International Flavors & Fragrances Inc. — Q1 2012 Form 10-Q
Business context and reporting period
IFF creates and supplies flavors and fragrances for food, beverage, personal care and household-product industries. The filing covers the unaudited three months ended March 31, 2012, compared with the three months ended March 31, 2011. Its operating segments are Flavors and Fragrances.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $710.6 million | $714.3 million | Down 1% |
| Gross profit / margin | $285.4 million / 40.2% | $297.5 million / 41.6% | Margin down 140 bps |
| Operating profit / margin | $120.9 million / 17.0% | $133.4 million / 18.7% | Down $12.5 million |
| Adjusted operating profit / margin | $122.6 million / 17.2% | $133.4 million / 18.7% | Margin down 150 bps |
| Net income | $81.1 million | $84.0 million | Down 4% |
| Diluted EPS | $0.99 | $1.03 | Down 4% |
| Operating cash flow | $52.6 million | $(34.9) million | Improved $87.5 million |
| Capital expenditures | $28.8 million | $19.4 million | Higher investment |
| Dividends declared per share | $0.31 | $0.27 | Higher |
Raw material costs increased approximately 9% year over year, driving the gross-margin decline. Research and development expense was $57.4 million, or 8.1% of sales, and selling and administrative expense was $105.4 million, or 14.8% of sales.
Flavors sales increased 3% on a reported basis and 5% in local currency, with segment profit of $79.7 million. Fragrances sales declined 4% on a reported basis and 3% in local currency, with segment profit falling to $56.1 million from $68.7 million, primarily because of lower volumes and higher input costs.
Cash and cash equivalents were $76.5 million at March 31, 2012, compared with $88.3 million at December 31, 2011. Total debt was $870.5 million, including $134.5 million under the revolving credit facility; net debt was $783.5 million. The company reported a covenant Net Debt/adjusted EBITDA ratio of 1.41 to 1, versus a maximum covenant of 3.25 to 1, and stated that it was in compliance with all covenants. Remaining overall borrowing capacity was $1.018 billion, with credit-facility drawdown capacity limited to $878.6 million.
Working capital increased to $824.5 million from $752.7 million at year-end. Management stated that operating cash flow and available credit facilities should meet investing and financing needs for at least the next 18 months.
Material changes versus the prior comparable period
- Reported sales decreased modestly because a 1% local-currency increase was more than offset by a 200-basis-point adverse currency effect, primarily from a stronger U.S. dollar against the euro.
- Flavors growth and pricing were offset by Fragrances volume declines, especially in Ingredients and certain existing businesses.
- Gross margin declined because of higher raw-material costs, although management reported signs of stabilization and ongoing pricing and cost-saving actions.
- Operating profit included $1.7 million of restructuring charges, compared with $28,000 in Q1 2011. The charge related to the 2011 strategic initiative; no further charges were expected for that plan.
- Other income and expense improved from $6.1 million of expense to $0.2 million of income, mainly because of lower foreign-exchange losses and gains on deferred-compensation plan assets.
- Operating cash flow turned positive, primarily because of lower incentive-compensation and tax payments and reduced working-capital requirements.
- Total debt declined from $894.9 million at December 31, 2011, while cash declined by $11.8 million during the quarter after investing and financing uses.
Guidance, outlook, risks and unusual items
- Management expected local-currency growth to strengthen as new business wins, easier comparisons and reduced Ingredients-related volume pressure contribute during the second half of 2012. Emerging markets remained the primary growth driver.
- Capital spending was expected to approximate 5% of 2012 sales, with emphasis on emerging markets, Flavors capacity and new technologies.
- Management expected raw-material costs to remain above historical levels and planned further price realization and cost-savings initiatives to close the pricing gap over the year.
- The company recorded a $10.9 million pretax charge, or $9.4 million after tax, related to an unfavorable Spanish dividend-withholding-tax ruling. Payment was expected in Q2 2012. In April 2012, two additional unfavorable rulings resulted in an expected Q2 charge of $3.3 million pretax, or $2.9 million after tax.
- Spanish tax assessments and related claims totaled approximately $125.6 million, while aggregate uncertain-tax-position provisions, including interest and penalties, were $79.9 million. The company had posted approximately $132.4 million of Spanish tax-related bank guarantees within total guarantees and standby letters of credit of $198.6 million.
- The company anticipated similar Spanish tax assessments for certain 2007–2011 periods, although the 2012 Spain and Netherlands reorganization was expected to eliminate substantially all of the challenged deductions in future returns.
- Environmental claims involved ten sites, with the company estimating its share of future cleanup costs at less than $5 million. Other litigation and tax contingencies could nevertheless materially affect results or cash flows if resolved unfavorably.
- Key ongoing risks include raw-material availability and pricing, currency fluctuations, Western European economic weakness, demand and consumer-preference changes, execution of restructuring and cost savings, pension funding, tax audits, litigation and regulatory developments.
Important facts for investors to verify
- Whether pricing and productivity actions offset continued raw-material inflation and restore gross margins.
- Whether Fragrances volume trends, particularly Ingredients, stabilize and whether the expected second-half growth improvement occurs.
- The cash impact and final accounting for the Spanish withholding-tax rulings and any additional Spanish income-tax or capital-tax assessments.
- Progress toward the expected 5% of sales capital-spending level and the effect on free cash flow.
- Compliance with debt covenants and the company’s ability to maintain liquidity while funding dividends, pension contributions, capital expenditures and tax payments.
- Whether emerging-market growth and new business wins compensate for currency headwinds and exits from low-margin business.