Sensient Technologies Corp (SXT) 2013 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2013 First 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 at Sensient Technologies Corporation. I would like to welcome all of you to Sensient's conference call to discuss 2013 first-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 and Chief Financial Officer; and Paul Manning, Sensient's President and Chief Operating Officer.

Yesterday we released our 2013 first-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 his 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'll hear from Ken Manning.

Thank you, Steve. Good morning.

Sensient had a record performance in the first quarter. Earnings per share reached $0.62, excluding the impact of the restructuring costs. This is an increase of 7% over the $0.58 per share reported in the first quarter last year. The results for this year's first quarter as reported was $0.43 per diluted share, which includes restructuring costs of $0.19 per share. Cash flow from operating activities were also strong in the first quarter, increasing by more than $16 million to $25.6 million. The cash flow was driven by our strong operating results and the improved utilization of working capital.

I am very pleased with the Company's performance in the first quarter. While revenue was flat compared to the first quarter last year, operating income, excluding the impact of the restructuring costs, increased 5.6% and net earnings increased 6.7%. Operating margin for the Company improved 70 basis points to 13.4%, from 12.7% in the first quarter of 2012. We achieved a small amount of savings from the restructuring plan during the first quarter, but most of the improvement was generated by stronger gross margins. The gross margin improvement is a result of our strategy focusing on higher-margin, value-added products. This was particularly true in the color group, which increased its operating margin by 80 basis points during the quarter.

The relocation of the flavor and fragrance group headquarters to Chicago is on schedule, and is expected to be completed before the end of the year. Our new facility is being designed and renovated to focus on customer presentations and demonstrating the group's entire product portfolio. Our staffing efforts are also progressing as planned. We are encouraged by the quality and availability of talent in the Chicago market, and we will be transitioning responsibilities to new personnel over the next few months.

The implementation of the worldwide profit improvement plan is also on schedule. Our efforts to consolidate selected operations are progressing according to our plans, and we expect that this transition will be completed by the end of the year. We incurred $12.8 million of pre-tax restructuring costs in the first quarter, and we expect to incur an additional $13 million to $16 million before the end of the year. As we indicated in our last conference call, these actions are expected to generate $6 million to $7 million of cost savings in 2013, with the realization of most of those savings in the second half of the year. Beginning in 2014, we expect to achieve cost savings between $10 million and $12 million annually.

We are focused on our strategy of recruiting and retaining strong performers and developing innovative products for growth markets all over the world. Our strong product development process will allow us to enhance our product portfolio, and we also seek growth opportunities via strategic acquisitions. We believe there are unique opportunities to expand our product offerings by acquisitions, particularly in the cosmetic, fragrance, personal care, and pharmaceutical markets.

Sensient has delivered strong results for several years, and the Company remains committed to increasing shareholder value. Sensient's Board of Directors increased its quarterly dividend one year ago to $0.22 per share. This was the sixth increase of the quarterly dividend since 2006, representing a 47% increase over that six-year period. The regular dividend increases have allowed shareholders to immediately benefit from the Company's growth and success.

I am very optimistic about the Company's future. We see many opportunities for growth, and we expect to reduce our cost structure as a result of the restructuring plan. I am raising our earnings guidance to be in the range of $2.66 to $2.73 per share, excluding restructuring costs. Our previous guidance had been $2.64 to $2.72 per share. Dick Hobbs, our CFO, will now provide you with the details for the quarter.

Good morning.

Sensient's revenue was $365.6 million for the first quarter of 2013, equal to last year's first quarter. Operating income as reported was $36.3 million, compared to $46.5 million in the first quarter of 2012. The 2013 first quarter operating results include $12.8 million of costs related to the restructuring program, which are reported in the Corporate and Other segment. Excluding the restructuring costs, operating income was $49.1 million, an increase of 5.6%. Interest expense was $4.3 million, down 3.3% from $4.4 million reported last year. The tax rates were 33.2% in the first quarter of 2013 and 31.3% in the same period of 2012. Excluding the restructuring impact, the rate was 31.2% in this year's first quarter.

