AMERICAN VANGUARD CORP (AVD) FY 2023 MD&A

ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS/RISK FACTORS:

The Company, from time-to-time, may discuss forward-looking statements including assumptions concerning the Company’s operations, future results and prospects. Generally, “may,” “could,” “will,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue” and similar words identify forward-looking statements. Forward-looking statements appearing in this Report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on our current expectations and are subject to risks and uncertainties that can cause actual results and events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions contained in the entire Report. Such factors include, but are not limited to: product demand and market acceptance risks; the effect of economic conditions; weather conditions; changes in regulatory policy; the impact of competitive products and pricing; changes in foreign exchange rates; product development and commercialization difficulties; capacity and supply constraints or difficulties; availability of capital resources; general business regulations, including taxes and other risks as detailed from time-to-time in the Company’s reports and filings filed with the U.S. Security and Exchange Commission (“SEC”). It is not possible to foresee or identify all such factors. We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Report.

The discussion and analysis of our financial condition and results of operations for 2023, as compared to 2022, appears below. As permitted by SEC rules, we have omitted the discussion and analysis of our financial condition and results of operations for 2022 compared to 2021. See Item 7, “Management’s Discussions and Analysis of Financial Condition and Results of Operations”, in our Annual Report on Form 10-K for the year ended December 31, 2022, filed on March 16, 2023 for this discussion.

MANAGEMENT OVERVIEW

The Company’s performance in 2023 declined as compared to the prior year due primarily to three factors: first customers in many regions implemented destocking directives in order to limit their carrying costs of inventory, second, weakening economic conditions in China manifested themselves in a glut of low-priced generic products in many regions, and third, supply chain constraints affecting one key product.

Within this context, the Company experienced a drop in overall sales of approximately 5%, with domestic sales down 6% and international sales down 4%. The unavailability of two high margin products, Aztec and Dacthal, due to supply issues in the first half of 2023, accounted for much of the drop in consolidated sales. With the resumption of production of those products, the Company’s US crop business, and the Company as a whole, generated much stronger sales performance in the fourth quarter of 2023.

Cost of sales dropped by about 4% on lower sales in 2023 compared to 2022. Factory performance generated higher net expense as compared to 2022, due largely to the unavailability of raw materials and reduced demand from destocking activity early in the year. As a result, gross margin percent dropped to 31% in 2023 from 32% as compared to the prior year.

Operating expenses rose by about 2% in 2023, as compared to 2022, due primarily to increased selling expenses and regulatory costs, partially offset by reduced general and administrative costs including recording no short-term incentive compensation expense. Further, operating expenses as a percent of net sales rose to 27% in 2022, compared to 25% in 2022. With lower sales during the first three quarters of 2023 in the face of reduced demand and product unavailability, the Company’s average indebtedness rose to $167,976 ($117,705 last year) and, coupled with significantly higher interest rates, interest expense for the year rose sharply. Sales activity in the fourth quarter coupled with customer pre-pay activity enabled the Company to lower inventory and reduce indebtedness by year-end. On a full-year basis, the Company generated net income of $7,519 (or $0.26 per share) which, while down from that of the prior year ($27,404 or $0.92 per share), represents a significant rebound from the first three quarters of 2023. Details of our financial performance are set forth below.

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Results of Operations

2023 Compared with 2022:

Net sales of our U.S. crop business were about 7% lower than those of the prior year. This performance was driven by several factors. The pacing of procurement in the domestic distribution channel relaxed from the strong purchasing practices of 2022 to more of a just-in-time approach in 2023, as higher interest rates increased the carrying cost of channel inventories, prompting distributors and retailers to respond with widespread destocking efforts. Additionally, our herbicide business was negatively affected by the supply-chain unavailability of Dacthal (for use on high-value crops, including onions) and increased competitive pressure on our Impact post-emergent corn herbicide brand caused by the steep decline in prices of many non-specific herbicides. Conversely, we experienced strong year-over-year sales of our granular soil insecticide products (including Aztec, Force, and Thimet). Our cotton products saw solid demand for our Bidrin foliar insecticides and a modest decline for our Folex harvest defoliant, as compared to 2022. We also recorded stronger sales of our soil fumigants (for use on a wide range of fruit and vegetables).

