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International Flavors & Fragrances 10-Q 2007

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OF
THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended September 30, 2007

Commission file number 1-4858

INTERNATIONAL FLAVORS & FRAGRANCES INC.

(Exact name of registrant as specified in its charter)


New York 13-1432060
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
521 West 57th Street, New York, N.Y. 10019-2960
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code (212) 765-5500

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   [X]    No   [ ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   [X]                 Accelerated filer   [ ]                Non-accelerated filer   [ ]

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   [ ]    No   [X]

Number of shares outstanding as of October 19, 2007: 80,971,042





PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
(Unaudited)


ASSETS 9/30/07 12/31/06
Current Assets:    
Cash and cash equivalents $ 61,964 $ 114,508
Short-term investments 600 604
Trade receivables 443,493 369,870
Allowance for doubtful accounts (12,832 )  (12,715 ) 
Inventories:    Raw materials 232,905 213,675
                            Work in process 9,671 12,686
                            Finished goods 225,327 220,245
                            Total Inventories 467,903 446,606
Deferred income taxes 69,076 89,448
Other current assets 88,057 71,482
Total Current Assets 1,118,261 1,079,803
Property, Plant and Equipment, at cost 1,145,395 1,074,772
Accumulated depreciation (652,802 )  (579,648 ) 
  492,593 495,124
Goodwill 665,582 665,582
Intangible Assets, net 69,467 80,134
Other Assets 187,756 158,261
Total Assets $ 2,533,659 $ 2,478,904
LIABILITIES AND SHAREHOLDERS’ EQUITY 9/30/07 12/31/06
Current Liabilities:    
Bank borrowings and overdrafts $ 52,578 $ 15,897
Accounts payable 116,919 111,661
Accrued payrolls and bonuses 51,883 71,976
Dividends payable 20,352 18,764
Income taxes 45,251
Restructuring and other charges 4,958 15,288
Other current liabilities 167,318 167,934
Total Current Liabilities 414,008 446,771
Other Liabilities:    
Long-term debt 1,134,493 791,443
Deferred gains 62,415 64,686
Retirement liabilities 161,066 170,719
Other liabilities 213,970 100,117
Total Other Liabilities 1,571,944 1,126,965
Commitments and Contingencies (Note 13)    
Shareholders’ Equity:    
Common stock 12½¢ par value; authorized 500,000,000 shares; issued
115,761,840 shares
14,470 14,470
Capital in excess of par value 42,869 96,635
Retained earnings 2,050,343 1,909,599
Accumulated other comprehensive income:    
Cumulative translation adjustment (27,811 )  (31,854 ) 
Accumulated gains (losses) on derivatives qualifying as hedges (net of tax) (1,432 )  (2,465 ) 
Pension and postemployment liability adjustment (net of tax) (141,828 )  (162,553 ) 
  1,936,611 1,823,832
Treasury stock, at cost – 34,843,214 shares in 2007 and 26,344,638 shares in 2006 (1,388,904 )  (918,664 ) 
Total Shareholders’ Equity 547,707 905,168
Total Liabilities and Shareholders’ Equity $ 2,533,659 $ 2,478,904

See Notes to Consolidated Financial Statements

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INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF INCOME
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(Unaudited)


  Three Months Ended September 30, Nine Months Ended September 30,
  2007 2006 2007 2006
Net sales $ 583,313 $ 539,135 $ 1,723,140 $ 1,581,072
Cost of goods sold 339,175 310,149 996,225 907,856
Research and development expenses 49,733 46,471 145,125 137,661
Selling and administrative expenses 94,464 88,092 276,933 261,364
Amortization of intangibles 3,555 3,713 10,666 11,134
Restructuring and other charges 316 673
Curtailment loss 5,943 5,943
Interest expense 8,596 6,475 25,306 18,148
Other (income) expense, net 1,239 (6,783 )  (1,747 )  (6,630 ) 
  502,705 448,433 1,458,451 1,330,206
Income before taxes on income 80,608 90,702 264,689 250,866
Taxes on income 21,764 27,056 64,784 72,348
Net income 58,844 63,646 199,905 178,518
Other comprehensive income:        
Foreign currency translation adjustments (12,959 )  10,050 4,043 24,404
Accumulated gains (losses) on derivatives qualifying as hedges (net of tax) (1,587 )  7,351 1,033 (10,396 ) 
Pension and postemployment plan
adjustment (net of tax)
14,183 20,725
Comprehensive income $58,481 $81,047 $225,706 $192,526
Net Income per share – basic $0.68 $0.71 $2.26 $1.97
Net Income per share – diluted $0.67 $0.70 $2.23 $1.95
Average number of shares outstanding – basic 87,063 90,053 88,538 90,786
Average number of shares outstanding – diluted 88,056 90,988 89,612 91,489
Dividends declared per share $0.230 $0.185 $0.650 $0.555

