PYXUS INTERNATIONAL, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Readers are cautioned that the statements contained in this report regarding expectations of our performance or other matters that may affect our business, results of operations, or financial condition are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. These statements, which are based on current expectations of future events, may be identified by the use of words such as "strategy," "expects," "continues," "plans," "anticipates," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. These statements also may be identified by the fact that they do not relate strictly to historical or current facts. If underlying assumptions prove inaccurate, or if known or unknown risks or uncertainties materialize, actual results could vary materially from those anticipated, estimated, or projected. These risks and uncertainties include those discussed in this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the year ended March 31, 2022 and in our other filings with the Securities and Exchange Commission. These risks and uncertainties include: • risks related to the Company's indebtedness, including that the Company has substantial debt which may adversely affect it by limiting future sources of financing, interfering with its ability to pay interest, and principal on its indebtedness and subjecting it to additional risks, the Company requires a significant amount of cash to service indebtedness and its ability to generate cash depends on many factors beyond its control, the Company may not be able to refinance or renew its indebtedness, which may have a material adverse effect on its financial condition, the Company may not be able to satisfy the covenants included in its financing arrangements, which could result in the default of its outstanding debt obligations, and despite current indebtedness levels, the Company may still be able to incur substantially more debt, which could exacerbate further the risks associated with its significant leverage; • risks and uncertainties relating to the Company's liquidity, including but not limited to: whether foreign lenders that have provided short-term operating credit lines to fund leaf tobacco operations at the local level cease to provide such funding, uncertainty and continuing risks associated with the Company’s ability to achieve its goals and continue as a going concern, and unanticipated developments with respect to liquidity needs and sources of liquidity could result in a deficiency in liquidity; • risk and uncertainties related to the Company’s leaf tobacco operations, including changes in the timing of anticipated shipments, changes in anticipated geographic product sourcing, changes in relevant capital markets affecting the terms and availability of short-term seasonal financing, political instability, currency and interest rate fluctuations, the impact of high inflation, shifts in the global supply and demand position for tobacco products, changes in tax laws and regulations or the interpretation of tax laws and regulations, resolution of tax matters, adverse weather conditions, the impact of climate change on weather patterns in tobacco-growing regions, the impact of disasters or other unusual events affecting international commerce, the impacts of potential international sanctions on the Company's ability to sell or source tobacco in certain regions, potential changes in governmental regulations applicable to tobacco products, and changes in costs incurred in supplying products and related services; and • risks and uncertainties related to the COVID-19 pandemic, including possible delays in shipments of leaf tobacco, including from the closure or restricted activities at ports or other channels, disruptions to the Company’s operations or the operations of suppliers and customers resulting from restrictions on the ability of employees and others in the supply chain to travel and work, border closures, determinations by Pyxus or shippers to temporarily suspend operations in affected areas, whether the Company’s operations that have been classified as "essential" under various governmental orders restricting business activities will continue to be so classified or, even if so classified, whether site-specific health and safety concerns related to COVID-19 might otherwise require operations at any of the Company's facilities to be halted for some period of time, negative consumer purchasing behavior with respect to the Company’s products or the products of its leaf tobacco customers during periods of government mandates restricting activities imposed in response to the COVID-19 pandemic, and the extent to which the impact of the COVID-19 pandemic on the Company’s operations and the demand for its products may not coincide with impacts experienced in the United States due to the international scope of its operations, including in emerging and other markets in which the Company operates where the timing and severity of COVID-19 outbreaks and the pace of COVID-19 vaccinations may differ from those in the United States. We