International Flavors & Fragrances Inc (IFF) 2005 Q2 法說會逐字稿

Welcome to the International Flavors & Fragrances second quarter 2005 earnings release conference call. Today's call is being recorded. The speakers for today's call will be Mr. Richard Goldstein, Chairman and Chief Executive Officer; and and Mr. Douglas Wetmore, Chief Financial Officer. Gentlemen, please go ahead.

Thank you very much. Good morning. Thank you for joining the quarterly call. Before we begin, I need to make 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. The 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 results to differ materially from any forward-looking statements and projections are specified in the Company's 10-K filed with the SEC and other IFF filings made with the SEC from time to time. IFF does not update forward-looking statements and expressly disclaims any obligation to do so. In addition to reviewing our results today, we will also discuss some of the actions and initiatives that are underway to drive long-term profitable growth at IFF. We will talk about the milestones we are reaching with respect to our corporate strategy and we will provide updates on the technological innovation that is so critical to our and our customers ongoing success.

We will then, of course, be happy to take your questions. Let me now turn the call over to Doug, to review our second quarter financial performance and achievements and where we see ourselves for the full year of 2005.

Thanks, Dick. Good morning everyone. Before I begin let me point out that the sales comparisons with 2004 throughout my remarks exclude the results of the European fruit business that we sold in the second half of last year. Relevant details regarding the fruit business are included in our press release and in various filings with the SEC. Second quarter 2005 sales totaled $516 million, increasing 3% in comparison to the prior-year quarter. Sales for the quarter benefited from the strength of various currencies, particularly the Euro in relation to the dollar. Had exchange rates remained constant sales for the quarter would have been flat in comparison to the prior-year quarter.

Our sales performance was led by a 2% local currency increase in fragrance sales. Non-translation fragrance sales increased 5% in reported dollars. Flavor sales, again, excluding the European fruit sales from the 2004 comparative, declined 2% in local currency and were flat in dollars. Flavor sales, most notably in North America and Europe, were unfavorably impacted by lower selling prices for naturals, mainly vanilla. As we mentioned in our first quarter call, selling prices for vanilla generally move in line with the cost of the underlying raw materials. Flavor sales were also impacted by approximately $5 million, or 1% of the current quarter revenues, because of the previously disclosed raw material issue that we and other companies in our industry faced during the quarter. At the time we filed an 8-K on this subject in mid-June, we thought we might lose as much as $10 million of sales in the quarter. I'm happy to note that the actual amount lost proved to be significantly less than that.

Fragrance sales were lead by fine fragrance, which increased 12% in dollars and 9% in local currency. The fine fragrance performance reflected the benefit of a number of new product wins. We continued to win a significant share of new fine fragrance launches, and some of the most recent wins include Christian Dior for Men for LVMH, Givenchy Very Irresistible for Men, also for LVMH, the Sarah Jessica Parker fragrance called Lovely for Cody, an Yves St. Laurent fragrance for Alexander McQueen for women, and L'Orial's Cacharel Promise for women.

Functional fragrance products were flat in dollars, and declined 2% in local currency, and aroma chemical sales increased 3% in local currency, and 6% in dollars. Sales growth, by region, is commented on in more detail in our press release. For the quarter, our sales performance was strongest in India and Latin America, and our 2005 growth in these regions is particularly impressive given the very strong performance we achieved in each region in 2004. In both cases, we continue to see substantial opportunities for growth in these markets and are strongly committed to them. We continue to invest and build upon our leadership positions in these regions in the upcoming fourth quarter. As further evidence of our commitment to these markets, we will commission our Mumbai, India Sales and Creative Center For Fragrances.

Net income for the quarter was flat in comparison to the prior year, as reported. Excluding the impact of restructuring and other charges from the '04 quarter, net income in the current 2005 quarter declined 8%. The 2004 restructuring charges totaled just under $8 million pre-tax and related to the disposition of the fruit business.

