Sensient Technologies Corp (SXT) 2008 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2008 third-quarter conference call. Today's call is being recorded. At this time for opening remarks, I would now like to turn the call over to Mr. Steve Rolfs. Please go ahead, sir.

Good morning. I am Steve Rolfs, Vice President, Controller and Chief Accounting Officer of Sensient Technologies Corporation. I would like to welcome all of you to Sensient's 2008 third-quarter earnings conference call. I'm joined this morning by Mr. Kenneth P. Manning, Sensient's Chairman and Chief Executive Officer; Dick Hobbs, Sensient's Vice President and Chief Financial Officer; and Rob Edmonds, Sensient's President and Chief Operating Officer.

Earlier today we released our third-quarter 2008 financial results. A copy of the release is now available on our website at sensient-tech.com. Before we begin, I would like to remind everyone that comments made this morning including responses to your questions may include forward-looking statements as defined in the Securities Litigation Reform Act of 1995. Our statements may be affected by certain factors, including risks and uncertainties, which are discussed in detail in the Company's filings with the Securities and Exchange Commission. We urge you to read Sensient's filings for a description of these factors. Please bear these factors in mind when you analyze our comments today.

Now we will hear from Ken Manning.

Thank you, Steve. Good morning. Sensient's revenue, operating income and earnings per share all reached a record level for the third quarter. This is the 11th consecutive quarter in which we have exceeded expectations. Our revenues increased 8.3% to a record third-quarter level of $318.6 million.

We also reported record third-quarter earnings of $0.50 per share. Earnings per share increased 14%, making this our sixth consecutive quarter of double-digit earnings growth. We have seen solid demand and improved pricing across our Flavor and Color businesses. In the Flavor & Fragrance Group, we reported a 7% increase in revenue to $206.5 million, which is a record for the third quarter. Operating income for Flavor & Fragrance Group was up 8% in the quarter to $31.6 million, which is also a third-quarter record.

The Color Group reported record third-quarter revenue of $103 million, an increase of 12.7% from prior year. Operating income for the Color Group was up 12.6% from last year's third quarter.

We continue to strengthen our balance sheet. Total debt fell by $25.5 million in the quarter. We have reduced debt by over $170 million since the beginning of 2004, and by $192 million if you exclude the impact of foreign exchange. Our debt to total capital ratio is now 35.9%, and I expect this to be less than 35% by the end of the year.

We recently announced the successful negotiation of a new $85 million term loan. The proceeds from this loan will be used to retire Sensient's public debt when it matures next year. This transaction demonstrates our consistently strong performance as being recognized in this difficult national market.

The Company continues to pursue initiatives to accelerate its growth. We are increasing our new product development with products such as our new line of preservative-free natural food and beverage colors. This is called Fusion. A next generation of self-disbursing pigments for inkjet ink use, and finally new cosmetic formulations which have been very successful and have contributed to sales in this quarter.

We are also further strengthening and extending our distribution network. This extended distribution will reach new geographic markets in order to generate even additional sales. We are on track for a strong year.

Our consistent long-term strategy is delivering good organic growth. Our markets continue to perform well, and as I have stated in previous calls, I see no obstacles to continued success. As a result, I am raising the EPS guidance for the year to a range of $1.86 to $1.88. Our prior guidance had been $1.80 to $1.84.

I will now turn the conference call over to our CFO, Dick Hobbs, to give you the details.

Good morning. I will now provide details of the results for the quarter and nine months ended September 30, 2008. Consolidated revenue increased 8.3% to $318.6 million, a record for the third quarter. Each of our groups reported record third-quarter revenues, benefiting from price increases and higher volumes across many of our product lines. Third-quarter revenue showed strong organic growth with foreign exchange representing only 2% of the increase.

Sensient's operating income for the third quarter was $40.9 million, an increase of 7.1% from the prior year. Diluted earnings per share increased 13.6% to $0.50 for the quarter ended September 30, 2008, from $0.44 per share in 2007.

