International Flavors & Fragrances Inc (IFF) 2003 Q3 法說會逐字稿

Good day everyone and welcome to the International Flavors & Fragrances third quarter 2003 earnings release conference. Today's call is being recorded. At this time, for opening remarks and introductions I would like to turn the call over to Mr. Douglas Wetmore, Senior Vice President and Chief Financial Officer. Please go ahead sir.

Thank you. Good morning everyone. Before we begin I'd like to read you 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. These statements are based on current expectations and the current economic environment.

Forward-looking statements and projections are inherently subject to significant economic, competitive and other uncertainties and contingencies which are beyond the control of management. The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements.

Important assumptions and other important factors that could cause actual results to differ materially from any forward-looking statements and projections are specified in the company's 10-K filed with the S.E.C., and IFF's other filings made with the S.E.C. from time to time. IFF does not update forward-looking statements and expressly disclaims any obligation to do so.

Secondly I'd also like to note that Dick is unable to join us for the call today. He had a longstanding commitment for a trip to Asia Pacific visiting various IFF locations and meetings with customers and we felt it inappropriate to attempt to reschedule so that he could join us.

Now, to move forward with our review of the third quarter. Our earnings per share for the quarter were 54 cents per share. These per-share results reflect the impact of restructuring and other charges equivalent to about 3 cents per share. Excluding the charges, our earnings per share would have been 57 cents per share.

The restructuring and other charges in the quarter and year-to-date represent the latest actions in our reorganization plan. And as we've previously stated, these actions could have only been undertaken after completing the integration of IFF and BBA, and after having performed a thorough analysis and assessment of our company's personnel and processes postintegration. Our actions year-to-date have eliminated approximately 260 positions. We'll complete the balance of the contemplated reorganization this year and will share the remaining details with you as and when appropriate.

Sales for the quarter increased 4% in comparison to the prior year quarter in reported dollars. The favorable currency translation was principally attributable to the strengthening of the euro, the pound sterling, and to a lesser extent the Australian dollar versus the U.S. dollar. In comparison to the prior year quarter these currencies strengthened versus the U.S. dollar by about 15%, 5% and 7% respectively. On a local currency basis the third quarter sales declined about 1%.

This performance represented an improvement over both the second quarter and six-month period ended June 30th, 2003, but the performance was still less than had been expected. We continue to experience weak sales, and fluctuating order patterns with our customers, most notably in the United States and to a lesser extent in Europe. Parts of Latin America and Asia Pacific, notably Japan, remain weak.

You'll recall that we saw significant withdrawal or cancellation of orders in the last two weeks of the second quarter, only to see a very strong order book for July. At that time, we also cautioned that we were uncertain as to whether the same pattern would emerge at the end of the third quarter or, for that matter, in ensuing quarters. And that in fact turned out to be the case--most Notably, in North America.

The shortfall arose mainly in the month of September when we saw in excess of $12 million of orders cancelled or deferred, the majority of which was in North America. The most significant portion of order cancellations were in fine fragrances, again most notably in North America. These cancellations especially those in fine fragrance significantly impacted both our consolidated sales performance and our gross and operating profits for the quarter.

We also have seen continued and in fact increased emphasis on reductions in inventory levels especially at quarter end. Remember our customers' sales patterns and their attempts to improve their investment in working capital are key factors in driving IFF sales patterns. On a positive note, we are seeing signs of economic recovery in various countries in which we operate, and are also seeing strong growth in certain countries and regions as we gain new wins and increase our market share. I'll discuss those in more detail when I discuss the individual regions.

We continue in our various R&D initiatives maintaining our spending on R&D at the targeted levels. We've noted in the past that we expect to see the fruits of these many R&D initiatives in 2003, and we are. An example being some new beverage wins using our patented cap lock encapsulation technology. We expect the R&D developments to accelerate in 2004 and the benefits resulting from those developments most likely in the second half of that year.

We also continue to take steps to better manage our balance sheet and to reduce our debt and with all the progress we've made and the steps we're taking, we firmly believe that IFF is well positioned to drive long term growth and shareholder value.