Net sales of our U.S. non-crop business were down about 2%. This decline was driven largely by a nationwide pattern of customer inventory destocking and purchasing control measures designed to deal with the challenge of high interest rate carrying costs. Net sales from our OHP nursery and ornamental business were slightly below those of 2022, as US consumer demand for plant materials softened. Sales of insecticides for commercial applications firmed during the year, as the professional pest-control market gradually regained more normal pre-pandemic levels.

Net sales of our international businesses decreased by 4% in 2023 vs. 2022. During 2023, our international group continued to integrate two important new businesses, AgNova in Australia and Agrinos biological products in more than a half dozen countries worldwide. We experienced a slight sales decline in our Central American businesses due to persistent drought conditions in Panama and a very significant influx of generic Chinese crop protection products which created a difficult pricing environment. Internationally, we experienced slightly lower demand for our soil fumigants due to increased Asian competition, partially offset by higher sales of herbicides. We saw a large increase in sales of our Counter nematicide in Brazil and in Mexico. Our Mocap brand improved sales in Mexico and Korea, while our Nemacur soil insecticide grew sales in Mexico, Argentina, and Taiwan.

Overall costs of sales declined by 4% across our U.S. crop, U.S. non-crop and international, which is roughly equivalent to the 5% average decline in net sales across those businesses.

Operating expenses increased by $4,132 in 2023, to $155,869 or 27% of net sales, as compared to $151,737 or 25% in 2022. The differences in operating expenses by department are as follows:

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Selling expenses increased by 7% to $56,015 for the year ended December 31, 2023, as compared to $52,512 in 2022. This included inflation related increased wages, additional people and expenses associated with the newly acquired AgriCenter business in Ecuador, and increased costs associated with travel expenses as the sales teams work to grow the global business.

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General and administrative expenses decreased by 10% to $47,049 for the year ended December 31, 2023, as compared to $51,671 in 2022. During the year, we increased our accruals for potential bad debts primarily related to our Latin American business. That increase in cost was more than offset by reduced incentive compensation expense driven by the Company's financial performance and lower legal costs.

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The Company spent $541 in fees associated with our Proxy defense activities in 2023, as compared to $1,785 for the year ended December 31, 2022.

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Amortization expense declined in 2023 as compared to 2022 as a result of fully amortized assets.

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Research, product development and regulatory expenses increased by 19% to $38,025 in 2023, as compared to $31,816 in 2022. The main drivers were increases in our product development costs, primarily resulting from increased international regulatory activities and work in support of our SIMPAS/ULTIMUS technology platform. In addition, wages and travel expenses increased in support of our business.

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Transformation costs relate to the Company’s digital and structural transformation project. The digital transformation effort is intended to ensure that business process owners have access to current and complete data that has been generated through standardized processes. The structural transformation effort is intended to improve operating leverage by applying business analytics to current operations, structures, products and services. The Company hired a Chief Transformation Officer to steer and drive the project. In addition, the Company engaged a Human Resources consultant to help plan, overhaul and update the Company's Human Resources processes. Further, Kearney Management Consulting is assisting the Company in navigating the project to gain the maximum benefit at the earliest possible time.

In July 2020, the Company made a strategic investment in Clean Seed Inc. (Clean Seed) in the amount of $1,190. The investment is carried at fair value and is included in other assets on the Company’s consolidated balance sheets. The Company recorded losses related to Clean Seed’s change in fair value in the amount of $359 and $732 in 2023 and 2022, respectively. These losses are included in change in fair value of equity investments on the Company’s consolidated statements of operations.

Net interest expense was $12,639 in 2023, as compared to $3,954 in 2022. Interest costs are summarized in the following table:

The Company’s average debt for the year ended December 31, 2023, was $167,976, as compared to $117,705 for the year ended December 31, 2022. The increase in average debt can be in large part attributed to the global agriculture market moving from buying early (during 2021 and 2022) to buying as close as possible to time of use. This effective destocking of the channel was a global Ag market reaction to high interest rates and the drive by distribution to push working capital back to manufacturers. Our effective interest rate on our senior credit facility increased to 7.4%, as compared to 3.6% in 2022.

