AgroFresh Solutions, Inc. (NASDAQ:AGFS) Q2 2022 Results Conference Call August 9, 2022 4:30 PM ET
Company Participants
Jeff Sonnek – IR, ICR, Inc.
Clint Lewis – CEO
Graham Miao – CFO
Conference Call Participants
Ben Klieve – Lake Street Capital Markets
Joel Jackson – BMO Capital Markets
Amit Dayal – H.C. Wainwright
Operator
Greetings, and welcome to AgroFresh Solutions Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Jeff Sonnek with ICR. Thank you. You may begin.
Jeff Sonnek
Thank you, and good afternoon. Today’s presentation will be led by Clint Lewis, Chief Executive Officer; and Graham Miao, Chief Financial Officer.
Comments during today’s call and the accompanying presentation contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are considered forward-looking statements. These statements are based on management’s current expectations and beliefs, as well as a number of assumptions concerning future events. Such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements. All of these risks and uncertainties are identified and discussed in the company’s filings with the SEC.
We’ll also refer to certain non-GAAP financial measures today. Please refer to the tables included in the slides accompanying this presentation as well as the press release, which can be found in the Investor Relations section of our website, agrofresh.com, for reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures.
With that, I’d now like to turn the call over to Clint Lewis.
Clint Lewis
Thank you, Jeff, and welcome to everyone on the call. The second quarter marks the completion of the Southern Hemisphere growing season, and I’m proud of our global team for their continued execution of our growth strategy.
Net sales for the second quarter of 2022 increased 17.5% to $25.8 million, and adjusted EBITDA increased $1.5 million to $2.4 million compared to the second quarter of 2021 despite significant foreign currency headwinds. On a constant currency basis, net sales grew 23.9%.
Our diversification strategy continues to drive results, as evidenced by a 21% increase in our diversification revenue in the first half of the year compared to the prior year period, with double-digit growth in each of our diversification product solution categories. As we look ahead to the second half and the Northern Hemisphere growing season, we are planning to continue to meet our goal of driving growth in both net sales and adjusted EBITDA through continued execution of our diversification strategy.
I’d like to review the business drivers for the quarter and the first half of this year, which covers the entire Southern Hemisphere season. And to further assist your understanding of our business and monitor the progress of our strategy to grow through diversification, we are providing you with additional disclosures on both a geographical and product solutions basis. The details can be found in our supplemental earnings deck in our Investor Relations website.
Diversification revenues grew 12% and represented 44.1% of consolidated revenues for the trailing 12 months ended June 30, 2022, versus 40.6% in the trailing 12 months ending June 30, 2021. This marks our sixth consecutive quarter of double-digit diversification category revenue growth. Remember, we define our diversification category as the components of our business, excluding SmartFresh for Apple, which covers all of the crops, solutions and technologies. While we continue to defend our legacy SmartFresh Apple business, our continued growth will be fueled by our ongoing diversification strategy.
In addition to being our engine to drive incremental growth, success and diversification also helps to build a natural hedge against many of the well-known risks in agriculture such as weather, which is visible in our second quarter results as we generated growth on a consolidated basis despite encountering weather headwinds in key markets such as Brazil, thus, diversification across products, platforms, crops, geographies and customers, minimizes the adverse impact that any one of those variables can have on our results.
From a geographical perspective, looking at the combined first half performance for the entire season, our Europe, Middle East and Africa region generated 17.9% growth or an increase of $3.4 million versus the prior year period. Our Asia Pacific region also supported growth, increasing 8.5%. And while small on a relative basis at this stage in the year, North America grew 25.5% due to strong demand stemming from continued recovery of the flower market. Latin America, which represents our largest and most diversified region during our Southern Hemisphere season decreased slightly by 1.3% versus the first half of 2021, but on a constant currency basis, grew 3.1%. I’d note that given the currency headwinds, we’ve selectively implemented some pricing measures to help protect our margin.
