International Flavors & Fragrances Inc (IFF) 2004 Q1 法說會逐字稿

Good day and welcome to the International Flavors & Fragrance's first quarter 2004 earnings release conference. Today's call is being recorded. The speaker for today's call will be Mr. Richard Goldstein, Chairman and Chief Executive Officer and Mr. Douglas Wetmore, Senior Vice President and Chief Financial Officer. Gentlemen, please go ahead.

Thank you. Before we begin, I need to read some cautionary remarks. This 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 that 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 SEC and IFF's other filings with the SEC from time to time. IFF does not update forward-looking statements and expressly disclaims any obligation to do so.

Okay. Now to move forward with our review of the first quarter. I am very pleased to report that our results for the first quarter were very strong, both in terms of local currency performance and reported dollars in both flavors and fragrances. Reported dollar sales for the quarter increased 15 percent in comparison to the prior year. On a local currency basis, sales increased 6 percent for the quarter. The local currency sales growth was particularly strong in our North American flavor operation, where we achieved an 18 percent increase this quarter, following a 19 percent increase in the fourth quarter of 2003. We are benefiting from new wins and strong customer demand for our products.

Latin America reported a 9 percent sales increase in both flavors and fragrances. Asia-Pacific reported local currency growth of 7 percent. And India reported a 31 percent increase -- all impressive increases.

Local currency sales in Europe declined 1 percent for the quarter, reflecting the continued weak economic picture in much of that region. However, due to the strength of the euro and the Pound Sterling, Europe sales increased 14 percent in reported dollars.

Our earnings per share for the quarter were 59 cents, increasing 23 percent relative to a comparable 2003 result of $0.48 per share. For purposes of this comparison, the 2003 per-share results exclude the impact of restructuring and other charges equivalent to $0.14 per share. 2004 earnings per share increased 74 percent, compared to 2003 reported per-share results of $0.34.

We continue to invest in research and development. Our spending on R&D was 8.3 percent of sales for the quarter, in line with our expectations for 2004. I know that I have stated many times in the past, but it warrants frequent mention. R&D is the cornerstone of our future profitable growth. We are a business that is customer-focused and technology-driven.

Before I turn the call over to Doug, there are two additional matters which I wish to discuss. First, as many of you know, during the first quarter, a judgment was entered against IFF related to the first of the butter popcorn lawsuits. On March 15th, a plaintiff was awarded $20 million in compensatory damages. We filed a Form 8-K that day advising that, one, we believe the verdict was not supported by the evidence of the law; two, that we would appeal the decision; and three, that in view of our insurance coverage, we did not expect a litigation to have a material adverse effect on our results of operation, financial condition, or liquidity. The statements we made in the March 18th 8-K remain applicable today, and beyond that, there's really not much more that we can add.

Secondly, as we noted in our press release earlier today, this year IFF intends to replace the use of stock options with restricted stock units for all eligible U.S.-based employees and a majority of eligible overseas employees. Previously, the Company did not recognize compensation expense associated with stock options, as permitted under the applicable accounting standards. In May of this year, the Company expects to issue time- and performance-based restricted stock units as an element of its equity compensation. The restricted units for the senior management team will be performance- and time-based. Units for the remainder of the eligible employees will be time-based only. As a result, the Company expects to record between 4.6 and $6 million in additional pre-tax compensation expense during 2004. The actual expense to be recorded will depend upon the value of the company's stock and the number of RSUs granted. Such costs were not contemplated in previous earnings guidance provided by the company. After consideration of the above additional expense, IFF continues to expect earnings per share for 2004 to be in the range of $2.24 to $2.31, compared to the $1.83 in 2003.

Now at this point, I will turn the call over to Doug to discuss our financial results in more detail. We'll then briefly discuss our updated expectations for 2004, and we'll then be pleased to take your questions. Doug?

Thanks, Dick. And good morning, everyone. Dick mentioned our local currency sales for the first quarter increased 6 percent from the prior year, resulting in a 15 percent increase in dollars. The favorable currency translation was principally attributable to the strengthening of the euro, the Pound Sterling, the Japanese yen, and the Australian dollar, versus the U.S. dollar. In comparison to the prior year, these currencies strengthened versus the dollar by about 17 percent, 14 percent, 10 percent, and 30 percent respectively. As Dick also mentioned, our per-share results were $0.59 per share compared to $0.34 in the prior year quarter, an increase of 74 percent.

