Sensient Technologies Corporation (NYSE:SXT)
Q4 2015 Earnings Conference Call
February 5, 2016 11:00 am ET
Paul Manning - President, CEO
Steve Rolfs - SVP, CFO
Brett Hundley - BB&T
Good morning, everyone and welcome to the Sensient Technologies Corporation 2015 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 am 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 2015 fourth quarter and full year financial results. I am joined this morning by Paul Manning, Sensient's President and Chief Executive Officer.
Yesterday, we released our 2015 fourth quarter and full year financial results. A copy of the release is now available on our Web site 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 measures remove the impact of restructuring costs, acquisition related costs, currency movements and other costs as noted in the company's filings.
Non-GAAP financial results should not be considered an 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 measures is available on the Investor information section of our Web site at www.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 the 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 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 will hear from Paul Manning.
Thanks Steve. Good morning.
Sensient reported adjusted earnings per share of $0.71 in the fourth quarter equal to the EPS reported in the comparable period last year. Foreign currency translation reduced earnings per share by $0.04 in the quarter and in local currency adjusted EPS increased by 6%. And local currency revenue grew 5% and adjusted operating income increased 3%. Most of our businesses performed very well in the fourth quarter, in local currency the flavors and fragrances groups operating income grew 8% and its operating margin improved by 100 basis points.
The Asia Pacific Group's operating income was up about 5% of local currency. And within the color group, the food color, cosmetics and pharmaceutical businesses all reported solid profit growth in local currency, but the color group's operating income declined due to the performance of the specialty inks business.
For the full year Sensient reported adjusted earnings per share of $3.05 compared to $3.02 in 2014. Foreign currency translation reduced adjusted earnings per share by $0.22 in 2015 and in local currency terms adjusted EPS grew 8% for the year.
In local currency, revenue increased by 3%, adjusted operating income was up 2% and the adjusted operating margin was 15.3%.
The flavors and fragrances group has strong capabilities in sweet, beverage and savory flavors, natural ingredients and fragrances. We are progressing with our efforts to ship the group's product mix from simple ingredients to more complex flavors, flavor systems and fragrances.
We are also making progress with our restructuring program and other efforts to lower costs. The combination of upgrading our product mix and reducing our cost structure has improved the group's margins and will enable us to deliver sustainable profit growth and additional margin improvement.
The flavors and fragrances group had a strong fourth quarter with most of the groups businesses reporting operating profit growth in local currency. Removing the impact of exchange rates, the group's revenue grew by 4% and its operating profit increased 8%.
The group's operating margin increased 100 basis points to 13.7 in the fourth quarter. The growth was broad based with most of the group's businesses showing solid growth and margin improvement.
For the year, the group's revenue was up 3% and operating profit grew by 4% in local currency and operating margin improved to 14.9%. The flavors and fragrances group performed well in the 2015 particularly in the second half of the year.
We are progressing with our restructuring activities; I'm looking forward to completing the restructuring in 2016. We stopped production in two of our flavor facilities in Europe during the fourth quarter and we expect our last facility closure to take place in the second half of this year.
When we initiated the restructuring plan, we estimated that the annual cost reductions would be approximately $30 million. The U.S. dollar has strengthened considerably since we initiated the plan and based on our current exchange rates, the dollar value of the same cost savings is approximately $22 million. Said differently, foreign currency movements have reduced the original savings expectations by approximately $8 million.
However, the company responded by identifying additional cost savings opportunities and implementing price increases to mitigate the impact of foreign currency movements. As a result of these actions, we still expect the total benefit of the plan to be approximately $30 million.
To-date, we have realized approximately $12 million of the cost savings including $9 million in 2015. We expect to achieve another $6 million to $7 million of incremental savings in 2016 with the full benefit to be realized in 2017.
Overall, I was pleased with the group's performance. The group delivered mid-single digit profit growth in 2015 and its margins improved nicely. Our strategy is coming together and I have high expectations for 2016.
For 2016, we are expecting local currency revenue growth to be in the low to single -- mid-single digits with high-single digit profit growth and additional margin improvement. We are closing in on our near term goal of operating margins in the high teens. Our longer term goal for operating margins remains at 20%.
Sensient's color group is a global leader for food and beverage colors and we have the unique ability to provide both synthetic and natural color solutions to our customers. We also have strong capabilities in cosmetic ingredients, specialty inks, pharmaceutical excipients and industrial colors. Most of the color group's businesses reported strong local currency profit growth in the fourth quarter. But, the group's results were down because of the specialty inks business.