The Company reported cash flow from operating activities of $66.3 million for the nine months ended September 30, 2008, in comparison to $80.7 million in the prior year. For the quarter, cash flow from operating activities was $27.8 million, down $4 million from last year's third quarter. This year's cash flow reflects an increase in inventory due to strategic purchases of key raw materials.

Accounts receivable are also up as a result of strong sales. The Company continues to expect that cash from operating activities will be in the range of $100 million for the year.

The Company reduced its total debt by $25.5 million in the third quarter for a debt to total capital ratio of $35.9 million, down from 38.4% -- to a ratio of 35.9%, down from a ratio of 38.4% at the beginning of the year. Debt to EBITDA has also continued to drop and is expected to be just over 2 by the end of this year, and under 2 by early 2009.

The third-quarter tax rate of 26.7% compares favorably to the prior year rate of 29.5%, reflecting benefits from the settlement of prior-year tax matters and other adjustments. In comparison to the prior year's rate, the favorable impact on net earnings is $900,000 for the quarter.

As recently announced, the Company completed a new $85 million term loan agreement. Proceeds from the loan will be used to retire public debt when it matures in 2009.

I would now like to take a brief look at the results of our operating groups. The Flavors & Fragrances Group reported a 7% increase in revenue in the quarter to a record level of $206.5 million versus $193 million last year. Group revenue for the nine months ended September 30, 2008 was $616.1 million compared to $572.3 million in the prior year period.

Revenue in this quarter and year to date benefited from improved pricing and favorable foreign currency translation. Flavors & Fragrances Group operating income rose 8% to $31.6 million for the third quarter compared to $29.2 million in the third quarter of 2007. Operating income for the nine-month period was $94.3 million compared to $85 million in the prior year period. In both periods we have been able to offset increases in raw materials and energy costs with improved pricing. Group operating margins improved 20 basis points to 15.3% for the quarter.

Sensient's Color Group reported revenue of $102.7 million for the third quarter compared to $91.1 million in 2007, an increase of 12.7%. Revenue for the nine months ended September 30, 2008 increased 10.5% to $312.8 million The higher revenue in this quarter and year to date was prematurely due to volume growth on price increases combined with favorable foreign currency translation.

Color Group operating income for the third quarter was up 12.6% to $17.7 million. Operating income for the first nine months increased 11% to $55.5 million from $50 million in 2007. Operating income for both the quarter and nine months ended September 30, 2008 increased as a result of higher sales and improved pricing which more than offset higher raw material costs. The operating margin for the Color Group of 17.3% in the third quarter of 2008 was equal to the prior year's level.

Revenue in the Corporate and Other segment increased 12.6% in the third quarter to $19.3 million on strong sales gains in China, the Philippines and Australia. As Mr. Manning stated, Sensient now expects 2008 diluted earnings per share to be between $1.86 and $1.88. This is an increase from the previously provided range of $1.80 to $1.84.

I'll now turn the call over to Rob Edmonds, President and Chief Operating Officer, for some concluding remarks on the quarter's performance.

Thank you, Dick. I would like to conclude the call by highlighting the achievements in the operating groups this quarter. Organic growth was strong again this quarter, with record revenues and increased quarterly profit. All groups benefited from improved pricing and volume gains in key product lines. In the Flavors & Fragrances Group, we saw strong volumes growth in [flavor] and dairy flavors in the US and Canada. Our price increases have offset the impact of higher raw materials and energy costs.

In the Color Group, consistent demand for food and beverage colors resulted in higher sales in all regions. In addition, sales of Cosmetic, Pharmaceutical and Technical colors were up in the quarter. We have been able to raise prices to more than offset the impact of higher raw material cost, and this has produced a 12.6% increase in operating profit.

