Sensient Technologies Corporation (SXT) Q4 2011 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Sensient Technologies Corporation 2011 Fourth Quarter and Year-End Conference Call. Today's call is being recorded. At this time for opening remarks, I would like to turn the call over to Mr. Steve Rolfs. Please go ahead, sir.

Good morning. I'm Steve Rolfs, Vice President, Administration of Sensient Technologies Corporation. I would like to welcome all of you to Sensient's conference call to discuss 2011 fourth quarter and year-end and financial results. I'm joined this morning by Mr. Kenneth P Manning, Sensient's Chairman, President and Chief Executive Officer; and Dick Cobbs, Sensient's Senior Vice President and Chief Financial Officer. Also with us today are Paul Manning, President of the Color Group; and Jim McCarthy, President of the Flavors & Fragrances Group. Earlier today, we released our 2011 fourth quarter and year-end 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.

Thank you, Steve. Good morning. Sensient has outstanding results in 2011. We established new records for revenue and earnings per share. Earnings per share increased by 11.1% to $2.41 in 2011 compared to $2.17 reported last year. Revenue in 2011 was $1.4 billion, an increase of 7.7% over the $1.3 billion reported in 2010. The Color Group and Flavor & Fragrance Group each achieved new highs for revenue and operating income. The company also established new fourth quarter records for revenue, earnings per share and operating income. Earnings per share were $0.57 in the fourth quarter, up 9.6% from the $0.52 reported in last year's fourth quarter. This is the ninth consecutive quarter we have met or exceeded EPS estimates. The Color Group had a great year reporting revenues of $491.9 million and operating income of $90.2 million. Revenue and operating income increased 9.9% and 16.6% respectively over the 2010 results. The Color Group's operating margin was 18.3%, up 100 basis points from last year. Our continued focus on the natural color market drove the Group's strong performance in 2011. Our Pharmaceuticals, Cosmetics and Digital Inks businesses also performed well this year and we see very exciting opportunities for growth in these businesses. In 2012, we expect the Color Group to achieve solid revenue growth and higher operating margins. The Flavor & Fragrance Group also had a solid year in 2011. Revenue grew 6.4% to $860.7 million for the year and operating income increased to $130.8 million, up 7.3% from 2010. The group's operating margin increased to 15.2% in 2011. The group's growth was driven by strong performances from the U.S. Flavor businesses and our Fragrance business. We made significant investments in our facilities during the year and we expect solid growth from the Flavor & Fragrance Group in 2012 as well as the next several years. We expect revenue to grow in the mid-single digit range with improved operating margins for the Flavor & Fragrance Group. The Asia Pacific and China groups reported revenues of $131.8 million in 2011, an increase of 16.5% from 2010 revenue. We saw a strong growth from all the businesses in this region. This is the second consecutive year that Sensient has delivered record revenues and earnings. Our balance sheet is strong. We have reduced debt by over $140 million in the last 3 years, improving our debt-to-total capital ratio to 24.2% from 32%. Our operations have delivered over $400 million of cash flow during the same period. In 2011, we made significant investments in our facilities, acquired 2 businesses, increased our dividends, and reduced debt by $14 million. The company is committed to building its global infrastructure, both in terms of facilities and people. We spent more than $75 million on capital investments and acquisitions in 2011, and we expect to increase our capital spending program in 2012. We recently announced major investments in our facilities in Switzerland and the United Kingdom. The expansion of our Digital Ink's plant in Switzerland will reinforce our leading position in the industrial inks market. The investment in our flavor facilities in the United Kingdom will improve efficiencies and expand production. We will continue to evaluate new acquisition opportunities in 2012. The 2 acquisitions we made in 2011 allowed Sensient to gain more control of operations in key strategic markets. We will consider opportunities that improve our commercial technologies, product offerings or access to new markets. We have expanded both the size and quality of our sales force. We have added 75 sales people across the company since 2009 and implemented training and development programs to enhance their capabilities. We are continuously focused on new product development and commercializing technologies. The Color Group has led the way in this area by implementing a highly effective new commercialization program. The Flavor & Fragrance Group will launch a similar program in 2012. We see many opportunities for growth and despite the challenging economic environment, I am very optimistic about the company's future. We expect to report earnings between $2.48 and $2.58 per share in 2012. Dick Hobbs, our CFO, will now provide you with the details for the quarter.

