IFF

Business Context and Reporting Period

Company: International Flavors & Fragrances Inc. (IFF)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2007
Business Overview: IFF is a leading creator and manufacturer of flavor and fragrance compounds for consumer products. Effective January 1, 2007, the company reorganized its reporting structure into two business segments: Flavors and Fragrances, replacing the previous geographic reporting model.

Key Financial Metrics

Material Changes vs. Prior Period

• Sales Growth: Net sales increased 11% to $566.1 million. Reported growth was driven by a weaker U.S. dollar (favorable currency translation). At comparable exchange rates, sales would have increased 6%. Both Flavors and Fragrances segments grew 11%.
• Profitability: Net income rose 17% to $62.7 million. Diluted EPS increased to $0.69 from $0.58.
• Margins: Gross margin percentage declined slightly from 42.4% to 41.8% due to a shift in product mix (higher sales of ingredients) and underabsorption of manufacturing costs at a new facility in China.
• Expenses: Interest expense increased by $3.0 million (to $8.3 million) due to higher average interest rates (4.1% in 2007 vs. 2.3% in 2006). Selling and administrative expenses as a percentage of sales improved to 16.1% from 16.7% due to prior year headcount reductions.
• Cash Flow: Operating cash flow decreased significantly to $7.5 million from $41.1 million, primarily due to a $45 million payout of incentive compensation related to 2006 results.

Guidance, Outlook, and Risks

• Capital Expenditures: Gross additions to property, plant, and equipment are expected to approximate $70 million in 2007.
• Dividends: The company declared a quarterly dividend of $0.21 per share, a 14% increase from the prior year. The next dividend is payable in April 2007.
• Share Repurchases: Under a $300 million program authorized in October 2006, the company repurchased approximately 0.7 million shares for $31 million in Q1 2007. Approximately $175 million remains available under the plan.
• Liquidity: Management anticipates that internal cash flows and existing credit facilities will be sufficient to fund operations, capital spending, and dividends for at least the next 18 months.
• Legal Contingencies: The company faces numerous lawsuits regarding respiratory injuries allegedly caused by butter flavoring ingredients (e.g., Benavides, Arthur, and Aldrich cases). Management believes adequate provisions have been made and does not expect a material adverse effect on financial condition, though outcomes remain uncertain.
• Restructuring: No new restructuring charges were incurred in Q1 2007. The company continues to utilize existing liabilities for employee-related and asset-related charges from prior reorganizations.

Investor Verification Checklist

• Currency Impact: Verify the extent to which reported sales growth is driven by foreign exchange fluctuations versus organic volume/price growth (organic growth was 6% vs. reported 11%).
• Cash Flow Volatility: Review the timing of incentive compensation payouts, as the $45 million payout in Q1 2007 significantly depressed operating cash flow compared to the prior year.
• China Facility Ramp-up: Monitor the scaling of the new fragrance ingredient facility in China, as underabsorption of costs currently impacts gross margins.
• Legal Exposure: Track the status of pending respiratory injury litigation (e.g., trials scheduled for 2007) and potential changes in insurance recoveries or accruals.
• Debt Servicing: Note the increase in interest rates on borrowings and the impact on future interest expense.