Now let me briefly touch on various aspects that impacted earnings in the current quarter and the corresponding comparison to the 2004 second quarter. First, as previously mentioned, the '04 results included net income attributable to the European fruit business, which amounted to approximately $2 million. A sales proceeds on the disposition of that business were used to reduce debt, but lost operating profit from disposition of the business was not replaced by interest savings on debt.

Gross profit as a percentage of sales was 42%, compare to 43.6% reported in the prior-year quarter. The gross margin performance was in line with our expectations for the quarter. The decline in comparison to the prior year was mainly attributable to the issues we discussed with you at the time our first quarter earnings call, a combination of increased raw material costs combined with delays in implementing price increases due to customer resistance to those increases. I'm happy to report the pace with which cost raw materials increased in the first quarter has abated somewhat and we have made progress, in terms of the price increases. There is, however, more work to do with respect to pricing.

As we advised at the time we released first quarter results, gross margins are expected to remain under pressure for the balance of this year. Also impacting margin, and net income for that matter, we had the lost sales and costs related to the product contamination issue. As discussed in our June 15 filing, we will seek indemnification from our supplier, the supplier's insurance, and our own insurers with regard to related costs incurred and potential claims from our customers. However, these claims have not been contemplated in the results presented, meaning we have not contemplated the insurance recoveries. We continue with many of our Research and Development efforts. Related R&D expense totaled 8.6% of sales, compared to 8.5% in the prior-year quarter, and this is pretty much consistent with our intended level of R&D spending. Selling, General and Administrative costs, as a percentage of sales, increased to 16.1%, from 15.9% last year.

The current quarter includes about $2 million of equity compensation expense. In 2004, there was approximately 800,000 of such expense included in the second quarter results. These are costs associated with restricted stock units that the Company began to award last year. However, these additional costs associated with restricted stock was essentially offset by lower year-over-year accruals under the Company's various incentive plans, which are linked to performance. Our capital spending plan remains on track for the full-year '05. We currently expect to spend between $90 million and $100 million this year. That will vary a little bit depending on currency.

During the second quarter, we repurchased approximately 832,000 Treasury shares at a cost of about $31 million. At June 30, with had a remaining authorization under all share repurchase programs of about $215 million. Reflecting our confidence in our cash flow and our debt reduction, in addition to the share repurchase program announced in May, the new program announced in May, we also announced that the Company's regular quarterly cash dividend would increase by 5.7%, to $0.18.5 per share.

Given the expected needs of the business, we believe this return of capital to our shareholders is an appropriate use of cash, and it underscores our commitment to delivering value to our shareholders. One final note with respect to debt. I should note that a substantial portion, as you'll note in the balance sheet that accompanied the press release, was classified as current in the quarter. The purpose of that reclassification was the $500 million of notes that we have outstanding in the U.S. mature in May 2006. We're currently working on refinance plans, which will, in many respects, be linked to our plans for repatriation and those plans we expect to discuss with you during the course of our next quarter conference call in late October. With that I'll turn it back over to Dick.

Thanks Doug. The actions we have taken to refocus on our customers and our heritage of innovation are creating positive momentum. This is demonstrated in IFF's improved win rate and sales trends, most notably in India and Latin America, as well as in parts of Europe. These are exciting regions filled with opportunity and we're committed to capturing long-term growth prospects there. It's clear that our customers have confidence in IFF, our people, and our products. This is setting us apart from the competition. It bodes well for our future.

To support our growth and sustain success, we continue to make targeted investments. Construction of our new, state-of-the-art chemical facility in China is on schedule for completion and commissioning in the second half of 2006, and we will be opening our new Fragrance Creative Center in India later this year. These two facilities will allow us to fulfill the needs of our global, regional, and local customers. At the same time we invest in infrastructure, we also continue to focus on customer service in most importantly, Research and Development. For example, newly created molecules and natural extracts will contribute to flavors and fragrance wins in 2005 and beyond. In 2004, we filed 28 patent applications, accelerating the pace of development we have been striving for. We are currently working with major customers to advance the commercialization of these new and exciting technologies. We have several where our proprietary encapsulation technology is being used. We are currently in market tests with major customers in various regions employing this technology. Early indications are that there are clearly discernible consumer preferences for the product containing our technology.

