INTERNATIONAL FLAVORS & FRAGRANCES INC quarterly report, Q3 FY2011

International Flavors & Fragrances Inc. — Q3 2011 Form 10-Q Summary

Business context and reporting period

IFF is a global creator of flavors and fragrances serving food, beverage, personal care, household products, fine fragrance and ingredient markets. The filing covers the unaudited three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. The Company operates through Flavors and Fragrances segments, with more than 75% of sales generated outside the United States and approximately 45% in emerging markets.

Financial performance and key metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Net sales	$713.8 million	$673.3 million	$2.144 billion	$1.993 billion
Income before taxes	$112.5 million	$106.2 million	$333.0 million	$288.9 million
Net income	$82.2 million	$77.0 million	$242.5 million	$208.0 million
Diluted EPS	$1.00	$0.95	$2.96	$2.58
Operating profit	$128.6 million	$120.5 million	$379.9 million	$332.9 million
Cash flow from operations	Not separately provided	Not separately provided	$116.7 million	$208.3 million

Reported Q3 sales increased 6%; local-currency sales increased 1%. Nine-month reported sales increased 8%, with 4% local-currency growth.
Q3 operating margin was 18.0%, versus 17.9% in the prior-year quarter. Excluding restructuring-related items, management stated that adjusted operating margin declined to 17.9% from 18.3%.
Q3 cost of goods sold was 61.0% of sales, up from 57.7%; nine-month cost of goods sold was 59.9%, up from 57.8%, reflecting higher raw-material costs and unfavorable mix.
Q3 effective tax rate was 26.9%, versus 27.4%; the nine-month rate was 27.2%, versus 28.0%.
Q3 Flavors sales were $340.6 million and operating profit was $71.2 million, compared with $300.5 million and $63.0 million, respectively, in Q3 2010.
Q3 Fragrances sales were $373.2 million and operating profit was $59.3 million, compared with $372.7 million and $68.6 million, respectively. Fragrance operating margin fell to 15.9% from 18.4%.
Cash and cash equivalents were $107.3 million at September 30, 2011, compared with $131.3 million at December 31, 2010. Working capital was $808 million, up from $664 million.
Total debt was $911.7 million at September 30, 2011, compared with $921.6 million at year-end 2010. Net debt, as defined for covenant purposes, was $793.0 million.
The Company repaid $100 million of senior notes in July 2011. Short-term borrowings largely offset the repayment because of working-capital needs.
Capital expenditures were $74.7 million for the first nine months, versus $53.6 million in 2010. Management expected full-year additions to approximate 5% of sales.
The quarterly dividend was increased 15% to $0.31 per share from $0.27. Nine-month dividends paid were $65.2 million.

Material changes versus the prior comparable period

Flavors was the principal growth and profit contributor: Q3 local-currency sales increased 8%, supported by new business, pricing and strong Savory and Beverage performance.
Fragrances declined 5% in local-currency sales in Q3. Lower existing-business volumes, particularly in Ingredients, Fine Fragrance and Beauty Care, outweighed pricing and new-business gains.
Raw-material costs increased approximately 13% year over year in Q3 and approximately 10% for the first nine months. Pricing, productivity and the European fragrance rationalization only partially offset the pressure.
Selling and administrative expense decreased $12 million in Q3 and $27 million year to date, primarily because of lower incentive-compensation and contingency-loss provisions and continued cost discipline.
Operating cash flow fell $91.6 million year to date, as higher earnings were more than offset by incentive-compensation payments, tax payments, trade payments and working-capital investment.
Other expense increased to $5.8 million in Q3 and $13.0 million year to date, including unfavorable changes in investment values and higher foreign-exchange losses.
The European fragrance manufacturing rationalization was substantially complete. Cumulative related expense was $34.1 million, and management did not anticipate further expenses.

Guidance, outlook, risks and unusual items

Management expected raw-material costs to remain elevated, especially in Fragrances, through at least the balance of 2011, and continued pursuing additional price increases.
Management described long-term industry growth as approximately 2% to 3% annually but cited near-term global economic uncertainty and demand risks.
Cash from operations and available revolving-credit capacity were expected to fund normal capital spending and other anticipated cash requirements for at least the next 18 months.
The existing facility had $926 million of overall borrowing capacity and $741 million of remaining drawdown capacity at September 30, 2011. The Company was in compliance with all covenants; net debt to adjusted EBITDA was 1.5 to 1 against a 3.25 to 1 maximum.
Management expected to repay the Japanese yen note maturing in November 2011 using cash and/or the existing credit facility. A commitment letter for a replacement revolving facility was signed in October, but completion and terms were not assured.
Gross unrecognized tax benefits were $66 million, excluding $13 million of accrued interest and penalties. European tax assessments and uncertain tax positions could affect future earnings and cash flows.
The Company settled previously outstanding popcorn and flavor litigation during Q3 for an amount, net of insurance recoveries, that was not material. Five new related actions had subsequently been filed, but management did not believe a material loss was reasonably possible based on available information.
Patent litigation involving V. Mane Fils remained unresolved and was subject to settlement discussions. The Company could not reasonably estimate potential losses above its recorded liability; an adverse injunction could affect sales of certain flavor products.
Environmental liabilities at ten third-party sites were estimated at less than $5 million, although future events could increase the required amounts.
Expected 2011 pension contributions were $12 million to $15 million for qualified U.S. plans and approximately $20 million for non-U.S. plans; expected postretirement contributions were approximately $6 million.
The filing states that there were no material changes to previously disclosed market risks, risk factors or internal control effectiveness.

Important facts for investors to verify

Whether pricing actions can offset continued raw-material inflation without causing additional volume declines, particularly in Fragrances.
The sustainability of Flavors growth and the extent to which reported growth reflects currency movements versus underlying demand and new business.
Working-capital trends and whether operating cash flow recovers from the year-to-date decline.
Completion, pricing and covenant terms of the proposed replacement revolving credit facility before the existing facility matures in November 2012.
The repayment of the Japanese yen note and the Company’s resulting short-term borrowing needs.
Developments in European tax audits, the V. Mane patent litigation and remaining flavor-related claims.
Actual pension funding requirements and exposure to currency, commodity, interest-rate and credit-market volatility.