Sensient Technologies Corporation
Q3 2013 Earnings Call Transcript

Published: 18 Oct 2013

[Operator:]

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2013 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.

[Stephen J. Rolfs:]

Good morning. I'm Steve Rolfs, Senior Vice President, Administration of Sensient Technologies Corporation. I would like to welcome all of you to Sensient's conference call to discuss 2013 third quarter financial results. I'm 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 third 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 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.

[Kenneth P. Manning:]

Thank you, Steve. Good morning. Sensient reported diluted earnings of $0.72 per share in the third quarter, excluding the impact of restructuring costs. This is a third quarter record and an increase of 9% over the $0.66 reported in last year's quarter. As reported, which included $0.09 per share of restructuring costs, third quarter earnings were $0.63 per share. Cash flow from operating activities was strong in the third quarter, reaching $47.7 million, an increase of 11% over last year's result. Cash flow from operations through September of this year as reported was $117.8 million. This is an increase of 28% over cash flow generated first 9 months of 2012. Excluding the impact of the restructuring, cash flow was up 21% in the third quarter and 35% year-to-date. Operating profit, excluding restructuring costs, was $55.4 million, an all-time quarterly high and a 9% increase over last year's third quarter. Operating margin increased 120 basis points to 14.9%, driven by the company's focus on selling high-margin, value-added products. The Color Group's operating income increased 10.8% in the third quarter and its operating margin increased 190 basis points to 21.7%. The food colors, pharmaceuticals, cosmetics and digital ink businesses all reported double-digit profit growth in the quarter. We completed the relocation of the U.S. Flavor operations to the new group headquarters in Chicago in September. We are continuing to make progress on the realignment of the commercial and technical activities of the Flavor business. Our strategy is to transition from being a supplier of simple ingredients to being a provider of more complex flavors, driven by innovation and technology. We will use our new product development capabilities to create flavors that allow our customers to differentiate their products. We have already developed a strong pipeline of opportunities and expect to commercialize many of these products within the next year. Our restructuring program is on schedule and we expect both the costs and savings to be within our original estimates. Including the expenses associated with the relocation to Chicago, we've incurred $26 million of costs through the end of September. We estimate that we will incur another $4 million to $6 million of costs in the fourth quarter. Our restructuring activities will generate $6 million to $7 million of savings this year. And beginning in 2014, the cost savings should be between $10 million and $12 million annually. I'm encouraged by opportunities in both Colors and Flavors in 2014. Our Color Group has a strong foundation and we see opportunities for growth in many of our markets including food colors, cosmetics, inks and pharma. We have made a number of changes to our Flavor organization and see substantial opportunities for growth in all of our businesses next year. We are moving in the right direction and I am very optimistic about the company's future. Sensient had an outstanding third quarter and the business is well positioned for the future. In spite of the current economic uncertainty, we are maintaining our previous guidance for 2013. We expect EPS to be in the range of $2.68 to $2.73 per share, excluding restructuring costs. Dick Hobbs, our CFO, will now provide you with the details for the quarter.

[Richard F. Hobbs:]

