Andersons, Inc. (ANDE) FY 2023 MD&A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

The following “Management's Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements which relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by these forward-looking statements. Without limitation, these risks include economic, weather and regulatory conditions, competition, geopolitical risk, and those listed under Item 1.A, "Risk Factors." The reader is urged to carefully consider these risks and factors. In some cases, the reader can identify forward-looking statements by terminology such as “may”, “anticipates”, “believes”, “estimates”, “predicts”, or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. These forward-looking statements relate only to events as of the date on which the statements are made and the Company undertakes no obligation, other than any imposed by law, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Executive Overview

Our operations are organized, managed and classified into three reportable business segments: Trade, Renewables, and Nutrient & Industrial. Each of these segments is generally based on the nature of products and services offered and aligns with the management structure.

The agricultural commodity-based business is one in which changes in selling prices generally move in relationship to changes in purchase prices. Therefore, increases or decreases in prices of the commodities that the business deals in will have a relatively equal impact on sales and merchandising revenues and cost of sales and merchandising revenues and a much less significant impact on gross profit. As a result, changes in sales and merchandising revenues between periods may not necessarily be indicative of the overall performance of the business and greater emphasis should be placed on changes in gross profit.

Trade

The Trade segment's operating results were consistent with the prior year as the segment continued to capitalize on strong agriculture fundamentals. The asset-based business benefited from strong elevation margins and good space income on a large and wet harvest combined with better wheat income opportunities during the year. Merchandising fundamentals were also solid during 2023, especially with a market inverse through the first part of the year, but were negatively impacted from fewer merchandising opportunities in the Middle East and North Africa including losses related to the currency liquidity issues in Egypt. The premium ingredients business also delivered positive results from acquisitions and other recently deployed capital.

Agricultural inventories on hand were 127.6 million and 129.7 million bushels at December 31, 2023, and December 31, 2022, respectively. These bushels consist of inventory held at company-owned or leased facilities, transload inventory, in-transit inventory, and third-party held inventory. Total Trade storage space capacity at company owned or leased facilities, including temporary pile storage, was approximately 168 million bushels at December 31, 2023, and 184 million bushels at December 31, 2022.

Looking forward, agriculture fundamentals are shifting due to increased global supply. The Company's mix of assets and merchandising businesses provide a solid foundation to benefit from large crops and carry markets. With lower commodity prices, domestic producers are hesitant to forward sell, but the Company's assets are well-positioned for the grains to flow in due course. With continuing global unrest, volatility exists in key international shipping lanes which could provide ongoing merchandising opportunities.

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Renewables

The Renewables segment performed very well in 2023 led by outstanding earnings from strong operations at the Company's ethanol plants. The plants continue to run efficiently with high ethanol yields and favorable ethanol crush margins. The Company's renewable diesel feedstock business continued to grow as it continued to add more products to its portfolio. While the segment's results were down from the prior period, the current year includes an $87.2 million impairment charge related to the ELEMENT ethanol plant.

While spot ethanol crush margins have softened into 2024, the first quarter generally experiences seasonally weak margins. Upcoming planned maintenance in the industry and the spring driving rebound should support improved plant economics; however, co-product values are facing headwinds as weaker corn prices are expected to compress feed values.

Volumes shipped were as follows:

(a) Includes corn oil, soybean oil, and other fats, oils, and greases.

(b) DDG tons shipped converts wet tons to a dry ton equivalent amount.

Nutrient & Industrial

The Nutrient & Industrial segment's 2023 operating results decreased from the strong prior year results. The Ag Supply Chain product line experienced compressed margins in 2023 that were partially offset with increased volumes as nutrient prices moved lower throughout the year providing fewer margin opportunities when compared to 2022. The Specialty Liquids and Engineered Granules product lines fell slightly behind the prior year mainly due to decreased volumes. Management is optimistic for a good spring application season as nutrient prices have stabilized, and farm economics should incentivize application of crop inputs.

Total storage capacity at our Ag Supply Chain and Engineered Granules locations was approximately 460 thousand tons for dry nutrients and approximately 513 thousand tons for liquid nutrients at December 31, 2023, which is similar to the prior year.

