Q3 2019 Earnings Call
Good morning, and welcome to the Sensient Technologies Corporation 2019 third quarter earnings Conference call.
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Now, let's turn the conference over to Steve. Please go ahead Sir.
Good morning, I'm, Steve Roberts, Senior Vice President and Chief Financial Officer of Sensient Technologies Corporation.
You're welcome all Buda Sensient is conference call to discuss 2019 third quarter financial results.
I'm joined this morning by Paul Manning, Sensient, Chairman, President and Chief Executive Officer.
This morning, we were really start 2019 third quarter financial results.
Copy of the release is now available on our web site at Sensient Dot com.
During our call today, we will reference certain non-GAAP financial measures, which we believe provide investors with additional information to evaluate the company's performance and improve the comparability of results between reporting periods.
These non-GAAP financial measures removed the impact of currency movements depreciation and amortization.
Noncash stock based compensation.
Back to the 2017 U.S. tax legislation.
In other items as noted in the company's filings.
non-GAAP financial results should not be considered in isolation from or as a substitute for financial information calculated in accordance with gap.
A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is available on the Investor information section of our web site at Sensient Dot com and in our press release.
We encourage investors to review these reconciliations.
In connection with the comments, we make this morning.
I would also like to remind everyone that comments made this morning, including responses to your questions May include forward looking statements as defined in the private 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 Exchange Commission.
We urge you to read sentence 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. Thank you Steve Good morning.
This morning, we released our third quarter results and they were below my expectations.
Before I provide an update on our businesses I would like to comment on what we're seeing in the market and how that is impacting our results.
The first market dynamic I'll comment on as the overall softness in a handful of product lines.
The overall market in North America in Europe for food and beverages, which includes a broad array of product categories from pet food to Sue.
Has been down for the trailing 12 months.
We have been directly impacted by the slowness.
By the slowness, particularly in our flavor ingredient product lines, which has a significant presence in soup and yogurt as well as other categories.
Despite the slowdown we're experiencing successes in a number of areas such as ice cream natural colors in pharmaceuticals.
In addition, our north American savvy businesses, turning around and is well positioned for next year.
Turning to cosmetics, the cosmetic make up market remained soft the rebound continues but is about a quarter or to slower than originally anticipated.
That said, we had seen promising signs in our order patterns and a full rebound in certain geographic locations and customer segments.
We expect the cosmetic business to be back on track in 2020.
Another market dynamic has been the challenges caused by economic political and trade uncertainty.
The impact of tariffs has resulted in higher cost for certain raw materials from China and has caused all their suppliers to raise their prices as well.
In most situation said, it's been difficult to pass on the full impact of the tariffs through pricing.
Carrots have also impacted revenue as they have created conditions in certain regions, which have led to deferred product launches de stocking in general uncertainty.
Shifting to Europe , Brexit continues to drag on impacting our customers order patterns and overall cautiousness on purchasing decisions.
Furthermore, recent discussions on U.S. imposing European tariffs have also contributed to this uncertainty.
During the third quarter, our UK business was down substantially we experienced lower demand in Europe for flavor color and cosmetics.
Another market dynamic relates to changing consumer trends and the impact on our customers.
Many of the largest multinational customers are struggling to address rapidly changing consumer preferences.
They are under pressure to find ways to grow many are focused on raw material cost reductions and are also rationalizing their product lines.
We have felt the impact of the cost focus and these rationalization efforts.
For smaller and mid sized companies, what we call B and C customers.
There is a continued focus on introducing new products.
This is good news, but these launches are smaller and the success rates had been on he then.
Now let me outline what do we are doing to address these market conditions.
First we're focusing on key markets food colors finished flavors in extracts cosmetics pharmaceuticals and natural ingredients.
Second we are divesting certain business lines.
Third we are continuing to reduce our cost structure and lastly, we are focusing on our free cash flow.
Going forward, we will exclusively concentrate on our key strategic markets food colors finished flavors and extract cosmetics pharmaceuticals, a natural ingredients.
Within the color group, we continue to see strong demand for natural colors in pharmaceuticals.
The pharmaceutical product line is up double digits for the year and natural colors are up nearly double digits for the year.
We expect this strong growth to continue into 2020 and beyond for both businesses.
Our cosmetic business continued to deliver strong margins and as the market normalizes, we should return to year over year growth in this business.
Hi, therefore expect growth in 2020 and beyond.
