International Flavors & Fragrances Inc (IFF) 2009 Q1 法說會逐字稿

At this time I would like to welcome everyone to the International Flavors & Fragrances first quarter 2009 earnings conference call.

(Operator Instructions)

I would like to introduce Richard O'Leary, interim Chief Financial Officer. You may begin.

Thank you William. And hello everybody. Welcome to IFF's first quarter 2009 conference call. With me today is Rob Amen, Chairman and Chief Executive Officer. Our earnings release and 10-Q were filed this morning, and are available on our website in the Investor Relations section. As you know during the call today, we may make forward-looking statements about the company's performance. These statements are based on how we see things today, so they do contain elements of uncertainty. For additional information concerning factors that could cause actual results to differ materially from these statements, we ask that you refer to the cautionary statements, and risk factors contained in the press release and in our filings with the SEC. Some of today's prepared remarks will exclude first quarter 2008 items that affect comparability. These items are captioned in our GAAP and non-GAAP reconciliations for the first quarter 2008 and are still available on our web site. What we want to cover, Rob will start off with an overview of first quarter performance, and I will follow up with a review of the financial results, and following closing comments from Rob, we will then take your questions. Now let me turn the call over to Rob.

Thanks, Rich. Good morning everyone. Before I address IFF results for the quarter, let me make a few comments on the economy and the markets. Clearly, the economic slowdown was sharp in the fourth quarter of 2008. And this was most pronounced in Europe and the United States. This situation carried forward in to the first quarter of 2009, and remains with us today. This has had a significant impact on the Fine Fragrance business, reflecting in a combination of lower consumption and inventory correction, not unlike what we experienced in the US, in the first quarter of 2008, but this time it impacts both Europe and the US. Second, the US dollar. The dollar strengthened for our basket of currencies about 14% versus the parity rate in the first quarter of 2008. Lastly, raw material and input pricing remain high, and increased from where they were a year ago. Those are a few things to keep in to focus as we talk about our results.

So now let's turn to the first quarter operating results. IFF's local currency sales for the first quarter were down 2%. Reported sales were down about 6%, reflecting the stronger dollar versus the Euro, Brazilian real, the India rupee and UK pound. Now, I will address the key drivers of the sales in the individual businesses later. I would like to talk a little about operating margins, our operating margins did decline, as you can see. That was due to weaker sales mix, higher input costs versus last year, and as I talked to you, the impact of the stronger dollar on translation on cost, and in selected markets on consumption. On the plus side, overhead expenses were lower. The last item to note which was unusual, was the closeout of a derivative contract during the quarter, that results in interest expense for the first quarter being $2 million higher than a year ago period.

Let's turn to the individual business. Our flavor team delivered excellent results again in a tough period, local currency sales were positive 2%. And this increase was achieved despite the market challenges. We did see meaningful volume erosion in most markets. Most especially on older products. The local currency sales growth was achieved broadly because of the number of new wins and launches, from dating in 2008 and 2009. The performance in North America and Asia were again especially strong. LATAM had solid underlying growth before the FX impact. And Rich will talk about that a little later.

This a clear demonstration that our offerings are succeeded with customers and consumers. The initiatives to restore margins we reported to you in the past are coming through. Gross margins were flat with the prior year, despite the higher raw material costs and FX impacts. The product reformulation done in collaboration with customers, cost recovery and the new products all contributed to this. Operating margins were down 90 basis points due to higher pension expense, and increased incentive compensation costs. I'm very pleased with the performance of this business and the trajectory of the business.

Now turning to our Fragrance business. The Fragrance business sales were impacted by the economy. Reported sales were down 9%. Local currency sales were 5% below the first quarter of 2008. The key driver of this decline, was the 12% drop in local currency sales in the Fine and beauty segment. Actually the decline was all in Fine. Beauty which comprises hair care and toiletries was up year-over-year. In Q1, we saw as we did a year ago, a significant inventory correction following a weak holiday sales period. I also believe end user consumption is off, as Fine Fragrances are discretionary luxury products. These two factors caused a sharp contraction in the market for our customers, and in turn for us.