If all goes well some of these products could be launched in early 2006. As I have said before, please remember that our customers establish the time frames for the launch of their products. We follow the path to market established by our customers. Our delivery and material technology research also continues to advance other commercial applications of flavor and fragrance encapsulation technology. We were particularly gratified that this quarter, that our Sensory Perception technology received the 2005 FiFi award, the highest honor in the fragrance industry, the Technological Breakthrough of the year. This is a micro-encapsulation delivery system for textiles that allows fragrance or active ingredients, such as Aloe Vera or Vitamin E, to be released from clothing, bedding, or other textiles over a period of time. The technology opens up an exciting new area of business for the fragrance industry, the textile market, and a world of possibilities for consumers.

In terms of customer service, we continue to build on our success. We expect to be our customer's number one provider of flavor and fragrance products. We remain dedicated to providing world class resources and service to them. We continue to invest in SAP and we develop proprietary applications to analyze the customer's product, the market, and our product to assist in determining ultimate acceptance in the market. SAP is an invaluable tool to better service our customers, better manage our resources of information so that we can better manage our business. We are already realizing enormous benefits from SAP and such benefits will only grow grow in the years ahead.

We are unwaivering in our strategy of being customer-focused and technology driven. Our primary objective is to provide our customers with technology and innovation, products and service that will help them win in the marketplace. Before we open the call to questions, it bears emphasizing that during the quarter we achieved a number of new wins and continue to see strong sales trends in many of the markets we have targeted for growth. We also believe that we are taking the right steps to successfully manage the raw material and pricing challenges that we and others face in the industry. Our remaining focus on innovations, superior service, and operating discipline. I'm confident that we can continue to differentiate ourselves from our competitors and drive market share gains to create value for our shareholders. We'll now open the call to questions.

Thank you sir. If you do have a question at this time it is star one on your touch tone telephone. Again, ladies and gentlemen, for any questions or comments please press star one at this time. We'll pause for just a moment to give everyone a chance to signal. Our first question comes from Jeff Zekauskas at JP Morgan.

Hi, good morning.

Hi, Jeff.

Just, I guess, a couple of questions. The first is there was another income item of $2.6 million. What is that and what was the after tax effect? And then I have a couple other questions.

That was, basically, just some exchange gains, Jeff. I'm sure you're aware the dollar and the euro moved fairly substantially during the month of June. And that was, simply, exchange. Nothing else in there. And the tax effect, or the after tax effect of that would just be 69% of the gain.

How much was the gain?

Couple million dollars. About $2 million.

About two? Okay.

Remember too, you look at our balance sheet, we also have some increased interest income simply because cash is accumulating, and that also contributed to the increase in other income and expense.

Secondly, were your average prices in the quarter up or down?

I think overall, obviously, it varies by mix. If you're talking about an average price on a per kilo (ph) basis that varies.

Yes, that's what I'm talking about. Is it up or down?

It varies by mix, but I would think overall we achieved modest price increases during the second quarter, but if you carve out the mix, I would think it's safe to say, basically, neutral pricing in the second quarter, and that's consistent with what we talked about at the time we released first first quarter earnings.

So your price commentary has been relatively negative, at least as far as 2005 goes. So is what you're implying that your pricing effects would be positive in 2006, rather than in '05, is that the conclusion we should draw?

I think you'll see some improvement during the course of the second half of 2005, but we said it was going to take, there are some things, in terms of negotiating with the customers where we won't achieve price increases in their entirety until 2006, and even then they may have to be phased in somewhat.

