Business Context and Reporting Period
International Flavors & Fragrances Inc. (IFF) filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2022. IFF develops and manufactures food, beverage, health and biosciences, scent, pharmaceutical and related specialty ingredients through four segments: Nourish, Health & Biosciences, Scent and Pharma Solutions.
Comparability is affected by the February 2021 merger with Nutrition & Biosciences (N&B): 2022 includes N&B for the full nine-month period, while 2021 includes N&B for eight months. The third-quarter periods include N&B for the full quarter.
Financial Performance and Position
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Net sales | $3.063 billion | $3.071 billion | Down 0.3%; up 6% currency-neutral |
| Gross profit | $1.001 billion | $1.090 billion | Down 8% |
| Gross margin | 32.7% | 35.5% | Down 280 basis points |
| Adjusted operating EBITDA | $612 million | $648 million | Down 6%; margin 20.0% versus 21.1% |
| Operating loss | $1.985 billion | $298 million profit | Primarily reflects $2.250 billion goodwill impairment |
| Net loss attributable to IFF | $2.197 billion | $194 million income | Loss per diluted share: $8.60 |
| Interest expense | $83 million | $74 million | Up 12% |
| Metric | Nine Months 2022 | Nine Months 2021 | Change |
|---|---|---|---|
| Net sales | $9.596 billion | $8.625 billion | Up 11% |
| Gross profit | $3.282 billion | $2.754 billion | Up 19% |
| Gross margin | 34.2% | 31.9% | Up 230 basis points |
| Adjusted operating EBITDA | $2.014 billion | $1.896 billion | Up 6%; margin 21.0% versus 22.0% |
| Operating loss | $1.431 billion | $412 million profit | Includes goodwill and long-lived-asset impairments |
| Net loss attributable to IFF | $1.846 billion | $180 million income | Loss per diluted share: $7.22 |
Third-quarter reported sales were pressured by a 6% unfavorable currency impact, volume declines and the net effect of the Microbial Control divestiture and Health Wright acquisition. Price increases partly offset these factors. Higher commodity and manufacturing costs reduced gross margin.
Third-quarter segment sales were: Nourish $1.703 billion, Health & Biosciences $512 million, Scent $591 million and Pharma Solutions $257 million. Health & Biosciences sales declined 17% primarily due to the Microbial Control divestiture, while Pharma Solutions sales increased 22%.
Nine-month operating cash flow was $189 million, versus $1.126 billion in the prior-year period. The decline primarily reflected working-capital investment, including an $808 million increase in inventories and a $309 million increase in receivables. Investing cash flow was $887 million, including $1.158 billion of net proceeds from the Microbial Control divestiture. Financing cash flow used $1.087 billion, including $604 million of dividends and $300 million of long-term debt repayments.
At September 30, 2022, cash and cash equivalents were $538 million, compared with $711 million at year-end 2021. Total debt was $10.772 billion, including $10.260 billion of long-term debt and $204 million of commercial paper. IFF had no borrowings under its $2.0 billion revolving credit facility and reported $1.489 billion of available capacity. The company reported a covenant net debt to credit-adjusted EBITDA ratio of 3.93 to 1.0 and compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales were essentially flat on a reported basis but increased 6% on a currency-neutral basis; pricing helped offset unfavorable currency and volume.
- Gross margin declined 280 basis points in the third quarter because of higher commodity and manufacturing costs, portfolio mix and lower volumes.
- IFF recorded a $2.250 billion goodwill impairment for Health & Biosciences after an interim test triggered by weaker projections, inflation, higher interest rates and foreign-exchange effects.
- IFF recorded a $120 million long-lived-asset impairment in the second quarter related primarily to Russian operations and recognized approximately $11 million of expected credit losses on Russia- and Ukraine-related receivables.
- IFF completed the Microbial Control divestiture on July 1, 2022, receiving $1.254 billion of cash proceeds and recognizing a preliminary $14 million pretax gain.
- IFF acquired Health Wright Products for approximately $157 million, including estimated contingent consideration, to expand health and nutrition formulation capabilities.
- Goodwill declined to $13.305 billion from $16.414 billion at year-end 2021, primarily because of the impairment and foreign-exchange translation.
- Cash generation weakened materially as inventories increased to $3.122 billion from $2.516 billion at year-end 2021.
Guidance, Outlook, Commentary and Risks
Management expects 2022 capital spending of approximately 5.0% of sales, compared with 3.4% in 2021. Management stated that operating cash flow and available credit facilities are expected to fund operations, capital investments, dividends and debt service. The filing does not provide a clear numerical full-year revenue or earnings guidance value.
Management identified inflation, higher raw-material, energy and transportation costs, supply-chain disruption, foreign-exchange volatility, COVID-19, the Russia-Ukraine conflict and changing consumer demand as continuing pressures. IFF is limiting production and supply to Russia to essential food, hygiene and medicine-related needs. The company expects to close approximately 30 manufacturing sites under its Frutarom integration initiative; 22 had closed through September 30, 2022.
Health & Biosciences goodwill remains subject to further impairment risk. Pharma Solutions had less than 10% excess fair value over carrying value, making it sensitive to lower growth or margins and higher discount rates. The company also faces substantial leverage, refinancing and interest-rate exposure.
Other matters include approximately $411 million of guarantees, commercial guarantees, standby letters of credit and surety bonds; an Avicel product-quality matter with approximately $19 million accrued and potential for additional claims; tax audits and disputes; Brazilian tax contingencies; China facility zoning and relocation matters; and ongoing legal and regulatory proceedings. The company estimates reasonably possible third-party losses in excess of accrued liabilities at zero to approximately $35 million, although ultimate outcomes could differ materially.
Facts Investors Should Verify
- Whether pricing actions can offset inflation, commodity costs, manufacturing expenses and volume declines without further margin erosion.
- The sustainability of only $189 million of nine-month operating cash flow and the timing of inventory and receivable normalization.
- Debt maturities, refinancing needs, covenant headroom and the effect of higher interest rates or credit-rating changes.
- The valuation assumptions supporting the remaining Health & Biosciences and Pharma Solutions goodwill balances.
- The financial effect of the Microbial Control divestiture, including post-closing adjustments, escrow proceeds and transition-service obligations.
- Potential additional charges related to Russia and Ukraine, China facility matters, Avicel claims, tax disputes and other litigation or contingencies.
- Progress toward the Frutarom manufacturing-site closures, N&B integration synergies and the expected 2022 capital-spending level.