Diluted earnings per share as reported were $0.43, including the $0.19 restructuring charge, compared to $0.58 last year. Excluding the impact of the restructuring charge, earnings per share were $0.62 in the quarter, an increase of 6.9%. Foreign currency translation did not have a significant impact on revenue, operating income, or earnings per share in the first quarter of 2013. Sensient's cash from operating activities for the first quarter of 2013 was $25.6 million, up significantly from the $9 million reported in the first quarter of 2012. The improvement was primarily due to lower use of cash for operating assets and liabilities, particularly inventories.

Sensient will continue to make strategic investments in its operations to expand our capabilities and improve efficiencies. In conjunction with the consolidation of selected operations resulting from the profit improvement plan, we are now estimating that capital expenditures for 2013 will be in the range of $100 million to $110 million. Debt increased slightly in the last 12 months, but the Company's debt-to-capital ratio improved 100 basis points to 23.9%, from 24.9% 1 year ago. Debt to EBITDA was 1.5 at both March 31, 2013 and 2012. Earlier this month, we announced that the Company entered into an agreement with investors to issue approximately $125 million of fixed-rate debt. This transaction strengthens the Company's capital structure at very attractive interest rates.

I will now take a brief look at the results of our operating groups. Sensient's color group reported revenue of $127.9 million in the first quarter of 2013, and $132.3 million in the first quarter of 2012. The color group reported record first-quarter operating income of $26 million, compared to $25.8 million last year. Operating margins increased 80 basis points to 20.3% in the first quarter of 2013, from 19.5% in 2012. The impact of Sensient's shift away from the lower-margin Desktop Inks business was offset in the quarter by growth in the more profitable Industrial Inks business. Margin improvement in the color group has benefited from strong performances in the Food and Beverage businesses in Latin America and Brazil.

The flavors and fragrances group reported revenue of $217 million in the first quarter of 2013, an increase of 1.1% from $214.7 million reported in the first quarter of 2012. Operating income was $28.9 million and $29.1 million in the quarters ended March 31, 2013 and 2012, respectively. Raw material costs increases were offset in the quarter by favorable pricing. Foreign currency translation did not significantly impact revenue or operating income.

Revenue in the Corporate and Other segment, which includes the Company's operations in China and the Asia-Pacific region, and certain flavor operations in Central and South America, was up 2.8% to $36 million in the first quarter of 2013, compared to $35 million prior year. As Mr. Manning stated, Sensient now expects 2013 diluted earnings per share, excluding the impact of restructuring charges, to be between $2.66 and $2.73. Previously, this range was $2.64 to $2.72.

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

(Operator Instructions)

Edward Yang, Oppenheimer.

The flavors margins were down slightly year over year. Could you provide some color around that?

Yes, Ed. That was certainly affected by some raw material costs, although we did have pricing affecting it favorably, and offsetting the raw material costs. That was a factor, which I bring that up because that's something that's going to mitigate as we go into the second half of the year. We certainly did have some inflationary increases, and that's going to get mitigated as we go forward and have the restructuring benefits coming into the future quarters. So it was really a factor of some costs up as to some extent expected and built into our guidance, but in most of the cases with those costs, that's going to be mitigated. As far as the overall business, I think Paul's going to talk about some of the opportunities there going forward. Paul, do you want to mention some of those before we go on to Ed's next question?

Yes. I would say briefly, Ed, certainly there is substantial upside in the gross margin and operating margins in flavors, to the tune of several hundred basis points. We see a lot of opportunity to up-sell this portfolio. We have some very novel and very good technology that we've developed very recently. Plus opportunities to really realize some important synergies with some previously developed technologies. So this up-selling of the flavors group is certainly under way. As we progress in the year, you're going to see some very nice improvements in the gross margin and the operating margin percentages.

Paul, this improvement in the margins, the opportunity there -- you said several hundred basis points. Is that going to be driven more by technology and products, or getting some of your more under-performing geographies to where you are in, in North America?