Colors cosmetics and pharmaceuticals will constitute the core strategic focus areas for the color group going forward.
In the flavor segment, we continue to deliver solid sales growth in finished flavors in xtracs.
Which are up mid single digits for the year.
We're also seeing positive momentum in our North American Savory, Sweet flavors, and Latin America flavor businesses, which are all winning many new projects.
Finished flavors extracts taste modulation technologies and natural ingredients, we'll continue to constant will constitute our core strategic focus for the flavor group going forward.
To further solidify our strategic focus we are divesting the inc.'s fruit prep and fragrance fragrance business lines.
We do not enjoy the scale in these markets to effectively compete in these business lines any longer.
These business lines had been significant headwinds for the company for several years.
We believe we can refocus and maximize our investments in our core businesses and improve our overall product portfolio and growth prospects.
I anticipate that our ability to deliver consistent results will be greatly improved without the headwinds and distractions of these business lines.
And the short term, we will use the proceeds to reduce debt and thereafter, we will use the proceeds to acquire businesses in our core focus areas.
Another way we overcome these market challenges is to continue to reduce our cost structure in both flavors and colors.
We have made progress in reducing our production NSG nay costs in both groups.
The reductions these costs better align our organization to our key strategic areas and we will improve and will provide an improved profit picture for both groups moving forward.
We also continue to focus on our free cash flow starting with inventory.
Coming out of restructuring, we built our inventory to improve our customer service commitments.
Having reestablish excellent customer service levels, we're now focused on reducing our inventory levels, which have come down by $20 million since December .
We have also reduced our capital expenditures consistent with our smaller post restructuring production footprint.
Taken together the reduction in inventory and capital expenditures has contributed to an increase in our free cash.
By 35 million more than 50% this year.
With this cash flow, we have reduced debt by 120 watt $29 million over the last 12 months.
We have experienced some exceptionally challenging market dynamics. This year, our actions to continue to focus the company.
Divest non strategic business lines reduce costs and focus on free cash flow will provide better results going forward.
Steve will now provide you with the additional details on the third quarter.
Thank you Paul.
Since since revenue was $317.7 million in the quarter compared to 342.7 million in last year's third quarter.
Operating income was 38.8 million compared to 50.3 million in the comparable period last year.
Local currency adjusted EBITDA was down approximately 15% during the current quarter.
Foreign currency translation reduce both revenue and operating income by approximately 1% in the core.
Diluted earnings per share were 75 cents in the quarter.
During last year's third quarter, we finalized our estimate.
Of the 2017 tax legislation.
The diluted earnings per share in last year's third quarter of $1.12 includes 17 cents of tax benefit related to finalizing our estimate of the U.S. tax law change.
The adjusted results for 2018 removed the impact of the tax legislation accounting and were 95 cents in last year's third quarter.
Foreign currency translation reduced EPS by approximately one cents in the quarter compared to last years adjusted EPS.
The company's consolidated tax rate was 5.9% in the quarter compared to an adjusted tax rate of 10.5% in last year's third quarter. This years third quarter rate includes approximately 15 cents a benefit related to a tax planning strategy.
Last year's third quarter adjusted tax rate benefited 13 cents related to tax planning actions taken in response to the tax law changes.
The company's year to date consolidated tax rate was 17.5%.
Compared to last years adjusted rate of 17.1%.
As reported cash flow from operations for the third quarter of 2019 was 51.4 million.
Capital expenditures in the third quarter of 2019 were 9.5 million compared to 10.1 million in the third quarter of 2018.
Cash flow from operations for the first nine months of 2019.
As a 127.6 million compared to the adjusted results of 100 million for the first nine months of 2018, an increase of 28%.
Our free cash flow in the first nine months to 2019 was 101.5 million compared to adjusted free cash flow of 65.9 million in the first nine months of 2018.
We continue to focus on reducing our working capital, particularly inventory and we're seeing positive results. The company's total debt decreased $40 million during the quarter at 120 might 129 million.
Since September of 2018 to its current level of 637 million.
The company now anticipates that our full year EPS will be in the range of $2, a 90 cents to $3 per share.
We continue to expect our full year local currency adjusted EBITDA to be below last year's results.
Thank you for your time. This morning, we'll now open the call for questions.
We will now begin the question and answer session to ask a question you mean press Star then one on your Touchtone phone.
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At this time pause momentarily to assemble a roster.
Our first question comes from Brett Hundley with Seaport Global Please go ahead.
