Sensient Technologies Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are U.S. dollars; financial statement amounts below are in millions except per-share data. Sensient makes flavors, fragrances, natural ingredients, and colors, reported across Flavors & Fragrances, Color, and Asia Pacific segments.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $342.7 | $353.5 | $1,062.3 | $1,033.4 |
| Gross margin | 33.7% | 34.7% | 33.9% | 35.1% |
| Operating income | $50.3 | $52.0 | $158.1 | $120.4 |
| Operating margin | 14.7% | 14.7% | 14.9% | 11.7% |
| Net earnings | $47.2 | $32.2 | $124.5 | $76.2 |
| Diluted EPS | $1.12 | $0.73 | $2.92 | $1.72 |
| Interest expense | $5.4 | $4.9 | $16.5 | $14.5 |
- Quarterly revenue declined 3.1%; nine-month revenue rose 2.8%. Foreign exchange reduced Q3 revenue by about 1.7 percentage points and added about 1.6 points to nine-month growth.
- Q3 operating income declined 3.4%; nine-month operating income increased 31.3%, substantially reflecting the absence of 2017 restructuring and other costs. On the company’s adjusted basis, operating income fell 13.4% in Q3 and 4.5% year to date.
- GAAP net earnings and EPS benefited from a $7.1 million tax-related adjustment to the provisional 2017 Tax Act accounting. Adjusted diluted EPS, which excludes that item and specified prior-year costs, was $0.95 for Q3, up 6.7%, and $2.76 for nine months, up 7.0%.
- Gross margin declined as higher raw-material costs, lower volumes and product mix weighed on results; nine-month results also reflected higher manufacturing and other costs. Higher selling prices and the absence of prior-year restructuring costs partly offset those pressures.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $8.9 million versus $22.2 million in 2017. Changes in operating assets and liabilities used $159.7 million. Cash flow from investing was $26.9 million, including $91.1 million of collections on previously transferred receivables, classified as investing cash flow under the adopted accounting guidance; capital expenditures were $34.1 million and acquisitions used $31.1 million.
- Cash at September 30 was $36.8 million. Short-term borrowings were $20.1 million and long-term debt was $746.0 million, up from $604.2 million at year-end 2017. The company attributed higher interest expense to a higher average debt balance.
- Current assets were $834.9 million and current liabilities $194.2 million. Inventory was $484.8 million and trade receivables $271.3 million. Management stated the company was in compliance with loan covenants and expected operating cash flow and available debt capacity to fund operations, capital expenditures, dividends, acquisitions and repurchases.
- Nine-month financing included $248.4 million of borrowings and $158.2 million of debt payments. The company repurchased $76.7 million of shares and paid $42.2 million of dividends. Dividends declared were $0.99 per share for the nine-month period, versus $0.90 in 2017.
Segments and material changes
- Flavors & Fragrances: Q3 external revenue was $179.1 million, down about 6%; operating income was $24.8 million, down about 25%. Management cited lower Flavors and Natural Ingredients volumes, unfavorable product mix/pricing and higher raw-material costs. It noted continuing weakness at a site affected by the prior plant consolidation and declines in certain dairy categories. Nine-month revenue was $553.4 million, nearly flat, while operating income fell about 18% to $74.1 million.
- Color: Q3 revenue was $132.2 million, up about 2%, while operating income declined about 5% to $27.3 million, mainly due to weaker Cosmetics results. Nine-month revenue rose about 7% to $416.6 million and operating income rose about 5% to $92.1 million. Food & Beverage Colors benefited from volume and the GlobeNatural acquisition.
- Asia Pacific: Q3 revenue declined about 4% to $31.3 million; operating income was approximately flat at $5.8 million. Nine-month revenue rose about 1% to $92.1 million and operating income increased about 3% to $15.3 million.
- The company acquired GlobeNatural’s natural color business in March for $10.8 million and botanical extraction business Mazza Innovation in July for $19.8 million. Mazza was reported in Corporate & Other while integration proceeded.
Outlook, risks and unusual items
- No specific numerical earnings or revenue guidance was provided. Management described the financial position as strong and said cash flow and debt capacity were expected to support future needs.
- Effective tax rates were unusually low: negative 5.2% for Q3 and 12.1% for the first nine months, compared with 31.6% and 28.1% in 2017. Tax rates reflected Tax Act adjustments, tax elections, transaction-related benefits, prior-period estimates and the mix of foreign earnings. Tax Act accounting remained provisional; further adjustments could be material, with finalization expected no later than Q4 2018.
- In October, the receivables program commitment increased from $60 million to $70 million and was extended to October 2019. In November, the company issued fixed-rate notes totaling £50 million and $25 million to refinance existing debt. It also announced a quarterly dividend increase to $0.36 per share, beginning with the December 2018 payment.
- An Illinois state complaint alleges wastewater violations at the Amboy facility in 2015–2016. Sensient disputes the allegations, is engaged in settlement discussions, and intends to defend itself; it does not expect penalties or settlement costs to be material. The company disclosed other ordinary-course claims, whose outcomes could differ from expectations.
- Other risks include raw-material and energy costs and availability, volume and customer-market declines, competition, customer relationships, foreign exchange, regulation, and execution of growth and productivity initiatives. No material changes to previously disclosed risk factors were reported. The company estimated adoption of the new lease standard would add $17–$22 million of lease assets and liabilities to the balance sheet.
Investor verification points
- Assess whether weak Flavors & Fragrances volumes, mix and segment margins persisted after Q3, and whether the affected site and dairy-category declines improved.
- Separate recurring operating performance from the prior-year restructuring/divestiture costs and the 2018 tax benefit; review the final Tax Act accounting and its effect on reported earnings.
- Track working-capital cash use, receivables and inventory, and the classification of receivables-program cash flows when evaluating cash generation.
- Review debt balances, refinancing terms, interest costs and covenant headroom, including the post-quarter note issuance and receivables facility amendment.
- Monitor integration and purchase accounting for Mazza and GlobeNatural, and developments in the Illinois wastewater litigation.