International Flavors & Fragrances Inc. (IFF Quick QuoteIFF - Free Report) reported better-than-expected results for the first quarter of 2018, delivering a positive earnings surprise of 7%. This was the company’s fourth consecutive quarter with better-than-expected results.

Concurrent with the earnings release, the company announced that it will combine its operations with Frutarom, by acquiring the latter in a $7.1-billion stock and cash transaction.

Frutarom specializes in making sweet and savory flavors as well as provides natural ingredients. It caters to customers in the food and beverage, cosmetics, pharmaceuticals, personal care, functional food, infant and elderly nutrition markets, among others. It markets roughly 70,000 products to its vast customer base in 150 countries. Revenues in 2018 are projected to be $1.6 billion.

The earnings results have been discussed below followed by the company’s Frutarom acquisition details.

Bottom-Line Results Solid

Adjusted earnings in the reported quarter were $1.69 per share, surpassing the Zacks Consensus Estimate of $1.58. Also, the bottom line grew 11.2% from the year-ago tally of $1.52. On a constant-currency basis, the company’s adjusted earnings increased nearly 12% year over year.

The bottom-line results benefited from healthy sales growth as well as costs and productivity measures.

Segmental Performances Drive Net Sales

In the reported quarter, International Flavors & Fragrances’ net sales were $930.9 million, reflecting year-over-year growth of 12.4%. On a constant-currency basis, revenues climbed 7% from the prior-year period. Also, the top line surpassed the Zacks Consensus Estimate of $910.1 million by 2.3%.

Geographically, revenues generated from the North American operations grew 10% year over year while revenues in Europe, Africa and the Middle East were up 20% or grew 7% on a constant-currency basis. Revenues from Latin American operations increased 6% year over year while that from Greater Asia increased 9% or grew 6% on a constant-currency basis.

The company operates in two segments — Flavors and Fragrances. The segmental information is briefly discussed below:

Revenues generated from the Flavors segment were $449 million, increasing 10.6% year over year. On a constant-currency basis, revenues grew 6% year over year. It represented 48.2% of the quarter’s net sales.

The Fragrances segment’s revenues were $481.9 million, rising 14.2% year over year. It accounted for 51.8% of net sales in the quarter under review. On a constant-currency basis, revenues grew 8% year over year.

Margin Profile Mixed

In the reported quarter, International Flavors & Fragrances’ cost of goods sold grew 13% year over year to $525.1 million. Adjusted gross profit increased 11.4% year over year to $411.3 million while the adjusted gross margin came in at 44.2% versus 44.6% in the year-ago quarter.

Research and development expenses increased 9% year over year to $78.5 million. As a percentage of net sales, it was at 8.4%, down 30 basis points (bps) year over year. Adjusted selling and administrative expenses in the reported quarter grew 6.9% year over year to $143.2 million. It represented 15.4% of net sales versus 16.2% in the year-ago quarter.

Adjusted operating profit increased 15.9% year over year to $181 million while adjusted operating margin grew 50 bps to 19.4%.

Balance Sheet and Cash Flow

Exiting the first quarter, International Flavors & Fragrances had cash and cash equivalents of $305.3 million, down from $368 million at the end of the preceding quarter. Long-term debt grew 2.7% sequentially to $1,676.2 million.

In the quarter under review, the company used cash of $11.4 million for its operating activities versus $18.5 million generated in the year-ago quarter. Capital invested in purchasing property, plant and equipment totaled $33.1 million, increasing 24.2% year over year. Dividend paid totaled $54.4 million while treasury stocks worth roughly $10.6 million were purchased.

Few days before the earnings release, the company announced that its board of directors approved the payment of a quarterly cash dividend of 69 cents per share to shareholders of record as of Jun 25. The dividend payment will be made on Jul 6.

Outlook

For 2018, International Flavors & Fragrances anticipates gaining from its efforts to check costs, strategic investments and expand businesses globally.

It anticipates achieving the upper-end of its previously-issued sales and operating income growth projections of 6-8% and 6.5-8.5%, respectively.  On a currency-neutral basis, sales growth is predicted to be 3-5% and operating income improvement is projected to be 5-7%. Earnings per share are projected to increase 5.5-7.5% or 4-6% on a constant-currency basis.

Business Combination With Frutarom

As noted, International Flavors & Fragrances will be buying the entire shareholding of Frutarom for $106.25 per share. Of this, roughly 67% or $71.19 per share will be paid in cash while the rest 33% will be paid through the exchange of 0.249 of the company’s common shares for one share of Frutarom. The total consideration of $7.1 billion includes the assumption of net debt of Frutarom.

The company anticipates using its existing cash as well as funds raised through new debt and equity to pay for the cash portion of the total transaction value. It also intends to lower its debt to at least three times of adjusted EBITDA in 18-24 months, following the closure of this deal.

As a result of the deal, the company intends to suspend its share buyback program while aims at maintaining its dividend payments. Also, before the deal closes, the company will be paying 0.249 of its dividend rate to Frutarom’s shareholders as a special dividend.

Benefits From the Business Combination: The transaction, anticipated to be completed in the coming six to nine months, is predicted to be neutral to International Flavors & Fragrances’ adjusted cash earnings per share in the initial full year of deal closure. For the second full year, Frutarom’s assets will be accretive to the company’s earnings in double digits.

In addition to these, run-rate cost synergies of $145 million are anticipated to be realized by the third year of the deal closure. Of this amount, roughly 25% is predicted to be realized in the initial year. Also, the top line is expected to get a boost from integrated solutions and cross-selling opportunities. Cash flow will be solid for the combined business.

The combined business will lead all players, who are dealing with scent, natural taste and nutrition, globally. Pro-forma revenues in 2018 are projected to be roughly $5.3 billion. Exposure to small- and mid-sized customers, as well as increasing business scope in new categories, including natural colors, antioxidants, health ingredients and enzymes, will be beneficial for International Flavors & Fragrances.

Internationa Flavors & Fragrances, Inc. Price, Consensus and EPS Surprise