Hey, good morning, guys warning.
Paul one of the questions that I'm getting a fair amount. This morning from clients is.
As you guys decide to explore strategic alternatives for certain product lines.
Why not sit down and review the entire business as a whole.
Well, so we I always look at the entire business and the pieces that we are selling or those that are most obviously.
Better.
Resting in the hands of another market participants. These are businesses that I think scale is very important.
Market position is very important in some cases these are very much legacy businesses a sense then.
And so these are.
Quite different from the businesses that we talk about from a core focus of food colors and flavors in pharma X et cetera. So.
Two different worlds and I think that based on where the company is right. Now these have been the biggest headwinds to us and it makes the most sense to to take these pieces.
To sell them again to a buyer with a much stronger position in the market, where they can take advantage of their scale and their ability to cover a wide range of customers and to maintain a good position.
Thanks for that Paul and to follow on I mean, what type of a markets. You think exists for these business lines at a high level.
For the three that we're selling these are obviously markets where scale is very important and you know as we describe our business. We are a specialty company, we're making specialty ingredients.
That are based on far greater degree of customization.
They're not necessarily built on large capital volume driven plants, and so again I would speak to these as being very much.
Legacy businesses for the company a one point the these.
These these are very different markets than they are today, so as markets mature and develop there's a natural progression of the product line and certainly we're no different.
But the remaining businesses that we focus on.
It's a very different situation for sense and right you saw our.
Food colors results you see that sensing is is a indisputable market leader in food colors, and we outgrow the market in just about every one of our.
Geographies.
You look at our cosmetic business, where we have a top market position.
We're in a situation right now with makeup that I think certainly we cycled through that one in the short term and we're back where we were very strong technically driven.
Compelling market position business.
Did go for as you think about the the rest of the focus areas that I've discussed Esa and I are our business our agricultural business, we are a top market participant.
So.
It's a lot easier to grow businesses, where you have that type of leadership position.
Where you have that type of influence its much more difficult to do that in a market where you're one of many.
Where perhaps scale is more relevant economic factor in your success.
So I think.
The divestitures make a great deal of sense for us and quite frankly, they make a great deal of sense for the buyer too. So I think this is a very good outcome for both parties and I think this will as you heard me say in the prepared comments. This removes a lot of the headwinds in the distractions that we faced.
In these business lines for the last several years, so I think thats, a real high positive for the company to to rethink the portfolio, how we as we have.
And how easily can these business lines be separated I guess two two part question how easily can these business lines be separated and then I had to go back to my old initiation that everything up but I am getting to around 2020, 5% plus of your come.
Bind revenue line that could be under review quote unquote.
Relative to the businesses that you mentioned the mine the right ballpark there.
So for the first part I think these are you could almost describe them as mutually exclusive from the other parts of the business right. They operate in different production type environments. In some cases, they have very different customers clearly in the case of inks that that's the case.
So the ability to separate them.
I think it's a pretty clean evolution, it's not easy, but it's a fairly clean.
Separation.
That that I think and can be readily done if you're thinking of kind of magnitude. Thank in terms of about 10% of the of the revenue.
Not 20, 525 will be we'd be at very high.
Estimates more like about 10.
Perfect. Thanks for clarifying that and then just one more for me.
At the outset here you talked about a number of the things that.
Have contributed to softer than anticipated results this year.
A couple of them you know we've been aware of they've been ongoing for Q3, specifically it sounds like cosmetics.
I didn't.
Progress as you thought it would.
And then it also sounds like.
Some of your ingredients.
Just havent progress as expected you also mentioned the UK as well, but is there something that really stands out in so far is the shortfall in Q3 and that's it for me. Thank you.
Okay. So what really stands out in Q3.
As contributing to the shortfall that too you mentioned these flavor ingredients.
And the cosmetic markets. So let me take the cosmetic piece first.
When we first observed the slowdown in demand for cosmetic makeup products.
It was very yet.
It was very much focused on makeup excluded skin.
And it was more of a mass market type.
Outcome this did not.
Really affects the high end to make up products those tend to be resistant to really any economic changes in the markets. As we saw that happening we had anticipated and go back about a year that these businesses. These geographies would sort of resume normal demand.
In in sort of this orderly fashion.
Beginning with the us in Europe , and then eventually flowing through to Latin America.
In reality what happened here.
It was kind of reverse too we had determined that are we've seen that Latin America is very much back on track that had a very strong outcome in Q3 and in Q4 here as we're sitting here in late October .
