Earnings Call Transcript - SXT Q2 2021

Operator, Operator

Good morning, and welcome to the Sensient Technologies Corporation 2021 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Steve Rolfs. Please go ahead, sir.

Steve Rolfs, Senior Vice President and CFO

Good morning. Welcome to Sensient's second quarter earnings call. I'm Steve Rolfs, Senior Vice President and Chief Financial Officer of Sensient Technologies Corporation. I am joined this morning by Paul Manning, Sensient's Chairman, President and Chief Executive Officer.

Paul Manning, Chairman, President and CEO

Thanks, Steve. Good morning. This morning, we released our second quarter results. Each of our groups delivered solid adjusted revenue and operating and adjusted operating profit growth in the quarter. Our Flavors & Extract Group had another outstanding quarter, reporting 9% adjusted local currency revenue growth and 13% adjusted local currency operating profit growth. Our Personal Care business rebounded substantially, contributing to the Color Group's 7% adjusted local currency revenue growth and 5% adjusted local currency profit growth. Asia-Pacific had another strong quarter, delivering 11% adjusted local currency revenue growth and over 22% adjusted local currency operating profit growth. On a consolidated basis, we reported 9% consolidated adjusted local currency revenue growth and mid-single-digit adjusted EBITDA growth in the quarter. I'm pleased with our results for the second quarter and for the first half of this year.

Steve Rolfs, Senior Vice President and CFO

Thank you, Paul. Our second quarter GAAP diluted earnings per share was $0.61. Included in these results are $7 million or approximately $0.16 per share of costs related to the divestitures and the cost of the operational improvement plan. In addition, our GAAP earnings per share this quarter include approximately $2.2 million of revenue, or $0.01 of cost related to the results of the divested operations. Last year's second quarter GAAP results included a gain related to the reclassification of accumulated foreign currency translation as a result of the sale of the Inks business and other divestiture-related costs. The combination of these items were included within the divestiture and other related costs, which increased last year's second quarter net earnings by $1 million, or approximately $0.02 per share. In addition, our GAAP earnings per share in the second quarter of 2020 include approximately $28.2 million of revenue and an immaterial amount of net earnings related to the divested product lines. Excluding these items, consolidated adjusted revenue was $333.6 million, an increase of 9.1% in local currency compared to the second quarter of 2020. Our adjusted local currency EBITDA was up approximately 6% for the quarter, and our adjusted local currency EPS was up 8.6% for the quarter. Our cash flow from operations was down in the second quarter, primarily due to an increase in sales activity in the second quarter of 2021 and the resulting use of cash to fund our working capital in the current quarter. While we are currently making strategic investments in our inventory positions to support our forecasted growth, we continue to remain focused on optimizing our working capital levels. In terms of capital expenditures, we continue to expect our spend to be around $65 million for the year. During the second quarter, we bought back approximately $11 million of company stock. As Paul stated earlier, we completed the acquisition of Flavor Solutions last week, and we are actively reviewing other potential acquisitions.

Operator, Operator

Our first question comes from Ghansham Panjabi with Baird. Please go ahead.

Ghansham Panjabi, Analyst

Yes. So just in context, as we kind of cycle through the back half of the year, we're seeing an increase in mobility in certain parts of the world, including the U.S., some lockdowns in Asia. A lot of companies have talked about raw material scarcity, there's an extreme weather event on the West Coast and so on. So can you sort of update us on, a, your updated outlook on volumes for the three segments as we cycle into the back half of the year? And then also, on the raw materials side, what are you seeing at this point from a raw material inflation standpoint?

Paul Manning, Chairman, President and CEO

I believe the second half of the year looks very promising for us across all segments. There are certainly some regions that are more open than others, but product launches are ongoing, and customer engagement remains strong. The fundamentals of our business are solid; people need to eat and drink, and they often continue to use personal care products. This trend is expected to remain robust. I'm optimistic about achieving mid-single-digit growth. Volumes are strong, with most of the growth in the second quarter and the first quarter driven by volume increases. Regarding raw materials, a key feature of our business is our ability to pass on rising input costs to the market. In some cases, we might reformulate products, but generally, we can adjust pricing to cover costs and maintain our margins, which has been our practice over the years. Current increases in costs for propylene, glycol, coconut oil, soy, and similar items don't seem permanent to me, and I expect some of these prices to return to normal levels. While we are experiencing inflation in transportation, these challenges are somewhat atypical. Businesses have always had to deal with rising input costs, and we feel very confident about our pricing strategy. Overall, I feel optimistic about the second half, and I do not see inflation as a concern for our company moving forward.

Ghansham Panjabi, Analyst

And then just my second question on the contribution margins. I mean, just looking at color, just looking on Slide 13, local currency adjusted revenues, plus 7%, and operating income, up 5%. Why wasn't it more substantial, just given that Personal Care is coming back for you?

