International Flavors & Fragrances Inc. — 2019 Q1 Form 10-Q Summary
Reporting period: Three months ended March 31, 2019, with comparison to March 31, 2018. The interim financial statements are unaudited. IFF operates through Taste, Scent and Frutarom, with Frutarom included in consolidated results from its October 4, 2018 acquisition.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $1,297.4 million | $930.9 million | +39% |
| Gross profit | $531.3 million | $405.8 million | — |
| Gross margin | 40.9% | 43.6% | Down 270 basis points |
| Operating profit | $163.9 million | $174.9 million | Down $11.0 million |
| Operating margin | 12.6% | 18.8% | Down 615 basis points |
| Adjusted operating profit | $204.7 million | $181.0 million | +13% |
| Net income attributable to IFF | $108.8 million | $129.4 million | Down 16% |
| Diluted EPS | $0.96 | $1.63 | Down 41% |
| Operating cash flow | $47.2 million | $(11.4) million | Improved $58.6 million |
Revenue growth was driven primarily by the Frutarom acquisition. On a currency-neutral basis, sales increased 44%; excluding Frutarom, reported sales were flat and currency-neutral sales increased 3%. Taste sales declined 1% reported and increased 2% currency-neutral; Scent sales increased 1% reported and 4% currency-neutral; Frutarom contributed $364.4 million of sales.
Interest expense increased to $36.6 million from $16.6 million because of additional borrowings used to finance Frutarom. The effective tax rate was 17.4%, compared with 18.5% in the prior-year quarter.
Cash and cash equivalents were $483.5 million at March 31, 2019, including $414.3 million held outside the United States. Total debt was $4.505 billion, including $4.421 billion of long-term debt. Net debt, as defined for debt-covenant purposes, was $4.022 billion, and the reported net debt to adjusted EBITDA ratio was 3.67 to 1.
- Cash used in investing activities was $90.3 million, including $57.6 million of capital expenditures and $33.9 million for acquisitions.
- Cash used in financing activities was $112.2 million, including $77.8 million of dividends and $36.2 million of debt repayments.
- The Company had $912.3 million of undrawn capacity under its amended revolving credit facility and approximately $107.7 million of additional available credit lines.
- IFF was in compliance with its debt covenants at March 31, 2019.
Material changes versus the prior comparable period
- Frutarom added substantial revenue and operating contribution but also increased amortization, interest expense, integration costs and leverage.
- Amortization of acquisition-related intangibles increased to $47.6 million from $9.2 million.
- Gross margin declined because unfavorable pricing relative to input costs was only partly offset by productivity and cost initiatives. Management expects lower margins for the next several quarters from pricing, input costs and higher selling and administrative expenses.
- Operating profit included $40.8 million of 2019 charges for operational improvement initiatives, integration costs, restructuring and Frutarom acquisition-related costs, compared with $6.2 million of comparable charges in Q1 2018.
- Q1 2019 severance charges were $16.2 million and related to approximately 190 headcount reductions, primarily in Scent and in connection with a new European shared-service center.
- The Company adopted the new lease standard, recording approximately $308.3 million of right-of-use assets and $313.3 million of operating lease liabilities at adoption.
Guidance, outlook, risks and unusual items
- Management expects to achieve $30 million to $35 million of Frutarom-related cost synergies by the end of 2019 and ultimately $145 million of cost synergies. Integration activities are expected to take 6 to 12 months from March 31, 2019 to complete.
- 2019 capital spending is expected to be approximately 5% to 6% of sales, net of potential government grants and reimbursements.
- Management’s capital allocation priorities are debt repayment, capital investment and maintaining the dividend. Share repurchases remained suspended pending achievement of the deleveraging target.
- Credit facilities require progressive reductions in the maximum net-debt-to-adjusted-EBITDA covenant from 4.5 to 1 at March 31, 2019, to 3.5 to 1 by March 31, 2021. A covenant default could permit acceleration of debt, and the filing states that available liquidity would not be sufficient to repay all indebtedness if acceleration occurred.
- Key risks include Frutarom integration and synergy realization, increased leverage, raw-material and energy cost inflation, supply-chain or manufacturing disruptions, currency fluctuations, international operating risks, regulatory and product-liability matters, tax audits, environmental claims and impairment of goodwill or intangible assets.
- Guarantees and standby letters of credit totaled approximately $58.5 million. The Company estimates environmental obligations at identified sites at less than $3 million and reasonably possible losses in excess of accrued liabilities for other third-party contingencies at $0 to approximately $10 million.
- The Guangzhou Taste plant, with a net book value of approximately $66 million, could be affected by a potential zoning change. The relocation of the Zhejiang Ingredients plant is expected to continue through 2020, with compensation potentially totaling approximately $50 million.
Important facts for investors to verify
- Whether Frutarom integration achieves the stated $30 million to $35 million 2019 synergy target and the longer-term $145 million target.
- Whether pricing actions and productivity initiatives offset raw-material inflation and restore gross and operating margins.
- Progress on debt repayment, leverage reduction and compliance with the tightening credit-facility covenants.
- The final purchase-price allocation for Frutarom, including goodwill, intangible assets, deferred taxes and redeemable noncontrolling interests.
- Cash conversion and working-capital trends, particularly receivables, inventories and operating cash flow.
- Developments involving the China facilities, tax disputes, environmental matters, product-liability claims and other contingencies.
- The sustainability of the dividend and the timing of any resumption of share repurchases.