Sensient Technologies Corporation (SXT) Q1 2014 Earnings Report, Transcript and Summary

Good morning everyone and welcome to the Sensient Technologies Corporation, 2014 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, Senior Vice President, Administration of Sensient Technologies Corporation. I would like to welcome all of you to Sensient's conference call to discuss 2014 first quarter financial results. I'm joined this morning by Paul Manning, Sensient's President and Chief Executive Officer; and Dick Hobbs, Sensient's Senior Vice President and Chief Financial Officer. Yesterday we released our 2014 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 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 Paul Manning.

Thanks Steve. Good morning. Sensient reported diluted earnings of $0.71 per share in the first quarter, excluding the impact of restructuring cost and other items. This is a first quarter record and an increase of 14.5% over the $0.62 reported in the comparable period last year. Each of the groups delivered solid operating profit growth to drive this very strong performance. In particular, the Color Group grew 10.2%, the Flavors & Fragrances Group grew 5.4% and Asia-Pacific grew by 18%. Overall, Sensient's operating income, excluding restructuring costs and other items increased by 10.6% in the quarter. We reported modest revenue growth in the quarter despite the continued rationalization of non-strategic and low margin business. Excluding these items revenue grew by 4% in the first quarter. We will continue to review our portfolio and shift our mix to more value added products that fit into our long-term strategic plans. Our strategy of emphasizing value added technology driven products and innovation, along with the focus on cost reductions has driven margin improvement across the company. Sensient’s consolidated operating margin excluding restructuring costs and other items increased 140 basis points to 14.8% and each of the groups reported improvement in the quarter. The Color Group’s operating margin improved 140 basis points to 22% and the Flavors & Fragrances Group increased 80 basis points to 14%. The Color Group is the global leader for food and beverage colors and we have the unique ability to provide both synthetic and natural color solutions to our customers. We are also the global leader for digital inks and cosmetic ingredients and we have strong capabilities in pharmaceutical excipients and industrial colors. The group continued its strong performance in the first quarter reporting double-digit operating profit growth. All the groups businesses delivered solid growth led by the Digital Inks and Cosmetics businesses. We are starting to see the benefits of the changes we have been implementing in the Flavors & Fragrances Group. Last year we completed the global realignment of this business to better orient our resources to meet the needs of our customers. The business has also benefited by shifting its focus to value added products. We have enhanced our capabilities by upgrading our management talent and opening a new state of the art facility in the Chicago area. We are encouraged by the first quarter results, which showed more than a 6% local currency profit growth and an 80 basis point increase in operating margins. The Natural Ingredients and North American Beverage businesses reported double-digit profit growth in the quarter. These are positive steps and we expect this improved performance to continue. Both the Color Group and the Flavors & Fragrance Group are delivering solid and sustainable results and this will drive improvements and return on invested capital. We expect return on invested capital to be at or above 10% by the end of the year. Last month the company announced a comprehensive plan to increase shareholder value, including a dividend increase and a plan to repurchase up to 2 million shares over the next 12 months. The Board of Directors increased the regularly quarterly dividend by $0.02 to $0.25 per share. Sensient has increased its annual dividend payments to shareholders in each of the last 9 years. The company’s purchase of common stock will be made in the open market on an opportunistic basis depending on market and other conditions. The combined impact of the dividend and share repurchase plan will return approximately $160 million of capital to shareholders over the next 12 months. This is an addition to the $230 million that we have returned over the last five years. These actions demonstrate our confidence in the business and our commitment to enhancing shareholder value. We completed our initial restructuring program in 2013, which generated annual saving of $12 million. Recently we announced that we are initiating a further restructuring program. The new plan is expected to generate cost savings estimated to be between $20 million and $25 million annually upon completion. We expect to incur pretax charges of approximately $90 million and the first quarter results include $53 million of restructuring and other charges. This plan will optimize our production capabilities with selected plant rationalizations. We will eliminate under performing operations and consolidate selected manufacturing facilities, which will result in improved efficiencies. We are carefully managing this process to ensure our ability to meet customers’ needs and to minimize the disruption to the business. The plan is expected to be completed in 2015. That will principally impact the Flavors & Fragrance Group, significantly improving its profitability. The cost savings are important, but they are by no means the most important element of our efforts to create sustainable long-term shareholder value. We continue to transform our product mix to emphasize higher margin value added products. We provide sophisticated and customized solutions to our customers using our state of the art technology platforms and we will continue to prune non-strategic and low margin business from our Flavors & Fragrances portfolio. We will invest in the businesses, both in terms of talent and assets. These investments will drive our future growth. We will keep debt levels in-line with an investment grade profile to maintain the flexibility for capital expenditures, dividend payments and acquisitions. To the extent that we generate cash above our needs for internal investments and acquisitions, we will return the excess to shareholders through additional share buybacks and increased dividends. Our strategy of transforming the product mix, reducing costs and efficiently allocating capital has proven successful. We implemented these principals in the Color Group beginning in 2009 and it has delivered substantial growth and increased margins ever since. Beginning in 2013, we began implementing a similar strategy at the Flavors & Fragrance Group and we are seeing improved results. Flavors & Fragrances Group reported modest growth in last year’s fourth quarter and healthy growth in the most recent quarter. It also delivered significant margin expansion in both quarters. We will continue to execute on our strategy to drive growth in this business and further improve its margins from the current levels to the high teens over the next few years. Management has actively collaborated with the board to deliver proven results. We have delivered record revenues and earnings in each of the past four years and the stock has performed very well over both short and long term periods. The Color Group has outperformed its competitors over the past five years and we are seeing encouraging results in the Flavors & Fragrances Group over the last two quarters. Our plan is working and we remain committed to delivering sustainable, long-term value to our shareholders. I am very optimistic about the future, and we expect another record year in 2014. We are therefore increasing our adjusted EPS guidance to be between $2.92 and $3. Our previous guidance was between $2.86 and $2.94. Dick Hobbs will now provide you with the details for the quarter.

