Sensient Technologies Corp (SXT) 2012 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2012 second-quarter conference call. Today's call is being recorded. At this time, for opening remarks, I would like to turn the call over to Mr. Steve Rolfs. Please go ahead, sir.

Good morning. I'm Steve Rolfs, Vice President - Administration of Sensient Technologies Corporation. I would like you welcome all of you to Sensient's conference call to discuss 2012 second-quarter financial results.

I am joined this morning by Mr. Kenneth P. Manning, Sentient's Chairman, President, and Chief Executive Officer, and Dick Hobbs, Sentient's Senior Vice President and Chief Financial Officer. Also with us today are Paul Manning, President of the Color Group, and Jim McCarthy, President of the Flavors and Fragrances Group.

Earlier today we released our 2012 second-quarter financial results. A copy of the release is now available on our website at Sensient.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 Private 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 Sentient's filings for a description of these factors. Please bear these factors in mind when you analyze our comments today.

Now, we'll hear from Ken Manning.

Thank you, Steve. Good morning. Sensient delivered a solid performance in the second quarter of 2012, establishing an all-time quarterly high for earnings-per-share. As reported, net earnings-per-share was $.70, an increase of 4.5% from $0.67 reported in the last year's second quarter. The impact of foreign currency reduced second-quarter net earnings by approximately $0.04 per share. The second-quarter results also include one-time legal costs of $0.02 per share, related to the Company's effort to recover some of its costs from a previously settled environmental claim. Excluding the impact of foreign currency and the legal costs, earnings-per-share increased by 12% in the quarter.

Color Group delivered another strong performance in the second quarter, reaching an all-time high for operating income. Local currency revenue growth was 2.5% in the second quarter and operating income increased 11.2% in local currency terms. The Color Group achieved an operating margin of 20.3% in the second quarter, up 170 basis points from the 18.6% reported in the last year's second quarter. All of the Group's businesses are focused on strong profit growth opportunities. We expect to deliver mid- to high single digit growth in local currency, and we believe that the operating margins achieved this quarter are sustainable.

The Flavor and Fragrance Group reported local currency revenue growth of 1.3% in the second quarter. Operating income was slightly lower, due to soft markets in Europe and higher raw material costs. We expect the Flavor and Fragrance Group to achieve mid-single-digit revenue growth in local currency in the second half of 2012.

The Corporate and Other segment, reported a local currency revenue increase of approximately 7% in the quarter, driven by strong performances from Thailand and the Philippines. Cash flow from operations was $40.1 million in the second quarter, an increase of 4.5% over last year's results.

The current economic conditions are challenging, but our balance sheet is strong. Our strong financial condition allows us to reinvest in the business and return value to our shareholders. We invested almost $50 million into capital projects in the first half of the year, and we expect this expenditure level to continue. In the past few years we have invested heavily in our facilities, incorporating new technologies. We will continue to identify investment opportunities within our existing businesses.

We are also considering acquisition opportunities. We made two acquisitions in 2011, allowing us to gain full control of operations in key strategic markets. We continue to look for opportunities to improve our commercial technologies, product offerings, and access to markets.

Increasing our sales coverage has been one of the key drivers of Sentient's success over the past few years. We have added more than 90 sales positions across the Company since 2009 and we will continue to expand our sales force. We have returned value to shareholders by increasing our dividend and repurchasing shares. In April we increased our quarterly dividend to $0.22 per share. This is the sixth increase of our quarterly dividend in the past six years, representing a 47% increase.

We have also repurchased 460,000 shares this year, including 50,000 shares in the second quarter. We will consider additional share repurchases based on market conditions.

Our investment in the Company will continue to drive our earnings growth, and I am very optimistic about the Company's future. We are maintaining our earnings guidance, which is in the range between $2.50 and $2.59 per share in 2012.

Dick Hobbs, our CFO, will now provide you with the details for this quarter.

Good morning. Sensient reported revenue of $367.8 million in the second quarter of 2012 compared with $377 million in the second quarter of 2011. Operating income was $54.3 million for both the 2012 and 2011 second quarters.

Foreign currency translation significantly reduced both revenue and operating income in the quarter. Stated in local currency, revenue and operating income increased 2% and 5%, respectively, from last year's second quarter.

The second-quarter earnings include legal costs of $0.02 per share, incurred in a suit against one of our former law firms. The action related to significant environmental claims arising out of a 1988 transaction, in which the law firm was the Company's legal adviser. The Company did not receive an award as a result of this action and has concluded its efforts to recover costs in this matter. The underlying environmental claims were settled in 2009.