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Our provision for income taxes for 2023 was $2,778, as compared to $8,561 for 2022. The effective tax rate for 2023 was 27.0%, as compared to 23.8% in 2022. The increase of the effective tax rate in 2023, as compared to 2022, was primarily due to reductions in income before provision for income taxes, release of certain uncertain tax positions due to statute of limitation expirations in 2022 and an increase in the change in valuation allowance recorded through the income statement in 2023, partially offset by a one-time tax benefit associated with the migration of certain Intellectual Property to the U.S..

The Company is subject to U.S. federal income tax as well as to income tax in multiple state jurisdictions. Federal income tax returns of the Company are subject to Internal Revenue Service (“IRS”) examination for the 2020 through 2022 tax years. State income tax returns are subject to examination for the 2019 through 2022 tax years. The Company has other foreign income tax returns subject to examination.

Net income was $7,519 or $0.27 per basic share and $0.26 per diluted share in 2023, as compared to $27,404 or $0.94 per basic share and $0.92 per diluted share in 2022.

Liquidity and Capital Resources

The Company used $58,748 of cash in operating activities during the year ended December 31, 2023, as compared to cash provided by operating activities of $57,105 in the prior year. Included in the $58,748 are net income of $7,519, plus non-cash depreciation, amortization of intangibles and other long-term assets in the amount of $23,534, amortization of deferred loan fees and discounted liabilities of $254, and provision for bad debts in the amount of $1,935. In addition, stock-based compensation of $6,139, change in fair value of investments of $359, change in value of deferred income taxes of $9,710, change in value for uncertain tax positions or unrecognized tax benefits of $508, non-cash lease expense of $256 and net foreign currency adjustment of $581, resulted in net cash provided by operating activities (prior to changes in assets and liabilities associated with operations, net of business combinations) of $29,713 as compared to $55,529 for the same period of 2022.

The Company’s working capital increased by $79,560 at December 31, 2023, accounts receivable increased by $20,278, inventories increased by $27,315, tax receivable, net decreased by $3,568, and prepaid expenses decreased by $1,269. Deferred revenue decreased by $45,079, driven by customer decisions to make early payments in return for early cash incentive programs. Our accounts payable balances decreased by $2,287, program accruals decreased by $7,244 and other payables and accrued expenses decreased by $5,066.

With regard to our program accrual, the year-over-year change is primarily driven by the mix of product line sales and customers in 2023, as compared to the prior year. The Company accrues programs in line with the growing season upon which specific products are targeted. Most of our programs relate to domestic sales. Typically, domestic crops have a growing season that ends on August 31st of each year. During 2023, the Company made accruals in the amount of $93,264 and made payments in the amount of $85,931. During 2022, the Company made accruals in the amount of $111,649 and made payments in the amount of $114,151.

Cash used for investing activities amounted to $17,017 for the year ended December 31, 2023, as compared to $14,470 in 2022. In 2023, the Company spent $11,878 on capital expenditures primarily focused on continuing to invest in manufacturing infrastructure to expand production efficiency and capabilities, spent $186 on registrations and patents and received $242 in disposal of fixed assets. In 2023, the Company spent $5,195 in business acquisitions including intangible assets, goodwill, working capital and fixed assets as well as patent application costs and $650 in product acquisition.

During the year ended December 31, 2023, financing activities provided $66,737, as compared to $38,260 used during the prior year. This included making net borrowings of $86,600 on the Company’s senior credit facility during the year ended December 31, 2023, as compared to a net repayment of $1,000, in 2022. During 2023, the Company paid dividends to stockholders amounting to $3,384, as compared to $2,787 in 2022. Further, the Company used $15,539 to repurchase common stock in 2023, as compared to $34,002 in 2022. The Company also made payment of $68 in 2022 for contingent consideration where no such payment occurred in 2023.

