International Flavors & Fragrances Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparative period ended March 31, 2015. The interim financial statements are unaudited. IFF develops and supplies flavor and fragrance compounds and ingredients for food, beverage, personal care, household and related products.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $783.3 million | $774.9 million | +1% reported; +6% currency neutral |
| Gross profit | $360.2 million | $346.3 million | +4% |
| Gross margin | 46.0% | 44.7% | +130 bps |
| Operating profit | $167.2 million | $161.8 million | +3% |
| Operating margin | 21.3% | 20.9% | +40 bps |
| Net income | $118.6 million | $128.3 million | -8% |
| Diluted EPS | $1.47 | $1.57 | -6% |
| Operating cash flow | $31.6 million | $31.5 million | Essentially flat |
- Segment sales: Flavors sales were $372.5 million, down 1% reported and up 4% currency neutral. Fragrances sales were $410.8 million, up 3% reported and 8% currency neutral.
- Segment profit: Flavors was $91.8 million, or 24.6% of sales, versus $92.7 million; Fragrances was $89.2 million, or 21.7%, versus $81.6 million.
- Profit drivers: Gross margin benefited from volume growth, productivity initiatives, acquisitions and favorable material costs. Higher amortization, selling and administrative expenses, interest expense and the effective tax rate reduced net income.
- Cash and working capital: Cash and equivalents were $528.9 million at March 31, 2016, versus $182.0 million at December 31, 2015. Working capital was $1.179 billion, versus $713.8 million at year-end.
- Capital expenditures: $22.5 million in Q1 2016 versus $19.4 million in Q1 2015. Management expects 2016 capital expenditures to be approximately 5% of sales, net of potential grants and reimbursements.
- Debt and liquidity: Total debt was $1.504 billion versus $1.070 billion at December 31, 2015. Net debt was $971.9 million. IFF issued €500 million of 1.75% senior notes due 2024 and repaid the $131.2 million outstanding under its credit facility. The company reported no revolving-facility borrowings, $950 million of drawdown capacity and compliance with all debt covenants.
- Debt covenant: Net debt to adjusted EBITDA was 1.36x versus a 3.25x maximum covenant. Twelve-month adjusted EBITDA was $716.3 million.
- Shareholder returns: Dividends declared were $0.56 per share versus $0.47. IFF repurchased 363,334 shares for $40.0 million at an average price of $110.11; $196.7 million remained available under the repurchase authorization.
Material changes versus the prior comparable period
- Reported sales increased modestly, while currency-neutral sales rose 6%; foreign exchange reduced reported sales growth by approximately 500 basis points.
- Acquisitions contributed approximately 4% to reported and currency-neutral sales growth, primarily reflecting the 2015 acquisitions of Ottens Flavors and Lucas Meyer.
- Operating profit increased $5.4 million, despite unfavorable currency effects and higher corporate expenses.
- Net income declined $9.7 million, principally because Q1 2015 included a $10.5 million tax benefit from favorable tax rulings and $5.7 million of other income, compared with $0.2 million in Q1 2016.
- Interest expense increased $1.4 million to $12.5 million, while average cost of debt declined to 3.9% from 4.7%.
- Amortization of acquisition-related intangibles increased to $6.1 million from $1.8 million.
- The effective tax rate increased to 23.4% from 18.0%; management reported an adjusted rate of 23.5% versus 24.7% in the prior-year period.
- Operating cash flow was stable, as increased core working-capital requirements were offset by lower pension contributions.
Outlook, commentary, risks and unusual items
- Management expects raw-material costs to remain broadly benign, with higher prices for certain naturals such as citrus and vanilla offset by benefits from oil-based derivatives.
- IFF intends to pursue margin improvement through productivity, cost reduction, operational performance and mix enhancement.
- The 2015 restructuring program is expected to cost approximately $10 million in total and be fully implemented in the second half of 2017. Q1 2016 payments were $0.9 million, with $0.1 million of accelerated depreciation.
- The company recognized $1.4 million of additional income related to a favorable Spanish capital-tax ruling. The previously recorded $10.5 million provision had been reversed in 2015.
- The Guangzhou Flavors plant in China had been temporarily idled because of odor-emission compliance issues; IFF invested approximately $6.5 million in odor-abatement equipment. A separate Chinese government request to relocate the Zhejiang Ingredients plant remains under discussion.
- Management expects approximately $24 million of contributions to non-U.S. pension plans and approximately $5 million to postretirement benefit plans during 2016.
- Reported risks include foreign-exchange volatility, international economic and political conditions, raw-material availability and pricing, supply-chain disruption, customer demand, acquisitions, regulatory and environmental compliance, litigation and tax contingencies, pension obligations, cybersecurity and execution of Vision 2020 and efficiency initiatives.
- Environmental liabilities at identified sites were estimated at less than $5 million. The estimated range of reasonably possible losses for specified contingencies was $0 to $31 million. The company also had approximately $40 million of bank guarantees and standby letters of credit, including $14.4 million related to Brazilian tax disputes.
- Management stated that operating cash flows, cash balances and available credit are sufficient to meet investing and financing needs for at least the next 18 months, subject to the risks described in the filing.
Important facts for investors to verify
- Confirm the sustainability of currency-neutral growth and the extent to which reported growth depends on acquisitions.
- Assess whether gross-margin gains and productivity benefits offset inflation in naturals, energy, transportation and other inputs.
- Monitor leverage, debt maturities, foreign-currency exposure and compliance with revolving-credit covenants after the 2024 euro-note issuance.
- Evaluate working-capital trends and the unusually large quarter-end cash increase, including the effect of receivables factoring.
- Track integration and performance of Ottens Flavors and Lucas Meyer, including acquisition-related amortization and costs.
- Follow developments involving the Chinese facilities, Brazilian tax disputes, environmental matters and the ZoomEssence litigation.
- Verify future pension contributions, capital expenditures and share-repurchase activity against management’s expectations.
- Review the impact of pending lease, revenue-recognition and share-based-payment accounting standards; the filing states that the lease standard is expected to significantly increase reported assets and liabilities.