Interest expense was down 15.3% to $4.3 million for the second quarter of 2012, from $5.1 million in last year's quarter. The tax rates were 30.1% and 31.9% for the quarters ended June 30, 2012 and 2011, respectively. The tax rates for both quarters reflect changes in estimates associated with the finalization of prior year items and other minor adjustments.

The 2012 rates also includes a change in the estimate of the current year effective tax rate. The tax rate for the remainder of 2012 is expected to be between 32% and 33%. Discrete items will be recorded in the period in which they occur.

Diluted earnings-per-share, as reported, were $.70, an increase of $0.03 or 4.5%, from last year's second quarter. Second-quarter earnings, as stated in local currency, would be $0.04 per share higher than reported earnings. Excluding the impact of foreign exchange rates and the costs related to the legal action, operating income and earnings per share were up 6.9% and 11.9%, respectively, in the quarter.

For the first half of 2012, revenue, as reported, was $733.4 million, compared to $726.7 million last year. Operating income, as reported, was up 2.9% to $100.8 million, from $97.9 million reported in the first six months of 2011. Foreign currency translation reduced revenue and operating income in the first six months of 2012 by approximately 3% and 4%, respectively. State and local currency revenue and operating income increased 4% and 7%, respectively, in the first six months.

Interest expense was $8.8 million for the six months ended June 30, 2012, a decrease of 12.3% from $10 million reported in 2011. Diluted earnings per share, as reported, were $1.28, an increase of 6.7% from $1.20 reported in the first half of 2011. Year-to-date earnings, as stated in local currency, would be $0.05 per share higher than reported earnings.

Sentient's cash from operating activities for the second quarter of 2012 was $40.1 million, an increase of 4.5% from the prior year's second quarter. The improvement was due to a lower use of cash for working capital needs in the second quarter of 2012 as compared to the prior year's quarter.

As previously mentioned, Sensient has several capital projects in progress to expand capabilities and improve efficiencies. Capital expenditures in the second quarter of 2012 were $30.9 million, compared to $13.6 million in the 2011 comparable quarter. For the six months, capital expenditures were $47.8 million in 2012 and $23.8 million in 2011. The Company also repurchased $17.1 million of its stock in 2012, primarily in the first quarter.

As a result of these items, debt increased to $357.8 million at June 30, 2012, from $331.4 million one year ago. The debt to capital ratio was 25% at June 30, 2012, and debt to EBITDA was 1.5%. Sensient's balance sheet remains very strong.

I will now take a brief look at the results of our operating groups. Revenue, as reported in Sentient's Color Group, was $127.9 million, and $132.4 million in the quarters ended June 30, 2012 and 2011, respectively. The Group reported all-time high operating income of $25.9 million, an increase of 5.3% from $24.6 million reported in last year's second quarter. Foreign currency translation decreased revenue and operating profit in the quarter by approximately 6%. Stated and local currency revenue and operating income increased 2.5% and 11.2%, respectively. Second-quarter operating margins increased 170 basis points to 20.3%, marking the first time since 2003 that the margins have exceeded 20%.

For the six months -- first six months of 2012 and 2011, Color Group revenue, as reported, was $259.2 million and $258.1 million, respectively. First-half operating income, as reported, increased 9.5% to $51.5 million from $47 million reported last year.

Foreign currency translation reduced both revenue and operating income by approximately 4%. Stated and local currency revenue and operating income increased 4.6% and 13.8%, respectively, in the first six months of this year.

The considerable improvement in margins for the group was primarily attributable to an improved product mix as the Group focuses on higher value products and divests low margin business. These results were particularly strong in the Global Food Colors and Inks businesses.

Revenue, as reported, for the Flavors and Fragrances Group was $218.9 million in the second quarter of 2012, compared to $225.8 million one year ago. Operating income, as reported, for the second quarter was $33.5 million in 2012 and $35.9 million in 2011. Foreign currency translation decreased revenue and operating income in the second quarter of 2012 by approximately 4% and 3%, respectively. For the first six months, revenue as reported for the Flavors and Fragrances Group was $433.6 million and $431.8 million in 2012 and 2011, respectively.

Operating income, as reported, was $62.5 million and $64.5 million for the six months ended June 30, 2012 and 2011, respectively. Foreign currency translation reduced the six-month revenue and operating income by approximately 3% and 2%, respectively. The Group saw softness in certain European markets in both the quarter and six months ended June 30, 2012. In addition, inventory destocking by key customers and higher raw materials costs contributed to the reduction in operating income.

Revenue in the Corporate and Other segment was up 6.1% to $38.5 million in the second quarter of 2012, compared to $36.3 million in the prior year. For the six months ended June 30, 2012, revenue increased 6.7% to $75.7 million, compared to $70.9 million last year. This segment includes the Company's operations in Asia Pacific and China. The Company's flavors operations in Central and South America are also there. Growth in the segment was driven by the Philippines and Thailand.