Now, turning to the individual geographic regions. North America fragrance sales declined by 13% for the quarter, representing a weaker performance than had been anticipated. Functional fragrance and aroma chemical sales declined by about 3% and 11% in the quarter respectively. We had forecasted (ph) a decline in functional fragrance sales elements of which are attributable to the continued destocking of products which contain our fragrances, however the performance was less than had been expected.

Our fine fragrance sales are substantially less in the quarter than had been expected. Fine fragrance declined 24% in the third quarter and this performance contrasts sharply with the performance in the second quarter and the six-month period ended June 30th where fine fragrance sales were flat. The weakness in fine fragrance sales span the entire range of our fragrance customers. Fine fragrance performance has been clearly aggravated by the macroeconomic factors including the persistent weak retail environment and the falloff in travel with the resultant impact on duty free sales.

North America flavor sales declined 1% for the quarter. This performance was also below expectations, and reflected a continuation of the slow down in customer order activity that we've seen throughout this year. Having said that, we continue to see a high level of new brief activity in North America and we've continued to win new business at a high level. What we are experiencing is a very cautious approach on the part of our customers in launching these new products. And even with new wins that had been launched many of our customers have chosen to downsize their product launches until they see evidence of a stronger economic recovery.

Turning to Europe, local currency fragrance sales decreased 2% for the quarter and on translation this resulted in a dollar increase of 11%. As we stated in our press release, the local currency performance reflected persistent economic weakness in much of the European region, most notably in France Germany Switzerland and the U.K., where sales performance was weakest in comparison to the 2002 third quarter.

The fragrance performance was dragged down by weak demand for aroma chemicals which declined 13%. Chemical sales did have a difficult comparison with the prior-year quarter, and chemicals grew by 20% in local currency in the 2002 third quarter. Fine and functional fragrance local currency sales increased 1% and 7% respectively. The fine fragrance performance was affected by very difficult comparatives with the 2002 third quarter, when fine fragrances -- local currency sales -- increased 25%.

Although fine fragrance grew 1% in the third quarter this year reflecting the benefit of new wins now being launched in Europe, the performance was aggravated by the same macro factors impacted North America, including the continued weak retail environment and the lower duty-free sales.

Europe flavors decreased 2% in local currency for the quarter resulting in a 9% increase in reported dollar sales. The performance was generally weak across all major western European countries which like fragrances reflected the very weak economic picture in the region.

Latin America fragrances reported a sales decrease of 4% for the quarter. The sales performance was driven by weak performance in Mexico and Brazil which declined 10% and 5% respectively. Sales in Argentina rebounded sharply though increasing 33% for the quarter, as economic circumstances stabilized there. Latin America flavor sales increased 31% in the quarter.

In contrast with our fragrance business in Brazil, flavors sales in Brazil grew 38% substantially exceeding expectations. This is a result of many new flavor wins in the Brazilian market. Moreover, this gives us further confidence that Brazil is starting to rebound and we look for further sales growth in the balance of the year and into 2004.

Argentina flavor sales grew 43% in the quarter and have increased 39% year-to-date, the Argentina performance in both flavors and fragrances based on 2002 that also is encouraging to see such substantial growth. Mexico flavor sales were also strong in the quarter growing 35% again due to new wins.

Asia Pacific fragrance sales increased 14% in local currency resulting in a 17% increase in reported dollars. Indonesia fragrance sales increased 27% for the quarter, continuing the performance we've achieved in the first half of the year. Indonesia sales increased 22% year to date. Thailand also significant growth, increasing 43% in the quarter, Thailand is up 46% year to date. And the growth in both Indonesia and Thailand reflect the growth of strong new fragrance wins.

Greater China fragrance sales, China and Hong Kong increased 39% recovering from a slow down the first half of the year. China is up 8% year to date. The performance was somewhat reduced by weakness in the Philippines which declined 12% in the quarter and by Japan which declined in the low single digits.