Paul Manning, Chairman, President and CEO

Yes. So that's a great question. There should be more operating leverage as we go into the back half of the year. A couple of factors there. The big one is that Personal Care volumes have really just been down for about the last year. So without getting into accounting gobbledygook, you can just see that as lower utilized plants, but we were hitting the inflection point kind of as we speak, maybe even a little bit at the end of Q2. So you'll see a much bigger uplift from the growth in Personal Care to the profit line as we get into the back half of the year. And then as we go through our pricing, the timing between input costs going up and pricing being effective, there's oftentimes a little bit of a gap there. So that might have compressed the margin 1 point or 2. But I would tell you that the bigger impact there on Personal Care is just the less than normally utilized plants carrying in. But you can project that out pretty cleanly and see as we get into Q3 and Q4, that the operating leverage will be quite a bit better in the Color Group for the rest of the year, and then, of course, driving us to maybe even beyond the 20% OP margin.

Operator, Operator

The next question is from Mark Connelly with Stephens. Please go ahead.

Mark Connelly, Analyst

Paul, can you discuss product development in comparison to typical patterns and share what customers are expressing? You mentioned the increase in sampling, but we are still observing that sectors like food service are hesitant to launch new products. Could you provide some insight into how the early and later stages of this situation are evolving?

Paul Manning, Chairman, President and CEO

In comparing 2020 to 2019, the total number of launches in the U.S. and Europe remained relatively stable. Companies that launched a certain number of products in 2019 did the same in 2020. The notable change was in the types of companies that were making these launches, with a greater number coming from local and regional customers rather than larger multinational firms. This trend continued into 2021, and while there has been improvement with more launch activities from multinationals this year, the most significant factor has been the growing involvement of these smaller companies. Additionally, many of the largest firms are seeing increased activity as more employees return to their labs to develop products, a process that was quite challenging for them over the past year due to remote work. We're noticing improvements in the U.S., parts of Europe, and parts of the Asia-Pacific region. China, for example, is largely open for business, and there is broad access to customers. Given that China faced significant COVID challenges early on, it offers a potential model for what we might expect in other regions of the world.

Mark Connelly, Analyst

That's helpful. And just a second question. The weather that Ghansham mentioned, are you concerned about the impact on your dehydrate natural products business? Do we have to worry about whether extremes creating more volatility there?

Paul Manning, Chairman, President and CEO

Well, weather moves in cycles. And so we've had to respond to that for decades in that business. And so like any agricultural company, you have times where the yield is what you expect, and sometimes it's a little bit more, sometimes it's a little bit less. And so the early indications for this year's crops are good in terms of yields. And so, yes, we grow in a fairly broad area. So while there may be drought-like conditions in some other parts where we're growing, may be just fine. And so I think the footprint for where we're growing is diversified enough at this point that I would not be ringing any alarm bells for our business there. And as much as we talk about the other parts of our business, say, natural colors, for example, or extracts, where we're either growing or working with contract growers, there again, having a diversified growing base has been a big, big part of our strategy for many years for this very reason. So I think we're very well prepared for it. And again, I think the biggest factor there is the footprint could really safeguard against any really catastrophic weather event that we could face.

Mark Connelly, Analyst

Sure. If I could just squeeze in a quick one for Steve. Last quarter, we had a couple of unusual impacts on cash flow with the incentives. Is there anything like that this quarter or that we should be thinking about for the second half?

Steve Rolfs, Senior Vice President and CFO

No. So you're right, year-to-date, if you look at our cash flow, it is down partly because of the incentive payments early in the year versus last year. But the main impact you see in this quarter is just with the rising sales, a little bit of working capital usage, particularly in receivables. So last year, Personal Care sales were declining. This year, they're increasing. So that is the main factor. And I don't have anything to call out other than that for the rest of the year.

Operator, Operator

Your next question is from Heidi Vesterinen with Exane BNP. Please go ahead.

Heidi Vesterinen, Analyst

First question on your upgraded top-line guidance. Which segment is driving this? And is this driven by volume, or price, or both? That's the first question.

Paul Manning, Chairman, President and CEO

Okay. So I would tell you, it's pretty broad-based. We're seeing good growth in flavors, in natural colors. We're seeing it in Personal Care. I would say Personal Care is probably going to be a little bit higher than the others at this point because there's a fair amount of recovery built into that number. Up until now, it's really been volume. I would suggest that there was very little price impact in the first half of the year. But as we get into the second half, it's going to be volume and price that's going to be driving that top line.

Heidi Vesterinen, Analyst

And digging into Personal Care, so you sound very upbeat on the outlook. Can you talk about what you're seeing in each region? And do you have a view on when we might get back to pre-pandemic levels in each region, please?

