International Flavors & Fragrances Inc (IFF) 2003 Q2 法說會逐字稿

Good day everyone, and welcome to the International Flavors & Fragrances second quarter 2003 earnings release conference call. Today's call is being recorded. The speakers for today's call will be Mr. Goldstein, Chairman and Chief Executive Officer, and Mr. Douglas Wetmore, Senior Vice President and Chief Financial Officer. Mr. Goldstein, please go ahead.

Thank you. Before we begin, I would like to read you some cautionary remarks. This conference call may contain statements that are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. The complete forward-looking statement is in our press releases, and is updated from time to time in the Company's SEC filings.

Now to move forward with our review of the second quarter. I'm pleased to report that our earnings were in line with expectations outlined to you in April, notwithstanding the very difficult sales environment which we, as well as many of our customers, continue to experience throughout the globe. Our earnings per share for the quarter were 54 cents. These per-share results reflect the impact of nonrecurring charges equivalent to about 5 cents per share. Excluding the charges, our earnings per share would have been 59 cents, consistent with the range we provided in April.

The nature and genesis of the charges are rooted in all that we have accomplished over the last 30 months. In this time, we undertook a number of initiatives, including the acquisition and integration of Bush Boake Allen, the reorganization of IFF. In so doing, we have emphasized speed and decisiveness in our actions. The integration of IFF and BBA operations, research, selling and administrative functions, completed in 2002, was a success; and in many respects, from an expense perspective, ideally positioned us to deal with the difficult economic times we currently face.

The last actions in our reorganization, which are ongoing this year, could only have been taken after completing the integration and after having performed a thorough analysis and assessment of our company's personnel and processes, post-integration. Our actions year-to-date have eliminated 190 positions. We will complete the balance of the contemplated reorganization this year, and we will share details with you as and when appropriate.

Sales for the quarter increased 1 percent in comparison to the prior year in reported dollars. For the sake of this comparison, 2002 results include approximately $4 million of sales associated with non-core businesses that we disposed of in June of last year. Excluding these sales from the prior year for comparative purposes, sales increased 2 percent for the quarter. On a local currency basis, again, excluding those sales attributed to non-core businesses, the quarter's sales declined about 5 percent. I cannot say that I'm pleased with the way the sales developed for the quarter, but nevertheless, understand how we performed as well as we did.

We have seen sales slow down at many of our customers. We have also seen continued, and in fact, increased emphasis on the reductions and inventory levels, especially at quarter end. Our customer sales patterns and their attempts to improve their investment in working capital are key factors in affecting IFF's sales patterns. We achieved our earnings for the quarter, while at the same time increasing our spending on R&D to the targeted levels. Research and development is the cornerstone of our future profitable growth.

We also continued to take steps to better manage our balance sheet and our debt position. We closed on the sale of our New York headquarters. Although we continue to occupy a portion of the structure, it no longer made sense for us to own the building. As I have stated before, this transaction in no way impacts on our employees and operations in New York, or on our ability to serve our many customers based in New York. The transaction closed in June, and the sales proceeds of approximately $90 million, after transaction costs, were used to reduce debt.

With all the progress we have made and the steps we are taking, I firmly believe that IFF is well positioned to drive long-term growth and shareholder value, and I can assure you we intend to continue delivering on our promises.

Before I turn the call over to Doug to discuss the second-quarter details, let me pause for a moment and comment on the future. Over the last several quarters, we have seen fluctuating order patterns in nearly every geographic region. These order pattern shifts make it increasingly difficult to accurately predict sales performance for an individual quarter. We believe that over the course of a year, such fluctuating patterns will have a tendency to even out, but they can have significant impact on an individual quarter. Accordingly, in this environment, we believe it more appropriate to provide our most current expectations for the full year 2003 performance rather than focusing on individual quarters. Based on the most recent estimates available, we expect that sales for the full year 2003 will be flat to modestly up in local currency. Exchange is expected to continue to be favorable, resulting in reported dollars sales increase of between 6 and 7 percent.

Despite the difficult economic environment, we expect earnings per share to be in the range of 2.12 to $2.18, excluding the impact of nonrecurring charges, as we discuss in our press release. We feel comfortable in our ability to deliver these earnings, due to our continued focus on operating efficiencies in all aspects of our costs. At the same time, we are unwavering in our commitment to research and development. Our future successes depend on our many initiatives in R&D.

Now I'll turn the call over to Doug to discuss our financial results in more detail, and after that, we would be pleased to take your questions. Doug?

