Frutarom Industries Ltd. (OTC:FRUTF) Q2 2016 Earnings Conference Call August 15, 2016 9:00 AM ET
Ori Yehudai - President & CEO
Alon Granot - CFO
Michael Klahr - Citibank
Declan Morrissey - Davy
Ladies and gentlemen, thank you for standing by. Welcome to the Frutarom Industries Limited Second Quarter 2016 Results Conference Call. All participants at present in listen-only mode. [Operator Instructions]. As a reminder this conference is being recorded August 15, 2016.
With us online today are Mr. Ori Yehudai, President and CEO and Mr. Alon Granot, CFO. I'd like to remind everyone that forward-looking statements for the respected company's business, financial conditions and results of its operations are subject to risk and uncertainties that could cause actual results to differ materially from those contemplated.
Such forward-looking statements include by not limited to product demand, pricing, market acceptance, changing economic conditions, risks and product and technology development and effect of the company's accounting policies as well as other risk factors, which are detailed from time-to-time in the company's filings with the various securities authorities.
Mr. Yehudai would you like to begin.
Thank you very much. Good morning, good afternoon and thanks a lot for participating in our second quarter and first half results. Second quarter, continue -- and maybe even boost and show another milestone in our profitable, quick gross journey, successful implementation of our gross strategy combining profitable internal growth and the contribution of the acquisitions, we did contributes to another record quarter and first half, both in sales and profits and cash flow from operations.
We are pleased with the continued internal growth trend that we are seeing for the last couple of years supported by, again, the same strategies, improving our geography mix, increasing our market share in growing emerging market in North America, primarily the U.S. Our special customer focus, mainly midsized and local customers, special emphasis on the private label sector, and niche-added value solutions to the global multinational -- the special emphasis on the fast-growing natural portfolio that we have, combining taste and health and being able to use the cross-selling opportunities following the acquisitions we did.
In the second quarter, we present internal growth, excluding currency effect and acquisition effect, while for the total company we've seen growth on a pro forma basis of 7.2% in our core business, the flavors and the fine ingredients, a growth of close to 8%. Our flavor business grew by 7.7% and our fine ingredients grew by 10%.
In the first quarter, gross profit jumped by 37%, EBITDA by 33% to reach $57 million, and net profit increased by 23% to reach $34 million. Earnings per share increased by 21%, and cash flow from operations more than doubled itself and extends at $37 million. All these with a currency effect of 2.7% in the second quarter, and 3.4% in the first half. And while excluding one-time effect following the integration of the savory business in Europe and some other one-time effect that I will talk about later in this call. The increase in revenue is a contribution of fast internal growth, much above the markets we are operating in, and the acquisitions -- we did 31 acquisitions in the last five years, 17 of them since the beginning of 2015 and six since the beginning of 2016 this year. No doubt, we will achieve another record deal in 2016 and personally I feel very confident that 2017 should be another record year for Frutarom going forward achieving our strategic goal of achieving above $2 billion with an EBITDA on our core business above 22% by, and hopefully before 2020.
Continuing on implementing our gross strategy and focusing on several key elements. The first, increasing market share in growing markets primarily North America and growing emerging market, continued focus on our product mix, I believe, a winning product mix combining natural tasty and healthy food that billions of consumers want to see in their food, nutraceutical, cosmetics and so on. We continue to grow faster than the others, our taste business is growing 26% by average in the last 15 years and when you look at the second quarter, even much higher, 44% increase compared to the parallel quarter. And the flavor business is already 75% of our total sales, while trade and marketing activities that is a non-core business for us is going down from around 10% to below 7%.
10 years ago we started to implement a fast growing strategy to build a position, a global position in the savory area. We did quite a lot of acquisitions including since the beginning of this year, we acquired AMCO in Poland, we acquired Wiberg, the largest acquisition we ever made, and two weeks ago, we announced the acquisition of Redbrook, the Irish-British company that brings us a very strong position in the Irish market, first time a local production in Ireland and a lot of synergies that we will extract in the UK between R&D, sales and marketing, purchasing, production and so on. Redbrook was growing double digits in the last three years and enjoy a very nice profit margin above Frutarom average. On top of that, and maybe even more important, we are building almost from scratch the savory business in the main emerging markets where we operate, in Asia, Latin America, Africa and in the U.S.