And, I guess, a last question. Is your raw material price inflation up somewhere between 6% and 9%? That's what we get.

Actually, it's, if you carve out vanilla, which can tend to skew things, it's probably close to the lower end of that range, rather than the higher.

If you carved out vanilla?

Yes, because vanilla has declined precipitously over the last --

About 6%. Okay, thank you very much.

You're welcome, Jeff.

Thank you.

We'll go next to Jim Halasie (ph) of the Bank of New York.

It's been about a year since many of us went down to visit your R&D facilities in New Jersey. I was wondering if you could give a little bit more detail, in terms of the commercialization of some of your new technology? We have been hearing for a couple of quarters it's the next quarter, the next six months, and wanted a little more detail on where things stand. For example, there was an article recently in Women's Wear Daily about P and G using it's proprietary time-release technology, and taking that product and focusing in on that product. Are there other competing technologies that you're going up against? Where does all this stand on a go forward basis? Thank you.

There are several answers to, you've got multiple questions there, and I'll try and take them in sequence. One is we're working with several customers on the encapsulation technology in a variety of products, as I thought, think we have indicated we believe that certain categories are more likely to move into the market with the technology sooner than others. But we continue to work aggressively with several of our major customers, and, as I indicated in my remarks we do expect to see product in the marketplace in the early part of 2006. I know in the past that we've talked in terms of perhaps seeing it in an earlier point in time. Again, I underscore that the phasing of this into a product with a customer really depends on the customer's timing with respect to restaging a product launch. You're reference to Procter & Gamble and their comment on encapsulation, I believe related to fine fragrance, to the cost fragrance, I can only tell you that that is our fragrance in the product, and we're delighted with the early indications with respect to its acceptance in the marketplace.

Great thank you.

Once again ladies and gentlemen it's star one for questions. We'll go to Paul Hudson at Rhombus Capital.

Hello Paul.

Hey guys. I want to better understand the updated guidance for the year. Could you talk, maybe in some more detail, about what changed in your outlook to bring the numbers down?

There was two elements. First of all, you may recall, we issued an 8-K in June talking about the product contamination issue, but we did not update full-year guidance at that point in time. We did say, at the time, it was going to cost, I think, between $0.06 and $0.07 per share on a full-year basis, taking into account the additional cost, as well the lost sales. Because of the less -- sales being lost and slightly lower expenses being incurred, the impact of product contamination is about $0.04 per share. Our previous guidance was on an earnings-per-share basis was 210 to 224. We have now taken that down to 208 to 218 contemplating the impact of the product contamination. Secondly, we always update the guidance based on current exchange rates. The euro has weakened about 8% in comparison to the dollar, compared to late April when we released first quarter results, and Europe is our largest area. It's 40% to 41% of sales so the impact of the euro on consolidated results was taken into account and that impacts the top line reporting in dollars, which we now expect to be in the low single digits. And also that top line growth was impacted by the loss of $5 million of sales, for the product contamination. So, it's our best guidance as of this point in time.

I think I would only -- just to underscore two points, Paul, on that, and there were two, what we call bumps in the road that we have experienced. One is the product contamination issue, which I think, we have discussed fully. With regard to that, I would simply underscore that in discussions with our customers, while no one likes to receive the news that there was contamination, as a result of an adulterment that was used in paprika that no one anticipated. Each and every one of our customers that I talked to at the top of the business applauded us for the action which we took, notwithstanding the fact that it was going to cause them some inconvenience. By that I mean we treated their brand as though it was our brand, and, therefore, protected it in terms of the end product reaching the consumer.

Okay that's helpful, but as I think about the second half the year, it looks like you guys had, you know, I would say a pretty strong quarter this time around. Yet your guidance for the full-year seems, it seems lower given what you just told me. I understand the $0.04 from kind of the one-time product issue, I'm having a hard time getting to the second half though, given where you got and given what you did for this quarter.