Good morning. Sensient's revenue was $372 million for the third quarter of 2013 from $369.4 million in last year's third quarter. Operating income, as reported was $48.8 million compared to $50.7 million in the third quarter of 2012. The 2013 third quarter results include $6.6 million of costs related to the restructuring program, which are reported in the Corporate & Other segment. Excluding the restructuring costs, operating income was $55.4 million, an increase of 9.2%. Interest expense in the third quarter was $4 million, down 9.7% from $4.5 million reported in the comparable quarter last year. The tax rates were 29.5% and 28.9% in the third quarters of 2013 and 2012, respectively. Excluding the restructuring impact, the tax rate was 30% in this year's third quarter. Diluted EPS as reported was $0.63, including $0.09 of restructuring costs compared to $0.66 last year. Excluding the impact of the restructuring costs, earnings per share were $0.72 in the quarter, an increase of 9.1%. For the first 9 months of 2013, revenue was $1.12 billion compared to $1.1 billion last year, an increase of 1.2%. Operating income as reported is $133.8 million in the first 9 months of 2013 and $151.5 million in the comparable period of 2012. Excluding the restructuring impact, operating income grew 5.5% to $159.8 million in the first 9 months of 2013. Interest expense was $12.3 million for the 9 months ended September 30, 2013, a decrease of 6.9% from $13.2 million reported in the comparable period last year. The tax rates were 29.8% and 30.1% in the 9 months ended September 30, 2013, and 2012, respectively. Diluted earnings per share, as reported was $1.71 in the first 9 months of 2013 and $1.94 in the comparable period of 2012. Excluding the impact of the restructuring costs, year-to-date earnings per share increased 7.2% to $2.08 per share. Sensient's cash from operating activities for the first 9 months of 2013 was $117.8 million, up 27.7% from the $92.2 million reported in the first 9 months of 2012. Excluding the impact of the restructuring, cash from operating activities increased 35% to $124.1 million for the first 9 months of this year. The improvement was primarily due to higher earnings and a lower use of cash for operating assets and liabilities, particularly inventory and payables. Sensient will continue to make strategic investments in its operations to expand our technical capabilities and improve operating efficiencies. As mentioned in previous conference calls, we expect capital expenditures for 2013 to be in the range of $100 million to $110 million. GAAP was $355.1 million at September 30, 2013, and $344.7 million at September 30, 2012. The company's debt-to-capital ratio improved 100 basis points to 22.7% from 23.7% 1 year ago. Debt-to-EBITDA was 1.4 at both September 30, 2013, and 2012. I will now take a brief look at the results for operating groups. Sensient's Color Group reported third quarter revenue of $123.9 million, an increase of 1.4% from $122.1 million in the third quarter of 2012. Operating income for the Color Group increased 10.8% to $26.8 million in the quarter from $24.2 million in the third quarter of 2012. Both revenue and operating income were third quarter records for the group. Operating margins increased 190 basis points to 21.7% in the third quarter, up from 19.8% in the third quarter of 2012. Most of the Color Group's businesses reported double-digit growth in the quarter. Revenue for the Color Group was $378.3 million and $383.6 million for the 9 months ended September 30, 2013, and 2012, respectively. Operating income was up 5.2% to $80.5 million for the first 9 months of 2013 from 76.5% reported in 2012. The Flavors & Fragrances Group reported revenue of $226.2 million in the third quarter of 2013, an increase of 0.7% from $224.7 million reported in the third quarter of 2012. Operating income was $31.8 million in both quarters ended September 30, 2013, and 2012, respectively. For the first 9 months, revenue was $671.2 million in 2013, an increase of 2% from $658.3 million in 2012. Operating income was $93.2 million and $94.3 million for the 9 months ended September 30, 2013, and 2012, respectively. Revenue in the Corporate & 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 $37.6 million in the third quarter of 2013, and $37.8 million in the prior year's third quarter. For the 9 months ended September 30, 2013, revenue was $112.4 million, an increase of 3.5% from $108.6 million reported in 2012. In local currency terms, revenue increased by 3.3% in the third quarter and 5% in the first 9 months of the year. As Mr. Manning stated, Sensient expects 2013 diluted earnings per share to be between $2.68 and $2.73, excluding the impact of the restructuring charges. This is consistent with our previous guidance.

[Stephen J. Rolfs:]

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

[Operator:]

[Operator Instructions] Your first question comes from the line of Edward Yang with Oppenheimer.

[Edward H. Yang:]

Could you provide some additional color on the strong performance in Color on the revenue side, relatively flat but operating income up 11%. What was the driver behind that?

[Kenneth P. Manning:]

Paul, do you want to take that?

