International Flavors & Fragrances Inc (IFF) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the International Flavors & Fragrances second-quarter 2006 earnings release conference call. Today's conference is being recorded. The speakers for today's conference will be Mr. Robert Amen, Chairman and Chief Executive Officer and Mr. Douglas Wetmore, Senior Vice President and Chief Financial Officer. Gentlemen, please go ahead.

Good morning. Thanks, everyone, for joining the conference 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. 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 made with the SEC from time to time. IFF does not update forward-looking statements and expressly disclaims any obligation to do so.

Now I'd like to take this opportunity to introduce Rob Amen, our Chairman and Chief Executive Officer. Rob has some opening comments before we delve into our discussion of the quarter. Rob?

Thanks, Doug. Good morning, everyone. First of all, I'm, as you know, very new to IFF having joined the Company on July 1st, so I'm going to have some limited comments to make. Let me start by saying how excited I am to joining IFF. It's a Company that has a rich history of success, of heritage, of superior technology and service to its customers based really on great product innovation. The products we make are critical to our customers' success and we have to do the right job for them for them to succeed.

Turning to the second quarter, I am pleased with how the second quarter turned out. It's a step in the right direction. Our sales growth in local currency was positive. Doug is going to describe that more later. Cost control efforts were on target and contributed to the margin improvement and we managed the issue of rising material costs. Included in today's press release is a table which gives a little bit more detail on sales both in local currency and U.S. dollars by major category and I hope you'll find that information helpful. We will be trying to provide you new information in future quarters so if there are things which you may find helpful, let us know. We're going to try to meet your needs.

I want to stress a couple of points though. First, North America had a terrific quarter. Fragrance growth was 10% and flavors was up by 4%; very good relative to the market and in absolute terms. Latin America was up 15% in flavor, which was very strong. India continues its track record of superior revenue growth. They grew 9% on top of 12% increase in the first quarter.

And certainly the highlight of the quarter was the performance of the fine fragrance business. This business has now averaged greater than 8% growth for the past ten quarters and we believe we have gained substantial share over that period of time.

Great quarter, great platform for which to build on. And Doug is going to go into more details but we have got a lot of good things going on in different product categories and in different regions.

Now as I indicated in my comments in the press release, at this stage, we are going -- steady as you go. But we are reassessing our plans and programs to determine what we need to do to further accelerate our growth. This Company has enormous potential and we want to unleash it.

But I'm going to turn it back to Doug so he can focus in on the second quarter. And we will answer your questions later on.

Thanks, Rob. The second-quarter 2006 sales totaled 531 million, increasing 3% in comparison to the prior-year quarter. Sales for the quarter were unfavorably impacted by currency, mainly of the dollar-euro relationship but also some impact from various Asian currencies. Had exchange rates remained constant between the periods, sales would have increased 4%.

The sales comparison with the prior-year quarter also benefited somewhat because the 2005 second-quarter sales were negatively impacted by approximately $5 million by the raw material product contamination issue, which we have now put behind us. Sales growth by region for the quarter for the first six months of 2006 is detailed in our press release so I won't go through the regions in detail now.

Let me briefly touch on some of the more significant factors that impacted earnings in the current quarter and the corresponding comparison to the 2005 quarter. In the current quarter, gross profit as a percentage of sales was 42.9% compared to 42% reported in the prior year. The margin improvement was primarily due to the local currency sales performance and improved manufacturing expense absorption as a result; favorable mix, notably the continued strong fine fragrance performance, which is one of the higher margin portions of our business; ongoing efforts to contain or reduce costs throughout the organization; the restructuring program that we embarked upon early on in this year; the effects of price increases instituted in 2005 which took effect in 2006; and finally, the absence of costs associated with the material contamination problem we experienced in the 2005 quarter.

We also continued with our many research and development efforts. For the quarter, R&D expense totaled 8.6% of sales, the same as in the prior year. Selling, general and administrative expenses as a percentage of sales were 16.5% compared to 16.1 in the prior-year quarter. SG&A expenses were impacted by higher incentive plan accruals than in the prior year, driven by the improved local currency sales and operating performance. SG&A expense also includes about $2 million in additional expense in the second quarter this year compared to '05 related to the implementation of FAS 123(R) and equity compensation expense in general.