Those 2003 results include a 20.4 million of pre-tax restructuring and other charges related to the Company's reorganization plan. And excluding the effects of these charges, earnings per share in the current quarter increased 23 percent in comparison to the prior-year quarter.

Turning to the regions -- North America fragrance sales increased 13 percent for the quarter, and was strong in all categories. Functional fragrances increased by 13 percent in the quarter, and we saw consistent customer demand throughout the quarter. This Functional Fragrance performance benefited from an easier comparison with the prior year. Functional Fragrance sales decreased 10 percent in the first quarter 2003. Fine Perfumery increased by 10 percent in the first quarter, benefiting from new wins and rebounding from the poor holiday season, which affected our fourth quarter 2003 results. Aroma chemical sales increased by 14 percent for the quarter.

North America flavor sales increased 18 percent for the quarter, and this performance exceed our expectations and reflected continued strength in our core flavor business. Strong demand from the fourth quarter, where sales increased 19 percent, continued into the first quarter of this year. New product introductions and the resumption of more normalized order patterns from our flavor customers continued to drive our growth. We also continued to see a high level of new brief activity in North America flavors, and expect that situation to continue this year.

Turning to Europe -- overall, we saw some modest improvement in some of the major economies of Western Europe, notably France, Italy and Great Britain. However, this improvement was essentially offset by weaker sales in Eastern Europe, the Middle East and Africa. Local currency fragrance sales decreased by 1 percent for the quarter. On translation, this resulted in a dollar increase of 15 percent. The performance benefited from growth in fine fragrance sales, which increased 2 percent in local currency, resulting in a 19 percent increase in reported dollar sales. Functional Fragrance product sales increased 4 percent in local currency, and on a reported dollar basis, 21 percent. Aroma chemical sales in local currency declined 10 percent, although on translation, this resulted in a 3 percent increase in reported dollar sales.

For the past several quarters, we've seen gyrating order patterns regarding chemical sales in Europe, particularly. Europe flavor sales declined 1 percent in local currency for the quarter, resulting in 14 percent increase in reported dollar sales. And this local currency performance was as expected. The performance reflected the benefit of some good wins and 2 percent growth in flavor compounds. Our fruit business declined by about 8 percent, more than offsetting the flavor compounds sales growth.

Latin American fragrances reported an increase of 9 percent for the quarter, a performance that was higher than expected. Argentina reported strong growth in the quarter, increasing by 25 percent, driven by a combination of new wins and continued improvement in the Argentine economy. Brazil achieved a 6 percent increase, driven mainly by new wins in both functional and fine fragrances. And Brazil also benefited from an easy comparison with the first quarter 2003. Mexico fragrance sales grew 5 percent, and Colombia grew 11 percent. And our smaller markets in Venezuela and Central America reported sales growth of 89 percent, and 27 percent, respectively.

Latin America flavor sales increased 9 percent in the quarter, and Brazil flavor sales increased 5 percent, while Mexico flavor sales increased 9 percent, rebounding from a poor 2003 first quarter. Venezuela flavors increased 91 percent, and Central America increased 50 percent in the quarter, mirroring the strong results in fragrances in those countries. Argentina flavor sales decline 7 percent compared to 2003, mainly due to a difficult comparative with the prior year. In the 2003 quarter, Argentine flavor sales increased 86 percent.

Asia-Pacific fragrances increased 7 percent in local currency, resulting in a 13 percent increase in reported dollars. This strong growth reflected the benefit of many new wins. Growth was led by China-Hong Kong, which grew 23 percent, and Thailand, which grew 36 percent. Vietnam and South Korea, while still small markets, grew 58 percent and 16 percent respectively. Japan reported a 2 percent decline in local currency fragrance sales, although this resulted in an 8 percent increase in dollar sales.