[Paul Manning:]

Yes. I think this is a continuation of the very good results we've been seeing in Color over the last several years. I think at the very highest level, it's a commitment to the strategy. We're really focusing on those products and technologies, which are going to generate the most level of difference in the marketplace. The 11%, I think it's consistent with that, I think that tells you that we've built a very good strategy there. We have a very differentiated business. But I think what it also tells you is that we've been working very diligently in this business for about the 3- or 4-year period and we're really continuing to see the growth because a lot of the things that we implemented were fairly long term in nature. For instance, some of the investments we made in cosmetics and pharma and inks, as I said 2, 3 years ago, these things don't necessarily move on a dime and I think we're now really seeing very nice results out of each of those businesses. As Dick mentioned, double-digit growth across food, pharma, cosmetics and our -- many of our technical businesses. When you look at the revenue, the overall strategy, of which we've been talking through is about, let's focus on generating the right types of sales, those sales that are at the most consistent with a technology leader and a leader in each of these segments. And so we referenced on the last call the fact that we were no longer participating in a fairly substantial tolling arrangement. Because, we believe it to be nonstrategic and of a less compelling nature than many of our industrial ink programs that we had in place and were doing very well with. If you were to factor that back in, the revenue growth in Color looks quite a bit different. It's more in that mid to high single-digit range. But again, as I mentioned in the last call, we'll see that lapse at the end of Q1. But I would tell you that x that, the growth looks very good and the prospects continue to look very good in the Color Group in 2014 and well beyond.

[Edward H. Yang:]

Got you. Thanks for the color on that, to excuse the pun. On the -- was raw material a tailwind in that business or in Flavors in the quarter?

[Kenneth P. Manning:]

Looking overall, we did get hit in some of the businesses with raw material, but we were able to make that up with pricing and certainly with the mix.

[Edward H. Yang:]

Okay. And related -- on the Flavor side, you saw some further margin degradation at least year-over-year. What was that? Was that driven by raw materials as well and what was the pricing like in that business in the quarter?

[Paul Manning:]

Some of it's driven by raw materials with some of our natural ingredients for instance, or even products based on soy and the like. There were certainly some raw material increases on a year-over-year basis. Similarly, with some of the aroma chemicals we deal in. But I think the real story with Flavors is that, this is a business that we've been transitioning. We are well on track. And I think that the types of products and technologies that we're now looking at, that we're executing on, we believe that, that impact and that change in mix is going to have a profound effect and profound improvement on that gross margin. And we're certainly looking to see those improvements in the coming quarters. But that is -- to give you the data point of the Color Group, this is something we have done. There's a lot of analogies and commonalities between these businesses. So this is a very achievable goal in Flavors and this is a business that can be well north of a 40% gross margin.

[Edward H. Yang:]

Okay. And just finally, maybe some commentary on what customers are doing with brief activities and proposals, but also with regards to pricing because I think Chivodoughn [ph] had some comments about maybe customers coming back for price concessions or the inability to kind of push through pricing above RAS [ph] or they're meeting some resistance from customers to that. So maybe with regards to customers, on the revenue side, their activity with new product innovations and new product introductions? And then on the other side, about pricing with customers.

[Paul Manning:]

The first piece on product development, I think we've all seen that in many of the markets, particularly the U.S., Europe and some others, even China for that degree -- a matter of -- for a certain degree, they were fewer the larger scale product releases. As a general statement, I think we can all agree that product introductions have dropped considerably in 2013 versus 2012 in those key markets. We see more along the lines of, let's just call it, for lack of a better expression, line extensions. Now, that is a very general statement. We obviously -- across the many industries and segments and customers that we serve, there are many customers who are still very aggressively pursuing opportunities in the marketplace. We are seeing improvements in that regard. With respect to new launches, maybe some launches that were delayed are being put back on track. I think from that standpoint, the market is coming around and we should see some improvement in activity there. With respect to price and raw materials and our ability to cover those raw materials and to maintain gross margins, we don't, at this point see a great deal of inflation in our forecast for 2014. Sure, there are couple of exceptions here or there, but certainly nothing that we don't believe is crippling to the business or of a considerable risk.