Well, I think the other piece of this is to recognize is that, as we also have indicated in terms of the need to recover the increase in raw material and petrochemical pricing, that this is something which gets phased in during the course of the year as a result of negotiations with our customers, and it isn't, it doesn't all occur at the same time and that's of course, because there are discussions to have with the individual customers and depending upon the agreements that we extract from them given the differences between their fiscal years and their calendar years, it doesn't all occur simultaneously.

To be quite frank, there is really not much difference between the guidance we issued at the end of April and now, but for the product contamination issue and currency.

Okay. Thanks guys.

Again, star one for questions. We'll go next to Richard O'Reilly at Standard and Poor's Equity Research.

Good morning, gentlemen.

Good morning, Richard. [Goldstein and Wetmore simultaneously.]

Hi, Doug. I'm sorry, I got interrupted near the end of your prepared comments and I missed what you said. What were you going to announce in October? Can you just repeat yourself? I'm sorry.

Our expectations with respect to repatriation of overseas earnings.

Okay.

We're just in the final process of putting those plans in place, and then they have to be reviewed and approved by the Board prior to implementing them.

Have you ever indicated how much, or the maximum that you could bring back?

Yes, we said in our Annual Report the maximum we could bring back is about $500 million. But we have not said what the exact amount, or round amount would be that we would repatriate, and that's disclosed in our Annual Report.

So up to 500 million and, what, a 5% to 10% tax rate, or, whatever?

It's not quite that easy, Rich, because you have to bring back a base period amount that is taxed at normal rates, and once you exceed that base period amount, which is an average of the last four years, once you get above the base period amount the excess is taxed at the 5%, which is why it's a fairly complex tax planning process.

Okay. And, back to your guidance, I guess the other thing, besides the EPS, is your guidance for the sales. It's now down a few percentage points instead of being up a few percentage points on an apples-to-apples basis?

I don't believe so Rich.

Am I wrong?

You may have, on, excluding the fruit sales from '04 we expect local currency sales to increase in low single digits, and that's going to translate into a low single digit increase in dollars.

Okay. It's the reported dollars, guidance that you brought down?

Yes, because of currency.

Because of currency, okay, I'm sorry.

And also as I mentioned with respect to Paul, the last questioner, the $5 million of lost sales, it's an impact, it's not that significant on annualized basis. Realistically, right now, we're assuming that we will not recover those sales in the third and fourth quarter.

Right, okay. It's hard to follow, you have too many apples-to-orange comparisons.

We provide both. If there's some details, I'm happy to flesh them out a little bit if you want to follow-up.

But it's the lost sales and it's the currency impact versus April. Okay fine. Thank you.

We'll return to Jeff Zekauskas at JP Morgan.

I have a follow-up question for Dick.

Yes, Jeff.

So you're fun fragrance volumes were up about 9%? So your, obviously, taking share. To what extent is the fine fragrance industry, in general, growing at a faster rate, or is it still flat, and to what extent are those sorts of numbers sustainable through the rest of the year?

Well, first of all, in terms of the industry, regrettably the fine fragrance industry is still flat. Overall, you know that the centers of gravity there are the U.S., Europe, and duty free. Our numbers are very robust and, yes, it's because we're taking business, we have more wins, disproportionate to our competition, and we're doing better. I am hopeful that this is going to continue for the balance of the year, but I don't want to have you engrave it in granite at the moment. But we're doing well, our customer service levels are strong, our customers have confidence in us. And, the fellow who was running the fragrance business for us, Nicholas Merziance (ph) is extraordinarily well respected and we have a cadre of world class perfumers supporting him, and we're doing a good job, Jeff, and I just hope it continues. If we get a bounce in the market, it will, in my view, only augment that segment of our business.