Tons of product sold were as follows:

In the table above, Ag Supply Chain represents facilities principally engaged in the wholesale distribution and retail sale and application of primary agricultural nutrients such as bulk nitrogen, phosphorus, and potassium. Specialty Liquid locations produce and sell a variety of low-salt liquid starter fertilizers, micronutrients for agricultural use, and specialty products for use in various industrial processes. Engineered Granules facilities primarily manufacture granulated dry products for use in specialty turf and agricultural applications. Prior year volumes have been reclassified for the twelve months ended December 31, 2022, to conform with current year presentation as the product mix in certain facilities has evolved.

Other

The Company's “Other” activities include corporate income and expense and cost for functions that provide support and services to the operating segments. The results include expenses and benefits not allocated to the operating segments and other elimination and consolidation adjustments.

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Results for Fiscal 2022 compared to Fiscal 2021

For comparisons of the Company's consolidated and segment results of operations and consolidated cash flows for the fiscal years ended December 31, 2022, to December 31, 2021, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on February 23, 2023.

Operating Results

The following discussion focuses on the operating results as shown in the Consolidated Statements of Operations with a separate discussion by segment. Additional segment information is included in Note 12 to the Company's Consolidated Financial Statements in Item 8.

The Company uses Non-GAAP Income (loss) before income taxes attributable to the Company from continuing operations, a non-GAAP financial measure as defined by the Securities and Exchange Commission, to evaluate the Company’s financial performance. This performance measure is not defined by accounting principles generally accepted in the United States and should be considered in addition to, and not in lieu of, GAAP financial measures.

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Management believes that Non-GAAP Income (loss) before income taxes attributable to the Company from continuing operations is a useful measure of the Company’s performance as it provides investors additional information about the Company's operations allowing better evaluation of underlying business performance and better period-to-period comparability. This measure is not intended to replace or be an alternative to Income (loss) before income taxes from continuing operations, the most directly comparable amount reported under GAAP, which is also presented in the table above.

Comparison of 2023 with 2022

Trade

Operating results for the Trade segment were consistent with the prior year results. Sales and merchandising revenues decreased $2,621.5 million and cost of sales and merchandising revenues decreased by $2,623.7 million resulting in an increase in gross profit of $2.2 million. The vast majority of the decrease in sales and merchandising revenues and cost of sales and merchandising revenues is attributable to sharp commodity price decreases from the prior year as the war in Ukraine created uncertainty around global supply which temporarily drove commodity prices higher in 2022. The $2.2 million increase in gross profit was due to increased asset based business results that were almost entirely offset by a decrease in the merchandising business results as premium ingredients was flat period over period. While the asset based business had strong results in both periods, the $35.2 million gross profit increase from the prior year includes an additional $24.3 million in insured inventory recoveries and $16.0 million in insured inventory write offs in the prior period that did not recur. Offsetting this increase was lower gross profit from the merchandising businesses of $35.6 million. The vast majority of this decrease was attributable to the international merchandising business in the Middle East and North Africa including losses related to the currency liquidity issues in Egypt.

Operating, administrative and general expenses increased $34.9 million compared to prior year results. The increase from the prior year is primarily related to an additional $14.5 million from acquisitions, of which approximately half of this increase is related to earn-out provisions recorded as additional compensation expense. The remainder of the increase from prior year is related to $4.3 million in insurable clean-up costs related to a fire at a Michigan grain asset, $5.5 million of increased insurance premiums and $6.4 million in additional bad debt expense.

Asset impairment decreased by $9.0 million from the prior year as the Company recorded charges on property, plant and equipment related to a Nebraska grain asset in the prior period.

Interest expense decreased $7.3 million due to reduced short-term borrowings from lower commodity prices in addition to the business managing working capital usage in the higher interest rate environment in 2023.

Other income increased by $17.3 million in the current year and was primarily attributable to $4.4 million of additional interest income from additional cash on hand, $4.8 million of favorable foreign currency movements from the prior year, a $4.5 million impairment of an equity method investment in the prior year, and an additional $1.2 million of insurance proceeds from damage to the Company's assets.