Yes. I would say it's going to be a little bit of both. Number one, we're going to focus on product development launches, and really products with very good barriers, similar to what we did in the color group. We really established some very strong business areas there. I would not anticipate getting a great deal of pricing. I think this is going to be principally about up-selling many of our technologies and introducing the new technologies. But obviously, there's some substantial room for improvement in Europe. We see a lot of opportunities in Europe. We've addressed many of these through our restructuring program. But I would say first and foremost, let's do a better job of leveraging many of the technologies that we have, and commercializing moving forward. That's going to be the real key to the strategy and the execution.

Okay. You mentioned pricing. Last quarter you mentioned there was a pricing gap. Have you caught up on that? Do you think that pricing's going to be pretty flat for the remainder of the year, or down or up?

Paul, why don't you take that?

Yes, we see the bigger impact, Ed, as being mix -- new products and improvements of some of our existing products. I think that certainly there may be some nominal opportunities for pricing, but fundamentally, we see this as being an improvement in mix as going to be the driving factor.

Okay. On the --

But to Dick's point, there's certainly upside in some of our raw materials for the second half.

Okay. The decline in color revenue, so that was all just kind of de-emphasizing some of the lower profitability businesses?

Yes. Essentially, Ed, we don't think the long and the short of it is we don't think there's much of a future in desktop printing. We think the future is far greater, and the margins are far larger in the industrial side, particularly the textiles. Paul, do you want to add anything to that?

No. I would say that's exactly our approach in the business. This is a classic case of having much better opportunities in the market place. The industrial space is a much more -- it's much more focused on new product introductions, technology. The desktop is effectively, certainly starting in Europe and continuing into North America, it really has become a much more fragmented field. There's become less opportunities to fundamentally differentiate with the end consumers. But certainly on the industrial side, again a much bigger market, a tremendous opportunity. We have demonstrated some very strong success in our businesses, reflecting on our investments in Switzerland and in North America. So this is a very good and strong market, and I think you'll see some good growth throughout the rest of the year on this area.

Okay. And touching on the idea of investments, are you still expecting to spend about $140 million in CapEx this year? How quickly can you bring that back down to a, I guess, lower level? Because three years ago you were spending around $50 million, so it's a big ramp.

Ed, in my prepared comments I had mentioned that we feel the number's going to mitigate down into the $100 million to $110 million range for the current year. I know Paul wants to talk about --

What accounts for that change, then?

Paul wants to address the details. We are --

Yes. I would say this, Ed. We have made -- we have progressed a lot more than I thought we would. We had mentioned we certainly have a balance between ROI opportunities, the pure investments in new technologies and capacity and the like; but there was certainly an emphasis on maintenance, some GMP issues, that we really wanted to establish world-class facilities globally. Plus, we also opened some new facilities, which obviously have a higher -- when you're factoring in building costs and some of the other infrastructure. Moving forward, that balance will shift substantially to the ROI portion of the business. We've got a lot of opportunities in this business to improve the return on invested capital. I think those are very clear. The expectation of that is very clear as well. I would anticipate CapEx in the range of $80 million to $100 million as we move beyond 2013, with a much, much greater weight towards ROI opportunities. That sounds great. Thank you.

Christopher Butler, Sidoti & Company.

I was hoping to dive a little deeper into this desktop color. When was it determined that this was not as appealing a business for you? Can you quantify the impact to the first quarter for us, too, please?

Just on the quantification, Chris, the amount of the reduction in that particular business as compared to the growth in the industrial, is offset. It's a wash.

Okay.

But the margins in the desktop continue to go down. It's not a growth market. We invest in people, products, and markets and we look for the growth markets.

If we go back a quarter or two, the thought was that the color group, that the trimming of lower profitable sales was coming to an end, that we were going to see organic growth accelerate going forward. Now even x-ing out the desktop color business, we were looking at flat top line year over year. Why aren't we seeing better growth out of this business with organic colors growing here in the US?

Paul, do you want to take that?

Yes. Well, I would say this, Chris -- and good morning to you. We are certainly still committed to our growth aspects -- our growth estimates for the year. I think top line and bottom line for the color group, we continue to see very good opportunities. I think you're going to see the improvements coming in cosmetics. I think you're going to see continued progress within natural food colors, particularly ex-US, Brazil, Latin America, Asia-Pacific. I think you'll see continued improvement within the inks and the industrials. I'm still very much committed to our growth goals for the year in colors and in flavors.