In local currency, the color group's revenue increased 7% and its operating income declined 8%. Excluding the specialty inks business, the group's revenue was up 12% and operating income increased 16% in local currency.
The food color, cosmetics and pharmaceutical businesses each reported strong revenue and operating profit growth in the quarter. Removing the impact of exchange rates, the food color business reported revenue growth of 14% and profit growth of 24%. Our sales of food colors in the fourth quarter included a one-off sales natural colors. Excluding these sales, the food color business still had strong results with revenue growth of 8% and profit growth of 9% in the quarter. Cosmetics and pharmaceuticals each reported double-digit revenue growth and strong profit growth and local currency in the fourth quarter.
For the year, the color group's revenue increased 1% and its operating income was off 8% in local currency. Removing the impact of exchange rates, the food color, cosmetics, pharmaceutical businesses all had good years with each business reporting at least mid-single digit revenue and profit growth. Excluding the specialty inks business, the group generated local currency revenue growth of 5% and local currency operating income grew by 8%. Throughout the last year, I noted several issues in our specialty inks business including a shift in customer demand toward natural fibers, production quality issues and the revaluation of the Swiss franc.
Prior to 2015, Sensient's inks business had delivered solid results. The business had a very strong second half in 2014, which created a difficult comparison in this year's fourth quarter. Despite the difficult year, we continued to see very good long-term opportunities in the digital inks market. The shift from analog to digital printing is a major trend that still in its very early stages. And we have made the investments necessary to take advantage of that trend.
The Xennia acquisition also improves our position in this market by strengthening our technical capabilities and broadening the product portfolio for the inks business. We are expecting better results from this business in 2016, starting in the first quarter and we expect the growth to improve sequentially throughout the year.
There continues to be strong interest in natural colors for food and beverage applications. Throughout 2015, many of the leading consumer products and food service companies made public commitments to use natural colors in their U.S. products. We have made significant investments in our natural colors business and we are ready to assist our customers in making these conversions.
Our natural color sales are showing strong growth with double-digit sales growth in the quarter. We had significant wins in North America during 2015 and both the number of natural color projects and their value have increased significantly over the last 12 months. Sensient is the market leader for food and beverage colors and we are very well positioned to lead the conversion to natural colors over the next few years.
Our food, cosmetics and pharma businesses are strong and we expect each of those businesses to perform very well in 2016. We also see a significant recovery from the specialty inks business. Removing the currency impact, we are expecting the color group to produce mid-single digit revenue growth and high-single digit profit growth in 2016.
The Asia Pacific group had solid results for both the fourth quarter and the year. Excluding the impact of currency, revenue increased 10% and operating income increased 5% in the fourth quarter. For the full year, revenue and operating income increased by 4% and 7% respectively in local currency.
We are increasing our presence in this region adding a regional R&D center in Singapore and localizing the manufacture more of the products that we sell in these markets. For 2016, we are expecting mid-to-high single-digit revenue growth and high-single digit profit growth in local currency.
Corporate costs were down significantly in 2015 primarily due to lower performance based compensation. Both our annual cash incentives and our long-term equity awards are closely aligned with the company's performance. Our results in 2015 were impacted by the decline in our inks business, but the effect of the downturn was mitigated by lower cost for performance based compensation. In 2016, these corporate costs will continue to be tied to our performance. As our performance improves, these costs will return to a more normalized level.
Looking ahead, the strong dollar will have a significant impact on our 2016 expectations. The dollar began strengthening against most currencies beginning in 2014 and it continued to get stronger throughout 2015. While the moment in the euro has been modest, many other currencies have weakened significantly in the last six months.
The current exchange rates for the Mexican peso, Brazilian real, British pound, Canadian dollar and most of the Asian currencies are off significantly from last year's rates. And this will have a negative impact on our U.S. dollar results for 2016.
On a local currency basis, our 2016 adjusted EPS range is $3.30 to $3.40. Based on our current rates, the currency impact will be approximately $0.15 which reduces our adjusted EPS guidance to a range between $3.15 and $3.25.
In summary, 2015 was a good year for Sensient and we are expecting a better year in 2016. We share the company's success with our shareholders in 2015 increasing our quarterly dividend to $0.27 per share in the third quarter and repurchasing more than 2.7 million shares during the year including 200,000 shares in the fourth quarter.