[Operator:]

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

[Christopher W. Butler:]

Looking at the Color Group, could you give us an idea of what the volumes were in the quarter from Colors? And then maybe a comparative number of what the volumes would have been without the walking away from some of the ink business?

[Paul Manning:]

Well I'll ask Dick to do some of the broader. Let me give you some specifics related to the businesses. I would tell you that certainly we're seeing volume improvements in many of those businesses. In fact, in particular, cosmetics had some nice volume improvements. Our industrial inks had some very nice volume improvements. Natural colors in some of our markets had some very nice volume improvements as well as synthetic in some of our markets. So kind of a snapshot by segments but...

[Richard F. Hobbs:]

Generally, Color had a positive increase in volumes. Paul did mention that there's some business that we've decided not to continue in strategically. And so that -- including even that, net-net, the Color Group did have positive volume in the quarter.

[Christopher W. Butler:]

And the commentary about some of the new product development getting back on track and some positive rhetoric from your customers. Is that -- post all of this government difficulties that we've run into? Or is that -- that those comments something that occurred beforehand and maybe that things got slowed up with debt ceiling talk?

[Kenneth P. Manning:]

Post would be a day or so. We didn't talk to the customers before we had this conference call this morning. But in general, we're very optimistic about the future. And we've been optimistic -- we've expressed our optimism since the beginning of the year despite a lot of things. But I'll let Paul get into the...

[Paul Manning:]

No, I think that -- as you look at the customers that we cover and we cover a very wide range of customers, I think the hesitancy principally, they're across large multinational branded companies. So my comments were -- are somewhat directed at them for right now. It's a little bit of a mixed bag in some of their emerging markets. They continue to push very heavily at new product releases, but I, I think as I mentioned in my comments about the Americas and Europe still remain. We're seeing an improvement there. Again, I guess we would have to wait to see how they have rebounded from the government shutdown. Perhaps the shutdown wasn't long enough to really alter their development. Most of these project developments are anywhere from 12 to 24, even 36 months. And when you look at something like the cosmetic industry, they'll plow forward through ups and downs because of the long lead time of the development cycle. So I think the shutdown was probably too short of a timeframe to really represent a big swing one way or the other.

[Christopher W. Butler:]

And just finally on the SG&A line, you came in a little lower than what I was expecting, sequential improvement and year-over-year improvement on keeping overhead costs down. Could you kind of walk us through what you did in the quarter to keep the costs down? And how we should think about that in terms of the fourth quarter and maybe 2014 as well?

[Paul Manning:]

Well, I think there's a couple of elements to that. But let me start with the restructuring piece. The restructuring piece really took a look at many of our operations and we reevaluated our ability to consolidate not only operations but perhaps some positions. And I think we're now starting to see some of those benefits flow through. This is was as we mentioned in February, very much was a year-long project to consolidate these sites to remove the heads and individual businesses and sort of work our way through some of the complexities there. I think we're going to continue to see those benefits as we've forecasted, but we believe we have upwards of $10 million to $12 million of savings forthcoming. Much of that will be SG&A, but there will be some direct labor and other direct overhead and other component-type costs that will also improve. So I think you'll see it in the SG&A and I think you'll see it on the gross margin line as well. But I think where we continue to operate in a very efficient and a very lean manner. We'd like our flat organization. We like having business units that are not bloated and filled with unnecessary staff roles. And our work here continues, we're finding more efficient and automated ways to implement change in our businesses whether it's IT related or introducing automation into our plants. This is an ongoing -- and I think we have a lot of opportunity and there's a very -- a lot of benefits forthcoming from that.

[Christopher W. Butler:]

So as we'd look to the fourth quarter, could we expect similar $65 million kind of quarter from the SG&A?

