International Flavors & Fragrances Inc. — Q2 2013 Form 10-Q Summary
Business context and reporting period
IFF creates and supplies flavors and fragrances for food, beverage, personal care, household and related products. The company operates through two segments: Flavors and Fragrances. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods. The actual fiscal quarter-end dates were June 28, 2013 and June 29, 2012.
Financial performance and key metrics
| Metric | Three months ended June 30, 2013 | Year-over-year change | Six months ended June 30, 2013 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $757.6 million | +5% | $1,485.5 million | +4% |
| Gross profit | $334.0 million | Not clearly stated | $645.3 million | Not clearly stated |
| Gross margin | 44.1% | +230 bps | 43.4% | +240 bps |
| Operating profit | $142.4 million | +8% approximately | $280.0 million | +11% approximately |
| Operating margin | 18.8% | +50 bps | 18.8% | +110 bps |
| Net income | $102.3 million | +15% | $193.0 million | +14% |
| Diluted EPS | $1.24 | +15% | $2.34 | +14% |
| Operating cash flow | Not provided for the quarter | Not provided | $118.0 million | Down from $135.4 million |
- Flavors sales were $374.0 million in the quarter, up 4%; segment profit was $89.9 million, up from $80.6 million.
- Fragrances sales were $383.6 million, up 7%; segment profit was $71.9 million, up from $63.6 million.
- Emerging markets represented 49% of sales and delivered 10% local-currency growth in the second quarter.
- Quarterly adjusted operating profit was $145.5 million and adjusted operating margin was 19.2%, excluding restructuring, accelerated depreciation and operational-improvement costs.
- Cash and cash equivalents were $365.9 million at June 30, 2013, including $186.7 million held outside the United States.
- Total debt was $1.033 billion, compared with $1.031 billion at December 31, 2012. Net debt was $659.0 million.
- The company reported a net-debt-to-adjusted-EBITDA ratio of 1.05 to 1, below its 3.25-to-1 covenant limit. No borrowings were outstanding under the revolving credit facility, and drawdown capacity was $942.8 million.
- Capital expenditures were $60.7 million for the first six months, and management expected full-year capital spending to approach 5% of sales.
- Dividends declared were $0.34 per share for the quarter and $0.68 per share for the six-month period. A $0.39 per-share dividend was declared for the third quarter.
Material changes versus the prior comparable period
- Sales growth reflected new product wins, improved Fragrance Compounds performance and strong emerging-market demand. Foreign exchange reduced second-quarter reported sales growth by approximately 100 basis points.
- Gross-margin expansion reflected favorable mix, manufacturing efficiencies, modestly lower raw-material costs and the completed or substantially completed exit from certain low-margin Flavors activities.
- Research and development expense rose 15% in the quarter and 9% year to date; selling and administrative expense rose 11% and 10%, respectively, primarily due to higher incentive compensation and other investments.
- Interest expense increased to $12.9 million in the quarter and $24.0 million year to date, principally following the issuance of new senior notes.
- Other income included a $16.1 million gain from the sale of a non-operating asset, materially increasing reported income.
- Operating cash flow declined year over year because of $30.0 million of U.S. pension contributions and higher incentive-compensation payments, partly offset by higher earnings and improved working capital.
- On April 4, 2013, IFF issued $300 million of 3.20% senior notes due 2023 and received $297.8 million of proceeds. It repaid the $283.1 million outstanding under its credit facility on April 26, 2013.
Guidance, outlook, risks and unusual items
- Management expected second-half growth rates to moderate from second-quarter levels because of strong 2012 comparisons, while remaining on target for its long-term strategic objectives.
- Management expected year-over-year gross-margin expansion in 2013, but at a slower rate in the third quarter. Raw-material prices remained near historical highs and crop-related volatility could affect margins.
- IFF announced the planned closure of its Augusta, Georgia fragrance-ingredients facility by July 2014. Expected total charges are $16 million to $21 million, including $10 million to $12 million of accelerated depreciation, $3 million to $4 million of personnel costs and $3 million to $5 million of shutdown costs. Forty-three positions are expected to be eliminated, with approximately $6 million to $9 million of future cash expenditures.
- The company continued testing and start-up activities at its China compounding facility and expected commercial production during the second half of 2013, which could increase depreciation and operating costs.
- Spanish tax matters remained significant. IFF paid $23.3 million during the second quarter related to a 2003 assessment and recorded a $6.2 million after-tax charge during the first six months related to the 2002–2003 matters. Remaining Spanish tax assessments, withholding-tax matters and capital-tax claims were subject to payments, appeals or reserves.
- At June 30, 2013, the company had approximately $60.3 million of bank guarantees and standby letters of credit, including $15.9 million related to Spanish income-tax disputes. Brazilian tax matters had an estimated reasonably possible loss range of $1 million to $17 million, and a Spanish capital-tax matter had an estimated possible loss of approximately $12 million.
- Environmental exposure at nine third-party waste sites was estimated at less than $5 million, although the company noted that future developments could increase costs.
- Management stated that existing cash, operating cash flow and available credit facilities should be sufficient for operating, investing and financing needs for at least the next eighteen months.
Most important facts for investors to verify
- Whether sales and margin growth can continue as second-half comparisons become more difficult and currency effects persist.
- The timing and total cost of the Augusta facility closure, including the remaining restructuring and cash expenditures.
- The sustainability of margin gains given raw-material volatility and the normalization of cost-reduction benefits.
- The final cash and accounting impact of Spanish tax assessments, withholding-tax controversies and related guarantees.
- Execution, start-up costs and capacity benefits from the China facility.
- Cash conversion and pension funding requirements, particularly in light of lower year-to-date operating cash flow.
- Debt repayment, covenant compliance and the effect of the 2023 senior notes on future interest expense.
- The effect of the $16.1 million non-operating asset gain and other unusual items when assessing recurring earnings.