Lower sales of SmartFresh for apples and Harvista in Brazil, where the industry was met with severe weather that reduced volumes, were nearly offset by strength in other markets such as Chile and Peru. From a product solutions perspective, once again, looking at the 6-month Southern Hemisphere season, we achieved double-digit growth across each of our diversification categories. In terms of dollar contribution, we had meaningful distribution across all our key diversification categories.
Our fungicide and disinfectant category grew 25.5% in the first half and contributed $1.9 million of growth versus the prior year period. Growth was driven by antimicrobial market penetration and product expansion in North Africa and Middle East markets such as Morocco and Turkey. Our other 1-MCP category, which represents our continued focus on leveraging our SmartFresh franchise beyond apple and into other crops and geographies and includes key solutions such as Harvista and Ethylbloc, grew 10.4% versus the first half of 2021 and contributed $1.6 million of growth. Harvista performed well in South Africa, which experienced an early part of the season and a larger crop size resulting in an increased need for storage and freshness solutions. Harvista also drove greater market penetration in New Zealand following last year’s market entry.
Our Ethylbloc solution was also notable, helping to drive growth in our North American region as the flower industry experienced continued recovery. Our coatings category grew 37.4% and contributed $1.1 million of growth. Teycer was the main driver of growth in the coatings product line, led by penetration of new markets such as Egypt, South Africa and Brazil, all of which generated significant growth versus the prior year period. Our plant-based coatings product, VitaFresh Botanical, nearly doubled with strong traction in Spain, Peru and Brazil and first-time sales in new markets such as Egypt, Netherlands and Chile.
Rounding out our diversification categories is the other category, which includes our Control-Tec equipment solutions and our FreshCloud digital platform. We have previously discussed the strategic value of FreshCloud, both in its ability to generate direct revenue as well as to support the rest of our portfolio. While we are still at an early entry point in our journey, we were recently able to leverage FreshCloud as an opportunity to enter the table grape sector with a new customer. While small on a relative basis, the other categories more than tripled and contributed $0.9 million of growth during the first half, mainly driven by growth in Spain and Chile. These gains versus the prior year period were partially offset by our SmartFresh for Apple category, which decreased 2.4% in the first half versus the prior year period, primarily due to foreign exchange impact and extreme weather in Brazil that reduced apple production there by 30% compared to 2021, according to the World Apple and Pear Association estimates. On a constant currency basis, our SmartFresh for apple category grew 0.2%.
Recently, we’ve communicated several new developments that we are especially excited about, each of which demonstrates our efforts to advance our business, leverage our research and development and regulatory capabilities and provide new services and innovative solutions to meet customer needs. In June, we entered into a strategic collaboration agreement with Novozymes, that looks for co-development of biological-based solutions to control fungal pathogens in fruits, vegetables and flowers. We anticipate that this agreement will accelerate the development of novel biologic solutions for post-harvest use through the combination of Novozyme’s advanced biotechnologies with our deep scientific and formulation expertise, global commercial footprint and comprehensive portfolio of integrated solutions. AgroFresh and Novazymes share very similar missions around sustainability and the introduction of differentiated technologies to address unmet needs across the food chain. We are excited to partner with Novozymes to pioneer the use of biological solutions in the post-harvest sector to help our customers provide a consistent supply of high-quality fresh fruit and produce and reduce food loss and rates, while alleviating the challenges that impact quality and quantity given supply chain issues.
Further to the advancement of our portfolio and product registration capabilities, in July we gained approval for our SmartFresh Inbox solution in California for a wider range of crops, which now includes apples, pears, avocados, KIWI and stone free. California is the largest and most diverse fruit growing region in the U.S., and our customers frequently tell us that they are in need of more flexible application methods and products to help preserve and protect their crops, especially while in transit.
SmartFresh Inbox offers the powerful protection of our pioneer 1-MCP technology and a small portable sachet, expanding the availability of SmartFresh technology for growers, packers and retailers who either don’t have storage room infrastructure, require more convenient option or face transit complexities. In addition to California, we are also pursuing similar registrations for SmartFresh Inbox in Europe and other key global markets. And last week, we achieved European organic certification for our VitaFresh Botanicals Select Life solution.
