Sensient Technologies Corp (SXT) 2012 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2012 third-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 to welcome all of you to Sensient's conference call to discuss 2012 third-quarter financial results.

I am joined this morning by Mr. Kenneth P. Manning, Sensient's Chairman and Chief Executive Officer; Dick Hobbs, Sensient's Senior Vice President, Chief Financial Officer; and Paul Manning, Sensient's President and Chief Operating Officer.

Earlier today, we released our 2012 third-quarter financial results. A copy of the release is now available on our website at Sensient.com.

Before we began, 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 (sic). 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 delivered a strong performance in the quarter, achieving a new third-quarter high for earnings per share. As reported, earnings per share were $0.66, an increase of 3.1% from the $0.64 per share reported in the third quarter of last year.

In local currency, earnings for the quarter were up $0.05 per share, an increase of 8% over the prior year's third quarter.

The Color Group continued its strong performance, establishing a new third-quarter record for operating income. In local currency, revenue increased 5% and operating income increased 8% year over year for the quarter. The Color Group's operating margin increased 50 basis points to 19.4% from 18.9% in last year's third quarter. For the fourth quarter, the Color Group expects to deliver mid- to high single-digit revenue growth in local currency, and we expect to maintain present operating-margin levels.

The Flavor & Fragrance Group revenue -- reported revenue growth of 5.4% for the third quarter in local currency. Operating income was slightly lower year over year, due to customer inventory destocking and higher raw material costs. We expect the Flavor & Fragrance group to achieve mid single-digit revenue growth in local currency for the fourth quarter. We also expect the reported fourth-quarter operating income to exceed last year's results.

Cash flow from operation was $43.1 million in the third quarter, an increase of more than 8% over last year's results.

We will continue to build the infrastructure necessary to support the growth of our business. This includes hiring, training, developing personnel, as well as investing in new technology and upgrading our facilities.

Sensient has increased its sale coverage by more than 90 sales positions across the Company since 2009. This has been one of the key drivers of Sensient's success over the past few years.

We have invested almost $70 million into capital projects so far this year, and we will continue to upgrade our facilities and develop new technologies. The focus of future capital spending will be on projects that generate a targeted return on investment, including projects that enhance our ability to develop new products.

We are also considering acquisition opportunities, including opportunities to license unique technology. We will continue to be selective in considering acquisition targets, focusing on opportunities that enable us to broaden our product portfolio and better serve our customers.

Sensient has consistently returned value to its shareholders. Earlier this year, we increased our quarterly dividend to $0.22 per share. It was the sixth increase of our quarterly dividend in the last six years, representing a 47% increase.

We are narrowing our guidance for 2012 diluted earnings per share, which is now expected to be between $2.51 and $2.56 a share. I remain very optimistic about the Company's future and believe that our investments in infrastructure will continue to drive earnings growth.

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

Good morning.

Sensient reported revenue of $369.4 million in the third quarter of 2012, compared with $363.8 million in the third quarter of 2011. Operating income was $50.7 million and $49.9 million for the quarters ended September 30, 2012, and 2011, respectively.

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

Interest expense was $4.5 million for the third quarter of 2012, a decrease of 9.1% from $4.9 million in last year's quarter. The tax rates were 28.9% for both quarters ended September 30, 2012, and 2011. The tax rates for both quarters reflect changes in estimates associated with the finalization of prior-year items, changes in the estimated effective tax rates, and other minor items. The tax rate for the remainder of 2012 is expected to be between 32% and 33%, excluding discrete items.

Diluted earnings per share, as reported, were $0.66, an increase of 3.1% from last year's quarter. Third-quarter earnings per share, if stated in local currency, would be $0.03 higher than reported earnings, an increase of 7.8%.

For the first nine months of 2012, revenue as reported was $1.1 billion, compared to $1.09 billion last year, an increase of 1.1%. Operating income, as reported, was $151.5 million, up 2.4% from $147.9 million reported in the first nine months of 2011.

Foreign currency translation reduced revenue and operating income in the first nine months of 2012 by approximately 3% and 4%, respectively. Stated in local currency, revenue and operating income increased 4.5% and 6.1%, respectively, in the first nine months.

Interest expense was $13.2 million for the nine months ended September 30, 2012, a decrease of 11.3% from $14.9 million reported in the comparable period in 2011.