Interestingly, this business had strong commercial results for the quarter. New launch revenues in Q1 were record high, reflecting the success of the past year. The volume erosion in the entire portfolio overwhelmed these excellent new product sales. Our Functional Fragrance business in total, was flat in local currency sales versus last year's first quarter. Interestingly, the business showed good growth plus 8% in the US, due to new product launches and new products. Adjusting for all the FX impact, Functional Fragrance sales were flat to up, in all regions except the EAME region, which is our largest, that's Europe. Air care volumes globally, were generally weaker, the Fragrance Ingredients business reflects the overall Fragrance market, and includes an important element of inventory adjustment. As I look at the total for this unit down, about 4%, I believe that reflects an approximates the shift in the market. The regional variations shows volatility, and that's more an issue of individual customers and inventory patterns. I remain very satisfied with the improving sales of new molecules coming from R&D, and the pace they are being adopted by our perfumers.

Clearly the weaker volume and mix, together with the negative impact of high material costs, and the stronger dollar caused a decline in margins. Expenses have been well managed, and will continue to reduce cost to improve performance of this business. So what are the highlights for me? Well, first the continued strong performance by our Flavors business. I believe the strategies and initiatives underway in this business are working well, and will demonstrate their impact in coming quarters. The Fine Fragrance market is facing significant retail challenges that will persist for sometime. It's impossible to anticipate when the inventory correction, or consumer demand will turn positive for this end use. The balance of the Fragrance business is doing quite well, with important progress being made in the US, and in many categories such as laundry and hair care. We will continue to adjust our resource deployment to link with the appropriate opportunity. I expect expense management will remain a key initiative. Lastly, we've begun to see improvements in working capital, and this will remain a key priority for us. But now, I would like Rich to walk you through a little bit more detail.

Thanks, Rob. Turning to page nine, let's start with the big picture. Now operating earnings are down about $14 million on a reported basis. And if you exclude the unusual items, the restructuring and the insurance recovery in the first quarter 2008, our operating margins are down about 200 basis points. This is driven by several key items. First. as Rob discussed, sharply lower sales and earnings in the Fine and Beauty category, with higher input costs across both businesses, and year-over-year approximately 5.5% increase across the input categories. We talked about unfavorable currency parity, with the dollar up, about 14%, across basket of key currencies. We are making good progress on price realization and the cost saving initiatives underway, but they were insufficient to offset these head winds.

As Rob mentioned, we closed out $300 million interest rate swap for about $16 million during the first quarter, $4 million of which was impacted the earnings during the quarter. We also had a lower effective tax rate by about 2% compared to the first quarter of 2008, this was really driven by the mix of earnings, country by country, as well as closeout of about a million dollars of prior tax positions. Let's take a look at the topline sales performance. As we mentioned net sales were down about 6% on a reported basis, which equates to about $37 million. About a quarter of that reflects the underlying commercial performance, and the balance is attributal to the currency movements that we mentioned already. We will get the results by category and region. Overall we feel quite good about the results. All the regions except for EAME, were up in local currency, and the decline in EAME really reflects lower demand, and significant inventory corrections for the customers in that region. North America was up nicely, driven by new wins in Flavors and Functional Fragrances.

LATAM had good results, concerning the fact that a 2% decline for Flavors is net of currency impacts. As we adjust for foreign exchange rates, we feel like the underlying -- we believe the underlying growth is closer to 11%. As you know historically, we reported our sales performance in LATAM, on a reported basis, and didn't adjust for changes in currency rates. Beginning in the second quarter, we intend to provide both local currency, and reported sales performance for the region. Turning to individual business performance, for the Flavors business, sales were up 2% local currency. We believe that our Flavors business continues to grow at or above market rates. This is driven by new wins and launches across all categories, with dairy the only real soft spot. Our operating earnings are down about $4 million, year-over-year, really driven by stronger dollar impact, between $2 million and $3 million. higher input costs, and about $2 million incremental expenses for pension and incentive compensation.

Looking at the Fragrance business for the quarter, results are really tied to a few key drivers. First, economic contractions reduced discretionary consumer spending, and inventory destocking for the Fine Fragrance category resulted in a sharp decline in top line sales. Second, while we are making good progress, in the Functional Fragrance sales development, price recovery and our cost savings initiatives, these were insufficient to offset negative effects of higher input costs, and the stronger US dollar, which was about a $5 million impact for the quarter. Translating this into earnings per share performance, price realization across both businesses, plus the volume growth in Flavors was a substantially offset by weak sales volume in Fine Fragrance. Overall, this net commercial activity, added about $0.03 for the quarter. Input costs really reflect in the consumption of higher price materials purchased late last year, cost us $0.15 per share year-over-year.