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The Company has long-term debt as of December 31, 2023 and 2022 relating to a senior credit facility as summarized in the following table:

The deferred loan fees as of December 31, 2023 are included in other assets on the consolidated balance sheets.

The Company and certain of its affiliates are parties to a senior credit facility agreement entitled the “Third Amended and Restated Loan and Security Agreement” dated as of August 5, 2021 (the “Credit Agreement”), which is a senior secured lending facility among AMVAC, the Company’s principal operating subsidiary, as Agent (including the Company and AMVAC BV), as "Borrowers", on the one hand, and a group of commercial lenders led by BMO Bank, N.A. (formerly Bank of the West) as administrative agent, documentation agent, syndication agent, collateral agent and sole lead arranger, on the other hand. The Credit Agreement consists of a line of credit of up to $275,000, an accordion feature of up to $150,000, a letter of credit and swingline sub-facility (each having limits of $25,000) and has a maturity date of August 5, 2026. The Credit Agreement amended and restated the previous credit facility, which had a maturity date of June 30, 2022. With respect to key financial covenants, the Credit Agreement contains two: namely, borrowers are required to maintain a Total Leverage (“TL”) Ratio of no more than 3.5-to-1, during the first three years, stepping down to 3.25-to-1 as of December 31, 2024, and a Fixed Charge Coverage Ratio ("FCCR") of at least 1.25-to-1. In addition, to the extent that it completes acquisitions totaling $15 million or more in any 90-day period, AMVAC may step-up the TL Ratio by 0.5-to-1, not to exceed 4.00-to-1, for the next three full consecutive quarters. Acquisitions below $50 million do not require Agent consent.

The Company’s borrowing capacity varies with its financial performance, measured in terms of Consolidated EBITDA as defined in the Credit Agreement, for the trailing twelve-month period. Under the Credit Agreement, revolving loans bear interest at a variable rate based, at borrower’s election with proper notice, on either (i) London Interbank Offered Rate ("LIBOR") plus the “Applicable Margin” which is based upon the Total Leverage (“TL”) Ratio (“LIBOR Revolver Loan”) or (ii) the greater of (x) the Prime Rate, (y) the Federal Funds Rate plus 0.5%, and (z) the Daily One-Month LIBOR Rate plus 1.00%, plus, in the case of (x), (y) or (z) the Applicable Margin (“Adjusted Base Rate Revolver Loan”). The Company and the Lenders entered into an amendment to the Credit Agreement, effective March 9, 2023, whereby LIBOR was replaced by the Secured Overnight Financing Rate ("SOFR") with a credit spread adjustment of 10.0 bps for all SOFR periods. The revolving loans now bear interest at a variable rate based at our election with proper notice, on either (i) SOFR plus 0.1% per annum and the “Applicable Margin” or (ii) the greater of (x) the Prime Rate, (y) the Federal Funds Rate plus 0.5%, and (z) the Daily One-Month SOFR Rate plus 1.10%, plus, in the case of (x), (y) or (z) the Applicable Margin (“Adjusted Base Rate Revolver Loan”). Interest payments for SOFR Revolver Loans are payable on the last day of each interest period (either one-, three- or six- month periods, as selected by the Company) and the maturity date, while interest payments for Adjusted Base Rate Revolver Loans are payable on the last business day of each month and the maturity date.

On November 7, 2023, the Company entered into Amendment Number Six to the Third Amended Loan and Security Agreement that provided relief in respect of both financial covenants. Specifically, with respect to the Maximum Total Leverage Ratio, the existing ratio of 3.5 through September 30, 2024 and 3.25 through December 31, 2024 and thereafter was changed to 5.5 through September 30, 2023, 4.5 for the periods ending December 31, 2023 and March 31, 2024, 4.0 for the period ending June 30, 2024, 3.5 through September 30, 2024 and returning to 3.25 from December 31, 2024 and thereafter. In addition, the Minimum Fixed Charge Coverage Ratio was changed from 1.25 to 1.0 for the periods ending September 30, 2023, December 31, 2023 and March 31, 2024 and returning to 1.25 for the period ending June 30, 2024 and thereafter. Further, after the delivery of financial statements and a covenant compliance certificate for the period ended December 31, 2023 assuming Total Leverage is less than 2.75, then Borrowers may terminate the covenant modification period (“CMP”) and revert to the terms of the existing Credit Agreement. Further, for the duration of the CMP, the Company is restricted from making share repurchases. Finally, the Applicable Margin (SOFR and Adjusted Base Rate) and Letter of Credit fees increase by 0.50 basis points for each tier of interest during CMP. The interest rate on December 31, 2023, was 8.33%.