See Notes to Consolidated Financial Statements

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INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)


  Nine Months Ended September 30,
  2007 2006
Cash flows from operating activities:>    
Net income $ 199,905 $ 178,518
Adjustments to reconcile to net cash provided by operations:    
Depreciation and amortization 62,825 66,910
Deferred income taxes (12,202 )  (8,904 ) 
Gain on disposal of assets (7,358 )  (14,682 ) 
Equity based compensation 13,310 13,015
Curtailment loss 5,943
Changes in assets and liabilities:    
Current receivables (66,354 )  (59,694 ) 
Inventories (2,381 )  12,328
Current payables (19,338 )  34,439
Changes in other assets, net 37,760 34,237
Changes in other liabilities, net (24,087 )  (18,660 ) 
Net cash provided by operations 188,023 237,507
Cash flows from investing activities:>    
Net change in short-term investments (311 )  25
Additions to property, plant and equipment (36,504 )  (30,883 ) 
Proceeds from disposal of assets 9,139 14,888
Net cash used in investing activities (27,676 )  (15,970 ) 
Cash flows from financing activities:>    
Cash dividends paid to shareholders (56,248 )  (50,815 ) 
Net change in bank borrowings and overdrafts (137,837 )  (36,804 ) 
Proceeds from long-term debt 500,000 375,000
Repayments of long-term debt (499,300 ) 
Proceeds from issuance of stock under stock plans 48,441 40,494
Excess tax benefits on stock options exercised 6,353 362
Purchase of treasury stock (576,832 )  (162,221 ) 
Net cash used in financing activities (216,123 )  (333,284 ) 
Effect of exchange rate changes on cash and cash equivalents 3,232 1,965
Net change in cash and cash equivalents> (52,544 )  (109,782 ) 
Cash and cash equivalents at beginning of year> 114,508 272,545
Cash and cash equivalents at end of period> $ 61,964 $ 162,763
Interest paid $ 33,513 $ 27,271
Income taxes paid $ 37,497 $ 48,680

See Notes to Consolidated Financial Statements

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Notes to Consolidated Financial Statements

These interim statements and management’s related discussion and analysis should be read in conjunction with the consolidated financial statements and their related notes and management’s discussion and analysis of results of operations and financial condition included in the Company’s 2006 Annual Report on Form 10-K. These interim statements are unaudited. In the opinion of the Company’s management, all adjustments, including normal recurring accruals necessary for a fair presentation of the results for the interim periods, have been made.

Note 1.    New Accounting Pronouncements:

In September 2006, the FASB issued SFAS No. 157 ‘‘Fair Value Measurements’’ (‘‘FAS 157’’). This standard defines fair value, establishes a framework for measuring fair value and expands disclosures regarding fair value measurements. FAS 157 is effective for years beginning after November 15, 2007. The Company is currently evaluating the potential impact of this standard.

In February 2007, the FASB issued SFAS No. 159 ‘‘The Fair Value Option for Financial Assets and Liabilities – Including an amendment of FASB No. 115’’ (‘‘FAS 159’’). This standard allows companies to elect, at specific election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option, subsequent changes in that item’s fair value must be recognized in current earnings. FAS 159 is effective for years beginning after November 15, 2007. The Company is currently evaluating the potential impact of this standard.

Note 2.    Reclassifications:

Certain reclassifications have been made to the prior period’s financial statements to conform to 2007 classifications.

Note 3.    Net Income Per Share:

Net income per share is based on the weighted average number of shares outstanding. A reconciliation of the shares used in the computation of basic and diluted net income per share is as follows:


  Three Months Ended
September 30,
Nine Months Ended
September 30,
(Shares in thousands) 2007 2006 2007 2006
Basic 87,063 90,053 88,538 90,786
Assumed conversion under stock plan 993 935 1,074 703
Diluted 88,056 90,988 89,612 91,489

Stock options to purchase 252,000 and 171,000 shares for the third quarter and the nine months of 2007, respectively, and 1,357,000 and 1,416,000 for the third quarter and nine months of 2006, respectively, were excluded from the computation of diluted net income per share for the respective periods since the impact was anti-dilutive.

