Business Context and Reporting Period
International Flavors & Fragrances Inc. filed its Form 10-K for the fiscal year ended December 31, 2013. The company creates and supplies flavor and fragrance compounds and ingredients for food, beverage, personal care, household and related products. Operations span 31 countries and more than 100 customer markets, with approximately 6,000 employees.
IFF operates through two segments: Flavors, representing 48% of 2013 sales, and Fragrances, representing 52%. Sales by destination were EAME 33%, Greater Asia 28%, North America 23% and Latin America 16%. Emerging markets represented 49% of sales and grew 10% in local currency.
Key Financial Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net sales | $2,952.9 million | $2,821.4 million | +4.7% |
| Gross profit | $1,284.2 million | $1,175.5 million | +9.2% |
| Gross margin | 43.5% | 41.7% | +180 bps |
| Operating profit | $516.3 million | $486.6 million | +6.1% |
| Operating margin | 17.5% | 17.2% | +30 bps |
| Net income | $353.5 million | $254.1 million | +39.1% |
| Diluted EPS | $4.29 | $3.09 | +38.8% |
| Cash flow from operations | $407.6 million | $323.8 million | +$83.8 million |
| Capital expenditures | $134.2 million | $126.1 million | +$8.0 million |
Adjusted operating profit, excluding specified restructuring, operational improvement, accelerated depreciation and Spanish capital tax charges, was $540.4 million, or an 18.3% adjusted operating margin, compared with $488.3 million and 17.3% in 2012.
- Flavors sales were $1,422.7 million, up 3.2%; segment profit was $323.6 million, with a 22.7% margin versus 21.6% in 2012.
- Fragrances sales were $1,530.2 million, up 6.0%; segment profit was $283.7 million, with an 18.5% margin versus 16.5% in 2012.
- R&D expense increased to $259.8 million, or 8.8% of sales, from $233.7 million, or 8.3%.
- Selling and administrative expense increased to $505.9 million, or 17.1% of sales, from $453.5 million, or 16.1%.
- Cash and cash equivalents were $405.5 million at year-end, including $186.6 million held outside the United States.
- Total debt was $932.8 million versus $1,031.2 million in 2012; net debt was $520.2 million versus $697.8 million.
- The current ratio improved to 2.9 from 2.5. Shareholders’ equity, including noncontrolling interest, increased to $1,467.1 million from $1,252.6 million.
Material Changes Versus the Prior Comparable Period
- Reported sales increased 5%, while local-currency sales increased 5% and like-for-like sales increased 6%, excluding the exit of low-margin Flavors activities.
- Growth was driven primarily by new customer wins, pricing and favorable mix. Existing-volume declines affected Fragrance Ingredients and certain Flavors activities.
- Gross margin expanded due to modestly lower raw-material costs, manufacturing efficiencies, pricing and mix improvements, although raw-material prices remained historically elevated.
- Net income benefited from lower taxes and the absence of the $72.4 million after-tax Spanish tax settlement charge recorded in 2012.
- Operating cash flow improved despite $32.5 million of Spanish tax payments and a $15.0 million year-over-year increase in pension contributions. Adjusted operating cash flow, excluding these items, was $455.1 million.
- IFF issued $300 million of 3.20% senior notes due 2023, repaid $283.1 million under its credit facility and repaid $100 million of 2006 senior notes.
- The company repurchased $51.4 million of common stock during 2013 and had approximately $198.1 million remaining under its $250 million repurchase authorization at year-end.
Guidance, Outlook, Risks and Unusual Items
Management expects 2014 local-currency sales growth consistent with its long-term 4%–6% target, with approximately one additional percentage point from the inclusion of Aromor. Management expects continued gross-margin expansion, but at a substantially slower rate than in 2013, and anticipates 2014 capital spending of approximately 4%–5% of sales, net of potential grants and reimbursements.
- IFF completed the acquisition of Aromor Flavors and Fragrances Ltd. on January 16, 2014, funded with cash. Aromor will become part of Fragrance Ingredients.
- The company plans to close and consolidate its Augusta, Georgia fragrance-ingredients facility by July 2014. Total expected charges are $16 million–$21 million, including approximately $6 million–$9 million of future cash costs; 43 positions are expected to be eliminated.
- 2013 included $13.0 million of pretax expense related to a Spanish capital-tax case, $7.4 million of Fragrance Ingredients rationalization charges, $8.8 million of operational improvement costs and a $14.2 million gain on sales of non-operating assets.
- IFF paid $11.2 million in the first quarter of 2014 related to the Spanish capital-tax case while appealing the ruling; the amount is refundable if the company prevails.
- Key risks include raw-material, energy and transportation inflation; crop and supply volatility; foreign currency movements; economic weakness and consumer spending changes; emerging-market political, regulatory and tax uncertainty; supply-chain disruptions; product integrity and regulatory compliance; competition; intellectual-property claims; pension funding requirements; cybersecurity; and execution of restructuring and acquisitions.
- The company reported $61.3 million of bank guarantees and standby letters of credit at year-end, including guarantees related to Spanish and Brazilian tax disputes. Management estimates reasonably possible losses related to disclosed contingencies at $2 million–$20 million, excluding the separately discussed Spanish capital-tax matter.
- IFF and its auditor concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2013.
Most Important Facts for Investors to Verify
- Whether 2014 sales growth reaches the stated 4%–6% long-term local-currency target and whether Aromor contributes the expected incremental growth.
- Whether gross-margin improvement continues after the unusually strong 2013 expansion.
- The actual cost, timing and savings from the Augusta closure and other manufacturing consolidations.
- The integration, purchase accounting and cash impact of the Aromor acquisition.
- Exposure to natural-ingredient prices, crop conditions and the ability to recover input-cost increases through pricing.
- Progress and ultimate cash impact of Spanish, Brazilian and other tax disputes, guarantees and pledged assets.
- Debt maturities, interest-rate exposure and compliance with the 3.25-to-1 net-debt-to-adjusted-EBITDA covenant.
- Future pension contributions, effective tax rates, share repurchases and dividend sustainability.