Good morning. Sensient’s revenue was $368.1 million for the first quarter of 2014, compared to $365.6 million reported in the first quarter of 2013. Operating income as reported was $1.6 million compared to $36.3 million in the first quarter of 2013. The 2014 first quarter operating results included $52.7 million of cost related to restructuring and other activities, compared to $12.8 million of restructuring cost reported in the first quarter of 2013. These costs are reported in the corporate and other segments. Excluding the restructuring costs, operating income was $54.3 million, an increase of 10.6%. Interest expense was $4.1 million, down 3.1% from $4.3 million reported last year. The tax rates excluding the restructuring impact in both periods were 29.5% in the current quarter and 31.2% in the prior year’s first quarter. Excluding the restructuring impact in both periods, earnings per share was $0.71 in the current quarter compared to $0.62 in the prior year’s first quarter, an increase of 14.5%. Diluted earnings as reported were a loss of $0.04 per share compared to income of $0.43 last year. Foreign currency translation reduced revenue and operating profits by approximately 1% in the first quarter of 2014. Sensient's cash from operating activities for the first quarter of 2014 was $19.8 million as reported, which includes $3.4 million of payments related to restructuring and other costs. Excluding the restructuring impact, cash provided by operating activities was $23.3 million compared to $25.6 million reported in last year’s first quarter. The decrease is primarily driven by a higher use of cash to fund working capital this year. Total debt as of March 31, 2014 was $400 million compared to $360 million as of March 31, 2013. Debt to EBITDA was $1.5 million at both March 31, 2014 and 2013. I will now take a brief look at the results of our operating groups. Sensient's Color Group reported revenue of $133.6 million in the first quarter of 2014 and $129.5 million in the first quarter of 2013. The Color Group reported record first quarter operating income of $29.4 million, an increase of 10.2% from the $26.7 million reported in last year’s first quarter. Operating margins increased 140 basis points to 22% in the first quarter of 2014 from 20.6% in 2013. Strong performances in digital inks and cosmetics ingredients drove the improvement. Foreign currency translations did not have a significant impact of either revenue of operating income in the quarter. The Flavors & Fragrances Group reported revenue of $213.4 million in the first quarter of 2014 compared to $215.8 million reported in the first quarter of 2013. Operating income increased to $29.9 million, an increase of 5.4% over the $28.4 million reported in the first quarter of 2013 and local currency operating profit increased by 6.3%. Operating margins increased 80 basis points to 14% in the first quarter of 2014. The Natural Ingredients and North American Beverage businesses each reported double digit growth in the quarter. 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 up 1.3% to $35.3 million in first quarter of 2014 compared to $34.9 million in the prior year. In local currency, revenue grew by approximately 7%. As Paul stated, Sensient now expects 2014 diluted earnings per share including the impact of restructuring changes to be between $2.92 and $3. Previously this range was $2.86 to $2.94.

