International Flavors & Fragrances Inc. — Q1 2017 Form 10-Q Summary
Business context and reporting period
IFF is a global developer and supplier of flavors, fragrances, cosmetic actives and functional ingredients. It operates through two segments: Flavors and Fragrances. This unaudited filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $828.3 million | $783.3 million | +6% |
| Gross profit | $364.7 million | $360.2 million | +1% |
| Gross margin | 44.0% | 46.0% | Down 200 bps |
| Operating profit | $137.4 million | $169.9 million | Down $32.5 million |
| Operating margin | 16.6% | 21.7% | Down 510 bps |
| Net income | $115.8 million | $118.6 million | Down 2% |
| Diluted EPS | $1.45 | $1.47 | Down 1% |
| Operating cash flow | $21.7 million | $39.9 million | Down $18.2 million |
- Segment sales: Flavors sales increased 9% to $406.2 million; Fragrances sales increased 3% to $422.1 million.
- Segment profit: Flavors increased to $98.0 million, while Fragrances declined to $81.7 million. Flavors margin was 24.1% versus 24.6%; Fragrances margin was 19.4% versus 21.7%.
- Adjusted results: Adjusted operating profit was $163.5 million, with a 19.7% margin, compared with $167.2 million and 21.3% in the prior-year quarter. Adjusted net income was $121.1 million versus $116.4 million.
- Taxes: The effective tax rate decreased to 16.4% from 23.4%; management reported an adjusted effective tax rate of 20.5% versus 23.5%.
- Liquidity and debt: Cash was $300.1 million at March 31, 2017, including $244.2 million held outside the United States. Total debt was $1.552 billion, and net debt was $1.251 billion. The company had $102.3 million drawn under its revolving credit facility and $107.4 million of commercial paper outstanding.
- Leverage and liquidity: Net debt to adjusted EBITDA under the debt agreements was 1.65x, versus a 3.25x covenant limit. The company reported $847.7 million of remaining draw capacity under the revolving facility and compliance with all covenants.
- Capital allocation: The company paid $50.7 million of dividends, declared a quarterly dividend of $0.64 per share, and repurchased 312,289 shares for $37.6 million. Approximately $71.7 million remained available under the repurchase authorization.
Material changes versus the prior comparable period
- Reported sales rose 6%, or 7% on a currency-neutral basis. Acquisitions contributed approximately 5% of sales growth, while currency translation reduced reported sales growth by approximately 100 basis points.
- Gross margin declined because of unfavorable price versus input costs and manufacturing performance. Raw-material costs were described as stable but trending upward, with particular pressure expected from vanilla, citrus and certain oil-based derivatives.
- Operating profit was reduced by $26.1 million of restructuring, acquisition-related, tax assessment, integration and operational-improvement items, compared with a net favorable impact from unusual items in the prior-year quarter.
- Operating cash flow declined primarily because of higher pension and incentive-compensation payments. The beneficial cash-flow impact from receivables factoring decreased by approximately $27.1 million in Q1 2017 compared with approximately $4.7 million in Q1 2016.
- Investing cash outflows increased to $162.2 million, primarily reflecting the Fragrance Resources acquisition and $26.7 million of capital expenditures.
- Total assets increased to $4.252 billion from $4.017 billion at year-end 2016, including increases in goodwill and intangible assets related primarily to acquisitions.
Guidance, outlook, commentary, risks and unusual items
- Productivity program: The company expects cumulative pre-tax cash charges of $30 million to $35 million, plus up to $5 million of accelerated depreciation. The program is expected to reduce the global workforce by approximately 370 positions and generate annual run-rate savings of $40 million to $45 million by 2019. Q1 charges were $10.1 million.
- Acquisitions: IFF completed the $150.5 million Fragrance Resources acquisition on January 17, 2017, and completed the approximately $55 million PowderPure acquisition on April 7, 2017. Purchase-price allocations for these acquisitions remained preliminary.
- Capital spending: Management expects 2017 capital expenditures to be approximately 5% of sales, net of potential government grants and reimbursements.
- Funding outlook: Management expects operating cash flow and existing credit facilities to fund operating, investing and financing needs for at least the next 18 months. The company may evaluate refinancing opportunities during 2017, subject to market conditions.
- China facilities: Regulatory and zoning matters could require changes to or closure of facilities in Guangzhou and Zhejiang. The company disclosed potential accelerated depreciation of up to $25 million for the Zhejiang facility; the carrying value of the Guangzhou plant was approximately $68 million.
- Legal and product contingencies: The company maintained a $50 million reserve related to the ZoomEssence litigation. A product recall-related matter resulted in an approximately $1.8 million Q1 charge, but additional losses were probable and not estimable. Aggregate reasonably possible estimable losses above accrued liabilities were estimated at $0 to approximately $28 million.
- Tax and accounting items: The company recorded approximately $5.4 million of expense for a prior-period tax assessment. Adoption of new intra-entity tax-transfer guidance reduced retained earnings and related balance-sheet amounts by approximately $33 million. Adoption of share-based-payment guidance also changed cash-flow classification and produced a $0.8 million tax benefit in Q1.
- Key operating risks: Major risks include raw-material and energy inflation, pricing pressure, currency volatility, supply-chain disruption, customer demand and preferences, acquisition integration, emerging-market conditions, cybersecurity, environmental compliance, tax audits, litigation, pension obligations and the outcome of Chinese regulatory matters.
Important facts for investors to verify
- Whether the productivity program delivers the projected $40 million to $45 million of annual run-rate savings by 2019 without materially disrupting operations.
- Whether gross-margin pressure from input costs, pricing and manufacturing performance persists, particularly in Fragrances.
- The final purchase-price allocations and integration performance for Fragrance Resources, David Michael and PowderPure.
- The ultimate financial impact of the ZoomEssence litigation, the product recall claim and other contingent liabilities.
- Whether Chinese authorities require facility relocation, closure or material accelerated depreciation charges.
- The sustainability of operating cash flow given pension contributions, incentive payments, working-capital needs, acquisitions, dividends and share repurchases.
- The effect of currency movements, raw-material prices and future refinancing conditions on earnings, leverage and liquidity.