We are maintaining our guidance for 2012 diluted earnings per share to be between $2.50 and $2.59.

Thank you very much for your time this morning. We will now open the call for questions.

(Operator Instructions). Christopher Butler, Sidoti & Company.

Good morning, everyone. Just to start with, as we look to the second half of the year, could you touch on any kind of impact that you would face from a challenging harvest with the drought conditions here in the US?

We are not directly affected by that in our businesses because where we do have operations, where we are controlling the farming activities, it's all irrigated. And we don't anticipate any issue there.

And the third quarter is looking good so far so I know that's going to affect people, but it doesn't seem to be affecting us, Chris.

And you're not worried it could affect your customers who then purchase less from you and (multiple speakers).

We're covered. We have some hedging on things like corn syrup through the end of the year.

But this is not a big issue for us at all. At all.

And with the gross margin improvement that we've seen, you did mention product mix being a big component of that and we've definitely seen that over time. But if we look at the improvement on a sequential basis, I can't see that -- I can't imagine that there's a big change in product mix from the first quarter to the second quarter. Could you give us some detail there?

Paul, why don't you take that?

Sure. I think the change in product mix, as you can imagine, is kind of an evolutionary process and we are very strongly directing each of the businesses -- pharma and food, cosmetics, et cetera -- towards this expectation and towards the sale of products that are very consistent with our strategy and, therefore, our value proposition. So I think you will continue to see continued improvement for the rest of this year and certainly into 2013 and beyond.

And to what do you attribute, then, the 110 basis point improvement sequentially on gross margin for the Company?

Well, looking at the total Company, there's no question that the Color Group was a big factor in that improvement. And that was the biggest driver and, as Paul just mentioned, that is expected to continue going forward. And we're feeling good about the third quarter. It's looking good as we start out. Things are going strongly for us and so --.

Yes, Chris, I think the term was used where divesting ourselves of low margin business, and I think that says it all.

I see. And can you talk to the softness that you spoke to and the destocking? Give us a little more color on that front.

Yes. Certainly, we did have some softness within the Flavor Group with some of the product lines that was in the Flavor Group but, again, we do feel a lot of that is behind us and we're feeling good about the rest of the year.

Yes, we are.

I appreciate your time.

Okay, Chris.

Edward Yang, Oppenheimer.

Hi. Good morning.

Good morning, Ed.

Just piggybacking on the prior question on the gross margin improvements sequentially. Isn't some of that attributable just to seasonality? It seems like the last couple of years you always seemed to have stronger margins in the second quarter, relative to the first quarter.

Yes, certainly there is -- the second quarter, Ed, is the strongest quarter. There's no question about that and so that does have a positive impact -- a positive sequential impact. Certainly, that is something that is a factor.

But the bigger factor is clearly that we're not taking low margin business.

Got it. Okay.

That's the big factor. That is a strategic priority that we're following.

But clearly, going back and looking at last year, in the quarter -- and that's a good comparison, to compare year to year -- we are up 50 basis points for the whole Company.

Okay. And you expect the Color operating margins to remain above 20%?

I just got -- I corrected it -- we are up 150 basis points within the last year.

Well, Paul, why don't you take that last question?

Yes, I think that we've demonstrated now some continuity in the higher operating margins. I would tell you that we would certainly be in the vicinity of 20% moving forward. I think this is the second quarter is now the eighth quarter in a row of double-digit operating profit growth in the Color Group. So I think between our ongoing sales efforts, we've expended tremendous amounts with respect to capital and I think what these really communicate is we see huge opportunities in the marketplace.

Now those opportunities don't necessarily develop this week or even next quarter, but they do develop. And I think we're seeing that with respect to our Food Colors and our Inks, which are up very, very strongly on operating income, due to new sales and also, again, improvement in the mix, and really focusing on those parts of the market for which we have a very strong position to our customers and, certainly, with respect to the competition.

Okay. Thanks, Paul. And on Flavors, that saw some decline year over year, and you mentioned Europe and raw materials and destocking. Within Europe, how has that impacted the margin in that business? I know your margins in North America are pretty impressive, but that's been an area that's been lagging. Has that taken a step down with some of the macro pressures?

Yes, if you look at Flavors, Flavors had a much tougher time in Europe. Colors seemed to do well worldwide. That's been our superstar. But Flavors, we are running into some headwinds in Europe.

We are, Ed, as we look at Q3 -- we look ahead to Q3 -- we are expecting certainly, as Paul mentioned, the margins are going to be up again in Color and we expect to maintain our margins in roughly that 15% or so range.

