International Flavors & Fragrances Inc. — 2017 Form 10-K Summary
Business context and reporting period
IFF is a global developer and manufacturer of flavors, fragrances, fragrance ingredients and cosmetic active ingredients. It operates through Flavors and Fragrances segments, serving food, beverage, fine fragrance, personal care, household and related consumer-product markets. The filing covers the 52-week fiscal year ended December 31, 2017; the actual fiscal year-end was December 29, 2017.
- Approximately 7,300 employees, 37 manufacturing facilities and 69 creative centers and application laboratories in 37 countries.
- Products are sold in approximately 162 countries. Flavors represented 48% of sales and Fragrances 52%.
- Sales mix by destination: Europe, Africa and Middle East 31%; Greater Asia 27%; North America 27%; Latin America 15%.
- Emerging markets represented 48% of 2017 sales, compared with 51% in 2016.
Financial performance and liquidity
| Metric | 2017 | 2016 | Change or comment |
|---|---|---|---|
| Net sales | $3,398.7 million | $3,116.4 million | Up 9.1%; approximately 5% of growth came from acquisitions |
| Gross profit | $1,479.0 million | $1,399.1 million | Gross margin declined to 43.5% from 44.9% |
| Operating profit | $581.4 million | $567.4 million | Operating margin declined to 17.1% from 18.2% |
| Adjusted operating profit | $647.4 million | $623.0 million | Adjusted margin declined to 19.0% from 20.0% |
| Net income | $295.7 million | $405.0 million | Down 27.0%, primarily due to U.S. tax reform charges |
| Diluted EPS | $3.72 | $5.05 | Down 26.3% |
| Adjusted EPS | $5.89 | $5.51 | Up 7% |
| Cash flow from operations | $390.8 million | $550.1 million | Declined due primarily to working capital, legal and restructuring-related payments |
| Capital expenditures | $129.0 million | $126.4 million | 3.8% of sales |
| Cash and equivalents | $368.0 million | $324.0 million | Approximately $286.6 million held outside the United States |
| Total debt | $1,639.2 million | $1,325.4 million | Net debt was $1,271.8 million |
Flavors sales increased 9.1% to $1,632.2 million, with segment profit increasing to $375.2 million and margin improving to 23.0% from 22.5%. Fragrances sales increased 9.1% to $1,766.6 million, while segment profit increased modestly to $335.4 million and margin declined to 19.0% from 20.6%.
R&D expense was $286.0 million, or 8.4% of sales, compared with $254.3 million, or 8.2%, in 2016. The current ratio improved to 2.5 from 1.8. IFF paid $206.1 million in dividends and repurchased $58.1 million of common stock during 2017.
IFF issued $500 million of 4.375% senior notes due 2047 and repaid $250 million of senior notes maturing in 2017. It had no commercial paper or revolving-credit borrowings outstanding at year-end, with approximately $950 million available under its revolving credit facility. The net debt-to-adjusted EBITDA covenant ratio was 1.59x versus a 3.50x limit.
Material changes versus the prior comparable period
- Reported and currency-neutral sales increased 9%; all regions and both segments grew. Exchange-rate effects did not materially affect revenue growth.
- Gross margin decreased 140 basis points, reflecting higher input and claim costs, unfavorable mix and unusual costs, partly offset by productivity initiatives.
- Operating profit increased $14.1 million, but operating margin declined because sales growth did not fully offset margin pressure and higher acquisition-related amortization.
- Operating cash flow decreased $159.4 million, driven by increased receivables and inventories, higher core working capital requirements and payments related to legal claims, severance, integration and acquisitions.
- IFF acquired Fragrance Resources for approximately $151.9 million and PowderPure for approximately $54.6 million. Fragrance Resources expanded the Fragrances platform, while PowderPure added clean-label flavor capabilities.
- Goodwill and intangible assets increased to $1.57 billion from $1.37 billion, principally due to acquisitions and foreign exchange. Annual goodwill testing identified no impairment.
Guidance, outlook, risks and unusual items
- Management expects 2018 capital spending of approximately 4.5% to 5.0% of sales, excluding potential government grants and reimbursements.
- Management expects market conditions to remain volatile but anticipates slight improvement in 2018. Higher raw-material costs and a BASF supply disruption involving a key ingredient are expected to reduce currency-neutral operating-profit growth; the disruption was not expected to be resolved until the second half of 2018.
- Management estimated an effective tax rate of approximately 21% for 2018, subject to further guidance and operating or structural changes.
- The Tax Cuts and Jobs Act produced a provisional fourth-quarter tax charge of $139.2 million, consisting principally of a $100.6 million deemed-repatriation toll charge and a $38.6 million deferred-tax remeasurement charge. The cash portion of the toll charge is payable over eight years beginning in 2018, and the computation could be revised through 2018.
- The 2017 Productivity Program generated approximately $20.6 million of personnel-related charges in 2017, with cumulative pre-tax cash charges expected to total $30 million to $35 million and approximately 370 workforce reductions.
- An FDA-mandated product recall resulted in approximately $12.8 million of cumulative charges by year-end, including $7.5 million in the fourth quarter. Additional losses were considered probable but were not yet estimable; potential insurance or supplier reimbursements were also uncertain.
- IFF paid $56 million in the second quarter to settle ZoomEssence litigation and recorded an additional $1.0 million charge.
- China facility matters remain material contingencies. The Guangzhou Flavors plant could face zoning-related production restrictions; the plant’s net book value was approximately $68 million. IFF expects up to $50 million of compensation related to relocating its Zhejiang Ingredients plant and received $15 million in 2017.
- Key risks include customer concentration, intense competition, raw-material and energy-price volatility, supply-chain disruption, regulatory and environmental compliance, foreign exchange, emerging-market exposure, cybersecurity, acquisitions and integration, intellectual-property claims, pension obligations, tax audits and potential asset impairment.
Most important facts for an investor to verify
- Whether the BASF supply disruption and raw-material inflation caused the expected 2018 margin and operating-profit pressure.
- The final amount and cash timing of the Tax Act toll charge and any revisions to the provisional $139.2 million tax charge.
- The ultimate cost, timing and insurance or supplier recovery associated with the FDA-related product recall.
- Progress and total cost of the productivity program, China relocations, Guangzhou zoning matter and new India and China facilities.
- Whether acquisitions deliver the expected growth and synergies without further increases in amortization, integration costs or goodwill-impairment risk.
- Working-capital trends and conversion of earnings into operating cash flow, particularly given the 2017 decline to $390.8 million.
- Debt maturities, refinancing capacity and compliance with the 3.50x net-debt-to-adjusted-EBITDA covenant.
- Customer concentration: the 25 largest customers represented 50% of sales and the largest customer represented approximately 11% to 12% of sales.