We were talking a lot about our unique product portfolio, mainly natural today, close to 75% of our total sales are with natural products, in the right directions the consumers want to see their food. We entered into very interesting, fast growing areas like natural color, natural food protection, antioxidant that replace synthetic in numbers in our food products. Natural ingredients based on biotechnology including in the algae-based; all these are growing double digits and that's the expectation for the next coming few years and these allow us to achieve double-digit growth in our fine ingredients business, both in the second quarter and in the first half of the year.
We continue and will continue to focus on internal R&D in natural product, supported by collaboration with external R&D, with collaboration with universities, start-ups and evaluating other possibilities, and on top of that, we see a very healthy pipeline for additional acquisitions in the natural fine ingredients area.
I will elaborate little bit more about our geography spreads and our main direction as far as geography is concerned. I'll start with North America. We continue to enjoy a nice double-digit internal growth in North America. The total sales of Frutarom in North America today, around 17% compared with less than 10% five years ago. We doubled the business and in the same period, doubled the portion of the U.S. We are working towards implementing and executing additional acquisitions in North America, and our aim and goal is to double again our U.S. and North American business within the next two years.
In emerging markets, we continue to invest in faster-growing emerging market. Emerging market today are around 40% of total Frutarom sales compared to only 25% five years ago. In Asia, we continue to see a very fast growth combination of internal growth and acquisition, leads to a 50% increase in our sales to Asia in the first half year, even more so in the second quarter. We enjoyed a cross-selling opportunity and continued to look for additional acquisitions in the area.
Speaking specifically about some key strategic markets in India, we see a nice internal growth of Sonarome that we acquired about a year ago. We already incorporate all other Indian operations into Sonarome and have very high expectation for further growth in the Indian market.
In China, our new production site is already operating and we start seeing a very interesting, healthy pipeline for savory projects, a business that we didn't have up until recently because we didn't have the production capacity and the R&D ability to deal with this interesting part of the business, I believe, around 30% of the total Asian flavor business.
We are in the process of combining inventive activities. The Company we acquired towards the end of last year, and we are about to move inventive R&D for flavors to our new site in Shanghai, China.
In Latin America again, we continued to enjoy a nice double-digit internal growth. Our market share, like in Asia, is still very, very small and our goal -- and I'm sure we'll be able to do that, is to increase our market share in these important markets. We are evaluating additional acquisitions including in some markets where we don't have Frutarom operation at the moment. I will mention for example Mexico, and we are looking at several vehicles to build from scratch the savory business in Latin America in our main operation mainly between Brazil, Chile, Peru and Guatemala.
We are happy with the growth we are achieving in Africa. We inaugurated a new production site in South Africa and we see a very interesting pipeline again for many projects with many customers supported from South Africa, but mainly towards growing the markets in the region like Kenya, Nigeria, Ethiopia and a few others. I believe that we'll be able to do again here as well some additional acquisitions that will support the growth and grow our market share in Africa markets that we're believing a lot. Central and East Europe, we are the largest player pursuing the savory arena but also a very strong position in the sweet side. We believe we are one of the only few global companies that has R&D, production operations in the key markets. Russia is the first one, and then Central Europe, Slovenia and the recent acquisition in Poland give us a very strong position in these growing markets.
Russia itself would continue to see the same trend. Russian consumers prefer to consume local product on the account of importation. We see that also in Frutarom sales from Italy and Germany into Russia that went down quite significantly. I believe that some -- many of our other competitors are seeing the same trend, but our strong position in local production of PTI that we acquired two and a half years ago is giving us the full compensation and more for this erosion. Even more so, in our margin increase and support, by having the local operation with 50% of cost in ruble and we were able to increase prices almost to the euro level and that gave us a nice contribution to the improved margin in the region. I'm also happy to say that in west Europe, we continue to see a nice growth -- internal growth, again, we believe nicely above the growth in the relevant markets.
