International Flavors & Fragrances Inc. — Q1 2015 Form 10-Q
Business Context and Reporting Period
IFF creates and supplies flavor and fragrance compounds and ingredients for food, beverage, personal care, household-product and related industries. The company reports two operating segments: Flavors and Fragrances. This unaudited filing covers the three months ended March 31, 2015; the actual fiscal quarter closed April 3, 2015. The comparable 2014 quarter closed March 28, 2014.
Financial Performance and Key Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $774.9 million | $770.2 million | 1% |
| Gross profit | $346.3 million | $341.4 million | 1% |
| Gross margin | 44.7% | 44.3% | +40 bps |
| Operating profit | $161.8 million | $156.1 million | 4% |
| Operating margin | 20.9% | 20.3% | +60 bps |
| Net income | $128.3 million | $106.7 million | 20% |
| Diluted EPS | $1.57 | $1.30 | 21% |
| Operating cash flow | $31.5 million | $35.0 million | Down $3.5 million |
- Flavors sales increased 3% reported and 9% on a currency-neutral basis; segment profit increased 5% to $92.7 million, with a 24.6% margin.
- Fragrances sales declined 1% reported but increased 5% on a currency-neutral basis; segment profit declined 6% to $81.6 million, with a 20.5% margin.
- Reported sales growth was reduced by approximately 500 basis points from foreign-exchange translation, primarily due to the weaker euro. Emerging markets represented 51% of currency-neutral sales and grew 9% on that basis.
- Other income was $5.7 million versus $1.4 million of other expense in the prior-year quarter, primarily reflecting higher foreign-exchange gains.
- The effective tax rate was 18.0% versus 25.3%, helped by a $10.5 million benefit from favorable tax rulings. Excluding that benefit, management reported an adjusted effective tax rate of 24.7%.
- Cash and cash equivalents were $443.7 million at March 31, 2015, including $344.0 million held outside the United States. Working capital was $1.27 billion.
- Total debt was $943.5 million, including $935.2 million of long-term debt. Net debt as defined under the credit agreements was $495.1 million, and the covenant net-debt-to-adjusted-EBITDA ratio was 0.69 to 1 versus a 3.25-to-1 limit.
- The company had $940.4 million of drawdown capacity under its revolving credit facility and reported compliance with all debt covenants.
- Capital expenditures were $19.4 million. Dividends paid were $38.0 million, and the company repurchased 98,113 shares for $10.7 million.
Material Changes Versus the Prior Comparable Period
- Net income increased $21.6 million, reflecting higher operating profit, increased foreign-exchange gains and the favorable tax-ruling benefit.
- Operating profit improved despite currency headwinds. Adjusted operating profit was $162.8 million, or 21.0% of sales, versus $158.8 million, or 20.6%, in Q1 2014.
- Flavors benefited from new wins and volume growth, while Fragrances faced unfavorable currency effects, competitive pressure on ingredient prices and higher input costs.
- Operating cash flow decreased despite higher earnings, principally because of substantially higher pension contributions, including $35.0 million to qualified U.S. pension plans and $19.1 million to non-U.S. plans.
- Investing cash use fell to $17.9 million from $122.4 million because the prior-year period included the approximately $102 million Aromor acquisition.
- Restructuring and operational-improvement costs declined substantially, although Q1 2015 included $0.2 million of restructuring charges, $0.3 million of operational-improvement costs and $0.5 million of acquisition-related costs.
Guidance, Outlook, Risks and Unusual Items
- Management continued to expect 2015 currency-neutral sales growth in line with its long-term targets.
- Management expected raw-material input costs to increase approximately 1% to 2% in 2015, with higher prices for certain natural ingredients expected to outweigh later benefits from oil-based derivatives.
- Capital spending was expected to approach 4% to 5% of sales. Management expected to contribute approximately $30 million to non-U.S. pension plans during 2015.
- On May 1, 2015, after the reporting period, IFF acquired Ottens Flavors for approximately $190 million from existing cash resources to strengthen its North American Flavors business. The acquisition was not included in Q1 results and was not expected to have a material consolidated impact.
- IFF estimated its reasonably possible loss from specified contingencies, collectively, at $0 to $31 million. Environmental exposure at eight third-party sites was estimated at less than $5 million.
- Spanish tax matters included $5.1 million of fully reserved dividend-withholding-tax controversies; $3.8 million was paid in April 2015 and the remaining payment was expected in Q2. A favorable Spanish tax ruling also enabled reversal of a $2.3 million reserve in Q1.
- Brazilian tax and indirect-tax matters were supported by approximately $31.9 million of bank guarantees and pledged assets. Total bank guarantees and standby letters of credit were approximately $36 million.
- The ZoomEssence trade-secret litigation was proceeding through discovery, with trial anticipated in mid-2016. Management did not believe the matter represented a material loss contingency at March 31, 2015.
- Key risks include raw-material, energy and transportation cost volatility; foreign-exchange movements; international political and economic conditions; supply-chain disruption; customer demand and competitive pressures; acquisition execution; pension funding; tax disputes; litigation; and regulatory or accounting changes.
Important Facts for Investors to Verify
- Whether currency-neutral sales growth and long-term targets are sustained after the significant Q1 foreign-exchange headwind.
- Whether Fragrances segment margins recover from the decline to 20.5% and whether ingredient pricing pressure persists.
- The recurring versus one-time nature of the $10.5 million tax benefit and the resulting normalized effective tax rate.
- Cash generation after pension contributions, dividends, capital expenditures and the $190 million Ottens acquisition.
- Progress, final purchase accounting and financial contribution from Ottens Flavors.
- Developments in Spanish and Brazilian tax disputes, ZoomEssence litigation and environmental contingencies.
- Raw-material inflation, pricing recovery, productivity gains and the effect of foreign-exchange hedging on future margins.