In addition to our full coatings product line that leverages natural and plant-based ingredients, we now have an organic option that helps meet the increased demand for these types of solutions. This organic certification signifies the focus we are bringing to the coatings category, which is the largest and fastest-growing category in the post-harvest industry. Today, this category is defined by older, conventional and more commoditized offerings, generally competing on price and often bundled with application equipment. However, we expect that growth in the coatings category moving forward will be driven by more natural, plant-based organic solutions with applications tailored to higher-value crops such as avocados, and increasing utilization of coatings in underpenetrated geographies such as Latin America and Asia.
Currently, AgroFresh is relatively underrepresented in the coatings category. However, we are strategically focused on effectively competing in the higher value growth segments of the category by expanding the penetration of our VitaFresh Botanicals portfolio and leveraging our internal R&D and external innovation teams to continue to innovate in this important category. We see an opportunity to differentiate our offerings through the creation of a suite of products that are natural, plant-based or organic.
We also plan to strengthen our presence in the retail sector, especially in key markets like the U.S. and Europe, where there is increasing interest and demand for newer coating solutions by retailers looking to address food loss and waste, while responding to the evolving desire of their consumers to have more natural organic options. And finally, we recently opened our new innovation and service center in Rancagua, Chile, marking our seventh strategic global center in operation, further expanding our worldwide footprint in key production regions around the globe. The new center advances our leadership position in Latin America, which is our fastest-growing and most diverse region from a product and crop standpoint. This new center will support our operations and customers in Chile, and serve as a center of excellence for the entire Latin America region. Chile has been at the forefront of adopting new innovations and crop production practices and was the first country to successfully commercialize SmartFresh more than 20 years ago. My leadership team and I travelled to Chile to mark the opening of this new innovation and service center, and it provides us with an opportunity to meet with many of our customers and other industry stakeholders during our visit. We saw firsthand how our various post-harvest solutions and technical service are being utilized for the benefit of our customers. The time spent in Chile reinforces and validates the important mission we have at AgroFresh, and inspires my team and me to continue working hard to support the efforts of our customers globally as they strive to produce an abundant supply of fresh, high-quality fruit and produce.
In summary, our Southern Hemisphere season was a success. We accomplished this in the face of macroeconomic, geopolitical and ever-present weather challenges, which continues to demonstrate the importance of what we do and the durability and the resilience of our business. Through consistent execution of our diversification strategy and a focus on financial discipline, we are in excellent position to achieve our goals for the full year, and that is to generate continued growth in revenue and adjusted EBITDA. Our team is continuing to pursue new innovations and engage in new collaborations with other industry leaders to advance produce freshness while leveraging our existing commercial capabilities and global footprint. We look to build on the momentum we generated in the Southern Hemisphere season to deliver continued performance as we transition into the Northern Hemisphere growing season.
I’ll now pass the call to Graham to speak to some of the financial highlights. Graham?
Graham Miao
Thank you, Clint, and good afternoon to everyone. The second quarter completes our Southern Hemisphere season. As a reminder, our business should be viewed in half versus quarters to consider seasonal fluctuations that can shift the sales between the quarters of each half of the year. Net sales for the second quarter of 2022 increased 17.5% to $25.8 million compared to $21.9 million in the second quarter of 2021. Excluding the impact of foreign currency exchange, revenue increased 23.9%. As Clint discussed, the net sales increase was primarily driven by leveraging our product portfolio of diverse solutions.
Each of the company’s diversification categories generated growth in the second quarter and the SmartFresh for Apple experienced growth on a constant dollar basis in Latin America despite unfavorable weather events and benefited from harvest of timing differences. For the first half of 2022, Southern Hemisphere season net sales were $65.6 million, an increase of 7.8% versus the prior year period. The impact of foreign currency translation decreased revenue by $2.6 million for the first half of 2022. Excluding this impact, revenue increased approximately 12.1%. The net sales increase was primarily driven by antimicrobials and the coatings, market penetration and expansion in EMEA, as well as strong growth in other 1-MCP solutions, such as SmartFresh diversification, Ethylbloc and Harvista. This was partially offset by SmartFresh for Apple due to the impact of lower crop production in Brazil and Argentina.