A few words about the currency effect. Last year was very-very significant, 13.4% currency effect, negative currency effect, both on sales and profit. In the second quarter, 2.7% in the first half, 3.4%. Looking at today, a currency rate, we believe that the third quarter we have even lower currency effect and for the rest of the year we should see the same trend as long as currencies will remain more or less where they are now. With your permission, I would like to emphasize a little bit more about the main project we are implementing to improve our cost structure, our efficiency, grow production capacity, allow ourselves to meet the fast growth that we are achieving. These projects should bring savings of close to $22 million compared to the cost structure that we have in the second quarter this year, I mean, the quarter that we are reporting now and that's important because that's easier to calculate and understand how we see these savings. I will [indiscernible] and say that $12 million out of this $22 will come from the integration of Wiberg in our European savory business, most of them will come towards the end of 2016, some of them will come to the P&L at the beginning of 2017.
$6 million, in addition, will come from the very important project of increasing and optimizing our production sites that produce natural botanical extracts. This $6 million will come to the P&L during the second half of next year, of 2017. I will elaborate a little bit more about these two important projects.
The Wiberg integration continue to progress very well according to plan, sometimes even faster than our original timetable. Most of the production site in our main historical Frutarom site in Stuttgart, Germany, has been transferred to the new, modern large efficient site of Wiberg on the border between Austria and Germany. We are integrating all functions, including management, administration, R&D, sales and marketing, logistics to all other sites that we operate today in Europe mainly in the North part of Germany, in Italy and the main site of Wiberg.
The management of the two companies is already merged in the headquarter in Salzburg in Austria. We already integrated the sales force, the R&D and the purchasing and these have important effect on the one-time cost in the second quarter and the first year mainly from reducing above 100 people in our Stuttgart and German operation.
Additional savings and additional improvement in margin should come from our purchasing power that increased dramatically following the acquisition, following the integration and harmonization of the raw material and operating in one purchasing organization for February that is being incorporated with our global purchasing organization that we are building.
The second project I want to discuss is the efficiency and increasing capacity in the natural botanical extract business in our fine ingredients. This comp is part of our strategy to grow and increase and improve our leadership position in the natural botanical extract, both for taste application, health application, natural color, natural antioxidant and food protection.
We did several acquisitions that are being integrated while creating a center of expertise for the different type of technology, both in R&D and production. Such acquisition was Montana en Peru that gave us an entrance -- first entrance into the natural color and then we did [Retivas] in Slovenia, Nutrafur and Ingrenat in Spain. Three of these acquisitions gave us a much stronger position in the food protection, stronger position in natural color and special natural ingredients with health property and of course, all the natural taste ingredients that we produce out of plant seeds and all types of botanicals.
Add to that our recent acquisition in Germany of Extrakt Chemie, primarily pharmaceutical GMP-approved pharma product with capacity that is more than double compared with the capacity that Extrakt Chemie were using before the acquisition and our goal and aim and project is to use this free capacity in order to be able to achieve the 6 million, hopefully more than 6 million savings in cost. No doubt, the world is moving fast, maybe even faster than what people anticipated two or three years ago towards more natural product that are considered to be healthier and replaced synthetic raw material in number, the direction of clean label is definitely taking more and more importance mainly in the developed market, but we start seeing that also in some emerging markets.
Following a very thorough strategic thinking, we realize, which seems to be quite obvious that billions of consumers would like to see more natural ingredients in their food, but in many cases these ingredients are not affordable since their cost is much-much higher than the cost of synthetic ingredients. Frutarom puts an important target. To be able to produce a reasonable cost product that will enable consumers to increase significantly, the usage of natural extract and natural ingredient in their food in the nutraceutical, pharmaceutical and so on. Part of the strategy is the reason to invest in additional capacity and that's what we are doing and when we bring the efficiency into the right level and achieving the savings that we expect to see, we'll be able to nicely improve our ability both to grow margin and to reduce costs of some product and grow sales in a nice way, much faster than what we have done up until now.
On top of these important projects, we continue to build our global purchasing organization. We already start seeing the first results out of a yearly contract for global usage in many of Frutarom sites following the last year and half or so, where when we work on harmonization of raw materials and being able to go with one tender to be able to buy important part of our raw materials from source and not from distributors and local suppliers that are typically more expensive than those sources that we are going to use in the near future. The combination of faster internal growth, together with the efficiency projects that I was discussing, and the contribution of the global purchasing, all these will bring the improved margin that we expect to see towards the end of this year and next year in our core business, both in flavors and in fine ingredients.
Discussion and elaborating on our results for the second quarter and the first year. Sales in the second quarter increased by 37%, reached a record of 300 million internal growth on a pro forma basis excluding currencies of over 7%, and in the first half, an increase of 35% to reach $558 million, internal growth of 6.6% on a pro forma basis.