If we're looking at the cost cutting, could you give us a sense on what was the benefits were in this quarter? Also, as we look out over the course of the year, I understand that most of the savings are going to be towards the back half of the year. But also as you build this R&D facility, can you give us a sense of what the net benefits would be with the added costs of the R&D facility as they increase over the course of the year?

Chris, looking at the year, and looking at the benefits that we would get from the restructuring, we were looking at a little bit over $7 million this year. Jeff, I think on an annualized basis it would be about 12 or so after this year. With the first quarter, we got roughly about 10% of that -- of this year benefit.

As far as the cost of moving is captured in the restructuring charge, certainly when we look at the cost of operating, we actually see the business as being able to replicate going forward pretty close to what our costs were. They're going to be up a little bit, but not -- I don't think it's going to be a significant amount going forward, as far as the difference between operating in Indianapolis versus Chicago. We'll have maybe a little bit more personnel cost in Chicago. It might cost a little bit more to retain people there, but we think we're going to get a much higher quality work force in Chicago. We have a lot more to pull from there. We think the performance is going to more than offset that.

In the short run, do we see excess costs due to having the two plants being either built or operated side-by-side temporarily?

Well, happily, the manufacturing portion of Indianapolis is severable. That's pretty much what occurred here. Part of the facility housed the administrative R&D staff, that's the portion that was moved up to Chicago. So that part of the building is just really kind of vacant. The remainder of it is dedicated to manufacturing, so we really don't have duplicate manufacturing. We're really not going to have duplicate anything once we get through 2013. As I said, any duplication has been captured in the restructuring costs.

I appreciate the clarity. I'll go back in the queue.

Okay.

Saurabh Jain, BHR Capital.

I wanted to just quickly ask you a little bit more detail on the up-selling on the flavor side of the portfolio. If you can explain the customer set today, what kind of value you are bringing to these customers, and where you see the opportunities to up-sell? Is it going to the same customer, is there going to a higher tier, larger companies? If you can give a little feel on customer mix, that would be helpful?

Paul, do you want to take that?

Sure. I think the customer mix will be fairly consistent in the Americas, although let's start with North America. I think that mix is going to be consistent. This is an opportunity to really take many of our base line technologies and combine them to integrate them into other parts of the business to create a more sophisticated end product. think in Latin America as --

What does that mean?

Sorry?

What does that mean? I don't --

That means if you sell a hydrolyzed vegetable protein and you start selling a savory flavor, you have much more valuable product to your customer. So in other words, you elevate from a more basic product to a more advanced product that has more value to that end customer. Because you've done more of the development for them, you've improved the level of vertical integration, you've improved product traceability, and you've given them a much more robust supply chain, for example.

And do you guys own that flavor in the IP? Or is that -- once you come up with it, you are essentially -- the customer owns that and your licensing -- how does that work in terms of who actually owns the IP around the flavor or the product?

Well, we own the IP to the extent -- depending on how robust -- there are various levels of IP. But fundamentally, we are a formulator. And as the formulator we own the formula with respect to the customer relationship.

But if you look at the products, as virtually all these products are unique product for the customer. A lot of it's trade secrets, some of it's IP, but it's a unique product. Then some cases --

Your continuing on after North America?

Yes.

Right. Then in Latin America -- so that would by my definition everything from Mexico south into South America, we do have opportunities to expand the customer base. There are a lot of very interesting regional customers that could really benefit from our approach of direct selling and products that are either developed in Latin America or have been developed in the US or Europe and have therefore been adopted for that market. Similarly for Europe, a lot of opportunities with regional customers. But I think in Europe there's also an opportunity to really improve the customer base amongst some of the larger customers. So it's a little bit of a -- it depends on the region -- but in answer to the broad question of will the customer mix change? It will. In some cases, you're going to see more regional customers, and in some cases you'll see better success with some of the larger multi-national customers.

So currently what's your highest penetration in terms of customers? Are we talking about the Coke's, Pepsi's, Frito-Lay's of the world, or are you talking more private label? Where does Sensient really -- has it -- where has it dominated and where is the future?