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

(Operator Instructions). Your first question comes from Christopher Butler with Sidoti & Company. Christopher W. Butler - Sidoti & Company: Hi, good morning guys.

Good morning Chris.

Good morning Chris. Christopher W. Butler - Sidoti & Company: I was hoping you might give us some more detail on the restructuring plan and rationalizations, the number of plants, the timing of when those are going to be closed, things of that nature.

Sure. So to begin, we are looking at roughly a half a dozen plants at this point as we comb the entire company. With respect to timing, we would be looking at elements, would we begin now as we speak and we continue until the end of 2015. Certainly the idea here is that we want to rationalize this, but we want to do this very thoughtfully. There are in some of the jurisdictions that we operate, there are very specific legal requirements and legal expectations, which have to be met before you can take such actions. When you step back and look at this, I mean we are operating across many different businesses. You know we’ve got food colors and cosmetics and inks and fragrances, etcetera. A lot of different types of plants, so we are being very mindful of the fact that yes, you could consolidate plants, but in some cases why would you want to. If the receiving plant, if you have to implement $10 million, $20 million of capital to accept another plant, that may not make that as desirable as say a straight consolidation and so we have be mindful of that. We have to be mindful of customers and contracts that we have in place and perhaps also the fact that in some cases customers are buying from us in a particular region, because we are producing in that region. So there are a lot of moving parts here; just the same. I think we have a very good understanding of what we need to do. I think as you think about the financials moving forward, this restructuring is really focused on plant consolidations and therefore the benefits you will see on the gross margin, I don’t think this is about SG&A, certainly not to the same turn as we did with restructuring last year, but either way we got a lot of opportunity to rationalize and consolidate. Christopher W. Butler - Sidoti & Company: On that note, by my calculation you have about $6 million of savings to be realized from the first restructuring this year. Do we see any of the savings from the second restructuring late in this year?

Well, I think we’re close. We would say its about $5 million that we would see in this year Q1 and we’ll see a little bit in Q2, Q3 from the restructuring part one. With respect to part two, yes I think its fair to say despite the complexities that I just outlined that you would be seeing savings this year. As we continue on these quarterly calls, we will certainly give you those updates, but as of this moment in time we have not closed any of those plants. Obviously there’s a lot of work that would go into such a project, but yes, we will certainly comment on those in each of the next quarterly calls. Christopher W. Butler - Sidoti & Company: And if we are looking at some of your annual expectations with this rationalization, can you give us a sense of where you think D&A is going to play out this year now and with the repurchase, what effect do you have from repurchases in your new guidance? Similarly interest expense, where do you have that going for the year as part of the new guidance in repurchase?

Yes, let me give you a few broader comments and them I’m going to let Dick answer a part of this question. I think you can assume reasonably that the purchasing will be fairly linier between now, what we’ve already begun and roughly this time next year consistent with our previous guidance on this one. So if you assume a linier progression and you assume an interest rate consistent with where we would expect that to be, we would anticipate about a penny and a half benefit this year. Obviously that’s going to be strongly linked to the interest rate and let me let Dick make some additional comments here.

