International Flavors & Fragrances Inc. — Q2 2020 Form 10-Q Summary
Business context and reporting period
IFF is a global producer of flavor compounds and ingredients in its Taste segment and fragrance compounds, fragrance ingredients and cosmetic active ingredients in its Scent segment. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. The 2020 fiscal quarter actually closed July 3, 2020. IFF operated as an essential business during the COVID-19 pandemic, and its manufacturing facilities remained open, although some research and creative centers operated on limited schedules.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $1,198.8 million | $1,291.6 million | $2,546.1 million | $2,589.0 million |
| Gross profit / margin | $481.8 million / 40.2% | $546.2 million / 42.3% | $1,047.7 million / 41.1% | $1,077.5 million / 41.6% |
| Operating profit / margin | $119.4 million / 10.0% | $199.9 million / 15.5% | $315.6 million / 12.4% | $363.8 million / 14.1% |
| Net income attributable to IFF | $86.2 million | $136.4 million | $210.8 million | $245.2 million |
| Diluted EPS | $0.74 | $1.20 | $1.89 | $2.16 |
| Operating cash flow | Not separately provided | Not separately provided | $208.4 million | $184.9 million |
Q2 reported sales declined 7% year over year, or 4% on a currency-neutral basis. Taste sales declined 8% reported and 5% currency-neutral; Scent sales declined 6% reported and 4% currency-neutral. For the first six months, sales declined 2% reported but increased 1% currency-neutral.
Adjusted Q2 operating profit was $158.1 million, or 13.2% of sales, versus $213.9 million, or 16.6%, in the prior-year quarter. Six-month adjusted operating profit was $380.4 million versus $418.6 million. These are non-GAAP measures and exclude specified acquisition, integration, restructuring, transaction and other items.
Cash, cash equivalents and restricted cash totaled $511.9 million at June 30, 2020, including $497.4 million of cash and cash equivalents, compared with $623.9 million at December 31, 2019. Net cash used in investing activities was $77.6 million, while net cash used in financing activities was $214.6 million. Dividends paid during the first six months were $160.1 million.
Total debt was $4.37 billion, including $185.2 million of short-term borrowings and $4.18 billion of long-term debt. Net debt was $3.87 billion. IFF reported $681.5 million of available capacity under its credit facility, $104.8 million under other lines of credit and no outstanding borrowings under the $1.0 billion credit facility. Its covenant net debt to adjusted EBITDA ratio was 3.40x versus applicable covenant limits, and the company stated that it was in compliance with its covenants.
Material changes versus the prior comparable period
- COVID-19 reduced demand in most categories, particularly Taste products used in retail food service, Fine Fragrances and Cosmetic Active Ingredients. Consumer Fragrances benefited from increased demand.
- Gross margin fell 210 basis points in Q2, primarily due to lower volume, unfavorable mix and higher raw-material costs.
- Operating margin declined 550 basis points in Q2, and diluted EPS decreased 38% to $0.74. Six-month diluted EPS decreased 13% to $1.89.
- Selling and administrative expense increased 10% in Q2 and 9% for the first six months, driven primarily by higher employee-related expenses, including salaries, wages and incentive compensation.
- Operating cash flow increased to $208.4 million from $184.9 million, principally due to working-capital effects, despite lower cash earnings.
- Capital expenditures declined to $80.0 million from $119.1 million in the prior-year six-month period. Management expects 2020 capital spending of approximately 4% of sales, down from 5% in 2019.
- Foreign currency translation produced a $305.8 million after-tax reduction in other comprehensive income for the first six months, contributing to a decline in total equity.
Guidance, outlook, commentary, risks and unusual items
Management expects demand to recover across affected categories, but the timing remains uncertain and depends on the duration and severity of COVID-19, economic conditions and consumer behavior. IFF expects additional labor, shipping, cleaning and potentially raw-material costs if supply-chain disruptions continue. The company increased inventories to support anticipated third- and fourth-quarter demand.
IFF expects to close approximately 35 manufacturing sites under its Frutarom integration program, with most closures targeted by the end of 2021. Fifteen sites had been closed through June 30, 2020. Total program costs are expected to be approximately $40 million to $50 million, and management continues to target $145 million of cost synergies. Approximately $32 million of cost synergies had been realized year-to-date as of the second quarter.
The pending Nutrition & Biosciences transaction with DuPont is expected to close in early 2021, subject to remaining conditions including IFF shareholder approval and regulatory approvals. DuPont is to receive a one-time special cash payment of approximately $7.3 billion, and DuPont shareholders are expected to own approximately 55.4% of IFF on a fully diluted basis. Financing includes a $1.25 billion term loan facility and a potential $6.25 billion bridge facility. If the transaction is not completed under specified circumstances, IFF could owe a $521.5 million termination fee and, in certain circumstances, up to $75 million of expense reimbursement.
IFF entered into a two-year, $200 million 2022 Term Loan facility, available for a single draw between September 15 and September 25, 2020. No borrowings were outstanding at June 30. Approximately $300 million of 3.40% senior notes mature in September 2020.
Significant unusual items included $38.7 million of Q2 N&B transaction and integration costs, $3.3 million of Frutarom integration costs, $1.9 million of restructuring charges and $0.4 million of fixed-asset disposal losses. The company also recognized Brazilian indirect-tax recoveries, including $5.7 million during the first six months, as a reduction of selling and administrative expense.
IFF does not currently anticipate COVID-19-related impairment charges, but a prolonged downturn could increase the risk of impairment of goodwill, intangible assets, equity investments and other long-lived assets. Other risks include supply-chain disruption, customer credit deterioration, raw-material inflation, foreign exchange volatility, leverage associated with the N&B transaction, litigation and investigations related to alleged improper payments involving former Frutarom operations, and potential future restrictions affecting Chinese facilities.
Facts investors should verify
- Whether COVID-19 demand weakness in retail food service and Fine Fragrances persists and whether Consumer Fragrances growth continues.
- Progress toward the N&B transaction, required shareholder and regulatory approvals, financing execution, closing timing and potential post-closing leverage.
- Repayment or refinancing of the approximately $300 million of notes maturing in September 2020 and any draw under the new $200 million term loan.
- Actual operating cash flow after considering the approximately $213 million of receivables removed through non-recourse factoring programs.
- Progress, costs and realized savings from the Frutarom manufacturing-site closures and integration program.
- Potential impairment charges, customer credit losses and additional allowances related to the pandemic.
- Developments in the Frutarom-related securities litigation, Israeli regulatory investigation and other legal or tax contingencies.
- Whether the planned 2020 capital spending of approximately 4% of sales and the $0.77 quarterly dividend authorized in August 2020 remain sustainable.