IFF

Business Context and Reporting Period

Company: International Flavors & Fragrances Inc. (IFF)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: IFF is a leading global creator and manufacturer of flavor and fragrance compounds used in consumer products including perfumes, cosmetics, food, beverages, and pharmaceuticals. The company operates 30 manufacturing facilities and maintains sales/distribution in 30 countries. In 2006, fragrance products accounted for 57% of sales, while flavor products accounted for 43%.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 5% to $2.095 billion, driven by strong growth in fine fragrances (13% increase) and volume growth in flavors. Growth was broad-based across North America, Europe, and Latin America.
• Profitability: Net income rose 17% to $226.5 million. Operating profit increased 23% to $329 million, aided by improved sales absorption of manufacturing expenses and cost-saving initiatives.
• Cost Management: Cost of goods sold as a percentage of sales decreased 80 basis points to 57.8%. Restructuring charges dropped significantly from $23.3 million in 2005 to $2.7 million in 2006.
• Debt Reduction: Total debt decreased by approximately $143 million to $807 million. The company refinanced $500 million in notes maturing in May 2006, issuing $375 million in new Senior Unsecured Notes and retiring the remainder with cash.
• Accounting Changes: The company adopted FAS 123(R) for share-based compensation and FAS 158 for pension accounting. FAS 158 adoption resulted in a $163 million liability adjustment recorded in Accumulated Other Comprehensive Income (AOCI).

Guidance, Outlook, and Risks

• Outlook: Management expects R&D spending to remain at approximately 9.0% of sales in 2007. Gross additions to property, plant, and equipment are expected to approximate $70 million in 2007.
• Dividends: The quarterly dividend was increased by 14% to $0.21 per share, effective January 2007.
• Share Repurchases: As of December 31, 2006, $206 million remained under the October 2006 share repurchase program.
• Key Risks:
  • Legal Proceedings: The company faces numerous lawsuits regarding respiratory illnesses allegedly caused by exposure to flavor ingredients (e.g., butter flavor). Management believes insurance coverage is adequate and does not expect a material adverse effect, though outcomes are uncertain.
  • Raw Materials: Results may be impacted by the price, quality, and availability of natural and synthetic raw materials.
  • Currency: Operations in many countries expose the company to foreign currency fluctuations, though hedging strategies are employed.
  • Regulatory: Compliance with new EU chemical registration legislation and other environmental regulations may increase costs.

Investor Verification Checklist

• Legal Exposure: Verify the status and potential financial impact of pending flavor-related litigation (e.g., Benavides, Arthur, and other cases) and the adequacy of insurance reserves.
• Pension Obligations: Review the impact of FAS 158 adoption on the balance sheet, specifically the $163 million pension liability adjustment and future funding requirements.
• Debt Covenants: Confirm compliance with the revolving credit facility covenant requiring a net debt to EBITDA ratio of not more than 3.25 to 1.
• Customer Concentration: Note that the top 30 customers accounted for 57% of sales, with the top 5 accounting for approximately 31%.
• Non-GAAP Adjustments: Review reconciliations for non-GAAP measures used by management, specifically the exclusion of the European fruit business (disposed in 2004) and the American Jobs Creation Act (AJCA) tax benefit from 2005 comparisons.