Diluted earnings per share, as reported, were $1.94, an increase of 5.4% from $1.84 reported in the first nine months of 2011. Year-to-date earnings, as stated in local currency, would be $0.07 per share higher than reported earnings, up 9.2% from last year's earnings.

Sensient's cash from operating activities for the third quarter of 2012 was $43.1 million, an increase of 8.4% from the prior year's third quarter. The improvement was due to higher cash earnings, partially reduced by a higher use of cash for operating assets and liabilities in the third quarter of 2012, as compared to the prior year's quarter.

Sensient continues to invest in its operations to expand capabilities and improve efficiencies. Capital expenditures in the third quarter were approximately $20 million in both 2012 and 2011. For the first nine months, capital expenditures were $67.6 million in 2012 and $44.1 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 $344.7 million at September 30, 2012, from $322.1 million one year ago. Even with the increased debt, Sensient's balance sheet remains strong. The debt to capital ratio improved to 23.7% at September 30, 2012, from 23.8% at September 30, 2011. Debt to EBITDA was 1.4 at both September 30, 2012, and 2011.

I'll now take a brief look at the results of our operating groups. Revenue, as reported, in Sensient's Color Group was $120.7 million and $121 million for the quarters ended September 30, 2012, and 2011, respectively. The group reported record third-quarter operating income of $23.5 million, an increase of 2.5% from $22.9 million for last year's third quarter.

Foreign currency translation decreased revenue and operating profit in the quarter by approximately 5%. Stated in local currency, revenue and operating income increased 5% and 7.9%, respectively. Third-quarter operating margins increased 50 basis points to 19.4% from 18.9% in last year's quarter.

For the first nine months of 2012 and 2011, Color Group revenue, as reported, was $379.9 million and $379 million, respectively. Operating income for the first nine months of 2012, as reported, increased 7.2% to $74.9 million from $69.9 million reported last year.

Foreign currency translation reduced both revenue and operating income by approximately 5%. Stated in local currency, revenue and operating income increased 4.7% and 11.9%, respectively, in the first nine months of this year.

The group is continuing to focus on higher-value products and divesting low-margin business. The results were particularly strong in global food colors.

Revenue, as reported, for the Flavors & Fragrances Group was $224.7 million in the third quarter of 2012, compared to $220.3 million one year ago. Operating income, as reported for the third quarter was $31.8 million in 2012 and $33.1 million in 2011.

Foreign currency translation decreased revenue and operating income in the third quarter of 2012 by approximately 3% and 1%, respectively.

For the first nine months, revenue for the Flavors & Fragrances Group, as reported, was $658.3 million and $652.1 million in 2012 and 2011, respectively. Operating income, as reported, was $94.3 million and $97.6 million for the nine months ended September 30, 2012, and 2011, respectively.

Foreign currency translation reduced year-to-date revenue and operating income by approximately 3% and 2%, respectively.

The group was impacted by customer inventory destocking and higher raw material costs.

Revenue in the corporate and other segment was up 8.4% to $40.8 million in the third quarter of 2012, compared to $37.6 million in the prior year. For the nine months ended September 30, 2012, revenue increased 7.3% to $116.4 million, compared to $108.5 million last year. The segment includes the Company's operations in Asia-Pacific and China and the Company's flavors operations in Central and South America. Growth in this segment was driven by operations in Thailand, Singapore, and the Philippines.

We are narrowing our guidance for 2012 diluted earnings to be between $2.51 and $2.56 per share.

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

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

I was hoping you might be able to give us a little bit more color on the destocking and how much longer you expect that to continue.

We did have that in the quarter and particularly in flavor. And in the quarter, we also saw versus our expectations by the time we got to September, there was, of course, two business days left in the prior year in September. And in addition to that, we saw some slowing in the order patterns of our customers.

As we look ahead to the fourth quarter, that has improved. The numbers are coming out as expected; the revenue is coming in as expected, in the mid-single digits.

And I might add, as an additional amount of color on the situation, we did have in the third quarter some impact from Europe that is mitigating in the fourth quarter. Our pipelines in Europe are very good. I was just over there recently and I was very impressed with the initiatives that the various groups are taking over there, and we will have a very, very nice increase in the flavor Europe business in the fourth quarter.

Looking at the whole flavor business, just to focus on that business, we do expect, as reported, profit in the fourth quarter will be up over last year.

