’s why I think there is an opportunity here in the emergence of a new category.
And what we are going to work on is defining a handful of products, and by handful I am thinking half a dozen products of which we have two and glyphosate and acetochlor. And those would become the base treatments to manage resistance before it becomes a problem, and the key in this is, offering the grower those half a dozen products at affordable prices. And I think if we can give them a little advice we can drive price discovery and we can help educate that grower and how to fight this rather than using expensive bundled materials you go a long way down the path in solving this in cotton and you head off of the path before it becomes an issue in soy.
So, that’s a piece of our go forward strategy on how we manage Roundup, how we link that to Roundup rewards and how we help the grower with affordable solutions.
Sandy Cogman – Susquehanna Financial Group
If I could just as a quick follow up on this SmartStax in RR2. We have seen at least in Illinois some indications that we have returned to more normal root worm infestation levels. Can you comment in any of the other key growing areas what you are seeing and how this will likely impact yield performance versus the VT Triple. And similarly for RR2, has white mold been less common this year and if so, are you anticipating that that’s going to help your yield results in RR2?
Yes, with a caveat of Scottish optimism, Sandy, white mold is a problem in cold wet years. And this year it’s been wet, with a lot of moisture, but it’s very warm. So far, we haven’t seen any instance of mold emerging, it’s looked like a more normalized year.
And so far, on early, early bug accounts, as you make the point in Illinois, we’re seeing a slight elevation. As I said to an earlier point, we are growing our own seed right now, it’s really-really early in the season.
So it’s probably from some of the earlier leads we’re seeing year earworm could be every bit as much a problem this year as corn root worm, but there is everything to play for still. You can see at this stage, we know we are not loosing but it’s still early to score victory I think.
Your next question is from the line of David Begleiter of Deutsche Asset Management.
David Begleiter – Deutsche Asset Management
Now you’ve dialed back on the value capture to a third, can you start walking up the value capture model in 2012 with higher pricing, and can RIB be an enabler of higher pricing starting 2012?
I had like to deliver on ’11 I think. We owe our owners that and we owe our farm customers that. So I think the key for us in this is, we placed our bets a few weeks ago on seeds that we’re producing. As you say we dialed back, I’d actually say we’ve advanced our thinking and we discovered the one-third, two-third value share. And with that, I think we’ve improved our sentiment and reputation with growers and we win on those head to head tests.
2012 RIB I think has the capacity to be a game changer in growers. And growers are anticipating that. And right on the back of RIB, particularly you know, having applied for the double stack RIB product a few days ago, that becomes the early flagship for drought.
So, I’ll tell what I’m thinking about 11, 12 and 13 is how do we continue to drive unit volume growth? How do we continue to satisfy growers? And how do we deliver innovation on these two new platforms and the platforms will be RIB and Roundup Ready 2 Yield in beans. And I think is way premature to be talking about are we going to be walking prices up. I’d just like to regain momentum that we’ve lost in the last two years.
David Begleiter – Deutsche Asset Management
Understood, but just longer term, do you think farmers are still willing to share half the value with you longer term on your technology?
I think the end points on the value that we create are exactly the same. I think how we get there is probably a more regulated march, but if I take you to 2013, one side of the house you’ve got RIB across all your major products. And you’ve loaded drought on it and you’ve delivered a yet another increment of yield.
And in the other side of the house, you got soybean business that looks a lot like cotton because of multiple stacks. So, then you have soy with dicamba and yield gene in that 13-14 timeframe and we should be first pick for the grower because we deliver more incremental yield than anybody else. And you know, it’s kind of the algebra of if then, if that, then what? I think job one for us is securing the certainty of that yield and then we can talk about that.
Our next question is from the line of Laurence Alexander with Jefferies & Co.
Lucy Watson – Jefferies & Co.
Hi, this is Lucy Watson on for Laurence today. Will it be possible to quantify by segment the cost savings that you’ve achieved so far from restructuring actions?
Basically we share SG&A across the enterprise. If you look at the actions that we did a year ago, those were predominantly directed at the direct SG&A support of the Roundup business. What we’re looking at now is basically the things that I would call the supporting SG&A that’s associated with the business. And those would be the areas that we’re looking at right now for 2011.
Let me comment in a few words about how you project SG&A going forward, because it kind of ties with Vincent’s question. We’re kind of looking at flat SG&A on a year-over-year basis, so we fundamentally shifted that, but we, with the exception of some cost erosion [ph] increases it’s flat, right?
We’re basically $2 billion to $2.1 billion this year. We’re basically seeing inflationary growth on top of that. But if you look at the big benefit that we got from the restructuring we took, it finally changed the slope of our run rate. And we just now fundamentally spend less as a company than the path that we were on in 2008. And if you look at that, the delta between those two run rates over time, there is a huge, huge SG&A avoidance benefit for the company.
Lucy Watson – Jefferies & Co.
Okay, and just a quick follow up on corn if I may. With the, I guess large-step change in your branded portfolio to 75% Triples and SmartStax, it looks like corn gross profits were still down about 10% year-over-year. And I know there were some long tier costs and restructuring in there, but I guess could you just be able to walk us through the year-over-year bridge in a little bit more detail.
It’s a great question. I’ll maybe ask Carl to just do a kind of a brief dissection in this, but were it not for some of the actions that we took this year in corn we would be exactly in line with our expectations. So we took a series of actions, I think clears the decks for 2011 growth. And they were largely conscious and they’re all onetime actions, that I think set us up nicely for next year, but Carl, maybe just kind of higher level in what they were and how they’d reflect on the margins?
Sure, so the way that I think about it is, about a $120 million in actions one-time as you said, it reflected the gross profit line for the business in corn this year. The composition of that 120 would be roughly one-third, some corn hedges that we had that we changed that basically allow us to have lower cost of goods going forward.
And then another third was our domestic corn portfolio to reshape it for the SmartStax family going forward. And the other third is largely international corn, predominantly Brazil, as we transition our portfolio in Brazil from a first generation single trade to our second generation single trade down there. But again, those are one-time effects that we had this year to position the business for growth for 2011.
Hey Rob, this is Bryan. I think we want to save just a minute for Hugh to do a quick wrap up. So if we could transition to that, I think we’d be ready to go.
Thank you, sir. I would now like to turn the floor back over to Mr. Grant for concluding comments.
Again, I’d just like to thank you for joining us on this morning. I think with everything we’ve came through, this is pretty straightforward quarter to report, and that’s a good thing. So there’s now a lot in use, there’s now a lot in new data points. So I guess there’s three things I would leave you with in a quarter like this. First, with the Roundup repositioning, we’ve made a number of significant decisions to improve the predictability of our business performance in Roundup. And I believe a straightforward quarter is the first step in that direction.
Secondly, it’s a year where we made adjustments, and I’m personally encouraged with the feedback from our customers, albeit on a early read on those adjustments and the course that we are on for next year. So it doesn’t guarantee success, but I think that’s some very good early indicators.
And thirdly, while there’s work to do closing out 2010, as a team we are increasingly turning our attention to 2011. And I feel very good about the product plan, the pricing, the operational focus, and the opportunities going into 2011 for our prospects, and delivering consistent annual earnings growth in the mid-teens.
So we hope that many of you will be able to join us in August for our Whistle Stop event which this year is in Nebraska, to see both our cotton products and some of our pipeline technologies in the field. So, until then, thanks very much for your support and for your time this morning.
This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.