Good morning. Sensient reported a second consecutive year of record revenue at the consolidated level and at each of the groups. Annual revenue for 2011 was $1.43 billion, an increase of 7.7% from 2010 revenue of $1.33 billion. Operating income in 2011 was $190.8 million compared to $174.6 million in 2010. The company adopted a cost reduction program to improve the efficiency and profitability of selected operation. This resulted in a pretax charge of $4.8 million, which is $3.7 million after-tax or $0.07 per share. The fourth quarter results also included a gain related to the company's acquisition of the remaining interest in a cosmetic color company in Brazil. Under our accounting standards, the company was required to revalue the previously held equity interest upon obtaining control of the business. This resulted in a pretax gain of $3.6 million. The after-tax gain was also $3.6 million or $0.07 per share. Excluding the impact of these items, operating income was up 10% for the year. Foreign currency translation increased consolidated annual revenue and operating income by approximately 2% and 3%, respectively in 2011. Diluted earnings per share were $2.41, an all-time high for the company and an increase of 11.1% from 2010. For the fourth quarter of 2011, Sensient's revenue was a record of $340.4 million compared to $339.3 million in last year's fourth quarter. Stated in local currency, revenue increased 1.3%. Operating income in the fourth quarter was $43 million and $41 million in 2011 and 2010, respectively. Excluding the impact of the revaluation of the equity interest and the restructuring charge in 2011, operating income was up 7.8% in the fourth quarter. Excluding the impact of currency, this represents an increase of 9.3%. Foreign currency translation reduced quarterly revenue and operating income by 1% and 2%, respectively. Diluted earnings per share in the fourth quarter of 2011 were up 9.6% to a record $0.57 compared to $0.52 in 2010. Sensient's cash from operating activities was $142.9 million for 2011 and $155.7 million for 2010. An increase in cash earnings in 2011 was more than offset by a higher use of cash for working capital compared to the prior year, primarily due to the rebuilding of the hydrated flavors inventory. Total debt was reduced by $14.4 million in 2011 and the debt-to-total capital ratio improved to 24.4% from 26.2% at the end of 2010. Debt to EBITDA decreased to $1.4 million at the end of 2011 from $1.6 million a year ago. Even with the acquisitions and capital spending on several large projects, the company was able to reduce debt levels. The company expects the balance sheet to continue to strengthen as strong cash flows fuel strategic investments and further improvements in debt ratios. I will now take a brief look at the results of our operating groups. Sensient's Color Group reported record revenue of $491.9 million for 2011, an increase of 9.9% from $447.5 million in 2010. Color Group record operating income of $90.2 million was up 16.6% from $77.4 million reported in 2010. Foreign currency translation increased revenue and operating profit in the year by approximately 3%. Operating margins increased 100 basis points to 18.3% in 2011. Revenue for the Color Group was $112.8 million and $113.3 million for the fourth quarters of 2011 and 2010 respectively. Volumes were relatively flat in the fourth quarter primarily due to the ongoing rationalization of some low profit business, onetime promotional items in 2010 as well as destocking of several of our European customers. Carmina pricing also reduced revenue in the fourth quarter with most of the impact in Europe. Foreign currency translation reduced revenue by approximately 2%. Color Group operating income for the quarter was $20.3 million, an increase of 10.6% from $18.4 million reported in the prior year's quarter. Foreign currency translation reduced operating income by approximately 1% in the quarter. The strong performance was driven by each of the company's North American businesses including Food, pharmaceutical, Cosmetics and inks. The global Nonfood businesses also recognized solid growth, particularly the inks operations. The Flavors & Fragrances Group reported record revenue of $860.7 million in 2011, an increase of 6.4% from $809.1 million in 2010. Operating income was $130.8 million in 2011 and $122 million in 2010. Foreign currency translation increased revenue and operating income in 2011 by approximately 2%. Revenue for the Flavors & Fragrances Group was $206.3 million and $206.1 million in the fourth quarters of 2011 and 2010, respectively. Several major customers had year-end initiatives to reduce inventory levels, which had a negative impact on the Group's volumes. Operating income was $32.2 million in 2011 and $29.4 million in 2010. Foreign currency translation reduced both revenue and operating income by approximately 1% in the quarter. The U.S. flavor businesses were the major drivers of the higher operating income for the fourth quarter and full year. Revenue in the Corporate and Other segment, which includes the company's operations in China and the Asia-Pacific region was up 16.5% to $131.8 million in 2011 compared to $113.2 million in the prior year. For the fourth quarter of 2011, revenue was $32.3 million, an increase of 4.6% from revenues of $30.8 million in the fourth quarter of 2010. State and local currency revenue in the Corporate and Other segment was up 11% for the full year and 3.4% for the fourth quarter. As Mr. Manning stated, we expect both the Color and Flavor & Fragrances group to generate solid revenue growth and higher margins in 2012. As a result, Sensient expects 2012 diluted earnings per share as reported to be between $2.48 and $2.58. Thank you very much for your time this morning. We will now open the call for questions.

