International Flavors & Fragrances Inc. — Q3 2017 Form 10-Q Summary
Business context and reporting period
IFF is a global developer and supplier of flavors, fragrances, fragrance ingredients, cosmetic actives and functional ingredients. It operates through two segments: Flavors and Fragrances. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $872.9 million | $777.0 million | $2.544 billion | $2.354 billion |
| Gross profit | $382.1 million | $346.3 million | $1.121 billion | $1.072 billion |
| Gross margin | 43.8% | 44.6% | 44.1% | 45.5% |
| Operating profit | $157.7 million | $124.4 million | $454.2 million | $459.0 million |
| Operating margin | 18.1% | 16.0% | 17.9% | 19.5% |
| Net income | $110.3 million | $89.8 million | $335.8 million | $325.1 million |
| Diluted EPS | $1.39 | $1.12 | $4.22 | $4.05 |
| Operating cash flow | Not separately provided | Not separately provided | $199.5 million | $341.8 million |
- Q3 sales increased 12% on both reported and currency-neutral bases. Acquisitions contributed approximately 6% of growth. Flavors sales increased 12%; Fragrances sales increased 13% reported and 12% currency-neutral.
- Nine-month sales increased 8% reported and 9% currency-neutral, with acquisitions contributing approximately 6% of growth.
- Q3 adjusted operating profit was $167.3 million, or 19.2% of sales, versus $151.1 million, or 19.4%, in the prior-year quarter. Nine-month adjusted operating profit was $502.6 million versus $484.0 million.
- Margins were pressured by unfavorable price-versus-input-cost performance, mix and manufacturing performance. Raw-material costs were described as stable but trending upward, particularly for vanilla, citrus and certain oil-based derivatives.
- Cash and cash equivalents were $316.0 million at September 30, 2017, including $201.2 million held outside the United States. Working capital was $1.154 billion.
- Total debt was $1.673 billion, compared with $1.325 billion at December 31, 2016. Net debt was $1.357 billion and covenant net debt-to-adjusted EBITDA was 1.72x versus a 3.5x maximum covenant.
- The Company had $950 million of revolving-credit capacity, no borrowings under that facility, approximately $40.0 million of commercial paper outstanding and approximately $75.6 million of additional available credit lines.
- Dividends paid during the first nine months were $151.7 million. The quarterly dividend was $0.69 per share. The Company repurchased $53.2 million of stock during the first nine months and had $56.1 million remaining under the then-existing authorization at September 30.
Material changes versus the prior comparable period
- Operating profit rose 27% in Q3, mainly because higher sales, acquisitions, productivity savings and the absence of the $25.0 million prior-year legal charge more than offset unfavorable mix, price-to-input costs and higher global expenses.
- Nine-month operating profit declined 1% despite higher sales because of increased acquisition-related costs, restructuring, product-recall costs, a tax assessment, integration costs and weaker Fragrances segment profitability.
- Q3 Fragrances segment profit increased approximately 10%, while its margin declined to 20.2% from 20.7%. Nine-month Fragrances segment profit decreased to $260.1 million from $261.8 million, and its margin declined to 19.8% from 21.2%.
- Flavors segment profit increased to $91.4 million in Q3 and $289.7 million for the first nine months; the nine-month margin improved to 23.5% from 23.2%.
- Operating cash flow fell $142.3 million year over year, primarily due to the $56 million ZoomEssence litigation settlement and higher receivables and working-capital requirements.
- Debt increased following the May 2017 issuance of $500 million face amount of 4.375% senior notes due 2047, partly offset by repayment of $250 million of 2007 senior notes.
Outlook, commentary, risks and unusual items
- The multi-year productivity program is expected to generate $40 million to $45 million of annual run-rate savings by 2019 and reduce the global workforce by approximately 370 employees. Expected cumulative pre-tax cash charges are $30 million to $35 million, plus up to $5 million of accelerated depreciation. Charges recorded through Q3 were $16.5 million.
- Management expects 2017 capital expenditures to be approximately 4.5% of sales and stated that operating cash flow, cash balances and credit availability should fund investing and financing needs for at least the next 18 months.
- Management expects 2017 U.S. pension contributions of approximately $3 million to $10 million and 2017 postretirement contributions of approximately $5 million.
- 2017 acquisitions included Fragrance Resources for approximately $150.5 million and PowderPure for approximately $55 million. Purchase-price allocations remained preliminary at quarter-end.
- The Company recorded a $12.2 million foreign-currency translation gain from liquidation of a foreign entity, a $56 million ZoomEssence settlement payment and a $5.3 million product-recall charge through September 30. Additional recall losses were probable but not estimable; potential insurance or supplier reimbursement was also undetermined.
- The Company estimates reasonably possible third-party contingency losses in excess of accrued liabilities at $0 to approximately $23 million. Environmental liabilities at eight sites are estimated at less than $5 million.
- Potential China-related exposure includes possible accelerated depreciation of $0 to $12 million for the Zhejiang plant relocation. The Guangzhou plant had an approximately $68 million net book value and could face zoning-related operating restrictions. The carrying value of six China plants was approximately $145 million.
- Other principal risks include raw-material inflation and availability, supply-chain disruption, customer claims and recalls, foreign-exchange volatility, international economic and political conditions, acquisitions and integration, litigation and tax disputes, environmental compliance, cybersecurity and pension obligations.
Most important facts for investors to verify
- Whether the productivity program achieves the projected $40 million to $45 million annual savings by 2019 and whether remaining charges stay within the stated range.
- Whether price increases, sourcing, productivity and mix improvements offset higher raw-material costs and restore gross margins.
- The ultimate cost of the product recall and the amount and timing of any insurance or supplier recovery.
- The outcome and compensation associated with the Zhejiang relocation and any Guangzhou zoning change, including possible impairment or accelerated-depreciation charges.
- Acquisition integration performance and final purchase-price allocations for Fragrance Resources and PowderPure.
- Working-capital trends and the sustainability of operating cash flow after the litigation settlement and acquisition spending.
- Debt-service capacity, commercial-paper refinancing, covenant compliance and the effect of higher interest expense.
- Developments in tax audits, Brazilian tax disputes, environmental matters and other contingencies, including potential losses beyond accrued amounts.