Gross profit for the second quarter was $16.5 million compared to $14.8 million in the prior year period, and the gross profit margin was 63.9% as compared to 67.6% in the prior year period. The margin variance was primarily mix related and reflects our transition to a more diversified product portfolio. Gross margin was further impacted by higher material costs associated with inflationary forces, which was partially offset by price increases. For the first half of 2022, gross profit increased 2.1% to $44.4 million, representing gross profit margin of 67.7%.
We were continuing to work hard on both cost savings and pricing initiatives to help mitigate these headwinds and expect some release later in the year as we generate the sales on lower cost inventories. While we always strive to maximize margin, our primary focus is on generating gross profit dollar growth, consistent with our growth through diversification strategy. Research and development costs were $2.9 million in the second quarter of 2022 compared to $3.5 million in the prior year period. For the first half of 2022, R&D decreased $0.9 million to $5.9 million compared to the prior year. These decreases were primarily driven by the timing of projects.
Our investment in R&D provides for increased support for product diversification activities to expand our registrations to new crops and geographies, develop new proprietary solutions, build out our coatings offerings and strengthen our technical service offerings in alignment with commercial growth objectives. SG&A expenses increased 5.2% to $14.3 million in the second quarter of 2022, as compared to $13.6 million in the prior year period, driven primarily by commercial investment and the reorganization activities. For the first half of 2022, SG&A expenses decreased 3.5% to $26.2 million.
While cost of discipline remains a focus for the business, our plan continues to contemplate some resource allocation this year as we steer the organization towards growth and revenue-generating activities. As a result, for the full year 2022, we now expect SG&A to increase in the mid-single-digit range versus the prior year.
Second quarter 2022 net loss was $18.4 million compared to net loss of $17.3 million in the prior year period. For the first half of 2022, net loss was $21.5 million compared to a net loss of $9.1 million in the prior year period. As a reminder, during the first quarter of 2021, the company recorded $14.4 million of other income, which related primarily to the receipt of proceeds from the settlement of a litigation matter.
Adjusted EBITDA increased by $1.4 million to $2.4 million in the second quarter of 2022. For the first half of 2022, adjusted EBITDA increased 15.2% to $17.4 million compared to prior year period. The increase in adjusted EBITDA was primarily due to higher sales and lower operating expenses as compared to the prior year period. Adjusted EBITDA for the trailing 12 months ended June 30, 2022, was $64.3 million, representing a margin of 37.7%. As a reminder, our adjusted EBITDA margin performance should be viewed in total for the year to align with the respective Southern and the Northern Hemisphere seasons, where our higher second half sales volume translate to correspondingly higher margins for the business.
Cash provided by operations was $4.3 million for the 6 months ended June 30, 2022, versus operating cash flow of $30.9 million in the comparable prior year period. Adjusting for the onetime benefit of $14.4 million of the litigation proceeds in the prior year, normalized operating cash flow from operations was approximately $16.5 million for the 6 months ended June 30, 2021, reflecting strong working capital improvement. The decrease in normalized cash flow from operations was mainly driven by incremental investment in inventory due to our strategic initiative to procure materials in advance to mitigate supply chain concerns, as well as timing of receivables as compared to the prior year period.
For the 6 months ended June 30, 2022, capital expenditure were $1.7 million compared to $1.3 million in the prior year period. We continue to expect our annual capital expenditures to range from 2% to 5% of sales, consistent with our asset-light business model. From a balance sheet perspective, cash as of June 30, 2022, was $51.5 million. Total debt was $262.3 million, and our $25 million revolver was undrawn as of June 30, 2022.
This concludes our prepared remarks. Operator, please open the call for questions.
Question-and-Answer Session
Operator
At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Ben Klieve with Lake Street Capital Markets. Please proceed with your question.