Where are the recovery has been a little bit slower than we had anticipated is in the us and in Europe .
Asia was really principally impacted by the the us China tariff, which had a profound impact on many of the customers that we sell to in China, who export to the us in other markets.
So when you look at this market you'd say, we're a market leader you would say that this downturn in our business is not the result of some competitive action thats taken our business. This is not the result of some technological innovation that sensient missed the boat on.
So it's still a fundamentally a very good market it still fundamentally a market that we're a leader in.
And so what's what's frustrating here is the recovery has not been as fast as I had anticipated.
But I think this is still a very strong market.
So I mentioned, we've already seen some some of them come back I think we can expect Asia.
To get very very close to resuming things here and even in Q4, but I think as you look at 2020.
We would anticipate that the rest of the geographies are back in place.
Perspective, the second one that I mentioned flavor ingredients, yeah that was an enormous headwind to us absolutely because you look at our natural colors were up our flavor sales were up mid single digits.
Our pharma business was up and where we really.
Felt the brunt of the revenue declines were in these flavor ingredients and this is why go back to the point of.
Having that market position that market share that volume that scale that that perhaps others do is not something that we have and so we have to respond to that in the in a thoughtful way and in my opinion, the best way that we do that as we as we pursue.
Sale of those product lines.
So.
Removing that significant headwind.
Okay, again flavors, where we have been focused slate finished flavors sales is a part of the portfolio that is up that is growing we are winning.
And I think I feel very good about that in the future and I feel even better when that type of success is not being can seal by the headwinds that are we feel routinely in this flavor ingredient space.
So.
I guess, that's all I have to say about that.
Thank you.
The next question comes from Heidi Vesterinen with Exane BNP Paribas. Please go ahead.
Hi, So first question is on the exit.
Would you be able to tell us how the core businesses has seen going see excluding debates you wanted to exit.
How have leaving going in the past few years and what will be in in terms of profitability fleets. That's my first question.
Okay. So the business is ex these flavor ingredients and ending straight so let let's take.
I mentioned natural colors is up.
Was up in the quarter mid single digits for the year nearly double digits and that other than Europe actually all the regions are are doing quite well on the natural colors front.
I mentioned that four flavors were up mid single digits in the quarter as well as the year.
Pharma has been double digits essentially for the year.
Cosmetics as a as a.
As a result of the market downturns I've referenced was down about mid single digits. So if you do the math you conclude that these flavor ingredients and thanks.
Tell a very different tail and so.
I don't know how that plays out but ultimately these were the single biggest headwind in terms of the results now there is another factor to that that I'd like to speak too and it doesnt often get a lot of attention, but the level of attrition that we are observing in the market is also.
Quite significant some of this is product rationalization, but some of this is just the failure rate of new product launches and so our new product launches, which which we review.
I should say sales that not only include new products, but also sales to existing customers continues to be quite good we are winning new projects.
But part of the headwind that we also see and particularly in the us market.
It's a lot of product attrition the failure at a new products is considerably hi, and so you can be winning a lot, but things are falling off the wagon so to speak that makes for a bit of the headwind. So we've seen throughout 2019.
A significant rising attrition rate now attrition is different from you lost it to a competitor my definition of attrition is customer a has a product and he discontinues that product or customer a launch as a product and the only launches it for six months as a limited time offering when in fact, we thought it was going.
To be a permanent fixture on his.
In his business.
So that is a dimension to the market that we are seeing right now.
That is much higher than what we've seen in previous years I think some of this as a result of of the uncertainty in certain markets. I think some of this is the result of again larger customers in particular rationalizing their portfolio.
Perhaps not unlike how we're proposing to rationalize our portfolio.
So that's how I would kind of break that up.
And then in terms of profitability will it be positive with you succeed with these exits.
Let's just say, we're going to take the proceeds were going to reallocate that capital.
For acquisitions.
I don't have to buy anything nearly as large as what on divesting to make up for that profit.
And the next question on the exit.
How far you progressed with these you said you process that youre, starting now how should we think about the timing of the shale.
Yeah, I don't want to get into this specific puts and takes on transaction simply because they are governed by Andy Ace. If they were do exist or or not exist. So I think it's probably easier for us to just say that at this point, it's about 10% of the revenue.
It's not as profitable obviously as the broad based businesses, whether colors or flavors.
And as we progress and as we eventually culminate these transactions in a signing and closing we would make the results of that publicly available to it to all of folks.