Okay. Got it, Dick. And just on the top line comments that you had. Are you expecting the mid-single digits' organic revenue growth, both in the second half for both Flavors and Color and what would account for that acceleration?

What we are expecting in local currency, of course, we are expecting growth certainly for the Flavor Group to be in that mid-single-digit area for the rest of the year. We're expecting increase in the Color Group, actually mid-to-high single digits. Looking at the profits by itself, probably double digits are possible.

And again, what would account for the acceleration? Is it just easier comps or less destocking or economic pickup?

Well, specifically in the case of Color, as I said in my prepared comments, there has been a very concerted effort to remove lower margin product and move into higher margin products. And Paul may want to --.

Paul, do you want to add anything?

Yes. I think, certainly, that reduces your total revenue output. The way we think about this is we want to drive operating profit. So, yes, at some point, you've divested the lowest of your low margin and less interesting business and then you stop taking away from the top line growth that you are still generating and I think that's why you're going to see the change. Again, there's only so much lower margin that you're going to process through and then you start to really benefit from your ongoing business closings.

And similar dynamic in Flavors as well?

Certainly in Flavor. We've moved technology within the group and --.

Maybe Jim would like to comment.

Yes, Jim? You want to comment on that?

Sure, Dick. Yes, I think that we continue to look at new products and developments. We have a strong pipeline going into the second half of the year and we think that, based on our new product development program, that we are going to see improved results moving forward.

Okay. Thank you, gentlemen.

(Operator Instructions). Summit Roshan, KeyBanc.

Gentlemen, back to the Colors business, on the topline so glad to see some color that you'll be re-accelerating topline growth there in the back half of the year. Just want to get a little bit more color on what happened this quarter and, more specifically, the delta and growth from -- what's changed, really, from the first quarter coming into the second (multiple speakers) gross?

Paul, why don't you take that?

Well, I guess I would be consistent with some of the previous concepts we've introduced and discussed here. There is generating operating profit and there is generating revenue. And from our standpoint, we have done a fairly good job of generating the operating profit through new sales. I think, once again, when you start divesting yourself of business, you're losing revenue. You're not necessarily losing a whole lot of operating profit, but you are losing revenue. And we are comfortable with how we are managing this process. We're comfortable with the operating profit growth that we're seeing. We believe these results are sustainable and I think, similar to my previous response, as you start to clean out that lower end of your portfolio, then you start seeing the acceleration of the top line growth. But the top line growth must come at a profitable level, and that is very much the way we think about this process. We're not just going to generate revenue to generate revenue.

Sure. over the past few quarters product rationalization, I think that's been a topic that's come up, did that accelerate at all going into the second quarter or maybe some of those product lines that you divested were just seasonally stronger in the second quarter?

Yes, I think you're exactly right. It's really both of those factors. There was some acceleration. There is some seasonality of certain products and so, yes, you're absolutely right. I think that's really what made Q2 a little bit different from Q1, but certainly conceptually the same thing.

Okay. So I mean, quantitatively, would that be something to the effect of 1% or 2% impact on the revenue line in the second quarter, if we had excluded those divested businesses?

No, it would be more than that. It would be several multiples. I would have to give you a specific number -- get back to you about a specific number, but it's several multiples.

Okay. Great. And just some clarification on the guidance range -- $2.50 to $2.59. Does that include that $0.02 legal charge or do we need to back that out to compare that on an apples to apples basis?

Well, we have certainly used our as-reported number in our range. And so that number is in that range for the guidance for the year.

Okay. And then, also kind of relating to the guidance here, foreign exchange headwinds seem to have gotten a little bit worse here heading into the year, while guidance has remained about the same. Is that speaking to your confidence, maybe on an underlying business growth?

Yes, I would say it is. The business has really never been stronger. Yes, we're going to have a headwind with foreign exchange and no one can say where that's going to go, ultimately. But at the end of the day, we're very confident about that guidance range. Very, very confident.

Fortunately, as we look at the year and we look at where the currencies are right now, that difference, that hit we are getting narrows as we get towards the end of the year and we get closer to lapping the currency amounts. It's anyone's guess, for example, where the euro is going to go. It was down a little bit more today, but we really can't predict it. It's based on a lot of events in Europe.

But certainly, this year we have -- like most companies have been particularly hit by it, but it will narrow and we will lap it as we get to the end of the year.

But we will make our guidance.

Great. Thank you.

(Operator Instructions). As there are no further questions, I would now like to turn the conference back to the Company for closing remarks.

If anyone has a follow-up question after the call, please call the Company. I'd like to thank everyone for participating this morning and that will conclude our call. Thank you.

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