Interest expense increased 4% from the prior-year quarter, mainly due to a slightly higher average rate on borrowings compared to the prior year and the higher level of debt prior to the maturity of the $500 million of notes. Those notes matured on May 15th, 2006.

Subsequent to quarter end, we issued $375 million of debt via private placement, which termed out our debt with staggered maturities over the next ten years. The average interest rate on the debt is just under 6%. And as of today, taking into account this latest financing, our overall cost of debt is around 3.7%. Half of the debt -- of the interest rate -- is fixed and the remainder, which is mainly in Europe, is floating-rate debt.

The effective tax rate for the quarter was 28% compared to 30.8% in the prior-year quarter. The decline in effective rate was the product of a number of factors, including earnings mix in the countries in which we operate, and we're also beginning to reap some of the benefits of tax planning strategies that we put in place over the last several years.

Net income for the quarter increased 8% compared to the prior year's reported and sales growth and operating profit leverage were the income drivers.

Earnings per share increased 12%, benefiting from the earnings growth and the leverage by the repurchase of shares during the quarter and year to date.

During the quarter, we repurchased a little over 400,000 treasury shares at a total cost of just under $16 million. And at the end of the quarter, we had a remaining authorization under our latest program of $86 million.

Now turning briefly to our full-year 2006 expectations, our press release affirms our guidance for the full year '06 and we will, consistent with past practice, update this guidance as appropriate as the year unfolds. Our guidance has not changed from that provided in April of this year and in brief that guidance is as follows. We continue to expect the 2006 local currency sales to increase in low single digits. Based on current exchange rates, this translates into a low single digit increase in reported dollars. Currency is expected to be somewhat favorable for the remainder of the year, having been slightly unfavorable for the first six months of the year.

Let me give you our latest view in terms of expected sales for each of the geographic regions. Again, these expectations have not changed much from what has been provided earlier in the year. North America fragrances and flavors are expected to increase in the low to mid single digits and fragrances will grow at a somewhat faster pace than flavors. Europe fragrances are expected to be flat to up in the low single digits in local currency while Europe flavors are expected to increase in the low single digits in local currency.

Latin America fragrances are expected to increase in the low to mid single digits while flavors in LatAm are expected to increase in the mid to high single digits.

Asia fragrances are expected to increase in the low single digits in local currency and flavors are expected to increase in the low to mid single digits in local currency.

In both, India, fragrances and flavors are expected to increase in the high single to low double digits in both local currency and dollars.

Gross profit as a percentage of sales is expected to improve slightly from 2005 and as was the case in the first half of the year, this improvement in margin will result from a combination of improved sales performance, product mix and savings resulting from the restructuring actions, as well as some benefit of price increases.

R&D we continue to expect will approximate 9% of sales, consistent with previous commentary. And SG&A expense as a percentage of sales is expected to decrease somewhat from 2005 levels, mainly as a result of restructuring activities and absence of costs associated with product contamination that we had in the second half of 2005. And partially offsetting these savings will be the inclusion in the second half of '06 of just under $10 million in equity compensation expense compared to just under $4 million of such expense in 2005. The 2006 amount includes approximately $1 million related to the adoption of FAS 123(R).

For the full year, interest expense is expected to be flat with 2005 levels and the effective tax rate in 2006 is now expected to approximate 28.5%, which is down about 2% from previous guidance. And based on the foregoing, IFF continues to expect earnings per share for 2006 to be in the range of $2.20 to $2.28 per share. And with that, we will open the call to questions. Laurie?

(OPERATOR INSTRUCTIONS). Todd Peters, American Century.

Thank you, good morning. Can you talk a little bit more about, Mr. Amen, your assessment of the Company plan and any sort of adjustments that you're thinking of to accelerate the growth in sales and profitability? Does that mean either capacity expansion or acquisition? And what is your approach to the dividend payout ratio?

