Business Context and Reporting Period
International Flavors & Fragrances Inc. (IFF) creates and supplies flavors, fragrances, and specialty ingredients for food, beverage, personal care, household, and related products. The filing is an unaudited Form 10-Q for the quarter and six months ended June 30, 2014; actual fiscal quarter-end dates were June 27, 2014 and June 28, 2013.
IFF operates through two reportable segments: Flavors and Fragrances. The company completed its acquisition of Aromor Flavors and Fragrances Ltd. on January 15, 2014 for approximately $102.6 million, funded with cash.
Financial Performance and Key Metrics
| Metric | Q2 2014 | Q2 2013 | Six Months 2014 | Six Months 2013 |
|---|---|---|---|---|
| Net sales | $788.4 million | $757.6 million | $1,558.6 million | $1,485.5 million |
| Operating profit | $153.1 million | $142.4 million | $309.2 million | $280.0 million |
| Operating margin | 19.4% | 18.8% | 19.8% | 18.8% |
| Net income | $110.3 million | $102.3 million | $217.0 million | $193.0 million |
| Diluted EPS | $1.35 | $1.24 | $2.64 | $2.34 |
| Gross margin | 44.7% | 44.1% | 44.5% | 43.4% |
| Effective tax rate | 24.6% | 27.3% | 25.0% | 28.0% |
- Q2 sales increased 4% on both a reported and local-currency basis; Aromor contributed approximately 1% of consolidated growth. Six-month sales increased 5% on both bases.
- Q2 Fragrances sales increased 8% reported and 6% in local currency, while Flavors sales were flat reported and increased 1% in local currency. Six-month segment sales increased 8% for Fragrances and 2% for Flavors.
- Q2 segment profit was $90.8 million for Flavors and $85.5 million for Fragrances. Fragrances margin improved to 20.7% from 18.7%; Flavors margin improved to 24.2% from 24.0%.
- Six-month operating cash flow was $154.0 million, compared with $118.0 million in the prior-year period. Operating cash flow represented 9.9% of sales versus 7.9% previously.
- Capital expenditures were $60.2 million for the first six months. IFF expects 2014 capital spending to approach 4%–5% of sales.
- Cash and cash equivalents were $326.9 million at June 30, 2014, down from $405.5 million at December 31, 2013; $239.2 million was held outside the United States.
- Total debt was $935.7 million, including $932.6 million of long-term debt. Net debt, as defined under the credit agreements, was $602.7 million.
- IFF declared a Q2 dividend of $0.39 per share and paid $63.4 million of dividends during the first six months. It repurchased 144,057 shares for $14.0 million during Q2, with $164.0 million remaining under the repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Profitability improved as gross margin expanded by 60 basis points in Q2 and 110 basis points for the first six months, primarily from cost savings, operational improvements, currency benefits, and the net effect of input costs and pricing.
- Net income increased 8% in Q2 and 12% for the first six months. Results benefited from lower effective tax rates and higher operating profit.
- Prior-year Q2 and six-month results included a $16.1 million gain on the sale of a non-operating asset, which reduced the year-over-year increase in other income in 2014.
- Interest expense declined 11% in Q2 and 4% for the first six months, principally reflecting the company’s 2013 debt refinancing.
- Selling and administrative expenses increased 6% in Q2 and 7% for the first six months, reflecting Aromor-related costs, commercial investments, currency effects, and discrete items.
- Investing cash outflows increased to $143.4 million from $42.8 million, mainly because of the $102.5 million Aromor acquisition payment.
- Financing cash outflows increased to $89.6 million from $27.2 million, primarily because of additional dividend payments and higher treasury-stock purchases.
- The company amended and restated its revolving credit agreement on April 4, 2014, reduced applicable interest margins, and extended the facility maturity to April 4, 2019.
Guidance, Outlook, Risks, and Unusual Items
- Management lowered its expected full-year 2014 local-currency sales growth outlook to 4%–6%, citing higher near-term erosion of existing Flavors business, particularly in the third quarter.
- Management expects continued year-over-year gross-margin expansion, but at a substantially lower rate than in 2013. Crop-related raw-material costs and other cost pressures are expected to increase in the second half of 2014.
- The Augusta, Georgia fragrance-ingredients facility was closed during the third quarter of 2014. Expected total closure costs were $15 million–$17 million, including approximately $11 million of accelerated depreciation, $3 million of personnel costs, and $2 million–$3 million of shutdown costs. Forty-three positions were or were expected to be eliminated, with estimated cash costs of $5 million–$7 million.
- Restructuring and operational improvement costs totaled $3.3 million in Q2 and $6.0 million for the first six months, including non-cash accelerated depreciation.
- IFF had approximately $43.7 million of bank guarantees and standby letters of credit outstanding. Brazilian tax and other disputes were supported by approximately $44.2 million of guarantees and pledged assets.
- Spanish tax matters included reserved assessments, posted guarantees, and an $11.2 million payment made in Q1 that is refundable if IFF prevails on appeal. Management did not expect pending tax assessments to have a material effect, but adverse outcomes remain possible.
- Environmental liabilities at eight third-party sites were estimated at less than $5 million. Collectively, other contingencies were estimated to have a reasonably possible loss range of $3 million–$20 million, excluding separately discussed matters.
- The ZoomEssence trade-secret litigation was in discovery, with a trial anticipated in mid-2015. Management did not consider the matter a material loss contingency at the filing date.
- At June 30, IFF had no borrowings under its revolving credit facility, $949.0 million of drawdown capacity, and a net debt-to-adjusted EBITDA covenant ratio of 0.90-to-1. The company was in compliance with its covenants.
- Management identified raw-material volatility, demand and consumer-preference changes, currency movements, interest rates, integration of Aromor, pension funding, litigation and tax disputes, and execution of cost-saving initiatives as important risks.
- Andreas Fibig was scheduled to become CEO on September 1, 2014. Douglas D. Tough was expected to remain an employee through December 1, 2014 for transition purposes.
Important Facts for Investors to Verify
- Whether the 4%–6% full-year local-currency sales outlook was achieved and whether Flavors erosion continued as expected.
- The realized benefits, costs, and integration progress associated with the Aromor acquisition.
- The final cost and savings impact of the Augusta facility closure and other operational improvement initiatives.
- Trends in raw-material prices, pricing recovery, product mix, and gross-margin expansion.
- Cash conversion after acquisition spending, capital expenditures, dividends, repurchases, tax payments, and pension contributions.
- Developments in Spanish and Brazilian tax disputes, guarantees, pledged assets, and other litigation contingencies.
- Debt maturities, revolving-credit availability, covenant compliance, and the company’s ability to maintain liquidity while returning capital to shareholders.
- The effect of the September 2014 CEO transition on strategy, execution, and financial targets.