Ben Klieve
All right. Thanks for taking the questions. And first of all, congratulations on a really good quarter and a good first half of the year here. First question, a couple of questions kind of on the initiatives that were announced recently that you touched on Clint. First on Novozymes relationship. I’m wondering if you can elaborate on kind of what benchmarks you’re anticipating that we can look out for from this relationship over the next couple of years?
Clint Lewis
Well, thank you for the question. I also want to take this opportunity to thank you and Lake Street for initiating coverage. With AgroFresh, we appreciate the engagement. Specifically to the question, we are also very excited about the Novozymes agreement. I think it’s a tangible example of leveraging leadership expertise in developing biological solutions in the crop and broader agricultural settings and leveraging the R&D formulation and the specific specialty crop experience and our commercial model that AgroFresh has and we think it’s a win-win.
In terms of milestones or benchmarks to look at, I think for us, we will look at it a couple of different ways. One is working to screen the library of enzyme assets that Novozymes has and from that screening we’ll be identifying what we believe are viable use cases. So I would say that would be one, and that obviously is a more internal metric. The second would be securing regulatory approval of the selected compounds that we have identified with Novozymes and then ultimately securing the regulatory approval on that.
And then as always is the case in agriculture, by working with the market to trial these applications for specific crops in specific geographies and working through that potential cycle. So let me pause there and see if there’s any more specific questions, but these are the kind of the milestones that we look at. And again, our agreement is kind of catered on those milestones as we advance the relationship.
Ben Klieve
No, that was helpful. I mean this is — there’s a lot of moving pieces with it. It’s new and long term in nature. So those very helpful color and look forward to hearing more about this in the coming quarters. Another question I have regarding one of your initiatives that you touched on InBox. Clint, you said that this was something that was really — that your customers have been asking for. So does — given that your customers were looking for the solution, does that imply that there can be kind of a more material launch of this product here in the early stages than you generally see from new products that come online? Or is this going to be kind of a modest revenue contribution in the first couple of years as you traditionally see across your product lines?
Clint Lewis
Well, I want to be pragmatic with that response. I mean I would say, centered around our diversification strategy and one of the reasons why we’re so excited in North America from a diversification standpoint and specifically here in the U.S., AgroFresh relative to the opportunities in the U.S. have been underrepresented from a broader crop diversification.
And even if you think about it from a geographic dynamic, I’ll turn specifically to our under penetrations in the largest and diverse crop producing state in the U.S., which is the state of California. And historically, as you know, the history for AgroFresh being much more focused on the apple and pear crop, largely focused geographically in the U.S. in those major apple growing regions like Pacific Northwest, Michigan, and kind of Northeast, kind of New York, Pennsylvania, apple going region, and quite frankly, as we are now fully pushing and leveraging this diversification strategy as the engine growth, we’re really excited about the opportunity not only to leverage our regulatory expertise with the leadership we have in 1-MCP in a very convenient sachet that provides much more flexibility to our customers, and quite frankly, really gives us the opportunity to build much greater presence and opportunity to drive growth in the important state of California.
And so I would say, because it leverages our deep understanding of 1-MCP in other crops and we’ve got that strongly endorsed by the regulatory concerns in California, I would say we’re excited about the opportunity to exploit the InBox in a relatively short period of time. But at the same time, you’re familiar that we often say, on one hand, the selling cycles can be a little bit longer, but they’re very robust and sticky.
Ben Klieve
Right. Okay. Beautiful. That was very helpful. If you don’t mind one more and then I’ll get back in queue. I’m wondering if you guys can kind of fill us in on kind of the state of especially the apple market in the Northern Hemisphere and maybe in particular in the Pacific Northwest and that the heat wave that’s going on right now. And then talk about kind of the challenges, how the crop looks especially this year versus last year when last year had just such a devastating drought across the Pacific Northwest one year ago.
Clint Lewis
Yes, a great and timely question. We’re actually trying to assess this from both the subjective and qualitative feedback that we get from our teams on the ground, but also looking at the U.S. Apple Association, World Apple and Pear Association that also trying to track it. So clearly, we know that last year we had a very long and extended heat waves that again in an unprecedented way, went way up into the Pacific Northwest and did impact volumes and quality. Oftentimes, the cycles and dynamic that we see is that if you have a weather challenge like this in a significant way that is, again, in some cases, defined as unprecedented, there is optimism that you don’t see that repeat.