All right, Todd. When I say we are reassessing, the fundamental strategy of this business is sound. The Company is on a good strategy. I think second quarter demonstrates the execution of that strategy is paying off. So when I say we are assessing, it really is sort of the tweaks, the mid course corrections that we needed to accelerate the good things going on. Where do we need to apply a little bit more resource to get a bang for it, where can we move it. The total level of spending in this Company I think is adequate to get the job done. We're going to take a look at whether or not it needs to be shifted a little bit, whether regionally or by activity. But there's plenty of resources to get the thing done.

At this stage, the improvement in manufacturing, which is starting to come on very nicely, is going to provide us a lot of capacity. There's no immediate need to invest to provide further growth. That will be a high-class problem we'll deal with down the line as we grow. And it's way too early for me to talk about acquisitions or other things. At this stage, we need to stay focused on executing our plans, meeting our customer needs.

So I think you can see we included a statement on cash flow in this press release and when this Company performs well, it generates a good deal of cash. The Board of Directors will have to consider how best to deploy that and it's just way too soon. I think we would take a look at it. The return in the quarter is something greater than 13% on invested capital. Return on equity is something around 24%. So I would think our shareowners would like us to grow and reinvest at those rates of return. If we see opportunities to grow profitably at those rates, we will consider it. But I don't want to mislead you. Our focus right now is on executing our plan and trying to add to that so we can do more quicker.

One last question if I can follow up. The lower tax rate in the quarter, that added about $0.02 to the reported number. So going forward, should we assume this lower 28, 29% tax rate versus the 30, 31 in the past?

Todd, this is Doug. For the current year, our guidance now is about 28.5%. I think it is always going to fluctuate a little bit depending upon earnings in the various countries and regions in which we operate. As you may appreciate, the United States is probably one of the higher tax jurisdictions that we operate in and rates have declined a little bit in certain jurisdictions that we do operate in. So it's a blend. Right now I think that 28 to 29% is probably a sustainable rate for the next couple of years.

(OPERATOR INSTRUCTIONS). Jeff Zekauskas, JPMorgan.

Good morning. This is Silke Kueck for Jeff. How are you? A couple of questions. Can you discuss business conditions in Western Europe? That's the first.

And what was the second question?

Then I'd like some follow-up. In addition maybe you can talk about local currency growth at your major customers, maybe your five largest customers. And also interested to find out whether you can categorize some business wins on the flavor side.

Let me talk briefly about the sales performance and Western Europe remains somewhat weak. That's not surprising; we've talked about that for the last several years. You are starting to see glimmers of optimism there but I don't think it's broad-based as yet. The relative weakness if you can characterize it as such in Western Europe for us is basically offset by continued very strong growth in Eastern Europe, which in the current quarter grew close to 20% again. If you continue to grow at that pace, it begins to be a fairly sizable portion of your overall business pretty quickly. So, there is some optimism in Western Europe from a macro perspective.

I think we are doing a pretty good job internally within IFF to manage our business portfolio and drive growth as best as we can. So it's somewhat optimistic that we have begun to see just a little bit of growth, as you can see in the table. We've got some growth in fragrances overall, again, driven by fine fragrances and flavors local currency decline of 1% but we're working on that and I think it bodes well for the future.

Okay. On the flavors side, can you categorize where the business wins came from, just like really broadly, whether that was more on the beverage side or what it was?

It was pretty broad-based amongst all the product categories. There's nothing that stands out. We've had good wins in beverage; we've had good wins in savory. It's really in every aspect of the business. And as you know, from the past, each of those businesses is basically very similar in size amongst the four main elements of flavors.

And Silke, you asked about our growth amongst the significant customers. The growth with the large customers is probably about 1% higher than the overall growth of the business overall and that's continuing the trend of the last couple of years, where the growth with the large global coordinated accounts has been at a higher pace than some of the smaller and regional accounts.

Then maybe if I can ask like one follow-up. On the functional fragrance side, I think that business also began to improve 2% in local currencies in the quarter. And I think it was flat in the first quarter. Does that reflect new product launches or is that like a trade restocking at the retail level?

Yes, it does. We're starting to now see the benefit of the new products that have been developed and are commercializing. They were wins of the past several quarters and they are starting to flow through and we're pleased. We've got some more things ahead of us but yes, it's very much driven by new wins.