Thanks Paul. Yes certainly, looking at the buyback as Paul mentioned its going to be over a period of time as we’ve announced and so if we stick to that timetable that would be roughly what he said about a penny and a half. Regarding the depreciation, you had asked about that. For 2014 we expect that to be roughly about $55 million for depreciation and amortization and you also asked about the interest expense. The interest expense we would expect and again, this is all based on a protracted buyback program. Any acceleration would increase this a little bit. But we are looking at roughly between $15 million and $16 million; I think it might be fair to call that roughly in the middle of that range. Christopher W. Butler - Sidoti & Company: I appreciate your time.

Thanks.

Okay, thanks Chris.

Your next question comes from Summit Roshan with KeyBanc.

Hey, good morning guys, nice quarter.

Good morning.

Hey Summit, thanks.

Paul, I like your comment about, noting that you’re going to get ROIC to 10% by year-end. If I think about the longer term thinking out next four or five years, how does that ramp-up? Do you have an internal target that you think you can hit any guidance there?

Yes, I think certainly - let me talk about some of the factors that go into that. Obviously I think we are on a nice trajectory right now in terms of operating profit growth and that’s certainly going to feed into the numerator of that scenario. On CapEx, as I guided to previously, we anticipate 80 to 100 this year and depending on market conditions and opportunities that we would evaluate, maybe on the higher end or the lower end of that range. But one of the things that we’ve done over the last several years is we have made a lot of investments in these businesses and you can look at that in particular with the Color Group, and understanding what we understand about the lead times in the industry, the product lifecycles, you spend the capital and the results come, they don’t come next month, they don’t come next quarter and in some cases they may not come for a year. That’s the nature of some of the businesses that we are in. When you think about the large multinational companies, they don’t close business on a whim and it’s a long, lengthy process, but those are the opportunities that move the needle and generate the type of operating profit that we have been generating in the Color Group. The other part of the capital equation is obviously GMP and product safety. We are all aware of a far more engaged regulatory group and in most of the company countries that we serve in. And so we made a lot of investments because we believe number one, that’s a compelling part of our quality and our product safety and product safety is the most significant risk. Beyond any other financial question or otherwise, product safety is the biggest risk we would face in the type of industry that we’re in today. So we did make a lot of investments in that realm over the last few years. So assuming that second part starts to slow down and it will, as we’ve now raised the level substantially throughout the business, then we can settle into a more steady state on CapEx, which we’re certainly going to begin to see. To the 80 to 100, obviously 80 is lower than the 103 that we spent last year. So I think as we look at internal targets then, where do we want to be? We absolutely want to be in the 14% to 15% return on invested capital. We do believe that’s very achievable. I think it’s both of those levers. It is operating profit growth of capital that you have today, but I think there’s also you’ll see some of the kind of non-ROI related capital slowing down consistent with we’ve raised the standards of our plants and that becomes more of a maintenance mode. So I would expect for the shareholders on this call and for all others that you’re going to continue to see those improvements. We have certainly introduced this as an element of compensation from myself on down and so it is very important, it is a priority and I expect that we’re going to make those improvements and the organization has committed to that.

Great. And then so if you look at the business, you kind of continue to go through and kind of prune encore, a little more (inaudible) the high value stuff. You haven’t done an acquisition in quite some time and I was wondering if you can comment on the environment there; whether your seeing some interesting technologies that you can go out and kind of roll up into the Sensient bottle and any color on the size of something to that degree.