Note 4.    Common Stock Repurchases:

During the first six months of 2007, under a share repurchase program of $300 million authorized in October 2006 (the ‘‘October 2006 Plan’’), the Company repurchased approximately 1.6 million shares at a cost of $81 million; at June 30, 2007, the Company had approximately $125 million remaining under the October 2006 Plan. In July 2007, the October 2006 Plan was terminated and superseded by a new program authorized by the Company’s Board of Directors (‘‘Board’’) to repurchase up to 15% or $750 million worth of the Company’s outstanding common stock, whichever is less (the ‘‘July 2007 Plan’’).

In September 2007, under the July 2007 Plan, the Company entered into two agreements to purchase shares of its common stock under a $450 million accelerated share repurchase (‘‘ASR’’)

5





program. On September 28, 2007, the Company paid $450 million in exchange for an initial delivery of 7.6 million shares under the ASR, representing 90% of the shares that could have been purchased, based on the average trading price of the Company’s stock, on that date. The remaining 10%, or $45 million, not used in the initial settlement will be included in the determination of the cost of the shares purchased on completion of the ASR. This amount was reflected in the accompanying Consolidated Balance sheet as a reduction to Capital in excess of par value.

Under the first agreement (the ‘‘Collared ASR’’), $112.5 million of share purchases are subject to collar provisions that establish minimum and maximum number of shares based on the volume-weighted average price of the Company’s stock (‘‘VWAP’’) over an initial hedge period. Under the Collared ASR, the minimum number of shares was set at 1.9 million and the maximum number of shares was set at 2.2 million shares when the hedge period ended on October 3, 2007.

Under the second agreement (the ‘‘Uncollared ASR’’), the number of shares to be repurchased is based on the VWAP of the common stock during the term of the Uncollared ASR.

On completion of the ASR, the Company may receive additional shares or may be required to pay cash or additional shares at the option of the Company, based on the VWAP of the common stock during the agreement term. Proceeds from the $500 million Senior Unsecured Notes described in Note 8 funded the ASR payment.

Note 5.    Restructuring and Other Charges:

As described in Note 2 to the Consolidated Financial Statements in the Company’s 2006 Annual Report, the Company had undertaken a significant reorganization, including management changes, consolidation of production facilities and related actions.

Movements in restructuring liabilities, included in Other current liabilities in the accompanying balance sheet, were (in millions):


  Employee-
Related
Asset-
Related
and Other
Total
Balance December 31, 2006 $ 12.9 $ 2.4 $ 15.3
Cash and other costs (8.2 )  (2.1 )  (10.3 ) 
Balance September 30, 2007 $ 4.7 $ 0.3 $ 5.0

The balance of the employee-related liabilities are expected to be utilized by the end of 2008 as obligations are satisfied; the asset-related charges are expected to be utilized in 2007 on final decommissioning and disposal of the affected equipment.

Note 6.    Goodwill and Other Intangible Assets, Net:

Goodwill by operating segment at September 30, 2007 and December 31, 2006 are as follows:


(DOLLARS IN THOUSANDS) Amount
Flavors $ 319,479
Fragrances 346,103
Total $ 665,582

Trademark and other intangible assets consist of the following amounts:


(DOLLARS IN THOUSANDS) September 30,
2007
December 31,
2006
Gross carrying value $ 165,406 $ 165,406
Accumulated amortization 95,939 85,272
Total $ 69,467 $ 80,134

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Amortization expense for the nine months ended September 30, 2007 was $10.7 million compared to $11.1 million for the nine months ended September 30, 2006; estimated annual amortization is $13 million in 2007 and $6 million in each year from 2008 through 2012.

Note 7.    Accumulated Other Comprehensive Income:

Changes in the Accumulated other comprehensive income component of Shareholders’ Equity were as follows:


(DOLLARS IN THOUSANDS) Translation
adjustments
Accumulated (losses)
gains on derivatives
qualifying as hedges,
net of tax
Pension and
post-employment
plan adjustment,
net of tax
Total
Balance December 31, 2006 $ (31,854 )  $ (2,465 )  $ (162,553 )  $ (196,872 ) 
Change 4,043 1,033 20,725 25,801
Balance September 30, 2007 $ (27,811 )  $ (1,432 )  $ (141,828 )  $ (171,071 ) 

(DOLLARS IN THOUSANDS) Translation
adjustments
Accumulated losses
on derivatives
qualifying as hedges,
net of tax
Minimum
pension
obligation,
net of tax
Total>
Balance December 31, 2005 $ (47,369 )  $ (2,606 )  $ (100,380 )  $ (150,355 ) 
Change 24,404 (10,396 )  14,008
Balance September 30, 2006 $ (22,965 )  $ (13,002 )  $ (100,380 )  $ (136,347 ) 