John Roberts, Buckingham.

A lot of times a new CEO will reset expectations and a little bit sometimes a new CEO is a little hesitant to adopt earnings expectations set by their predecessors. Your reiteration today and your comment in the press release that 2006 earnings is sort of the primary near-term target, is that simply because you haven't been there long enough to sort of think about things or is that an educated comment that you're making there after reviewing things?

Well as I indicated, I am here all of three weeks. I've got some quality colleagues who work on this pretty hard. Looking ahead, there are uncertainties in the world -- the impact of foreign exchange, the direction of the U.S. and Western European economies and other things. And given this short tenure, I was not really comfortable with reassessing the balance of the year. Should our expectations for the year change, we will communicate that. But I do think the second quarter was a good example of this Company executing at the fundamental level and a lot of these things should carry over into the future.

Secondly is there any one thing in your background that you would like to point us towards as being a particularly good fit with IFF?

I guess there's lots of different -- everyone has a set of skills and then you supplement that with experiences. I guess I have been a guy who has worked around the world for something close to 30 years. So, I am as comfortable doing business in Dubai as I am in Dubuque. I have lived abroad a lot of my life and worked abroad a greater part of it. So the reality is the model of this enterprise, I feel very comfortable with because this is truly a global business. And it's about executing for our customers, conceptualizing on a global level but obviously every order has to be executed at a local level.

Lastly, you made a comment about steady as she goes sort of in the near-term strategy. And I was curious in terms of how important it was for the board to have someone come from outside the industry. I would have expected a steady as you go comment from maybe someone inside the industry coming into IFF but how important is it for someone to take a fresh look coming in from the outside here?

I think the issue -- steady as you go is we are a flavors and fragrance company. That's what we are going to be. We're not going into batteries or radio stations. We think there's a very exciting marketplace for this Company. We've got great tools. We believe we can grow substantially by serving the customers we know in these areas. Yes, I'm going to look for adjacencies and new areas and new applications. But quite honestly, we are excited with the growth potential in our core businesses of flavors and fragrances. And that is what I meant steady as you go.

Now how you apply it and the rate you apply it will be the thing that the management team has got to reevaluate because ultimately that is what our performance is going to be judged on. But there is no questioning the core commitment of this business to flavors and fragrances.

(OPERATOR INSTRUCTIONS). Richard O'Reilly, Standard & Poor's.

Welcome aboard. I guess my question is similar to John Roberts but may be going in the other direction. If I understood you, you beat the second quarter; you beat two out of the three estimates for the second quarter. You lowered your tax rate and if I heard your numbers right, I think your incentive -- your stock incentive expense is going to be lower than what you talked about earlier. Why haven't you raised your full-year guidance? Was there something that we just don't know that we should be conscious of for the second half, the seasonality or whatever?

Rich, this is Doug. We haven't changed the estimate of the equity compensation (multiple speakers). I provided - -the comment I made about $9 plus million or just under $10 million, that was the second half of the year.

Oh, I misunderstood you. I am sorry.

And the second element is in the past, we talked about interest expense declining somewhere along the lines of 10% for the full year 2006 and right now we forecasted interest expense overall will be flat to down just slightly with the prior year.

The reason for that is twofold. One, interest rates have increased. And secondly, we did, particularly in the first half of the year, have additional debt because of the funding, the preparatory funding for the notes that matured on May 15th. So interest expense is expected to be up a little bit more and equity comp did not change.

Your tax rate is lower and I think that has been $0.04 through the first half.

Overall, the tax expense is just one element of the income statement and we have to look at overall. There is the -- remember, the fourth quarter --second and third quarter are our most significant quarters. The fourth quarter is smaller. We'll have a very good sense of the year when we complete the third quarter. But I think some of the risk factors that Rob mentioned earlier combined with the factors that I just mentioned leads us to -- we're very comfortable with the guidance we've provided right now.

We'll go back to John Roberts with a follow-up question.

Maybe Doug, you could give us an update on the sustained fragrance product launch?

