Sensient Technologies Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. Comparisons are with 2016. The interim results are unaudited.
Business context and results
Sensient makes colors, flavors and fragrances. Its reportable segments are Flavors & Fragrances, Color and Asia Pacific. Beginning in 2017, certain Asia Pacific cosmetic and fragrance operations were reallocated to Color and Flavors & Fragrances; 2016 segment results were restated.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $353.5 | $349.7 | $1,033.4 | $1,053.0 |
| Gross margin | 34.7% | 35.1% | 35.1% | 34.5% |
| Operating income | $52.0 | $51.2 | $120.4 | $142.3 |
| Operating margin | 14.7% | 14.6% | 11.7% | 13.5% |
| Continuing-operations earnings | $32.2 | $35.6 | $76.2 | $91.6 |
| Diluted continuing-operations EPS | $0.73 | $0.79 | $1.72 | $2.04 |
| Interest expense | $4.9 | $4.6 | $14.5 | $14.0 |
Q3 revenue rose 1.1% reported, but declined 0.4% in local currency. Nine-month revenue fell 1.9% reported and 1.6% in local currency. Q3 net earnings were $32.2 million, versus $35.6 million; nine-month net earnings were $76.2 million, versus $94.9 million, which included a $3.3 million discontinued-operations gain. Q3 and nine-month 2017 had no discontinued-operations earnings.
Cash flow, balance sheet and capital
- Operating cash flow: $111.1 million for the first nine months, down from $150.6 million, primarily due to greater working-capital use and timing of tax payments. Capital expenditures were $32.8 million, versus $58.0 million.
- Cash and liquidity: Cash was $24.7 million at September 30, versus $25.9 million at year-end 2016. Current assets were $754.3 million and current liabilities $210.2 million; working capital was approximately $544.1 million.
- Debt: Long-term debt was $607.4 million and short-term borrowings $20.1 million, or $627.5 million combined, compared with $603.4 million combined at year-end. The company reported covenant compliance and said operating cash flow and available debt capacity should cover expected needs. Net debt decreased $1.8 million during the nine-month period, excluding foreign-exchange effects.
- Financing and shareholder returns: The company repurchased $64.5 million of stock and paid $39.7 million in dividends during the first nine months. It declared dividends of $0.90 per share for the period, versus $0.81 a year earlier. After quarter-end, it announced a quarterly dividend increase to $0.33 per share, payable December 1, and the board added three million shares to the repurchase authorization.
- Debt refinancing: In May, Sensient issued fixed-rate euro and dollar notes and amended its credit facilities, extending the revolving credit maturity to May 2022 and increasing the term loan to $145 million; proceeds refinanced existing debt.
Material changes and segment trends
- Nine-month operating income fell 15.4% and diluted continuing-operations EPS fell 15.7%. Restructuring and other costs were $45.2 million for the period, versus $19.9 million. Excluding those costs, adjusted operating income increased 2.1% and adjusted diluted EPS increased 6.6% (non-GAAP).
- Q3 adjusted operating income increased 7.2% to $58.0 million and adjusted diluted EPS increased 7.2% to $0.89. These adjusted measures exclude restructuring and other costs and are not GAAP results.
- Flavors & Fragrances: Q3 segment revenue declined 2.4%, mainly due to European divestitures and lower volumes; segment operating income increased 1.9%. For nine months, revenue declined 6.6% and operating income declined 5.5%, with lower volumes, divestitures and manufacturing costs among the factors.
- Color: Q3 revenue increased 6.0% and segment operating income increased 7.9%; nine-month revenue increased 4.1% and operating income increased 6.0%, led primarily by non-food colors, including cosmetics.
- Asia Pacific: Q3 revenue increased 1.9% while operating income declined 7.5%. Nine-month revenue increased 1.0%, but operating income declined 15.7%, reflecting higher manufacturing costs and unfavorable volume and mix.
Outlook, unusual items and risks
- Restructuring: The 2014 plan was substantially completed by September 30. Nine-month 2017 costs were $33.6 million, including a $21.6 million non-cash loss on the sale of the European Natural Ingredients business. Q3 included $3.1 million of inventory write-downs and approximately $1.0 million of asset impairments associated with the Indianapolis facility; management said these costs were not anticipated at June 30. The Strasbourg business sale also generated additional non-cash losses in 2017.
- Management expected another $1 million to $2 million of restructuring costs by year-end 2017. It reported approximately $22 million of cumulative savings to date, no further savings expected in the remainder of 2017, and approximately $4 million to $5 million of additional savings expected in 2018. The expected savings timing shifted partly because of a delay in closing the Indianapolis facility.
- No broad revenue or earnings guidance is provided in the supplied filing text. Management described the financial position as strong and said cash flow and debt capacity were expected to support operations, capital spending, dividends, acquisitions and repurchases.
- The effective tax rate on continuing operations was 31.6% in Q3 versus 23.5% a year earlier; the nine-month rates were 28.1% and 28.6%. Management cited restructuring, prior-year tax estimates, audit settlements, valuation allowances and foreign earnings mix, among other factors.
- In October 2017, the receivables securitization commitment increased from $40 million to $60 million and was extended to October 2018; the company received $20 million for receivables sold. At September 30, receivables sold under the program totaled $64.9 million, including a $24.9 million deferred purchase price receivable recorded in accounts receivable.
- The company disclosed an ongoing informal SEC Enforcement Division inquiry, begun in 2015, concerning restructuring disclosures, long-lived-asset accounting and non-GAAP measures. Sensient said it was cooperating and could not predict the outcome or potential impact. It also reported ordinary-course claims and litigation, with outcomes that could affect results or cash flows in a particular period.
- Management identified risks including raw-material and energy costs and availability, customer and market changes, competition, currency movements, credit availability, regulation, litigation and execution of growth and restructuring plans. It reported no material changes to previously disclosed risk factors or market-risk exposure, and said disclosure controls were effective.
Important facts for investors to verify
- Whether the restructuring and divestiture costs are substantially complete, and whether the expected 2018 savings are realized—particularly given the Indianapolis facility timing and additional inventory write-downs.
- Whether operating cash flow recovers from the working-capital and tax-payment pressures, and how inventory and receivables levels develop.
- Progress in Flavors & Fragrances volumes and Asia Pacific profitability, alongside continued Color growth.
- The outcome and potential consequences of the SEC inquiry, including any implications for prior disclosures or non-GAAP reporting.
- Debt and liquidity developments, including the expanded receivables program, foreign-currency debt exposure and continued share repurchases and dividend increases.