do not undertake to update any forward-looking statements that we may make from time to time. -22- Executive Summary We have experienced strong demand thus far in fiscal 2023. As expected, our first quarter was consistent with the prior fiscal year, with increased demand and more normalized timing of shipments from Asia, partially offset by the timing of shipments from Africa and South America. As of June 30, 2022, our inventory increased $126.0 million compared to the prior year primarily due to higher new crop green tobacco prices and processing costs in South America, and accelerated new crop buying activities in certain key markets. In addition, our processed tobacco inventory continues to be more than 90% committed to specific customers. The overall increase in inventory and our committed inventory levels for processed tobacco position us to meet near-term demand and we expect to see stronger shipments in subsequent quarters in fiscal 2023, consistent with historical trends. Despite higher green tobacco prices and processing costs in South America, we were able to effectively manage our working capital to meet our purchasing goals for the current crop cycle. Crop sizes in certain markets in Africa, Asia, and South America are below expectations due to the adverse impacts of prevailing La Nina weather patterns during the growing season, which has exacerbated supply shortages. We continue to engage with customers in transparent dialogue regarding the impact of inflation and La Nina on our business. In response to these and other market dynamics, we accelerated buying activities in certain key markets, and continued to invest in research trials, local programs, and additional training for our global agronomy team to further support our efforts to maximize grower efficiencies and yield despite unpredictable weather patterns. Moving forward, we are committed to recovering crop sizes, and aligning volumes in future years with customer expectations, as we work to deliver stakeholder value, and together, grow a better world. Overview Historically, Pyxus’ core business has been as a tobacco leaf merchant, purchasing, processing, packing, storing and shipping tobacco to manufacturers of cigarettes and other consumer tobacco products throughout the world. Through our predecessor companies, we have a long operating history in the leaf tobacco industry with some customer relationships beginning in the early 1900s. We are committed to responsible crop production that supports economic viability for the supplier, provides a safe working atmosphere for those involved in crop production and minimizes negative environmental impact. Our agronomists maintain frequent contact with suppliers prior to and during the growing and curing seasons to provide technical assistance to improve the quality and yield of the crop. Throughout the entire production process, from seed through processing and final shipment, our SENTRI® traceability system provides clear visibility into how products are produced throughout the supply chain, supporting product integrity. We also provide agronomy expertise for growing leaf tobacco in numerous markets. Our contracted tobacco grower base produces a significant volume of non-tobacco crop utilizing the agronomic assistance that our team provides. Pyxus works with our grower base, as needed, to find markets for these crops as part of our ongoing efforts to improve farmer livelihoods and the communities in which they live. Historically, the Company had nine operating segments that were organized by product category and geographic area and were aggregated into three reportable segments for financial reporting purposes: Leaf - North America, Leaf - Other Regions, and Other Products and Services. During year ended March 31, 2022, the Company reevaluated its operating and reportable segments under ASC Topic 280 - Segment Reporting . As a result of this reevaluation, effective during the fourth quarter of the year ended March 31, 2022, the Company has eight operating segments organized by geographic area and product category and are aggregated into one reportable segment for financial reporting purposes: Leaf. An All Other category is included for purposes of reconciliation of the results of the Leaf reportable segment to the consolidated results. See " Note 1. Basis of Presentation and Summary of Significant Accounting Policies " for additional information. -23- Results of Operations Three Months Ended June 30, 2022 and 2021 Change (in millions, except per kilo amounts) Three months ended June 30, 2022 Three months ended June 30, 2021 $ % Sales and other operating revenues $ 343.9 $ 333.3 10.6 3.2 Cost of goods and services sold 303.2 291.2 12.0 4.1 Gross profit* 40.8 42.1 (1.3) (3.1) Selling, general, and administrative expenses 34.6 33.8 0.8 2.4 Other income, net 1.1 0.2 0.9 450.0 Restructuring and asset impairment charges 0.3 0.2 0.1 50.0 Operating income* 7.0 8.2 (1.2) (14.6) Loss on deconsolidation/disposition of subsidiaries 0.6 — 0.6 100.0 Interest expense, net 25.5 26.8 (1.3) (4.9) Income tax benefit 0.9 8.4 (7.5) (89.3) Income (loss) from unconsolidated affiliates 3.7 (1.4) 5.1 364.3 Net income (loss) attributable to noncontrolling interests 0.2 (0.1) 0.3 300.0 Net loss attributable to Pyxus International, Inc. $ (14.7) $ (11.5) (3.2) (27.8) Leaf: Sales and other operating revenues $ 322.9 $ 311.7 11.1 3.6 Tobacco costs 266.0 251.8 14.2 5.6 Transportation, storage, and other period costs 20.6 21.5 (0.9) (4.1) Total cost of goods sold 286.6 273.3 13.3 4.9 Product revenue gross profit 36.3 38.5 (2.2) (5.7) Product revenue gross profit as a percent of sales 11.2 % 12.3 % Kilos sold 72.1 69.1 3.0 4.3 Average price per kilo $ 4.48 $ 4.51 (0.03) (0.7) Average cost per kilo 3.98 3.96 0.02 0.5 Average gross profit per kilo 0.50 0.55 (0.05) (9.1) Processing and other revenues $ 17.7 $ 18.1 (0.4) (2.1) Processing and other revenues costs of services sold 12.5 12.4 0.2 1.2 Processing and other gross profit 5.2 5.7 (0.5) (9.2) Processing and other gross profit as a percent of sales 29.3 % 31.6 % All Other: Sales and other operating revenues $ 3.3 $ 3.4 (0.2) (4.5) Cost of goods and services sold 4.0 5.5 (1.5) (27.5) Gross loss (0.7) (2.1) 1.4 65.7 Gross loss as a percent of sales (21.6) % (60.2) % * Amounts may not equal column totals due to rounding -24- Sales and other operating revenues increased $10.6 million , or 3.2%, to $343.9 million for the three months ended June 30, 2022 from $333.3 million for the three months ended June 30, 2021. This increase was primarily due t o a 4.3% increase in leaf volume driven by greater demand and more normalized timing of shipments from Asia. This increase was partially offset by the timing of shipments from Africa and South America. Cost of goods and services sold increased $12.0 million, or 4.1%, to $303.2 million for the three months ended June 30, 2022 from $291.2 million for the three months ended June 30, 2021. This increase was mainly due to the increase in sales and other operating revenues. Gross profit decreased $1.3 million, or 3.1%, to $40.8 million for the three months ended June 30, 2022 from $42.1 million for the three months ended June 30, 2021. Gross profit as a percent of sales decreased to 11.9% for the three months ended June 30, 2022 from 12.6% for the three months ended June 30, 2021. These decreases were driven by delayed shipments from Africa and South America and were partially offset by accelerated shipments from Asia. Income tax benefit decreased $7.5 million, or 89.3%, to $0.9 million for the three months ended June 30, 2022 from $8.4 million for the three months ended June 30, 2021. The decrease was driven by the Company utilizing a different method for estimating tax expense (benefit) for the period ended June 30, 2022. Using the discrete method for the period ended June 30, 2022, the Company determined current and deferred income tax expense (benefit) as if the interim three-month period was a year-end period, which resulted in the recognition of the fiscal 2023 year-to-date benefit in the quarter. Refer to See " Note 4. Income Taxes " to the "Notes to Condensed Consolidated Financial Statements" for additional information. -25- Liquidity and Capital Resources Overview Our primary sources of liquidity are cash generated from operations, cash collections from our securitized receivables, and short-term borrowings under our foreign seasonal lines of credit. Our liquidity requirements are affected by various factors from our core tobacco leaf business, including crop seasonality, foreign currency and interest rates, green tobacco prices, customer mix, crop size, and quality. Our leaf tobacco business is seasonal, and purchasing, processing, and selling activities have several associated peaks where cash on-hand and outstanding indebtedness may vary significantly compared to year end. The first three quarters generally represent the peak of our working capital requirements. Although we believe that our sources of liquidity will be sufficient to fund our anticipated operating needs for the next twelve months, we anticipate periods during which our liquidity needs for operations will approach the levels of our anticipated available cash and permitted borrowings under our credit facilities. Unanticipated developments affecting our liquidity needs, including with respect to the foregoing factors, and sources of liquidity, including impacts affecting our cash flows from operations and the availability of capital resources (including an inability to renew or refinance seasonal lines of credit), may result in a deficiency in liquidity. To address a potential liquidity deficiency, we may undertake plans to minimize cash outflows, which could include exiting operations that do not generate positive cash flow. It is possible that, depending on the occurrence of events affecting our liquidity needs and sources of liquidity, such plans may not be sufficient to adequately or timely address a liquidity deficiency. Debt Financing We continue to finance our business with a combination of short-term and long-term credit lines, the long-term debt securities, advances from customers, and cash from operations when available. See " Note 11. Debt Arrangements " to the "Notes to Condensed Consolidated Financial Statements" for summary of our short-term and long-term debt. We continuously monitor and, as available, adjust funding sources as needed to enhance and drive various business opportunities. From time to time we may take steps to reduce our debt or otherwise improve our financial position. Such actions could include prepayments, open market debt repurchases, negotiated repurchases, other redemptions or retirements of outstanding debt, and refinancing of debt. The amount of prepayments or the amount of debt that may be repurchased, refinanced, or otherwise retired, if any, will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants, and other considerations. The following summaries our maximum borrowing amount under our short-term and long-term credit lines and letter of credit facilities and the remaining available amount after the reduction for outstanding borrowings and amounts reserved for outstanding letters of credit: June 30, 2022 (in millions) Maximum Borrowing Amount Remaining Amount Available ABL Credit Facility $ 100.0 $ 10.0 Foreign seasonal lines of credit 717.2 171.9 Other long-term debt 0.6 — Letters of credit 18.3 3.9 Total $ 836.1 $ 185.8 -26- Net Debt We refer to "Net debt", a non-GAAP measure, as total debt liabilities less cash and cash equivalents. We believe this non-GAAP financial measure is useful to monitor leverage and to evaluate changes to the Company's capital structure. A limitation associated with using net debt is that it subtracts cash and cash equivalents, and therefore, may imply that management intends to use cash and cash equivalents to reduce outstanding debt and that cash held in certain jurisdictions can be applied to repay obligations owing in other jurisdictions and without reduction for applicable taxes. In addition, net debt suggests that our debt obligations are less than the most comparable GAAP measure indicates. (in millions) June 30, 2022 June 30, 2021 March 31, 2022 Notes payable to banks (1) $ 545.2 $ 403.8 $ 378.6 Current portion of long-term debt (2) 13.8 2.7 107.9 Long-term debt (3) 678.8 669.8 580.5 Total debt liabilities $ 1,237.8 $ 1,076.3 $ 1,066.9 Less: Cash and cash equivalents 165.4 79.6 198.8 Net debt $ 1,072.3 $ 996.7 $ 868.2 (1) The increase from June 30, 2021 to June 30, 2022 is due to higher borrowings under the Company's foreign seasonal lines of credit in Africa and South America driven by higher prices for green tobacco purchases. The increase from March 31, 2022 to June 30, 2022 is due to seasonality of the business, with higher working capital requirements in the first quarter of the fiscal year. (2) The decrease from March 31, 2022 is due to reclassifying the portion of the outstanding amount under the DDTL Facility from current to noncurrent as of June 30, 2022 to the extent borrowings thereunder were refinanced under the Amendment and Restatement of the DDTL Facility Credit Agreement, which became effective prior to issuance of the Company's condensed consolidated financial statements for the three months ended June 30, 2022. (3) The increase from March 31, 2022 is due to the reclassification of a portion of the outstanding amount under the DDTL Facility from current portion of long-term debt to long-term debt as of June 30, 2022 for the reason described above. The increase in long-term debt from June 30, 2021 is due to borrowings under the new ABL Credit Facility implemented in February 2022, which increased the maximum borrowing capacity from the Exit ABL Credit Facility that it refinanced. Working Capital The following summarizes our working capital: (in millions except for current ratio) June 30, 2022 June 30, 2021 March 31, 2022 Cash, cash equivalents, and restricted cash $ 174.9 $ 82.1 $ 200.9 Trade and other receivables, net 182.8 232.0 260.2 Inventories and advances to tobacco suppliers 1,024.1 890.7 798.4 Recoverable income taxes 8.7 10.9 7.9 Prepaid expenses and other current assets 61.2 54.9 60.3 Total current assets* $ 1,451.8 $ 1,270.7 $ 1,327.6 Notes payable to banks $ 545.2 $ 403.8 $ 378.6 Accounts payable 144.9 88.8 179.0 Advances from customers 46.1 29.6 53.0 Accrued expenses and other current liabilities 91.1 91.4 82.2 Income taxes payable 6.7 4.1 5.6 Operating leases payable 8.5 9.0 8.1 Current portion of long-term debt 13.8 2.7 107.9 Total current liabilities $ 856.3 $ 629.4 $ 814.4 Current ratio 1.7 to 1 2.0 to 1 1.6 to 1 Working capital $ 595.5 $ 641.3 $ 513.2 * Amounts may not equal column totals due to rounding Working capital decreased from June 30, 2021 to June 30, 2022 by $45.8 million, or 7.1%, primarily due to delayed shipments from Africa and South America, increased foreign seasonal lines of credit mainly driven by higher green tobacco prices and processing costs in South America, and increased foreign seasonal lines of credit in Africa mainly driven by higher capacity and more efficient utilization. -27- Inventories The following summarizes inventory committed to a customer and uncommitted inventory balances for processed tobacco: (in millions) June 