Renewables

The Renewables segment had another robust year as income before income taxes only fell $17.0 million short of the prior year, despite an $87.2 million impairment in the current year. Sales and merchandising revenues increased $202.1 million and cost of sales and merchandising revenues increased $126.7 million compared to the prior year. As a result, gross profit increased by $75.4 million. The increase in both sales and merchandising revenues and cost of sales and merchandising revenues can be attributed to increased third-party trading volumes mainly in renewable diesel feedstocks as the merchandising businesses continue to diversify and grow. This increase was partially offset from the tapering down of operations at the ELEMENT facility and the ultimate deconsolidation of the entity that occurred in April of 2023 resulting in a reduction of both sales and merchandising revenues and cost of sales and merchandising revenues from the prior period of approximately $170 million. The main driver of the increased gross profit was an improvement from the ethanol plants as TAMH improved by $62.2 million from prior year due to stronger ethanol margins and significantly decreased natural gas prices. The deconsolidation of the ELEMENT ethanol plant also resulted in an improvement in gross profit of $11.7 million when compared to prior year.

Asset impairment charges increased by $87.2 million from the prior year as the Company recorded an impairment charge related to ELEMENT in the first quarter of 2023, as the plant faced operational and market-based challenges which were exacerbated by a shift in the California Low Carbon Fuel Standard credit markets and high western corn basis.

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Interest expense, net decreased by $2.4 million from the prior year with substantially all of the decrease a result of the deconsolidation of ELEMENT.

Other income decreased by $5.7 million from prior year due to $15.4 million more proceeds received in the prior year as a part of the USDA Biofuel Producer Program that was enacted as a part of the CARES Act. This was partially offset by a $6.5 million gain on the deconsolidation of the ELEMENT joint venture and $4.5 million of additional interest income received in 2023.

Nutrient & Industrial

The Nutrient & Industrial segment results decreased by $14.1 million when compared to strong results in the prior year. Sales and merchandising revenues decreased $155.9 million and cost of sales and merchandising revenues decreased $139.5 million resulting in decreased gross profit of $16.4 million from the prior year. The decrease in sales and merchandising revenues and cost of sales and merchandising revenues was due to a lower priced nutrient market after the segment capitalized on margin opportunities when nutrient prices increased rapidly in the prior year. This decrease in fertilizer prices from the prior year was partially offset by a modest increase in demand as volumes sold increased by approximately 5%. The $16.4 million decline in gross profit across the segment is represented by a $21.4 million margin difference from the prior year that was partially offset by a $5.0 million increase in gross profit directly correlated with increased sales volumes. Ag Supply Chain made up $10.1 million of the reduction as the market dynamics significantly shifted and the strong margins realized in a tight 2022 supply market were unable to be repeated.

Operating, administrative and general expenses decreased $2.7 million from the prior year from approximately $3.9 million in reduced incentive compensation expense.

Other

Results improved by $5.1 million from the prior year. This improvement from the prior year was primarily driven by a $4.8 million revaluation gain of a cost method investment.

Income Taxes

In 2023, the Company recorded Income tax expense from continuing operations of $37.0 million. The Company's effective rate for 2023 was 21.8% on Income before income taxes from continuing operations of $169.6 million. The difference between the 21.8% effective tax rate and the U.S. federal statutory tax rate of 21% is primarily attributable to state and local income taxes and changes in unrecognized tax benefits offset by the effect of non-controlling interest and foreign tax credits.

In 2022, the Company recorded Income tax expense from continuing operations of $39.6 million. The Company’s effective rate for 2022 was 20.4% on Income before income taxes from continuing operations of $194.6 million. The difference between the 20.4% effective tax rate and the U.S. federal statutory tax rate of 21% is primarily attributable to the tax benefit generated from federal research and development credits, foreign tax credits and the effect of non-controlling interest offset by state and local income taxes, nondeductible compensation, and changes in unrecognized tax benefits.