Cost savings at the manufacturing overhead level, as well as the lower effective tax rate added $0.03 for each category. Finally, foreign exchange at the operating -- operational level, net of gains realized in the corporate level reduced overall EPS by about $0.04 per share. Overall, adjusted EPS decreased 14%, from $0.70 in 2008, to about $0.60 in 2009. We talked as Rob mentioned, and we talked several cases about the negative impact of the dollar on our current results. Let's take a look at what this means a little bit in more detail. This table provides recap of the US - Euro exchange rates during the past five quarters. As you can see the dollar strengthened against the Euro, and 9% for the first quarter of 2009. As we mentioned earlier against the core basket of currencies, the change is closer to 14% on a global basis.

If the exchange rate in Q2 averages the actual rate as of yesterday, we would see a corresponding increase in year-over-year strengthening of the dollar about 16% for the Q2 of 2009. And clearly, this represents an additional head wind that we face. Maintaining the sound financial position is important to us. However, looking at the first quarter is a difficult period to assess how we we are doing. It's typically our weakest quarter in terms of cash generation. The first quarter of 2009 was also impacted by a couple of unusual items. First, the $16 million payment closeout the interest rate that I mentioned earlier. And second, during the quarter we recognized two dividend payments within the period. This is due to the fact, we are closing our books on a 52, 53 weak calendar basis. And in the first quarter, the dividend payment for the first quarter, was on the same date as our closing balance sheet date. As a result, we have two dividend payments in the cash flow statement for the second quarter.

Overall, from a financial perspective, we feel we are on track to pay off scheduled debt maturity in early in the third quarter, and we continue to have substantial draw down capacity on the multi-year credit facility. In conclusion, clearly we face some real challenges in terms of economic contraction, currency parity shifts and uneven demand patterns, but we are not going to wait for the external environment to improve. Our win rates in 2008, 2009 are clearly a positive for us. Our cost reduction inference will continue, and we expect the rate of increase on the input cost to moderate around mid year. And finally, we are taking steps to improve working capital and reduce our interest burden going forward. Let me turn it back over to Rob.

Thanks, Rich. I remain optimistic that IFF's business strategies will deliver against our long-term goals, of growing local currencies sales faster than world economy, providing for margin expansion, and trend line EPS growth. The feedback I received from our customers is encouraging, and the number and the value of new projects we have in-house continues to run well ahead of where we were a year ago. I'm also realistic. In Q2 I'm not expecting any meaningful change in demand from what we saw in Q1. Excluding Fine Fragrance, I can see local currency sales broadly speaking to be about flat, or slightly less. Fine Fragrance sales will again be weak, perhaps down as much as 20%, maybe more from a year ago period. Currency parity will be more adverse in Q2, perhaps 15%. And this will be a strong head wind. Raw material cost escalation will continue, but I believe it will be at a lower rate. And our savings initiatives, which are showing up in margin recovery efforts, which are being positive will continue to tribute. Our leaders and I are balancing meeting the requirements of short-term performance improvement, with those of building a stronger Company. We committed to our R&D and technical development programs, as these will drive value creation in the future. Our investments in the creative centers have been well received by our customers. We will continue to invest in our facilities to provide needed capacity in Asia, and for improved efficiency throughout the Company. I believe the people of IFF are focused on the right priorities, and delivering on their promise to make IFF a great company. Now, William, if you could help me, we will be happy to receive and answer questions for people on the call.

(Operator Instructions)

We will take our first question from Michael Sison, KeyBanc.

Hey, guys. Good morning.

Good morning Mike.

Looks like the, when you take a look at your first quarters results, that the raw material situation, is really the big head wind. I know Fine Fragrance was pretty weak, but when you look at the little chart, the input chart sort of that minus $0.15, so I mean, these just sort of have to wait unfortunately -- until that reverses, until the raw materials fall before you can get some margin expansions going forward?

