Sensient Technologies Corporation
Q1 2008 Earnings Call Transcript

Published: 21 Apr 2008

[Operator:]

Good morning everyone and welcome to the Sensient Technologies Corporation 2008 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.

[Steven J. Rolfs:]

Thank you. Good morning. I'm 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 First Quarter Earnings Conference Call. I am 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 first quarter 2008 financial results. A copy of the release is now available on our web site at www.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

[Kenneth P. Manning:]

Good morning. Today we reported our quarterly earnings. This was our ninth consecutive quarter of earnings growth. EPS increased over 16% to $0.43 per share. Revenue this quarter reached a record level of $307.4 million, up 7.8% from last year’s first quarter. Both the Flavor and Color Groups also reported record revenues. Margins in both groups were up as a result of favorable pricing and improved product mix. We have seen a number of important sales wins this quarter and our sales pipeline continues to build. As a result, we expect our strong performance to continue throughout the year. Consequently, I am raising the EPS guidance for the year to a range of $1.77-$1.80. Our previous guidance had been $1.74-$1.78. Our emphasis on new product development is the central element of our strategy for growth and is contributing to our results. Recent successes include our micro-emulsion technology, which improves the stability of both clear and colored beverages. We are also launching a new line of natural colors in order to capitalize on the growing demand for these products. Other recent new products include innovated power-to-cream for cosmetic applications and self-dispersing pigments for ink jet inks. In the future we will continue to focus on acquiring, licensing, and transferring technology in order to create new product groups in food, beverage, fragrance, cosmetics, and pharmaceuticals. The company’s global expansion has also been successful. Our operations outside of the U.S. continue to contribute to our success. Europe performed particularly well. We continue to invest capital in our global operations, particularly in the areas of distribution and customer service. We also have new centers for R&D and manufacturing coming on line in China and Canada. We continue to pay particular attention to emerging markets. As I have stated during the past two years, I see no obstacles to continued growth and as mentioned previously, we are increasing our 2008 earnings guidance to a range of $1.77-$1.80. I will now turn the conference call over to Dick Hobbs, our CFO.

[Richard F. Hobbs:]

Good morning. I will now provide details of the results for the quarter ended March 31, 2008. As Mr. Manning stated, revenue for the first quarter of 2008 increased 7.8% to $307.4 million, an all-time quarterly record. Both our Flavors & Fragrances Group and our Color Group achieved record first-quarter sales. The impact of exchange rates, improved pricing, and solid demand in several markets were key drivers of the revenue growth. Operating income for the three months ended March 31, 2008, increased 15.8% to $39.6 million. This is a first-quarter record for the company. Sensient’s Flavors & Fragrances and Color Groups saw higher margins and profits in the first quarter. Earnings before income taxes for the first three months of the year increased 24.4% to $31.1 million from $25 million in the prior year’s first quarter. Diluted earnings per share increased 16.2% to $0.43 from $0.37 in the first quarter of 2007. Sensient’s effective tax rate for the first quarter was 33.4% compared to 30.5% in the first quarter of 2007. The tax rate in both quarters included adjustments related to the resolution of prior-year matters. The company reported an increase in cash flow from operating activities to $9.7 million for the quarter; this is in comparison to $5.1 million in the prior-year’s comparable period. Total debt at the end of the quarter was $528 million, a decrease of $10.7 million since March 31, 2007. If the impact of foreign currency translation is removed, Sensient’s total debt would have decreased by $43 million during this time period. I will now take a brief look at the results of our operating groups. The Flavors & Fragrances Group reported an 8.1% increase in first-quarter revenue, to $195.2 million from $180.5 million in last year’s first quarter. Group operating income rose to a first quarter record of $28.8 million in 2008 compared to $25.4 million in the first quarter of 2007, an increase of 13.2%. Group operating margins improved 70 basis points to 14.8% in the quarter. Sensient’s Color Group reported record revenue of $102.8 million in the first quarter of 2008, up 6.8% compared to $96.2 million in the 2007 comparable period. Quarterly operating income for the Color Group grew 8.1% to $18.5 million from $17.1 million reported in the first quarter of 2007. Operating margins for the Color Group in the quarter improved 20 basis points to 18%. Revenue in the corporate and other segment increased 15.2% in the first quarter of 2008 to $18.6 million. This segment includes the company’s Asia Pacific Group, and now the China Group, which previously had been reported in the Flavors & Fragrances Group. Historical results have been restated to reflect this change in our organization. As Mr. Manning discussed, Sensient has increased its guidance for 2008 diluted earnings per share to between $1.77 and $1.80. The previous range for guidance had been between $1.74 and $1.78 per share. I will now turn the call over to Rob Edmonds, our President and Chief Operating Officer, for some remarks on the quarter’s results.

