Earnings Call Transcript - SXT Q2 2020

Operator, Operator

Good morning, and welcome to the Sensient Technologies Corporation 2020 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 also note that today’s 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. I'm Steve Rolfs, Senior Vice President and Chief Financial Officer of Sensient Technologies Corporation. I would like to welcome all of you to Sensient's conference call to discuss 2020 second quarter financial results. I'm joined this morning by Paul Manning, Sensient's Chairman, President and Chief Executive Officer. This morning, we released our 2020 second quarter financial results. A copy of the release and our investor presentation is now available on our website at sensient.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 results should not be considered in isolation from or as a substitute for financial information calculated in accordance with GAAP. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is available on the Investor Information section of our website at sensient.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 in responses to your questions, may include forward-looking statements. Our actual results may differ materially, particularly in view of the uncertainties created by the COVID-19 pandemic, governmental attempts at remedial action and the timing of a return of more normal economic activity. We urge you to read Sensient's filings, including our 10-K, our first quarter 10-Q and our forthcoming second quarter 10-Q for a description of additional factors that could potentially impact our financial results. Please bear these factors in mind when you analyze our comments today. Now we will hear from Paul Manning.

Paul Manning, Chairman, President and CEO

Thank you, Steve. Good morning. Sensient reported second quarter earnings this morning. I’m very pleased with the results of our flavors and fragrances group as well as our food and beverage business in the color group. Flavors and fragrances are up mid-single digits in revenue and high-single digits in operating profit during the quarter, continuing its revenue growth trend from the first quarter. We also had favorable growth in our natural colors and pharmaceutical businesses, which were up in the quarter. The growth in these businesses is offset by the adverse impact of COVID-19 in the personal care market and throughout Latin America, Europe and Asia Pacific. Despite these COVID-19 headwinds and based on current trends, we expect to deliver on our EPS outlook for the year. I'm also pleased with the progress we have made during the quarter on our divestitures. We completed the sale of our inks business and signed a definitive agreement to sell our yogurt fruit prep business. We anticipate closing the yogurt fruit prep sale in the third quarter. We continue to make progress on that divestiture of our aroma chemical and fragrance compound business. Although we have been delayed by COVID-19, we believe we can close this transaction by the end of the year. All of our production facilities are open and have been throughout the pandemic. Our on-time delivery remains high and we have successfully managed our raw materials. Our staffing and attendance at our facilities remains outstanding, and I'm very proud of the dedication of our employees. We will continue to closely monitor each of our production facilities to remain ahead of prevailing GMP and sanitation practices. As a result of COVID-19, we have incurred additional costs and we have experienced significant revenue headwinds in a number of businesses. Overall, the impact of COVID-19 has reduced our EPS by approximately $0.10 year-to-date. The impact of COVID-19 on our food and beverage business is mixed. However, the impact is significantly negative for our personal care business. Now let me turn to the groups. The flavor group had another nice quarter. Adjusted local currency revenue for the group was up 5.7%. The group continues to experience positive sales growth in the finished flavors and extract product lines, as well as an improving picture in the flavor ingredient product lines. The natural ingredients business also had a solid quarter. The overall impact of COVID-19 was negative to the group's revenue. The group's revenue growth is based on strong new wins generated throughout 2019 and the first part of 2020, retaining existing business and an overall decline in attrition, which was a lingering effect from our earlier restructuring activities. Net