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As of December 31, 2023, the Company is deemed to be in compliance with its financial covenants.

According to the terms of the Credit Agreement, as amended, and based on our performance against the most restrictive covenant listed above, the Company had the capacity to increase its borrowings by up to $115,002 and $200,372 as of December 31, 2023 and December 31, 2022, respectively. Furthermore, at December 31, 2023, the Company’s leverage, as defined in the Credit Agreement, was 2.46.

The Company believes that the combination of its cash flows from future operations, current cash on hand and the availability under the Company’s credit facility will be sufficient to meet its working capital and capital expenditure requirements and will provide the Company with adequate liquidity to meet its anticipated operating needs for at least the next 12 months from the issuance of these consolidated financial statements. Although operating activities are expected to provide cash, to the extent of growth in the future, its operating and investing activities will use cash and, consequently, this growth may require the Company to access some or all of the availability under the credit facility. It is also possible that additional sources of finance may be necessary to support additional growth.

Recently Issued Accounting Guidance

Please refer to Note 1 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for recently issued and adopted accounting standards.

CRITICAL ACCOUNTING ESTIMATES

The preparation of our consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

The Company’s critical accounting estimates include:

Current Expected Credit Losses —The Company maintains an allowance to cover its Current Expected Credit Losses ("CECL") on its trade receivables, other receivables and contract assets arising from the failure of customers to make contractual payments. The Company estimates credit losses expected over the life of its trade receivables, other receivables and contract assets based on historical information combined with current conditions that may affect a customer’s ability to pay and reasonable and supportable forecasts. In most instances, the Company’s policy is to write-off trade receivables when they are deemed uncollectible. The vast majority of the Company's trade receivables, other receivables and contract assets are less than 365 days. Under the CECL impairment model, the Company develops and documents its allowance for credit losses on its trade receivables based on multiple portfolios. The determination of portfolios is based primarily on geographical location, type of customer and receivables aging.

Inventories — The Company values its inventories at lower of cost or net realizable value. Cost is determined by the first-in, first-out (“FIFO”) or average cost method, including, as appropriate, raw materials, labor, factory overhead and subcontracting services. The Company writes down its inventory to the net realizable value following assessments of slow-moving and obsolete inventory and other annual adjustments to ensure that our standard costs continue to closely reflect actual manufacturing cost.

Intangible Assets—The primary identifiable intangible assets of the Company relate to assets associated with its product and business acquisitions. All of the Company’s intangible assets have finite lives and are amortized. The estimated useful life of an identifiable intangible asset is based upon a number of factors including the effects of demand, competition, and expected changes in the marketability of the Company’s products.

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Business Combinations—The Company uses its best estimates and assumptions to assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. The Company’s estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed, with the corresponding offset to goodwill or an adjustment to the gain from a bargain purchase. In addition, uncertain tax positions and tax-related valuation allowances are initially recorded in connection with a business combination as of the acquisition date. The Company continues to collect information and re-evaluates these estimates and assumptions quarterly and records any adjustments to the Company’s preliminary estimates to goodwill provided that the Company is within the measurement period. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in the Company’s consolidated statement of operations.

From time to time, certain of our acquisition agreements include contingent earn-out arrangements, which are generally based on the achievement of future income thresholds. The fair values of these earn-out arrangements are included as part of the purchase price of the acquired companies on their respective acquisition dates. For each transaction, we estimate the fair value of contingent earn-out payments as part of the initial purchase price and record the estimated fair value of contingent consideration as a liability on the consolidated balance sheets.

