International Flavors & Fragrances Inc. — Q2 2016 Form 10-Q Summary
Business Context and Reporting Period
IFF creates and supplies flavors, fragrances, fragrance ingredients and cosmetic active ingredients for food, beverage, personal care and household products. The unaudited filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. The company reports two operating segments: Flavors and Fragrances.
Key Financial Metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $793.5 million | $767.5 million | $1,576.8 million | $1,542.4 million |
| Gross profit | $365.6 million | $345.0 million | $725.8 million | $691.3 million |
| Gross margin | 46.1% | 45.0% | 46.0% | 44.8% |
| Operating profit | $164.5 million | $148.8 million | $331.7 million | $310.6 million |
| Operating margin | 20.7% | 19.4% | 21.0% | 20.1% |
| Net income | $116.7 million | $105.4 million | $235.3 million | $233.6 million |
| Diluted EPS | $1.46 | $1.29 | $2.93 | $2.86 |
| Operating cash flow | Not separately provided | Not separately provided | $154.6 million | $166.3 million |
- Q2 reported sales increased 3%; currency-neutral sales increased 4%. Acquisitions contributed approximately 2% to both measures.
- Six-month reported sales increased 2%; currency-neutral sales increased 5%, with acquisitions contributing approximately 3%.
- Q2 segment sales were $379.5 million for Flavors and $414.0 million for Fragrances. Six-month segment sales were $752.0 million and $824.8 million, respectively.
- Q2 segment profit increased to $90.3 million for Flavors and $87.6 million for Fragrances. Segment margins were 23.8% and 21.2%, respectively.
- Cash and cash equivalents were $540.0 million at June 30, 2016, compared with $182.0 million at December 31, 2015; approximately $357.8 million was held outside the United States.
- Total debt was $1.491 billion at June 30, 2016, compared with $1.068 billion at year-end 2015. Net debt for covenant purposes was $948.9 million, and the stated net debt-to-adjusted EBITDA ratio was 1.29x.
- Capital expenditures were $43.2 million in the first six months. The company expects 2016 additions to property, plant and equipment to be approximately 5% of sales, net of potential grants and reimbursements.
- Dividends paid were $89.5 million in the first six months. The quarterly dividend was $0.56 per share. Share repurchases totaled $71.7 million for 622,224 shares, with $165.0 million remaining under the authorization at June 30.
Material Changes Versus the Prior Comparable Period
- Operating profit rose 11% in Q2 and 7% for the first six months, supported by volume growth, productivity initiatives, acquisitions and improved gross margins.
- Gross margin expanded 110 basis points in Q2 and 120 basis points year to date, primarily from cost savings and productivity initiatives.
- Net income increased 11% in Q2 but only 1% year to date. Year-to-date earnings benefited from operating improvement but were affected by higher taxes and the absence of a $10.5 million favorable tax ruling benefit recorded in 2015.
- Interest expense increased 32% in Q2 and 22% year to date because of the 2016 Euro Senior Notes, although the average cost of debt declined to 4.0% in Q2 and 3.9% year to date from 4.7% in both 2015 periods.
- Operating cash flow declined 7% year to date, principally because of higher core working-capital requirements, partly offset by lower pension contributions. Non-recourse factoring provided an incremental $17.7 million benefit to operating cash flow versus $1.3 million in the prior-year period.
- Cash used in investing activities fell to $40.2 million from $215.0 million because the prior-year period included acquisition spending.
- Amortization of acquisition-related intangibles increased to $5.1 million in Q2 and $11.2 million year to date, reflecting the Ottens Flavors and Lucas Meyer acquisitions completed in 2015.
Outlook, Commentary, Risks and Unusual Items
- Management expects raw-material costs to remain broadly benign in 2016, with higher costs for certain naturals, including vanilla, largely offset by benefits from oil-based derivatives.
- Management expects operating cash flow and available credit facilities to fund investing and financing needs for at least the next 18 months and believes existing cash balances are sufficient for debt service.
- The company issued €500 million of 1.75% senior notes due 2024 in March 2016. It repaid $125.0 million of 2006 senior notes on July 12, 2016, after quarter-end.
- The company was in compliance with its debt covenants at June 30, 2016. The revolving credit facility had no borrowings and $950.0 million of stated drawdown capacity.
- Restructuring and operational-improvement initiatives are expected to cost approximately $10.5 million in total and be fully implemented in the second half of 2017. The remaining restructuring liability was $6.4 million at June 30, 2016.
- The Spanish capital-tax matter produced $1.4 million of additional income in Q2 following a favorable Supreme Court ruling. The year-to-date effective tax rate was 23.3%, versus 20.4% in 2015.
- The Guangzhou Flavors facility in China was temporarily idled over odor-emission compliance issues. A second China Flavors site is expected to be completed in 2018. A requested relocation of the Zhejiang Ingredients plant could result in accelerated depreciation of $0 million to $25 million, depending on government discussions.
- Management estimates reasonably possible losses for specified contingencies, collectively, at $0 to $46 million. Environmental liabilities at eight sites are estimated at less than $5 million. The ZoomEssence litigation was expected to proceed to trial in late 2016 or early 2017, but management did not consider it a material loss contingency at the filing date.
- The company identified currency fluctuations, raw-material availability and pricing, supply-chain disruptions, acquisitions, consumer demand, international operations, litigation and tax audits, environmental compliance, cybersecurity, pensions and execution of Vision 2020 as material risks.
- The filing provides no explicit consolidated sales or EPS guidance.
Important Facts for Investors to Verify
- Verify the sustainability of gross-margin expansion and the extent to which growth depends on acquisitions, productivity initiatives and favorable input costs.
- Monitor working-capital intensity, factoring activity and the conversion of earnings into operating cash flow.
- Assess leverage, refinancing needs and the effect of the Euro Senior Notes, including currency exposure from designating the notes as a hedge of European investments.
- Track the China facility compliance and relocation matters, including potential accelerated depreciation and required capital spending.
- Review the tax-rate normalization after the favorable 2015 tax ruling and the status of uncertain tax positions totaling $26.0 million including interest and penalties.
- Evaluate the remaining share-repurchase authorization, dividend commitments and pension funding requirements, including expected 2016 contributions of approximately $30 million to non-U.S. plans and $20 million to U.S. plans.