Now, our core business, flavor and fine ingredients, we noticed 43% increase in revenue that reached a record of $280 million -- an increased internal growth of close to 8% divided between 44% increase in taste in the flavor business, for a record of $224 million internal growth of 7.7%, and in fine ingredients, an increase of $39 million internal growth of 10%.
We noticed in the first half and in the second quarter, one-time cost mainly from the integration of our savory business, and partly, from the natural extract project, on the other hand, we have seen one-time income from selling our old, inefficient site in North Bergen, New Jersey that we closed at the end of last year beginning of this year. The net effect of one-time in the quarter, $2.6 million in gross profit, $4.4 million on EBIT, $2.9 million on EBITDA and 3.4 million on our net profit. We believe that as of the actual quarter, I mean, the third quarter, the one-time cost will be much lower going towards the much, much lower one-time cost at the beginning of 2017.
Our profit continued to increase nicely. Gross profit increased by 40%, gross margin 40.6% in our core business, excluding one time a cost. Our EBIT increased by 31% with EBIT margin of 16.3% and EBITDA increased by 34% to which $57 million with EBITDA margin above 20%, 20.4%.
In our taste business, EBIT increased by 33%, EBIT margins 17.3%, EBITDA margin 21.4%. In the last three years, EBITDA increased by 90% from $36 million to $69 million. This year, in fine ingredients, EBIT increased by 20% and in the last three years, EBIT of the fine ingredients increased by 40% to reach $40 million in the relevant period.
I remind ourselves that the second quarter results and the first half results hardly see the effect of the cost savings and the project that we are implementing and we're just starting now the effect of the global purchasing organization. All these will bring the expected improvement in margins compared with what we are seeing at the moment.
Frutarom has a very strong balance sheet and very strong cash flow from operations, more than doubled in the second quarter to which $37 million -- over $55 million in the first half, an increase of 47%. These allow us to execute -- will allow us to execute the very healthy pipeline of additional acquisition. Some of them, I believe we will see during the rest of this year and next year. Our net debt to EBITDA at the moment tendered 2.2 million, meaning we have enough room until reaching our level where we feel very comfortable like three times EBITDA to net debt.
To sum up, we are happy with the results of the second quarter and the first half. They represent good implementation of our growth strategy. We are very optimistic about 2016. 2017 will be another record year for Frutarom supported by faster internal growth, a very healthy product mix, unique offering and bundling that we can offer to our customers using the cross-selling opportunity following the 17 acquisitions we did recently, a better geography mix than what we have seen a couple of years ago, a very healthy pipeline with thousands of customers between multinational and global companies and midsized local with special emphasis on the private label sector that is growing in many markets faster than the branded product. The contribution of the efficiency program will contribute as well to the improved profit and the margin and we feel very-very comfortable with the future pipeline for a good strategic acquisition. All these would allow us to continue improve the results; continue to bring additional value to our shareholders in achieving our 2 billion goal in revenue with EBITDA in our core business of above 22% by 2020, and I believe, before 2020.
Thank you so much for participating and we will be delighted to answer any question you might have.
Thank you. Ladies and gentlemen, at this time we'll begin the question-and-answer session. [Operator Instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.
Hi, this is Chris on for Tavy. Thank you for taking my question. Would you please repeat your comment about the one-times going forward, do you have a sense if there'll be any more from the acquisitions you've made up until now?
We believe that there will be additional one-time, both from new acquisitions that we will make but also some -- but a much smaller amount that will be the result of very significant projects that we are implementing, both in the savory -- European savory operations and our natural extract business. Again, we will see some, but there will be much lower than what we have seen in the second quarter and the first half.
And also, you commented on currency that you don't think you'll see any drastic changes the next two quarters. Does that mean you don't expect any impact from Brexit?
The effect that we see from Brexit is very-very minor. Even though we have a healthy, profitable business in the U.K., we believe that there are plusses and minuses, meaning we have production cost in British pound and we export to some other markets in other currencies. Our position in the U.K. will allow us, I believe, to enjoy further growth that we are achieving in the U.K. market. So, we don't see any meaningful effect from that.
The next question is from Michael Klahr of Citibank. Please go ahead.
