International Flavors & Fragrances Inc. — 2012 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; filed November 6, 2012. IFF creates and supplies flavors and fragrances for food, beverage, personal care and household products through its Flavors and Fragrances segments. The interim financial statements are unaudited.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net sales | $709.0 million | $713.8 million | $2.141 billion | $2.144 billion |
| Operating profit | $134.2 million | $128.6 million | $387.4 million | $379.9 million |
| Operating margin | 18.9% | 18.0% | 18.1% | 17.7% |
| Net income | $16.4 million | $82.2 million | $186.0 million | $242.5 million |
| Diluted EPS | $0.20 | $1.00 | $2.26 | $2.96 |
| Operating cash flow | Not separately provided | Not separately provided | $142.9 million | $116.7 million |
- Q3 gross profit was $301.5 million, with a 42.5% gross margin versus 39.0% in the prior-year quarter. Nine-month gross margin was 41.5% versus 40.1%.
- Q3 income before taxes increased to $121.8 million from $112.5 million, but taxes on income rose to $105.5 million from $30.2 million.
- Research and development expense increased 7% in Q3 to $57.7 million; selling and administrative expense increased 13% to $109.7 million.
- Cash and cash equivalents were $97.2 million at September 30, 2012, versus $88.3 million at December 31, 2011. Working capital was $736.1 million versus $752.7 million at year-end 2011.
- Total debt was $903.7 million, compared with $894.9 million at December 31, 2011. Net debt for covenant purposes was $797.0 million, and the net debt-to-adjusted EBITDA ratio was 1.38x versus a 3.25x covenant limit.
- Capital expenditures were $84.2 million in the first nine months, and the company expects 2012 capital spending to approximate 5% of sales.
- Dividends paid in the first nine months were $75.5 million; the Q3 dividend declared was $0.34 per share.
Material changes versus the prior comparable period
- Reported Q3 sales declined 1%, while local-currency sales increased 5%; foreign exchange, principally the weaker euro, reduced reported sales by approximately 600 basis points.
- Q3 Flavors sales were essentially flat on a reported basis, while local-currency sales increased 6%. Fragrances sales declined 1% reported but increased 5% in local currency.
- Emerging markets represented 47% of sales and grew 10% in local currency during Q3. Latin America led regional growth with 11% local-currency growth.
- Flavors segment profit increased to $76.1 million from $71.2 million, and Fragrances segment profit increased to $65.3 million from $58.7 million.
- Operating performance benefited from pricing, favorable mix, new wins, manufacturing efficiencies and the exit from selected low-margin Flavors activities. These benefits more than offset approximately 2% year-over-year raw-material cost inflation in Q3.
- Q3 net income fell approximately 80% and diluted EPS fell approximately 80%, primarily because of the Spanish tax charge described below. Excluding the $72.4 million Spanish tax charge and the prior-year restructuring reversal, management reported adjusted Q3 net income of $88.8 million, up 9%.
- Nine-month sales were essentially unchanged reported and increased 3% in local currency. Nine-month Flavors sales increased 3% reported, while Fragrances sales declined 3%.
Guidance, outlook, risks and unusual items
- Management expected Q4 2012 local-currency growth at rates similar to the prior two quarters and continued to expect emerging markets to be the primary growth driver.
- Management expected continued margin recovery from pricing, mix, productivity, manufacturing efficiencies and the exit of low-margin sales. However, raw-material prices remained near historical highs and crop-related volatility made future gross-margin trends difficult to predict.
- Management identified weaker Western European economic conditions, the effect of exiting low-margin sales, Fragrance Ingredients demand volatility and foreign-exchange movements as risks to achieving long-term growth targets.
- On August 1, 2012, IFF settled Spanish income-tax disputes for 2004–2010 for €86.0 million. It paid $105.5 million during Q3 and expected to pay approximately $1.9 million in Q4. The company recorded a $72.4 million after-tax Q3 charge, comprising $56.0 million for the settled years and $16.4 million for additional uncertain tax positions.
- The 2002–2003 Spanish tax assessments, the 2011 Spanish tax year and Spanish capital-tax claims remained unresolved. Spanish dividend-withholding disputes also remained, with approximately $2.1 million of additional payments expected by year-end.
- At September 30, 2012, bank guarantees and standby letters of credit totaled $90.7 million, including $42.0 million related to Spanish tax disputes. The company had $71.5 million of additional lines of credit available and stated that cash flow and credit availability were sufficient for at least the next 18 months.
- The company expected fourth-quarter 2012 contributions of $15–$20 million to U.S. qualified pension plans and $3–$8 million to non-U.S. pension plans.
- Hurricane Sandy affected several Northeast U.S. locations and information-technology infrastructure in late October 2012. Management was evaluating potential costs and disruptions, which could affect fourth-quarter or future results.
- Environmental liabilities for identified sites were estimated at less than $5 million, although management cautioned that future events could require higher payments.
Investor verification points
- Verify the cash and earnings effects of the Spanish tax settlement, remaining Spanish assessments, guarantees and expected fourth-quarter payments.
- Assess whether local-currency growth and margin improvement persist after the exit from low-margin sales and amid continued Fragrance Ingredients weakness.
- Monitor raw-material prices, pricing recovery, product mix and the sustainability of the 42.5% Q3 gross margin.
- Review debt maturities, revolving-credit availability, covenant calculations and the company’s ability to fund dividends, capital spending and pension contributions.
- Determine the financial impact of Hurricane Sandy and any related business-continuity or information-technology disruptions.
- Distinguish management’s non-GAAP local-currency, like-for-like, adjusted earnings and covenant EBITDA measures from GAAP results; these measures may not be comparable with those of other companies.