Sure. It’s a great question and I think that as you look at our businesses, certainly there are opportunities that are stronger than there are in others. We see acquisitions on a very thoughtful basis as being an important part of completing a portfolio of products, of also potentially expanding into a geographical region that we’re not in today. Now that being said, the environment is kind of interesting. I don’t think it’s a particularly – in our case is a particularly compelling thing to do. We’re certainly not going to overpay, because then we got a whole different problem on earning a return and really giving shareholders their money’s worth for that, so we’re not going to do an acquisition for the sake of acquisitions. We have a very disciplined program here. Certainly I engage regularly in discussions with a whole host of companies in different parts of the world and in different sets of our businesses and it is a process. It is not something that somebody is interested in doing in the next two weeks, so that’s another point. So I see it principally focused on technology and how do we expand our portfolio, how do we continue to add value and innovation. The quality of the people you therefore have in that acquired company is particularly compelling to achieve that goal, but we can overpay and that can be very easy to do in today’s climate. We’ve seen bids for which there are more than 60 bidders and so you can imagine what the price of some type of opportunity like that would be going and probably not in the right direction and probably not in a way that’s going to really earn shareholders an appropriate retune. So we will continue to look at acquisitions. We will continue in the interest of expanding this question a bit, certainly we will continue to look at dividends, we will continue to look at repurchasing. It is my job to maximize shareholder value in the long term and so each of those components plays a part in that discussion. So I would say that acquisitions is important, but we’re going to be very disciplined about how we execute upon that.

Great, thanks.

Your next question comes from Edward Yang with Oppenheimer. Edward Yang - Oppenheimer & Co.: Hi, good morning guys.

Good morning Ed. Edward Yang - Oppenheimer & Co.: Hey Paul, you had a new hire on your Flavors side, on the President’s side and I was wondering how that changes the strategy for the Flavors business going forward or any color there?

Yes, I think number one, it enhances the strategy; that there has been some discussion about what kind of company that we really are. Certainly as I look at the company and as others look at the company, they would see that today we do a lot within the realm of ingredients. Things like yeast extracts, HDPE’s, aroma chemicals, botanical extracts and these are ingredients by any definition of that term. There’s another part of our business related to what some may describe as traditional flavors. Traditional flavors generating a better return, typically providing a more defensible position in the market and it provides an opportunity to really differentiate yourself from your competitors. So the marriage of ingredients and more value added products can make some very good sense in a lot of scenarios. That is our strategy, as we want more of the portfolio to move from the ingredient to the traditional flavors. That doesn’t mean we abandon ingredients, but we use those and so far as they create better cost position, better supply chain and ultimately they enable us to make better flavor type applications. So I think there is a marriage that makes sense. If you look at our new President, you can see from his background he comes from the customer side of this industry and so I think that makes a great deal of sense. We’re aligning ourselves to our customers, we are developing and continue to develop innovation programs based on market needs and what our customers want and having somebody like Sam in position is only going to enhance our ability to capture those opportunities. I mean we had a very nice improvement in Flavors. For a nearly $900 million business we made an awful lot of changes and we’ve instituted a lot of approvance in a very short period of time and so we think the 6.3% gross in local currency is a good indication of that, but we continue to find new ways to improve it and a big part of that is getting the right management talent in place and Sam is clearly the right management talent to bring this business more towards becoming a flavor house, but also helping us to really focus our product development, innovation, product mix and pricing towards those products that are most compelling to our customers. Edward Yang - Oppenheimer & Co.: Okay, and along that vein, Natural seem to be a very hot area right now. We saw a, almost $2 billion acquisition that Symrise had for Diana and your Naturals business is growing very nicely as well. How big is your Naturals business at this point, spread out between colors and flavors and is that a business that you continue to grow just incrementally or again similar to Summit’s question, do you see some opportunities for M&A there? I mean, the multiples are quite high at this point thought.

