International Flavors & Fragrances Inc. — 2016 Q3 Form 10-Q Summary
Business context and reporting period
IFF creates and supplies flavor and fragrance compounds and ingredients for food, beverage, personal care, household and related products. The company operates through Flavors and Fragrances segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $777.0 million | $765.1 million | $2,353.8 million | $2,307.5 million |
| Gross profit | $346.3 million | $347.1 million | $1,072.1 million | $1,038.4 million |
| Gross margin | 44.6% | 45.4% | 45.5% | 45.0% |
| Operating profit | $124.3 million | $156.7 million | $456.0 million | $467.3 million |
| Operating margin | 16.0% | 20.5% | 19.4% | 20.3% |
| Net income | $89.8 million | $106.4 million | $325.1 million | $340.1 million |
| Diluted EPS | $1.12 | $1.31 | $4.05 | $4.18 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $329.4 million | $294.7 million |
- Q3 reported sales increased 2%; currency-neutral sales increased 3%. The Lucas Meyer acquisition contributed approximately 1 percentage point of growth.
- For the first nine months, reported sales increased 2% and currency-neutral sales increased 4%; acquisitions contributed approximately 2 percentage points to growth.
- Q3 adjusted operating profit was $151.1 million, or 19.4% of sales, compared with $163.8 million, or 21.4%, in Q3 2015. Adjusted net income was $107.3 million versus $112.7 million.
- Q3 effective tax rate was 20.8%, compared with 25.5%; the nine-month rate was 22.7%, compared with 22.1%.
- Cash and cash equivalents were $498.7 million at September 30, 2016, versus $182.0 million at December 31, 2015. Approximately $239.8 million was held outside the United States.
- Total debt was $1.368 billion, compared with $1.068 billion at year-end 2015. Net debt was $867.4 million, and the debt-covenant net debt-to-adjusted EBITDA ratio was 1.18 to 1.
- The company reported $950.0 million of available capacity under its revolving credit facility and stated that cash flows and existing facilities should meet investing and financing needs for at least the next 18 months.
- Capital expenditures were $70.2 million for the first nine months; management expected full-year capital spending of approximately 5% of sales.
- Dividends paid were $134.1 million, and share repurchases were $94.1 million for the first nine months. The quarterly dividend was $0.64 per share, and $142.6 million remained available under the repurchase authorization.
Material changes versus the prior comparable period
- Q3 operating profit declined 21% and net income declined 16%, despite 2% sales growth. The decline reflected a $25.0 million ZoomEssence legal reserve, higher acquisition and operational-improvement costs, increased global expenses and weaker margins.
- Q3 gross margin declined 80 basis points, primarily because of unfavorable mix, manufacturing performance and input costs. Cost savings and productivity initiatives only partly offset these pressures.
- Q3 selling and administrative expense rose 24% to $152.0 million, or 19.6% of sales, driven by acquired-company costs, strategic investments, compliance, litigation and acquisition-related expenses.
- Q3 Flavors segment profit decreased to $77.5 million from $79.8 million, while Fragrances segment profit decreased to $85.0 million from $90.9 million. For the nine-month period, both segment profits increased modestly.
- Operating cash flow increased $34.7 million year over year, aided by lower pension contributions and lower core working-capital requirements. Factoring programs contributed approximately $25.8 million of incremental operating cash benefit versus approximately $0.2 million in 2015.
- Debt increased primarily because of the March 2016 issuance of €500 million of 1.75% senior notes due 2024. The company also repaid $125.0 million of 2006 senior notes during Q3.
Guidance, outlook, risks and unusual items
- Management did not provide a specific sales or earnings forecast in the filing. It expected raw-material costs to remain broadly benign, with higher prices for certain naturals, including vanilla, largely offset by benefits from oil-based derivatives.
- Management expects restructuring initiatives to be fully implemented in the second half of 2017. Total plan costs are expected to be approximately $10.5 million.
- On October 7, 2016, after quarter-end, IFF completed the approximately $242 million acquisition of David Michael & Company using existing resources. The acquisition is intended to strengthen North American Flavors and was not expected to materially affect 2016 earnings.
- On November 3, 2016, IFF agreed to acquire Fragrance Resources, with closing expected in 2017.
- The company recorded a $25.0 million reserve for the ZoomEssence litigation. Mediation in October 2016 did not resolve the matter, and a trial was expected in 2017. Aggregate reasonably possible losses above accrued liabilities for disclosed third-party contingencies were estimated at $0 to approximately $53 million.
- China facility matters remain a risk. The company is constructing a replacement Flavors site, and a requested relocation of its Zhejiang Ingredients plant could result in accelerated depreciation of $0 to $27 million. The carrying value of five China facilities was approximately $130 million.
- Other risks include foreign-currency volatility, raw-material availability and pricing, supply-chain disruption, acquisition integration, litigation and tax contingencies, environmental obligations, regulatory compliance, pension funding and execution of the Vision 2020 strategy.
- At September 30, 2016, the company had approximately $39.2 million of bank guarantees and standby letters of credit, including guarantees related to Brazilian tax disputes, and estimated environmental liabilities at identified sites of less than $5 million.
Most important facts for investors to verify
- Whether margin and segment-profit pressure in Q3 was temporary or indicates a broader deterioration in mix, manufacturing performance or cost discipline.
- The ultimate outcome and financial exposure from the ZoomEssence litigation and other disclosed legal, tax and environmental contingencies.
- Integration performance, financing impact and earnings contribution from the David Michael acquisition and the planned Fragrance Resources acquisition.
- Debt repayment capacity, currency exposure from the euro-denominated notes and continued compliance with debt covenants.
- Whether operating cash flow remains strong after considering pension contributions, working-capital movements and the $25.8 million factoring-related cash benefit.
- The potential financial impact of China plant relocation or closure decisions and the timing of restructuring and operational-improvement savings.