As Rob mentioned, that's one of the new products that's been introduced and it's continued to do very well in the marketplace as I understand it. As I've mentioned in various calls in the past or as we have mentioned in various calls in the past, the overall impact on 2006 results is fairly nominal. Because this is the first launch, we expect to have a more significant impact in 2007 and even more significant impact in 2008. And remember those are the briefs that we're working on right now. So it's done very well and we believe internally that it will continue to do very well and we're beginning to commercialize some of those technologies that R&D have developed over the last couple of years.

When should we expect maybe a second product, either a second product with the same customer or a second customer with a similar product?

I think, John, it's going to be 2007 and that's why I say that there will be more of an impact on our top line in 2007 as a result of that. Remember the staging for these are fairly long in duration and we operate at our customers' timeframe or within our customers' timeframe rather than our own. Obviously if it was our timeframe, it would be much sooner rather than much later.

Then Robert, could you give us your thoughts on industry consolidation? I mean IFF acquired BBA from your former alma mater. There's still a fair amount of fragmentation out there in the industry and some of the competitors have talked about further consolidation. Do you have any -- and plus at least the paper industry has been undergoing consolidation for a long time. So I assume you have a fair amount of exposure and thought process about industry consolidation?

Yes, I mean there's no magic in consolidation. Just consolidating and not taking a second step is not a good outcome. This Company will look at opportunities that advance its capabilities or reach if there are companies either that add to our portfolio of technologies, strengthen individual geographies or capabilities, it makes some great sense. But simply consolidating so there's fewer players out there rarely has a good reward for the shareowners. You really need to have a couple of different legs of strategic logic before you go do it.

Now to be honest with you, I have the comfort of saying I don't know enough about those companies out there to opine on it. But it's highly likely that some further consolidation will occur in this industry.

Mike Sison, KeyBanc

Welcome aboard, Robert. Nice quarter, by the way. A couple of general questions for you, Robert. In terms of -- you've been with the company now for about a month. Anything particularly positive that you have learned about your new Company?

Yes, I, like anybody coming in from the outside, you do a certain amount of due diligence and one nice thing is I haven't learned anything after I've joined that I didn't understand ahead of time. This is a good company. You take a look at it, the business model is sound. They've got some very, very good technologies, great customers and they're doing a good job of dealing with that. I think we have good people. We want to invest in them and grow them and challenge them and I think the people are really the great foundation of this Company and probably our greatest opportunity.

You know, the balance sheet is sound. The income statement obviously demonstrates it's a company that has good margins, is able to generate cash so we have money to do smart things with. So I really feel better today than when I made the decision to join the Company.

I'm not trying to look into your daily calendar but can you just give a sense of what your priorities are near-term, meeting customers, meeting employees or just sort of walk me through what your next six months will look like?

I haven't planned out my calendar for six months but I would say the next 60 days, what I call is a reality check. I'm spending a lot of time with the key leaders, understanding what they're doing and calibrating expectations. I'll be traveling and meeting more and more customers. Again, that's part of a reality check because meeting a customer today is pretty much listening. I don't have that much to convey.

And then the last part is taking those two reality checks and assessing that versus the current strategic plan. And a question I have asked my colleagues and me to address very soon are, are we confident our current plans and initiatives are highly likely to result in the financial outcome that is implicit in our strategic plan. So, I'm sort of retesting all of that without trying to have the organization take its eye off the ball. I mean we've got to execute every day. So this is a discovery phase for me.

Right, okay. In terms of fine fragrances, continues to post strong results. Do you expect that level to continue in the second half?

Fine fragrance results are a factor of two things. They've had a terrific string of wins for a long time and some of the erosion of older products hasn't occurred as rapidly as projected.

You know it's not by chance. They're winning in fine fragrance because they've got great process. It's impossible for me to say what rate the future is going to be relative to the past but it's a core business and they're executing very well.

Mike, it will probably tail off just a bit from the first-half pace too simply because of comparisons. And we will have a very good handle on the fine fragrance performance for the full year '06, again, at the completion of the third quarter, simply because by the end of the third quarter with very few exceptions, that will indicate how the holiday season is going to progress from a fine fragrance perspective, from our perspective, not necessarily from the retail perspective.

