International Flavors & Fragrances Inc. — Q3 2013 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 filing covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. The interim financial statements are unaudited.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $742.3 million | $709.0 million | $2.228 billion | $2.141 billion |
| Operating profit | $141.5 million | $134.2 million | $421.5 million | $387.4 million |
| Operating margin | 19.1% | 18.9% | 18.9% | 18.1% |
| Net income | $99.0 million | $16.4 million | $292.1 million | $186.0 million |
| Diluted EPS | $1.20 | $0.20 | $3.54 | $2.26 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $257.3 million | $137.6 million |
- Revenue: Q3 reported sales increased 5%; local-currency sales increased 4%. Nine-month reported sales increased 4%, while local-currency sales increased 5%.
- Segment performance: Q3 Flavors sales increased 3% and Fragrances sales increased 7%. Segment profit increased to $81.1 million for Flavors and $81.3 million for Fragrances, with margins of 23.2% and 20.7%, respectively.
- Margins: Q3 gross margin improved to 43.8% from 42.5%; nine-month gross margin improved to 43.6% from 41.5%. Improvement reflected mix, manufacturing efficiencies, pricing and modestly lower raw-material costs.
- Expenses: Q3 R&D increased 14% and selling and administrative expense increased 8%. R&D and S&A represented 8.8% and 15.9% of sales, respectively.
- Taxes: The effective tax rate was 26.1% in Q3 and 27.4% for the first nine months, versus 86.6% and 47.6% in the comparable 2012 periods.
- Liquidity: Cash and equivalents were $343.1 million at September 30, 2013, including $181.6 million held outside the United States. Working capital was $1.124 billion.
- Debt: Total debt was $933.6 million, compared with $1.031 billion at December 31, 2012. The Company issued $300 million of 3.20% senior notes due 2023, repaid its $283.1 million revolving-credit balance and repaid $100 million of 2006 senior notes.
- Leverage: Covenant-defined net debt to adjusted EBITDA was 0.86x, below the 3.25x covenant limit. The Company had no revolving-credit borrowings and reported $947.9 million of drawdown capacity.
- Capital allocation: Nine-month capital expenditures were $86.4 million. Dividends paid were $55.5 million, and $31.9 million was spent on treasury-stock purchases. The Company expected approximately $50 million of repurchases for full-year 2013.
Material Changes Versus the Prior Comparable Period
- Net income increased substantially primarily because Q3 2012 included a $72.4 million after-tax Spanish tax-settlement charge.
- Operating profit improved despite higher R&D, selling and administrative costs and increased global expenses. Fragrances produced the largest segment-profit improvement.
- Other income in the first nine months of 2013 included a $16.1 million gain on the sale of a non-operating asset.
- Operating cash flow increased by $119.7 million year over year, primarily because 2012 included a $105.5 million payment under the Spanish tax settlement, together with higher earnings and improved core working capital.
- The Company substantially completed its exit from certain low-margin Flavors sales activities by the end of Q2 2013. Nine-month Flavors local-currency growth was 6% on a like-for-like basis excluding that exit.
- Global expenses increased to $18.3 million in Q3 and $47.2 million for the first nine months, reflecting higher incentive compensation, deferred-compensation remeasurement costs and unfavorable cash-flow-hedging impacts.
Guidance, Outlook, Risks and Unusual Items
- Management remained on target to meet its long-term strategic targets, but expected Q4 growth rates to be affected by strong 2012 comparisons, particularly in Fragrances.
- Emerging markets represented 48% of Q3 sales and grew 8% in local currency. Management expected emerging markets to remain the primary growth drivers.
- Management expected continued year-over-year gross-margin expansion in the near term, although the rate of improvement was expected to moderate. Raw-material prices remained near historical highs and crop-related input volatility was identified as a risk.
- The Augusta, Georgia fragrance-ingredients facility is expected to close by July 2014, with production consolidated elsewhere. Estimated total charges are $16–$21 million, including $6–$9 million of future cash costs; 43 positions are expected to be eliminated. The facility is expected to generate annual savings of approximately $6–$8 million once fully implemented.
- Q3 included $2.2 million of non-cash accelerated depreciation related to the Augusta closure and approximately $0.4 million of operational-improvement costs. Nine-month restructuring and operational-improvement costs totaled $6.9 million before tax.
- Commercial production at the Company’s China compounding facility was expected to begin in Q4 2013, which would increase depreciation and other start-up costs.
- The Company expected 2013 capital spending to approach 5% of sales and expected $18–$28 million of contributions to non-U.S. pension plans.
- Spanish tax matters remained outstanding. The Company paid the remaining $4.0 million related to the 2003 assessment in Q3; the remaining 2002 assessment was approximately $2.4 million. A separate Spanish dividend-withholding case involved approximately $4.3 million and was fully reserved.
- Other contingencies included Brazilian tax and indirect-tax matters with an estimated reasonably possible loss range of $2–$20 million, a potential Spanish capital-tax loss of approximately $13 million, and environmental exposures estimated at less than $5 million.
- IFF identified risks related to demand, raw-material prices and availability, currency movements, interest rates, hedging effectiveness, tax disputes, litigation, pension funding, facility start-up, regulatory changes and execution of cost-saving initiatives.
Most Important Facts for Investors to Verify
- Whether revenue growth and Fragrances momentum persisted after the unusually strong 2012 comparison.
- Whether gross-margin expansion continued as raw-material prices and mix changed.
- The final cost, timing and savings realization from the Augusta facility closure and other operational-improvement initiatives.
- The resolution and cash impact of remaining Spanish tax, Spanish capital-tax and Brazilian tax contingencies.
- Whether capital spending, pension contributions, dividends and share repurchases remain consistent with operating-cash-flow generation.
- Compliance with debt covenants and the effect of the 2023 senior notes and interest-rate swaps on future interest expense.
- The impact of foreign exchange, hedging results and the $16.1 million non-operating-asset gain on period-to-period comparability.