Well, certainly there are opportunities in branded customers and in private-label customers. The impact of the private-label market still continues to be very strong. However, it's very clear that the branded customers are also starting to make some very good improvements in many of the markets. I don't think it's necessarily about saying I'm going to go for private label or branded customers. It's really, it's starting from what does the market need? In some cases that's regardless of branded or private label, and regardless of multi-national or regional. Where is this product -- where is this market need, my technology that I develop for it now? Okay, from a marketing standpoint, where do I deploy my sales force? I think we take it much more from that standpoint.

Okay. I'll get back in the queue.

[Antonio Barros, Kember Lee].

Could you give us a little bit more color from your operations in Brazil?

Paul, do you want to take that?

Sure. Yes, Brazil is a very attractive market. Not only do we think it's attractive, we've started to achieve some very attractive results. As you may have read, about two years ago, we opened up a new facility for food colors in Brazil. This facility would be able to produce food colors, flavors, and some of our cosmetic ingredients, which are three areas of interest to us. We are now also developing a cosmetics site to fundamentally focus on local production of our products, many of which have been developed in the US and Europe, but have very widespread appeal in Brazil. So Brazil is -- the sky is the limit. I think we also, even outside the non-food areas -- for instance inks, there are very good opportunities for inks, particularly industrial inks, in that Brazil market. So we have really made substantial investments in terms of developing the talent base, acquiring the talent base, that will be necessary to grow these businesses.

Thank you. Thank you very much.

(Operator Instructions)

Summit Roshan, KeyBanc.

I just wanted to get an update on the natural colors business. I know the idea there has been that naturals tend to need more volume versus the synthetic. Just kind of the growth rates there the past couple quarters? I know you used to break that out. Then more broadly, where we are in that cycle of natural adoption, both in kind of the developed and developing regions?

Paul?

Sure. I think our thinking was that as natural colors grew synthetics would decline, but actually as natural colors have been growing, synthetics have also been growing. To answer your question from a market standpoint, clearly Europe has led the world in terms of the push towards natural colors, and coloring foodstuffs maybe more specifically for that market. Despite the growth we've seen in Europe, we're still off to a good start in Europe for 2013 on natural colors. Our natural color business continues to do very well in Latin America and Asia-Pacific. I think that as well though, our synthetic business has been doing quite -- has been growing quite successfully in many of those regions as well.

Many customers have a bit of a hybrid approach, so they don't necessarily want to be all synthetic and they don't necessarily want to be all natural. They may be in various points along that trajectory. Our ability to service both, not only technically -- most important technically -- but also from a production standpoint and supply chain standpoint, makes our position very, very strong in the market place. We are truly the only fully integrated food color business in the world when it comes to our ability to produce and technically support and develop products related to synthetic and natural colors. So the future continues to be very good there. As I mentioned for some of the other businesses, we still see this as a very good and viable business in each of the geographies that we serve.

Okay. Are we still talking about a double-digit type of growth rate there, or do you think that's slowed towards the mean in the industry?

Well, certainly our focus is on growing the bottom line. There are various segments within natural colors. There is a portion of that market is reserved for more commodity-type selling -- carmine products for instance. Our answer to things like that are developing alternatives to carmine, which is viewed as an allergen. It's viewed fairly poorly in parts of the world. So we see that as being one example of up-selling, one example of really improving and increasing the size of the market, and also growing our operating profit -- effectively elevating a commodity to a more specialized sale. So yes, the growth rates have been very good in natural colors, and the volume shall we say the larger volumes certainly plays out in improving the operating margin. I think you've seen over the last few years a distinct improvement in that operating margin, which I would continue to tell you has upside to it.

Okay. Kind of taking a tangent off that and staying in colors, and Chris touched on this a bit earlier. With respect to the pruning you've taken, walking away from certain businesses there, can you give us an idea and quantify maybe how much business you've walked away from over the last couple years, highlighting how much of the higher-value applications have grown there? Then also how much room do you think is left to walk away from?

