Business Context and Reporting Period
International Flavors & Fragrances Inc. filed this Form 10-K for the fiscal year ended December 31, 2012. The filing presents 2012 full-year results and unaudited quarterly data, including fourth-quarter results. IFF creates and supplies flavor and fragrance compounds and ingredients for food, beverage, personal care and household products. Operations span 32 countries, approximately 5,700 employees and more than 100 customer countries, with Flavors and Fragrances as its two operating segments.
Flavors represented 49% of 2012 sales and Fragrances 51%. Emerging markets represented 47% of sales and grew 8% in local currency. The 25 largest customers accounted for 53% of sales; the largest customer represented 11%.
Financial Performance and Key Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net sales | $2,821.4 million | $2,788.0 million | +1.2% reported; +4% local currency |
| Gross profit | $1,175.5 million | $1,104.7 million | +6.4% |
| Gross margin | 41.7% | 39.6% | +210 basis points |
| Operating profit | $486.6 million | $427.7 million | +13.8% |
| Operating margin | 17.2% | 15.3% | +190 basis points |
| Net income | $254.1 million | $266.9 million | -4.8% |
| Diluted EPS | $3.09 | $3.26 | -5.0% |
| Operating cash flow | $323.8 million | $189.2 million | +71.2% |
| Capital expenditures | $126.1 million | $127.5 million | Approximately 4.5% of sales |
| Effective tax rate | 42.7% | 28.6% | Higher due primarily to Spanish tax charges |
Flavors sales increased 2.3% to $1,378.4 million, with local-currency growth of 5% and like-for-like growth of 8% excluding exited low-margin activities. Flavors segment profit rose to $298.3 million, with a 21.6% margin. Fragrances sales increased 0.2% to $1,443.1 million, with local-currency growth of 3%; Fragrance Ingredients declined 10% in local currency, primarily because of price-driven volume declines in commodity products. Fragrances segment profit increased to $238.4 million, with a 16.5% margin.
Raw material costs increased approximately 4% year over year but began to decline slightly late in the fourth quarter. R&D expense rose to $233.7 million, or 8.3% of sales. Interest expense declined to $41.8 million from $44.6 million, reflecting lower average debt levels and a 4.6% average cost of debt.
Fourth-quarter sales were $680.6 million versus $644.4 million in the prior-year quarter. Fourth-quarter net income was $68.1 million versus $24.4 million, and diluted EPS was $0.83 versus $0.30. The 2011 fourth quarter included $29.8 million of after-tax Mane patent litigation settlement costs and $6.9 million of restructuring-related costs.
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents increased to $324.4 million from $88.3 million, including $102.7 million held outside the United States.
- Total debt was $1,031.2 million, up from $894.9 million; net debt declined to $697.8 million from $795.6 million because of the higher cash balance.
- The $942 million unsecured revolving credit facility had $296.7 million drawn and approximately $648.2 million available at year-end. The facility matures in 2016 and requires net debt to adjusted EBITDA of no more than 3.25-to-1.
- IFF reported a covenant net debt-to-adjusted EBITDA ratio of 1.20-to-1 and compliance with all debt covenants.
- A $150 million debt maturity was due in 2013, including $100 million of Senior Notes due July 12, 2013. Management stated that cash balances and available facilities were sufficient for debt service and expected needs for at least the next 18 months.
- Dividends paid were $130.9 million, and declared dividends increased to $1.30 per share from $1.16. The Board authorized a $250 million share-repurchase program beginning in the first quarter of 2013; no fourth-quarter 2012 repurchases occurred.
Material Changes, Outlook and Unusual Items
- Margin expansion reflected price realization, moderating input-cost inflation, manufacturing leverage, favorable mix, cost reduction and the exit of low-margin Flavors activities.
- Operating profit benefited from the absence of the 2011 Mane patent settlement and lower restructuring charges. 2012 restructuring and other charges were $1.7 million versus $13.2 million in 2011.
- The 2012 effective tax rate included $72.4 million of charges related to the Spanish tax settlement and approximately $12 million of charges related to Spanish dividend-withholding cases. Excluding these items and restructuring, management reported an adjusted effective tax rate of 26.4%.
- IFF settled Spanish income-tax matters for 2004-2010, paid $105.5 million during 2012 and expected to pay approximately $1.9 million in the first quarter of 2013. Disputes remained for the 2002-2003 and 2011 tax years and certain capital-tax and withholding-tax matters.
- Management expected 2013 local-currency sales growth, including the effect of exiting low-margin activities, to be at the lower end of its long-term 4%-6% target because of macroeconomic uncertainty and continued pressure in commodity Fragrance Ingredients. The adverse sales effect of the Flavors exit was expected to end after the first half of 2013.
- Management expected further year-over-year gross-margin expansion in 2013 and capital spending near 5% of sales, supported by lower raw-material costs, emerging-market investments and Flavors capacity expansion.
- IFF opened a Singapore manufacturing facility, planned to open a Guangzhou, China flavors facility in the first half of 2013, and announced an investment of more than $50 million over three years in its Turkey facility.
Principal Risks and Contingencies
- Volatility in natural ingredients, chemicals, energy and transportation costs may pressure margins or require price increases that reduce volume or market share.
- Demand is exposed to global consumer spending, European fiscal conditions, emerging-market growth, currency movements and changing consumer preferences.
- Supply-chain disruption, sole-source ingredients, product-quality failures, recalls, regulatory compliance and environmental obligations could adversely affect results.
- IFF faces intense competition, customer supplier consolidation and dependence on innovation, patents, trade secrets and specialized perfumers and flavorists.
- Pending Spanish tax matters included assessments of approximately $29.3 million for 2002-2003 income taxes, a possible $12 million capital-tax exposure, and a remaining dividend-withholding controversy of approximately $10.8 million, including estimated interest. Bank guarantees supported certain appeals.
- Environmental exposure involved nine third-party waste sites; management estimated IFF’s share of future cleanup costs at less than $5 million, while noting that actual obligations could increase.
- Pension and postretirement obligations, information-technology disruptions, natural disasters including Hurricane Sandy, foreign-exchange volatility and tax audits could affect liquidity and earnings.
Investor Verification Checklist
- Reconcile reported earnings with adjusted results, particularly the $72.4 million Spanish tax charge and the 2011 Mane settlement.
- Verify the status, cash cost and ultimate exposure of the remaining Spanish tax disputes, including the 2011 assessment and 2002-2003 appeals.
- Monitor Fragrance Ingredients volumes and commodity exposure, as well as the timing and magnitude of the Flavors low-margin business exit.
- Assess whether expected 2013 margin expansion and 4%-6% long-term local-currency growth remain achievable amid macroeconomic and currency risks.
- Review debt maturities, revolver availability, covenant headroom and the effect of the 2013 debt repayment and share-repurchase program on liquidity.
- Confirm execution, cost and returns from the Singapore, China and Turkey capacity investments and planned capital spending near 5% of sales.