And looking at the color business, you had 5% topline growth on a local currency basis. If I remember correctly from the last call, you were looking for something a little bit better than that. Could you talk to the growth of natural products in the US and expectations going forward?

Paul, why don't you take that?

Yes, I think fourth quarter, as I'll mention here, is also looking good. The strength of the food colors business has never been better. Despite the economic malaise in North America and Europe, we're performing very well.

Operating profit is up substantially. Operating margins are up. The revenue growth right now is coming from new wins. This is from new wins generated from products. Even with the reduced rate of product introductions at these customers, we are winning the majority of those types of opportunities. We're doing very well there. That growth is certainly well under the double digits.

One of the factors that we did see quite a bit of in the third quarter was that our customers' business -- our organic growth, as we would define it -- was down. So we are winning new products, we are taking business from our competition, but in many cases we had very well-known customers with very substantial drops in their business, and, therefore, we saw that impact.

But because of our new win generation and our ability to take business from the competition, we're feeling very good, we're feeling very bullish, and we'll see some continued growth in the fourth quarter.

And I know you'll probably ask about the divestment piece as well. As I mentioned to you before, this is an evolution. We've taken a lot of these low-margin nonstrategic items out of the portfolio. We're letting the competition deal with those. We are focusing on the end of the value chain that is very core and very consistent with our strategy, which is very much tied to innovation.

And looking at the gross margin for the quarter, the sequential decline from the second quarter, you had mentioned raw material costs. Was there any shift in product mix that hurt you also in this quarter? And could you talk to the confidence that it's going to bounce back for the fourth quarter?

Yes, it was principally the impact on the raw materials. We do have pricing in the fourth quarter going in place to offset that, to mitigate that.

This is in flavor.

It's in flavor.

That was the principal item. It was, in fact, the raw materials.

I should point out that throughout the Company, volumes were good. They were strong in the quarter. And obviously the currency was a real negative, but there was very good volume growth throughout the Company in the quarter.

Yes, Chris, one of the raw material issues was the drought and lower yields in crops and things of this sort, and consequently we use some of this as raw material and it was more expensive than (technical difficulty) anticipated.

I appreciate your time. I'll go back in the queue.

Summit Roshan, KeyBanc.

You touched on this last quarter a bit, and just kind of going over the raw materials situation, it didn't seem like the drought was going to have a big impact. Did something change in the quarter that you didn't foresee or was this largely in line with what you'd expected?

It certainly was not a shock, but there were some areas that were more of an impact than what we expected.

Yes, yields were a big part of this. The yields were down from what we had anticipated, and some raw materials find themselves into hydrolyzed vegetable proteins. Some of them find themselves into dehydrated flavors, but this was primarily a flavor issue.

Great. Thanks for the color there. And Paul, you touched on this a little bit here. Broadly, the macro is what it is, and to a certain extent organic sales are going to be down. Can you talk about how -- the body language you're seeing from your customers, and to the extent that any read, say, as we go into the next year on product innovations, switch to natural colors there, and if there is any sort of pushback on pricing, kind of what you're hearing from your customers?

Well, the body language for the customers is -- it's mixed.

There are some customers who see this downward economy as an opportunity to really take a new position in the market. And so, while we are a value to them as we bring them innovative ideas and things that can be commercialized, whether that's coloring foodstuffs in Europe, natural colors in the US, or even synthetic colors, for that matter, which continue to grow very nicely for our business.

I would tell you that looking at 2013, I would anticipate that our ability to grow new wins will be even bigger. We continue to have a very strong innovation pipeline, and so. I've been in this business for three years, and for the last three years, the economy has not been particularly robust. And we have been successful despite this, and a big part of that is we continue to focus on providing customers with things that will innovate their products.

And oftentimes, and where this is becoming more successful in 2012 and we would anticipate this into 2013, as many as some of the older and more established brands, which would essentially just rely on annuity to really -- for those businesses, are really trying to revitalize those brands and given our position, which is very strong at the majority of the multinational corporations and for many of those iconic brands, we are very well positioned to capture that.

So whether the product innovation, even though it's slowed down on the truly new products -- again, we're getting the lion's share of those -- but even on some of those iconic brands that you've seen in the store for years and years, we see that taking a lot more of front center -- center stage for these customers. And we would anticipate being very successful in those as well.

Summit, if I could just make a comment in the spirit of what Paul just said that I think is important, and we can traverse this over to flavor a little bit, since Paul has been running the business in color, the revenues have gone up on an average of 10% per year.