Well, certainly we've walked away from enough to improve our operating profit by more than 65% in the last couple years while raising our operating margin. So we don't see buying market share as really a viable path. We view this market as how do we grow our operating profit? What is our share of the industry profit? I would tell you that it's very good, and it's very strong. I think again, we would continue to see upside in that dimension. Was there another piece there?

Maybe a little bit, if you look at -- looking at the business today, beyond desktop printers, do you see more opportunities to walk away from business, or do you think the set you have now is what you may be working with going forward?

I think there's always opportunities to evaluate your portfolio. The market is constantly changing. Much of what's happened in the desktop industry has been very public, and it's been very recent. Two years ago, we would have a little bit of a different perspective on that market; but we are very close to our markets and we develop products that can help us to have defensible positions in those markets that's sustainable. The reason we haven't retreated in these markets is because we are constantly looking for up-sell opportunities.

From where I sit today, I would tell you that clearly there's up-selling opportunities in inks. I think that most of the up-selling that we've done and sort of trimming of low-margin products within the food and the cosmetics areas has been substantially completed. But again, I would never say it's totally completed, because there's always opportunities to do better as we introduce new technologies or as there are changes in the market place. But I think right now the focus is really on the industrial or technical colors side of our business. That's where we see the most important need to up-sell and continue to create very defensible positions.

Then switching gears to the flavors side of it, you talked a little bit about introducing new technologies and up-selling there. Kind of in the context of that, can you talk about the dehydrated business -- sort of the importance of that and the value that has for customers and as well as the flavors franchise more broadly?

Well, I think it certainly has created a lot of value for us over time. We see a lot of opportunity to broaden the range of products that we are providing there. We have a rather unique ability from a product safety and supply chain standpoint to really provide customers with a very strong sense of security when it comes to those products. That couldn't be any more important now -- it is about as important as it's ever been in its history. With the advent of the Food Safety Modernization Act by the FDA, customers are demanding more, and they want to see more out of suppliers with respect to these elements of product safety. We're very well-positioned for that. We see opportunities to expand the portfolio of those products. We see enormous opportunity to expand outside the US. We haven't done enough to expand beyond the US, and this is something that is strongly under way at this time -- not only in the Americas but in Asia-Pacific.

Are you talking dehydrated specifically?

That's right.

Okay. All right, great. Thanks.

Garo Norian, Palisade Capital Management.

I wanted to circle back to the comment earlier about the growth goals that you guys have for the year, and see if there's some color you can set on what, by segment, are your guys' revenue growth expectations for this year?

We're looking at roughly, when you look exclusively at revenue, we're looking at mid-single digits in both cases. But I would add to that, that for the year, we are also looking at growing our margins. Again the focus is on the bottom line, but we certainly have businesses that will result in roughly mid-single-digit growth, is what our expectation is in both segments.

In light of the debt transaction, I just wanted to make sure I would understand what's the expected interest expense for the year?

Looking at the year, and I'll start with where we are right now, we've picked up in the last year about 30 basis points on our interest rate. So we're below 5% now on our all-in rate for the whole Company. The private placement is a delayed take-down. We'll be replacing debt that's coming due in November. On an annualized basis, that will pick up another 50 basis points there, which will get us to roughly just a little bit over 4% all in after 2013. So as we look at this year, our expectation is that it will probably be in that 16.5% to 17% range, roughly.

Great. My last question is -- I'm just curious, as far as the guidance increase that you guys provided, is that more of a reflection of one first quarter being a little bit better than planned, or more of a reflection of what you see going forward?

We certainly, as Mr. Manning has noted we don't want to disappoint. Certainly there is a factor in there that we did have a successful first quarter. We were over the consensus by $0.03 a share. So certainly that's a factor. We feel comfortable with the range that we have.

Yes. The net-net is; though, to answer your question a little bit more directly we feel good about the year. We feel very good about the business.

Great. Thank you.

I will now turn the conference back over to the Company for closing remarks.

Thank you again for your time this morning. Since there are no further questions, that will conclude our call. If there are any follow-ups after the call, please feel free to call the Company. Thank you.

Thank you. This concludes today's conference. You may now disconnect.