Thanks Dick, and good morning everyone. Local currency sales for the second-quarter 2003 decreased about 5 percent from the prior year quarter. This performance excludes, for comparison, 4.3 million of sales in the second-quarter 2002 attributable to the non-core businesses disposed of. Including the sales relating to those non-core businesses in the 2002 comparative (technical difficulty), sales for the current quarter declined about 6 percent versus the prior year in local currency, and increased about 1 percent in dollars. The favorable current translation was principally attributable to the strengthening of the euro, and to a lesser extent, the Australian dollar and the Japanese yen versus the U.S. dollar. In comparison to the prior year quarter, these currencies strengthened versus the U.S. dollar by about 25 percent, 15 percent and 7 percent, respectively. As Dick noted, per-share results were 54 cents, including nonrecurring charges, and would have been 59 cents per share without such charges, in the middle of the range that had been forecast back in April.

Turning to the regions -- North America fragrance sales declined by 6 percent for the quarter, representing a weaker performance than had been anticipated. Both functional fragrance and aroma chemicals declined by about 8 percent in the quarter. We had forecast a decline in functional product sales, elements of which are attributable to continued de-stocking of products which contain our fragrances; however, the performance was less than had been previously expected. Fine fragrance sales were flat for the quarter. The benefit of the many wins we've developed over the last several quarters essentially offset the impact of continued overall weakness in the fine fragrance market. Fine fragrance weakness was clearly aggravated by macro economic factors, including the persistent weak retail environment and the fall-off in travel, with a resultant impact on duty-free sales.

North America flavor sales declined 6 percent for the quarter. For the sake of this comparison, the 2002 results include approximately 4 million of sales associated with the non-core businesses. Excluding these sales from the prior year comparative, flavor sales declined 1 percent for the quarter. This performance was below expectations, and reflected the continuation of the slowdown in customer order activity that we first saw in the fourth quarter of last year, and which has continued as 2003 has progressed. Having said that, we continued to see a high level of new brief activity in North America flavors, and we have continued to win new business at a high level. And we expect the situation in North America flavors to improve somewhat in the second half of the year.

Turning to Europe -- local currency fragrance sales decreased 11 percent for the quarter. On translation, this resulted in a reported dollar increase of 8 percent. As we stated in our press release, the local currency performance reflected the persistent economic weakness in much of the European region, most notably in France, Germany, Switzerland and the UK, where sales performance were weakest in comparison to the 2002 second-quarter. The performance in European fragrances was driven by weak demand for functional fragrance products and aroma chemicals. The functional fragrance and chemical sales performances were further aggregated by very difficult comparatives with the 2002 second-quarter.

In the 2002 second-quarter, functional fragrances achieved a 13 percent local currency sales increase, while chemical sales nearly doubled that level of growth, achieving a 25 percent sales increase in the quarter. As we have stated regularly in past earnings calls, we continue to see gyrating order patterns regarding chemicals and functional fragrance products in Europe, and this quarter was no exception. Fine fragrance sales in Europe, in local currency, were essentially flat with the prior year. As was the case in North America, the benefit of the many wins developed over the last several quarters essentially offset the impact of continued overall weakness in fine fragrance. Fine fragrance weakness was clearly aggravated by the macro factors, just as in North America, including a continued weak retail environment and sharply lower duty-free sales, due to the diminished international travel.

Europe flavors decreased 3 percent in local currency for the quarter, resulting in a 16 percent increase in reported dollar sales. The local currency performance was somewhat less than had been expected, and the performance was generally weak across all major Western European countries, which, like fragrances, reflected the very weak economic picture.

Latin American fragrances reported a decrease of about 13 percent for the quarter. This sales performance was weak throughout the region, but most notably in Brazil, Mexico, Venezuela and Central America. The performance, again, was driven by very weak macro factors confronting the entire Latin American region. Latin America flavor sales increased about 3 percent in the quarter. In contrast with our fragrance business in Brazil, flavor sales in Brazil grew 21 percent, exceeding our expectations. This performance was the result of many new flavor wins in the Brazilian market. Moreover, the performance gives us further confidence that Brazil is beginning to rebound from its recession. We look for further sales growth there in the balance of the year.

Partially offsetting a strong performance in Brazil, Mexico, Colombia and Venezuela flavor sales all declined by 20 percent or more in the quarter. The performance in Mexico was aggravated by a very difficult comparison to the 2002 second-quarter, when flavor sales increased 26 percent.