[Paul Manning:]

I think SG&A is going to continue to improve versus prior year and even perhaps on a sequential basis. We have -- depending on the business unit you're referring to, there are certainly some SG&A costs that are sort of in the one-time nature only occurring in Q4, which will okay, that will perhaps affect the number. But I think as an overall statement, that the trend in SG&A is in downward direction. And I think that would -- that's probably the best guidance I can give you.

[Operator:]

[Operator Instructions] Your next question comes from the line of Summit Roshan with KeyBanc.

[Summit Roshan:]

So you completed the move to Chicago. I know it's still only been a month but I was hoping you guys could share some thoughts there that you've seen in terms of any traction over the first month, and any -- if you can elaborate on some of the changes that you talked about and when you can we expect to see some benefits from the move?

[Kenneth P. Manning:]

Yes, well, first of all -- and I'll let Paul give us some details. The move was done on time and without disruption to the business and this doesn't always happen in other companies. We achieved everything that we planned to achieve and a few things more than we had even hoped for. So we have a first-rate group, a first-rate facility, a place that has very easy access to our customers and they have easy access to us. So this is a very, very important accomplishment in our overall global strategy for Flavor. And Paul, if you wanted to add anything to it?

[Paul Manning:]

No. I think that, that largely captures it. This is a fundamental change in the business. We have upgraded in many areas of the staff. We've upgraded our access to customers and for customer visits. And this is going to pay big dividends for us. I think the center we've established is a world-class center. We've already brought new customers and existing customers into this site and we're seeing that at a much greater pace than we would have in our old facility. So I think this is really the part of the infrastructure change and it's as much part of our strategic plans as it is, as part of improving our staff and making a world-class organization in all sense of the word or the phrase.

[Summit Roshan:]

And then Ed touched on this earlier in his question. I think the response was you're going to get -- I believe there is some upside to 40% margin on the Flavor side. As we think about the evolution of this, we've -- could we view this as something similar to what you've done on the Colors business, where you may not necessarily see much on the revenue front in terms of growth, but really that mix up strategy that gets you there?

[Paul Manning:]

Well, I think the Color Group's a good analogy. And we demonstrated our ability to really integrate new technology and execute on that commercially. And one of the things that is really going to separate this business is our ability to execute. And whether it's executing a move and doing so in a very efficient, timely manner, at budget and with as little disruption as possible, and again, an event that oftentimes cripples and really damages companies, we executed. So I think we have a very strong management group. I think we have very good leaders in the business. And these are the differentiators to Sensient. And that's what's ultimately going to drive the success on any number of dimensions. Gross margin in particular is a lot about execution. It's a lot about taking existing technologies, perhaps marketing them differently, perhaps packaging them with other technologies in a very unique way. This product mix will have a profound impact on improving that gross margin. And the improvements you will begin to see, I think will be very strong and they will be very consistent. And I think, most importantly, they will be very defensible and very sustainable.

[Summit Roshan:]

Okay. And Dick, maybe one for you, the $6.5 million in restructuring charges. When I break that out into op income by segment, does that primarily fall under the Corporate & Other line? Or was there some built into the other segments?

[Richard F. Hobbs:]

It's all in the Corporate & Other line.

[Summit Roshan:]

Okay, great. And then Paul, going back to you, as I look at sort of cash generation here, it looks like it's successfully ramped up over the last couple of years. CapEx has certainly -- in the trajectory there is lowered a bit. I was wondering if you could just touch on sort of the priorities of use of cash, where you see areas for investment beyond the move to Chicago internally?

