International Flavors & Fragrances Inc. — Q3 2014 Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2014; interim financial statements are unaudited. IFF creates and supplies flavors, fragrances, compounds and specialty ingredients to food, beverage, personal care and household-products markets. Its reportable segments are Flavors and Fragrances.
Financial performance
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $773.8 million | $742.3 million | $2.332 billion | $2.228 billion |
| Gross profit | $340.1 million | $325.4 million | $1.034 billion | $970.8 million |
| Operating profit | $152.6 million | $141.5 million | $461.8 million | $421.5 million |
| Net income | $107.4 million | $99.0 million | $324.4 million | $292.1 million |
| Diluted EPS | $1.31 | $1.20 | $3.95 | $3.54 |
| Gross margin | 44.0% | 43.8% | 44.3% | 43.6% |
| Operating margin | 19.7% | 19.1% | 19.8% | 18.9% |
| Effective tax rate | 24.5% | 26.1% | 24.8% | 27.4% |
- Q3 sales increased 4% on both reported and local-currency bases; nine-month sales increased 5%. Aromor contributed approximately 1% to total sales growth.
- Q3 Fragrances sales increased 6% and Flavors sales increased 3%. Nine-month Fragrances sales increased 7% and Flavors sales increased 2%.
- Q3 segment profit was $79.7 million for Flavors, down from $81.1 million, and $86.6 million for Fragrances, up from $81.3 million. Nine-month segment profit was $258.6 million for Flavors and $259.3 million for Fragrances.
- Management reported Q3 emerging-market local-currency growth of 6%, while North America declined 3%.
Cash flow, liquidity and capital structure
- Operating cash flow for the first nine months was $317.5 million, compared with $257.3 million in the prior-year period, increasing from 11.5% to 13.6% of sales.
- Cash and cash equivalents were $404.8 million at September 30, 2014, broadly unchanged from $405.5 million at December 31, 2013. Approximately $300.6 million was held outside the United States.
- Net cash used in investing activities was $180.5 million, including $102.5 million for the Aromor acquisition and $97.8 million of capital expenditures.
- Debt totaled $943.2 million, compared with $932.8 million at year-end 2013. Net debt, as defined under the credit agreements, was $532.7 million.
- The amended revolving credit facility matures April 4, 2019 and provides aggregate availability of approximately $950 million across two tranches. No borrowings were outstanding under the revolving facility at September 30, 2014; drawdown capacity was $940.4 million.
- The company reported a net debt-to-adjusted EBITDA ratio of 0.79x versus a covenant limit of 3.25x and stated that it was in compliance with all debt covenants.
- Dividends paid during the first nine months totaled $95.1 million. The Q3 dividend was $0.47 per share. Share repurchases totaled $52.5 million for the first nine months, with $145.7 million remaining under the authorized program at September 30.
Material changes versus the prior comparable period
- Net income rose 8% in Q3 and 11% for the first nine months; diluted EPS rose 9% and 12%, respectively, aided by higher operating profit, lower effective tax rates and a lower share count.
- Operating profit increased 7.8% in Q3 and 9.5% for the first nine months. Adjusted Q3 operating margin was 19.8%, compared with 19.4% in the prior year.
- Cost of goods sold as a percentage of sales improved 20 basis points in Q3 and 70 basis points for the first nine months. Management stated that underlying Q3 margin performance, excluding restructuring and operational-improvement items, declined slightly because cost savings were offset by weaker operational performance, mix and elevated raw-material costs.
- Interest expense declined 6% in Q3 and 4% for the first nine months following the 2013 debt refinancing.
- Other income declined to $0.6 million in Q3 from $4.1 million and to $3.8 million for the first nine months from $16.4 million, primarily because the prior-year period included a $16.1 million gain on disposal of a non-operating asset.
- Aromor, acquired January 15, 2014 for approximately $102.6 million, added specialty fragrance and flavor ingredients and approximately $53 million of identifiable intangible assets and $10 million of goodwill. Management stated that its Q3 consolidated financial impact was not significant.
Guidance, outlook, risks and unusual items
- Management maintained its expectation for full-year 2014 local-currency sales growth of 4% to 6% and capital spending of approximately 4% to 4.5% of sales.
- Management expects continued raw-material cost pressure for the remainder of 2014, with prices for certain key supplies near historical highs.
- The Augusta, Georgia fragrance-ingredients facility was closed in Q3. Expected total costs are $14 million to $15 million, including approximately $10 million of accelerated depreciation, $3 million of personnel costs and $1 million to $2 million of shutdown costs. Approximately 43 positions are expected to be eliminated, and approximately $4 million to $5 million of costs are expected to require cash expenditures.
- Spanish tax matters remained subject to appeals. The company had fully reserved certain assessments and had posted approximately $10.1 million of related bank guarantees. A favorable ruling on one dividend-withholding matter was received in Q4 2014, but the Spanish Tax Authority could appeal.
- Brazilian tax disputes were supported by approximately $21.8 million of bank guarantees and approximately $21.1 million of pledged assets. Total bank guarantees and standby letters of credit were approximately $42.8 million.
- Environmental liabilities at eight sites were estimated at less than $5 million. Other contingencies, including litigation, had an estimated aggregate reasonably possible loss range of $3 million to $20 million, excluding separately discussed reserved matters.
- The company identified risks from raw-material, energy and transportation costs; foreign exchange; demand and consumer preferences; integration of Aromor; litigation and tax disputes; pension obligations; regulatory changes; and execution of cost savings and facility rationalization programs.
- Cash flows from operations and available credit facilities were expected to be sufficient for investing and financing needs for at least the next eighteen months. The filing cautions that acceleration of debt following a covenant default could exceed available liquidity, although management reported substantial covenant headroom.
Investor verification points
- Verify whether the 4%–6% local-currency sales-growth outlook and margin-improvement plans were achieved, particularly given raw-material inflation and weaker Q3 Flavors margins.
- Assess Aromor’s ongoing contribution, integration costs and contingent consideration, including the $15 million escrowed amount earned over three years based on key personnel participation.
- Track remaining Augusta closure costs, cash expenditures and realized savings.
- Monitor Spanish and Brazilian tax disputes, related reserves, guarantees, pledged assets and potential cash recoveries.
- Reconcile reported operating cash flow with working-capital movements, pension contributions, incentive compensation payments and capital expenditures.
- Review debt maturities, interest-rate and foreign-currency hedging exposure, covenant calculations and remaining share-repurchase authorization.
- Consider the distinction between GAAP results and management’s non-GAAP local-currency, adjusted-margin and covenant-defined adjusted EBITDA measures.