of these factors, we have generated mid-single digit growth year-to-date and I anticipate the same growth rate for the remainder of the year. This quarter, the flavor group returned to quarterly profit growth with adjusted local currency operating profit up 8%. The higher profit was a direct result of the higher volumes, new wins and the group's production cost initiatives. Moving forward. I anticipate continued profit growth. Overall, the group's operating profit margin was up 30 basis points in the quarter, and I would anticipate a 50 to 100 basis point improvement for the year. In summary, I expect mid-single digit revenue growth and mid to high single-digit operating profit growth for the flavor group for the remainder of the year. Within our color group, revenue for food and beverage colors was up low single digits for the quarter. Pharmaceutical had a nice quarter, up double digits and natural colors continues to grow. And that product line is up mid-single digits for the year. Similar to the flavor group, colors continue to focus on retaining existing business and improving the group's overall sales win rate. Unfortunately, the growth in food and beverage colors revenue was offset by a more than 20% decline in our personal care business revenue. While we saw some improvement in our personal care business in Asia and Latin America, the demand for makeup in Europe and North America was down substantially in the quarter. Given the uncertainty with COVID-19 and continued restrictions, I would anticipate continuing challenges for this product line in the second half of the year. In terms of operating profit, the color group achieved mid-single digit profit growth in food and beverage colors for the quarter and has generated double-digit operating profit growth for the year. However, profit in personal care in the quarter was down by more than 35% due to the lower demand in makeup and other personal care products. And that was the main reason for the color group's overall decline in profit. The color group remains focused on production takeout actions. However, these actions need more time to realize their full potential. And we do not expect that the actions will outpace the profit decline in personal care. Short of a significant opening of the world economy, I would expect the profit declines in the personal care business to continue for the remainder of the year. In summary, food and beverage colors revenue is up nearly mid-single digits year-to-date and double digits for profit. For the back half of the year, I would expect mid-single digit revenue growth and mid to high single-digit profit growth for that product line. Because of the impact of the personal care, we would expect the color group to be flat in revenue and profit for the year. Our Asia Pacific group had solid revenue growth in some regions, but this growth was offset by declines in other regions as government COVID-19 restrictions have significantly impacted many sales channels. The group delivered outstanding profit growth in the quarter, and I anticipate the group to return to revenue growth once restrictions in certain areas begin to ease. Based upon current trends, I expect Asia to deliver low single-digit sales growth and mid to high-single digit profit growth for the year. Overall for the company, we continue to focus on our supply chain. We have increased our inventory levels on certain key raw materials. And as a result, we are providing outstanding on-time delivery to our customers around the world. While we do experience supply chain disruptions, we have avoided any significant financial disruptions and we continue to reduce our overall inventory levels for the company. I'm pleased with the progress we've made in the first six months of this year. The flavor group has had a great first half, and I would anticipate this to continue in the second half. Our food and beverage colors business is also performing well. In Asia Pacific, I'm confident that the strategy and investment we have in place will return this group to revenue growth. While I'm optimistic about our food businesses, our personal care business will continue to struggle. Furthermore, the ultimate impact of COVID-19 remains uncertain. New product launches are significantly below prior year, and there has been some customer SKU rationalization. Nevertheless, our business is strong and well positioned to grow for the year. Steve will now provide you with additional details on the second quarter results.