[Operator Instructions] Your first question will come from the line of Mike Sison with KeyBanc.

In terms of your outlook for 2012, it sounds like you could generate another year of let's say mid- single digit sales growth, is that sort of the arena of growth?

Yes. I think that's correct. But we're hoping that, that is a little bit higher but we don't want to disappoint. So right now, we are being conservative in our forecast. But yes, for sure that.

Okay. And then when you take a look at the cost savings, Dick, that you noted in terms of the programs you're implementing now, what should that yield in sort of savings heading into next year?

Well looking at 2012, certainly we're going to get at least $2 million to $3 million minimum and perhaps more -- a little bit more than that from the restructuring. We'll also get some benefit from the acquisition of the partners that we talked about that resulted in the revaluation that went through the fourth quarter. So we'll get something from that as well some revenue and in addition to that, because it had been reported previously on a cost basis. It's now reported on a consolidated basis. And so, we'll get some benefit to the bottom line and the top line for those acquisitions as well, particularly the one in Brazil.

Okay, great. And then Paul, could you give us an update on natural colors and what was the growth in 2011 and what type of growth do you foresee in the next several years? Is there's still a lot of momentum in that trend?

The growth in 2011 was very good. I think, certainly it will vary by geography. North America led the way with growth well in excess of double digits. I would foresee that happening throughout the Americas for the foreseeable future. Europe, where we have a bit more competition in these markets and the growth rates have not been as strong as say the Americas. I would tell you that the growth rate is still there. We have diversified the product line to also include coloring foodstuffs, which is really essentially a regulatory distinction rather than any major product distinction. We've got some strong product releases within coloring foodstuffs which will complement our natural color as lined. So we foresee good growth in Europe. As you look at Eastern Europe and into Russia, we will continue to see excellent growth there. So in short, it's a good market. The market has generated tremendous interest, our customers have generated interest for a variety of different products not only for conversions, but also for new product releases.

And how big is it now, roughly?

Natural colors, it's more than half of our food colors right now. And food colors is about 60% of our overall revenue. It's between about 55% and 60%.

Great. And so the last question -- so this part of the portfolio should still grow, sort of high single digits, double digits in the foreseeable future. Is that...

I think we'll have a good growth there. I think certainly double-digits in the majority of our regions is certainly achievable. And I think similarly in some of our other businesses, take Pharma where we've expanded strategically to move beyond just colors into a wider market. A bigger market with stronger growth rates, we can call it an incipient market. I think we'll continue to see very strong growth there. We've also expanded, as you saw in our release, about our inks operation in Switzerland. We've expanded considerably on the digital inks as opposed to more the traditional inks for industrial applications. I think you're going to -- this is another strategic alignment change for the Color Group. You're going to continue to see very strong growth in Europe and the Americas on that front. And then in our cosmetic division, as we continue to expand the range of products we can provide to the market, we've got tremendous upside in that market as well.

Your next question will come from the line of Edward Yang with Oppenheimer.

If I could start with some modeling questions. The restructuring charge of $4.8 million. How was that segmented by Flavors, Colors and Corporate?

