International Flavors & Fragrances Inc. — Q3 2015 Form 10-Q Summary
Business Context and Reporting Period
IFF creates and supplies flavors and fragrances for food, beverage, personal care and household products. The filing covers the unaudited three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. The company operates through Flavors and Fragrances segments. Fiscal quarter closing dates were October 2, 2015 and September 26, 2014, although the filing presents them as September 30.
During 2015, IFF completed the acquisitions of Ottens Flavors and Lucas Meyer Cosmetics, expanding North American Flavors and Fragrance Ingredients, respectively.
Financial Performance and Key Metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $765.1 million | $773.8 million | $2.308 billion | $2.332 billion |
| Operating profit | $156.7 million | $152.6 million | $467.3 million | $461.8 million |
| Operating margin | 20.5% | 19.7% | 20.3% | 19.8% |
| Net income | $106.4 million | $107.4 million | $340.1 million | $324.4 million |
| Diluted EPS | $1.31 | $1.31 | $4.18 | $3.95 |
| Gross margin | 45.4% | 44.0% | 45.0% | 44.3% |
| Effective tax rate | 25.5% | 24.5% | 22.1% | 24.8% |
Reported sales declined 1% in both the quarter and nine-month period, primarily because foreign currency translation reduced reported results. Currency-neutral sales increased 7% in the quarter and 6% for the nine months. Management attributed underlying growth to new wins, lower volume erosion and acquisitions.
- Flavors: Q3 sales were essentially flat on a reported basis and increased 8% currency-neutral; nine-month reported sales increased 1% and currency-neutral sales increased 8%.
- Fragrances: Q3 reported sales declined 2% but increased 6% currency-neutral; nine-month reported sales declined 3% and increased 5% currency-neutral.
- Cash flow: Operating cash flow was $294.7 million for the first nine months, down from $317.5 million. The decrease reflected higher working-capital outflows and pension contributions.
- Investing: Investing cash outflow was $546.1 million, including approximately $493.5 million for acquisitions and $66.6 million of capital expenditures.
- Liquidity: Cash and equivalents were $272.3 million at September 30, 2015, compared with $478.6 million at December 31, 2014. Approximately $204.9 million was held outside the United States.
- Debt: Total debt was approximately $1.191 billion, up from $942.3 million at year-end 2014, principally due to a $247.7 million credit-facility borrowing used to support acquisitions.
- Leverage: Net debt to covenant-defined adjusted EBITDA was 1.3x, versus a 3.25x covenant limit. The company reported compliance with all debt covenants and $692.8 million of remaining draw capacity under its revolving facility.
- Capital returns: Dividends declared were $0.56 per share in Q3 and $1.50 per share for the nine months. The company repurchased 726,115 shares for $81.2 million during the nine months and had $277.7 million remaining under its repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Gross margin improved 140 basis points in Q3 and 70 basis points for the nine months, despite acquisition-related inventory step-up and operational-improvement costs.
- Q3 operating profit increased 3%, while nine-month operating profit increased 1%. Adjusted Q3 operating profit was $163.8 million, or 21.4% of sales, compared with $153.5 million, or 19.8%, in the prior year.
- Q3 net income decreased 1%, while nine-month net income increased 5%, supported in part by a $10.5 million tax benefit from favorable tax rulings recorded in the first quarter.
- Foreign currency had an approximately 800-basis-point unfavorable impact on Q3 sales and approximately 3% unfavorable impact on Q3 operating profit. Accumulated other comprehensive loss increased to $611.6 million, principally reflecting foreign-currency translation and hedge movements.
- Global expenses declined to $6.9 million in Q3 from $12.9 million and to $27.1 million for the nine months from $49.2 million, primarily due to cash-flow hedging effects and lower incentive compensation.
- Acquisition-related costs were $6.8 million in Q3 and $13.9 million for the nine months. Q3 included $2.8 million of acquisition-related inventory step-up and operational-improvement costs.
Guidance, Outlook, Commentary and Risks
Under its Vision 2020 strategy, IFF targets 2016–2020 currency-neutral sales growth of 4%–6%, operating-profit growth of 7%–9% and EPS growth of 10%. It also targets $500 million to $1 billion of acquisition-related sales growth by 2020 and intends to return 50%–60% of adjusted net income to shareholders. Management did not provide a specific full-year earnings or sales outlook in the filing.
- Management expected 2015 raw-material cost inflation of less than 1% and capital expenditures of approximately 4%–5% of sales.
- Management expected operating cash flows and available credit facilities to fund operations, capital investment, dividends and debt service for at least the next 18 months.
- A Flavors facility in China was temporarily idled and another facility operated at reduced workload because of odor-emission compliance issues. Further remediation, permanent closure or reduced production could result in material future charges.
- Management estimated reasonably possible losses from disclosed contingencies collectively at $0 to $31 million. Environmental obligations at eight sites were estimated at less than $5 million.
- The ZoomEssence trade-secret litigation was in discovery, with trial anticipated in mid-2016; management did not consider it a material loss contingency as of September 30, 2015.
- Other principal risks include currency volatility, raw-material availability and pricing, execution of acquisitions and Vision 2020, supply-chain disruptions, changing consumer demand, pension funding, tax disputes, litigation and international regulatory conditions.
- The company had $31.3 million of bank guarantees and standby letters of credit, including $13.2 million related to Brazilian tax disputes, and had pledged approximately $12.0 million of assets for certain Brazilian assessments.
Important Facts for Investors to Verify
- Whether currency-neutral growth converts into sustained reported sales and profit growth as foreign-exchange effects change.
- The final purchase-price allocations, intangible-asset amortization and earnings contribution from Lucas Meyer and Ottens Flavors.
- The effect of higher debt, interest expense and acquisition financing on future leverage and cash generation.
- Progress and potential costs associated with the China odor-compliance matters and facility operations.
- Working-capital trends, pension contributions and the company’s ability to maintain operating cash flow after acquisitions and shareholder distributions.
- Achievement of Vision 2020 targets, acquisition-related sales objectives and the stated 50%–60% adjusted-net-income shareholder-return target.
- Potential outcomes of Brazilian tax matters, environmental claims, ZoomEssence litigation and other contingencies.