The operating income has gone up 63%, so about 20% per year. The gross margins have gone up 500 basis points and the operating margins have gone up 390 basis points. So the color business has performed very, very well, and Paul, would you mind just commenting on flavor and what you're seeing there as you take on your broader responsibilities?

Sure. I think flavors is a lot of what we've done in colors that can be applied to flavors. We're dealing with many of the same customers, many of the same markets, in fact, and sometimes, many of the same resources and individuals at those companies.

But let's face it, flavors has not performed. And it's time, quite frankly, to shake the hell out of that organization. And we are going to do it. We're going to apply best practices. We're going to evaluate the strategy. We're going to focus on the commercial side of that business. We're going to focus on innovation and product development, and we are going to execute better, and we're going to start to see some results out of flavors.

Great. I appreciate you kind of segueing that into the flavors business. Just one more, if I could sneak this in. Broadly in the chemical space, there is an increasing interest, I would say, in the food ingredients, and in particular, a lot of the naturals businesses. From a competitive standpoint, are you seeing anything that would, say, keep you up at night?

And secondly, on the acquisitions front, are you seeing maybe deals a little bit harder to come by or multiples a little bit elevated versus historically?

Let me talk about the acquisitions, Summit, and then Paul can talk about the competition.

In the acquisitions, when we went through the first round of acquisitions, we were really trying to build a basic business from what our business had been -- yeast, frozen potatoes, cheese. It was not a particularly good business. The business we have today is spectacular in comparison.

But I would say this, on the acquisition front, the acquisitions that would be suitable to us in terms of our technical portfolio, yes, there are fewer of those because we definitely want to get an acquisition that has unique technology. We're not going to buy market share. We're not going to be a me-too type of person.

So we have been doing some licensing, and hopefully we'll be in a position to announce a new license that we have on the color side in just a few weeks.

But, yes, it's not the multiples that are the problem. It's really finding companies that really add some unique technology to our portfolio. So that's kind of where we are. And Paul, if you want to take on the competitive thing.

Yes, well, we are never satisfied. We were certainly never satisfied in the Color Group, and despite our success, we haven't even scratched the surface of the things we're going to continue to do better.

I am aware, not just at night, but during the day, that I have competition, and it is their wish that we fail. Well, we're going to continue to focus this organization and we're going to continue to make it better, and we will never stop making it better, whether it's innovation or supply chain or capitalizing. We are singularly focused on success and operating profit in the Color Group, and I can assure you that we will have the same approach in the Flavors group as well.

But this is a long burn. There are a number of these markets; there are a lot of competitors. Some of these are very good; some of these are not as good. Some of them focus in the same types of areas that we do and some of them do not. We are here for the long term. We see the growth, we see the opportunity in this market, but it is a market that is fundamentally based on value. It's based on innovation and what are we doing to these customers. And we have been successful there, but we are by no means even close to being satisfied with where we are in this business.

Great. Thanks for your time.

Okay. Thank you, Summit.

(Operator Instructions). Edward Yang, Oppenheimer.

On the Flavors side, the destocking that you saw, was that concentrated in any particular products or geographies, or was that pretty broad-based?

It was broad-based.

And the margins there, they were down year over year, how was that broken out between North America and Europe?

Certainly in the case of Europe, that did have an impact on it, and -- but we would have to say that it would be equally, as far as the margins, per se, Europe into North America. But I would note again, as I did earlier, for the fourth quarter, the flavor Europe is going to be up significantly over 2011, including their margins as well.

And why is that?

Well, for one thing, it's comparisons, but for another thing, it's related to the management in Europe.

As I mentioned, I was just over there reviewing their pipelines. And their pipelines are like they haven't been in the past. They are getting these sales. It's occurring and it's happening in places like Germany, for example, and it's happening in places like France, and it's happening in places like the UK.

Ed, if I had to add something to what Dick just said, we have developed a sales force at last over there more along the lines that we operate domestically. So I would say we have a much improved sales force. They seem to be driving a lot of things, and we're very optimistic about the fourth quarter as a result.

Okay. And CapEx spending, where do you think you'll end the year? And the level of spending has been elevated in the last couple of years, relative to historical norms. What would you expect for 2013?

We would expect that to be about $100 million this year, and for next year, we'd be seeing that kind of a level again, $100 million to $110 million.

