Business Context and Reporting Period
International Flavors & Fragrances Inc. (IFF) filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2010. IFF develops and manufactures flavor compounds for food and beverage products and fragrance compounds for personal care, household, fine fragrance, beauty care, and ingredient applications. The company operates through Flavors and Fragrances segments.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $665.8 million, up 17% | $1.320 billion, up 17% |
| Income before taxes | $93.6 million, up 38% | $182.7 million, up 39% |
| Net income | $67.2 million, up 40% | $130.9 million, up 37% |
| Diluted EPS | $0.83 versus $0.60 | $1.63 versus $1.20 |
| Operating cash flow | Not separately provided | $127.6 million versus $87.5 million |
Second-quarter cost of goods sold was 57.2% of sales versus 59.9% in the prior-year quarter, implying gross margins of approximately 42.8% and 40.1%, respectively. Six-month cost of goods sold was 57.9% versus 60.1%, implying gross margins of approximately 42.1% and 39.9%. Second-quarter net margin was approximately 10.1% versus 8.5%; six-month net margin was approximately 9.9% versus 8.4%.
- Second-quarter segment sales were $304.3 million for Flavors and $361.5 million for Fragrances. Segment operating profit was $64.5 million and $65.4 million, respectively.
- Six-month segment sales were $604.5 million for Flavors and $715.2 million for Fragrances. Segment operating profit was $126.1 million and $121.4 million, respectively.
- Cash and cash equivalents were $110.6 million at June 30, 2010, compared with $80.1 million at December 31, 2009. Working capital was $728.3 million, up from $643.6 million.
- Total debt was $983.3 million, down from $1.012 billion at year-end. Net debt under the debt-agreement definition was $858.8 million, and the net debt-to-adjusted-EBITDA ratio was 1.76x versus a 3.25x covenant limit.
- The company had $122 million outstanding under its revolving facility, approximately $729 million of remaining overall borrowing capacity, and $713 million of remaining lending capacity.
- Capital expenditures were $37.0 million in the first six months. Management expected full-year gross additions to property, plant and equipment to approximate 4% of sales.
- Quarterly dividends remained $0.25 per share through June 30. On July 27, 2010, the board authorized an increase to $0.27 per share.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher volumes, new customer wins, demand recovery, lower 2009 comparison levels, and some customer restocking. Management estimated that new business contributed approximately 40% of local-currency sales growth.
- Flavors second-quarter sales rose 13% on a reported basis and 11% in local currency; operating margin increased to 21.2% from 20.2%.
- Fragrances second-quarter sales rose 21% on a reported basis and 23% in local currency; operating margin increased to 18.1% from 12.6%.
- Profitability benefited from favorable input costs, higher-volume absorption, and margin-recovery initiatives. These benefits were partly offset by higher incentive compensation, increased research and development spending, litigation costs, and restructuring expenses.
- Research and development expense increased to $55.8 million in the second quarter from $44.2 million. Selling and administrative expense increased to $119.5 million from $96.0 million, principally reflecting higher incentive compensation and litigation-related costs.
- Interest expense declined to $12.1 million from $14.0 million in the quarter and to $24.8 million from $33.8 million for the six-month period, primarily due to debt repayments exceeding $210 million in the second half of 2009.
- Restructuring and other charges were $1.8 million in the quarter and $6.8 million year to date, compared with $4.1 million in each prior-year period. Expected total costs for the European restructuring plan increased to approximately $31 million to $34 million.
- Foreign-currency translation reduced comprehensive income, with accumulated other comprehensive loss increasing to $303.6 million from $271.0 million at year-end.
Outlook, Risks, Contingencies, and Unusual Items
Management stated that operating cash flows and available credit facilities were expected to fund normal capital spending and other anticipated cash requirements for at least the next 18 months. The filing does not provide a specific full-year revenue or earnings guidance range.
- Management observed that the benefit from customer restocking had slowed during the second quarter and could not quantify its total effect on sales.
- Key operating risks include economic weakness, customer cost-reduction programs, raw-material price and availability changes, foreign-exchange volatility, commodity and energy prices, interest rates, credit-market disruption, and execution of cost-savings and growth initiatives.
- The company had $67 million of gross unrecognized tax benefits and $11 million of accrued interest and penalties. Tax audits and open tax years primarily covered 2002 through 2009.
- The company expected 2010 contributions of approximately $12 million to U.S. pension plans, up to $16 million to non-U.S. pension plans, and $6 million to postretirement benefit plans. Contributions to non-U.S. pension plans were $7.8 million through June 30.
- Fourteen popcorn-flavor litigation actions involving 228 claimants were pending. Management believed adequate provisions had been recorded and did not expect a material adverse effect, although future accruals could be required.
- In the V. Mane Fils patent litigation, patent claims were reallowed after reexamination, both parties filed summary-judgment motions, and no trial date had been scheduled. IFF recorded a second-quarter provision but could not estimate potential losses above the recorded liability. An adverse outcome could affect cash flows, results, or the sale of certain flavor products.
- IFF was identified as a potentially responsible party at ten environmental sites and estimated its share of future costs at less than $5 million.
- The company reported effective disclosure controls and procedures and no material changes in internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether sales growth remains sustainable after the reported recovery, low prior-year comparisons, and restocking effects moderate.
- Whether favorable raw-material costs and volume absorption continue to support gross and segment operating margins.
- The timing and ultimate $31 million to $34 million cost of the European restructuring program.
- Compliance with debt covenants, available revolving-facility capacity, and refinancing requirements for debt maturing in 2011 and later.
- Potential changes in tax reserves, pension funding requirements, and the ability to obtain collateral for tax exposures.
- Developments in the V. Mane Fils patent case and popcorn-flavor litigation, including possible cash costs, injunctions, or product restrictions.
- Whether the newly authorized $0.27 quarterly dividend is maintained and supported by operating cash flow.