The Company's subsidiary partnership returns are under federal tax examination by the Internal Revenue Service ("IRS") for tax years 2015 through 2018. The Company’s subsidiary is under federal tax examination by the Mexican tax authorities for tax year 2015. The IRS and Mexican tax authorities’ examinations could potentially be resolved within the next 12 months. The resolution of these examinations could change our unrecognized tax benefits and favorably impact income tax expense by a range of $2.9 million to $7.6 million.

On December 20, 2021, the Organization for Economic Co-operation and Development ("OECD") issued Pillar Two model rules introducing a global minimum tax of 15% on large corporations. Although the U.S. has not yet adopted the Pillar Two model rules, several foreign countries enacted legislation in 2023 which closely follow OECD’s Pillar Two guidance to be effective January 1, 2024. Management is currently reviewing the Pillar Two legislation in our relevant jurisdictions to determine the potential impact to the Company's effective tax rate.

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Liquidity and Capital Resources

Working Capital

At December 31, 2023, the Company had working capital of $1,170.6 million, an increase of $226.0 million from the prior year. This increase was attributable to changes in the following components of current assets and current liabilities:

Current assets decreased $659.0 million in comparison to prior year. This decrease was primarily related to the reduction of receivables, inventories and current commodity derivative assets which was partially offset by a sharp increase in cash. The decreases in receivables, inventories and derivatives can largely be attributed to the stabilization of agricultural commodity prices in the current year in comparison to the significant increases in the prices of agricultural commodities, including fertilizer, in the same period of the prior year. The decreases in inventory and derivatives also had a direct impact on cash as the Company was not deploying cash to hold as significant amounts of working capital as it had done in the previous year.

Current liabilities decreased $885.0 million compared to the prior year as all working capital liability accounts decreased from the prior year. The decrease in short-term debt, trade and other payables, and customer prepayments and deferred revenues are a result of the stabilization of commodity prices in the year compared to the severe increase in commodity prices in the same period of the prior year, as well as a strategic focus on managing the use of short-term debt to fund working capital in light of the rising interest rate environment. The large decrease in current maturities of long-term debt is primarily related to the deconsolidation of ELEMENT in 2023.

Sources and Uses of Cash in 2023 Compared to 2022

Operating Activities and Liquidity

Operating activities provided cash of $946.8 million in 2023 compared to $287.1 million in 2022. The vast majority of the increase in cash provided by operating activities was due to favorable changes in operating assets and liabilities as commodity prices dropped in the current year and the Company increased its focus on managing working capital balances in light of the rising interest rate environment. This coupled with strong cash generation from the Company's core businesses created significant growth in cash provided by operating activities that ultimately led to a significant amount of cash on hand as of December 31, 2023.

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Net income taxes of $45.7 million and $88.7 million were paid in the years ended December 31, 2023, and 2022, respectively. The decrease in the current year is driven by decreased Income before income taxes from continuing operations combined with the taxable gain associated with the sale of the remaining pieces of the Company's Rail segment in 2022.

Investing Activities

Investing activities used cash of $153.9 million in the current year compared to $52.9 million used in the prior year. The significant change from the prior year was mainly driven by approximately $58.7 million of additional net proceeds from the sale of discontinued Rail operations received in the prior year combined with approximately $42.1 million of additional purchases of property, plant and equipment in the current year.

Capital expenditures of $150.4 million for 2023 on property, plant and equipment and capitalized software includes: Trade - $49.7 million; Renewables - $54.5 million; Nutrient & Industrial - $42.5 million; and $3.6 million in Other.

We expect to invest approximately $150 to $175 million in property, plant and equipment in 2024; approximately 50% of which will be to maintain current facilities.

Financing Arrangements

Net cash used in financing activities was $264.0 million in 2023, compared to $334.7 million used in 2022. The decrease in cash used in financing activities from the prior year was mainly due to the issuance of a $100.0 million term note in 2023. The Company continued to make substantial distributions to the non-controlling interest shareholder of TAMH due to the strength of the entity's financial results in both 2023 and 2022. Lastly, the Company continued to repurchase common shares under its Repurchase Plan where $100 million of repurchases were authorized to be repurchased on or before August 20, 2024. As of December 31, 2023, approximately $14.5 million of the Repurchase Plan had been utilized.