Paul Manning, Chairman, President and CEO

The regions have been experiencing interesting cycles. We categorize them into four areas: Latin America, Europe, Asia, and North America. Currently, Europe and North America are showing the strongest recovery. We're seeing significant growth in color cosmetics and hair care, while skin care has remained stable in those regions. Latin America has been a robust and growing market for us, with an exceptional performance last year. However, we're now witnessing a slowdown primarily due to COVID-related factors. In 2020, despite the challenges posed by COVID, we and our customers managed to perform well, resulting in a strong year. At this moment, the COVID impacts are becoming more pronounced for our customers and populations, leading to a temporary dip in growth in Latin America. In Asia, the situation varies by country. Overall, they did reasonably well last year but are subject to fluctuations depending on lockdowns, which create a lot of instability in the outcomes there. Lockdowns seem to be inconsistent, coming and going, but I believe Asia should be well-positioned for the latter half of the year. In summary, Europe and North America are anticipated to drive significant growth in the latter half. I hope Latin America can navigate through its current COVID challenges and regain a stronger position as we move into 2022. Asia's performance could vary, but overall, we expect Personal Care to have a strong second half now that plant utilization has improved. This improvement will enhance operating leverage, contributing positively to both revenue and profitability for the Color Group. Additionally, we are also experiencing commendable growth in natural colors, which will support this growth trend.

Heidi Vesterinen, Analyst

And then as a final one, when we look at flavors, extracts and flavor ingredients, very nice double-digit growth. Could you give some color on the three parts?

Paul Manning, Chairman, President and CEO

Sure. Flavors has traditional sweet, savory, and beverage segments showing double-digit growth, performing well in most regions. We are continuing to focus on this part of our product line. Our ingredients have increased, showing high single-digit growth. For S&I, we are seeing mid-single-digit growth. Overall, this places us in the high single-digit growth category, indicating strong performance across the board. However, there is still much work ahead. We have numerous customers to engage with and many opportunities to seize, so I feel very optimistic about our growth prospects moving forward.

Operator, Operator

The next question is from Mitra Ramgopal with Sidoti. Please go ahead.

Mitra Ramgopal, Analyst

First, I just want to follow back up a little more on the Personal Care side. I know you're very upbeat in terms of outlook there. And the one thing I think is a concern for some is with the surge of delta variant in places like the market that has already had a difficult time, people returning to the office, etc., this might sort of prolong that. And I'm just wondering if we do have that kind of a situation, if you still feel very upbeat or bullish in terms of that business recovering even faster than you've seen so far?

Paul Manning, Chairman, President and CEO

I prefer not to comment on public policy regarding government responses to the delta variant or any other changes related to COVID. However, I believe there is a significant number of countries and customers that will contribute to growth. Looking back at 2020, we really hit a low point in that business. Now, with many parts of the world reopening and others becoming more active, consumers are engaging with these products, which gives me confidence. Asia remains somewhat unpredictable due to fluctuating lockdowns, impacting the market there. In contrast, I expect continued momentum in Europe and the Americas, particularly in North America. Our pipeline, customer launch activities, and sample requests all indicate a positive outlook for the latter half of this year and into early 2022. As of today, that's my perspective. We're also diversifying our product line. Historically, color cosmetics were a strong part of our portfolio, but we've expanded into hair care, skin care, oral care, and bath and shower products. Some of these categories performed well in 2020 because they didn’t rely on social interaction, such as skin care. For these reasons, I believe the second half of the year will be strong. Currently, our daily sales data looks promising for July, August, and September, reinforcing my confidence based on the numbers and customer activity.

Mitra Ramgopal, Analyst

Okay. No, that's great. And then just I think you mentioned this earlier, but as it relates to the supply chain challenges as some companies have communicated, for example, demand is not the issue. Just getting the product out is just a shortage in terms of trips or getting sort of to move the product. Just wondering if you have any of those issues on your end?

Paul Manning, Chairman, President and CEO

Okay, yes. It seems there was a bit of a connection issue during your question. However, I believe you're asking about the overall supply chain challenges. It's indeed difficult to acquire resources and carriers, as you've read in the news. Friction is an inherent part of running a business, and we hold our managers and the teams overseeing our plants and supply chains accountable for delivering results. Regardless of whether the circumstances are challenging or favorable, meeting our commitments is essential. Our emphasis on timely delivery and fulfilling our customers' needs remains unwavering. This commitment is a significant reason for our successes last year and our ongoing achievements this year. We expect our teams to navigate these challenges effectively. In some situations, we manage by increasing safety stock, while in others, we find various approaches to ensure our supply chains meet customer expectations. Yes, conditions are tough, but that's precisely why we employ capable leaders who can tackle such challenges, and I can confidently say we're managing these situations well. Labor shortages are a topic of discussion, yet good recruiters excel regardless of the environment. Similarly, proficient plant managers can produce effectively no matter the circumstances, and these are the high expectations we have for our team. I am optimistic about our ability to cope with challenges such as inflation and shipping issues, thanks to our dedicated workforce. For us, it's all about achieving results, and this culture is evident across all our locations and business lines. Our employees are well aware that the expectation is to deliver for our customers, without excuses. This situation exemplifies that expectation in action.