Over the last two years, Sensient has repurchased approximately 5.2 million shares and in total, the company returned about $225 million to shareholders in 2015 and more than $400 million since the beginning of 2014. It was a successful year for the company and its shareholders and I'm optimistic about the company's future.
Steve Rolfs will now provide you with additional details on the quarter.
Thank you, Paul.
In the fourth quarter Sensient reported revenue of $339.2 million and operating income of $31.6 million, which includes $15.1 million of restructuring and other costs. Excluding these costs, fourth quarter adjusted operating income was $46.7 million. Foreign currency translation reduced revenue by 6% and adjusted operating income by 5% in the quarter.
Diluted earnings per share from continuing operations were $0.43, compared to $0.55 in last year's fourth quarter. Restructuring and other costs reduced earnings per share by $0.28 in this year's fourth quarter and $0.16 per share in the capital period last year. Adjusted earnings per share from continuing operations were $0.71 in both this year's and last year's fourth quarter. Foreign currency translation reduced adjusted EPS by 6% or $0.04 per share. In local currency, adjusted earnings per share grew 6%.
Sensient's revenue was $1.38 billion in 2015 and $1.45 billion in 2014. Foreign currency translation reduced revenue by 7.4% and in local currency revenue increased by 2.5% for the year. As reported operating income was $166.3 million in 2015 compared to $130.7 million in 2014. Operating income included restructuring and other costs of $43.6 million and $90.6 million in 2015 and 2014 respectively.
Adjusted operating income was $210 million in 2015 and $221.2 million in 2014. Foreign currency translation reduced adjusted operating income by 7% and in local currency adjusted operating income grew by 2%.
Earnings per share from continuing operations as reported were $2.32 in 2015 and $1.67 in 2014. Restructuring and other costs reduced reported EPS by $0.73 in 2015 and $1.34 in 2014.
Adjusted earnings per share were $3.05 this year and $3.02 in 2014. Foreign currency translation reduced adjusted EPS by $0.22 or 7% in 2015. Adjusted earnings per share increased by 8% in local currency.
Cash flow from operations was $128 million in 2015 and $189.2 million in 2014. The lower cash flow is primarily attributable to currency impact higher restructuring payments and higher receivable balances. Capital expenditures were $80 million in 2015 and we expect 2016 capital expenditures to be between $75 million and $85 million. This number should decrease in 2017 to between $60 million and $70 million as we moved beyond the significant restructuring related capital spending that has taken place over the last two years.
We remain focused on our return on invested capital and adjusted return on invested capital increased 30 basis points to 10.5% in 2015. We expect to see at least a comparable improvement in 2016.
Our balance sheet is strong. Our year end debt balance is at 2.5x adjusted EBITDA. We plan to keep debt levels in line with an investment grade profile to maintain the flexibility for capital expenditures, dividend payments, share buybacks and acquisitions. We will continue to evaluate opportunistic share repurchases as part of our capital allocation strategy. But we don't expect our 2016 activity to be as significant as it was in the last year.
Thank you very much for your time this morning. We will now open the call for questions.
[Operator Instructions] Your first question comes from the line of Brett Hundley with BB&T.
Hey, good morning, guys. And thanks for taking my question.
Good morning, Brett.
Good morning, Brett.
Steve, just real quick on something you just mentioned, is there a reason in particular that you wouldn't expect 2016 share repurchase to be as robust year-on-year at this point?
I think the only thing I would say is, we will look at it opportunistically. One of the reasons, we've been able to do what we have is because where our leverage ratio was. We are very comfortable with where it is now. But, as to how much share repurchase we do, it's going to depend on one of the attractive acquisition opportunities. So we do want to keep the flexibility to do acquisitions and to some extent share repurchase is going to be the variable that we used to fill-in based on what opportunities we see in acquisitions.
That's helpful. And I don't know, if I'm just doing incorrect math here relative to what you guys provided in your prepared comments and I appreciate the color by the way on the currency aspect of things, I think I under-appreciated some of the other currencies that you had exposure to and the weight against down the wall with your cost savings, those good color on your cost savings expectations. But I'm getting a lot of questions on margins.