And I would say as we sit today and even as we track real high weather temperatures across much of the U.S., we are not seeing the same type of environmental and weather impact that we saw last year. And I would just kind of remind yourself and the audience, as we get educated by our customers, I think the resilience of the crop can stand higher — various fluctuations in temperature. I think the issue becomes the sustained nature of that high level of heat, right?
And so what we saw last year was an extended period of real high heat lapping really throughout the day. What we’re seeing here, while you might have periodic spikes we’re clearly not seeing at this point, knock on wood, the same type of dynamic. So all that said, we have every reason to believe to expect kind of what I would argue is a more normalized growing season for the U.S. in specific regions like Pacific Northwest. There have been some reports I think even as recent as this week that also bodes well for Michigan. But again, we’ll wait to see how that plays out. I put it more in a pragmatic way, more of a normal crop than a more challenged one like we saw last year.
Ben Klieve
Got it, got it. Very good. That’s very helpful and we’ll stay tuned for hear your update on the next quarter call. Very good. Well, I appreciate you taking my questions and I’ll get back in queue.
Clint Lewis
Thanks, Ben.
Operator
Our next question is from Joel Jackson with BMO Capital Markets. Please proceed with your question.
Joel Jackson
Good morning, Clint — excuse me, good afternoon, Clint. So I think we talked a little while ago — a few months ago, I think the goal, like you said you have lot of gross margin dollar growth and maybe $1 million to $2 million growth this year. It looks like you’ve got about $1 million now of gross margin dollar growth in the first half. Should we see — what should second half performance look like? Should we see expansion? Is the goal to be flat? What should we see?
Clint Lewis
First of all Joel, good to connect with you. Appreciate the question. I think just building on the response to the last question that Ben Klieve had, I would kind of answer it this way. We are continuing to focus on driving consolidated top and bottom line growth through the full year and also included into the second half, which is Northern Hemisphere. As we think about it from a gross profit standpoint, let’s also recognize the Northern Hemisphere in the second half of the year is on a revenue, but also margin size a much larger half and growing season than the first half, which corresponds to the Southern Hemisphere.
And if we assume using North America as a surrogate and believe kind of normalized kind of crop growth in markets like North America and in Europe, then we believe not only will we continue to contribute to our growth, but also gross profit dollar growth into the second half of the year. I don’t know, Graham, if you want to add anything additional to that?
Graham Miao
Yes, I agree, Joel. If you look at our business seasonality and overall throughout the year, sales pattern, the second half in Northern Hemisphere accounts for more than 60% of our sales and also tend to be higher margin as well. That includes Northern Asia, Europe and North America. So I think your observation is the right one that the first year we had profit growth in dollars of about $1 million, and then we would expect the second half certainly will follow in a proportionally to the sales.
Joel Jackson
Okay. That’s helpful. So I think I was reading the other day that apple production in the U.S. is expected to be up maybe 3% this year, but it’s still kind of 2% below the average. Can you talk about that, what you’re expecting and how that might impact profitability for you?
Clint Lewis
Yes. I think following on, I mean, listen, we — as we model — and again, there’s always fluctuation year-to-year from some of these forecasts and then they get reconciled at the end. We have tended to use kind of a five-year rolling average as we look at kind of modeling the year. And we’ve done pretty well using that kind of more pragmatic modeling. Remember, again, given the history of this company, largely in the global apple and pear crop, it’s where we — the data is riches and is where we have the most familiarity. And so taking your numbers around that 3%, again, I would say that fits within the threshold of what kind of a normal crop and we try to model our assessments off of that.