Mike, the first of all raw materials response is a function of it flowing through the inventory. It's an average of inventory, so its there for a while We've begun to see the incremental purchase prices moderate, but it's going to take a while for that to average down. And I think earlier for the fourth quarter call, we said we didn't really expect to see improvement in material cost until the second half of the year. And I still think that's accurate. We may see some commodities come in sooner, but many of the natural materials continue to be at high levels,and that's been a big drag.

And Mike, as we talked about last time, (indiscernible) several of the key contracts have either quarterly or semiannual resets, so those -- we do believe from a market standpoint that the peak levels, in terms of purchase prices were late last year, but we got to go through the reset process on the contracts and then have it flow through the inventories.

Okay. Then, on a sequential basis, when we think about second and third quarter, it looks like in total Flavors and non -- non- Fine Fragrances are going to hold up pretty well. So you assume Fine Fragrances are down in that range that you suggested, it looks like local currency sales growth will be down, sort of low, sort of mid single digits, so when you think about profitability, as we think about second, third, fourth quarter, do you -- can you see a sequential improvement, sort of in that given the raw material head wind?

Sequential to what?

To the first quarter.

To the first quarter.

Right.

I mean, I think the second quarter tends to be a stronger quarter than the first quarter, and is typically is better. The revenues as I said, I don't expect the growth in revenues to be dramatically different than the first quarter.

Right.

Cost initiatives, where they were with some moderation in raw materials, I suspect the company will operate constructively, could imagine sequential improvement? Yes, I can absolutely imagine sequential improvement.

Great. And I just want to ask one follow up. Congrats on getting your CFO, can you give us some background, and why Kevin, and what he offers to IFF, and why he was the right person for you? Thank you.

We were very demanding in looking for a CFO. I was looking for a partner who could help me address the strategic needs of the enterprise, was a strong business analyst, and somebody who was comfortable dealing with a complex international organization. And Kevin, I thought, fit the bill really wonderfully. He's a very warm engaging guy, He has had a very successful career at Nestle, has been an ex-pat twice, which I think to gain a perspective on international business helps a good deal. He had broad total company exposure at Nestle, so he understands the complexity of reporting and dealing with things. He was the CFO at the Purina business following the acquisition by Nestle, so integrating a company, and seeing the totality was something he was comfortable with. He is -- he has got a lot of skills, and he is roughly 50. And I think he is going to be a very good partner for me, and the other senior leaders of IFF.

Okay. Thanks, Rob.

We will move to our next question from Lauren Lieberman, Barclays.

Hi, good morning. This is actually Ryan sitting in for Lauren today.

Good morning, Ryan.

So just a couple questions, in the press release, mentions that the company will be working on some initiatives to reduce fixed and variable costs, can you just talk a little bit about what the initiatives are, I'm assuming incremental, if they are restructuring in the fourth quarter.

It's really continuation of the things we started in the fourth quarter. As I indicated, there is selective reductions in resources in areas that are under performing, or don't have the growth demands. We are clearly continuing to invest in the areas where we think have the most promising growth in the emerging markets ,China, India and Brazil. We are going to look at the facilities and see what can be done to reduce our fixed cost and simplify our footprint. There is some very, very good exciting work being done on the procurement and logistic side. I'm not really prepared to give you all the details of it, but they are aimed at having impact in the next quarter, as well as the quarters ahead.

Okay. There was an article yesterday in AdAge talking about how product launches were down 51% in the first quarter. Are you seeing a pull back in the product activity at your customers?

Good question, I'll try to note that. That's something we are monitoring very closely on both sides of the house, Flavors and Fragrances, that really, the largest part of our S&A cost structure is really related to the work we are developing for new products or reformulations of existing products. As I indicated, the new projects in house are greater or more numerous and of greater value than they were a year ago. So we are not seeing any diminution, now I can't guarantee you that all of those are going to be launched, but at this stage we have not seen our customers pull back from the commitment. Maybe some change in shift, there has been focus on taking cost out of products, and reformulating to avoid materials. But we still see a very healthy flow of products from our customers.

And just to follow up on that, the new product activity, I guess the briefs that IFF is one that are launched, that really is the best, I guess most -- and that's the biggest way IFF has gained market share, right? Is actually by launching those new briefs?

Organically that's the best way. I mean, what it does, it not only gives us more of our customer, but if we help our customers win with that, we will grow as they grow their share in the market.