The Company's operations in Asia also saw higher sales, driven by markets in Australia, the Philippines and China. Combined sales in the region increased nearly 13% in the quarter. Our strategy is proving successful, and we expect this impressive performance to continue.

Thank you very much. We will now open the call for questions.

(Operator Instructions) Christopher Butler, Sidoti & Company.

Good morning, guys. First question is looking at SG&A; we are looking at a number that as a percentage of sales was flat in the third quarter. I know you were working to broaden some of your sales function to go after some new markets. Is that what we are looking at here? Is there an increase to R&D spending? What is going on?

We did have some one-time items in there, including a settlement of a suit that had been going on for many years, and that was a pretty substantial amount in a range of $600,000 or so plus dollars. Also, we had some reorganization that we did in one of our businesses, and we had some severance in there and some other items that are not going to repeat in the fourth quarter.

When you look at the year and the way the SG&A flows out through the year, last year was 18.1%, and we are still targeting to have the year-to-date by the end of the year below 18%. And we are working to get it to approximately 17.8%.

Shifting gears to demand a little bit, could you give us an idea of what your private label sales are looking like as it looks more and more like we're going into a prolonged recession here in the United States?

Yes. Chris, this is Ken Manning. For starters, recessions have actually been okay with the business for a variety of reasons, both in private label and then branded foods, and we do a good amount in both. One, things like premium ice cream, and this is a phenomena but I have been watching premium ice cream for the last 30 years. And during a recession, it always goes up. It's going up now. Dairy flavors in general are going gangbusters.

Also, we are not much in the food service business, but in the packaged food area, whether it be private label or branded products, people tend to eat more at home and that helps us immensely. We are not really in the food service business. So if they eat at home, that is better for us.

And then finally, and this is probably one of the most important aspects for our market and it keeps the market extremely healthy during these times, many manufacturers start to use less expensive ingredients. And to make the product attractive, they have to reformulate sometimes with more expensive flavors, sometimes with more colors. Calling a product natural, obviously, is a real seller.

So you may want to get a natural color this time rather than a synthetic color. You may want to get a natural flavor or a more expensive emulsion of some sort or another. But reformulation, which goes on during periods like this, really, really drives the business up. So we are certainly not happy about the times, but it is not -- we don't see it as affecting our business in a negative way. In fact, we see a lot of upsides.

If we are looking at your international business, I think I can fairly comfortable talk to trends in the United States and probably in Western Europe as well. Are there trends in some of the more developing regions in a slowing economy that may differ from what we would expect with a US centric viewpoint on the world?

In food? Not really. Out in the Far East, I am talking when I say in food Europe, the EU. If you go out into the Far East, they may use more color, things of that sort. That seems to be a trend as they reformulate products to use more color.

There are certain products that stay constant throughout the world. We're a big producer of colors for lipsticks and other cosmetics. And even during the Great Depression, ladies did not stop using lipstick.

Also in Asia, we are starting to sell a lot of cosmetic colors. Once people become accustomed to those products and start to use them, it is sort of the last thing they would give up. So, in general, the trends as you look throughout the world are good. I am glad we are in this business. I would not want to be in some other businesses, but this is a good business if you are in a recession.

Thank you for your time.

Eric Swanson, KeyBanc Capital Markets.

Hey, guys, great quarter. You guys had good organic growth in the quarter. Can you guys just give us a sense of how much of that was price and how much of that was volume?

When you look at the total increase of 8.3%, a little bit less than half would technically be price, but part of that is the premium products we are selling which also affected the mix. So as we move up into more upscale products, and we have had a number of areas where we have had some successes in that that has driven some of this, we are finding that even the price areas where price has gone up is related to selling the higher premium products as we have new launches.

Okay. On the Colors front, it appears that you had pretty strong volumes growth in the quarter. Can you guys expand just a little bit on what drove that volume growth in Colors?