As of December 31, 2023, the Company was party to borrowing arrangements with a syndicate of banks that provide a total borrowing capacity of $1,863.9 million. There was $1,817.5 million available for borrowing at December 31, 2023. While in the current year the Company's cash on hand exceeds total debt, typically, its highest borrowing occurs in the late winter and early spring due to seasonal inventory requirements in the fertilizer and grain businesses. At December 31, 2023, the Company had total available liquidity of $2,461.4 million comprised of cash and cash equivalents and unused lines of credit.

The Company paid $25.4 million in dividends in 2023 compared to $24.6 million in 2022. The Company paid $0.185 per common share for the dividends paid in January, April, July and October 2023, and $0.180 per common share for the dividends paid in January, April, July and October 2022. On December 14, 2023, the Company declared a cash dividend of $0.190 per common share, payable on January 22, 2024, to shareholders of record on January 2, 2024.

Certain of our long-term borrowings include covenants that, among other things, impose minimum levels of working capital and a minimum ratio of owner's equity. The Company is in compliance with all covenants as of December 31, 2023. In addition, certain of our long-term borrowings are collateralized by first mortgages on various facilities.

Because we are a significant consumer of short-term debt in peak seasons and the majority of this is variable rate debt, increases in interest rates could have a significant impact on our profitability. In addition, periods of high commodity prices and/or unfavorable market conditions could require additional margin deposits on the Company's exchange traded futures contracts. Conversely, in periods of declining prices, the Company would receive a return of cash.

Management believes the sources of liquidity will be adequate to fund operations, capital expenditures and payments of dividends in the foreseeable future.

Contractual Obligations

Long-term Debt

As of December 31, 2023, the Company had total outstanding long-term debt with both floating and fixed rates of varying maturities for an aggregate principal amount outstanding of $593.6 million. $27.6 million of the outstanding principal of the long-term debt is payable within 12 months. See Note 4 to the Consolidated Financial Statements for additional information.

Future interest payments associated with the long-term debt total $192.5 million, with $36.6 million payable within 12 months. See Note 4 to the Consolidated Financial Statements for additional information.

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Operating Leases

The Company has lease arrangements for certain equipment and facilities, including grain facilities, fertilizer facilities and equipment. As of December 31, 2023, the Company had fixed operating lease payment obligations of $59.1 million, with $23.8 million payable within 12 months. See Note 13 to the Consolidated Financial Statements for additional information.

Commodity Purchase Obligations

The Company enters into forward purchase contracts of commodities with producers through the normal course of business. These forward purchase contracts are largely offset by forward sales contracts of commodities and the net of these forward contracts are offset by exchange-traded futures and options contracts or over-the-counter contracts. As of December 31, 2023, the Company had forward purchase contracts of $2,575.7 million, with $2,468.3 million payable within 12 months. See Note 5 to the Consolidated Financial Statements for additional information.

Postretirement Healthcare Program

The Company has a postretirement health care benefit plan that covers substantially all of its full-time employees hired prior to January 1, 2003. Obligations under the retiree healthcare programs are not fixed commitments and will vary depending on multiple factors, including the level of participant utilization and inflation. Our estimates of postretirement payments have considered recent payment trends and actuarial assumptions. As of December 31, 2023, the Company had outstanding benefit obligations of $17.3 million, with $1.2 million payable within 12 months. See Note 6 to the Consolidated Financial Statements for additional information.

Off-Balance Sheet Transactions

During the periods presented we did not have, nor do we currently have, any off-balance sheet transactions as defined under SEC rules, except as follows: The Company may issue standby letters of credit through banking institutions. At December 31, 2023, the Company had standby letters of credit outstanding of $3.3 million.

Critical Accounting Estimates

The process of preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Management evaluates these estimates and assumptions on an ongoing basis. Estimates and assumptions are based on historical experience and management's knowledge and understanding of current facts and circumstances. Actual results, under conditions and circumstances different from those assumed, may change from these estimates.