Steve Rolfs, Senior Vice President and CFO

Thank you, Paul. In my comments this morning, I'll be explaining the differences between our GAAP results and our adjusted results. The adjusted results for 2020 and 2019 remove the impact of the divestiture related costs and the operations divested, or to be divested. The second quarter 2019 results do not include any divestiture related costs. We believe that the removal of the gains and losses connected to the businesses that we are divesting provides a clearer picture to investors of the company's performance. This also reflects how management reviews the company's operations and performance. Included in this year's second quarter reported results is a gain realized related to the reclassification of accumulated foreign currency translation as a result of the sale of the inks business, as well as other divestiture related costs, which were primarily non-cash. These items, which are included in the divestiture and other related costs, increased net earnings by $1 million or approximately $0.02 per share. In addition, this year's second quarter reported results include $28.2 million of revenue and an immaterial amount of operating income related to the results of the operations to be divested. Last year's second quarter results include $36.4 million of revenue and an immaterial amount of operating income from the operations to be divested. Excluding divestiture related costs and the results of operations to be divested, consolidated adjusted revenue was $294.9 million in the second quarter of 2020 compared to $302.8 million in the second quarter of 2019. Consolidated adjusted operating income was $40.3 million in the second quarter of 2020, compared to $47 million in the second quarter of 2019. Adjusted diluted earnings per share was $0.70 in this year's second quarter compared to $0.81 in last year's second quarter. We’ve reduced debt by approximately $60 million since the beginning of the year and approximately $120 million over the last 12 months. We have adequate liquidity to meet operating and financial needs through our cash flow and available credit lines. Our debt to EBITDA is now just under 2.7. Cash flow from operations was $107.6 million for the first six months of 2020, an increase of 41%. Capital expenditures were $21.4 million in the first six months of 2020, compared to $16.6 million in the first six months of 2019. We expect our capital expenditures to be approximately $50 million for the year. Our free cash flow increased approximately 45% during the first six months of 2020 to $86.2 million. We expect continued strong cash flow growth for the remainder of the year. Consistent with what we communicated during our last call, we expect our adjusted consolidated operating income and earnings may be flat to lower in 2020, because of the level of non-cash performance-based equity that may be deducted in 2020 based on our results. We also expect a higher tax rate in 2020 compared to our 2019 rate, which was lower as a result of a number of planning opportunities. Based on current trends, the company is increasing our GAAP earnings per share guidance to $2.10 to $2.35. This guidance now includes $0.35 to $0.40 per share of divestiture and other related costs and the results of the operations to be divested. This guidance also includes approximately $0.10 of currency headwinds based on current exchange rates. On an adjusted basis, based on current trends, we are maintaining our original estimate for the year of a range of $2.60 to $2.80, which excludes divestiture related costs, the impact of the divested, or to be divested businesses and foreign currency impacts. We are also maintaining our adjusted EBITDA guidance of low to mid-single-digit growth. Please see our press release for a simple summary table of this EPS guidance. Thank you for your time this morning. We will now open the call for questions.

Operator, Operator

Thank you. And our first question today will come from Heidi Vesterinen with Exane. Please go ahead.

Heidi Vesterinen, Analyst

Hi. Good morning. So, Paul, I think you said in your opening comments that COVID was a net negative for flavors. Could you elaborate on what you meant if I heard that correctly? Because I thought you may have benefited from pantry loading; a lot of your peers are talking about that. And then as a related question, I guess, to finish on flavors, some of your peers have talked about pressure in food service. Did you see that as well and how big is your exposure to this area? That's my first two questions. Thanks.

Paul Manning, Chairman, President and CEO

Good morning, Heidi. Yes, I would agree that COVID was a net negative for flavors. Looking at revenue, while some segments like processed foods and soups saw an increase, others such as ice cream, confectionery, and beverages experienced declines. From a sales channel perspective, we faced significant challenges, particularly in the QSR sector across various regions, affecting not just flavors but also colors, especially in Asia Pacific. However, traditional retail food outlets did not encounter the same challenges. As COVID has progressed, it has impacted countries at different times; currently, Latin America is experiencing significant challenges, which began towards the end of Q2 and continue into Q3. In Europe, we see an improving situation, and the U.S. has also shown improvement. Overall, considering all these factors, we would classify the revenue situation as a net negative. This also affects profit, especially due to increased costs related to cleaning, PPE, air freight, and other logistical issues. Additionally, much less travel has compounded these challenges. Overall, while there were some favorable aspects, many factors negatively impacted the flavors group.

Heidi Vesterinen, Analyst

Thank you. And then, separately, there’s a view out there and some peers have talked about this, that smaller customers are challenged. You have historically said that you work a lot with the so-called B and C customers. So have you seen any smaller customers being challenged? There's a general view that larger multinationals are winning. So, what's your view there?

Paul Manning, Chairman, President and CEO

My view is that the situation is quite mixed. In some areas, multinationals have definitely reduced their product offerings. There are also multinationals that are closely tied to certain channels, such as quick service restaurants, which are not performing particularly well. Conversely, some smaller local brands are proving to be essential to the markets they serve. Overall, I would say there is a noticeable decrease in the number of product launches for our business, whether they are smaller B and C types or larger A types. However, it seems to me that we are witnessing more activity in product development at the B and C levels as we consider what to develop now and in the future, following the pandemic. Additionally, I observe more activity overall among customers and employees returning, particularly in some of these B and C categories compared to several A categories.

Heidi Vesterinen, Analyst

Thank you.

Paul Manning, Chairman, President and CEO

Okay. Sure thing.