And just I guess, last question for Doug, and you may have answered this question, in your response to Jim Halasie (ph), I don't know if I caught it. In Women's Wear Daily, there was a discussion of fine fragrance technology, of the time-release technology, and in Women's Wear Daily it said, that it was P&G's technology. Is it P&G's technology, or your technology, can you clarify that issue?

I think that was actually Dick's answer, but I'll respond to it. I'll repeat what Dick said. We can acknowledge that we created the fragrance because Proctor has recognized and named IFF as the creator of that fragrance, but we're really not at liberty to comment any further on that.

So the answer was no comment?

Yes.

Thank you very much.

Thank you.

We'll return to Jim Halasie (ph) at the Bank of New York.

Thank you. Just to ask another question on new products, given what you see now in the potential commercialization of some of these new products, if we were to go out two years from now, or whatever time horizon you want to focus in on, at what percent of your revenue do you think you'll gain from those products, because I'm trying to look at the R&D spending and to justify that level of spending relative to other chemical companies, or relative to other food companies. Thank you.

It's always difficult to predict, but what I can underscore for you is that the investment in research is truly the bedrock of what this Company was, in the past, and will be in the future. Without that investment, this business would rapidly erode into a commodity chemical business. It was built on the back of proprietary chemicals, and the future is on the back of proprietary molecules that can be used in both flavors and in fragrances, and that's the key, the twin pillars on which the business is going to continue to grow will be the technology, and then the customer service. And linking those two together we believe will give us a disproportionate amount of the growth that is going to come from our sector.

Once again star one for questions. And we'll return to Jeff Zekauskas at JP Morgan.

One of the things that's remarkable about your results is the very strong growth in India versus very strong comparisons in the year ago, whereas the results in Asia were relatively weak relative to very strong comparisons in the a year ago. Can you compare and contrast on what is going on in those markets, such that, India continues to grow very strongly, but Asia is softer?

I'll let Doug get into the specifics with you, but I would just, as a comment to you overall, and Doug will take you through the pieces, is that, remember, that Asia is a huge region. And, India and the subcontinent, while very large, is nowhere, it's not the same size and doesn't have as many constituent pieces which can be a confusion if you just try and compare Asia and India. But ,Doug, why don't you walk Jeff through the pieces.

Jeff, just so that everybody has the same comparison as you, in the second quarter last year, Asia grew by 10% in local currency, and 16% in dollars, and that growth was lead in flavors, with 13% local currency, and fragrances grew 7% in local currency. So the comparison was somewhat difficult and Dick's absolutely right, India is smaller so it's easier to grow in larger percentages, but also, it is basically all developing markets with a very strong and growing demand for the better quality consumer products, whereas you have some very mature economies, most notably Japan and Australia, in Asia Pacific, as we define them. It's kind of a mixed bag, we're still seeing, and continue to expect to see, very strong growth in the major markets in Asia. China is certainly going to continue to grow as the year progresses, and for the next several years. Southeast Asian countries, Thailand, Indonesia, the Philippines, and so forth, are also going to continue to grow. But Australia and Japan are two of our biggest countries right now in Asia,so the growth in the center of Asia Pacific is somewhat mitigated by not weakness, but say an absence of real substantial growth in Japan and Australia, which are more mature markets.

How fast did you grow in China this quarter?

China this quarter, let me flip through and cheat because I don't have that at the tip of my fingers, 11% in greater China. It was, China was a little bit weak in the first quarter of the year. There was, I think there was just a little bit of slow down and not as much business was won in the first quarter, and China is not that strong on a year-to-date basis, but we're seeing China activity pick up strongly now, and we just reviewed the full-year forecast for China. We expect it to sustain, or reach the same levels of growth that we've had in the past, high single to low double digits.

Okay, thank you very much.

A final reminder star one for questions.

Any other questions?

I have no other questions holding.

Well, then thank you very much. Thanks for joining us and we'll talk to you the next quarter.

Thank you.

Ladies and gentlemen, that will conclude today's teleconference. We thank you for your participation and you may disconnect at this time.