Asia Pacific flavor sales in local currency increased 2% resulting in a 6% increase in dollars. The growth in the region was driven by Indonesia, which reported a 7% increase in the quarter and China increased 12%. South Korea and Vietnam also contributed to the performance, increasing 59% and 19% respectively in the quarter. Japan flavor sales declined 13% in local currency during the quarter and are down 8% in local currency year-to-date. Our results in Japan continue to be impacted by the economic weakness in that country.

Another bright spot is India. India fragrances reported a 13% local currency increase in sales, 17% increase in dollars. And India flavors reported a local currency increase in 6% resulting in a dollar increase of 7 (ph). Both flavor and fragrance performance for the region was better than better than had been expected, and reflected the benefit of new wins.

On a year-to-date basis the India region has increased 9% in local currency and 13% in dollars. Performance in India continues to validate one of the principal strategic reasons underlying the acquisition of BBA--the market leader in India at the time we acquired them. We expect continued strong growth prospects in that region for the next several years.

Looking at our operating results and margin and expenses, our gross margin was 42.2% for the quarter, that's 140 basis points lower than the prior-year quarter. As I've already mentioned the decline in margin was attributable to the very weak performance in fine fragrance, most notably in North America. Our operating costs were in line with expectations, and such cost include about $1 million incurred in connection with the implementation of SAP.

During the quarter we successfully implemented SAP in our largest aroma chemical plant in the world in Benirarlo Spain. The implementation went without disruption of our operations there, and more importantly, customer service.

Our next implementation of SAP in the fourth quarter will be in Singapore, Thailand and our fragrance operations in the Netherlands and by the end of this year nearly 70% of the company's sales and operating base will be operating in an SAP environment. SAP is a real success at IFF.

Now, we also continue to benefit from our cost reduction and headcount reduction efforts. Selling general and administrative expenses have declined as a percentage of sales for the quarter they were 15.7% of sales compared to 16.3% in the prior year quarter. And year-to-date they're 15.7% of sales compared to 16.5% in 2002. These levels are now approaching the historical averages of IFF.

Although we will continue to focus on ways to reduce further. In this regard SAP is a real enabler, enabling us to streamline processes and eliminate lower value-added work as well as being a tool to better leverage our asset base and productive capacity.

Operating margin was 17.6% in the quarter and 17.8% on a year-to-date basis. And we achieved this operating performance while maintaining our increased level of spending on R&D. Interest expense decreased 27% in comparison to the prior-year quarter, reflecting the continued reduction in debt and our continued success in managing interest rate exposure. Year-to-date interest has declined 21% in comparison to 2002.

Our average interest rate this quarter was 2.7% versus 3.4% last year, and at quarter-end, the average interest rate on debt outstanding approximated 2.5%. Interest also declined due to lower debt levels. Debt per borrowed money -- meaning debt excluding deferred gains on interest rate swaps -- outstanding at the quarter end totaled $923 million about $94 million less than September 30th, 2002. We will continue to reduce debt as the year progresses.

There is nothing unusual in other income expense in the quarter and the amount is pretty much in line with the prior-year quarter. During the quarter we repurchased approximately 650,000 treasury shares under our buy-back program. At September 30th, 2003, we had a remaining authorization of about $42 million.

We remained committed to properly balancing the repurchase of shares with reduction of our overall debt levels. The effective tax rate before charges for the quarter and nine-month periods was 32% as expected. There's a slight variation from that when you take into account the restructuring and other charges and the reason for that difference is that the charges are mainly in higher tax jurisdictions, resulting in higher tax benefit to the company from those jurisdictions.

A couple of other items--our days sales inventory declined to 142 days at the current quarter-end. We expect further declines in inventory over the next several quarters. Most significantly, after we progress further in our implementation of SAP. Receivable days remain fairly constant at 71 days at September 30th,2003, compared to 70 days at December 31st, 2002, and 71 days at June 30th, 2003. Our capital investments for the quarter totaled about $14 million and depreciation was $18.2 million.

At this time we expect capital spending in 2003 to approximate $60 million to $65 million. This represents a further decline of about $10 million from that expected in July. The revised expectation reflects our continued focus on tight control over capital expenditures.