And I had a couple myself. When I tried to adjust for currency at both of the revenue and earnings line. And I look back at 2015, I mean you guys ended the year with really solid currency neutral sales growth in your two main segments. I just didn't see it translate to profit the way I thought it would. And so I just want to get qualitative, quantitative color for you guys. If I try and adjust for currency, at both the top line and middle of the P&L, I get improvement in your flavors margin for sure, but on the consolidated earnings basis, again, adjusted for currency, I kind of get flattish operating margins year-on-year. And I think most of that is due to the issues in the color segment with specialty inks. I guess, I would have expected better performance in flavors with some of the culling you guys have been doing and some of the cost savings work. So anyway just want to match that up against your expectations and get an answer from you on that?
Yes. Let me address first part of it, Brett. And then I will let Steve reflect on the math behind the revenue and earnings and how that nets out. I think that, yes, as you look at color, the biggest impact on the operating margin there was certainly the inks business. As I reflected on or as I commented in the script, each of the other segment food, pharma, cosmetics, each had very nice revenue growth along with operating profit growth of a typical nature. In other words, the operating profit growth exceeded the revenue growth. It's kind of the leverage that we were able to obtain. Because the inks business was typically -- it runs typical -- a little bit more profitable than the average on a gross margin basis because that was a disproportionate fall out. I think that's why you see the operating margin impact as you did the color group.
So the flip side of that is, as we expect and have guided towards significant improvement in that business in 2016, I think you will see the reversal of the operating margin impacted that business had in 2015 much improved in 2016. So certainly that would be our expectation. I think color would be very much back on the track towards where we had been operating in the low 20% category with potentially in a longer term even additional upside on that.
As you look at flavors, certainly I wanted -- I want to be at a pace or getting at least a 100 basis point improvement in the operating margin on a quarterly basis. I think we certainly demonstrated that improvement in the second half of the year. Again, to some degree the magnitude and the pacing may very well be related to the culling efforts. Some of those again, the culling, it's a deliberate attempt to price ourselves at a more profitable level and we may lose that volume.
In other cases, it maybe dispositioning of product lines in some form or fashion. So those aren't necessarily always predictable outcomes, but I think as you saw what the revenue in the fourth quarter, obviously, we weren’t culling to the extent that we had expected that we would. And I think that's -- had you seen a little bit more of that, I think you would have seen a little bit more on the -- than the 100 basis points. But I think that's a good as you look at 2016 for flavors, you are going to continue to see the improvement in the operating margin. And again, it's the combination of culling, it's the restructuring cost savings and is the -- it's the new wins consistent with the strategic direction of the flavor group towards a more flavor technology based applications, which generate a higher operating margin, so principally a mixed issue.
The last piece on flavor is that certainly had an impact and as we look at 2016, because we look at our crop based, our natural ingredients business, the garlic crop in the U.S. and this is obviously no secret has had a two years in a row which is kind of getting into the unprecedented category, 10% reduction in yield. So what you put in the ground and what you ultimately got was off by 10% at least in each of the last two years. And that had a profound impact on the raw material cost in that business. So certainly that was an issue there on the flavor side, which I think we are certainly going to see for the first half of 2016.
But again, longer term and we see a flavors group that is more than capable of getting to that 20% operating margin. We've seen very strong improvement. I said many times before on these calls that the majority of our flavor businesses have now reached a point whether operating in the upper teens and low 20 operating margin. The handful of businesses that are not and have not historically each had a significant improvement in operating margin in the fourth quarter and the second half of the year. So I think the approach we are taking is working. It's working particularly well in those businesses and it's raising the operating margin of those business that's going to lift the overall group's margin as you look at 2016 and beyond.
So hopefully that gives you a little of context and somewhat background on the operating margin and how I'm seeing that one.
Well, I will add garlic to the list of crops that I watch every year. Two other questions, one can be quick here -- maybe a quick answer from you guys. Your guidance for 2016 disappointed me because I had underestimated the impact from currency. But even x-currency [indiscernible] what I was expecting and Paul, Steve, just a kind of build up from the expectations obviously came from the cost language, the cost restructuring language that you guys gave this morning. I would see about 3% earnings growth alone from cost benefits. I would see about a 2% earnings growth just from lower share count in 2016 versus 2015.
And then to the point you just made Paul, on your inks business coming back, I mean I could get up to 3% earnings growth just from inks "normalizing" and getting back to that low 20s margin on color. So I'm at 8% alone just from those three items. And then you have a better mix potentially in flavors, you have the back half of the year maybe even earlier benefiting from conversion in colors.
And so, I feel like your guidance is conservative on a currency neutral basis and I just want to see if you guys could address that quickly. And discuss whether it's due to the overall macro environment, currency or if you think I'm just -- if my building blocks are just too high?