Okay. And I guess my last question is really for Rich. I just wanted to ask about the tax rate for the year, I think last time the guidance was somewhere around 27 to 27.5, is that still the anticipated tax rate? And was there anything special in the first quarter, that we should be thinking about, I think the tax rate is a little bit lower?

It was lower than last year. as I mentioned in my comments, there was a million dollars of close-out of provisions and positions that we were in previously, that helped in the Q1 2009. If all else stays equal through the end of the year, I say we have an opportunity be in between 26.5% and 27%, so no major changes. Most of the difference between this quarter and last year, was just where the mix of earnings were and the mix of the performance, country by country.

Great, thanks so much.

Yes.

(Operator Instructions)

We will move to our next question from Jeff Zekauskas, JPMorgan.

Good morning. This is Silka for Jeff.

Good morning. Good morning.

When I looked at some of your customers results this morning, as well Colgate as reported, and Procter & Gamble reported, what was remarkable was the, I guess the amount of incremental prices that the company achieved. And so I guess I was interested in finding out how much price benefit you saw, like the Fragrance or the Flavor business in the quarter? And whether that should improve throughout the year?

We have continued, we talk about the price increases that were initiated to a large extent the latter part of last year, we continued to make progress on that. What I would say is, as we head in to the second and third quarters, those benefits year-over-year will be down, because we started to get particularly in the ingredients business, price increases in the second quarter.

They wont be down.

Less of an increase, less than what we saw in the Q1.

How much was it in the first quarter?

It was about $20 million. Pretax.

Okay. Was it mostly on the flavor side, or what was the Fragrance business benefit as well?

Both businesses benefited from it. It's about a third of that on Flavors and two-thirds in the Fragrance and Ingredients business.

That's helpful thank you. Maybe I can ask one more question, when I look at EPS water fall, what is the impact from lower volumes to earnings?

The commercial impact of about $0.03 really takes the pricing impact net of volume and mix. And so you got positive got the positive $20 million, and then you have about $17 million combination of volume and mix going the other way.

Most pronounced volume decline was in Fine Fragrance. Other than that, volume was fairly flat.

The prices about $0.18 to $0.19, and then the volume and mix was about $0.15, in that range.

Okay. That's helpful. Maybe one cash flow question. What is your expectation for capital spending this year? And should working capital, at the end of the year be a contributor to operating cash flow?

I think we will be in the range of low $80 million in terms of CapEx, assuming the market stays where we expected to be. We talked about that earlier. And then in terms of working capital, clearly we've got initiatives internally to reduce working capital, and I expect we will have a year-over-year benefit.

Thank you very much, and I will get back in to queue.

(Operator Instructions) We will take our next question from Erik Sjogren, Morgan Stanley.

Yes. Good afternoon.

Good afternoon.

Hi, I just had a quick question on the destocking. Looking at the Staples company, listening to the staples company, visibility is obviously quite lower across the supply chain, but have you noticed during the first quarter now in April, any kind of shift, or I should say normalization in the order patterns? Or any kind of indications that the destocking is at least tapering off so to say, verse the fourth quarter and earlier this year?

We haven't seep destocking broadly across either business, the destocking that is very, very clear is Fine Fragrance. And that's with a number of the Fine Fragrance accounts. But you know Europe, I think there is some decline, but it's hard for me to separate the destocking, from consumption declines because of the declining economy. And the economy in southern Europe is off so much. But we haven't seen too much pronounced outside of that, so I can't tell you it's shifting around. It's one of the reasons I feel good about the Flavors business performance. You would have thought the consumption and destocking in North America, would have been more adverse, and in the fourth quarter, and again in the first quarter our Flavors business in the US showed very, very, solid good growth in sales.

Okay. Great, thanks very much.

It appears we have no further questions at this moment.

Well, I do appreciate you taking the time to be with us. It is an interesting time, and I'm pleased with overall performance of the enterprise. The Fine Fragrance team, is I think is doing a very, very, good job in a tough market condition. And I know the initiatives that both businesses, have underway to both grow their top line improve cost structure, are showing good progress and will continue. And I look forward to reporting on the progress of that in the next couple of quarters. Thank you very much, and good luck to you.

That concludes our conference for today, we thank you for your attendance.