Asia-Pacific fragrance sales were flat in local currency, resulting in a 5 percent increase in reported dollars. Indonesia fragrance sales increased 20 percent for the quarter, continuing a performance we saw in the first quarter this year. Thailand and Taiwan also recorded significant double-digit sales growth; however, the growth was offset by weakness in Australia, China, Japan, Singapore and South Korea. Asia-Pacific flavors local currency sales decreased 5 percent, resulting in a 1 percent increase in reported dollar sales. The Philippines and Australia were the principal causes of the decline. The Philippines declined 40 percent, while Australia declined 10 percent. Partially offsetting the declines, Indonesia reported a 7 percent increase in the quarter and China increased 6 percent.

India fragrances reported a 6 percent local currency decrease in sales, resulting in flat sales on reported dollars, and India flavors reported a local currency increase of 12 percent, resulting in a reported dollar growth of 14 percent. Both flavor and fragrances' performance for the region were better than had been expected, and generally reflected the benefit of new wins in the marketplace. Performance in India continues to validate the principal strategic reasons underlying the acquisition of BBA, the market leader in India at the time we acquired them -- the strong growth prospects in India for the next several years.

Turning to operating results and expenses. Our gross margin of 43 percent came in slightly better than the prior year quarter, as reported, and in line with what had been expected. Operating costs were below previous expectations, notwithstanding that such cost included expenses of approximately $1 million incurred in connection with the implementation of SAP. During the second quarter, we successfully implemented SAP in Brazil -- three locations in Brazil -- without disruption of our operations there, and more importantly, without any disruption in customer service. We will implement SAP in our aroma chemical facility in Beni Carlos (ph), Spain later this summer.

Our operating margin improved to 19.2 percent of sales for the quarter, improving from 18.2 percent in the prior year comparable period, reflecting our continued efforts to include cost control. On a year-to-date basis, operating margin has improved to 17.9 percent of sales, from 17.2 percent of sales for the 2002 6 month period. We achieved this operating performance while at the same time increasing our spending on R&D to the target level of approximately 8 percent of sales, compared to 7.4 percent of sales in the prior year quarter.

Interest expense decreased 14 percent in comparison to the prior year quarter, reflecting the continued reduction in debt and our continued success in managing interest rate exposure. Our average interest rate this quarter was 3.2 percent versus 3.3 percent in the last year quarter. And at quarter end, our average interest rate on debt outstanding approximated 2.7 percent. Interest also declined due to lower debt levels. Debt for borrowed money -- by that I mean debt, excluding the deferred gains on interest rate swaps -- outstanding at this quarter end is about $148 million less than at June 30 2002. We will continue to reduce debt as the year progresses.

Other income expense declined in comparison to the prior year, primarily for two reasons -- first, the '02 results included favorable exchange gains, most notably in Argentina, and there are no exchange gains of this order of magnitude in the current quarter; and secondly, other income and expense reflects the loss on the repurchase of debt that we announced at the time we released first-quarter earnings. The full details regarding the repurchase of debt and its impact on other income and expense is included in our press release. During the quarter, we repurchased approximately 531,000 treasury shares under our buyback program. At June 30, 2003, we had a remaining authorization of about $62 million. We remain committed to properly balancing the repurchase of shares with reduction in our overall debt levels.

The effective tax rate before charges for the quarter and six-month periods was 32 percent, as expected, and we expect that to be the full year effective rate. When considering the nonrecurring charges, the effective rate for the quarter and year-to-date was 31.8 percent and 31.6 percent, respectively. The reason for the difference is that the charges are mainly in higher tax jurisdictions, resulting in a higher tax benefit to the Company as a result of the charges.

Just looking at the balance sheet and some other items -- our says sales in inventory declined from about 150 at December 31st, 2002, to 147 days at the current quarter end. And we expect further declines in inventory over the next several quarters, but the most significant elements of those declines will be after we progress further in our implementation of SAP. Receivable days remained fairly constant at 71 days at June 30 this year, compared to 70 at December 31st, 2002, and 71 days at June 30, 2002.

Our capital investments for the quarter totaled about $15 million, and depreciation for the quarter totaled $18.5 million. At this time, we expect capital spending in 2003 to approximate 70 to 75 million, representing a decline of about 10 million from that expected in April. This revised expectation reflects our continued focus on tight control over capital expenditures, as well as our ability to better leverage existing assets as we he rollout and better utilize SAP.