On April 3rd, we announced the latest step in our reorganization plan and to date, as a result of those actions we've eliminated more than 260 positions, including over 70 in the third quarter. Jobs eliminated were principally in North America and Europe, although there were some reductions in Latin America and Asia.

As a result, we recorded restructuring and other pretax charges of $3.9 million which was about $2.4 million after tax or about 3 cents per share. Year-to-date, we've recorded $31 million of restructuring and other pretax charges which represents about $20 million after tax or 22 cents per share. Essentially all charges taken in the quarter and year-to-date represent cost incurred in connection with the elimination of those 260 positions.

As we've 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 million to $100 million. The reason for the increase from the original cost is some actions now contemplated by the plan and exchange has also played a role because of the weakening of the dollar to the extent reorganization take place outside the United States. To date we have recorded $105 million of the expected pretax charges.

Now looking at the outlook for the balance of the year, as we stated in our press release earlier today, we adjusted our outlook for the full year 2003. We now expect local currency sales to decline 2% to 3% for the full year 2003. Excluding for comparative purposes approximately $9.4 million of 2002 sales related to the noncore businesses we disposed of last year. Based on current exchange rates, currency is expected to be favorable by approximately 6% to 7% for the year. And we expect a dollar increase in sales of somewhere between 3% and 5%.

As I've noted today and as we discussed in July we have seen significant weakness in order activity at the end of each of the second and third quarters, and quite frankly until we see evidence to the contrary, we have to expect this pattern of weak sales and order activity will continue for at least the balance of the year. With respect to the individual geographic regions, for the full year 2003, North America fragrances are expected to decline approximately seven to 8%. Reflecting anticipated ongoing weakness in fine fragrances.

Flavors in North America are expected to be flat or increase just slightly. And this anticipated performance excludes the 2002 sales attributable to the noncore businesses. Including such sales in the 2002 comparative, 2003 flavor sales in North America would decline about 3%.

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

Latin America fragrances will decrease in the mid single digits although this will still represent progressive improvement over the earlier part of the year. Latin America flavors are expected to increase in the high single digits, and this performance reflects a combination of improved business conditions and the benefit of continued wins in the marketplace.

Asia Pacific fragrances are expected to increase in the low to mid single digits in local currency resulting in a high single digit increase in dollars. Asia flavors are expected to decline in low single digits in local currency, resulting in a low single digit growth in reported 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 full year earnings per share to be in the range of $1.86 to $1.91 including the impact of other charges to date and earnings per share excluding any restructuring or other charges to be in the range of $2.05 to $2.09 per share.

For comparative purposes 2002 earnings per share would have been $1.92 excluding the restructuring and other charges and $1.84 including such charges. We're lowering the earnings expectations mainly due to the anticipated continued weakness in our fine fragrance business and its resultant impact on gross margin operating margin and operating results.

Having said that we'll now open the conference call to questions.

Thank you. (Operator’s instructions) We'll go first to Alice Longley at CS First Boston.

Hi Alice.

How are you? I'm having trouble with blaming these disappointments on the environment. We have Gividan (ph), your biggest competitor reporting local currency sales of 4.5% in the same quarter. Some of these trends-- we have Estee Lauder and Elizabeth Arden talking about travel rebounding especially in Europe. These numbers you are giving us and the explanation that it's the environment at fault isn't adding up with what we're getting else with where.

I think you're seeing a little bit of a pickup in the duty-free sales. But that has not yet benefited us. I think the sell-through is still a little bit stronger than the sell-in. We have continued to win a lot of business and we've had some new wins in fine fragrance and we're continuing to execute on our plan.

It is a bit disappointing that fine fragrance sales particularly in North America declined as they did in the third quarter. But again we're still pretty confident that we're moving in the right direction and we continue to win business both in fragrance and flavor.

Thank you.

We'll go necessary to Jeff Zekauskas at J.P. Morgan.

This is Silke Kueck-Valdes for Jeff. The decrease of fine fragrances of 24% in North America, can you sort of talk about what the revenue impact and EPS share effect? And also can you tell those were orders that were sort of like shifted and dropped completely or did those, you know, go to your competitors?