Well, a number of things. One, food and beverage is very good, particularly in North America. Cosmetics were good. Pharmaceutical colors are starting to really emerge, and our industrial colors were extraordinarily good. So I would have to say it is kind of across the board.

Now there is some very interesting technology in that group. We don't have a competitor in that group that can compete with us in all sectors. So we might have one guy in the food and beverage, we might have a guy in the cosmetics or the pharmaceutical, but nobody really competes with us across the board. So it really was an across-the-board growth. We, in color particularly, have the reputation as being the industry solution provider. If you've got a problem, you come to us. So color is going to be very strong.

And do you see these volume levels sustainable heading into the fourth quarter and 2009?

Yes.

Great. On the raw material front, obviously you guys continue to remain successful in driving the price increases to offset the higher costs. Now that we've seen certain of the raw materials side, do you sense you'll be able to retain the pricing that you've announced?

Yes, because we are not really affected by oil, per se. The only effect would be basically what it might have in natural gas to fuel dryers where we have to dry our product. A lot of our raw materials are not commodities. And one of the things in a -- it's a project that [Dr. Herring] is working on throughout the Company, is to develop unique raw materials, particularly in the natural color area, and we are in the process of doing that.

And these would not -- there would not be a market like in cocoa or sugar or wheat or things of that sort for many of the raw materials we use. Although if it is a widely-used material like sulfanilic acid or Schaeffer's salt, we might make some strategic purchases. But typically, people pay for performance in Flavors and Colors. They also are a very de minimis part of the total cost of goods sold on any finished product. So we don't expect to have any affect on that really at all. In fact, that is kind of an upside.

Just a couple more quick questions here. It looks like you got a 2% benefit from favorable FX in the quarter. With the recent strengthening of the dollar, do you see this affecting your results in the fourth quarter?

We have done those calculations. Certainly at the end of the quarter, as we put our balance sheet, together, the euro, for example, probably the currency that has the biggest impact on us was about $1.46. Today I think it was running between $1.34 and $1.35.

We ran some numbers, approximate those levels that you are seeing now. And we feel as we look at our plans and our forecast, that we are comfortable that we are covering that.

Okay. And last question, can you quantify the year-over-year impact or increase in raw material costs for the quarter?

Looking at the quarter and looking at the impact of raw materials, it was in the quarter roughly an impact of a little bit over $6 million. Energy was more on top of that. And between the pricing that we have talked about and the mix moving up to the more premium products, we more than offset that.

Great, thank you very much.

(Operator Instructions) Edward Yang, Oppenheimer.

Your flavors margins have continued to tick up. Was that more on the North American side or on Europe?

Good morning, Ed. Yes, we did have good business in North America. It was very strong for us, and certainly as we talked about the improvement in our products and selling the more sophisticated products, we got a lot of benefit out of that in North America. So North America did have more of an impact on that.

Were European margins up, Dick?

The European margins were not. We did not see the increase there that we saw in the US.

Okay. Was that affected by FX at all in Europe?

No, it was de minimis. As a matter of fact, if you take the pretax number, the pretax was up 11.5% for the Company. And of that 11.5%, the currency component was only 1.5%. So at the profit level, the currency impact was much, much smaller. We certainly, in Europe, we have a business that is doing well, and we are continuing to have improvements in that business.

On the color side, margins were flat year-over-year. You've been improving that steadily as well. Was that related to some increased marketing spend with some of the new products that you were talking about, or what was driving the margins there?

Well, in the case of color, of course, it's a lot of different products in any given quarter. And we came in roughly at our forecast of, for Color, 17.3% was in the range that we were comfortable with. But we continue to endeavor to ROI projects and improving our product mix to bring that up.

Just on cash flow and some additional modeling questions. CapEx was -- you are spending at a fairly low level versus your year-end forecast. What do you expect to spend in CapEx by the end of 2008? And also what is it your assumption on the tax rate for the fourth quarter?