Right. And it seems this year to date that functional fragrances has been let's say slower than the growth in fine fragrances and flavors. Is there a catch-up in terms of new product development or is the market just slower?

We lost a little bit in some of the functional fragrance areas. It's an area that we want to grow in. These new wins we referred to earlier are going to pay off for us, looking ahead.

I think too, that's the area that has been most impacted by destocking, most notably in the United States. On the last call, a certain retailer was emphasizing destocking efforts. And it's also the area that has been most susceptible to pricing pressure and we have talked about that for the last several quarters and that does impact your sales performance.

But quite frankly, I was really pleased that for the first six months, we've got the local currency increase of 1% and in the second quarter it's a local currency increase of 2%. I think that's a very positive development for the functional fragrance aspect of the business and it's reflective of the wins and how we're doing in those areas with our customers.

When you take a look at Latin America and India, growth rate just appeared a little slower on a year-over-year basis in the second quarter versus what you have seen the last couple of quarters. Any particular reason?

That fine fragrance growth of 17% was pretty solid in Latin America. I think two things. One, in India, we affirmed our full-year guidance. I think you see a little bit of disruption in order patterns there; you get impacted by monsoon. There's obviously been some strife there in certain pockets of the country that may have impacted it a little bit. But we are confident that India is going to deliver another high single to low double digit top-line growth.

Latin America, remember they're going up against some very difficult comparison. They have been delivering mid teen growth for the last six or so quarters. And I don't see anything disruptive in that -- in one quarter. We really take a full year view of those things and we're very confident that Latin America is going to continue to deliver very solid top-line growth.

Okay. Just generally when you take a look at the guidance for sales, I mean my calculations suggest that organic sales growth would be stronger year-over-year in the third versus what you did in the second and maybe about the same in the fourth. So it does look like organic growth could be a touch stronger in the second half than the first half. Tax rate is lower, foreign currency less -- say negative generally speaking and your gross margins seem to be probably a little better than we thought. So it gets back to that same question, it seems to me that maybe the guidance is a little bit conservative and that or maybe there's some seasonality that I missing in the second half that would cause the earnings not be -- [might] be better than I thought.

Mike, those are all good questions or good observations in isolation. We just try to piece it altogether in the context of our income statement. And what we're seeing based on the latest information we've received from our various regions and the business leaders is the predicate for the guidance that we provided. And if there's a little bit of currency benefit in the second half of the year, that's great. But there's a little bit of to-ing and fro-ing of the currency and that does impact us from an earnings perspective. We're pretty comfortable with the guidance that we provided.

Great, thanks again and look forward to working with you, Rob.

Look forward to working with you. Thanks.

A follow-up from John Roberts.

Thanks. Robert, you asked for some feedback on communication with investors and so forth. Maybe I will just take the public opportunity here. For a Company that spends as much on R&D as IFF does, I think a much better job could be done on communicating where that spending hoes and what the expected payoffs might be.

Thank you for that. It's important that we communicate what we are doing and what the expectations are. But I don't want our communications to lead to any sort of competitive disadvantage. And what we work on is some breakthrough products for our customers.

So I don't disagree with you. We probably need to explain a little bit better what is going on and what are we getting for it, with perhaps not granular level of information.

You're spending almost as much as some drug companies if you will or life science companies and many of those companies provide at least sort of a pipeline of the new products. They talk about percent of sales from products new in the past five years; they talk about NPV of the pipeline. I would think there is some way to at least aggregate up some of your information to give people something to track?

Yes, I think that's a very fair observation. Thank you for bringing it up.

Gentlemen, there are no further questions at this time. I'd like to turn the conference back over to you for any additional or concluding remarks.

Again, let me say thank you for joining us this morning. We feel very good about the second quarter. We feel that a lot of the key elements are executing well and we feel good about the -- as we move into the second half of the year, our challenge will be to judge exactly based on the third quarter, as Doug said, how we're doing and that will give us a better sense of the year. But we are all very optimistic that we're going to continue down this path to improving the results of the enterprise. And I look forward to talking to you at the end of the third quarter. So thanks very much.

Once again, that does conclude today's conference. I'd like to thank everyone for joining us. Have a good day.