On April 3, we announced the latest steps ion our reorganization, and to date, as a result of these actions, we've eliminated more than 190 positions, including over 40 in the second quarter. Jobs eliminated were principally in North America and Europe. As a result of actions taken in the quarter, we recorded nonrecurring pre-tax charges of 6.7 million, which is 4.4 million after-tax, or about 5 cents per share. And year-to-date, we have recorded nonrecurring pre-tax charges of 27 million, which represents about 17.9 million after-tax, or 19 cents per share. Essentially all of these charges relate to the elimination of positions. As we have noted in past earnings releases, we expect the final cost of the reorganization to be as much as 110 million, increasing from the original range of 90-100. To date, the Company has recorded approximately 101 million of the expected pre-tax charges.

As Dick mentioned on June 18th, we closed the sale of our New York headquarters and entered into a long-term lease with respect to the space we currently occupy. The proceeds were approximately 90 million and were used to reduce short-term borrowings. And the gain on sale, which approximated $53 million, will be deferred and amortized over the initial lease term of 27.5 years, as required under applicable accounting standards. That deferred gain is essentially all included in our nonrecurring liability -- excuse me -- noncurrent liabilities in the balance sheet that accompanies the press release.

Looking at the balance of the year, with respect to the individual geographic regions -- we now expect North America fragrances to be flattish in comparison to 2002. North America flavors are expected to increase approximately 3 to 4 percent for the full year, with a strong performance in the second half of this year. This anticipated performance excludes the 2002 sales attributable to the non-core business. Including such sales in the 2002 comparative, 2003 flavor sales in North America would decline about 2 percent.

Europe fragrances will decline in the low single digits in local currency terms, which will result in a dollar increase in the high single to low double-digits. Europe flavors are expected to also be flat in local currency, which will result in a dollar increase in the high single to low double-digits.

Latin America fragrances will decrease in the low single digits, although this performance will represent progressive improvement as 2003 proceeds. And Latin America flavors are expected to increase in the high single to low double-digits. This performance reflects a combination of improved business conditions, continued wins in the marketplace and the benefit of easier comparatives in the second half of this year versus 2002.

Asia-Pacific fragrances are expected to increase in the low single digits in local currency, resulting in a high single digit increase in reported dollars. And Asia-Pacific flavors are expected to be flattish in local currency, resulting in a low single digit growth in dollars. In India both fragrances and flavors are expected to increase in local currency in the high single digits, with a dollar increase in the high single to low double digits. We expect earnings per share, excluding any nonrecurring charges, to be in the range of 2.12 to 2.18 per share, and we expect full year earnings per share to be in the range of $1.93 to $1.99, including the impact of nonrecurring charges taken year-to-date. For comparative purposes, 2002 earnings per share would have been $1.92, excluding nonrecurring charges, and $1.84, including such nonrecurring charges.

With that, we will now open the conference call to questions.

(CALLER INSTRUCTIONS). Alice Longley of CS First Boston.

I have two questions. Could you just comment a detail more specifically on North American household fragrances and chemicals, why that was so particularly -- why that would be weaker than flavors, for example? And then the other question is -- you have got quite a lot of strengthening planned for the second half of the year it looks like, and I can understand how travel retail would improve -- but why else are you so comfortable that you'll get all this strengthening in the second half?

Let me start Alice with the first part, and a lot of that I think is a function of some de-stocking on that side of the business. As far as the growth in the second half of the year, we are fairly comfortable with it, particularly on the flavor side in North America, on the basis of what our win rate has been. In addition, as you know from our comments before, that we had several customers backing out orders near the end of the second quarter, and we are finding that those orders are coming back into the order books now; and therefore, that gives us confidence that the back half of the year on the flavor side should give us that type of growth in North America.

Okay. I guess one other thing -- your gross margins were not up that much, but you got a huge cut in the other SG&A line aside from R&D. Could you explain, number 1, why you're not getting more gross margin expansion simply because of your upward shift in mix? And then the other thing is what are you cutting in that other SG&A line so much?

The gross margin -- we're actually pretty pleased that it came in at the 43.6, when you look at the 5 percent decline in local currency sales. Because you do get, at some point in time, a challenge a chance to absorb your fixed expenses over that reduced sales level. So had sales come in where we initially thought they would have come in when we provided guidance earlier, our margin would have improved more than it did. With respect to the SG&A expenses, it's really -- as Dick talked about, and as we have mentioned before, in terms of the reorganization -- we've really looked at essentially all aspects of how we do things, now that we have completely put the two organizations together, and we have eliminated 190 positions. And a lot of those were in SG&A, there were some in manufacturing, but a lot in SG&A. And finally, we get the benefit as we continue to roll out SAP. And as you know from past conversations, what we are able to do -- what that enables us to do is eliminate a lot of non-value-added costs by streamlining the way we conduct business.

