International Flavors & Fragrances Inc. — Q1 2020 Form 10-Q Summary
Business context and reporting period
IFF filed an unaudited Form 10-Q for the three months ended March 31, 2020. The company operates through two reportable segments, Taste and Scent, following the reorganization that combined substantially all of the former Frutarom segment into Taste. Fiscal quarter-end dates are presented as March 31, although the actual 2020 quarter closed April 3.
IFF was designated an essential business in most locations during the COVID-19 pandemic. Most manufacturing facilities remained operational, but certain facilities and research or creative centers experienced closures, reduced operations, or logistical constraints.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $1,347.3 million | $1,297.4 million | 4% reported; 6% currency neutral |
| Gross profit | $565.9 million | $531.3 million | 7% |
| Gross margin | 42.0% | 40.9% | +110 bps |
| Operating profit | $196.2 million | $163.9 million | 20% |
| Operating margin | 14.6% | 12.6% | +200 bps |
| Adjusted operating profit | $222.3 million | $204.7 million | 9% reported growth |
| Net income attributable to IFF | $124.6 million | $108.8 million | 14% |
| Diluted EPS | $1.15 | $0.96 | 19% |
| Operating cash flow | $16.9 million | $47.2 million | Down $30.3 million |
Net sales increased in both segments: Taste rose 3% reported and 5% currency neutral to $830.3 million, while Scent rose 5% reported and 7% currency neutral to $517.0 million. Segment profit margins were 16.5% for Taste and 20.4% for Scent.
Cash, cash equivalents, and restricted cash totaled $448.4 million at March 31, 2020, including $433.2 million of cash and cash equivalents. Cash declined by $175.6 million during the quarter, including a $42.5 million adverse foreign-exchange effect. Capital expenditures were $48.3 million, and the company expects 2020 capital spending to be approximately 4% of sales.
Total debt was $4.33 billion, including $385.6 million of short-term borrowings and current maturities. Long-term debt was $3.95 billion. Net debt for covenant purposes was $3.90 billion, and the covenant net debt-to-adjusted-EBITDA ratio was 3.33x versus a 4.0x limit at March 31, 2020. IFF reported $790 million of available capacity under its $1 billion credit facility and no outstanding borrowings under that facility.
Material changes versus the prior comparable period
- Sales growth reflected new wins, volume increases, and increased shipments of certain products associated with COVID-19 demand; foreign exchange reduced reported sales growth by approximately 2 percentage points.
- Gross margin improved from 40.9% to 42.0%, primarily due to higher volumes, new business wins, cost savings, and productivity initiatives, partly offset by higher raw-material costs.
- Operating profit benefited from lower restructuring and other charges, which declined to $4.9 million from $16.2 million, and lower interest expense of $32.1 million versus $36.6 million.
- Other loss, net was $10.6 million compared with other income of $7.3 million in Q1 2019, primarily reflecting foreign-currency derivative effects.
- Operating cash flow declined because of higher working capital, particularly receivables and payables. The company increased bad-debt allowances by approximately $3.0 million due to expected COVID-19-related customer write-offs.
- Accumulated other comprehensive loss increased substantially, primarily from a $452.3 million after-tax foreign-currency translation loss.
Outlook, commentary, risks, and unusual items
- Management expects second-quarter 2020 operating margin to decline year over year because fine fragrances and cosmetic actives are higher-margin categories affected by retail and travel restrictions, while COVID-19-related labor, shipping, cleaning, and raw-material costs are expected to increase.
- Demand increased for flavor compounds and consumer fragrances but declined significantly beginning in March for retail food-service flavors, fine fragrances, and cosmetic actives. The timing of any recovery remains uncertain.
- Supply-chain disruption was limited at quarter-end but affected raw-material distribution and transportation in locations including Italy, Spain, and India. IFF increased inventory levels to support anticipated second- and third-quarter demand.
- The Frutarom integration program includes approximately 35 planned manufacturing-site closures, total expected costs of approximately $60 million, and a $145 million synergy target. The company realized approximately $15 million of cost synergies year to date and expects some restructuring activities to extend into 2021, with full savings realization potentially delayed into 2022.
- The pending Nutrition & Biosciences transaction with DuPont is expected to close in early 2021, subject to shareholder, regulatory, and other conditions. It requires a $7.3 billion special cash payment, and DuPont shareholders are expected to receive approximately 55.4% of the fully diluted combined company. IFF may become responsible for up to $7.5 billion of related financing commitments and could owe a $521.5 million termination fee in certain circumstances.
- IFF faces securities and related litigation concerning alleged improper payments and disclosures associated with Frutarom. The filing does not provide a clear estimate of potential exposure. Aggregate reasonably possible losses in excess of accrued liabilities for third-party contingencies were estimated at $0 to approximately $10 million, but the company cautioned that actual losses could differ materially.
- Other contingencies include Brazilian tax disputes, China facility zoning and relocation matters, and $47.8 million of bank guarantees and standby letters of credit. The company recognized $5.7 million of income related to expected Brazilian indirect-tax recoveries during the quarter.
Most important facts for investors to verify
- Whether COVID-19 causes a sustained decline in fine fragrances, cosmetic actives, or retail food-service demand and how quickly higher-margin demand recovers.
- Operating cash conversion, receivable collections, customer payment-term extensions, and further bad-debt allowance increases.
- Liquidity and leverage after funding the Nutrition & Biosciences transaction, including the final financing structure and covenant capacity.
- Whether the transaction closes on the expected timetable and whether termination fees or additional transaction costs arise.
- Progress, costs, timing, and realized savings from the Frutarom site-closure and integration program.
- Potential effects of foreign-exchange movements on cash, equity, earnings, and debt covenant calculations.
- Developments in Frutarom-related litigation, compliance reviews, Brazilian tax matters, and China facility relocation or zoning issues.