International Flavors & Fragrances Inc. — Q1 2014 Form 10-Q Summary
Business context and reporting period
IFF creates and supplies flavors, fragrances and specialty ingredients for food, beverage, personal care and household-product customers. The filing covers the unaudited three months ended March 31, 2014; actual fiscal quarter-end was March 28, 2014. Operations comprise Flavors and Fragrances.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $770.2 million | $727.8 million | +6% |
| Gross profit | $341.4 million | $311.4 million | +10% |
| Gross margin | 44.3% | 42.8% | +150 bps |
| Operating profit | $156.1 million | $137.6 million | +13% |
| Operating margin | 20.3% | 18.9% | +140 bps |
| Net income | $106.7 million | $90.7 million | +18% |
| Diluted EPS | $1.30 | $1.10 | +18% |
| Operating cash flow | $35.0 million | $18.7 million | +87% |
- Local-currency sales increased 7%, including a 1% contribution from the Aromor acquisition. Foreign exchange reduced reported sales growth by approximately 100 basis points.
- Flavors sales increased 3% reported and 5% in local currency; Fragrances sales increased 9% reported and 8% in local currency.
- Segment profit was $88.1 million for Flavors, with a 24.0% margin, and $87.2 million for Fragrances, with a 21.6% margin.
- Adjusted operating profit was $158.8 million and adjusted operating margin was 20.6%, excluding $2.6 million of restructuring and operational-improvement costs.
- The effective tax rate was 25.3%, compared with 28.9% in the prior-year quarter. The prior-year rate included a $6.2 million after-tax Spanish tax charge, partially offset by a $2.7 million U.S. tax benefit.
- Cash and cash equivalents were $268.6 million at March 31, 2014, versus $405.5 million at December 31, 2013. Net cash declined primarily because of the Aromor acquisition, capital spending, dividends and share repurchases.
- Capital expenditures were $33.8 million. The company expects 2014 capital spending to approach 4%–5% of sales.
- Total debt was $933.9 million and net debt was $658.7 million at March 31, 2014. The covenant net debt-to-adjusted-EBITDA ratio was 1.02x, versus a 3.25x maximum.
- The company had no borrowings under its revolving credit facility, with $950.5 million of drawdown capacity reported at quarter-end.
Material changes versus the prior comparable period
- Sales growth accelerated through new wins, emerging-market performance and Fragrance Ingredients demand. Emerging markets represented 49% of sales and grew 7% in local currency.
- Gross margin improved because of the net effect of input costs and pricing, product mix and cost-reduction initiatives.
- Research and development expense increased 4%, while selling and administrative expense increased 8%, principally because of higher incentive compensation and Aromor-related expenses.
- Other expense changed from $1.1 million of income to $1.4 million of expense, largely because of foreign-exchange gains and losses on working capital.
- Operating cash flow improved from the prior year partly because Q1 2013 included a $30.0 million pension contribution; higher incentive compensation payments partly offset the benefit in 2014.
- IFF acquired all of Aromor Flavors and Fragrances Ltd. on January 15, 2014, for $102.5 million, including $15 million of contingent consideration held in escrow. The purchase-price allocation remained preliminary.
- The company repurchased 226,857 shares for $20.1 million, or $88.70 per share, during the quarter. Approximately $178.0 million remained available under the $250 million repurchase authorization.
Guidance, outlook, risks and unusual items
- Management expected Q2 2014 growth rates to remain in line with long-term strategic targets, supported by new wins, innovation and emerging-market leverage.
- Management continued to target year-over-year gross-margin expansion but expected the 2014 improvement rate to be substantially below the strong improvement achieved in 2013. Crop-related raw-material cost pressures were expected to develop in the second half of 2014.
- IFF plans to close its Augusta, Georgia fragrance-ingredients facility by July 2014 and consolidate production elsewhere. Total expected costs are $16 million–$21 million, with approximately $6 million–$9 million expected to require future cash expenditures; 43 positions are expected to be eliminated.
- Q1 included $2.3 million of non-cash accelerated depreciation and $0.1 million of severance related to the Augusta rationalization. Additional costs were expected in the following quarter.
- Management expected approximately $21 million of contributions to non-U.S. pension plans and approximately $5 million to postretirement benefit plans during 2014.
- On April 4, 2014, the credit facility was amended and extended to April 4, 2019; applicable interest margins were reduced and available tranches were modified.
- Significant exposures include raw-material prices and availability, foreign exchange, interest rates, emerging-market conditions, integration of Aromor, pension funding, litigation and tax disputes.
- Spanish tax matters remain pending. The company paid $11.2 million during Q1 relating to a capital-tax appeal, refundable if it prevails. Spanish tax guarantees and related guarantees totaled approximately $10.7 million at quarter-end.
- Total bank guarantees and standby letters of credit were approximately $45.9 million. Brazilian tax disputes were supported by approximately $42.6 million of guarantees and pledged assets.
- Management estimated reasonably possible losses for specified contingencies collectively at $3 million–$20 million, plus approximately $13 million for a separate Spanish capital-tax matter if the appeal is unsuccessful. Environmental exposure was estimated at less than $5 million.
Important facts for investors to verify
- Whether local-currency sales growth, new wins and Fragrance Ingredients momentum continue after the Aromor contribution.
- Whether raw-material inflation in the second half of 2014 limits further gross-margin expansion.
- Actual costs, timing and savings from the Augusta facility closure and other operational-improvement initiatives.
- Aromor’s final purchase-price allocation, ongoing contingent consideration and contribution to earnings and cash flow.
- Cash conversion, working-capital requirements, capital expenditures and the effect of dividends and share repurchases on liquidity.
- Progress and ultimate cash impact of the Spanish, Brazilian and other tax and legal contingencies.
- Compliance with debt covenants and continued availability under the revolving credit facility.