Sensient Technologies Earnings Call INSIGHTS: Product Mix, Gross Margin Seasonality and Strategy

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On Friday, Sensient Technologies Corporation (NYSE:SXT) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Product Mix

Christopher Butler – Sidoti & Company: Just to start with as we look to the second half of the year could you touch on any kind of impact that you would face from a challenging harvest with the drought conditions here in the U.S.?

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Richard F. Hobbs – SVP and CFO: We’re not directly affected by that in our businesses because where we do have operations, where we’re controlling the farming activities, that’s all irrigated and we don’t anticipate any issue there.

Kenneth P. Manning – Chairman, President and CEO: The third quarter is looking good so far. So, I know that’s going to affect people, but it doesn’t seem to be affecting us of course.

Christopher Butler – Sidoti & Company: You are not worried that could affect your customers then purchase less from you?

Kenneth P. Manning – Chairman, President and CEO: We have some hedging and things like corn syrup through the end of the year.

Richard F. Hobbs – SVP and CFO: But this is not a big issue for us at all.

Christopher Butler – Sidoti & Company: With the gross margin improvement that we’ve seen, you did mention product mix being a big component of that and we’ve definitely seen that over time. But if we look at the improvement on a sequential basis, I can’t see that – I can imagine that there is a big change in product mix from the first quarter to the second quarter? Could you give us some detail there?

Kenneth P. Manning – Chairman, President and CEO: Paul, why don’t you take that?

Paul Manning – President, Color Group: I think the change in product mix as you can imagine is kind of an evolutionary process and we are very strongly directing each of the businesses pharma and food, cosmetics etcetera, towards this expectation and towards the sale of products that are very consistent with our strategy and therefore our value proposition. So I think you will continue to see continued improvement for the rest of this year and certainly into 2013 and beyond.

Christopher Butler – Sidoti & Company: To what do you attribute then the 110 basis point improvement sequentially on gross margin for the company?

Kenneth P. Manning – Chairman, President and CEO: Looking at the total company there is no question that the Color Group was a big factor in that improvement and that was the biggest driver and as Paul just mentioned that is expected to continue going forward and we are feeling good about the third quarter, it’s looking good as we start out, things are going strongly for us and so…

Paul Manning – President, Color Group: Chris, I think the term was used we are divesting ourselves of low margin business and I think that says it all.

Christopher Butler – Sidoti & Company: Can you talk to the softness that you spoke to in the destocking, give us a little bit more color on that front?

Kenneth P. Manning – Chairman, President and CEO: Yes, certainly we did have some softness within the Flavor Group with some of the product lines within the Flavor Group, but again we do feel a lot of that’s behind us and we’re feeling good about the rest of the year.

Gross Margin Seasonality and Strategy

Edward Yang – Oppenheimer & Company: Just piggy backing on the prior question on the gross margin improvement sequentially. Isn’t some of that attributable just to seasonality, it seems like the last couple of years you always seem to have stronger margins in the second quarter relative to the first quarter?

Richard F. Hobbs – SVP and CFO: Certainly, there is – that the second quarter Ed is the stronger quarter, there is not question about that and so that does have a positive impact, a positive sequential impact. Certainly, that is something that is a…

Kenneth P. Manning – Chairman, President and CEO: The bigger factor clearly that we are not taking low margin business, that’s a big factor that is a strategic (indiscernible) that we are following.

Richard F. Hobbs – SVP and CFO: But clearly going back and looking at last year in the quarter and that’s a good comparison to compare year-to-year, we are up 50 basis points for the whole company.

Edward Yang – Oppenheimer & Company: You expect the Color operating margins to remain above 20%?

Richard F. Hobbs – SVP and CFO: I just, I corrected, we’re up 150 basis points in the last year. Paul, why don’t you take that last question.

Paul Manning – President, Color Group: I think that we’ve demonstrated now some continuity in the higher operating margins. I would tell you that we would certainly be in the vicinity of 20%. Moving forward, I think this is the – the second quarter is now the eighth quarter in a row of double-digit operating profit growth in the Color Group. I think between our ongoing sales efforts, we have extended tremendous amounts with respect to capital. And I think what these really communicate is, we see huge opportunities in the marketplace. Now, those opportunities don’t necessarily develop this week or even next quarter, but they do develop and I think we are seeing that with respect to our food colors and our inks which are up very, very strongly on operating income due to new sales and also – again, improvement in the mix and really focusing on those parts of the markets for which we have a very strong position with – to our customers and certainly with respect to the competition.

Edward Yang – Oppenheimer & Company: On Flavors, that was – that saw some decline year-over-year and you mentioned European raw materials are destocking. Within Europe, how has that impacted the margin in that business? I know your margins in North America are pretty impressive, but that’s been an area that’s been lagging has that taken a step down with some of the macro pressures?

Kenneth P. Manning – Chairman, President and CEO: Yeah, if you look at Flavors. Flavors had much tougher time in Europe. Colors seem to do well worldwide, that’s been our superstar. But Flavors we are running into some headwinds in Europe.

Richard F. Hobbs – SVP and CFO: As we look at Q3, we look at the Q3 we are expecting – assuming as Paul mentioned, the margins are going to be up again in Color and we expect to maintain our margins in roughly that 15% or so range.

Edward Yang – Oppenheimer & Company: Just on the top-line comments that you had are you expecting the mid single digits organic revenue growth both in the second half for both Flavors and Color. What would account for the acceleration?

Richard F. Hobbs – SVP and CFO: What we are expecting in local currency, of course, we are expecting growth certainly for the Flavor Group to be in that mid single digit area for the rest of the year. We are expecting increase in the Color Group actually mid to high digits with looking at the profits by itself probably double digits are possible.

Edward Yang – Oppenheimer & Company: What would account for the acceleration, is it just easier comps or less destocking or economic pickup?

Richard F. Hobbs – SVP and CFO: Well, specifically in the case of Color, as I said in my prepared comments there has been a very concerted effort to remove low margin products and move into higher margin products. Paul, maybe you want to…?

Paul Manning – President, Color Group: Yeah, I think, certainly that reduces you total revenue output. The way we think about this is, we want to drive operating profit. So, yes, at some point, you’ve divested the lowest of your low margin and in less interesting business and then you stop taking away from the top-line growth that you are still generating and I think that’s why you’re going to see the change. Again, there is only so much low margin that you are going to process through and then you start to really benefit from your ongoing business closings.

Edward Yang – Oppenheimer & Company: Similar dynamic in Flavors as well?

Kenneth P. Manning – Chairman, President and CEO: Certainly in Flavor, we’ve moved technology within the Group and…

Richard F. Hobbs – SVP and CFO: Maybe Jim would like to comment.

James P. McCarthy – President, Flavors & Fragrances Group: Sure, Dick. I think that we continue to look at new products and developments. We have a strong pipeline going into the second half of the year and we think that based on our new product development programs that we’re going to see improve results moving forward.

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