Operator, Operator

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

Mark Connelly, Analyst

Thank you. I'd like to follow up on that. What type of product development are you seeing? Have you noticed a change in your customers' priorities? It seems like gluten-free options are less popular now that people are baking bread again. Are your customers moving more toward the food as medicine trend, or is there simply a faster pace of activity overall?

Paul Manning, Chairman, President and CEO

Yes, that's a great question. When I mention pantry loading, a lot of that involves processed foods or items with longer shelf lives, which typically do not align with the natural nutraceutical profile that gained attention during COVID, as these usually have shorter shelf lives. I can say that there is significant interest in functional and nutraceutical attributes among customers. For instance, our Pharmaceutical business is performing well, with strong sales of functional ingredients that are suitable for both over-the-counter pharmaceutical applications and nutraceutical uses. We are observing considerable activity in that area. In personal care, while the makeup segment faces challenges, there is a growing interest in a category similar to the nutraceutical market known as cosmeceuticals. These are cosmetic products that offer functional benefits for the skin, hair, or other features people want to enhance. This area is seeing heightened activity, surpassing what we encountered even before COVID-19. However, given that product development has slowed down substantially, in some cases coming to a halt at certain companies, it's accurate to say that there has been a decline in interest for certain gluten-free products and others. Moving into 2021 and 2022, it will be intriguing to observe how the market reacts and how quickly customers return to prioritizing fresher, healthier, and more natural products, as well as the continued focus on more traditional or legacy products at our customers. While I can't provide a definitive answer on that yet, I can confirm that there is a lot of activity regarding the functional nutraceutical aspects of our products across pharma, food, and personal care.

Mark Connelly, Analyst

It's helpful. Just two more things. First, with the administration basically saying Phase 2 is no longer a priority or at least no longer a near-term priority, does that cause you to shift any of your Asia Pacific priorities? I know China is not a big market, but I'm curious whether China is causing you more competition over there now?

Paul Manning, Chairman, President and CEO

Every country has a unique approach to governmental policies, and even within a single country, various local governments may create their own programs. This leads to differing situations and timelines across regions. Our stance is that we are an essential business and will continue our operations. If customers are interested in developing new products, we are eager to assist as our labs remain open. We are also equipped to support existing products, and our on-time delivery remains exceptional. Typically, our business model, similar to many others in the ingredients sector, focuses on producing locally for local customers in their respective markets. For instance, we manufacture in China specifically for the Chinese market. We do not export many, if any, products from China to the U.S. or other regions. This local model will persist, which has been advantageous for us, as it minimizes logistical challenges when sourcing manufacturing, product support, and supply chain services tailored to local customers.

Mark Connelly, Analyst

Okay. And just one last question. Working capital was quite a bit better than we expected and better than what I'm seeing elsewhere. Is there anything we should be thinking about for the second half?

Steve Rolfs, Senior Vice President and CFO

We have been focused on this initiative for the past year and a half. We are exercising tight control over our inventories, receivables, and payables. Over the last 12 months, we have done well with inventory. In this quarter, like Paul mentioned, we encouraged some of our businesses to stock up on specific raw materials, leading to some investments in inventory. However, we performed well with receivables, reducing our receivable days by about one day. Additionally, we are seeing a better mix of cash earnings from the business this year, which is aiding our cash flow.

Paul Manning, Chairman, President and CEO

But I would also say this, we certainly have more work to do on reducing our inventory levels throughout the company. We've taken many, many days out, not only on the trailing 12 months, but even on the trailing 6 months. So, we've got a lot of supply chain initiatives that probably have a lot less to do with specifically serving customers, but they have a lot more to do with generating internal cash and improving efficiencies. There's a lot more of that underway. So I would anticipate we have inventory reductions well into the rest of the year and into next year. And so that, that could be something to anticipate for everybody.

Mark Connelly, Analyst

Very nice to see in this environment. Thank you.

Operator, Operator

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

Mitra Ramgopal, Analyst

Yes. Hello and good morning. Thanks for taking the questions. First, I just wanted to clarify something. Paul, you mentioned that COVID has had about a $0.10 impact on EPS for the half. I wanted to confirm whether that is a net number or just reflects the headwinds you've been experiencing, since I know there have also been some benefits.

