International Flavors & Fragrances Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; filed May 7, 2013. The unaudited interim statements use March 31 as the reporting date, although the actual quarter-end was March 29, 2013.
Business Context
IFF creates and supplies flavors and fragrances for food, beverage, personal care and household-product customers. Operations comprise the Flavors and Fragrances segments, with emerging markets representing 49% of sales during the quarter.
Financial Performance and Position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $727.8 million | $710.6 million | Up 2% |
| Gross profit | $311.4 million | $285.4 million | Up $26.0 million |
| Gross margin | 42.8% | 40.2% | Up 260 bps |
| Operating profit | $137.6 million | $120.9 million | Up 14% |
| Operating margin | 18.9% | 17.0% | Up 190 bps |
| Net income | $90.7 million | $81.1 million | Up 12% |
| Diluted EPS | $1.10 | $0.99 | Up 11% |
| Operating cash flow | $18.7 million | $52.6 million | Down $33.9 million |
- Segment sales: Flavors sales were $356.4 million, up 2%; Fragrances sales were $371.5 million, up 3%.
- Segment profit: Flavors increased to $83.0 million from $79.7 million; Fragrances increased to $68.4 million from $56.1 million.
- Underlying growth: Local-currency sales increased 3%, or 4% on a like-for-like basis excluding the exit of low-margin Flavors activities. Emerging-market local-currency sales increased 9%; Latin America led with 11% growth.
- Cash and liquidity: Cash was $300.0 million at March 31, 2013, compared with $324.4 million at year-end 2012. Working capital was $994.4 million.
- Debt: Total debt was $1.016 billion at March 31, 2013, including $282.2 million outstanding under the credit facility. Net debt for covenant purposes was $707.4 million, and the net-debt-to-adjusted-EBITDA ratio was 1.18 to 1, below the 3.25 to 1 covenant limit.
- Capital expenditures: Additions to property, plant and equipment were $29.9 million. Management expected full-year capital spending to approach 5% of sales.
- Dividends and repurchases: A quarterly dividend of $0.34 per share was declared and paid April 4, 2013. The company repurchased 203,068 shares for $14.2 million during the quarter; $235.8 million remained under the $250 million authorization.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected new product wins, favorable pricing, lower declines in existing business and emerging-market strength, partly offset by foreign-exchange pressure, declining Fragrance Ingredients volumes and the planned exit from low-margin Flavors sales.
- Gross-margin expansion resulted from favorable mix, manufacturing efficiencies, cost reductions and modestly lower raw-material costs. Raw-material prices nevertheless remained near historical highs.
- Operating profit benefited from margin expansion and the absence of the $1.7 million restructuring charge recorded in Q1 2012. Q1 2013 included $1.2 million of operational-improvement costs.
- Selling and administrative expenses increased 9%, primarily due to higher incentive compensation, deferred-compensation remeasurement and pension expense.
- Operating cash flow declined largely because of $30.0 million of U.S. pension contributions and approximately $36 million of additional incentive-compensation payments.
- The effective tax rate increased to 28.9% from 26.5%, including a $6.2 million after-tax charge related to Spanish tax matters. Management reported an adjusted Q1 2013 tax rate of 24.0% excluding that charge.
Guidance, Outlook, Risks and Unusual Items
- Management expected stronger local-currency sales growth in Q2 2013, driven by Flavors and Fragrance Compounds, with more modest declines in Fragrance Ingredients. The negative sales impact from exiting low-margin Flavors activities was expected to continue through Q2.
- Management expected continued year-over-year gross-margin expansion in 2013, assuming favorable operational improvements and a relatively benign raw-material cost environment.
- IFF expected $2–$3 million of additional operational-improvement costs during the remainder of 2013.
- The company expected commercial production at its China compounding facility during the second half of 2013, which could increase depreciation and start-up costs.
- IFF announced plans to close its Augusta, Georgia fragrance-ingredients facility by July 2014. Expected costs were $16–$21 million, including $10–$12 million of accelerated depreciation, $3–$4 million of personnel costs and $3–$5 million of shutdown costs. Approximately 43 positions were expected to be eliminated, with $6–$9 million of future cash expenditures.
- On April 4, 2013, IFF issued $300 million of 3.20% senior notes due 2023 and received $297.8 million of proceeds. On April 26, it repaid the $282.2 million outstanding credit-facility balance.
- IFF paid $23.3 million in Q2 2013 relating to the Spanish 2002–2003 tax cases. The 2002 assessment remained under appeal, while the company had decided not to appeal the 2003 ruling. Additional Spanish tax payments and assessments remained possible.
- At March 31, 2013, bank guarantees and standby letters of credit totaled approximately $81.1 million, including $38.2 million related to Spanish tax disputes. Brazilian tax matters were supported by approximately $48.7 million of bank guarantees and pledged assets.
- Key risks include raw-material cost and availability, foreign-exchange movements, economic and consumer-demand conditions, execution of restructuring and facility projects, pension funding requirements, tax disputes, litigation and covenant compliance.
Investor Verification Checklist
- Verify Q2 and full-year results against the stated expectations for local-currency growth, gross-margin expansion and the completion of low-margin Flavors exits.
- Track the Augusta facility closure charges, cash expenditures, workforce reductions and production-consolidation benefits.
- Reconcile the April debt issuance and credit-facility repayment with subsequent debt, interest expense and liquidity balances.
- Monitor Spanish tax proceedings, including the unresolved 2002 assessment, 2011 tax matters and remaining withholding-tax payments.
- Assess operating-cash-flow recovery after the unusually large pension and incentive-compensation payments in Q1.
- Review the pace and economics of the China facility start-up and the planned 2013 capital-spending level.
- Distinguish GAAP results from management’s local-currency, like-for-like, adjusted operating-profit and adjusted-tax-rate measures.