Certain of our accounting estimates are considered critical, as they are important to the depiction of the Company's Consolidated Financial Statements and/or require significant or complex judgment by management. There are other items within the Company's Consolidated Financial Statements that require estimation, however, they are not deemed critical as defined above. Note 1 to the Consolidated Financial Statements in Item 8 describes the Company's significant accounting policies which should be read in conjunction with our critical accounting estimates.

Management believes that the accounting for readily marketable inventories and commodity derivative contracts, including adjustments for counterparty risk, impairment of long-lived assets and goodwill, and uncertain tax positions involve significant estimates and assumptions in the preparation of the Consolidated Financial Statements.

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Readily Marketable Inventories and Derivative Contracts

Readily Marketable Inventories ("RMI") are stated at their net realizable value, which approximates fair value based on their commodity characteristics, widely available markets, and pricing mechanisms. The Company marks to market all forward purchase and sale contracts for commodities and ethanol, over-the-counter commodity and ethanol contracts, and exchange-traded futures and options contracts. The overall market for commodity inventories is very liquid and active; market value is determined by reference to prices for identical commodities on regulated commodity exchange (adjusted primarily for transportation costs); and the Company's RMI may be sold without significant additional processing. The Company uses forward purchase and sale contracts and both exchange traded and over-the-counter contracts (such as derivatives generally used by the International Swap Dealers Association). Management estimates fair value based on exchange-quoted prices, adjusted for differences in local markets, as well as counterparty non-performance risk in the case of forward and over-the-counter contracts. The amount of risk, and therefore the impact to the fair value of the contracts, varies by type of contract and type of counterparty. With the exception of specific customers thought to be at higher risk, the Company looks at the contracts in total, segregated by contract type, in its quarterly assessment of non-performance risk. For those customers that are thought to be at higher risk, the Company makes assumptions as to performance based on past history and facts about the current situation. Changes in fair value are recorded as a component of Cost of sales and merchandising revenues in the Consolidated Statements of Operations.

Impairment of Long-Lived Assets and Goodwill

The Company's business segments are each highly capital intensive and require significant investment. Long-lived assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. This is done by evaluating the recoverability based on undiscounted projected cash flows, excluding interest. If an asset group is considered impaired, the impairment loss to be recognized is measured as the amount by which the asset group's carrying amount exceeds its fair value.

Goodwill is tested for impairment at the reporting unit level, which is the operating segment or one level below the operating segment. During the year ended December 31, 2023, the Company evaluated goodwill for impairment using a quantitative assessment in three reporting units and using a qualitative assessment in one reporting unit. The quantitative review for impairment takes into account our estimates of future cash flows, as well as a market based approach. Critical estimates in the determination of the fair value of each reporting unit include, but are not limited to, future expected cash flows, estimated gross margins, and discount rates based on a reporting unit's weighted average cost of capital. Our estimates of future cash flows are based upon a number of assumptions including operating costs, life of the assets, potential disposition proceeds, budgets and long-range plans. The market based approach compares results of public companies that reflect economic conditions and risks that are similar to the Company to calculate an estimated enterprise value. These factors are discussed in more detail in Note 16, Goodwill and Intangible Assets, to the Consolidated Financial Statements.

Our annual goodwill impairment test is performed as of October 1 each year which is discussed in further detail in Note 16 to the Consolidated Financial Statements.

Management considers several factors to be significant when estimating fair value including expected financial outlook of the business, changes in the Company's stock price, the impact of changing market conditions on financial performance and expected future cash flows, the geopolitical environment and other factors. Deterioration in any of these factors may result in a lower fair value assessment, which could lead to impairment charges in the future. Specifically, actual results may vary from the Company's forecasts and such variations may be material and unfavorable, thereby triggering the need for future impairment tests where the conclusions could result in non-cash impairment charges.

Uncertain Tax Positions

Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior year audit settlements. To account for uncertainty in income taxes, the Company evaluates the likelihood of a tax position based on the technical merits of the position, performs a subsequent measurement related to the maximum benefit and degree of likelihood, and determines the benefits to be recognized in the Consolidated Financial Statements, if any.

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