[Robert J. Edmonds:]

Thank you, Dick. I would like to conclude the call with some brief comments on our performance. We have begun the year with a very strong first quarter. Success was broad-based with both the Flavors & Fragrances Group and the Colors Group reporting higher revenue and profit for the quarter. The Flavors & Fragrances Group saw improved pricing and volume gains in several key product categories. In the U.S. the Flavors Group benefited from strong demand for savory flavors and new beverage wins. Our Flavor operations outside the U.S. also performed well this quarter. Operating margins in the European business increased 140 basis points, driven by improved operating efficiencies. As Dick said, revenue and operating income reached a first quarter record for our Flavors & Fragrances Group. The Color Group reported record revenue with improved profitability on higher margins. The group benefited from solid volume gains in food and beverage colors, especially in North America. In addition, we saw pricing improvements across several product lines. The Color Group also benefited from a number of promising new product launches this quarter and we continue to see strong interest in our natural colors. Combined sales in the Asia Pacific region were up over 15% on strong demand for flavors in Thailand and China contributing to the company’s record revenue. Overall we had strong earnings growth in our first quarter based on our geographic expansion, new product introductions, and operating efficiencies. We anticipate that our businesses will continue to perform well this year.

[Steven J. Rolfs:]

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

[Operator:]

(Operator Instructions) Our first question comes from the line of Mike Sison.

[Mike Sison:]

Hey, guys. Congrats on another great quarter. In terms of organic volume growth, or sales growth minus foreign currency, it was a little bit slower than I thought. Was there any timing in terms of the new product launches that maybe got pushed out into the quarter?

[Richard F. Hobbs:]

No, actually, Mike, we’re looking at the year as being up on an organic basis in the mid-single digits. We continue to see that and what we had in the quarter regarding the currency impact was a very favorable mix and as a result of that we saw our gross margins go up by 90 basis points and we’ve seen our margins in general come up with a strong showing in the U.S. and, as Rob mentioned, in the European Flavors. If you look at the pre-tax income, which is up 24.4%, the portion that’s foreign exchange is a little bit over a third of that, so 15.2% is the increase in the pre-tax earnings prior to any impact of foreign exchange. So, we performed very strongly, we had excellent quality of earnings; what you saw in the top line did not drop to the bottom line. And we expect that organic mid-single digit top-line growth for the remainder of this year.

[Mike Sison:]

If you think about the 10% sales growth, ex-foreign currency, generating, let’s say, sort of 15% earnings growth, if you will, if your organic sales growth less foreign currency ramps up to, let’s say, mid-single digits, should the operating leverage be even stronger?

[Richard F. Hobbs:]

We certainly, when we look at the year and we look at the currency markets—and of course no one can predict where they’re going to go, but based on where they’re at right now—we certainly could see a little bit of a lift to the organic numbers from the currency.

[Kenneth P. Manning:]

Mike, we’re looking for a strong year and we would rather sell a lot of the high-priced items than the stuff like Red 40, Yellow 5, Yellow 6, which is more of a commodity product. So we continue our effort to push towards a more value-added product mix.

[Mike Sison:]

When you think about the organic growth for the rest of the year, the bulk of that—or how much of that growth comes from sort of wins that you have in the bag, if you will, versus a reliance on market demand, which seems to be okay, from what I’m hearing from you guys?

[Robert J. Edmonds:]

Mike, we have, in the first quarter, a very strong pipeline, particularly in beverage in North America, so that’s looking very promising going forward and that should show into the remainder of the year. Our savory products continue to perform well in this economy, where we’ve got the opportunity to sell flavor enhancers which take out fat, take out salts, and take out sort of saturated fat ingredients and cost are also doing very well. So there’s a lot that we have coming forward, still.

[Mike Sison:]

Okay. Thanks.

[Operator:]

Your next question comes from the line of Christopher Butler with Sidoti & Company.

[Christopher Butler:]

Hi. Good morning, guys. I just wanted to follow up on the gross margin; you had mentioned that you had improved the mix of products. What are we looking at from the raw material side during the first quarter?

[Steven J. Rolfs:]

Raw materials in the first quarter, we saw some items increase, I think as a lot of companies have, but we use a wide range of products and some, in fact, were favorable. So I think we just saw a moderate impact in the first quarter. And we’ve been able to more than offset that with price increases. And we also have some very effective purchasing programs, which we think over the rest of the year are going to yield some savings.

[Robert J. Edmonds:]

As an example of that, Chris, our natural colors are growing extremely fast, so they’re growing more than 15%, which is quite a bit higher than the market. The raw materials for those are natural products. They’re usually agriculturally derived, like amethystine and things of that type. So that’s not really been affecting us; it’s certainly not like oil or something of that sort.

