International Flavors & Fragrances Inc. — 2015 Q2 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; the company’s actual quarter-end date was July 3, 2015. The filing is unaudited. IFF develops and supplies flavor and fragrance compounds and ingredients globally through its Flavors and Fragrances segments.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $767.5 million | $788.4 million | $1,542.4 million | $1,558.6 million |
| Gross profit | $345.0 million | $352.6 million | $691.3 million | $694.1 million |
| Gross margin | 45.0% | 44.7% | 44.8% | 44.5% |
| Operating profit | $148.8 million | $153.1 million | $310.6 million | $309.2 million |
| Operating margin | 19.4% | 19.4% | 20.1% | 19.8% |
| Net income | $105.4 million | $110.3 million | $233.6 million | $217.0 million |
| Diluted EPS | $1.29 | $1.35 | $2.86 | $2.64 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $166.3 million | $154.0 million |
- Reported Q2 sales declined 3%, while currency-neutral sales increased 5%; foreign exchange was an approximately 800-basis-point unfavorable sales headwind.
- Six-month reported sales declined 1%, while currency-neutral sales increased 6%. Emerging markets represented 52% of currency-neutral second-quarter sales and grew 7% on that basis.
- Q2 adjusted operating profit was $155.3 million, or 20.2% of sales, compared with $156.4 million, or 19.8%, in the prior-year quarter. Adjusted figures exclude acquisition, restructuring and operational-improvement items.
- The Q2 effective tax rate was 23.1%, versus 24.6% in the prior-year quarter. The six-month rate was 20.4%, versus 25.0%, benefiting primarily from favorable tax rulings that produced a $10.5 million first-quarter benefit.
Segments and material changes
- Flavors: Q2 sales were $372.5 million, down 1% reported and up 7% currency-neutral. Segment profit was $84.0 million, down from $90.8 million, with margin declining to 22.6% from 24.2%. Six-month sales increased 1% reported and segment profit declined 1%.
- Fragrances: Q2 sales were $395.1 million, down 4% reported and up 4% currency-neutral. Segment profit was $79.9 million, down from $85.5 million, with margin declining to 20.2% from 20.7%. Six-month sales declined 3% reported but increased 4% currency-neutral.
- Currency pressure, lower prior-year incentive compensation comparisons, startup costs at facilities in Turkey and Indonesia, and additional China facility costs reduced segment profitability.
- IFF completed the $199.2 million acquisition of Ottens Flavors during Q2, funded with existing resources. Preliminary purchase accounting allocated approximately $85 million to identifiable intangible assets and $77 million to goodwill.
- On July 30, 2015, after quarter-end, IFF completed the approximately €283 million, or $311 million, acquisition of Lucas Meyer Cosmetics. Management did not expect a material consolidated financial statement impact.
- Other intangible assets increased to $156.2 million from $76.6 million at year-end, primarily due to Ottens Flavors.
Cash flow, debt and liquidity
- Cash and cash equivalents were $377.3 million at June 30, 2015, down from $478.6 million at December 31, 2014; $275.4 million was held outside the United States.
- Six-month investing cash outflow was $215.0 million, including approximately $188.8 million for Ottens Flavors and $37.9 million of capital expenditures. Management expected 2015 capital expenditures to approach 4%–5% of sales.
- Six-month financing cash outflow was $47.0 million, including $75.9 million of dividends, $38.8 million of treasury-stock purchases and $30.0 million of debt repayments, partly offset by $86.2 million of long-term debt issuance.
- Total debt was $998.0 million at June 30, 2015, compared with $942.3 million at December 31, 2014. Net debt, as defined under the credit agreement, was $616.5 million.
- IFF had $55.0 million drawn under its revolving credit facility and approximately $923.1 million of drawdown capacity. The company was in compliance with all covenants; covenant net debt to adjusted EBITDA was 0.88 to 1.00 versus a 3.25-to-1.00 limit.
- Management stated that operating cash flow, cash balances and available credit were sufficient to meet investing and financing needs for at least the next 18 months.
Guidance, outlook and management commentary
- Vision 2020 targets include 4%–6% currency-neutral sales growth, 7%–9% currency-neutral operating-profit growth and 10% currency-neutral EPS growth for 2016–2020.
- The company also targeted $500 million–$1 billion of acquisition-driven sales growth by 2020 and cash returns to shareholders of 50%–60% of adjusted net income.
- Management expected 2015 input-cost growth of less than 1%, with higher naturals costs largely offset by expected later-year benefits from oil-based derivatives.
- Management expected approximately $30 million of 2015 contributions to non-U.S. pension plans and approximately $5 million to postretirement benefit plans.
- In August 2015, after the reporting period, the board authorized an additional $250 million share-repurchase authorization through December 31, 2017, and increased the third-quarter dividend by 20% to $0.56 per share.
Risks, contingencies and unusual items
- Raw-material, energy and transportation cost volatility, foreign-exchange fluctuations, international operating risks, supply-chain disruptions, changing consumer demand and acquisition execution were identified as key risks.
- A Flavors facility in China was temporarily idled and another facility was operating at reduced workload because of odor-emission compliance issues. Additional remediation investments and production transfers were under way; permanent closures or reduced production could result in material future charges.
- Estimated reasonably possible losses related collectively to disclosed contingencies were $0–$31 million. Environmental liabilities at eight sites were estimated at less than $5 million.
- Brazilian tax and other disputes were supported by approximately $29.9 million of bank guarantees and standby letters of credit, including $16.5 million related to tax assessments, plus approximately $15.1 million of pledged assets.
- The ZoomEssence trade-secret litigation remained in discovery, with trial anticipated in mid-2016. Management did not believe it represented a material loss contingency at June 30, 2015.
- Unrecognized tax benefits were approximately $15.0 million, with accrued interest and penalties of $0.7 million. Spanish dividend-withholding tax controversies were resolved, with $4.9 million paid during Q2.
Important facts for investors to verify
- Whether currency-neutral growth converts into reported growth as foreign-exchange pressures evolve.
- The realized earnings, cash-flow contribution and final purchase accounting for Ottens Flavors and Lucas Meyer Cosmetics.
- Progress, costs and potential production disruption related to the China odor-compliance matter.
- Raw-material pricing, gross-margin performance and the ability to achieve stated operational-improvement targets.
- Debt covenant headroom, post-acquisition leverage, pension funding requirements and liquidity after dividends and share repurchases.
- Resolution and cash impact of Brazilian tax matters, environmental claims, ZoomEssence litigation and other contingencies.
- The comparability of adjusted operating profit, currency-neutral sales, adjusted tax rate, adjusted EBITDA and net debt with GAAP results and other companies’ measures.