Well, first of all they would not go to the competitors. As you know, first of all we said it's across our entire portfolio of fine fragrance customers. And it was fairly sharp and fairly pronounced in the third quarter.

But to talk about the shifting and the cancellation, just as we said in the second quarter, the order book in July was quite strong. But we cautioned at that time, it was not really July that was the question. It was what September would prove to be. And that turned out to be the case. The orders shifted from June to July were fine, and we had a good July.

But then the orders shifted in September. Are they ultimately cancelled or are they delivered later, depends on the end demand for fine fragrance.

Can you talk a little bit what's happening in functional fragrances? That was an area of weakness in the second quarter. Has that sort of improved versus sequentially or has it gotten worse as well?

Well, it shifts among the various geographic regions. For the quarter, functional fragrances were up 2% in local currency on a global basis. A lot of that was driven by good wins in Asia and India, as well as, I mentioned, that they were up in Europe.

North America is what we've talked about for a long period of time, that's the area where the most pronounced effect of destocking has been experienced, and we've said that we expect it to continue for some time further. But overall I think we're holding our own in functional fragrances with a 2% local currency increase.

Okay, thanks very much.

Thank you.

And we'll move next to Bob Buetner at Strong Capital Management.

If you have seen this pattern twice over if last couple of quarters, where you see cancellation late, and you see strength is subsequent months at the orders come back in. Are you seeing that same strength in October, you're seeing those orders flow back in, we don't know if they're going to get cut again in December but are you seeing it come back in October?

October has been a fairly good month in North America. That's a fairly good question. It is following the same pattern that we saw in July. But we have to be -- we're being cautious because the pattern we expect is likely to continue for at least the balance of this year.

And a lot of it, particularly in fine fragrance, depends on the success of the holiday season. Approximately 40% to 45% of fine fragrance is sold in the retail environment between Thanksgiving and the Christmas holidays. So a lot of it is going to depend on the success in the retail environment in the next couple of months.

I've got two other quick questions.

Sure.

Did you give cash flow in the quarter, cash provided by operations? Could you give that number?

We did not provide it in the press release but it was roughly about $150 million of net cash provided by operations in the quarter. And that's -- let me caveat that by saying that we're still finalizing the shape of cash flows. That's down a little bit from last year and the main reason for that is the timing of some tax payments, and also we did not generate as much cash from reducing inventory levels as we did last year.

And the main reason for that is, we built up inventory levels, particularly in chemicals coming from our Benicarlo plant in preparation for any potential disruption that might have arisen from the implementation of SAP. As I said we had a successful implementation. We'll now be working down those inventories but it makes business sense to build up inventories in the event there is a problem or difficulty.

And last question is just following up on Alice's question, is there a particular reason that your sales would be weaker than Gividan? If you sit back and speculate why the results of the two companies, at least on the top line, wouldn't be more comparable in this kind of environment?

Well, I know -- obviously know the most about IFF since this is where I work and I think the Gividan folks which is a well respected competitor can lend insight into their performance. We had the impact of a difficult comparative particularly in fine fragrance.

We had a substantial number of wins in 2002. Through nine months last year, our fine fragrance was up something like 8% or 9% in local currency, and about 12% in dollars. And it's a very difficult comparative against that. And then you apply the -- these order disruptions in North America, and that just makes it all the more difficult. I think we're holding our own, and we're winning a lot of business. There's going to be some new announcements over the course of the next couple of months in terms of additional fine fragrance wins.

One of the newest ones in the marketplace that we won earlier was the Givenchy Very Irresistible. And there are new wins for Arden that have been announced. I'm confident we're on track and going to continue to win.

And finally Q4 guidance on the top line, you said you saw about $12 million worth of orders cancelled or deferred in North America. Are you just assuming a similar deferral amount for Q4? Are you assuming a larger amount that would be cancelled or deferred for Q4 in North America? Just trying to put some numbers around the reduction in Q4 guidance.