[Paul Manning:]

Sure. Well, we like capital expenditures to invest in our own businesses, to integrate new technologies and to improve our capacity and our responsiveness to customers. And if I could borrow an expression from Dick, internal investment is one of the purest forms of investment. We don't have goodwill. We don't have the complexities of an integration or other challenging-type evolution, as you would see with an acquisition. So I think internal investment is number one priority. Certainly we've been very strong with our dividend returns in the past. This is an important part of our program moving forward as well and then acquisitions will always be something to consider. But we certainly would have to make the right acquisition. It would have to be for a unique technology or unique market access. We have really no intention to pay for market share. We're not really interested in generating a lot of goodwill to hang up on the balance sheet. And so acquisitions could very much be a part of it but they have to be very strategic and they have to be very thoughtful acquisitions because we -- you could pay an awful lot of money for an acquisition, introduce a lot of complexity to the business, a lot of poor balance sheet utilization and then at the end of the day, maybe not get as much as you could have if you had made the investments internally. So it's a little bit of a combination of those. I would also comment that certainly we've had a very good debt payoff. We have a very good debt to total capital ratio right now, we like that. That could be part of our calculus as well moving forward. So I would tell you that those would be 4 -- we also did a share repurchase within about the last 12 months. So that's a -- I'm really kind of reporting on many of the activities we participated in. And I wouldn't tell you that anyone of them -- I wouldn't rank them 1 through 5 because I think it's a constantly changing and developing picture. But certainly internal capital investment is our hallmark move.

[Operator:]

Your next question comes from the line of Garo Norian with Palisade Capital Management.

[Garo Norian:]

Could you help me understand what kind of underlying revenue growth has been this year? I guess kind of maybe backing out that tolling arrangement impact on the business?

[Paul Manning:]

Well I think Color it's -- I think it's really still that we're looking at the mid to high single digits on the revenue. And I think we're very pleased with the operating profit growth of this business, as we reported, we're up about 11%. And we think that's a good and sustainable rate. But I think that as we complete Q1 of next year, we will effectively lap that and you'll see a more steady state and better-looking picture for Color Group revenue. But most important from my standpoint is the operating profit. And I think you're going to continue to see very sound and positive results there.

[Garo Norian:]

And how should I think about Flavors over the next couple of years as far as top line? I mean, I understand that margin improvement is likely. But how should I try to understand where your top line might trend those next couple of years?

[Paul Manning:]

Well I would be thinking very positively about Flavors in all regards. The Flavors market is a very large market and we have a lot of distinct advantages. And so, in addition to those gross margin and operating margin improvements that I highlighted, you're going to see some improvements in operating profit and you're going to see some improvements in revenue. There's a lot of very strong growth prospects in this business and we're very excited, very optimistic and you will start to see a very different Flavors Group.

[Operator:]

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

[Christopher W. Butler:]

Going back to the cash flow conversation as we're thinking about capital expenditures looking into 2014. Knowing that the last year or 2, you've been building out Color and this facility in Chicago. How should we think of capital expenditures as you continue to invest in the company? Sensient used to have CapEx around $50 million. That would seem to be far lower than we would expect at this point with some of the plans that you were talking about.

[Kenneth P. Manning:]

Chris, looking ahead to 2014, we've -- I think talked about it maybe in the last call that $80 million to $100 million is roughly a number that we have in mind. And certainly, that takes into consideration a variety of maintenance projects, product safety, ROI-type projects. So we feel that would be a range that would be very appropriate. And we would only see anything more than that if we get great opportunity. If something came up that would involve a huge opportunity, certainly we'd look at that, as Paul just noted. But $80 million to $100 million is where we'd see it right now.

[Christopher W. Butler:]

And with your cost cutting, do you have a sense on how much savings you claimed here during the third quarter from cost cutting?

[Richard F. Hobbs:]

When we look at the year-to-date, we're looking at roughly about $5 million. We talked about in 2013 that we'd have a range that would be up to $7-or-so million for the full year. We talked about $10 million to $12 million for an annualized basis. So that's what we're looking at right now and year-to-date, we've seen about $5 million.

[Operator:]

If there are no further questions, I will now like to turn the conference back over to the company for closing remarks.

[Stephen J. Rolfs:]

Thank you again for your time this morning. That will conclude our call for today. If there are any follow-up questions, please feel free to call the company. Thank you.

[Operator:]

Ladies and gentlemen, this concludes Sensient Technologies' Corporation 2013 Third Quarter Conference Call. You may now disconnect.