Local currency sales in Australia and the Philippines declined by 19 percent and 11 percent, respectively. Asia-Pacific flavor local currency sales increased 7 percent, resulting in a 17 percent increase in reported dollars. This performance was better than had been expected. The local currency new wins and strengthening economies in a number of companies, notably Australia, Taiwan and China-Hong Kong, which each increased 10 percent; Thailand, which increased 19 percent; and Vietnam, which grew 40 percent. Indonesian grew 6 percent. South Korea and the Philippines, partially offsetting the strong growth elsewhere, declined by 5 percent and 6 percent, respectively. And Japan flavor sales increased 1 percent in local currency, resulting in a 12 percent increase in reported dollars.

India fragrances reported a 25 percent local currency increase in sales, resulting in a dollars increase of 30 percent. This performance exceed previous expectations and reflected the benefits of new wins and continued strong growth of our business in India.

India flavors reported a local currency increase of 37 percent, resulting in a reported dollar growth of 38 percent. This performance was also better than had been expected, and as with fragrances in the region, reflected the benefits of new wins in the marketplace and the benefit of a very strong economy.

Our gross margin of 42.7 percent came in better than the prior year quarter as reported, primarily driven by our improved sales performance. Operating costs were in line with expectations. Such costs include expenses of approximately $1 million incurred in connection with the implementation of SAP. During the quarter, we had very successful implementation of SAP in our operations in India. When you consider that our sales increased 31 percent in the quarter and the implemented SAP, we really have to commend our team in India on a job well done. We also went live at our locations in Mexico and Colombia, both quite successfully as well. In each instance, there was no disruption of operations, management reporting, our customer service. And at the end of the first quarter, approximately 75 percent of the Company is operating on the complete SAP package.

R&D spending at 8.3 percent of sales was in line with our expectations, and will continue at this same approximate rate for the balance of the year. SG&A expense is increased to about 16.8 percent of sales, compared to 16.3 percent in the prior-year quarter. A number factors led to the increase, but the most significant was an increase in cost associated with the company's various incentive compensation plans, driven by the Company's strong sales and operating performance.

Operating margin improved to 16.9 percent of sales, compared to 16.6 percent in the prior-year comparable period. Interest expense decreased by 20 percent in comparison to the prior quarter. Our average interest rate this quarter was 3 percent versus 3.4 percent in the prior-year quarter. Interest declined primarily due to lower debt levels. Debt outstanding at the end of this quarter is about $200 million less than at March 31, 2003. 841 million, compared to 1,042,000,000 in the prior-year quarter. And we'll continue to reduce debt as the year progresses.

Other income and expense improved in comparison to prior-year quarter, because the 2003 results included about 2.7 million in losses on the repurchase of our long-term debt, and there were no similar transactions in the current quarter. During the quarter, we repurchased approximately 300,000 treasury shares under our buyback program. And at March 31st, 2004, we had a remaining authorization of about $31 million.

The effective tax rate for the quarter was 31.5 percent, in line with guidance provided in our January call. And we expect that rate will continue for the full year 2004.

IFF day sales and inventory declined from 152 at 12/31/2003 to about 140 days at the current quarter end. And receivable days declined from 65 to 64. Our depreciation for the quarter was about 19 million, and capital investments for the quarter totaled 12 million. We expect the capital spending to accelerate, particularly in the second half of the year, but we also continue to be very cautious in our capital spending. At this time, we expect capital spending for the full year to approximate 80 to $85 million, down slightly from that which we forecast in January.

And looking at the full year 2004, we now expect revenues in local currency to grow in the low to mid single digits. Previously, we had forecast low single digit growth. This local currency growth, based on current exchange rates, is expected to result in a high single digit increase in reported dollars. Previously, we had forecast mid to high single digit growth.

Now let me give you some updated guidance in terms of where we expect the sales to be for each of the regions. North America fragrances is expected to increase in the low single digits, due to improved fine fragrance sales, in line with previous full-year expectations. North America flavors will increase in the high single digits, compared to 2003, representing an improvement over earlier expectations.

Europe fragrances will increase in the low single digits in local currency terms, resulting in low double-digit increase in reported dollars, in line with previous expectations. Europe flavors are expected to decline in the low single digits in local currency, although this will result in an increase in mid to high single digits in reported dollars. This performance is also in line with previous expectations.

Latin America fragrances will increase in the mid single digits, reflecting improved economic conditions throughout much of the region, and improving somewhat from earlier expectations. And we continue to expect Latin America flavors to increase in the high single digits.