30, 2022 June 30, 2021 March 31, 2022 Committed $ 617.6 $ 514.8 $ 471.9 Uncommitted 28.9 70.0 45.7 Total processed tobacco $ 646.5 $ 584.8 $ 517.6 Total processed tobacco increased from June 30, 2021 to June 30, 2022 by $61.7 million, or 10.6%, primarily due to higher green tobacco prices and processing costs in South America, and accelerated buying activities in certain key markets. This increase was partially offset by the restructuring of certain African operations in the prior year where the Company no longer operates. See " Note 1. Basis of Presentation and Summary of Significant Accounting Policies " and " Note 6. Inventories " to the "Notes to Condensed Consolidated Financial Statements" for additional information. Sources and Uses of Cash We typically finance our non-U.S. tobacco operations with uncommitted short-term foreign seasonal lines of credit. These foreign lines of credit are generally seasonal in nature, normally extending for a term of 180 to 270 days, corresponding to the tobacco crop cycle in that market. These short-term foreign seasonal lines of credit are typically uncommitted and provide lenders the right to cease making loans and demand repayment of loans. These short-term foreign seasonal lines of credit are generally renewed at the outset of each tobacco season. We maintain various other financing arrangements to meet the cash requirements of our businesses. See " Note 11. Debt Arrangements " to the "Notes to Condensed Consolidated Financial Statements" for additional information. We utilize capital in excess of cash flow from operations to finance accounts receivable, inventory, and advances to tobacco suppliers in foreign countries. In addition, we may periodically elect to purchase, redeem, repay, retire, or cancel indebtedness prior to stated maturity under our various foreign credit lines. As of June 30, 2022, our cash and cash equivalents was $165.4 million of which approximately $55.3 million was held in foreign jurisdictions, certain of which are subject to exchange controls and tax consequences that could limit our ability to fully repatriate these funds. Fluctuation of the U.S. dollar versus many of the currencies in which we have costs may have an impact on our working capital requirements. We will continue to monitor and hedge foreign currency costs, as needed. The following summarizes the sources and uses of our cash flows: (in millions) Three months ended June 30, 2022 Three months ended June 30, 2021 Operating activities $ (242.5) $ (186.0) Investing activities 47.0 29.7 Financing activities 168.8 140.6 Effect of exchange rate changes on cash 0.3 0.5 Decrease in cash, cash equivalents, and restricted cash $ (26.4) $ (15.2) Cash, cash equivalents, and restricted cash decreased by $11.2 million more during the three months ended June 30, 2022 compared to the decrease during the three months ended June 30, 2021. This decrease was primarily due to cash used by operating activities driven by delayed shipments from Africa and South America. This decrease was partially offset by cash provided by financing activities from higher foreign seasonal lines of credit mainly driven by higher green tobacco prices and processing costs in South America, increased foreign seasonal lines of credit in Africa mainly driven by higher capacity and more efficient utilization, and cash provided by investing activities from higher collections from securitized trade receivables. Planned Capital Expenditures Capital investments in our leaf operations have been made primarily for routine replacement of machinery and equipment, as well as investments in assets that will add value for our customers and increase our efficiency. We have incurred approximately $2.2 million in capital expenditures for the three months ended June 30, 2022 , and are expecting to incur an additional $20.0 million for the remainder of the fiscal year ending March 31, 2023. -28- Pension and Postretirement Health and Life Insurance Benefits The following summarizes cash contributions to pension and postretirement health and life insurance benefits: (in millions) Three months ended June 30, 2022 Contributions made during the period $ 1.4 Contributions expected for the remainder of the fiscal year 3.2 Total $ 4.6 No cash dividends were paid to shareholders during the three months ended June 30, 2022. The payment of dividends is restricted under the terms the ABL Credit Agreement, the Term Loan Credit Agreement, and the Indenture. Critical Accounting Policies and Estimates As of the date of this report, there are no material changes to the critical accounting policies and estimates previously disclosed in Part I, Item 7 "Critical Accounting Policies and Estimates" in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2022. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no significant changes to our market risk exposures since March 31, 2022. For a discussion of our exposure to market risk, see Part II, Item 7A "Quantitative and Qualitative Disclosures About Market Risk" contained in our Annual Report on Form 10-K for the fiscal year ended March 31, 2022.