Thank you and then lastly.
I guess going back to the earlier question. The first question. So are you really sat on just divesting the 10% to sales.
If somebody wanted to come with an offer for for the whole business do you just see no would you be open to a discussion.
Hi, I'm here to drive value and as you look at the business, we had a tough quarter. So I suppose most pragmatically speaking this would be the absolute worst time to think about something like that I think what we want to do is take care. These pieces and then as we as we always do around here continue to look at the portfolio.
Leo markets change markets mature and then we re respond accordingly, as I mentioned, we have in mind, some inorganic approaches to the business.
That I think we could potentially discussed here and in the future.
So I think Thats, what were focused I think thats whats going to turn the ship around so to speak but I think removing these ingredients and removing these other lines, where again, we are not the market leaders I think we'll give you and others are very different feel and look for for what's happening in the business and a very positive things that are happening.
In these core.
Strategic.
Strategic areas, but again my easiest answer there's I'm always looking to maximize shareholder value.
I think we're as I see it right now the best way for us to do that is to divest these three pay down debt.
Acquire selectively and continue to focus in these core areas that I described food color.
Flavor Xtracs.
Cosmetics.
Thank you.
Again, if you have a question. Please press Star then one.
The next question comes from Mitra Ramgopal with Sidoti. Please go ahead.
Hi, good morning.
Just wanted to follow up again on the.
Last question regarding the divestitures.
Obviously.
A few years ago, you did a restructuring initiative you divested some noncore businesses identified three more today and I'm just wondering if it's fair to assume after this process couple of years or few years out you pretty much set now in terms of the portfolio you have.
Yes, I mean, I think the pieces that I'd describe where we have market leading positions are areas that I think we can be quite successful and we're quite profitable, they're very technically driven they're very defensible sticky businesses.
Very different from from from some of the other pieces that we've had over the years.
So yeah as I sit here today.
Turning to the 18th I think the residual components looked pretty good to me.
Okay, No that's fair.
And on the call. The group I know you want to things you highlighted in terms of softness in the quarter in terms of profitability was the higher input costs and I was wondering if you.
I would add.
Some more detail there in terms of what you're seeing in any potential ways of using that pressure.
Yeah, where we where we see the inflation on raw materials is principally on on.
The synthetic food colors inc.'s.
Within the color group anyway, those are the areas that that we had the most.
Inflation.
A lot of that was was driven by the tariff.
We can measure the explicit impact of the tariff on those raw materials.
But what you also have is that dynamic where we're the only country at war with China in a tariff and so our competitors who are not us based are not at at war with China, and then imposing tariffs and so therefore, they're not subject to that raw material inflation many of them.
Can take different pricing strategies with their products to to further take advantage of that situation and so you have kind of a double whammy.
You get the raw material inflation, and yes struggled to to pass along the pricing because.
Passing the of the pricing is only by US based firms and so that's been a bit of a profit drag for us.
In color.
I'm not going to opine as to the remediation of that tariff war.
All assays that.
We will we will work our way through it and I think as you think about our business over time.
It's one where we can ultimately either formulate out certain raw materials or we can convert folks to natural colors. We can do a lot of things too to remediate. This if this were to lag on and on a non.
But we've established new suppliers.
Unfortunately, many of those new supply as are fairly aware of the tariff impact and they can cost their raw materials at parity with the Chinese plus tariff.
Factors so.
The raw material inflation is it goes well beyond just things coming out of China because of the entire market response to that dynamic as well.
Okay. Thanks for that.
And then finally on the guidance.
Steven just.
Wondering what I should be looking at in terms of potential tax rate for the fourth quarter.
Right of the shifts you've seen already sure.
So you know coming into this year I had expected.
Tax to be a headwind we had some significant planning.
Opportunities last year in connection with the new tax law.
We're having some new regs that recently came out.
The did provide some opportunity for additional planning.
We essentially we're fortunate to have a significant amount of credit carry forwards and so we'll continue to look for ways to use those to reduce our future taxes.
And so in the fourth quarter.
Again, whereas we originally assumed tax would be a headwind I would say for the year now, we'll probably be after a couple of points below.
Last year's full year tax rate.
Okay. Thanks, again for taking the questions.
Thank you, Missouri.
This concludes our question and answer session I will turn the conference back to the company for any closing remarks.
Thank you everyone for participating in the call today that will conclude our call.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Thanks.