And I'd like to point out that we've had quite a few ROI projects, particularly coming from the color group, and to Paul's point about where we are going down the road, a lot of that is coming onstream here in the next 12 months or so. And so, it's money that provides organic growth and organic results, so we're seeing that as a very, very good opportunity as these capital projects come on.

Yes, since this is an open forum, I can talk about South Africa. We will be releasing on that in just a few moments, but that is a nice ROI project, the development of the color business in South Africa. And that will be released today, but that is a very, very handsome ROI project.

So we've never seen so many attractive ROI projects, and given the strength of our balance sheets and our comfort level that these are hard-dollar projects that we're very confident we're going to get the results, we feel very good about spending at the level, given those types of projects.

Okay. And finally, congratulations to Paul on his promotion.

Oh, thank you.

And how should we think about this move in terms of a succession standpoint? I know Mr. Manning had delayed his retirement a year or two. How should we think about it from that (multiple speakers)

Well, I would say this. The results have spoken for themselves. And if they continue to speak for themselves, I guess you can pretty much figure it out.

Okay. Maybe just a question for Paul directly. You spoke pretty passionately about getting the Flavors business to improve its performance. An area where that's kind of lagged has been in Europe. But that's an area historically, I think it's tough to change. So how would you go about tackling some of the structural issues there or is it more about growth versus costs in Europe?

Yes, I would say this, Ed. I've been in the role about 15 minutes now (laughter), so give me a little bit of time on that (multiple speakers)

Why haven't you fixed it already, Paul? (laughter)

Give me at least a few quarters. But I think that, fundamentally, in the very short time span I have met some very impressive individuals, and fundamentally with every business you start by focusing on the culture and putting the right group of A players in the organization.

And then you move to strategy, and before I get to strategy, you have to collect a lot of data. You have to collect a lot of information about these markets.

But the one thing we have demonstrated in the Color Group is our ability to grow very nicely in Europe, whether it's inks, whether it's food colors, whether it's -- pharmaceuticals is a business that we've recently entered in the last six months in Europe. We see Europe certainly as being a unique opportunity, but it's not about going after the existing competition and coming up with me-too products. That is, I guess what they would say in the world of strategy, the race to the bottom.

So this is about positioning ourselves in a unique fashion so that we are providing something of true value to the customers. And so, if you would, give me a little bit of time to visit Europe, to spend some time with the business, before I give you a more definitive answer. But you'll have it.

Okay. Thank you for your time.

Christopher Butler, Sidoti & Company.

Just wanted to touch on Asia. The corporate and other segment, it was, to the best of my knowledge, the best quarter that you'd put up in that business from a topline and bottom line, understanding that it also includes corporate costs. Could you talk to sustainability in this range, as far as what the operating losses, I guess, for this segment would be?

And then, also, do you hit a point where you need to start making investments in Asia to continue this kind of growth?

Okay, well, let me give you kind of the -- an overview, Chris, and then Dick can get into some of the details.

We're seeing a lot of strength in places like Thailand, New Zealand, Singapore, and even the Philippines. We're seeing improvements in Japan. China is kind of flat right now, as it is for most groups, but we have been making capital investments in these places for a while. And Dick, if you want to continue with that.

Yes, we -- to add onto Mr. Manning's point, particularly as it relates to China, we recognized a long time ago the importance of getting into China, both in terms of strategic material purchases, both -- in the case of facilities we've put into China, as well as where we're going direct in acquiring strategic materials.

So as our expertise grows and we get to know more people in China, that's just going to continue to strengthen.

On the market side, it kind of speaks for itself. All those people now moving up the chain, as far as the kind of things they consume. We're seeing the popularity of Western-type food over in China, so with our significant capability and the hard assets that we've put into China, we see that opportunity to just continue to grow as (multiple speakers)

Yes, and we're really very optimistic about the cosmetic market in China, and also the pharmaceutical market in the whole of Asia-Pacific.

So there is a lot of interest in really the high end of the product line. Natural flavors and colors are really in demand in places like China and Thailand and other places. So we're quite optimistic about that. That has been pretty much a grassroot operation, but it's grown very nicely.

All right. Thank you. That's all I have.

As there are no further questions, I will now turn the call back over to the Company for closing remarks.

Thank you. That will conclude our call today. Thank you to everyone who has participated. If there are any follow-ups, please feel free to call the Company after the call. Thank you.

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