Steve Rolfs, Senior Vice President and CFO

Sure. So, Mitra, that is a net number. So we really, we looked at the sales impact, which Paul spoke to. We looked at the one-time costs. And then we've also fortunately had some offsetting savings in the area of travel. So when you net all that together, that was $0.10 year-to-date. I think there may have been a little bit of positive impact in Q1 and a little bit of a greater negative impact in Q2, but year-to-date net of $0.10.

Mitra Ramgopal, Analyst

Thank you. That's great. Regarding the divestiture, you are making good progress with the sales. I have a couple of questions about that. First, how will the proceeds be used, specifically for debt reduction? Also, as you navigate this process and considering the effects of COVID, has this impacted your long-term growth strategy, especially concerning the remaining businesses and possible areas for increased activity?

Paul Manning, Chairman, President and CEO

The proceeds from the divestitures will be used to reduce debt. We've significantly reduced our debt over the past year, and our debt to EBITDA ratio is now just below 2.7, specifically 2.68, which I monitor closely. This will remain our primary focus for now. While we will consider other uses for our cash, our immediate plan is clear. Regarding our business strategy, we've been actively pursuing a diversification program in cosmetics, exploring how our technologies can better serve the skin care market and other personal care categories, such as oral care and hair care. COVID-19 has actually accelerated our entry into these segments, and we have a strong product line that fits well in these areas. There is substantial customer demand for our products across the Americas, Asia, and Europe, which gives us confidence in this growing market. It's a robust technology-driven market, and we believe we can achieve significant success. Additionally, we will continue to focus on colors and flavors, and we are starting to demonstrate our capability to succeed with this strategy. I am optimistic about our progress for the remainder of the year and into 2021.

Mitra Ramgopal, Analyst

Okay, that's great. I'd like to follow up on that. Regarding COVID, how do you perceive the competitive landscape and could you provide an update on the raw materials and your ability to implement favorable pricing?

Paul Manning, Chairman, President and CEO

Let me address the first part. Regarding raw materials, we proactively prepared for the situation earlier this year by strategically sourcing our key raw materials, particularly those with higher sensitivities. This effort has been significant. However, having raw materials alone isn't enough; effective production and supply chain management are critical. Our team has excelled in this area, contributing to robust results across production, quality, and lab support. I am optimistic about our supply chain moving forward and will continue to monitor it in light of potential lockdowns, adopting a cautious outlook. It is essential to deliver on time to our customers, and presently, our delivery performance is better than it was pre-pandemic. Our team is committed, understands their objectives, and is motivated to achieve them. As for competition, we engage with various companies around the globe across multiple product lines. We're pleased to take advantage when competitors are struggling, which allows us to better serve our customers. That sums up my thoughts on that matter.

Mitra Ramgopal, Analyst

Okay, that's great. Finally, Steve, I was wondering where there might be some leverage in the model. I noticed that selling and admin costs in the first half and the second quarter are quite similar to what we saw in the first quarter. How should we consider the second half in light of the ongoing divestitures?

Steve Rolfs, Senior Vice President and CFO

Yes. So I think any increase that you saw in SG&A in the quarter, again was attributable to primarily incentive accruals. We're actually watching SG&A very closely and getting some benefits from the reduced travel that we see right now. With this type of volume growth, particularly in flavors, we should continue to see good operating leverage. We've spent a number of years rationalizing our production footprint. We have SG&A capable of supporting significant growth without having to make new investments. So with revenue growth, we should be able to generate good operating leverage.

Mitra Ramgopal, Analyst

Okay. Thanks again for taking the questions.

Paul Manning, Chairman, President and CEO

Okay. Thanks, Mitra.

Operator, Operator

At this time, there are no further questions. I would now like to turn the conference back to the company for any closing remarks.

Paul Manning, Chairman, President and CEO

Okay. Thank you everyone for your time this morning. That will conclude our call. Goodbye and have a good day. Thank you.

Operator, Operator

Thank you. The conference has now concluded. You may now disconnect your lines.