Well, we build our forecast based on the order patterns that we receive from our customers. They generally give us 3 to 6 month outlook. So that we can plan our raw material purchases and so forth.

Now, we did have about $12 million of back out -- it was mainly in North America, not solely in North America, in the second half of September. We are anticipating that we will continue to see some level of back outs during the month of December. And we are taking a cautious view of it. Again, particularly as it relates to fine fragrance, a lot of it depends on, really, the next couple of weeks and the next month, to see what that demand for fine fragrance is in the retail environment.

I must say that I've been in some department stores recently, and there has not been a lot of activity in the fragrance counters. And if that's any indication, then there's -- I would expect some continued weakness in fine fragrance for the balance of the year from a retail perspective.

But you feel like you've been conservative enough with Q4 guidance, or there's a potential that you haven't gone quite far enough? I mean it's obviously a judgment calling.

It's a judgment call. I'd like to think we have a pretty proven track record of providing good guidance before these disruptions in the last two quarters. I think we've provided the best guidance we have based on the information we have at this point in time and taking a conservative view in terms of how it's going to develop for the balance of the year.

Thank Doug.

Thank you.

As a reminder, if you do have a question press star 1. We'll go next to Alex Pasini (ph) at Lombard.

Good monk from Switzerland. What I can say is that they do have in the fine fragrances a lower base of comparison which does help them currently but it does seem that the situation is rather difficult.

My questions in this regard have been answered. I would like you to expand maybe a little bit on your position in China. What kind of growth you're seeing there the number of production sites where you position yourself in relation to competition and also the same question for Japan. I guess it's the market that's rather weak rather than yourself. What is exactly your position in Japan and how are the Japanese players doing, please?

I'll answer your first question first. We've historically been in China for probably over 30 years now and we've had operations in China for close to 20. We currently have three manufacturing locations in China as well as additional sales office necessary Beijing, Quangjho and Shanghai. Our growth in China, for the last oh, let’s say 10 years, has probably been at a compound rate of 8% to 9% annually. As I said, year-to-date China is up about 8% and, we're very enthusiastic about the continued success and growth in the Chinese market.

And we service the multinationals that are based in China, and we also service some very sizable local Chinese companies that are also very successful in that market. We expect that we'll continue to expand and grow in China for the next several years. China and India are the two real big growth opportunities for us, and for consumer products companies, for probably the next generation. Because you've got roughly 2.5 billion people there that is acquiring greater disposable income.

As relates to Japan, Japan was at its peak at about 5% to 6% of our consolidated sales. It has declined in the last couple of years because of the persistent weakness in that environment. It is challenging for multinational companies to still work in Japan but it's always been the case. Year on year the comparatives of are the same. The flavor companies or the food companies, our flavor business has not grown this year. And I think that's really still reflective of the eventual turn-around in the Japanese market. I think there's still some work that needs to be done before the Japanese economy really begins to strengthen.

But Japan's a very important country for us and the current weakness should not in any way be inferred about our taking a dim view about the long term prospects of Japan. I'm still mindful that it's the second largest economy in the world.

Going a bit more into detail, could you break down in China the percentage of sales for multinationals and those with local Chinese companies and what does China represent approximately in percent of sales for you? And finally detail on Japan, are you number four in that market, would you say that?

I must apologize, I don't have market statistics for our market share in Japan. So I'm unable to answer that question.

Okay.

We don't break out sales of the individual countries. I will say the breakdown between flavors and fragrances in China and in Japan basically mirrors our breakdown on a consolidated basis of roughly 55% fragrance, 45% flavors. We sell to a combination, just as we do around the world, a large multinationals, as well as some large local and regional players.

You know, the top 5 customers on a consolidated basis represent about 27% or 29% of our consolidated sales. And then we get some large regional and local. I think that same sort of breakdown would apply in the Chinese market.

Okay, thank you.

Thank you.

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

I have no additional closing remarks. Thank you for calling in. If you have any additional questions or require further follow-up please contact me and my number is on the bottom of the press release. Thank you very much.

That does conclude today's conference call. Thank you all for joining us.