Okay. As we look at the CapEx, we are expending that to be in the mid-50s. It is down a little but just on the rate of spending. So about mid-50s for the year. And as I mentioned in my comments, we expect the operating cash flow for the year to approximate $100 million again this year.

We did have some timing of some inventory. A lot of that is going to adjust out in the fourth quarter. We'd had some strategic purchases, for example, of some rather sophisticated natural colors. We bought ahead with the Olympics in China, some inventory there, and as well our cost of our inventory was up. But we are going to be able to manage our working capital to approximate the $100 million for the year.

And you had one other question?

The tax rate.

Yes, the tax rate. In the quarter compared to last year, the tax rate was about $900,000 benefit in the quarter. Last year was 29.5%. We expect the rate in the fourth quarter to be between 30% and 32%, which is roughly what we are looking at for next year as well.

As you know, we've had success with our tax planning. We've had the benefit of bringing that rate down in individual quarters, and so certainly we are comfortable in that 30% to 32% range.

And my final question, as you know, even Pepsi saw some effect from the economy. It sounds like you are not seeing the face of reformulations and project activities slow --.

But Ed, let me explain what Pepsi was talking about. Pepsi sells a lot of very good pure water with no flavors or colors in it. And this suggestion that people would start to drink tap water is possible, because what they are selling is water. What we sell are basically natural flavors and colors to very specialized water, and we don't see that being a problem.

The comment about carbonated beverages, that trend is probably about 15 years old. Everybody sort of adjusted to that 10 years ago. So I don't see either one of those things applying to our forecasts or to our optimistic views of the future. It was an interesting release, but it really -- the CEO was talking about water, not flavored water, not colored water, but water. And the comment on carbonated beverages, that's been our round years and years and most flavor and color companies have made the adjustment in their forecasts and their product mix.

Okay, thank you for the clarification.

(Operator Instructions). Violet Osterberg, Pacific Life.

Congratulations on the quarter. I was wondering if -- although you're performing really well, has your stance towards your cash management and maybe your cash position changed a little bit to be, I guess, in a prudent position for cash?

Happily the Company and the Company's success in our strategy for the balance sheet have positioned us a better than a lot of companies in the US. For example, Violet, you probably noted and, as I said in my comments and Mr. Manning noted, we were able, during the most difficult of the crisis before the government had even approved the action and that they recently took, were able to raise $85 million in the credit markets.

And when you do that you're doing due diligence with those banks. And so they were looking at our financial statements and the quality of our balance sheet and the quality of our ability to generate cash flow in the future. And we raised that to protect the Company because of the fact that we have public debt maturing in April of 2009 and it was critical to us to be prepared to have enough capacity to cover that.

And as a matter of fact, with the raising of the $85 million we'll have plenty of capacity and, as a matter of fact, we'll have enough with our cash flows to last about three and a half years. So we feel we're very, very well-positioned to weather the storm.

And as we look at the ratios on our balance sheet, as we said, by the end of the year we expect debt to total capital to be around 34%, debt to EBITDA we expect to be a little bit over 2, and as we look at the end of '09 we expect debt to capital to be under 30% at the end of the year and debt to EBITDA to be about 1.7%.

And I made those calculations without regard to what currency is today; I made those calculations or we made those calculations based on the EUR1.46. So those numbers -- if the currencies stay where they are those numbers are going to get even better as far as the strength of the balance sheet.

In fact, Violet, we see the whole business getting stronger, the P&L, the balance sheet -- we're feeling very good about things.

As a matter of fact, you mentioned specifically cash flow. When we look at 2009 we expect the cash flow again to be over $100 million. As a matter of fact, our forecasts right now have it over $110 million and EBITDA over $220 million for 2009.

Great, thank you very much.

This concludes the Q&A session. Do you have any closing remarks?

No. Thank you very much for your time this morning. And if there are any follow-up questions, please feel free to call the Company. Thank you.

This concludes today's conference call. You may now disconnect.