Mitra Ramgopal, Analyst

Okay. No, that's great. And then finally, just if you could provide maybe a little more color on the Flavor Solutions acquisition. Now with the divestitures pretty much behind you, the appetite for being even more aggressive on that front and if it's going to be more technology driven like we saw with Flavor Solutions.

Paul Manning, Chairman, President and CEO

Yes, we have a lot of positive aspects regarding Flavor Solutions. It contributes approximately $10 million in revenue and enhances some of our technology platforms. As I've mentioned in previous calls, no flavor company has complete control over every case modulation technology. For instance, a flavor company might excel in sweetness enhancement for a specific drink, but that doesn’t guarantee effectiveness in all sweet-related applications. The ability to offer complementary technologies and a wide range of solutions is what defines a strong flavor company, and Flavor Solutions adds to that capability. They possess a solid library of reaction flavors and have built strong customer relationships over the years. Contrary to the perception that only large flavor companies have access to top customers, Flavor Solutions has demonstrated that they can provide excellent products to their clients. This is one of the reasons we believe in their potential. Additionally, we prioritize ease of integration without major cultural challenges, and there is a strong cultural alignment between our companies. We share a commitment to customer-centric practices, which is evident in both our sensing and flavor solutions. I am very optimistic about Flavor Solutions. Regarding acquisitions, we seek reasonable opportunities—those that can be acquired at fair multiples, easily integrated, and added to our business. Flavor Solutions meets all those expectations. Looking ahead, I have a list of businesses we’re interested in, and we might discuss more later in the year. However, we won’t rush into anything that isn’t strategically or financially sound for our company, so we will maintain our discipline. But yes, we do anticipate having more updates as we progress into the future.

Mitra Ramgopal, Analyst

Okay. No, that's great. And before I go, congrats on the box. Great .

Steve Rolfs, Senior Vice President and CFO

Congratulations on the box.

Paul Manning, Chairman, President and CEO

Yes. Thank you. I can't say I had much to do with that, but I enjoyed watching them on TV.

Mitra Ramgopal, Analyst

It's nice to enjoy it. There you go.

Operator, Operator

The next question is from Leigh Ferst with HighTower Advisors. Please go ahead.

Leigh Ferst, Analyst

I have a follow-up question about inflation. I understand you can usually pass along inflation in the form of price, and I understand that's a moving target with the supply chain right now. But is there any ingredient or any price point where you would get concerned that you could not pass on price and protect your margins?

Paul Manning, Chairman, President and CEO

I'm not going to say that every product meets the expectations of all customers. In some cases, we have the ability to create alternatives to our existing formulations. Overall, I believe we're going to end up in a favorable position, and I have considerable confidence in that. This confidence stems from observing market trends and our historical pricing performance. I don't foresee any significant issues arising, as no single raw material will undermine our business. One of the advantages of our ingredient business is the diverse supply of raw materials, which offers some protection against widespread inflation. In summary, we're managing this situation effectively, and I have no doubts about our capacity to navigate it, just as we've successfully done in the past.

Leigh Ferst, Analyst

And in terms of the acquisition, can you give us any more insight into their end markets or end products that they're complementary to what you're doing already? Or if there's something new? And also, what is the deal environment? Is there more competition for acquisitions right now?

Paul Manning, Chairman, President and CEO

Sure. When discussing Flavor Solutions, it's important to note the complementary technologies in taste modulation. These technologies allow for sweetness without as much sugar and a salty sensation without excessive salt. They enhance our savory flavors platform. Regarding potential acquisitions, many companies are involved in auction processes, while others develop relationships over time that may lead to an acquisition. In some cases, we might choose to license instead of acquiring fully, allowing us to obtain what we need without the complexities of an acquisition. The competitiveness of acquiring a company hasn't changed much over the years; it primarily depends on the seller's willingness to sell. Not every company is on the market, as many are family-owned for generations and are not interested in selling. Timing and mutual financial benefits are key factors in these situations. Overall, I haven't noticed anything particularly unique about the current landscape regarding the types of businesses we are considering, although others might have differing views.

Operator, Operator

There are no further questions at this time. I will turn the conference back over to the company for any closing remarks.

Steve Rolfs, Senior Vice President and CFO

Okay. Thank you very much for your time this morning. That will conclude our call.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.