Asia-Pacific fragrances are expected to increase in the low single digits in local currency, resulting in low to mid single digit increase in reported dollars. And Asia flavors are expect to increase in mid single digits in local currency, resulting in a mid to high single digit increase in reported dollars.

India fragrances and flavors are expected to increase in the high single digits in both local currency and dollars. And as Dick mentioned, we expect earnings per share to be in the range of $2.24 to $2.31 for the full year, after taking into account the cost resulting from our use of restricted stock units.

And with that, we'll now open the conference call to questions.

Thank you, sir. (OPERATOR INSTRUCTIONS). Jeff Zekauskas, J.P. Morgan.

Good morning, this is Silke Kueck-Valdes for Jeff. How are you? A couple of questions -- how much of the volume growth in the quarter was due to your proprietary compounds?

All of our compounds are proprietary, Silke.

How much of it is -- what you patent or what you keep for yourself rather than --? How much of the volume growth comes from new compounds?

If you're asking the question in terms of -- we talked to you about new molecules that had been, patented. And they are beginning to find their way forward, but actually none of the brand new molecules that we've talked about would really -- very little of them, I would say, are factored into these sales. To say none, would go too far. But remembering the lead-time on moving from the development of the molecule, the patenting of the molecule, and then putting it into the creative process with our customers -- that creative process can take us eighteen months to two years. So, in answer to your question, very little at the moment.

Okay. And then secondly, one of your competitors this morning also reported results, and it seems like across-the-board volumes are sort of flat. So do you think that you're beginning to gain some share in various markets?

Yes, I think that is a fair analysis, Silke. Given that we still have proprietary molecules in the pipeline to commercialize, an awful lot of the improvement that you are seeing right now is really traced to just back-to-basics selling, and back-to-basic servicing of our customers, much of which you've heard us talk about for the last few years.

And then lastly, and then I'll go back into queue, how does your general order backlog look at the end of April? And long-term, how do you think the performance in Europe will shape up?

Taking the back half first, I continue to be concerned about Europe, as we mentioned. It's the one region right now where we are not seeing the same type of growth. There are, I think, some still structural issues that need to be sorted out in more than one of the Western European countries. My hope is that we do see a resurgence in those countries. But I will tell you that at the moment, we're not planning for that type of turnaround. We don't see it.

It is good, though, that we are seeing -- while Europe still declined, the pace of the decline was substantially lower than it had been in the past. So there might be some stabilization in the economies. And also, as we noted, we did see some growth in a couple of the key Western European countries, but that was basically offset by some weakness in Eastern Europe, the Middle East, and Africa. And to answer your second question, Silke, in terms of where the order book stands right now -- through today, it seems like we're in pretty good shape and we are in line with our forecast. But remember, we're still only into the fourth month of the year. So there's a lot of time that has to pass.

Thanks very much.

(OPERATOR INSTRUCTIONS). Chip Ruley (ph), Kramer Rosenthal (ph).

Hi, guys. I have a few of them -- I missed some of the discussion on the fragrance side. Can you go again and break out fine fragrance versus flavor and give me some of the color there. I'm sorry to make your repeat it. And secondly -- I guess I'll just give them to you -- actually on the fragrance side, is what I missed; I think that's with flavor. Secondly, can you talk about your wins? Are you participating in all these low-carb products that are coming out? Are you seeing that as a driving factor? And third, just given the fact that -- especially in the U.S., you guys had great results on local currency. I would have thought you had more sales leverage than what was put up in the quarter, especially -- and I understand you had some one-time things going into the rest of the year. Can you talk about with recovering volumes, what you think your leverage could be going forward? And is your guidance very conservative?

On your first question, Chip -- just for the sake of all the others, why don't we -- can we talk after the conference call?

Sure, that's fine. But I guess, relating to the last question of the fragrance -- talk about a little bit of fine fragrance and how much of that was the strength?

Well, I think that we have had good win rates in North America, virtually in all of our categories. And with reference to the low-carb phenomenon, of course, that is an area where all of the food companies are racing to market with new product entries. Any time that happens, it's an opportunity for us because you're talking about new formulations. And in the context of new formulations, you need new flavor systems in order to be sure that the structure of the offering that the company is putting forward to the consumer, in the end, tastes good. It doesn't matter whether or not it's healthy; in the end, if it doesn't taste good, experience has taught us over many, many years that in the end, the promise is no good if the taste isn't any good.