Hi, good afternoon everyone, couple of questions. Firstly, the like-to-like growth over the last couple of quarters, which has been 7%, 8% very high. Is that a step up for the next few quarters or for the short and medium term? Or should we expect that to come down a little bit?
And the second question is on working capital. It was better in the second quarter. Should we expect you to get some of that back in the second half? Or is there something specific going on there. Thank you.
I will answer the first one. Alon here will answer the second one. As far as the internal growth, it's true that we are very happy to see the internal growth that we are achieving. We believe that there are very good reasons from that focus on natural products that are growing faster, enjoying growth in natural color, natural antioxidant in some geographies.
I don't know to say that this can be maintained at 7%, 8%, but we feel very comfortable to say that we feel quite certain that we are able to achieve internal growth that is much higher than the growth in the relevant market where we operate. If you assume that the world is growing at 2%, 3%, we believe that we can do much better than that.
I would not take 7%, 8% as something that definitely we can do every quarter in the next coming quarter, but this is not a surprise for me and it should not be a surprise for our investors because believe that we have the right ingredient to be able to grow faster.
And regarding the working capital, the cash provision was strong this quarter, we expect to maintain our working capital on the level and not expecting negative results in the next quarter.
That's clear then. Could I just have a follow up, quickly? I mean, you mentioned in your comments, Ori, about the U.S., doubling the size of the U.S. business in the next couple of years. Is that from M&A already done, or is that -- is there -- you took potential M&A there or is that organic growth? Can you just give a bit of color on that?
First of all, we more than doubled our North American business in the last couple of years in this effect. Supported by typically double-digit internal growth plus the acquisitions that contributed nicely to this growth. When we look at the next two to three years, we have a very healthy pipeline for additional acquisitions.
We continue to enjoy a faster internal growth based on hundreds of new customers that we didn't have before, a good product portfolio, the U.S. market is going faster towards natural color, natural antioxidant, natural flavors, natural health ingredient and this really helped us. Together with the expected and good healthy pipeline for acquisition, we believe that this is very-very feasible. Bearing in mind, by the way, that in the U.S. you have over 150 privately owned flavor companies and more or less the same amount of companies in the natural health ingredients and relevant businesses for Frutarom, meaning that there are a lot of opportunities for additional acquisitions in the U.S. in the coming few years.
The next question is from Declan Morrissey of Davy. Please go ahead.
A couple of questions, just the cost savings planned in the second half. I'm just wondering, will there be any, say, cash impacts from the last -- what you see -- I know you've given some commentary around working capital there, but I'd imagine in the medium term this should be a positive on your working capital. And secondly, just on the raw material environment out there, pricing and some of your natural ingredients that you use, it seems to be back in an inflationary time again and I'm just wondering if you have any comments on those?
I will answer the second one. Alon will answer the first one. Raw materials, we have seen, in a way, some stability in average price of our close to 6,000 different raw materials since the beginning of 2013. Indeed, I agree with you that we are starting some inflation in some key ingredients. I will mention vanilla, I will mention citrus-like, orange, grapefruit, some spices, some fruits. I believe that on the other end you see some prices that are relatively soft and we have to see what will be the trend there. If prices will continue of -- these products that went up significantly, we are dealing with some very focused necessary price increases that we will be able to achieve, I believe. So, as far as what we see now, we don't expect to see any negative effect on our margin. But, of course, we follow that very-very closely. I believe also that when implementing our global purchasing organization, this will help us to mitigate some of these increases. Alon, you want to…
Regarding the cash flow, in the first half, we made some provision for the one-time expense that the cash flow will be probably in the second half. But that will be balanced by -- we sold our property in North Bergen in the USA in the second quarter and the cash will be up here on the first quarter. So, that will be balanced on each other, so not effect a big difference in the cash flow.
[Operator Instructions] There are no further questions at this time. Mr. Yehudai, would you like to make concluding statement?
Yes, first of all thanks again to all of you for participating in this call and more than that, supporting Frutarom growth Alon, Ori myself, are at your disposal for any other questions, clarifications, or whatever you have in mind. The most important is that we continue to work hard and we are really enjoying what we are doing and feel very confident that we will continue to see the positive trends that we are seeing in our space and for Frutarom particularly. So, thank you very much, have a great day and evening.
Thank you. This concludes the Frutarom Industries Limited 2nd Quarter of 2016 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.
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