Note 8.    Borrowings:

Debt consists of the following:


(DOLLARS IN THOUSANDS) Rate Maturities September 30,
2007
December 31,
2006
Bank borrowings and overdrafts     $ 52,578 $ 15,897
Total current debt     52,578 15,897
Senior notes – 2006 5.94 %  2009 – 16 375,000 375,000
Senior notes – 2007 6.37 %  2017 – 27 500,000
Bank borrowings 4.29 %  Various 127,916 287,904
Japanese Yen notes 2.45 %  2008 – 11 132,544 127,684
Other   2011 32 38
Deferred realized gains on interest rate swaps     848 817
FAS 133 adjustment     (1,847 ) 
Total long-term debt     1,134,493 791,443
Total debt     $ 1,187,071 $ 807,340

On September 27, 2007, the Company issued $500 million of Senior Unsecured Notes (‘‘Senior Notes – 2007’’) in four series: (i) $250 million in aggregate principal amount of 6.25% Series A Senior Notes due September 27, 2017, (ii) $100 million in aggregate principal amount of 6.35% Series B Notes due September 27, 2019, (iii) $50 million in aggregate principal amount of 6.50% Series C Notes due September 27, 2022 and (iv) $100 million in aggregate principal amount of 6.79% Series D Notes due September 27, 2027. In contemplation of this debt issuance, the Company entered into interest rate hedge contracts, with a notional amount of $400 million to manage its exposure to changes in interest rates. The contracts were designated as hedges of the variability of the cash flows due to changes in the long-term benchmark interest rates and the credit spread. The Company recorded a $1.6 million gain on the settlement of these interest rate hedge contracts, which coincided with the issuance of the long-term fixed-rate debt. The gain was recorded in Other comprehensive income and is being amortized as a reduction of interest expense over the term of the related debt.

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Note 9.    Income Taxes:

In June 2006, the FASB issued Interpretation No. 48 (‘‘FIN 48’’), Accounting for Uncertainty in Income Taxes, which clarifies the application of FAS 109 by prescribing the minimum threshold a tax position must meet before being recognized in the financial statements. Under FIN 48, the financial statement effect of a tax position is initially recognized when it is more likely than not the position will be sustained upon examination. A tax position that meets the ‘‘more likely than not’’ recognition threshold is initially and subsequently measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement with the taxing authority.

As a result of adopting FIN 48, the Company recognized a $1 million increase in Other liabilities for unrecognized tax benefits and a corresponding cumulative effect adjustment to Retained earnings. Also as prescribed by FIN 48, certain tax related amounts in the Consolidated Balance Sheet are classified differently than in prior periods. Amounts receivable from various tax jurisdictions are now included in Other current assets and tax reserves previously classified as accrued taxes on income are now included in Other liabilities.

As of the adoption date, the Company had $73 million of gross unrecognized tax benefits; if recognized, $72 million, net of federal benefits, would have been recorded as a component of income tax expense and affected the effective tax rate. At September 30, 2007, the Company had $79 million of gross unrecognized tax benefits, included in Other Liabilities. If recognized, $78 million, net of federal benefits, would be recorded as a component of income tax expense and affect the effective tax rate.

The Company has consistently recognized interest and penalties related to unrecognized tax benefits as a component of income tax expense. At December 31, 2006, the Company had accrued $7 million of interest and penalties. On adoption of FIN 48, this balance was reclassified to Other liabilities.

The Company conducts business globally and remains open to examination in several tax jurisdictions for various years from 2000 to 2006. The Company is currently under examination in several significant tax jurisdictions for various years from 2001 to 2006. Upon the completion of these examinations, it is reasonably possible that a change in certain unrecognized tax benefits may occur; currently, it is not reasonably possible to estimate the magnitude of these changes.

The effective tax rate for the three and nine months ended September 30, 2007 was 27.0% and 24.5% compared with 29.8% and 28.8% in the three and nine months ended September 30, 2006. The lower effective tax rate for the three months ended September 30, 2007 was the result of a greater percentage of pre-tax earnings in lower tax jurisdictions. The lower effective tax rate for the nine months ended September 30, 2007 was due primarily to the release of tax accruals related to favorable rulings from applicable tax jurisdictions and the greater percentage of pre-tax earnings in lower tax jurisdictions.

Note 10.    Equity Compensation Plans:

The Company has various plans under which the Company’s officers, senior management, other key employees and directors may be granted equity-based awards including restricted stock, restricted stock units (‘‘RSU’s’’), stock settled appreciation rights (‘‘SSAR’s’’) or stock options to purchase the Company’s common stock.

