IFF

Business Context and Reporting Period

Company: International Flavors & Fragrances Inc. (IFF)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: IFF is a leading creator and manufacturer of flavor and fragrance compounds for consumer products. The company operates two primary segments: Flavors (46% of 2008 sales) and Fragrances (54% of 2008 sales). It maintains 31 manufacturing facilities and sales operations in over 30 countries. The company is one of the top four global players, representing approximately 16% of the estimated $14 billion global market.

Key Financial Metrics

Note: Figures are in millions unless otherwise noted. Net Income decreased due to higher interest expense and restructuring charges, despite a lower effective tax rate.

Material Changes vs. Prior Period

• Sales Growth: Total sales increased 5% to $2.39 billion. Flavors sales grew 9% driven by new product wins, particularly in Latin America. Fragrances sales grew 2%, with organic growth offset by currency impacts and volume declines in the U.S. and EAME regions.
• Margin Compression: Gross margin declined from 41.8% to 40.6%. This was primarily due to higher input costs, lower absorption of manufacturing expenses (notably in North America fragrances), and unfavorable product mix.
• Interest Expense Surge: Interest expense more than doubled from $41.5 million to $74.0 million. This increase was driven by higher borrowings incurred to fund a $450 million Accelerated Share Repurchase (ASR) program and wider spreads on interest rate swaps.
• Restructuring Charges: The company incurred $18.2 million in restructuring and other charges in 2008, compared to none in 2007. These charges related to a global shared service center initiative and a performance improvement plan eliminating 218 positions.
• Tax Rate: The effective tax rate dropped significantly from 24.8% to 18.1%, largely due to $23 million in benefits from tax settlements related to prior years and a higher proportion of earnings in lower-tax jurisdictions.

Guidance, Outlook, and Risks

Management Commentary & Outlook: Management anticipates continued volatility in global economic conditions and credit markets. While the company expects cash flows from operations and credit facilities to be sufficient for the next 18 months, they noted that reduced consumer spending could lead to order cancellations. The company plans to maintain R&D spending at approximately 9% of revenues in 2009. Capital expenditures are expected to approximate $100 million in 2009.

Key Risks & Contingencies:

• Economic Volatility: Recessionary pressures and credit market tightening could adversely affect customer order patterns and the company's cost of capital.
• Raw Material Costs: Approximately 50% of raw material purchases are natural products, which are subject to significant price and supply volatility.
• Legal Proceedings: The company faces approximately 18 pending actions involving 392 claimants alleging respiratory illness from flavor ingredients (primarily butter flavor). Management believes adequate provisions have been made and does not expect a material adverse effect, though outcomes are uncertain.
• Environmental Liabilities: IFF is a Potentially Responsible Party (PRP) at ten waste sites. Estimated future costs are less than $5 million, which management deems immaterial.
• Pension Funding: Market volatility impacts pension plan assets. The company recorded a $5.9 million curtailment loss in 2007 and continues to monitor funding obligations.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the Net Debt/Adjusted EBITDA covenant (limit 3.25:1). As of Dec 31, 2008, the ratio was 2.34:1.
• Share Repurchase Program: Confirm the status of the $750 million authorization. Approximately $450 million was used in the ASR program, with $268.7 million remaining available as of Q4 2008.
• Legal Accruals: Review Note 16 for details on the "flavor-related" litigation accruals and insurance recoveries to assess potential future cash outflows.
• Foreign Exchange Exposure: Assess the impact of currency fluctuations, as reported sales were boosted by a weaker U.S. dollar; organic growth was lower (2%) than reported growth (5%).
• Interest Rate Sensitivity: Monitor the impact of rising interest rates on the $1.25 billion debt portfolio, particularly given the increase in interest expense in 2008.