The Company reviews and re-assesses the estimated fair value of contingent consideration on a quarterly basis until the contingent period ends, and the updated fair value could be materially different from the initial estimates or prior quarterly amounts. Changes in the estimated fair value of our contingent earn-out liabilities are reported in operating results.

Asset Acquisitions—If an acquisition of an asset or group of assets does not meet the definition of a business, the transaction is accounted for as an asset acquisition rather than a business combination. An asset acquisition does not result in the recognition of goodwill and transaction costs are capitalized as part of the cost of the asset or group of assets acquired. The Company uses its best estimates and assumptions to assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. In most cases, the Company engages third party valuation specialists to assist the Company in its assessment. The acquisitions costs are allocated to the assets acquired on a relative fair value basis. From time to time, certain of our acquisition agreements include contingent earn-out arrangements, which are recognized only when the contingency is resolved, and the consideration is paid or becomes payable.

Goodwill—The Company reviews goodwill for impairment utilizing either a qualitative or quantitative assessment. If the Company decides that it is appropriate to perform a qualitative assessment and concludes that the fair value of a reporting unit more likely than not exceeds its carrying value, no further evaluation is necessary. If the Company performs a quantitative assessment, the Company compares the fair value of a reporting unit with its carrying value and recognizes an impairment charge for the amount that the carrying amount exceeds the reporting unit’s fair value. The Company annually tests goodwill for impairment at the beginning of the fourth quarter, or earlier if triggering events occur. Fair value determinations require considerable judgment and are sensitive to inherent uncertainties and changes in estimates and assumptions regarding revenue growth rates, gross margins, expenses, capital expenditures, working capital requirements, tax rates, terminal growth rates, discount rates, and synergies available to market participants. As of October 1, 2023, the Company conducted its most recent annual impairment test by quantitively testing goodwill assigned to its domestic and international reporting units. Based on the results of the quantitative test, the Company concluded that the fair value of both the domestic and international reporting units exceed their respective carrying value. The fair value of the domestic and international reporting units exceeded the carrying value by 18% and 9%, respectively. As of December 31, 2023, the goodwill related to the domestic and international reporting units amounted to $9,132 and $42,067, respectively. The carrying value of both reporting units is mainly sensitive to discount rates, the projected net sales growth rates, gross margin improvements, and terminal growth rates. Negative deviations from the Company’s projections and assumptions used in its quantitative impairment test may result in an impairment.

Impairment—The carrying values of long-lived assets other than goodwill are reviewed for impairment annually and/or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. The Company evaluates recoverability of an asset group by comparing the carrying value to the future undiscounted cash flows that it expects to generate from the asset group. If the comparison indicates that the carrying value of an asset group is not recoverable, measurement of the impairment loss is based on the fair value of the asset. There were no circumstances that would indicate any impairment of the carrying value of these long-lived assets and no material impairment losses were recorded in 2023, 2022, or 2021.

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Income taxes—Income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best estimate of current and future taxes to be paid. The Company is subject to income taxes in the U.S. and several foreign jurisdictions. The Company assessed the ability to realize deferred tax assets and determined that based on the available evidence, including a history of taxable income and estimates of future taxable income, it is more likely than not that the net deferred tax assets relating to the Company’s operations in Brazil, Spain, Singapore and Ukraine will not be realized and a full valuation allowance has been recorded in those jurisdictions. Significant management judgment is required in determining the provision for income taxes and deferred tax assets and liabilities. In the event that actual results differ from these estimates, we will adjust these estimates in future periods, which may result in a change in the effective tax rate in a future period. Accounting for income taxes involves uncertainty and judgment on how to interpret and apply tax laws and regulations within the Company’s annual tax filings. Such uncertainties from time to time may result in a tax position that may be challenged and overturned by a tax authority in the future, which could result in additional tax liability, interest charges and possibly penalties. The Company classifies interest and penalties as a component of income tax expense.