Both if I could add, I'd like to respond about the revaluation and the restructuring. Both of which are for reporting purposes in the Corporate & Other segment. In a net out at the operating line to an expense of $1.250 million, but at the bottom line they net out to 0. And the reason for that, the restructuring charges $4.8 million is subject to tax but the gain on the revaluation is not taxable and that was $3.6 million. So at the operating line, we have an expense of $1.250 million. At the bottom line, it's almost a wash. It's $3.6 million, which is the after-tax gain and $3.7 million, which is restructuring. And again those are both in the Corporate & Other segment. Now, what I'd like to also add is that when you look at the as reported numbers, you're going to note a tax rate for the quarter of 25.6%. But because of the -- what I've just described with the restructuring and the revaluation, you really have to take that out of consideration for determining the tax rate because if you take those individually, as I said, they're a wash and so the tax rate really is 28%. And you also have to relook as I said in my prepared comments at the operating income increase and the percent change there is up actually in local currency, over 9% in the quarter. So those are important to note because where they're located as I've said in Corporate and Other, the effect on the tax rate and the effect on the operating profit, what you call the EBIT.

What do you think the tax rate would be in 2012?

Right now, we are looking at between 32% and 33%. Of course, we always endeavor to have tax planning that can somewhat mitigate that, but roughly that's the range we're looking at right now.

If I normalize for the different puts and takes with the gains and the charge then you mentioned, Dick, that the tax rate in the fourth quarter was 28%. Second half tax rate was a lot lower than the first half tax rate. How does that -- is there any seasonal effect there or what's baked into that?

It's based on -- when we have an event, which could be an audit, it could be a reconciliation between the books and the tax return. When we have such an event, it could be a change in the law or statute of limitations running out, that will result sometimes in a credit to the tax accounts, which reduces the tax rate. Those occur based on events that would happen in any quarter. And that's the point in time when that adjustment would be taken. Jeff Makal, our Chief Accounting Officer, is here. I don't know if you have anything to add to that.

I would say that we did see a slight reduction in the ongoing rate in the back half of the year based on earnings mix and where we were making income. But to Dick's point, I think most of it was -- we resolved some things in the back half of the year and that's what really drove the decrease.

Okay, got it. And when you talk about the segment results, you mentioned that in -- I think in Color, you saw flattish volumes. What was volume growth in Flavors, was that flattish as well?

Actually, in the case of Flavors, there was one area that took a small hit on volume. It was to be anticipated and it was within the dehydrated flavors business that garlic -- last year because of global shortages in garlic, we had record demand for that product. And so last year, we depleted inventories and sold every bit of garlic that we could get together and put on a truck. Whereas this year, we're seeing that back more to a normal situation. So the inventory is adjusted back to what would be a normal inventory and that's what the comment I made about the cash flow and as a result, our volumes were less than last year. So that was the only real decrement we saw to volumes. But I should point out that looking at the top line of the company has focused on weeding out unprofitable business.

Or marginally profitable.

Or marginally profitable as we've said, the destocking by the customers. And I think that reflects in the quarterly margins. The fact that the Color margin is up 180 basis points in the quarter, we were quite pleased with that rather spectacular results. And the Flavor group as well, the Flavor group margins were up 130 basis points in the quarter. So we're seeing that in the margins in the bottom line results, the actions we're taking and the types of sales that we're making and focusing on.

I would tell you this, and excuse my cold, but the pipelines are particularly strong going into the new year. So we're very optimistic.

Okay. And you mentioned customer destocking. How confident are you that, that's all done at this point? And to the destocking in the fourth quarter, I mean several other companies pointed this out in terms of destocking, does that provide any opportunity for restocking to start the year?

Yes. Well Paul has covered this on an account by account basis. So I'm going to let him talk about that.