I would also remind that this speaks to the durability and the resilience of this business. Keep in mind that our business model is somewhat paradoxical. A good day for our customers is also a good day for AgroFresh. But given the nature of the work that we do, a bad or challenging day or season for our customers, also technically is a good day for AgroFresh because it shines even a brighter light on the criticality of the products and solutions that we have, the technical expertise of our people and the service model that goes along with our products. And so again, I think as we continue to grow out our diversification strategy, it not only becomes a great engine for incremental growth, it also becomes a really good risk mitigation hedge as well.
Joel Jackson
Modeling perspective, you talked about in the release R&D, some delay in expenses because of timing of projects or something like that, expenses. Should we expect the R&D spend to be similar in 2022 or 2021? And looking at 2023, would you expect a similar R&D expense with the Novozymes partnership impact at all?
Clint Lewis
So let me answer it kind of going in backwards, right? So again, with the Novozymes agreement and how we structured, I think a really efficient and responsible way, that’s milestone-driven. So it also provides greater predictability of the future revenues that come out of targets that we select and also our understanding and appreciation of the regulatory path in that regard. As always, I think it’s healthy, it’s a constant kind of annual reassessment of the prioritization of the portfolio and reallocating dollars as appropriate to make sure the key critical and bigger revenue or margin-generating opportunities are funded. And so that’s how we look at being able to manage some of the milestone commitments that we have, multiple payment commitments we have as it relates to Novozymes.
With respect to this year, you are correct, as we’ve noted, the underspend that we see in the first half is really focused on timing of projects and we feel comfortable that we’ll make up in a responsible way that in the second half. As we look towards 2023, I think first, as a percentage of sales, we should still be consistent with our general threshold that I think is somewhere in the 7% to 8% of sales. You might see, and I think this is smart and healthy, some step-up in investments, in things like R&D as well as sales, marketing, tech service to continue to underscore and support our diversification efforts. Graham, I don’t know if you want to anything else to it.
Joel Jackson
Okay. Thank you very much.
Clint Lewis
Thanks Joel. Appreciate it.
Operator
Next question is from Amit Dayal with H.C. Wainwright. Please proceed with your question.
Amit Dayal
Thank you. Good afternoon everyone. Some of my questions have already been addressed. With respect to the ForEx side, I know you guys commented a little bit that you’re taking measures on the pricing side to alleviate any pressures from that angle. But is there any help from a hedging perspective, etc., that you might be undertaking to mitigate some of these ForEx pressures?
Clint Lewis
Yes. So Amit, first of all, thank you for the engagement and the question. I also appreciate your recognition of the opportunity to, what I would say, smart and responsible to take price. Remember also that our seasons don’t necessarily correspond to individual financial quarters. And so when we define what we thought was the focus on price for 2022, we’re already well in the planning stages and commitments to be locking with customers in the Southern hemisphere season, but still were able, especially in some of the higher inflationary markets to take price to offset some of that impact to foreign exchange. I would also guide you to Graham’s comment relative to smart and responsible management of our inventory that while we have some step-up in inflationary costs, we also believe that some of that will mitigate in the second half based on the inventory revaluation and that we will be generating sales with lower assessed inventory costs that will also help with some margin opportunities in the second half of the year.
With respect to hedging, I’ll ask Graham to answer any specific questions relative to hedging strategies and approach.
Graham Miao
Yes. So there are two aspects to your question. One is how do we manage our global business in an environment where you see foreign currencies fluctuate. So I would say that our global footprint across the world in and of itself provides a natural hedging mechanism by the fact that we have operations in the major markets where we book revenue and also we incur expenses in those markets. And then, two, where appropriate, and we also manage our global cash flow and repatriation in a timely manner so that we build in the global transfer pricing mechanism so we can repatriate cash back to the U.S.
And then when appropriate, we do look into opportunities to hedge our cash in a responsible way, right? So in today’s environment, we also need to be mindful that when we put in hedging instrument in place, we want to make sure our economic gain outweigh the cost of hedging, right? So particularly when dollar strengthens and then against the major currency like euros and today the cost of hedging also increases quite tremendously. So we have to be strategic about that by utilizing our global natural hedging, also our operating cash flow management at the same time.