[Christopher Butler:]

And looking at your increased guidance for the year, what expectations on raw materials are baked into that?

[Richard F. Hobbs:]

We feel, as Steve mentioned, we have some programs to really effectively handle a lot of the raw materials. We’ve had other classes in the company that we’ve been very much managing and under control and I think we’re going to get a lift from that. And as Steve also mentioned, we have gotten the pricing to offset it. In addition to that, the mix puts a lot of lift in, as well.

[Kenneth P. Manning:]

But there are some slight increases; we’ve managed for that. If, for instance, the raw materials were flat, that’s a further upside.

[Christopher Butler:]

And looking at the cash flow statement, cash flow from operations was up pretty handily year-over-year. Hoping to get a little bit of color there, but also CapEx was up. Are we looking at the R&D center in China that you were talking about earlier?

[Richard F. Hobbs:]

We’re finishing up the Canadian factory this year and also the factory in China and with that we see the CapEx being in the mid-fifties, roughly. That’s something we had planned for; it looks all right. And when we look at the end of the year, as far as where we’re going to be on the balance sheet, we’re still looking at a debt to capital of about 35% and debt to EBITDA of about 2.26% or so. We expect the cash flow to be strong, we expect the EBITDA to be strong, and we expect this year that both of those will be up double-digits for the year.

[Christopher Butler:]

And I guess finally, with the shift of the China business into Asia Pacific, is the thought process behind this is just because it’s the more logical place or is there a sort of . . . [overtalk]

[Kenneth P. Manning:]

It’s more focused; we feel it’s a fantastic opportunity. We went to China initially to produce things to export and we’re really getting a lot of things consumed domestically. We just see more promise in that than we had initially seen and that’s reporting directly to Rob Edmonds, the new President and Chief Operating Officer. So it’s a case of focus and we really feel that that’s a big opportunity for us.

[Christopher Butler:]

Thank you for your time.

[Operator:]

Your next question comes from Edward Yang with Oppenheimer & Co.

[Edward Yang:]

Good morning, gentlemen. Nice quarter. Margins in Flavors ticked up nicely. Is that mostly Europe? And what about North American margins?

[Richard F. Hobbs:]

Well, looking at the Flavor Group, we did have certainly a strength that we got in Europe. That was a big factor. But we did have, in the U.S., a lot of strength as well. So those two areas both contributed to the increase in the margins.

[Edward Yang:]

And in Europe, is that mostly just getting your capacity utilization up or is that also just a function of mix and new products?

[Kenneth P. Manning:]

It’s more a function of mix than it is anything else. And as we transfer technology—there’s some very good technology in Europe--the micro-emulsions, a lot of better ink jet ink production in Switzerland is doing well--so some of that technology will be transferred to the United States. They’re doing very well in Europe. We make products that nobody else can make. Our micro-emulsions medium are patented. These are doing very, very well. So I would say it’s more product mix than anything else. If we start to get the other things that you mentioned it should be a further up side.

[Edward Yang:]

Okay, thank you. And in Colors margins were up less than in Flavors. In the previous years both groups improved margins by about an equal amount. What sort of margin improvement in the Colors Group should we expect this year?

[Richard F. Hobbs:]

When we look at the year we certainly expect to hold where we’re at, as we look through the remainder of the year. So we’re continuing to do a lot of things in Color and we feel good about getting the 20 basis points and we’re going to continue to be focused on getting that and more as we go forward.

[Kenneth P. Manning:]

If you look at Color, as we transfer more technology throughout the company, particularly this stuff that we have in Europe, you could see those go up. But you’ll certainly see them go up next year. They may just hold the line this year, as Dick is talking about, but these are longer-term prospects that we have. I would say next year looks even better than this year.

[Richard F. Hobbs:]

And probably hold the 20 basis points anyway.

[Kenneth P. Manning:]

Yeah. We should ideally see that for the year.

[Edward Yang:]

Okay. That’s helpful. And a follow-up question on the China and Canadian CapEx. As those plants come on line, how will that affect margins and revenue growth in 2008?

[Richard F. Hobbs:]

That’s a very positive opportunity for us. What we’ve determined with the Canadian plant is that there is a lot of demand for our capability there and by having that new Flavor facility in Canada, and we’ve had some major customers come forward and ask us to put equipment in the plant for sophisticated products. Those are the kinds of products that we seek; they improve the mix and you make more margin on them. And so certainly with that Canadian plant—and this will be true with the plant in China as well—it’s just a great opportunity to improve our mix and to get more business.

