International Flavors & Fragrances Inc. — 2012 Q2 Form 10-Q Summary
Business context and reporting period
IFF creates and supplies flavors and fragrances for food, beverage, personal care and household products. The company operates through Flavors and Fragrances segments, with sales concentrated across North America, Europe/Africa/Middle East, Latin America and Greater Asia.
This unaudited Form 10-Q covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. The filing was signed August 8, 2012. IFF had 81.5 million shares outstanding as of July 25, 2012.
Financial performance and key metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $721.3 million | $715.6 million | $1,431.9 million | $1,429.9 million |
| Operating profit | $132.3 million | $118.0 million | $253.2 million | $251.3 million |
| Operating margin | 18.3% | 16.5% | 17.7% | 17.6% |
| Net income | $88.6 million | $76.2 million | $169.7 million | $160.2 million |
| Diluted EPS | $1.08 | $0.93 | $2.06 | $1.96 |
| Gross margin | 41.8% | 39.7% | 41.0% | 40.7% |
| Effective tax rate | 27.7% | 27.4% | 27.2% | 27.3% |
| Operating cash flow | Not separately provided | Not separately provided | $135.4 million | $2.1 million |
- Q2 reported sales increased 1%; local-currency sales increased 4%, or 5% excluding the effect of exiting low-margin Flavors activities. Foreign exchange reduced reported sales growth by approximately 300 basis points.
- Flavors Q2 sales increased 5% reported and 8% in local currency; segment profit increased to $80.6 million from $71.0 million, and margin rose to 22.3% from 20.6%.
- Fragrances Q2 sales declined 3% reported and were flat in local currency; segment profit increased to $63.6 million from $62.3 million, and margin rose to 17.7% from 16.8%.
- For the first six months, Flavors sales increased 4% reported and 6% in local currency, while Fragrances sales declined 3% reported and 1% in local currency.
- Raw material costs increased approximately 5% year over year in Q2 and approximately 7% for the first six months, although price realization, mix and manufacturing efficiencies improved margins.
- Cash and cash equivalents were $104.6 million at June 30, 2012, compared with $88.3 million at December 31, 2011. Approximately $77.5 million was held outside the United States.
- Total debt was $864.9 million at June 30, 2012, versus $894.9 million at year-end 2011. Net debt, as defined under the credit agreement, was $750.3 million.
- The company had $883.6 million of remaining drawdown capacity under its revolving credit facility and $81.7 million of additional available lines of credit. It was compliant with all debt covenants; net debt to adjusted EBITDA was 1.34 to 1 versus a maximum covenant ratio of 3.25 to 1.
- Capital expenditures were $53.8 million during the first six months. The company expected 2012 capital spending to approximate 5% of sales.
- Quarterly dividends declared increased from $0.27 to $0.31 per share year over year. On July 24, 2012, the board authorized a further 10% increase to $0.34 per share beginning with the October 2012 payment.
Material changes versus the prior comparable period
- Q2 operating profit increased 12% and net income increased 16%, primarily due to pricing, favorable mix, volume improvements and manufacturing efficiencies, as well as the absence of the $4.0 million Q2 2011 restructuring charge.
- Six-month net income increased 6%, but operating profit increased less than 1% because lower Fragrances profitability substantially offset improvement in Flavors.
- Six-month Fragrances segment profit declined to $119.7 million from $131.0 million. Management attributed the decline to higher costs and lower volumes, particularly in Fragrance Ingredients.
- Six-month operating cash flow increased by $133.2 million, reflecting lower incentive compensation and tax payments, improved earnings and lower core working-capital requirements.
- Selling and administrative expense increased as a percentage of sales to 15.6% in Q2 and 15.2% for the first six months, driven by planned emerging-market spending, higher incentive compensation and pension costs, insurance deductibles and bad-debt provisions.
- The company recorded $1.7 million of restructuring charges during the first six months related to its 2011 Strategic Initiative and stated that no additional charges were expected for that plan.
Guidance, outlook, risks and unusual items
- Management expected modest growth for the remainder of 2012, with emerging markets as the primary growth driver. It cautioned that the exit of low-margin Flavors activities, continued weakness in Fragrance Ingredients and economic weakness in Western Europe could put the low end of long-term growth targets at risk.
- IFF reached an August 1, 2012 settlement with Spanish tax authorities covering income-tax disputes for 2004–2010, requiring an aggregate payment of €86.0 million, or approximately $105.7 million, before year-end 2012.
- The filing states that the Spanish settlement and related accruals would produce a third-quarter after-tax charge of $58.5 million in one disclosure and an aggregate after-tax charge of $72.4 million in the MD&A, including $13.9 million for additional 2002–2003 uncertain-tax-position accruals. This difference should be reconciled against subsequent filings.
- The 2002–2003 Spanish tax assessments remained under appeal, and the 2011 Spanish tax year had not yet been audited. Spanish capital-tax matters and other foreign tax disputes also remained outstanding.
- At June 30, 2012, the company had $80.4 million of aggregate uncertain-tax-position provisions, including interest and penalties, and $168.1 million of bank guarantees and standby letters of credit. Spanish tax disputes accounted for approximately $118.4 million of the guarantees.
- Management expected to fund the Spanish settlement using operating cash flow and/or available revolving-credit borrowings.
- Management identified risks from raw-material price, quality and availability; foreign-exchange movements; global economic conditions and consumer demand; Fragrance Ingredients volume declines; pension funding requirements; tax audits and litigation; regulatory changes; and execution of strategic and cost-saving initiatives.
- Environmental liabilities at ten third-party waste sites were estimated at less than $5 million, although the company noted that future costs could differ from current estimates.
Important facts for investors to verify
- Reconcile the disclosed $58.5 million versus $72.4 million after-tax impact of the Spanish tax settlement and confirm the ultimate third-quarter accounting treatment.
- Review subsequent filings for payments under the €86.0 million Spanish settlement, the 2011 assessment and the continuing 2002–2003 appeals.
- Assess whether Fragrances Ingredients weakness persists and whether Flavors growth excluding exited low-margin activities offsets that decline.
- Monitor raw-material inflation, pricing recovery and gross-margin sustainability.
- Verify cash generation after the Spanish tax payments, capital spending, dividends and pension contributions.
- Confirm debt covenant compliance and available borrowing capacity after settlement-related funding needs.