Amit Dayal
Understood. Thank you for that. Then with respect to fungicide, you’re showing pretty decent growth on that front. I know it’s small numbers today, but still the growth is relatively strong. You mentioned market penetration and product expansion in certain geographies as one of the drivers. Is there anything else that is supporting this like that’s supporting the adoption in these areas? Are you taking share? Like — or is it at an early stage where there aren’t too many competitors offering these types of products in those markets that is helping you post these numbers?
Clint Lewis
Yes. Again, I think it’s a focus on execution of that diversification strategy and I appreciate your engagement on this from the beginning. Clearly, leveraging a very successful model that we’ve built for the global apple and pear crop, but now leveraging both our R&D and regulatory team to accelerate the data generation and the regulatory submission and approval for the use of other products and platforms, including our 1-MCP pioneering technology in use cases for other crops across other geographies. And as we secure those in-country registrations, also continuing to expand and focus and deploy our commercial and technical teams to be generating demand in those markets.
Again, the beautiful thing about our model, we have a direct selling model. We are not as dependent as other companies and other industries, including ours for third-party distributors that are representing multiple companies, multiple products and SKUs, we have our own field force that is directly engaging with our customers to generate that demand across the supply chain. So I think it is the tangible expression of our R&D and regulatory capabilities, matched with our field, customer and technical service that really is contributing to that growth in markets heretofore, not just emerging or developing markets like Latin America and as we’re also starting to explore more in Asia. But as I shared earlier with one of the other research analysts, is looking even a state of California.
Today, we are underpenetrated in the state of California where I think we should be. And we are not only registering the products that we think will be applicable for that state like the recent approval of our SmartFresh InBox, but in parallel, also putting additional boots on the ground, sales and technical expertise to really make sure we’re having adequate coverage and demand generation in the important state of California, and I would also argue down the East Coast of the U.S. as well.
Amit Dayal
Understood. Thank you for that. Just lastly, Clint, maybe any update on FreshCloud?
Clint Lewis
So I appreciate it Amit. In some respects, I want to talk about FreshCloud a little bit more, sometimes when — where the platform is fully ready. But I feel the responsibility to continue to point out the — what we see is the strategic opportunity for FreshCloud and how it complements our existing portfolio and capabilities. As we’ve defined, while still early days, there’s really two ways that we’re going to market and assessing the longer-term viability. One is, again, from a financial responsibility, a stand-alone model where we are discretely charging for the various services and modules with FreshCloud and it’s more like a subscription model, similar to other SaaS offerings.
The second one is in its strategic nature where we are clear with the customer with the distinct value proposition that FreshCloud’s bringing to their operations. But we, if you will, bundle FreshCloud with other products and services, so we can increase the share of wallet to our customer. In this particular quarter release, I mentioned albeit briefly in my opening remarks that we have an example of FreshCloud. We’ve not announced it only because we’re still working with that customer to be able to share their name publicly. But I think it’s a tangible example of the strategic opportunity we see with FreshCloud where we were able to penetrate a customer that is disproportionately focused on the high-value table grapes crop.
And here, we don’t have really any penetration in that setting. We see the attractiveness of that crop. We believe that we have other products that can lend itself to that space, and we’re working from a regulatory standpoint to generate that data, but irrespective of that, we were able to use FreshCloud and the interest that, that customer has to really get a foot in the door and to give us access and the opportunity to connect deeply with their teams that we otherwise would not have had. And I think that speaks to the potential and the power of FreshCloud.
Amit Dayal
Understood. Thank you for that. That’s all I have. I really appreciate all the color and good the see the aggregation come through. I’ll take my other questions offline. Thank you.
Clint Lewis
Thank you Amit, and thank you for the recognition of the efforts of the team.
Operator
We have reached the end of the question-and-answer session. I’d now like to turn the call back over to management for closing remarks.
Clint Lewis
Thank you, operator, and to all the participants, whether you asked the question or you were just on the line listening, we appreciate very much the interest, the engagement and the support of our company, and we look forward to continue to share with you the progress that we’re making on our diversification strategy. Thank you. Stay well.
Operator
This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation.
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