Yes. I would say that certainly, the destocking trend is particularly strong in certain geographies for instance, Europe. To the extent, Europe comes from that, I don't necessarily want to speak to the quarter that we're in. But I think certainly, we can say that we're optimistic that it would create opportunities throughout 2012. I think that we had less of that trend in the U.S. and, for instance, and for South America, for that matter. So it's a little bit geography dependent. It seems to be driven very strongly by some of the macroeconomic concerns within these regions. But I think the answer to your question is that it certainly always does represent an opportunity for us throughout the world, I think that depending on their tolerance for inventory, and what they're willing to handle, but yes, I think this is -- should materialize into a positive development for us throughout 2012.

Maybe just the final question for me on the guidance and revenue expectations of mid-single digits and your earnings guidance is basically up 3% to 7% as well, so let's call that mid-single digits. When I look at the currency, that was an impact in the fourth quarter and at current exchange rates, I would expect that, that would still be an impact, maybe 2% or 3% negative headwinds. So, what's your level of confidence that volume and price again will offset that? It seems like you would need at least pretty significant rebound at least from fourth quarter levels to get there.

Ed, looking at the average of the currencies for 2011, and looking at what's in our planning, we certainly have put into our planning models, an expectation of some headwind versus where the currencies were in 2011. So we've built that in based on across-the-board roughly where the currencies are right now. We've built that in. So certainly, any weakening of the dollar would certainly help those numbers. If the dollar strengthens a little bit, I think we have enough built into our modeling and other things -- positive things in the company, that should position us well for offsetting that.

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

Just keeping on that same subject. As you move away from your less profitable business. This is the second quarter that this has become apparent. So it would seem that we've got just to grandfather in some of the cuts you've made, another 2 quarters to go and then you throw in the FX headwind. It does seem like we're looking at normalized double-digit top line growth minus some of these headwinds in order to get to the mid-single digits. Is that the right way of thinking of things?

Yes. I think that's reasonable, certainly.

And shifting gears with the Natural Color business. can you give us an idea of the wins that you're getting on the Natural Color business. How much of that is coming from new customers that you haven't worked with much versus existing synthetic customers?

Paul, why don't you take that?

Sure. I would say that the majority of the movement we see outside of Europe is going to be more of our larger customers, more of our established customers for which we can provide a complete portfolio of products whether they be synthetic or natural. And so, most of the growth has come through new product introductions outside of Europe. I think while that trend, well while that trend in the market was for a reduction in new product releases in 2011. I think we're still able to grow that part of our business very effectively through good execution, good sales force coverage and quite frankly, better products. So we're going to continue to be successful on those dimensions. And then as we see a rebound in some of these markets, I think new product introductions will become an even bigger portion of the natural color wins. But there had still been a steady pace of conversions of existing products. Again, many of these from -- from some of our established customers. But we have made good progress on growing our customer base, particularly in South America. We've made progress in North America as well and in Europe. And so, these 2 growth areas, I think I see continued progress as we move into 2012 and beyond.

And with your comments, a lot seem to kind of exclude Europe and understanding that that's where you have more competition on the natural colors side, wouldn't an existing client base on synthetics in Europe give you easier pickings as far as migrating them over to synthetics and not spacing similar competition because you have an established relationship?

It certainly does. It gives us a very good position with respect to conversions. And not only in Europe but outside of Europe. And I think the fact that we are recognized globally, as the leader in food colors. I think the convenience of being able to deal from a customer standpoint across a very wide portfolio puts us in a very good position. Not every customer wants to convert every product and they certainly don't necessarily want to do it all right now. So to the extent they could deal with one technical partner through this conversion, I think for the most part these customers see this as a real advantage to their business.

And just finally, I apologize if I missed it before but expectations for depreciation and CapEx for 2012?

Well, we certainly have a number of projects that are going to make a difference to our capabilities going forward. We talked a little bit previously about the fact that looking ahead to 2012, based on what we're budgeting in the projects and the works, we think that we could be over $100 million on capital expenditures and certainly as we go through the year, we will refine that forecast more. But we could be over $100 million and Jeff, depreciation close to $50 million?

I would say it's probably going to be between $45 million and $50 million, probably closer to $45 million.

And you're taking the amortization out of that.

Correct, that's just pure depreciation.

[Operator Instructions] And there are no further questions. I would now like to turn the call back over to the company for any closing remarks.

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

Thank you for your participation, this does conclude today's conference call. You may now disconnect.