I think overall, to answer your question about the leverage, we are fairly satisfied with where we are in terms of the operating profit. I think the leverage, to a certain extent, depends upon mix. And also, remember, Europe represents about 40 percent of our sales. And in Europe, although we reported a dollar increase, the local currency performance, which is the basis on which fixed expenses are absorbed, the sales declined in both flavors and fragrances. But all in all, we continue to expect further improvement in both gross and operating profit as the year progresses. And I think we are fairly satisfied with where we came out in the first quarter.

Okay.

(OPERATOR INSTRUCTIONS). Lamont Richardson (ph), Peg (ph) Capital Management.

Good morning. I want to get more information on the opportunities for IFF with respect to the low to no-carbohydrate kick that the big food processors and manufactures are on. I've bought some bread that's pitched to be low-carb, and it tastes lousy. Are there opportunities for you folks to make low-carb food items taste better?

Lamont, there's no question there is. If you'll send me the product label and the company that makes it, we'll be sure to knock on their door and offer them a good-tasting, low-carb product. We've got an awful lot of expertise and skill. This is not the first time that there have been what I will call "flavors of the month" that come through with respect to what captures the attention of consumers. Lowfat has historically been something which has always been a challenge when you're talking about a flavor profile. We have a lot of experience in that. And we also know how to deal with a low-carb diet product just as well.

Well, you must be seeing some beneficial impact on flavor sales --

Yes, indeed. And I think that's one of the things that we point to when we talk about our strong North American flavors performance.

Okay. Thank you.

You're welcome.

Jeff Zekauskas, J.P. Morgan.

Just a couple of follow-ups, not to beat the subject to death, but when you say you see a lot more -- a lot new briefs (ph) coming out in North America, what other areas do they appear in besides in a low-carb food? Is there anything happening in the beverage area or snack food area? Can you give some direction?

I would say it's really across the board, Silke. But if you want me to pick a couple of categories, I would say the beverage market, number one, and the foodservice area, which, as you know, from our discussions over the past years, was not an area that we majored in, in the pass. It's an enormous opportunity. Over the last couple of years, we've begun to turn our attention towards it. You know, as we've talked before, what the lead-times are in these areas. But we're now beginning to see the fruits of those initiatives. Foodservice, in my view, continues to be an enormous opportunity, particularly here in North America where the eating habits are such that more and more people continue to either eat outside of the home or they buy outside of the home for consumption in the home. I do not anticipate this to change; and therefore I continue to believe that the opportunities for us in this segment is very, very strong. And I would say within all basic areas, and that's whether one were talking about beverages or savory, sweet or snacks.

Okay. And if I could ask a second follow-up question on the fragrance side -- I think you had a couple of fragrance launches this quarter. I think like Amour (ph) by Cacharelle (ph) and Provocative by Elizabeth Arden. Have any of these launches already contributed to your 10 percent sales growth in North American Fine Fragrances? And for the year, what are your expectations for growth in Fine Fragrances versus Functional Fragrances, both in North America and Europe?

First, responding to your comments about Amour and Provocative, they absolutely have contributed to the strength that we have had in the quarter. Those sales have begun to be reflected in our numbers. And we hope that they will continue to do well. You know, as I said earlier on, in terms of the prospects for the balance of year, I think you'll see a little bit more growth in the Functional Fragrances than you will in Fine as the year progresses. One, I think that's driven by the recovering economies, particularly in the developing areas of the world. But we continue to benefit from the wins, and you mentioned a couple that were launched recently that we created. And there will be more launches through the balance of the year. But it also depends, to a certain extent, on how the Fine Fragrance market overall performs, and I think that's still uncertain at best.

As you well know, that part of the business is either a success or a failure for the industry on the basis of the fourth quarter and how the Christmas season goes. And it's just much too early for us to be able to predict. And given the very strong position that we have with the classics within the industry, that is an area where if there is a strong fourth quarter for the fragrance industry in general, then we would benefit from that, Silke.