(CALLER INSTRUCTIONS). Jeff Dukakis of J.P. Morgan.

Actually it's sitting in for Jeff today. Two questions. Can you talk about the sequential difference in the quarter? Does that sort of reflect a slowdown in areas that have been growing faster in the first quarter? And then, exactly how do you analyze the sharp decline in functional fragrances? How much of it is a timing issue and other share shift issues?

Silke, could you repeat the first question? It came off across a little garbled -- I'm sorry.

Can you sort of explain the sequential difference in the quarter? It seems that your various areas in the first quarter have grown stronger, and then weaker in the second quarter. Is that just sort of that the first quarter was really strong, second quarter is falling off a little bit? Is it just a shift, or how much is a timing issue?

Okay. Doug, do you want to start?

I think we talked about it in our opening comments, and this has been the case for the last several quarters. We have seen gyrating order patterns, most notably in North America and Europe, and as we mentioned in our July 7th press release when we commented on sales, we saw a fairly sharp drop-off in order activity in the latter stages of June. And as Dick just mentioned a moment ago, order activity has picked up considerably in July. So a lot of it is the fluctuating order patterns of our customers. And while we have some insight into what is driving those, I think our customers are in a much better position to provide commentary on that, because we are responding to their order patterns.

Significantly, what I would add to Doug's comments is that it is significantly more active in this area than we have seen in the past.

Do you feel any pressure from product line consolidation at all? there was this big article -- or not big, but there was an article in the Journal yesterday, where they talked -- where consumer product companies talked about strengthening core product lines, and really trimming off a lot of the --

Yes. I think the answer to that is it can be post both positive and negative, it depends upon where we happen to be within the range on those products. When you have consolidations, there are some SKUs that survive, there are some SKUs that don't. If we happened to be in the surviving SKUs, it will in fact strengthen our business. If we happen to be in one that is eliminated, then, of course, it will hurt us. I think that this is a continuing inevitability within the sectors, and I think that -- I don't anticipate this . There will be continued pressure on our customers in order to be able to find the shelf space for new products going into the market, and in doing that, there may be more pressure on them to replace existing SKUs.

(CALLER INSTRUCTIONS). Peter Thompson of Coho Partners.

I'm sorry, I got on late. Can I just -- I just quickly read your release, and I'm sorry -- I missed your outlook for third quarter. Could I just quickly get a summary on that?

We did not provide specific guidance on third-quarter, what we've indicated is that, given the fluctuating order patterns that we are seeing and the shifting patterns, that it is increasingly more difficult for us to be able to provide quarterly guidance in that fashion; and therefore, we believe that over the course of the year, the fluctuating order patterns will in fact even out. But in this environment, it's more appropriate for us to give expectations for the full year 2003 rather than focusing on individual quarters.

Can I have one follow-up? I did catch your share repurchase in the quarter, and you said $62 million is left on the authorization. That obviously implies that soon you'll be through with your authorization, and is it logical to expect the board to re-up that one?

We've been engaged in various share repurchase activities since 1992, and have actually repurchased almost $1 billion worth of shares in that period of time to the current date. I think that we would propose a follow-up program, but I think we have to defer that to the board when that time approaches.

A follow-up from J.P. Morgan.

Yes, I have one follow-up question. You mentioned that you lowered your CapEx expectations for the year to 70 to 75 million. Has anything changed in your early expectations, and what's your depreciation outlook for the year?

Depreciation -- to answer the latter question first -- depreciation -- since 70 percent of our business is overseas, it is influenced by foreign currency fluctuations, but it probably should be in the range of 72 to $75 million. As I mentioned in the comments, we have been very -- and I don't think we are alone in this -- we have been very cautious and very tight in terms of capital expenditures, and we are also finding in many instances in those plants that have implemented SAP that we are getting much greater leverage out of existing.

Gentlemen, at this time there are no further questions. I will turn the call back over to you for any closing remarks.

Thank you very much. Thank you for calling in, and we will talk to you at the end of the next quarter.

That does conclude today's conference. We would like to thank you all for your participation, and have a great day.

(CONFERENCE CALL CONCLUDED)