INTERNATIONAL FLAVORS & FRAGRANCES INC quarterly report, Q2 FY2011

International Flavors & Fragrances Inc. — Q2 2011 Form 10-Q Summary

Business context and reporting period

IFF is a global creator and supplier of flavors and fragrances, organized into Flavors and Fragrances segments. The filing covers the unaudited quarter and six months ended June 30, 2011, compared with the corresponding 2010 periods. More than 75% of sales were generated outside the United States, including approximately 45% from key emerging markets.

Financial performance and position

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Net sales	$715.6 million	$665.8 million	$1,429.9 million	$1,319.7 million
Income before taxes	$104.9 million	$93.6 million	$220.5 million	$182.7 million
Net income	$76.2 million	$67.2 million	$160.2 million	$130.9 million
Diluted EPS	$0.93	$0.83	$1.96	$1.63
Operating profit	$118.0 million	$107.8 million	$251.3 million	$212.4 million
Operating margin	16.5%	16.2%	17.6%	16.1%
Effective tax rate	27.4%	28.3%	27.3%	28.3%

• Q2 reported sales increased 7%; local-currency sales increased 3%. Six-month reported sales increased 8%, with 6% local-currency growth.
• Flavors Q2 sales increased 14% reported and 8% in local currency; segment operating profit rose to $71.0 million from $64.5 million, although margin declined to 20.6% from 21.2%.
• Fragrances Q2 sales increased 2% reported but declined 2% in local currency. Operating profit declined to $58.3 million from $65.4 million, and margin declined to 15.7% from 18.1%.
• Q2 cost of goods sold rose to 60.3% of sales from 57.2%, primarily because of higher raw-material costs. Selling and administrative expenses declined to 14.8% of sales from 18.0%.
• Operating cash flow was $2.1 million in the first six months, down from $127.6 million in the prior-year period. Capital expenditures were $45.7 million versus $37.0 million.
• Cash and cash equivalents were $123.4 million at June 30, 2011, compared with $131.3 million at December 31, 2010. Working capital increased to $811 million from $664 million.
• Total debt was $983.7 million versus $921.6 million at year-end 2010. Net debt, as defined for covenant purposes, was $848.4 million, and the net debt-to-adjusted EBITDA ratio was 1.60 to 1 versus a covenant maximum of 3.25 to 1.
• The company had $115 million drawn under its revolving facility, $777 million of remaining drawdown capacity, and was in compliance with its debt covenants.

Material changes versus the prior comparable period

• Sales growth was led by Flavors and emerging markets, while Fragrances faced difficult prior-year comparisons, volume erosion and weaker demand in certain categories.
• Higher raw-material costs reduced gross margin, particularly in Fragrances. Management stated that additional price increases would be needed to recover expected cost increases.
• Cost discipline, lower incentive compensation provisions, reduced litigation costs and lower global expenses improved operating leverage.
• Net income increased 13% in Q2 and 22% for the first six months; diluted EPS increased 12% in Q2 and 20% year to date.
• Operating cash generation weakened substantially because of incentive compensation, taxes, trade-payable payments and working-capital investment in receivables and inventories.
• Other expense increased year to date to $7.1 million from $4.9 million, primarily because of foreign-exchange losses on working-capital exposures.

Guidance, outlook, risks and unusual items

• Management expected raw-material costs to remain elevated for the next several quarters, especially in Fragrances, and anticipated further pricing actions.
• Gross additions to property, plant and equipment were expected to approximate 5% of full-year 2011 sales, primarily supporting capacity and technology investments in emerging markets.
• Management expected operating cash flows and available credit facilities to fund normal capital spending and other expected cash requirements for at least the next 18 months.
• The European fragrance manufacturing rationalization generated a $3.9 million Q2 charge for an Ireland pension settlement and special termination benefits. Total related expenses were $34.7 million, and the company did not anticipate further expenses from this rationalization.
• A $5.8 million deferred-tax-asset write-off resulted from U.S. state-law changes, substantially offset by other tax benefits and reserve adjustments.
• On July 12, 2011, the company repaid $100 million of senior notes, funded primarily with cash and partly through its credit facility. On July 26, the board authorized a 15% increase in the quarterly dividend to $0.31 per share from $0.27.
• Key risks include raw-material, energy and commodity costs; pricing pressure; foreign-exchange volatility; demand and consumer-spending changes; emerging-market execution; pension funding; tax audits; credit-market access; and litigation.
• Sixteen popcorn-flavor-related actions involving approximately 260 claimants remained pending. Management believed insurance and existing accruals were adequate and did not expect a material adverse effect, although outcomes remain uncertain.
• A patent dispute with V. Mane Fils could result in damages or an injunction affecting certain flavor products. The company could not estimate reasonably possible losses above its recorded liability.
• Environmental claims involved ten third-party sites; the company estimated its share of future costs at less than $5 million.

Important facts for investors to verify

• Whether pricing actions fully offset continuing raw-material inflation and preserve Fragrance margins.
• Whether working-capital requirements normalize and operating cash flow recovers from the sharply reduced first-half level.
• The timing and funding impact of debt maturities, including the July 2011 $100 million repayment and remaining revolver borrowings.
• Progress in emerging markets and the sustainability of Flavors’ growth relative to Fragrances’ volume and mix pressures.
• Updates on the V. Mane patent litigation, popcorn-flavor claims, tax audits and other contingencies.
• The effect of the increased quarterly dividend on liquidity, leverage and capital allocation.