Well, I think the quick answer is, we don't want to disappoint. I think the other quick thing is that you mentioned a lot of very positive things that we're expecting in the company not only in flavors but in colors in Asia Pacific. So I think you hit on a lot of those items as well that we believe what we are going to continue to execute on in 2016. So again, my quick answer is, I don't want to disappoint.
My more elongated answer would be as you look at the year and as we look as we describe for each of the businesses like a color flavor in Asia Pacific, we have very high expectations for each one of them on operating profit improvement for the year. I quoted high-single digit operating profit growth, my expectation for each of those groups. What offset some of that is that that corporate expense that I noted in the commentary most notably linked to performance based compensation. So I think that's a little bit of an offset to some of that.
As you look at the macro economic environment in many of these markets and on many of these product lines, we are certainly seeing movement towards customers delaying launches until the second half of the year. When you take for example natural colors many of the announcements that were made last year were for companies to achieve this natural color milestone by the end of 2016. And so certainly that is playing out a little bit in terms of how I see the year progressing, stated a little bit differently, for us to achieve high single digit operating profit growth that over the year, I don't necessarily see each quarter playing out precisely that way again owing to a number of different factors. Some of this is, is related to the natural colors and other customers back loading some of their launches and new wins. We noted the strengthening U.S. dollar has had an even stronger impact and so we've had to go out in certain markets with additional pricing. And we've to do that early in this year.
So as I result, you don't get the benefit of that until later in the year. But when the Canadian dollar declines another 10% to 15% in the first say in the last 30 days, you got to be able to respond, but it also the impact of your response may take a little time to come through. I mention the natural ingredients to raw material inflation that we've seen. So in short, we have high expectations for the year. We have a lot of things going for us. I would see that the year would be sequentially better. I think the first half of this year is going to be much more difficult than the second half of this year for those four or five reasons I just gave that I would still feel very confident for the overall year that this is what we could achieve. But I would anticipate in some of these businesses we are seeing strong double-digit growth in the second half of the year and maybe a little bit more than a mid single digit for the first part of the year.
So I gave you a short and a long version of that. You can --
That's very helpful. I want to just say one more and I promise I will leave the floor. Paul, I just want to congratulate you on the chair announcement. I think it’s a positive change. I can no doubt deserve praise for assembling this company as it is today. But clearly, you are your own person and I think you've your own ideas. And I think wall street has historically wanted more accountability and more drive from this company every time and I think that you have that within your arsenal to deliver, you've affected a number of changes early on in your tenure both as colors manager and CEO. But, can you just talk to the street now about what's important for you to drive going forward. I mean I think your evaluation is really attractive here and so I think there is a little bit of a disconnect still between investors and what you're trying to do as a company. So I just wanted to birch that subject with you and I appreciate you're taking the questions.
Sure. Brett, I think this certainly I'm very grateful for the opportunity to take on that role as well starting in April. But, I think that the company has got a lot of very positive things going for it. Ultimately people will respond to results and they will respond to our ability to execute on the things that we say we are going to do. And I think that we've demonstrated over the last say five or six years as we've been talking about things we are doing in the color group and the things we are doing in the flavors group that we define a strategy. I think we articulate it. But, we would like to discuss this very openly on these calls and certainly in one on ones with our shareholders.
So I think that -- to me -- that's a very important part of how we like to manage in the company and we believe very strongly about accountability. We talk about this performance based compensation that we've introduced as a company over the last few years. And I think that -- as much as companies talk about it, I would like to say that we are very cutting edge on that. Less than 10% of companies -- public companies have a policy in which the CEO's pay is 70% to 75% performance based and there is also a retirement requirement. We have both of those things.
So I think this is the ultimate pay for performance scenario that I think we could put together as I company. I think that's going to continue to be a fundamental tenant of how we govern and how we manage the company and ultimately how we interact with our shareholders. So I think those were important. I think we're going to continue to emphasize those elements. And we're going to continue to really execute on our strategy in a very open and clear manner with each of our shareholders.
Thanks so much.
[Operator Instructions] I would now turn the conference back over to the company for closing remarks.
Okay. Thank you everyone for your time this morning. I assume there maybe follow-up questions and if that's the case as always please feel free to call the company. But, at this time we'll end the call. Thank you, again.
Thank you for joining us today. This does conclude today's conference call. You may now disconnect.
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