[Kenneth P. Manning:]

You will see some of that at the end of this year. Most of it’s going to start next year.

[Edward Yang:]

Okay. Thank you very much.

[Operator:]

(Operator Instruction) The next question comes from Conan Heilan from First National Bank.

[Conan Heilian:]

Good morning. I had a quick question on cash flow. Is there something seasonal about Q1 that it’s slower than the other quarters?

[Richard F. Hobbs:]

There is and it has to do with accruals and it’s something that relates to the working capital. When we look at the year, as I mentioned a little bit ago, we still expect our cash flow for the year certainly to be over $100 million and we’re looking at a good possibility of a double-digit increase in the operating cash flow for the year.

[Conan Heiling:]

Okay. That’s all I had. Thank you.

[Operator:]

The next question is from Mike Sison with Keybanc Capital Markets.

[Mike Sison:]

A couple of quick follow-ups. If foreign currency remains at current levels, what are sort of the contributions you see in 2008 versus 2007 to your pre-tax income growth? You sort of mentioned that it represented about a third of the growth in the first quarter; would it represent about a third of the growth for the full year?

[Richard F. Hobbs:]

Well, what we would say is when we look at our guidance we’re comfortable with our guidance, we feel certainly we could get a lift, and we’re comfortable with the $1.77-$1.80, and at this point in time we don’t want to necessarily speculate that the currency is going to take it beyond that range.

[Mike Sison:]

For the second, third, and fourth quarter you’re essentially using foreign currency as a neutral? To get to the $1.77-$1.80?

[Richard F. Hobbs:]

There might be a lift in there—a slight lift. I don’t want to suggest—let’s take the current quarter as an example. Because I think it’s a good conversation but I think we have to get into a little bit of some of the detail in order to effectively answer your question. The foreign currency lift was $0.02-$0.03 in the quarter. But, in addition to that, we had an income tax hit of—if you look at what our arithmatic rate is, we got a hit $0.01 a share. If you look at what taxes were last year, we got a hit of $0.02 a share. So certainly in the current quarter the currency helped us; we got hurt by the taxes. So on a peer basis we’re doing quite well. Now when we look at the rest of the year we’re assuming a tax rate of 31%-32%, so certainly there’s a possibility we could get some help but we’re not putting that in our . . .

[Kenneth P. Manning:]

I think where we’re going, Mike—there could be an upside but the last thing we would want to do is disappoint, so we’re sticking to that range.

[Mike Sison:]

I understand. But when I think about excluding foreign currency it seems to me that the conservatism that lies there is as your organic sales growth ramps up to mid-single digits, it seems to me that the operating leverage should be stronger so I’m sort of wondering . . .

[Kenneth P. Manning:]

You’re right, but we really want to kind of keep it in this range right now.

[Mike Sison:]

Okay. I got you. And in terms of general market demand—you know, there continues to be fears about a U.S. recession. Could you just comment on what you typically see or what you’re hearing from your customers heading into the second and third quarter?

[Kenneth P. Manning:]

The history of these businesses, particularly businesses that deal with the food industry and some of the other industries that we’re dealing with, has been very good. And we don’t see that as a problem; it has not really been a problem in recessions gone by. So I think we’re—you know, there is no such thing as a recession-proof industry, but we’re feeling pretty good, even with a recession.

[Mike Sison:]

Okay, great. Thank you.

[Operator:]

The next question is from Nick Kovich with Kovich Capital Management.

[Nick Kovich:]

Good morning, gentlemen. I’ve got a question—I was reviewing the Annual Report and Proxy and I wonder does Sensient have a mandatory retirement age for directors or corporate officers? I know, in looking at the proxy, you have a couple of directors that are 70 or older and I know, Mr. Manning, after joining from W.R. Grace, you’ve been on the Board for almost 20 years now and I know you appointed, in August 2007, Bob Edmonds as President of the company, and I wondered what your intentions were, in terms of leadership transition.

[Kenneth P. Manning:]

Okay. Sure. Good question. First of all, we have, like many corporations, no mandatory retirement. It’s up to--if the officer or director is still capable there’s no reason why he shouldn’t continue to work and people are working longer these days rather than shorter. In terms of my plans, that was filed with the SEC a couple of years ago. I plan to remain CEO until about two years from now and then will continue as a Chairman-employee for a year and then retire. Those are my plans.

[Nick Kovich:]

Okay. Thank you very much.

[Operator:]

Since we have no further questions, at this time I would like to turn the conference call back over to the company for closing remarks.

[Kenneth P. Manning:]

Thank you very much for your time this morning. If there are any follow-up questions after the call, please feel free to call the company. Thank you again.

[Operator:]

This concludes the conference call. You may now disconnect.