In 2007, the Company’s Board changed the operating methodology of the Company’s Long Term Incentive Plan (‘‘LTIP’’) for executive officers and other Company executives beginning with the three year cycle from 2007 through 2009 and thereafter. Under this modified LTIP, the targeted payout of the LTIP 2007 – 2009 cycle and thereafter will be 50% cash and 50% Company common stock. The targeted number of shares for the 50% stock portion was determined by the closing share price on the first trading day at the beginning of the cycle. The executive generally must remain employed with the Company during the cycle to receive the award.

8





Principal assumptions used in the Binomial model were:


  2007 2006
Weighted average fair value of options and SSAR’s granted during the period $ 11 .50 $ 7 .66
Assumptions:    
Expected volatility 21 .8 %  21 .3 % 
Expected dividend yield 1 .6 %  2 .1 % 
Risk-free interest rate 5 .0 %  5 .0 % 
Expected life, in years 5 5

Stock option and SSAR activity for the nine months ended September 30, 2007 was as follows:


(SHARE AMOUNTS IN THOUSANDS) Shares Subject to
Options/SSAR’s
Weighted
Average
Exercise Price
Balance at December 31, 2006 3,633 $ 33.56
Exercised (439 )  $ 31.72
Cancelled (4 )  $ 30.82
Balance at March 31, 2007 3,190 $ 33.91
Granted 254 $ 51.47
Exercised (590 )  $ 36.51
Cancelled (53 )  $ 41.50
Balance at June 30, 2007 2,801 $ 35.41
Exercised (200 )  $ 32.92
Cancelled (12 )  $ 41.04
Balance at September 30, 2007 2,589 $ 35.57

Restricted stock and RSU activity for the nine months ended September 30, 2007 was as follows:


(SHARE AMOUNTS IN THOUSANDS) Number
of Shares
Weighted
Average Grant
Date Fair
Value Per
Share
Balance at December 31, 2006 1,346 $ 37.22
Cancelled (16 )  $ 38.10
Balance at March 31, 2007 1,330 $ 37.21
Granted 418 $ 51.78
Vested (420 )  $ 50.89
Cancelled (20 )  $ 38.40
Balance at June 30, 2007 1,308 $ 42.53
Granted 18 $ 51.83
Vested (11 )  $ 50.12
Cancelled (14 )  $ 42.29
Balance at September 30, 2007 1,301 $ 42.72

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Pre-tax expense related to all forms of equity compensation was as follows:


  Three Months Ended
September 30,
Nine Months Ended
September 30,
(DOLLARS IN THOUSANDS) 2007 2006 2007 2006
Restricted stock and RSU’s $ 4,241 $ 4,104 $ 10,682 $ 10,019
Stock options and SSAR’s 821 817 2,628 2,996
Total equity compensation expense $ 5,062 $ 4,921 $ 13,310 $ 13,015

Tax related benefits of $1.6 million and $4.2 million were recognized for the third quarter and nine months of 2007, respectively, and $1.5 million and $4.1 million for the third quarter and nine months of 2006, respectively.

Note 11.    Segment Information:

On January 1, 2007, the Company was reorganized into two business segments, Flavors and Fragrances; these segments align with the internal structure used to manage these businesses. Accounting policies used for segment reporting are identical to those described in Note 1 of the Notes to the Consolidated Financial Statements included in the Company’s 2006 Annual Report. Prior year segment information, which had been reported by major geographic region, has been reclassified to conform to the current presentation.

The Company evaluates the performance of its business segments based on segment profit which is Income before taxes on income, excluding Interest expense, Other income (expense), net and the effects of Restructuring and other charges and Accounting changes. Segment profit is equal to Operating profit in periods where Restructuring and other charges were not incurred. The Global expense caption represents corporate and headquarters-related expenses which include legal, finance, human resources and other administrative expenses that are not allocated to individual business units. Unallocated assets are principally cash, short-term investments and other corporate and headquarters-related assets.

The Company’s reportable segment information follows:


  Three Months Ended September 30, 2007
(DOLLARS IN THOUSANDS) Flavors Fragrances Global
Expenses
Consolidated
Net sales $ 256,423 $ 326,890 $ $ 583,313
Operating profit $ 48,111 $ 55,779 $ (7,504 )  96,386
Interest expense       (8,596 ) 
Curtailment loss       (5,943 ) 
Other income (expense), net       (1,239 ) 
Income before taxes on income