Okay. Maybe I can ask one more, since it's (indiscernible) time -- as I look at the North American -- if I look at the performance in North American flavor volumes, I think last quarter, I think the performance -- in the year-ago, the performance was probably negative. And this year, it is -- in this quarter, it's strong and in the previous quarter it was really strong. What really is -- what percentage of that really is wins versus demand improvement? And all things being equal, could your North America flavor volumes really grow double digit, rather than high single digits for the remainder of the year?

To answer your first question, Silke, the comparison with the prior-year first quarter, you're right, we declined about 3 percent in flavors in North America. So we did have the benefit of a somewhat easier comparative. But I think 18 percent -- we are still trying to sort out, too, how much of it is a restocking effect to a certain extent. We've talked about restocking in the past, and I think there's been a number of articles in the press about companies having taken their inventories down too low, and they're now rebuilding inventories. And what portion is driven by new wins -- I think it's probably split pretty evenly between North America, between resumed normalized ordering patterns and restocking. And then, the impact of new wins or new versions of previous formulas.

Okay. Thank you.

Scott Hill (ph), Brown Brother Pyramid (ph).

Good morning. Either one of you -- do you guys expect a positive impact with the roll-out of the Estee Lauder product line through Kohl's? And is that contemplated in your forward guidance?

I think the Kohl's experiment, which Lauder is working with, is going to be very interesting to watch. My one concern is that, in looking at retail sales data of late, my recollection is that of all of the chains, Kohl's was not showing positive growth, whereas several of the other chains were, in fact, beginning to show turnarounds. So, I really don't know. We have not gone to the bank, in your terms, on the future expectations with respect to the Lauder experiment and Kohl's. I applaud them in the sense that they are looking for a modest change at this point in the distribution channel, which -- and we have all talked about the fact that the current distribution channels have not appeared, of late, to be doing the job that they did do historically. So, my hope is that it will be some uplift. And I continue to watch the Kohl's experiment with a great deal of interest.

Thank you. Secondly, with regard to the popcorn-related litigation -- I know you guys don't want to go too far from what's there, but this is really as a point of clarification. In your descriptions and disclosures about material impacts, are we looking at this too narrowly? Are you really talking about not only the one specific litigation and verdict, but really those which you actually have knowledge of and which have already been filed or contemplated?

We are talking about all known cases. So, we are not talking about one ox (ph). When we talk to you and we refer to the language in the 8-K, it continues to be our view that, given our insurance coverage, we do not expect the litigations to have material adverse effect on the business.

In fact, Scott, we say in the 8-K, and I'm quoting, "this case or the remaining cases." So, just to be clear.

That's terrific. And then lastly, Doug, on your tax rate guidance, how far are you carrying this into the future? Were you really limiting just to this year, you're thinking, this 31.5? Or do you think that's really your normalized rate, given the mix of business and geographic representation going forward?

I would like to think that it would be representative of where we would be for the next couple of years. And I said that, actually, in the January conference call. But the only caveat to that is barring any significant changes in overall corporate tax rates or tax legislation, particularly in the United States or in some of the major European countries. So I am pretty comfortable with that rate.

Great. Congratulations on your progress.

(OPERATOR INSTRUCTIONS). Chip Ruley, Kramer Rosenthal.

Thanks. When you launch a new product, and it could be anything, the low carb or any of your encapsulation or new molecules going forward, is the quarter in which you first launch it more detrimental to expenses? And you earn that out once it's launched? Or how does the cost versus the realized profit play out in the quarter or two quarters when you're launching it?

The expense is actually most significantly incurred during the creative process, before the business is actually won. And it varies. Remember that product mix does impact it a little bit, and I think that the strong demand to keep pace with the demand in the current quarter, which was very strong in many areas of the world, keeping pace and keeping customer satisfaction up, there may have been some overtime incurred in getting that business done and the product out the door. But again, the heavy cost is the cost up front in getting the -- to winning the business.

Okay.

That concludes our question-and-answer session for today. At this time, gentlemen, I will turn the conference call back over to you for closing remarks.

Well, thank you very much for tuning in. And we look forward to talking to you at the end of the second quarter.

And that does conclude today's presentation. We thank you for your participation and you may disconnect at this time.