International Flavors & Fragrances Inc. — 2010 Form 10-K Summary
Business context and reporting period
IFF creates and manufactures flavor and fragrance compounds and ingredients used in food, beverages, personal care, household products, fine fragrances and pharmaceuticals. The filing covers the fiscal year ended December 31, 2010, with quarterly data including the fourth quarter. IFF operates through Flavors and Fragrances segments across a global manufacturing and sales network.
- 2010 sales mix: 46% Flavors and 54% Fragrances.
- Geographic sales mix: 34% EAME, 26% Greater Asia, 25% North America and 15% Latin America.
- The 25 largest customers represented 52% of sales; the largest customer represented 10%.
Financial performance and liquidity
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Net sales | $2,622.9 million | $2,326.2 million | +13% |
| Gross profit | $1,092.6 million | $934.2 million | +17% |
| Gross margin | 41.7% | 40.2% | +150 bps |
| Operating income | $416.4 million | $340.3 million | +22% |
| Income before taxes | $359.6 million | $276.5 million | +30% |
| Net income | $263.6 million | $195.5 million | +35% |
| Diluted EPS | $3.26 | $2.46 | +33% |
| Operating cash flow | $315.1 million | $291.6 million | +8% |
| Capital expenditures | $106.3 million | $66.8 million | +59% |
| Cash and equivalents | $131.3 million | $80.1 million | +64% |
| Total debt | $921.6 million | $1,011.5 million | -9% |
- Net income margin increased to 10.0% from 8.4%.
- Cost of goods sold declined to 58.3% of sales from 59.8%, reflecting favorable input costs, higher volume absorption, mix and margin initiatives.
- The effective tax rate declined to 26.7% from 29.3%, reflecting earnings mix, tax-reserve adjustments and lower repatriation costs.
- Adjusted EBITDA, as defined for debt covenants, was $497.6 million versus $441.4 million. Net debt was $777.4 million, and net debt to adjusted EBITDA was 1.56x versus a 3.25x covenant limit.
- Working capital was $664 million at year-end versus $644 million. Inventory increased to $531.7 million from $445.0 million, partly due to higher activity and contingency stocks related to the European rationalization.
- IFF had approximately $818 million of available drawdown capacity under its revolving credit facility and stated that operating cash flow and available credit were sufficient for capital spending and other requirements for at least the next 18 months.
- Dividends paid were $81.2 million, and the annual dividend declared increased to $1.04 per share from $1.00. No shares were repurchased in 2010.
Material changes versus the prior comparable period
- Flavors sales increased 11% to $1.203 billion, with operating profit rising to $242.5 million from $208.3 million; operating margin improved to 20.2% from 19.3%.
- Fragrances sales increased 14% to $1.420 billion, with operating profit rising to $234.9 million from $170.5 million; reported operating margin improved to 16.5% from 13.7%.
- Growth reflected higher volumes, customer re-stocking, new business wins, stronger sales mix and recovery from weak 2009 demand. Approximately half of local-currency sales gains came from new wins in both businesses.
- Research and development expense increased to $218.8 million from $184.8 million, or approximately 8% of sales. Selling and administrative expense increased to $447.4 million from $390.9 million, driven principally by higher incentive compensation and planned growth investments.
- Interest expense declined to $48.7 million from $61.8 million, reflecting prior debt repayments and lower borrowing costs.
- Operating cash flow improved despite increased working capital investment. Investing cash use increased to $106.8 million, primarily because of capacity and technology investments in emerging markets and Flavors.
- Debt declined by approximately $90 million, while current debt increased because $122.3 million of long-term debt was classified as current, including a $100 million 2011 maturity.
Guidance, outlook, risks and unusual items
- Management expected 2011 research and development spending to remain approximately 8% of revenues and capital expenditures to approximate 4%–5% of sales.
- Management expected to spend approximately $6–$7 million on environmental capital projects and approximately $18 million on related operating expenses and governmental charges in 2011.
- IFF expected total costs for its European Fragrance and Ingredients restructuring plan to reach approximately $34 million. Cumulative costs recorded through year-end were $30.8 million, and the Drogheda, Ireland facility ceased operations on September 30, 2010.
- 2010 restructuring and other charges were $10.1 million, compared with $18.3 million in 2009. Fourth-quarter 2010 net income included $0.9 million of additional European reorganization costs.
- Key risks include global economic weakness, customer spending and inventory changes, raw-material price and availability volatility, currency movements, competitive pricing, customer concentration, regulatory and environmental compliance, product-integrity claims, litigation, pension funding and tax audits.
- Pending matters include popcorn-flavor respiratory-injury litigation, a patent dispute concerning a cooling-effect flavor ingredient and environmental claims at ten third-party sites. Management believes adequate provisions and insurance exist and does not expect the matters collectively to have a material effect, although an adverse patent outcome could affect cash flows, results or the ability to sell affected products.
- Environmental liabilities were estimated at less than $5 million. Unrecognized tax benefits were approximately $63.9 million, plus approximately $11 million of accrued interest; timing and ultimate outcomes remain uncertain.
- Goodwill and other intangible assets totaled approximately $714 million. The annual goodwill impairment test found no impairment, but valuation depends on forecasts, discount rates and market assumptions.
- The CEO transition was completed when Douglas D. Tough became Chairman and CEO on March 1, 2010. The filing states that disclosure controls and internal control over financial reporting were effective at year-end.
Most important facts for investors to verify
- Whether the 2010 recovery in volumes and customer re-stocking continued after the favorable 2009 comparison period.
- Progress, remaining costs and operational benefits from the European restructuring program.
- Raw-material inflation, pricing recovery, product mix and their effects on gross margin.
- Refinancing or repayment of the approximately $134 million of borrowings due in 2011 and continued compliance with debt covenants.
- Working-capital normalization, particularly the significant increase in inventory.
- Developments in the patent litigation, popcorn-flavor claims, environmental matters and European tax audits.
- Future pension contributions and the sensitivity of benefit obligations to discount rates and investment returns.