Yes. Well, I would say this. So one of the biggest things that everybody has read about over the last several years is the conversion from synthetic to natural colors. Much of this was initiated in Europe back in 2006 due to some legislative changes. I would not anticipate a similar approach in the U.S. The FDA doesn’t necessarily – I don’t think they are going to adopt the same type of approach that was adopted in Europe, that’s just my opinion. I think that that was a big reason behind that movement and which was very strongly felt from about 2006 to 2009. The way I see this market developing would be more of an incremental approach. Most of the new products or a substantial number of new products, and depending on segments, certainly beverage is very strong and in dairy its very strong, but on a lot of these new products, it is natural ingredients being introduced as part of the product. So the natural growth is commensurate with the growth of new product introductions and I think as many people have noted over the last several years, myself included, new product introductions have slowed considerably in the marketplace; in places like the U.S. and in Europe. The raw numbers would tell you that, but also the nature of the new product introductions has changed, whereas a few years ago you may see whole new products and in different segments. Now we see more of on the lines of line extensions, products that are sort of incrementally different from the original, so less boldness as a general statement is what I would suggest as the new product introduction climate in say North America, parts of Latin America and Europe. As that improves though, I would anticipate an additional improvement in the growth of natural ingredients of which we’re servicing; obviously natural colors, natural flavors and certain other extracts related to both. So I think as the market continues to improve, we would anticipate an up-tick there, but for right now I think it’s more of an incremental process. Customers converting select products on a selected basis across a range of different raw materials with a goal that they would continue to implement more natural products in their end products. Edward Yang - Oppenheimer & Co.: Okay, and a final question just on natural gas, that’s been fairly volatile. I know you’re on longer-term contracts, but do you see that being an issue for you either positively or negatively in the coming quarters?

Yes, we have budgeted based on forward contracts and we are comfortable with that, we’re comfortable to where we’re sitting in general on those costs that are mainly affected by it. We’re affected by a number of different locations that would use natural gas, but the principal one is in the natural ingredients and that looks pretty good as far as the cost structure and yes, we have seen certainly an up-tick in natural gas, but we don’t see it as anything that’s going to move the dial, certainly not in 2014. Edward Yang - Oppenheimer & Co.: Okay. Thank you Dick. Thank you Paul.

Yes, well and if I could just make one more point on that one. To the extent raw materials would impact results or utilities or other elements such as that, we don’t anticipate major inflation across any of those. Obviously when we’re dealing with natural products there are always issues that may come up there related to weather or availability, but ultimately I think our supply chain is very good, our contracts tend to be very good, we have taken some long positions on certain key raw materials in the market place and I think that’s an important consideration. So as we look forward, just as another comment, as we look forward to the rest of the year, we obviously have very high hopes for the business. We have done an awful lot to improve these businesses over the last several years. I think the fruits of that labor continue to be shown in Color and Asia Pacific, which again both delivered a very strong quarter, but clearly the difference maker in this quarter was the improvement that we are able to generate in the Flavors group and that is not a one time thing, and let me just say that again in the event there’s any question about, to quote on that one, “this is not a one time thing”. The Flavor Group will continue to improve. We’re very optimistic about the future of this business. We have a lot of opportunity to improve. I’ll restate that our 40% gross margin and our 20% operating margin continue to be the benchmarks that we are shooting for internally. They are very achievable. I see the path to getting there and so to the extent I can make a very short comment about our proxy contest, we have an approach that when this strategy wins, this strategy was implemented in the Color Group five years ago and it continues to deliver. This strategy is being implemented in the Flavor group and it delivers. This is what is going to create the highest shareholder value in the long term. This is not a slash and burn lever up the company and get out quick type approach. This is value creation that is very achievable in both of our businesses and again, we delivered before, we’re going to do it again. It’s based on strategy, linked to innovation, up-selling products, price mix and an element is also cost reductions. So that is the approach we’re taking. I think the results demonstrate that the operations, the governance and the management quality are aligned and that this is very achievable. I wish the proxy contest could go away and I suppose it could, but this was sort of strung on me rather suddenly two weeks after I took this position. Fair or unfair, that’s how it came, but as most of you know, as I’ve talked to most of you over the last year, I’m a very reasonable person and I listen to shareholders and I talk to shareholders routinely and I knew that shareholders would want me to try to work something out here. They would want me to try to eliminate this distraction and let me focus on the business and so for that reason I initiated discussions with the opposition. I offered to work out a mutual candidate for our Board after our April meeting. I thought that was a very reasonable, pragmatic and fair approach. I thought that was a win-win and I think that’s what this is all about and I think shareholders would expect me to come up with a win-win. However despite my best intentions, this offer was rejected and so ultimately in my opinion I don’t think this is about governance. I think this maybe about something else, but we will continue to perform and that’s what my message is to the shareholders today.

I will now turn the conference back to Steve Rolfs for closing remarks.